Federal Signal Corp (FSS) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2007 Federal Signal second quarter earnings conference call. My name is Eric, and I will be your audio coordinator for today.

(OPERATOR INSTRUCTIONS)

As a reminder, your conference is being recorded for replay purposes. I would now like to turn our presentation to our host for today's call, Mr. David Janek, Vice President and Treasurer. Please proceed, sir.

Thank you, Eric. Good afternoon, everyone. Joining me today are Bob Welding, our CEO and Stephanie Kushner our CFO.

Before we begin, please be advised that some of our comments may contain forward-looking statements about the future prospects of Federal Signal. As such, please refer to our latest form 10k filed with the SEC and news release issued in conjunction with the conference call today for a more detailed disclosure with the risks associated with the forward-looking statements. These documents are available on our web site, federalsignal.com.

I will now turn the call over to Bob.

Thanks, Dave.

Good afternoon, everyone. Thanks for joining our second quarter 2007 conference call.

I'm pleased that our results for the quarter indicate several encouraging signs of improving performance, including better gross margins, higher operating cash flow and lower debt. We experienced strong revenue growth in both our environmental solutions and safety and security systems groups, the latter being up an impressive 27% year-over-year. Additionally, we announced a small but strategically significant acquisition of Riverchase, a developer of public safety software which takes us another step towards realizing our goal of becoming a leader in enhancing security and well being for municipalities and workplaces around the world.

Despite these positive developments, our results were adversary impacted by worse than expected performance at E-ONE and we've taken significant action to get the recovery of that business back on track. Although fire rescue's results fell short of expectations, the sweeping initiatives that have been underway at E-ONE for the past three years have gotten us on a much more solid foundation as we progress throughout turn around of this business. We now have great products and stable business processes and a determine and re-energized management team and workforce under the leadership of Peter Guile. The important focus in the coming months is to work closely with our dealer partners to restore volumes and we are working on a number of initiatives in this regard, from improving the performance of our EZ-ONE portal to revising option content based on feedback from our dealers to expanding the coverage of our dealer network across North America.

FRG will miss their 2007 margin goal. But our aggressive new action should enable a quick recovery to achieve a 4% to 5% margin in the second half of 2008. We are maintaining our long-term goal of 9% to 10% margins for this group.

Turning to safety and security, the star performer in the group was our mobile systems division, which reported robust worldwide growth in orders for police light bars and sirens. Mobile systems new business is up 29% for the first half of 2007, much of this driven by the introduction of our very innovative Model JA light bar platform late last year, which has significantly generated additional global interest. The light bar platform, for which we have patents pending, is designed in a modular fashion providing ease of customization, fast manufacturing cycle times and outstanding reliability. This new platform allows us to easily integrate other types of municipal security systems in the future such as radios, video cameras, air quality sensors, G.P.S., video analytic software and so on. This system is lightweight, has a lower production cost, more robust and is very easy to install and service on the vehicle.

We anticipate that the market will continue to gravitate to this advanced technology, and we expect to continue to gain market share around the world. To underscore this, we received orders from several, very large police agencies that we've not supplied for many years.

Industrial systems in the group also reported strong results in the second quarter. We saw a 20% increase in orders year-over-year for this division with higher demand for hazardous area lighting for marine and oil rig applications, mining related products and other electrical products and systems.

In warning systems, since the tragic shooting at Virginia Tech, we received orders for campus alerting and notification systems from 20 college campuses with very high levels of quote activity continuing in the third quarter. Contracts for F.S. Codespear-enabled applications are growing in both our industrial systems and public safety systems businesses. During the quarter, we landed orders for three notable applications. The Kentucky State Police selected the smart message radio interoperability solution. In Nebraska, the Omaha tri-county region comprised of the City of Omaha, Douglas County, Sarpy County and Washington County have started implementation of the F.S. Codespear interoperability platform within each agency's emergency operations center. And Sky Harbor Airport in Phoenix implemented the F.S. Codespear interoperability platform with both the smart message and scenario manager modules. Sky Harbor is now able to provide interoperability between communication devices of all of the airlines operating there and all area emergency responders in the event of a crisis.

Think about it. F.S. Codespear seamlessly links together all of the communication platforms used by about 20 different airlines and dozens of first responder agencies. No one had to spend money to buy new radios or communication systems.

Next I'd like to comment on the Riverchase acquisition that we announced late yesterday. This is an exciting development for Federal Signal because it adds key system modules to our interoperability platform which will enable us to provide municipal and industrial operations centers. With Riverchase, we obtain five now modules that plug seamlessly into the F.S. Codespear platform and extend our capabilities significantly. The new modules are a computer-aided dispatch module, an electronics records management module, a module that supports realtime data transfer between mobile data terminals and vehicles and the emergency operations center, software supporting video systems in first responder vehicles and a software package that supports data communication between vehicles and on-person P.D.A.s.

Recall that we've described our view of the future as one where municipalities, large industrial complexes, institutions or any large campus environment have comprehensive safety and security solutions deployed that provide everything from threat detection to emergency response and management. The system starts with the deployment of various types of sensor technologies such as meteorological sensors, video cameras, chemical and biological sensors, radiation sensors and so forth. The streams of data are constantly analyzed against established norms to determine whether developing situation could represent a threat to the community or facility. In the event that a potential threat is developing, alerts are fed to the emergency operations center consoles where managers can quickly access the appropriate sensor date it and decide if a response is necessary. And as usual, our traditional vehicles and products will be involved in the response. But now, they will be F.S. Codespear-enabled and equipped with sensors and electronics so they are not only part of the response but they're nodes in the threat detection network itself.

We've created a new business unit within FSG that will be focused on emergency operations centers for municipalities and county, state and national governments. The Codespear solutions, the Riverchase solutions and our public safety broadband wireless solutions will be combined to provide a very comprehensive systems offering to this customer set, a brand new market for Federal Signal.

The business unit will be led by a very passionate Greg Sink, who has been the spark plug behind this effort since we first communicated this about a year and a half ago. As we've been working to assemble technologies to fill the gaps, Greg's team has been developing the product that brings all of this together, a dynamic interactive dashboard that will provide emergency managers with extensive visibility into all of the data that is being collected in the community. This product will be released for beta testing later this quarter.

Next on to the environmental Solutions group, which continues to perform well. Second quarter revenue was up 13% from last year and operating margin was a healthy 9%. New orders for Q2 were down slightly from last year. U.S. industrial markets and international markets were stronger overall with the weakness largely in the U.S. municipal sector. On the sweeper side, we believe the relative weakness in U.S. municipal orders is due to a number of factors, from the late start of spring sweeping in the Northeast, fewer large fleet orders in 2007 compared to last year, and the slowdown in housing construction. With fewer housing starts, there are fewer messes being made on neighborhood streets. Municipal budgets are also straining under higher than expected costs in things like fuel and employee healthcare that is delaying some orders. Orders for sewer cleaners from municipal customers have also been weaker compared to last year where last year some demand was being driven by heavy use due to the storm cleanup situations.

The recent launches of the new Pelican sweeper and the Prodigy mid-sized hydro excavator have been well received by their respective markets. The new Pelican provides significantly improved operator ergonomics and increased sweeping productivity. The new Hydro excavator targets municipal customers for the first time and utility contractors with the capability of using either compressed air or water to loosen the soil for vacuum excavation. U.S. industrial market orders in ESG continue to be very strong with contractors and rental fleets still busy with high machine utilization. We enjoy robust orders for all three of our product lines - sweepers, vacuum trucks and water blasters - up a combined 26% year-over-year in this sector. In addition, Jetstream recently opened its rental store in Toledo, Ohio; it's the first one, and rental demand has been much stronger than anticipated.

Sweeper orders in Europe were off somewhat but this is in comparison to a record second quarter last year. In 2006, we received two large fleet orders in Italy and Turkey, which were not expected to repeat this year. We've been shipping refuse trucks from our China JV operation throughout the first half of 2007 and are gearing up to manufacture truck-mounted sweepers by the end of this year. The refuse truck market in China is highly fragmented and somewhat regional. So we stepped up marketing and sales efforts to promote our brand and game market share. We're making steady progress and will continue to build momentum in this important market.

Finally, I'd like to comment on performance within our tool group. During the quarter, we've seen some steady recovery in Europe and Japan where our sales are largely driven by new automotive projects. In the U.S., where our sales are about 50% auto industry and 15% housing related, remains weak. We expect some strengthening in U.S. auto related sales in the latter half of the year as new projects that have been delayed are increasingly released following the pattern in other regions. We are not counting on any meaningful recovery in the U.S. housing this year.

The U.S. tool operations continue to improve productivity and control spending to mitigate the impact of weaker primary markets. Additionally, we've been expanding our sales efforts to gain traction in market segments outside of auto and housing to diversify. The benefits of this activity should increasingly add to our revenues in the coming quarters.

Earlier this week, we introduced an innovative punch material technology that had been under development for the past year. This technology will substantially performance life of the tools and as such will carry a premium price. Customers that are forming parts from high tensile strength materials or producing very high volumes from more conventional steels will find the value of the tools to be highly attractive. We've applied for a patent for this innovation and it can be applied across a broad array of metal form and tooling.

Now I'd like to turn the conference over to Stephanie who will comment further on our Q2 results and prospects for the balance of the year.

Thank you, Bob. Good afternoon. Our orders totaled $319 million in the quarter, up 3% from the prior year with considerable strength outside of the U.S. more than offsetting weakness in our municipal U.S. order flow. In the quarter, orders outside of the U.S. rose an impressive 23%, to $129 million. To date, international business now accounts for more than 40% of our order intake. Our increasingly global market position is bearing fruit, and compensating for domestic weakness. U.S. municipal orders totalled $113 million, down 15% from last year. Our sweeper orders were lower due to the absence of any large fleet orders which tend to be lumpy. And our U.S. fire truck orders, although up sequentially from the first quarter, fell 19% below last year. On a positive note as Bob mentioned, our light bar and siren sales continue to be extremely brisk as the take uprate of our new LED light bars is exceptionally strong.

Our U.S. industrial and commercial orders improved this quarter, up 5% year on year, with significant strength in our environmental solutions business up more than 25% against last year on strong demand for industrial vacuum trucks and water blasters. We have recently entered into the water blaster rental markets and are seeing good demand there as well. At quarter end, our backlog was stable at $449 million up 3% from a year ago.

Consolidated revenue totaled $317 million, up 3% from last year due to the favorable impacts of price and currency, which more than offset about a 2% volume reduction. Our consolidated operating margin averaged 6.6% in the quarter down from 7.3% a year ago due to increased SEG&A expenses. Our consolidated gross margin rose to 25.1%, up 170 basis points from a year ago. The improvement reflects the high growth rate of the relatively higher margin safety and security and Bronto aerial device businesses. As you may recall, our 2007 objective was to raise our gross margins by about 1% from 23.5% a year ago and we are well on our way. Our SEG&A expenses, conversely, rose to 18.5% up 230 basis points due in large part to increased engineering and marketing expenses associated with our new product development and launches. For the first half of the year, sales from new products rose $25 million from the 2006 level, as the new product investments are bearing fruit. Also impacting SEG&A expenses were higher corporate expenses, in part due to increased spending on legal defense for the hearing loss cases. We're very pleased to have been granted firm 2008 trial dates for the Chicago cases. However this will mean higher spending in the near term.

Turning to safety and security, another very strong quarter, orders up 16% and sales up 27% to $96 million. Operating income was $14.3 million or 14.9% of sales, up 90 basis points from a year ago. Given the strength of orders plus the acquisitions of Codespear and Riverchase, we now expect full year revenue to be up 20% with margins of the high end of our previously indicated range, or about 15%. Considering that this business is nurturing some embryonic new sales initiatives plus investing heavily in new product development and lean expertise, we're pleased with the results they're posting.

Our fire rescue group saw second quarters rise to $89 million, up just slightly from last year due mainly to the strong euro. The distribution of these orders continued the recent trend of strength for Bronto aerial devices offsetting weaker North American municipal orders.

Net sales totaled $75 million significantly below last year due to the weak backlog in sales rate North America. The quarter's results were also affected by two large fleet deliveries, where customer acceptance was delayed at the end of the quarter. This shipping status also contributed to the company's high reported inventory level at quarter end. FRG's operating margin was slightly positive, 0.7% in the quarter, down from 3.2% a year ago. The deterioration was in Ocala where the impact of the low volume throughput plus high fixed costs put the operation into a loss. As indicated in the press release, consistent with the business priorities between now and year end, we're making significant reductions totaling approximately $10 million and our fixed costs to restore the business' profitability. In the short term, however, we expect the North American business to remain in recovery and to post adverse comparisons for this segment during the second half of the year. For the segment we now expect full-year revenues could be down 10% or more from 2006 and expect a modest operating loss for the full year.

Our environmental solutions business is performing well. New orders totaled $108 million in the quarter, down from $114 million a year ago due mainly to the timing of fleet orders for sweepers. Sales revenue rose 13% to $117 million and the operating margin declined to 9.5% from 10.1% a year ago. We saw some erosion in our Elgin sweeper margin associated with the rollout of our next generation three-wheeled Pelican. The conversion is now complete and the plant is working to restore efficient production and lower costs. Elsewhere in the group, our Vactor business continues to develop impressive year-over-year performance. Given our strong performance during the first half, we are revising our sales increase estimate up to 12% to 15% with an expected margin between 9% and 10%.

Our tool business sales were down 7% in the quarter due solely to weakness in North America offset by strength in our overseas market. The margin declined to 5.1% as the impact of lower sales more than offset the beneficial impact of tight cost management and improved productivity. We expect our international sales momentum to accelerate in the second half with some slight year-over-year improvement with sales and profitability.

As we indicated last quarter, our tax rate came down in the quarter to 24% bringing the year-to-date rate to 27%. We're continuing to work on tax planning strategies which are likely to bring the rate into the low to mid 20% range by year end.

Our operating cash flow improved in the quarter bringing the six-month figure to $14.6 million against about $800,000 a year ago. Our working capital performance has been disappointing, however, with inventories now up almost $40 million from year end. While a portion of this is cyclical, we are taking specific actions to make reductions between now and year end.

On a positive note, our net debt to cash ratio was 29%, just below the low end of our targeted range of 30 to 40%. We had $10 million drawn on our $250 million revolving credit facility and we're in compliance with all covenants. We have the liquidity to date to make acquisitions and support growth initiatives as we continue the transformation of the company into a leadership of the global security and well-being space. Just yesterday we invested $7 million to acquire Riverchase. We are currently in advanced discussions in at least one other more material acquisition and may expect an announcement later in the third quarter.

This completes my prepared remarks, and I'll turn the call over to Bob to moderate questions.

Thanks, Stephanie.

Eric, let's open it up to questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Charlie Brady with BMO Capital Market.

Charlie Brady here of BMO. How are you guys?

Good.

On the fire business, can we talk about that for a minute? How much, you talk about the timing of these two large fleet orders impacting unit shipments in the quarter. Are those then sliding into third quarter and so, you know, they should have a positive impact on that or is that further delayed out towards 08?

Charlie, the fleet orders were about $10 million and they will in fact, you know, get recognized. The revenue will be recorded in the third quarter.

Okay. And did I hear you correctly when you talk about the margin in the fire rescue business? You don't expect to get to the 4% range until Q3 of '08?

Yes, for the second half of '08.

Okay. I guess on the tools business, similar question on the fire as far as the euro and the housing market. I don't know if I missed it on the call. Do you have clarification as to how much that was down and how much up the Euro and Asia business was?

Charlie, we didn't say anything relative to the euro in that context. I talked about U.S. automotive being down and housing being down.

Could you quantify?

Okay. You know, in the U.S., about 50% of our business goes into the auto industry. Very little of it directly to the automakers. Most of it goes to suppliers and, in fact, the tooling suppliers to the part suppliers. So we're typically down into the third or fourth tier. And about half of our automotive volume goes to -- goes into new projects. So if there's a new model being introduced, they'll make the new dies, and so on, and about half goes into replacement. So both of those have been down because the automotive production volumes are down so they don't wear out the punches. As automakers are struggling, they delay new projects. So those have been delayed as well. What we anticipate happening we've seen early signs is that the automakers in the U.S. will be releasing more of their new projects in the second half. And we expect to see some recovery in that regard.

On housing, about 15% go into products that go into homes, things like furnaces and air conditioners and water heaters and anything that has a metal housing. That's been down hard as you know. We don't expect to see any recovery for the rest of this year at least.

Okay. Thank you. I'll get back to the queue.

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

Good morning or good afternoon. Just on fire here. What, if any, effect was the emissions standards on your orders in fire?

We didn't experience very much effect at all, Ned. You know, the trucks essentially all of them are sold to municipalities. Most of the customers buy one or two or so trucks, in some cases large fire departments buy a fleet of them. In the case of the larger departments, they -- the impact of the '07 engines, that is something that they would have taken into account and thought about and perhaps tried to develop a strategy around. Nonetheless, these things have to be budgeted for. The net result of that, we didn't experience a lot of pull ahead of fire trucks into last year.

Okay. Then on the comments in the release earlier, I think it was last week, the management change at FRG, you talk about a $20 million investment over next two to three years. Can you give us some color on the things you are looking at?

We're still going through the planning process. As I talked about before, you know we've done a number of things in this business over the last two or three years to improve. We've invested in a lot of new products and improved a lot of our business systems, installed a lot of IT And at some point, as we're making all of these improvements, our manufacturing footprint becomes a bigger and bigger constraint. So we recognize that for the last couple of years. That hasn't been high on our priority list. These other things have been. So as we told our employees, we tend to invest in our manufacturing footprint over the next several years. That $20 million is a place holder. It could very well be in that ballpark. We don't know yet whether it would encompass improving or existing facility or moving into a brand new purpose-built facility. Our objective would be to stay in the Ocala area.

Am I to interpret some of this $20 million would go to adding manufacturing capacity?

Yes. Yes. I don't know if you've been to our place, Ned, but we operate out of four different buildings. Three of those are at least on the same piece of property. One is down the road a couple of miles. We need to do something about that. The best thing would be for us to start over into a brand new facility. And we're evaluating that versus taking one of our existing locations and expanding there. But the intent would be to have a much more efficient layout first of all, and for us to be able to address additional capacity that we would attempt to gain down the road - for additional volume we could attempt to gain down the road.

And either of those would be in Ocala.

Absolutely. That's certainly our intention. We have a very skilled, very dedicated workforce there, and it would be our intention to stay there.

Okay. Great. Thanks.

Your next question comes from the line of Jerry Reavis with Goldman Sachs. Please proceed.

Good afternoon.

Good afternoon.

Can you please discuss the new division you just formed in safety and security in terms of the potential market size and how your -- excuse me, how your solutions stack up relative to the existing product offering in the business?

Yes. You know, Jerry, I don't have a real crisp answer to that, but that's something we've been talking about here for some time.

This is an emerging opportunity. This is an emerging market. Let me give you a couple of place holders. It starts with the traditional 911 call-in centers with the computer aided dispatch, and those have been around for a number of years. That market is probably somewhere south of $1 billion although we don't have a real good number for that. But on top of that now, since September 11th, what we've seen emerge are the emergency operations centers where emergency managers are coordinating the response of first responder agencies across the community. Now, what's also being added to that, communities that are deploying a number of sensors like video cameras that have been in the papers quite a bit lately but also chemical sensors and those kinds of things deploying those throughout the community because they need to do a better job of detecting when a situation might be developing. There's a lot of investment going into what we broadly categorize as sensors. Now you have to analyze all of this data that's being generated by all of these sensors. Bring it together into the emergency operations center and analyze and dispatch the appropriate response, responder vehicles.

Interoperability's a part of this, too. The ability for different first responder agencies within a region to be able to talk to each other when they are converging on the scene of a situation. Just two weeks ago, I guess, Michael Chertoff announced $1 billion federal grant pool available for municipalities to address the interoperability problem. So, you know, we're trying to do some work and put some structure around what this amounts to. It's in the several billions of dollars. This is growing, too. Because the need for communities to do more to prevent terrorist attacks and prevent crime actually, also, there is going to be a lot of investment in this throughout the world. There have been a couple of studies that have been done that we've looked out during the past year that predict that the global growth in safety and security systems are going to be around 8% a year. And this emergency operations center is a real big piece of that.

Thank you for the color there. In terms of the major players that are currently in the market, how does your product stack up relative to theirs? What's your assessment of the competitive landscape here?

We think we're in pretty good shape. First of all, there's very few competitors that participate in all of these areas. If you combine all of these tasks that I just described, there are a number of competitors that have been around for a while in the 911 call-in and computer-aided dispatch technology. There are a different set of competitors in the video and video intelligence space, there are a different set of competitors in all these sensors. There's a different set in the wireless broadband network, and to our knowledge, we're the only one that has the capability now of pulling all this together. It's not to say others aren't out there thinking about the same thing because it's a very attractive emerging market.

Okay. Thank you for that. Just a clarification question and fire and rescue. You mention possible opportunity of $10 million for cost savings. Is that off of the CapEx spending that you mentioned in the press release on the organizational changes. Is that the driver of the cost savings. Can you give us a little more color on that, please.

No. The cost reduction is independent of any longer term impact of capital spending. That CapEx would not really be started before 2008 in any material way. Whereas the cost reductions would be implemented by the end of this year.

Thanks Stephanie. Just a quick question on Bronto. Can you give us the sales or order performance in the quarter on the year-over-year basis? Obviously, that's business that's done well for you.

You know, we don't disclose the specifics for Bronto, although we do talk about our international sales in our Q, which covers both Bronto and then international exports from the U.S. So I can give you that number if someone can find it for me here. When I have it I'll go ahead and comment.

Okay. Meantime, can we go to the next question?

That's it for us. Thank you.

All right. I have the number now. So for the quarter, our non-U.S. revenues in fire rescue, sorry, non-U.S. orders $47.6 million. For the quarter last year, $34.4 million.

Were the sales breakouts roughly similar?

Sales breakouts. Yes. No, not typically. The order pattern leads sales by, you know, perhaps six months or so. That's one of the reasons that what you're seeing in our fire rescue group, you're seeing our fairly constant orders but reduced sales. That's because we are having disproportionately, you know, disproportionate order growth for long lead time aerial devices which we can't, you know, we can't produce and record as quickly, which is why we have a kind of a revenue gap, if you will in North America, and a stretching out backlog in finland.

Got it. Thank you.

Your next question comes from the line of Steve Barger with KeyBanc Capital Markets. Please proceed.

Hi, Steve.

Mr. Barger, your line is open.

Sorry. In the context of the management change at fire and rescue, would you be fundamentally changing the strategy you are following with respect to turning the segment or is this more of just kind of tweaking the initiatives that are already underway?

It's really tweaking the initiatives, Steve. One of the characteristics that Peter Guile brings with him is a very collaborative style and a proven track record of working with outside distributors and dealers to grow the company. And at this point in our turnaround, we have great products out there now. We've worked hard on those the last two years. We have a lot of new systems and processes in place that are stable. We can reduce man hours as a result of that. The thing we're missing right now are having enough orders. We just need it to be working much harder on that and Peter brings with him that kind of background and that kind of a skillset that will accelerate this in the coming months.

So when you think about your -- the need to get more orders, are you going to focus on plugging holes in the dealer network or are you going to be taking internal sales guides out to these uncovered markets? How are you going to approach that in the near term?

It's a combination of all those. Over the last 12 months or so, we've hired a number of additional direct sales people that are doing a couple things. One is, they are filling some gaps where we do have gaps in our dealer network. Also working with our dealers on some customers that want to deal directly with the factory, typically large cities. We will continue that. We're not going to add to that right now. But what we are doing a lot more of is first of all, taking the response that we're getting from our dealers after we've implemented these, the EZ-ONE Configurator. And making some changes and improvements to that to make it more portable. We're also looking at the way we've lined up options in some of our models again as a result of our dealer feedback. We want to make some changes to make it easier for them to sell. Frankly, as we retool this whole thing over the last couple years, we didn't get everything right. So we want to go back and make that right. We're doing a lot more training. This a much different way to sell than we've done in the past. In the past we had a free-for-all product offering and very informal sales tools. Having a structured product line and walking the customer through matching his requirements with the appropriate vehicle design through a structured and automated tool it's a much different process. And we underestimated the amount of change that this would require from our sales people. So we're doing a lot more training. Then finally, we are certainly working on these remaining holes in our dealer network.

Okay. So where are we seeing reductions in the staff relative to the operation?

We haven't discussed that with the individuals who were affected so we don't want to talk --

Okay that's fine. As you are out in the market talking to your sales and your dealers, is it on price or is it on options?

It's not on options. I mean, even though we've structured our product offering but we're really not missing anything. When we went out there in the initial Configurator, we didn't put everything out there we knew we'd need. So there's a demand for things that are repeatable. We're adding those things. I think we just -- it's just a much different, longer selling process and this new way of going about it at least right now until we get everything working right. And frankly, we haven't been as fast responding to some of the issues that we brought up as they should have been.

So really, the sales process itself more than the price or options?

Yes. I think so. The options, again, we will absolutely offer all of the options that the market needs. If we have one customer wanting something extremely usual and that's a different story. That's not a problem. That's really not been a problem.

Sorry if I missed this, but did you say you're opening rental locations?

Yes. Our jet stream business unit makes high pressure water blasters. Most of our customers are contractors and what we found is that there are some users around the country that don't need to own a machine but they'd like to use one for two months or three months or something like that to do a project. So we've decided to set up a business unit to go after that market. We're very pleased with our first one.

That's a corporate function. That's not located with dealers?

That's correct.

It is collocated, though, with service centers for our Guzzler industrial vacuum truck. Those are both part of the ESG group.

Right.

Now, the one in Toledo, that one is a free standing one. The other ones around the country, we will locate with where we have a Guzzler service center.

Right. Okay, thanks.

Next question comes from the line of Charlie Brady with BMO Capital Markets. Please proceed.

Thanks. Yes. Just a follow-up on the corporate expense commentary having I guess the higher litigation expense that's going to be with us for a little while. Can you give us quantification on where you think that's going to go. It was up obviously in Q2. Are we going to be at this level or do you anticipate it rising above the Q2 level in dollar terms?

The trials right now in Chicago are scheduled for February and June and, you know, of next year, so I think during next year, our burn rate could certainly be higher. But our overall objective is to hold our corporate expenses at, you know, 2% of sales or less we think we'll still be able to do that.

I guess a lull and kind of a rise as the trials get closer to happening.

Yes. They will certainly continue at least at this quarter's level. Probably start to creep up as we're doing planning, and advance work for the trial. Then I think the peak spending will be during the course of the trials next year.

Okay. Then on tax rate. I don't think I heard you correctly is to where you expect the tax rate to go. Did you say you expect it to be in the low 20s by year end some.

I think I said low to mid-20s.

Low to mid?

We're somewhere right now about 27% cumulatively. It will go down a little bit as the year progresses.

And just on the tool segment, I'm sorry, could you just repeat your revenue and top margin expectation for '07.

What we were saying is we thought the third and fourth quarter we would start seeing some improvement, year-over-year improvement in both the sales and the profitability.

Thanks a lot.

Ladies and gentlemen, we have no more time for questions. I would now like to turn the call over to Mr. Robert Welding for closing remarks.

Okay. Eric, actually, we do have a little bit more time if there was another question on, we'd be happy to take it. If not.

Did you mean we have no time or no questions?

We have no more questions, thank you. I'm sorry.

All right, if there are no more questions, we really appreciate your continuing interest in Federal Signal. We've had a little bit of a disappointment here in fire rescue, but we remain very optimistic and encouraged about the prospects going forward. So thanks again for your interest. Have a good day, everyone.

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