Federal Signal - Earnings Call - Q1 2018

Transcript

Speaker 0

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.

Speaker 1

Good morning and welcome to Federal Signal's first quarter twenty eighteen 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 of this year includes the operating results of Truck Bodies and Equipment International or TBEI, which we acquired last June. 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 orders driven by both organic growth and contributions from TBEI. We delivered significant margin expansion with our adjusted EBITDA margin up 110 basis points year over year, strong cash flow generation and robust earnings per share growth.

Consolidated net sales for the quarter were $249,700,000 up $72,000,000 or 40% compared to last year with approximately $21,000,000 or 12% coming from organic growth. Consolidated operating income for the quarter was $19,600,000 up $8,200,000 or 72 percent. On an adjusted basis, consolidated operating margin for the quarter was 8.5%, up from 7.5% in Q1 last year. Consolidated adjusted EBITDA for the quarter was $29,500,000 up $10,500,000 or 55%, which translates to a margin of 11.8% for the quarter, up from 10.7% last year. Income from continuing operations was $12,900,000 in Q1 this year compared to $7,200,000 last year.

That equates to GAAP EPS of $0.21 per share, up from $0.12 per share last year. On an adjusted basis, EPS for Q1 this year was $0.23 per share, which compared to $0.14 per share last year. As in the fourth quarter of last year, orders in the first quarter of this year were up significantly in comparison to the prior year period. Total orders for the quarter were $330,000,000 an increase of $115,000,000 or 54%. The improvement was largely driven by organic order growth of approximately $52,000,000 or 24% and the effects of the TBEI acquisition.

Jennifer will discuss some of the factors contributing to the order growth during her remarks. The significant order intake contributed to a consolidated backlog at the end of the quarter of $337,000,000 which was up $79,000,000 or 31% from the 2017 and up $163,000,000 or 94% in comparison to the prior year quarter. The increase in sales contributed to an $18,300,000 improvement in gross profit and consolidated gross margin improved to 24.8%, up from 24.5% last year. As a percentage of sales, our selling, engineering, general and administrative expenses for the quarter were down 100 basis points from Q1 last year. Compared to the prior year quarter, they were up 33%, primarily due to the addition of expenses associated with TDDI, a $2,000,000 increase in amortization expense and higher corporate operating expenses.

Other items affecting the quarterly results include a $300,000 decrease in restructuring charges, a $300,000 reduction in other income and a $1,900,000 increase in interest expense associated with higher average debt levels following the TBEI acquisition. Tax expense for the quarter was up $300,000 largely due to higher pretax income levels offset by the impact of the lower U. S. Federal tax rate following the enactment of tax reform in December. Primarily due to the recognition of a nominal discrete benefit from the release of tax reserves, our effective tax rate for the quarter was 24.1, a little lower than the rate that we expect for the full year and down from 34.5% last year.

The lower rate in comparison to the prior year reflects the reduction in The U. S. Federal tax rate. On an overall GAAP basis, we therefore earned $0.21 per share from continuing operations in Q1 this year compared with $0.12 per share in Q1 last year. To facilitate earnings comparisons, we typically adjust our GAAP earnings per share for unusual items recorded in the current or prior year quarters.

In the current year quarter, we made adjustments to GAAP earnings per share to exclude acquisition related expenses, purchase accounting expense effects and hearing loss settlement charges. On this basis, our adjusted earnings from continuing operations for Q1 this year were $0.23 per share compared with $0.14 per share in Q1 last year. Turning now to our group results. Within ESG, each of our businesses are performing well across our key market segments. First quarter sales were $196,600,000 up $68,800,000 or 54% compared to last year.

TBEI added $51,300,000 of sales during the quarter and higher domestic shipments of sewer cleaners and vacuum trucks contributed to a $17,500,000 organic sales improvement. ESG's operating income for the quarter was $20,600,000 double the $10,300,000 generated in Q1 last year. Adjusted EBITDA for the first quarter was $29,000,000 an improvement of $13,500,000 or 87% compared to $15,500,000 a year ago. That translates to an adjusted EBITDA margin of 14.8% in Q1 this year, which compares to 12.1% last year. The year over year margin improvement was realized in spite of the extended winter season in much of North America, which delayed the start of cleaning and maintenance projects for our street sweeping, parts and solutions businesses.

ESG reported total orders of $274,400,000 in Q1 this year, an increase of $107,800,000 or 65% compared to the prior year quarter. The improvement included organic growth of approximately $44,200,000 or 27%, which largely consisted of improved domestic orders for vacuum trucks and sewer cleaners. In what is typically its strongest quarter of bookings, TVEI also added almost $64,000,000 of orders in Q1 this year. Within SSG, first quarter sales were up $3,100,000 or 6%, largely due to higher global sales of public safety products and favorable foreign currency translation effects. Operating income for the quarter was $6,100,000 compared to $6,400,000 in Q1 last year.

Adjusted EBITDA for the first quarter was $7,000,000 down from $7,700,000 a year ago and SSG's adjusted EBITDA margin for Q1 was 13.2% compared to 15.4% last year. Although unfavorable sales mix and a soft earnings quarter for our Valmer public safety business in Spain resulted in SSG's margin for the quarter being lower than the prior year, its margin was in line with our expectations. With the political situation in Spain appearing to have stabilized, our pharma business reported stronger orders in Q1. We anticipate that it will recover from a soft first quarter and contribute to SSG's margin improving over the balance of the year. SSG reported total orders of $55,300,000 an increase of $7,300,000 or 15% from last year, primarily due to improved global orders for public safety products and domestic orders for warning systems.

Corporate operating expenses of $7,100,000 increased by $1,800,000 from last year, primarily driven by higher expenses associated with hearing loss litigation and increased employee benefit related costs. Looking now at cash flow, we generated $10,300,000 of operating cash flow in Q1 this year compared to $13,700,000 last year. During the quarter, we paid down an additional $9,000,000 of borrowings, bringing the total amount of debt paid down since we completed the TBEI acquisition to approximately $44,000,000 Our pro form a debt leverage ratio at the March was 2.1x, down from 2.7x at the closing of the acquisition in June. We ended the quarter with $232,000,000 of net debt and availability under our credit facility of $121,000,000 With the healthy cash flows expected to be generated by our businesses, we continue to focus on delevering in the short term. However, the long term priorities for our capital are unchanged.

And while maintaining strong liquidity and flexibility, we remain committed to investing in organic growth initiatives, considering additional M and A opportunities and returning value to shareholders. On that note, we paid a dividend of $07 per share during the first quarter, amounting to $4,200,000 and we recently announced an increased dividend of $08 per share for the second quarter. That concludes my comments and I would now like to turn the call over to Jennifer.

Speaker 2

Thank you, Ian. I would like to reiterate Ian's comments on the outstanding quarter. Our businesses are capitalizing on our leading niche positions in attractive markets while also benefiting from 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 $330,000,000 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.

On our last earnings call, we indicated that approximately 15,000,000 to $20,000,000 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 that this resulted in the acceleration of an additional $25,000,000 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 have experienced over the last year have resulted in lead times for certain of our product lines becoming extended.

Early in the quarter, we started taking actions in response. At some of our facilities, we added additional shifts and we have the ability to add more capacity. We have also added resources at key locations. For example, at our Vactor Streator plant, we have added 50 people since the beginning of the fourth quarter last year and are planning to add more as needed. We are fortunate to have a dedicated group of employees and good access to skilled labor at most of our manufacturing locations.

In addition, we have made incremental investments in new machinery such as laser cutting tools and robotic welding. These capital investments have quick paybacks and are expected to improve our productivity. We've also applied our flexible manufacturing model by moving production of certain low volume product lines to some of our FS solution centers. For example, we have moved production of our guzzler products to our Leeds facility in Alabama and our three yard smaller Vactor sewer cleaner to our service center in Illinois. This has freed up valuable capacity as we seek to reduce lead times.

The second factor relates to the increasing lead tightness in the availability of some chassis and more specifically situations where the customer is supplying the chassis. Because of concerns over the timing of chassis deliveries, we have seen some customers accelerate the placement of their orders because of concerns over the timing of chassis deliveries so that they've had more time to manage their chassis procurement. For our legacy ESG businesses, while it can vary year to year, typically customers supply about two thirds of the chassis and Federal Signal supplies about a third of the chassis. In situations where Federal Signal is providing the chassis, we have performed a detailed analysis of chassis orders and lead times within each of our businesses and we believe that we have secured adequate supply to cover our needs for the rest of twenty eighteen. We have also made certain strategic decisions to pre buy chassis in order to take advantage of short term customer demand.

In summary, the impact of this order acceleration will likely cause some distortion in our quarterly numbers order numbers in 2018, which might impact the comparability of our orders to prior periods. And although we aren't expecting the same run rate in terms of organic order growth as in the first quarter, we are anticipating strong order influence the rest of the year. I also wanted to address chassis availability at TBEI. For TBEI, the customer almost always supplies the chassis. On that note, we've actually seen chassis deliveries increase year over year at TBEI.

What we are hearing is that OEMs are giving named customer orders priority over dealer stock inventory in terms of delivery. So far this year, we have not seen any pressure from these constraints with very strong first quarter orders at TBEI, but it is something we will continue to monitor throughout the year. Similar to many industrial companies, we have noted the significant increase in the price of steel and other commodities since the beginning of the year. However, to put this in context for Federal Signal, we have about $40,000,000 of direct steel purchases each year, of which more than 50% relates to TBEI and about $10,000,000 of direct aluminum purchases, which is all TBEI. It is all sourced from North America.

I've been impressed with how the teams have managed their procurement of steel faced with the challenges of the market. We launched pricing for the first half of the year at favorable rates and we recently locked in pricing for the second half of the year within some of our businesses albeit at higher prices than in the first half of the year. The decision was as much about securing availability of steel given increased demand for domestic steel as it was about pricing. With the actions that we have taken, we feel confident that our supply of steel is sufficient to meet the increased production that we are anticipating at many of our facilities. In addition, during the quarter, the majority of our businesses implemented price increases and we also have the ability to pass on surcharges where applicable.

By locking in pricing for the first half of the year at favorable rates and with the pricing actions we have taken, we expect the impact of material cost increases in the second quarter to be minimal. But there is some risk that the impact of higher material costs flow through the income statement starting in the third quarter, which has been factored into our updated outlook. With that in mind, we are proactively addressing these challenges through our eightytwenty improvement or ETI program. As we mentioned last quarter, as part of our ongoing commitment to maintaining and improving our competitiveness in the marketplace, each of our businesses have incorporated specific productivity improvement targets into their operating plans for 2018. Utilizing eightytwenty principles, these initiatives include a combination of material cost reductions, manufacturing efficiencies, refinement of pricing strategies and working capital optimization.

While we aim to reduce the impact of material and wage inflation with these initiatives, we also seek to generate additional savings. In addition to our flexible manufacturing model that I previously discussed, I'd like to give you another example of a specific initiative we have recently implemented. We continue to make meaningful investments to improve our business performance and flexibility. At our back to plant in Streator, Illinois, we recently replaced one of our laser machine centers used for cutting sheet and plate with a new laser utilizing fiber optic technology. This new machine has doubled the output versus the previous machine while reducing overall maintenance cost.

The results for the Vactor plant is a 30% increase in total laser capacity, a primary work center that feeds all departments and a dramatic improvement in flexibility as we continue to respond to strong customer demand. We are already starting to see the benefits of these productivity improvements with shipments in April out of our Vactor Streator facility at record levels. We have also been applying our ETI program at TBEI. For example, our Vactor team has been working with the TBEI team in Rugby, North Dakota to share best practices to increase productivity through increased investment in laser technology. We believe that the aggressive actions that we have taken will help us improve our full year adjusted EBITDA margin from 12.6% last year.

As Ian mentioned, our pro form a debt leverage ratio at the end of the quarter is now down to a level that puts us in a solid position with significant flexibility to fund both organic growth initiatives and M and A. Acquisitions remain a priority for the deployment of our free cash flow. Our deal pipeline remains active. With our healthy cash flow generation and strong financial position in addition to the flexibility provided by tax reform, we are well positioned to strategically pursue attractive acquisition candidates. We are also relentless in our commitment to investing in organic growth through new product development.

Our businesses continue to unveil new products and solutions that are solving our customers' greatest challenges. One such example of delivering innovative new products focusing on solving historical customer pain point for store clear operators is our new Vactor rapid deployment boom. It has been a long desire of operators to be able to pull up to a job site and start cleaning without having to first set up two to three additional vacuum tubes on the end of a boom hose. This is a time consuming procedure that is also hard work, particularly in cold weather. Our new boom has virtually eliminated the need to add vacuum tubes at the majority of sewer cleaner jobs.

On a typical day, our customer averages five setups per day and each setup usually takes about twenty minutes. Without the need for this setup effort, the user can save up to one hundred minutes per day. We believe this new patent pending technology will give us a competitive advantage and will improve operator productivity by significantly reducing setup and teardown time over conventional boom design. From a safety standpoint, the new unit will also allow users to work in areas with low overhead clearance without raising the boom and still reach needed depths. The new unit will be available for delivery in the second half of this year and we've already started receiving orders after demonstrating the product at a large trade show earlier this year.

On the SSG side, we have recently introduced our new Allegiant product, a value line light bar with increased features and functionality. The Allegiant provides dual color light head capability at a price point which is very competitive with less feature rich light bars. The Allegiant light bar targets customers with tight budgets, but who need better emergency warning equipment. We estimate that this market segment represents about 35% of the total market in North America and creates an opportunity for us to grow our market share. New products such as these are key drivers to sustained organic growth and our long term success of Federal Signal.

I would now like to move on to our earnings outlook. The strength of our backlog, the aggressive actions we have taken to minimize the impact of increased commodity costs and the favorable conditions in our end markets provide us with increased confidence for the rest of the year. With that, we are raising our full year 2018 adjusted EPS outlook to a new range of $1.15 to $1.22 from a range of $1.1 to $1.2 In summary, we started off the year with outstanding performance. Our talented teams and their businesses have positioned the company for another year of growth. Our foundation is strong and we are focused on delivering profitable long term growth through the execution of our strategic initiative.

At this time, I think we are ready for questions. Operator?

Speaker 0

Thank And your first question will come from Chris Moore with CJS Securities.

Speaker 1

Hey guys. Good morning Chris.

Speaker 3

Good morning. Thanks for taking my

Speaker 1

questions. Maybe

Speaker 3

just quick on oil and gas, any kind of you seeing much improvement on that front or I know it had been mostly through TBEI before this, but I mean, excuse me, through Joy Johnson, but have you seen much in the last few months?

Speaker 2

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 fleet. 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 it's something we continue to monitor closely and we're encouraged by what we're seeing.

Speaker 3

Got it. Maybe we could just talk a little bit more about the 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.

Speaker 2

Yes, a couple of things there. Mark is spending about 50% of his time out of 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 although it was down from last year, it really was in line with our expectations.

We had previously talked about the political situation in Barcelona where our Obama business is that has stabilized. And although Obama 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.

Speaker 3

Got it. And that's on the margin side as well or?

Speaker 2

Correct.

Speaker 3

Okay. 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 twenty six percent and twenty seven for the year?

Speaker 1

Yes. It was a little lower, Chris. In Q1, we had 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 two just to take over 24%. We still think for the full year, we're to

Speaker 4

be within that 26%

Speaker 1

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. But right now, our best estimate is the low end of the previously issued tax rate range of like $0.26 to $0.27

Speaker 3

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

Speaker 2

I think that we're looking at both our ESG legacy businesses and TBIs. There was a product line opportunity at SSG. We would also consider that. Our pipeline is we're very active right now in the markets. But again, it's at the right valuation and it has to advance the strategic initiatives.

So we've got a number of opportunities right now that we're exploring.

Speaker 3

Got it. I appreciate it guys. I'll jump back in line.

Speaker 2

Thank you.

Speaker 0

From KeyBanc Capital Markets, Steve Barger.

Speaker 5

Hey, good morning.

Speaker 2

Good morning, Steve.

Speaker 1

Good morning, Steve.

Speaker 5

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

Speaker 2

Sure. Right now, we haven't seen outside of 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 26% 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 $40,000,000 we have about $40,000,000 of steel purchases and another $10,000,000 of aluminum purchases. The vast majority of that relates to TDDI. So it's about 5% to 6% of our total sales and about 10% of our material costs. So looking at this, we locked in on steel aluminum prices for the first half of the year for some of our businesses that we've 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 TDDI, for example, can their quotes are only good for thirty to sixty 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've had some success on that this year. So we're taking a look at it from a number of different perspectives depending on the market conditions, really in terms of making sure that we pass on the increased costs where applicable, but also we're critically we're focused on securing availability given the production levels that we expect in the second half of this year.

Speaker 5

Yes. No, 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? And I guess really would you expect to capture all price sorry, cost increases in this fiscal year?

Speaker 1

Yes. And 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 we are still with the size of the backlog entering the year, a lot of what was shipped 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 probably going to start shipping, I would say, the second half of the year.

But that's also when we're expecting to see the impact of the material costs. As we talked about, 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 ship 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. We think that they'll largely offset in the second half of the year and that's reflected in our outlook.

Speaker 5

Right. So I guess as you think about the positive benefits you get from volume absorption and the dynamics from pricecost as you get into the back half, would you expect stronger incremental margins in ESG than what you see in one half?

Speaker 1

Yes. I certainly think we are expecting a strong second quarter. Q2 tends to be a strong quarter for TDDI. We are expecting that the rental and service activity is going to pick up with the improving weather conditions. Jennifer mentioned, we've also 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 of ACTA with record shipments in April as we aim to reduce those lead times. So I think Q2 we are certainly expecting improvement. As I mentioned, the impact of the material cost 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 over twenty seventeen EBITDA margin, which was 12.6%.

Speaker 2

Yes. Guess the other thing 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 sleeping maintenance season get pushed out and we'll see the benefits of that in the second quarter.

Speaker 5

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

Speaker 2

We're off to a solid start in April. I think I mentioned on the production side we hit a record at Vactor during April, but we're off to a solid start. But we do expect as I mentioned that there was about 25,000,000 of orders that were pulled forward into Q1 from Q2, Q3 and Q4 really because for two reasons: one, because of our backlog and two is customers want to make sure they can procure chassis.

Speaker 5

Right. 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?

Speaker 2

So we source the chassis in our ESG legacy businesses about onethree, 30% to 40% of the time. And 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've got stock inventory available.

And that's really where it gives us the competitive advantage is if somebody needs a truck quick, we've 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 and ESG legacy side of the businesses to make sure that they've got the necessary chassis to support our production for 2018. On the TDDI side, the customers supply the chassis and to date, we haven't seen an issue, but it's something we're continuing to monitor closely.

Speaker 1

Yes. And then 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 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.

Speaker 5

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

Speaker 1

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

Speaker 5

Understood. Thanks.

Speaker 2

Thank you.

Speaker 0

We'll hear from Greg Burns with Zoe Company.

Speaker 6

Hi, good morning.

Speaker 2

Good morning, Greg.

Speaker 1

Hi, Greg. Hi.

Speaker 6

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 in capacity, 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 a downturn in the business? How what's your ability to adjust going forward?

Speaker 2

Yes, we can adjust up and down pretty quickly and I can give you an example. Our Vactor facility, which is our largest plant, we've added 15 employees starting in the fourth quarter of this year of 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.

Speaker 1

Okay. Thank you.

Speaker 0

From Stonegate Capital Markets, Marco Rodriguez.

Speaker 4

Good morning, guys. Thank you for hey, thanks for taking my questions. 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 this pull through that you're seeing in last couple of quarters?

Speaker 1

I wouldn't say so much geographies, Marco, but what we saw with some of our dealers would have accelerated. I suppose that probably does translate to geographies. So there are certain states where our dealers may have placed their orders for the next six to nine months in the first quarter and in the fourth quarter of last year. The other thing just to note is just as it relates to the replenishment of their rental fleet, 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.

Speaker 4

Understood. And you had in your prepared remarks some comments about expectations of continued strong orders through the rest of fiscal twenty eighteen. Is there an assumption that you guys continue to see these sort of pull throughs or has that kind of run its course, any sort of color there?

Speaker 2

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 the majority of that has occurred in the first quarter, so we'll continue to monitor it closely.

Speaker 4

Got you. 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?

Speaker 1

Yes. So 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. Okay.

Speaker 4

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?

Speaker 2

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

But right now, we're very busy.

Speaker 1

Got

Speaker 4

you. And last quick question, 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 maybe perhaps some thinking through as far as the potential cost inflation as you may potentially see in the

Speaker 1

second half of the year?

Speaker 2

Yes. So in terms of we raised the bottom 0 $5 and we raised the top zero two dollars And we also factored in the impact of commodity price increases in the 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 face. We're aggressively addressing them, but we'll move forward.

Speaker 4

Got you. Thanks a lot guys. I appreciate your time.

Speaker 2

Thanks, Melissa. Thank you.

Speaker 0

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

Speaker 5

Hey, thanks. 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?

Speaker 1

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

Speaker 5

Good. 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 at which you'd be more inclined to let the cash balance grow?

Speaker 1

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 anything can happen with acquisitions. So if they don't pan out, we would continue to pay down debt.

Speaker 5

Understood. Thanks.

Speaker 0

In

Speaker 2

closing, we recently posted our annual report video on our Web site and I would encourage you to go on our Web site and review it. Finally, I would like to reiterate that we are confident in 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 their continued support. Thank you for joining us today and we will talk to you next quarter.

Speaker 0

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