Federal Signal Corp (FSS) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2006 Federal Signal earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Miss Stephanie Kushner, Chief Financial Officer. Please proceed, ma'am.

Good morning and welcome. Before we begin I'd like to take the opportunity to introduce Dave Janek, our new Vice President and Treasurer. Dave came to the corporate office about two months ago after spending the past four years as Vice President of Finance for our Safety Products Group. Dave will also serve as head of Investor Relations for the Company. So I'd like to turn it over to Dave for an important message.

Thank you, Stephanie. Good morning, everyone. 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 today for a more detailed disclosure of the risks associated with our forward-looking statements. These documents are available on our website, FederalSignal.com. I will now turn the call over to Bob Welding, our CEO, for his initial comments.

Good morning, everyone. Thank you for joining our third-quarter conference call. As you will note from our press release, we continued to report steady progress toward restoring Federal Signal's profitability. Successfully executing our strategic initiatives has effectively positioned the Company for sustained revenue and economic growth. This quarter we've posted earnings from continuing operations of $0.22 per share, compared to $0.29- in the year earlier period. But the period last year benefited from a $0.13 gain from the sale of two industrial lighting product lines. Serving out the one-time gain, our earning per share grew by about 38% on a year-over-year basis.

Importantly we continue to make meaningful progress in transforming our business in line with our new vision of becoming the leader in advancing security and well-being for communities and workplaces around the world. Some recent examples -- we delivered an E1 command and control vehicle to the city of Chicago. Our tsunami warning systems are being deployed in the Pacific region to help protect people and property. Our integrated security systems are being deployed in critical government buildings. And in the Persian Gulf, our integrated communications and warning systems remain in demand for high-profile industrial installations.

Our new strategy and vision are in concert with what's going on in the world today. Government, municipal, and industrial leaders are expected to provide for enhanced security and well-being in an increasingly uncertain world. They desire integrated solutions with increased functionality and intelligence. Federal Signal's been able to leverage its core competencies to provide solutions for these pressing market needs, and in the process position the Company for growth and prosperity.

Offering customers integrated solutions is a logical progression from our core strength, and the concept is not new to Federal Signal. For example, our federal APD parking business has been providing integrated solutions to the parking industry for years. A few years ago, Federal APD developed and implemented an integrated next-generation system targeted at the large airport market. This solution introduced security features of interest to local law enforcement agencies in addition to features that improve reliability, revenue collection, and customer convenience for the airport. The system was enabled by software and controls that integrate APD's traditional mechanical and revenue control equipment with added intelligence and analytical capability. This important shift in how we position our company is already opening new doors for Federal Signal.

For example, during Q3, we shipped two large-scale integrated security systems for high-profile buildings and industrial complexes. These systems provide a customized and comprehensive array of sensing and communication and warning functionality. One is for a US government building in Washington, and the other is for a new liquefied natural gas plant being built in the country of Qatar that was covered in our press release yesterday. Total revenue earned for these projects exceeded $2.3 million. Previously on the same projects, we might have sold box products for perhaps 20 to 30% of the revenue that we were able to realize by providing the integrated system solution.

Now I'd like to turn the call over to Stephanie, who will provide an overview of our orders and markets and details on our financials. Then following Stephanie's comments, I'll be back to address performance in our four business groups and provide a few final thoughts. Stephanie?

Thanks, Bob. I'll begin by commenting on conditions in our broad markets, then cover results from our four business groups, and conclude by discussing our consolidated information and outlook before turning the call back over to Bob. Third-quarter orders were solid, up 6% from last year. As many of you know, we segment our markets into three major sectors, US municipal and government, US industrial and commercial, and non-US. US municipal orders totaled $102 million. 8% lower than the corresponding quarter in 2005. This is the first down quarter we've seen in eight quarters, but we don't believe it is indicative of any fundamental municipal budget weakness. Rather the relative weakness was focused in just two of our seven product lines. And these are situational.

Sewer cleaner orders were down from last year, but last year included a significant order speak driven by demand resulting from Hurricane Katrina cleanup efforts. And fire apparatus orders were weak due to some of the dealership change we're making and the delay in the release of fire grant money. Bob will comment some more on the fire apparatus order trend. I would characterize the US municipal market as one where the growth rate has leveled off but we expect orders to continue to grow for the foreseeable future as budgets aided by increasing tax revenues continue to grow. Moving on to the US industrial and commercial sector, overall orders of $77 million were up 6.6% compared to the third quarter of 2005. And the strength was nearly universal across our markets.

Outside of the US, orders rose to $104 million, up a very impressive 26% year over year. Demand for our Bronto aerial devices accounted for much of the improvement but we are also seeing robust demand for our pullies, lights, and sirens where we believe we are picking up market share in many areas of Europe and Asia. Non-US orders represented 37% of our new business compared to 30% in Q3 last year. We anticipate that the share of orders represented by the non-US market will continue to grow in coming quarters. You may recall that we have a medium-term target of growing our non-US sales to reach 40% of our total revenues.

Now I'll talk about results from our four business segments beginning with the safety products group. Safety products posted another excellent quarter with orders up 23%. Year to date orders for this group are now up 20% from the same period of 2005, despite last year's divestiture of an $11 million industrial lighting product line. Back on for safety products was $69 million, up 19% from year end, and about the same as a year ago despite the $12 million reduction in our parking business backlog which is occurring as planned as the large airport contracts are built out. This business is positioned for strong fourth-quarter deliveries. Sales totaled $78 million, up 16% from the year-ago period. All businesses were up nicely with the exception of industrial lighting which was affected by the product line divestiture.

Our operating margin averaged 13.6% this quarter, versus 14.2% a year ago, if you exclude the $6.7 million gain on the product line sale. The 60 basis point reduction was at the gross margin level, mainly in our European police products business and in our mine lighting business where we experienced some commodity price squeeze primarily on our heavy brass electrical couplers and in our parking business, where we are working to complete the final go-live stage of the Dallas-Fort Worth airport parking installation. Regarding DFW, we have had a dispute with our customer about the final reporting features of the system and they contend that we are in default on our contract while we disagree. While the two parties' lawyers are working toward a solution, contract work continues, and we are working with DFW to agree a change order for the job. Assuming this dispute is resolved and with pricing actions that have been taken to cover commodity cost increases, we look forward to a modestly higher margin for the group in the fourth quarter.

At the beginning of the year, we were forecasting this business to deliver 4 to 6% top line growth, modest by historical standards due to the product line divestitures. However, demand has been stronger than expected, and we have made share inroads in our pullies products business. And we have booked some complex integrated warning and communications systems projects. We now believe the full-year sales will be up 9 to 10% for safety products with average margins slightly lower in the 13 to 13.5% range. And the business will start 2007 with a very strong backlog.

Fire rescue's third-quarter results were mixed. Orders rose 3% from a year ago, but the big story continues to be our Bronto aerial business, which is seeing high double-digit increases in orders. Our municipal orders for North America are down from last year, which largely offset Bronto's strong performance. At quarter end our backlog remained strong for FRG. $234 million, unchanged from January 1, and down slightly from $238 million a year ago. At $86 million, third-quarter sales fell 6% below prior year due to a weakness in North America's shipments. The operating margin rose to 2.7% from 2% a year ago. The 70 basis point increase includes two significant items. The business benefited by $1.6 million due to the settlement of pending litigation associated with the components used on trucks sold to the Dutch Air Force under a contract that was closed out in 2004. And the business incurred $700,000 in closure costs associated with the wind down of production at our Canadian fire truck plant. The net of these unusual items increased margins by 1%.

Final shipments out of the Red Deer, Canada, plant are scheduled for November. We will close on the sale of the facility next month, receive about $2 million in proceeds, and record a small gain, which should offset most of the further closure costs.

Absent the unusual items, our margins declined slightly year over year due to lower sales volumes in North America, particularly for traditional aerial units and rescue vehicles. Regarding fire and rescue's full year, we now project top line sales for this group, up only 3 to 4%, versus the 6 to 8% forecast provided at the beginning of the year. And operating margins will be up from 2005, but slightly below the 2.5% low end of the range provided in February. Nonetheless, this business will report its second year of operating income and EV improvement, has a healthy backlog, and will be positioned for further earning improvements next year.

Our environmental products group had an outstanding quarter. Orders were up only slightly from last year, but the year earlier period included an initial demand surge for sewer cleaners and industrial vacuums due to the impact of Hurricane Katrina. Quarter-end backlog totaled $111 million, up 31% from a year ago, and up 24% from the beginning of the year. This business has experienced very strong order demand. Employees at our Vactor-Guzzler plant in Streeter, Illinois, have been pushing capacity limits all year and establishing production records in order to deal with the surge in orders.

Operating margin for the group averaged 9.5%, up sharply from 7.2% a year ago. The 230 basis point increase was mainly attributable to higher gross margins with all operating units posting increases. Selling, engineering, general, and administrative as a percent of sales is also down slightly due to volume leverage, despite increased spending on the ERP implementation, the setup of the China joint venture, key technical headcount additions, and higher bonus expense. We had come into the year expecting 5 to 7% revenue growth for this group, but we now expect growth to be nearly double that level for the year. Our targeted operating margin range of 8 to 9% remains valid, although we are likely to be at the high end of that, and we expect to finish the year with very strong backlog.

Our tool business had a disappointing quarter due to weak operating results in our dye, punch, and mold tool operations, where volumes are lower due to production and development cutbacks by the automakers and their suppliers both in the US and in Europe. And to lesser extent due to the weak US housing starts. Lower volumes impacted year-to-year profits by $1 million. Net margins also declined because price increases did not fully offset higher operating and wage expenses, and there was a higher mix of less profitable custom punches. Although it did not impact the year-to-year comparison versus our expectations last quarter the business was also impacted by lower productivity and higher overtime at our Dayton, Ohio, plant.

In February of this year, we expected our tool business to grow revenues 5 to 6%, and improve operating margins to the 11 to 12% level. Given the weak performance of this segment, particularly the impact of the automotive customers and lower productivity in our dye components business, it now appears that full-year sales will be flat with the prior year, and average operating margin will be in the 9 to 10% range with no meaningful improvement from 2005 results.

Now I'd like to continue with a summary of our consolidated information. Third quarter sales of $298 were up 4% from the year ago. Of the $12 million increase almost all was due to higher prices, particularly for our vehicle companies where material prices are being recovered with the end customer, and some improved margins are being realized. As the consolidated growth margin improved to 26.8% in the quarter, up both sequentially and against prior year on a continuing operations basis. Due principally to higher environmental products margins. 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 few years. Our selling, engineering, general, and administrative expenses as a percent of sales rose to 20.3%, up from 19% a year ago. This brings the year-to-date figure to 20.1%, slightly above 19.8% for the first nine months of 2005.

During the quarter we took a net $500,000 charge associated with the curtailment and revaluation of our US defined benefit pension plan. As part of our ongoing strategy to commonize our various benefit programs, the Board has approved the adoption of a single enhanced defined contribution retirement plan for all US employees. And the soft freeze of our previous defined benefits plan. The new plan will be effective on January 1.

As a reminder, for the full year of 2005, SEG&A expense averaged 19.8% excluding the impact 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 some slight further improvement in the percentage by year end despite absorbing the negative impact of the accounting change for stock options and some unusually high severance expenses.

Corporate expense at $5.7 million was slightly below the prior year but up sequentially in the quarter. Versus a year ago, legal costs associated with the hearing loss defense case were $600,000 lower because the case has been delayed due to reassignment of the judge and prolonged Discovery. We expect relatively lower costs to continue during the fourth quarter. Our full-year estimate for corporate expenses has declined to $23 million. Interest expense was $5.9 million this quarter, equivalent to the prior year. The relative increase in short-term rates was offset by lower overall borrowings. Our income tax rate on operating earnings was 20% in the quarter versus 17% for the year ago period. The 2005 rate included tax of only $100,000 on the pretax gain from the sale of product lines of $6.7 million. Putting aside this favorable tax impact, the 2005 rate would have been 27%. The current quarter's rate was lower due to a foreign tax issue which was resolved in our favor, and better export tax benefits than previously forecast. We have revised down our expected effective tax rate this year to be in the range of 26 to 30%, improved from our prior guidance of 30% to 33%. The low end of the range assumes Congress will extend the R&D tax credit.

The loss from discontinued operations totaled $1.2 million after tax compared a loss of $3.6 million last year in the period. During the third quarter the company ceased production and completed the sale of refuse assets to Labrie Equipment, Limited. We also recently reached an agreement to sell the Medicine Hat production facility for about $3 million, which should be completed before year end.

Operating cash flow was $14 million in the quarter compared to only $3 million in the prior year period. On a year-to-date basis operating cash flow is $15 million versus $39 million last year. We're increased working capital this year in part to hold more stock vehicles for sale and to support the increased sales level and also to pre-buy some 2007 engines. Bay comparison last year we were reducing receivables significantly at fire rescue. We also increased our discretionary pension contributions by $3.5 million this year versus the prior year-to-date period and have experienced lower run-off of our leasing portfolio. At 20.2%, our nine-month average operational working capital as a percent of sales is just below 20.6% a year ago. We still expect to see significant reductions, $25 million or more, in the fourth quarter. And remain committed to a gradual reduction in working capital to 15% of sales over the medium term.

Turning to non-operating cash flows, in the third quarter, we repurchased a further 400,000 shares of Federal Signal stock, which was authorized by the Board in July. This purchase totalled $6 million and brings the total to $12 million for the year. This completes the authorized repurchases for 2006 and offsets dilution for both 2006 and 2007 associated with our stock-based compensation plan. At quarter end, our manufacturing debt was $239 million, down $37 million from year end. Our manufacturing debt net of cash rose to $219 million from $184 million at year end 2005. And at 37% of capital reflects a working capital increase, the planned pension dispersements, and stock buy-backs.

During the quarter we borrowed a further $24 million from the Banc of America leasing facility, and our $125 million revolving credit facility was undrawn at September 30. We continue to have a comfortable liquidity cushion. Cash plus available debt capacity in excess of $100 million, and we're in compliance with all debt covenants. In November, we will pay off a $25 million traunch of long-term debt that matures using operating cash flow and available credit lines. 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 on track to deliver performance at the high end of this range for 2006. With that I will turn the call back over to Bob for additional insights.

Thank you, Stephanie. Beginning with the Safety Products group I would like to comment on developments in each of our four business segments. Safety Products had another strong quarter for new business and as Stephanie mentioned margins for the group continue to be strong in spite of increased investment for new product development. The exciting new systems I discussed earlier are part of the story, but demand for the group's traditional products continues to be robust in all three market segments. At this point, we see no weakness in the coming months.

Our environmental products group continues to improve margins with strong, new business levels and operational improvements, while funding increased spending on its strategic initiative. The completion of the refuse divestiture, the leadership of EPG now has been able to devote their attention to growth strategies for the core products, where we have considerable strength and enjoy sustainable, competitive advantages. EPG's innovative, waterless sweeper models that were introduced into the US market in the last 12 months are ramping up quickly after having demonstrated superiority over a competing brand, which were subsequently withdrawn from the market. During 2007, EPG will introduce a number of new, innovative products in the North American, European, and Chinese markets. In all instances, consistent with their DNA and the Federal Signal product leadership focus, the EPG product offerings around the world will be clearly viewed as the performance and durability leaders.

Next I'd like to discuss developments in fire and rescue. Although the group exhibited improved margins compared to the year earlier period, results were not as positive as expected. And while new business, revenue, and income at our finished Bronto unit exceeded expectations, our North American unit had weaker results than anticipated.

I'll drill down into each of these markets beginning with North America. The intensive operational improvements underway in our Ocala, Florida, location are continuing to gain traction, and the progress remains evident across the spectrum of measurements. I continue to be pleased with the progress and commend the performance of our management team and all of our employees there. However, new orders in the North American market were weaker than expected during the quarter. This had a cascading impact on revenue as some of the shortfall was in our pipeline units that have short lead times.

A portion of the new business shortfall is the result of the late release of the 2006 round of FEMA grant money which didn't occur until early October this year. Certainly another contributing factor was stress in our dealer channel, induced by the changes that we've been making to the front end processes of our business. Including the rollouts of our new EZ-ONE configurator tool and changes in channel structure and policies. Over the past several weeks, we've launched EZ-ONE modules for the remainder of our aerial lines, as well as for our arts. With these added modules, about 90% of our offerings by volume are now structured.

Ongoing enhancements to EZ-ONE will help us to continue to reduce lead times, sustaining the progress made in the past year. As an example, in our most complicated custom pumper line, unless something very unusual is specified, the lead time has been reduced by about two months. We're now down to about five months and still improving. Although EZ-ONE has already had an undeniably positive impact, we're still working through learning curve issues in our dealer channel and to some degree internally. This structured approach to configuring a highly customized fire truck is a huge change for our employees and our channel partners. We've recently stepped up our training activity to accelerate the learning curve.

While our sales force is increasingly enthusiastic about the power of the tool and the validity of the approach, the initial ramp-up resulted in delays. This impacted our new business to some degree in Q3, as some deals were simply not able to be finalized as expected. We're working through the issues in our front end processes and policies. Many dealers recognize that even though they may not like some of the changes. They are necessary, and as a group, they've been very helpful and supportive. We deeply appreciate their involvement and commitment to work with us to return the E-ONE brand to the leadership position which will enable everyone to prosper.

To accelerate the transition, during the quarter, we added three new aerial experts to our field sales force, providing additional technical resources to help our dealers sell these complex products. Also, five additional direct sales resources have been employed to augment regions where we are undergoing dealer transformations or to support our focus on targeted accounts. We're confident that this more intensive involvement with our customers will help us get through the transformation as quickly as possible.

Moving ahead now I'd like to discuss our Bronto unit. Their Q3 order set another record as fire apparatus markets around the world continue the transformation from ladder-based aerial devices to the more versatile, articulated aerial solution. This conversion is much further along in Europe and Asia but remains at the early stages in North America. We estimate that Bronto enjoys over 50% of the worldwide market for articulated aerials in the fire-fighting industry. Bronto has been able to capture this commanding position by leveraging its outstanding reliability record and continuously raising the performance bar through the introduction of improved products and increasingly sophisticated controls. The most recent example of this innovation stream cited in a press release a few weeks ago is Bronto's newest offering, an aerial that can extend up to about 34 stories of a highrise building. 2006 Bronto orders will be substantially above 2005 with more growth beyond that. This remarkable growth resulted in some capacity issues in the second quarter, but initiatives implemented to address this have put our operations in Finland back on track early in Q3.

Now back in the US, I'm confident that FRG will continue to make progress in the coming quarters. Critical changes in our market facing processes will be far enough along, and we plan to introduce three new products at the fire industry show in April on top of our new Bronto offering. Combined this will enable market share recovery during 2007 and beyond. Our intensive cost reduction efforts are continuing, empowered by EZ-ONE and dedicated cost reduction teams. This will enable us to sustain our margin recovery progress.

During the past few quarters we've seen increased competitive activity in certain segments of the market which has resulted in additional price pressure. We intend to maintain appropriate discipline to ensure our work to restore margins continues. But at the same time, we're increasing our cost reduction efforts to make sure we're not at a disadvantage in the event this would continue. I'll comment briefly on 2007 engine emission changes. Truck chassis and engine prices are increasing significantly with the 2007 engines, but this has been understood for some time, and we have the increases reflected in our pricing. We believe we are protected for the upcoming transition. For some specific applications, we are buying chassis ahead at both EPG and FRG and at FRG we are purchasing additional 2006 engines to provide some cushion during the changeover. These pre-buys had some impact on inventory in Q3, and will have additional impact in Q4.

At the recent IFC fire show in Dallas, E-ONE was the only manufacturer that showed a custom chassis with a 2007 engine installation. We expect to have 2007 equivalents for all of the engines we currently offer in our custom chassis and we are already accepting orders for fire trucks with these 2007 engines.

Now let's move on to the tool group. Stephanie covered the market and operating particulars very well. So I'll just comment that our people are working very hard to extend our reach into new accounts and new industries to offset the softness in the auto and housing sectors. On the metal forming side, they've been able to accomplish this so far but have lost some margin in the process. On the cutting tool side, our team at Clapp Dico has made progress in expanding their business with Japanese and Korean OEMs, and in non-auto-related industries.

Internationally, we are welcoming some signs of recovery in Europe, as auto projects that were on hold are gradually being reactivated. Looking out to the remainder of the year, we expect the tooling markets in North America to remain weak but anticipate positive momentum in Europe. Even with the pressure on pricing that we would expect to continue, margins in the tool group should recover in Q4 as a result of our Dayton, Ohio, unit finally getting through the productivity issue I discussed last quarter.

In summary, Federal Signal remains on track to meet the revenue and margin goals articulated by management in late February. We're pleased with the progress our businesses are making, and we continue to address issues that have affected progress in specific areas. I'm confident in the Company's ability to reach its 2006 goals. Longer term, we're positioning the Company to more fully address the highly fragmented $60 billion global security market, which is growing at 8 to 9% per year. As we align more of our resources to provide integrated solutions in the security space, in the coming years we should be able to grow an increasingly larger portion of our business in step with the higher growth rate of this market.

I've mentioned the growth of businesses within SPG as a result of larger system solutions. Similar work is occurring in FRG and EPG but changes there will appear more subtly as market share growth over time since complete systems are already provided in the form of vehicles. New product development is also underway within our tool group which will become apparent in the coming years when tool begins offering innovative solutions that help industrial customers reduce their manufacturing costs. Tool will also begin to take advantage of the investment in their new China plant in 2007 as shipments begin early in the year.

As we've communicated previously, management has targeted high single digit revenue growth rate for the overall business, and we would expect to achieve roughly 2/3 of this expansion from organic initiatives such as the examples mentioned earlier, and about 1/3 from strategic acquisitions. We have nothing to disclose today on the acquisition front, but we're working on a list of targeted technologies and companies that we would like to acquire in order to fill some identified gaps. Discussions are underway in a number of these cases, and we expect to make some announcements in the coming quarters. We're committed to making acquisitions that support our growth initiatives such as filling a product or technology gap or providing expanded distribution in regions where we might be relatively weak.

Finally, I'd like to announce the newest addition to the Federal Signal leadership team. Mike [Wans] will be joining us in November in the capacity of VP and Chief Information Officer. Mike's background is a perfect fit for us. He has considerable experience in the nuts and bolts ERP implementation side, as well as a keen understanding of the leading edge technologies that Federal Signal is increasingly incorporated into our products and solutions. Mike has spent the last four-plus years at Microsoft as the lead technology strategist for the global financial services group. Prior to Microsoft Mike served in IT leadership roles in a number of manufacturing and logistics firms including 13 years at Waste Management during the time they were busy consolidating the industry, and knitting together disparate ERP platforms.

So I'll bring our prepared remarks to a close by saying that -- well, what I've covered this morning are the early steps in a journey that will transform Federal Signal from a diversified industrial business to a company with a laser focus on security and well-being solutions. We have a lot more work to do, of course, and we have short-term problems yet to resolve. But I'm very happy with our progress and look forward to providing updates on our progress in future calls. With that, I'd like to open it up for your questions.

Yes, sir. [OPERATOR INSTRUCTIONS] And your first question is from the line of Jack Kelly of Goldman Sachs.

Good morning, Bob.

Good morning, Jack.

Just a two-part question on fire. One on production and one on distributors. On the production side, based on the numbers that Stephanie gave, it looks like margins were down year over year. Because you mentioned the 1% benefit. So we're kind of down on margins. And -- and while I understand some of that was probably hit by sales being a little bit light because of what you described in the municipal market, I still would have thought year over year given the big effort on the factory floor at E-ONE that we would have seen some improvement. So I guess the thrust of the question is in the last three our four months, is what you expected to happen on the factory floor happening? And at the pace you expected?

I'll let Stephanie comment on the margin first, Jack, and then I'll jump back in.

Jack, you -- yes, you're correct. If you take out those two items, our margins would have been down by 30 basis points.

Okay. From the improvements on the factory floor, in fact, gross margins are up. So from a material cost, a direct labor productivity, and overhead, our guys keep continuing to make progress. So what is impacting us, of course, is the -- for the most part is the volume. The lower volume which we weren't expecting in Q3.

Okay. And then secondly on the -- in terms of your distributors, I guess a couple of things. One, in terms of you mentioned coming up the learning curve. Could part of it be that as you price the products more efficiently from your perspective that you're becoming less competitive in the marketplace because effectively your price is going up? In other words, in the past maybe the vehicle wasn't being priced correctly. Now it is. Does that hurt volume? Secondly, you mentioned transformation of dealers. Could you just give us a sense of where you are in that process, how many more have to be replaced, or what gaps you have?

Sure. First of all, from the pricing standpoint, you're right, Jack. EZ-ONE has given us now the structure in order to be able to understand our cost much more accurately and what kind of selling price is appropriate. As we look at the discounts levels, they're really not that much different than they have been in the past. In fact, over the last 12 to 18 month our discount levels actually have been coming down a little bit. So we don't think that the EZ-ONE has resulted in us pricing ourselves out of the market.

What is occurring, though, is that in some specific segments the competition has increased. And with that there is some pressure on prices that is not related to EZ-ONE. As we're digging into this and we're finding some additional issues I guess in the way that some of our policies are applied between the Company and the dealer channel, we've uncovered some other problems that we think will help us attack that. We're not concerned, Jack, that now that we do understand our costs better that we can't be competitive. EZ-ONE has given us the transparency into -- we're able to much better understand what the costs are, but it's really also helped us to reduce our costs substantially over the last couple of quarters. Our labor efficiency improvements have been pretty remarkable across a number of our product lines. So that's what -- that's the benefit we're getting.

Okay.

Comment on dealers.

I'm sorry. Yes. On dealers, this really started about two years ago. There are about seven dealers that were with us two years ago that are no longer with us. Now that's a combination of dealers that we've encouraged to resign, dealers that have elected to resign, and then some that went bankrupt. And the bulk of those in the bulk of the cases, they are dealers that went bankrupt or we encouraged to resign. So they're seven out over the last two years. And actually, we were just looking at this this morning, there are seven in. We haven't -- we've added in -- three of those seven adds were in regions where we were not well represented in the past, and we've talked about those. For example, California and Ontario. Minnesota is the third one. So of the other four we've replaced dealers in most of the locations. And we still have a couple that we're working on and hope to have some announcements over the next couple of months.

Okay, good. Thank you.

And I would add, too, Jack, that in those regions where we do have an opening right now, we put some direct resources there in order to make sure that we're not leaving the market uncovered.

Basically of the seven that were gone, you're really looking to replace I guess three?

Four.

Four, right.

The next question is from the line of Walt Liptak of Barrington.

Good morning. I'm with Barrington. My question, I guess, I'm not understanding the volume decline in FRG. And I wonder if you could -- because it appears the backlog is high enough at 234 million. What are the issues or is there an issue getting throughput at the Ocala facility?

Actually through-put continues to improve. Part of the backlog increase is the fact that, on average the units have prices selling higher content and so on. But that's only a portion of it. We ended Q3 again with -- with a number of vehicles, quite a number of vehicles that were complete, but we were not able to ship because we couldn't get the customer there for the final inspection, and there were a couple that the -- the financing wasn't in place. So we did have some hangover from the third quarter that was much higher than what we expected. So from a throughput standpoint, we keep getting better and better.

So if I'm understanding this right, then the profitability should improve in the fourth quarter because you're going to have better volumes and better overhead absorption?

Yes. Now the -- yes. Yes. We should. The unit that we completed in '03, of course, absorbed that overhead. If we only shipped those and didn't have a full schedule to build in the fourth quarter, that would impact us negatively. But we -- with those backlogs, we have every production slot filled in the fourth quarter. So we expect to do much better.

Okay. Okay. Thanks. And then -- Stephanie, on the working capital you mentioned that the inventory was up, and I think you said primarily because of the -- the pre-buy of 2006 engines in front of the 2007 emissions change for diesel engines--?

Sorry, I wouldn't have said primarily because that's actually a relatively small number. It's -- more of the increase is taking place at fire rescue.

Okay. So the reason that Bob just mentioned because of the orders that slip into the fourth quarter?

Yes. The pre-buy is pretty modest in the third quarter, although it will be a little bit more in the fourth quarter.

Okay. So I imagine that any engines that you bought will be out of your inventory by the end this year or do some of those -- will you be shipping trucks, in either FRG or EPG in 2007?

Yes. We'll -- well, we'll still be shipping trucks in 2007. The -- the law is that those 2007 engines, the changeover occurs with the build of the engine, not the build of the truck that it goes into.

Okay. And you mention that you're compliant for 2007. You're already ready with trucks that you expoed at [NALIS]. I wonder, have you taken orders already for trucks with the 2007 engines in it?

Yes, we have.

Okay. Thank you.

Your next question comes from the line of Charlie Brady of BMO Capital Markets.

Hi. Thanks. Good morning. On fire rescue segment in regards to the fire grant, have you seen in the fourth quarter that we're in any impact from those grants finally coming out? I know it's early, but just curious on that.

Yes. We -- there were a number of deals that we were on where the customer was waiting for the disbursement so we've seen movement on some of those, although as you say, it's only a couple of weeks ago that the money was released.

Okay. I just wondered on the pricing and the orders, the order was up 3%. In looking at your backlog, how much that is attributable strictly to higher prices this quarter?

We don't -- we don't actually segment our backlog into kind of price versus volume. We do that on the revenue side. I'm going to guess, though, that it's probably approaching 10% of the increase year over year.

10% of the 3%?

I'm sorry -- I thought you were talking about backlog.

Well, I -- it was both. I'm just trying to -- on backlog, it's probably 10% of the increase. If we look at -- at orders being up year-on-year, I get the sense that a good part of that might be due to pricing.

Yes. I think that's fair.

Okay. Can you quantify if you exclude Bronto just in the US how much orders might have done down without Bronto at all?

We don't actually disclose individual product line volume details.

Okay. And just from the operating margin for fire then. Looking into the fourth quarter, is it -- given your comments. Is it fair to assume then that the operating margin and if we include the -- if we include the items that you had in the quarter which kind of propped up the margin a little bit that the fourth-quarter operating margin should be up slightly year over year, Q4 versus Q4 of '05, or would you expect that to be lower year-on-year?

I -- it's -- we had a pretty strong -- let's see, last year we were at 3.7%, so I think I would say comparable.

And would a majority of that be because you sort of had built-in shipment kind of waiting to go out the door that slipped from Q3 into this Q4?

The toughest thing for us is always balancing, we always have a stock of trucks on hand at the end of a quarter that are waiting for customer pickup, and it's always tough, particularly in the holidays at the end of the calendar year. So we're not actually counting on a lot of reduction in that overall stock level. If we're more successful it would be beneficial to our reported margins.

Okay. But if we -- if we look at the orders that -- because the financing wasn't in place so we couldn't get the customer in to do the final inspection at the end of Q3, was that out of a normal range for what you would have expected at the end of a quarter?

Yes. Yes. I think -- there was more of that impact than we've seen in the past.

Okay. On the tool side of the business, can you quantify just how much of a drag on margin was due to the productivity issues?

Well, if you look year over year, our productivity was really comparable this year versus last year. The negative impact is really against where we had expected it to be in this quarter when we talked to you three months ago. But on an absolute level -- think of it this way, last year -- sorry, during the course of the third quarter, the productivity was improving. So we left the quarter at a higher productivity level than we were at a year ago, but on average, it was comparable.

Okay. And in your comments, you talk about the pricing not -- kind of material costs outweighing the pricing. Can you give us a sense sort of what that spread looks like and do you expect that gap to narrow in Q4 or when do you expect that to narrow?

The -- we do expect it to narrow. And part of the reason is that in the third quarter of last year, we benefited -- our materials costs were relatively lower. We had prepaid some material surcharges as part of negotiations to lower some of the purchase prices in the second quarter of 2005. So on a relative basis, this quarter looks bad relative to last quarter but I think next quarter we ought to see something that's more neutral year over year.

One question and I'll get back in the queue. On your stock repurchase in the quarter what's the average price that shares were repurchased at?

I'll look for that maybe while we go on to the next question, okay. I can't remember the number.

Thanks.

All right.

Your next question is from the line of [Steve Barger], KeyBank.

Hi. In the press release you talked about higher spending on growth initiatives. Could you describe what you're targeting and how far along are you are in the process, how that's unfolding.

Okay. What we said in February as we rolled this out, that we intend to increase our spending in two areas. For -- to pursue white space opportunities and new product development. That's in the area of market intelligence and of course product engineering for new products. At the time, we said that our target was to increase the -- that spend by about 0.5% point over the year. And probably by the end of the year we'll be there, but certainly if you take the overall year it will be less than that. So we've increased spending in that area. We've also -- we're also implementing a JD Edwards installation in our EPG group. We've -- went live on our first location earlier this year, and we'll roll that out over the next several years. And also we are funding the China JV for our EPG, we're funding a China startup for our tool group. And we've been funding some other growth activities outside of North America that we -- we don't have any further comment on at this time.

And one other area is our environmental products group has been launching a dedicated service parts business. Prior to this each of our business within safety products distributed their own parts and we now have a dedicated management team, and they've been implementing that through the year. So, the ERP spending will continue for the next several years. New product development, of course, we'll continue to expand. But we intend to offset those increases through reductions and purchased material costs and productivity in our plant. But that will continue to grow into next year and the year after that.

Okay. You talked about the three direct Bronto salesmen to help the dealers understand the product, and I think five other direct salespeople that you've deployed. How do they fit in relative to the dealer channel? Are they directing sales there, or are you taking more sales direct?

Okay, the -- I have a couple of answers to that, Steve. The three aerial sales specialists are not only helping with Bronto but also our traditional ladder-based aerial apparatus. These products, both the ladder-based ones and the articulated ones, are relatively complex, and for some time, we've assisted our dealers in making these sales by providing experts from the factory. So what we're doing is we're augmenting that force of people that are helping our dealers. And typically we would take a unit to the dealer location, one of the specialists would go there, and for several days they would go around to the various fire departments and demonstrate these products. So we're just going to do more of those. And in particular, the Bronto is much different, much more sophisticated than the aerial device so we need to provide more intimate support.

In the area for the five additional direct salespeople, it's a combination. In some cases in these areas where we do have an open dealer position now, we have inserted some direct salespeople into those regions to bridge us, if you will. And in other areas we've targeted some key accounts where we haven't been very active over the last several years. And we're directing some people into those areas, as well. If there's a dealer in that area, they would be working with the dealer. If it's an area that's not covered right now, of course they'd be going direct.

Okay. Given your dealer footprint, going forward, do you expect a shift potentially of more sales going direct to you outside the dealer channel, or are you going to expand the dealer network to try and cover more of those markets?

Well, the dealer network has served us very well for many years. And things are changing now because the products are becoming more complicated, and the market is becoming more competitive. And so we need to be looking at those things in our distribution model where we need to make some changes in order to respond to what's happening in the market. So I guess I would characterize it like this, Steve, that as we go through time we'll probably have -- we will have more direct people out across the country, and for the most part helping our dealers with training salespeople, training dealers, helping them with the rollout of EZ-ONE, for example, helping with more complicated products, and in some areas we may not be able to find a dealer right away. And we're going to do everything that we can to maintain our presence in that market and to try to gain momentum. And so at least for a time those would be handled on a purely direct basis. It's difficult to say right now whether that -- whether that proportion would be changing over time although we keep looking for -- we keep thinking about ways that we can improve.

Okay. Thanks. And just one final -- you talked about increasing material costs at Ocala, but is that raw material or is there a component cost increase in there, as well? And can you tell us kind of what the items are?

If you look at it from a percent standpoint, copper is more than double what it was a year ago. So that affects us not directly, but indirectly. It affects us in electrical wiring, in motors, and it really affects us in brass because a large component of brass is copper. And if you look at the plumbing in a fire truck there's a lot of brass in there. So that's where it's impacting FRG.

Okay, thanks, Bob.

I'll come back on Charlie's question about our average share repurchase price. It was $14.90 in the third quarter.

Your next question comes from the line of Ned Borland of Next Generation Equity Research.

Hello, Bob, Stephanie.

Good morning.

Just one quick one here on -- I guess the commentary about the delay in the federal funding, the fire grants. How many of your -- how much volume or potential volume or potential customers do you think have been hanging back waiting for this funding, and what kind of a volume would you expect that to drive going forward?

I don't have a precise answer for that.

Let me -- let me try and give you some perspective. We've seen this happen once before. What happens when the grants are pending is that there is just some sluggish in getting the orders actually placed. It's important to keep in mind that with the grant program, only about 25% of the grants go to fire apparatus. So it's something north of $100 million a year in a 1.4 , 1.3 billion, $1.4 billion market. So it's not an overwhelming share but it's significant. And where it affects what people think they might be able to get a grant or where there's a question about where the grant money is coming, they do tend to hold back. We have trouble identifying exactly what share of our missed units aren't going to ultimately come through as a result of grants. But it's a similar fraction.

Okay. Thanks. That's all I had.

And your final question is a follow-up from the line of Charlie Brady. Please proceed.

Thanks. Just want to go back to the -- two questions ago on the direct salespeople that you're adding into the infrastructure. I mean, what sort of impact on longer term margins -- I would imagine that is going to have a negative impact at some point to some degree. But can you quantify what that would be?

Charlie, I don't think that this is going to have an impact on us in the medium to longer term. Certainly right now it's additional resources that we didn't have out there. But as we look at the overall pricing and discounting model that we've used over the years, we need to make some changes to that. We're committed to doing what it takes to restore the margins at E-ONE. At the same time, we're taking into account the needs of our dealer partners and making sure that there's an appropriate balance in there for the amount of risk that people are taking and the amount of involvement in making a sale. So if you look at our products, they're becoming more sophisticated, more complicated, and, therefore, more expensive. And if you can maintain the same margin even then you have some additional capacity to add some support. So at the end of the day, we believe that this is an important step for us to continue the progress that we've been making in order to restore our margins.

Okay. But just on the fire side, on the volume, the reason cited for volumes off in the quarter was changes in the dealer channel policies and the shortage of federal grants. And really the federal grant is really a pretty small piece of the overall volumes in the market. And if you're bringing in new salespeople, presumably it's going to take some time to get up to speed and make connections and try to run some orders in through that business segment. And I'm just wondering, then, would you -- what your expectation is really on getting volumes back up to a decent growth level over the next one to two quarters. I mean, is that really a reasonable expectation given what happened in the third quarter on the volume falloff?

We've been focusing on fixing a lot of thing in our business to make sure that we are getting ourselves into position where we can compete effectively and make an adequate return. We haven't been focusing on market share as we've been going through these things. Some of the things we've been doing we recognize have a negative impact on market share in the short term. We're most of the way through that now. We still from an internal process standpoint we're well on our way. EZ-ONE is nearly implemented. We're beginning to see the advantages of that as I cited in reducing labor costs and reducing lead times by a significant amount. These changes in our distribution channel were something that got underway later than the initiatives focused on improving our internal operations. And we still have some time before we get to the other end. But as I indicated in my comments before, we believe that we're getting to the point now that in 2007 we will be able to start recovering market share.

One of the problems even though we get good data in this business, good industry data from the pharma organization, the data isn't very timely. For example, the last numbers we have in 2006 are from the first quarter and on a quarter-by-quarter standpoint, we have to be careful because there are different drivers for different competitors that would cause one competitor to have a strong fourth quarter, for example, and a different competitor would have a strong third quarter. So we look at it on a year-over-year basis. And 2005 the most complete data, is that we were about the same as we were in 2004, even though a lot of these changes had been initiated during that time.

In 2006, we don't know for sure, but we won't be surprised if we -- if we do lose market share because of some of these changes that we're making. It just -- Q3 turned out to be a bigger impact than we expected. And some of it is because of these changes that we're making and some because of the other reasons that we cited. Don't know for sure, but we think that the fourth quarter is going to be -- we're going to have a better result, and we certainly are very confident that throughout 2007 that the things that we're doing will have taken hold and gained traction, and will show improvement in 2007 from previous years.

Okay. Thanks. Just a question on the tool segment again. I don't know if you mentioned already, I apologize. Could you quantify the cost for the global expansion, I'm assuming that's the thing going on in China; is that correct?. Or is there additional to that?

There are some other things going on in Eastern Europe and Russia and so on to get some distributorship started, and to set up some very small finishing operations, but it's primarily China. And we're looking at that number right now.

And just on the margins then, would you expect -- from the -- would you expect margins in Q4 to get back into a double digit range?

For tool?

Yes.

Yes, we are expecting tool to get back in double digits in the fourth quarter.

Thanks. That's all I've got.

This concludes the question-and-answer session for this call. I would now like to hand the call back over to Bob for any closing remarks.

Okay. Thanks, Jeremy. And we really appreciate everyone's interest, continuing interest in Federal Signal. Even though we didn't quite get to the finish line the way we thought we would early in the quarter, nonetheless we're satisfied with the results in the third quarter, our overall results. We have initiatives underway to address those areas that are not where we want them to be yet, and we'll make further progress in -- in the fourth quarter, and we're very excited about the investments that we've been making in expanding our product offerings, and believe that we're going to have continuing successes to report on in the fourth quarter and in the years ahead. Again, thanks for your interest and support and have a great day.

Thank you for your participation in today's conference, ladies and gentlemen. This concludes the presentation. You may now disconnect. Have a great day.