Federal Signal Corp (FSS) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Federal Signal first quarter 2009 earnings conference call. My name is Mary and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS.) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Bill Barker, Senior Vice President and CFO. Please proceed.

Thank you. Good morning and welcome to Federal Signal's first quarter 2009 conference call. I'm Bill Barker, Federal Signal's Chief Financial Officer. Joining me on the call today is Bill Osborne, our President and Chief Executive Officer.

Before we get to the business review, I would like to remind you that some of our comments made today may contain forward-looking statements that are subject to the Safe Harbor language found in today's news release and in Federal Signal's filings with the Securities and Exchange Commission. These documents are available on our website, www.FederalSignal.com. We will file our 10-Q shortly.

We will be using some slides in the presentation. The slides can be found by going to our website, clicking on the Q1 Investor Call icon, and selecting the webcast. We will post the slides to our website after the call.

Now I will turn the call over to Bill Osborne.

Thank you, Bill. As we discussed in our press release, we reported earnings per share from continuing operations of $0.02 for the quarter. These results are in line with the guidance we issued a few weeks ago. While I'm pleased that we were able to generate a profit in these extremely challenging economic times, we still have a lot of work to do. Bill Barker will go through the first quarter financials in detail in a few minutes, but I'd like to offer some observations on the quarter first.

A primary focus for us has been cost reduction, and it is clear that our efforts are gaining traction. We will continue to drive cost efficiencies as we move throughout the year. And just let me say that we are on track to deliver the $20 million of year-over-year overhead cost reductions that we previously discussed.

Specifically for the quarter, we reduced overhead costs--which we define as fixed manufacturing expenses and SG&A costs--by $4 million compared to last year. Included in the 2009 number is $1 million of one-time severance expense in the quarter, which will yield cost reductions in quarters two through four.

I want to add that our employees are working harder than ever to deliver results. These are very challenging times, but our employees have stayed focused on outstanding execution.

Another area of cost reduction we are targeting is product costs, such as redesign and finding lower-cost sourcing options. Although it will take some time to implement these types of initiatives, I want to emphasize that I am committed to making ongoing cost reduction a key part of the culture here at Federal Signal. And I'm pleased with the focus our management team has brought to this critical issue. Once we reach our $20 million cost reduction goal, we will continue to focus on identifying efficiencies that will enhance our profitability without sacrificing our competitive advantages.

On the revenue front, we're beginning to see some data points that suggest some of our markets are beginning to stabilize. Although orders for the quarter were down 29% in total, the quarter had two distinct phases, with the first part of the quarter being far more challenging. Orders for both January and February were down more than 35% versus last year, while March orders were down only 8%.

So more encouraging news in March. We saw order increases versus last year in some of our individual businesses in the month. Orders from US municipal markets were up slightly, and our export orders for March also increased versus last year. In addition, orders for our US PIPS camera business more than doubled in the quarter. Orders for our UK PIPS business were right in line with our internal expectations, although reported UK orders are down versus last year. This is because the first quarter 2008 included a very large order related to the London congestion tolling project.

While these are encouraging data points, we have also seen some continued weakness in other market segments, particularly the domestic industrial market and our fire rescue business. Industrial orders in the US were down more than 20% in March and more than 40% in the quarter. Fire rescue orders were also down more than 20% in March as our Bronto business continues to work through its sizable order backlog.

So, on balance, I would characterize our markets as still unsettled, but with more signs of stability than what we saw at the beginning of the year. We still have an order backlog of $273 million at the end of the first quarter, which helps provide some visibility for our revenues in the near term.

In terms of guidance, the forecasting environment still remains very challenging. While we have some visibility for the near term, little has changed with regard to our ability to confidently project revenues for the full year. Currently, we expect to generate earnings per share of between $0.05 and $0.08 for the second quarter.

Furthermore, we currently expect the second half of the year to be above the Q2 estimated run rate. Traditionally, our Q4 has been bigger than Q3 due to seasonal factors.

During the course of our meetings with several of the shareholders, many of you expressed an interest in learning more about our balance sheet, our debt, and our covenants. I'm pleased to report that we recently amended the network covenant relating to our private placement notes, which made that covenant significantly less restrictive. We were able to do this without increasing our forecasted interest expense for this year and next.

I will now turn the call back over to Bill Barker, who will give a financial review of the quarter and some more specifics on our debt situation, after which I will come back with some closing thoughts and remarks.

Thanks, Bill. I will give a fairly brief review of our first quarter results, which are included in today's press release, and then I will spend some time discussing our current debt situation and the status of our debt covenants, as Bill mentioned. I'd be happy to answer any questions at the end of the call or later today.

Looking at our P&L for the quarter, revenue was $203.5 million, which was down 10% versus last year. The net currency impact on revenue for the quarter was negative 4%. Strong revenue growth at Bronto, our fire rescue business, partially offset revenue declines at our ESG and SSG divisions.

As indicated on the slide, we reduced our fixed manufacturing overhead costs by over $2 million in the quarter. However, gross profit fell from $58 million last year to $51 million this year due to the sales decline.

Total operating expenses, or SG&A, were reduced by $2 million versus 2008. There were non-recurring items in each year. Last year we recognized a $1.5 million charge related to a contract dispute, and this year we incurred $600,000 for proxy solicitation costs. Both years include about $1 million of severance expense related to cost reduction initiatives.

Operating income for the quarter was $5.6 million, or 2.8% of sales compared to $11.2 million or 4.9% of sales last year. Interest expense of $3.3 million in the quarter was below last year's $5.1 million due to lower borrowings and lower interest rates in the quarter.

Our effective tax rate was 12.3% compared to 27.6% last year, as we recently resolved an IRS audit relating to our 2006 tax year.

Our reported EPS from continuing operations for the quarter was $0.02 compared to $0.09 last year.

Turning to the segments, SSG's net sales declined 16% versus last year for the quarter, from $91 million to $76 million. Currency negatively impacted SSG sales by $4 million in the quarter.

Our PIPS business and warning systems business both generated double-digit sales increases in the quarter, but that was more than offset by sales declines of more than 20% in our domestic and European mobile emergency products business of light bars and sirens and our parking systems business.

SSG orders were down 21% for the quarter, although down only 6% in the month of March. SSG ended Q1 with an order backlog of $53 million. Operating income for SSG was $6.1 million, and the Q1 operating margin was 8%. Operating income was down from last year's $8.3 million as the sales decline more than offset a $3 million reduction in overhead costs.

Bronto had another strong quarter, with sales up 41% despite a negative 18% currency impact versus last year. Operating income more than tripled, and operating margin improved more than four points.

As we have discussed previously, the capacity expansion that was completed last year enabled higher volume throughput and reduced costs related to production outsourcing. Bronto's Q1 orders were down significantly from last year due to both economic weakness across the markets it serves and the fact that Bronto is working through its substantial order backlog, which remains robust at $128 million at the end of Q1.

ESG sales were down 16% to $95 million in the quarter, as we saw double-digit sales declines in our Elgin, Vactor and Jetstream businesses. Currency impacted ESG sales by only about 1%. Total ESG orders were down 17% in the quarter but down only 1% in March. Orders for both Elgin and Ravo, our European sweeper business, increased by roughly 5% in the quarter. ESG ended Q1 with an order backlog of $92 million.

ESG's sales decline resulted in operating income falling from $9.5 million last year to $3.1 million this year. Corporate expenses in the first quarter improved by $1.3 million. Legal costs associated with the hearing loss litigation were $600,000 less than last year.

The Company's first quarter P&L shows revenues of $203.5 million and operating income of $5.6 million. Income from continuing operations was $1.1 million, and earnings per share from continuing operations was $0.02.

On Slide 5, we show our cash flow for the quarter. To summarize, cash flow from continuing operations was $6.4 million, CapEx was $3.8 million, and dividends were $2.8 million. Our CapEx was equal to depreciation and amortization for the quarter. We saw a modest improvement in working capital usage versus year end, but we still have more work to do to bring our inventories in line with our current sales outlook.

We expect working capital to provide more than $10 million of cash in 2009. We did have about a $2 million cash outflow related to discontinued operations, relating primarily to the buyout of some IT assets.

Turning to the balance sheet, we used some of our excess cash to pay down debt during the quarter and reduced our total debt from $279 million at year end to $267 million at the end of the first quarter. Our debt-to-capital ratio declined from 50% at year to 48% at the end of Q1. We had $20 million of cash on hand at the end of the quarter and also had $128 million of availability under our $250 million revolving credit agreement, giving us a total of $148 million of available liquidity. Our revolving credit agreement matures in April of 2012. We were in compliance with all of our debt covenants at the end of the quarter.

In addition, as Bill mentioned, we recently reached agreement with the holders of the Company's private placement notes to amend the covenant regarding minimum net worth. The previous covenant required the Company to maintain a minimum net worth of at least $275 million and did not allow for any adjustments to the net worth calculation. Even though we were in compliance with the minimum net worth covenants--our net worth was above the $275 million minimum at both year end and at the end of the quarter--we decided to take a proactive approach, and we reached out to the note holders.

We agreed to modify the net worth covenant to parallel the net worth covenant in our revolving credit agreement. The net worth calculation now allows for add-back to some non-cash charges and carves out the impact of pension fund returns. As of the end of the first quarter, the minimum net worth requirement as calculated in the revised covenant was $390 million. Our adjusted net worth was $100 million above that threshold.

In return for the covenant amendment, the Company agreed to the following.

Prepay $50 million of the outstanding notes at par value. The prepayment fee was waived by the note holders. The outstanding amount of the notes was thus reduced from $173 million to $123 million. Agreed to a higher rate of interest on the remaining $123 million of notes. Pay a 10-basis-point amendment fee of $173,000. And covenants for the remaining notes were aligned with those of the revolving credit agreement.

We used our existing lower-cost available liquidity to prepay the $50 million of notes at par value, which will result in a significant savings in interest expense on that $50 million. These savings will offset the higher interest rate for the remaining $123 million of notes, and thus we expect our projected interest expense for 2009 and 2010 to remain unchanged from our prior forecast.

So in summary, we now have a less stringent minimum net worth covenant on the remaining private placement notes, and we were able to keep our forecasted interest expense the same as before. We did use $50 million of our available liquidity to complete the transaction, but as I said before, we ended the first quarter with a total of $148 million of available liquidity and feel comfortable that we will have sufficient liquidity going forward.

This transaction was the result of a lot of hard work and collaboration by our finance team and by the note holders, and I think we reached an agreement that was a positive outcome for both sides.

Our other key debt covenants are a debt-to-capital calculation and an interest coverage test. Our debt-to-capital test uses the adjusted net worth calculation I previously described. The maximum allowable debt-to-capital ratio is 50%; our adjusted ratio at the end of the quarter was 38%. The interest coverage test is a trailing 12-month calculation. Our current minimum ratio of EBID to interest expense is 3.0 for the trailing 12 quarters. The EBID calculation allows for add-backs of up to $200 million of non-cash charges and up to $15 million of cash charges in the trailing 12 months. As of the end of the first quarter, our adjusted 12-month EBID was more than $10 million above the minimum required in the interest coverage test.

I realize that was a lot to cover on debt covenants, but I wanted to keep you updated on where we stand and let you know that we are comfortable from a balance sheet perspective. As I mentioned before, I would be happy to answer any questions at the end of the call or later today.

And now I'll turn the call back over to Bill Osborne.

Thank you, Bill. Two months ago I had the opportunity to share with all of you my strategy for Federal Signal--drive cost improvements and higher margins at some of our key legacy business, invest to grow our higher-margin businesses, and expand our public safety systems platform. While not much time has passed since then, I can tell you that we have definitely made progress. As I mentioned earlier, we reduced our overhead costs in the quarter and are on track to deliver $20 million of year-on-year reductions in overhead costs.

Our capacity expansion investment at Bronto enabled that business team to deliver a large revenue increase and a four-point margin improvement in the quarter. Orders for PIPS cameras in the US market more than doubled versus last year, and we've made improvements to our balance sheet and cash flow.

These are some examples of the progress we are making, and we still have a lot of work ahead of us. While the economic outlook is far from certain, as I said before, we are seeing some data points reflecting stability in some of our markets. We remain focused on continuing to drive growth in public safety and intelligent transportation. As an example, we're working to get PIPS cameras included in major projects targeted for this year's highway bill, which the Congress will take up in the fourth quarter of this year.

We will continue to drive improvements from our businesses and in our cash flow. My goal over the next few quarters is to continue to position the Company to prosper in any economic environment and to keep our teams focused on executing the key elements of our strategy. At the same time, we intend to improve our profitability as we move through this year and into 2010.

I would like to again publicly thank the employees of Federal Signal, who have made significant sacrifices and are working harder than ever to deliver results. I firmly believe that the Company's best days lie ahead. Thank you for your time, and we will now open the call for questions.

(OPERATOR INSTRUCTIONS.) Our first question comes from the line of Charlie of BMO Capital Markets.

Hi. Charlie Brady, BMO Capital Markets. Bill and Bill, can you talk about the order trends as you went into April? Did you see a continuation of the better trend that you saw in March relative to the first part of Q1?

Right now, Charlie, April orders look to be flat sequentially, so again more signs of stabilization.

Can you speak what your margin expectations might be across the three business segments looking out through '09?

I'd suggest that we'll continue to see margin improvements as we move through '09, particularly at SSG and ESG as our cost reductions begin to take hold. The capacity expansion that we've seen at Bronto has already delivered significant margin improvements. And in order for us to see more improvements there, we've got to take additional steps. We're in the process of evaluating new sources of low-cost Parts for Bronto.

Okay, thanks. One more and I'll get back in the queue. Could you discuss your tax rate expectations for the rest of '09?

Hey, Charlie, Bill Barker. I would assume something in the high 20s, probably around 28%. We got the benefit of resolving the IRS audit issue from 2006, which brought down the first quarter rate, and because our income was a fairly low number, that rate impacted the tax--that adjustment in pace impacted the tax rate. But I'd assume something in the high 20s.

Thanks a lot.

Yes.

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

Hello, Bill and Bill.

Good morning, Ned.

On safety, the margin sequentially, a pretty dramatic falloff there. I know you reduced some overhead, and I know it seems like you've got some mix issues with some of the light bar products. Can you help us out with what's going on within the segment on the products and on mix?

Yes, it's a little bit mixed, but it's also the fact that sales were down quite a bit in the first quarter. Our first quarter across our businesses tends to be the smallest quarter of the year, and so the volume impact would be a significant sales decline more than offset what we were able to take out in cost from a margin perspective. As Bill mentioned, we do expect the margins to improve throughout the year. And last year, SSG's margin in the fourth quarter was the highest it was during the year. So it's not really so much of a mix impact, because the public safety businesses that we talked about, the PIPS cameras, have very attractive margins. It's just more the impact of the volume decline.

Can you give us some color on the parking business, then?

Parking business actually was one of the businesses that experienced an order increase in March. It's something that, as Bill said, we're seeing some fits and starts in orders out there, but we've got some, making some progress on that front.

We do expect some improvement in the parking business throughout the year, Ned, because we have a major product launch coming up this summer. Our new MV line that will be launching, I think, in the June time frame, and we expect an improvement in orders based on that new product launch.

Okay. And then internationally, what's your outlook for business in China with some of the stimulus activity that's going over there? Is that going to be helpful to you all at all?

No, I think that's premature for us. As you know, we recently closed our joint venture operation in China. We have a much smaller operation. It's a wholly-owned subsidiary. We're just now ramping up production for that operation, so we don't have particularly high expectations in the near term for China's stimulus, because we're really just ramping up that wholly-owned subsidiary as we speak.

Okay. And then the trajectory for legal expense going forward? I know that there was a case earlier in the year. Can you help us think about that going forward?

Our strategy on the hearing loss litigation remains the same. We incurred about $10 million of expenses in 2008. We expect a similar level in 2009, but we've had a string of successes in these cases that we intend to lodge an appeal on the February verdict as well, and we believe we have strong grounds for appeal. The Company feels very strongly that our case has merit, and we intend to vigorously fight these claims.

Are there any significant trial dates upcoming that would cause legal expense to spike up in subsequent quarters?

Nothing in terms of a spike, but we do have a new trial scheduled. Our Track 2 trial is scheduled to begin in July.

And we talked about roughly $10 million of expense last year, and we were expecting about the same thing this year in our last call. That number hasn't changed. We're still using that as our estimate for the year, something in the neighborhood of $10 million.

Okay, thank you.

Yes.

Your next question comes from the line of Steve Barger, KeyBanc Capital Markets.

Good morning.

Hi, Steve.

I got on the call a little late. I actually came in when you were talking about the covenants, so if I ask anything that's been covered, tell me and I'll catch it in the transcript. But thinking about the broader picture, with $20 million in cash, the debt that you have, and some decent growth prospects in some of the segments, can you just talk about your expectations for free cash flow for the year, how are you thinking about the dividend, any thoughts on potential portfolio shaping, and just kind of an overview there?

Yes, I'll take a first crack at it--Bill Barker. On the cash flow front, we talked about in the call that we expect to generate more than $10 million from improved working capital. We expect CapEx to basically offset depreciation and amortization, so those two items would be about a push. On a dividend perspective, our Board reviews the dividend quarterly. At the most recent meeting, they approved the dividend for the upcoming quarter. It's about--every time they make the decision, it's roughly a $3 million decision for the following quarter. Right now we don't have any plans to change that, but that's subject to future conditions.

I think I lost part of your question there, Steve. Sorry.

Just thinking about portfolio shaping, potentially, going forward. Anything that you want to add or subtract?

No, I think, Steve, as we've said in prior calls, we are open to opportunities to improve our portfolio of businesses. We are continually studying the market for those opportunities where we can acquire at reasonable prices. And obviously, we're also listening to interested buyers of our existing businesses, because we know overall, it's a difficult market to get deals done. But I can tell you that we aren't turning away phone calls when people come to talk to us about our businesses, and we're actively looking at opportunities.

Okay. You had mentioned you need to take some additional steps for Bronto. Where do you think margins can sustainably go in that seg--in fire and emergency, as you--thinking about more of a normalized demand environment? And at what rate do you expect that business can grow?

Growth prospects in this market are hard to forecast. Bronto has really been affected by what I consider to be the world's first global recession in 50 years. So growth projections are pretty difficult for Bronto right now. Bronto's environment, Bronto tends to grow with overall investment and spending by municipal governments around the world, and a lot of those governments are cutting back. So it's difficult to forecast. However, we do think there's still a little bit of room for margin in Bronto for further improvement, and it's just a question of sourcing at this point. And as I said, we're looking for lower cost opportunities to source Bronto's parts. It really isn't a question, right now, I think, of business structure. It's just a question of finding lower cost opportunities for sourcing.

Right. Can you tell us what percentage of working cap Bronto represents, and does it generate cash in this environment? Or is it a consumer?

Now that we've got the CapEx behind us from the expansion program, Bronto should be generating good cash flow given their positive margin.

Is it a higher percentage of working capital of the three segments?

Yes.

Yes, it is, just because of the size and the nature of their products, some of theirs. But it's not dramatically so, but it is a little higher.

Yes, of our---well, I'm not sure what the actual working capital per se is.

Steve, let me get that number and I'll get back to you.

Okay. Going to PIPS, I heard you talk about the double-digit growth rate in the camera business. Did you talk about the margin profile there?

No, we did not.

Anything you'd like to say?

No, I don't want to disclose our margins. We consider that confidential information.

Okay. And any way you could frame up the potential opportunity for getting PIPS cameras included in the highway bill? What could that be?

That's very difficult to say, Steve. Congress hasn't taken up the bill. We expect the House won't even have an initial markup until May, and the Senate hasn't even started. Right now we're working specifically on the House side, but it's difficult to say at this point.

Is the opportunity relative to the highway bill single-digit millions or double-digit, would you say, if it plays out the way you'd like to see it?

Well, I don't think it's worth the trip if it's single-digit. So we're obviously working on relatively large projects. There are a couple of things we know from our discussions with Congress, and one is that the Congress is looking for new sources of funding for the transportation bill for roads. And they are looking very heavily at things like vehicle miles traveled and additional tolling systems. And we believe our technology has strong applications in tolling, particularly open road tolling.

We also know that they are looking for forms of performance measurement with the states. And we think that our time over distance technology with PIPS would help for measuring congestion, and that's one of the things that we think is going to be important in the bill, that they're looking to hold states accountable for congestion management projects. So that if an investment is made in reducing congestion, we believe Congress is going to be looking for evidence that those congestion goals were met. And our time over distance technology with PIPS would allow us to provide concrete evidence from state and municipal governments that they are meeting their congestion management goals.

Right. So stipulating that you've got the best technology program, this could be a sizable opportunity?

I would say it would be a significant opportunity, because it's, we expect that the transportation authorization bill will revolutionize how funding is done for road projects.

Okay.

And we expect tolling to be a big piece of that.

Great. And one more and I'll get back in line. Relative to the cost takeouts that are ongoing, which segment should we expect to see the most substantial improvements coming from over the next couple of quarters?

You mean in terms of overhead costs?

Yes. Just being able to right-size the business or take out working cap relative to that $10 million, or however you see that playing out. What's the biggest opportunity, and which segment can we watch to see how that progress is taking hold?

We've got a very strong working capital focus right now in our safety and security group. That's an area we think we still have a lot of opportunity. And we're working very heavily on the gross margin side in our ESG businesses, where we're focused on taking out design costs as well as an ongoing focus on overhead.

Steve, on the SG&A front, the places where we do have the opportunity are the places where we're moving to simplify things, whether that's going to more common IT platforms or, as we've already done at SSG, simplifying the division structure. There's more opportunity there in ESG and SSG, just because of some of the complexity of their business rather than Bronto, which is a single line portfolio.

I just wanted to follow up quickly on your working capital question. Bronto accounts for about 15% of our revenue and about 20% of our working capital, so it is running a little bit higher than the average.

Okay, great. And I will ask one more. The $45 million in SG&A in the quarter, is that sustainable sequentially? Or should we think about that as a run rate, plus or minus?

We would hope to bring that down going forward.

Okay. I'll get back in line. Thanks very much.

Your next question comes from the line of Walt Liptak from Barrington Research.

Good morning, Bill and Bill.

Good morning, Walt.

A couple of follow-up questions. What is the new interest rate on the notes?

We agreed to take it up. It varies because the rates have different maturities, the notes have different maturities. But we agreed to a 100-basis-point increase now and another 100 basis points the beginning of next year. And then future increases will be somewhat determined by our debt rating.

Okay. And you mentioned that your interest expense is unchanged from your previous forecast. What are you expecting for 2009 interest expense?

This quarter, interest came in at about a little over $3 million, and I think that's probably a pretty good run rate.

Okay, good. And then I wanted to ask about a couple of other things. I feel like we probably asked this before, but how big is the PIPS business in total?

We don't report PIPS separately.

The one number we did break out was our pubic safety business, which includes both PIPS, our federal warning systems business, and our light bar businesses. That was over $200 million as a subdivision.

Okay. You mentioned in the press release, and I think in your comments, that PIPS USA doubled, right?

That's correct.

But it's hard to know what that means. It could be $50,000 had doubled to $100,000.

Yes, and I apologize, Walt, but it's not our policy to report PIPS separately. As you can imagine, with the various businesses that we have, we don't want to establish a precedence of reporting every individual business.

Okay. Okay. And then last week at FDIC, I had an opportunity to talk to a couple of your competitors and look at your light bar booth, and there was some talk about market share gains and losses. I wonder if you'd mind commenting on how your market share is going with some of your older customers like E-One and if you've been able to add any new accounts at that business?

In all honesty, it's a little difficult to get accurate market share information in this business. As you can imagine, there's no clear trade association where numbers are reported centrally. But I can tell you we've been very competitive in terms of our won-loss ratio. Over the first quarter, we have seen no deterioration in our won-loss ratio on bids. And that's the metric that we look at as a proxy for market share, just simply because accurate share information is not available in that business.

Okay. Okay, thanks very much, guys.

Thank you. There are no other questions at this time. I would like to hand the call to Bill Osborne for closing remarks.

I'd like to first thank all of you for calling in. We appreciate the opportunity to speak to you on a regular basis. And again, I'd like to wrap up by thanking Federal Signal employees for their diligent work. And we continue to gain traction, and I look forward to speaking with you all again soon. Thank you.

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