Brian Cooper - CFO Dennis Martin - CEO & President Jennifer Sherman - COO.

Steve Barger - KeyBanc Capital Markets Walter Liptak - Global Hunter Securities.

Welcome to the Federal Signal Corporation Second Quarter Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brian Cooper, Senior Vice President and Chief Financial Officer. Please begin..

Good morning and welcome to Federal Signal's second quarter 2015 conference call. I'm Brian Cooper, the company's Chief Financial Officer. Also on this call with me are Dennis Martin, President and Chief Executive Officer and Jennifer Sherman, our Chief Operating Officer.

We will refer to some presentation slides today, as well as to the news release which we issued this morning. The slides can be followed online by going to our website federalsignal.com, clicking on the investor call icon and signing into the webcast.

We have also posted the slide presentation and the news release under the Investor tab on our website.

Dennis will lead off today, but before we begin, I would 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 our Form 10-Q today. Now, I’ll turn the call over to Dennis..

Thanks, Brian. We are happy to report another strong quarter and before Brian goes into more detail on the results for the quarter, I want to give a brief update on some of our strategic initiatives. We continue to focus on discipline growth making investments in businesses that we want to grow.

These investments typically include producing newer, more sophisticated manufacturing equipment, adding capacity to the existing facilities and funding new product development initiatives.

As you can see from the significant improvement in operating margin during the quarter, which included the improvement in each of our groups, we continue to benefit from leveraging invested capital and manufacturing efficiencies and cost.

The 12.7% consolidated operating margin reported for the quarter was a record high and exceeded the long-term target that we have set for ourselves.

Although it will vary from quarter-to-quarter, with continued focus on executing our strategies already twenty initiatives, our goal is to maintain a consolidated operating margin in the margin of 12% over the long-term. We continue to strive to diversify our customer base as well as our markets.

With our innovation initiatives we’re responding quicker to the market needs, with the introduction of new products are designed to give us access to new customers.

Of course one other way of achieving our objective of growing our industrial business at a faster pace than our missile business would be through an industrial focused acquisition program. With the additional M&A resources that we added earlier in the year, we are strengthening our acquisition pipeline.

While we intend to continue to fund internal growth opportunities, we’re also committed to acquisition that create value for our shareholders and we would like to add at least $250 million from acquisitions to our revenue run rate over the next three years. We intend to continue to exercise discipline in considering acquisition opportunities.

Jennifer is going to talk a little more on our evaluation process shortly. She’ll also provide some perspective on our performance and market conditions and talk about some of our growth initiatives. She’ll also give a detail of our outlook for the remainder of 2015.

But first I’m going to turn things over to Brian to address our financial results for the quarter..

Thank you, Dennis. As you’ve seen in our earnings news release, our second quarter results reflect a significant increase in operating income despite relatively flat sales. This translated to a significant improvement in consolidated operating margin. Consolidated net sales were $231 million for the quarter, down 2% compared to the prior year quarter.

However, excluding foreign currency translation effects, consolidated net sales were up $4 million or 2%. Operating income was $29.2 million, up 22% versus last year. Consolidated operating margin was 12.7%, up an impressive 250 basis points compared to 10.2% a year ago.

Income from continuing operations was $18.3 million for the second quarter, up 8% compared to the prior year. That translates to EPS $0.29 per share, which is up 7% compared to $0.27 per share last year. There are no material non-GAAP adjustments to our results in either period.

Also in the quarter orders declined by 16% versus last year and backlog was $269 million, down from $356 million a year ago. Jennifer will elaborate on how we’re responding to softness in some of our markets and how these results factor into our view of the second half of 2015.

As you can see in our group results, all three of our business groups reported improved operating margin versus Q2 last year. Foreign currency translation reduced second quarter orders and sales in our Fire Rescue Group and to a lesser extent in our Safety and Security Systems group.

Although our top-line was affected, foreign currency changes have had no material impact on our bottom-line. The impact on second quarter consolidated operating income was less than 2%. Environmental Solutions Group drove much of the overall improvement in operating results, reporting a net sales increase of $7.4 million or 5% versus last year.

This came on the strength of a significant increase in shipments of street sweepers. ESG operating income was up an impressive 26%, as we continue to benefit from operating leverage, capacity enhancements, productivity improvements and a favorable mix of products sold.

On this increase, ESGs operating margin rose to a record high of 19.9%, compared to 16.6% last year. Orders and backlog at ESG were each down about 25% when compared to record levels a year ago. The prior year included several large fleet orders for street sweepers.

And recent demand has been softer from our Vactor and jet-stream customers who serve oil and gas upstream markets. We also continue to see fewer advanced stocking orders and we continue to capture additional product sales opportunities that result from shorter lead times.

At SSG, sales were down 4% compared to last year’s quarter, primarily due to unfavorable foreign currency translation effects. Operating income of $7.3 million was down slightly, while operating margin improved to 12.4% compared to 12.2% in Q2 last year. Orders at SSG were generally flat in comparison to the second quarter last year.

As we’ve noted previously, most of SSGs business normally operates with relatively low backlog. In the Fire Rescue Group, net sales were $8.7 million lower than the prior year quarter. Excluding the effects of foreign currency translation, FRGs net sales decreased by $3.4 million or 10%.

FRG reported nominal operating income for the quarter versus an operating loss of $0.3 million last year. In local currency, FRGs second quarter orders were up 18% compared to the second quarter of last year as we saw strong order flow from Asia Pacific and the Middle East, including certain large multiunit orders.

Corporate operating expenses of $7.3 million were up compared to $6.4 million a year ago, largely due to higher professional service fees. From a consolidated perspective, we reported a 12% improvement in gross profit and a gross margin of 28.5% for the quarter, which compares to 25.1% last year.

Selling, Engineering, general and administrative expenses of $36.1 million were up 3% compared to the prior year quarter and we saw a slightly higher cost associated with restructuring activities. All these factors rolled into the company’s $29.2 million of second quarter operating income.

Other items affecting the quarter, these results include small reductions in interest expense and other expense. Tax expense for the quarter was up $4.5 million with an effective tax rate for the quarter of 35.8%, which was similar to the first quarter. The rate is higher than the 25.1% reported in Q2 last year.

This is largely because of a $1.5 million tax benefit recognized in the prior year quarter in connection with the release of tax reserves. We continue to estimate our full year effective tax rate for 2015 to be approximately 36%. From a cash perspective, we’re projecting a cash tax rate in the low to mid-teens.

The difference between effective tax rate and our cash tax rate relates to use of differed tax assets to reduce our tax payments, these assets primarily consists of net operating loss carry forwards and tax credit carry forwards.

On an overall basis we therefore earn $0.29 per share from continuing operations in Q2, compared to $27.7 per share in Q2 last year. The balance sheet remains extremely strong with our robust cash flow continues to improve. Operating cash flow was $24 million for the second quarter and is up $4 million or 16% for the year-to-date period.

Total debt was $49 million, down from $76 million a year ago and net debt was only $13 million. In addition, our leverage ratio of debt to adjusted EBITDA dropped to 0.4 times. Our strong operating performance and our low level of debt obviously give us excellent flexibility to fund growth initiatives and return value to shareholders.

During the second quarter, we paid a quarterly dividend of $3.7 million and also funded $1.4 million of share repurchases. We have just under $75 million under our share repurchase authorization. That concludes my comments and I’d like to turn the call over to Jennifer..

Thank you, Brian. I’ll like to start by adding a couple of comments on our strong quarterly results. I’ll then provide some perspective on what we’re seeing in our markets and talk about progress we’re making against some of our growth initiative, before wrapping things up with an update on our outlook for the rest of the year.

As Brian mentioned, the Environmental Solutions Group had an outstanding quarter. It’s new 20% operating margin for the quarter is the highest it has ever been and reflects continued execution on 80/20 and lean initiative, leveraging capacity and utilizing our flexible manufacturing model.

A highlight for the quarter was that our Elgin Sweeper facility completed to ship [ph] the highest number of street sweepers since 2006.

At the Safety and Security systems Group, we continued to see strong performance in public safety markets both domestically and overseas, particularly in Southern Europe, which continues to show signs of improvement. On the Integrated Systems side, we saw some year-over-year decline in results.

This is driven in part for the timing of orders and deliveries and by the unfavorable oil and gas market. However, we continue to be encouraged by the number of projects in our pipeline. The Fire Rescue Group, which is our Bronto Skylift business, reported nominal income for the quarter compared to a weak second quarter a year ago.

As we’ve discussed previously, Bronto’s results can fluctuate significantly from period to period and could be impacted by the volume of unit shipments. During the second quarter, approximately $5 million of revenue and $1 million of profit was temporarily deferred.

This was because the terms of a customer contract prevented us from recognize revenue in the second quarter despite the units being delivered. The Fire Rescue group’s second quarter gross margin improved to 19.7% from 13.5% in the prior year.

With this improvement, we are starting to see some efficiency gains from the significant investments we’ve made over the last few years to improve our manufacturing facilities, combined with the results of the concentrated effort to reduce the intake of low margin orders.

We are also very encouraged by the volume of orders in the second quarter, which were up 18% in local currency and included winning a number of large multiunit opportunities. While our overall operating results for the second quarter were strong, orders particularly at ESG were much lower than last year.

ESG orders reported in the second quarter of last year were the highest they’ve ever been in any quarter due to a number of significant freight orders for street sweepers that did not repeat this quarter.

The street sweeper freight orders which were received from customers in Middle East and United States represented about $27 million or 72% of the year-over-year ESG orders reduction. The remainder of the declining orders is associated with oil and gas exploration effects or some is the result of shorter lead times.

As we’ve discussed on previous calls, our key initiative over the last year has been to put a new production line to reduce our lead times and enhance our capacity. As expected, we saw a reduction in stocking orders from many of our customers as a result of these improvements.

In the past, customers have placed orders up to eight months ahead of market demand [indiscernible] in our production schedule. As our lead times have reduced, our dealers can satisfy market demand without placing these advance orders. This reduction in dealer advance orders does not indicate deterioration in the market demand.

On the municipal side, demand has been strong with second quarter municipal orders up 37% over the first quarter. We expect activity in our municipal markets remain healthy for the balance of the year. I now like to provide a brief update on our growth initiatives.

As we’ve discussed on previous calls, our priorities for capital in descending order are, first to fund organic growth; second, for acquisitions; third, dividends; and finally share repurchases. In relation to organic growth, we continue to invest in research and development as we strive to introduce new products to new and existing markets.

We have previously discussed our innovation initiative that is focused on developing new products faster to meet customer need. We are pleased to report that we’ve designed and built prototype units for our new trucks in less than five months.

This new design is specifically targeted at expanding our reach and competitiveness with customer serving utility market. We’ve also recently invested in a modest expansion of our facility in Alabama in order to further develop our flexible manufacturing model and expand it to new markets. On acquisitions, we’ve been actively evaluating opportunities.

M&A markets continue to drive elevated valuation expectations and we continue to be committed to being selective and disciplined to find acquisition opportunities that create value. To do that, our criteria are focused primarily on acquisitions that fit closely with our products and services, manufacturing competencies, channels and customers.

For example, we value opportunities to put our products through expanded channel or take –acquire products through our existing channels. These synergies should help us create lasting value. Other criteria that will make acquisitions attractive to us include an industrial market focus, recurring revenues, sound management, and earnings decreasing.

We have previously mentioned that we typically target a capital structure with the debt at about two to two point times EBITDA in order to meet the incremental revenue target that Dennis discussed at the beginning of the call, we will consider a series of tuck-in acquisitions as well as a larger transformational type acquisition.

Acquisitions will be a critical part of our long-term growth strategy. With our balance sheet strength and low leverage ratio, we have significant capacity in our existing capital structure for the right acquisition opportunities. We also continue to be committed to returning value to shareholders in the form of dividends.

As Brian mentioned, we paid a quarterly dividend of $3.7 million in the quarter and our board recently declared a similar dividend for the third quarter. And finally after repurchasing 124 million of shares during the second quarter, we have approximately 75 million remaining under our existing authorization.

This equates to about 8% of our current market cap. With that, I would like to move on to our earnings outlook. At this point in the year, we have increased visibility into the third and fourth quarters.

Despite the recent softness and orders for US exports and for products serving upstream oil and gas markets, we are affirming our expectation that full-year adjusted earnings per share will be in the range of $0.95 to $1.02. With that I think we are ready to open the lines for questions.

Operator?.

Thank you. [Operator Instructions] And we’ll go to Steve Barger with KeyBanc Capital..

Good morning..

Good morning, Steve..

Good morning, Steve..

Good morning. Just let’s start on the acquisitions, $250 million and deals over three years certainly would be an exciting thing to see.

You talked about wanting things that fit closely or you would be something transformational, how should we think about that in the context of the three segments? Could there be a fourth in the way that you see the realm?.

We haven’t focused on that, but there could be..

And just as you go out, you talked about being selective and disciplined, what’s your general philosophy around whether it’s better to buy a well-run business for a higher multiple or a fix it up for a lower multiple?.

I think, Steve, it will depend on how closer this is to the core of the company. So if we found a business that was very close to our distribution core, our manufacturing core, that needed to be 80/20, we would certainly take that project on and move ahead. We’d paid a little more obviously for something that’s running well.

Again if it’s close to the core or we can see how it develops perhaps into a new area that we can be successful and for shareholders..

But it sounds like you wouldn’t buy something that was fixed up [ph] unless you felt like you really understood the business?.

We wouldn’t..

Okay.

And I mean you’ve talked about both tuck-ins versus transformational, but just as you look at the acquisition environment out there right now and does this - does it seem more like you lean more towards a couple of $100 million deals? Or is this more like five, $50 million deals just based on the [indiscernible] of things that you see?.

Yeah, everything that we’ve looked at is range from $10 million to $800 million and obviously on the high end, 800 million would be too big I think for us. But it could be a combination of three or four smaller things, but as you know, we could do three or four each one takes the same amount of effort.

So for example, one that we like that was in a couple of hundred million, 300 million range, we would certainly feel good about that too, so..

Okay, you definitely can get some product lines..

And Steve, I was just going to say, I mean, to the extent we are doing a smaller acquisition, it’s more likely to be more in line to the product line acquisition or something like that, which again would fit the tuck-in category..

Understood, you’ve timed up some product lines over the past couple of years, anything else that you see as possible divestiture to kind of clean up the portfolio?.

Well, we constantly look at it and so we have nothing on the plan at this point, but one of our evaluation points is that constantly go back and look at the value to the shareholders over the long run of all our businesses. So we will continue to do that, but nothing on the immediate horizon..

And when you look value to the shareholders, is your primary filter? Or what is your primary filter whether it’s return on capital earnings growth? How do you think about the kind of business that fits into the portfolio?.

We really look at earnings growth. We look at where is our opportunity to use that business with the platform for future acquisitions which is critical and we look at the mix of industrial versus municipal, we’ve talked about that before. And as Dennis mentioned, we are constantly evaluating all of our businesses using those criteria..

Got it. One more and I will get back in line. You reaffirmed your guidance, which is good to see, implies $0.43 to $0.50 in the back half.

Can you just give us a little more color on what you see as the primary factors or the big swing factors that could cause results to come into the high end or the low end?.

It really depends on performance at our Environmental Solutions business. Their backlogs right now, they’re full to the third quarter and we’re looking at the fourth quarter. So we feel good about our current guidance and we’ll update you at the end of the third quarter in terms of where we are for fourth quarter..

FRG continuing to shift their backlogs will also make a big difference, Steve, so really a combination of that. We seem to be steady at SSG. So it really is already around the company..

All right. Thanks very much for the time..

Thanks..

Thank you..

Thank you. [Operator Instructions] We’ll go to Walter Liptak with Global Hunter..

Hi, good morning guys. Congratulations on a nice quarter..

Thanks, Wal..

I wanted to ask about kind of along the lines of the M&A and your comments on corporate expense being up a little bit for professional fees.

Can you give us some detail on what kind of professional fees you’re paying for?.

They relate to actually corporate matter. So I mean there are some legal costs and some other things, but it’s not a stuff that we would necessarily expect to continue over time..

Okay, got it. [indiscernible] What do you think the - you’ve been talking about acquisitions for a while now.

I wonder what you are thinking now for timing or are you close on something where we see something before the end of the year or is it 2016?.

So, Wal, I mean, the markets out there, they are very hard to call and you never know when things will get done. All I can tell you is, we have some active opportunities we’re looking at. Some of them are pretty small. A couple of them are a little bigger. They all kind of have their own pace and sometimes they fall off the tracks real fast.

So we’re working on things, the pipeline or the funnel is a lot fuller than it used to be. We kind of had to rebuild our process. A couple of years ago, we had not really been in a position to be looking very actively at acquisitions and we’re doing that now.

So more things are coming to us and we’re being more proactive with our businesses in identifying things. We would like to go after companies that we’d like to talk to and approach. So there are things going, but exactly when something can happen is something I’m not comfortable calling..

Okay, great.

And then one last one about the ESG business and your comment about trends in the market, I wonder if we can get more colors on North America or is it international where we’re seeing positive trends that should flow through into fourth quarter and maybe next year, then the third quarter production and mix for our products, how is that looking?.

We’re seeing activity, certainly activity in the sewer cleaner market. That’s good.

Jennifer mentioned in her note that because we shortened our lead times with our new assembling processes of Vactor that we actually reduced the lead for customers, the dealers to place orders eight months out and that equates to our reduced backlog, probably 30 million of our reduced backlog, Wal.

It’s just relative the fact that we can now shipped product out of stock in case of our Guzzlers. So I think some of the adjustments that we saw in the first quarter and the second quarter will kind of go away and we’ll see more normal trends of business in the third and fourth quarter for the ESG side.

The international business, the orders there tend to be opportunistic and they come and go as we said last year that second quarter we had huge orders or multiple huge orders. We still see good order activity, but it’s not quite the same level of big fleet.

So I think it’s going to be more of a steady trend and then at the end of the half we think we’ll - as we said that our guidance, mid guidance that we gave prior and we feel pretty good about that considering what’s going on in the economy..

And we talked specifically about our municipal orders were up 37% over the last quarter and we continue to see a healthy outlook for municipal demand in our Environmental Solutions Group and our SSG businesses..

Okay, great.

Along those lines with the municipal orders up 37%, yeah, I guess, in SSG, where do you think orders picking up sequentially? Are you seeing it in North America? Or is it in Europe? Or where they’re becoming better?.

Right, Wal, they’re actually seen in both places. We’ve seen in our VAMA business as well as in the US..

Okay, great. Okay thanks very much, guys. I will get back in queue..

Thanks, Wal..

Thank you..

[Operator Instructions] And we have a follow-up from Walter Liptak with Global Hunter..

Okay, guys, I guess, I’m back..

Yes..

I wanted to ask about your O&G exposure and just the percentages we are looking at especially on SSG and what you’re hearing from the customer around timing for replacement trucks?.

I will give a short at that, Wal, and Jennifer and Dennis may want to elaborate. When we look at our exposures, ESG is probably pretty typical of the company between the ESG and SSG. We’ve got less than 10% of our revenue that we identified as coming from sort of oil and gas.

Some of that is downstream, so it’s not necessarily affected by the oil and gas prices the way the other things are. But what we have seen is that a lot of our ESG products are serving - the fracking operations have reduced in oil and gas fields.

So as that changes, our demand has been affected by more than just the direct effect, because some of the equipment that used to be deployed in the oil fields has been redeployed elsewhere.

So I mean it’s somewhere in that rage 10% or so, which is attractive business for us, but we’ve done a nice job I think of capturing other business as we go and we’re using this as an opportunity to pursue some other markets..

I think in this last quarter, Wal, we’ve had a bigger impact than the 9% or 10%. What’s happened here is lot of our rental customers and a lot of the customers who purchased equipment over the last year to serve the oil and gas had begun to sell off their equipment in the used market.

So we’ve seen some deflation of demand by that, but I think that will - that should work its way through the market here and through this quarter, I think, eventually on to a more normal stream of orders through the factory for that, but there was more of that than we did expect..

We have a concentrated effort right now to redeploy many of our sales people from oil and gas to other markets including utility. I talked about the new product introductions we have and we are encouraged by the results that we’ve seen to-date and we expect that to be a growing market for us..

Okay. It sounds very good. Thanks very much..

Thanks, Wal..

Thank you..

[Operator Instructions].

Okay, it sounds like we have no more questions. So in closing, I would like to reiterate that we’re excited about our progress and the opportunities in front of us and we appreciate the continued support of our stockholders, employees, distributors, dealers and customers and we thank them all. And thank you for joining our call today. Good-bye..

And that concludes today’s conference. We thank you for your participation..