Federal Signal Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; unaudited. Federal Signal supplies safety and security systems, fire-rescue aerial platforms, and environmental vehicles and equipment. Results are presented with Federal Signal Technologies (FSTech) classified as a discontinued operation after its sale.
Financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales from continuing operations | $185.0 million | $167.8 million | $585.5 million | $493.7 million |
| Gross profit | $45.6 million | $36.5 million | $140.1 million | $109.7 million |
| Operating income | $12.4 million | $8.5 million | $38.5 million | $21.7 million |
| Operating margin | 6.7% | 5.1% | 6.6% | 4.4% |
| Continuing-operations income | $4.4 million | $3.3 million | $17.2 million | $6.6 million |
| Net income (loss), including discontinued operations | $(14.7) million | $2.4 million | $(32.2) million | $1.0 million |
| Continuing-operations diluted EPS | $0.07 | $0.05 | $0.28 | $0.11 |
| Total diluted EPS | $(0.24) | $0.04 | $(0.51) | $0.02 |
Sales increased about 10% in Q3 and 19% year to date. Management attributed growth primarily to higher shipments, favorable product mix, and modest price increases, partly offset by weaker exports to some Asian customers and unfavorable currency effects. Gross profit and operating income rose in both periods. Orders were $187.7 million in Q3 versus $194.9 million a year earlier, but nine-month orders increased to $618.3 million from $592.0 million. Backlog was $325.9 million at September 30, up $30.7 million from year-end 2011.
- Segment performance: Nine-month sales and operating income increased in Safety and Security Systems ($173.2 million and $18.7 million), Fire Rescue ($90.7 million and $4.4 million), and Environmental Solutions ($321.6 million and $33.8 million). Environmental Solutions generated the largest sales and operating-income gains.
- Cash flow: Continuing operations provided $18.8 million of operating cash in the first nine months, while discontinued operations used $21.1 million; total operating cash flow was therefore negative $2.3 million, versus positive $0.8 million a year earlier. Capital expenditures were $9.2 million. Cash declined $0.4 million to $9.1 million.
- Liquidity and debt: At September 30, cash was $9.1 million and restricted cash was $1.5 million. Borrowings and capital lease obligations totaled $159.9 million, including $2.0 million of short-term borrowings and $157.9 million of long-term borrowings including current portions. The ABL facility had $6.9 million drawn and $31.3 million of letters of credit; reported net borrowing availability is stated as both $24.7 million and $24.8 million in different parts of the filing. The company reported compliance with debt covenants.
- Other balance-sheet items: Total assets were $607.2 million, down from $706.7 million at December 31, 2011; shareholders’ equity was $158.5 million, down from $174.7 million. Inventories increased to $129.5 million from $104.3 million.
Material changes and unusual items
- FSTech divestiture: Sold to 3M on September 4, 2012 for $110.0 million, subject to a $5.9 million working-capital adjustment in the buyer’s favor. Federal Signal received $82.1 million at closing and placed $22.0 million in escrow. The company used $75.0 million of proceeds to repay debt. It recorded a $35.7 million pretax disposal loss for the nine-month period; discontinued operations and disposal produced an after-tax loss of $49.4 million year to date, including operating losses.
- Refinancing and debt costs: In February 2012, Federal Signal entered a $100 million ABL facility and a $215 million term loan, replacing prior facilities and notes. The term loan carries a stated margin of 9%–11%, depending on rate option. Q3 included $1.9 million of debt-settlement charges; year-to-date charges were $3.5 million. A $65 million term-loan prepayment and $10 million ABL repayment were made with FSTech sale proceeds.
- Taxes: Domestic cumulative losses and uncertainty over deferred tax asset realization led to a valuation allowance, effectively preventing a tax benefit for domestic operating losses. Nine-month tax expense was $1.9 million.
- Dividends: No dividends were declared in the reported periods. The term-loan agreement restricts dividends, including fixed-charge coverage and leverage tests.
Outlook, risks, and contingencies
Management expected 2012 capital expenditures of approximately $13 million, subject to a $20 million covenant limit, and stated that operating cash flow and borrowing capacity should be adequate for operating and capital needs and financial commitments. No earnings or revenue guidance was provided. The filing notes seasonal patterns, cyclical end markets, customer financing availability, foreign-exchange exposure, debt covenants, pension funding, product liability, supply disruptions, and potential impairment as risks.
- Firefighter hearing-loss litigation remains ongoing. An Illinois appellate court rejected the company’s appeal of a $0.4 million verdict; a rehearing petition and possible further appeal were pending, and another trial was scheduled for December 2012. The company says it intends to defend claims.
- Neology patent-infringement lawsuits remain outstanding. In connection with the FSTech sale, 3M agreed to assume their defense; escrowed proceeds support specified indemnification and litigation obligations.
- The company retained environmental remediation exposure at its former Pearland, Texas facility, with a $1.9 million reserve at September 30. Management did not expect remediation costs to materially affect results, financial position, or liquidity, but noted estimates could change.
- Interim CFO Braden N. Waverley was appointed effective October 10, 2012, after the prior CFO resigned. Management reported disclosure controls were effective at September 30 and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- How much of the $22.0 million FSTech escrow will be released, and whether working-capital and indemnity claims change the final sale proceeds or disposal loss.
- Whether operating cash generation improves as inventory and working-capital requirements evolve, particularly given negative total operating cash flow year to date.
- Debt service costs and covenant headroom under the high-cost term loan, including the effect of scheduled 2013 installments and the company’s reported borrowing availability.
- Developments in firefighter and Neology litigation, environmental remediation estimates, and related insurance or indemnification recoveries.
- Whether order trends, backlog conversion, export demand, and favorable segment margins continue; Q3 total orders declined year over year despite higher nine-month orders.