Business context and reporting period
Federal Signal Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. It makes environmental-maintenance vehicles and equipment, and safety, security and communications products. Its reportable segments are Environmental Solutions and Safety and Security Systems. Comparisons are affected by the 2017 acquisition of TBEI, which contributed more months of activity in 2018 than in the prior-year periods.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $291.0 million | $224.4 million | $540.7 million | $402.2 million |
| Gross profit | $79.2 million | $54.7 million | $141.1 million | $98.3 million |
| Operating income | $38.1 million | $18.8 million | $57.7 million | $30.2 million |
| Net income | $26.9 million | $11.4 million | $39.8 million | $18.7 million |
| Diluted EPS | $0.44 | $0.19 | $0.65 | $0.31 |
| Operating margin | 13.1% | 8.4% | 10.7% | 7.5% |
Gross margin was 27.2% in Q2 versus 24.4%, and 26.1% for the first half versus 24.4%. Management cited higher volumes, improved operating leverage, sales mix and actions addressing commodity-cost increases. The effective tax rate fell to 23.6% for Q2 and 23.8% for the half, from 34.7% and 34.6%, respectively, reflecting the lower U.S. corporate tax rate and a $0.5 million excess stock-compensation tax benefit.
First-half operating cash flow was $37.8 million, down from $45.8 million. Higher earnings were offset by increased tax payments, working-capital and rental-asset investment, and higher incentive compensation payments. Capital expenditures were $7.0 million. Cash was $36.0 million at June 30, versus $37.5 million at year-end.
Long-term borrowings and capital lease obligations totaled $248.1 million, compared with $277.7 million at December 31, 2017; net debt was approximately $212.1 million after cash. The company had $140.3 million of net availability under its $400 million revolving facility and was in compliance with its financial covenants. Current assets were $325.0 million and current liabilities $151.2 million. Dividends paid in the first half were $9.0 million; the quarterly dividend was increased from $0.07 to $0.08 per share.
Material changes versus prior period
- Q2 sales rose 30% and first-half sales rose 34%. Environmental Solutions accounted for most of the growth, including TBEI incremental sales of $39.4 million in Q2 and $90.7 million in the first half, as well as stronger vacuum-truck, sewer-cleaner, sweeper, rental and parts activity. Refuse-truck sales declined.
- Safety and Security Systems sales increased 15% in Q2 and 11% in the first half, primarily on public-safety products and, for the half, favorable foreign currency translation.
- Orders were $277.6 million in Q2, up 2%, and $607.3 million in the first half, up 25%. Backlog reached $322.3 million, 45% above June 2017, largely reflecting sewer-cleaner and vacuum-truck demand.
- Interest expense increased $1.2 million in Q2 and $3.1 million in the first half, mainly because of higher average debt following the TBEI acquisition. First-half debt repayments reduced borrowings by $26.6 million net.
Outlook, commentary, risks and unusual items
Management anticipates 2018 capital expenditures of $15 million to $20 million and believes cash, operating cash flow and available credit should fund operating needs and planned uses absent significant unanticipated demands. The filing gives no specific revenue or earnings guidance. Management noted that up to $45 million of orders received in late 2017 and Q1 2018 may have been pulled forward from later in 2018 as customers sought to secure products or chassis with extended lead times. This may affect subsequent order comparisons.
Reported 2018 sales include a Topic 606 principal-versus-agent presentation change that reduced Environmental Solutions revenue by about 1%—$4.3 million in Q2 and $7.5 million in the first half—with an equal reduction in cost of sales and no gross-profit effect. The Tax Act accounting and GILTI treatment remained subject to evaluation; tax estimates were provisional. The company also expected Topic 842 adoption to add lease right-of-use assets and liabilities and to affect the accounting for deferred sale-leaseback gains.
Contingencies include ongoing firefighter hearing-loss litigation. The company recorded an estimated liability for a potential settlement framework covering eligible claimants in most jurisdictions, but the amount is not stated in the filing text. Management said a loss above the accrual was reasonably possible, though the incremental loss was not expected to be material. Class-certification activity remained pending in Cook County, and the company intended to defend the claims. Other ordinary-course claims were not expected to have a material adverse effect based on current information. The filing reports no material change in risk factors or market-risk exposure.
Important facts for investors to verify
- How much of sales and earnings growth is organic versus attributable to TBEI and the differing acquisition-comparison periods.
- Whether strong backlog and vacuum-truck/sewer-cleaner demand convert to shipments, especially given order pull-forward and weaker refuse-truck activity.
- Working-capital and rental-asset cash needs, tax-payment timing, and the sustainability of operating cash flow.
- Debt, borrowing availability, interest expense and covenant headroom as the company continues to invest and pay dividends.
- The eventual eligible claimant count, final terms and recorded amount for the hearing-loss settlement, and any changes in the related litigation exposure.
- Final Tax Act estimates and the balance-sheet and retained-earnings effects of lease-standard adoption.