FSS
#Good morning and welcome to Federal Signal's second-quarter 2016 conference call.
I am <UNK> <UNK>, the Company's Corporate Controller.
Brian Cooper, our Chief Financial Officer, is unable to participate in today's call as he is recovering from a sports-related injury.
Brian has had a successful surgery and is expected to make a full recovery.
While recovering he is still performing his duties as our CFO and he is currently expected to return to the office in August.
In Brian's absence I will be presenting on today's call alongside <UNK> <UNK>, our President and Chief Executive Officer.
We are also joined today by Svetlana Vinokur, our Vice President, Treasurer and Corporate Development.
We will refer to some presentation slides today as well as to the earnings 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 signing into the webcast.
We have also posted the slide presentation and the news release 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 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 for Form 10-Q later today.
I'm going to start today by addressing our financial results.
<UNK> will then provide her perspective on our performance, current market conditions and our outlook for the remainder of 2016.
After our prepared comments <UNK>, Svetlana and I will be prepared to address your questions.
Our consolidated second-quarter financial results are provided in today's earnings release.
The second-quarter financials include one month of operating results of Joe Johnson Equipment which we acquired on June 3.
Please also note that historical and current-year information presented in the release excludes the results of the Fire Rescue Group which was discontinued in connection with the sale of the Bronto Skylift business that was completed in January this year.
Consolidated net sales for the second quarter were $172 million, down 16% compared to the prior-year period and operating income of $14.3 million was down from $29.2 million last year.
This quarter's reported operating income included $0.4 million of acquisition and integration-related expenses.
Consolidated operating margin was 8.3% compared to 14.2% a year ago.
Income from continuing operations was $9.4 million for the second-quarter compared to $18.2 million last year.
That translates to GAAP earnings of $0.15 per share which compares to $0.29 per share last year.
On an adjusted basis, EPS for the second quarter this year with $0.17 which again compares to $0.29 per share last year.
Orders reported in the second quarter were $187.3 million, reflecting a 7% improvement compared to the prior-year period and a 38% increase compared with the first quarter of 2016.
The increased orders were largely driven by orders acquired in the Joe Johnson Equipment transaction which we completed at the beginning of June.
We ended the quarter with a consolidated backup of $150 million which was up $14 million or 11% from the end of the first quarter.
Importantly, our financial condition continued to be extremely strong, facilitating investments such as our acquisition of Joe Johnson Equipment as well as returns to shareholders in the form of dividends and share repurchases which exceeded $21 million this quarter.
As you can see in our group results, the lower demand from industrial market that we began to see in 2015 has translated into reduced operating results in Q2 of this year, especially when compared to a very strong Q2 last year.
Sales at ESG were down 19% versus last year primarily due to decreases in shipments of vacuum trucks and street sweepers.
Lower shipments of vacuum trucks are tied primarily to ongoing softness in oil and gas markets whereas the reported reduction in street sweepers sales is associated with fewer large fleet shipments when compared to the prior-year quarter.
On this lower sales volume ESG's operating income dropped to $14.9 million.
ESG's operating margin for the quarter was 12.5%, down when compared to a record 19.9% a year ago.
Orders at ESG were up 18% year over year benefiting from the Joe Johnson acquisition.
Excluding the effects of the Joe Johnson acquisition, ESG orders were up $5.7 million or 6% compared to the prior-year quarter and $28.6 million, or 36% compared to the first quarter of 2016.
While demand and order flow from our municipal markets continues to be solid industrial markets remain soft.
<UNK> will go into more detail on some of the contributing market factors and impact in her remarks.
At SSG sales were down 10% compared to last year's quarter reflecting lower sales of industrial products that related to impacts from oil and gas market and softness in industrial markets generally, partially offset by improved sales into global public safety markets.
Our US public safety business also delivered improved operating margins and operating income for the quarter.
SSG's operating income for the quarter was $6.6 million compared to $7.3 million last year and operating margin was consistent with last year a 12.5%.
Orders at SSG were down 14% mainly due to lower orders for industrial products from international markets.
As we have noted previously most of SSG's business normally operates with relatively low backlog.
Corporate operating expenses of $7.2 million were largely unchanged from a year ago with increases in professional service fees incurred in connection with the acquisition being largely offset by lower employee compensation cost.
Turning now to the consolidated income statement, the reduction in year-over-year sales translated to lower gross profit.
Gross profit was also negatively affected by a $0.5 million charge, non-cash charge related to purchase accounting.
This was the additional cost of sales during the quarter after acquired JJE inventory was stepped up to approximately its sale value as part of the initial purchase price allocation.
These step ups will affect our earnings but not our cash flow for the next couple of quarters.
On this basis consolidated gross margin of 26.1% for the quarter was down from 29.6% last year.
Selling, engineering, general and administrative expenses of $30.3 million were down 3% compared to the prior-year quarter.
During the current-year quarter we also incurred $0.4 million of acquisition and integration expenses in connection with the Joe Johnson transaction.
Those costs primarily consisted of legal and professional service fees.
All of these factors roll into the Company's $14.3 million of second-quarter operating income.
Other items affecting the quarterly results include other income of $0.3 million largely related to foreign currency transactions and a $0.2 million reduction in interest expense resulting from our lower average level of debt.
Tax expense for the quarter was down as a result of our lower income with an effective rate for the quarter of around 34%, which was slightly lower than the 36.4% in Q2 last year because of a small discrete tax benefit recognized in the quarter.
Our full-year effective tax rate for 2016 is currently expected to be about 35%.
From a cash perspective we are projecting a cash rate of between 15% and 20%.
The difference between our effective tax rate and our cash tax rate relates to the use of deferred tax assets to reduce our tax payment.
These assets primarily consist of net operating loss carryforwards and tax credit carryforwards.
On an overall GAAP basis we therefore earned $0.15 per share from continuing operations in Q2 compared with $0.29 per share in Q2 last year.
To facilitate earnings comparisons we typically adjust our GAAP earnings per share for unusual items recorded in the quarter in the current year or the prior year.
In the current-year quarter we made adjustments to GAAP earnings per share to exclude the purchase accounting effects and acquisition expenses that I just discussed.
On this basis our adjusted earnings from continuing operations for the second quarter was $0.17 per share compared with $0.29 per share in Q2 last year.
Turning now to the balance sheet and cash flow, we generated $10.6 million of cash from continuing operations in the quarter compared to $30 million during Q2 last year.
The comparability of operating cash flow between the current-year and prior-year periods is adversely impacted by the non-cash settlement of $11.4 million of accounts receivable that were due from Joe Johnson Equipment as of the acquisition date.
As I mentioned earlier, we completed the acquisition of JJE for an initial payment of $96.9 million during the quarter and also received additional sale proceeds of $5.7 million relating to the sale of our Bronto Skylift business that closed in January of this year.
With total debt of $67 million and cash on hand of $39 million we ended the quarter with $28 million of net debt.
Availability under our credit facility at the end of the quarter was $240 million and our leverage ratio was low at 0.7 times.
We are obviously in a strong financial position.
At this point we have significant flexibility to invest in organic growth, pursue acquisition opportunities and return value to shareholders.
On that note we paid a dividend of $0.07 per share during the quarter amounting to $4.3 million and we recently announced a similar dividend for the third quarter.
We also increased the level of our share repurchases during the quarter, spending $16.8 million to buy back approximately 1.3 million shares at an average price of $13 per share.
We typically approach share repurchases opportunistically and this quarter's repurchase activity brings total repurchases in the first half of 2016 to $33.1 million.
That compares with share repurchases of $10.6 million in all of 2015.
We had about $36 million remaining under our share repurchase authorization as of June 30.
That concludes my comments.
And I would now like to turn the call over to <UNK>.
Thank you, <UNK>.
I'd like to start by providing some color on the second quarter.
Our results for the quarter end this year continue to reflect a tale of two markets.
Our municipal markets, which constitute about 60% of our revenues, remain solid.
It was pleasing to see us report an increase in total orders which was largely driven by the JJE acquisition.
But even after excluding the effects of the JJE acquisition, ESG orders were up about 36% on a sequential-quarter basis and up almost 6% versus the prior-year quarter.
Much of that was due to steady performance in municipal markets and we are optimistic about a couple of near-term opportunities for larger fleet orders.
While there is some caution in municipal markets in any election year, we continue to see steady demand in the US as well as in Canada.
The growth and improving profitability of our US and European public safety systems businesses which are part of our Safety and Security Systems Group were also encouraging.
These businesses make lightbars, sirens and related products for municipal customers in the police, fire and heavy duty markets.
They continue to gain share and benefit from a number of new product introductions in recent years.
While municipal markets remain solid our industrial markets continue to be impacted by the lingering effects associated with the downturn in the oil and gas market.
Within our Environmental Solutions Group an overhang of used equipment at reduced prices continues to impact demand for the new equipment we sell from customer service being oil and gas and other adjacent industrial markets.
As you have seen this has impacted ESG's revenues and margins.
As a result, incoming industrial order activity has remained low with the biggest effects occurring in our vacuum truck line.
As we indicated last quarter, we are uncertain how long the influx of used equipment may continue affecting our demand but we are laying our plans to manage through softness that may persist well into 2017.
Within our Safety and Security Systems Group industrial orders, particularly orders for our emergency warning systems business, have also been adversely impacted by a number of large projects being canceled or delayed.
We're not losing these orders, there just aren't as many opportunities due to the ongoing uncertainty in the industrial oil and gas market.
We are sizing or business activity to match current demand and have taken actions to reduce our costs including early retirement, reductions in force, expense control and cost savings on direct material.
While we are focused on cost management I also want to emphasize that we continue to invest in top-line growth in key opportunities for the future of the business.
These investments include sales resources and the development of additional new products, for example an improved street sweeper design.
We are also working on a line of new Jetstream accessory products and we have introduced our new Tier 4 compliant street sweepers ahead of many of our competitors.
In addition, we are moving forward with new offerings for the utility market.
We have a dedicated and focused team working on the launch of a line of tools for hydroexcavation work and our ParaDIGm purpose-built vacuum truck designed for that market.
The ParaDIGm went into full production in the third quarter and while we expect it will take time to earn an expanded position in its market we are encouraged by the initial level of interest in this product.
Within our Safety and Security Systems Group we are launching a redesign of many of our industrial product offerings and are adding additional engineering and product manager resources to support a number of new product development projects.
Our balance sheet continues to be strong which helps us to navigate through our near-term market challenges, continue our needed investment and return value to shareholders.
In the second quarter we paid over $21 million to shareholders in the form of cash dividends and opportunistic share repurchases.
That is our highest cash return to investors in a single quarter in almost 15 years.
So far this year we've returned almost $42 million of value to shareholders.
This time last year we talked about our appetite for adding at least $250 million from acquisitions to our revenue run rate by 2018.
With that goal in mind, we were delighted to complete the acquisition of JJE as a meaningful step along that path.
Looking further down the road, we continue to seek additional acquisition opportunities.
Like Joe Johnson, future acquisitions will need to meet our acquisition criteria and are likely to include businesses with recurring revenue or product lines that leverage our channels or manufacturing capabilities.
I'd like to spend a few minutes on the strategic rationale behind the Joe Johnson Equipment acquisition.
As <UNK> mentioned we closed the transaction at the beginning of June and our integration team is continuing to make great progress.
Joe Johnson is a strong municipal equipment distributor that operates in four areas of business starting with new equipment sales.
Although about 90% of their new equipment sales are to municipal customers we plan to use their platform to increase our industrial sales in Canada.
They have a strong parts and service business that nicely complements Federal Signal's existing industrial platform in the United States.
We aim to leverage their equipment rentals and used equipment business.
Rentals and used equipment are additional offerings that will allow us to serve additional customers in both industrial and municipal markets, helping us reach more of the market for Federal Signal equipment.
We believe that there are significant opportunities in all of these areas.
Now that we've completed the transaction, I also want to take some time to go into the detail on some of the financial reporting implications of acquiring a significant customer and how these considerations impact our outlook for the year.
As we noted in February when we announced the JJE acquisition and on our first-quarter earnings call, a likely accounting implication resulting from the JJE acquisition would be a change in the timing of revenue and profit recognition that should normalize over time.
With the closing of the acquisition in June, the initial response to our new rental equipment offering has been encouraging.
Therefore, we are considering accelerating some investment in the rental fleet, both in Canada as we execute on our strategy of increasing sales of our industrial products as well as in certain strategic US geographies.
This temporary deferral of profit results from units transferred to JJE that have either not been sold through to end customers or have been placed in the rental fleet.
Previously we would recognize revenue and profit in both cases when the units were shipped to JJE.
Now under a common ownership model, those transactions are considered intercompany sales and do not result in immediate profit recognition.
Specifically for the units transferred to JJE for subsequent sale to an end customer the associated profit it is not recognized until units sell through.
This is more of a short-term profit deferral as those units typically flow through to the end customer within 60 to 90 days.
However, for units transferred to JJE for placement in a rental fleet, the profit deferral may be long term as the upfront revenue and profit recognition is effectively replaced with rental income and the profit on the eventual sale as a used piece of equipment.
To give you an idea of how the profit deferral works I thought it might make sense to walk through an example.
During the month of June we transferred 26 units to JJE.
Of those 11 were transferred in anticipation of the sale to an end customer whereas the other 15 units were intended to be placed in a rental fleet primarily in response to demand for rental offerings from our dealer and direct sales force in the US.
Prior to the acquisition of JJE, upon shipment of these units to JJE in June we would have recognized approximately $1.8 million of gross profit with a corresponding amount of revenue.
However, now that we own JJE these shipments are intercompany transactions and we did not recognize any revenue or profit in Q2 for these sales as the units destined for end customers were not yet sold through to the end customers before the end of Q2 and the units added to the rental fleet would have only generated a month of rental income.
In subsequent months we expect to see the reversal of previously deferred sales and profit offset by the addition of new deferrals.
For example, of the $1.8 million profit differed in Q2, we expect to recover about half of that during the remainder of 2016 as units are sold through by JJE.
The other half will largely be deferred until the equipment is sold out of the rental fleet, a period we expect to be about three years.
As a consequence, we expect this should normalize over a period of about three years.
With that I'd like to move on to our earnings outlook.
As we mentioned, we continue to benefit from relatively steady municipal markets and we remain confident in our businesses and markets for the long term.
However, softness in oil and gas and related industrial markets continued into the second quarter.
With our strong balance sheet and ongoing actions to bring our construction in line with current demand we are well-positioned to work through the industrial headwind.
We are committed to pursuing additional strategic acquisitions and maintaining appropriate levels of investment in our sales efforts and new products to build momentum for future growth.
The ongoing softness in industrial demand has weighed on our orders and revenue outlook during the first half of the year, particularly in our businesses that serve oil and gas-related end markets.
And we do not believe these markets will recover meaningfully during the second half of the year.
On a positive note, some of this decline has been offset by healthy municipal demand, our cost reduction initiatives and sales of newly introduced products.
When we provided our outlook for 2016 early in the year we mentioned the likely accounting implication of the JJE acquisition on the timing of revenue and profit recognition which I just described should normalize over a period of about three years.
We now expect this temporary profit deferral could reduce our 2016 EPS outlook by up to $0.05.
Considering these factors, we are adjusting or 2016 EPS outlook from a range of $0.70 to $0.80 to a new range of $0.65 to $0.75.
With that I think we're ready to open the line for questions.
Operator.
Yes, <UNK>, this is <UNK>.
I will take this one.
Obviously the cash flow in the first of six months of the year, especially as we just presented, it is impacted by the transaction as we described and the associated non-cash settlement of the receivables from JJE.
The working capital that we have is if you look at it as a percentage of sales, it is distorted this quarter largely because of the acquisition as well as the inventory and rental fleet step-ups in value.
So that is impacting it for the quarter.
We've only had one month of results of JJE.
So we expect that to normalize over time, certainly later this year.
And we expect that our cash flow is obviously going to pick up in the second half of the year.
I think pricing remained pretty stable.
It's a combination of both mix and volume.
The hydroexcavation trucks that we sell into the oil and gas market have higher margins.
So we're feeling the impact of that going forward.
But the encouraging news is that we've talked about the improvement in ESG orders, particularly on the municipal side, and they tend to have not as good of margins as the hydroexcavation trucks but healthy margins.
On the new product development side we're very focused on our innovation initiatives.
Particularly on ESG side we introduced a new product to the utility market and we plan on introducing additional products into that market.
We also introduced our recycling product and our trailer jetter product earlier this year.
On the SSG side we're undergoing some redesign of our industrial floor products and we continue to benefit from the new products that were introduced on our public safety system side.
So as we move forward we're very focused on how do we utilize our existing technologies to open up new market opportunities for us or is there opportunities for some of our existing products in new geographies.
Not always.
But we think that we're able to differentiate our product.
And we've been ---+ we're maintaining pricing.
Sure.
You know, we have Joe Johnson and one of our Jetstream general manager leading that project.
And we have a team focused on the strategic objectives that we set forth behind the acquisition, which is also tied to the earnout that we have previously discussed.
And as we mentioned on the call, we have a new product offering, the rental equipment.
The initial demand has been encouraging there as we discussed.
With respect to used equipment we've done cross-training because we've introduced our Jetstream, our Guzzler and Westech products to Joe Johnson's Canadian salesforce.
So they've been trained on those products and we plan on leveraging their service centers and their sales teams to increase sales of those products.
Then on the parts and service side we now have aggregated 25 locations across North America that should allow us to better service our products in those strategic areas where our customers reside.
Then we also believe this used equipment offering we've sold some used equipment but we will have more of that available to sell and that will ---+ it's something that thus far has been received very positively.
So we're encouraged.
We're in the early days.
We just closed the transaction about six weeks ago.
We're encouraged, though, by the progress we've made today.
When we announced the acquisition we talked about an incremental $15 million to $20 million investment in their rental fleet.
We have obviously certain internal metrics that guide when we make those investments and the market reaction to the rental offering, both by our dealers that we're going to re-rent to and by the industrial salesforce in certain areas, has been encouraging.
So we anticipate that the amount likely won't change but we could be making those investments earlier than we originally thought.
<UNK>, this is <UNK>.
Yes we have.
Obviously we have the rental fleet that is going to be an asset that we're going to depreciate over time.
You will see, when we file our Q later today you will see how we're planning to depreciate that, the policy that we're going to apply.
So we've thought about it, it's obviously, our D&A is obviously going to increase over time because of the addition of the fleet.
So you will get a feel for how we're thinking about modeling it when we file the Q later today.
We typically don't break out the results of the JJE is not part of our ESG Group and we don't break out those results.
Beyond that to state that thus far, and we're in the very beginning period, it is performing at or better than we had modeled as part of the acquisition analysis.
When we think about it we obviously ---+ there's a change now because of the interplay between ESG and JJE now it's a different dynamic to what we previously had before the acquisition.
So that's really what is reflected in the deferral impact of up to $0.05 that we reference.
We're assuming for the second half of the year that it is going to remain the same with respect to the first half of the year.
We are ---+ our internal plans have the overhang that we've talked about bleeding into 2017.
Over the last couple of months we haven't seen it deteriorate further.
So that's encouraging.
But we're not expecting any meaningful recovery for the second half of the year and we believe this overhang of excess inventory will bleed into 2017.
We have not had any trials in the first half of the year.
We put out a press release, we were successful in getting one of the cases dismissed.
We have two trials scheduled, perhaps three depending on the timing in the second half of the year and we're moving forward with aggressively defending those cases.
Hello, <UNK>.
I think it would be up in the second half of the year mainly because we're going to have the effects of the Joe Johnson acquisition for the second half of the year that wasn't in there in the first half of the year.
And we also talked about the increased orders and we tried to break it out for you with Joe Johnson, without Joe Johnson.
And we are encouraged by the sequential improvement.
Some of them, yes.
I mean we're not expecting the mix to change significantly.
So we're not expecting to see an increase in, for example hydroexcavators, which are higher margin.
So I think there are going to be some impacts with the JJE acquisition which you'll need to factor in, but it should be a stable margin basis now.
A lot of it depends on mix.
We also have the impact of the JJE acquisition moving forward but we do remain confident in our long-term margin target of for ESG sorry.
Sure.
We have a number of active projects on the pipeline.
We look at our management bandwidth, we completed the JJE acquisition so right now we are focusing more on the SSG side but if something were to pop on the ESG side and we thought it made sense and we had the bandwidth we'd move forward.
The areas where my focusing on are other adjacent, we're staying pretty close to the core.
Does this acquisition give us access to new geographies, can we leverage channels and market.
Are there adjacent markets with new products.
Those are all some of the acquisition criteria that we're looking at very closely and obviously acceptable returns.
So I would say the pipeline is healthy right now.
We're pursuing a number of options.
We're looking at the more bolt-on less than $100 million-type opportunities.
From a standalone contribution, JJE except for the month of June contributed about $10 million of revenue and just a little shy of $1 million of operating income.
If that helps.
Okay, there are no more questions.
In closing I'd like to reiterate that we are confident in the long-term prospects for our businesses in our markets.
We'd like to express our thanks to our stockholders, employees, distributors, dealers and customers for their continued support.
Thank you for joining us today and we'll talk to you at the end of the third quarter.
