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CECE > SEC Filings for CECE > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for CECO ENVIRONMENTAL CORP

Form 10-Q for CECO ENVIRONMENTAL CORP


8-Nov-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

ITEM 2. Management discussion and analysis of financial condition and results of
operations

The Company's consolidated statements of income for the three month and nine month periods ended September 30, 2013 and 2012 reflect the consolidated operations of the Company and its subsidiaries.

Significant Recent Development

On August 27, 2013, we completed our acquisition of Met-Pro Corporation, a Pennsylvania corporation ("Met-Pro"), which resulted in the acquisition of 100% of all outstanding shares of Met-Pro for $13.75 per share in a cash and stock transaction. In addition, holders of outstanding Met-Pro options and restricted stock units received an aggregate amount of cash equal to approximately $4.9 million as consideration for the cancellation of the options and restricted stock units held by them immediately prior to the closing of the acquisitions. The purchase price consisted of approximately 7,726,235 shares of Company common stock and $104.4 million in cash. Following the issuance of these additional shares, there were approximately 25,614,539 shares of Company common stock issued and outstanding. The cash portion of the purchase consideration was financed with borrowings from a new credit facility. See "Financial Condition, Liquidity and Capital Resources" below. Because the acquisition closed on August 27, 2013, the Company's financial information does not include any of the results of operations from Met-Pro prior to the acquisition date. The financial results of Met-Pro are included in the "Met-Pro Group" segment as of the date of the acquisition.

Acquisition and integration expenses on the condensed consolidated statements of operations are related to acquisition activities, which include legal, accounting, banking, and other expenses.

General Oveview

We are a leading global environmental technology company focused on critical solutions in the product recovery, air pollution control, fluid handling and liquid filtration segments. Through its well-known brands, CECO provides a wide spectrum of products and services including dampers & diverters, cyclonic technology, thermal oxidizers, filtration systems, scrubbers, fluid handling equipment and plant engineered services and engineered design build fabrication. These products play a vital role in helping companies achieve exacting production standards, meeting increasing plant needs and stringent emissions control regulations around the globe. CECO globally serves the broadest range of markets and industries including power, municipalities, chemical, industrial manufacturing, refining, petrochemical, metals, minerals & mining, hospitals and universities. CECO is focused on building long-term shareholder value by bringing its unique technology, portfolio and operational excellence to strategic key growth markets around the world, while maintaining the highest standards of employee development, project execution and safety leadership.

We believe that as economic conditions continue to improve, there will be an increase in the level of pollution control capital expenditures driven by an elevated focus on environmental issues such as global warming and energy-saving alternatives as well as a U.S. Government supported effort to reduce our dependence on foreign oil through the use of bio-fuels like ethanol and electrical energy generated by our abundant domestic supply of coal. We also feel that similar opportunities will continue to develop outside the United States. Much of our business is driven by various regulatory standards and guidelines governing air quality in and outside factories. Our Chinese operation is experiencing expansion due to the tightening of air pollution standards by China's Ministry of Environmental Protection.

We continue to focus on increasing revenues and profitability globally while continuing to strengthen and expand our presence domestically. Our operating strategy has historically involved horizontally expanding our scope of technology, products, and services through selective acquisitions and the formation of new business units that are then vertically integrated into our growing group of turnkey system providers. By employing this strategy, we have expanded our business and increased our revenues by adding CECO Abatement Systems, KB Duct, CECO Environmental India, Effox, Fisher-Klosterman, Buell, Flextor, A.V.C., Adwest, Aarding, and Met-Pro. At the same time, we have been able to consolidate these new entities into our existing lean corporate structure without increasing costs proportionally. Our continuing focus will be on global growth, market coverage, and specifically expansion of our China and India operations. Operational excellence, margin expansion, after-market growth, and safety leadership are also critical to our growth strategy.

On February 28, 2013, we acquired Aarding Thermal Acoustics B.V., a Netherlands company ("Aarding"), pursuant to the terms of a Share Purchase Agreement, (the "SPA") dated February 28, 2013, among the Company, CECO Environmental Netherland B.V., N.F.J.A. Pieterse Beheer B.V., and W.M. Pranger Beheer B.V., and ATA Beheer B.V. Aarding is a global provider of natural gas turbine exhaust systems and silencer applications and is now part of our Engineered Equipment Technology and Parts Group. The purchase price included cash of $24.4 million and 763,673 shares


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CECO ENVIRONMENTAL CORP. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

of restricted common stock. The preliminary fair value of the common stock issued has been determined to be $7.4 million which reflects the closing price of the Company's common stock on the Closing Date and a discount related to the sale and transfer restrictions on the shares. The cash paid was funded by the Company's cash reserves. Of the total consideration paid, 4 million ($5.4 million as of September 30, 2013) is contingent upon the future employment by the Sellers and, therefore, has been classified as prepaid compensation by the Company. The current portion of the prepaid compensation of $1.1 million is in "Prepaid expenses and other current assets", while the non-current portion of $3.7 million is in "Deferred Charges and other assets" on the balance sheet. For the three month and nine month periods ended September 30, 2013, $0.2 million and $0.5 million, respectively, of compensation expense has been recorded. Additionally, the former owners of Aarding are entitled to earn-out payments of up to 5.5 million ($7.4 million as of September 30, 2013) upon the attainment of specified financial targets through December 31, 2017. Such earn out payments are contingent upon the continued employment of the Sellers. Accordingly, no value for the potential earn out consideration has been allocated to the purchase price of Aarding as any such payments will be reported as future compensation expense by the Company. For the three and nine month periods ended September 30, 2013, $0.4 million and $0.9 million, respectively, of earn-out expense has been recorded. An accrual of $0.9 million relating to the earn-out is included within "Accounts payable and accrued expenses" on the condensed consolidated balance sheets.

Operations Overview

We operate under a "hub and spoke" business model in which executive management, finance, administrative and marketing staff serves as the hub while the sales channels serve as spokes. We use this model throughout our operations. This has provided us with certain efficiencies over a more decentralized model. The Company's division presidents and general managers are responsible for successfully running their operations, that is, sales, manufacturing, pricing, safety, employee development, and customer service excellence. The managers work closely with the Chief Executive Officer on global growth strategies, operational excellence, and employee development. The headquarters (hub) focuses on enabling the core back-office key functions for scale and efficiency, that is, accounting, payroll, human resources/benefits, IT, safety support, audit controls, marketing, and administration. We have organizational focus from headquarters throughout our divisional businesses with minimal duplicative work streams. We are structured for growth and will do strategic future bolt-on acquisitions with a full integration strategy.

Our four operating segments are: the Engineered Equipment Technology and Parts Group ("EET&P"), which produces various types of air pollution control equipment, the Met-Pro Group ("MP"), which produces product recovery and pollution control, fluid handling, filtration, and purification technologies, the Contracting / Services Group ("C/S"), which produces air pollution control and industrial ventilation systems and the Component Parts Group ("CP"), which manufactures products used by us and other air pollution control companies and contractors. It is through combining the efforts of some or all of these groups that we are able to offer complete turnkey systems to our customers and leverage the operational efficiencies between our family of companies.

Our contracts are obtained either through competitive bidding or as a result of negotiations with our customers. Contract terms offered by us are generally dependent on the complexity and risk of the project as well as the resources that will be required to complete the project. For example, a contract that can be performed primarily by subcontractors and that does not require us to use our fabrication and assembly facilities can be quoted at a lower gross margin than a more typical contract that will require additional factory overhead and administrative expenses. Our focus is on increasing our operating margins as well as our gross margin percentage which translates into higher net income. Our sales typically peak in the fourth quarter due to a tendency of customers to want to fully utilize annual capital budgets and due to the fact that many industrial facilities shut down for the holiday season and that creates demand for maintenance and renovation work that can be done at no other time.

Note Regarding Use of Non-GAAP Financial Measures

The Company's unaudited Condensed Consolidated Financial Statements are prepared in accordance with GAAP. These GAAP financial statements include certain charges the Company believes are not indicative of its ongoing operational performance.

As a result, the Company is providing financial information in this filing 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, which the Company's management utilizes to evaluate its ongoing financial performance and which the Company believes provides greater transparency to investors as supplemental information to its GAAP results.


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CECO ENVIRONMENTAL CORP. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The Company has provided the non-GAAP financial measures of non-GAAP gross profit and gross profit margin, non-GAAP operating income, non-GAAP operating margin, and non-GAAP net income as a result of items that the Company believes are not indicative of its ongoing operations. These include charges associated with the Company's acquisition and integration of Adwest, Aarding, and Met-Pro 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. As a result of the Company's acquisition of Adwest, Aarding and Met-Pro, which closed on December 31, 2012, February 28, 2013 and August 27, 2013, respectively, the Company has incurred and expects to continue to incur substantial charges associated with the acquisition and integration of these companies. While the Company cannot predict the exact timing or amounts of such charges, it does expect to treat these charges as special items in its future presentation of non-GAAP results. See Note 15 to the unaudited condensed consolidated financial statements for further information on the Met-Pro and Aarding acquisitions.

Results of Operations

Consolidated Results

Our condensed consolidated statements of operations for the three month and nine
month periods ended September 30, 2013 and 2012 are as follows:



                                                  Three Months Ended September 30,                   Nine Months Ended September 30,
(dollars in millions)                             2013                        2012                   2013                       2012
Net sales                                    $         49.8              $         33.1         $         128.6            $         100.7
Cost of sales                                          35.2                        22.6                    88.6                       69.5

Gross profit                                 $         14.6              $         10.5         $          40.0            $          31.2
Percent of sales                                       29.3 %                      31.7 %                  31.1 %                     31.0 %
Selling and administrative expenses          $          9.3              $          6.2         $          24.0            $          18.7
Percent of sales                                       18.7 %                      18.7 %                  18.7 %                     18.6 %
Operating (loss) income                      $         (3.4 )            $          4.3         $           3.3            $          12.3
Operating margin                                       (6.8 )%                     12.8 %                   2.6 %                     12.2 %

To compare quarterly operating performance between the three month and nine month periods ended September 30, 2013 and 2012, the Company has adjusted GAAP operating income and GAAP net (loss) income to exclude (1) acquisition and integration related expenses, including legal, accounting, and banking expenses,
(2) amortization and contingent acquisition expenses, including amortization of acquisition related intangibles, retention, severance, and earn-out expenses,
(3) legal reserves, (4) inventory valuation and plant, property and equipment valuation adjustments related to the Met-Pro acquisition, and (5) with respect to net (loss) income, associated tax benefits of these charges. The Company has adjusted GAAP gross profit to exclude inventory valuation and plant, property and equipment valuation adjustments related to the Met-Pro acquisition. See "Note Regarding Use of Non-GAAP Financial Measures" above. The following tables present the reconciliation of GAAP gross profit and GAAP gross margin to non-GAAP gross profit and gross profit margin, 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 September 30,                 Nine Months Ended September 30,
(dollars in millions)                          2013                      2012                   2013                      2012
Gross profit as reported in
accordance with GAAP                      $         14.6            $         10.5         $         40.0            $         31.2
Gross profit margin in accordance
with GAAP                                           29.3 %                    31.7 %                 31.1 %                    31.0 %
Inventory valuation adjustment                       0.4                        -                     0.4                        -
Plant, property and equipment
valuation adjustment                                 0.1                        -                     0.1                        -

Non-GAAP gross profit                     $         15.1            $         10.5         $         40.5            $         31.2
Gross profit margin                                 30.1 %                    31.7 %                 31.5 %                    31.0 %


Table of Contents

                   CECO ENVIRONMENTAL CORP. AND SUBSIDIARIES

          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

                           AND RESULTS OF OPERATIONS



                                                Three Months Ended September 30,                  Nine Months Ended September 30,
(dollars in millions)                           2013                        2012                   2013                      2012
Operating income as reported in
accordance with GAAP                       $         (3.4 )            $          4.3         $          3.3            $         12.3
Operating margin in accordance with
GAAP                                                 (6.8 )%                     12.8 %                  2.6 %                    12.2 %
Inventory valuation adjustment                        0.4                          -                     0.4                        -
Plant, property and equipment
valuation adjustment                                  0.1                          -                     0.1                        -
Acquisition and integration expenses                  4.0                          -                     6.6                        -
Amortization and earn out expenses                    2.0                          -                     3.5                       0.2
Legal reserves                                        2.5                          -                     2.5                        -

Non-GAAP operating income                  $          5.6              $          4.3         $         16.4            $         12.5
Operating margin                                     11.4 %                      12.8 %                 12.8 %                    12.4 %




                                            Three Months Ended September 30,                Nine Months Ended September 30,
(dollars in millions)                        2013                       2012                 2013                       2012
Net (loss) income as reported in
accordance with GAAP                    $          (1.5 )           $        3.3        $           3.8             $        7.8
Inventory valuation adjustment                      0.4                       -                     0.4                       -
Plant, property and equipment
valuation adjustment                                0.1                       -                     0.1                       -
Acquisition and integration
expenses                                            4.0                       -                     6.6                       -
Amortization and earn out expenses                  2.0                       -                     3.5                      0.2
Legal reserves                                      2.5                       -                     2.5                       -
Tax benefit of expenses                            (2.6 )                     -                    (3.3 )                     -

Non-GAAP net income                     $           4.9             $        3.3        $          13.6             $        8.0

Consolidated sales for the third quarter increased $16.7 million to $49.8 million from $33.1 million in 2012. The increase in sales was primarily due to the approximately 46.8% sales increase in our Engineering Equipment Technology and Parts Group segment due to our acquisitions of Adwest Technologies at the end of 2012 and Aarding Thermal Acoustics at the end of February 2013, which collectively accounted for $10.2 million of sales for the quarter. The third quarter of 2013 also included $7.3 million for one month of sales from our August 2013 acquisition of Met-Pro.

Consolidated sales for the first nine months of 2013 were $128.6 million compared with $100.7 million in 2012. The $27.9 million increase in sales was primarily due to the 40.0% sales increase in our Engineering Equipment Technology and Parts Group primarily due to the acquisitions of Adwest and Aarding as noted above, which collectively accounted for $25.5 million of sales for the nine months ended September 30, 2013. As mentioned above, Met-Pro provided $7.3 million of revenue. Excluding acquisitions, revenues decreased $4.9 million due principally to a few order delays.

Gross profit increased by $4.0 million, or 38.1%, to $14.6 million in the third quarter of 2013 compared with $10.5 million in the same period of 2012. Gross profit as a percentage of sales was 29.3% in 2013 compared with 31.7% in 2012. The net decrease in gross profit as a percentage of sales was primarily due to a decrease at Effox which was partially offset by increases at CECO Filters, Busch and A.V.C.

Gross profit increased by $8.8 million, or 28.2%, to $40.0 million for the first nine months of 2013 compared with $31.2 million in the same period of 2012. Gross profit as a percentage of sales was substantially flat at 31.1% in 2013 and 31.0% in 2012.

Orders booked were $48.0 million during the third quarter of 2013 and $132.4 million for the first nine months of 2013, as compared with $41.8 million during the third quarter of 2012 and $113.4 million in comparable period in 2012.


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CECO ENVIRONMENTAL CORP. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

Selling and administrative expenses for the third quarter of 2013 were $9.3 million as compared with $6.2 million during the third quarter of 2012. During the first nine months of 2013, selling and administrative expenses were $24.0 million compared with $18.7 million in the comparable period in 2012. The increase for the three month and nine month periods in 2013 was primarily due to the Met-Pro, Adwest and Aarding acquisitions, which added $2.6 million during the quarter and $4.4 million during the nine months ended September 30, 2013.

Acquisition and integration expenses during the third quarter of 2013 and first nine months of 2013 of $4.0 million and $6.6 million, respectively, are for legal, accounting, banking, and other related expenses for the Aarding and Met-Pro acquisitions.

Amortization and earn out expenses were $2.0 million in the third quarter of 2013 and none in the third quarter of 2012. During the first nine months of 2013 and the first nine months of 2012, amortization and earn out expense was $3.5 million and $0.2 million, respectively. The increase in amortization expense was the result of certain finite life intangibles related to the Met-Pro, Adwest, and Aarding acquisitions. The earn out expense in the third quarter of 2013 was $0.4 million and $0.9 million for the first nine months of 2013.

Operating loss was $3.4 million in the third quarter of 2013 compared with operating income of $4.3 million during the same quarter of 2012. Operating loss as a percent of sales in the third quarter of 2013 was (6.8)% compared with operating income of 12.8% for the same period in 2012. The decrease is principally related to the acquisition related expenses discussed earlier, and the legal reserves.

Operating income for the first nine months of 2013 was $3.3 million compared with operating income of $12.3 million during the same period of 2012. Operating income as a percent of sales for the nine months ended September 30, 2013 was 2.6% compared with 12.2% for the same period in 2012. The decrease is principally related to the acquisition related expenses and legal reserves discussed earlier.

Interest expense increased to $0.5 million in the third quarter of 2013 from $0.3 million in the third quarter of 2012, due to the debt incurred for the acquisition of Met-Pro. Interest expense was $0.7 million for the first nine months of 2013 compared with $0.8 million for 2012. The interest for the first nine months of 2013 includes interest incurred since the August acquisition of Met-Pro, which is comparable to the interest incurred for the first nine months of 2012 due principally to the interest on our convertible notes, all of which converted in 2012.

Consolidated income tax (benefit) expense was ($2,259) in the third quarter of 2013 and $623 in the third quarter of 2012. During the first nine months of 2013 and the first nine months of 2012, consolidated income tax (benefit) expense was ($1,044) and $3,524, respectively. The effective tax rate for the third quarter of 2013 and 2012 was (60.7%) and 16.0%, respectively. The effective tax rate for the first nine months of 2013 was (38.0%) compared with 31.1% in 2012. For the three and nine months ended September 30, 2013, the effective tax rate was impacted by $0.5 million and $2.9 million of additional research and development tax credits available to the Company. These tax benefits are offset by $600 of fees related to the calculation of the credits included in Selling and administrative expenses. Along with the tax benefit of research and development income tax credits, our effective tax rate is additionally affected by certain permanent differences including non-deductible acquisition expense, non-deductible incentive stock based compensation, reversals of certain income tax reserves/deferrals, and tax holidays in foreign jurisdictions.

The Company files income tax returns in various federal, state and local jurisdictions. The Company is no longer subject to federal, state and local income tax examinations by tax authorities for years before 2008.

The Company accounts for uncertain tax positions pursuant to ASC Topic 740, "Income Taxes." As of September 30, 2013 and December 31, 2012, the liability for uncertain tax positions, which is included in "Other liabilities" on our condensed consolidated balance sheets, totaled approximately $653 and $162, respectively. The Company recognizes interest accrued related to uncertain tax positions in interest expense and penalties in income tax expense.

Business Segments

The Company's operations are organized and reviewed by management along its product lines and presented in four reportable segments. The results of the segments are reviewed through to the "Income from operations" line on the condensed consolidated statements of operations.


Table of Contents

                   CECO ENVIRONMENTAL CORP. AND SUBSIDIARIES

          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

                           AND RESULTS OF OPERATIONS



                                                   Three Months Ended             Nine Months Ended
                                                     September 30,                  September 30,
(dollars in thousands)                            2013            2012           2013           2012
Net Sales (less intra-, inter-segment sales)
Engineered Equipment Technology and Parts
United States                                   $  21,741       $ 18,425       $  64,444      $  55,889
. . .
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