CECO ENVIRONMENTAL CORP (CECO) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 leading environmentally focused, diversified industrial company, serving the broad landscape of industrial air, industrial water and energy transition markets globally by providing innovative technology and application expertise. We help companies grow their business with safe, clean, and more efficient solutions that help protect people, the environment and industrial equipment. Our 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.
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 portfolio, 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 increase in demand for air quality and water treatment solutions, the energy transition, a shift towards cleaner sources of fuel such as natural gas, hydrogen, nuclear, and renewable sources, and increased awareness of our customers about corporate social responsibility and interest to procure equipment and solutions that protects employees, the environment and their industrial equipment.
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 the largest source of electricity generation. We supply product offerings throughout the entire natural gas value chain and believe expansion will drive growth within our Engineered Systems segment for our gas separation & filtration, pressure products, acoustical equipment , water treatment solutions and DeNOx SCR systems for natural-gas-fired power plants. Increases in global natural gas, installed miles of new pipeline, including future CO2 and hydrogen pipelines, and liquified natural gas ("LNG") demand and supply all stand to drive the need for our products.
We also believe there is a growing demand to control and reduce air and water emissions from industrial facilities for which our pollution control equipment will serve. In 2021, the US Congress passed the Infrastructure Investment and Jobs Act with $550 billion of new federal spending aimed at rebuilding roads and bridges, climate resilience, and other environmental initiatives. Similar investments are being made in many other countries in which we do business. As industrial capital expenditures grow, corporations are seeking to do so with a smaller environmental impact. These regulatory and economic tailwinds coupled with shareholder pressure on companies to improve their sustainability and reduce their global carbon footprint serve as catalysts for a growing set of opportunities for our portfolio of equipment and solutions.
We continue to focus on increasing revenues and profitability in developing markets, where environmental awareness and associated regulatory standards are increasing, while continuing to strengthen and expand our product offerings and channels in our domestic market of the United States. Our enterprise strategy consists of a combined operational strategy and capital allocation strategy.
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Our operational strategy is implemented through our technology and application-based platforms aligned around target customers and end markets where our solutions are particularly valuable. Core elements of our operational strategy are commercial and operational excellence, margin expansion, recurring revenue growth, cash flow generation, product management, and project management execution.
Our capital allocation strategy supports the growth and value creation generated by our operational strategy. We will focus our capital deployment on building out our leading industrial air solutions portfolio, advancing our emerging industrial water treatment position, and supporting our customers as they make the transition to cleaner more sustainable forms of energy, while also shifting our portfolio mix towards businesses with more recurring revenue and more predictable cash flows, strong secular growth trends and less cyclicality.
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 shortages of raw materials and inflationary pressures for certain materials and labor. We have secured raw materials from existing and alternate suppliers and have taken other mitigating actions to mitigate supply disruptions; however, 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.
Operations Overview
We operate our segments and the underlying platforms serving their respective niche end markets. Our platforms are structured to win in their target markets with a core focus on understanding customer needs and providing best-in-class solutions. Our business model provides 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. For our project-based platforms, we leverage third-party subcontract fabrication partners in a global network to execute for our customers world-wide. Our platforms are focused on sales, application engineering, product management, project management, and supply chain execution for our customers.
Our operations management team has distinct industry expertise coupled with strong leadership skills resulting in a customer-first mindset across the business. Our operations management team works closely with our Chief Executive Officer on global fulfillment strategies, operational excellence, resource allocation, and employee development.
Within our segments we have monthly business reviews to ensure we are serving customers, achieving our operating plan, and executing on strategic growth initiatives. These reviews include, but are not limited to pipeline reviews, quotation reviews, project management reviews, financial performance, manufacturing scorecards, safety, and customer feedback. In these reviews we focus on metrics such as quality, customer satisfaction, on-time-delivery, lead-times, price, inflation, project margins, backlog, and above all, safety.
In support of the segments, centralized teams provide back-office functions for scale, efficiency, and compliance. These key functions include: accounting, treasury, tax, payroll, human resources and total rewards management, legal, information technology, marketing, and internal control over financial reporting. We have excellent collaboration between our platforms and our centralized service teams ensuring optimal efficiency and alignment on growth and improvement initiatives.
Our reportable segments are:
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Engineered Systems segment: Our Engineered Systems segment serves the power generation, hydrocarbon processing, water/wastewater treatment, oily water separation and treatment, marine and naval vessels, and midstream oil and gas sectors. We seek to address the global demand for environmental and equipment protection solutions with our highly engineered platforms including emissions management, fluid bed cyclones, thermal acoustics, separation and filtration, and dampers and expansion joints.
•
Industrial Process Solutions segment: Our Industrial Process Solutions segment serves the broad industrial sector with solutions for air pollution and contamination control, fluid handling, and process filtration in applications such as aluminum beverage can production, automobile production, food and beverage processing, semiconductor fabrication, electronics production, steel and aluminum mill processing, wood manufacturing, desalination, and aquaculture markets. We assist customers in maintaining clean and safe operations for employees, reducing energy consumption, minimizing waste for customers, and meeting regulatory standards for toxic emissions, fumes, volatile organic compounds, and odor elimination through our platforms including duct fabrication and installation, industrial air, and fluid handling.
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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, as follows:
•
Subcontracts—Electrical work, concrete work, subcomponents and other subcontracts necessary to produce our products;
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Labor—Our direct labor both in the shop and in the field;
•
Material—Raw materials that we buy to build our products;
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Equipment—Fans, motors, control panels and other equipment necessary for turnkey systems; and
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Factory overhead—Costs of facilities and supervision wages necessary to produce our products.
In general, subcontracts are the highest percentage of costs and also the most flexible followed by labor, material, and equipment. Due to the project nature and global orientation of several of our platforms, leveraging subcontract fabrication partners close to our customers increases our ability to meet customer delivery expectations at market competitive pricing. In periods where orders are infrequent, we do not have to maintain the fixed cost of a manufacturing plant. Across our various product lines, the relative relationships of these cost categories change and cause variations in gross margin percentage. Material and labor costs can increase quickly, 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. An advantage of our operating model is that as revenue grows, we have significant operating leverage on our fixed selling and administrative cost structure.
Note Regarding Use of Non-GAAP Financial Measures
The Company’s 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 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, 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 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, 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 generated substantial income associated with acquisitions. 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.
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Results of Operations
Consolidated Results
Our consolidated statements of income for the years ended December 31, 2023, 2022 and 2021 are as follows:
| Year ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in millions) | 2023 | 2022 | 2021 | |||||||||
| Net sales | $ | 544.8 | $ | 422.6 | $ | 324.1 | ||||||
| Cost of goods sold | 373.8 | 294.4 | 223.2 | |||||||||
| Gross profit | $ | 171.0 | $ | 128.2 | $ | 100.9 | ||||||
| Percent of sales | 31.4 | % | 30.3 | % | 31.1 | % | ||||||
| Selling and administrative expenses | $ | 122.9 | $ | 93.4 | $ | 81.8 | ||||||
| Percent of sales | 22.6 | % | 22.1 | % | 25.2 | % | ||||||
| Amortization and earnout expenses | 8.2 | 6.8 | 7.8 | |||||||||
| Acquisition and integration expenses | 2.5 | 4.5 | 0.8 | |||||||||
| Executive transition expenses | 1.5 | 1.2 | — | |||||||||
| Restructuring expenses | 1.3 | 0.1 | 0.6 | |||||||||
| Operating income | $ | 34.6 | $ | 22.2 | $ | 9.9 | ||||||
| Percent of sales | 6.4 | % | 5.3 | % | 3.1 | % | ||||||
| Other income (expense), net | $ | 0.4 | $ | 6.9 | $ | (2.2 | ) | |||||
| Interest expense | (13.4 | ) | (5.4 | ) | (3.0 | ) | ||||||
| Income before income taxes | $ | 21.5 | $ | 23.7 | $ | 4.7 | ||||||
| Income tax expense | 7.0 | 5.4 | 2.7 | |||||||||
| Net income | $ | 14.5 | $ | 18.3 | $ | 2.0 | ||||||
| Noncontrolling interest | (1.6 | ) | (0.8 | ) | (0.6 | ) | ||||||
| Net income attributable to CECO Environmental Corp. | $ | 12.9 | $ | 17.4 | $ | 1.4 |
Non-GAAP Measures
To compare operating performance between the years ended December 31, 2023, 2022 and 2021 the Company has adjusted GAAP operating income to exclude (1) amortization of intangible assets, and earnout 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 the Company's former executives, fees and expenses incurred in the search, for and hiring, of new executives and (5) 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 to non-GAAP net income.
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in millions) | 2023 | 2022 | 2021 | |||||||||
| Operating income as reported in accordance with GAAP | $ | 34.6 | $ | 22.2 | $ | 9.9 | ||||||
| Operating margin in accordance with GAAP | 6.4 | % | 5.3 | % | 3.1 | % | ||||||
| Amortization and earnout expenses | 8.2 | 6.8 | 7.8 | |||||||||
| Acquisition and integration expenses | 2.5 | 4.5 | 0.8 | |||||||||
| Executive transition expenses | 1.5 | 1.2 | — | |||||||||
| Restructuring expenses | 1.3 | 0.1 | 0.6 | |||||||||
| Non-GAAP operating income | $ | 48.1 | $ | 34.8 | $ | 19.1 | ||||||
| Non-GAAP operating margin | 8.8 | % | 8.2 | % | 5.9 | % |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in millions) | 2023 | 2022 | 2021 | |||||||||
| Net income as reported in accordance with GAAP | $ | 12.9 | $ | 17.4 | $ | 1.4 | ||||||
| Amortization and earnout expenses | 8.2 | 6.8 | 7.8 | |||||||||
| Acquisition and integration expenses | 2.5 | 4.5 | 0.8 | |||||||||
| Executive transition expenses | 1.5 | 1.2 | — | |||||||||
| Restructuring expenses | 1.3 | 0.1 | 0.6 | |||||||||
| Foreign currency remeasurement | (1.0 | ) | (1.3 | ) | 2.0 | |||||||
| Tax (benefit) expense of adjustments | 1.2 | (2.8 | ) | (2.8 | ) | |||||||
| Non-GAAP net income | $ | 26.6 | $ | 25.9 | $ | 9.8 | ||||||
| Non-GAAP net income as a percentage of sales | 4.9 | % | 6.1 | % | 3.0 | % |
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Comparison of the years ended December 31, 2023 and 2022
Consolidated net sales in 2023 were $544.8 million compared with $422.6 million in 2022, an increase of $122.2 million or 28.9%. The increase was led by increases of $88.2 million in our separation, filtration and industrial water businesses and $21.2 million in our thermal acoustics technologies. Approximately 58.2%, or $71.1 million, of the increase in net sales is attributable to organic revenue growth, defined as revenue recorded subsequent to the twelve-month period post-acquisition date, while $51.1 million is attributable to acquisitions that have occurred during the preceding twelve-month period.
Gross profit increased by $42.8 million, or 33.4%, to $171.0 million in 2023 compared with $128.2 million in 2022. The increase in gross profit was primarily attributable to the increase in sales volume as described above. Gross profit as a percentage of sales increased to 31.4% in 2023 compared with 30.3% in 2022 due to higher project margin mix executed during the year and price increases. We continue to experience shortages of raw materials and inflationary pressures for certain materials and labor. We have secured additional raw materials from existing and alternate suppliers and have taken other mitigating actions to mitigate supply disruptions, such as implementing price increases and applying material surcharges, we cannot guarantee that we can continue to do so in the future. In this event, our business, results and financial condition could be adversely affected.
Orders booked were $582.8 million in 2023 compared with $526.6 million in 2022. This $56.2 million increase is primarily attributable to recent acquisitions.
Selling and administrative expenses were $122.9 million in 2023 compared with $93.4 million in 2022. The increase is primarily attributed to acquisitions during 2023, as well as increased investment to support our revenue growth and increased backlog. Selling and administrative expenses as a percentage of sales were flat, with 22.6% in 2023 compared with 22.1% in 2022.
Amortization and earnout expenses were $8.2 million in 2023 and $6.8 million in 2022. The increase in expense is attributable to an increase of $0.9 million in definite lived asset amortization due to recent acquisitions and $0.5 million in earnout expense. See Note 7 to the Consolidated Financial Statements for further discussion on earnout expenses.
Acquisitions and integration expenses related to various merger and acquisition diligence activities, which include legal, accounting and banking expenses, were $2.5 million in 2023, as compared with $4.5 million in 2022. The decrease is due to the timing of acquisition activity. See Note 14 to the Consolidated Financial Statements for further discussion on recent acquisitions.
Executive transition expenses were $1.5 million in 2023 compared to $1.2 million in 2022. These expenses related to fees and other expenses incurred in the search for and hiring of new executives, specifically the Chief Administrative and Legal Officer and Chief Finance and Strategy Officer for 2022 and Chief Operating Officer and Chief Accounting Officer for 2023.
Restructuring expenses were $1.4 million in 2023 compared to $0.1 million in 2022. These expenses related to severance, facility exits, and associated legal expenses, primarily as it relates to the exit of certain operations in China at the end of 2023.
Operating income for 2023 was $34.6 million, an increase of $12.4 million from $22.2 million in 2022. Operating income as a percentage of sales for 2023 was 6.4% compared with 5.3% for 2022. The increase in operating income is primarily attributable to increases in net organic sales and gaining operating leverage.
Non-GAAP operating income was $48.1 million in 2023 and $34.8 million in 2022. The increase in non-GAAP operating income is primarily attributable to the increase in net organic sales and improved operating leverage. Non-GAAP operating income as a percentage of sales for 2023 was 8.8% compared with 8.2% for 2022.
Other income for 2023 was $0.4 million compared to $6.9 million in 2022. The decrease in other income was primarily attributable to net foreign currency transaction losses in the current year based on changes in exchange rates at our foreign subsidiaries.
Interest expense increased to $13.4 million in 2023 from $5.4 million in 2022. The increase in interest expense is primarily due to higher interest rates and increased debt balances to fund acquisitions.
Income tax expense was $7.0 million and $5.4 million in 2023 and 2022, respectively. The effective tax rate for 2023 was 32.6% compared with 22.9% in 2022. Income tax expense and the effective tax rate for 2023 were affected by changes in valuation allowances, and the net impact of global intangible low-taxed income ("GILTI") and foreign-derived intangible income ("FDII"), as well as certain permanent differences including state income taxes, non-deductible incentive stock-based compensation, and differences in tax rates among the jurisdictions in which we operate.
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Comparison of the years ended December 31, 2022 and 2021
See the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2022 for a discussion of our consolidated results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021.
Business Segments
The Company’s operations are organized and reviewed by management along its product lines and end markets that the segment serves and are presented in two reportable segments. The results of the segments are reviewed through the “Income from operations” line on the Consolidated Statements of Income. 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 at the reportable segment level include both intra-segment and inter-segment operating income.
| 2023 | 2022 | 2021 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Sales (less intra-, inter-segment sales) | |||||||||||
| (table only in thousands) | |||||||||||
| Engineered Systems Segment | $ | 380,108 | $ | 263,224 | $ | 186,926 | |||||
| Industrial Process Solutions Segment | 164,737 | 159,403 | 137,214 | ||||||||
| Total net sales | $ | 544,845 | $ | 422,627 | $ | 324,140 |
| 2023 | 2022 | 2021 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Income from Operations | ||||||||||||
| (table only in thousands) | ||||||||||||
| Engineered Systems segment | $ | 59,846 | $ | 36,200 | $ | 25,770 | ||||||
| Industrial Process Solutions segment | 21,630 | 22,705 | 15,054 | |||||||||
| Corporate and Other (1) | (46,907 | ) | (36,744 | ) | (30,967 | ) | ||||||
| Total income from operations | $ | 34,569 | $ | 22,161 | $ | 9,857 |
(1)
Includes corporate compensation, professional services, information technology, and other general, administrative corporate expenses. This figure excludes earnout expenses / income, which are recorded in the segment in which the expense / income occurs.
Comparison of the years ended December 31, 2023 and 2022
Engineered Systems segment
Our Engineered Systems segment net sales increased $116.9 million to $380.1 million in 2023 compared with $263.2 million in 2022, an increase of 44.4%. The increase is broad-based, led by increases of $88.2 million in our separation, filtration and industrial water businesses and $21.2 million in our thermal acoustics technologies. Approximately 56.6%, or $66.2 million, of the increase in net sales is attributable to organic revenue growth, while $50.7 million is attributable to acquisitions that have occurred during the preceding twelve-month period.
Operating income for the Engineered Systems segment increased $23.6 million to $59.8 million for 2023 compared with $36.2 million in 2022, an increase of 65.2%. The increase in operating income in primarily attributable to higher gross profit related to increased sales.
Industrial Process Solutions segment
Our Industrial Process Solutions segment net sales increased $5.3 million to $164.7 million in 2023 compared with $159.4 million in 2022, an increase of 3.3%. The increase is primarily attributable to an increase of $4.7 million in our duct fabrication and installation businesses. Approximately 62.3%, or $3.3 million, of the increase in net sales is attributable to organic revenue growth, while $2.0 million is attributable to acquisitions that have occurred during the preceding twelve-month period.
Operating income was $21.6 million in 2023 compared with $22.7 million in 2022. The decrease is primarily attributable to $1.0 million of restructuring expenses incurred in 2023.
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Corporate and Other segment
Operating expense for the Corporate and Other segment increased $10.2 million to $46.9 million for 2023 compared with $36.7 million for 2022. The increase is primarily attributable to inflationary increases in wages and services, as well as increased headcount in order to support our revenue growth.
Comparison of the years ended December 31, 2022 and 2021
See the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2022 for a discussion of business segment results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021.
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.
At December 31, 2023, the Company had working capital of $78.3 million, compared with $94.0 million at December 31, 2022. The ratio of current assets to current liabilities was 1.39 to 1.00 at December 31, 2023 as compared with a ratio of 1.64 to 1.00 at December 31, 2022.
At December 31, 2023 and 2022, cash and cash equivalents totaled $54.8 million and $45.5 million, respectively. As of December 31, 2023 and 2022, $38.5 million and $31.7 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) | 2023 | 2022 | ||||||
| Outstanding borrowings under Credit Facility 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 | $ | 112,424 | $ | 41,309 | ||||
| – Revolving Credit Loan | 17,300 | 61,300 | ||||||
| Total outstanding borrowings under the Credit Facility | 129,724 | 102,609 | ||||||
| Outstanding borrowings under the joint venture term debt | 8,855 | 10,083 | ||||||
| Unamortized debt discount | (1,296 | ) | (1,488 | ) | ||||
| Total outstanding borrowings | 137,283 | 111,204 | ||||||
| Less: current portion | (10,488 | ) | (3,579 | ) | ||||
| Total debt, less current portion | $ | 126,795 | $ | 107,625 |
In 2023, the Company made repayments of $44.0 million on the revolving credit line and $1.2 million on the joint venture term debt, with net borrowings of $71.1 million on the term loan.
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").
On October 30, 2023, the Company entered into Amendment No. 4 to the Second Amended and Restated Credit Agreement. Pursuant to this amendment, the lenders provided an additional term loan in the aggregate principal amount of $75.0 million.
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). In the third quarter of 2023, the Company entered into an Elevated Ratio Period resulting in a maximum Consolidated Net Leverage Ratio of 4.00 through June 30, 2024, after which time it will decrease to 3.50 until the end of the term of the Credit Facility.
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As of December 31, 2023 and 2022, the Company was in compliance with all related financial and other restrictive covenants under the Credit Facility.
Joint Venture Debt
On March 7, 2022, the Company's Effox-Flextor-Mader, Inc. joint venture ("EFM JV") entered into a loan agreement secured by the assets of the EFM JV in the aggregate principal amount of $11.0 million for the acquisition of General Rubber, LLC ("GRC"), as further described in Note 14 to the Consolidated Financial Statements.
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 $65.0 million from the bilateral lines of credit secured by pledged assets and collateral under the Credit Facility.
See Note 8 to the Consolidated Financial Statements for further information on the Company’s debt facilities.
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, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||
| (dollars in millions) | ||||||||
| Credit Facility, revolving loans | $ | 140.0 | $ | 140.0 | ||||
| Draw down | (17.3 | ) | (61.3 | ) | ||||
| Letters of credit open | (13.3 | ) | (18.9 | ) | ||||
| Total unused credit availability | $ | 109.4 | $ | 59.8 | ||||
| Amount available based on borrowing limitations | $ | 99.8 | $ | 59.8 |
Overview of Cash Flows and Liquidity
| For the year ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | 2023 | 2022 | 2021 | |||||||||
| Total operating cash flow provided by operating activities | $ | 44,647 | $ | 29,649 | $ | 13,298 | ||||||
| Net cash used in investing activities | (56,486 | ) | (48,257 | ) | (2,083 | ) | ||||||
| Net cash provided by (used in) financing activities | 21,144 | 38,176 | (15,556 | ) | ||||||||
| Effect of exchange rate changes on cash and cash equivalents | (442 | ) | (4,978 | ) | (1,475 | ) | ||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 8,863 | $ | 14,590 | $ | (5,816 | ) |
Operating Activities
In 2023, $44.6 million of cash was provided by operating activities compared with $29.6 million provided by operating activities in 2022, an increase of $15.0 million. Cash flow from operating activities in 2023 had a favorable impact year-over-year primarily due to changes in net working capital.
In 2022, $29.6 million of cash was provided by operating activities compared with $13.2 million in 2021, an increase of $16.4 million. Cash flow from operating activities in 2022 had a favorable impact year-over-year primarily due to increases in net earnings, partially offset by increases in net working capital.
Investing Activities
In 2023, $56.5 million of cash was used in investing activities, which consisted of $48.1 for current year acquisitions and $8.4 million for acquisition of property and equipment.
In 2022, $48.3 million of cash was used in investing activities, which consisted of $44.9 for current year acquisitions and $3.4 million for acquisition of property and equipment.
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Financing Activities
Financing activities in 2023 provided cash of $21.1 million, which consisted primarily of $27.1 million of net borrowings under the Credit Facility, used to finance current year acquisitions, as well as $1.4 million of proceeds from employee stock purchase plan and exercise of stock options. This was partially offset by $2.1 million of earnout payments, $1.7 million in distributions to non-controlling interest, $1.2 million of deferred consideration for acquisitions, $0.9 million in payments on our capital leases, and $0.4 million of financing fees.
Financing activities in 2022 provided cash of $38.2 million, which consisted primarily of $39.3 million net borrowings on our revolving credit line and $11.0 million borrowings of joint venture term debt, both of which were used to finance current year acquisitions. These were partially offset by $3.1 million paydown of our term debt, $7.0 million for the repurchase and retirement of our common stock, $1.4 million in distributions to non-controlling interest, and $0.6 million in payments on our capital leases.
Our primary sources of liquidity are cash generated from operations and borrowing availability under the Credit Facility. 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 prevailing economic conditions and to financial, business, regulatory, legislative and other factors, many of which are beyond our control.
Our material cash requirements included (i) debt repayments under with respect to our Credit Facility and joint venture term debt, (ii) interest expense, (iii) purchase obligations for costs associated with uncompleted sales contracts, (iv) operating and capital lease obligations and (v) contingent liabilities related to acquisitions, including earnout liabilities and retention payments.
We are party to many contractual obligations involving commitments to make payments to third parties, and such commitments require a material amount of cash. The following table summarizes the Company’s material cash requirements from known contractual obligations as of December 31, 2023:
| Payments Due by Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
| Term Loan Debt, including joint venture debt | $ | 121,279 | $ | 10,488 | $ | 107,023 | $ | 3,768 | $ | — | |||||||||
| Revolving Credit Loan | 17,300 | — | 17,300 | — | — | ||||||||||||||
| Interest expense (estimated) | 26,825 | 11,154 | 15,344 | 328 | — | ||||||||||||||
| Purchase obligations (1) | 109,957 | 109,957 | — | — | — | ||||||||||||||
| Operating lease obligations | 16,938 | 4,363 | 6,372 | 2,723 | 3,480 | ||||||||||||||
| Capital lease obligations | 6,409 | 925 | 1,905 | 1,983 | 1,596 | ||||||||||||||
| Liabilities related to acquisitions (2) | 3,700 | 1,115 | 2,585 | — | — | ||||||||||||||
| Totals | $ | 302,408 | $ | 138,001 | $ | 150,529 | $ | 8,802 | $ | 5,076 |
(1)
Primarily consists of purchase obligations for costs associated with uncompleted sales contracts.
(2)
Includes notes payable and expected earnout liability.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in conformity with GAAP. Preparation of the consolidated financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses and related contingent liabilities. Critical accounting estimates or assumptions are those where the nature of the estimates or assumptions is material given the level of subjectivity and judgment necessary to account for uncertain matters, and the potential impact of the estimates and assumptions on financial condition or operating performance is material. We consider the estimates discussed below to be critical to the understanding of our financial statements. Actual results may differ from our estimates and assumptions, and any such differences could be material to our consolidated financial statements.
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.
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We recognize revenue as performance obligations are satisfied. A significant amount of our revenue 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 December 31, 2023, 2022 and 2021.
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 our forecast of future demand and market conditions. Significant unanticipated changes to our forecasts could require a change in the provision for excess or obsolete inventory.
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 such events or changes in circumstances occur, 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 also 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 review the remaining useful lives of assets 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 depreciated/amortized prospectively over that revised remaining useful life.
We complete an impairment assessment of the Company's indefinite life intangible assets on an annual basis, or more often as circumstances require. As a part of its annual assessment, we first qualitatively assess 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 2023, 2022, and 2021, our annual impairment test indicated no impairment of our indefinite-lived tradenames. Accordingly, we recognized no impairment charges in our financial results for the years ended December 31, 2023, 2022, and 2021. For additional information on impairment testing results, see Note 6 to the Consolidated Financial Statements.
Goodwill
We complete a goodwill impairment assessment on an annual basis as of October 1, or more often as circumstances require, on a reporting unit level, at or below the operating segment level. As a part of the annual assessment, we first qualitatively assess 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
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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, we do 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.
We base our 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 of December 31, 2023. For additional information on goodwill impairment testing results, see Note 6 to the Consolidated Financial Statements.
Income Taxes
Income taxes are determined using the asset and liability method of accounting for income taxes in accordance with Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) Topic 740, “Income Taxes”. Income tax expense includes federal, state and foreign income taxes.
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. We record 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 the U.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.
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
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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.