Advanced Drainage Systems Inc (WMS) 2015 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' fiscal first-quarter 2015 results conference call. My name is Hilda, and I am your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the presentation over to your host for today's call, Mr. Michael Higgins. Please, sir, you may begin.

Thank you. Good morning. With me today is Joe Chlapaty, our Chairman and Chief Executive Officer; and Mark Sturgeon, our Chief Financial Officer. Joe will provide a brief introduction to ADS, summarize our results for the fiscal first quarter and touch on our markets, growth strategies and competitive position, among other things. Mark will then provide details on our financial results for the quarter and a look ahead to the full fiscal year 2015 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 earlier this year. While we may update forward-looking statements in the future, we disclaim any obligations 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 in 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 for a limited time over the telephone at the number set forth in our press release and via webcast available on the Company website.

With that, I will turn the call over to Joe Chlapaty.

Thank you, Mike. And good morning, everyone. Welcome to ADS's first fiscal quarter 2015 earnings conference call. As you know, this is our first earnings call since going public in late July. We are excited to be here and want to thank all of you for joining us this morning. With that in mind, I would like to spend a few minutes introducing the ADS story, which for some of our listeners today will be their first time hearing it.

Advanced Drainage Systems is the world's largest manufacturer of thermoplastic corrugated pipe. We are the dominant player in our space, 10 times the size of our nearest competitor. Competitors simply cannot match up with what ADS brings to the table: a truly national footprint with 48 domestic manufacturing plants; a distribution platform with our own fleet of 625 tractor-trailers enabling us to deliver product next day to almost anywhere in the US. We have a highly skilled sales staff of professionals, technical engineers and customer service representatives. It would be difficult, if not impossible, for competitors to replicate what we have developed.

At its core, our story is one about conversion, displacing alternative materials like concrete, metal and PVC pipe with our superior, high-density polyethylene and polypropylene pipe. In this area, we have a long history and impressive track record that dates back to our founding in 1966. Our first product revolutionized the American agricultural industry by replacing clay tile drainage systems with high-quality, durable and cost-effective thermoplastic corrugated pipe.

Over time, our focus shifted to the large and attractive construction markets, which today represents roughly 80% of our business. Much like our beginning in agriculture, we are revolutionizing water management in the nonresidential, residential and infrastructure markets. In fact, the conversion to thermoplastic corrugated pipe, driven by ADS, has grown significantly from virtually nothing in 1990 to, we believe, 25% of the storm sewer market by 2013.

Importantly, we have gained market share steadily over time through both good and bad economic cycles. We are very proud of our history but even more excited for our future. As we look ahead, our growth will be driven by three areas: number one, market conversion, which I just touched on; number two, allied products; and number three, market recovery.

Our allied products, which include fittings, structures, chambers and other related products, enable us to offer a comprehensive product offering that further differentiates ADS as a solutions provider, not just a product supplier like many of our competitors. This allows us to not only sell the entire package but also build deeper and stronger relationships with our customers. As a result, over the past three years Allied Products have grown 10% annually as compared to flat growth in the overall markets.

While we are not in the business of predicting the behavior for the broader markets, we pay close attention to the experts that expect a solid recovery in the nonresidential construction markets, our largest end market, as well as an improving housing market. You don't have to be an economist to notice that construction activity has picked up from the bottom of the cycle in 2009 and 2010. Simply put, when dirt is moving there is a good chance that ADS products will be there. And we are seeing a lot of dirt moving this year.

As I mentioned before, we have performed well in all economic cycles and have a demonstrated track record of above-market growth. In fact, from fiscal year 2014 -- 2010 to 2014, ADS significantly outpaced the industry in each of its end markets. For example, in nonresidential ADS grew 10% over this time period, whereas the market actually declined 6%.

So it is with this backdrop that I turn to our results for the first fiscal quarter of 2015, which were strong, particularly in light of the reported results of homebuilders and construction companies earlier this quarter. During the quarter, we reported net sales of $328 million, an increase of 12% over the prior year, and adjusted EBITDA of $49 million, which was slightly lower than the previous year. Excluding the one-time gain of nearly $5 million in fiscal first quarter of 2014, adjusted EBITDA would have increased 10.1%.

Our growth this quarter was primarily driven by strong domestic sales demand for both pipe and allied products, which offset slower demand in international markets. Domestic pipe sales increased approximately 15% due to strong sales volume in the nonresidential, residential and infrastructure markets, slightly offset by reduced sales volume in the agricultural market, which was impacted by a late start to spring after the long and cold winter. The sales momentum of our high-density polyethylene and polypropylene storm sewer pipe products are accelerating conversion of market share. Allied Products sales increased approximately 13.4% compared to last year's first quarter, which excludes $2.9 million of sales related to product lines sold in fiscal 2014. The growth was due to strong sales volume in the nonresidential, residential and infrastructure markets.

We saw growth across all of our domestic geographies in the first quarter, led by the northeast and southeast regions. We are also encouraged by strengthening activity in areas like Florida that were hit hard by the downturn in construction activity. Recent approvals for our N-12 and HP pipe by the Florida Department of Transportation are helping us accelerate the conversion to our pipe from traditional materials.

International net sales were essentially flat year over year as we expected, which is primarily due to a late start to the spring construction season in Canada and slower public spending in Mexico. These areas are showing renewed growth in the second quarter, and we expect to gain momentum over the balance of fiscal year 2015.

Further, we are cautiously optimistic about the recovery in the US construction markets. However, as I have said, we are not relying on market improvements for growth and have performed well in all economic and housing market cycles due to our core strategy and strength of driving conversion to our products for water management solutions.

In closing, I am pleased with our results for the quarter. This has been an important year in our Company's proud history. We continue to innovate and lead our industry in both the quality of our products and our ability to deliver unique water management solutions. Our strong results this quarter underscore the strength of our competitive position and demonstrate the continued track record of our success in leading market conversion and gaining share. More importantly, we believe there are significant opportunities ahead of us to continue delivering above-market growth while driving significant operating leverage over time.

Now I will turn the call over to Mark Sturgeon to discuss our financials in more detail as well as provide guidance for full fiscal year 2015. Mark?

Thank you, Joe. For the first quarter of fiscal year 2015, we reported net sales of $328 million, an increase of 12% or $35.2 million from the prior-year period. Pipe revenue increased 13% or $28.5 million to $247 million, compared to $219 million in the first quarter of last year. The increase was driven primarily by domestic sales growth in the nonresidential, residential and infrastructure markets, which increased a combined 17% compared to the prior year. We continued to benefit from the execution of our growth strategy to increase conversion to our pipe products as well as an increased overall construction activity in the markets we serve.

In addition, we are seeing a steady increase in market acceptance of our HP pipe product line, specifically in areas that have been historically slow to specify our high-density polyethylene pipe collect offerings.

Pipe revenue for our international operations was flat compared to the first quarter of last year. Pipe sales in our Mexican joint venture remained affected by depressed spending in public infrastructure markets. The spring construction season started later than normal and combined with a softening of the Canadian dollar, keeping sales lower in the first quarter. This has picked up late in the quarter in both markets, providing good momentum into the second quarter.

Allied Products revenue for the first quarter increased 9%, or $6.7 million year over year, to $81 million, with strong growth in fittings, storm chambers, Nyloplast and other storm water management product lines. As mentioned earlier, sales of continuing products increased 13%, which excludes non-core product lines sold in fiscal 2014. Growth of these products also benefited from increased construction activity in the nonresidential and residential end markets as well as higher pipe sales, which served to prolong sales of Allied Products.

In addition, over the past year we have increased the number of salesman and field engineers to improve our sales coverage; and, combined with our broadened product line, help support strong growth through our distributor network. We believe this strategy has led to increased specification of our Allied Products against competing alternatives.

Moving down the income statement, gross profit increased $6 million, or 9.1%, to $72 million for the first quarter of fiscal 2015, compared to $66 million in the first quarter of last year. As a percentage of net sales, gross profit totaled 21.9% compared to 22.5% for the first quarter of last year. This slight compression in overall margin was primarily the result of higher raw material prices and freight costs and lower international margins, partially offset by stronger margins in Allied Products.

Total selling, general and administrative expenses for the first quarter of fiscal 2015 increased $4.4 million to $39.8 million. As a percentage of net sales, SG&A expenses declined to 12.9%, compared to 13% for the same period last year. Selling expenses increased $1.6 million, or 8.9%, compared to the first quarter of last year. The increase was primarily due to higher variable selling -- variable expenses as a result of an increase in sales and investments in our growth initiatives centered on conversion and allied products.

As a percentage of net sales, selling expenses decreased 17 basis points compared to the first quarter of last year as we leveraged our fixed costs three sales increases. General and administrative expenses increased $2.9 million, or 16.3%, compared to the first quarter of last year. This increase was primarily the result of a $1.6 million increase in non-cash stock-based compensation, both the vesting of restricted stock in the first quarter and compensation expense tied to the stock options issued in 2013; and higher professional expenses related to being a public company, including $715,000 of audit fees relating to the completion of the S-1 for our IPO.

Adjusted EBITDA in the quarter was $49.2 million, compared to $49.5 million in the first quarter of last year. Prior-year adjusted EBITDA included a gain on the sale of a non-core product line of $4.8 million. Excluding this one-time gain, adjusted EBITDA would have increased 10.1%, or $4.5 million, as compared to the prior-year period.

Interest expense was $4.6 million in the first quarter, up 12.5% from $4.1 million in the first quarter of last year. The increase was primarily the result of higher debt levels tied to $108 million dividend paid in January of 2014. Our effective tax rate on a GAAP basis for the first quarter was 38.8%, compared to 39.5% in the first quarter of fiscal 2014. Taking all this into consideration, net income for the first quarter of 2015 was $14.2 million, 9% lower compared to net income of $16.3 million for the first quarter of fiscal 2014.

Earnings per diluted share for the first quarter as reported was a loss of $0.09 a share based on weighted average common shares of 47.5 million. This calculation excludes the 20.1 million fully converted common stock equivalent shares held in the ESOP. The loss per share for the first quarter of fiscal 2015 is primarily related to a non-cash charge of $18.4 million for the increase in the fair value of redeemable convertible preferred stock, which is presented in mezzanine equity. This charge does not affect net income recorded in the financial statements but is included in the determination of basic and diluted earnings per share.

Excluding these charges and other miscellaneous adjustments, adjusted earnings per fully converted common share for the first quarter of fiscal 2015 was $0.25 per share. This includes all shares outstanding, both the common stock shares and the 20.1 million common stock equivalent shares held in the ESOP. Please refer to the tables provided in our earnings press release that detail our shares outstanding.

Moving over to the balance sheet, total assets grew to just over $1 billion as our seasonal working capital build hit its peak at the end of June 2014. This $75 million of asset growth from March 31, 2014 was funded by a combination of accounts payable and long-term debt. Our equity balances at June 30, 2014 continue to be broken out into mezzanine equity and stockholders' equity. With the completion of our successful IPO, these mezzanine equity balances will be again combined with stockholders' equity, simplifying the accounting treatment of our balance sheet.

In terms of capital expenditures, CapEx for the first quarter was $7.5 million. For the full fiscal year 2015, we expect CapEx to be approximately $35 million. We ended the quarter with long-term debt obligations of $481 million. As of June 30, our leverage ratio was 3.4 times our 12-month trailing EBITDA.

Our highest priority for uses of cash in the future are to support growth, primarily investing in our business, and making strategic acquisitions that complement our product offering. In addition, we are committed to return a portion of our excess cash to shareholders through restarting our dividend program.

Now for our financial guidance for fiscal year 2015, which reflects our views and outlook as of today. Based on current visibility, backlog of existing orders and business trends, the Company expects net sales for fiscal year 2015 to be in the range of $1.21 billion to $1.26 billion, generating adjusted EBITDA of $165 million to $175 million.

Now we would be happy to take your questions. Operator, please open the line for questions.

(Operator Instructions) Stephen Kim from Barclays.

Hey, guys. Congratulations. Thank for taking my questions. I have a couple, and I think John may actually jump on with a couple of housekeeping items. But first, can you talk a little bit about the Allied Products? Obviously, that has been a very intriguing part of the story. I was curious as to what do you think the future opportunity is for perhaps either acquisitions in the future or expansion into adjacent markets with the products you already have. If you could just talk about the Allied Products and the pipeline there.

Stephen, we are really excited about the opportunities that we see with Allied Products. This product arena for us has been performing very well on an accelerated basis over the past several years. And what's really exciting about this -- we have several of our newer acquisitions that have yet to really reach the level of growth that we anticipate will come from them.

In addition, we continue to look and scour that arena for possible other acquisition targets. And I believe we will have success in that arena.

And thirdly, just to echo what you said, we have been focusing mainly on domestic internal growth of these products. But there are significant offshore opportunities for these products. So this is going to be a very meaningful strategy for ADS going forward and a successful one, I'm convinced.

That's great. Good to hear. I wanted to switch to the weather. I think you indicated that last year weather had a $25 million impact on sales. We were wondering to what extent you already -- had already factored in that last year's harsh winter in your outlook, given that you are going to be going up against a fairly easy comp.

Yes. Our business has seasonality, specifically in the northern climates, as cold weather and frozen ground impacts underground construction. Our slower construction season is December to February, with our sales more reliant on the Southern and Western part of the United States and Mexico during the winter.

I would say this. The weather is so unpredictable, it's tough to know what is going to happen. Given normal weather conditions, we feel very positive about our going-forward plans. We are on target with where we felt we would be with our sales revenue for this year. We see nothing on the horizon that should impact that. Again, just understanding how the weather -- as evidenced by last year, what can happen.

And Stephen, to add to that, your comment about last year, winter was harsh. We had an early start to winter in the beginning of December, and spring was late. And so, assuming normal conditions this year, normal weather seasons, that will bode positively for our performance for the year compared to the prior year.

And just so I can clarify, Mark, so your outlook -- does that embed a sort of a normal weather pattern next winter? Is that what I'm hearing?

It does.

Okay. Perfect. And I think, John, you maybe have a couple of others?

Yes, I just wanted to touch base on the recent business trends. Could you maybe give us some color for the backlog, how much that was up at month's end in August and July? And then the level of technical service requests or the jobs that the in-house engineers are working on in July and August?

Good question, John. We are pleased with what we see in our open order backlog, and it continues to remain at levels above the prior year. This is a trend that started leading into the first quarter. And what we have seen as the fiscal year has progressed leaves us optimistic about the future sales levels.

And as it relates to project activity, we analyze levels of project tracking activity through our sales force and Technical Services group, which are involved in design collaboration with the engineering community. The amount of projects in design that we see through our teams began to elevate at the end of fiscal 2014, and that trend has remained positive as we progress through fiscal 2015.

All right. And could you maybe quantify the level of growth you've seen in backlog and the technical service request?

We are not in a position that we want to talk about specifics as it relates to those items other than what we've said here, that the trends that we have experienced over the past several months continue.

Okay. Thanks, guys.

Rob Hansen from Deutsche Bank.

I just wanted to ask about -- I appreciate you guys giving the guidance; that's always very helpful. I just want to -- I know you just touched on the backlog. But how did actual sales trends -- how are they in July and August?

On target with our expectations.

Okay. Would you be able to provide any quantification for that?

Yes. I think, Rob, as we have talked about, because of weather impacting individual seasons, we are positioning our Company to give annual guidance. We think that's the most reflective of giving guidance to the Street. And our performance over the two months we just ended would continue to give us strong confidence that the guidance that we've provided to the analysts and today in our press release are very achievable.

Okay. Appreciate that. You mentioned restarting the dividend program. Have you begun to have those discussions with the Board about this? And what is the potential timeframe for reinstating the dividend? And have you looked at what kind of payout ratios you have a target for longer-term?

Well, keep in mind that a dividend program is really initiated or approved by the full Board of Directors. And we have had some very preliminary discussions concerning this, I'd say supportive discussions. I believe, with us being early in our IPO process, we are going through a process of updating our Board on our whole strategic look over the next several years and making sure that we provide, number one, the funds for growing the business meaningfully; number two, providing the funds for acquisitions; and lastly, returning cash to shareholders. I would believe that we will begin again our dividend program in the near future.

Okay. Got it. And then --

At levels comparable with our historical payments.

Okay. All right. And then the last question I had is just relating to the sales people that you've added. About how many people have you added? And are these the sales people from competitors? I guess I'm asking, how quickly can they jump in and start impacting the top line?

We believe that our sales force right now is at appropriate levels to meet our revenue objectives. We have had -- and we believe that we have, I'll just say this, the boots on the ground to accomplish these sales goals that we've established for ourselves. In addition to that, Rob, I think we as a management team added people. We felt the business activity was going to be definitely stronger this year, as we discussed both on the road and with the analysts. And those people are already having an impact. And as the business continues to pick up, we will be aggressive and continue to make sure we have the coverage necessary to grow the top line.

Okay. Appreciate the color, guys. Thanks.

(Operator Instructions) Bob Wetenhall from RBC Capital Markets.

Congratulations on the IPO. Can you touch on what's driving raw material costs and what you are trying to do in terms of raising price to offset it to protect gross margin performance?

Well, as we have been in a very challenging period over the past several years of historically high virgin raw material costs, as we speak the virgin resin costs remain at elevated levels. And this to me is not too, how can I say this, surprising, given the time of year that we are in here because we are in an uncertain time from the weather standpoint for the producers in the Gulf coast; meaning it's hurricane season. And so there historically has been, I would say, a cushion and a factor built into those fellows maintaining pricing to make sure that they've covered themselves in the event of any outage.

We pass our raw material costs on to the market through appropriate increases of pricing of our products; we have been successfully doing that. And we continue to aggressively develop our recycled materials strategies, lowering costs but without sacrificing quality. And so we have been able to maintain a stable base here of costs over the period, and we are comfortable where we are at.

So you are really not expecting a lot of gross margin volatility, given the current set-up. Is that correct?

That's correct.

Fair enough. And this is a question for Mark. Your net sales guidance for the full year of $1.21 billion to $1.26 billion -- what's like percentagewise -- just on a ballpark basis, how much of that spend is in backlog?

Our backlog, because of all our 48 manufacturing sites around this country and our international operations and the fact that our inventory is sitting in our yards ready to ship -- we ship when a contractor or another customer asks for the material. We typically are couple days backlog in terms of how we ship our product.

Our total backlog is typically 30 days. We are now just completed the fifth month of this fiscal year. In terms of what is our busiest season, our busy months are from March to November. So we have good feeling about where our sales are going to come in for the end of the year. The only big unknown typically is in the winter months in the North when the ground freezes; in December, January and February when winter hits, when the construction activity is shut down and then when it starts back up. Again, assuming a normal winter season, we anticipate -- with the help of stronger markets in the South and with the pick-up in Mexico, we are anticipating that the range that we gave is certainly achievable this year.

That's really helpful color. And could you elaborate for a second on what your growth expectations are domestically, not for you guys but really for the market when you are thinking about the three categories that Joe was touching on between resi, non-resi and commercial construction markets?

Yes. We put together in terms of our assumptions for this year -- we took -- we considered 2015 with conservative market growth for the year. We were anticipate our own revenue growth to out-place the market; and forecasted share gains, as have occurred for the last several years, of approximately 1% in primarily the storm sewer business, gaining that share from traditional materials -- concrete, steel and PVC pipe.

In terms of the assumptions we used in coming up with our guidance, we assume nonresidential construction of 7.5% growth, which was taking from a number of different leading prognosticators; residential construction in the 1 million to 1.1 million range of housing starts, and we assume flat infrastructure market and flat agricultural market. So in coming up with those, we came up with the -- based on the conversion that we continue to enjoy and our new product HP storm sewer pipe helping with that, accelerate that, we came up with the $1.21 billion to $1.26 billion sales growth for the year.

Totally get that. And this is kind of a not about the quarter question but long-term. You are obviously posting a lot of strong growth. How much upside is there in terms of margin expansion due to incremental operating leverage as you continue to grow sales?

Yes. I think that with the sales growth, we obviously will get leverage on our fixed footprint on the selling side. We want to remain aggressive. We will also get leverage on our G&A expenses. And then in terms of our EBITDA margin, we would anticipate picking up 50 to 100 basis points a year potentially if we achieve our sales growth with where we are today. That would be annually, for the next several years.

And thank you very much. Final question -- any surprises or big customer wins this order? Thanks again, and good luck.

No surprises, but a lot of positive feedback from our customers as it relates to the integration of Allied Products and new products that we've offered to them.

Got it. Thanks very much.

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

We are extremely proud of the success our Company has achieved over the course of approximately 50 years, but we are even more excited about our future. Our market conversion opportunity, combined with our unique allied products and ongoing market recovery, means we are well-positioned to continue delivering strong results, as we have this quarter. I would like to take this moment to thank all of our employees, customers, advisors and new shareholders for the incredible support we have received throughout the IPO process.

Thank you again for participating in today's call and your interest in ADS. I look forward to meeting and speaking with many of you in the coming weeks and months.

Operator, that concludes our call.