FEDERAL SIGNAL CORP quarterly report, Q3 FY2018

Federal Signal Corporation — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Federal Signal manufactures environmental and infrastructure vehicles and equipment, and safety, security and communications products. Its reportable segments are Environmental Solutions and Safety and Security Systems. The TBEI acquisition, completed in June 2017, affects year-to-date comparisons.

Financial performance

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Net sales	$269.4 million	$248.7 million	$810.1 million	$650.9 million
Gross profit / margin	$69.0 million / 25.6%	$61.3 million / 24.6%	$210.1 million / 25.9%	$159.6 million / 24.5%
Operating income / margin	$30.4 million / 11.3%	$22.3 million / 9.0%	$88.1 million / 10.9%	$52.5 million / 8.1%
Net income	$21.7 million	$12.5 million	$61.5 million	$31.2 million
Diluted EPS	$0.36	$0.21	$1.01	$0.52

Q3 sales increased 8% and operating income rose 36%. Nine-month sales increased 24% and operating income rose $35.6 million. Nine-month Environmental Solutions sales included $94.1 million of incremental TBEI revenue due principally to five additional months of consolidation versus 2017; TBEI contributed $9.5 million of incremental operating income. Higher volume, improved operating leverage, pricing and favorable mix supported margins, partly offset by higher material costs and depreciation.

Cash flow and liquidity: Continuing operating cash flow was $71.9 million for the first nine months, versus $52.1 million in 2017. Capital expenditures were $10.1 million, compared with $5.3 million. The company used $53.6 million to reduce revolving-credit borrowings and paid $13.8 million in dividends. Cash was $35.0 million at September 30, including $20.9 million held by foreign subsidiaries.

Debt: Long-term borrowings and capital lease obligations totaled $222.2 million, including $221.4 million drawn on the revolving credit agreement, down from $277.7 million at December 31, 2017. Net borrowing availability was $166.3 million; the company was in compliance with its financial covenants. A $150 million interest-rate swap fixes the floating-rate component on that amount of debt through June 2020.

Changes, orders and segment results

Q3 Environmental Solutions sales rose 9% to $216.3 million and operating income increased to $28.3 million from $21.2 million. Growth reflected vacuum trucks, sewer cleaners, dump truck bodies and aftermarket activity; lower refuse-truck sales partly offset gains.
Q3 Safety and Security Systems sales rose 6% to $53.1 million and operating income rose to $8.0 million from $6.1 million, supported by public-safety products and international warning systems.
Orders were $268.1 million in Q3, up 17%; nine-month orders were $875.4 million, up 22%. Backlog reached $320.6 million, 57% above September 2017, driven mainly by vacuum-truck and sewer-cleaner demand.
Topic 606 adoption reduced reported 2018 sales by $3.5 million in Q3 and $11.0 million year to date, with an equal reduction in cost of sales and no gross-profit impact. Comparative periods were not restated.
Interest expense fell $0.5 million in Q3 due to lower average debt, but increased $2.6 million year to date versus 2017, reflecting higher average debt following the TBEI acquisition.

Outlook, risks and unusual items

Management expected a full-year effective tax rate of approximately 24% and 2018 capital expenditures of approximately $15 million. The filing does not provide a specific full-year revenue or earnings-per-share forecast.
Management said cash, operating cash flow and available credit were expected to be sufficient for operating needs, investment, debt reduction, dividends and potential acquisitions, absent significant unexpected cash demands.
The 2017 Tax Act’s effects remained subject to provisional estimates; the company was still evaluating its accounting policy for GILTI. The company estimated no transition tax based on an overall accumulated foreign earnings-and-profits deficit.
Firefighter hearing-loss litigation remains a material matter to monitor. A settlement framework covering eligible claimants in most jurisdictions contemplated payments of $700 per eligible claimant with a filed suit and $300 per eligible claimant without one. The company had accrued an estimated liability; a greater loss was reasonably possible, though incremental loss was not expected to be material. Cook County, Lackawanna County and one New York City case were excluded from the framework.
Other contingencies include product warranties, environmental remediation and product-liability claims. A specific Environmental Solutions warranty estimate could change, but management did not expect its resolution to materially adversely affect results, financial position or cash flow.
The company planned to adopt lease accounting Topic 842 on January 1, 2019. It anticipated recognizing right-of-use assets and lease liabilities and recording the remaining sale-leaseback deferred gain as an adjustment to opening retained earnings.
Management reported no material changes to the risk factors in its 2017 Form 10-K, no significant change in market-risk exposure, and effective disclosure controls as of September 30, 2018.

Important facts for investors to verify

How much of continued sales, order and backlog growth is organic, and how durable is demand for vacuum trucks and sewer cleaners?
Whether the company can sustain margin gains amid higher material costs, depreciation, and integration-related expenses.
Debt, interest costs, covenant headroom and the use of the remaining $166.3 million credit availability.
The final accrual, claimant eligibility and outcome of the hearing-loss settlement framework, including excluded jurisdictions.
Final Tax Act estimates and the balance-sheet and retained-earnings effects of Topic 842 adoption.
Whether the approximate 24% tax-rate expectation and $15 million capital-spending estimate remain consistent with subsequent results.