Federal Signal Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; unaudited. Federal Signal manufactures environmental vehicles and equipment, safety and security systems, and fire-rescue aerial platforms. The filing compares continuing operations with 2012; the FSTech business was sold in September 2012 and is reported as discontinued operations.
Financial results
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $222.6M | $204.4M | $422.4M | $400.5M |
| Gross profit | $51.8M | $49.2M | $98.6M | $94.5M |
| Operating income | $18.2M | $15.8M | $30.3M | $26.1M |
| Income from continuing operations | $117.8M | $9.6M | $116.7M | $12.7M |
| Net income (loss) | $117.5M | $(16.5)M | $116.9M | $(17.5)M |
| Diluted EPS from continuing operations | $1.87 | $0.15 | $1.86 | $0.20 |
- Operating margin improved to 8.2% from 7.7% in Q2, and to 7.2% from 6.5% for the first half. Gross margin was approximately 23.3% in both 2013 periods, versus 24.1% in Q2 2012 and 23.6% in first-half 2012.
- The large reported profit increase chiefly reflects a $101.4M Q2 income tax benefit ($101.2M for the first half), principally from releasing $102.4M of U.S. deferred-tax valuation allowance. This is a material non-cash/non-operating comparison driver, not a measure of recurring operating growth.
- Operating cash flow was $5.9M for the first half, versus cash use of $0.5M a year earlier; continuing-operations operating cash flow was $10.9M, partly offset by $5.0M used by discontinued operations. Capital expenditures were $9.5M. Cash fell $16.6M from year-end to $13.1M.
- At June 30, total borrowings and capital lease obligations were $144.2M, down from $157.5M at year-end; long-term borrowings, net of current maturities, were $137.6M. The company reported $69.0M drawn on its revolving facility, $28.9M in letters of credit, and $52.1M net borrowing availability. It was in compliance with debt covenants.
- Total assets were $650.0M and shareholders’ equity $267.7M. Total debt to adjusted EBITDA was 2.1x on a trailing-12-month basis, compared with 4.0x one year earlier.
Changes and operating drivers
- Q2 sales rose $18.2M year over year; first-half sales rose $21.9M. Environmental Solutions drove much of the increase, supported by vacuum-truck and sewer-cleaner shipments, improved pricing, and a large Asia-Pacific shipment. Fire Rescue benefited from volume and product mix, including stronger fire-lift demand in Asia and Europe.
- Q2 operating income improved $2.4M. Environmental Solutions’ Q2 operating income rose to $15.8M from $12.5M; Fire Rescue rose to $3.4M from $1.7M. Safety and Security Systems fell to $3.6M from $6.3M, with lower fixed-cost absorption, unfavorable mix, and ERP implementation disruption and costs.
- Orders were $209.7M in Q2, up $2.2M, but $401.9M for the first half, down $28.7M. Backlog was $294.9M, compared with $321.5M a year earlier and $318.4M at December 31, 2012; management attributed the decline mainly to higher production and deliveries.
- Interest expense declined to $1.7M in Q2 from $5.4M and to $6.2M for the first half from $10.5M, reflecting prior debt reduction and lower rates after refinancing. First-half results included $8.7M of debt-settlement charges: a $4.2M prepayment premium and $4.5M write-off of old financing costs.
Liquidity, outlook, risks, and unusual items
- In March 2013, Federal Signal replaced its prior financing with a five-year, $225M senior secured facility: a $75M term loan and a $150M revolving facility, maturing March 2018. A $75M interest-rate swap hedges variable-rate debt. The facility has leverage and fixed-charge coverage covenants; dividends and other restricted payments are subject to conditions, including a pro forma leverage ratio below 3.25x.
- Management said operating cash flow and available borrowing capacity should be adequate for operating and capital needs, absent significant unanticipated cash demands. It expected 2013 capital expenditures of approximately $15M and pension contributions of up to $6.8M to the U.S. plan and $2.3M to non-U.S. plans. The filing provides no specific earnings or revenue guidance.
- Management cited cyclicality and demand in municipal, industrial, government, and commercial markets; competition, customer financing, supply disruptions, labor, pensions, environmental compliance, product liability and warranty claims, acquisitions, and debt-covenant restrictions among key risks. It warned actual results may differ materially from forward-looking statements.
- Firefighter siren-related hearing-loss litigation remains a contingency; the company paid judgments totaling about $0.4M after the Illinois Supreme Court declined review, while other claims and class-certification proceedings continued. Neology patent litigation and an ITC investigation were settled and dismissed in June 2013; related escrow releases were expected in Q3, with no material adjustment expected. The company stated it could not estimate losses for many claims, though it did not expect known claims to materially affect consolidated results or financial position.
- Other items include a $1.7M reserve for environmental remediation at the former Pearland facility and continuing discontinued-business liabilities. A $0.6M restructuring reserve was reversed in Q2 after the costs were found unnecessary. The company reported disclosure controls were effective as of June 30, 2013.
Investor verification priorities
- Separate the $101.4M Q2 tax benefit and valuation-allowance release from recurring operating performance; verify deferred-tax-asset realization assumptions and remaining valuation allowances.
- Assess order trends and backlog conversion, especially the first-half order decline and Safety and Security Systems’ ERP-related shipment and cost effects.
- Review cash generation, working-capital movements, capital spending, and the basis for management’s liquidity assessment alongside the $52.1M revolver availability.
- Confirm refinancing terms, covenant headroom, floating-rate exposure after the swap, and the restrictions on dividends and other payments.
- Track firefighter, environmental, warranty, and other discontinued-operation contingencies, including expected escrow releases and any resulting financial-statement adjustments.