Federal Signal Corporation (FSS) Earnings Call Transcript & Summary

Welcome, ladies and gentlemen. On behalf of UBS, I'd like to introduce the Federal Signal leadership team, who we're very excited to have here at our conference today. Federal Signal has a long corporate history, and today is a leader in manufacturing and designing products that enhance safety and clumsiness of the various environments where we all work and live. The company's brands are well-recognized industry leaders in the sectors where they operate. From the Elgin Street Sweeper brand to the Vactor vacuum trucks along with the company's portfolio of lights and warning signal devices. Federal Signal's products touched our lives in various areas across the municipal, industrial and commercial landscape. So with that, I'd like to turn the presentation over to Jennifer Sherman, CEO; and Ian Hudson, the CFO of Federal Signal, to provide additional depth on the company. I'd also like to remind participants that you may submit questions via our online portal, which we'll turn to after Jennifer and Ian conclude their remarks. So with that, Jennifer and Ian, I'll let you take it away.

Good afternoon, everybody. I will be referring to certain slides that you have access to. I thought I'd start on Slide 6 to give you a brief overview of the company, and then I'll get into more details about each of our groups. To start, if you look at the company, we've done quite a transformation over the last 3 or 4 years. We used to be 4 groups. We now have 2 groups. 20% of our business, if you look at Slide 6, on the right-hand side, is our Safety and Security group. And that group provides audible and visual safety and security notification devices and systems. What are those? Lights and sirens, signaling devices and warning systems. And you should think there's different end market applications for this technology. So the commonality in that group is the technology. The one that people most recognize would be light bars for police. We have operations in the states and operations in Europe. We have a leading market position. And in addition to that, we take the same technology, the audible and visual warning devices and apply it to other end market applications, specifically outdoor warning. It's an important end market. We've been in the outdoor warning systems business for over 50 years. We have an initiative now to use that platform as a recurring revenue stream going forward to provide municipalities with additional capabilities or industrial facilities regarding notification. It could be anything from weather situations to the ability to be able to address a large gathering of people and provide warning and information. In addition to that, we use this technology for a variety of different end market applications in industrial and other settings. So for example, the equipment might be on a machine, to tell you the machine is in use or there's a problem with the machine. It might be used as a notification system in a facility. It might be used as a -- situation in a neighborhood to notify a group of residents about wildfires. And what we found is that the barriers of entry for this particular line of products are the certifications that are required by those end market applications. We have products that are in medical, food processing. And as a company, we have over 5,000 certifications that are required for different types of uses of these products. That's 20% of our business. That business supplies certain lighting to the other half of our business, which is 80% of our business. And this is a really kind of simple mission statement. We want to be the leading provider of specialty vehicles for maintenance infrastructure hauling. Cleaning is an important part of it as you'll see as we walk through the different product lines. The commonalities, as you look at screens, both for organic growth and for M&A, our first is it a work truck; and second, we're not interested in competing with the larger players like CAT and Deere. So we're interested in this niche specialty vehicle opportunity. And examples of that equipment includes street sweeping, sewer cleaning, safe digging, which will spend some time on, industrial cleaning, dump truck bodies and trailers and our recent acquisition, road-marking and line-removal. I'll refer to Page 7, this is a good pictorial of our strategy going forward. The bottom half of that page really captures the aftermarket distribution, the investments we have made. Kind of pre-2016, we really focused on sale of new equipment. The first thing we did as we started executing on this strategy was understanding the importance of both parts, service, rental and used equipment, which will -- and in some situations, distribution. And that now comprises about 23% of ESG's revenue and is a growing important part of the business. It also creates a platform, which allows us for both organic growth and for M&A to plug-and-play and leverage that platform. So a good example of that is our acquisition of MRL. That's our road striping business that we bought that's located in Billings, Montana. They have a very significant number of proprietary parts to the complicated pieces of machinery, that are anywhere from $100,000 to $700,000 and all parts prior to our ownership were shipped out of Billings, they would put people on airplanes. We're now in the process and part of the integration of having certified mechanics at each of our solution centers where there is a large install base and also starting to distribute our parts outside of Billings, Montana. So there's really good synergies in these particular opportunities. Street sweeping, I'll kind of walk through this chart. We're the #1 manufacturer of street sweepers. We're the #1 manufacturer of sewer cleaners, it's our largest single product line, a very important growth area for us. Safe digging, another important growth area. We are the largest manufacturer. Safe digging, we'll talk about a little bit more in detail. But really, it's nondestructive digging with air and water. So it replaces backhauls and shovels. You would use it where you have a discrete need to -- a utility company might use it to fix something or you might use it to create some type of trench for pipeline installation. Industrial cleaning operates on a number of different brands. The material hauling is our dump truck and open trailer business and then road marking. And then our JJE business is the primary component of or aftermarket that supports those applications. I'll refer to Page 8. Just to give you an idea of the market size and the different end market applications, as I discussed earlier, for our Safety and Security Systems Group. Moving on, I'm going to -- in terms of pandemic, probably, I'll talk at a higher level. It's important to understand, and Ian is going to walk through some of the details on Page 12 about our strong balance sheet and financial flexibility. But we are in -- this is a tragic, difficult situation. But as a company, we're in a very good position. Moving forward, we believe we have an initiative called Reclaiming Tomorrow, Together that is highlighted on Page 10 of the materials. It has 4 different parts to it. The first is improving our digital customer experience, and we've expedited a lot of that. The second part is really how do we add features and functionality to our equipment to help our customers operate safer in this pandemic world. A good example of that would be the opportunity to have some type of sterilization or some type of cleaning process of the cab, cleaning process of our -- the trucks we manufacture, cleaning process for the tool. Third is our opportunity to gain market share. A very focused effort. A number of our competitors our smaller, sub-$50 million businesses. Many of them are struggling. We have concentrated efforts to gain market share. We also are, in some of our businesses, being able to -- there's requirement for recipients of PPP loans that -- thereby American were feasible. We're targeting specific customers that we know. We see those loans that might have bought from non-American manufacturers. And then finally, we're creating a new use case, which is really important for some of our equipment going forward. That you'll be able to use our equipment to sanitize outdoor spaces. We have a number of demos going on right now. So basically, you're going to be able to use a sewer cleaner with a $5,000 modification, compound waters through it and very efficiently sanitize outdoor spaces. With that, I'll turn it over to Ian, and he's going to walk through Page 12, and why we believe this company -- our company is well positioned with respect to our balance sheet and financial flexibility.

Sure. Thanks, Jennifer. So just yes, on Page 12 here. We just wanted to kind of highlight the strength of the financial position, and these are as of the end of the first quarter. So as of the end of Q1, we had approximately $70 million of cash. About $210 million available under our credit facility. And that credit facility, we executed a 5-year revolving credit facility of $500 million in July of 2019. So we don't have any debt maturities until July of 2024. The credit facility, we can increase further by another $250 million for acquisitions. When you think of our debt leverage, we're around about 1x levered right now. Essentially, that's unchanged from where we were at the end of 2019. So we're in a fairly strong position with respect to the leverage. As it relates to cash flow, we typically generate good cash flow from our businesses, and our backlogs typically give us some fairly good visibility into the cash that we're expecting to generate over the next few months. Our cash flow in the first quarter -- operating cash flow was up $14 million year-over-year. Cash flow to date -- sorry, through April, at least, was -- remained strong. If we -- at the time we did our earnings call at the end of April, our net debt position was actually at a lower point than it was at the end of 2019. So we are pretty pleased with the cash we've been able to generate. We did take a number of actions, as you can probably imagine, in order to kind of preserve some working capital in the short term, things like extending some payment terms and other things about inventory and working with customers on receivables. So those are some actions that we took just to preserve that flexibility in the short term. As it relates to funding cash returns to stockholders, that again is an important part of our capital allocation strategy, which is enlisted in prior to order would be to continue to fund organic growth. Second priority would be acquisitions, which will continue to be an important part of our growth story. And then third would be dividends. We paid a dividend of $4.8 million in Q1. And we recently -- we declared an $0.08 dividend for the second quarter as well. Also during the first quarter, we obtained authorization to repurchase another $75 million of shares. We spent $13.5 million buying back almost half of -- 500,000 shares during the first quarter, but we have at least temporarily suspended any additional repurchases under that program, given the effects of the pandemic. So in a nutshell, really, fell in a strong position to weather the financial issues in the short term, but also then as we think about how do we grow and come out of this, we think we're in a pretty strong position to fund opportunistic M&A as well as to continue to fund those organic growth initiatives as well as cash returns to stockholders.

Yes. Let me add a little bit color commentary to what Ian just said. We're typically the #1 or 2 player in the markets that we operate in. We've done 4 acquisitions since 2016. Organic growth will continue to play an important part of our growth story, but so will acquisition. And we believe that is pandemic, unfortunately for others, unfortunately for us, has created some attractive opportunities to acquire assets and businesses at very, very reasonable valuation, and we're working on those. I talked about it in detail on the earnings call. In addition to that, we believe there is opportunities to acquire perhaps some of the buildings that we lease for attractive valuations. So we've got a very specific plan in terms of how do we, as a company, become stronger than we already are, and our balance sheet and our ability to execute on this is going to be an important part of that. So I talked a lot. I bought stock a couple of weeks ago. I think that this is an important -- this will be a -- we talked about a challenging quarter, but we want to reiterate our discipline through our 80/20 or ETI principles, and we talk about this later in the material. To the EBITDA margin targets that we have set of 15% to 18% for each of our groups, and 12% to 16% for the company. We also have -- a portion of our short-term incentive bonus plan is tied to achievement of those targets. And I firmly believe that it is the disciplined application of our 80/20 principles that will -- and our EBITDA margin performance that will distinguish us from our peers in 2020. We have a number of strategic initiatives that are highlighted in material. I wanted to spend a minute though on Page 14 on our safe digging. I made reference to it earlier. Safe digging essentially is the use of air-water today. It's an alternative, as I talked about, to backhoes and shovels. We have seen -- we are investing a lot in this, and we did 1 acquisition and a lot on the organic side to have the -- in terms of 5 different safe digging types of machines for different applications. We have another in the works. And I previously talked about it. We have a 30-year track record of manufacturing these types of equipment. We're in very early innings. And what's changed? In Ontario, this technology has been accepted and mandated in certain applications for over 10 years. That is our largest -- for our largest installed bases. And what's changed in the last 3 years in the states is we've seen 19 states, and OSHA include vacuum excavation as part of its safe excavation practice as the best practice. This is often a precursor to regulation. It's both safer and more productive in certain applications. We believe that we're very well positioned moving forward, and it's going to be an important growth engine. The pandemic has created an obstacle, merely because of our inability to do demos, and be given the travel restrictions that are in place. And as those restrictions are lifted, we're starting to see the demand for demos continue to increase, and this, long run, will be an important part of the story. The other dynamic for us, which is favorable, is unfortunately, for others, due to the pandemic, a number of companies that were our competitors were very oil and gas focused. And between the oil and gas, downturn and the pandemic, they're really struggling. So we believe that also creates opportunity for us. It probably makes sense just to spend a minute. Ian, can you touch on some of it on Page 17?

Yes. So 17 just gives you some information on the historical financial performance, and what you'll really see from 2016 is the growth that we've experienced through both the combination of M&A as well as the organic growth initiatives. And really, that's been a very measured step of how we not only diversify our revenue streams, but also our end market exposures. Prior to 2016, our aftermarket business, which is really comprised of part sales, rental income and service was really a fairly immaterial part of our business. But since the acquisition of Joe Johnson in 2016, we've experienced double-digit growth every year. And aftermarket revenues has now -- represents about 24% of our overall ESG revenues. So that's been a very important strategic initiative because it's enabled us to gain access to customers that we've never had before. And now we can offer people, customers rentals, we can offer them used equipment sales where they can buy a 2- or 3-year-old piece of equipment that might meet their budget. And we also still sell new equipment, of course. What it also did is it doubled the footprint across North America. So now we have about 22 locations that are strategically positioned across North America. And from those locations, we can sell parts, we can service the equipment and we can provide rentals. And that's the platform that Jennifer talked about. For future acquisitions, we can plug them into that aftermarket platform. On the organic growth side, with the growth that we've seen on safe digging, that was really the new product introductions that we made towards the end of 2017, a custom-designed hydro excavator vehicle that was specifically focused on the utility market. We've seen some really good traction with that. And that has also allowed us to diversify our end market exposures and get away from a reliance that we had in 2015 and '16, we had a fairly large exposure to oil and gas. And you'll see the effects of that in the dip that we had in 2015 and '16. That was really primarily -- like primarily related to the drop in oil and gas. And since that time through the acquisitions, we've acquired -- the Truck Bodies acquisition was $210 million of revenue on a trailing 12 basis. That had 0 oil and gas exposure. It added new end markets like construction, landscaping, waste, rendering, so different industrial end markets. And then the MRL acquisition that Jennifer mentioned was focused on road marking and line removal. And that business, really with the growth that we've seen and the evolution of smart technology in our vehicles, that is very reliant upon the markings and the effective striping on the road. So adding a different end market so that we're not exposed to any 1 single market. Jennifer talked about the EBITDA margin ranges that we have, both 15% to 18% for each of our groups. Consolidated, that would be 12% to 16%. Those are -- those ranges are really long-term through the cycle of ranges that we want to function within those ranges. Now I'll be the first to admit that when we talked about through the cycle, we weren't necessarily considering a global pandemic, but we are -- our goal is to continue to operate with those -- within those ranges. And many of the decisions that we took recently as it relates to the second quarter and some of the cost reduction initiatives were really taken through that lens of operating within those ranges. As you'll see, on a trailing 12 basis, we were slightly ahead of the high end of that range at 16.2% on a trailing 12 basis. What we've indicated is that we would be willing to adjust those ranges if we see kind of a material change or a step change in the nature of the business, and we changed the SSG targets. I think it was the second quarter of last year. We increased the high end of that range from 17% to 18%. Just to the right of this page, it just gives a quick snapshot of some of the highlights from the first quarter. We had a very strong first quarter. And if you think about the fact that we started feeling some of the impacts of the pandemic towards the end of March, it would have been even stronger but for those effects. But I think the main takeaway here is the last bullet that we have here that we -- at the end of the quarter, we had a record backlog, just over -- a tick over $400 million. And that backlog, while we don't typically see many cancellations, certainly from municipal customers, we may see a couple on the industrial side. And that backlog did reflect any cancellations that we had seen through the end of April. So that should give you an indication that the cancellations that we had were not overly material with the fact that our backlog was at that record level.

So with that, I think we'll open the lines up for questions.

Yes. Perfect. [Operator Instructions] The first question that we have is, it's around the return of demand to certain pieces of your business. They'd like to know how are you seeing the certain parts of your business rebound as states have begun opening up for business again.

So on the earnings call, which took place at the end of April, we talked about that April orders were low. And 50% of our manufacturing employees are located in Illinois, and Illinois had one of the more stricter stay-at-home orders that went longer. What I'm looking for is sequential improvement. And that's what we believe will be an important indicator of recovery. What we're starting to see is -- so Illinois, we -- versus some of our southern facilities and other facilities, we're about 6 weeks behind other governor schedules. We're starting to see requests for demos, which is very important. We're starting to see requests for quotes. We're starting to see, particularly on the rental and all of those are green shoots in terms of moving in the right direction. One area that we talked about in the call, is our first responder business. It has been solid, good and continues to be stable inside the states and outside the states. So we are taking it like most companies, 1 day at a time. But I think what's really going to benefit us is the features and functionalities that we're adding to our products, we think are going to be desired in terms of either the sanitation or the ability to outdoor sanitize. In addition to that, our longevity. What we're hearing is that more and more customers are coming -- we're talking to customers that might have gone to smaller players that are now concerned about, okay, Federal Signal is going to be around services, expensive piece of equipment that I am purchasing. This is a long-term investment for customers, and we want to make sure the same. We also believe that our parts business and the work that we've done in the aftermarket is going to be important. Not in April, not in May, but longer term, as people look to alternatives. So the diversification of the revenue stream will benefit us. We're also working very hard to reduce our lead times. Our Vactor plant expansion was delayed a quarter. We had to shut it down in March because we didn't want on-site visitors. We've reopened, reinitiated that plant expansion. It will be done now by the end of the third quarter. That's going to be very important in terms of our ability to, both to support organic growth initiatives and some of these acquisition opportunities that I talked about. I've -- we're also looking at how do we produce products that -- may be refresh products that we can put on the front. What we mean by that is we want to have a certain level of stock available. Because what we've seen happen in the past is that, was some of the smaller competitors have had opportunities because things will come back and the lead times will be -- our lead times will be too long. So we're working very hard to make sure we're in a position that we capture all of the business opportunities we may have going forward, a long answer. I know.

Okay. And one other question that we have is just around chassis availability. This investor wanted to know if you've been seeing any recent improvements over the course of the past few weeks with regard to chassis availability as OEM manufacturing has started to come back online.

Yes. So as we talked about in the call, that chassis availability really impacts our dump truck business because you're not going to buy -- we don't own the chassis in that business. You're not going to buy dump tracks. Can't get a chassis. So that's where we've seen the impact. I would say, again, we're kind of seeing greens sprouts of life. It's getting slowly better. I'd also point out, that's a business too where we have a number of smaller competitors that we think there's opportunity to gain share through the -- the chassis availability doesn't impact our Vactor and Elgin businesses really because the types of GSEs they use and the longer lead times that we have and in 50% situations, we procure the chassis. So we're able to manage our production schedule accordingly. So it really impacts us more on the dump truck side, and I guess we're starting to see some improvement. We just wish it were a little bit quicker.

Okay. Thank you. That's all the questions that are in the queue. So with that, I wanted to thank the Federal Signal management team for their participation in the conference. And we appreciate your time. Thank you, everyone.

Okay. Bye-bye.

Thank you.