Federal Signal Corporation (FSS) on Q2 2021 Results - Earnings Call Transcript
Operator: Thank you for standing by. This is the conference operator. Welcome to the Federal Signal Corporation Second Quarter Earnings Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Ian Hudson, Chief Financial Officer. Please go ahead.
Ian Hudson: Good morning, and welcome to Federal Signal’s second quarter conference call. I’m Ian Hudson, the company’s Chief Financial Officer. Also with me on the call today is Jennifer Sherman, our President and Chief Executive Officer. We will refer to some presentation slides today as well as to the earnings news release, which we issued this morning. The slides can be followed online by going to our website, federalsignal.com, clicking on the investor call icon and signing into the webcast. We have also posted the slide presentation and the earnings release under the Investor tab on our website.
Jennifer Sherman: Thank you, Ian. I’d like to start my comments with a quick update on a subject that we’ve been talking about for a long time, an infrastructure bill. The reports from late yesterday were encouraging. It finally appears that infrastructure legislation is likely. Some components reported to be part of the deal, which includes a total of $550 billion in new federal investment in U.S. infrastructure include: $110 billion for roads; $73 billion for power infrastructure; $65 billion to expand broadband access; $55 billion for water infrastructure; $46 billion for environmental resiliency; and $11 billion for transportation safety.
Operator: Thank you. We’ll now begin the question-and-answer session. The first question is from Chris Moore from CJS Securities. Please go ahead.
Chris Moore: Hey, good morning guys. Thanks for taking the question.
Ian Hudson: Good morning, Chris.
Chris Moore: Good morning. Yes. So maybe just, obviously, recognizing kind of typical seasonality in Q4, given all the uncertainty on supply chain commodity costs from where you sit today. I know it’s a big statement, but could you review a little bit in terms of kind of the puts and takes of the relative strength that you’re looking at between Q3 and Q4? I know you talked about kind of price increases perhaps hitting in Q4. And maybe could you talk about Q3 versus Q4 a little bit?
Ian Hudson: Yes. I think, Chris, one of the things that we’ve seen obviously, in the second quarter was really the strength of the aftermarket business. And some of that, we believe is tied to just what is happening in the marketplace with respect to lead times and the availability of equipment. So we’ve seen a nice uptick in the aftermarket business, both on the rental side as well as used equipment sales, both in Canada, where we’ve seen a really strong utilization really throughout Q2. But we’ve also seen improvement in the U.S. with the utilization of the fleet. So that trend has continued into July, in the early part of July. So we expect that to continue to be strong into Q3. And as long as the weather stays decent in the northern parts of North America, that could also continue into Q4. We talked about the impact from the unfavorable price cost impact in Q2. We’re expecting something in a similar kind of neighborhood in the third quarter before that starts to turn in Q4. But I think overall, the environment is really – the benefits we’re seeing from the diversification of our revenue streams, I think that certainly helped us in Q2, and we would expect that to continue for the balance of the year.
Jennifer Sherman: Yes. I think in a nutshell, look, we’re sitting on record backlog. And subject to supply chain constraints, our intention is to produce as much of that as possible. I’d note that we had $3 million headwind in Q2. We expect it to be somewhere in that neighborhood in Q3, and we expect that to recover given the price actions that we’ve taken to more favorable place in Q4. But again, our objective is to produce as much of that backlog as we can subject to supply chain challenges.
Chris Moore: Got it. I appreciate. That’s helpful. Maybe just talk a little bit more on gross margin. So obviously, they were – year-over-year, they were down 160 basis points. You talked a little bit about some of the things for higher percentage of low-margin chassis and kind of indicated they could be down a little bit near-term on a relative basis, but kind of the focus is on share at this point in time. Maybe you could just expand a little bit on the gross margins?
Ian Hudson: Yes. I think, Chris, it’s a combination of things. I think when you look at SSG and the comps that that had in Q2 of last year, it had – we referenced a sizable fleet order that we received and shipped in our European business in the second quarter of the last year. That was a large order with very strong margins. And that can sometimes cause some issues with respect to comparisons on a quarter-over-quarter basis within SSG, if there’s a large fleet order. And really, that’s what we saw in SSG. So SSG’s gross margin was down about 210 basis points quarter-over-quarter. We also referenced the fact that last year had the impact of a number of cost saving actions. There were things – temporary salary actions that were taken as well as the impact of some furloughs. And the other thing that is a factor is the medical expense was a lower last year with people not going to the doctor. So that was a headwind, and that did impact gross margin within SSG. As it relates to ESG, the gross margin was down about 60 basis points, and there were a couple of moving pieces there, as we referenced, as the chassis mix issue as well as some subcontractor work that we had for our road marking services business. We actually used some subcontracting services there, and that gets included in both our revenue as well as our costs. So that can have a dilutive impact on our gross margins. There’s also the material cost impact that we referenced, which is partially offset by the improved mix from higher aftermarket business. And then there’s also just general inefficiencies associated with some of the supply chain disruption as our teams have kind of maneuvered a number of ways to juggle production schedules to deal with supply chain issues. So a couple of – a number of different moving pieces, but those are kind of the main points.
Chris Moore: Very helpful. I’ll leave it there. Jump back in line. Thank you, guys.
Ian Hudson: Thank you, Chris.
Jennifer Sherman: Thank you, Chris.
Operator: The next question is from Felix Boeschen of Raymond James. Please go ahead
Jennifer Sherman: Good morning, Felix.
Felix Boeschen: Hey, good morning, everybody. Hey, I just wanted to start off on the price cost commentary, just to make sure I’m crystal clear. But $3 million in net headwinds this quarter, similar to 3Q, and I think you point to improving trends into 4Q. Would you expected to be kind of net neutral at that point? And can you just kind of talk about your price visibility into 2022, maybe some of these costs reversing back out?
Ian Hudson: Yes. I think, Felix, certainly, the $3 million headwind that we saw in Q2, that was mostly within the dump truck business. We think that will be in a similar range in Q3, and then that will start to turn. I don’t know if it will be net positive for that business overall. But I think for overall ESG, we are expecting it to be neutral in Q4. But there are certain pockets where they will – it will turn at different points in time. So I think, overall, it will be neutral in Q4. And as we look further out, as it relates to kind of the pricing power and the pricing dynamics we have. Obviously, for certain businesses that have longer lead times with backlogs, and this is primarily for sewer cleaners and at the moment. That backlog is already is priced. But as again, we’ve talked about the fact that we’ve taken actions to secure pricing on steel for that product line. So we feel pretty good going into 2022 with the pricing and the cost that we know what we’re going to be dealing with. On the dump truck side, we have, as Jennifer mentioned, we’ve taken a series of actions as it relates to price. And we think that as we enter 2022, we will start to realize benefits. And certainly, that will be – we are expecting that to turn positive as we enter 2022.
Jennifer Sherman: And then I differently add something that we’re monitoring it very closely. So we’re going to take the price actions that we need to in order as we move forward.
Felix Boeschen: Got it. That’s very helpful. And then maybe staying on the dump body side, could you just broadly characterize the demand environment for us there? And in that vein, sort of maybe how the OSW integration has tracked? Maybe what surprised you getting to know the team more?
Jennifer Sherman: Sure. Sure. So demand for dump bodies has been strong, and as I noted, exceeded our expectations. It’s one of the reasons that we were in the position during Q2 that we had purchase deal, and we weren’t expecting, frankly, the level of demand that we have. The teams really about 1.5 years ago with the new product development initiatives that we introduced there, we’re seeing a lot of traction on that. And we believe that we’re gaining share. So encouraged by the outlook for that particular business and just really overall outstanding operation teams in some pretty challenging environments. OSW, we’re on track. So that’s always good to be able to say. Great team out there, a lot of opportunity in that part of the country, given kind of the construction and different activities in the northwest part of the United States. We held our 80/20 training sessions. The teams really responded well. And we’re – couldn’t be – we’re very encouraged about the outlook. And the other thing that’s encouraging is we’re starting to see those teams really optimize production in terms of certain equipment that’s going to be supplied by other TBI facilities and then OSW will concentrate on certain types of equipment. So overall, we’re in a good place.
Felix Boeschen: Got it. Super helpful. And then I just have one last one. It’s on safe digging. But I think you point to some pretty big increases in demo activity year-over-year. I was wondering if you could maybe comp that to pre-COVID levels. Are you sort of tracking ahead of what you were doing sort of going into the pandemic as it relates to demo activity on that front?
Jennifer Sherman: Yes. We think we’re pretty good. And I can give you a little bit more detail. Our TRUVAC demos are up 39% year-over-year. Vactor demos are up 122% year-over-year. And Elgin, which you didn’t ask, but I got the data here up 38% year-over-year. So it’s something that we think is particularly important. And what’s exciting too is we’re starting to see even new applications. Some of the training that we’ve done, I talked about the utility companies’ initiative to bury underground lines for 10,000 miles. We did a demonstration of our equipment to that utility. It was well received. In addition to that, take a look at the slides, in terms of some of the environmental benefits that our customers are starting to see and promote; in terms of preserving trees using this equipment, not damaging tree roots. The other thing that’s really encouraging, we talked about the strength of our aftermarkets business, but we’re seeing that strength for – in our rental business for safe digging equipment. So we believe that we’re back to where we were in 2019 close, and we’ll continue to see progress on that front.
Felix Boeschen: Got it. And then maybe because you brought up one last, I’ll squeeze in. But on the rental side, can you remind us of your geographic exposure on the company-owned fleet? I was under the impression it was very Canada North, up north focus? Any color would be sort of appreciated.
Ian Hudson: Yes, its…
Jennifer Sherman: Sure. We’ve got strong rental partners that cover – that have defined geographies. And we – our rental fleet is, as you said, Canadian focused. We also cover the Dakotas, Texas, certain parts of the Midwest. So it’s really in areas where we have chosen that we’re going to move forward, and we don’t have a rental partner in that particular area.
Ian Hudson: Yes. In terms of units, Felix, it’s about a 60/40 split with weighted more towards Canada. That’s kind of the split.
Jennifer Sherman: But one of the advantages we have is that we can move equipment pretty easily to respond to customer demand. And we also supply equipment to our rental – we also supply equipment to our rental partners when needed.
Felix Boeschen: Got it. Its helpful. I’ll leave it there and pass it on.
Operator: The next question is from Steve Barger from KeyBanc Capital Markets. Please go ahead.
Steve Barger: Good morning, everyone.
Jennifer Sherman: Good morning.
Ian Hudson: Hi, Steve.
Steve Barger: Obviously, a really strong overall revenue quarter in ESG. As you net out the shutdowns, capacity expansions, aftermarket strength, is this revenue level of $335 million sustainable in 3Q? Or does that step down, do you think?
Ian Hudson: I think, Steve, we obviously had benefits from accelerating some of the deliveries prior to the shutdown, that – so some of that probably moved from Q3 into Q2. But I think we’re still expecting strong revenue performance and still meaningful year-over-year improvement in Q3, yes.
Steve Barger: It’s possible, just given all the puts and takes that it could be even – could it meet that level of 2Q?
Ian Hudson: Yes, it’s possible. Yes.
Steve Barger: And then I presumably, you’re modeling 4Q as the highest revenue level of the year, Jennifer, just going back to your comments that you’re going to make as much of the backlog as you can?
Jennifer Sherman: Yes. I mean, some of it depends on supply chain. But yes.
Steve Barger: Right. You’ve done a good job managing that so far it appears. And just modeling it out, it looks like if I’m at the midpoint or above on guidance, you’ll be back to double-digit incremental margins in the back half. So is it fair to say that 8% is likely the low point of the year for incremental?
Ian Hudson: Yes. I think as we talked about, Steve, we’re – Q3, as it relates to price cost, that will likely be similar to Q2, but we’re expecting that to turn in Q4. So yes, I think we are – we would expect that to pick up a little bit.
Steve Barger: Yes. And Jennifer, I understand the desire to take market share even with the margin pressure from expedited freight or overtime. I just have a couple of questions. First, why do you think those customers will be loyal to you in the future, just given everyone’s responding to unusual circumstances right now?
Jennifer Sherman: I think that some of the features that the NPD is starting to make a difference, so some of the features and functionality that we offer on our equipment differentiates us from the competition. I think the – again, the used equipment market is playing more and more of a role. And so the value that our equipment commands on the used equipment market has been in a critical differentiating factor for many of our businesses. So those are two of the critical drivers.
Steve Barger: Yes. So what you think once you convert those customers, they’ll stay?
Jennifer Sherman: Yes. That’s what we’re working for.
Steve Barger: Yes, I know. And how do you walk the line between wanting to take share on a specific order versus selling something that might not make as much economic sense just given the margin profile due to these unusual factors? Like what’s the thought process that goes into that?
Jennifer Sherman: Again, as we talked about, we’re playing the long game here. So if there’s an opportunity to convert a large strategic customer, typically, people don’t buy federal signal products across the board because of price. They buy them because of the features and functionality, the reliability and the resale value. So we typically try to sell on that. And we’ve been successful with that particular initiative. So very rarely are we in the price game.
Steve Barger: Right. Yes. No, it’s just right now with expedited freight and things, you just may have a little lower incremental margin like we saw this quarter, but you don’t expect that to last because of the value proposition of the products?
Jennifer Sherman: Exactly.
Steve Barger: And just one more. On the PPG initiative to bury power lines, are there any specific regulations in California that would advantage your products over excavators? I know in some places, they’re mandated or required, right?
Jennifer Sherman: Yes. We’re not aware of any regulations in California that would mandate use of our product. But as we said, we’ve been very actively involved in demos, and they’ve been well received. And we think that this is the first of many conversations.
Steve Barger: Great, thanks for the time.
Jennifer Sherman: Thank you.
Operator: The next question is from Greg Burns from Sidoti. Please go ahead.
Jennifer Sherman: Good morning, Greg.
Greg Burns: Good morning. I just wanted to kind of, I guess, talk about some of the supply constraints. I know it doesn’t sound like – it sounds like you have a handle around the chassis situation, so there’s not going to be any shutdown. So when we think about your ability to produce in the second half, is it more about inefficiencies dealing with the supply chain as opposed to actual shutdowns that we saw from the chassis earlier this year? Or what’s going to be the limiting factors or bottlenecks that might limit your ability to produce in the second half?
Jennifer Sherman: Yes. So I want to be clear about the chassis situation. It’s challenging. We have weekly communications with our teams about the chassis availability. And what’s challenging is that the situation changes. So you think you’re getting chassis on a certain date, and then you get a note that it’s getting pushed out a couple of weeks. So I don’t want to communicate anything else, but our teams have done an excellent job in terms of addressing a very fluid situation. And at some level, we don’t produce chassis, except for one product line, the Pelican at Elgin. So we’re dependent upon others. We’ve seen supply chain challenges across the Board. We talked about everything from wiring harnesses to cylinders to limitations on epoxy for our road marking equipment. So it does feel like, and I’ve seen other industrial companies use this word, and we agree. It feels like whac-a-mole. We get one thing under control and there’s something up. So it creates inefficiencies. We’re air freighting things. We’re sending people on planes to go pick up chassis. We’re doing what we need to do to convert that backlog and meet customer demand. And we expect that to continue through the rest of the year. But our teams have done an excellent job in these very challenging circumstances addressing it.
Greg Burns: Okay. And then in terms of the investments you’re making on the rental fleet, is there any way you could quantify that in terms of number of vehicles or amount of dollars you’re putting into the – your fleet?
Ian Hudson: Yes. It’s something that we track very closely, Greg. And I think if you look back to last year, we scaled back the investment in the fleet because we saw utilization levels decline a little bit with the pandemic. As we saw those start to pick back up again, we made the decision to add some more units into the fleet. So we probably added – the net addition has been somewhere in the range of $10 million, but that also is net of some strong used equipment sales. And again, that’s something we monitor closely because we also track the age of the equipment in the fleet. So it’s probably been about a net increase of about $10 million on a year-over-year basis.
Jennifer Sherman: The teams have done a really nice job in a pretty difficult environment beginning in 2020, kind of one metering investments down. And then we started last year, increasing our investments in the rental fleet. So we’re in a pretty good place there.
Greg Burns: I guess, would your view or your inclination be to continue to invest more dollars there, given what you’re seeing? It sounded like I think you had mentioned that, obviously, the aftermarket and fleet are strong because supplies are constrained. Okay. Okay. Thank you.
Jennifer Sherman: And the other thing that’s important to note is it gives us other options with our customers. So if in fact, we’re in a unique situation. If we can’t provide them a new piece of equipment on their timetable, then we’ve got either a rental opportunity or a piece of used equipment.
Greg Burns: Okay, great. Thanks.
Operator: Next is a follow-up from Steve Barger from KeyBanc Capital Markets. Please go ahead.
Steve Barger: Hey, thanks for taking one more. Just a modeling question on SG&A. You’ve talked about some inefficiencies in terms of airfreight, sending people on planes to get the chassis. And I’m sure incentive comp is going to be strong this year. But even with all that, given how strong revenue is, is it reasonable to think you can drive some pretty solid SG&A leverage, maybe 30, 40 basis points this year?
Ian Hudson: Yes. I think, Steve, obviously, this quarter, there was some impact because of the SG&A was look – as a percentage of sales, at least was lower because our revenue included the chassis and the subcontractor like in the revenue. So that was favorable as it relates to SG&A as a percentage of sales. But yes, I think, we’re – obviously, we always – with our ETI principles, we’re always striving to get savings in our SG&A. So I think there is always room for improvement. I don’t know that it will continue at the same rate that it was in Q2 as a percentage of sales. We’re expecting that to revert to kind of more normal patterns in which we somewhat similar to what we saw in 2020, maybe a little better. But yes, we always aim for improvement. We – incentive comp, as you mentioned, is obviously a big factor in the SG&A line. So that’s something of a no, no. That’s always going to be dependent on how we do the right year. So that’s the one variable. The other variable we have, and we’ve referenced this on prior calls, is this – the mark-to-market liability on the non-qualified plan that flows through that line. And that’s a little unpredictable at times that really tied to the performance of the market.
Steve Barger: Yes. But just given the strength of the revenue, that’s likely to come through in the back half. If you step back up to a high 13% range, you’re still going to have some pretty nice year-over-year leverage, it looks like?
Ian Hudson: Yes.
Jennifer Sherman: That’s fair.
Ian Hudson: Yes, that’s fair.
Steve Barger: Okay. Thanks.
Operator: This concludes the question-and-answer session. I would like to turn the conference back over to Jennifer Sherman for any closing remarks.
Jennifer Sherman: Thank you. In closing, I would like to reiterate that we are confident in the long-term prospects for our businesses and our markets. Our foundation is strong, and we are focused on delivering profitable long-term growth through the execution of our strategic initiatives. Federal Signal is in a very good place. I would also like to give a public thank you to all of our employees with a special shout out to our purchasing and our operation teams at our businesses for their commitment, creativity and dedication addressing this challenging supply chain environment. In addition, I would also like to express our thanks to our stockholders, distributors, dealers and customers for their continued support. Thank you for joining us today, and we’ll talk to you soon.
Operator: This concludes today’s conference. You may disconnect your lines. Thank you for participating and have a pleasant day.
