Federal Signal: The Lights Are Flashing, Get Out Of The Way

| About: Federal Signal (FSS)

The other day I was reading a review of Spartan Motors (NASDAQ:SPAR) on Seeking Alpha and the company reminded me of another company involved in firetrucks - Federal Signal Corporation (NYSE:FSS). Naturally, being a curious analyst, I had to look at Federal Signal (all data taken from company reports and filings except the Yahoo stock chart).

The equity chart painted a grim picture:

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I am not a technical analyst by nature, but the stock cruising through its 50-day moving average and looking like it is going to fall below its 100-day moving average with a falling RSI does not bode well for the equity.

The company is struggling mightily with its financials.

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Not to paint a completely bleak picture, recognize the following:

  • Orders increased 26% and 20% for the three months and nine months ended September 30, 2011, respectively, compared to the prior year periods. In the three months ended September 30, 2011, U.S. and non-U.S. orders increased 11% and 55%, respectively, compared to the prior year period. In the nine months ended September 30, 2011, U.S. and non-U.S. orders increased 15% and 28%, respectively, compared to the prior year period.
  • Backlog is $300.9 million at September 30, 2011, which is $83.1 million higher than the same period in 2010.

I also like some of the product lines, notably the Vactor Environmental line, the Bronto aerial line and parts of the Toll solutions business. The company does have some decent products and market share. The problem is financial.

The best way to point out the nature of the financial issues (aside from the financials presented earlier) is to look into the company's new credit facility and term loan.

On February 22nd, the company entered into a new credit facility and a five-year term loan. Below are some of the terms from the 8k:

Credit line:

The obligations under the Credit Agreement are secured by (i) a first priority security interest in the company's and its domestic subsidiaries' accounts, inventory, chattel paper, payment intangibles, cash and cash equivalents and other working capital assets (the "ABL First Priority Collateral") and (ii) a second priority security interest in all other now or hereafter acquired domestic property and assets, the stock or other equity interests in each of the domestic subsidiaries and certain of the first-tier foreign subsidiaries, subject to certain exclusions.

Term loan:

Pursuant to the Financing Agreement, the Term Loan is a five-year single advance, secured term loan maturing February 22, 2017. The Term Loan will bear interest, at the company's option, at a base rate or LIBOR rate, plus, in each case, an applicable margin set forth in the Financing Agreement. The applicable margin ranges from 9.00% to 10.00% for base rate borrowings and 10.00% to 11.00% for LIBOR borrowings. The company is required to pay certain customary fees in connection with the Term Loan.

Mandatory prepayments, subject to customary exceptions and baskets, are required in the event of equity issuances, debt issuances, excess cash flow, asset sales, tax refunds and other extraordinary receipts and upon receipt of insurance reimbursements and condemnation proceeds.

The obligations under the Financing Agreement are secured by (i) a first priority security interest in all now or hereafter acquired domestic property and assets (excluding the ABL First Priority Collateral) and the stock or other equity interests in each of the domestic subsidiaries and certain of the first-tier foreign subsidiaries, subject to certain exclusions, and (ii) a second priority security interest in the ABL First Priority Collateral.

The key points here are that essentially every asset has a lien on it and the company still has to pay LIBOR+10%. This shows that the company is distressed as they are agreeing to distressed terms at distressed rates. The only news that is good here is relevant to the private placement (privately placed and negotiated debt - typically with insurance companies) holders in that part of the proceeds will retire their debt.

The lenders:

Highbridge, Cerberus, TPG, Regiment and others.

One interesting point within the credit agreement is the portions that have been redacted for confidentiality reasons.

Examples of the redacted sections include:

  • (i) Voluntary prepayments shall not be permitted at any time prior to [***] (or at any time prior to [***], if either (X) as of [***], the Company has not entered into a letter agreement with a prospective purchaser to consummate [***], or (Y) as of [***], the outstanding ABL Loans plus the outstanding Term Loan exceeds [***]), but shall be permitted thereafter from time to time as follows:
  • Post [***]Fixed Charge Coverage Ratio Covenant and Leverage Ratio Covenant. Notwithstanding anything in the foregoing Sections 6.8(a) and (B) to the contrary, at any time after the consummation of [***], the Company and the Collateral Agent agree to negotiate in good faith to amend the tables set forth in Sections 6.8(a) and to reflect revised Fixed Charge Coverage Ratio and Leverage Ratio levels, respectively, commencing with the first full Fiscal Quarter ending after the consummation of [***].
  • Asset Sales (other than [***]

They refer to an event, so the company is in the middle of a transaction (I would guess sale of a business or business line) which appears to be beneficial to the lenders (or else it would not be permitted). As proceeds from any sale transactions are earmarked to repay lenders, this will help reduce some leverage, but I cannot think it will be enough to put a base under the stock.

As well, the lenders have fixed charge coverage covenants in place that show an assumed 0.8:1 for the remainder of the year, briefly going to 1:1 and then falling to 0.9:1 beginning March of 2013. This company will not be able to cover its fixed charges, or, at best, will just cover them.

Federal Signal is a global manufacturer and supplier of safety, security and communication equipment, street sweepers and other environmental vehicles and equipment, and vehicle-mounted, aerial platforms for fire fighting, rescue, electric utility and industrial uses. The company is also a designer and supplier of technology-based products and services for the public safety and intelligent transportation systems markets. In addition, they sell parts and tooling, and provide service, repair, equipment rentals and training.

Conclusion: Federal Signal may be viewed as a deep value play or a turnaround situation, but I have a hard time getting involved with a company that cannot pay its fixed charges and will be reliant on the banks to pay the deficit. As well, the fact that everything the company owns is collateral for the banks makes me nervous. As I stated, something is going on with the company, and perhaps what ever it is will help provide a much needed boost, but until I see it, I would avoid the stock of this company and if I owned it, I would have to take a hard look in the investment mirror to see if that capital should not be deployed elsewhere.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.