Welcome to the Federal Signal Corporation second quarter conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brian Cooper, Senior Vice President and Chief Financial Officer. Please begin.
Good morning, and welcome to Federal Signal second quarter 2015 conference call. I'm Brian Cooper, the company's Chief Financial Officer. Also on this call with me are Dennis Martin, President and Chief Executive Officer, and Jennifer Sherman, our Chief Operating Officer. We'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. Dennis will lead off today, but 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-Q today. Now I'll turn the call over to Dennis.
Thanks, Brian. We are happy to report another strong quarter. Before Brian goes into more detail on the results for the quarter, I want to give a brief update on some of our strategic initiatives. We continue to focus on disciplined growth, making investments in businesses that we want to grow. These investments typically include purchasing newer, more sophisticated manufacturing equipment, adding capacity to the existing facilities, and funding new product development initiatives. As you can see from the significant improvement in operating margin during the quarter, which included improvement in each of our groups, we continue to benefit from leveraging invested capital and improving manufacturing efficiencies and costs. The 12.7% consolidated operating margin reported for the quarter was a record high and exceeded the long-term target that we have set for ourselves.
Although it will vary from quarter to quarter, with continued focus on executing our strategies, our 80/20 initiatives, our goal is to maintain a consolidated operating margin in the region of 12% over the long term. We continue to strive to diversify our customer base as well as our markets. With our innovation initiatives, we are responding quicker to the market needs with the introduction of new products that are designed to give us access to new customers. Of course, one other way of achieving our objective of growing our industrial business at a faster pace than our municipal business would be through an industrial-focused acquisition program. With the additional M&A resources that we added earlier in the year, we are strengthening our acquisition pipeline.
While we intend to continue to fund internal growth opportunities, we are also committed to acquisitions that create value for our shareholders, and we would like to add at least $250 million from acquisitions to our revenue run rate over the next three years. We intend to continue to exercise discipline in considering acquisition opportunities. Jennifer is going to talk a little more on our evaluation process shortly. She will also provide some perspective on our performance and market conditions and talk about some of our growth initiatives. She'll also give a detail of our outlook for the remainder of 2015. First, I'm going to turn things over to Brian to address our financial results for the quarter.
Thank you, Dennis. As you have seen in our earnings news release, our second quarter results reflect a significant increase in operating income despite relatively flat sales. This translates to a significant improvement in consolidated operating margin. Consolidated net sales were $231 million for the quarter, down 2% compared to the prior year quarter. Excluding foreign currency translation effects, consolidated net sales were up $4 million, or 2%. Operating income was $29.2 million, up 22% versus last year. Consolidated operating margin was 12.7%, up an impressive 250 basis points compared to 10.2% a year ago. Income from continuing operations was $18.3 million for the second quarter, up 8% compared to the prior year. That translates to EPS of $0.29 per share, which is up 7% compared to $0.27 per share last year. There are no material non-GAAP adjustments to our results in either period.
In the quarter, orders declined by 16% versus last year, and backlog was $269 million, down from $356 million a year ago. Jennifer will elaborate on how we are responding to softness in some of our markets and how these results factor into our view of the second half of 2015. As you can see in our group results, all three of our business groups reported improved operating margin versus Q2 last year. Foreign currency translation reduced second quarter orders and sales in our Fire & Rescue Group, and to a lesser extent, in our Safety & Security Systems Group. Our top line was affected, foreign currency changes have had no material impact on our bottom line. The impact on second quarter consolidated operating income was less than 2%.
The Environmental Solutions Group drove much of the overall improvement in operating results, reporting a net sales increase of $7.4 million, or 5%, versus last year. This came on the strength of a significant increase in shipments of street sweepers. ESG operating income was up an impressive 26% as we continue to benefit from operating leverage Favorable mix of products sold. On this increase, ESG's operating margin rose to a record high of 19.9%, compared to 16.6% last year. Orders and backlog at ESG were each down about 25% when compared to record levels a year ago. The prior year included several large fleet orders for street sweepers, and recent demand has been softer from our Vactor and Jetstream customers who serve oil and gas upstream markets.
We also continue to see fewer advance stocking orders, and we continue to capture additional product sales opportunities that result from shorter lead times. At SSG, sales were down 4% compared to last year's quarter, primarily due to unfavorable foreign currency translation effects. Operating income of $7.3 million was down slightly, while operating margin improved to 12.4%, compared to 12.2% in Q2 last year. Orders at SSG were generally flat in comparison to the second quarter last year. As we've noted previously, most of SSG's business normally operates with relatively low backlog. In the Fire Rescue Group, net sales were $8.7 million lower than the prior year quarter. Excluding the effects of foreign currency translation, FRG's net sales decreased by $3.4 million, or 10%. FRG reported nominal operating income for the quarter versus an operating loss of $0.3 million last year.
In local currency, FRG's second quarter orders were up 18% compared to the second quarter of last year, as we saw strong order flow from the Asia-Pacific and the Middle East, including certain large multi-unit orders. Corporate operating expenses of $7.3 million were up compared to $6.4 million a year ago, largely due to higher professional service fees. From a consolidated perspective, we reported a 12% improvement in gross profit and a gross margin of 28.5% for the quarter, which compares to 25.1% last year. Selling, engineering, general and administrative expenses of $36.1 million were up 3% compared to the prior year quarter, and we saw slightly higher costs associated with restructuring activities. All these factors rolled into the company's $29.2 million of second quarter operating income. Other items affecting the quarter results include small reductions in interest expense and other expense.
Tax expense for the quarter was up $4.5 million, with an effective tax rate for the quarter of 35.8%, which was similar to the first quarter. The rate is higher than the 25.1% reported in Q2 last year. This is largely because of a $1.5 million tax benefit recognized in the prior year quarter in connection with the release of tax reserves. We continue to estimate our full year effective tax rate for 2015 to be approximately 36%. From a cash perspective, we are projecting a cash tax rate in the low to mid-teens. The difference between our effective tax rate and our cash tax rate relates to use of deferred tax assets to reduce our tax payments. These assets primarily consist of net operating loss carryforwards and tax credit carryforwards.
On an overall basis, we therefore earned $0.29 per share from continuing operations in Q2, compared with $0.27 per share in Q2 last year. The balance sheet remains extremely strong, and with our robust cash flow, it continues to improve. Operating cash flow was $24 million for the second quarter and is up $4 million, or 16%, for the year-to-date period. Total debt was $49 million, down from $76 million a year ago, and net debt was only $13 million. In addition, our leverage ratio of debt to adjusted EBITDA dropped to 0.4 times. Our strong operating performance and our low level of debt obviously give us excellent flexibility to fund growth initiatives and return value to shareholders. During the second quarter, we paid a quarterly dividend of $3.7 million and also funded $1.4 million of share repurchases.
We have just under $75 million remaining under our share repurchase authorization. That concludes my comments, and I'd like to turn the call over to Jennifer.
Thank you, Brian. I would like to start by adding a couple of comments on our strong quarterly results. I will then provide some perspective on what we are seeing in our markets and talk about progress we are making against some of our growth initiatives before wrapping things up with an update on our outlook for the rest of the year. As Brian mentioned, the Environmental Solutions Group had an outstanding quarter. Its near 20% operating margin for the quarter is the highest it has ever been and reflects continued execution on 80/20 and lean initiatives, leveraging capacity, and utilizing our flexible manufacturing model. A highlight for the quarter was that our Elgin sweeper facility completed and shipped the highest number of street sweepers since 2006.
At the Safety and Security Systems Group, we continue to see strong performance in public safety markets, both domestically and overseas, particularly in Southern Europe, which continues to show signs of improvement. On the integrated system side, we saw some year-over-year decline in results. This is driven in part by the timing of orders and deliveries and by the unfavorable oil and gas markets. However, we continue to be encouraged by the number of projects in our pipeline. The Fire Rescue Group, which is our Bronto Skylift business, reported nominal income for the quarter compared to a weak second quarter a year ago. As we have discussed previously, Bronto's results can fluctuate significantly from period to period and can be impacted by the volume of unit shipments. During the second quarter, approximately $5 million of revenue and $1 million of profit was temporarily deferred.
This was because the terms of a customer contract prevented us from recognized revenue in the second quarter, despite the units being delivered. The Fire & Rescue Group's second quarter gross margin improved to 19.7% from 13.5% in the prior year. With this improvement, we are starting to see some efficiency gains from the significant investments we have made over the last two years to improve our manufacturing facilities, combined with the results of the concentrated effort to reduce the intake of low-margin orders. We are also very encouraged by the volume of orders in the second quarter, which were up 18% in local currency and included winning a number of large multi-unit opportunities. While our overall operating results for the second quarter were strong, orders, particularly at ESG, were much lower than last year.
ESG orders reported in the second quarter of last year were the highest they had ever been in any quarter due to a number of significant fleet orders for street sweepers that did not repeat this quarter. Those street sweeper fleet orders, which were received from customers in the Middle East and the U.S., represented about $27 million or 72% of the year-over-year ESG orders reduction. The remainder of the decline in orders is associated with oil and gas exploration effects, while some is a result of shorter lead times. As we have discussed on previous calls, a key initiative over the last year has been to put in new production lines to reduce our lead times and enhance our capacity. As expected, we saw a reduction in stocking orders from many of our customers as a result of these improvements.
In the past, customers placed orders up to eight months ahead of market demand to hold slots in our production schedule. As our lead times have reduced, our dealers can satisfy market demand without placing these advanced orders. This reduction in dealer advanced orders does not indicate deterioration in the market demand. On the municipal side, demand has been strong, with second-quarter municipal orders up 37% over the first quarter. We expect activity in our municipal markets to remain healthy for the balance of the year. I'd now like to provide a brief update on our growth initiatives. As we have discussed on previous calls, our priorities for capital in descending order are, first, to fund organic growth, second, for acquisitions, third, dividends, and finally, share repurchases.
In relation to organic growth, we continue to invest in research and development as we strive to introduce new products to new and existing markets. We have previously discussed our innovation initiative that is focused on developing new products faster to meet customer needs. We are pleased to report that we have designed and built prototype units for a new truck in less than five months. This new design is specifically targeted at expanding our reach and competitiveness with customers serving utility markets. We have also recently invested in a modest expansion of our facility in Alabama in order to further develop our flexible manufacturing model and expand into new markets. On acquisitions, we've been actively evaluating opportunities. M&A markets continue to drive elevated valuation expectations, and we continue to be committed to being selective and disciplined to find acquisition opportunities that create value.
To do that, our criteria are focused primarily on acquisitions that fit closely with our products and services, manufacturing competencies, channels, and customers. For example, we value opportunities to put our products through expanded channels or to take acquired products through our existing channels. These synergies should help us to create lasting value. Other criteria that will make acquisitions attractive to us include an industrial market focus, recurring revenues, sound management, and earnings accretion. We have previously mentioned that we would typically target a capital structure with a debt at about two to two-and-a-half times EBITDA. In order to meet the incremental revenue targets that Dennis discussed at the beginning of the call, we would consider a series of tuck-in acquisitions as well as a larger transformational-type acquisition. Acquisitions will be a critical part of our long-term growth strategy.
With our balance sheet strength and low leverage ratio, we have significant capacity in our existing capital structure for the right acquisition opportunities. We also continue to be committed to returning value to shareholders in the form of dividends. As Brian mentioned, we paid a quarterly dividend of $3.7 million in the quarter, and our board recently declared a similar dividend for the third quarter. Finally, after repurchasing $1.4 million of shares during the second quarter, we have approximately $75 million remaining under our existing authorization. This equates to about 8% of our current market cap. With that, I would like to move on to our earnings outlook. At this point in the year, we have increased visibility into the third and fourth quarters.
Despite the recent softness in orders for U.S. exports and for products serving upstream oil and gas markets, we are affirming our expectation that full-year adjusted earnings per share will be in the range of $0.95 - $1.02. With that, I think we're ready to open the lines for questions. Operator?
Thank you. To ask a question, please press star one. If you are using a speakerphone, please make sure your mute function is turned off so that we may receive your signal. Again, that's star one to ask a question. We'll go to Steve Barger with KeyBanc Capital.
Morning.
Morning, Steve.
Morning. We will start on the acquisitions. $250 million in deals over three years certainly would be an exciting thing to see. You talked about wanting things that fit closely, but you would do something transformational. How should we think about that in the context of the three segments? Could there be a fourth in the way that you see the world?
We have not focused on that, but there could be.
As you go out, you talked about being selective and disciplined. What is your general philosophy around whether it is better to buy a well-run business for a higher multiple or a fixer-upper for a lower multiple?
I think, Steve, it would depend on how close it is to the core of the company. If we found a business that was very close to our distribution core or manufacturing core that needed to be 80/20, we would certainly take that project on and move ahead. We'd pay a little more, obviously, for something that's running well. Again, if it's close to the core or we can see how it develops, perhaps into a new area that we can be successful with for shareholders.
It sounds like you wouldn't buy something that was a fixer-upper unless you felt like you really understood the business.
We wouldn't.
Okay. I know, you've talked about both tuck-ins versus transformational, just as you look at the acquisition environment out there right now, does it seem like you lean more towards a couple of hundred million dollar deals, or is this more like five $50 million deals just based on the slate of things that you see?
Yeah. Everything that we've looked at is ranged from $10 million-$800 million. Obviously, on the high end, $800 million would be too big, I think, for us. It could be a combination of three or four smaller things, but as you know, if you do three or four, each one takes the same amount of effort. If we found one that we liked that was in the $couple hundred million, $300 million range, we would certainly feel good about that too.
Okay. You've definitely trimmed out some product lines. Sorry, go ahead.
Steve, I was just going to say, to the extent we were doing a smaller acquisition, it's more likely to be more along the lines of a product line acquisition or something like that, which again, would fit the tuck-in category.
Understood. You've trimmed out some product lines over the past couple of years. Anything else that you see as a possible divestiture to kind of clean up the portfolio?
Well, we constantly look at it. We have nothing on the plan at this point, but one of our evaluation points is to constantly go back and look at the value to the shareholders over the long run of all the businesses. We'll continue to do that, but nothing on the immediate horizon.
When you look at value to the shareholders, is your primary filter, or I guess, what is your primary filter, whether it's return on capital or earnings growth? How do you think about the kind of business that fits into the portfolio?
We really look at earnings growth. We look at where is there opportunity to use that business as a platform for future acquisitions, which is critical. We look at the mix of industrial versus municipal. We've talked about that before. As Dennis has mentioned, we are constantly evaluating all of our businesses using those criteria.
Got it. One more. I'll get back in line. You reaffirmed your guidance, which is good to see. Implies $0.43 to $0.50 in the back half. Can you just give us a little more color on what you see as the primary factors or the big swing factors that could cause results to come into the high end or the low end?
Really depends on our performance at our environmental solutions business. Their backlogs right now, they're filled through the third quarter, and we're looking at the fourth quarter. We feel good about our current guidance, and we'll update you at the end of the third quarter in terms of where we are for fourth quarter.
FRG continuing to ship their backlogs will also make a big difference, Steve. Really a combination of that. We seem to be steady at SSG. Really it's all the way around the company.
All right. Thanks very much for the time.
Thanks. Thank you.
Thank you. As a reminder, please press star one to ask a question. We'll go to Walter Liptak with Global Hunter Securities.
Hi, good morning, guys. Congratulations on a nice quarter.
Thanks, Walt.
Thank you.
I wanted to ask about, kind of along the lines of the M&A and your comments on corporate expense being up a little bit for professional fees. Can you give us some detail on what kind of professional fees you're paying for?
They relate to basically corporate matters. There's some legal costs and some other things. It's not stuff that we would necessarily expect to continue over time.
Okay. Got it. I guess what I'm getting at is, you've been talking about acquisitions for a while now, and I wonder what you're thinking of for timing. Are you close on something? Will we see something before the end of the year? Is it 2016?
Walt, you know the markets out there. They're very hard to call, and you never know when things will get done. All I can tell you is, we have some active opportunities we're looking at. Some of them are pretty small. A couple of them are a little bigger. They all kind of have their own pace, and sometimes they fall off the tracks real fast. We're working on things. The pipeline or the funnel is a lot fuller than it used to be. We kind of had to rebuild our process. A couple of years ago, we had not really been in a position to be looking very actively at acquisitions, and we're doing that now.
More things are coming to us, we're being more proactive with our businesses and identifying things we would like to go after, companies we'd like to talk to and approach. There are things going, but exactly when something can happen is something I'm not comfortable calling.
Okay, great. One last one about the ESG business and your comment about trends in the market. I wonder if we can get more color. Is it North America or is it international where we're seeing positive trends that should flow through into fourth quarter and maybe next year? The third quarter production and mix of products, how is that looking?
We're seeing certainly activity in the sewer cleaner market is good. Jennifer mentioned in her notes that because we had shortened our lead times with our new assembly processes at Vactor, that we actually reduced the need for customers, the dealers to place orders 8 months out. That equates to our reduced backlog. Probably $30 million of our reduced backlog loss is just relative to the fact that we can now ship product out of stock in case of our Guzzlers. I think some of the adjustment that we saw in the first quarter and the second quarter will kind of go away, and we'll see more normal trends of business in the third and fourth quarter for the ESG side. The international business, the orders there tend to be opportunistic, and they come and go.
As we said last year in that second quarter, we had huge orders or multiple huge orders. We still see good order activity, but it's not quite the same level of big fleet. I think it's going to be more of a steady trend, and at the end of the half, we think we'll, as we said with our guidance, meet guidance that we gave prior, and we feel pretty good about that considering what's going on in the economy.
We talked specifically about our municipal orders were up 37% over last quarter, and we continue to see a healthy outlook for municipal demand in our Environmental Solutions Group and our SSG businesses.
Okay, great. Along those lines with the municipal orders up 37%, yeah, I guess in ESG, where are you seeing the orders are picking up sequentially? Are you seeing it in North America, or is it in Europe? Where are the orders coming back?
Right, Walt. Actually, we've seen it in both places. We've seen in our Vama business as well as in the U.S.
Okay, great. Okay, thanks very much, guys. Okay, bye. Thank you.
Thanks, Walt.
Thank you.
To ask a question, please press star one. We have a follow-up from Walter Liptak with Global Hunter.
Okay, guys. I guess I'm back.
Yeah. Hey, Walt.
I wanted to ask about your O&G exposure and just the % of sales that we're looking at, especially on ESG and what you're hearing from the customer on timing for replacement trucks.
I'll give you a shot at that, Walt. Then Jennifer, Dennis may want to elaborate. When we look at our exposures, ESG is probably pretty typical of the company between ESG and SSG. We've got less than 10% of our revenue that we identified is coming from sort of oil and gas. Some of that is downstream stuff, so it's not necessarily affected by the oil and gas prices the way other things are. What we have seen is that a lot of our ESG products are serving the fracking operations that have reduced and oil and gas fields. As that changes, our demand has been affected by more than just the direct effect because some of the equipment that used to be deployed in the oil fields has been redeployed elsewhere. It's somewhere in that range, 10% or so, which is attractive business for us.
We've done a nice job, I think, of capturing other business as we go, and we're using this as an opportunity to pursue some other markets.
I think, though, in this last quarter, Walt, we've had a bigger impact than the 9% or 10%. What's happened here is a lot of our rental customers and a lot of the customers who purchased equipment over the last year to serve the oil and gas have begun to sell off their equipment in the used market. We've seen some deflation of demand by that, but I think that should work its way through the market here through this quarter, I would think, and we should be on to a more normal stream of orders through the factory for that. There was more of that than we did expect.
We have a concentrated effort right now to redeploy many of our salespeople from oil and gas to other markets, including utility. I talked about the new product introductions we have. We're encouraged by the results that we've seen to date, and we expect that to be a growing market for us.
Okay. Sounds great, guys. Thanks very much.
Thanks a lot, Walt.
Thank you.
To ask a question, please press star one.
Okay, it sounds like we have no more questions. In closing, I'd like to reiterate that we're excited about our progress and the opportunities in front of us, and we appreciate the continued support of our stockholders, employees, distributors, dealers, and customers, and we thank them all. Thank you for joining our call today. Goodbye.
That concludes today's conference. We thank you for your participation.