MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Company’s Condensed Consolidated Statements of Income for the three-month periods ended March 31, 2022 and 2021 reflect the consolidated operations of the Company and its subsidiaries.
CECO Environmental Corp. (“CECO,” “we,” “us,” or the “Company”) is a leading environmentally focused, diversified industrial company whose solutions protect people, the environment, and industrial equipment. We focus on engineering, designing, building, and installing systems that capture, clean and destroy air- and water-borne emissions from industrial facilities as well as fluid handling, gas and water separation, and filtration systems. CECO provides innovative technology and application expertise that helps companies grow their businesses with safe, clean, and more efficient solutions to protect our shared environment.
CECO serves diverse industries globally by working to improve air and water quality, protect customer’s equipment, and provide customized engineered solutions in our customers’ mission critical applications. The industries CECO serves include power generation, petrochemical processing, general industrial, refining, midstream oil & gas, electric vehicle production, poly silicon fabrication, battery recycling, and wastewater treatment, along with a wide range of other industries.
COVID-19
A novel strain of coronavirus (“COVID-19”) surfaced in late 2019 and has spread around the world, including to the United States. In March 2020, the World Health Organization characterized COVID-19 as a pandemic. The COVID-19 pandemic persists in geographic areas in which we have operations, suppliers, customers and employees, and has had a significant impact on worldwide economic activity and on macroeconomic conditions and the end markets of our business.
As a key supplier to critical infrastructure projects, CECO has worked to maintain ongoing operations. Within the United States, certain portions of our business have been designated an essential business, and we continue to operate our business in compliance with applicable state and local laws and are observing recommended Centers for Disease Control and Prevention guidelines to minimize the risk of spreading the COVID-19 virus including implementing, where possible, work-from-home procedures and additional sanitization efforts where facilities remain open to provide necessary services. This allows us to continue to serve our customers, however, the COVID-19 pandemic has also disrupted our international operations. Some of our facilities and our suppliers have experienced temporary disruptions as a result of the COVID-19 pandemic, and we continue to work closely with our global supply chain to proactively support customers during this critical time. We cannot predict whether our facilities will experience more significant disruptions in the future or the impact on our suppliers.
The senior management team meets regularly to review and assess the status of the Company's operations and the health and safety of its employees. The senior management team continues to monitor and manage the Company’s ability to operate effectively. We are currently experiencing shortages of raw materials and inflationary pressures for certain materials and labor. We expect these supply chain challenges and cost impacts to continue for the foreseeable future as markets recover. Although we have secured additional raw materials from existing and alternate suppliers and have taken other mitigating actions to mitigate supply disruptions, we cannot guarantee that we can continue to do so in the future. In this event, our business, results and financial condition could be adversely affected. Although vaccines are available in various countries where we operate, health concern risks remain and notwithstanding the Company's continued efforts, it is possible the COVID-19 pandemic could further impact our operations and the operations of our suppliers and venders, particularly in light of newly emerging variant strains of the virus becoming more dominant and the potential resumption of high levels of infection and hospitalization. We cannot predict whether any of our manufacturing, operations or suppliers will be disrupted by these events, or how long such disruptions would last. COVID-19 has had and may have further negative impacts on our operations, customers and supply chain despite the preventative and precautionary measures being taken.
Note Regarding Use of Non-GAAP Financial Measures
The Company’s unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These GAAP financial statements include certain charges the Company believes are not indicative of its core ongoing operational performance.
17
As a result, the Company provides financial information in this Management’s Discussion and Analysis that was not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. The Company provides this supplemental non-GAAP financial information because the Company’s management utilizes it to evaluate its ongoing financial performance and the Company believes it provides greater transparency to investors as supplemental information to its GAAP results.
The Company has provided the non-GAAP financial measures of non-GAAP operating income and non-GAAP operating margin as a result of items that the Company believes are not indicative of its ongoing operations. These include transactions associated with the Company’s acquisitions, divestitures and the items described below in “Consolidated Results.” The Company believes that evaluation of its financial performance compared with prior and future periods can be enhanced by a presentation of results that exclude the impact of these items. The Company has incurred substantial expense and income associated with the acquisition and divestitures. While the Company cannot predict the exact timing or amounts of such charges, it does expect to treat the financial impact of these transactions as special items in its future presentation of non-GAAP results.
Results of Operations
Consolidated Results
Our Condensed Consolidated Statements of Income for the three-month periods ended March 31, 2022 and 2021 are as follows:
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(dollars in millions) |
|
2022 |
|
|
2021 |
|
Net sales |
|
$ |
92.4 |
|
|
$ |
71.9 |
|
Cost of sales |
|
|
66.0 |
|
|
|
47.5 |
|
Gross profit |
|
$ |
26.4 |
|
|
$ |
24.4 |
|
Percent of sales |
|
|
28.6 |
% |
|
|
33.9 |
% |
Selling and administrative expenses |
|
|
18.6 |
|
|
|
19.4 |
|
Percent of sales |
|
|
20.1 |
% |
|
|
27.0 |
% |
Amortization and earnout expenses |
|
|
1.5 |
|
|
|
1.8 |
|
Restructuring expenses |
|
|
0.1 |
|
|
|
— |
|
Acquisition and integration expenses |
|
|
1.0 |
|
|
|
0.1 |
|
Operating income |
|
$ |
5.2 |
|
|
$ |
3.1 |
|
Operating margin |
|
|
5.6 |
% |
|
|
4.3 |
% |
To compare operating performance between the three-month period ended March 31, 2022 and 2021, the Company has adjusted GAAP operating income to exclude (1) amortization of intangible assets, earnout and retention expenses, (2) restructuring expenses primarily relating to severance, facility exits, and associated legal expenses, and (3) acquisition and integration expenses, which include legal, accounting, and other expenses.
The following tables present the reconciliation of GAAP operating income and GAAP operating margin to non-GAAP operating income and non-GAAP operating margin, and GAAP net income to non-GAAP net income.
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(dollars in millions) |
|
2022 |
|
|
2021 |
|
Operating income as reported in accordance with GAAP |
|
$ |
5.2 |
|
|
$ |
3.1 |
|
Operating margin in accordance with GAAP |
|
|
5.6 |
% |
|
|
4.3 |
% |
Amortization and earnout expenses |
|
|
1.5 |
|
|
|
1.8 |
|
Restructuring expenses |
|
|
0.1 |
|
|
|
— |
|
Acquisition and integration expenses |
|
|
1.0 |
|
|
|
0.1 |
|
Non-GAAP operating income |
|
$ |
7.8 |
|
|
$ |
5.0 |
|
Non-GAAP operating margin |
|
|
8.4 |
% |
|
|
7.0 |
% |
Net sales for the first quarter of 2022 increased $20.5 million, or 28.5%, to $92.4 million compared with $71.9 million in the first quarter of 2021. The increase is primarily attributable to increases of $8.9 million in our emissions management technologies, $3.8 million in our fluid bed cyclone technologies, $3.2 million in our custom thermal acoustics technologies, $2.3 million in our damper and expansion products and $2.1 million in our industrial air control technologies.
Gross profit increased $2.0 million, or 8.2%, to $26.4 million in the first quarter of 2022 compared with $24.4 million in the first quarter of 2021. Gross profit as a percentage of sales decreased to 28.6% in the first quarter of 2022 compared with 33.9% in the first quarter of 2021 due to inflation, supply chain challenges, and lower project margin mix partially offset by price increases. We
18
continue to experience shortages of raw materials and inflationary pressures for certain materials and labor. We expect these supply chain challenges and cost impacts to continue for the foreseeable future as markets recover. Although we have secured additional raw materials from existing and alternate suppliers and have taken other mitigating actions to mitigate supply disruptions, such as implementing price increases and applying material surcharges. We cannot guarantee that we can continue to do so in the future. In this event, our business, results and financial condition could be adversely affected.
Orders booked were $160.9 million during the first quarter of 2022 as compared with $92.1 million during the first quarter of 2021. The increase is primarily attributable to increases of $27.2 million in our emission management technologies, $23.0 million in industrial air control technologies, and $22.4 million in our custom thermal acoustics technologies, partially offset by a decrease of $10.7 million in our fluid bed cyclone technologies.
Selling and administrative expenses were $18.6 million for the first quarter of 2022 compared with $19.4 million for the first quarter of 2021. The decrease is primarily attributed to a $2.5 million favorable insurance settlement, partially offset by inflationary increases for wages and services. Selling and administrative expenses as a percentage of sales were 20.1% in 2022 compared with 27.1% in 2021.
Amortization and earnout expenses was $1.5 million for the first quarter of 2022 compared with $1.8 million for the first quarter of 2021. The decrease in expense is attributable $0.3 million decrease in definite lived asset amortization.
Operating income increased $2.1 million to $5.2 million in the first quarter of 2022 compared with $3.1 million during the first quarter of 2021. The increase is attributable to the factors described above.
Non-GAAP operating income was $7.8 million for the first quarter of 2022 compared with $5.0 million for the first quarter of 2021. The increase in non-GAAP operating income is primarily attributable to the increase in sales and lower selling and administrative expenses. Non-GAAP operating income as a percentage of sales increased to 8.4% for the first quarter of 2022 from 7.0% for the first quarter of 2021.
Interest expense increased to $0.8 million in the first quarter of 2022 compared with $0.7 million in the first quarter of 2021. The increase in interest expense is primarily due to higher debt balance for the three-month period in 2022 compared to 2021.
Income tax expense was $1.1 million and $0.6 million for the first quarter of 2022 and 2021. The effective income tax rate for the first quarter of 2022 was 28.3% compared with 29.8% for first quarter of 2021. The effective income tax rate for the first quarter of 2022 is higher than the United States federal statutory rate. Our effective tax rate is affected by certain other permanent differences, including state income taxes, non-deductible incentive stock-based compensation, and differences in tax rates among the jurisdictions in which we operate.
Business Segments
The Company’s operations are organized and reviewed by management along its product lines or end market that the segment serves and are presented in two reportable segments. The results of the segments are reviewed through “Income from operations” on the unaudited Condensed Consolidated Statements of Income.
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(dollars in thousands) |
|
2022 |
|
|
2021 |
|
Net Sales (less intra- and inter-segment sales) |
|
|
|
|
|
|
Engineered Systems segment |
|
$ |
56,975 |
|
|
$ |
42,057 |
|
Industrial Process Solutions segment |
|
|
35,461 |
|
|
|
29,835 |
|
Net sales |
|
$ |
92,436 |
|
|
$ |
71,892 |
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(dollars in thousands) |
|
2022 |
|
|
2021 |
|
Income from Operations |
|
|
|
|
|
|
Engineered Systems segment |
|
$ |
6,470 |
|
|
$ |
6,170 |
|
Industrial Process Solutions segment |
|
|
4,139 |
|
|
|
3,822 |
|
Corporate and Other(1) |
|
|
(5,407 |
) |
|
|
(6,938 |
) |
Income from operations |
|
$ |
5,202 |
|
|
$ |
3,054 |
|
(1) Includes corporate compensation, professional services, information technology and other general and administrative corporate expenses.
19
Engineered Systems Segment
Our Engineered Systems segment net sales increased $14.9 million, or 26.1%, to $57.0 million in the first quarter of 2022 compared with $42.1 million in the first quarter of 2021. The increase is primarily attributable to $8.9 million in our emissions management technologies, $3.8 million in our fluid bed cyclone technologies, $3.2 million in our custom thermal acoustics technologies, and $2.3 million in our damper and expansion products, partially offset by a decrease of $4.1 million in our separation and filtration technologies.
Operating income for the Engineered Systems segment increased $0.3 million to $6.5 million in the first quarter of 2022 compared with $6.2 million in the first quarter of 2021. The change is primarily attributable to higher gross margin related to increased sales of $14.9 million, partially offset by increases of $1.0 million in acquisition and integration expenses related to the General Rubber, LLC acquisition.
Industrial Process Solutions Segment
Our Industrial Process Solutions segment net sales increased $5.7 million, or 16.1%, to $35.5 million in the first quarter of 2022 compared with $29.8 million in the first quarter of 2021. The increase is primarily attributable to $2.8 million in our duct fabrication products and services, and $2.1 million in our industrial air control technologies.
Operating income for the Industrial Process Solutions segment increased $0.3 million to $4.1 million in the first quarter of 2022 compared with $3.8 million in the first quarter of 2021. The increase is primarily attributable to higher gross margin related to increased sales of $5.7 million, partially offset by $0.4 million increase in selling and administrative expenses.
Corporate and Other Segment
Operating expense for the Corporate and Other segment decreased $1.5 million to $5.4 million in the first quarter of 2022 compared with $6.9 million in same period in 2021. The decrease is primarily attributed to a $2.5 million favorable insurance settlement, partially offset by inflationary increases for wages and services.
Backlog
Backlog (i.e., unfulfilled or remaining performance obligations) represents the sales we expect to recognize for our products and services for which control has not yet transferred to the customer. Backlog increased to $283.2 million as of March 31, 2022 from $213.9 million as of December 31, 2021. Our customers may have the right to cancel a given order. Historically cancellations have not been common. Backlog is adjusted on a quarterly basis for adjustments in foreign currency exchange rates. Substantially all backlog is expected to be delivered within 12 to 18 months. Backlog is not defined by United States generally accepted accounting principles (“GAAP”) and our methodology for calculating backlog may not be consistent with methodologies used by other companies.
New Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 2 to the unaudited condensed consolidated financial statements within Item 1 of this Quarterly Report on Form 10-Q.
Liquidity and Capital Resources
When we undertake large jobs, our working capital objective is to make these projects self-funding. We work to achieve this by obtaining initial down payments, progress billing contracts, when possible, utilizing extended payment terms from material suppliers, and paying sub-contractors after payment from our customers, which is an industry practice. Our investment in net working capital is funded by cash flow from operations and by our revolving line of credit under our Credit Facility (as defined below).
At March 31, 2022, the Company had working capital of $79.2 million, compared with $72.3 million at December 31, 2021. The ratio of current assets to current liabilities was 1.60 to 1.00 on March 31, 2022, as compared with a ratio of 1.62 to 1.00 at December 31, 2021.
At March 31, 2022 and December 31, 2021, cash and cash equivalents totaled $28.4 million and $29.9 million, respectively. As of March 31, 2022 and December 31, 2021, $22.4 million and $22.6 million, respectively, of our cash and cash equivalents were held by certain non-United States subsidiaries, as well as being denominated in foreign currencies.
20
Debt consisted of the following:
|
|
|
|
|
|
|
|
|
(table only in thousands) |
|
March 31, 2022 |
|
|
December 31, 2021 |
|
Outstanding borrowings under the Credit Facility (defined below). Term loan payable in quarterly principal installments of $0.6 million through September 2023, and $0.8 million through September 2025 and $1.1 million thereafter with balance due upon maturity in September 2026. |
|
|
|
|
|
|
- Term loan |
|
$ |
42,961 |
|
|
$ |
43,511 |
|
- Revolving Credit Loan |
|
|
32,600 |
|
|
|
22,000 |
|
Total outstanding borrowings under the Credit Facility |
|
|
75,561 |
|
|
|
65,511 |
|
Outstanding borrowings under the joint venture term debt |
|
|
10,910 |
|
|
|
— |
|
Unamortized debt discount |
|
|
(1,767 |
) |
|
|
(1,731 |
) |
Total outstanding borrowings |
|
$ |
84,704 |
|
|
$ |
63,780 |
|
Less: current portion |
|
|
(3,303 |
) |
|
|
(2,203 |
) |
Total debt, less current portion |
|
$ |
81,401 |
|
|
$ |
61,577 |
|
Credit Facility
The Company’s outstanding borrowings in the United States consist of senior secured term loan and a senior secured revolver loan with sub-facilities for letters of credit, swing-line loans and multi-currency loans (collectively, the “Credit Facility”). As of March 31, 2022 and December 31, 2021, the Company was in compliance with all related financial and other restrictive covenants under the Credit Facility.
See Note 7 to the unaudited condensed consolidated financial statements within Item 1 of this Quarterly Report on Form 10-Q for further information on the Company’s debt facilities.
Total unused credit availability under our existing Credit Facility is as follows:
|
|
|
|
|
|
|
|
|
(dollars in millions) |
|
March 31, 2022 |
|
|
December 31, 2021 |
|
Credit Facility, revolving loans |
|
$ |
140.0 |
|
|
$ |
140.0 |
|
Draw down |
|
|
(32.6 |
) |
|
|
(22.0 |
) |
Letters of credit open |
|
|
(17.3 |
) |
|
|
(14.5 |
) |
Total unused credit availability |
|
$ |
90.1 |
|
|
$ |
103.5 |
|
Amount available based on borrowing limitations |
|
$ |
59.9 |
|
|
$ |
45.9 |
|
Overview of Cash Flows and Liquidity
|
|
|
|
|
|
|
|
|
|
|
For the three months ended March 31, |
|
(dollars in thousands) |
|
2022 |
|
|
2021 |
|
Net cash (used in) provided by operating activities |
|
$ |
(202 |
) |
|
$ |
9,908 |
|
Net cash (used in) provided by investing activities |
|
|
(20,241 |
) |
|
|
42 |
|
Net cash provided by (used in) financing activities |
|
|
19,859 |
|
|
|
(4,155 |
) |
Effect of exchange rate changes on cash and cash equivalents |
|
|
(1,111 |
) |
|
|
(356 |
) |
Net (decrease) increase in cash |
|
$ |
(1,695 |
) |
|
$ |
5,439 |
|
Operating Activities
For the three-months ended March 31, 2022, $0.2 million of cash was used by operating activities compared with $9.9 million provided by operating activities in the prior year period, a $10.1 million decrease. Cash flow from operating activities in the first quarter of 2022 had an unfavorable impact year-over-year primarily due to certain decreases in net working capital, partially offset by increases in net earnings.
Investing Activities
For the three-months ended March 31, 2022, net cash used in investing activities was $20.2 million, which was primarily attributed to the net cash paid for the acquisition of GRC of $19.6 million and $0.7 million in acquisitions of property and equipment, compared with $42,000 in the prior year period.
21
Financing Activities
For the three-months ended March 31, 2022, net cash provided by financing activities was $19.9 million, which was primarily attributable to net borrowings on term debt and revolving credit lines of $21.0 million, which was used to fund the acquisition of General Rubber, LLC and related acquisition and integration expenses. This was partially offset by a noncontrolling interest distribution of $0.9 million.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s condensed consolidated financial statements. The preparation of these financial statements requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities and reported amounts of revenues and expenses. Such estimates include revenue recognition, the valuation of trade receivables, inventories, goodwill, intangible assets, other long-lived assets, legal contingencies, guarantee obligations and assumptions used in the calculation of income taxes, assumptions used in business combination accounting and related balances, and pension and post-retirement benefits, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors. Management monitors economic conditions and other factors and will adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates.
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934 which are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. Any statements contained in this Quarterly Report on Form 10-Q, other than statements of historical fact, including statements about management’s beliefs and expectations, are forward-looking statements and should be evaluated as such. These statements are made on the basis of management’s views and assumptions regarding future events and business performance. We use words such as “believe,” “expect,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” “will,” “plan,” “should” and similar expressions to identify forward-looking statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from any future results, performance or achievements expressed or implied by such statements. Potential risks and uncertainties, among others, that could cause actual results to differ materially are discussed under “Part I – Item 1A. Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021, and include, but are not limited to:
•the sensitivity of our business to economic and financial market conditions generally and economic conditions in CECO’s service areas;
•dependence on fixed price contracts and the risks associated therewith, including actual costs exceeding estimates and method of accounting for revenue;
•the effect of growth on CECO’s infrastructure, resources and existing sales;
•the ability to expand operations in both new and existing markets;
•the potential for contract delay or cancellation as a result of on-going or worsening supply chain challenges;
•liabilities arising from faulty services or products that could result in significant professional or product liability, warranty or other claims;
•changes in or developments with respect to any litigation or investigation;
•failure to meet timely completion or performance standards that could result in higher cost and reduced profits or, in some cases, losses on projects;
•the potential for fluctuations in prices for manufactured components and raw materials, including as a result of tariffs and surcharges;
•the substantial amount of debt incurred in connection with our strategic transactions and our ability to repay or refinance it or incur additional debt in the future;
•the impact of federal, state or local government regulations;
22
•our ability to repurchase shares of our common stock and the amounts and timing of repurchases, if any;
•economic and political conditions generally;
•our ability to successfully realize the expected benefits of our restructuring program;
•our ability to successfully integrate acquired businesses and realize the synergies from strategic transactions; and
•unpredictability and severity of catastrophic events, including cybersecurity threats, acts of terrorism or outbreak of war or hostilities or public health crises, such as uncertainties regarding the extent and duration of impacts of matters associated with the novel coronavirus (“COVID-19”), as well as management’s response to any of the aforementioned factors.
Many of these risks are beyond management’s ability to control or predict. Should one or more of these risks or uncertainties materialize, or should any related assumptions prove incorrect, actual results may vary in material aspects from those currently anticipated. Investors are cautioned not to place undue reliance on such forward-looking statements as they speak only to our views as of the date the statement is made. Furthermore, the forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the Securities and Exchange Commission (the “SEC”), we undertake no obligation to update or review any forward-looking statements, whether as a result of new information, future events or otherwise.