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Edited Transcript of FSS earnings conference call or presentation 2-May-19 2:00pm GMT

Q1 2019 Federal Signal Corp Earnings Call

OAK BROOK May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Federal Signal Corp earnings conference call or presentation Thursday, May 2, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ian A. Hudson

Federal Signal Corporation - Senior VP & CFO

* Jennifer L. Sherman

Federal Signal Corporation - President, CEO & Director

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Conference Call Participants

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* Christopher Paul Moore

CJS Securities, Inc. - Senior Research Analyst

* Gregory John Burns

Sidoti & Company, LLC - Senior Equity Research Analyst

* Marco Andres Rodriguez

Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to the Federal Signal Corporation first quarter earnings conference call. (Operator Instruction] I will now turn the conference over to your host, Ian Hudson, Chief Financial Officer. Mr. Hudson, you may begin.

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [2]

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Good morning and welcome to Federal Signal's first quarter 2019 conference call. I'm Ian Hudson, the company's Chief Financial Officer. Also with me on the call today is Jennifer Sherman, our President and Chief Executive Officer. We will refer to some presentation slides today. As well as to the earnings news release which we issued this morning. The slides can be followed online by going to our website federalsignal.com. Clicking on the Investor Call icon and signing into the webcast.

We have also posted the slide presentation and the earnings release under the Investor tab on our website. 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 US 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 today 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 2019. After our prepared comments. Jennifer and I will address your questions. Our consolidated first quarter financial results are provided in today's earnings release. We had another strong quarter with results reflecting impressive increases in sales and income driven by strong broad-based organic growth.

We delivered significant margin expansion and a 30% improvement in adjusted earnings per share. Consolidated net sales were $273.8 million, up $24 million or 10% compared to last year. Consolidated operating income was $25.8 million, up $6.2 million or 32% from Q1 last year. On an adjusted basis, consolidated operating margin was 9.7% up from 8.5% in Q1 last year. Consolidated adjusted EBITDA was $35.9 million, up $6.9 million or 24% from Q1 last year. That translates to a margin of 13.1% in Q1 this year, up from 11.6% last year. Net income in Q1 this year was $17.5 million compared to $12.9 million last year, that equates to GAAP EPS of $0.29 per share, up 38% from $0.21 per share last year. On an adjusted basis, EPS for Q1 this year was $0.30 per share, which compares to $0.23 per share last year.

Order intake in the first quarter of this year continued to be strong at approximately $300 million that was up sequentially from the fourth quarter of last year but down in comparison to the record levels in Q1 last year, which included approximately $25 million of sewer cleaner and vacuum truck orders which were accelerated from subsequent quarters in 2018. With a significant order intake in the first quarter of this year, our consolidated backlog at the end of the quarter was at a record level of $364 million that represents an increase of $26 million or 8% from the end of 2018, and an increase of $27 million or 8% compared to Q1 last year. In terms of our first quarter group results, ESG reported first quarter sales of $219.5 million up $22.9 million or 12% compared to last year.

All of that growth was organic. ESG's operating income for the quarter was $25.7 million, up $5.1 million or 25% from Q1 last year. Adjusted EBITDA for the quarter was $34.7 million, an improvement of $6 million or 21% from a year ago. That translates to an adjusted EBITDA margin of 15.8% in Q1 this year, which compares to 14.6% last year. The increase was largely driven by improved operating leverage and benefits from pricing actions that were realized in spite of higher material costs compared to Q1 last year. We also had to overcome several days of production disruption at certain of our facilities caused by the polar vortex and other severe weather conditions. ESG reported total orders of $243.7 million in Q1 this year, up $4.1 million or 2% sequentially but down in comparison to the record order intake of $274.4 million in Q1 last year with the majority of the reduction attributed to the orders acceleration that I just referenced. SSG delivered another strong quarter with sales up $1.2 million or 2% largely due to increases in global sales of public safety products and industrial signaling equipment in the US, partially offset by lower domestic warning system sales, which tend to be lumpy.

Operating income for the quarter was much improved at $8.7 million compared to $6.1 million in Q1 last year. Adjusted EBITDA for the quarter was $9.6 million, up from $6.8 million a year ago and adjusted EBITDA margin for Q1 this year was 17.7% compared to 12.8% last year. The 490 basis point improvement was largely the result of our pricing actions. Improved sales mix and a much improved first quarter for VAMA Public Safety business in Spain. SSG's orders of $55.3 million were consistent with its order intake in Q1 last year. Corporate operating expenses of $8.6 million increased by $1.5 million from last year, primarily due to higher employee-related costs, which were partially offset by lower expenses associated with hearing loss litigation.

Turning now to the income statement, where the increase in sales contributed to an $8.4 million improvement in gross profit. Consolidated gross margin improved to 25.7% for the quarter, up from 24.8% last year. As a percentage of sales, our selling, engineering, general and administrative expenses for the quarter were down 70 basis points from Q1 last year. Other items affecting the quarterly results include a $300,000 increase in other expense and a $500,000 reduction in interest expense associated with lower average debt levels. Tax expense for the quarter was up $1.8 million largely due to higher pretax income levels. Our effective tax rate for the quarter was 25.2% in line with expectations and up slightly from Q1 last year when a nominal discrete benefit from the release of tax reserves was recognized. On an overall GAAP basis, we therefore earned $0.29 per share in Q1 this year compared to a $0.21 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 and purchase accounting expense effects. On this basis, our adjusted earnings for Q1 this year was $0.30 per share, up 30% compared with $0.23 per share in Q1 last year. Looking now at cash flow, where we used $8.8 million of cash in operations in the quarter, the first quarter is typically a period in which our businesses add working capital. In addition, in Q1 this year, we funded higher incentive compensation and tax payments, an additional rental fleet investment in comparison to last year's Q1. We are expecting our operating cash flow to improve in the second quarter and continue to target similar cash conversion as in 2018.

We ended the quarter with $194 million of net debt and availability under our credit facility of $173 million. Our debt leverage ratio remained at a comfortable level and unchanged from year-end. Our strong financial position allows us to continue to invest in organic growth initiatives like ongoing new product development and the expansion of our Vactor facility. At the same time, we remain committed to pursuing strategic acquisitions and funding cash returns to shareholders. On that note, we paid a dividend of $0.08 per share during the first quarter amounting to $4.8 million and we recently announced a similar dividend for the second quarter.

We also funded opportunistic share repurchases during the first quarter, spending $1 million to buy back shares at an average price of $19.84. We have about $29 million remaining under our share repurchase authorization at the end of Q1. That concludes my comments and I would now like to turn the call over to Jennifer.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [3]

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Thank you, Ian. I would like to reiterate Ian's comments on the outstanding quarter. Each of our groups reported top line growth and margin improvement, and on a consolidated basis, our adjusted EBITDA margin was up 150 basis points. We were expecting year-over-year improvement in our first quarter results and our actual results, did not disappoint. Within ESG, we saw stronger aftermarket demand in certain parts of North America with rental activity starting slightly earlier this year, as well as some earlier than expected deliveries. Within SSG, our police business in Europe successfully delivered on a number of projects to satisfy accelerated customer requirements.

We also saw some customers in the U.S. place orders for public safety equipment earlier than expected in anticipation of the Ford model year changeover scheduled for the second quarter of 2019. This changeover may cause a temporary delay in the number of Ford police vehicles available beginning in Q2. Collectively, we estimate that these factors resulted in the acceleration of about $0.02 of earnings from the second quarter into Q1.

Our first quarter orders were generally in line with our expectations with higher than expected orders for vacuum trucks resulting from continued momentum on our safe digging initiative, being partially offset by slightly lower than expected orders for dump truck bodies and trailers. Orders in the first quarter of this year were our third highest on record surpassed only by the fourth quarter of 2017 and the first quarter of last year, which collectively included an estimated $40 million to $45 million of accelerated orders as customers placed orders earlier as they sought to secure availability of certain product lines like sewer cleaners and vacuum trucks or to manage the procurement of their related chassis. We expect that this order acceleration, which we believe has now normalized, may cause some short-term distortion in the comparability of our quarterly orders and as such consider comparisons of backlog levels to be a more reasonable indication of the strength of our market.

At the end of March, our backlog was at a record level and was up over $25 million or 8% compared to both year-end and the prior year quarter.

As we look forward, we continue to feel good about conditions in our end markets. I recently attended our bi-annual ESG dealer meeting with a sentiment among our municipal dealer network relating to market conditions in 2019 was very positive.

However, with current lead times, continuing to be extended for sewer cleaners and vacuum trucks, orders received in the second quarter and beyond may not translate to revenue and income during 2019.

I am excited to share that during the first quarter, we launched our new TRUVAC brand, a dedicated line of industrial vacuum excavation trucks designed specifically to satisfy the safe digging requirements of organizations, that locate and verify underground utility lines and pipes. TRUVAC vacuum excavators use high-pressure air or water to loosen soil providing a non-destructive means to safely locate, excavate and uncover underground utilities. The loosened soil is removed through a vacuum hose and may be deposited into a debris tank for disposals or backfilling. The TRUVAC brand will focus on vacuum excavation brand while the Vactor brand will continue to focus on equipment solutions for cleaning and maintaining sewers and catch basins. A separate brand TRUVAC for our safe diggings products will allow us to continue to focus and distinguish ourselves in the marketplace in this critical growth area for the company. TRUVAC has been established to address the need for safe digging in the United States and Canada. Our safe digging equipment can be used in markets, with strong growth potential given the increased speed to address both aging infrastructure, that is currently in place and support new infrastructure, that will be needed for next-generation technologies like 5G.

In addition, with more than 90 million miles of buried utilities in the United States alone, the risk of utility strikes caused by poor excavator digging practices, are too great to ignore and incidents of gas line explosions, power outages and burst water lines causing injuries, fatalities and property damage continue to occur at an alarming rate.

While the TRUVAC brand is new, the products, technology and quality are well-established by the Vactor brand which brings more than a 100 years of operator-focused innovation excellence more than 50 years of experience building equipment that combines high-pressure water and vacuum technology and more than 20 years of experience manufacturing vacuum excavators.

The current TRUVAC product line includes the versatile ParaDIGm sub-compact vacuum excavator, the Prodigy vacuum excavator that offers power and performance in a smaller footprint and the HXX series of full-sized vacuum excavators designed to tackle the biggest digging projects.

We continue to invest in new product development relating to safe digging and recently kicked off a project to further enhance our safe digging product portfolio.

TRUVAC will serve to differentiate our position in the marketplace with a complete range of truck-mounted safe digging equipment and a dedicated aftermarket infrastructure.

We believe that these factors, along with our deep expertise and our history of delivering exceptional value to a growing customer base, give us a strong competitive advantage. In response to this growth potential, we see for safe digging, we recently announced plans to invest up to $25 million to expand our Streator, Illinois manufacturing facility.

This project is now underway and is expected to be completed by the end of 2019. As Ian mentioned, our debt leverage ratio at the end of the quarter is at a level that puts us in a solid position with significant flexibility to fund both organic growth initiatives and M&A.

While we will remain disciplined in our approach as we were in 2018, acquisitions remain a key priority for the deployment of our free cash flow and the company's growth. We target companies that accelerate our current strategic initiatives or provide a platform for growth in adjacent markets for new geographies. We also see niche market leaders that have a sustainable competitive advantage and have strong management team. We look for companies that have solid growth potential and operate within our target EBITDA ranges, either currently or after the application of our ETI principal.

Our deal pipeline remains active, and we expect future strategic acquisitions to be a meaningful part of our growth.

Finally, as you may have heard earlier this week, there were some positive developments relating to a potential infrastructure bill. If infrastructure legislation were to pass, with our various businesses, which support maintenance and infrastructure markets, Federal Signal would stand to benefit. We will continue to monitor any additional development.

I would now like to move on to our earnings outlook. With the better than expected performance in the first quarter and the strength of our backlog, we have greater confidence in the year and are raising the low end of our 2019 adjusted EPS outlook range by $0.02, establishing a new range of $1.50 to $1.60. In summary, we started the year with outstanding performance. Our talented and dedicated teams and their businesses have positioned the company for another year of growth. During Q1, we faced some unusually tough weather conditions at several of our northern locations and the teams did a super job navigating through these challenges to deliver our strong results. At this time, I think we are ready for questions, operator?

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Questions and Answers

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Operator [1]

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At this time, we'll be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Chris Moore from CJS Securities.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [2]

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You touched on it, but maybe we could just talk a little bit about, some of the things that are likely to affect kind of the revenue and earnings cadence over the next 3 quarters, there's the Ford model year changeover which looks like you stole little bit of Q2 earnings perhaps and there is, and you talked about the extended lead times on the sewer cleaners and vac trucks some of those orders may not happen in '19 but maybe can you just touch on the key elements that we should be considering?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [3]

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Sure, absolutely, Chris. First of all, we saw as we mentioned $0.02 move from Q2 to Q1 and that was really driven by strong aftermarket in certain parts of the US, some pre-buyings that occurred in our Public Safety Systems business in advance of the Ford year model changeover, and some cut -- acceleration of customer orders and deliveries at our business in Spain. But I think what -- we're really encouraged by even with that $0.02 shift and the Ford model year changeover, we expect Q2 that will do nominally better than we did last year. And you might recall that last year was a really strong quarter for Q2.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [4]

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Absolutely. Okay, that's helpful. And then in terms of the, I guess 2 part question. So the lead times with the sewer cleaners and vacuum truck is part of -- of why the Streator facility is being expanded, so is there likely much order flow that's going to -- revenue is not going to get recognized this year. And then secondly, after Streator is completed are there any other areas that likely need to be expanded to allow for continued growth?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [5]

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Yes, good question. First of all, last year, we made some investments in our service center in Leeds, Alabama and we should start to see the benefits of that in the second half of the year for our Guzzler product lines, and we will be building more trucks there this year versus last year. As you know, we continue to believe that the growth opportunities for our safe digging are significant. Early in the quarter, we announced up to a $25 million expansion of our Vactor facility, pleased to report that we are on track with that expansion. We purchased the land, we're waiting for some zoning permits and we expect that to be completed at the end of this year. We are looking within our TDI facilities. There is some growth that we will be expanding our Rugby facility up in Rugby, North Dakota and we expect again to have that completed this year. And these expansions, a large part are driven by the success that we're having with respect to introduction of new products.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [6]

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Got it. Very helpful. It's only a small number, the 600,000 acquisition integration related to anything that we should read into that?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [7]

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Nothing really, Chris, it's really just kind of a standard. We have the JJE earn-out payment that is coming due in the second quarter and a lot of that is really just accreting that liability, it's recorded present value right now and a lot of that is just the accretion as we get closer to payment when we'll actually make the cash payment.

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Operator [8]

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Our next question comes from the line of Greg Burns from Sidoti & Company.

I'm sorry, if something was altered in the queue. One moment.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [9]

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Running at or above the high end of your...

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Operator [10]

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Greg, your line is now live.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [11]

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Okay, so with the -- the SSG margins, you probably benefited a little bit from the pull-forward from Q2 this quarter, but they have been running at or above the high end of your target range. How should we think about the margin profile of that business? Is this, do you see -- do you think the margins. This is the kind of the new normal, the higher-end more like a 16% to 18% range as opposed to what you've previously targeted.

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [12]

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Yes, Greg, I think we've obviously the last couple of quarters we've benefited -- I think the margin has exceeded, our target range for 15% to 17% range each of the last two quarters. That business, it can be pretty lumpy there can be systems orders that have -- the mix can be a factor in that equation. I think the 15% to 17% range is where we feel comfortable quarter in quarter out, we want to be within that range. I think if you look back to the first quarter of last year, you know, we were lower than that and that was really the function of a soft quarter in our VAMA business in Spain really the residual effect of the (inaudible) uncertainty that was in place in that location kind of throughout 2017 that lingered into the first quarter of '18. So that business has recovered very nicely, had a very strong Q1 of this year. So I think as we go forward, we still feel pretty comfortable with that 15% to 17% range.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [13]

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Yes, because -- the other thing I think can add to what Ian said, is that, again we are really seeing the benefits of the increased volume as a result of our new product development initiatives with SSG and continued application of our ETI (inaudible).

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [14]

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Okay, and Jennifer, you had mentioned orders dump, trucks and body orders were down a little bit, I know that housing data has been a little bit soft over the last couple of months. So what's your outlook for that business? Are you seeing a little bit of a slowdown, given what we're seeing in the housing market. Thanks.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [15]

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Yes. I guess I see a couple of things. First of all is both bump trucks and trailers, we saw weather played a factor there because of kind of some of severe weather conditions across North America, the construction work was delayed. We also saw that the chassis -- some of the chassis challenges that we -- there weren't as many stock orders placed at some of our distributors and with that business orders tends to be a less relevant metric than for example Vactor Elgin because we often [get] -- we were going to ship it within the quarter. Looking forward, we are expecting top line year-over-year revenue growth for that business, so I continue to be encouraged by, we've got a number of new customers, we are expanding our Rugby facility to accommodate growth, so overall, I am focused on the year-over-year top line growth.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [16]

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Okay, great. And obviously, you mentioned the benefit that you got from some of the pull-forward from the SSG, but you also had some weather-related issues. So what the offset in terms of the weather. How much did that detract from -- from earnings in the quarter?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [17]

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I think, Greg, when we, when we talked -- at the end of February, we gave our full year outlook and at that time I was right in the midst of some really, certainly in Chicago, some really unfavorable weather, the polar vortex and so at that time we kind of signaled that -- that was all factored into our outlook that we gave. I think what we found is that in March, the businesses just did a great job kind of overcoming those effects, certain of our facilities were shut down for a couple of days and I think, we recovered -- the recovery was better than what we expected.

So I think Q1, we talked about it being slightly better than expected and I think the, the quicker than expected recovery from those effects were the factor in -- in our strong results in the first quarter.

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Operator [18]

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Our next question comes from the line of Marco Rodriguez from Stonegate Capital Partners.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [19]

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I was wondering if maybe you can talk a little bit more about the, your safe digging. If you can maybe help provide any sort of framework in terms of maybe what sort of percentage of revenues is coming from that that new line and then also in the past, you've talked about some regulatory shifts that have kind of helped spur that market. I was wondering if you can maybe talk to that if you've seen any other additional regulatory shifts that are driving demand or business more of just the end markets kind of recognizing the application little bit more readily.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [20]

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Yes, couple of things. One is we are continuing to see traction and vacuum truck orders were up just even compared to Q4 and compared to Q1 of last year, even despite the pull forward. So that to me is a really important indicator of the continuing success of that initiative. As I mentioned in my prepared remarks, we launched a separate brand, TRUVAC this quarter for our safe digging products. I was with our -- at our dealer meeting a month ago. And there's a lot of energy around this particular product and we'll watch -- we are now seeing our dealers invest in rental equipment, which as we previously talked about, demos are so important to introducing in many cases this new -- new technology to end customers. We're much more active in trade shows world. We've been -- spent a lot of time, Q1 out at utility type trade shows and we are seeing traction there. So overall, we believe with the new brand, TRUVAC and the strong channel, so this will be continuing to be a growth area for us. And as I previously mentioned that was really the driver of the $25 million plant expansion in Vactor. Because ultimately, we believe that our safe digging product line will be as big as sewer cleaners and we're preparing for that. The final thing I'd mention is, we're continuing to invest in new product development and we kicked off of a project in Q1 to enhance our safe digging portfolios of products. So this is a critical area and we're encouraged by what we're seeing .

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [21]

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Got you, and given the strength that you're seeing there on the safe digging side, can you talk a little bit about your ability to kind of push prices a little bit higher there?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [22]

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Sure. You know it depends in terms of what region we are in but it is product that typically we're able to command a premium price because of the quality, and durability of our products.

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [23]

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Yes. I'd also add Marco that it's -- the nature of the product, it's a nice play on the rental side as well. So we have a number of safe digging vehicles in our rental fleet. And those are in pretty high demand and we monitor both time utilization and financial utilization and both of those rates have been in excess of our target range for that certainly for the last couple of quarters. And so that's where, when you have the demand for the product that you start to see some of that through the rental rates.

So it's also a part of the reason that you may have seen that we made some additional investment in the rental fleet during the first quarter certainly in comparison to Q1 of last year. So that's really a function, it's just the continued strength that we see in the safe digging market.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [24]

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Got it. That's helpful and then kind of in the same line of thinking here. Just on the cash flow from operation aspects that -- that the changes in working capital were relatively significant here in Q1, driving usage. Am I to assume that that's mainly a function of the investments in the rental fleet. Just kind of looking at comparisons to your historical Q1s are they're not normally down, but it has happened in the past. Just trying to get a better feel for that.

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [25]

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Yes, Q1 is typically, we build working capital in the first quarter as we ramp up production. So it's not unusual for us to use cash in the first quarter, as we mentioned, the biggest part of the change year-over-year, it was really the additional rental fleet investment compared to Q1 last year. That was about $10 million. That really is kind of a strategic move really because you want to be adding to the rental fleet prior to the peak season for rental and aftermarket which is typically the Q2 and Q3 when a lot of the activity is taking place. So that was, that was really a shift in timing of the investment. Others -- other than that we had higher tax payments that was there about $3 million higher than they were in Q1 last year and incentive compensation payments in Q1 this year were higher than they were in 2018. So those are the primary drivers. Some of the working capital changes as the timing-related, and I think, we'll -- we expect our operating cash flow in Q2 to improve and we said on the call, I think that we are targeting the same cash conversion as we had in 2018.

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Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [26]

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Got you. And last quick question, I'll jump back in the queue. Maybe if you guys can talk a little bit more about the M&A landscape, is your pipeline increasing, decreasing? And then if you can maybe talk a bit about the valuations you're seeing out there.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [27]

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Yes, our pipeline is full. We continue to be active in the M&A market, so we believe that long-term that this is going to be an important part of our growth. I said last year and I reiterated in the shareholder letter that we are committed to being disciplined with shareholders' money and paying a fair valuation and that unfortunately during 2018, there were a couple of deals that didn't work out for us, because in our opinion the valuations got too high. But as we sit here right now, and -- we are encouraged by what we're seeing.

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Operator [28]

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[Operator Instruction] Our next question comes from the line of Steve Barger from KeyBanc.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [29]

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How are you marketing TRUVAC? Is that a corporate function? Or do the dealers do that?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [30]

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It's really a combination. Certain of our dealers have the rights to TRUVAC. In other areas, particularly, we have service centers, we've gone direct. And the marketing though has been coordinated out of our ESG group, it's a pretty significant effort.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [31]

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Yes. And do you expect to see more traction for TRUVAC in direct sales or through the rental channel, whether it's dealer-based or your captive fleet?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [32]

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Again, orders were up for vacuum trucks both from Q1 of last year and Q4. So I think it's going to be a combination. What makes the sale different than anything we've done before is that the sales often contingent upon from a successful demo of the equipment. So why we measure those demos because it's new technology for many people, not all, and we need to show them both the productivity benefits of the equipment and the safety features of the equipment. So we believe that we're in a unique position, because we've got our TRUVAC dealers are making their own investments in rental fleet and the sale of new equipment. We're in a position with our asset solution centers, our aftermarket group to support that direct where we need to and we really can offer the customer either new equipment, rental or used equipment, and then between us and our dealers, we have over 60 service centers in North America to support that equipment.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [33]

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Got it. And can you remind us how you view current market size for safe digging in 2019 and 2020 and any guess what your market share is right now?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [34]

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Yes. With respect to market share, there isn't a lot of good data out there. I do know that in terms of the breadth of our product offering, we've got a small version, ParaDIGm, and medium version the Prodigy and the large version HXX. We have also introduced a lighter version and a quieter version. And as I mentioned, we kicked off another project during Q1 to continue to invest. We have the -- in terms of broad breadth of equipment. With respect to market size, we are still working on it. We talk about $250 million. We think that's very conservative because what makes it challenging here, we are seeing backlift and shovels. And so that's, we're still working through that, but we're really encouraged by the growth that we're seeing and I know the TRUVAC dealers are often encouraged by it.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [35]

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When you say $250 million, are you talking about potential for 2020 or is that kind of a multi-year target out there?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [36]

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Really potential for the market ties, potential for 2020.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [37]

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Okay, that's impressive. Can you talk about the gross margin expansion you saw in the quarter?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [38]

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Yes, but I want to be clear to you, I'm talking about market size potential.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [39]

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Market size. Yes, yes. But when you look at your product category, I mean you would think you are the market share leader right now, right?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [40]

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Yes. Although we don't have any third party data to support that.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [41]

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But when you go to trade shows or whatever, do you see other really sizable credible competitors out there in the safe digging space?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [42]

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In niche areas, yes, but nobody with the breadth of our product offerings.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [43]

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Right. Gross margin expansion. What drove that? And do you have a target for gross margin expansion for the year?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [44]

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So what drove it, Steve on, kind of with primarily within the SSG business. If you looked at SSG, their gross margin went from 35.8% to 39%. So that was the primary driver of kind of the overall improvement in the margin that was driven in part by the benefits from the pricing actions that we took both last year as well as beginning this year. It's -- some of it's also a mix factor, as I mentioned the VAMA business in Spain had a much better first quarter than it did in Q1 of last year. So it was primarily driven by SSG. We don't specifically have a spirited gross margin target, we really focus on offering within those EBITDA margin ranges obviously of which gross margin is clearly a factor. But there isn't anything that we publish in terms of an external goal that we measure to. We have a -- we have our internal metrics and that we could factored into kind of the -- the overall EBITDA margin ranges.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [45]

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Just the other thing, the other thing I would add, Steve, is last year was the first year that we added to all salary employees short term compensation, a metric around EBITDA margins and we really believe that drove some great behavior by our teams.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [46]

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Good to hear and just last one for me. Thinking about free cash flow and the $45 million in combined CapEx, just round numbers, if you hit your target, you could have $80 million to $90 million in free cash flow this year, so do you have a debt reduction target beyond saying less than last year and ex-potential M&A, is that your first priority?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [47]

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Yes, I think we -- as Jennifer mentioned, Steve, we're encouraged with what we see on the M&A pipeline, so at the leverage range we are at right now, we are at 1.3x, I think that's a very comfortable range for us. So I think our focus obviously post TBEI acquisition was really to pay down debt and delever quickly. I think, we're now at a point where, we -- organic growth, clearly with the Vactor expansion and as Jennifer mentioned, we are looking to expand the Rugby facility as well. Organic would be the #1 priority but then #2 would be M&A and we are encouraged with what we see there. So I don't think -- we don't have a stated debt reduction target for the year, but we're -- we're clearly -- we are very comfortable with the leverage we're at right now.

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Operator [48]

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Our next question comes from line of Walter Liptak from Seaport Global Securities.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [49]

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Congratulations on a nice quarter. I wonder -- I got on the call little bit late. I want to ask about TRUVAC, and I apologize if you went through this already, but -- so going forward, TRUVAC is the same thing as safe digging. Is that right? So...

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [50]

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Yes.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [51]

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TRUVACs that are used for safe digging? Okay.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [52]

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Correct.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [53]

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Okay. And last year, you talked about orders being up $60 million incrementally for TRUVAC. Is that right?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [54]

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Total vacuum truck orders, Walt, that would primarily be the TRUVAC round, yeah, they were up $60 million year-over-year for [2018].

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [55]

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Okay. And then what I heard from one of the answers, was that your orders for TRUVAC trucks, was it, or do you include sewer cleaners in there, were up quarter-over-quarter and year-over-year. And so I guess if that's right the question is that you would be expecting that you would have incremental order, you grow orders faster in 2019 for the TRUVAC.

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [56]

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I think what we said, so if you think about Q1 of last year we had some of the effects of the pull forward, which was a combination of both sewer cleaners and vacuum trucks. What we said was despite the effects of that $25 million pull forward in the first quarter, the first quarter orders for vacuum trucks was up even notwithstanding the effects of that portfolio. So sewer cleaner orders were down largely because of the effect of the portfolio in that prior year quarter, but vacuum trucks were up despite those effect. So that's where we continue to be encouraged with what we're seeing on safe digging and we feel so the growth in Q1 and as Jennifer said in comparison to Q4, the orders were up sequentially as well. So we continue to be bullish on safe digging. As Jennifer mentioned, it's the reason, primary reason that we are expanding the Streator facility.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [57]

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Okay.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [58]

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I had spent a lot of time in Q1 with TRUVAC dealers, Walt. I was just recently down in Atlanta with our dealer from Atlanta -- from Georgia, Florida. I was there the last month on a meeting of many of our TRUVAC dealers and what I am encouraged to see is the investments that they're making, both in terms of people to support this brand, rental fleets stem out because of the opportunities that they are also seeing, so not only through our direct sales force but through the new TRUVAC dealers, we continue to be encouraged to believe that we're in early innings here.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [59]

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Okay, great. Yes, I think we all realize that. I was just trying to triangulate the growth rate though for the vacuum trucks and maybe around TRUVAC. So is it -- does this math work if we take the $25 million pull forward and annualize it that you're now looking at vacuum trucks being up incremental $100 million for orders for 2019, is that what you are tracking towards?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [60]

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Well the $25 million, Walt is a combination of sewer cleaners and vacuum trucks. So probably, the majority of it would have been on the sewer cleaners side, so I wouldn't necessarily annualize this whole $25 million, as most of that was on the sewer cleaner side.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [61]

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Okay. All right. Fair enough. If you think about industrial trucks excluding truck bodies or TRUVAC, was that weak during the quarter too and I wonder why that's weak. I know you mentioned, weather, it might have been an impact for the truck body but how was the industrial part of the business trending?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [62]

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The industrial part of the business was good, it was in line with our expectations and I want to also state that our orders were aligned with our expectations, they were the third highest on record and within a couple of million dollars, it was second highest on record. Annual sequential improvement between Q4 and Q1, so we are seeing strong reaction on the industrial markets and the municipal markets, we are continuing to see very stable growth opportunities.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [63]

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Okay, great. And on a previous question, you said that truck body was down, but it was impacted by weather. So the outlook for the year is that that will firm up starting the second quarter in the second half.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [64]

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Yes. We're -- for our TBEI truck body business, we are expecting top line year-over-year revenue growth.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [65]

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Okay. And how about orders?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [66]

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Orders are a less relevant metric because they are often received and shipped during the same quarter, but we're -- as we have talked about before with respect to [8020], we expect our first year of acquisition, we are getting the companies compliant to SOX and public company and all that fun stuff. And now we're really working with our TBEI businesses, applying our 8020 principles and focused on improving the bottom line and that's -- we're expecting success.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [67]

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Okay. All right, great. And just thinking about the Streator plants expansion, what I heard you say is that you're on track, but I wonder if we should be concerned at all about weather delays, it has been a -- was a really cold winter and (inaudible) spring, have you broke ground on the project yet, could weather push back the timing of that project?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [68]

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Yes. We are -- right now, the delay has really been around getting some final permitting, we purchased the land, we did talked with the teams last week. And there are -- still believe that we will hit the end of the year target to complete the building and they're moving forward. The teams I was talking. We had a sewer cleaner at our board meeting earlier this year to show some of the new features of that -- their rapid deployment boom and our control panels and the operators that was there was telling us their more exciting time of their career in terms of being in Vactor, so a lot of good growth activities going on and we think we're on time and on, so.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [69]

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Okay. And if the buildings complete by the end of the year. When do you think you could have the first production starting, would it happen in the fourth quarter of first quarter, you would start?

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [70]

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I don't think we'll see any meaningful benefits from Q4, but we do believe Q1 we should start to see the benefit of that. And I also from -- earlier mentioned that, we did some expansion of our Leeds, Alabama FS Solution Center and we will be producing more Guzzler there this year versus last year and we expect to see that benefit in Q3 and Q4.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [71]

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Okay. And then just one last one for me. Thinking about the operating leverage, which was great and SIFI and I think you called out mix and predominantly, VAMA but was there other mix that was going on there besides just VAMA?

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Ian A. Hudson, Federal Signal Corporation - Senior VP & CFO [72]

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There was also some acceleration well on the domestic police business in anticipation really of that Ford model year changeover that we talked about is scheduled for the second quarter. So there was some incremental benefit there but there was also some benefits that we saw from pricing actions that we took both towards the end of last year and beginning of this year. So the pricing actions really were also a factor in some of that improvement.

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Operator [73]

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We have reached the end of the question and answer session. And I will now turn the call over to Jennifer Sherman for closing remarks.

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Jennifer L. Sherman, Federal Signal Corporation - President, CEO & Director [74]

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Before we wrap up, I'd like to call our attention to our annual report video that recaps our key accomplishments in 2018 and our plans for the future growth. We previewed this video at our Annual Meeting of Stockholders earlier this week. It will be posted on our website under the Investors tab shortly. In closing, so we would like to reiterate that we are confident in the long-term prospects of our business and our markets.

Our foundation is strong and we are focused on delivering profitable long-term growth through the execution of our strategic initiatives. We'd like to express our thanks to our stockholders, employees, distributors, dealers and customers for their continued support. Thank you for joining us today. We'll talk to you after the second quarter.

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Operator [75]

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This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.