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 months ended March 31, 2023 and 2022 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, serving the broad landscape of industrial air, industrial water and energy transition markets globally providing innovative technology and application expertise. CECO helps companies grow their business with safe, clean, and more efficient solutions that help protect people, the environment and industrial equipment. CECO solutions improve air and water quality, optimize emissions management, and increase the energy and process efficiency for highly engineered applications in power generation, midstream and downstream hydrocarbon processing and transport, chemical processing, electric vehicle production, polysilicon fabrication, semiconductor and electronics production, battery production and recycling, specialty metals, aluminum and steel production, beverage can manufacturing, and industrial and produced water and wastewater treatment, and a wide range of other industrial end markets.
Market Pressures
The senior management team monitors and manages the Company’s ability to operate effectively as the result of market pressures. In particular, we are currently experiencing challenges in obtaining certain raw materials and labor on a timely basis at a reasonable cost. We expect these supply chain challenges and cost impacts to continue for the foreseeable future. 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.
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 of America (“GAAP”). These GAAP financial statements include certain charges the Company believes are not indicative of its core ongoing operational performance.
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 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 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 acquisitions. 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 months ended March 31, 2023 and 2022 are as follows:
19
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(in millions, except ratios) |
|
2023 |
|
|
2022 |
|
Net sales |
|
$ |
112.6 |
|
|
$ |
92.4 |
|
Cost of sales |
|
|
77.7 |
|
|
|
66.0 |
|
Gross profit |
|
$ |
34.9 |
|
|
$ |
26.4 |
|
Percent of sales |
|
|
31.0 |
% |
|
|
28.6 |
% |
Selling and administrative expenses |
|
|
27.2 |
|
|
|
18.6 |
|
Percent of sales |
|
|
24.2 |
% |
|
|
20.1 |
% |
Amortization and earnout expenses |
|
|
1.7 |
|
|
|
1.5 |
|
Acquisition and integration expenses |
|
|
0.5 |
|
|
|
1.0 |
|
Restructuring expenses |
|
|
— |
|
|
|
0.1 |
|
Operating income |
|
$ |
5.5 |
|
|
$ |
5.2 |
|
Operating margin |
|
|
4.9 |
% |
|
|
5.6 |
% |
To compare operating performance between the three months ended March 31, 2023 and 2022, the Company has adjusted GAAP operating income to exclude (1) amortization of intangible assets, earnout and retention expenses, (2) acquisition and integration expenses, which include legal, accounting, and other expenses, and (3) restructuring expenses primarily relating to severance, facility exits, and associated legal expenses.
The following table presents the reconciliation of GAAP operating income and GAAP operating margin to non-GAAP operating income and non-GAAP operating margin:
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(in millions, except ratios) |
|
2023 |
|
|
2022 |
|
Operating income as reported in accordance with GAAP |
|
$ |
5.5 |
|
|
$ |
5.2 |
|
Operating margin in accordance with GAAP |
|
|
4.9 |
% |
|
|
5.6 |
% |
Amortization and earnout expenses |
|
|
1.7 |
|
|
|
1.5 |
|
Acquisition and integration expenses |
|
|
0.5 |
|
|
|
1.0 |
|
Restructuring expenses |
|
|
— |
|
|
|
0.1 |
|
Non-GAAP operating income |
|
$ |
7.7 |
|
|
$ |
7.8 |
|
Non-GAAP operating margin |
|
|
6.8 |
% |
|
|
8.4 |
% |
Orders booked decreased $14.8 million, or 9.2%, to $146.1 million during the three months ended March 31, 2023 compared with a record $160.9 million in the three months ended March 31, 2022. The decrease is primarily attributable to a decrease of $31.7 million in our emissions management technologies, partially offset by increases of $18.2 million in our engineered cyclone systems. Of the $146.1 million orders during the three months ended March 31, 2023, $23.4 million is attributable to prior and current year acquisitions.
Net sales for the three months ended March 31, 2023 increased $20.2 million, or 21.9%, to $112.6 million compared with $92.4 million for the three months ended March 31, 2022. The increase is led by increases of $12.6 million in our separation, filtration, and industrial water technologies and $8.0 million in our thermal acoustics technologies. Approximately 40%, or $8.3 million, of the increase in net sales is attributable to organic revenue growth, while $11.9 million is attributable to prior and current year acquisitions.
Gross profit increased $8.5 million, or 32.2%, to $34.9 million in the three months ended March 31, 2023 compared with $26.4 million in the three months ended March 31, 2022. The increase in gross profit is primarily attributable to the increase in sales volume as described above, higher project margin mix and acquisitions of businesses with favorable margins. Gross profit as a percentage of sales increased to 31.0% in the three months ended March 31, 2023 compared with 28.6% in the three months ended March 31, 2022.
Selling and administrative expenses were $27.2 million for the three months ended March 31, 2023 compared with $18.6 million for the three months ended March 31, 2022. The increase is primarily attributable to acquisitions during the prior and current year, a $2.5 million favorable insurance settlement in the prior year, and increased headcount in order to support our revenue growth and global footprint.
Amortization and earnout expense was $1.7 million for the three months ended March 31, 2023 compared with $1.5 million for the three months ended March 31, 2022. The increase in expense is attributable to a $0.2 million increase in definite lived asset amortization due to increased intangible assets attributable to current and prior year acquisitions.
20
Operating income increased $0.3 million to $5.5 million for the three months ended March 31, 2023 compared with operating income of $5.2 million for the three months ended March 31, 2022. The increase in operating income is primarily attributable to increases in net sales.
Non-GAAP operating income was $7.7 million for the three months ended March 31, 2023 compared with $7.8 million for the three months ended March 31, 2022. Non-GAAP operating income as a percentage of sales decreased to 6.8% for the three months ended March 31, 2023 from 8.4% for the three months ended March 31, 2022.
Interest expense increased to $2.4 million in the three months ended March 31, 2023 compared with interest expense of $0.8 million for the three months ended March 31, 2022. The increase in interest expense is primarily due to increased debt balances and rising interest rates.
Income tax expense was zero for the three months ended March 31, 2023 compared with income tax expense of $1.1 million for the three months ended March 31, 2022. The effective income tax rate for the three months ended March 31, 2023 was 0.4% compared with 28.3% for the three months ended March 31, 2022. The effective income tax rates for the three months ended March 31, 2023 differ from 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, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Net Sales (less intra- and inter-segment sales) |
|
|
|
|
|
|
Engineered Systems segment |
|
$ |
74,454 |
|
|
$ |
56,975 |
|
Industrial Process Solutions segment |
|
|
38,109 |
|
|
|
35,461 |
|
Total net sales |
|
$ |
112,563 |
|
|
$ |
92,436 |
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Income from Operations |
|
|
|
|
|
|
Engineered Systems segment |
|
$ |
9,805 |
|
|
$ |
6,470 |
|
Industrial Process Solutions segment |
|
|
5,546 |
|
|
|
4,139 |
|
Corporate and Other(1) |
|
|
(9,890 |
) |
|
|
(5,407 |
) |
Total income from operations |
|
$ |
5,461 |
|
|
$ |
5,202 |
|
(1) Includes corporate compensation, professional services, information technology and other general and administrative corporate expenses.
Engineered Systems Segment
Our Engineered Systems segment net sales increased $17.5 million to $74.5 million for the three months ended March 31, 2023 compared with $57.0 million for the three months ended March 31, 2022. The increase is led by increases of $12.6 million in separation, filtration, and industrial water technologies and $8.0 million in our thermal acoustics technologies. Approximately 40%, or $6.6 million, of the increase in net sales is attributable to organic revenue growth, while $10.9 million is attributable to prior and current year acquisitions.
Operating income for the Engineered Systems segment increased $3.3 million to $9.8 million for the three months ended March 31, 2023 compared with $6.5 million for the three months ended March 31, 2022. The operating income increase is primarily attributable to higher gross profit related to increased sales of $17.5 million, partially offset by an increase of $4.2 million in selling and administrative expense.
21
Industrial Process Solutions Segment
Our Industrial Process Solutions segment net sales increased $2.6 million to $38.1 million for the three months ended March 31, 2023 compared with $35.5 million for the three months ended March 31, 2022. The increase is primarily attributable to increases across all products serving industrial air end markets. Approximately 60%, or $1.6 million, of the increase in net sales is attributable to organic revenue growth, while $1.0 million is attributable to prior year acquisitions.
Operating income for the Industrial Process Solutions segment increased $1.4 million to $5.5 million for the three months ended March 31, 2023 compared with $4.1 million for the three months ended March 31, 2022. The increase is primarily attributable to higher gross profit related to increased sales of $2.6 million, offset by an increase of $0.7 million in selling and administrative expense.
Corporate and Other Segment
Operating expense for the Corporate and Other segment increased $4.5 million to $9.9 million for the three months ended March 31, 2023 compared with $5.4 million for the three months ended March 31, 2022. The increase is primarily attributable to investments made to support growth, inflationary increases for wages and services, and a favorable insurance settlement of $2.5 million in the prior year period.
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 $356.1 million as of March 31, 2023, inclusive of $10.8 million from current year acquisitions, from $311.7 million as of December 31, 2022. 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 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, 2023, the Company had working capital of $103.9 million, compared with $94.0 million at December 31, 2022. The ratio of current assets to current liabilities was 1.61 to 1.00 on March 31, 2023, as compared with a ratio of 1.64 to 1.00 on December 31, 2022.
At March 31, 2023 and December 31, 2022, cash and cash equivalents totaled $41.2 million and $45.5 million, respectively. As of March 31, 2023 and December 31, 2022, $23.9 million and $31.7 million, respectively, of our cash and cash equivalents were held by certain non-United States subsidiaries, as well as being denominated in foreign currencies.
22
Debt consisted of the following:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
March 31, 2023 |
|
|
December 31, 2022 |
|
Outstanding borrowings under the Credit Facility (as defined below)
Term loan payable in quarterly principal installments of $550 through September 2023,
$825 through September 2025 and $1,100 thereafter with balance due upon maturity in
December 2026. |
|
|
|
|
|
|
Term loan |
|
$ |
40,758 |
|
|
$ |
41,309 |
|
Revolving credit facility |
|
|
96,100 |
|
|
|
61,300 |
|
Total outstanding borrowings under the Credit Facility |
|
|
136,858 |
|
|
|
102,609 |
|
Outstanding borrowings under the joint venture term debt |
|
|
9,680 |
|
|
|
10,083 |
|
Unamortized debt discount |
|
|
(1,269 |
) |
|
|
(1,488 |
) |
Total outstanding borrowings |
|
|
145,269 |
|
|
|
111,204 |
|
Less: current portion |
|
|
(3,854 |
) |
|
|
(3,579 |
) |
Total debt, less current portion |
|
$ |
141,415 |
|
|
$ |
107,625 |
|
Credit Facility
The Company’s outstanding borrowings in the United States consist of a 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, 2023 and December 31, 2022, 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:
|
|
|
|
|
|
|
|
|
(in millions) |
|
March 31, 2023 |
|
|
December 31, 2022 |
|
Credit Facility, revolving loans |
|
$ |
140.0 |
|
|
$ |
140.0 |
|
Draw down |
|
|
(96.1 |
) |
|
|
(61.3 |
) |
Letters of credit open |
|
|
(16.5 |
) |
|
|
(18.9 |
) |
Total unused credit availability |
|
$ |
27.4 |
|
|
$ |
59.8 |
|
Amount available based on borrowing limitations |
|
$ |
22.5 |
|
|
$ |
59.8 |
|
Overview of Cash Flows and Liquidity
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Net cash used in operating activities |
|
$ |
(12,021 |
) |
|
$ |
(202 |
) |
Net cash used in investing activities |
|
|
(26,655 |
) |
|
|
(20,241 |
) |
Net cash provided by financing activities |
|
|
34,359 |
|
|
|
19,859 |
|
Effect of exchange rate changes on cash and cash equivalents |
|
|
(64 |
) |
|
|
(1,111 |
) |
Net decrease in cash |
|
$ |
(4,381 |
) |
|
$ |
(1,695 |
) |
Operating Activities
For the three months ended March 31, 2023, $12.0 million of cash was used in operating activities compared with $0.2 million used in operations in the prior year period, representing a $11.8 million additional use of cash. Cash flow from operating activities in the first three months of 2023 had an unfavorable impact year-over-year primarily due to timing of receipt of outstanding receivables and payments to suppliers, as well as the decrease in net income compared to the prior year period.
Investing Activities
For the three months ended March 31, 2023, net cash used in investing activities was $26.7 million compared with $20.2 million used in investing activities in the prior year period. For the three months ended March 31, 2023, the $26.7 million cash used in investing activities was the result of $24.1 million cash used for acquisitions as described in Note 14 to the unaudited condensed consolidated financial statements, and $2.5 million for the acquisition of property and equipment. In the prior year period, the $20.2 million cash
23
used in investing activities was the result of $19.6 million used for acquisitions as described in Note 14 and $0.7 million for the acquisition of property and equipment.
Financing Activities
For the three months ended March 31, 2023, $34.4 million was provided by financing activities compared with $19.9 million provided by financing activities in the prior year period, for an increase of $14.5 million. For the three months ended March 31, 2023, the Company used $34.8 million for net borrowings on the Company’s revolving credit lines, primarily used to finance current year acquisitions, and $0.8 million in repayment on long-term debt. The Company also received $0.6 million of proceeds from the exercise of stock options. In the prior year period, the Company used $10.6 million for net borrowings on the Company’s revolving credit lines and $10.4 million for net borrowings on long-term debt, primarily used to finance acquisitions, as well as $0.9 million on distributions to the noncontrolling interest.
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.
Management believes there have been no changes during the three months ended March 31, 2023 to the items that the Company disclosed as its critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended, 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, 2022, 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;
24
•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;
•the impact of adverse developments affecting the banking and financial services industries on our ability to access our funds and deposits and our ability to raise or access capital in the future;
•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 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, 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.