Federal Signal - Earnings Call - Q4 2015
February 29, 2016
Transcript
Speaker 0
Good day, ladies and gentlemen. Welcome to the Federal Signal Corporation Fourth Quarter Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Brian Cooper, Senior Vice President and Chief Financial Officer. Please go ahead, sir.
Speaker 1
Good morning and welcome to Federal Signal's fourth quarter twenty fifteen conference call. I'm Brian Cooper, the company's Chief Financial Officer. Also on this call with me are Dennis Martin, our Executive Chairman and Jennifer Sherman, our President and Chief Executive Officer. We'll refer to some presentation slides today and to two news releases which we issued this morning. Slides can be followed online by going to our website federalsignal.com, clicking on the Investor Call icon and signing into the webcast.
We have also posted the slide presentation and the news releases under the Investor tab on 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 releases 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 earnings news release and our filings, we reconcile these non GAAP measures to GAAP measures. In addition, we will file our Form 10 ks later today. Dennis is going to begin today with some introductory comments. Jennifer will follow that with some important context for our key topics and I will go into some detail on our fourth quarter and full year results.
Jennifer then will address our agreement to acquire Dow Johnson Equipment and wrap things up with her thoughts on our outlook for 2016. I'd now like to turn the call over to Dennis.
Speaker 2
Thank you, Brian. As you all know, Signal recently announced some important management changes and most notably my move to Executive Chairman. Jennifer's promotion to the role of President and Chief Executive Officer and the appointment of Senior Vice Presidents for each of our groups. These senior leadership changes were the result of a thoughtful and orderly transition plan. Jennifer has played an important pivotal role in our successful turnaround in recent years, and she has developed strong working relationships with our customers, dealers, employees, investors and our financial partners.
We're working hard to ensure a seamless transition for the benefit of our stakeholders. I would like Jennifer to provide some perspective on what we have accomplished and what we planned for. So let me just say what a privilege it has been to lead Federal Signal for the last five years. I'm extremely proud of what we've accomplished and I will remain actively involved in M and A activities, Investor Relations and development of our leadership team. I want to emphasize my confidence that we have a solid platform that will assure Federal Signal's continued long term success.
I appreciate the opportunity I've had serving our shareholders and stakeholders, and I look forward to guiding our future success as the Executive Chairman of the Board of Directors. Thank you. And with that, I'd like to turn the call over to Jennifer.
Speaker 3
Thank you, Dennis, and thanks to all of you for joining our call. I'm honored to be speaking today as the President and CEO of Federal Signal. I'm also very proud of our team for turning in another strong year and solid fourth quarter. Following a strong 2015, we've had a busy and productive start to 2016. We acquired Westech, refinanced our credit facility, sold our Bronto business and as announced this morning, we executed an agreement to acquire Joe Johnson Equipment.
For a number of years, we have considered whether the Bronto stylus business was strategic to Federal Signal. Our investors have also asked the same question. We have now divested Bronto, which was not considered close to our core and suffered from an inconsistent earnings stream. We were very pleased with both the price and terms we received for the business. As we move forward, we will be able to redeploy the sale proceeds to fund strategic acquisitions like Joe Johnson and position the company for growth.
All of these changes are built on the foundation we've been laying for several years. This foundation positions us to pursue profitable growth and to remain healthy while we weather economic headwinds and business cycles. Let me talk about a few of these building blocks in this foundation. First, we have worked to communicate our strategies, objectives and plans more effectively. Shareholders know about our eightytwenty culture, our operating margin targets, our capital priorities, our acquisition approach and our strategic initiatives.
Next, we have steadfastly pursued operating efficiencies through our eightytwenty efforts and we have nurtured our flexible manufacturing model. That is we have managed capacities and costs by flexing what we source internally and externally by shifting production among our facilities and by building a strong core of dedicated employees. On the capital structure front, we are now debt free. We've leveraged our assets and steadily increased our return on capital employed. We've reinstituted and grown our dividend.
We've refinanced our debt agreement so that we can continue to invest for the future. And with respect to investments, we built a solid organization and we continue to add capabilities and depth. This includes additional sales resources, M and A capabilities and a focused innovation effort that is helping us move forward with market based faster new product development initiatives. I was just in an industry trade show for Environmental Solutions Group where we introduced four brand new products. These include a water recycling option for sewer cleaning equipment and a purpose built hydroxylator truck for the utility market.
And of course, we are well positioned to invest in acquisition opportunities. More about that later. 2015 was another strong year of financial performance. Now I'd like to turn the call back to Brian to take us through the numbers.
Speaker 1
Thank you, Jennifer. Our consolidated fourth quarter and full year financial results are provided in today's earnings news release. The historical and current year information presented in the release exclude the results of the Fire Rescue Group, which was discontinued in connection with the sale of the Bronto Sky Lift business was completed in January. For the full year, I would like to briefly highlight some of our consolidated results. Net sales totaled $768,000,000 down 1% versus 2014.
Despite this slight reduction in sales, operating income of $103,000,000 was up 16%, translating to a much improved operating margin of 13.4%. On an adjusted basis, we reported full year earnings per share of $1.2 up $0.16 from $0.88 per share last year. Operating cash flow for the year was also outstanding at $91,000,000 up 12% from last year. We delivered this cash flow on the strength of our earnings even as we continue to invest in our businesses and fund operating expenses and working capital to support our growth initiatives. Overall, our full year results are very good and our improvement has been impressive in spite of the challenging conditions in some of the markets we serve.
For the rest of my comments, I'll focus mostly on the comparison of the 2015 to the 2014. Starting with the top line, consolidated net sales were $186,000,000 for the quarter, down 11% compared to the prior year quarter. Operating income was $24,300,000 down 6% versus last year. In fourth quarter consolidated operating margin was 13%, up from 12.3% a year ago. Income from continuing operations was $17,400,000 for the quarter compared to $19,900,000 in the prior year.
After adjusting for certain special tax items in both the current and prior year periods, adjusted fourth quarter earnings were $0.25 per share, which is unchanged from last year. Orders continued to be soft and were 15% lower than last year. At 171,000,000 our backlog was down from $179,000,000 at the end of the 2015 and from $255,000,000 a year ago. Looking briefly at our group results, our Environmental Solutions Group reported a net sales decrease of $18,300,000 or 13% versus last year, largely due to reduced sales of domestic sewer cleaners and vacuum trucks including hydro excavation products. By the lower sales, ESG operating income was up slightly translating to an operating margin of 17.9, up from 15.5% last year.
Orders were down 19% for ESG when compared to high levels a year ago, reflecting reduced demand for vacuum trucks associated with the significant downturn in oil and gas markets. With our expanded capacity and shorter lead times, we also continue to see fewer advanced stocking orders, which contributes to lower backlog. HD backlog at the end of the year was $133,000,000 down $4,000,000 from the end of the 2015. At our Safety and Security Systems Group, sales were down 7% compared to last year's quarter. Operating income of $9,100,000 was down 17%, while operating margin was 14.7% compared to 16.4% in Q4 last year.
Orders at SSG were down 5% compared to the fourth quarter last year. As we have noted previously, it is normal for most of SSG's businesses to operate with relatively low backlog. Corporate operating expenses of $7,100,000 were in line with prior year levels. From a consolidated perspective, we reported a gross margin of 29.7 for the quarter, up from 27.5% last year. Selling, engineering, general and administrative expenses of $31,000,000 were down 3% compared with the prior year quarter.
All these factors roll into the company's $24,300,000 of fourth quarter operating income. We also reported other income of $600,000 in the current year compared to an expense of $900,000 a year ago. Current year income and prior year expense primarily relate to foreign currency transaction effects. On lower debt levels, interest expense was down $300,000 compared to the prior year. Income tax expense for the quarter was $6,900,000 compared with $4,100,000 a year ago.
Effective tax rate for 2015 was low at 28.4% largely due to the inclusion of a $1,400,000 net benefit from special tax items. This included $4,200,000 of benefit associated with tax planning strategies offset by a $2,400,000 adjustment of deferred taxes and $400,000 of expense associated with a change in The UK income tax rate. Effective tax rate in 2014 was also lower than usual because of certain special tax items including the impact of a $3,500,000 release of valuation allowance on certain foreign deferred tax assets as well as a $400,000 benefit from a change in the enacted tax rate in Spain. I would also note that our effective tax rate in 2015 for the full year excluding special tax items was approximately 36%. We currently expect our financial book effective tax rate to be in a similar range in 2016.
Cash taxes paid will be lower than that at a percentage rate that we estimate in a range of about 15% to 20% based on our anticipated use of deferred tax assets consisting largely of net operating loss carry forwards and tax credit carry forwards. On an overall GAAP basis, we are at $07 per share from continuing operations in Q4 compared with $0.31 per share last year. To facilitate earnings comparisons, we typically adjust our GAAP earnings per share for any unusual items reported in the current or prior year quarter. In the fourth quarter, we made adjustments to GAAP earnings per share in each of the reported periods to exclude the special tax items I just discussed. On this basis, our adjusted earnings for the fourth quarter were $0.25 per share, which is consistent with the fourth quarter last year.
I would note too that our strong performance this quarter brings us to adjusted earnings of $1.2 per share for the year, which is up 16% compared to $0.88 in 2014. I'd like to turn now to the balance sheet which remains extremely strong. In fact with our robust cash flow and proceeds from the sale of Blanteau it continues improving. Operating cash flow was $91,000,000 for the year up 12% from last year. On the strong cash flow, our cash position is up significantly from last year.
At the 2015, we had $76,000,000 in cash, up from $24,000,000 at the 2014. Total debt was $44,000,000 down from $50,000,000 a year ago. Cash on hand at the end of the fourth quarter exceeded total debt by $32,000,000 We used some of our cash flow to pay an increasing I'm sorry, an increased quarterly dividend of $4,300,000 For the full year, we paid dividends totaling $15,600,000 in 2015, up $10,000,000 versus 2014. Funded $10,600,000 of share repurchases throughout the year and have approximately $69,000,000 remaining under our share repurchase authorization. That concludes my comments and I'd like to turn the call back to Jennifer.
Speaker 3
Thank you, Brian. Before we talk about the acquisition of Joe Johnston Equipment, I'd like to briefly provide some color on the performance in our group. At SSG, we continue to see healthy performance from our Public Safety Systems operations, which are focused on police lights, sirens and related businesses. The end markets in The U. S.
Have been relatively stable last couple of years and we continue to see improvement in Southern Europe. Our teams have been steadily working on eightytwenty including things like streamlining our product offerings and reducing our lead times to improve our competitiveness and profitability. Our Integrated Systems business, which provides customized warning and security systems to municipalities, government agencies and industrial customers has lumpy demand and industrial exposures including oil and gas. This business offers profitable growth opportunities where we continue to invest. As Brian mentioned, the Environmental Solutions Group reported a robust 17.9% operating margin despite lower sales in the fourth quarter.
This outstanding performance is a reflection of our continued execution on eightytwenty and lean initiatives maintaining discipline on our pricing and leveraging our capacity. It also reflects quick responses to significant changes in our marketplace. In particular, the crash in oil and gas markets has had a much larger impact than we initially anticipated. You have seen the impact in slowed orders during 2015 and a much smaller backlog as we started 2016. While oil and gas may have represented only about 10% of our overall revenue, adjacent markets are absorbing used equipment that has been redeployed from oil and glass displacing our sales of new equipment.
We've seen an influx of used equipment into our markets at reduced prices or rental equipment rates that are lower than historical levels such that renting may be more attractive than buying new equipment. We've also seen the sharp decline in demand for industrial vacuum trucks, particularly our hydro excavation products, which tend to have higher margins. In addition, projects on the SSG side have slowed significantly as well. One obvious response to such a market change is careful cost management and our flexible manufacturing model allows us to adjust our capacity more rapidly than in prior downswing. However, we've also taken advantage of our expanded capacity and shorter lead times to capture additional sales opportunities, including our pursuit of opportunities in adjacent markets such as utilities.
The two individuals that we recently promoted to lead our Environmental Solutions and Safety and Security Group are tasked with driving these initiatives and the execution of our strategic plan. While demand from oil and gas markets and to a lesser extent other industrial markets has been soft recently, we have seen steady demand in our municipal based businesses, both domestically and Europe. With municipal demand partly offsetting the softness in our industrial markets, our backlog is down about 4% from the end of the third quarter, but there's been something of a shift in the mix of our backlog, which now carries a higher concentration of municipal orders. Based with the challenges created by oil and gas effects, we continue to focus on new product development and believe these efforts will provide additional opportunities to further diversify our customer base. Vacuum excavation demand outside of oil and gas continues to grow.
Municipalities, utilities and construction companies continue to adopt vacuum excavation as a best practice and our continued investment in people and products dedicated to these markets will position us to capitalize on this growth. We are committed to investing in new excavator designs to target broader markets. Within SSG, we've also introduced internationally certified safety products to expand our global reach. As we enter into 2016, we are continuing to work these strategies and initiatives that should help us sustain our profitable growth. We've talked about these initiatives previously.
I want to briefly revisit them. Our first initiative is disciplined growth. As I just mentioned, we have a variety of new product development initiatives and investments that we are driving to stimulate organic growth in our businesses. We also want to complement that growth with acquisitions that leverage our core competencies or give us access to adjacent or new markets like Westpac and like Joe Johnson. We continue to be committed to a disciplined approach in evaluating acquisition opportunities in the market.
We are also continued to focus on leveraging our invested capital and improving our manufacturing efficiencies and costs with eightytwenty now an important part of our federal signal culture. Our strong 2015 performance depended heavily on these two areas of focus. The final initiative is to diversify our customer base. Historically, 60% or more of our domestic net sales were derived from municipal and other government markets. Municipalities will continue to be important customers and our leadership in municipal and government markets remains a strength of our company.
At the same time, our organic and acquisition growth initiatives generally will focus on expanding our industrial customer base. Although near term industrial demand has been soft, notably in relation to oil and gas markets, we continue to believe that industrial markets tend to offer better margin and growth opportunities over the longer term. Our long range goals remain unchanged as well. On the top line, we want to grow faster than GDP while increasing the share that comes from industrial. We aim to generate a strong return on invested capital.
We also strive for a long term consolidated operating margin of 12% with targeted average growth of earnings per share at a rate in the low to mid teens. As part of our commitment to growth, we've also talked previously about our aspiration of adding $250,000,000 of revenue to our annual run rate over the next three years. With that goal in mind, we are delighted to report that today we signed a definitive agreement to acquire substantially all of the assets and operations of Joe Johnson Equipment. Joe Johnson Equipment is a leading Canadian based distributor that specializes in serving municipalities, municipal contractors and industrial contractors with high quality equipment that includes street sweepers, sewer cleaners, vacuum trucks, snow removal and refuse collection. Joe Johnson Equipment represents a number of leading brands that include our environmental solutions group, Elgin, Vactor, Guzzlin and Jetstream lines.
It also offers equipment, rental options, parts, service and ancillary equipment. It's headquartered in Isola, Ontario with 13 branches throughout North America. Joe Johnson Equipment also has operations in Chile and we are currently in discussions with respect to potentially acquiring these operations at a later day. Joe Johnson Equipment brings us a comprehensive platform that will allow us to grow our business in Canada and better serve our customers across North America with broader product offerings, including rental and used equipment options. It's an outstanding organization with impressive leadership, attractive customer and supplier relationships, a commitment to excellence, robust business processes and a history of success.
Joe Johnson's revenues in North America were approximately $112,000,000 during its two thousand fiscal year. We estimate that in 2016, the JoJohnson acquisition will be modestly accretive to non GAAP adjusted earnings per share, which excludes acquisition related and purchase accounting effects. The acquisition is likely to result in changes in the timing of revenue and profit recognition that should normalize over a period of about three years. We therefore expect Joe Johnson Equipment to be about $0.10 to $0.15 accretive on an annual basis by the 2018. We aim to close the transaction by the end of the 2016.
On the heels of an extremely strong financial performance in 2015, we continue to believe in our long term operating margin targets. Our municipal markets, which represent about 60% of our revenues remain healthy. However, similar to other companies that have recently provided guidance, we expect 16 industrial markets to be challenging. The negative impact of the oil and gas downturn on some of our industrial businesses has been greater than we anticipated. For example, there is excess oil and gas related equipment in the marketplace that could take up to eighteen months to be fully absorbed.
It also creates pricing pressures on these products. Overall, the broader impacts of the oil and gas downturn are expected to reduce our 2016 operating income by about 12,000,000 to 14,000,000 In addition, we entered the year with a smaller backlog with a less favorable mix compared to last year. This lower backlog makes us much more dependent on the flow of orders and reduces our visibility into revenue for the year. In each of the last three years, we've also benefited from a low level of hearing loss trial activity. Consistent with our past practice, the company will vigorously defend its self assessed actions, but we may see a rise in hearing loss defense costs in 2016 if the number of trials increase.
So considering the headwinds that we are facing and the ongoing uncertainty in industrial markets, we are tempering our expectations for 2016. Assuming no further significant deterioration in Industrial Markets, we expect adjusted earnings per share for the year to be between $0.07 0 and $0.80 including a modest contribution from JJE. As we move forward, we are expanding our focus on new markets, accelerating the introduction of new product offerings, managing our costs and maintaining our eightytwenty efforts. Our strong cash flow, healthy balance sheet, Bronto sale proceeds and new credit agreement give us significant financial flexibility to invest in these growth initiatives, pursue strategic acquisitions and continue to return value to shareholders through dividends and share repurchases. We will update you as the year develops.
At this point in time, I'd like to open the line for questions. Operator?
Speaker 0
Thank you. And And we'll take our first question from Walter Liptak with Seaport Global.
Speaker 3
Good morning, Walt.
Speaker 4
Hey, good morning, guys.
Speaker 1
Hey, Walt. Good morning,
Speaker 4
I guess I wanted to ask about the revenue that's assumed in your 2016 guidance. And specifically for ESG, what kind of a revenue decline are you expecting for this year?
Speaker 3
Well, we don't guide the revenue. However, we expect our revenue to be down on a year over year basis. And that's really being driven by the impact of oil and gas in our ESG businesses, particularly Vactor. We're seeing reduced sales of our hydro excavation product, a little bit of Jetstream. And then our Safety and Security business, our Industrial Systems business that's focused on oil and gas, we'll see downturns there.
I do want to emphasize that municipal demand remains stable and we are we've introduced new products. So a lot of it depends on the adoption rate of new products, but the initial signs are encouraging.
Speaker 4
Okay. I appreciate that you guys aren't giving revenue guidance. But if I make some assumptions looking at kind of the order level, the order declines over the last couple of quarters, And then if I start looking at your decremental margins, the decremental margins look a little bit larger than I would have expected. And so I'm wondering what kind of margin level are you expecting in ESG specifically? And or what kind of decrementals are you looking for?
And if they are larger, is it a pricing issue? Is it a volume issue? Just a little bit more color, I guess, on what's leading to your guidance for this year.
Speaker 1
Walt, I think your insight there is correct. It's not purely a revenue impact. We are getting some negative leverage effects on our operations from the lower volumes. We're also seeing some price pressure in the market. On the municipal side again, things are pretty solid as Jennifer said.
It's really on the industrial side and we're looking at different mix of products. So when you combine the mix and some of the pressures that are coming mainly because of the oil and gas that impacts through the markets, the margin is coming down some as well.
Speaker 4
Okay. Okay. I also wanted to ask about the acquisition. And it looks like it was very strategic. And so I wonder if you could just provide a little bit more color on the strategy behind the acquisition and maybe what valuation metrics that you're looking at.
And then I'll go back into queue.
Speaker 3
Sure, absolutely. We're pleased with this opportunity. We think this is strategic. It remains close to our core. What was particularly attractive about it was that Joe Johnson gives us the footprint in 13 locations and a distribution channel that allows us to introduce our industrial products, particularly our guzzler products, our wet spec products and our jet steam products and grow our business in Canada.
We also have an initiative on our public safety systems side to introduce product through that same distribution channel. In addition, it gives us an option with respect to rental. Joe Johnson currently has a program in place where they partnered with four of our current dealers on a rent to re rent program. And this allows us to offer that program to all of our municipal dealers. And that will be another tool in the toolbox.
We have a parts and service platform that we think is attractive and over time has high growth and attractive margin opportunities.
Speaker 1
And in terms of valuation metrics, Walt, I don't think we did anything terribly unusual. We looked at cash flow from the businesses, synergies we can get and so forth in valuing it. And we didn't talk in terms of a multiple, but you can see we're spending about $126,000,000 at the upside in Canadian dollars or about $93,000,000 on this transaction. And we expect it to have a return in excess of our cost of capital.
Speaker 4
Okay. Is their revenue more stable than yours is on the equipment side because this is a rental business?
Speaker 2
Their Their mix of equipment, Walt, is different. They're serving in municipal markets. So beyond the traditional Vactor, Algin and Gessler products, they have a broader mix, includes both service, rentals and that mix of equipment. So it is more stable, more consistent.
Speaker 1
And one of the things we love about Joe Johnson is they have great relationships with their customers. So that does, I think, provide stability going forward.
Speaker 0
Our next question comes from Steve Barger with KeyBanc Capital Markets.
Speaker 5
So I'm going go back to ESG for a minute. If we assume that oil prices isn't coming they won't come back anytime soon, what is the right long term growth rate for ESG that you think about?
Speaker 3
We are we believe that we're committed to our long term ESG operating margin. We have a number of initiatives right now to grow our hydro excavation business outside of oil and gas, particularly focused on the utility market and construction markets. We're starting to see traction in some of those As I mentioned, we've introduced new products, particularly our recycling products and our JETR products. Both also provide growth opportunities. But long term, we think we feel really good about this business.
JJE or Joe Johnson Equipment is an important part of that growth strategy. And we think the margin targets we previously set forth are achievable.
Speaker 1
Yes. And Steve, one of the things we like about all those products is the hydro excavation adoption rate is still increasing. So although it's been slowed by oil and gas, we're pursuing it in other markets like utility and targeting our innovation to help us get there.
Speaker 5
Yes, understood. And you guys have done a nice job on the margins. But I'm just thinking when you talk about ESG from a top line perspective over the longer term, do you think it's a is it a 5% growth business? Do you think it can be double digit on a regular basis? Just trying to get an idea of how you think about growth there.
Speaker 3
We think it has the opportunity for high single digit growth without acquisitions.
Speaker 2
Without acquisitions. And then when oil and gas comes back, Steve, that's a wildcard.
Speaker 5
Understood, right. I know that's
Speaker 3
But like you, we're not counting on oil and gas coming back in 2016.
Speaker 5
Right. And ESG orders averaged $112,000,000 per quarter in 2015 versus $139,000,000 per quarter in 2014. And I'd say that 2015 level is basically in line with what you put up in 2011, 'twelve and 'thirteen. So the question is, should we be thinking the 2015 run rate is the right number for the next couple of years? Or do you think you potentially come in below that on a quarterly basis?
Speaker 2
I think it's the right number, Steve, once we get past another quarter or two of the excess sale of used equipment to the market. I think that's a pretty good estimate for run rate.
Speaker 6
Yes. I think part of what
Speaker 1
you're seeing Steve is 2015 oil kept going down. So the pressure on the markets got worse. And then in addition to that, you have the inventory effect, if you will, of the rental market and the other equipment coming out of the oil and gas patch and diluting just creating a glut of equipment frankly that competes with our new equipment. So there's been a headwind.
Speaker 3
Yes. Those numbers can fluctuate depending on large fleet orders. For example, in 2014, we had a number of large fleet orders. And those tend to be every couple of years depending on the cycle.
Speaker 5
How do you gauge excess used equipment in the market? Is there does the Rausch data, for instance, which covers some of the other rental companies, is there a service like that, that helps you understand where the market is?
Speaker 2
No, that we don't see it that way. What we really have been doing is monitoring auctions and sales and
Speaker 1
Rental rates. Pardon me. And rental rates.
Speaker 2
And rental rates. Rental rates have dropped significantly in the monthly rates. And so we're it's really not as it's not as
Speaker 1
it's not reported. Is there
Speaker 5
a business that tracks those rental rates or is that anecdotal from talking to your dealers and the channel?
Speaker 2
Primarily dealing with our dealers and the And
Speaker 5
so looking at ESG margin, obviously, the guidance implies a pretty big step down in 2016. So the question is, given really strong orders 14 and very good production in 2015, did you over earn relative to longer term trends? Or do you view as
Speaker 4
you said, do view more
Speaker 5
as 2016 will be unusually low?
Speaker 2
Well, if you recall, we went back, we gave you estimates of our margin expectations by business unit prior to last year, and then we actually ended up exceeding that during a few of the quarters because of just running at the very high end of the capacity curve. So we still believe in the run rate percentages that we put out there as margin targets.
Speaker 1
And there is a little bit of extra headwind in 2016. So I think we would expect the volume side to pull back as we move forward.
Speaker 3
And I think you also have to look at the mix issue. The municipal margins are typically less than the industrial margins. We're focused on both from an acquisition perspective and organic growth perspective on growing that Industrial business. We have a number of initiatives to diversify our product offerings, particularly out of oil and gas. So I think that this is unusually low year and we're encouraged by where we're investing and we think we're well positioned to grow.
Also, depending on what happens in oil and gas in 2017 and 2018, we think we're very well positioned to supply any demand there also.
Speaker 5
Understood. One question just for modeling and then I'll ask a couple of acquisition questions. For SG and A, should I be thinking a low $30,000,000 range per quarter with the exit of Bronto and JJE coming in? Is that fair?
Speaker 1
That sounds about right, Steve.
Speaker 5
Okay. And can you CapEx for 2016 and D and A?
Speaker 3
We expect it is generally run between 10,000,000 and $15,000,000 We expect 2016 to be in a similar range. For P the changed and A is around $12,000,000
Speaker 5
Okay, perfect. Is there any room for conflict with you buying a distributor? And how do you even gauge the risk of that given that you sell through distribution?
Speaker 3
Yes. The first thing I want to talk about, this is not a distribution roll up strategy. We believe that the acquisition of Joe Johnson, in fact, helps us enhance our current municipal dealers. We've had an opportunity this morning. I've talked to three so far of our major dealers and they've really embraced the idea that they're going to have a rental fleet available to re rent to their municipal customers.
We look at this as giving them another tool in their toolbox moving forward.
Speaker 2
Whenever you make a move, Steve, in a market like this, there is a potential for some disruption and we're going to do our best to minimize it. But we think our forecast includes any amount that might occur with that.
Speaker 1
And we have limited conflicts between dealers. So one of the things when you look at acquiring a dealer, they have a geography and certainly on the municipal side that's more contained.
Speaker 5
Right. Well, and I hear you it's not a distribution roll up strategy, but if the other dealers like the idea of re rent, does that mean you need to open more facilities beyond the 13 or 14 that you said are already in North America? Are you well covered to provide that with the dealer network?
Speaker 2
Yes. If you look at our business today, Steve, we have our solution centers. We have nine or 10 solution centers plus their 13 now in addition. And so there would be some additional ones open, but the market will drive that. And all of our distributors have substantial yards and service capabilities.
Partnering with them, we were hoping to leverage off of their locations with them and give them the benefit of doing that with us. We're not going to wholesale open tons of locations.
Speaker 5
Right. Okay. I saw in the press release that it's one of the best managed company award for five years. So obviously, already well run. Are you doing this strictly for the revenue synergy or the opportunity to grow the business?
Or even with those awards, do you view it as a margin expansion story? And how do you get there?
Speaker 2
Yes. There's a couple of answers to that question. One, eightytwenty works everywhere and I think they're excited about investigating how eightytwenty could help with their business model. We also know we can learn an awful lot from them and we can bring that to how we go to market, serving the municipal user markets. We'll learn a lot more about products and services that the municipal customers demand or need.
And also so I think it's an opportunity not only just to add revenue immediately but to leverage the better service of customers and users to grow that way.
Speaker 3
And specifically, it gives us a distribution channel that allows us to grow our industrial market share through our Guzzler Westrac industrial products.
Speaker 5
Okay. Can you give us an idea of where JJE's EBIT margin is now and how much they have in D and A?
Speaker 3
JJE will operate within a division of ESG, and we typically don't talk about the division results or break those down.
Speaker 1
Okay. Well, guess, can
Speaker 5
you give us the revenue number associated with the $00 to $0.15 accretion in 2018 just to at least help us think about what the return profile is of the acquired company?
Speaker 1
Well, Steve, have they had revenues last year of CAD150 million, so CAD112 million or so U. S. We'll have some offset to that in that we sell to them. We don't get to count that twice. Then we expect them to grow at a pretty healthy pace, especially in some of their service businesses and their municipal business remain strong.
I think Pretty healthy, you're seeing
Speaker 5
above the high single digit rate that you think about ESG with?
Speaker 1
In the high single digit rate range. Yeah. Think that's a fair assumption at this point.
Speaker 5
All right. I'll hop back in line and see if anybody else has any.
Speaker 1
Thank you. Thank you.
Speaker 0
Thank you. And we'll go for a follow-up with Walter Liptak.
Speaker 4
Hi. So as a follow-up to the last question, just on you discussed the new products. I wonder how much utility trucks and some of the hydro excavators are factored into the 2016 guidance? And maybe any color how the utility truck is selling?
Speaker 3
Yes. I mean for 2016, we've assumed a modest adoption rate. So there is upside there. We remain very committed to our new product development that requires R and D investments. And just to give you some color, our R and D spend in 2015 was about $14,000,000 which was up 7% versus 2014.
We have the innovation team that is continuing throughout and study markets and identify new product opportunities. We work closely with our engineering group. The feedback will be in full production on one of our purpose built utility trucks by the beginning of the third quarter and the initial interest has been extremely high. We've also introduced a Jetta product to our distribution network and again the interest is high. And then we think the patents recycling products that we're offering for our vacuum trucks presents significant growth opportunity.
We're not going to stop investing in new product development and 2016 reflects that.
Speaker 4
Okay. Do some of these products go like the hydro excavators? I know the application is going into utility. Do any of these new applications go into the construction markets?
Speaker 3
Yes. Some of the contractors that utilize this equipment also use them for construction markets.
Speaker 4
Okay. Sounds good. And the corporate expense, what number are you using for 2016?
Speaker 1
We're assuming it's fairly flat if you with the exception of hearing loss expense, we are anticipating will probably be higher in 2016 based on the number of trials that we foresee at this point in time.
Speaker 4
Collyn. All right, thank you.
Speaker 3
The trials are currently scheduled in the second half of the year. But depending on whether they move forward or not, we would update our guidance accordingly.
Speaker 0
Thank you. And then we'll go to Alex Yagi with Cortina Asset Management.
Speaker 6
Hi, good morning. I wanted to follow-up on the revision to the guidance that you've given for the year. I want to try to understand what's actually going underneath the surface here. I mean, understand that oil and gas has come down quite a bit. But sequentially, are we to expect a big downturn in the first half of
Speaker 1
the year and a pickup in
Speaker 6
the back half? Or are you assuming a steady run rate? Because it's such a big decremental as one of the other questions I was referring to, it's obviously surprising to investors. So can you help put a little color on that?
Speaker 3
Sure. We've entered the year with a low backlog. We've talked about the mix and the mix is less favorable. Our municipal business remains strong. We expect the first half of the year to be lower.
And the second half of the year, candidly, is a wait and see game. We are seeing traction on our new product development in the adoption rate, but we need to see more orders in order to give you a better picture in terms of what the second half of the year. The hearing loss expense, as Brian previously mentioned, is also an issue. We continue to be positive about both our municipal markets and some of the diversification we're doing on the industrial side. So it's a wait and see game for the second half.
I
Speaker 2
was just going to add, Some of the equipment that's moving back into the market from the used rental and also from contractors selling off their equipment that are getting out of the oil and gas exploration really is moving has moved into the industrial side. So it's really as we said before, there's no direct way to gauge the percentage. We think it's moving through. We're hopeful that over the next twelve months, it's all through. So it's hard to gauge because there's just no way to record that amount of equipment that's coming into the market.
Speaker 6
Right. So you can't really estimate how much of lost sales opportunities you think have developed as Well, a result of
Speaker 2
we've tried to estimate it in our forecast and brought down our numbers.
Speaker 6
It's Can you put a revenue number roughly?
Speaker 2
It's hard to know for actually what it is.
Speaker 1
I mean, basically, we don't know how long it will take for the overhang to work its way through. So we're anticipating in the second half that that has not really occurred yet. To the extent that it does, we'll feel better about it. But at this point in time, we just don't have good visibility for the second half. Okay.
Thank you. Thanks, Alex.
Speaker 0
Thank you. And we have a follow-up from Steve Barger.
Speaker 5
Hi, thanks. Thinking about JJE, just from a modeling standpoint, is there seasonality in that business? Or should we think about the revenue as basically level loaded?
Speaker 3
There is seasonality in that business. They're primarily south of municipalities and government entities. So a lot of it depends on their buying cycle.
Speaker 2
And a good deal of their business is in Canada, so they have a little more severe weather certainly in the West.
Speaker 3
So the summer months tend to be higher.
Speaker 5
Okay. Since you brought it up to us, what percentage of revenue is U. S. Versus Canada? And can you give us an idea of how the Canadian side is growing right now?
Speaker 1
You're talking about for Joe Johnson? Joe Johnson, yes.
Speaker 3
Yes. It's about 70 five-twenty five split between Canada and U. S.
Speaker 2
And they've been growing in both markets?
Speaker 5
At the same rate, plus or minus?
Speaker 1
Pretty much, yes. Close, yes.
Speaker 5
When you think about EBIT for Joe Johnson, what's the primary driver for the business? Is it new equipment sales or rental or parts and service? And maybe can you give us an idea of those three buckets from a percentage standpoint?
Speaker 3
New equipment sales is the primary driver. The parts and service has been growing impressively over the last couple of years and we expect that to continue at relatively high margins. The rental business is a smaller portion of that.
Speaker 1
Smaller but growing.
Speaker 5
So are they going to face the same headwinds that you are on the new equipment side for 2016? Is that the expectation?
Speaker 2
Well, believe their mix of products is different, Steve. While we're the largest categories with Vactor and Algium products, they also have a number of other products related to the winter snow removal, refuge and other things. Their mix is different. It won't be impacted the same way.
Speaker 1
And it's primarily municipal?
Speaker 3
Over 80% of their business right now is municipal market. They have very limited exposure to oil and gas.
Speaker 1
So it could be confusing. They are primarily municipal today. One of the things we like about them is the opportunity that we can use to leverage them in the industrial market.
Speaker 5
I see. And just two more. Can you talk about working capital and CapEx characteristics for JJE? Is it more intense from a capital standpoint than your business?
Speaker 1
It hasn't been in the past. The rental business, if it grows, will be more capital intensive to a certain extent. They also have some cyclicality to it. They tend to build up on their working capital and their inventory sort of through the winter months and then bring it down as they have higher sales in the summer period.
Speaker 5
I guess, yes, when you think about growing that rental opportunity for the other dealers, is that something that you'll use your balance sheet for? Or will you is there any way that you would start to finance deals or things like that? Or would that all be from third party?
Speaker 1
At this point, Steve, it's a great question and a hard one to answer. I think at this point, we're assuming we would be using our balance sheet and we're evaluating opportunities to make sure they have good returns and provide a solid opportunity for us. It's harder to go outside and do financing of those things in today's world.
Speaker 3
So right now, we believe they currently have a rental fleet of about $50,000,000 We think that's generally sufficient to meet the current market needs. We do plan on supplementing that rental fleet with some industrial products, particularly our Gazzler, our Jetstream and our Westat brand. So we estimate that to be somewhere between 15,000,000 and $20,000,000 in 2016, if in fact the market supports it.
Speaker 5
Okay. And you should have pretty good free cash flow in the primary business this year, I would think, even with the decline in guidance. Is and you've said this is not a distribution roll up strategy. What is the other what's the next avenue that you'll look to in terms of acquisitions as you try and augment organic growth?
Speaker 3
We continue to be committed to or close to our core in terms of where can we leverage our existing capabilities either in adjacent markets and new geographies within the margin targets that we set. And we have a right now, we've been working diligently on that. We have
Speaker 1
a good
Speaker 3
pipeline of opportunities that we will continue to pursue in a disciplined way.
Speaker 2
And Steve, they go across really all three of our business units or business groupings. We've been looking at things in Europe with our police business. We're looking at things in the SSG side as well as on the ESG side. As Jennifer said, there's quite a few things in the pipeline, and it's varied, which is what we like about it.
Speaker 5
Alright. Thanks so much for the time.
Speaker 1
Thank you. Thank you.
Speaker 0
You. And we'll go back to Walter Liptak for a final question.
Speaker 4
This will be the final, I guess, for me. The balance sheet is in great shape. How much net cash do you expect to take in this quarter from Bronto?
Speaker 1
So the sale proceeds are about $88,000,000 We will get most of that this quarter. There's a post closing adjustment that might increase or decrease that number a little bit. And then we will end up paying taxes on the gain. So there's a little bit of a reduction for that.
Speaker 4
Okay. Sounds like a minor tax adjustment.
Speaker 1
Well, it's fairly good sized tax piece, but I mean the proceeds will still be north of easily north of $60,000,000
Speaker 2
Okay.
Speaker 4
And then so with the net cash coming in with the company cash flowing well, the balance sheet debt free, can you talk to us about the upside for the strategic acquisition versus your own share repurchase?
Speaker 2
You said we did or you want us to.
Speaker 4
Yes, I wonder if with your stock down this much, maybe you could refresh us on just how much is left on the repurchase program and
Speaker 1
we've got 60 So $9,000,000 remaining on the authorization and our Board would be flexible on that. So I wouldn't view that as a cap or a limit or anything. But we will look at that and Joe Johnson acquisition is a good return on our money. Our stock would be a good return on our money right now too, I think.
Speaker 4
Yes, I agree. Okay, thank you.
Speaker 0
Thank you. And now I'd like to turn the conference back over to Jennifer Sherman for any additional or closing remarks.
Speaker 3
In closing, I want to thank Dennis for his significant contributions to the company over the last five years. I'm fortunate to have him both as a mentor and a friend. We look forward to working together in our new role. I also want to emphasize that we remain committed to growing our business and leveraging our profitability. Our strong fourth quarter and annual results for our product is the hard work of our employees, the dedication of our distributors and dealers and the depth of our relationship with customers.
Thank you. We remain optimistic about the long term prospects for our businesses and we'll look forward to talking with you again after the first quarter.
Speaker 2
With that, thank you.
Speaker 0
Thank you. And ladies and gentlemen, once again, that does conclude today's conference. Thank you all again for your participation.