Federal Signal Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Federal Signal manufactures environmental vehicles and equipment and safety, security and communications products. Results include TBEI only from its June 2, 2017 acquisition date.
Financial performance
- Q2 revenue: $224.4 million, up 30% from $172.3 million. Environmental Solutions sales rose 46% to $174.3 million; Safety and Security Systems sales fell 5% to $50.1 million.
- Q2 earnings: Operating income was $18.7 million versus $14.3 million; operating margin was unchanged at 8.3%. Continuing-operations income was $11.5 million versus $9.4 million, and diluted continuing-operations EPS was $0.19 versus $0.15. Net income was $11.4 million versus $9.1 million.
- First-half revenue and earnings: Sales were $402.2 million, up 17%. Operating income was $30.0 million versus $30.4 million; operating margin declined to 7.5% from 8.8%. Continuing-operations income was $18.7 million versus $19.8 million, and diluted EPS was $0.31 versus $0.32. Net income was $18.7 million versus $22.7 million; the prior-year period included a $2.9 million gain from discontinued operations and disposal.
- Margins: Q2 gross margin declined to 24.4% from 26.1%; first-half gross margin declined to 24.4% from 26.8%. Management cited higher depreciation and acquisition purchase-accounting expenses, including acquired rental equipment and TBEI intangible assets.
- Orders and backlog: Q2 orders increased 45% to $271.1 million; first-half orders increased 50% to $485.7 million. Backlog at June 30 was $222.7 million, up 49% year over year, including $39.8 million of TBEI backlog.
- Cash flow: First-half operating cash flow was $45.5 million, versus $5.2 million. Continuing operating cash flow was $45.8 million versus $3.9 million; management attributed improvement partly to working-capital timing, collections and extended payables. Investing cash outflow was $272.9 million, including $269.2 million net cash paid for TBEI. Financing cash inflow was $213.0 million.
- Balance sheet and liquidity: Cash was $37.0 million, down from $50.7 million at year-end 2016. Long-term borrowings and capital lease obligations totaled $289.2 million, compared with $64.0 million at year-end, principally reflecting TBEI financing. The amended revolving facility has $400 million capacity, with $93.4 million net availability at June 30. The company reported compliance with its financial covenants.
- Other metrics: Q2 and first-half dividends declared were $0.07 and $0.14 per share, respectively. The company expected 2017 capital expenditures to be less than $10 million.
Material changes and management commentary
- TBEI was acquired for preliminary consideration of approximately $271.8 million. The company expects it to strengthen its specialty-vehicle position and balance municipal and industrial revenue exposure. TBEI contributed $18.1 million of post-acquisition sales and $0.8 million of operating income in the quarter. Purchase-price allocations remain preliminary; additional integration costs were expected during the rest of 2017.
- JJE, acquired in June 2016, also contributed to year-over-year sales growth because 2017 included a full quarter and first half of operations compared with only one month in the comparable 2016 periods.
- Environmental Solutions growth reflected acquisitions and stronger orders and shipments for sewer cleaners and vacuum trucks. Street-sweeper shipments were lower, particularly in the first half. Safety and Security Systems sales declined, primarily due to lower public-safety market sales; management cited strategic product-development investment and cost-reduction initiatives.
- Management expected substantially all June 30 backlog to be produced during the remainder of 2017. Backlog is not a guarantee of future sales, and seasonality can affect quarterly results.
- The company expected adoption of the new revenue-recognition standard in 2018 to have no material financial impact based on work completed to date, with expanded disclosures expected to be the primary effect.
Risks, contingencies and unusual items
- Federal Signal faces ongoing firefighter hearing-loss product litigation in multiple jurisdictions. The company said it intends to defend the claims; the ultimate outcome and potential losses may be difficult to estimate. Certain class-certification and venue issues remained pending, with a Pittsburgh trial scheduled for September 2017.
- Other ordinary-course legal claims could have a material adverse effect if developments are unfavorable. A Latvian commercial dispute related to the former Bronto business was settled during the first half of 2017 after a prior-year charge.
- Outstanding letters of credit and bonds totaled $21.7 million; management considered calls remote. Equipment repurchase guarantees carried maximum potential payments of $4.1 million, partially mitigated by the value of the equipment.
- The company entered a $150 million interest-rate swap to fix the floating-rate component on part of its variable-rate debt. It estimated a 100-basis-point rate movement would change second-half 2017 interest expense by approximately $0.7 million at current debt levels.
- Disclosure controls were judged effective as of June 30, 2017. Management had not yet fully assessed TBEI’s internal controls over financial reporting.
Important facts for investors to verify
- How much of sales, orders and backlog growth reflects organic demand versus TBEI and JJE acquisitions, and whether acquired businesses meet expected returns.
- Whether margin pressure from purchase accounting, depreciation, and integration costs eases as acquisitions are integrated.
- Debt reduction, borrowing availability, covenant headroom and interest costs following the TBEI acquisition.
- Developments in hearing-loss litigation and other contingencies, including any change in potential exposure or insurance recoveries.
- Final TBEI purchase-price allocation and working-capital adjustment, and the realized timing and conversion of backlog into revenue and cash flow.