Good day, and welcome to the Federal Signal Corporation fourth 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. You may begin.
Thank you. Good morning, and welcome to Federal Signal's fourth quarter 2014 conference call. I'm Brian Cooper, the company's Chief Financial Officer. Also with me on this call are Dennis Martin, President and Chief Executive Officer, and Jennifer Sherman, our Chief Operating Officer. We'll 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. 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. 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-K today. I'm going to start by addressing our financial results. I will then hand the call over to Jennifer, who will provide an overview of our operations, Dennis will wrap up our prepared comments with an update on our goals and our outlook for 2015. Our consolidated fourth quarter and full year financial results are provided in today's news release. For the full year, I would like to briefly highlight some of our consolidated results. Net sales totaled $919 million, which is up 8% over 2013.
Operating income was $93 million, up 31%. Operating margin was 10.1%, exceeding the 10% target we set for ourselves several years ago. These results are very good. Our improvement has been impressive. For the rest of my comments, I will focus mostly on comparisons of the fourth quarter to the fourth quarter of 2013. Our Q4 results were solid across the board. Sales of $264 million were up 20% as the Fire Rescue Group recovered on most of its deferrals and the Environmental Solutions Group continued strong. We were able to leverage the strong sales to grow consolidated operating income by 44%. That is a huge improvement over an already strong performance in last year's Q4. In addition, each of our groups reported improved operating margin, with consolidated operating margin expanding to 11.7% compared to 9.8% in last year's quarter.
On the bottom line, our adjusted EPS from continuing operations is $0.30 per share, up 30%, and we ended the year with a very healthy backlog of $328 million entering 2015. Looking briefly at our group results, our Fire Rescue Group, which is our Bronto business, delivered a strong quarter. After operational challenges that affected the first three quarters and facing a foreign currency headwind, FRG reported its highest quarterly sales and operating income since the fourth quarter of 2009. FRG sales were $55.3 million, up $22.6 million compared to last year's quarter. This 69% improvement includes the effects of a number of deliveries that were deferred from prior quarters. FRG's operating income jumped to $5.2 million, which translated to an operating margin of 9.4%, up significantly from 4.9% in the same period of 2013.
The Environmental Solutions Group also contributed strongly to our consolidated top-line growth, up $21.7 million, or 18%, compared to the prior year quarter. This growth was driven by increased domestic vacuum truck sales, higher international street sweeper shipments, and strength broadly across its markets. Leveraging the higher sales and a more profitable mix, ESG operating margin was up 26% to $22.1 million. At the Safety and Security Systems Group, operating margin of $10.9 million was up 9% in spite of relatively flat sales. SSG's operating margin to 16.4% was up 120 basis points.
Want me to go?
Yeah.
Corporate operating expenses for the quarter were $7.2 million, down from $7.7 million in the prior year. We have continued to benefit from low level of trial activity and associated costs related to our defense of hearing loss litigation. Reflecting all these factors, Q4 consolidated operating income was $31 million, up 44% against the prior year quarter. We also recorded a 4% increase in consolidated orders, which was driven by an 18% improvement at Fire Rescue Group and a 9% increase at the Safety and Security Systems Group. Looking at the income statement, our 20% increase in sales drove a 24% increase in gross profit and consolidated gross margin of 26.2% for the quarter, which compares to 25.5% in the prior year. Selling, engineering, general administrative expenses were 15% higher than last year, primarily as a result of sales expenses related to higher revenue levels.
In the prior year quarter, we also recorded $1.3 million of restructuring charges. All of these factors roll into the company's $31 million of operating income. Interest expense also remains low, reflecting low interest rates and our declining debt balances. Income tax expenses for the quarter were $5.9 million, compared with a benefit of $6.5 million a year ago. Two factors lowered our tax expense in the prior year quarter, as we captured benefits associated with the release of valuation allowances on domestic deferred taxes, assets, and also recognized a $6.7 million benefit from a tax planning strategy, which helped preserve some expiring tax credits. The effective tax rate for Q4 of 2014 also was low at 20.3% and included the impact of a $3.5 million released valuation allowance on certain foreign deferred tax assets, as well as $0.4 million benefit from change in the enacted tax rate in Spain.
I would also note that our effective tax rate in 2014 for the full year, excluding special tax items, was approximately 32.4%. We currently expect our financial book effective tax rate to increase slightly in 2015 to approximately 34%. Cash taxes paid will be lower than that at a percentage rate that we estimate in the range of 10%-15% based on our anticipated use of deferred tax assets, consisting largely of net operating loss carryforwards and tax credit carryforwards. On a GAAP basis, we therefore earned $0.36 per share from continuing operations in Q4 compared to $0.42 per share last year. To facilitate earnings comparison, we've adjusted for unusual items recorded in 2013, including restructuring activity, debt settlement charges, and income taxes.
The income tax expense included in our adjusted earnings per share for 2013 therefore reflects a normalized effective tax rate of 32%, which excludes the effect of unusual tax items, most notably valuation allowance effects. We also made adjustments in Q4 of 2014 to exclude the special tax items I just discussed. On this basis, our adjusted earnings for the fourth quarter were $0.30 per share, up 30% compared to $0.23 per share in the fourth quarter last year. I would note too that our strong performance this quarter brings us to an adjusted earnings of $0.93 per share for the year, which is up 39% compared to $0.67 last year.
Turning to the balance sheet and cash flow, cash provided by continuing operations was strong at $28 million for the quarter. For the full year, cash provided by continuing operations was $72 million, down from $80 million in the prior year. The change in cash provided by continuing operations relative to the prior year was largely due to an increase in working capital at the end of 2014. This was driven by higher inventory levels associated with a higher backlog. It also included higher accounts receivable as a result of the high volume fourth quarter shipments, primarily in the Fire Rescue Group. Cash flow from continuing operations also was reduced by income tax payments and pension contributions that were higher than in 2013.
With the strong cash flow, we were able to reduce our borrowings by more than $18 million during the quarter. This included making a voluntary term loan prepayment of $15 million. Total debt of $50 million at the end of Q4 was down $42 million since the beginning of the year, and our leverage ratio dropped to 0.5 times adjusted EBITDA. Our strong operating performance and this low level of debt obviously give us good liquidity and flexibility to consider funding growth initiatives and returning value to shareholders. During the quarter, we paid dividends of $1.8 million and also funded $3.6 million worth of share repurchases. We have about $80 million remaining under our share repurchase authorization. As we have discussed in the other calls, our priorities for cash in descending order are to fund organic growth, acquisitions, dividends, and finally, share repurchases.
We would typically target a capital structure with a debt at about 1.5 to 2 EBITDA. That includes my comments, and I'd like to turn the call over to Jennifer.
Thank you, and thanks to all of you for joining our call. I'm proud of our teams for turning in an excellent year in fourth quarter, and I'd like to provide some color on the outstanding performance across our groups. Let me focus first on the Environmental Solutions Group, which grew both sales and operating income extremely well. As most of you know, ESG has strong channels for municipal and government business, primarily through a dealer network that captures about 60% of the group sales. Our municipal products are primarily street sweepers and sewer cleaners. We have also been working to grow our industrial base, which covers sales on a direct basis. Industrial products include vacuum loaders, hydro excavators, and water blasting tools. A good portion of our recent growth on the industrial side has been related to oil and gas markets.
All of these municipal industrial markets remained strong throughout 2014, and ESG capitalized by leveraging and expanding its existing capacity, which was able to do with minimal investment. Our greatly improved ESG operating margins reflect this. We also exited the year with a healthy backlog. Looking forward, we continue to experience solid demand and positive signals in our municipal markets. In our industrial markets, low oil prices have led to caution and hesitancy among our customers, with orders slowing in some areas. As a result of the delay and/or shutdown of many North American oil-related projects, we have seen a significant decrease in the demand for our environmental and security products that support the oil and gas industry, which represent less than 10% of our consolidated sales. As we previously mentioned, we have strong backlogs and have decent visibility for the first half of the year.
Like many other companies, it is difficult to predict what the impact will be on our business for the second half of the year. However, if the current oil and gas market conditions continue, this could serve as a headwind to growth in our environmental and security systems groups. Our teams are closely following the market conditions and have been refocusing their efforts on the industrial and utility markets. We continue to feel that there are good opportunities to grow on the industrial side, and our teams plan to treat any pause in the upstream oil markets as an opportunity to focus on expanding our market share and growing in these other areas. During 2014, we reorganized several of our engineering functions and added additional resources to focus our efforts on new product development that responds to the needs of our customers.
As a result, we have ongoing new product introductions at both our ESG and SSG businesses during 2015 and 2016. Our Safety and Security Systems Group reported nominal fourth quarter sales growth when compared to the same period of the prior year, but improved its operating margin to 16.4%, its best level since the third quarter of 2008. The increased operating income has come from growth in profitable business lines, our continuing 80/20 efforts, a steady focus on improving our productivity, and close management of our cost structure. Improvement has been gradual but steady in our municipal-based police, fire, and emergency businesses. Our police business in Europe, which has weathered a number of years of weak demand, also had a relatively strong fourth quarter.
SSG's integrated security systems businesses, which serve both government and industrial applications, tend to carry higher profit margins, but revenues can also fluctuate more significantly based on large orders. We continue to invest in engineering new products and adding the right sales resources to grow the systems businesses. Although backlog is not as significant for SSG as for our other groups, it is at a relatively high level for that group. The Fire Rescue Group, or Bronto, struggled through the first three quarters of 2014, and we have talked on previous calls about various issues and elements of their recovery plan. I'm pleased to report that we have made progress, and Bronto turned in a strong fourth quarter. In spite of adverse foreign currency effects, fourth quarter sales of $55.3 million caught up on most deferred deliveries and brought annual revenues in line with last year's levels.
Operating margin for the quarter was a respectable 9.4%. Margins on units in our backlog have returned to acceptable levels, manufacturing is operating more smoothly, and our recent investments, like our new machining center, are contributing positively. Orders and backlog have remained solid, too. While this was a good quarter, Bronto's results for the year obviously were disappointing, and we continue to work through some issues and improvements. Bronto also remains subject to first quarter seasonal softness and large order volatility from quarter to quarter. As we have previously discussed, depending on seasonality, the timing of shipments and customer inspections, Bronto's performance can vary from quarter to quarter. We expect this to continue in 2015. Overall, we expect Bronto to have a better year in 2015. This covers my update on operations, and Dennis will now conclude with some perspective on our initiatives, goals, and outlooks.
Thank you, Jennifer. As we enter 2015, we are continuing to work with our strategies and initiatives that should help us to sustain our profitable growth. I want to briefly revisit them. Our first initiative is disciplined growth. I talked at length on our last call about a variety of initiatives and investments that we are driving to stimulate organic growth in our businesses. We want to complement that growth with acquisitions that leverage our core competencies or give us access to adjacent or new markets. We continue to be committed to a disciplined approach in evaluating opportunities in the marketplace. We also continue to focus on leveraging our invested capital and improving our manufacturing efficiencies and costs with 80/20, now an important part of our Federal Signal culture. Our strong 2014 performance depended heavily on these two areas of focus. The final initiative is to diversify our customer base.
We continue to focus a lot of our growth efforts on the industrial side of our business because we feel opportunity for long range growth and profitability in that area tends to be higher. Oil and gas markets, upstream and downstream, have been part of that focus, along with utilities and industrial contractors. Our municipal and government business, which grew well in 2014, remains an important part of our portfolio. Our long range goals remain unchanged as well. On the top line, we want to grow faster than GDP while increasing the share that comes from industrial. We aim to continue to improve our return on invested capital. During 2014, we also raised our long-term consolidated operating margin target to 12%, and we have targeted an average growth of earnings per share at a rate in the low to mid-teens.
Before we look forward into 2015, I'd like to note that we've just concluded a pretty exceptional year in 2014, with excellent momentum in our businesses and in our markets. We continue to feel good about our direction, including the way we have leveraged our capabilities and our assets to create value and to improve our performance. We also remain optimistic about most of our markets, and we are continuing to invest in new products and additional sales resources to drive organic growth. Jennifer has talked about oil and gas challenges. Low oil prices have reduced activity in the upstream oil and gas markets, creating caution around a portion of our businesses. At this point, we have seen some order softness for certain oil-related products.
It seems to be a mixed bag, as not all customers and all products seem to be affected, and our customers seem unsure how they should react. Like many other companies, we have less visibility into the second half of the year because of that. Should the softness continue, it may create opportunities for us to go after other markets and market share that we could not address during the last few years when we did not have excess capacity for products like the hydro excavators. However, said shifts and efforts also usually take some time to produce results. Another potential factor is the strong U.S. dollar, which will create some drag on our performance. It has reached a point at which it may affect the competitiveness or profitability of some of our U.S. products in foreign markets. In addition, our overseas results translate to a lower dollar value.
Considering the exceptional year and momentum that we just completed and the headwinds, we are tempering our long-range goals and setting expectations for 2015. On the earnings per share, we are targeting a range of $0.95-$1.02, which represents improvement over 2014 adjusted EPS of $0.93. We will continue to update this as the year continues. I should mention that these targets do not include effects from acquisitions. Acquisitions remain high on our agenda or effects from share repurchases. I would like to conclude by highlighting the increased dividend, which we announced two weeks ago. We doubled the dividend from $0.03-$0.06 a share, and you know that many of our shareholders appreciate the dividend. It remains a high priority for us. At this point, we would like to open the lines for questions. Operator?
Thank you. If you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press *1 to ask a question. We will pause for just a moment to allow everyone an opportunity to signal for questions. We will take our first question from Steve Barger with KeyBanc Capital Markets.
Hey, good morning. It is Ken Newman on for Steve.
Hey, Ken. Good morning.
Good morning, Ken.
Good morning. Morning. Wanted to talk about the dividend. Just curious why increase the dividend at this point versus further debt reduction. I'm curious, are there no worries about cyclicality in the next few years affecting revenue? If not, why not put out some revenue guidance to help investors think about growth potential?
Yeah, we cherish both the dividend and other strategies on our capital structure. While we think that the next few years will have some cyclicality in it, the reduction in our overall debt and our confidence in the businesses, we feel that the dividend was something that should be reenacted before we do some of the other strategies.
Okay. Back to your guidance. I'm just curious, what is the operating margin expectation embedded in the $0.95-$1.02 EPS range? Do you expect margins to grow in 2015? I guess the same question for operating cash flow.
We expect most of our margins will remain solid and may grow, although, as Dennis said in his comments, 2014 was an exceptional year. We expect them to remain very solid. Some of the businesses will continue improving, and we're driving that improvement all the time. Operating cash flow will probably be similar to what it was last year. We have a lot of the same factors. We will pay a little bit more in taxes in the coming year. Pension contributions are similar. If we generate more operating income
We'll generate more cash flow from that. One of the answers to your questions on dividends is our cash flow is so strong that we can fund that and fund our other opportunities.
Got it. Then just one more, if I could. You talked a little bit in the press release about some stronger European public safety markets. Could you provide a little bit more color? Has order inquiries in that market suggested that there's some more large orders out there for backlog? Where, in particular, are you seeing the most impact from an inquiry standpoint?
We've seen solid demand in Spain, Italy, and France, and that continues. The team's made an effort to diversify into Eastern Europe. We're starting to see the positive benefits from that effort. At the fourth quarter of last year, although the markets continue to remain tough, we're cautiously optimistic about 2015 for that group.
Got it. Thanks. I'll get back in queue.
Thanks.
Thank you. We'll take our next question from Robert Kosowski with Sidoti.
Hi. Good morning, everyone. How you doing?
Morning, Rob.
Morning.
I was wondering on ESG. It was another strong quarter, and the backlog obviously looks pretty good as well. Can you tell us, is there any pull forward or positive lumpiness on the municipal side? Do you see growth from the municipal market into 2015?
We don't think there's a pull forward, Rob, into the market. We think there is returning strength in broad municipal markets around the whole U.S. The activity, though, that added to a a fair amount of the growth in 2014 was also driven by international orders, which they do tend to be spiky. In 2014, we experienced very good Middle East orders, and that on top of the strong U.S. and North American municipal markets really drove the performance that we see. The backlog is not just advanced order placement. It's real demand to the market.
That's helpful. Secondly, on the Fire Rescue, how close is this segment operating the way you wanted it to be? Because I know you had a lot of, I guess, supplier issues and also just material flow issues throughout the plant.
Yeah, if you look at how you evaluate a business like that, you look at the operating pieces within the business. What are our core competencies and how are they performing? Within this last year, we implemented automatic welding, rearranged the factory, a new paint system, and an automated machining center. All of those pieces are functioning as we would expect. Coming into 2015, really for the first time in a couple of years, we're hitting on all cylinders in the main boom factory in Pori, and the assembly business at Tampere also seems to be flowing well. We think they're operating the way they should be. They're still operating in very competitive end markets, and there's a mix of orders and margin levels in the backlog, but we think we're heading off to a pretty good start to the year.
Right. Finally, Brian, did you say what CapEx might be for this year?
I didn't, Rob, it's a fair question. It'll probably be pretty similar to what it was last year in the $15 million-$20 million range.
All right. Thank you very much and good luck.
Thanks, Rob.
Thank you.
We'll take our next question from Walter Liptak. As a reminder, hit star one if you have a question. Again, that is star one to ask a question. We'll go now to Walter Liptak with Global Hunter.
Okay, great. Thanks. Good morning, guys.
Good morning.
Good morning.
I wanted to ask about the currency headwind. What's in your forecast? What kind of a revenue hit or EPS hit?
Our plan includes a forecast on foreign exchange with rates about where they are today. That's maybe 10% less than what they were last year. That headwind is included in all of the plans that our units have made and how it rolls up into what we look at. I'd say it's probably maybe a 3% headwind on the top line. It's a little bit of a guess, but that's just based on our first look at it.
Okay. I think Dennis commented that there might be some markets, or maybe it was Jennifer, that might be less competitive. I guess you're exporting from the U.S. to other parts of the world because of the strong U.S. dollars. Is that factored into the guidance as well?
Yes.
Okay
We talked about our visibility on the second half of the year, and that still remains uncertain.
Okay. On the energy markets, Jennifer, I think you mentioned 10% of sales, and it wasn't clear to me. Is it 10% of ESG sales are energy-related or 10% of the company overall?
10% of the company overall.
Okay. Are you seeing any order cancellations now?
We haven't seen order cancellations as much yet. We have seen projects being put off. A fair amount of our dealers rent equipment to that oil patch, and there's been some reduction in rental units in that market. We've seen activity. We've actually seen it come down.
Okay. I wonder if you could just help refresh my memory on this, on your energy exposure. What's the mix of streams? Is it all upstream, or is there some also that's midstream and downstream?
It is a mix. Our systems businesses serve a lot of downstream uses, so does Jetstream. It's probably about two-thirds to the upstream or midstream.
one third of that nine, 10% or so is the other piece.
Okay. Maybe it's a third, a third, and a third.
Yeah. I don't know. It's harder for me to break the midstream apart, so we sort of lump those together as two-thirds, and it's probably mostly upstream.
Okay. You mentioned kind of the outlook for Bronto. The orders look up pretty nicely year-over-year. What's the timing on shipments and the seasonality? Is this one where it's more back-half loaded?
I mean, typically, our fourth quarter has been a strong quarter for Bronto, and our first quarter has been softer, although it can vary from year to year. We're starting to see, as Dennis mentioned, progress on our turnaround initiative, although Bronto's results can vary from quarter to quarter depending on the timing of the shipments and customer inspections. Although we expect improvement in 2015, it will vary quarter to quarter.
Okay. Are you suggesting that the first quarter is going to be seasonally weaker than normal, or is it just normal seasonality?
At this point, it's probably normal. Bronto's backlog, they'll be working it steadily through the year.
Okay. Great. One last one. I think you mentioned acquisitions, that you're stepping things up there, and I wondered if you provided some color on what you're looking for. Would you look at a transformational acquisition? Are you looking at bolt-ons, the kind of multiples or geographic regions that you're looking at?
I think when we do our evaluation of acquisitions, we think about shareholder value. If we could create a transformational acquisition that created shareholder value, that would be something we would consider and our board would consider. We are looking at some international activities as well as domestic U.S. activities. It's a pretty broad range, Walt. We do want them to be near our core in manufacturing or market or distribution channels. We're not trying to get way outside the line.
Okay. Multiples are up, I think, for a lot of private companies. What kind of range are you willing to pay?
Well, that question really can't be answered until we look at what the business is. The multiple may be strong. If there's a huge synergy or it breaks us into a different channel of market or an adjacent channel market that we really care about, we'd pay a little more. You're right, the ratios are high, but we really would look at each one on a one-off basis.
Okay. Fair enough. Thanks, guys.
Thank you.
As a reminder, if you have a question, it is star one. Again, it is star one to ask a question.
Okay. We have no further questions, I'd like to emphasize that we remain committed to growing our businesses and leveraging their profitability. Our outstanding fourth quarter and 2014 results are really, as I always said, a product of the hard work of all of our employees, the dedication of our distributors and dealers, and the depth of our relationship with our customers. I want to thank all of them, and we remain optimistic about our businesses, and I look forward to talking with you again after the first quarter. Thank you and goodbye.
That concludes today's conference call. Thank you for your participation.