Federal Signal Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Federal Signal manufactures environmental and infrastructure equipment and safety, security, and communications products. Its reportable segments are Environmental Solutions and Safety and Security Systems.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $308.8 million | $269.4 million | $906.9 million | $810.1 million |
| Gross profit | $82.0 million | $69.0 million | $241.3 million | $210.1 million |
| Gross margin | 26.6% | 25.6% | 26.6% | 25.9% |
| Operating income | $38.6 million | $30.4 million | $110.7 million | $88.1 million |
| Operating margin | 12.5% | 11.3% | 12.2% | 10.9% |
| Net income | $28.4 million | $21.7 million | $78.7 million | $61.5 million |
| Diluted EPS | $0.46 | $0.36 | $1.28 | $1.01 |
| Operating cash flow | Not presented for the quarter | $58.6 million | $71.8 million |
- Revenue and segments: Q3 sales rose 15%; nine-month sales rose 12%. Environmental Solutions generated $254.0 million of Q3 sales and $740.7 million year to date. Safety and Security Systems generated $54.8 million and $166.2 million, respectively. MRL, acquired July 1, contributed $22.6 million of post-acquisition sales and $2.3 million of operating income.
- Cash flow and investment: Nine-month operating cash flow declined $13.2 million year over year, despite higher earnings, as working-capital and rental-fleet investment, higher tax payments, incentive compensation, and JJE-related payments affected cash generation. Investing used $70.3 million, including $49.6 million net cash paid for MRL and $21.2 million of capital expenditures. Financing provided $10.5 million, including $37.5 million of net revolving-credit borrowings.
- Liquidity and debt: Cash was $35.9 million at September 30, versus $37.4 million at year-end 2018. Long-term borrowings and finance lease obligations totaled $249.3 million, including $248.7 million drawn under the revolving facility. The $500 million credit facility had $240.0 million of net availability after $11.3 million of undrawn letters of credit. The company reported compliance with its financial covenants.
- Balance sheet: Total assets were $1,173.6 million and total liabilities were $569.4 million. Inventories were $189.1 million, up from $157.3 million at year-end; the filing says the September balance includes MRL inventory.
Material changes and management commentary
- Q3 operating income increased 27%; nine-month operating income increased 26%. Management attributed improvement mainly to higher Environmental Solutions volumes and operating leverage, with pricing and favorable mix also supporting margins. Safety and Security Systems had higher Q3 and nine-month operating income, although sales growth was modest.
- MRL expanded Environmental Solutions’ product offerings and market access. Its acquisition consideration included $49.8 million of preliminary purchase price and an estimated $7.9 million fair value for contingent consideration; further earn-out payments of up to $15.5 million may be payable if specified results are achieved. Purchase-price allocations remain preliminary.
- Orders were $328.8 million in Q3, up 23%, and $935.8 million for nine months, up 7%. September 30 backlog was $366.9 million, 14% above the prior-year quarter; Environmental Solutions accounted for most of the increase.
- Management expects a full-year effective tax rate of 24%–25%. It anticipated up to $25 million for the Vactor facility expansion, with approximately $15 million expected in 2019, plus $15 million–$20 million of other 2019 capital expenditures. The filing provides no full-year sales or earnings guidance.
- The company adopted lease accounting standard Topic 842 on January 1, 2019, recognizing operating-lease right-of-use assets and liabilities. Management said adoption did not materially affect results, cash flows, liquidity, or covenant compliance, apart from ending recognition of a deferred sale-leaseback gain.
Risks, contingencies, and unusual items
- Firefighter hearing-loss litigation remains ongoing. The company has accrued an estimated liability for a potential settlement framework; a loss above the accrual is reasonably possible, but the incremental loss is not expected to be material. Related claims and class-certification proceedings remain unresolved.
- Other legal claims, product warranties, equipment repurchase guarantees, and letters of credit or bonds create contingent exposure. The company stated that it believes outstanding bonds and letters of credit are unlikely to be called and that legal matters are not expected to materially affect results or financial condition based on current information.
- The MRL acquisition’s fair-value estimates are provisional. Its contingent earn-out liability is measured using Level 3 inputs and depends on future financial performance.
- The company replaced its prior credit agreement with a $500 million revolving facility maturing July 30, 2024. It terminated its prior $150 million interest-rate swap during Q3; on October 2, 2019, it entered a new $75 million swap. These changes expose results to financing costs and interest-rate movements.
- Management cautioned that actual results may differ from forward-looking statements due to risks and uncertainties. It reported effective disclosure controls; MRL’s internal controls had not yet been fully assessed.
Investor verification points
- Separate organic growth from MRL’s acquired sales and orders, and assess the sustainability of the stronger backlog and order trends.
- Track working capital, inventory, rental-fleet investment, and operating cash conversion against earnings growth.
- Review MRL integration, final purchase-price allocation, and any earn-out exposure.
- Monitor debt utilization, covenant headroom, borrowing costs, and the effect of interest-rate hedging.
- Follow the hearing-loss litigation accrual and settlement process, as well as the planned Vactor expansion and capital spending.