Good day, everyone, and welcome to the Federal Signal Corporation First Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ian Hudson, Chief Financial Officer. Please go ahead, sir.

Good morning, and welcome to Federal Signal's First Quarter 2018 Conference Call. I am 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. 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 earnings release and filings, we reconcile these non-GAAP measures to GAAP measures. In addition, we will file our Form 10-Q later today. I'm going to begin by providing some detail on our first quarter results before turning the call over to Jennifer to provide her perspective on our performance, market conditions and our outlook for the remainder of 2018. After our prepared comments, Jennifer and I will address your questions. Our consolidated first quarter financial results are provided in today's earnings release. As a reminder, the first quarter this year includes the operating results of Truck Bodies and Equipment International or TBEI, which we acquired last year. The results of TBEI have been included within our Environmental Solutions Group for the quarter. Our first quarter results reflect impressive increases in sales and…

Thank you, Ian. I would like to reiterate Ian's comments on the outstanding quarter. Our businesses are capitalizing on our leading niche positions and attractive markets are also benefiting on the strategic initiatives implemented in recent years and our acquisitions. On the back of strong order growth, we saw in the second half of last year, orders in the first quarter, again, were outstanding with the $330 million representing the highest quarterly orders on record surpassing the previous high established last quarter. With that, over the last few quarters, we have seen some changes in our customers' procurement strategies with some of them placing a significant portion of their full year orders late last year or early this year. At our last earnings call, we indicated that approximately $15 million to $20 million of our fourth quarter orders were pulled forward from later in 2018. This trend continued into the first quarter with customers placing orders earlier as they seek to secure availability of certain product lines like sewer cleaners and hydro-excavators, which currently have extended lead times or to manage the procurement of their related chassis, which also have extended lead times. We estimate this -- that this resulted in the acceleration of an additional $25 million of orders into the first quarter that we would have previously expected to receive later this year. I'd like to take a minute to talk in more detail about some of the factors that we believe are contributing to this order acceleration. First, the strength of conditions in our markets and the strong demand for our products that we experienced over the last year have resulted in lead times for certain of our product lines becoming extended. Earlier in the quarter, we started taking actions in response. At some of our facilities,…

[Operator Instructions] And your first question will come from Chris Moore with CJS Securities.

Maybe just quick on oil and gas. Any kind of you're seeing much improvement on that front? Or I know had been mostly through TBEI before this, but I think -- excuse me, through Joe Johnson, but have you seen much in the last few months?

We have previously stated that we're seeing signs of improvement in our parts and service businesses, and we're also seeing the used equipment coming back to work and strong utilization levels across our rental fleets. Based on that, some of our customers have placed orders to replenish their rental fleet. And I would say there's growing optimism about improving conditions in the oil and gas market. So something we continue to monitor closely and we're encouraged by what we're seeing.

Maybe if you could just talk a little bit more about -- you touched on the SSG kind of action plan moving forward. I know that's a key focus of Mark Webber and maybe just provide a little more detail there.

Yes. A couple of things there. Mark is spending about 80% of his time out at SSG. We've made some changes in management. We've got a new General Manager that joined us in November, and we're bringing someone else -- another General Manager on the team to supplement the strong team that's currently in place. And while it was down from last year, it really was in line with our expectations. We have previously talked about the political situation in Barcelona, where our VAMA business is. That has stabilized. And although VAMA had a kind of soft earnings quarter, we're encouraged by their Q1 orders. We expect that to benefit us beginning in Q2. We also had some unfavorable sales mix in the quarter. And overall, we think that Q1 was a low point, and we're expecting it to improve throughout the year.

And then that -- that's on the margin side as well or...

Correct.

And just for Ian, in terms of the tax rate as you talked about is a little bit low this quarter. The effective rate is still somewhere between 26% and 27% for the year or...

Yes. It was a little low, Chris, in Q1. We had a -- the resolution of a tax audit, which meant that we had a tax reserve we could release, so that pulled down the rate for the quarter to just a tick over 24%. We still think for the full year, it's going to be within that 26% to 27% range, but with this tax reserve release in Q1, it's probably closer to the low-end of that range. The one caveat I'll probably put out there is that there is -- we're still looking at additional interpretive guidance that may be released about some of the provisions of tax reform so -- but right now our best estimate is the low-end of the previously issued tax rate range of like 26% to 27%.

And last question; just on the kind of acquisition pipeline, it sounds like it remains full. I kind of had looked at it, it is most likely would be something along the lines of TBEI. Is that a fair statement? Or are there multiple areas that you're looking at?

You know, I think that -- we're looking at both our ESG legacy business, the TBEI, there was a product line opportunity with SSG, we would also consider that. Our pipeline is very active right now in the market. But again, it sets the right valuation and they have to advance the strategic initiative, so we've got a number of opportunities right now that we're exploring.

From KeyBank Capital Markets, Steve Barger.

Can you talk about the size of the price increases that you are pushing through? And what percentage of product lines have surcharge attached?

Sure. Right now, we haven't seen -- outside the chassis, we really haven't seen a lot of surcharges from third-parties. We've addressed the situation in terms of price increases, and they really vary business-to-business. So they varied anywhere between 2% and 6% depending on the business. I think it's important to put all this in context. I mentioned on the call that for Federal Signal, about $40 million -- we have about $40 million of steel purchases and another $10 million of aluminum purchases, the vast majority of that relates to TBEI. So it's about 5% to 6% of our total sales and about 10% of our material costs. So in looking at this, we locked in on steel and aluminum prices for the first half of the year. For some of our businesses, we have locked in for the second half of the year. And we're able to, if necessary, have additional price increases as we go throughout the year. For TBEI, for example, increased from 30 to 60 days, so if necessary, they can react very quickly to increase material cost changes and are prepared to do so. I would also mention our ETI program that we have in place that aims to offset the impact of material and labor costs and we have had some success on that this year. So we are taking a look at it from a number of different perspectives depending on the market conditions really in terms of making sure that we cap on the increased cost where applicable. We're also critically focused on securing availability given the production levels that we expect in the second half of this year.

Yes. It sounds like you're being really proactive here. Can you talk about what price realization will look like versus input cost increases in 2Q or the back half? I guess really would you expect to capture all price -- or sorry, costs increases in this fiscal year?

Yes. I think, Steve, if you look at kind of the backlog that we had entering the year, the price increases went into effect really January 1 for most of our businesses. So with the size of the backlog entering the year, a lot of what would shift in Q1 reflected kind of the old pricing. That's probably going to be -- and this isn't for our legacy ESG businesses. That's probably going to be pretty similar in the second quarter, because the pricing -- the incoming orders that we're receiving aren't really -- are probably going to start shipping, I would say, in the second half of the year. But that's also when we are expecting to see the impact of the material costs as we locked in pricing really through the first half of the year. So expect the impact in Q2 to be minimal, I would say. There will be some price realization, primarily on the TBEI side, which Jennifer just mentioned, they have shorter lead times so the incoming orders that we received post-price increase, some of those will shift in Q2. But for the legacy ESG businesses, it's more -- the impact will likely be felt in the second quarter, but that's when we'll start seeing the price realization. So we think that, that'll largely offset in the second half of the year and that's reflected in our outlook.

So I guess as you think about the positive benefits you get from volume absorption and the dynamics from price costs as you get into the back half, would you expect stronger incremental margin in ESGs and what you see in one half?

Yes. I certainly think we are expecting a strong second quarter. Q2 tends to be a strong quarter for TBEI. We're expecting that the rental and service activities kind of picked up with the improving weather conditions. Jennifer mentioned we have also -- we -- our backlog -- we referenced on the year-end call that we had a number of deliveries that were scheduled for April and beyond in our backlog. As Jennifer mentioned, we're off to a strong start at Vactor with record shipments in April as we aim to reduce those lead times. So I think Q2, we're certainly expecting improvement. As I mentioned, the impact of the material costs is largely going to be in the second half of the year. But overall, for the year, I think -- we are for the full year expecting improvement of the 2017 EBITDA margin, which was 12.6%.

Yes. I guess the only thing that I would add, Steve, is that the extended weather conditions in North America impacted our ESG business in the first quarter. We saw the street sweeping maintenance season that pushed out. And we'll see the benefits of that in the second quarter.

And I hear what you're seeing in terms of the change in customer procurement patterns, but can you talk about inquiry activity in April or May? Has that remained strong?

We're off to a solid start in April. I think I mentioned on the production side, we had a record at Vactor during April, but we're off to a solid start. But we do expect, as I mentioned, there was about $25 million of orders that were pulled forward into the Q1, from Q2, Q3 and Q4 really because for 2 reasons: one, because of our backlogs and two is customers wanted to make sure they can procure chassis.

Last question for me and I'll get back in line. Do you think you have better access to chassis supply than your customers and competitors? And is there a benefit to you if you source the chassis?

So we source the chassis in our ESG legacy businesses about 1/3, 30% to 40% of the time. And we -- we're looking at those issues very carefully and as I mentioned, we've secured the necessary chassis for 2018. We also have the ability to secure additional chassis, which we've done, so we have got stock and inventory available. And that is really where it gives us the competitive advantage, is if somebody needs a truck quick, we have got it available. And in some cases depending on the model if a customer couldn't get a chassis, we could potentially supply it to them. But we worked very closely with our customers in the ESG legacy side of the businesses to make sure that they've got the necessary chassis to support our production for 2018. On the TBEI side, the customers supply the chassis and yes, to date, we haven't seen an issue, but it's something we're continuing to monitor closely.

Yes. And Steve, I'll just add from the margin perspective, when we supply the chassis, it's less attractive from a margin standpoint, so that's one thing that -- to factor in, because we include the chassis in both the top line as well as our cost of sales, so it's less attractive from a gross margin standpoint.

But higher from a dollar standpoint, I would think, especially in this environment, can't you charge more for that chassis?

Correct, correct, correct. That was more -- historically, that's been the case.

We'll hear from Greg Burns with Sidoti & Company.

In terms of the capacity you're bringing online, it doesn't sound like you're expecting it to have much of an impact on margins, but can you give us a sense of the incremental investments and capacity and how that might impact margins? And then longer term, obviously the business is strong now, but how flexible is this added capacity you're adding if we see a little bit of the downturn in the business? How -- what's your ability to adjust going forward?

We can adjust up and down pretty quickly. And I can give you an example, the Vactor facility, which is our largest plant. We've added 50 employees starting in the fourth quarter of this year -- last year, sorry, and we're going to add another 30 to 40 employees. And we're very fortunate that we're considered a preferred employer in that area and we're able to attract talent to fill that need, which puts us in a unique position. So we're able to flex up and flex down pretty quickly. And we do have capacity at most of our plants to support the increased demand. And as the volume increases, for example, at our Vactor facility, we would see the margins also improve.

From Stonegate Capital Markets, Marco Rodriguez.

I was wondering if you could talk a little bit more about the pull-throughs. Were there any sort of, I don't know, certain geographies or end-market segments that are sort of driving these pull-through that you're seeing in the last couple of quarters?

I wouldn't say so much geographies, Marco, but what we saw with some of our dealers would have accelerate -- and I suppose that probably does translate to geographies. So there were certain states where our dealers may have placed their orders for the next 6 to 9 months in the first quarter and in the fourth quarter last year. The other thing just to know is just as it relates to replenishment of the rental fleets, those would likely be orders that were placed in the first quarter that were essentially just replacing units that they may have sold out that fleet.

And you had in your prepared remarks and comments about expectations of continued strong orders through the rest of fiscal '18? Is there an assumption that you guys continue to see these sort of pull-throughs? Or is that kind of run its course? Any sort of color there?

I think until some of our backlogs are extended right now and until we see those backlog numbers come down, we'll still see some advanced placement of orders, but we believe that majority of that has occurred in the first quarter, so we'll continue to monitor it closely.

And in terms of -- I know you guys published your gross margins by group in your filings, but do you by chance have those numbers offhand?

Yes. So it's not -- Marco, it's not gross margin. We published the EBITDA margins by group and so for SSG, it's 15% to 17% is the target. For ESG, it's 15% to 18%. And overall for the corporation, it's 12% to 16%, but it's EBITDA margin not gross margin.

And then in terms of the acquisition landscape, just to kind of follow-up on a prior question, can you comment a little bit about as far as what the valuations kind of look like out there for you guys?

Sure. With tax reform, there's more capital available and we see some of the valuations increase. We're continuing to work with a number of kind of private family companies, and so we're fortunate to have access to those opportunities. In addition, we're looking at the larger acquisitions where there's more of a process and those acquisitions' values tend to be a little bit higher, but right now, we're very busy.

And last quick question and I'll jump back in the queue. Just on the updated guidance here. You sort of narrowed the range, didn't really necessarily pick up the high-end of the range. A little bit higher than the low-end. Just kind of wondering, is that just being conservative? Or is there going to be perhaps some thinking through as far as the potential cost inflation as you may potentially see in the second half of the year?

Yes. So in terms of -- we raised the bottom $0.05 and we raised the top $0.02. And we also factored in the impact of commodity price increases in -- which we believe will impact us more in the second half of the year. So we think that, that was a material move, particularly given some of the commodity price increases that we pay. We are aggressively addressing them, but we'll move forward.

[Operator Instructions] And we'll take a follow-up from Steve Barger with KeyBanc Capital Markets.

Free cash flow conversion last year, if my model is right, was almost 130%. I know working cap may be a drag this year given the growth, but how are you thinking about conversion if you have a target this year?

Yes, it's -- we aim, Steve -- we always aim for like in excess of 100%. I think right now, it's probably -- it will hit our target. It may not be as high as the 130%, but that's -- we're expecting something north of 100%.

And if no acquisitions come through in the near term or it just takes a while, would you continue to delever or is there a leverage ratio, which you'd be more inclined to let the cash balance grow?

I think we would continue to pay down debt in the short-term, but I think, as Jennifer mentioned, the acquisition pipeline is full; so -- but if -- anything can happen with acquisitions, so if they don't pan out, we would continue to pay down debt.

[Operator Instructions]

In closing, we recently posted our annual report video on our website, and I would encourage you to go on our website and review it. Finally, I would like to reiterate that we are confident of the long-term prospects for our businesses and our markets. We would like to express our thanks to our stockholders, employees, distributors, dealers and customers for the continued support. Thank you for joining us today, and we will talk to you next quarter.

Ladies and gentlemen, that does conclude today's presentation. We do thank, everyone, for your participation, and you may now disconnect.