Federal Signal Corp (FSS) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2006 Federal Signals earnings conference call. My name is Janelle and I will be your coordinator for today. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Karen Latham, Vice President and Treasurer. Please proceed.

Thank you, Janelle. Good morning and welcome.

As usual, some of our comments contain forward-looking statements about the future prospects of Federal Signal, so please refer to our latest annual report to shareholders, our recent SEC filings and the press release issued in conjunction with this conference call for a more detailed discussion of the risks in our forward-looking statements.

The press release is available on our website, federalsignal.com. I will turn this over to Bob for his initial comments.

Thank you, Karen, and good morning, everyone. Thanks for joining our second quarter conference call. As you will note from our press release, Federal Signals posted strong financial and operating results for the second quarter, driven by our continued effort to redefine the company under a new vision and mission statement.

We posted earnings from continuing operations of $0.24 per share compared to $0.32 in the year-earlier period. Although perhaps a more telling non-GAAP comparison would be the $0.24 this year against $0.17 excluding one-time tax and restructuring adjustments realized last year.

The quarter featured meaningful advancements in our strategic and operational initiatives, providing continuing assurance that our efforts to return the company to sustainable growth and profitable remain on track. I'm very happy with the progress Federal Signal has made, but certainly realize that additional strides remain as we complete our turnaround. I remain highly confident in this company and its future.

I'd like to begin with a few highlights for the quarter. First, Federal Signal remains on track to meet the financial goals outlined at February's investor day. New business continues to be robust in all of our market sectors and in virtually all of our business units. In fact, new orders in the second quarter nearly matched our record intake established last quarter.

Orders improved 9% year-over-year while revenue grew 6% from the year-earlier period. Over the first half of 2006, revenue grew 7% compared to the same period last year.

Yet the improvement I find most gratifying and encouraging is our gross margin, which has improved from 24.3% in Q2 of 2005 to 26.1% this quarter. Each of our four operating groups posted higher gross margin, indicating a broad-based improvement.

Second, I'm pleased to report that SEG&A as a percent of sales decreased by 0.6% compared with the year-earlier period. This improvement was registered despite expenses that we did not face last year, including severance charges, stock-option expenses and increased spending on our strategic initiatives.

Earlier this month we implemented two important software applications that are part of our multi-year strategy to streamline and consolidate transactional operations directed at reducing cycle times and SEG&A costs. We have completed the second of two steps in the migration of our entire U.S. payroll to a common platform and outsourcing the administration of the process.

Additionally, we went live on our first JD Edwards installation within EPG that will automate their new parts distribution business unit. Two additional locations within EPG will go live by the end of next year.

Third, in May we announced that Federal Signal entered into an agreement with Labrie for the sale of certain Leach refuse truck body business assets. This sale was consistent with our determination in December 2007 that the refuse truck business was no longer strategic, at which time the business was classified as a discontinued operation. Concurrent with this agreement, we are winding down operations at our Medicine Hat, Alberta, facility.

The decision to exit the Leach refuse business was a difficult but necessary step in our turnaround effort. We are committed to our long-term strategy of creating a portfolio of businesses that contribute to sustained, profitable growth.

To accomplish this goal we must exit businesses where we either lack competitive advantages or where the businesses simply do not fit with the strategy of Federal Signal going forward, even if products and served markets of a particular business might be competitive and profitable. This will enable us to focus our attention on those businesses that will allow us to benefit from product leadership and are aligned with our new focus on municipal and workplace security and well-being.

Fourth, we booked our first orders for refuse trucks at our China JV, with the expectation for additional orders to flow through during the remainder of the year. This is an exciting development as Federal Signal continues to increase its global footprint.

With that, I'll dive into the details by first commenting on conditions in our broad market and then covering results from our various operations. As many of you know, we segment our markets into three major components -- U.S. municipal and government, U.S. industrial and commercial and non-U.S.

On the U.S. muni side, orders were up 8% over the previous quarter and 13% year-over-year. Sales from our environmental products and safety products groups remained very strong in this segment, while fire rescue orders were down compared to a robust Q2 last year.

Encouragingly, U.S. muni market activity in the early days of Q3 remains brisk and we expect this strength to continue.

U.S. industrial commercial orders were also strong in Q2, with new business up over 16% from the year-earlier period. We were particularly pleased by the breadth and depth of the gains.

New order intake was down about 15% compared with the previous quarter, but sequential comparisons for this market are difficult given that our Q1 orders are historically higher than Q2.

In the non-U.S. market sector, export orders were up 10% compared with Q2 2005. Exports of fire trucks and SPG products showed particular strength. Exports of EPG equipment, although lower against a very strong year-earlier comparison, continued at a robust level. Exports of tooling products were the only area of weakness compared to the year-earlier period on both a quarter and year-to-year-- year-to-date basis.

While orders for our non-U.S. operations remained strong, they came in approximately 2% lower than the year-earlier period.

Now let me quickly walk you through highlights from our European locations. Sweeper orders reached an all-time high and orders for emergency vehicle lights and sirens nearly matched the record levels we established in Q2 of 2005. New business for articulated aerial devices in the quarter set a new Q2 record and that was coming off of a record Q1 level, as well.

Overall, we expect our non-U.S. business to remain strong in the coming quarters. Given the combination of factors, including the weak dollar, encouraging signs of recovery in major European economies and our business in China coming on line, and our strategic initiatives on growing revenue outside of the U.S., we expect to be able to chart growth on a sustained basis in non-U.S. business.

Now let's review the fundamentals in each of our four business groups.

This time we'll start with safety products. For the group, new orders were up about 19% for the quarter, compared with the same period last year, with strength across all product lines and markets. Particularly impressive were outdoor warning sirens, which included the sale of a tsunami warning system to the State of Washington; emergency vehicle signalling equipment orders in the U.S. and Europe; integrated warning systems for large industrial and military installations; and multiple large parking projects. Additionally, hazardous lighting equipment for oil rigs and coal mines continued to build off the strength exhibited in prior quarters.

We observed no areas of softening in the group and expect to be able to maintain robust orders in the coming months.

Operating income for the group was up 23% for the quarter and 5% for the first half of the year, even after taking into account selected but significant one-time charges related to management changes. Dave McConnaughey is in place as SPG President and he recently installed new vice presidents in operations and in human resources.

In alignment with our ambitious organic growth initiatives for this business, SPG has boosted its product development spending. SPG's growth initiatives focus on developing integrated solutions for emergency vehicles, integrated solutions for hazard sensing and mass warning for large installations, and integrated revenue control and security solutions for parking and transportation.

In most cases, our leading-edge technology is prominent in these solutions. Federal Signal enjoys significant positions in these markets in various countries around the world, providing one of the most widely recognized brand names around the globe for these types of products.

Next, let's review results from the environmental products group. New business was up 24% compared with the second quarter of 2005 and up 28% for the first half of the year.

U.S. muni orders were up 45% and U.S. industrial up 19%. Non-U.S. was down slightly, but it should be noted that this is against the year-earlier period in which we received a large sweeper order from Kuwait.

During the recent period, sweeper orders in Europe were up 36%. Following two outstanding quarters for orders, our backlogs are substantial and we are taking the necessary steps to increase capacity.

Revenues increased 16% in the quarter and operating income was up 27%. This was achieved in spite of increased spending on strategic initiatives, selected charges for management changes, and costs related to stock option expenses.

As I indicated, EPG is winding down operations at the Medicine Hat, Alberta, refuse truck body plant. Closing on the deal to divest certain assets to Labrie remains on track for next week.

I'd like to express my deep appreciation to all of our Leach employees in Medicine Hat and Appleton, Wisconsin, who have performed remarkably during this phase-down process and have maintained the Leach brand's proud reputation for a high-quality product and great after-sales support. Our colleagues will transition to new careers, with our sincere thanks and best wishes and, fortunately, in an environment of plentiful jobs in the region.

We will continue to work closely with Labrie to ensure a smooth transfer of production to their plant in Quebec and a seamless support for Leach dealers and customers in the months to come. With this closure, the leadership of our EPG group will be able to devote their full attention to growth strategies for our core products where we have considerable strength and enjoy sustainable competitive advantages.

To energize their growth initiatives, Mark Weber and his EPG team are focusing on new product development-- are focusing new product development on improving the performance of their market-leading environmental maintenance equipment and incorporating additional intelligence and wireless communication to enhance functionality and to lower costs for our customers.

Another growth focus for the group is in the area of international expansion. Now moving on to our fire rescue group, new orders received in Q2 were weaker than the comparable period last year, down approximately 9%-- or 8%. However, for the first six months, FRG orders are up roughly 4% over last year.

Now that E-One's operations have been stabilized in Ocala and we're down the path to closing the Red Deer facility in Alberta, Mark Gustafson and the FR leadership team have been focusing on building the necessary business processes and policies to support initiatives around restoring margins and getting back on a growth path.

The rollout of the EZ-One sales tool is an example and this alone represents a sea change for us and for our dealers. Establishing policies that enable both the company and the dealer channel to prosper equitably has been another area of focus for us.

Some of the changes are difficult in the short term, but we believe this is what's necessary to establish a foundation upon which we can build and prosper.

While we've seen some share decline in North America in the past two years as we've been working through these changes, we continue to receive strong orders and still enjoy a substantial backlog. We're determined to do what it takes to restore the E-One brand to a leadership position on the aspirational scale. This will ultimately translate into increased customer satisfaction, which, in turn, enables share growth and margin growth.

Looking at Europe within the fire rescue group, we're very pleased with the dramatic growth of our Bronto articulated aerial device as our orders are up 52% in the first half compared to last year. The concept continues to gain share around the world and, as we indicated previously, we believe the U.S. market will increasingly shift to this concept from turntable-designed aerial ladders and platforms because of greatly increased functionality.

The articulated aerial segment is the fastest-growing segment in the North American market and we currently enjoy a commanding share. By combining the Bronto and E-One product development teams, we are moving to the next frontier by introducing a broad new range of aerial technology.

Having discussed markets, let's now review operational specifics for FRG. Revenue for the group was down slightly from Q2 last year, with both North America and Bronto down slightly.

First, let's review the North American comparison, which was negatively affected by revenues realized last year, resulting from a failed Texas dealership that we took over for a brief period. After eliminating this special situation, revenue was up-- was actually up roughly 5% in North America.

Next, let's discuss Bronto results, which were impacted by production disruptions that occurred after we implemented to increase capacity earlier in the year. After making changes to their production processes, a couple of our key suppliers had difficulties getting up to speed and keeping up with demand. These issues, as well as the few internal glitches, are largely behind us and we expect the rest of the year to be very strong.

FRG continued making progress in restoring margins, as we predicted, reporting operating income that was much improved compared to the year-earlier period. We expect this progress to continue for the remainder of the year. This gratifying trend is resulting from the continuous improvement efforts, particularly in E-One's Ocala operation, cost containment and improved pricing.

FRG's sales tool, EZ-One, has now been fully implemented for those models originally scheduled and 100% of our orders in June for those models were processed through the new tool. As is seemingly the case in any significant software implementation, we did experience some start-up issues with the EZ-One rollout, but the tool is now working extremely well and our sales force is getting acclimated and enjoying its great productivity improvement. Internally we're beginning to see the anticipated positive impact of EZ-One on our front-end business processes in reducing lead time and man hours in the quote-to-release-for-production phase.

On the distribution front, we announced three new dealer appointments during the quarter, significant closing the gap. We were delighted that our new dealer in California, Valley Fire, was awarded a major contract by the Orange County Fire Authority for a fleet of new E-One pumpers. The authority is among the largest in the country, with 62 stations serving 22 communities throughout the state. It's been many years since we've landed an order like this in California and we look forward to many more as a result of the hard work by Jason Walston and his determined sales team at Valley Fire.

In other examples of progress on the distribution front, we're encouraged to see our dealers in other areas recapturing former E-One customers like Seattle, Chicago and Boston. The City of Boston just purchased their 104th E-One apparatus after a six-year hiatus.

Finally, let's move on to our tool group. New business for the group was up slightly year-over-year. Drilling down, we were up domestically, but weaker exports and weaker orders at our non-U.S. operations largely offset these gains. Internationally we were down about 9% in the first half of the year with weakness in Europe and Japan continuing from the previous quarter.

Looking forward, we still expect our tool European operations to show some positive momentum in the second half, but have slightly lowered our expectations for the remainder of the year. Our analysis of the Eurozone indicates that the economies are recovering, but we don't see some of the delayed automotive new model projects coming on track as we had hoped.

On a positive note, despite the well-publicized auto industry woes in North America, our Dayton Progress business unit is growing revenue. They've made a number of changes to it's sales and distribution processes since Alan Shaffer joined us last October and we're gaining in some market regions and segments that were underserved in the past.

Some of Dayton's success achieved in the U.S. has been offset by other business units that are more closely related to the auto industry. These segments are being adversely impacted by reduced production and extended shutdowns at many North American auto plants.

Referencing the previous quarter's conference call, the operational issue that we experienced at Dayton, which led to weaker earnings in Q1 and Q2, is now behind us. Our employees did an outstanding job implementing their recovery plan and I compliment their hard work and tenacity. Overtime hours are declining significantly and on-time deliveries have shown improvement this month as operations return to normal. In line with our estimates at the beginning of the quarter, the inventory problem at Dayton impacted the group by about $800,000 in Q2.

In spite of the market softness and operations issues, the group maintained operating income equal to Q2 of last year and is on track to post an improvement over full-year 2005 results. The major risks are whether Europe and Japan will recover sufficiently and some U.S. sectors, such as auto and new housing construction, don't worsen.

Associated with our company-wide goal of organic growth, the tool group is working on some very innovative concepts, which would help our customers greatly improve productivity and reduce costs. Additionally, they are gearing up their new operation in southern China.

I'll end my comments by repeating my gratification with the company's progress. Our improving results have energized our employees, as well as the management team. We look forward to reaching our 2006 goals, equipped with robust backlogs, still-brisk market activity and improving operational metrics.

Having said that, we're certainly aware of the angst surrounding the slowing U.S. economy. The pundits seem to have [consensed] on a nominal growth rate of around 3% in the coming quarters, although this morning's news about 2.5% growth in the second quarter was a bit of a surprise. If the number is around 3% or so, generally we will continue to do well.

Our business profile has changed over the past two years as we have completed the first half of our “shrink-to-grow” strategy. Formerly, we talked about our business being about one-third municipal, one-third industrial and one-third non-U.S. In the first half of 2006, about 40% of our orders were U.S. municipal, 27% U.S. industrial and 33% non-U.S.

In the industrial market, our products are those that tend to get the highest priority during the budgeting process. We sell the same kind of products into industrial and commercial markets, where, again, they are less discretionary than many other capital goods purchases.

We believe this profile provides us with a buffer that most companies don't enjoy. This is the profile we will enhance as we now focus on the “to-grow” portion of our strategy.

Regardless, we'll certainly be closely watching the demand pattern for the roughly 15% of our business that is short-cycle consumable oriented as an early indicator of where the economy might be headed. We're in the process of developing contingency plans to have on the shelf in the event we sense softening beyond the prevailing view.

Now I'll turn the discussion over to Stephanie for some additional commentary around the numbers.

Thank you, Bob, and good morning.

Our backlog reached a record level this quarter at $438 million. This represents a 1% rise from last quarter and is up 6% from a year ago. This is particularly noteworthy, since it does not include any significant new multi-year contracts and it positions us well for deliveries during the second half of the year. The backlog for environmental products ended the quarter at $116 million, up 10% from last quarter; fire rescue, $240 million, down 5%; safety products, $73 million, up 7%; and tool at $9 million.

Now I'll turn to the income statement. As Bob discussed, second quarter sales of $319 million were up 6% from a year ago. Of the $19 million increase, about 40% was due to higher volumes, mainly at environmental and safety products, and about 50% was due to higher prices, mainly at our vehicle companies where a number of pricing actions were taken during 2005, and the balance was mainly favorable currency effects.

Our gross margin rose to 26.1% in the quarter on a continuing operations basis, up from 24.3% reported a year ago. Notably, every group posted an increase versus both the second quarter of last year and the first quarter of this year.

The margin for fire rescue rose 170 basis points from a year earlier, due to operational improvements in Ocala. The margin for environmental products rose 80 basis points as the benefit of higher volumes more than offset the addition of expenses for the J.D. Edwards implementation.

At safety products, the margin improvement was more modest, about 50 basis points, due to higher sales, which was partly offset by higher administrative expenses associated with management changes and increased product development expense.

The margin for tool improved 90 basis points on flat sales due to cost-reduction initiatives.

As you may recall, our average margin for 2005 was 25.2% and we are focused on gradually improving that to 28% over the next several years.

Our selling, engineering, general and administrative expenses, as a percent of sales, recovered to 18.4% against 19.1% a year ago. This brings the year-to-date figure to 20.1%, just below 20.2% for the first half of '05.

As a reminder, for the full year of 2005, SEG&A expense averaged 19.7%, excluding the benefit of the product line sale gain, and we have a medium-term objective of lowering the figure to 18% while reallocating the components of the spend as we improve our transactional efficiencies. We are expecting further improvement as the year progresses, despite absorbing the negative impact of the accounting change for stock options.

In the quarter, the 70 basis point improvement was largely in corporate and at fire rescue. At fire rescue, we experienced a dealer credit loss last year, which was a non-recurring item. Partly offsetting lower corporate and FRG were higher spending at our other businesses. Our corporate expense, at $4.2 million, was significantly lower in the quarter, both versus the prior year and sequentially.

Versus a year ago, legal costs associated with the hearing loss defense case were $700,000 lower because the case has been delayed due to the reassignment of the judge and prolonged discovery. This could catch up with us in the back half of the year, depending on the timing of the trial date established by the new judge.

Also favorable was improved bad debt expense associated with our taxable lease portfolio runoff. After several years of running off our portfolio, we are now seeing better recoveries and expense and actually realized a credit of almost $200,000 in the quarter versus an expense in the quarter of more than $500,000 last year.

Despite the relatively low level of spending in the second quarter, we believe that corporate expense for the year will be close to the $23.9 million figure experienced in 2005. The only sizable wild card is the timing on the hearing-loss trials. If they slip into next year, our 2006 expense might be lower by $1 million or more. Having said that, we remain anxious to see this litigation brought to trial so that we can demonstrate to the plaintiffs' attorneys that these are frivolous lawsuits and that our sirens are important to save lives and property and to protect firefighters.

Interest expense was $6.3 million this quarter, up from $5.8 million a year ago, reflecting the steady increase in short-term rates, which more than offsets the impact of lower borrowings.

Our income tax rate on operating earnings remained at 33% in the quarter versus a large negative number for the year-ago period. In the second quarter of 2005 we benefited by $7.6 million from the reversal of reserves associated with the completion of a multi-year IRS income tax audit. Looking forward, we expect an effective tax rate this year of between 30% and 33%, depending on the geographical distribution of our earnings and the success of key tax planning strategies.

The other wild card is the question of whether Congress will extend the R&D tax credit, which has been allowed to expire. Our current working assumption is that it will not, which raises our tax rate by almost a percentage point.

Our loss from discontinued operations totaled $13.6 million, including a revised estimate of the write-down associated with exiting the Leach business of $10.5 million after tax. This is consistent with the disclosure in our May 31st press release.

Operating cash flow was $5 million in the quarter, bringing the year-to-date figure only very slightly positive to $1 million, mainly due to increased working capital and the impact of the discretionary $10 million pension contribution, which we made earlier in the year.

In 2005 first half operating cash flow was very high, $37 million, as fire rescue, in particular, was making significant improvements in collections and advance payments from customers. At June 30th of this year, our primary working capital totaled $249 million, up about $26 million from a year ago. Half of the increase was at fire rescue, mainly in Finland and Canada.

In Finland, we are increasing production in response to higher growth and are tying up more capital in the medium term due to additional outsourcing projects. In Canada the increased working capital reflects the temporarily longer supply chain due to sourcing trucks in the U.S. The rest of the increase was primarily environmental products, mainly due to higher sales for European sweepers and sewer cleaners and industrial vacuums.

On a positive note, at 19.8%, our six-month average operational working capital remains below 20.8% a year ago. We expect to see significant reductions, $25 million or more, in the back half of the year and remain committed to a gradual reduction in working capital to 15% over the medium term.

Year-to-date, we have invested $10.6 million in new capital spending, about the same as depreciation, and have also repurchased a total of 350,000 shares of Federal Signal stock, costing $6.1 million. As you may recall, it is our policy to purchase shares in the open market to offset dilution from stock compensation and we have completed the program for 2006. However, as a result of the very low stock price, the board has authorized the repurchase before year end of up to an additional 400,000 shares of stock, approximately the amount of dilution that we would otherwise face in 2007.

At quarter end, our manufacturing debt was $238 million, down $38 million from year end. Our manufacturing debt, net of cash, rose to $221 million, from $184 million a year end 2005 of 38% of capital, reflecting the working capital increase, the planned pension disbursements and the stock buy-back.

During the second quarter we-- we repaid a maturing $17 million tranche of long-term debt. We face another maturity in November of $25 million, which we will repay using operating cash flow and available credit lines.

On June 30th, we had $20 million drawn under our revolving credit facility. After the end of the quarter, we took advantage of a one-time option under the facility and increased the size of the credit line to $125 million. We currently have a comfortable liquidity cushion, that is, cash plus available debt capacity, of about $90 million and we are in full compliance with all debt covenants.

Just a couple of comments looking forward. As we closed out 2005, we indicated that we expected to improve year-over-year performance by 10% to 15%, excluding the $0.34 of one-time gains from the product-line divestiture and income tax resolutions. We remain committed to delivering this level of performance.

As you may recall, last year's Q3, restated, was $0.29, including a $0.13 benefit from the sale of the product line, the safety products product line, and Q4 was reported at $0.28, including $0.05 of tax savings associated with repatriating off-shore cash. We expect to show modestly positive year-over-year comparisons for both quarters.

Now I'll turn it back over to Bob to moderate questions.

Thank you, Stephanie. Janelle, why don't you open it up for questions, please?

Thank you. [OPERATOR INSTRUCTIONS] And our first question comes form the line of Jack Kelly from Goldman Sachs. Please proceed.

Hello, Jack.

Hi, Bob, how are you?

Great.

Just a couple questions. On fire rescue, given the-- the--

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Hello?

Hello?

Still there?

Yes, I'm still here.

Okay.

Okay, looking at EZ-- EZ-One, the order input system, does that give you better visibility in looking out over the next couple of quarters, Bob, in terms of the margin ramp-up in fire rescue? I think in the past longer term you talked about maybe high-single-digit, low-digit margins in that business. And so can you give us, as you look out over the next year, do you think that's an objective you can get to?

Well, first of all, EZ-One does give us better visibility into what our costs will be and this is a very important improvement. The-- as we've indicated in the past, we intend to grow margins over the next several years and we believe we can get this business to the high-single-digits or-- or 10%. It's still our objective. The things that we have in the pipeline right now won't get us there, Jack, because, as I've indicated, now that we have EZ-One in place, we're just beginning to see the productivity improvements on the very front end of the business process.

As these trucks now, work-- work their way through the plant where we can start implementing different manufacturing processes to take advantage of the fact that we now understand what it is that we're going to be building much better, then we'll be able to take advantage of this structure and gain improvements in the coming several years. So we won't see those kinds of margins in what we have in the backlog now.

Okay, but that's-- that's just because of what's in the backlog rather than-- than what's happening at the plant?

Yes and what's happening at the plant, Jack, we just now have this structure and definition in place and so as these orders now are being processed, we can start to do things in the plant to take advantage of the fact that we can-- we have a better view about what it is we're going to be making. So we can start making welding fixtures and things like that that help improve the productivity on the floor. But these things will take some time.

Okay. And then just secondly, in regard with the EZ-One, to the extent you're pricing the product better, if I can phrase that way, is that, in any way, related to the decline in orders? In other words, are you pricing the product more richly now because that is, indeed, what your cost structure is and, as a result of that, could be losing share?

Well, I don't-- certainly, Jack, we've been very aggressive on pricing and our competitors have-- have-- we've been, perhaps leap-frogging each other on the way up the ladder. We're starting to run into some areas now where there is some resistance to the pricing, so we're looking at that.

But I think most of the-- most of the issues regarding share have not been as a result of pricing. It's been a result of all the changes that we're making, the tension that has been in our dealer channel with-- with some of our dealers, with the fact that we're making some substantial changes, first of all, with EZ-One and secondly, with some of our other business processes.

So-- and you'll recall, too, that we've elected to get out of some-- some businesses or some product lines, if you will. When we closed the Preble plant in-- at the end of 2004, we were walking away just-- just by decision with about-- of about 1% of the market, a little over 1%.

Some of the other changes that we've made in-- in deciding to close down the Red Deer plant, many of the products that they had made in past years there were the low-end, wildlands-type of vehicles that we found ourselves not being competitive in. We've been shifting production of those vehicles to our alliance partner, but in the meantime, those kinds of changes result in some disruption.

So it's a wide variety of things. I think the pricing is probably less of an issue than the other things that I mentioned.

Okay.

EZ-One is more accurately pricing, not higher pricing. The price increase movement has been independent of the implementation of the system.

Okay. And then just secondly, on commodity costs, Stephanie, you had mentioned gross margins were up. Bob, could you just comment, broadly speaking, across the businesses how-- how you're dealing with it? I mean, looking at the gross margin, it sounds like you're-- you're more than offsetting it, but there might be other things going on there. So I guess the point is, are you able to recoup commodity cost increases in terms of price increases?

For the most part we have, Jack. One of the things that makes the-- our comparison a little bit murky is that during the same period of time we've been outsourcing quite a bit more and this is one of the ways that we've addressed not only reducing cost but increasing capacity and we still need to do a deeper dive to figure out if we are fully recovering, but the fact that our gross margins are up is very encouraging.

I don't-- I don't pretend to believe that we've-- that our pricing is terribly out in front of the commodity cost increase, because our folks are making a lot of progress in plant productivity and other areas, as well.

Okay, thanks.

And our next question comes the line of Michael Harris from BDR Research. Please proceed.

Good morning, Bob.

Good morning, Michael.

Good morning.

Just a quick question on fire rescue, Bob. I was listening to some comments from a supplier of pump modules and they cited state and federal funding as a potential tailwind for the second half. I was just curious if you, perhaps, shared that same enthusiasm about state and federal funding going into the second half?

Well, first of all, I just checked yesterday and there's no update in regard to what Congress is going to do with federal funding. The President originally proposed something that was well below what the level has been the last few years, but I think it was the House, as opposed to the Senate, in their version of the spending bill, restored it back to-- to the levels that we've seen the last two years.

That's the last I've heard. So my sense is that-- that, particularly in an election year that the-- we won't see any-- any kind of significant deterioration.

Okay. And just kind of a broader question, given your confidence level right now, what are the chances of beating that 28% gross margin goal before 2008?

Well, that's our goal in 2008 and right now it looks like we're on a trajectory that will get us there. I won't suggest that we're going to get there before 2008, though.

Okay. Thanks and I'll get back in queue.

And our next question comes the line of Charlie Brady from BMO Capital Markets. Please proceed.

Hi. Thanks. Good morning, Bob.

Good morning, Charlie.

Could I just-- I just wanted to clarify from Stephanie's comments, make sure I heard you right. When you were talking about the sales increase and you gave us percentages from volume and from pricing, is-- did you say that 40 was from volume, 50 from pricing and 10 from other and that was on sales?

Yes.

Okay. I just wanted to make sure I heard you correct. Any change to your-- the outlook that you had given us as far as operating margin guidance in '06 and sort of your long-term outlook, given where you are today, halfway through '06?

No. We still think those are the right-- those are the right numbers, the right estimates.

Okay. On the tools business, how much of that tools business is out of Europe?

The international business is about a third and about two-thirds of that third is European, Western Europe.

Great. Thanks very much.

And our next question comes from the line of Steve Barger from KeyBanc Capital Markets. Please proceed.

Good morning.

Good morning, Steve.

I just wanted to talk about Bronto for a second. I know you had another strong performance, but can you kind of quantify the Bronto order rate and talk a little bit about whether you're changing your opinion about where you think that product can go from a volume standpoint?

Well, the order rate in the last couple of quarters has exceeded what we-- what we thought we would see. So I guess we expect-- we expect this to be a very, very popular product in most regions throughout the world. So we'll have to take another look at this and perhaps we'll-- we'll be more optimistic about where it's going, but it's really been very, very strong in the last couple of quarters.

Okay, thanks. And the finished production constraints, are they completely behind you and can you tell what the product was that was really giving you the problem?

Well, the only thing we make there are these articulated aerial devices and we've introduced a number of new models at the same time we've been trying to increase our capacity because of these very robust orders and a part of the capacity increase initiative has been to do more outsourcing and outsourcing to some of our suppliers that have done a very good job for us for a number of years.

And the-- the issues were around a couple of key suppliers that as they made the changes to their process to increase capacity and to manufacture the components for the new design, they just got tripped up and couldn't keep up with demand. And-- and we also had a couple of internal glitches in-- along the same lines where our own processes, as we implemented the changes we had a couple of hiccups.

For the most part, those are behind us. So we-- we would expect Q3 and Q4 to be much stronger.

Okay, so going forward there shouldn't be any additional delays to delivery?

Not that I know of. Obviously, these that hit us during the first part of this year we didn't anticipate, but we have those worked out. As far as we know, we're in much better shape.

All right. Thanks, I'll jump back in line.

And our next question comes from the line of Walt Liptak from Barrington Research. Please proceed.

All right, thank you. Good morning and congratulations on a good quarter and some improvement in margin.

Thanks, Walt, and good morning to you.

My question on FRG is the revenue, especially given in the first quarter I think there was some delayed shipment, the revenue was a little bit lighter than expected, so I wonder what the impact of Bronto was and if there are any other things that impacted the quarterly revenue?

Well, Bronto was pretty significant, but from the U.S. standpoint, we really didn't have any significant production issues in the second quarter at Ocala.

Okay. Can you quantify the Bronto impact?

The year-over-year reduction is-- was really in Bronto.

Okay. And-- and as we go and look at the third quarter, I wonder if there were any incremental costs in the second quarter that don't recur in the third? What I mean by that is Red Deer, maybe there were incremental costs that hurt the margin or Bronto? We talked about that. Can you quantify what some of those might have been?

I would just comment, the Red Deer closure, we think over the course of the year is going to be just a very small negative and we're not sure exactly which quarter that might fall in, so it could be $0.5 million in a quarter. It was not-- we did not have very much of an impact from Red Deer in the second quarter.

Okay. And then how about on Bronto?

Bronto's earnings are, in general, back-end loaded in the year and that's probably, if anything, more the case this year because of these production delays.

Okay. Okay and in your guidance you talked about EPS numbers and gave us a view on what those could get to. I wonder if we could go through the groups and talk about what-- are we going to see sequential margin improvement throughout the rest of the-- I guess, obviously, that has to happen, but maybe I get a little bit more detail on what you're expecting for the third quarter?

I guess the main thing to keep in mind is that our environmental products business is always the strongest in the second quarter, just because of orders cleaning up roads and things like that. So they-- that's just, I think, something you should keep in mind.

Fire rescue tends to be the strongest in the fourth quarter and second strongest in the second quarter.

Safety products we should continue to see improvements as the year progresses, except you need to keep in mind that they had that product line sale gain in the third quarter last year.

And tooling tends to be weaker in the third quarter because of auto shutdowns and also kind of a slower European market.

Okay.

So I think it's mainly seasonality factors that you need to consider as you look at the rest of the year.

Okay, got it. Thanks for that. And then with regard to the industrial vehicles, I wonder-- I know we talked about this last quarter, but have you looked into the pre-buy situation if you are getting impacted by that or is there any change to that and what that may mean to the order trend in the back half of the year?

Yes, the only area where we see a little bit of pre-buy is in the industrial vacuum truck and we are seeing a little bit of it, but-- but not much. So we don't think that that's going to be a big impact on us.

Okay. Okay. Thanks very much.

And our next question comes from the line of Ned Borland from Next Generation Equity Research. Please proceed.

Hi. Ned Borland.

Good morning, Ned.

Two quick ones on orders. In the environmental segment, were there any particular orders that were of a larger nature like the Kuwaiti order?

No. We didn't have any of those this year-- this quarter.

Yes, it was very broad-based strength, which is good.

Okay. And on the fire rescue group, is there any way you can give us the orders ex that KC order that sort of inflated the second quarter of '05?

Did-- have we--? I don't think we disclosed what the level of that order was.

Well, I mean, would it make the orders positive?

Yes.

Oh, sure. Oh, yes. That was a big order.

Okay. Let's see and on the pension with the contribution, what does that do to the funding status of the pension?

At the end of last year, we-- the gap between our funding and our PBL was just under $50 million. It ballooned because of the change in mortality assumptions. So we were just a little over 70% funded. The $10 million eliminates, I guess, a fifth of that.

The other thing that will happen as we look at the end of '05 is that our discount rates are moving in our favor for a change. So that should also improve that funding gap by another $10 to $15 million.

Okay. Thanks.

[OPERATOR INSTRUCTIONS]

Okay. Janelle, it sounds like we've covered it. I would like to just end the session by thanking everyone again for your interest in Federal Signal, for your continuing support of what we're trying to do here and look forward to our discussion three months from now. Thanks, Janelle, for a very fine job and have a good day, everyone.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.