Federal Signal Corporation

quarter 2022 earnings conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Ian Hudson, Chief Financial Officer. Please go ahead.

Good morning, and welcome to Federal Signal's second quarter conference call. I'm Ian Hudson, the company's chief financial officer. Also with me on the call today is Jennifer Sherman, our president and chief executive officer. 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 earnings 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 Signals 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 release and filing, we reconcile these non-GAAP measures to GAAP measures. In addition, we will file our Form 10-Q later today. I'm going to begin today by providing some detail on our second quarter results before turning the call over to Jennifer to provide her perspective on our performance, market conditions, and our outlook for the remainder of 2022. After our prepared comments, Jennifer and I will address your questions. Our consolidated second quarter financial results are provided in today's earnings release. In summary, our financial results for the quarter were strong, with double-digit improvement in sales and operating income, improvement in margins, and continued momentum in demand. Consolidated net sales for the quarter were $367 million, up $32 million, or 10% compared to last year. Consolidated operating income for the quarter was $46.2 million, up $7.7 million, or 20% compared to last year. Consolidated adjusted EBITDA for the quarter was $58.2 million, up $6.3 million, or 12% compared to last year. That translates to a margin of 15.9% in Q2 this year, up 40 basis points compared to last year. GAAP EPS for the quarter was $0.55 per share, up 15% compared to last year. On an adjusted basis, EPS for the quarter was $0.53 per share, up 6% compared to last year. Order intake for the quarter was again outstanding, with orders of $413 million, representing an increase of $53 million, or 15% compared to Q2 last year. Backlog at the end of the quarter was $795 million, another all-time high for the company and an increase of $358 million, or 82% compared to Q2 last year. In terms of our group results, ESG's net sales for the quarter were $306 million, an increase of $25 million, or 9% compared to last year. ESG's operating income for the quarter was $39.1 million, of $600,000 or 2% compared to last year. ESG's adjusted EBITDA for the quarter was $51.6 million, up $1 million or 2% compared to last year. That translates to an unadjusted EBITDA margin for the quarter of 16.8% compared to 18% last year. ESG's orders for the quarter were $352 million, an improvement of $52 million, or 17% compared to last year. Turning now to SSG, who reported net sales of $60 million in Q2 this year, an improvement of $7 million, or 13% compared to last year. SSG's operating income for the quarter was $10.3 million, up $2.5 million, or 32% compared to last year. SSG's adjusted EBITDA for quarter was $11.4 million, up $2.7 million, or 31%. That translates to an adjusted EBITDA margin for the quarter of 18.9%, up 260 basis points compared to Q2 last year. SSG's orders for the quarter were $62 million, up 1% compared to last year. Corporate operating expenses for the quarter were $3.2 million, compared to $7.8 million in Q2 last year. The reduction in corporate expenses was partly driven by a favorable year-over-year variance of $2.4 million associated with changes in mark-to-market adjustments of post-retirement reserves. These market-based adjustments benefited our earnings in Q2 this year by approximately two cents per share, but were unfavorable in Q2 last year. Corporate expenses in Q2 this year also included an acquisition-related benefit of approximately $2 million relating to a post-closing adjustment that was received during the quarter. Turning now to the consolidated income statement, where the increase in sales contributed to an improvement in gross profit of $8.2 million, or 10%. Consolidated gross margin for the quarter was 24.5% of 10 basis points compared to last year. The improvement in gross margin was achieved despite a 30 basis point headwind, resulting from an increase in the mix of chassis that we supply. These chassis carry very low margins, but allow us to better manage our production schedules and serve our customers. As a percentage of sales, our selling, engineering, general and administrative expenses for the quarter were down 50 basis points from Q2 last year. During the quarter, we recorded a $1.7 million benefit from acquisition-related activity compared to $300,000 of expense last year, with the majority of the year-over-year change driven by the receipt of the post-closing adjustment I just referenced. Other items affecting the quarterly results include a $400,000 increase in amortization expense and an $800,000 increase in interest expense, with recent increases in interest rates we currently expect an EPS headwind of two cents in the second half of the year compared to our prior outlook. That assumes no significant change in debt levels. Tax expense for the quarter was up $3.1 million, largely due to higher pre-tax income levels and a $1.5 million reduction in excess tax benefits from stock compensation activity in comparison to Q2 last year. As a result, our effective tax rate for the quarter was 24.9% compared to 21.2% last year, representing a year-over-year EPS headwind of about $0.02. At this time, we continue to expect our full-year effective tax rate to be approximately 25%. On an overall gap basis, we therefore earned $0.55 per share in Q2 this year compared to $0.48 per share in Q2 last year. To facilitate earnings comparisons, we typically adjust our GAAP earnings per share for unusual items recorded in the current or prior year quarters. In the current year quarter, we made adjustments to GAAP earnings per share to exclude acquisition-related benefits. On this basis, our adjusted earnings for the quarter were 53 cents per share compared with 50 cents per share last year. Looking now at cash flow, we generated $15 million of cash from operations during the quarter. representing an increase of 16% over Q2 last year, despite incremental investments in chassis and other raw materials. We ended the quarter with $296 million of net debt and availability under our credit facility of $166 million. Our current net debt leverage ratio remains low and essentially unchanged from Q1. With our financial position remaining strong, we have significant flexibility to invest in organic growth initiatives pursue strategic acquisitions, and return cash to stockholders through dividends and opportunistic share repurchases. On that note, we paid dividends of $5.4 million during the quarter, reflecting a dividend of 9 cents per share, and we recently announced a similar dividend for the third quarter. We also funded $2.5 million of share repurchases during the quarter, bringing the total share repurchases so far this year to approximately $16 million. That concludes my comments, and I would now like to turn the call over to Jennifer.

Thank you, Ian. Our businesses were again able to deliver strong operational performance during the quarter, despite the ongoing challenges associated with the current supply chain environment, where shortages of hydraulic components, pump cylinders, and certain electrical components continued to make production challenging. I'm continuously impressed by the creative and nimble solutions our teams identify in response to these supply chain challenges. For example, our teams have secured alternative suppliers, purchased certain buffer inventory, sought to in-source or re-engineer products where possible, and modified production schedules based on component availability. Despite the challenges we faced during the quarter, our teams were successful in delivering double-digit top-line growth, gross margin improvement, and a consolidated EBITDA margin, which was at the high end of our target range and up 40 basis points compared to last year. We continue to see increased demands for rental, parts, and used equipment sales with the current tightness in the supply chain and extended lead times for new equipment deliveries. In the first half of this year, our aftermarket revenues totaled $161 million, a 12% improvement over last year. With additional benefits from our pricing actions and contributions from our recent acquisitions, our environmental solutions group reported a $25 million year-over-year sales increase. Although inflationary pressure persists, our second quarter results included the effects of improved price-cost realization both sequentially and on a year-over-year basis, with the improvement most notable within our dump truck and trailer businesses. We currently expect margins in the second half of the year to be higher than the first half of the year as more of our higher-priced backlog shifts. Our Safety and Security Systems Group had an outstanding quarter with double-digit top-line improvement and a 170 basis point increase in gross margins largely due to increased sales volumes and higher price realization. With our efforts to expand our supply base and execution of our ETI principles to in-source production of certain materials, component availability for these products has improved in recent months, which resulted in an increase in shipments compared to last year, most notably within our public safety businesses. Operationally, we benefited from limited coronavirus-related disruption during the quarter. Although coronavirus-related absences were relatively low during the second quarter, we are continuing to monitor case levels associated with emerging variants. Other highlights of the quarter included the publication of our latest sustainability report demonstrating our ongoing commitment to environmental, social, and governance initiatives. In the report, we highlight the ways in which we make a difference to our customers, our communities, and our environment. We know that as a global manufacturer of critical infrastructure and safety products, we have the responsibility to do the right thing, operate sustainably with a long-term fact-based view on issues regarding the environment, society, and corporate governance, and positively impact our employees, customers, partners, and stakeholders at large. These efforts also position us well in the communities in which we operate and serve as a differentiating factor in our ability to attract labor at most of our facilities. Turning now to market conditions, where demand for our products and aftermarket offerings remains at unprecedented levels, the order momentum has been across the board with year-to-date orders from both municipal and industrial customers each up around 20% year-over-year. On the municipal front, recent discussions with several of our dealer partners have echoed this positive sentiment, with many seeing robust demand across virtually all product lines. The $350 billion American Rescue Plan Act, which has earmarked funding for state, local, and territorial governments for a variety of purposes, including the maintenance of essential infrastructure such as sewer systems and street sweeping, is continuing to benefit our municipal markets across the country. For example, we are seeing incremental order strength beginning with smaller municipalities purchasing both new and used street sweeping and sewer cleaning equipment in several states where the equipment purchases are directly attributed to this public funding source. With the second 170 billion tranche expected to be distributed later this year, including multi-year appropriation and spending deadlines, we expect to see a prolonged, meaningful tailwind from the stimulus package. On the industrial side, demand remains high, particularly for our safe digging products with orders in the first half up 26 million or 69% year over year. During the quarter, we saw strong demand for our trailer products, but some softer orders for dump trucks associated with some tightness in customer chassis supply. We remain bullish on the potential impact of the 1.2 trillion infrastructure bill, which has 550 billion for new investments in roads, bridges, power, water, and broadband infrastructure, public transport, and airports. Our equipment sales and rentals of material, hauling, road marking, street sweeping, sewer cleaning, safe digging, and industrial cleaning equipment stand to benefit from this investment as our equipment is integral to the process of improving and expanding this infrastructure. Given that these funds have not yet been distributed, we have not yet seen any impact to date in our orders, although we continue to monitor the developments closely. I now want to take a few minutes on some of our growth initiatives, starting with an update on new product development initiatives. Our R&D teams remain committed to providing solutions to solve our customers' problems by incorporating state-of-the-art technology enhancements into developing new products. With a focus on features and functionality, our solutions aim to simplify ease of operation and training, reduce operating costs, and maximize asset utilization. A recent example of this approach is the launch of the Broom Badger, a compact, highly maneuverable street sweeper manufactured by Elgin Sweeper. In launching our Broom Badger, we have developed a new sweeper that replaces a product which we previously sourced from a third party with an innovative street sweeper which incorporates multiple enhancements based on extensive customer feedback. Of growing importance to the needs of our customer, This new product does not require that the operator have a commercial driver's license, which can be more challenging to obtain due in part to the legalization of marijuana that has occurred in many states. Internally and externally, the product launch has truly been a collaborative effort, and we look forward to growing our share in the marketplace. We also continue our efforts to enhance our TruVac safe digging product offerings with the recent introduction of the APXX, a heavy-duty vacuum excavator designed for the toughest of conditions. With its innovative design, the APXX maximizes legal payload and aims to make customers' time on the job more profitable while providing operators with high levels of comfort and protection from the elements to support productivity in cold climates. Other recent examples include reducing operating costs by developing single engine platform solutions for our street sweeping, sewer cleaning, and road marking businesses, and reducing equipment downtime and troubleshooting by offering onboard diagnostics in the control systems of our sewer cleaners and safe digging trucks. We continue to identify ways to integrate electrification into our suite of products and offer solutions to our customers on their path towards reducing their carbon footprint and improving air quality without compromising performance. We continue to collaborate with multiple chassis LEMs and have recently taken delivery of our first fully electric chassis and plan to begin field testing an all electric truck mounted sweeper later this year. In addition, we are experiencing high demand from our dealer network for demonstrations of our plug-in hybrid electric products, specifically the broom bear and the three-wheel pelican. Our aftermarket business has grown to represent approximately 30% of ESG's revenues, and we see additional opportunities to grow that business by expanding it into new geographies we believe to be underserved. In connection with those expansion efforts, this year we have acquired certain distribution rights from dealers in Colorado, Montana, and Wyoming. By establishing a presence in these territories for relatively low investment, we expect to increase sales of our products and grow our parts, service, and rental revenues. On the M&A front, we are making good progress integrating our recent acquisitions, Ground Force and Dice, and we are pleased with our contributions in the second quarter. Our deal pipeline remains very active, and we continue to expect M&A to be an important part of our future growth. With our investments in new product development, the potential for M&A, our recently completed capacity expansions at several facilities, relatively good access to labor, and multi-year tailwinds from recent economic stimulus and infrastructure legislation, we are well positioned for long-term growth. Turning now to our outlook for the rest of the year. The momentum and demand for our products and our aftermarket offerings that we have seen in recent quarters continued in the second quarter, with a 15% year-over-year improvement contributing to another record backlog. Although we expect the volatile supply chain environment to continue, we are encouraged with how our teams have navigated through these challenges so far this year. Notwithstanding the EPS headwind in the second half of the year associated with higher interest expense, With our performance in the first half of the year, our record backlog, and current expectations of component availability, we are raising the midpoint of our full-year adjusted EPS outlook by establishing a new range of $1.85 to $2, updated from the previous range of $1.80 to $2. At this time, I think we're ready for questions. Operator?