Federal Signal Corporation

Good day and welcome to the Federal Signal Corporation second quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press start and 1 on your touchtone phone. To withdraw your question, please press Start in 2. Please note this event is being recorded. 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'll 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've 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 filings, 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 2023. 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, we delivered record financial results for the quarter with double-digit year-over-year net sales and earnings growth, gross margin expansion, improved cash generation, a 120 basis point improvement in EBITDA margin, and new records in orders and backlogs. Consolidated net sales for the quarter were $442 million, a new quarterly record, and an increase of $76 million, or 21% compared to last year. Organic sales growth for the quarter was $54 million, or 15%. Consolidated operating income for the quarter was $59.4 million, up $13.2 million, or 29% compared to last year. Consolidated adjusted EBITDA for the quarter was $75.5 million, up $17.3 million, or 30% compared to last year. That translates to a margin of 17.1% in Q2 this year, up from 15.9% in Q2 last year. Gap EPS for the quarter was $0.66 per share, up $0.11 per share, or 20% from last year. On an adjusted basis, EPS for the quarter was $0.67 per share, up $0.14 per share, or 26% from last year. Order intake for the quarter was again outstanding, setting a new record and surpassing the previous high which we set last quarter. In total, orders in Q2 this year were $480 million, an increase of $67 million or 16% compared to last year. Backlog at the end of the quarter was $1 billion, another all-time high, and an increase of $212 million or 27% compared to Q2 last year. In terms of our group results, ESG's net sales for the quarter were $373 million, up $67 million or 22% compared to last year. ESG's operating income for the quarter was $56.2 million, up $17.1 million, or 40% compared to last year. ESG's adjusted EBITDA for the quarter was $70.7 million, up $19.1 million, or 37% compared to last year. That translates to an adjusted EBITDA margin for the quarter of 19%, an improvement of 220 basis points compared to last year, despite higher chassis revenue, which represented a year-over-year headwind of approximately 90 basis points. ESG's orders for the quarter were $409 million, an improvement of $57 million, or 16%, compared to last year. SSG's net sales for the quarter were $69 million this year, up $9 million, or 15%. SSG's operating income for the quarter was $14.1 million, of $3.8 million or 37% compared to last year. SSG's adjusted EBITDA for the quarter was $15.2 million of $3.8 million or 33%. That translates to an adjusted EBITDA margin for the quarter of 21.9% of 300 basis points compared to last year. SSG's orders were $72 million of $10 million or 16% compared to last year. Corporate operating expenses for the quarter were $10.9 million compared to $3.2 million last year, with the majority of the increase resulting from unfavorable changes in fair value adjustments of post-retirement reserves and the non-recurrence of an acquisition-related benefit of approximately $2 million relating to a post-closing adjustment that was received during Q2 of last year. Turning now to the consolidated income statement, where the increase in sales contributed to a $27.5 million improvement in gross profit. Consolidated gross margin for the quarter was 26.5%, a 200 basis point increase over last year. As a percentage of sales, our selling, engineering, general, and administrative expenses for the quarter were up 60 basis points from Q2 last year. Other items affecting the quarterly results include a $700,000 increase in amortization expense, a $2.3 million increase in acquisition-related expenses, a $1.4 million increase in other expense, and a $3.7 million increase in interest expense. Tax expense for the quarter was $12.4 million, up $1.3 million from the prior year. Our effective tax rate for the quarter was 23.5% compared to 24.9% last year. with the reduction primarily due to a $700,000 increase in excess tax benefits associated with stock-based compensation activity. At this time, we expect our full-year effective tax rate to be approximately 24%, excluding any additional discrete tax benefits. On an overall gap basis, we therefore earned 66 cents per share in Q2 this year, compared with 55 cents per share in Q2 last year. To facilitate earnings comparisons, we typically adjust our gap earnings per share for unusual items recorded in the current or prior quarters. In the current year quarter, we made adjustments to gap earnings per share to exclude acquisition-related expenses and environmental remediation costs of a discontinued operation. On this basis, our adjusted earnings for the quarter were $0.67 per share compared with $0.53 per share last year. Looking now at cash flow, we generated $36 million of cash from operations during the quarter, which was up $21 million from Q2 last year. We ended the quarter with $360 million of net debt and availability under our credit facility of $381 million. Our current net debt leverage ratio remains low, even after funding the acquisition of Trackless that we completed in April for an initial payment of approximately $43 million. 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 $6.1 million during the quarter, reflecting an increased dividend of $0.10 per share, and we recently announced a similar dividend for the third quarter. That concludes my comments, and I would now like to turn the call over to Jennifer.

Thank you, Ian. Impressive execution by both of our groups contributed to a record-setting quarter on many metrics. Within our environmental solutions group, an improving supply chain supported higher production levels, and with increased sales volumes, contributions from recent acquisitions, robust aftermarket demand, and strong price realizations, we were able to deliver a 22% year-over-year net sales increase and a 220 basis point improvement in adjusted EBITDA margin. During Q2, we were again able to increase production levels at our largest manufacturing facility, achieving the third successive quarter of production growth as the overall supply chain environment continues to improve. This strong execution contributed to a 35% year-over-year increase in sewer cleaner sales. In what is typically a seasonally strong quarter, our aftermarket revenues were also up 18% over last year with particular strength in part sales. In addition to strong organic growth, our recent acquisitions also contributed with trackless, our most recent acquisition completed early in the quarter off to a strong start. Collectively, the acquisitions added approximately $22 million to our top line during the quarter. While we are encouraged by the improving supply chain environment, we are still not out of the woods, and there continue to be pockets of supply-related disruptions for certain components like hydraulics and pumps. Given that, we are not yet maximizing our production capacity and continue to experience some inefficiencies. Chassis availability also continues to be a constraining factor within our dump body businesses, particularly for our businesses that build on classified chassis. Our safety and security systems group, again, delivered impressive results during the quarter with record net sales and adjusted EBITDA. SSG's second quarter results included 15% top line growth and an adjusted EBITDA margin of 21.9%, a 300 basis point improvement compared to last year, and above its target range, which we increased earlier this year. Over the last few years, we have made several investments in organic growth within SSG, including purchasing the University Park facility and insourcing production of several key components. These investments include the addition of a third printed circuit board line to increase production volumes of public safety equipment, achieve cost savings, and reduce reliance on suppliers. The new production line is expected to be operational in the third quarter. We expect that the broad actions we have taken to mitigate component shortages, including investments to in-source production and bring additional suppliers online, will provide meaningful long-term benefits to federal signal. Other highlights of the quarter include the publication of our latest sustainability report demonstrating our ongoing commitment to environmental, social, and governance initiatives. The report highlights the progress we have made against our sustainability goals that were established in 2018, including achieving our targeted 10% reduction in water and electricity intensity early. 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, and 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. Demand for our products and our aftermarket offerings remains at unprecedented levels, with both our orders and backlog this quarter again setting new company records. As we've talked about previously, there are several macroeconomic tailwinds contributing to the strong demand we are currently experiencing. Within our municipal markets, we are continuing to see the benefits from the American Rescue Plan, which in 2021 earmarked $350 billion for state, local, and territorial governments for a variety of purposes, including the maintenance of essential infrastructure, such as sewer systems and streets. In the second quarter, municipal orders were up 13% compared to last year, primarily driven by significant increase in demand for sewer cleaners. As a reminder, approximately 75% of our sewer cleaner orders include a hydro excavation or safe digging package, allowing the unit to be utilized in a variety of applications. We also continue to expect meaningful multi-year tailwinds arising from the $1.2 trillion Infrastructure Act, which has $550 billion earmarked for new investments in roads, bridges, power, water, and broadband infrastructure, public transportation, and airports. To date, nearly 35,000 projects have been awarded funding from the bipartisan infrastructure law. They range from repaving roads and water system upgrades funded through formula grants to state to competitive funding for massive bridge and transit projects. Our teams are working with our customers in the designated areas as they evaluate their equipment needs to support these large multi-year scale projects. With the funding available to support broadband infrastructure development, we have seen additional interest in our broad range of safe digging product offerings that can vacuum excavate and or convey materials in a safe and efficient manner. With that, orders for safe digging trucks were up 20% compared to the prior year. As another example of the potential application for the use of our safe digging products, there is a significant effort in California to mitigate the risk associated with wildfires with a major utility company recently announcing that it is seeking $8 billion in funding to bury power lines underground. We are also continuing to see benefits from the infrastructure bill within SSG, in particular with higher demand for warning systems. The Infrastructure Act earmarked $6.8 billion for the Federal Emergency Management Agency, or FEMA, to invest in disaster mitigation programs. This includes $500 million over five years to provide hazard mitigation assistance to local governments through the Storm Act. To date, we have received over $4 million in warning system orders supported by FEMA funding and are currently working with several counties that have been awarded grants totaling several million dollars to expand their tornado warning systems. we have received multiple proposals from communities across the country that are seeking government grants from this funding source to update or expand warning systems. As part of our warning system offerings, we also provide ongoing maintenance and subscription alerting services, which, following the initial sale of the warning equipment, provide for a long-term recurring revenue stream. SSG has recently introduced a couple of new features key to advancing the safety and security of communities and workplaces. The first is lightning detection and alerting, which are additions to our flagship Commander One outdoor warning siren activation and monitoring system. This feature is ideal to alert industrial and chemical plants, outdoor recreational areas, parks, and campuses where lightning is a threat to employees and communities. The second is a new option for siren communication with our IoT family of products. These devices allow for quick upgrades from legacy radio technologies to secure cellular communication. With higher frequencies of natural disasters such as wildfires, hurricanes, tornadoes, and floods, we are proud that our products play a role in helping to keep communities safe. During the second quarter, the U.S. Department of Energy also released a notice of intent to invest $2 billion in from the Inflation Reduction Act to accelerate domestic manufacturing of electrified vehicles. These investments are expected to be made available in the coming months. Electrification remains a key area of investment for the company, and we expect this public funding source to support future growth related both to our EV product lines as well as our platform of specialty vehicles that support metal extraction. During the second quarter, Despite increased production levels that contributed to record quarterly sales, our orders once again exceeded shipments. In fact, the second quarter represented the 10th successive quarter that our orders have outpaced sales. With this unprecedented demand contributing to record backlogs, lead times for certain products have become extended, and consequently, we may see some lumpiness in ESG order trends as we move forward, which may impact comparability from quarter to quarter. In addition, while orders within SSG in the front half of the year were outstanding, including benefits from certain large fleet orders, we may see some moderation in SSG orders in the second half of the year with Ford scheduling a police vehicle model year changeover in Q4. We remain focused on increasing production levels to build more trucks as we aim to reduce current backlog and lead times while continuing to maintain healthy order intake. I now want to take a few minutes to provide an update on a couple of our organic growth initiatives. Our focus on 80-20 improvement is deeply ingrained in our culture and it's played and will continue to play a key role in driving our organic growth and industry-leading margins. As discussed in the last earnings call, we hired a dedicated resource tasked with driving additional throughput projects across many of our businesses as we seek to reduce current lead times at several of our businesses. This resource has already conducted a series of 80-20 and lean manufacturing sessions. At our Elgin Street sweeper facility, lean initiatives have initially focused on synchronizing fabrication and paint processes within assembly demand. This improved flow is expected to increase throughput by eliminating double handling of materials, maximizing paint line capacity, and assembly productivity. At our Travis body and trailer facility, the management team initiated a product line simplification initiative similar to the successful Oxbody's dump body SKU reduction that we talked about in our last earnings call. The Travis team identified over 9,500 current combinations of trailer offerings, and the first round of its 80-20 analysis achieved a 30% reduction in variations with continued standardization underway. Moving on to aftermarkets, which represented approximately 28% of ESG's revenues during the quarter, mainly due to the strength in part sales that I noted earlier. Aftermarkets remains a key strategic initiative of ours, and we see additional opportunities to grow that business by expanding into new geographies. In addition, we made meaningful investments in the first half of 23 to replenish our rental fleet and support the anticipated continuation of high demand for rentals and used equipment. We also continue to invest in new product development, and I wanted to touch on a few recent product innovations. During the second quarter, SSG introduced the Highlighter Elite, a new design of our popular mini light bar with improved optical performance and a sleeker, more attractive appearance. The wide variety of mounting options, colors, and flash patterns ensure there is a suitable model for on-road or off-road utility towing and construction vehicles. In addition, reduced availability of class three to five chassis continues to be a constraint for our dump body business. As a result, our teams have launched products that utilize chassis that currently have more availability. As an example, we recently introduced an aluminum dump body product offering designed for the widely available Ford F-350 pickup chassis that has been well received in the market. On the M&A front, we were pleased to announce the closing of the trackless acquisition in April and are encouraged with its financial performance in the quarter. Trackless is a leading Canadian manufacturer of multipurpose off-road municipal tractors and a variety of attachments which provide year-round value to its customers. The Trackless integration is well underway, and we are excited about the opportunity to leverage our existing distribution channel in the U.S. to expand the geographic reach of Trackless products and accelerate the growth trajectory of this business. Our continued growth through disciplined M&A differentiates Federal Signal as an accumulator of leading brands of specialty vehicles and supporting aftermarket offerings. Our deal pipeline remains very active, and we continue to expect M&A to be an important part of our future. Turning now to our outlook for the rest of the year, demand for our products and our aftermarket offerings remains at unprecedented levels, with both our orders and backlog this quarter, again setting new company records. With our second quarter performance, our record backlog, and improving supply chain conditions, we are raising our fully-adjusted EPS outlook to a new range of $2.30 to $2.46 from the prior range of $2.21 to $2.43. We are also increasing the low end of our full year net sales outlook range by $30 million, establishing a new range of $1.65 billion to $1.72 billion. At this time, I think we are ready for questions. Operator?