Federal Signal Corp (FSS) 2014 Q1 法說會逐字稿

Good day, and welcome to the Federal Signal Corporation first quarter conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brian Cooper, Senior Vice President and Chief Financial Officer. You may begin, sir.

Thank you, Lauren. Good morning, and welcome to Federal Signal's first quarter 2014 conference call. I'm Brian Cooper, the Company's Chief Financial Officer. Also with me on this call are Dennis Martin, President and Chief Executive Officer, and Jennifer Sherman, Chief Operating Officer.

We will refer to some presentation slides today, as well as to the news release, which we issued this morning. The slides can be followed online by going to our website, federalsignal.com, clicking on the investor call icon, and selecting the webcast. We have also posted the slide presentation to our website.

Before we begin, 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.

Our presentation also contains some measures that are not in accordance with US generally accepted accounting principles. In our news release and filings, we reconcile these non-GAAP measures to GAAP measures. In addition, we will file our Form 10-Q today.

I am going to start by addressing our financial results. Dennis will then provide his perspective on our performance and direction. And Jennifer will wrap up our prepared comments with a discussion of some of our progress on our corporate initiatives and our outlook for the remainder of 2014.

As you have seen in our earnings news release, our first quarter highlights reflect solid consolidated results and strong order growth. Our first quarter is typically our weakest quarter in terms of financial results, as a result of seasonal factors including how budgets are spent. This year, weather played a little larger role as we lost some days of production to closed plants and it reduced or delayed customer demand for some of our products.

Even with the unfavorable weather, consolidated operating income was up 6% versus last year on flat sales and operating margin rose to 6.4%. Interest expense was $1 million, $3.5 million lower than last year, and adjusted net income from continuing operations from Q1 was $7.5 million or $0.12 per share.

In last year's first quarter, we also had significant debt settlement charges associated with our prior year debt financing. Adjusting for those charges and for the change in our tax position, our adjusted EPS last year was $0.08 per share and this year's result represents a 50% improvement.

Perhaps the biggest highlight for Q1, though, are orders and backlog. Orders totaled $232 million, up 21%, and backlog was at a very healthy level of $338 million. In fact, as you can see in our group results that all three of our business groups reported double-digit percentage increases in orders versus Q1 last year. Orders of ESG were up 13%, reflecting some nice pickup on the street sweeper side, together with continued strong demand for vacuum trucks and sewer cleaners. Sales were up 8% versus last year and operating income was up 20%. The operating margin rose to 12.6% compared to 11.4% a year ago.

At SSG, orders were up 16%, primarily reflecting strength in our police businesses. Tails were down 6% compared with last year's quarter, primarily reflecting low shipments in alerting and notification systems. Tails mix also worked against operating margins in the quarter, producing operating margin of 7.8% and operating income of $4.3 million, which was down 22%.

In the Fire Rescue Group, orders were up 52%, contributing to a significant backlog of $106 million, 25% higher than at March 31 a year ago. On the other hand, sales of only $24.5 million were disappointing. As we've discussed in the past, deliveries for FRG can be highly irregular. At the end of Q1, a higher than normal number of deliveries of completed vehicles were deferred with an associated operating income impact of about $1.5 million. Consequently, FRG lost money in the quarter.

Corporate operating expenses at $5.9 million were relatively low in Q1. Professional fees were lower and we continue to benefit from a low level of trial activity and costs related to any defense of hearing loss litigation. In total, Q1 consolidated operating income was $12.8 million, up 6% versus last year. Operating margin increased from 6.1% last year to 6.4% this year.

When we compare income from continuing operations, you can see the flow through of this operating performance to the bottom line. The three other key items effecting the quarter are interest expense, which is down significantly, last year's debt settlement charges, and income taxes, which are higher this year. For those who may not have followed our story closely, the increase in income tax expense resulted from our conclusion last year that we no longer need to record a valuation allowance against our domestic deferred tax assets. We therefore are reflecting a full tax rate in the US as of the beginning of 2014.

From a cash perspective, we continue to pay little tax in the US, but our income continues to be offset by the use of deferred tax assets consisting of net operating loss carry forwards and tax credit carry forwards. ON this GAAP basis, were therefore earn $0.12 per share from continuing operations in Q1 compared with a loss of $0.02 per share in Q1 of last year. There were no significant unusual adjustment items in Q1 this year. However, to facilitate earnings comparisons, we've adjusted for unusual items last year, which included debt settlement charges and the change in income taxes.

The income tax expense included in our adjusted earnings per share for the first quarter of 2013 reflects a normalized effective tax rate of about 32%, which excludes the effects of special tax items, most notably the change in the Company's valuation allowance position. For 2014, we anticipate the comparable effective tax rate, excluding any special tax items, to be about 33%. On this basis, our adjusted EPS for the quarter was $0.12 compared to $0.08 per share in Q1 a year ago.

Looking at the balance sheet and cash flow, the first quarter of each year is typically a period in which our businesses add working capital and this year is no exception. As a result, cash use by continuing operations was $7 million during Q1. This is less than the cash used a year ago, which was about $13 million. In spite of the cash used by continuing operations, total debt declined during the quarter to $88 million compared to $92 million at the end of 2013. Debt benefited from our receipt of approximately $7 million of escrow funds from the FSTech investiture. Our leverage ratio of debt to adjusted EBITDA dropped to 1.0 times. That compares to 1.1 at December 31 and 2.4 a year ago, as we've seen steady improvement. In addition, our average interest rate during the quarter was about 3% compared to about 12% in the first quarter of 2013.

That concludes my comments on the numbers and I would like to turn the call over to Dennis.

Thank you, Brian. Before I comment about the quarter, I'd like to address two recent announcements. First, last week, Federal Signal's Board of Directors declared a dividend of $0.03 per share, and as we have discussed, our Board of Directors has continually considered reinstating that dividend. We last declared a dividend in the fourth quarter of 2010 and that dividend reflects the Board's confidence in strong recovery in our business that we have achieved over the last few years. We view our dividend as one important way to return value to shareholders. That is our focus and we want to be clear that our dividend does not limit our growth opportunities. We are fortunate to have attractive opportunities for growth within the Company and we are pursu9ing them. We will also continue to look at acquisition opportunities that would build on our core competencies and that we can leverage (inaudible).

Our management and our Board believe that we can build a discipline, obtaining regular dividends, while still investing in our growth. We have a constant focus on creating value for our shareholders and we are pleased to be able to return some of the value in the form of this dividend. The same announcement also described the Board authorization to repurchase up to $50 million of Federal Signal stock. This is intended primarily to facilitate protection in the Company's stock held by our US pension plan and to reduce dilution resulting from issuance of stock under our employee equity incentive programs. I

I also want to comment on our announcement of Jennifer Sherman as our Chief Operating Officer. Jennifer has partnered closely with me through the last three and a half years to restructure Federal Signal and to return us to profitability. She has been pivotal in all of our strategic moves, which certainly include the sale of our FSTech business to 3M and the refinancing of our debt. Those are some of the most visible contributions, but Jennifer has also become increasingly close and involved in our business operations, as we have refocused our strategy to deliver the improvements that you have seen from Federal Signal. Her most direct operating responsibility has been with our Safety and Security group. The announced change formalizes the role and the responsibilities that Jennifer has been carrying during the last several years, and naturally, is indication of the high level of confidence the Board, our Company, and I have in her leadership.

With that, I'd like to make a few comments about the quarter and then ask Jennifer to update you on some of the specific areas of progress. From my perspective, our consolidated results from the quarter were very much in line with our internal expectations. Our orders were exceptionally strong and our resulting backlog is healthy and supports our outlook for the rest of the year.

At ESG, we benefited from continued strong growth in operating leverage, additional volume that leverages our existing operations, makes a strong contribution to the bottom line. I believe that we are doing the right thing to improve productivity and output. Our products are well positioned in and the markets are progressing. We already have our new production line operating (inaudible), and across ESG, we have had a good demand for both the industrial and municipal markets.

SSG got off to something of a slow start for this year, mostly as a result of the irregular nature of our systems businesses. These systems can be large implementations with long gestation periods and fewer were completed in Q1. In contract, I was very encouraged by the improving results in our police and other public safety businesses. In addition, we had good order flow across SSG, which will benefit the next few quarters.

FRG was significantly impacted by deferred sales. We frequently talk about how deliveries in the Bronto business can be at risk for any given quarter, but this quarter had an unusual high number of deferred deliveries on completed units. That carries directly to the bottom line, resulting in a loss for the quarter and obscures the progress that Bronto has made, particularly with operational improvements. The good news is that the deferred units will fall into Q2, so barring similar issues at the end of Q2, their second quarter should be much stronger.

In addition, their order intake was impressive and gives them a backlog of $106 million, which sets Bronto up to have a solid year. Now, I'm pleased to turn the call over to our newly named Chief Operating Officer. Jennifer?

Thank you, Dennis. Regarding my new title, I'd like to start by thanking Dennis, our Board, and the Federal Signal organization for their constant support and the expanding challenges I've enjoyed with the Company. I'm committed to continuing our focus on improvement and creating value, and I'm excited about the opportunities and prospects for Federal Signal.

Today, I'd like to describe some of our specific activities and successes that are helping us improve, create value, and move forward on our initiatives and goals. I will talk about developments and connections with specific initiatives, but many of them stay in multiple goals.

Regarding our initiatives to support organic growth and diversification, there are a number of notable items. We have a renewed focus on new product development and innovation. Our teams are assembled and are prioritizing projects. We are excited to have them actively working on new growth opportunities. At the recent National Fire Trade Show, we also introduced a new product that arose from our historical product development efforts that is our Navigator Lightbar for fire markets and it was well received.

We have been piloting a project to do more complete upfitting of police cars, similar to what we do in Europe, which allows us to deliver turnkey vehicles. This approach has proved a success with the Los Angeles police department and has attracted additional interest from other customers.

During 2014, we have also restructured our organization of SSG on the systems side to foster greater collaboration and position us for growth. Similar moves at ESG over the last few years have produced some excellent results and we are encouraged by how these SSG changes are progressing so far.

More generally, ESG sales growth in Q1 was largely in industrial markets, with more promising margins. Elgin succeeded on additional international opportunities and Bronto's development of opportunities in the industrial markets in the United States is off to a promising start. There are also a number of good examples supporting our progress on manufacturing efficiencies and cost optimization. ESG and Bronto continue to apply lean strategies to their operations, resulting in improved productivity. During Q1, SSG implemented new productivity measures that have been facilitated by the JD Edwards ERP system, which we implemented in SSG last year. These measures are gaining traction and over the long run will improve our profitability.

On the cost side, we continue to closely manage corporate and other expenses, and we've tackled some of our largest spending areas, including freight and IT. On the freight side, we have begun consolidation of carrier relationships across our SSG and ESG groups and are tackling opportunities for better negotiated rates. In IT, we've assembled a cross functional senior team to prioritize and challenge our IT practices and spending. One success alone is slated to save us over $1 million over the next two years.

Finally, some of our biggest opportunities are in leveraging our existing operations. For example, Vactor has been increasing output by improving quality and productivity while making targeted investments and we continue to reap the benefits. One of the Vactor initiatives was the addition of a new line. The Vactor team managed an exceptionally rapid implementation, moving from conception during the fourth quarter last year to startup in April and we are beginning to ramp up production for hydro-excavation products that have a very strong demand.

I hope this gives you a flavor for our progress and our excitement. There are a lot of positive developments in our businesses. I would encourage you to go to our website to view our annual report video, which details our goals and accomplishments.

I would like to conclude with brief comments about our outlook. Our Q1 consolidated financial results were in line with our internal expectations. While we had some tradeoffs among businesses, as always, that is one of the advantages of having a portfolio of businesses. The quarter exceeded our internal expectations for orders and backlogs, which reinforces our confidence in an outlook for earnings per share of at least $0.79 for 2014.

With that, I think we're ready to open the line for questions. Operator?

Our first question comes from Matt McConnell with Citi Research.

Thank you. Good morning and congratulations to Jennifer.

Thank you, Matt.

Good morning, Matt.

If I could say on ESG, you've had a couple nice order quarters here, I think, three in a row. So how much of that is from the throughput improvements that you've made versus maybe an improvement in municipal markets or anything else that's really contributing to the recent quarter trend?

Yes, I think we've improved our margin capability by a little more efficient production, but the markets, Matt, certainly have increased in both the baseline and the industrial market. The industrial market is way ahead of the municipal, but we are seeing good strong demand for municipal, sewer cleaners and so forth. So really (inaudible).

Great. And do you have a sense of maybe the age of the installed base for sweepers? I wonder if there's pent up demand that could be unlocked? Is that something that you have any way to quantify?

We guess at it more than we quantify it, Matt. When you think about the number of sweepers that go into the market every year, there's about 1,500 maybe or a little more and they have a 10 to 15 year life. Some of them now have been switched out, so I'm sure there are some that are ready to be replaced. But there's also been a change to the demographic of sweeping in some cities where they're not operating as many. So it's really difficult to pin down what the pent up demand is. We certainly have seen more small fleets released by cities in the last six months than we have, say, a year ago or three years ago.

Great. That's helpful. And then you were clear that the dividend and buyback aren't going to impact your ability to make Europe investments, including bolt-on deals. So I wonder if you could just discuss briefly, how do you go about the process of reinstituting an M&A pipeline and it seems like some of the best acquirers are very systematic about continually developing a pipeline sourcing targets. And how do you start that from kind of a standing stop?

Hey, Matt. This is Brian. I'll take a stab at your question. What we've been doing is talking with our businesses. I think that's where you start. We want to stay close to home, close to the core businesses and our core competencies with anything we would buy. So we talk to the people running our businesses for their ideas, what they see. We also have made sure that we have our message out there with investment bankers and others who might be in the markets with opportunities. And I would just say it can take a long time to build a pipeline, but I think we're encouraged by the number of opportunities we've seen so far. I don't know if Dennis or Jennifer want to add on to that.

Yes, I think I would add that internally, we've developed an M&A protocol and a robust diligence process. So when the right opportunity comes along, we feel that we're prepared to examine the opportunity using both internal and external resources.

We've also looked at a number of things over the last few years that we've kept in the warming oven, if you will, so we're not starting from zero. But again, we're trying to be very close to the core. They need to line up with profitable growth and they need to be in areas where we're competent to do manufacturing or in market.

And we're pleased to date with the opportunities that exist.

Good. Good to hear. Thank you.

Thanks, Matt.

(Operator Instructions) Our next question comes from Robert Kosowsky with Sidoti.

Good morning. Congratulations, Jennifer and hello Brian and Dennis. How are you doing?

Thank you.

How are you Rob?

Doing pretty good. Quick question on the environmental, the ESG backlog or I guess it's the order growth. Was the order growth rate for your industrial markets, the areas you want to grow, and was that higher than what the average was for the group?

Yes, it continues to be a very strong driver. At the same time, though, we've seen very good growth on the (inaudible) side. So it's not one sided.

Okay, and I guess within those industrial growth areas, is there any particular end market or product that's shooting the lights out versus some other ones?

Well, I think with all the pressure on the environmental markets, the hydro-excavators, and the (inaudible) and backing products are begin driven by a broad market. But certainly, in the energy markets are creating a high level of demand. We just went to South Dakota to rent a building to provide service for our customers and there are very few buildings available. So there are hotspots. And so we think the hotspots in those core markets like oil exploration and energy are probably driving a big piece, but we're seeing it in a very broad way.

Okay, so you think this was just -- we've seen energy CapEx increasing it seems like. Do you think that was something that was a major driver in the quarter?

I think it helped a lot, sure.

Okay, and then also, could you maybe talk about the complexion of the backlog in SSG and just specifically talk about the large order that was added into backlog in the quarter. Was that just more warning systems for, I guess, industrial kind of petrochemical applications? Is that what we should read into?

As we look at that market, it's made up of multiple pieces, but also multiple orders and we have a very large order we received on the Middle East and we had to work on for the last six months. And at the same time, there's others in the refining area that have had been a little slower to come together. But on the police, on SSG, the police side has been driving some very nice orders with our work on the Los Angeles Police Department and other major cities with some of our new light products.

So it's not one sided. It really is kind of being driven by multiple pieces, but the big projects do tend to go month to month and some of them have lagged in our performance. We just haven't seen the same orders.

Okay, and then looking out over the next few quarters, how do you see the implementation of these large orders that can be lumpy? Is it going to be fairly uniform? Is any quarter going to be particularly lumpy, or is there risk that some of this could get shifted out to next year too?

Well, part of the mystery of the large orders is you don't know. What you do know is where you are in the quoting cycle in the funnel. We have a very large funnel of projects that we're hoping will fall and help us achieve the operating income level and the targets that we put out last year. So we're (inaudible) a good funnel and we're focusing our teams on them and as I say, because of the uncertainties of how things close, where they fall in which quarter is really hard to predict.

Okay. Thank you very much and good luck.

(Operator Instructions) Our next question comes from Brad Evans with Heartland Sons.

Good morning everybody and congratulations to Jennifer on the promotion and Dennis, I tip my hat to you and the Federal Signal team here. I mean you've come a long way. I mean the balance sheet is a thing of beauty and the laser focus you have on the operations right now in terms of operational execution as well as being great at what you're -- at your existing businesses, I think it has manifested itself in the restoration of a lot of shoulder value. And it looks like there's exciting days for Federal Signal shareholders here going forward. So we want to thank you for being a very, very strong steward of shareholder capital.

Well, thanks Brad and I just want to thank you and the other shareholders for being patient and supporting our last three and a half years. As you know, it's been very strategic and it's been very disciplined and we tend to continue to do that.

I just had a couple of -- just a quick housekeeping question just to kind of understand you're talking about the buyback and the dividend not having a major limiting factor on your ability to grow both internally investing as well as through, perhaps, tuck-in acquisitions. If you take the low end of your guidance, I guess, I guess you're roughly $50 million of net income and on a pre-tax basis that gets you roughly $75 million to $80 million of pretax. And it looks like interest is, if it currently kind of, if you run out -- annualize the first quarter, that's roughly $4 million. So you're about $80 million plus or minus an EBIT and the depreciation and amortization kind of gets you into the range of I think about $95 million or $100 million of EBITDA for the year.

Your CapEx budget currently stands at what?

We've been running around $15 million. We're going to run a little higher this year so $15 million to $20 million.

We've been adding some strategic initiatives as we have the availability and if they'll improve productivity. So it will be a little bit higher.

Okay, and does working capital swing in a large direction either positive or negative for the full year from a cash flow perspective?

Well, from this point forward, we'll probably see some improvement to year end. Fourth quarter is usually our biggest year of upswing in cash flow out of working capital.

Okay. I'm sorry, Brian, I clicked off the press release. So was that a small use of working capital in the first quarter?

It was a use of it in the first quarter, yes.

Okay, so maybe call the full year neutral to be conservative.

Q1 is usually the quarter we build working capital the most. There's a little bit during the rest of the year as well because we have pretty significant business running through the year and then fourth quarter it reduces again.

Got it. So CapEx of $20 million, interest of roughly $5 million and the dividend now of roughly $8 million. So call it roughly $30 million to $35 million of those outflows. So clearly, you have the ability to generate, if the stars align here, if you're able to meet your expectations generating kind of $60 million to $65 million of free cash flow. Is that about right?

That is, yes.

Okay, keep up the good work, you guys.

Capacity on top of that. So I mean we have our debt down to a fairly low level and we have tolerance, I think, for a higher level of debt. Not to say we want to go back to where we used to be.

So do you think -- would you go -- roughly at 2 to 2.5 turn leverage is something you'd be comfortable with at this point?

Yes, and I think it always depends on what takes you there. If it's because operations aren't going as well, that's not as comfortable as we bought a highly profitable business or something. But yes, that's about the range we talked about also.

Okay, well thank you for taking the questions. Good luck.

Thank you, Brad.

(Operator Instructions) Our next question comes from Ryan Castle with Global Hunter Securities.

Hi, guys. Hi, just to hit on SSG again, could you talk about the quoting activity and the order trends as we've gone into Q2? Have they remained strong and do you think we're at an inflection point with customers on the timing of these larger projects?

The funnel on proposals and SSG remains very robust and consistent as it has over the last three or four quarters. So it's really timing of projects closing. I'm not sure I could say we're on an inflection point, but I think we have a good backlog of orders to support our annual plan.

Okay. Okay. Sounds good. And then lastly, is there a way to quantify the impact of severe weather in the quarter?

We played with that and I don't think we want to make too big a deal about it. We do know that we've lost four or five days in one of our factories because of cold and snow and another one, we lost three or four days. But at the end of the day, every year you do have some weather and so I think what may have been delayed out of the month that the weather occurred would likely have been recovered in the next month or so. I think we're past that, but really can't give you numbers.

Okay, great. Thank you.

(Operator Instructions)

Well, we have no further questions, I think. In closing, I would like to reiterate that we're excited about the changes we are making, the progress we have already made in our outlook for the year. We remain focused on creating shareholder value and appreciate the continued support of our shareholders. We also could not be at this point without the hard work of our employees, the dedication of our distributors and dealers, and the good relationships we have with our customers. And we thank them all. Thanks again for joining us and look forward to talking to you next quarter.

This concludes today's conference. Thank you for your participation.