Federal Signal Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The filing is unaudited. Federal Signal manufactures environmental equipment and safety, security and communications products through its Environmental Solutions and Safety and Security Systems segments.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $186.7 million | $179.7 million | $531.8 million | $581.6 million |
| Operating income | $13.5 million | $25.2 million | $43.9 million | $78.9 million |
| Operating margin | 7.2% | 14.0% | 8.3% | 13.6% |
| Continuing-operations income | $7.5 million | $15.8 million | $27.3 million | $48.4 million |
| Net income | $8.5 million | $18.8 million | $31.2 million | $52.0 million |
| Diluted EPS, continuing operations | $0.12 | $0.25 | $0.45 | $0.76 |
Q3 gross margin fell to 24.3% from 30.4%; nine-month gross margin was 25.9% versus 29.3%. Lower operating leverage and less favorable product mix, JJE acquisition-related purchase-accounting costs, and the prior-year benefit from a Safety and Security Systems order-cancellation fee weighed on margins. Q3 net income included a $1.0 million after-tax gain from discontinued operations; nine-month net income included $3.9 million.
Cash flow and liquidity: Nine-month cash provided by operating activities was $17.9 million, including $17.1 million from continuing operations, compared with $67.9 million and $60.4 million, respectively, in 2015. Continuing operating cash flow was affected by lower earnings and a non-cash settlement of JJE receivables. Cash was $50.8 million at September 30, versus $76.0 million at year-end 2015. The company had $65.6 million of total borrowings and capital leases, including $64.7 million drawn on its revolving facility, with $240.9 million of net borrowing availability. The reported debt-to-adjusted-EBITDA ratio was 0.7, up from 0.4 a year earlier. The company reported compliance with credit-facility covenants.
Capital allocation: Nine-month investing cash use for continuing operations was $101.9 million, largely reflecting the $96.6 million initial JJE purchase price and $6.0 million for Westech. The company repurchased $33.8 million of stock and paid $12.8 million in dividends during the period. Capital expenditures for 2016 were expected to be less than $10 million.
Material changes and operating trends
- Q3 sales rose 4%, primarily reflecting JJE, acquired June 3; JJE contributed $31.0 million of Q3 sales. Nine-month sales fell 9%, with lower Environmental Solutions shipments partly offset by $35.0 million of incremental JJE sales.
- Environmental Solutions Q3 sales increased 9% to $134.3 million, but operating income declined to $12.5 million from $21.5 million. Nine-month sales fell 10% to $369.1 million and operating income fell to $43.9 million from $74.6 million. Weak U.S. vacuum-truck and sweeper demand, softer oil-and-gas markets, mix, and JJE purchase accounting were significant factors.
- Safety and Security Systems Q3 sales fell 8% to $52.4 million and operating income fell to $6.5 million from $9.3 million. Nine-month sales fell 5% to $162.7 million and operating income fell to $18.0 million from $23.2 million, with weakness in industrial and international markets. Prior-year results benefited from an order-cancellation fee.
- Orders increased 11% in Q3 and 0.5% for the first nine months. Backlog was $148.7 million, down $30.6 million, or 17%, from September 2015; management noted a less favorable Environmental Solutions backlog mix.
- Federal Signal completed the sale of Bronto Skylift in January 2016, reporting it as a discontinued operation. It acquired Westech in January and JJE in June, expanding Environmental Solutions’ products, distribution and service footprint. JJE’s purchase-price allocation remained preliminary; its reported post-acquisition results included $3.0 million of purchase-accounting expenses and $0.3 million of acquisition-related effects through September 30.
Outlook, risks and unusual items
- Management expected JJE purchase-accounting costs to continue for several quarters, but anticipated less impact on quarterly results than in Q3. The filing does not provide numerical earnings or revenue guidance.
- The company expected up to $1.5 million of additional 2016 restructuring charges for its Safety and Security Systems cost-reduction plan.
- Management cited soft oil-and-gas and industrial demand, lower equipment volumes, product mix, and a lower-margin share of products supplied by other manufacturers as pressures. Foreign-currency exposure remains, though management estimated a 10% U.S. dollar appreciation would reduce full-year sales and operating income by less than 1%.
- Canadian deferred tax assets of $4.7 million were fully valuation-allowed because of cumulative Canadian losses. Management said it would continue assessing whether some or all of the allowance could be released in Q4 2016 or later.
- Hearing-loss litigation relating to sirens remained ongoing, including proceedings over class certification and individual claims. The company said it intended to defend the cases; it could not estimate losses for many claims. The Bronto-related Latvian dispute was upheld on appeal; the company recorded a $1.5 million charge and expected to pay its agreed share in Q4 2016.
- JJE-related equipment repurchase guarantees had maximum potential payments of $3.6 million, partly mitigated by resale value and seller reimbursement provisions. Outstanding letters of credit and bid/performance bonds totaled $23.7 million; management considered calls unlikely.
- Disclosure controls were concluded effective. Management had not yet fully assessed JJE’s internal control over financial reporting.
Key facts for investors to verify
- Whether Environmental Solutions’ underlying volumes and margins recover, and how much reported growth depends on JJE and lower-margin third-party products.
- JJE’s final purchase-price allocation, earn-out assumptions and the timing and remaining amount of acquisition-related costs.
- Cash conversion, working-capital requirements, and borrowing levels after the acquisition, repurchases and dividends.
- Backlog quality and order trends in municipal, industrial, oil-and-gas and international markets.
- Developments in siren litigation, the expected Bronto dispute payment, and the realization prospects for Canadian tax assets.