Federal Signal Corporation — Q3 2011 Form 10-Q
Business context and reporting period
Federal Signal manufactures safety, security and communications products, environmental vehicles and equipment, fire-rescue aerial platforms, and intelligent transportation technology. This unaudited filing covers the three and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods. Financial amounts are in millions of dollars except per-share data.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $194.2 | $179.6 | $572.3 | $539.8 |
| Gross profit | $46.3 | $44.5 | $139.5 | $136.0 |
| Operating income | $7.3 | $4.8 | $15.0 | $5.8 |
| Operating margin | 3.8% | 2.7% | 2.6% | 1.1% |
| Income from continuing operations | $2.0 | $2.2 | $2.4 | $(2.3) |
| Net income (loss) | $1.7 | $1.2 | $2.4 | $(6.5) |
| Diluted EPS from continuing operations | $0.03 | $0.04 | $0.04 | $(0.04) |
- Cost of sales was $147.9 million in Q3 and $432.8 million year to date. Gross margin was approximately 23.8% in Q3 and 24.4% year to date, versus approximately 24.8% and 25.2%, respectively, in 2010.
- Interest expense rose to $4.3 million in Q3 from $2.4 million, and to $11.3 million year to date from $8.5 million, primarily following higher borrowing rates under amended debt agreements.
- Cash and equivalents were $13.2 million at September 30, down from $62.1 million at December 31, 2010. Nine-month operating cash flow was $2.8 million, versus $12.6 million; working capital uses contributed to the decline. Capital expenditures were $12.3 million.
- Reported total current assets were $256.9 million and current liabilities $315.5 million. Revolver borrowings were $186.0 million; total short- and long-term borrowings were approximately $229 million, including non-U.S. borrowings and financial-services debt. The filing reports $48.4 million of revolver availability, including $28.8 million used for letters of credit.
- Debt, net of cash, was 48.6% of capitalization, versus 47.6% at year-end 2010. The revolver matures in April 2012 and is classified as current. Management intends to refinance the revolver and private-placement notes before maturity.
Material changes and segment trends
- Sales increased 8% in Q3 and 6% year to date. Orders rose 26% in Q3 and 20% year to date; backlog was $300.9 million, $83.1 million above the prior-year level. Management attributed order growth to continuing recovery in U.S. and global markets.
- Environmental Solutions led sales growth: Q3 sales rose $10.2 million and nine-month sales rose $26.7 million, mainly on stronger industrial vacuum and sewer-cleaner shipments. Q3 operating income increased to $7.7 million from $4.9 million.
- Fire Rescue orders increased substantially, but nine-month sales fell $6.2 million and operating income fell $3.3 million, reflecting lower volumes and unfavorable product mix. Q3 operating margin was 0.9%, down from 7.0%.
- Safety and Security Systems sales were slightly higher, but operating income declined $1.6 million in Q3, principally from increased warranty and legal expenses.
- Federal Signal Technologies sales increased year to date, partly reflecting the Sirit and VESystems acquisitions completed in 2010. The segment continued to report an operating loss, although it narrowed to $6.0 million year to date from $8.3 million.
- Corporate expenses declined year to date, aided by lower legal expenses, the absence of 2010 acquisition and integration costs, and a reduction in an insurance reserve. The 2011 year-to-date results also included a $1.6 million credit adjusting the prior-year-end goodwill impairment; 2010 included $4.0 million of restructuring charges and $3.8 million of acquisition and integration costs.
Outlook, risks and unusual items
- Management expected 2011 capital expenditures of approximately $15 million; the amended debt terms cap spending at that amount. The filing gives no earnings or revenue guidance.
- The company had breached its interest-coverage covenant for the quarter ended December 31, 2010, then obtained waivers and amended its debt agreements. As of September 30, 2011, it reported compliance with all debt covenants. Amendments raised borrowing costs, introduced minimum-EBITDA tests, required excess-cash-flow prepayments, and restricted acquisitions, capital spending, dividends, share repurchases and other payments.
- The company paid $6.5 million under the excess-cash-flow prepayment requirement in August. It paid no common dividend in Q3 2011; future dividends are limited by lender terms, including a cap generally tied to $0.01 per share per quarter and free cash flow. Share repurchases and other restricted payments require lender and noteholder consent.
- Management warned that market conditions could prevent refinancing on acceptable terms or at all; alternatives could include asset sales or recapitalization. This is a significant liquidity and financing risk.
- Firefighter hearing-loss litigation remains a notable contingency. A settlement covering 1,125 claimants was concluded for $3.6 million in April 2011; separate Cook County cases and an appeal of an adverse verdict remain. A patent-infringement complaint filed by Neology in July 2011 is being contested. The filing states that other legal matters are not expected to materially affect results based on current knowledge, but unfavorable developments could be material.
- A $2.2 million reserve was recorded for possible remediation at the former Pauluhn facility in Pearland, Texas; the company said costs were not expected to have a material adverse effect. Discontinued operations also include estimated product-liability obligations related to the former North American refuse-truck business.
- Adoption of new multiple-deliverable revenue guidance increased nine-month revenue by $3.8 million and cost of sales by $1.5 million; management expected a similar revenue effect in Q4 as in Q3. Domestic tax benefits remain constrained by valuation allowances on deferred tax assets.
Important facts for investors to verify
- Progress, terms and lender availability for refinancing the April 2012 revolver and private-placement debt.
- Compliance with minimum-EBITDA covenants and the effect of scheduled cash-flow prepayments on borrowing capacity.
- Whether strong orders and backlog convert to sales and improved margins, especially in Fire Rescue and Federal Signal Technologies.
- Working-capital trends, cash generation, capital spending, and the quality of the reported earnings improvement.
- Developments in firefighter litigation, the Neology patent case, and environmental and discontinued-operation liabilities.
- Effects of warranty costs, foreign currency and revenue-recognition estimates on segment profitability and reported growth.