Federal Signal Corporation — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The company manufactures environmental equipment and safety, security and communications systems, and also distributes third-party equipment. Comparisons are with FY 2015 unless noted.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $707.9 million | $768.0 million |
| Gross profit / margin | $183.1 million / 25.9% | $225.6 million / 29.4% |
| Operating income / margin | $57.7 million / 8.2% | $103.2 million / 13.4% |
| Continuing-operations income | $39.4 million | $65.8 million |
| Net income, including discontinued operations | $43.8 million | $63.5 million |
| Diluted EPS, continuing operations | $0.64 | $1.04 |
| Cash from continuing operations | $26.7 million | $91.1 million |
| Total debt | $64.0 million | $44.1 million |
| Debt / adjusted EBITDA | 0.8x | 0.4x |
| Orders / year-end backlog | $674.4 million / $137.0 million | $686.1 million / $171.3 million |
Cash and cash equivalents were $50.7 million at year-end, versus $76.0 million. Debt exceeded cash by $13.3 million. The $325 million revolving credit facility had $243.8 million of net borrowing availability; the company reported compliance with its financial covenants. Capital expenditures were $6.1 million. Management expects 2017 capital expenditures of $10–15 million.
For the fourth quarter, net sales were $176.1 million, continuing-operations income was $12.1 million, net income was $12.6 million, and diluted continuing-operations EPS was $0.20. In Q4 2015, those figures were $186.4 million, $17.4 million, $11.5 million and $0.27, respectively.
Material changes and drivers
- Sales fell 8%, while operating income declined 44%. Management attributed the pressure principally to lower volumes, unfavorable mix, and reduced operating leverage, particularly in Environmental Solutions.
- Environmental Solutions sales fell $43.4 million to $490.7 million and operating income fell $42.8 million to $54.1 million. Lower U.S. vacuum-truck and sweeper sales and weaker international shipments were partly offset by JJE-related sales.
- Safety and Security Systems sales decreased $16.7 million to $217.2 million; operating income declined $5.3 million to $27.0 million, reflecting weaker global industrial markets, including oil and gas.
- Gross margin was also affected by a higher proportion of lower-margin third-party products and $3.9 million of acquisition purchase-accounting expense. Restructuring charges were $1.7 million; acquisition and integration-related expenses were $1.4 million.
- Orders decreased 2% and backlog fell 20%. U.S. municipal and government orders declined about 6%; non-U.S. orders rose 4%, supported substantially by JJE-related Canadian business.
- Continuing operating cash flow fell to $26.7 million, driven by lower earnings, a $23.5 million increase in year-end primary working capital, rental-fleet cash outflows and higher tax payments. The filing also cites an approximately $11 million reduction from non-cash settlement of receivables due from JJE.
Transactions, outlook and risks
- The company acquired JJE on June 3, 2016, paying approximately $96.6 million initially; JJE contributed $87.2 million in post-acquisition sales and $1.9 million of operating income after purchase-accounting and acquisition-related effects. The company also acquired Westech for approximately $6.0 million.
- Federal Signal sold Bronto, its Fire Rescue business, on January 29, 2016, receiving approximately $88 million in proceeds. The sale generated a reported $4.2 million net disposal gain; FY 2016 net income includes discontinued operations.
- No specific 2017 revenue or earnings guidance is provided in the filing. Management said it expects liquidity and operating cash flow to support operations, investment, acquisitions and shareholder returns, while pursuing cost and manufacturing-efficiency initiatives.
- Key exposures include municipal budget cycles, industrial-market cyclicality and oil-and-gas weakness, competition and pricing pressure, foreign exchange, supply availability, customer/dealer financing, cyber risk, and restrictive debt covenants. A 10% U.S. dollar appreciation was estimated to reduce annual sales and operating income by approximately 2%.
- Defined-benefit pension plans were approximately 77% funded at year-end; lower discount rates can increase obligations and contributions. Plans became fully frozen at the end of 2016, and the company expected up to $6.3 million in 2017 pension contributions.
- Firefighter hearing-loss litigation remains outstanding; the company has not recorded a reserve for potential losses and states insurance may not cover all costs. The company recorded a $1.3 million liability related to the Latvian dispute arising from the Bronto sale and expected settlement in Q1 2017. A $0.6 million reserve remains for remediation at a discontinued Texas facility.
- The annual goodwill impairment test found no impairment in continuing operations. Goodwill was $236.5 million, approximately 37% of total assets. The auditor issued an unqualified opinion and reported effective internal control overall; JJE, representing about 21% of assets and 12% of sales, was excluded from the internal-control assessment.
Important facts for investors to verify
- Whether orders and backlog stabilize and convert to revenue, particularly given the lower-margin mix in Environmental Solutions.
- Whether JJE integration, rental operations and expanded distribution improve growth and margins enough to offset acquisition-related costs and working-capital demands.
- Whether operating cash flow recovers after the 2016 decline and supports dividends, repurchases, pension contributions and planned investment.
- Developments in firefighter litigation, pension funding, and the remaining Bronto-related obligations.
- Ongoing covenant compliance, borrowing availability and the effects of increased debt following acquisitions and shareholder returns.