Federal Signal Corp (FSS) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Federal Signal Corporation First Quarter 2011 Earnings Conference Call. My name is Maria and I will be your operator today. At this time, all participants are in listen-only mode. Later, we will facilitate a question-and-answer session. If at any time you would like to ask a question during the call, you may do so by pressing *1 on your phone. If you require assistance from an operator, please press * followed by 0 and someone will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Bill Barker, Senior Vice President and Chief Financial Officer. Please proceed.

Thank you. Good morning and welcome to Federal Signal's First Quarter 2011 Conference Call. I'm Bill Barker, Federal Signal's Chief Financial Officer. Joining me on the call today is Dennis Martin, Federal Signal's President and Chief Executive Officer, and Jennifer Sherman, Federal Signal's General Counsel and Chief Administrative Officer.

We'll be using some slides in the presentation. The slides can be found by going to our website, www.federalsignal.com, clicking on the Investor Call icon and selecting the webcast. We'll also post the slide presentation to our website after the call.

Before we get to the business review, I'd 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. We expect to file our Form 10-Q shortly.

And now, I'd like to turn the call over to Dennis Martin.

Thank you, Bill, and good morning to everyone.

I will keep my comments fairly brief today as it's only been a few weeks since our last call together. As always, I'll be happy to answer any of your questions at the end of the call.

Our order trends continue to be encouraging. Q1 orders were up 6% versus last year and continue to grow sequentially. Total orders have grown from $170 million in the third quarter of last year to $187 million in the fourth quarter and up to $210 million in the first quarter of this year. I will talk a bit more about the various market dynamics a little later, but as shown on the slide, we have seen significant increases in orders for ESG and Bronto. Both have longer order lead times and provide a growing backlog which will generate revenue later in the year. Our total order backlog at the end of Q1 was $258 million, nearly 20% higher than it was at the end of December.

In addition, we recently announced a memorandum of understanding with Kapsch, a global leader in intelligent transportation systems, to cooperate in North American markets. Kapsch is the parent company of Mark IV. Mark IV currently holds the IAG EZ-Pass contract to supply its transponders and readers to the 14 states -- EZ-Pass states. We will supply through Kapsch and co-develop products for the market. I believe this provides us with a great opportunity to leverage their portfolio of leading technologies in our FSTech group and to achieve profitable growth.

As I mentioned a few weeks ago, we'll pursue a variety of business models to leverage our strong businesses, brands and technologies, and these will generate growth. Our partnership with Pierce to create revenue opportunities for Bronto is one example, this agreement with Kapsch is another, and we have others that we're implementing.

We are still expecting to generate EPS of between $0.25 and $0.30 a share. We'll recognize a bulk of our earnings in the second half of the year. This is primarily due to the revenue growth and backlog trend that we are developing. It is partially due to our tax valuation allowance situation, which Bill will explain later. Basically, we are not able to show a tax benefit on domestic operating losses in Q1, but we will be able to recognize domestic income essentially tax-free as it is generated in the second half of the year.

We were in compliance with our debt covenants in the first quarter. Our current forecast shows that we expect to be in compliance through the year and we intend to refinance our debt later this year.

And now I'd like to turn the call over to Bill for a financial review.

Thanks, Dennis. I'll give a fairly brief review of our financial results for the quarter which are included in today's press release.

Looking at our P&L for the first quarter, orders were $210 million, which was up 6% versus last year, as Dennis has mentioned. Sales of $174 million were up 5% versus last year. Both gross margin and SG&A ratio were flat to last year. SG&A increased in absolute dollars versus last year due to the inclusion of a full quarter of expenses from the businesses acquired in March of 2010. This year's P&L includes a positive $1.6-million impact from a reduction of the good will impairment charge recognized for the FSTech business in Q4 of last year, as the company completed the second step of the impairment analysis in the first quarter.

Reported operating loss is $1.2 million compared to a $1.5-million operating loss last year. Pre-tax loss is $4.6 million versus a loss of $5.3 million last year. However, as Dennis mentioned, due to the fact that we are in a valuation allowance situation, we are not able to assume any tax benefit from the Q1 loss. Thus, despite the pre-tax loss, we recognized $700,000 of tax expense this year versus a tax benefit of $1.3 million last year.

As we discussed on our year-end call, we are in a valuation allowance situation for our domestic operations. For reporting purposes, we are not able to recognize any benefits for tax credits or operating losses. However, we will be able to use the tax credits and NOLs when we make domestic profits in future periods, which will significantly lower our effective tax rate.

On slide 4, we show the results by segment for the quarter. For purposes of comparability, we've excluded restructuring and impairment charges on this slide. The segments shown reflect the new operating group structure we began reporting under in Q2 of last year, and prior years have been restated for the transfer of our PIPS and parking businesses from our Safety and Security Group to the FSTech group.

Our Safety and Security Group, or SSG, generated $5.2 million of operating income in the quarter, resulting in a 10% operating margin. SSG's operating margin improved a point versus last year, driven by double-digit sales growth in our higher-margin core industrial business. Total Q1 orders for SSG were lower than last year, primarily due to overlapping a large Q1 2010 order in our European public safety business.

As Dennis mentioned, orders for our Bronto business continue to show good trends both sequentially and versus last year. Bronto's orders have continued to rebound after being weak in Q2 and Q3 of last year. Q1 orders this year for Bronto were $36 million, up from $29 million in Q4 of last year and $21 million in Q3 of last year. As a result, Bronto's order backlog has grown to $77 million at the end of the first quarter versus $57 million at the end of last year. Q1 revenue was lower than last year due to the lower order backlog resulting from weak orders in the middle of last year. However, operating income was flat to last year as cost initiatives and productivity offset the impact of lower revenue.

Our Environmental Solutions Group, or ESG, had strong order growth in the quarter, both versus last year and, as Dennis mentioned, sequentially. The order growth was primarily driven by increased demand for Guzzler vacuum trucks in the industrial market. However, operating income was lower than last year due to a variety of factors -- unfavorable product mix at Elgin and Jetstream, and some production inefficiencies resulting from both a lower order backlog and the final deployment of a common ERP system across the ESG group. All of these margin issues are expected to dissipate in Q2, helped by ESG's increased order backlog of $106 million, up from $83 million at year-end.

In addition, ESG's productivity and profitability were negatively impacted by a union campaign at our Vactor facility. The election to determine whether hourly employees desired to be represented by the union for purposes of collective bargaining was held on April 21, at which time a majority of the employees voted against union representation.

FSTech generated $23 million of revenue in the quarter and a $5.1 million operating loss, excluding the positive impact of the final impairment calculation. FSTech's quarterly P&L also included $2.4 million of depreciation and amortization. We expect to see revenue and income growth for FSTech through the year as contracts are finalized and FSTech's robust bid pipeline generates orders and revenues.

Corporate expenses in the second quarter -- in the first quarter were lower by $3.6 million versus last year due to lower costs related to hearing loss litigation and an absence of M&A-related costs this year versus $2.6 million of such costs last year.

On slide 5, we show our year-to-date cash flow. Operating cash flow for the quarter was negatively impacted by an increase in receivables due to heavy ESG shipments toward the end of the quarter, and some shipments were delayed by the production inefficiencies I referenced earlier.

In addition, Q1 cash flow was negatively impacted by payments relating to our debt amendment. Cash flow has been positive in April and we expect to generate positive operating cash flow in Q2 and beyond.

Turning to the balance sheet, the biggest change since year-end was the reduction in our cash and debt balances related to the payments made as part of the debt amendment agreement. In addition, our current assets increased due to the increase in ESG receivables I mentioned earlier.

As shown on slide 7, we are in compliance on each of our key debt covenants -- net worth, debt to capital and the new minimum cumulative EBITDA covenant that was instituted as part of our recent debt amendment. The amendment calls for a measurement of cumulative 2011 EBITDA at the end of Q1 and at the end of Q2, then monthly thereafter. As a reminder, the amendment places limits on the dividends the company can pay. As a result, the company will not pay a second-quarter dividend. The company will review the dividend each quarter.

The company has minimal debt maturities coming due in 2011. However, a revolving credit facility matures next April and we intend to refinance our debt later this year.

That wraps up the financial summary. I'll now turn the call back over to Dennis.

Thank you, Bill.

I spoke about our encouraging order trend in my earlier remarks, and now I'd like to take a few minutes to give you some more insight into our markets.

While I focus on the sub-segments of our business groups and their respective competitive sets and market dynamics, it's probably easier to talk about the overall market trends by three different categories -- the domestic municipal, the domestic industrial and then the international.

The domestic municipal market represents about 30% of our total business; the domestic industrial, another 30%; and the international markets, including our export business, about 40%. I'd like to take a minute to discuss each of these.

While the domestic municipal market is clearly facing challenges, our total orders in this market for 2010 were up 1% versus 2009, but we had a decline of 6% in the first quarter versus the same period last year. We are not expecting a rapid return to growth in this market, nor a return to order levels of a few years ago, but we do believe we should see relative stability here.

There may be some quarterly variations, but we expect the domestic municipal market for our business to be about flat this year and this is compared to a relatively low base in 2010.

The domestic industrial market, on the other hand, has been strong. In 2010, orders for the full year in this market were up 50% versus 2009. Q1 orders were up 25% versus last year in the same period. Our Guzzler vacuum trucks, Jetstream water blasters and industrial safety systems all experiencing strong order growth a double-digit operating margins, and we remain bullish on our businesses in this segment.

Internationally, we have been experiencing moderate growth, as growth in many regions is offset by the economic challenges in Europe. In addition, orders for our alerting and notification business were impacted by the unrest in several key markets in the Middle East. We believe these are very attractive markets for our safety and security products, but we are experiencing some short-term order disruption due to the significant levels of unrest in that region.

Total international orders were up 4%, both for the full year of 2010 versus '09 and for Q1 of 2011 versus 2010. Our key business in the international market are Skylift -- Bronto Skylift, our VAMA light bar and siren business, and our Victor mining products. As well, we do export ESG, SSG and FSTech products into the international markets from the United States.

So you can see our three markets are in a different state of growth -- relatively stable off a low base in domestic municipal, moderate growth internationally and strong, profitable growth in the industrial market.

We do not expect to see significant changes in these trends in the near future, and we will continue to take appropriate actions in each market to deliver profitable growth at Federal Signal.

Six weeks ago, on our year-end earning call, I set forth my fourth objectives. I believe that success in these four areas will drive improved shareholder value and I'd like to reiterate my four areas of focus and give you some examples of actions we are taking in each of these areas since the last call.

First, I am focused on improving cash management, including improving inventory management. With the help of our financial advisor, we have instituted a robust 13-week companywide cash forecast. Each group is making progress on actions also to improve inventory turns. This will all help as we have increased order backlog.

Second, I am focused on margin improvement in all of our businesses. We have segmented and reorganized our domestic public safety business to bring more focus on the specific markets of police, fire and amber warnings lights. This 80/20 implementation will enable us to better identify the profitable segments within our public safety business and those which need improvement. In addition, we expect to realize margin improvement in our FSTech business from the recent Kapsch agreement and other successful order trends.

Third, I am focused on delivering the financial results that we commit to and we're maintaining our 2011 EPS target of $0.25 to $0.30.

And fourth, I'm committed to transparency and cooperation with shareholders. We held our annual meeting Tuesday here. As part of the process, I met with several of our shareholders to solicit input on our director nominees and shareholder proposals. 91% of our shareholders voted their shares, which is the highest percentage we have had in the last several years. I am also pleased to report that all shareholder resolutions passed, and our 5 director nominees were elected by a significant margin. The details will be available in the 8-K, which will be filed shortly.

In summary, it's safe to say that my views and approach haven't changed over the past 6 weeks. Federal Signal will continue to operate as a diversified industrial manufacturing company and we'll continue to execute our 80/20 profitable growth strategies. We will continue to focus on generating cash flow from improving inventory management, and I'll continue to focus on improving shareholder value.

I look forward to sharing our successes with you on the future calls.

At this time, we'd be glad to open our phone line for questions. Thanks.

(OPERATOR INSTRUCTIONS.) Your first question comes from the line of Deane Dray with Citigroup. Please proceed.

Hi. Good morning. James Bank filling in for Deane.

Good morning, James.

Hi. Dennis, I was wondering if you could just elaborate on this partnership you have with Kapsch. What type of growth are you expecting from this partnership and how soon do you think you can expect to see positive results from it?

Yes, I'll go with the end first. I think it will take into next year before we see revenues come from this agreement. And the amount of the revenue is still undefined. The thing I can tell you, that if you look at the 14-state agreement that they have, the projected income over the last few years was $40 million or $50 million a year from transponders and tags, and this agreement is us supplying them with the latest technology in that area. So some portion of that over the next few years, and this really has not been defined.

Okay. And the upcoming potential re-compete on EZ-Pass essentially at the end of the summer. Is that also waiting on this forecast?

That's what that's all about.

Okay.

It's totally about the re-compete/re-bid of that contract, which actually has been delayed for a few years here. So we see it as an opportunity to supply our very advanced products that are being asked for by a lot of our (inaudible) customers through then to that channel.

Okay. Great. Now as you're kind of well into your growth initiatives, what would you say is giving you confidence that you should be able to meet the objective that you gave on the last conference call of two-thirds of these businesses being able to meet those 2012 margin targets by the end of this year? And then on the flip side, what do you think are still some of the biggest hurdles to that?

Yes. The -- that's a great question. The thing that gives me confidence is that because we are looking at each one individually, I can define it by individual business. I'll give you an example on Bronto. We're going the final stages of increasing our flow process through both our assembly plant (inaudible) booms and the final assembly manufacturing. And some examples -- the boom plant will drop in the labor hours from 650 to about 250 for each boom produced --

Wow.

And the main plant will go from 30 shifts to produce the final assembly to maybe 10 or 12.

Okay.

So it's pretty factual-based stuff. It's a result of a lot of good work of our teams for a long time. And likewise, in our SSG business, we've got some really good things going on in alerting and notification. I mentioned the Middle East unrest. They have a huge need for the kinds of products we have. The west coast with all -- with the tsunami that just occurred, we're lining up some orders relative to that. So market by market, we can give you examples. We have some early-stage things going on in some of the businesses that are a little more stressed, but it's really good work that's been done to identify good products, good customers, where the weaknesses are, what the manufacturing needs are, and we're beginning the early implementation process. So we feel good about the whole mix and it's one at a time.

Okay. Terrific. I'm sorry -- the 650 to 250 hours, that was per Bronto Skylift or that was one --

For Skylift, yes. For Bronto Skylift.

Okay. Similarly with the shifts. Those were for Skylift?

The shift was also for Skylift, but final assembly of the entire truck.

Okay. Great. Now the -- I guess going through your press release, you seem to be a little bit more positive on the longer-cycle businesses given the backlog. What are your customers saying about those markets? And do you see any better visibility on maybe municipal spending, I guess, given your guidance is flattening this year, potentially rebounding next year, or is that still too soon?

The visibility is still very difficult to see beyond a month or two. There really are no strong indicators that the municipal is going to pop up at any extent. We think what we're seeing is replenishment of products that have just been taken out of service on that side. The industrial customers are telling us -- I'll give you an example. The -- a lot of the products go into oil refinery and production, so you know what's going on there because of the cost of oil. Our jet stream benefits from that -- the Guzzler, the Vactor. So I think we're still cautious about the municipal, both in Europe and here.

Okay. And then lastly, on the corporate expense, I guess with the hearing loss litigation not partially out but almost majority out and then the (inaudible) cost out from last quarter, is this a good run rate we're using relative to the sales you put up in the quarter?

Yes. I think actually we had probably a decent run rate. It might go up a little bit as we move ahead. We had, like you said, very, very low hearing loss expenses and that may go up a little bit as we go forward, but I think it's probably in the right range.

Okay. Great. That's all I have. Thank you.

Thank you.

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

Good morning, guys. It's actually Alex Walsh in for Steve. I was hoping just to kind of follow on to the Kapsch question, and I think you mentioned that it was going to potentially provide some upside to margins in the segment and I was wondering if you could kind of just give us a better sense as to the difference in the margins in that program relative to the rest of your FSTech business and kind of what's a right way to think about run rate margins in the segment.

We really haven't quoted anything there yet so it would be difficult to give you any kind of an estimate, but we expect our business runs pretty consistent in terms of margins.

Okay. And then I know it's only been 6 weeks since the last call, but just in terms of getting to your margin targets, have you -- could you just provide a little bit more detail on some of the cost actions that you've seen so far or, I guess, when the -- what's the timeframe for some of the rollout for those?

When we talked about it last year, we put it out there as targets for 2012. And we're going to see some movement up and down on margins. So -- example. We saw SSG move up a point this quarter and that's obviously mix, price, some of the actions. We're working a lot on inventory. We're working on flow. So it's going to be incremental over the years. So it won't bang in -- it won't kick in on a certain day. We'll see growth this year through next year.

Okay. And then just turning to order rates. Just so far moving through Q2, would you say it's been pretty consistent with the guidelines that you set out or -- just by segment?

Met the expectation. The -- it's early in the quarter, but it seems as though the same areas where we saw the good order rates in the first quarter on the industrial side are still active and so it's -- I think so. The answer is I think so.

Okay. Alright. Thank you. I'll jump back in line.

Thank you.

(OPERATOR INSTRUCTIONS.) There's a question from the line of Charles Brady with BMO Capital Markets. Please proceed.

Thanks. Good morning, guys. And I apologize if I missed this in your comments on ESG. Did you break out the impact from the ERP and the union campaign -- what that did to margins in the quarter?

Charlie, it's Bill. We didn't break that out. I think that the different items I listed there are all significant factors. We don't want to get too much into the union costs, but each of the ones I talked about -- the (inaudible) implementation, the union drive and having a lower order backlog causing production efficiencies. Those are all sort of the significant factors in the profit decline.

I'm just trying to get to a normalized kind of -- what a normalized margin ought to be at this kind of revenue run rate. Can you lump it all together?

Yes. I think last year's margin is a pretty reasonable target to shoot for.

Okay. For -- you're talking about the full year?

No. Just in the -- the run rate at this revenue level. So we had about a 5% margin last year at ESG.

Yes.

As we talked about, we expect revenues to grow there because the order backlog is growing. But we think (inaudible) for 2012, our targets are closer to 10% for this business. So we think 5% growing throughout the year is a reasonable target.

Okay. Thank you.

Yes.

Your next question is a follow-up from the line of Deane Dray with Citigroup. Please proceed.

Hi. Just something on pricing. I saw on the safety and security group you had some good benefit from pricing initiatives. I was wondering if you could give us the overall price to cost relationship you had in the quarter and maybe how you see this playing out through the year, especially with steel climbing?

Yes. It's Bill. Steel is our biggest single commodity and we're pretty well locked in on that through the year. We took pricing coming into the year to offset the increase in the steel price that we're seeing, and that's locked in. So we don't have as much exposure to commodities as some other businesses out there and really, for us, pricing offset the cost increase and that was how we budgeted and that's what we're seeing.

Okay. So on the -- with the contracts, I guess you have the order backlog. You have price escalators in those?

On -- I'm sorry -- which one?

Well, I guess I'm a little confused in terms of if the steel's locked in and the price climbs -- cost climbs, how are you able to offset that with price? Do you have escalators in your orders?

No. I'm sorry. Let me -- maybe I didn't say it clearly. We've got our steel cost and supply locked in for the year.

Oh I -- okay.

We set our prices based on those costs. Now moving into 2012, (inaudible) to climb and we're not locked in there, we may have to look at some more pricing for that.

Okay. I see. Thank you. And then just on the cash outflow in the quarter. Sort of a common theme we're seeing across the (inaudible) industry group is everybody's ramping up working capital for demand they're seeing, but given your initiatives that you have in place, Dennis or Bill, is this something where we could see a cash inflow and maybe even 100% conversion on net income?

We're going to see a reduction from the inventories as we reduce the capital down, and so I think -- it may not be an even wash but I think we'll see the benefit of it.

Okay.

Our target is to lower working capital throughout the year versus the year-end last year. We had a little bit of bump up in the first quarter and that wasn't really inventory-driven; that was more driven by receivables at ESG as we got shipments out very late in the quarter because of some of the production inefficiencies. So we actually feel relative good where our inventories are, given the order backlog. As we fill those orders and they become revenues, we expect inventories to come down a little bit.

Okay. Great. And then -- I'm sorry -- lastly, on the FSTech, I'm still not clear. Is this -- I think earlier or on the last conference call, you expected that to be profitable for the year. Is that still the target or break-even even for the year?

That's still the target for the year.

Okay. Okay. Great. Thank you.

Yes.

Thank you.

Your next question comes from the line of Brad Evans with Heartland. Please proceed.

Good morning.

Good morning, Brad.

Could you just give -- yes, Dennis. Good morning. Can you just give us your thoughts in terms of the magnitude of capital you hope to free up off the balance sheet from a working capital perspective? Give us some bookmarks if you could.

We're thinking at this point, Brad, that probably $10 million as a minimum. We've got some higher targets in a few of the businesses, and as long as all the 80/20 work is pulled together, it could be higher.

How much higher than $10 million could it be, do you think?

It could be anywhere between $10 million and $17 million or $18 million.

That's what you hope to get in 2011?

During this year, yes.

Okay. Would there be further opportunity beyond that?

There is. There is further opportunity beyond that. And probably in the similar magnitude over the next year. We have one example in Bronto where it's $20 million on its own -- the target. But we're not going to achieve all that during this year. So each of the businesses has specific goals, Brad, so I think if you use those numbers for this year and next year, that would be good numbers.

Could you just -- if you mentioned this, I apologize. Could you just comment on what you've seen from an order perspective through April?

The order rates through April are consistent with what we've seen through the first quarter. What we've seen -- the industrial continues to be at a pretty good pace. And April's such an early month in the quarter, it's hard to say that it'll make the quarter, but the tempo we're seeing feels about the same.

Brad, it's Bill. Very early days obviously for the quarter, but right now, the rate is about the same in total as the first quarter. So not sequentially growing, but about the same rate as we saw in the first quarter.

Okay. Do you have any internal targets for where you'd like to see leverage in the business over the medium term as a multiple of, say, adjusted EBITDA?

Yes. It's Bill again. I think our longer-term goal is to try to get our debt to EBITDA in the range of 2 to 3 times. We've obviously got some work to do to get there, but if we can continue to squeeze out the capital and turn some of these orders into revenue and profits and cash flow, that's our long-term target.

Your capital budget this year is currently expected to be --

CapEx (inaudible)?

Yes.

In the neighborhood of $15 million.

Okay. And you feel that the 2 to 3 turn target on a debt to EBITDA basis is something you can accomplish organically without asset sales?

Yes.

Okay. And then just one last question. Could you just -- if you mentioned this, again I apologize. Just tax rate going forward? Can you just give us your thought for full-year tax rate?

Yes. It's -- the full year is probably around 30%, Brad, but the second half is going to be more like 20% and maybe a nudge below that because of the tax valuation impact. So it really swings by quarter depending on the domestic profits. We're forecasting those to increase in the back half so that'll really bring down the rate. At that point, we're effectively really only going to be paying -- or recognizing taxes on our foreign earnings, so the domestic profits are largely going to be tax-free.

Okay. Thank you very much.

Yes.

Thank you, Brad.

(OPERATOR INSTRUCTIONS.) There are no further questions at this time. I'll turn the call over to Mr. Dennis Martin for final remarks.

Thank you very much. I would like to thank all of you for supporting Federal Signal and we'll keep the dialogue open and look forward to our next call. Thank you very much.

Ladies and gentlemen, that concludes today's presentation. All parties may now disconnect. Have a great day.