Good morning, and welcome to the Federal Signal Corporation Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Ian Hudson, Chief Financial Officer. Please go ahead.

Good morning, and welcome to Federal Signal's Third Quarter 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 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 today by providing some detail on our third-quarter results before turning the call over to Jennifer to provide an update on our performance, current market conditions, recent acquisition activity, and our outlook for the remainder of the year. After our prepared comments, Jennifer and I will address your questions. Our consolidated third-quarter financial results are provided in today's earnings release. In summary, our businesses were able to deliver another solid quarter with double-digit growth in net sales and earnings, gross margin improvement, and an adjusted EBITDA margin towards the upper end of our target range. Consolidated net sales for the quarter were $346 million, up $48 million or…

Thank you, Ian. With benefits from pricing actions, strong aftermarket demand and contributions from recent acquisitions, our businesses were able to deliver double-digit year-over-year net sales and earnings growth, gross margin improvement, and an EBITDA margin towards the high end of our target range despite supply chain disruption, which impacted production and shipments at certain facilities within our Environmental Solutions Group early in the quarter. Within our Environmental Solutions group, we again saw increased demand for rentals, parts and used equipment, driven in part by the extended lead times for new equipment. Overall, our aftermarket revenues in Q3 this year were up 10% over last year, with particularly strong demand for rentals and parts sales. The growth of our aftermarkets business remains a key strategic initiative and with benefits from pricing actions, geographic expansion into new territories, and acquisitions leveraging our aftermarkets platform, we were pleased to report our highest aftermarket revenues in any third quarter. In total, aftermarket revenues represented about 30% of ESG's revenues for the quarter. The volatile supply chain environment in which we are currently operating is causing us to constantly adjust our production schedules, creating a high degree of inefficiency and impacting our ability to ship units. During the quarter, production shipments at our Streator and Elgin manufacturing facilities were adversely impacted by supply chain disruptions, primarily related to sporadic shortages in hydraulics and specialty control components. We are partially building trucks and completing them when the missing parts arrive. For example, in July, 30% of the units scheduled to be built at our Streator facility, we're waiting for parts at the end of the month. In response, the teams worked diligently to secure additional parts as well as to qualify alternative suppliers. The encouraging news is that as the quarter progressed, we saw sequential…

[Operator Instructions]. The first question comes from Steve Barger from KeyBanc Capital Markets.

Your updated guidance implies a record 4Q revenue performance. Is that coming more from the line to already build product that you can ship on top of plan production? Or do you just expect fewer constraints in 4Q?

Yes. I think, Steve, what we've seen in the last couple of months, certainly of Q3 with the improvement in production. We're expecting some of that to continue. Now we have some seasonality there where aftermarket tends to taper off a little bit. But I think the combination of the size of our backlog and the production improvements we've seen in the recent months gives us confidence that the revenue will certainly be up over Q3. And so that's what's implied in the outlook.

Also, we expect our margins in Q4 to be up year-over-year.

Yes. I guess to that point, ESG incremental margin has obviously been tough for the last 5 quarters. I know a big driver of that is all the operational challenge that you discussed. I just want to gauge your confidence that nothing has really changed on your ability to convert higher sales to higher margin as you get past some of these supply chain constraints.

Yes. The most encouraging fact that I saw is we track pretty carefully our production levels at Elgin and . And as I talked about in my prepared remarks, as we move through July, August, and September, we saw a sequential improvement each month. And in September, we were up 35% over January. So although there's still some pockets of supply chain, overall, we're moving in the right direction, and we're encouraged by that. And that was baked into the guidance.

Yes. In an unconstrained environment, how much of the $765 million of ESG backlog is shippable in 2023?

All of it would be, yes.

All of it.

So nothing scheduled for '24. That all represents orders that people want right now, if they could get it.

Correct.

Correct.

And I think I've asked this before, but just to remind us, what do you -- given the capacity expansions, what do you think quarterly revenue capacity is at ESG? Again, unconstrained.

I think unconstrained, Steve, I think we've obviously added a couple of companies into the mix over the last couple of years. But I think unconstrained. I think if you looked at some of our order cadence within SSG, it's certainly been in the $300 million, if not in excess of the $300 million range. So I think north of $300 million plus the impact of acquisitions.

The next question comes from Mike Shlisky from D.A. Davidson & Company.

Can you hear me okay?

Yes.

Great. Can I first touch on the new facility that you've got out there? Can you just give us a couple of points as to some of the changes that might be in terms as far as the spread or any ticking fees or other fees that may be involved just eking out our model properly calibrated here?

Yes. So no real change in the terms in terms of pricing, Mike. It's the same -- very similar spreads that were in the prior agreement. Now obviously, we've switched from LIBOR to the new sulfur rate. And so with the increase in rates, the interest expense is going to be higher. But in terms of the other terms of the agreement that changed, there's some more favorable terms in terms of the covenant calculations that benefit us. Obviously, there is the increase in the overall size of the facility. There's also the ability to increase it further for acquisitions, but that -- if that need arises. So I think overall, we had the credit agreement was -- that we previously had was going to expire in 2024. We thought it was an opportunistic time to look to refinance it for another 5 years and also increase the facility. And so we're really pleased with the outcome.

Obviously had one thing to reiterate what Ian said in these challenging credit markets, we were extremely pleased with the response that we got and the terms that we got. And we feel like it well positions us going forward in terms of optionality for both organic growth and inorganic growth.

Excellent. And Jennifer, I wanted to just get some more color on from those, the dump body order comments you made during your prepared remarks. I wasn't sure I quite followed it. Did you say that dump bodies get a little bit lower priority in times of chassis shortages and that seems in a somewhat new comment? Is that a new development in the industry? Or is that the way it's always been, we just haven't heard about it since?

Yes. No. That's the way it's always been. And when chassis are on allocation, it is -- many dealers won't want to commit to necessarily dump truck fleet. They want to keep their options open. So we've seen some of that over the last several quarters. As we move forward, we believe that a couple of things, one, there's pent-up demand. Number two is we've diversified the end markets of that business pretty significantly since we purchased TBI in 2017. OSW Switch & Go both have strong municipal exposures. So we'll start to see the benefits of that. And then infrastructure bill, it's very difficult to imagine an infrastructure project that doesn't need a dump body. So as we move forward, we're encouraged by the opportunity, particularly around the infrastructure funds and we wanted to just point out in perhaps a clearer way. One of the drivers of the softness in orders is just the prioritization of dump truck in the queue for chassis.

The next question comes from Chris Moore from CJS Securities.

Yes, maybe just back to the September highest production rates this year. Was that follow-up? And how did it look in October?

Yes, we're still getting our October . So more to come on that. But overall, we saw the beginnings of supply chain improvement at our SSG group in Q2 and that continued in Q3 for SSG. And as we move through the quarter at specifically our Streator and Elgin facilities, we saw that improvement, and we are encouraged. The other thing that's happening, and this will have a long-term benefit for the company is we've now qualified additional suppliers. We've streamlined some of our product offerings as a result of the supply chain challenges. So we've become much more nimble in terms of responding to this. And I believe that we will be in a better position longer term as a result of it.

Got it. Very helpful. Just with respect to the adjusted EPS range. The tax rate is 22%. Is that a lower tax rate assumption from -- after Q2 or the same?

It is, Chris, because I think we talked about the discrete benefits that we had in Q3. So it is slightly lower than what we've previously signaled in Q2, but 22% would be the full-year effective rate that we're expecting.

Got it. And that wouldn't necessarily be a new normalized level moving forward to just desperate to...

Sorry, Chris... Not necessarily. No, that would include -- that 22% would include the discrete benefits we recognized in Q3, which I think we talked about on the prepared remarks that we also had some fairly significant discrete benefits in Q3 last year. So when you look at it year-over-year in Q3, I think our effective rate was at a fairly similar level, 13% this year. I think it was a high 12s last year. So we had a fairly similar amount of discrete benefits in Q3 of both periods. But the 22% for the full year would include the impact of the discrete benefits in the third quarter.

Got it. I appreciate that. And just from a volume price discussion, the midpoint of current revenue guidance, 17.5%, something like that. What's the rough split between volume and price?

Yes. It's probably -- in terms of the organic growth, if you look at Q3, we had organic growth was about $27 million, about 9%, and of that, about half of it was pricing. So we would expect similar dynamics, I think, entering the fourth quarter.

The next question comes from Greg Burns from Sidoti Income.

Is there any way you could quantify how much revenue the disruptions in the ESG side of the business cost.

Sorry to interrupt you. The audio is not clear from your line. Please use the handset mode.

Okay. Do you hear me now?

We heard you.

Okay. Yes. So is there any way you could quantify how much the disruptions cost you in terms of revenue and margin this quarter?

It's a little tough to quantify the pinpoint an exact number, Greg, because it had some knock-on effect because as we talked about in July, we were impacted more than in August and September. So there is some catch-up effect that we had. But if I were to ballpark an estimate, we're talking $20 million-ish would be a high-level estimate, but as I said, it's a fairly difficult number to pinpoint.

Okay. And then with the TowHaul acquisition, how much revenue -- is ground force a reseller of TowHaul, -- like how much revenue -- those ground force account for TowHaul or is that not a meaningful number? And is there any additional revenue synergies between the 2 acquisitions.

Yes. It's not so much -- not so much a reseller, but what they can do, and this is where we see some opportunities. They can go to market together. We -- there is situations where Ground Force has a strong presence in a certain geographic market where TowHaul doesn't necessarily have a strong presence, and it also works vice versa. So I think the combination of the 2 teams can attack all of the geographic markets in which they operate. So I think that's where we see a nice opportunity from a synergy standpoint. In terms of the TowHaul deal, we're targeting synergies of around about $3 million by the end of year 3. The majority of those are revenue synergies from leveraging both the distribution channels.

The next question comes from Walt Liptak from Seaport.

Congratulations on the good quarter I've got a couple of follow-ons for you. First on the TowHaul. I think in your prepared remarks, you talked about TowHaul as a platform, and I assume that's with Ground Force. I wonder if you could talk about that? And are there other M&A deals that you could -- that you're looking at in this metal distractions or middle distraction space?

Yes. So Ground Force and TowHaul sell to the same customers, and they support the equipment that's in the mine. So they basically transport to and from the mine is a way to think about it. They're the leading providers in the world. TowHaul has certain geographic areas that it focuses on the Ground Force doesn't and Ground Force is focused on certain areas and certain customers that TowHaul is not. So we're very excited about putting the 2 together under the same management team, leveraging the same sales channel because as we mentioned, we think there's synergies there. There's probably -- there could be one more deal that completes that platform. But we're still right now very focused on integrating the 2 companies that we purchased. But as we previously talked about, Ground Force is off to a strong start. And both of those companies operate within our target EBITDA margin ranges. There's opportunity for improvement. So very solid businesses. And what we really like about them also is their parts business. We talked about TowHaul has 30% plus parts business. And so as we move forward, it does a really nice job with some proprietary parts in this particular market.

Okay. Great. And then switching gears to another follow-on. It's great to see that the supply chain started to improve production levels are getting better. A follow-on to that last question about delayed shipments. I wonder if you can quantify it a different way, what are your lead times now in terms of months or whatever? And in normal times, where were those lead times? How much -- how supply chains get better, how quickly could you work down that ESG backlog?

Yes. So for several of our product lines, I'll start with they're too long. And we have very focused efforts to reduce those lead times. Particularly Vactor, we've seen very strong orders for many of our products, including our Vactor and Elgin products. So that's an area where we will be focused on reducing those lead times moving forward. Particularly, we're encouraged by because we've got the capacity, and we've got the people. And so as we move forward, we should easily be able to reduce lead times, and we should be able to increase throughput.

Okay. Fair enough. And then just a new question, I guess, is that we're in this rise, the interest rate environment, it's right that you've got all the government spending for infrastructure and other things. But how do you think the rising interest environment impacts your customers' purchases of your products?

Yes. So on the municipal side of things, we don't see a big impact, particularly as you know, sewer cleaners are often funded by water taxes, and then we have the multiple layers of government spending that will benefit purchases of our products. On the industrial side of things, that's where we believe our aftermarkets business is so important because we have rentals as an option. Because as I mentioned in my prepared remarks, we are starting to -- our customers are starting to plan for some of these big infrastructure projects. So we have programs that are available through our aftermarkets group if they can't afford to buy new equipment where they can run equipment and buy it over time, if necessary. So we think we're uniquely positioned because of our ability to offer both new, used and rental equipment in this rising interest rate environment.

[Operator Instructions]. The next question comes from Felix Boeschen from Raymond James.

Ian, I was hoping just to follow up on something real quick, and I'm not sure if I missed it, but can you provide how much chassis pass-through revenue was in the quarter and how that compares to last year?

Yes, it was a little higher. It was about GBP 6 million higher. So it was about 1% of the overall revenue increase was higher chassis revenue. It was about a drag on our margin of around about 15 basis points this period. So not as much of a drag as it was in Q2, but still a slight drag on gross margin.

Okay. Super helpful. And then I wanted to follow up on the September build rate commentary being the highest of the year. I think you said up 35% versus January. And I think there was a comment across both and Elgin. A, I was hoping a, could you confirm that it was across both of those? And then b, any idea or any color for us how volumes at this point compared to sort of pre-COVID, pre-after expansion levels?

Yes. So I will confirm, yes, it was for and out for Streator Elgin. Number two is with respect to pre-COVID levels, we're not there.

Okay. Still lower than pre-COVID.

Yes.

Okay. And then just my last one. I understand you're not giving guidance for 2023. But I am kind of curious if you could directionally talk about maybe what you're hearing out of the OEMs on chassis allocation into next year. Any directional color on maybe how you're thinking about that specifically in the municipal part of your book?

Sure. So we received initial allocations from the chassis OEMs. And the messaging is about the same as 2022 with potential upside for the second half of the year. However, all that being said, as we've talked about several times, we have programs that in place with our dealers where we encourage them to go out and secure chassis outside of our allocations. And then in addition to that, we also go out and try to secure chassis. We call it the onesie-twosie program for various distributors across North America. And I know we've started that. So as we move into '23, we have several programs in place where we're trying to increase the number of chassis that are available to us, either through our dealers, our customers, or going out and trying to procure them on an individual basis.

The next question comes from Steve Barger from KeyBanc Capital Markets.

Just a quick follow-up. Sorry if I missed this. Operating cash flow is running below prior year. I know 4Q is typically a cash release period. Do you have a forecast for operating cash flow for either 4Q or the year?

We don't have a forecast necessarily, Steve. But I think one thing we would say is that we would expect our cash conversion in Q4, obviously, to improve from where it's been. I think as you can probably see, we've had some strategic inventory build really to serve the backlog that we have. There is some, obviously, increase in our receivables that is primarily timing related. I think we started to see some of that turn in the early part of October. The encouraging thing that we see in terms of our receivables is that we haven't seen any deterioration in terms of the aging profile of our receivables, even though it's up significantly at the end of September versus where it was at the end of December. So I think the receivables will start to turn as we enter Q4, and that's where we're expecting to see some of the cash conversions start to improve in Q4.

This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Sherman for closing remarks.

Thank you. In closing, I would like to reiterate that we are confident in the long-term opportunities for our businesses and the prospects for our recent acquisitions. Our portfolio of businesses includes many market-leading brands with solid fundamentals. Our foundation is strong, and we are focused on delivering profitable long-term growth through the execution of our strategic initiatives. I'd like to give a public thank you to all of our employees for their commitment, creativity and dedication addressing this challenging supply chain environment. I would also like to express our thanks to our stockholders, distributors, dealers and customers for their continued support. Thank you for joining us today, and we'll talk to you soon.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.