Federal Signal - Earnings Call - Q1 2014
May 1, 2014
Transcript
Speaker 0
Good day and welcome to the Federal Signal Corporation First Quarter Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over Brian Cooper, Senior Vice President and Chief Financial Officer. You may begin, sir.
Speaker 1
Thank you, Lauren. Good morning and welcome to Federal Signal's first quarter twenty fourteen 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'll 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'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. Our presentation also contains some measures that are not in accordance with U.
S. 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'm 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 close 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 $1,000,000 $3,500,000 lower than last year and adjusted net income from continuing operations for Q1 was $7,500,000 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 $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 $232,000,000 up 21% and backlog was at a very healthy level of $338,000,000 In fact, 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 at 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.
Sales were down 6% compared with last year's quarter, primarily reflecting low shipments in alerting and notification systems. Sales mix also worked against operating margins in the quarter, producing an operating margin of 7.8% and operating income of $4,300,000 which was down 22%. In the Fire and Rescue group, orders were up 52%, contributing to a significant backlog of $106,000,000 25% higher than at March 31 a year ago. On the other hand, sales of only $24,500,000 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 $1,500,000 Consequently, FRG lost money in the quarter. Corporate operating expenses at $5,900,000 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 defensive hearing loss litigation. In total, Q1 consolidated operating income was $12,800,000 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 affecting 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 U. S.
As of the 2014. From a cash perspective, we continue to pay little tax in The U. S. Where 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, we therefore earned $0.12 per share from continuing operations in Q1 compared with a loss of $02 per share in Q1 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. Income tax expense included in our adjusted earnings per share for the 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 $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, used by continuing operations was $7,000,000 during Q1. This is less than the cash used a year ago, which was about $13,000,000 In spite of the cash used by continuing operations, total debt declined during the quarter to $88,000,000 compared to $92,000,000 at the 2013. Debt benefited from our receipt of approximately $7,000,000 of escrowed funds from the FS Tech divestiture. Our leverage ratio of debt to adjusted EBITDA dropped to one point zero times that compares to 1.1 at December 31 and two point '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 2013. That concludes my comments on the numbers. And I would like to turn the call over to Dennis.
Speaker 2
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 $03 per share. And as we have discussed, our Board of Directors has continually considered reinstating the dividend. We last declared a dividend in the 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 pursuing them. We will also continue to look at acquisition opportunities that would build on our core competencies and that we can leverage for profitable growth. Our management and our Board believe that we can build a discipline of paying 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 describes the Board authorization to repurchase up to $15,000,000 of federal single stock. This is intended primarily to facilitate reduction in company stock held by our U. S. Pension plan and to reduce dilution resulting from issuance of stock under our employee equity incentive programs.
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 point five 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 FS Tech business to three ms 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 within our Safety and Security group.
The announced change formalizes the role and the responsibilities that Jennifer has been carried during the last several years and naturally is an indication of the high level of confidence the Board of our company and I have in her leadership. With that, I would 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 Mike's perspective, our consolidated results for 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 and 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 things to improve productivity and output. Our products are well positioned and the markets are progressing. We already have our new production line operating at Vactor. 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 irregular nature of our systems businesses. These systems can be large implementations with long gestation periods and fewer were completed in Q1. In contrast, 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 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. That 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 $106,000,000 which sets Pronto up to have a solid year. Now I'm pleased to turn the call over to our newly named Chief Operating Officer. Jennifer?
Speaker 3
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 in connections with specific initiatives, but many of them span 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 Light Bar 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 Turncrete 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 at 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 improved productivity. During Q1, SSG implemented new productivity measures that have been facilitated by the J. D.
Edwards ERP system, which we implemented at 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 $1,000,000 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 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 start up 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 trade offs 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?
Speaker 0
Thank Our first question comes from Matt McConnell with Citi Research.
Speaker 4
Thank you. Good morning and congratulations to Jennifer.
Speaker 3
Thank you, Matt.
Speaker 2
Good morning, Matt.
Speaker 4
If I could start on ESG, you've had a couple of nice order quarters here, 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 order trend?
Speaker 2
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 municipal 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 a combination
Speaker 5
Okay. Of
Speaker 4
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?
Speaker 2
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 ten to fifteen year life. Some of them now have been pushed out. So I'm sure there are some that are ready to be replaced. But there's also been a change in the demographic as we think 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 had say a year ago or two years ago.
Speaker 4
Great. That's helpful. And then you were clear that the dividend and buybacks aren't going to impact your ability to make growth 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 and 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?
Speaker 1
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 that we've seen so far. I don't know if Dennis or Jennifer want to add on to that.
Speaker 3
Yes. I think I would add that internally, we've developed an M and 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.
Speaker 2
And that we've also looked at a number of things over the last few years that we've kept in the warming of it if you will. We're not starting from zero. But again, we're trying to be very close to the core. They need to line up profitable growth and they need to be in areas where we're confident to do either the manufacturing or market.
Speaker 3
And we're pleased to date with the opportunities that exist.
Speaker 4
Good to hear. Thank you.
Speaker 2
Thanks, Matt.
Speaker 0
Our next question comes from Robert Kusoski with Sidoti.
Speaker 6
Good morning. Congratulations, Jennifer and hello, Brian
Speaker 1
and Dennis. How are doing? Thank How
Speaker 7
are you, Rob?
Speaker 6
Doing pretty good. Quick question on the environmental, the ESG backlog, or I guess just the order growth. Was the order growth rate for your industrial markets, areas you want to grow in, was that higher than what the average was for the group?
Speaker 2
Yes. It continues to be a very strong driver. At the same time though we've seen very good growth on the municipal side. So it's not one side.
Speaker 6
Okay. And I guess within those industrial growth areas, is there any particular end market or product that's really shooting the lights out versus some other ones?
Speaker 2
Well, I think with all the pressure on the environmental markets, the hydro excavators and the guzzlers and vacuum products are being driven by broad market. But certainly in the energy markets are creating a high level of demand. Example, 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.
Speaker 7
Okay. So you think this was just
Speaker 6
we've seen energy CapEx increasing it seems like. Do think that was something that was a major driver in quarter?
Speaker 2
I think it helped a lot sure.
Speaker 7
Okay. And then also can you maybe talk about
Speaker 6
the complexion of the backlog in SSG and just specifically talk about the large order that was added into backlog in the quarter? What was that? Is this more warning systems for I guess industrial kind of petrochemical applications? Is that what we should read into?
Speaker 2
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 out of The Middle East and that we had been working on for the last six months. And at the same time, there's others in the refining area that have 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. 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.
Speaker 6
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 be fairly uniform? Or is any quarter going to be particularly lumpy? Or is there a risk that some of this could get shifted out to next year too?
Speaker 2
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 and 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 have a good funnel and we're focusing our teams on them. And as I said, because of the uncertainties of how things close, where they fall and which quarter is really hard to predict.
Speaker 7
Okay. Thank you very much and good luck.
Speaker 0
Our next question comes from Brad Evans with Heartland Funds.
Speaker 7
Good morning, everybody.
Speaker 2
Good morning.
Speaker 7
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, 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 your existing business is. I think it has manifested itself in the restoration of a lot of shareholder 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.
Speaker 2
Well, thanks Brad. And I just want to thank you and the other shareholders for being patient and supporting our last three point five years. As you know, it's been very strategic and it's been very disciplined and we tend to continue to do that.
Speaker 7
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, guess, it gets you to roughly $50,000,000 of net income. And on a pretax basis that gets you to roughly 75,000,000 to $80,000,000 of pretax. And it looks like interest is if it currently kind of if you run out annualized the first quarter that's roughly $4,000,000 So you're about $80,000,000 plus or minus of EBIT.
And depreciation and amortization kind of gets you into the range of I think about 95,000,000 to $100,000,000 of EBITDA for the year. Your CapEx budget currently stands at what?
Speaker 1
We've been running around $15,000,000 We're going to run a little higher this year. So 15,000,000 to 20,000,000
Speaker 2
We've been adding some strategic TEGs initiatives as we have the availability and if they all improve productivity. So it will be a little bit higher.
Speaker 7
Okay. And does working capital swing in a large direction either positive or negative for the full year from a cash flow perspective?
Speaker 1
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.
Speaker 7
Okay. I'm sorry, Brad, I just I clipped off the press release. So did you was that a small use of working capital in the first quarter?
Speaker 1
It was a use of it in the first quarter, yes. Yes.
Speaker 7
Okay. So maybe call it full year neutral to be conservative?
Speaker 1
Q1 is usually the quarter we build working capital the most. There's a little bit during the rest of the year too because we have pretty significant business running through the year. And then fourth quarter it reduces again.
Speaker 7
Got it. So CapEx of 20,000,000 interest of roughly 5,000,000 and the dividend now of roughly 8,000,000 So call it roughly 30,000,000 to $35,000,000 of kind 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 60,000,000 to $65,000,000 of free cash flow. Is that about right?
Speaker 1
That is yes. It's 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 a tolerance I think for a higher level of debt not to say we want to go back to where we used to be.
Speaker 7
So do you think would you go roughly at two to 2.5 turn leverage is something you'd be comfortable with at this point?
Speaker 1
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.
Speaker 7
But yes, that's about the
Speaker 1
range we talk about also.
Speaker 7
Okay. Well, thank you for taking the questions. Good luck.
Speaker 1
Thank you, Brad. Thanks, Brad.
Speaker 0
Our next question comes from Ryan Castle with Global Hunter Securities.
Speaker 5
Hi, guys. Good 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?
Speaker 7
The
Speaker 2
funnel on proposals at 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 at an inflection point, but I think we have a good backlog of orders that will support our annual plan.
Speaker 5
Okay. Okay. Sounds good. And then lastly, is there a way to quantify the impact of severe weather in the quarter?
Speaker 2
We've 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 factory 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. So I think we're past that, but I really can't give you a number.
Speaker 5
Okay, great. Thank you. Thanks. Thank you.
Speaker 2
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 and 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.
Speaker 0
This concludes today's conference. Thank you
Speaker 3
for
Speaker 0
your participation.