Federal Signal Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; comparative periods are the corresponding 2012 periods. Amounts are in U.S. dollars.
Business context
Federal Signal manufactures environmental vehicles and equipment, safety and security systems, and aerial platforms for fire rescue and industrial uses. It sells globally to municipal, governmental, industrial, and commercial customers. The former Federal Signal Technologies (FSTech) business is reported as discontinued operations following its 2012 sale.
Financial results and liquidity
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $209.3M | $185.0M | $631.7M | $585.5M |
| Gross profit | $50.5M | $45.6M | $149.1M | $140.1M |
| Operating income | $18.8M | $12.4M | $49.1M | $38.5M |
| Operating margin | 9.0% | 6.7% | 7.8% | 6.6% |
| Income from continuing operations | $16.8M | $4.4M | $133.5M | $17.2M |
| Net income (loss) | $16.0M | ($14.7M) | $132.9M | ($32.2M) |
| Diluted EPS from continuing operations | $0.26 | $0.07 | $2.12 | $0.28 |
Cash flow: Nine-month operating cash flow was $32.2M, versus cash used of $2.3M in 2012. Continuing-operations operating cash flow was $37.3M, partly offset by $5.1M used by discontinued operations. Capital expenditures were $13.7M. Cash and cash equivalents were $20.9M at September 30, down from $29.7M at December 31, 2012.
Debt and liquidity: Total borrowings and capital lease obligations were $127.5M, including $6.5M current; long-term debt and leases, net of current maturities, were $121.0M. The company had $52.5M drawn on its revolving facility, $29.1M of letters of credit, and $68.4M of net revolver availability. It reported compliance with debt covenants. Trailing-12-month total debt to adjusted EBITDA was 1.7x, compared with 2.5x a year earlier. The company also reported $77.0M of long-term pension and other postretirement liabilities.
Material changes and drivers
- Q3 sales rose $24.3M year over year; nine-month sales rose $46.2M. Growth was led by Environmental Solutions, supported by higher shipments of vacuum trucks and sewer cleaners, increased capacity, and improved pricing. Fire Rescue sales also increased, helped by Middle East and European demand, U.S. industrial sales, and favorable currency.
- Operating income improved in both periods, with Environmental Solutions and Fire Rescue gains partly offset by lower Safety and Security Systems income. The latter faced ERP implementation costs and inefficiencies, higher IT and engineering costs, product-mix pressure, and lower fixed-overhead absorption.
- Interest expense declined to $1.5M from $5.2M in Q3 and to $7.7M from $15.7M for the nine months, reflecting lower debt balances and refinancing. The March 2013 refinancing generated $8.7M of nine-month debt-settlement charges, including a $4.2M prepayment penalty and a $4.5M write-off of old financing costs.
- Nine-month net income includes a $100.7M income-tax benefit. In Q2, the company released $102.4M of its valuation allowance on U.S. deferred tax assets after concluding a significant portion was more likely than not to be realized. The unusually high reported nine-month earnings therefore are not solely indicative of operating performance.
- Q3 gross margin was 24.1%, down from 24.6%; nine-month gross margin was 23.6%, down from 23.9%. Backlog was $286.5M, versus $325.9M a year earlier; the company attributed much of the reduction to increased production and delivery of previously long-lead vehicles and lower Fire Rescue orders.
Outlook, risks, and unusual items
- Management expected 2013 capital expenditures of approximately $15.0M and said operating cash flow and available borrowing capacity should be adequate for operating and capital needs, absent significant unanticipated cash demands. No specific earnings or revenue guidance was provided.
- Orders were mixed: Q3 total orders increased to $197.1M from $187.7M, while nine-month orders declined to $599.0M from $618.3M. Fire Rescue orders and backlog were lower against a strong prior-year Asia-Pacific order cycle; Safety and Security faced weak coal-mining demand and timing-related systems orders.
- Key disclosed risks include cyclical municipal, industrial, government, and commercial markets; customer financing availability; competition and product liability; supply, labor, pension, environmental, and regulatory matters; debt covenants; and realization of deferred tax assets.
- Firefighter hearing-loss litigation remained ongoing, including challenges to class certification and new Pennsylvania claims. The company said outcomes and potential losses may be difficult to estimate, but believed the matters would not have a material adverse effect based on current information. Neology patent litigation and the related ITC investigation were settled and dismissed in 2013.
- The company retained environmental remediation and product-liability obligations from discontinued businesses. The Pearland remediation reserve was $1.4M; management did not expect the cost to materially adversely affect results, financial position, or liquidity.
Most important facts for investors to verify
- How much of the reported nine-month earnings improvement is attributable to the $102.4M deferred-tax valuation-allowance release versus recurring operating performance.
- Whether growth and margins in Environmental Solutions and Fire Rescue can continue as production normalizes and backlog declines.
- Safety and Security Systems’ recovery from ERP-related disruption, cost pressures, and weak mining demand.
- Revolver availability, covenant headroom, debt amortization, and the effect of variable-rate borrowing despite the $75.0M interest-rate swap.
- Developments in firefighter litigation and the ultimate cost of retained discontinued-operation environmental and product-liability obligations.