Federal Signal Corporation — Q2 2011 Form 10-Q
Business context and period. Federal Signal manufactures public-safety and security equipment, environmental vehicles and equipment, fire-rescue aerial platforms, and intelligent transportation technology. This unaudited filing covers the quarter and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods. Amounts are in millions of dollars except per-share data.
Financial results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $204.5 | $195.6 | $378.1 | $360.2 |
| Gross profit | $51.7 | $51.2 | $93.2 | $91.5 |
| Operating income | $8.9 | $2.5 | $7.7 | $1.0 |
| Operating margin | 4.4% | 1.3% | 2.0% | 0.3% |
| Income from continuing operations | $5.7 | $(0.5) | $0.4 | $(4.5) |
| Net income (loss) | $6.0 | $(2.7) | $0.7 | $(7.7) |
| EPS | $0.10 | $(0.05) | $0.01 | $(0.15) |
Q2 sales rose 5% and first-half sales rose 5%. Gross margin was approximately 25.3% in Q2 and 24.6% for the first half, versus approximately 26.2% and 25.4%, respectively, in 2010. Operating income improved largely with higher sales volume, lower restructuring and acquisition-related costs, and operating efficiencies. Interest expense increased to $3.8 in Q2 and $7.0 for the first half, primarily reflecting higher debt pricing under amended credit agreements.
Cash flow and liquidity. First-half operating cash use was $5.5, an improvement from $7.9 used in 2010. Capital expenditures were $7.3. Cash fell to $14.3 at June 30 from $62.1 at year-end, including $34.4 of net cash used in financing activities and $6.4 used in investing activities. Current assets were $269.9 and current liabilities $326.7; the current ratio was approximately 0.83. The company said it had not experienced material liquidity issues and expected available liquidity and capital-raising opportunities to meet anticipated needs.
Debt. The company reported $190.0 drawn on its revolving credit facility, with $50.0 of stated remaining availability, including $28.8 used for letters of credit. Non-U.S. short-term borrowings were $9.5. Long-term borrowings and capital lease obligations were $226.0 before current-maturity classification and other balance-sheet presentation. The revolver was classified as current because it matures in April 2012. Debt net of cash was 48.6% of capitalization, versus 47.6% at December 31, 2010.
Material changes and segment performance
- Operating income improved by $6.4 in Q2 and $6.7 for the first half versus 2010. The prior-year periods included restructuring charges of $3.7 and $4.0, respectively, and acquisition/integration costs of $1.1 and $3.7; none were recorded in the corresponding 2011 periods.
- Environmental Solutions sales increased $10.1 in Q2 and $16.5 year to date, supported by higher shipments. Q2 operating income rose to $9.2, while first-half operating income declined to $10.1, partly due to ERP implementation costs and disruption in Q1; management reported recovery in Q2.
- Fire Rescue sales decreased $4.9 in Q2 and $8.5 year to date as prior-period backlog was lower. Operating income fell $2.1 in both comparisons; new orders strengthened, but the company cited weak Western European backlog and unfavorable product mix.
- Federal Signal Technologies sales rose $4.2 in Q2 and $9.8 year to date, partly reflecting acquired businesses and RFID demand. The segment remained loss-making, with operating losses of $1.5 in Q2 and $5.0 year to date.
- Safety and Security Systems sales were approximately flat. First-half operating income improved $1.0, primarily reflecting the absence of prior-year restructuring costs.
- Orders increased 29% in Q2 and 17% for the first half. Backlog was $292.7 at June 30, $72.9 higher than a year earlier.
Outlook, risks and unusual items
- Outlook: Management described U.S. and global markets as recovering and cited stronger orders and backlog. No specific revenue or earnings guidance was provided. The company expected 2011 capital expenditures of approximately $15, subject to the debt-agreement limit.
- Debt covenant and refinancing: The company had breached its interest-coverage covenant for Q4 2010, then obtained waivers and amended its credit agreements in March 2011. The amendments introduced minimum-EBITDA tests, increased borrowing costs, required excess-cash-flow and asset-sale prepayments, and restricted dividends, share repurchases, acquisitions, dispositions, and certain capital spending. The company reported covenant compliance at June 30 and intended to refinance the revolver into senior secured notes and an asset-based lending facility before December 31, 2011.
- Dividends: No dividend per share was reported for the first half of 2011, and the credit amendments substantially restrict future dividends. Any permitted quarterly dividend is generally capped at the lesser of $625,000 or free cash flow, subject to additional conditions.
- Accounting change: New revenue guidance adopted prospectively in 2011 increased first-half revenue by $3.3 and cost of sales by $1.5; management expected a similar effect in subsequent 2011 quarters.
- Legal and environmental matters: The company paid $3.6 in April to resolve a firefighter hearing-loss claimant settlement. Other Cook County trials were scheduled through February 2013, and the company was appealing an earlier verdict. A patent-infringement complaint was filed July 29, after quarter-end; the company said it was investigating and intended to defend the claims. A $2.4 reserve was recorded for remediation at a discontinued-operation site; the company did not expect those costs to have a material adverse effect. Discontinued operations also included $5.9 of estimated product-liability obligations.
- Other risks: The filing highlights cyclical end markets, debt restrictions and refinancing, customer financing availability, competition and pricing, foreign exchange, warranty and product liability, litigation, environmental and safety compliance, supply interruptions, and execution of restructuring and integration efforts. Management reported effective disclosure controls as of June 30.
Most important facts for investors to verify
- Progress, terms, and availability of the planned refinancing before the April 2012 revolver maturity, and compliance with the new EBITDA covenants.
- Whether the sharp order and backlog growth converts into shipments, revenue, margins, and cash flow, particularly in Environmental Solutions and Fire Rescue.
- Cash conversion and working-capital requirements, given first-half operating cash use and the decline in cash balances.
- Whether ERP-related productivity effects have fully abated and whether Federal Signal Technologies can reduce operating losses.
- Developments in the remaining firefighter litigation, the post-quarter patent case, and estimates for environmental and product-liability obligations.
- The effect of the 2011 revenue-accounting change when comparing reported sales and cost of sales with prior periods.