Federal Signal Corporation (FSS) Earnings Call Transcript & Summary

Greetings, and welcome to the Federal Signal Corporation's Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Felix Boeschen, Vice President, Corporate Strategy and Investor Relations. Thank you, Felix. You may begin.

Good morning, and welcome to Federal Signal's Second Quarter 2024 Conference Call. I'm Felix Boeschen, the company's Vice President of Corporate Strategy and Investor Relations. Also with me on the call today is Jennifer Sherman, our President and Chief Executive Officer; and Ian Hudson, our Chief Financial Officer. We will refer to some presentation slides today as well as to the earnings 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 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 U.S. GAAP 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. Ian will start today by providing details on our second quarter financial results. Jennifer will then provide her perspective on our performance and update on our multiyear growth outlook and our updated guidance for 2024. After our prepared comments, we will open the line for any questions. With that, I would now like to turn the call over to Ian.

Thank you, Felix. Our consolidated second quarter financial results are provided in today's earnings release. In summary, we delivered strong financial results for the quarter with double-digit year-over-year organic net sales and earnings growth, gross margin expansion and a 280 basis point improvement in EBITDA margin. Consolidated net sales for the quarter were $490 million, a record high for the company, and an increase of $48 million or 11% compared to last year. All of the growth this quarter was organic. Consolidated operating income for the quarter was $81.1 million, up $21.7 million or 37% compared to last year. Consolidated adjusted EBITDA for the quarter was $97.7 million, up $22.2 million or 29% compared to last year. That translates to a margin of 19.9% in Q2 this year, up from 16.1% (sic) [ 17.1% ] in Q2 last year. GAAP EPS for the quarter was $0.99 per share, up $0.33 per share or 50% from last year. On an adjusted basis, EPS for the quarter was $0.95 per share, up $0.28 per share or 42% from last year. Order intake for the quarter is again strong with second quarter orders of $473 million, contributing to a backlog of $1.08 billion at the end of the quarter, an increase of $73 million or 7% compared to Q2 last year. In terms of our group results, ESG's net sales for the quarter were $409 million, up $36 million or 10% compared to last year. ESG's operating income for the quarter was $72.9 million, up $16.7 million or 30% compared to last year. ESG's adjusted EBITDA for the quarter was $88.2 million, up $17.5 million or 25% compared to last year. That translates to an adjusted EBITDA margin for the quarter of 21.6%, an improvement of 260 basis points compared to last year and performing towards the upper end of our current target range. ESG reported total orders of $396 million in Q2 this year compared to $409 million last year. SSG's net sales for the quarter were $82 million this year, up $12 million or 18%. SSG's operating income for the quarter was $18.3 million, up $4.2 million or 30% compared to last year. SSG's adjusted EBITDA for the quarter was $19.3 million, up $4.1 million or 27%. That translates to a margin of 23.7%, above SSG's current target range and up 180 basis points compared to last year. SSG's orders for the quarter were $77 million, an increase of $5 million or 7% compared to last year. Corporate operating expenses for the quarter were $10.1 million down from $10.9 million last year. Turning now to the consolidated income statement, where the increase in sales contributed to a $26.7 million improvement in gross profit. Consolidated gross margin for the quarter was 29.4%, a 290 basis point increase over last year. As a percentage of sales, our selling, engineering, general and administrative expenses for the quarter were down 20 basis points from Q2 last year. Other items affecting the quarterly results include a $200,000 increase in acquisition-related expenses, a $100,000 reduction in amortization spend, a $700,000 decrease in other expense and a $2.4 million reduction in interest expense. Tax expense for the quarter was $16.7 million, up $4.3 million from the prior year. Effective tax rate in Q2 this year was 21.5% compared to 23.5% last year, with the reduction primarily due to a $2.6 million discrete tax benefit recognized in connection with the amendment of certain state tax returns to claim a worthless stock deduction. At this time, we expect our effective tax rate for the remaining half of the year to be between 25% and 26%, excluding any additional discrete tax benefits. On an overall GAAP basis, we therefore earned $0.99 per share in Q2 this year compared with $0.60 per share -- $0.66 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 expenses and the discrete tax benefits I previously mentioned. On this basis, our adjusted earnings for the quarter were $0.95 per share compared with $0.67 per share last year. Looking now at cash flow. We generated $41 million of cash from operations during the quarter, an increase of $5 million from Q2 last year. That brings the total cash generated from operations in the first half of this year to $72 million, an increase of 67% over the first half of last year. We ended the quarter with $207 million of net debt and availability under our credit facility of $533 million. Our current net debt leverage ratio remains low. 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 opportunities to take share repurchases. On that note, we paid dividends of $7.4 million during the quarter, reflecting a dividend of $0.12 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. Our second quarter results represent another outstanding quarter as our team set quarterly performance records across many metrics in the net sales, EBITDA margins and adjusted EPS, all while maintaining a healthy order intake. Within our Environmental Solutions Group, we were able to deliver 10% year-over-year net sales growth and a 25% increase in adjusted EBITDA, with increased production at several of our businesses and continued price realization representing meaningful year-over-year drivers. Overall, in what is typically a seasonally strong quarter, ESG's adjusted EBITDA margin was up 260 basis points year-over-year. We were particularly encouraged with the progress we have made across the enterprise on our build more trucks initiative this quarter. Our dump truck body businesses had another strong quarter, with sales up 22% on the back of improving chassis availability and higher build rates. The increased dump truck body production, coupled with our ongoing 80/20 initiatives at several key facilities, was again a contributing factor in our year-over-year margin improvement within our ESG segment. In fact, monthly chassis receipts at our Ox Bodies facility grew sequentially throughout the quarter, with June chassis deliveries the highest experienced since the first quarter of 2021. We remain focused on maintaining our industry-leading lead times in this space as we raise our production levels. Our strategic dump truck growth initiatives are also gaining momentum. Ox Bodies is broadening its geographic reach in key states such as Texas. The Rugby team is progressing along its 80/20 journey in the form of product and SKU simplification. And Switch-N-Go is on track to start production of its new Class 3 interchangeable multibody product in August. The Switch-N-Go Class 3 product launch provides customers additional flexibility in what remains a constrained medium-duty chassis environment. At our largest manufacturing facility in Streator, production increased by 15% year-over-year, including the $13 million of sewer cleaner shipments that were affected by the third-party component supply issue that we experienced in March. MRL, our road marking and line removal business, is also benefiting from improving supply chain conditions and a constructive demand backdrop as the team was able to drive a 29% year-over-year increase in sales. In addition to anticipated multiyear benefits stemming from the infrastructure bill, we are also seeing ongoing shift towards early autonomous vehicle functionality and the addition of smart features for passing cars as a key long-term driver of road striping demand. Big picture, while supply chain performance has not yet fully recovered to prepandemic levels, supply chains are consistently improving for our family of specialty vehicle businesses. This improvement in supply chain should, over time, allow us to drive additional output and gain manufacturing efficiencies as we aim to reduce lead times for certain products, including vacuum trucks and street sweepers. From a capacity perspective, our access to labor remains good and our large-scale capacity expansions that we completed between 2019 and 2022 position us well to profitably absorb incremental volumes into the current facility footprint. Shifting to aftermarkets, activity levels remained strong across our offerings. Performance was led by increase in part sales, service rental and rental income, partially offset by lower used equipment sales, as our teams are working diligently to balance rental unit availability and used equipment sales to best serve our customers. In short, rental utilization and demand for our rent-to-own equipment offerings remains high. From a strategic perspective, our growing aftermarket ecosystem allows us to better serve our customer needs throughout the entire business cycle. Especially in the higher interest rate environment that we are experiencing today, the option to rent new or acquire used pieces of equipment represents an important alternative for many of our industrial customers to access equipment in a timely and affordable manner. As we continue to scale our aftermarket business, we see additional long-term growth opportunities. As acquired businesses are integrated into the platform, we further increased our parts capture rate, optimize underserved regions and address nontraditional Federal Signal customer cohorts through our rent-to-own service offerings. In total, aftermarket represent approximately 25% of ESG revenue in the second quarter of 2024. Shifting to our Safety and Security Systems Group. The team delivered another quarter of outstanding results with 18% top line growth, a 27% increase in adjusted EBITDA and a 180 basis point improvement in adjusted EBITDA margin on the back of sales volume increases and price realization. Sales of public safety equipment paved the way with 25% year-over-year growth as our lightbars and sirens products are resonating in the marketplace. This strong underlying demand for our products, coupled with the insourcing investments we've made in recent years and our ongoing 80/20 efforts, have contributed to achieving a mid-teens year-over-year improvement in volumes. Going forward, our teams remain energized to continue to execute on a robust NPD pipeline across all of our SSG businesses as we aim to fortify and grow our position as the industry leader of audible and visual safety equipment. We have also been pleased with our cash generation through the first half of the year as cash generated from operations rose 67% compared to last year. On an annual basis, we continue to target 100% cash conversion levels. Another highlight of the quarter included the publication of our latest sustainability report. 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 operate sustainably with a long-term positive impact to 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. The report also highlights the progress we have made against our sustainability goals that were initially established in 2018. And having achieved our electricity, water and CO2 intensity reduction goals early, we have announced our new 2030 energy intensity reduction goals. Shifting now to current market conditions. Demand for our product offerings and services remains high, with our second quarter order intake of $473 million just falling short of last year's record second quarter orders of $480 million. For comparison purposes, please note that last year's orders included approximately $8 million of acquired backlog from the Trackless acquisition. In recent years, we have supplied a higher concentration of chassis than our customers. But as chassis availability has improved, customer buying patterns have started to revert to the more typical 50-50 split that we have historically experienced. This shift resulted in 9 million fewer chassis orders in Q2 this year compared to last year. This trend is also expected to represent a year-over-year net sales headwind of approximately $10 million in the second half of the year, but should have some nominal margin benefits. The composition of orders remains balanced between our publicly funded and industrial end markets, as contribution from both subsets were similar on a year-over-year basis. On the publicly funded side, demand for our flagship sewer cleaners has remained consistently high throughout 2024 on the back of solid core funding mechanisms. Our SSG business is experiencing a similarly stable growth pattern as orders increased 7% in the quarter. This includes a $6 million public safety equipment order from a major municipality slated for delivery in 2025. Lastly, resulting from our ongoing end customer and market diversification efforts, our dump truck body business enjoyed double-digit order growth with municipal customers in the second quarter. On the industrial side, orders for dump truck bodies continue to lead the charge with orders up 32% year-over-year. Similar to last quarter, we believe this to be driven by a combination of pent-up replacement demand, execution on our strategic initiatives across different end markets and high current equipment utilization levels. We are also seeing strong demand for our metal extraction support equipment as we are starting to reap distribution benefits from the combined Ground Force and TowHaul platform. Lastly, our teams remain laser-focused on positioning our businesses to be able to capitalize on projects resulting from the $550 billion Bipartisan Infrastructure Bill (sic) [ Bipartisan Infrastructure Deal]. Although we believe the opportunity still remains in its early stages today, we anticipate many of our special vehicle offerings to participate in an array of projects and, importantly, at different stage of projects. As an illustrative example, while we expect use of dump trucks to be fairly consistent throughout the life of a project, we expect road marking or street sweeping demand to be weighted more heavily towards the end of a project when a new road that's marked for projects are cleaned. In fact, we have seen some examples of dump truck orders tied to early infrastructure projects, including a multi-unit order for a highway construction project in the Southwest that we booked this quarter. We are also encouraged with early feedback we've received on our Guzzler microtrenching vacuum truck, which is ideally suited for the installation of broadband infrastructure. Our teams will be showcasing our Guzzler microtrencher at the upcoming Fiber Broadband Association show. In summary, demand for our products remain strong and our teams are focused on executing our growth initiatives and building more trucks, while continuing to maintain a healthy order intake. I now want to take a few minutes to provide an update on our through-the-cycle revenue targets and growth initiatives. While we have historically talked about a high single-digit annual revenue growth target, we are officially raising the bar to a low double-digit annual growth target, which is roughly consistent with our actual track record since 2016. Achieving that growth will be multifaceted as we expect low to single -- low to mid-single-digit base level and market growth to be supplemented by outsized growth from our organic initiatives and contribution from M&A. In fact, we see opportunities for several businesses to expand their geographic reach as we start to harness the increasing benefits of the power of our growing specialty vehicle platform with our aftermarket operations at the heart of that value proposition. An excellent example of that platform power is the 30% year-over-year growth we achieved at Trackless in the first year of Federal Signal ownership. We also see these platform benefits fueling other strategic growth initiatives, including new product development, aftermarket support, sales channel and procurement optimization. Shifting to inorganic growth. Our M&A pipeline remains active with several opportunities currently under evaluation. In line with our M&A strategy set forth in 2016, we are primarily focused on 3 types of acquisition opportunities. First, identifying new market adjacencies to penetrate within our ESG and SSG segment. Second, opportunistically adding to verticals in which we already operate. And finally, acquisitions to further accelerate our aftermarket growth. We remain rigorous, and vigorous, in our due diligence processes as we aim to identify the right strategic additions for Federal Signal. But we believe our track record, integration process, modest debt profile and strong free cash flow generation all position us as an acquirer of choice in our markets. Lastly, as we indicated, we were pleased with our margin performance in the quarter with performance towards the upper end of our current target range. Recall, our stated margin targets are meant to be annual and through-the-cycle targets. When we last raised our targets on our third quarter 2023 earnings call, we outlined 4 foundations supporting the raise, including, leveraging our capacity expansions, the rollout of our codified Federal Signal operating system, continued growth in our aftermarket business and value-added M&A. At Elgin, our pilot plant for the rollout of our recently codified Federal Single operating system, we saw some initial productivity and cost optimization benefits associated with this initiative in Q2. We are pleased with the progress we've made on a number of these foundations through the year at many of our businesses. But we are not done here. We see ourselves as being in the early innings in what we view as a multiyear opportunity to drive structural improvement. Turning now to our outlook for the rest of the year. Demand for our products and our aftermarket offerings remains high, with our strong order intake this quarter contributing to a backlog which provides us with excellent visibility into the second half of the year. With our second quarter performance, our current backlog and continued execution against our strategic initiatives, we are raising our full year adjusted EPS outlook to a new range of $3.20 to $3.35 from the prior range of $2.95 to $3.15. We also reaffirming our full year net sales outlook of between $1.85 billion and $1.9 billion. This outlook, which does not assume any M&A, reflects our view of continued healthy demand for our new equipment, parts and aftermarket services, and also assumes a continuation of daily build rate increases at several key facilities, somewhat offset by fewer production days in the second half of the year. We also continue to expect double-digit improvement in pretax earnings and EBITDA margin performance in the upper half of our target range. Lastly, we are maintaining our CapEx outlook of $35 million to $40 million for the year. At this time, I think we are ready for questions. Operator?

[Operator Instructions] Our first question comes from the line of Steve Barger with KeyBanc Capital Markets.

Really strong quarter. I wanted to start with the ESG incremental...

We agree.

Yes. I want to start with the ESG incremental margin of 46%, following 40% in the first quarter. Can you talk through volume, mix and price? And just what do you expect for incrementals in the back half?

Yes. So Steve, I think as we look kind of the breakdown on the top line, volume, that was 8% of the 10% growth. Price was about 2.5%. We had a little bit of a headwind from fewer chassis, I think Jennifer talked about that impact, so that was about a 1% drag on the top line there. So as we think about kind of the drivers of the margin improvement, volume was the biggest driver of that and just the efficiencies that we get from ramping up production in several of our facilities. We did have favorable price cost dynamics in the quarter. So that was also a factor. And then the other thing is we have the aftermarket business, as well as some of our recent acquisitions, which have a slightly more attractive margin profile. As those businesses have grown, that's pulled up kind of the overall average, and so that's had some margin benefits as well. As we think about kind of the back half of the year, I think the guidance that we've given would indicate that we're still expecting incrementals for ESG to be kind of north of 30%. So that's kind of what's implied in the outlook.

Yes. For sure. If I model to the high end of the new guidance, the quarters in the back half will certainly have good margins, but will run [ maybe ] $0.07 to $0.08 lower than what you just put up. Is mix getting worse? Is it holidays? Can you talk about why $0.95 isn't a sustainable run rate given the backlog and the capacity you have?

Yes. A couple of things that I think Jennifer alluded to, the fewer production days that we have in the second half of the year versus the first half of the year. That's kind of always something that we face in the second half of the year. There's a couple of others. We talked about the chassis impact, the $10 million that will impact the top line. That won't be much of an earnings impact because it's typically passed through. So that should have a little bit of a lag benefit there. And then just the other thing to remember, as we talked on our last earnings call about some incremental rental fleet investment that we were making, most of that is in the second half of the year. So that will also be a factor.

And sorry if I missed this, what's the difference in production days between the first half and the back half?

I think we're in kind of the 6 to 7 range.

And did you say what the incremental investment in rental is?

So this was on our first quarter call, we talked about a $20 million incremental fleet investment. So that will have some impact, with most of that being in the second half of the year. That's nothing new. That's the same as what we talked about in Q1.

Our next question comes from the line of Walt Liptak with Seaport Research.

Great quarter. I wanted to ask about the dump truck orders were very strong. It's nice to see that recovery happening. I think that's the second or third quarter in a row. I wonder if you could talk a little bit about the cadence of orders. And I think you kind of alluded to some of this in your -- Jennifer, in your presented comments. Are those -- I mean, at what point do you start getting into tough comps? Do you see sort of this pent-up demand giving way to sort of a normalized growth rate? How should we think about the second half for dump truck ordering?

Yes, neat. First of all, we were pleased with orders overall. And as we noted on the call, dump truck orders were strong. I think that was -- it is a combination of execution on strategic initiatives, particularly some of the geographic expansion issues initiatives. Initiatives that the teams have done a really nice job. There's pent-up demand. Chassis improvement. We talked about during this quarter, Ox Bodies, we saw kind of the highest number of cases available that we've seen for several years. And then finally, there's pent-up demand. And then we're starting -- we have some examples that we cited one on the call of benefits from infrastructure. And their lead times are much shorter than, for example, right now, sewer cleaners and certain street sweepers. So we're able to, for many of those orders, slip those orders when the order comes in and we're able to deliver it within the quarter. The other thing that was encouraging on the dump truck order side is it was pretty balanced between municipal and industrial.

Okay. Great. So it sounds like the order activity was good and kind of consistent during the quarter, and your you're feeling good going into the third quarter for order activity?

Yes, the order activity was consistent throughout the quarter. And really, accolades to the team for just strong performance and continued execution on the strategic initiatives.

Okay. And going back to the production question. And what are the pluses and minuses around you guys increasing the production in the second half? Because you got the backlog, that's there. It sounds like the orders are coming in strong. Is it supply chain that's the biggest risk? Is it factory productivity? And what could help you build more trucks in the second half?

So I'll start with, again, we were really encouraged by what we saw in Q2. So I'll start there. The teams did a really nice job in terms of building more trucks in many of our facilities. It can always vary business to business. But some of the critical considerations are we need to ramp and train labor. We generally have pretty good access to labor, we would hire and train them. Supply chain, always remains a factor. We've talked about chassis availability is pretty good. The medium-duty chassis market continues to be tight. It represents a pretty small percentage of our overall business. We -- the fewer production days in the second half of the year. But again, I want to emphasize, we would expect kind of gradual continued improvement as we work our way through the year because this is -- the teams are razor-focused on reducing lead times at several of our facilities and increasing production rates.

Okay. Great. And sticking with ESG, you made a comment that I hadn't heard before about autonomous vehicles and the MRL road striping. Is there something that's changed in that market? Or are there like regulations or something or some funding for that? Or is it just the product development that you're working on?

Yes. I think as more and more people have smart features on their cars that notify you, for example, when you're changing lanes and alert you, you need road striping, solid road striping to utilize those features. And our teams are talking to customers and talking to agencies, having the ability to utilize those features that are in many of the automobiles we drive, continues to be an important part of the driver for our products.

Our next question comes from the line of Chris Moore with CJS Securities.

Another terrific quarter. No surprises.

Thanks, Chris.

Right. So you've discussed rental. In many cases, the rent-to-own strategy really been helpful in this high rate environment, a differentiator. If rates come down a little this year, more in '25, is that going to have a meaningful impact on the aftermarket mix?

We believe, with the infrastructure bill, there's going to continue to be demand for rental products. This is particularly important to our industrial customers, particularly around safe digging. And as product adoption of that particular product line increases, rental is often a format to try before you buy. So I think, again, part of our strategy that we've talked a lot about is we're very flexible in terms of whether you want to buy new equipment, you want to rent equipment, you want to buy a used equipment at different price points, we can respond to all those various needs. The other thing I'd point out is, as you know, 50% of our business is publicly funded, which is really kind of immune to the interest rate environment.

Got it. Very helpful. You guys have done a really good job leveraging acquisitions into new geographies. You talked about Mark Rite and Trackless as an example. Are there any meaningfully underpenetrated geographies for any of your product lines at this point in time?

Yes.

Will you be...

Short question, did that answer it?

That's fair enough. I was hoping you'd get more specific, but I also understand from a competitive standpoint...

Sure. No, I'm more than happy to give some examples. But like this room was cringing. So specifically, let's talk about dump trucks. So we have geographic areas where we're the #1 market provider. And part of the strategic initiatives of several of those dumb truck business is to extend that geographic reach. Number two is Trackless would be a good example. We've not fully optimized our go-to-market strategy. There are several geographies where Trackless doesn't really -- does nominal sales of any. And we're in the process by either leveraging our JJE footprint or pairing with other dealers to expand their geographic reach and it creates opportunities. We believe that Ground Force and TowHaul, and the optimization we've done our distribution, has allowed us to penetrate new geographies and we think we're at early stages there. So geographic expansion for many of our product lines is a critical strategic initiative.

Our next question comes from the line of Ross Sparenblek with William Blair.

This is Sam calling on for Ross. So the ESG segment backlog declined 1% from the first quarter. Can you talk about what this means for top line growth given that the ESG book-to-bill is less than 1 for the quarter? Is there a possibility that once you work through this backlog, that sales could be pressured?