CECO ENVIRONMENTAL CORP.
Management's discussion and analysis ("MD&A") should be read in conjunction with
the consolidated financial statements and accompanying notes included in Item 8
of this Annual Report on Form 10-K, which include additional information about
our accounting policies, practices and the transactions underlying our financial
results. The preparation of our consolidated financial statements in conformity
with GAAP requires us to make estimates and assumptions that affect the reported
amounts in our consolidated financial statements and the accompanying notes
including various claims and contingencies related to lawsuits, taxes,
environmental and other matters arising during the normal course of business. We
apply our best judgment, our knowledge of existing facts and circumstances and
actions that we may undertake in the future in determining the estimates that
affect our consolidated financial statements. We evaluate our estimates on an
ongoing basis using our historical experience, as well as other factors we
believe appropriate under the circumstances, such as current economic
conditions, and adjust or revise our estimates as circumstances change. As
future events and their effects cannot be determined with precision, actual
results may differ from these estimates.
Overview
Business Overview
CECO is a global leader in industrial air quality and fluid handling serving the energy, industrial and other niche markets through an attractive asset-light business model. We focus on engineering, designing, building, and installing systems that capture, clean and destroy airborne contaminants from industrial facilities as well as equipment that controls emissions from such facilities, as well as fluid handling and filtration systems. CECO provides innovative technology and application expertise that helps companies grow their businesses with safe, clean, and more efficient solutions to help protect our shared environment. CECO serves diverse industries globally by working to improve air quality, optimize the energy value chain, and provide customized engineered solutions in our customers' mission critical applications. The industries CECO serves include power generation, petrochemical processing, general industrial, refining, oil & gas, electric vehicle production, poly silicon fabrication, battery recycling, and wastewater treatment, along with a wide range of other industries.
COVID-19
OnJanuary 30, 2020 , the WHO announced a global health emergency because of a new strain of coronavirus ("COVID-19") originating inWuhan, China and the risks to the international community as the virus spreads globally beyond its point of origin. OnMarch 11, 2020 , the WHO characterized COVID-19 as a pandemic. As ofMarch 3, 2021 , the virus continues to spread and has had a significant impact on worldwide economic activity and on macroeconomic conditions and the end markets of our business. Vaccine administration is underway, however new variants of COVID-19 continue to emerge. There is uncertainty regarding the efficacy of vaccines and current tests and treatments with regard to the new variants. Several countries, includingthe United States , have taken steps to restrict travel, temporarily close businesses and issue quarantine orders, and it remains unclear how long such measures will remain in place or whether efforts to contain the spread of COVID-19 will continue to intensify. Withinthe 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. This allows us to continue to serve our customers, however, the COVID-19 pandemic has also disrupted our global operations. Some of our facilities and our suppliers have experienced temporary disruptions as a result of the COVID-19 pandemic, and we cannot predict whether our facilities will experience more significant disruptions in the future or the impact on our suppliers. CECO has undertaken necessary measures in compliance with government directives to remain open across its business and continues to work closely with its global supply chain to proactively support customers during this critical time. As a key supplier to critical infrastructure projects, CECO has worked to maintain ongoing essential operations while observing recommended CDC 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. Additionally, in 2020, CECO took several proactive cost reduction measures in response to the economic pressures brought on by the COVID-19 pandemic, including: headcount reductions, lower discretionary spend, senior management team's temporary salary reduction, elimination or reduction of certain corporate-level costs, travel restrictions across all segments, and the Company implemented a number of furloughs which included, a rolling 2-week furlough ofUnited States -based employees during the 6-week period beginning the week ofApril 6, 2020 . 25 -------------------------------------------------------------------------------- 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 and, to date, the Company has not experienced any significant disruptions within its supply chain as a result of the COVID-19 pandemic. Notwithstanding the Company's continued efforts, COVID-19 has had and may have further negative impacts on its operations, customers and supply chain despite the preventative and precautionary measures being taken. COVID-19 began to impact the Company during the first quarter of 2020 and the impact of the COVID-19 pandemic is fluid and continues to evolve, and therefore, we cannot currently predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted.
Industry Trends and Corporate Strategy
We are a global corporation with worldwide operations. As a global business, our operations are affected by worldwide, regional and industry-specific economic factors, wherever we operate or do business. Our geographic and industry diversity, and the breadth of our product and services portfolios, have helped mitigate the impact of any one industry or the economy of any single country on our consolidated operating results.
We believe growth for our products and services is driven by the increasing demand for energy consumption and a shift towards cleaner sources such as natural gas, nuclear, and renewable sources. These trends should stimulate investment in new power generation facilities, pipeline expansion and related infrastructure, and in upgrading of existing facilities.
With a shift to cleaner, more environmentally responsible power generation, power providers and industrial power consumers are building new facilities that use cleaner fuels. In developed markets, natural gas is increasingly becoming one of the energy sources of choice. We supply product offerings throughout the entire natural gas infrastructure value chain and believe expansion will drive growth within our Energy Solutions segment for our pressure products and SCR systems for natural-gas-fired power plants. Increased global natural gas production as a percent of total energy consumption, miles of new pipeline being added globally, and an increase in liquification capacity all stand to drive the need for our products. We also believe there is a trend in both developed and emerging markets to control and reduce emissions of harsher fuel sources for which our air pollution control equipment is required. In emerging markets includingChina ,India , andSouth East Asia our business is positioned to benefit from tightening of air pollution standards. In developed markets, growth of industrialization will drive greater output of emissions requiring our equipment as well. In both markets, we expect capital expenditures for our equipment to increase and the need for our aftermarket services to grow as companies seek to meet new standards. 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. Our continuing focus will be on global growth, market coverage, and expansion of ourAsia operations. Operational excellence, margin expansion, after-market recurring revenue growth, and safety leadership are also critical to our growth strategy.
Operations Overview
We operate using an "outside-in" customer approach to our business model. We are
structured to win in target markets with a core focus on understanding customer
needs. Our business model requires scalable efficiencies enabling us to serve
our customers with a variety of products that we typically classify into three
categories: make-to-order, configure-to-order, and engineer-to-order. We use an
asset light model to accomplish this by focusing on application and technical
expertise throughout our operations.
The Company's segments are led by presidents with distinct industry expertise
coupled with strong leadership skills resulting in a customer-first mindset
across the business. They manage their teams who are responsible for
successfully running the segment operations. The segment presidents work closely
with our Chief Executive Officer on global growth strategies, operational
excellence, and employee development.
Within our segments we have monthly operating reviews to ensure we are both
winning in the markets and winning as a business. These reviews include, but are
not limited to, deal reviews, project reviews, and manufacturing reviews. Each
of these reviews takes a customer-first approach where we adopt the metrics that
matter most to our customer and to our stockholders. In these reviews we focus
on metrics such as quality, customer satisfaction, on-time-delivery, lead-times,
price, position, project margins, backlog, and above all, safety.
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The headquarters focuses on enabling the core back-office key functions for
scale and efficiency, that is, accounting, payroll, human resources/benefits,
legal, information technology, marketing, safety support, internal control over
financial reporting, and administration. We have excellent organizational focus
from headquarters throughout our divisional businesses with clarity and minimal
duplicative work streams.
Our three reportable segments are:
• Energy Solutions segment: Our Energy Solutions segment serves the Energy
market, where we are a key part of helping meet the global demand for clean
energy and lower emissions through our highly engineered and tailored
emissions management, silencers and separation solutions and services. Our
offerings improve air quality and solves fluid handling needs with market
leading technologies, efficiently designed, and customized solutions for the
power generation, oil & gas, and petrochemical industries.
• Industrial Solutions segment: Our Industrial Solutions segment serves the
Air Pollution Control market where our aim is to address the growing need to
protect the air we breathe and help our customers' desires for
sustainability upgrades beyond carbon footprint issues. Our offerings in
clean air pollution control, collection and ventilation technologies improve
air quality with a compelling solution that enable our customers in the
semiconductor manufacturing, electric vehicle production, battery recycling,
and wood manufacturing industries to reduce their carbon footprint, lower
energy consumption, minimize waste and meet compliance targets for toxic
emissions, fumes, volatile organic compounds, and industrial odors.
• Fluid Handling Solutions segment: Our Fluid Handling Solutions segment
offers unique pump and filtration solutions that maintain safe and clean
operations in some of the most harsh and toxic environments. In this market,
we provide solutions for mission-critical applications to a wide variety of
industries including, but not limited to, plating and metal finishing,
automotive, food and beverage, chemical, petrochemical, pharmaceutical,
wastewater treatment, desalination and the aquarium & aquaculture markets.
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. Our focus is on increasing our operating margins as well as our gross margin percentage, which translates into stronger operating results.
Our cost of sales is principally driven by a number of factors, including material and subcontract prices and labor cost and availability. Changes in these factors may have a material impact on our overall gross profit margins.
We break down costs of sales into five categories. They are:
• Subcontracts-Electrical work, concrete work, subcomponents and other
subcontracts necessary to produce our products;
• Labor-Our direct labor both in the shop and in the field;
• Material-Raw material that we buy to build our products;
• Equipment-Fans, motors, control panels and other equipment necessary for
turnkey systems; and
• Factory overhead-Costs of facilities and supervision wages necessary to
produce our products.
In general, subcontracts provide us the most flexibility in margin followed by
labor, material, and equipment. Across our various product lines, the relative
relationships of these factors change and cause variations in gross margin
percentage. Material costs have also increased faster than labor costs, which
also reduces gross margin percentage. As material cost inflation occurs, the
Company seeks to pass this cost onto our customers as price increases.
Selling and administrative expense principally includes sales and engineering
payroll and related fringes, advertising and marketing expenditures as well as
all corporate and administrative functions and other costs that support our
operations. The majority of these expenses are fixed. With our asset light
model, we expect our operations to leverage our fixed cost structure as revenue
grows.
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Note Regarding Use of Non-GAAP Financial Measures
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). These GAAP financial statements include certain charges the Company believes are not indicative of its ongoing operational performance. As a result, the Company provides financial information in this MD&A 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. The Company has provided the non-GAAP financial measures including non-GAAP operating income, non-GAAP operating margin, and non-GAAP net income as a result of the adjustment for items that the Company believes are not indicative of its ongoing operations. These items include charges 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 acquisitions and divestitures. 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. Results of Operations Consolidated Results
Our consolidated statements of operations for the years ended
Year ended December 31,
(dollars in millions) 2020 2019 2018
Net sales $ 316.0 $ 341.9 $ 337.3
Cost of goods sold 210.9 227.8 225.8
Gross profit $ 105.1 $ 114.1 $ 111.5
Percent of sales 33.3 % 33.4 % 33.1 %
Selling and administrative expenses $ 76.9 $ 85.9 $ 87.4
Percent of sales 24.3 % 25.1 % 25.9 %
Amortization and earnout expenses 8.8 8.5 9.7
Restructuring expenses 2.3 1.1 - Acquisition and integration expenses 1.4 0.5 - Executive transition expenses 1.5 - - Loss on divestitures, net of selling costs - 0.1 4.4 Intangible asset impairment 0.9 - - Operating income$ 13.3 $ 18.0 $ 10.0 Percent of sales 4.2 % 5.3 % 3.0 % 28
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Non-GAAP Measures To compare operating performance between the years endedDecember 31, 2020 , 2019 and 2018, 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, (3) acquisition and integration expenses, which include legal, accounting, and other expenses, (4) executive transition expenses, including severance for its former Chief Executive Officer, fees and expenses incurred in the search, for and hiring, of a new Chief Executive Officer, (5) loss on divestitures, net of selling costs necessary to complete the divestiture such as legal, accounting and compliance and (6) intangible asset impairment. See "Note Regarding Use of Non-GAAP Financial Measures" above. 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 (loss) to non-GAAP net income. Year Ended December 31, (dollars in millions) 2020 2019 2018
Operating income as reported in accordance with GAAP
4.2 % 5.3 % 3.0 %
Amortization and earnout expenses 8.8 8.5 9.7
Restructuring expenses 2.3 1.1 -
Acquisition and integration expenses 1.4 0.5 -
Executive transition expenses 1.5 - -
Loss on divestitures, net of selling costs - 0.1 4.4
Intangible asset impairment 0.9 - -
Non-GAAP operating income $ 28.2 $ 28.2 $ 24.1
Non-GAAP operating margin 8.9 % 8.2 % 7.1 %
Year Ended December 31,
(dollars in millions) 2020 2019 2018
Net income (loss) as reported in accordance with GAAP $ 8.2 $ 17.7 $ (7.1 )
Amortization and earnout expenses 8.8 8.5 9.7
Restructuring expenses 2.3 1.1 -
Acquisition and integration expenses 1.4 0.5 -
Executive transition expenses 1.5 - -
Loss on divestitures, net of selling costs - 0.1 4.4
Intangible asset impairment 0.9 - -
Deferred financing fee adjustment - 0.4 -
Foreign currency remeasurement 0.3 (0.5 ) 0.8
Tax (benefit) expense of adjustments (3.9 ) (2.5 ) 2.4
Zhongli tax benefit - (4.4 ) -
Non-GAAP net income $ 19.5 $ 20.9 $ 10.2
Non-GAAP net income as a percentage of sales 6.2 % 6.1 % 3.0 %
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-------------------------------------------------------------------------------- InJune 2020 the Company acquired Environmental Integrated Solutions ("EIS"), EIS engineers products that clean air through a variety of technologies including volatile organic compounds ("VOC") abatement, odor control, regenerative thermal oxidizers, and other air pollution control solutions, which complements our Industrial Solutions Segment businesses. InJuly 2020 , the Company entered into joint venture agreement (the "JV agreement") withMader Holding L.P. ("Mader") in which CECO contributed the net assets of its Effox-Flextor damper business and Mader contributed the net assets of their damper business. During 2020, EIS and the joint venture accounted for$15.8 million in revenue. In 2018, we divested three non-core businesses; the Keystone Filter brand ("Keystone") andStrobic Air Corporation ("Strobic") in the first quarter and Zhongli in the fourth quarter (collectively, "the Divestitures"). The exclusion of the operating results subsequent to their disposition impacts the comparability of our consolidated and segment operating results.
Comparison of the years ended
Consolidated net sales in 2020 were$316.0 million compared with$341.9 million in 2019, a decrease of$25.9 million . The decrease is primarily attributable to decreases of$24.5 million in our Industrial Solutions air pollution control technologies,$18.2 million in custom-designed FCC cyclone systems serving the refinery markets, and$4.4 million in volume decreases in the Company's filtration and pump solutions sales. These decreases in net sales are offset by increases of$10.1 million in the Company's custom acoustical technologies that serve the natural gas power generation markets,$8.1 million in volatile organic compounds ("VOC") abatement solutions from the EIS acquisition and$3.3 million in volume increases in our emissions management and water filtration solutions technologies. Gross profit decreased by$9.0 million , or 7.9%, to$105.1 million in 2020 compared with$114.1 million in 2019. The decrease in gross profit is primarily due to the decrease in sales as noted above, partially offset by favorable changes to product mix from previous period and cost reduction actions including employee furlough. Gross profit as a percentage of sales was 33.3% and 33.4% in 2020 and 2019, respectively. Orders booked were$279.6 million in 2020 compared with$383.7 million in 2019. The decrease is primarily attributable to decreases in refinery, oil & gas, and pollution controls end markets due to the COVID-19 pandemic impacting our customers starting inMarch 2020 . Selling and administrative expenses were$76.9 million in 2020 compared with$85.9 million in 2019. The decrease in administration expenses is primarily attributable to proactive cost reduction measures noted above taken in response to the COVID-19 pandemic including: headcount reductions, lower discretionary spend, the senior management team's temporary salary reduction, elimination of certain corporate-level costs, a 2-week furlough ofUnited States -based employees, and travel restrictions across all segments. Selling and administrative expenses as a percentage of sales were 24.3% in 2020 compared with 25.1% in 2019. The decrease in selling and administrative expenses as a percentage of sales is primarily attributable to the items described above. Amortization and earnout expense was$8.8 million in 2020 and$8.5 million in 2019. The increase in expense is primarily attributable to$1.4 million in earnout expenses related to the EIS acquisition. The fair value adjustments to the earnout that were recorded in 2020 were the result of EIS performing above the acquisition operational expectations. The increase was partially offset by$1.1 million decrease in definite lived intangible asset amortization. Acquisitions and integration expenses related to the acquisition of EIS and the Mader joint venture were$1.4 million in 2020, which include legal, accounting and banking expenses, compared to$0.5 million in 2019 related to various merger and acquisition diligence activities.
In 2020, the Company incurred
In 2020, after conducting the annual impairment testing for goodwill and indefinite lived intangible assets, the Company recorded an impairment charge of$0.9 million . The charge of$0.9 million was recorded to impair the carrying value of a tradename intangible asset in the Company's Fluid Handling Solutions Segment. The impairment was recorded due to declining revenue related to the tradename exacerbated by the COVID-19 pandemic. Operating income for 2020 was$13.3 million , a decrease of$4.7 million from$18.0 million in 2019. Operating income as a percentage of sales for 2020 was 4.2% compared with 5.3% for 2019. The decrease in operating income is primarily attributable to$1.5 million in executive transition expenses which did not occur in 2019,$1.2 million increase in restructuring expenses,$0.9 million increase in acquisition and integration expenses in connection to the EIS acquisition and the Mader joint venture, intangible asset impairment of$0.9 million ,$0.3 million increase in amortization and earnout expenses, and a decrease in net sales as noted above, 30 --------------------------------------------------------------------------------
partially offset by the decrease in selling and administration expenses due to the cost reduction measures taken in response to the COVID-19 pandemic.
Non-GAAP operating income was$28.2 million in 2020 and 2019. Non-GAAP operating income as a percentage of sales for 2020 was 8.9% compared with 8.2% for 2019. Non-GAAP operating income was equal year over year due to cost reductions described above offset by the decline in sales. Other income for 2020 was$2.0 million , an increase of$1.2 million from$0.8 million in 2019. The increase in other income was primarily attributable to a net periodic gain on pension assets of$0.3 million in 2020 compared to a net periodic expense of$0.3 million on pension assets in 2019 and$0.4 million increase year over year in foreign currency transaction gains. Interest expense decreased to$3.5 million in 2020 from$5.4 million in 2019. The decrease is due to lower interest rates and lower average debt balances in 2020 compared to 2019. During the year 2020, the Company had net borrowings of$9.5 million on its revolving credit facility, which consisted of$10.3 million used to fund the EIS acquisition onJune 4, 2020 and$2.6 million used to pay term debt assumed in connection with the Mader joint venture, and$3.4 million in net repayments on the revolving credit facility.
Income tax expense (benefit) was
Income tax expense and the effective tax rate for 2020 were affected by certain
permanent differences, including state income taxes, non-deductible incentive
stock-based compensation, the Global Intangible Low-Taxed Income ("GILTI")
inclusion and Foreign-Derived Intangible Income ("FDII") deduction, tax credits,
and differences in tax rates among the jurisdictions in which we operate.
Income tax benefit and the effective tax rate for 2019 were significantly
impacted by a
Comparison of the years ended
See the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year endedDecember 31, 2019 for a discussion of our results of operations for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 .
Business Segments
The Company's operations in are organized and reviewed by management along its
product lines or end markets that the segment serves and are presented in three
reportable segments. The results of the segments are reviewed through the
"Income from operations" line on the Consolidated Statements of Operations. The
amounts presented in the Net Sales table below and in the following comments
regarding our net sales at the reportable business segment level exclude both
intra-segment and inter-segment net sales. The Income from Operations table and
corresponding comments regarding operating income (loss) at the reportable
segment level include both intra-segment and inter-segment operating income. The
exclusion of the Divestitures' operating results subsequent to their disposition
impacts the comparability of our segment operating results.
2020 2019 2018
Net Sales (less intra-, inter-segment sales) (table only in thousands) Energy Solutions segment$ 205,494 $ 210,319 $ 211,185 Industrial Solutions segment 74,697 91,347 80,699 Fluid Handling Solutions segment 35,820 40,203 45,455 Net sales$ 316,011 $ 341,869 $ 337,339 31
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2020 2019 2018
Income from Operations
(table only in thousands)
Energy Solutions segment $ 34,170 $ 33,886 $ 28,797
Industrial Solutions segment 2,183 5,679 6,308
Fluid Handling Solutions segment 5,037 5,558 7,730
Corporate and Other (1) (28,044 ) (27,133 ) (32,833 )
Income from operations $ 13,346 $ 17,990 $ 10,002
(1) Includes corporate compensation, professional services, information
technology, other general and administrative corporate expenses and loss on
divestitures, net of selling costs. This figure excludes earnout expenses /
income, which are recorded in the segment in which the expense / income
occurs.
Comparison of the years ended
Energy Solutions segment Our Energy Solutions segment net sales decreased$4.8 million to$205.5 million in 2020 compared with$210.3 million in 2019, a decrease of 2.3%. The decrease is primarily attributable to decreases of$18.2 million in custom-designed FCC cyclone systems serving the refinery markets offset by increases of$10.1 million in the Company's custom acoustical technologies that serve the natural gas power generation markets and$3.3 million in volume increases in our emissions management and water filtration solutions technologies. Operating income increased$0.3 million to$34.2 million for 2020 compared with$33.9 million in 2019, an increase of 0.8%. The increase in operating income in 2020 is primarily attributable to the decrease of$2.6 million in selling and administrative expenses related to the cost reductions as described above and the decrease in amortization expenses of$1.1 million partially offset by a decrease in gross profit of$3.1 million due to lower net sales and unfavorable product mix and an increase of$0.3 in restructuring expense. Industrial Solutions segment Our Industrial Solutions segment net sales decreased$16.6 million to$74.7 million in 2020 compared with$91.3 million in 2019, a decrease of 18.2%. The decrease is primarily attributable to decreases of$24.5 million in our air pollution control technologies partially offset by$8.1 million increase in VOC abatement solutions from the EIS acquisition. Operating income decreased$3.5 million to$2.2 million for 2020 compared with$5.7 million in 2019. The decrease is primarily attributable to a$4.6 million decrease in gross profit due to lower net sales, an increase of$0.5 million in restructuring expenses, and items related to the EIS acquisition including an increase of$1.4 million in earnout expense and$0.4 million in amortization expense. These decreases were partially offset by$3.2 million decrease in selling and administration related to cost reductions described above.
Fluid Handling Solutions segment
Our Fluid Handling Solutions segment net sales decreased$4.4 million to$35.8 million in 2020 compared with$40.2 million in 2019, a decrease of 10.9%. The decrease is primarily attributable to volume decreases in the Company's filtration and pump solutions product line driven by lower demand from oil & gas and automotive end market customers. Operating income decreased$0.6 million to$5.0 million for 2020 compared with$5.6 million for 2019, a decrease of 10.7%. The decrease is primarily attributable to$1.6 million decrease in gross profit due to lower net sales and a$0.9 million intangible asset impairment expense partially offset by$1.8 million decrease in selling and administration related to cost reductions described above. Corporate and Other segment Operating expense for the Corporate and Other segment increased$0.9 million to$28.0 million for 2020 compared with$27.1 million for 2019. The increase is primarily attributable to a$1.5 million increase in executive transition expenses,$0.9 million increase in acquisition and integration expenses, partially offset by$1.5 million decrease in selling and administration expenses related to cost reductions described above. 32 --------------------------------------------------------------------------------
Comparison of the years ended
See the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year endedDecember 31, 2019 for a discussion of our results of operations for our business segments and cash flows for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 .
Liquidity and Capital Resources
Our principal sources of liquidity are cash flow from operations and available borrowings under our Credit Facility (as defined below). Our principal uses of cash are operating costs, payment of principal and interest on our outstanding debt, working capital and other corporate requirements. Depending on market conditions, our liquidity requirements, contractual restrictions and other factors, we may also repurchase some of our outstanding shares of common stock. 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. AtDecember 31, 2020 , the Company had working capital of$74.1 million , compared with$64.3 million atDecember 31, 2019 . The ratio of current assets to current liabilities was 1.68 to 1.00 atDecember 31, 2020 as compared with a ratio of 1.56 to 1.00 atDecember 31, 2019 . AtDecember 31, 2020 and 2019, cash and cash equivalents totaled$36.0 million and$35.6 million , respectively. As ofDecember 31, 2020 and 2019,$28.0 million and$27.4 million , respectively, of our cash and cash equivalents were held by non-U.S. subsidiaries, as well as being denominated in foreign currencies.
Debt consisted of the following:
December 31,
(table only in thousands) 2020
2019
Outstanding borrowings under Credit Facility Term loan payable in quarterly principal installments of$0.6 million throughJune 2021 ,$0.9 million throughJune 2023 , and$1.3 million thereafter with balance due upon maturity inJune 2024 . - Term loan$ 46,250 $ 48,750 - Revolving Credit Loan 27,700 18,500 - Unamortized debt discount (1,334 ) (1,749 ) Total outstanding borrowings under Credit Facility 72,616
65,501
Less: current portion (3,125 ) (2,500 ) Total debt, less current portion$ 69,491 $ 63,001 In 2020, the Company made repayments of$2.5 million on the term loan and net borrowings on the revolving credit lines of$9.5 million , consisting of$10.3 million used to fund the EIS acquisition onJune 4, 2020 and$2.6 million used to pay term debt assumed in connection with the Mader joint venture, offset by$3.4 million in net repayments on the revolving credit facility. Under the terms of the Credit Facility, the Company is required to maintain certain financial covenants, including the maintenance of a Consolidated Net Leverage Ratio (as defined in the Credit Facility). ThroughSeptember 30, 2021 , the maximum Consolidated Net Leverage Ratio is 3.50, after which time it will decrease to 3.25 until the end of the term of the Credit Facility.
As of
Foreign Debt
In addition, the Company has a number of bank guarantee facilities and bilateral lines of credit in various foreign countries currently supported by cash, letters of credit or pledged assets and collateral under the Credit Facility.
The Credit Facility allows letters of credit and bank guarantee issuances of up to$50.0 million from the bilateral lines of credit secured by pledged assets and collateral under the Credit Facility. 33 --------------------------------------------------------------------------------
See Note 8 to the Consolidated Financial Statements for further information on the Company's foreign debt.
Total unused credit availability under our Credit Facility and other non-U.S. credit facilities and agreements, exclusive of any potential asset base limitations, is as follows: December 31, 2020 2019 (dollars in millions) Credit Facility, revolving loans$ 140.0 $ 140.0 Draw down (27.7 ) (18.5 ) Letters of credit open (7.6 ) (11.0 ) Total unused credit availability$ 104.7 $ 110.5
Amount available based on borrowing limitations
Overview of Cash Flows and Liquidity
For the year ended December 31,
(dollars in thousands) 2020 2019 2018
Total operating cash flow provided by
operating activities $ 4,421 $ 10,227 $ 21,952
Net cash (used in) provided by investing
activities (9,235 ) (5,146 ) 38,258
Net cash provided by (used in) financing
activities 3,724 (12,116 ) (44,900 )
Effect of exchange rate changes on cash
and cash equivalents 1,943 (445 ) (1,531 )
Net increase (decrease) in cash, cash
equivalents and restricted cash $ 853 $ (7,480 ) $ 13,779
Operating Activities
In 2020, $4.4 million of cash was provided by operating activities compared with
$10.2 million in 2019, a decrease of $5.8 million . Net earnings, adjusted for
non-cash items decreased $5.7 million year-over-year. Additionally, working
capital change year over year increased by $0.1 million which negatively
affected cash flow from operations.
In 2019, $10.2 million of cash was provided by operating activities compared
with $22.0 million provided in 2018, a decrease of $11.8 million . Net earnings,
adjusted for non-cash items increased $16.0 million year-over-year. Working
capital change year over year from operating activities in 2019 had a negative
year-over-year net impact primarily from increases in accounts receivable and
costs in excess of billings and decreases in other liabilities as reflected in
the Consolidated Statement of Cash Flows.
Investing Activities
In 2020,$9.2 million of cash was used in investing activities, which consisted of$5.9 million for acquisitions,$3.9 million of acquisition of property and equipment, offset by$0.6 million of proceeds from the disposal of assets held for sale. In 2019,$5.1 million of cash was used in investing activities, which consisted of$5.7 million of acquisition of property and equipment offset by$0.5 million of proceeds from disposals of assets held for sale.
Financing Activities
Financing activities in 2020 provided cash of$3.7 million , which consisted primarily of$9.2 million in net borrowings from our revolving credit lines of which$10.3 million was used to fund the EIS acquisition onJune 4, 2020 . This was offset by$2.5 million of payments on our term loan,$2.6 million used to pay term debt assumed in connection with the Mader joint venture onJuly 31, 2020 , and$0.5 million in payments on capital leases.
Financing activities in 2019 used cash of
We believe that cash flows from operating activities, together with our existing
cash and borrowings available under our Credit Facility, will be sufficient for
at least the next twelve months to fund our current anticipated uses of
cash. After that, our ability to fund these expected uses of cash and to comply
with the financial covenants under our debt agreements will depend on the
results of future operations, performance and cash flow. Our ability to fund
these expected uses from the results of future operations will be subject to
34
--------------------------------------------------------------------------------prevailing economic conditions and to financial, business, regulatory, legislative and other factors, many of which are beyond our control.
Employee Benefit Obligation
Based on current assumptions, estimated contributions to our pension plan required in 2021 is zero. The amount and timing of required contributions to the pension trust depends on future investment performance of the pension funds and interest rate movements, among other things and, accordingly, we cannot reasonably estimate actual required payments. Currently, our pension plan is under-funded. As a result, absent major increases in long-term interest rates, above average returns on pension assets and/or changes in legislated funding requirements, we will be required to make contributions to our pension trust of varying amounts in future years.
Off-Balance Sheet Arrangements
None.
Contractual Obligations
The following table summarizes the Company's contractual obligations as ofDecember 31, 2020 : Payments Due by Period Less than 1 More than (dollars in thousands) Total year 1-3 years 3-5 years 5 years Term Loan Debt$ 46,250 $ 3,125 $ 8,200 $ 34,925 $ - Revolving Credit Loan 27,700 - - 27,700 - Interest expense (estimated) 7,087 2,129 4,017 941 - Purchase obligations (1) 65,005 65,005 - - - Pension obligations (2) 995 - 400 595 - Operating lease obligations 13,831 2,872 4,257 3,481 3,221 Capital lease obligations 9,077 872 1,796 1,868 4,541 Contingent liabilities related to acquisitions (3) 2,202 2,202 - - - Totals$ 172,147 $ 76,205 $ 18,670 $ 69,510 $ 7,762
(1) Primarily consists of purchase obligations for costs associated with
uncompleted sales contracts.
(2) Future expected obligations under the Company's pension plan is included in
the contractual cash obligations table above, up to, but not more than five
years. The Company's pension plan policy allows it to fund an amount, which
could be in excess of the pension cost expensed, subject to the limitations
imposed by current tax regulations.
(3) Includes expected earnout liability and retention payment.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in conformity with GAAP. The preparation of these financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We believe that, of our significant accounting policies, the following accounting policies involve a higher degree of judgments, estimates, and complexity.
Use of Estimates
Preparation of the consolidated financial statements in accordance with GAAP
requires management to make estimates and assumptions affecting the reported
amounts of assets, liabilities, revenues and expenses and related contingent
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenues, bad debts, warranties, share based compensation, income
taxes, goodwill and intangible asset valuation, and contingencies and
litigation. We base our estimates on historical experience and on various other
assumptions that we believe are reasonable under the circumstances. Actual
results may differ from these estimates under different assumptions or
conditions.
35
--------------------------------------------------------------------------------Revenue Recognition
A substantial portion of our revenue is derived from fixed-price contracts. We account for a contract after it has been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.
We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. A significant amount of our revenue within the Energy Solutions and Industrial Solutions segments is recognized over a period of time as we perform under the contract because control of the work in process transfers continuously to the customer. For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation. Progress is measured based on the ratio of costs incurred to date to the total estimated costs to complete the performance obligation. For these contracts, the cost-to-cost measure best depicts the continuous transfer of goods or services to the customer. The judgments and estimates involved include management's ability to accurately estimate the contracts' progress to completion at each financial reporting period. In addition, certain contracts are highly dependent on the work of contractors and other subcontractors participating in a project, over which we have no or limited control, and their performance on such project could have an adverse effect on the profitability of our contracts. Delays resulting from these contractors and subcontractors, changes in the scope of the project, weather, and labor availability also can have an effect on a contract's profitability. Changes to job performance, job conditions, and estimated profitability may result in revisions to contract revenue and costs and are recognized in the period in which the revisions are made.
Provisions for estimated losses on uncompleted contracts are made in the period
in which such losses are determined. No provision for estimated losses on
uncompleted contracts was needed at
Credit and Collections
The Company maintains allowances for doubtful accounts receivable for probable estimated losses resulting from either customer disputes or the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in their inability to make the required payments, the Company may be required to record additional allowances or charges against income. The Company determines its allowance for doubtful accounts by considering all known collectability problems of customers' accounts and reviewing the aging of the outstanding receivables. The resulting allowance for doubtful accounts receivable is an estimate based upon the Company's knowledge of its business and customer base, and historical trends. The amount ultimately not collected may differ from the reserve established.
Inventories
The Company's inventories are valued at the lower of cost or net realizable value using the first-in, first-out inventory costing method. Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory are recorded primarily based on the Company's forecast of future demand and market conditions. Significant unanticipated changes to the Company's forecasts could require a change in the provision for excess or obsolete inventory.
Property, plant and equipment
Property, plant and equipment are carried at the cost of acquisition or construction and depreciated over the estimated useful lives of the assets. Depreciation and amortization are provided using the straight-line method in amounts sufficient to amortize the cost of the assets over their estimated useful lives (buildings and improvements-generally five to 40 years; machinery and equipment-generally two to 15 years).
Intangible assets
Indefinite life intangible assets are comprised of tradenames, while finite life
intangible assets are comprised of technology, customer lists, and tradenames.
Finite life intangible assets are amortized on a straight line or accelerated
basis over their estimated useful lives of seven to 10 years for technology,
five to 20 years for customer lists, and 10 years for tradenames.
36
--------------------------------------------------------------------------------Long-lived assets
Property, plant and equipment and finite life intangible assets are reviewed whenever events or changes in circumstances occur that indicate possible impairment. If events or changes in circumstances occur that indicate possible impairment, our impairment review is based on an undiscounted cash flow analysis at the lowest level at which cash flows of the long-lived assets are largely independent of other groups of our assets and liabilities. This analysis requires management judgment with respect to changes in technology, the continued success of product lines, and future volume, revenue and expense growth rates. We conduct annual reviews for idle and underutilized equipment, and review business plans for possible impairment. Impairment occurs when the carrying value of the assets exceeds the future undiscounted cash flows expected to be earned by the use of the asset or asset group. When impairment is indicated, the estimated future cash flows are then discounted to determine the estimated fair value of the asset or asset group and an impairment charge is recorded for the difference between the carrying value and the estimated fair value.
Additionally, we also evaluate the remaining useful life each reporting period to determine whether events and circumstances warrant a revision to the remaining period of depreciation or amortization. If the estimate of a long-lived asset's remaining useful life is changed, the remaining carrying amount of the asset is amortized prospectively over that revised remaining useful life.
The Company completes an annual (or more often if circumstances require) impairment assessment of its indefinite life intangible assets. As a part of its annual assessment, typically, the Company first qualitatively assesses whether current events or changes in circumstances lead to a determination that it is more likely than not (defined as a likelihood of more than 50 percent) that the fair value of an asset is less than its carrying amount. If there is a qualitative determination that the fair value of a particular asset is more likely than not greater than its carrying value, we do not need to proceed to the quantitative estimated fair value test for that asset. If this qualitative assessment indicates a more likely than not potential that the asset may be impaired, the estimated fair value is determined by the relief from royalty method. If the estimated fair value of an asset is less than its carrying value, an impairment charge is recorded for the amount by which the carrying value of the asset exceeds its estimated fair value. During 2020 and 2019, our annual impairment test indicated that one and zero, respectively, of our indefinite-lived tradenames was impaired. Accordingly, we recognized impairment charges in our financial results of$0.9 million and zero for the years endedDecember 31, 2020 and 2019, respectively. For additional information on impairment testing results, see Note 6 to the Consolidated Financial Statements.
The Company completes an annual (or more often if circumstances require) goodwill impairment assessment onOctober 1 on a reporting unit level, at or below the operating segment level. As a part of its annual assessment, the Company first qualitatively assesses whether current events or changes in circumstances lead to a determination that it is more likely than not (defined as a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If there is a qualitative determination that the fair value of a particular reporting unit is more likely than not greater than its carrying value, the Company does not need to quantitatively test for goodwill impairment for that reporting unit. If this qualitative assessment indicates a more likely than not potential that the asset may be impaired, the estimated fair value is calculated using a weighting of the income method and the market method. If the estimated fair value of a reporting unit is less than its carrying value, an impairment charge is recorded. The Company bases its measurement of the fair value of a reporting unit using a 50/50 weighting of the income method and the market method. The income method is based on a discounted future cash flow approach that uses the significant assumptions of projected revenue, projected operational profit, terminal growth rates, and the cost of capital. Projected revenue, projected operational profit and terminal growth rates are significant assumptions because they are three primary drivers of the projected cash flows in the discounted future cash flow approach. Cost of capital is a significant assumption as it is the discount rate used to calculate the current fair value of those projected cash flows. The market method is based on financial multiples of comparable companies and applies a control premium. Significant estimates in the market approach include identifying similar companies with comparable business factors such as size, growth, profitability, risk and return on investment and assessing comparable revenue and operating income multiples in estimating the fair value of a reporting unit. Based on the analysis, the resultant estimated fair value of all of the reporting units exceeded their carrying value as ofDecember 31, 2020 . For additional information on goodwill impairment testing results, see Note 7 to the Consolidated Financial Statements.
Income Taxes
Income taxes are determined using the asset and liability method of accounting for income taxes in accordance withFinancial Accounting Standards Board ("FASB"), Accounting Standards Codification ("ASC") Topic 740, "Income Taxes". Income tax expense includes federal, state and foreign income taxes. 37 -------------------------------------------------------------------------------- Deferred income taxes are provided using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases and are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Tax credits and other incentives reduce income tax expense in the year the credits are claimed. Management must assess the need to accrue or disclose uncertain tax positions for proposed potential adjustments from various federal, state and foreign tax authorities who regularly audit the Company in the normal course of business. In making these assessments, management must often analyze complex tax laws of multiple jurisdictions, including many foreign jurisdictions. The accounting guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company records the related interest expense and penalties, if any, as tax expense in the tax provision. Management must assess the realizability of the Company's deferred tax assets. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carry forward periods), projected future taxable income, and tax-planning strategies in making this assessment. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The company has made an accounting policy election to record theU.S. income tax effect of future global intangible low-taxed income ("GILTI") inclusions in the period in which they arise, rather than establishing deferred taxes with respect to the expected future tax liabilities associated with future GILTI inclusion. Certain of the Company's undistributed earnings of its foreign subsidiaries are not permanently reinvested. A liability has been recorded for the deferred taxes on such undistributed foreign earnings. The amount is attributable primarily to the foreign withholding taxes that would become payable should the Company repatriate cash held in its foreign operations.
Pension Benefit Plan Assumptions
We sponsor a pension plan for certain employees. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense and liability related to the plan. These factors include key assumptions, such as a discount rate and expected return on plan assets. In addition, our actuarial consultants use subjective factors such as withdrawal and mortality rates to estimate the liability. The actuarial assumptions we use may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in a significant impact to the amount of pension expense we have recorded or may record in the future. An analysis for the expense associated with our pension plan is difficult due to the variety of assumptions utilized. For example, one of the significant assumptions used to determine projected benefit obligation is the discount rate. AtDecember 31, 2020 , a 25 basis point change in the discount rate would change the projected benefit obligation by approximately$1.1 million and the annual pension expense by approximately$16,000 . Additionally, a 25 basis point change in the expected return on plan assets would change the pension expense by approximately$69,000 .
Share-Based Compensation
We measure the cost of employee services received in exchange for an award of equity instruments and recognize this cost over the period during which an employee is required to provide the services, based on the fair value of the award at the date of the grant as determined by the Black-Scholes valuation method for stock options, or current publicly traded market price on the grant date for restricted stock units. Certain of our awards of restricted share units include performance conditions for achieving designated levels of operating performance. We must estimate the probability of achieving the performance condition at each reporting period.
Product Warranties
The Company's warranty reserve is to cover the products sold. The warranty accrual is based on historical claims information. The warranty reserve is reviewed and adjusted as necessary at each reporting period.
38
--------------------------------------------------------------------------------Other significant accounting policies
Other significant accounting policies, not involving the same level of uncertainties as those discussed above, are nevertheless important to an understanding of our financial statements. See Note 1 to the Consolidated Financial Statements, Summary of Significant Accounting Policies, which discusses accounting policies that must be selected by us when there are acceptable alternatives.
New Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 1 to the Consolidated Financial Statements included in this annual report on Form 10-K.
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