Advanced Drainage Systems, Inc. (WMS) Q4 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Advanced Drainage Systems’ Fiscal Year 2016 Results Conference Call. All participants will be in listen-only mode [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. Now I'd like to turn the conference over to Mike Higgins, Director of Investor Relations and Business Strategy. Please go ahead.

Thank you. Good morning. With me today is Joe Chlapaty, our Chairman and CEO; and Scott Cottrill, our CFO. On today’s call, Joe will summarize our results for the fiscal year 2016. Scott will then provide more detail on our financial results for this past year as well as our guidance for fiscal 2017 before we open the call up to your questions. I would also like to remind you that we will discuss forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forward-looking statements as a result of various factors, including those discussed in our press release and the risk factors identified in our Form S-1 filed with the SEC. While we may update forward-looking statements in the future, we disclaim any obligation to do so. You should not place undue reliance on these forward-looking statements all of which speak only as of today. Lastly, the press release we issued earlier this morning is posted on the Investor Relations section of our website. A copy of the release has also been included in an 8-K we submitted to the SEC. We will make a replay of this conference call available via webcast on the company website. With that I’ll turn the call over to Joe Chlapaty.

Thank you, Mike, and good morning, to everyone. Welcome to ADS’ fiscal 2016 earnings conference call. We’d like to thank all of you for joining us this morning. I am pleased to share with you a brief summary of our performance during fiscal 2016. Overall our top line performance this past year was strong, generating 9.3% growth or 6.2% organic growth in net sales to $1.290 billion coming in slightly higher than the updated guidance we provided on our call at the end of March. Our performance was especially strong during the second half of the year, reflecting solid execution against our conversion efforts as well as favorable weather conditions in the majority of our end markets. Related to weather specifically we estimate that our fiscal 2016 net sales were favorably impacted by approximately $10 million to $15 million with the majority of this benefit being picked up in the fiscal fourth quarter. We also generated adjusted EBITDA of $186 million for the year, which reflects a 29% increase over 2015, and in line with our expectations previously communicated on our call in March. Our adjusted EBITDA margin of 14.4% improved 220 basis points over the prior year driven by our strong top line results, solid operational execution and lower raw material cost. We believe that raw material cost will continue to remain favorable in fiscal 2017 as cost moderate and additional resin production capacity comes online. Turning to slide five we once again generated above market growth in fiscal 2016. This is particularly evident in our core construction markets, where we significantly outpaced the market by 600 basis points, growing roughly 11% compared to the estimated market growth of 5%. Our performance was driven primarily by our efforts to gain market share through material conversion as well as exceptionally strong growth in Allied Products, which increased more than 19% compared to the prior year. We also generated strong growth in our HP pipe product line which we anticipate will continue to experience excellent growth in the coming years. In summary I am very pleased with our performance in fiscal 2016, which underscores the fact that the fundamentals of our business and end markets remain strong. Going forward we will remain focused on conversion opportunities where we can displace alternative materials like reinforced concrete, corrugated metal and PVC pipe with our superior high density polyethylene and polypropylene pipe. It is this strategy that will continue to enable us to consistently outperform the market. Further we anticipate that adjusted EBITDA will continue to trend favorably this year, driven by healthy volumes, higher Allied Product sales and favorable raw material cost. Scott will provide more detail on our guidance in just a moment. Ultimately we feel very good about our position to continue driving above market growth with significant operating leverage overtime. Now I will turn the call over to Scott Cottrill to discuss the details of our results this year as well as our fiscal 2017 guidance. Scott?

Thank you, Joe. On slide seven we provide a detailed summary of our financial results for fiscal 2016. As Joe mentioned we generated net sales of $1.29 billion, an increase of 9.3% over the prior year. These results were driven primarily by strong growth in our domestic business, notably healthy growth in pipe and allied products of 6.2% and 19.1% respectively. We also experienced significant growth on the international side from our acquisition of Ideal Pipe of Canada, which offset foreign exchange headwinds in Canada and a weaker market in Mexico. Adjusted EBITDA for the full year increased over 29% to $186 million, representing margin expansion of 220 basis points to 14.4%. During the year we incurred approximately $28 million of restatement-related expenses. Due to the fact that these expenses are non-recurring in nature we have treated them as one-time costs and have excluded them from our adjusted EBITDA calculation. During the early part of fiscal 2017 we anticipate that there will be an additional $9 million of restatement-related costs to support the accelerated process of filing our three 10-Qs and annual report on Form 10-K for fiscal 2016, all of in a three to four months period of time. We are also treating these as one-time costs and have excluded them from our fiscal year 2017 adjusted EBITDA guidance. Beyond the $28 million of restatement-related expenses which are non-recurring, G&A increased $15 million during fiscal 2016. The increase related primarily to the Ideal and BaySaver acquisitions, additional bonus expense and cost related to the financial transformation project. As it relates to the additional bonus expense you may recall that we did not take bonuses in fiscal 2015, which makes the fiscal 2016 bonuses fully incremental on a year-over-year basis. On slide eight, I would like to briefly highlight our top line performance by geography. For fiscal 2016 our domestic net sales contributed the lion's share of our growth year-over-year with $86 million of incremental growth. Canada added an additional $35 million of growth, primarily due to the Ideal Pipe acquisition. The remaining legacy Canadian business was roughly flat on a constant currency basis. These positive contributors were slightly offset by a $9 million decline in Mexico, driven by lower public spending, which negatively impacted our infrastructure end market. Now looking at fiscal 2016 by quarter on slide nine, you will see that domestic sales got off to a slower start to the year, but have steadily accelerated as the year progressed. This includes both pipe and allied products, which grew 13% and 27.4% in the second half of the year respectfully. Conversely results in our international segment progressively got weaker throughout the fiscal year, as strong first half results, driven by solid agricultural demand and conversion efforts in the construction markets increasingly gave way into a challenging macro environment in Mexico. Looking more closely at our domestic performance by end market on slide 10, we see a similar story here with net sales growth accelerating through the year in each of our end markets. In the non-residential market net sales growth was driven by conversion efforts and strong performance in allied products, which are primarily sold into this end market. In the residential market we generated double digit increases from new development activity which were further complemented by retail sales that significantly improved towards the end of the year as retailers started building inventory earlier than they did last year. We also saw an improvement in infrastructure sales driven by growth in states where we are building our market position. This includes states such as Florida, Texas and Missouri where we have benefited from regulatory approvals and increased market acceptance. Lastly, the favorable performance in our agriculture market in the second-half of the year was driven primarily by mild weather conditions which allowed for an earlier and longer season for purchasing and installing our products. Please turn to slide 11. In fiscal 2016 we continued to generate strong free cash flow of approximately $90 million, more than double the amount we generated last year. We believe there remains additional upside to our free cash flow in fiscal 2017 due to increased earnings lower restatement-related cost and continued working capital improvements. During the year we repaid $50 million in debt which brought our leveraged ratio down to 2.4 times. We also had $45 million in capital expenditures, which included investing in our HP and N-12 production capacity, adding production capacity in Florida and other initiatives. Looking ahead to 2017 we expect to invest between $50 million and $55 million in capital expenditures. The increase is driven primarily by our planned investment in a new pipe manufacturing plant targeting the Central Midwest. Finally, in 2016 we paid off $50 million in quarterly dividends at $0.05 per share. Slide 12 highlights our disciplined capital deployment strategy and current priorities. As we look to deploy cash in fiscal 2017, we're first committed to investing in capital expenditures to drive profitable growth. Currently, one of our top CapEx initiatives includes investing in our HP production capacity and capability, a newer product line that has been growing significantly albeit on a smaller base. As I mentioned earlier, we are evaluating options for a new manufacturing facility in the Central Midwest, where we need to be closer to the market to support current and future demand. Based on recent approvals as well as other favorable market conditions, we see good growth opportunities in the construction markets within this region. Given that we are currently serving this market from other ADS locations, there are significant logistical savings that will come once the plant is operational. This plant will also help to free up production capacity in other parts of the Midwest, which is needed based on current and projected growth in demand. We are equally committed to our current quarterly dividend, which we increased to $0.06 per share as announced in our press release issued earlier this morning. Beyond organic investments and our dividend we are very focused on identifying strategic bolt-on acquisition opportunities. We have a long history of being active in the M&A markets and will continue to evaluate opportunities that complement our product and solution set as well as geographic footprint. Lastly, due to the combination of debt repayment and strong adjusted EBITDA growth, we were able to bring our leverage ratio down to 2.4 times, which is well within our target range of two to three times. Now let me switch to our fiscal 2017 guidance which we've highlighted on slide 13. We are expecting net sales to be in the range of $1.33 billion to $1.38 billion, which represents growth of between 3.1% and 7%. We are also expecting adjusted EBITDA for the year to be in the range of $205 million to $230 million, which represents an adjusted EBITDA margin in the range of 15.3% to 16.7%, based on our forecasted net sales. I would like to make one important call out as it pertains to the pace and progression of our financial performance in fiscal 2017. On a year-over-year basis we expect the first half of the year to show good top line growth and adjusted EBITDA performance driven by the strong momentum we have carried into the new fiscal year, which will be compared against our relatively weak start to fiscal 2016. The opposite will be true as we get into the back half of the year as we will be facing more challenging comps due to our strong performance during the second half of fiscal 2016. Furthermore the incremental benefit from favorable resin prices will be lower on a year-over-year basis in the second half of fiscal 2017 as a result of the favorable resin prices we experienced in the second half of fiscal 2016. In addition, the second half of the year will also be impacted by the normal seasonality of our business, where we generate higher volumes during the first half of the year compared to the second half of the year. Taking all these factors into consideration, the year-over-year improvements in net sales and adjusted EBITDA will be less pronounced in the second half of the year as compared to the first. On slide 14 we have provided some color on the end market dynamics that are underpinning our top line growth expectations for the year. We are expecting that our largest end market domestic construction will remain healthy with expected market growth of 4% to 7%. We will of course look to grow above this market rate, as we did in fiscal 2016 and have throughout our history. Favorable growth in our domestic construction markets will be someone offset by continued softness in the agriculture end market, which we expect will decline by 5% to 12% in fiscal 2017. We are also expecting the second half 2016 weakness in our international markets to persist in fiscal 2017, largely driven by challenging market conditions in Mexico as well as softness in Canada tied to the weaker agricultural market that will offset anticipated growth in their construction markets. Lastly, assuming raw material costs continue to remain favorable, we expect that pricing will decline approximately 2% to 3% in fiscal year 2017. Taken together, we anticipate our top line growth will land in the 3% to 7% range. On slide 15, we have provided a bridge to detail what is driving our sales performance expectations for fiscal 2017. We are expecting incremental growth of approximately $50 million to $85 million from our domestic operations, driven primarily by our conversion efforts in our core construction markets with solid growth in our pipe product lines and the continuation of the strong growth we have seen in our allied products. We are expecting incremental growth of up to approximately $5 million from Canada, driven by our continued efforts on converting market share from competitors and through additional materials in construction market with our pipe and allied products. In Mexico, the challenging economic environment is expected to have a $5 million to $10 million negative impact to our fiscal year 2017 sales. This brings us to our fiscal 2017 net sales guidance range of $1.33 billion to $1.38 billion. Lastly on slide 16, we've provided a bridge to further detail what is driving our adjusted EBITDA expectations for fiscal 2017. We are expecting incremental growth of approximately $35 million to $45 million to adjusted EBITDA from healthy volumes as well as lower raw material costs, partially offset by modest price declines. We also expect to gain roughly $5 million to $10 million from higher allied product sales due to increased sales and market share growth. SG&A will be about $15 million to $21 million higher year-over-year. This includes additional selling expenses to support higher net sales and profitable growth, including additional engineering and tech support personnel, an increase related to our finance transformation project, reflecting additional FTEs as well as outside professional service fees, and finally additional build out of corporate support staff. As I mentioned before we anticipate incurring an additional $9 million, in re-statement related costs; primarily related to the completion and audit of the three fiscal 2016 10-Qs and fiscal 2016 annual report on Form 10-K, all of in a roughly three to four month time period. All these changes are a result of the accelerated filing process and will not be incurred on an ongoing basis. As such we are treating these expenses as one-time costs and have excluded them from our adjusted EBITDA guidance range for fiscal 2017. Lastly, we anticipate getting slightly favorable impact from our diesel and resin hedges, as well as operational efficiencies. This brings us to our fiscal 2017 adjusted EBITDA expectations of $205 million to $230 million. Overall we are excited about our prospects in fiscal 2017 and believe we are positioned well to have another successful year. As we’ve previously communicated on our call on March 30, we have dedicated significant time and resources to the completion of the fiscal 2015 audit and restatement along with the preparation of the filing of the three quarterly filings for fiscal 2016. As a result we were unable to file our fiscal 2016 Form 10-K within the prescribed due date, which was the 31 of the May. We intend to file the fiscal 2016 Form 10-K as soon as reasonably practical, which we anticipate will be by the end of July. As we continue to work our way back to our normal quarterly filing process, we anticipate we will have one more quarter of playing catch up. We expect that we will file our first quarter 10-Q for fiscal 2017 by the end of August. We should be back on a normal schedule thereafter. With that I’d like to open up the call to your questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rob Hansen of Deutsche Bank. Please go ahead.

Thanks. So I just wanted to ask a little bit about the weather pull forward, I think you mentioned around $15 million in 4Q in pull forward there. I guess, what have sales done in April and May? Have you, has that definitely come through, right? Or have you, because you had some very strong end market numbers exiting March, and now we are in obviously in June now. So I just want to see how that kind of has played out here?

Yeah, Rob, Mike Higgins, I would say in terms of that, what we have recently given –we gave today on guidance we’re comfortable with that – with where that is and what we’re seeing so far. So I think we’re very comfortable with what we’ve said and what we see in the market specifically our construction end markets right now.

Rob, this is Joe. Rob one of the things that's so difficult to quantify what the pull forward or pull back dollars would be, quite honestly as it relates to non-agricultural sales, but more on the commercial construction side that really won’t show up to a large degree till later in the year because even if we pull some business in to March they had other business that was projected, or on the books to begin in April, and well the season slowed down earlier because of that and that’s a question right now, we just can’t answer.

So you haven’t necessarily seen a slowdown yet?

No. I would say what – we’ve seen, what we expected to see.

Got it, okay and then just – I wanted to ask about the EBITDA to free cash flow conversion rate. I think in the past few years it’s been that kind of 20% to 30% range and then last year 48% right. And then also so what's changed compared to the prior year is it just all in the margins right for yeah so what’s changed there and then what changed since you gave us that additional guidance of free cash flow in that kind of $40 millionish range at the end of, in the last call?

Yeah, Rob. This is Scott. I'd say the biggest change from fiscal ’15 was in working capital and again the way we look at working capital is receivable inventory and payables. So in ’15 we had a use of cash there close to $20 million and fiscal ’16 we generated I would say lot of that was driven by lower resin cost and inventory of about $15 million net-net of raw --inventory was much greater than that but working capital in total was about $15 million source of funds. I think for the strong performance versus what we indicated at the end of March, quite honestly a little of that was visibility, a little bit of that was still in the middle of the throes of the restatement and wanting to be conservative as we were finishing that up. So again very happy with the conversion, that we’ve seen there. And again on the working capital side we would expect as we go in fiscal ’17 for us to be positive on working capital side as well.

So what is the right level of conversion to free cash flow from EBITDA kind of going forward? And then additionally how do you kind of think about the – because you used to have operating basis right and that would come through net income and therefore the operating line and now that down below in financings. So it kind of maybe distorts the free cash flow picture a little bit compared to historically. How do you kind of think about it in that way as well?

Yeah, on your second point all of the periods have been restated and they’re all consistently presented. So to your point that came in other capital leases is now treated as a financing or repayment of debt if you will. So it’s out of our free cash flow definition but that's the same for every period. So it’s not like we’ve just done that for ’16 and ’17. The way I think about it is on the EBITDA side, working capital obviously as a percent of sales for us is in the low 20%. So as we grow sales we’re going to need a little bit of additional capital to support that additional growth. That being said, in a lower resin cost environment you’ll have a positive going the other way. So that’s how I think about working capital. We project that will be slightly positive to us net-net in fiscal ’17. And then on the CapEx, which is the other key piece to this we will be up around $5 million to $10 million based on our guidance in fiscal ’17 versus ’16. So again $32 million we’re going to have that EBITDA growth, some of that will be [indiscernible] into by additional CapEx and I believe working capital both on supporting the growth in sales but then favorably based on lower resin cost, I think that will net-net prove out to be a slight source of funds. So we should have pretty good conversion of that incremental EBITDA and incremental cash flow.

Okay, got it. That’s all I have for now. Thanks guys.

[Operator Instructions] Our next question comes from Mike Halloran of Robert Baird. Please go ahead.

Hey, good morning everyone.

Good morning.

So appreciate the addition color you gave on how the year-over-year growth rates track through fiscal ‘17, but could we talk about that in terms of the sequential pattern. Now, you just mentioned that we won’t know the full impact of whether or not weather pull was really pulled forward demand or not until you get later in the year. So when you think about it in terms of your guidance, does guidance assume a pretty normal sequential pattern as you work through the year or do you build in a little bit cushion as you went to the back part just in case weather did pull some demand forward?

No, it represents a pretty consistent pattern of what we’ve seen. Usually the first half of the year is around 60% of due to seasonality of our total sales. So we would expect to see kind of that same pattern here as we go into fiscal ‘17.

And then on the hedging side what’s the actual number from a hedging loss perspective that’s embedded in this? I know you are saying it’s a modest positive year-over-year. I think it was what above $15 million of a loss in fiscal ‘16. Maybe just help us what that is in fiscal ‘17, and then whether you are expecting any of those losses to carry through into fiscal ‘18 if prices hold steady?

Yeah, I think so you are right ‘15 was the impact in fiscal ‘16. Right now we project the number was about $12 million going into fiscal ‘17 with oil strengthening a little bit. That number is probably going to be coming down a little bit as we go into the year. The propylene hedges pretty much end in December of this year. So as you talk about fiscal ‘18 there's not an overhang there and the diesel will probably stay at around 40% to 50% hedged as we move forward.

Great, that’s all I had, guys. Thanks.

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

Yes. This is Joe Chlapaty. In summary we are pleased with our results for fiscal 2016 and look forward to carrying this momentum into this year. The fundamentals of our business remain strong and we look forward to the opportunities in fiscal 2017 to continue our legacy of outperforming the overall market by driving conversion opportunities from traditional materials as well as generating significant operating leveraging overtime. Thank you all again for joining us today and we look forward to speaking with many of you very soon. Operator, that concludes the call.

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