Federal Signal Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. The company manufactures environmental vehicles and equipment and safety, security and communications products. Results include TBEI from its June 2, 2017 acquisition; TBEI’s post-close results are reported in Environmental Solutions.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $248.7 million | $186.7 million | $650.9 million | $531.8 million |
| Gross profit | $61.3 million | $45.3 million | $159.6 million | $137.7 million |
| Operating income | $22.2 million | $13.5 million | $52.2 million | $43.9 million |
| Operating margin | 8.9% | 7.2% | 8.0% | 8.3% |
| Income from continuing operations | $12.5 million | $7.5 million | $31.2 million | $27.3 million |
| Net income | $12.5 million | $8.5 million | $31.2 million | $31.2 million |
| Diluted EPS from continuing operations | $0.21 | $0.12 | $0.52 | $0.45 |
Q3 gross margin was 24.6%, versus 24.3%; nine-month gross margin was 24.5%, versus 25.9%. Nine-month net income was flat year over year despite higher continuing-operations income, as 2016 included a $3.9 million gain from discontinued operations and disposal.
Cash flow and liquidity: Continuing operating activities generated $52.1 million in the first nine months, compared with $17.1 million in 2016; total operating cash flow was $51.6 million. Continuing investing activities used $274.3 million, including $269.2 million for acquisitions, principally TBEI. Financing activities provided $200.0 million. Cash was $28.2 million at September 30, down from $50.7 million at year-end 2016.
Debt: Long-term borrowings and capital lease obligations totaled $283.1 million, compared with $64.0 million at year-end. The $400 million revolving facility had $282.6 million drawn, $18.1 million of letters of credit and $99.3 million of net availability. The company reported compliance with its financial covenants. A $150 million interest-rate swap fixes the floating-rate component on that portion of debt.
Material changes and operating drivers
- Q3 sales increased 33%; nine-month sales increased 22%. Growth was concentrated in Environmental Solutions, reflecting TBEI, a longer period of JJE contribution than in 2016, and stronger U.S. shipments of sewer cleaners and vacuum trucks. TBEI contributed $65.3 million of post-acquisition sales and $3.9 million of operating income through September 30.
- Environmental Solutions Q3 sales rose 48% and operating income increased to $21.2 million from $12.5 million. Nine-month operating income rose to $52.5 million from $43.9 million, while segment margin declined to 10.5% from 11.9%, reflecting acquisition-related depreciation and amortization and purchase-accounting effects.
- Safety and Security Systems Q3 sales fell 4% to $50.2 million; nine-month sales fell 8% to $150.3 million, primarily on weaker public safety and international industrial sales. Nine-month operating income was broadly stable at $18.1 million.
- Consolidated orders rose 23% in Q3 and 41% for nine months. Backlog was $203.7 million, up $55.0 million, or 37%, from September 2016; the filing attributes the increase to TBEI and stronger demand for vacuum trucks and sewer cleaners.
- Interest expense increased $2.1 million in Q3 and $3.2 million for nine months, mainly because of higher average debt following the TBEI acquisition.
Outlook, risks and unusual items
- Management expected 2017 capital expenditures to be less than $10 million. Substantially all September 30 backlog was expected to be produced during the remainder of 2017; this is not earnings guidance.
- The company expected a non-cash, pre-tax pension settlement charge of up to $7 million in Q4 2017 from a voluntary lump-sum offer to eligible terminated vested participants.
- TBEI’s purchase-price allocation and working-capital adjustment remained preliminary; the adjustment was expected to be finalized before year-end. The filing also anticipated further integration expenses during 2017.
- Key exposures include floating interest rates, acquisition integration and valuation estimates, and product-liability and other litigation. A hypothetical 100-basis-point rate change was estimated to affect Q4 2017 interest expense by about $0.3 million at then-current debt levels.
- Hearing-loss litigation remained ongoing. The company reported a proposed global settlement offer of $700 per plaintiff for approximately 1,090 plaintiffs, expected to be finalized in November 2017; other cases remained pending. Management stated that it intended to defend the claims and did not believe currently known legal matters would materially adversely affect results or financial condition, while acknowledging outcomes could differ.
- Disclosure controls were assessed as effective. Management had not yet fully assessed TBEI’s internal controls and expected to exclude them from its year-end 2017 internal-control assessment.
Important facts for investors to verify
- Final TBEI purchase accounting, working-capital adjustment, integration costs and post-acquisition performance.
- Whether order growth and backlog convert to shipments and margins, particularly in Environmental Solutions, and whether demand remains weak in Safety and Security Systems.
- Debt paydown, interest costs, covenant headroom and the company’s capacity to fund dividends and other cash needs.
- The amount and timing of the Q4 pension settlement charge and its effect on pension liabilities.
- Developments and potential financial exposure in hearing-loss and other litigation, including settlement participation and insurance recoveries.