Business context and reporting period
Federal Signal Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2021. It manufactures specialty vehicles and equipment, and safety, security and communication systems. Its reportable segments are Environmental Solutions and Safety and Security Systems. Results include OSW Equipment & Repair from its February 17, 2021 acquisition date.
Financial results and liquidity
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $298.3 million | $279.8 million | $911.8 million | $836.0 million |
| Gross profit | $70.9 million | $72.6 million | $221.3 million | $217.7 million |
| Operating income | $34.3 million | $34.0 million | $100.6 million | $97.6 million |
| Net income | $29.2 million | $25.3 million | $81.1 million | $70.1 million |
| Diluted EPS | $0.47 | $0.41 | $1.31 | $1.14 |
| Operating margin | 11.5% | 12.2% | 11.0% | 11.7% |
- Gross margin was 23.8% in Q3 versus 25.9%; for the nine months it was 24.3% versus 26.0%. Management cited higher material costs and supply-chain-related production inefficiencies, partly offset by pricing actions and sales mix.
- Cash provided by operations was $55.1 million for the nine months, down from $79.6 million. Cash and equivalents were $88.0 million at September 30, 2021, versus $81.7 million at year-end 2020.
- Long-term borrowings and finance lease obligations totaled $252.4 million, compared with $210.0 million at year-end. The company had $239.5 million of net availability under its $500 million revolving facility and was in compliance with its financial covenants.
- Investing activities used $64.5 million, including $53.5 million for OSW; capital expenditures were $12.5 million. Financing activities provided $16.4 million. Dividends paid were $16.5 million and share repurchases were $3.4 million.
Material changes versus prior periods
- Q3 sales increased 7%; nine-month sales increased 9%. Environmental Solutions drove growth, while nine-month Safety and Security Systems sales declined 3%.
- Operating income rose 1% in Q3 and 3% for the nine months, but operating margins fell 0.7 percentage points in both comparisons. Environmental Solutions Q3 operating income declined $2.2 million; Safety and Security Systems nine-month operating income declined $2.6 million.
- Orders increased 32% in Q3 and 42% for the nine months. Backlog reached $487.1 million at September 30, up 52% from a year earlier.
- Lower income tax expense contributed to higher net income. The nine-month effective tax rate was 17.6%, versus 23.0%, including $3.4 million of state valuation-allowance benefits and $1.1 million from deferred-tax remeasurement.
- Operating cash flow was lower, primarily due to higher tax payments, timing of payments and increased working capital, including strategic inventory stocking.
Outlook, commentary, risks and unusual items
- Management expected a full-year effective tax rate of approximately 18% and 2021 capital expenditures of $20–$25 million.
- Management described recovering demand and strong order growth, but warned that semiconductor and component shortages, chassis availability, labor and transportation constraints, and raw-material inflation could limit production, customer deliveries, pricing execution and margins. The continuing COVID-19 pandemic and emerging variants add uncertainty.
- On October 4, 2021, the company completed the Ground Force acquisition for an initial $43.1 million, funded with cash and revolving borrowings. On November 9, it signed an agreement to acquire Deist for $32.5 million plus a potential earn-out of up to $7.5 million, subject to closing conditions.
- Following a November 5 pension annuity commitment, the company expected an approximately $11 million non-cash, pre-tax settlement charge in Q4 2021.
- The OSW purchase-price allocation remained preliminary. The company recorded an estimated liability for hearing-loss litigation; it said additional loss beyond the accrual was reasonably possible but not expected to be material. Other claims could nonetheless have a material adverse effect if resolved unfavorably.
Important facts for investors to verify
- Whether backlog converts into revenue on schedule, and whether order growth is sustained across both segments.
- Whether pricing and operating improvements offset materials inflation, supply constraints and production inefficiencies, particularly in Environmental Solutions.
- The effect of acquisitions on debt, cash flow, margins and results after purchase accounting is finalized; also monitor the proposed Deist transaction.
- How much Q3 and year-to-date earnings benefited from tax items that may not recur, and the expected Q4 pension settlement charge.
- Updates to the hearing-loss litigation accrual, other contingencies, and the company’s liquidity and covenant headroom.