Federal Signal Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Federal Signal manufactures environmental-service vehicles and equipment and safety, security and communications products. Its reportable segments are Environmental Solutions and Safety and Security Systems.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $249.7 million | $177.8 million | Up 40% |
| Gross profit / margin | $61.9 million / 24.8% | $43.6 million / 24.5% | Margin up 0.3 percentage points |
| Operating income / margin | $19.6 million / 7.8% | $11.4 million / 6.4% | Income up 72%; margin up 1.4 points |
| Income from continuing operations | $12.9 million | $7.2 million | Up $5.7 million |
| Net income | $12.9 million | $7.3 million | Up $5.6 million |
| Diluted EPS from continuing operations | $0.21 | $0.12 | Up $0.09 |
| Operating cash flow | $10.3 million | $13.7 million | Down $3.4 million |
Income tax expense was $4.1 million, with a 24.1% effective tax rate, versus $3.8 million and 34.5% a year earlier. The lower rate principally reflects the reduced U.S. federal corporate tax rate under the 2017 Tax Act; the current-quarter rate also included a nominal discrete benefit from releasing tax reserves.
Segments, orders and backlog
- Environmental Solutions: Sales of $196.6 million, up 54%; operating income of $20.6 million, up $10.3 million; operating margin of 10.5%, versus 8.1%. Growth reflected the TBEI acquisition and higher U.S. sewer-cleaner and vacuum-truck shipments.
- Safety and Security Systems: Sales of $53.1 million, up 6%; operating income of $6.1 million, down $0.3 million; operating margin of 11.5%, versus 12.8%. Higher sales were offset by lower gross margin, unfavorable mix and currency effects.
- Total orders were $329.7 million, up 54%. Management reported Environmental Solutions organic order growth of approximately 27%, alongside acquired TBEI orders.
- Backlog was $336.7 million, up 94% from $174.0 million at March 31, 2017, including $54.8 million of TBEI backlog.
Financial position and liquidity
- Cash and cash equivalents were $35.4 million at March 31, 2018, versus $37.5 million at December 31, 2017. Current assets were $321.2 million and current liabilities $131.2 million.
- Long-term borrowings and capital lease obligations totaled $267.3 million, including $266.5 million drawn under the revolving credit agreement. Debt declined from $277.7 million at year-end.
- The company had $120.8 million of net availability under its $400 million revolving facility and was in compliance with its financial covenants. It also reported $12.7 million of undrawn letters of credit.
- Operating cash flow was $10.3 million; capital expenditures were $3.0 million. Investing activities provided $0.1 million, including $3.0 million received from final TBEI post-closing adjustments. Financing activities used $12.7 million, including $8.6 million of net debt repayment and $4.2 million of dividends. Cash declined by $2.1 million during the quarter.
- Quarterly dividends declared were $0.07 per share. On May 1, the board declared a subsequent-quarter dividend of $0.08 per share.
Material changes and unusual items
- TBEI, acquired in June 2017, contributed $51.3 million of current-quarter sales and $4.8 million of operating income. Acquisition-related intangible amortization contributed to higher depreciation and amortization.
- Interest expense rose $1.9 million to $2.5 million, primarily due to higher average debt following the TBEI acquisition.
- Operating cash flow fell despite higher earnings, largely because of increased incentive-compensation payments and a larger use of cash from changes in operating assets and liabilities.
- Adoption of Topic 606 reduced reported Environmental Solutions sales by approximately $3.2 million through a gross-to-net presentation change; cost of sales declined by the same amount, with no gross-profit impact. The adoption was not material to the company’s financial position, results or cash flows.
- First-quarter results may not indicate full-year performance; the company says sales are generally lower in the first calendar quarter due to seasonality.
Outlook, risks and contingencies
- The filing provides no specific earnings or sales guidance. Management expects 2018 capital expenditures of $15 million to $20 million and says cash, operating cash flow and available borrowing capacity should fund expected needs absent significant unanticipated demands. The company also remains interested in strategic acquisitions.
- Hearing-loss litigation remains a material matter to monitor. In March 2018, the company and plaintiffs agreed in principle on a settlement framework outside Cook County and one New York case: generally $700 per eligible firefighter who filed suit and $300 per eligible firefighter who did not, subject to proof of qualifying hearing loss. Approximately 3,700 firefighters could be considered, including about 1,250 who filed suits. The company recorded an estimated liability, but the filing does not provide a clear amount; it said any incremental loss beyond accrual was not expected to be material. Cook County class-certification proceedings continued separately.
- A specific Environmental Solutions warranty liability recorded in 2017 had no significant change in the quarter. Management said the estimate could change as information develops but did not expect the matter to materially adversely affect results, financial position or liquidity.
- The company had $16.7 million of outstanding letters of credit and bonds and potential equipment repurchase payments of $4.8 million in a single year and $6.0 million maximum. Management considered calls on outstanding instruments remote; repurchase exposure is partly mitigated by resale value and potential reimbursement.
- Tax accounting under the 2017 Tax Act remained provisional, including the company’s evaluation of GILTI accounting. Management estimated no transition tax based on an overall accumulated foreign earnings-and-profits deficit.
Most important facts for investors to verify
- How much of sales, earnings, order growth and backlog improvement is sustainable organic growth versus the TBEI acquisition, and whether the strong order intake converts to revenue.
- Whether Environmental Solutions’ margin improvement persists and whether Safety and Security Systems can recover its margin.
- The unreported dollar amount of the accrued hearing-loss settlement liability, participant eligibility and final settlement cost, as well as the outcome of Cook County proceedings.
- Cash conversion and working-capital trends, debt and interest costs, covenant headroom, and the planned $15 million to $20 million of 2018 capital expenditures.
- Any subsequent adjustments to provisional tax estimates and the effect of Topic 606’s presentation change when comparing reported sales.