Advanced Drainage Systems Inc (WMS) 2015 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Advanced Drainage Systems second-quarter 2015 financial results conference call. (Operator Instructions) Today's event is being recorded.

I would now like to turn the conference call over to Mr. Mike Higgins, Director, Business Strategy and Analysis. Please go ahead.

Good morning. With me today is Joe Chlapaty, our Chairman and CEO, and Mark Sturgeon, our CFO. On today's call, Joe will summarize our results for the second fiscal quarter and touch on our markets, growth strategies, and competitive position, among other things. Mark will then provide detail on our financial results for the quarter and a look ahead to the full fiscal-year 2015 before we open up the call 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 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.

I will now turn the call over to Joe Chlapaty.

Thank you, Mike, and good morning to everyone. Welcome to ADS's second fiscal-quarter 2015 earnings conference call. We want to thank all of you for joining us this morning.

We experienced solid operating performance during the second quarter, reflecting continued momentum in our growth initiatives and strong execution across our business. During the quarter we generated net sales of $365 million, nearly 10% higher compared to the prior year.

Our top-line growth was driven by strong performance in our domestic construction markets and improved results from our international operations. For the second quarter, we generated strong growth in our nonresidential and infrastructure end markets, up 17% and 19%, respectively. The nonresidential markets benefited from growth in both pipe and Allied Products sales, while the strong growth in the infrastructure markets was led by market-share gains from our N-12 high-performance product line.

During the quarter, we saw solid fundamentals across all our geographies, and it is encouraging to see the strongest growth in the Southeast and West, which were two areas hit hardest by the construction downturn. Our sales by domestic end market in the second quarter were as follows: 52% in the nonresidential market, 18% in the residential market, 11% in the infrastructure market, and 19% in the agricultural market.

Sales in our agricultural market experienced a soft quarter in terms of sales performance. The late spring planting has led to a later harvest; and as a result, drainage work has been delayed in comparison to recent years.

For example, the US Department of Agriculture is estimating the current corn harvest product progress, reflected at the end of October, as compared to the 5-year average; in some of our larger agricultural states, they look as follows: Iowa, 36% versus 65% normally harvested; Michigan, 21% versus 38% normally harvested; and North Dakota, 22% versus 52% harvested.

However, our order volume has been solid in this market. And as the late harvest is completed, shipments will be strong, as long as weather permits.

International net sales increased 21% year-over-year, regaining their momentum, driven by a rebound in both Canada and Mexico. These areas showed renewed growth during the second quarter after a somewhat disappointing first quarter. Going forward, we expect solid growth in our international sales over the balance of fiscal-year 2015.

We continue to see strong growth in sales of our Allied Product lines, which increased over 12% on an apples-to-apples basis compared to the prior year, led by strong demand for our Nyloplast and StormTech product lines. Growth in these two products underscores the strength we have seen in nonresidential construction, the end market where they are primarily sold. In addition, we are converting share from other traditional materials used for these applications, as we believe both Nyloplast and StormTech offer a higher quality, more cost-effective solution.

As we have said before, our Allied Products, which included fittings, structures, chambers, and other stormwater-related products, allow us to sell the entire package as well as build deeper and stronger relationships with our customers. As a result, our customers view us as a partner and trusted expert in stormwater management, not just a product supplier like many of our competitors. This is a very important differentiator for us in the marketplace, which has helped us to take market share and drive material conversion.

Importantly, we were able to capture operating leverage from the higher sales volume during this quarter. We generated adjusted EBITDA of $60.5 million, an increase of over 17% compared to the prior-year quarter. In addition, we generated more than a 100 basis point improvement in our adjusted EBITDA to net sales margin, reaching 16.6% in the second fiscal quarter.

In terms of market recovery, we remain encouraged by the strength we are seeing in our core domestic construction markets which we view as sustainable and perhaps gaining some momentum. Our leadership position in the markets we serve allows us to take advantage of this market recovery; but it is our ability to drive conversion opportunities from traditional materials that enables us to grow significantly above market rates.

In fact, during the first 6 months of the current fiscal year, our sales grew approximately 15% in our domestic construction markets, which outpaced the broad market growth rate. The current estimated growth rate in the overall construction market ranges from 5% to 8%. This is precisely why we have said that we are not reliant on market improvements for growth and have performed well in all economic and housing market cycles.

In closing, I am pleased with our results for the quarter. 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. As we move forward, our growth will continue to be driven by three areas: number one, market conversion; number two, Allied Products; and number three, market recovery.

We believe there are significant opportunities ahead of us to continue delivering above-market growth while driving significant operating leverage over time. Now I'll turn the call over to Mark Sturgeon to discuss our financials in more detail as well as provide guidance for the full fiscal-year 2015. Mark?

Thank you, Joe. For the second quarter of fiscal-year 2015, we reported net sales of $365 million, an increase of 9.4% or $31 million versus the prior-year period.

Pipe revenue increased to 9.5% or $24 million to $278 million compared to the second quarter of last year. This increase was driven by domestic growth of our N-12 and high-performance product line, which offset lower pipe sales in the agricultural market due to less summer drainage work.

We also experienced growth in Canada and Mexico. In Canada, we were able to convert share from traditional materials, which led to growth in our commercial construction markets. In addition, favorable weather conditions helped fuel growth in agricultural pipe sales.

Improved public spending and positive sales momentum in our electric conduit products drove growth in Mexico.

Overall, we continue to benefit from the execution of our growth strategy to increase conversion to our pipe products as well as increased construction activity in the markets we serve. Importantly, we are seeing a steady increase in market acceptance of our high-performance pipe product line, specifically in areas that have been historically slow to specify our high-density polyethylene pipe offerings.

Second-quarter Allied Product revenue increased 9.2% year-over-year to $86 million, with strong growth in StormTech and Nyloplast as well as other stormwater management product lines. As we mentioned earlier, sales of continuing products increased 12.4% in this category, which excludes noncore product lines sold in fiscal 2014.

Growth of these products also benefited from increased construction activity in the nonresidential markets, but we feel market recovery is only one factor helping drive growth of our Allied Products. Our commitment and investment in adding to our field sales and engineering team to improve our sales coverage with contractors, engineers, and distributors has led to increased specification of our Allied Products against competing alternatives.

Gross profit increased 12.6% to $82 million for the second quarter of fiscal 2015, compared to $73 million in the second quarter of last year. Importantly, as a percentage of net sales, gross profit totaled 22.6% compared to 22% for the second quarter of last year, a gain of 60 basis points in our margins. This improvement in overall margin was primarily attributed to the increased volume of our pipe and higher-margin Allied Products, coupled with strong cost performance in our manufacturing and logistics operations.

Total selling, general, and administrative expenses for the second quarter of fiscal 2015 increased $2.6 million to $38.7 million. As a percentage of net sales, SG&A expenses declined to 10.6%, compared to 10.8% for the same period of last year. The decrease in SG&A expenses as a percentage of net sales was driven primarily by the Company's ability to leverage the incremental expense with higher sales volumes.

Adjusted EBITDA in the quarter totaled $60.5 million compared to $51.6 million in second quarter last year, an increase of 17.2%. As a percentage of net sales, adjusted EBITDA improved to 16.6% in the fiscal quarter, compared to 15.5% in the year-ago period.

Interest expense was $4.3 million in second quarter, up 12.2% from $3.9 million in the prior year. The increase was due to higher average interest rates on our outstanding indebtedness and a higher average long-term debt balance.

Our effective tax rate on a GAAP basis for the second quarter was 38.2%, compared to 40.6% in the second quarter of fiscal 2014.

Taking all of this into consideration, net income for the second quarter of fiscal 2015 was $22.4 million, 29% higher than the net income of $17.3 million for the second quarter of fiscal 2014. Earnings per diluted share for the second quarter of 2015 totaled $0.51 per share based on an average weighted shares of 51.5 million of common shares outstanding.

Adjusted earnings per share on the second quarter of fiscal 2015 was $0.35 per share, based on total diluted common shares outstanding of 71.8 million. This was up from $0.29 per share in the prior year.

This calculation includes all shares outstanding, both the common shares and the 20.1 million common stock equivalent shares held in the ESOP. Please refer to the table provided in our earnings press release that details our shares outstanding for this calculation.

In terms of capital expenditures, CapEx for the second quarter was $8.1 million. For the fiscal-year 2015 we continue to expect capital expenditures to be approximately $35 million for the year.

We ended up the quarter with long-term debt obligations of $386 million. We repaid $95.3 million in long-term debt for the quarter, paid for by proceeds from the Company's IPO of a little over $72 million and cash generated from stronger earnings. As of September 30, 2014, our leverage ratio was just below 2.6 times our 12-month trailing EBITDA.

Looking forward, our highest priority for uses of cash continues to be focused on supporting growth, primarily investing in our business and making strategic acquisitions to complement our product offerings. 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 2015, which reflects our views and outlook as of today. Based on current visibility, backlog of existing orders, and business trends, the Company updated its financial targets for fiscal-year 2015.

The range of net sales for fiscal-year 2015 was tightened slightly to $1.21 billion to $1.25 billion, while the outlook remains unchanged for adjusted EBITDA and is expected to be in a range of $165 million to $175 million.

Let me provide a little more color on the updated top-line guidance. As Joe noted earlier, we experienced softer conditions in the agricultural market than we previously anticipated. When we developed the forecast, we assumed relatively flat growth in the agricultural market.

There has been less summer drainage work, with most fields planted this year and little incentive to go through those crops with good yields expected. We do anticipate a stronger half of the year in the agricultural market, although the harvest has been delayed by a couple weeks, making it more dependent on good weather.

Performance in our construction end markets has been in line and in some cases slightly ahead of our expectations, which has more than offset weakness in the agricultural market. The adjustment we made to the top end of our net sales guidance reflects these dynamics.

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

(Operator Instructions) Stephen Kim, Barclays.

How you doing, guys? It's John filling in for Steve today. Really quick, just given the big decline we've recently seen in oil and that being one of the principal inputs into your resin used for pipe production, could you maybe give me a sense for the sensitivity to declines in resin prices that would have on your gross profit?

Well, John, let's just say this. The recent positive phenomena in the fracking of natural oil and gas in the US has driven oil prices down to levels that we haven't seen for several years. We are not prognosticators, to be honest with you, of future prices or material cost, but obviously this is a very positive development for ADS both in terms of our resin costs and, perhaps somewhat unnoticed at times, the very significant impact on our freight cost of diesel fuel.

So we view this as a meaningful benefit going forward. The timing of that benefit is a little bit up in the air because there has been significant outages in the ethylene capacity in the Gulf Coast due to some units that were off-line due to repairs and unforeseen problems. But going forward, this is a very positive development for ADS.

Got it. Thanks for that. Then secondly, can we just turn the focus really quick to the international growth opportunities? Does the current manufacturing capacity in those countries look sufficient to serve your intermediate-term opportunity?

If so, is distribution the way forward? And how do you target to grow distribution? Is it more via M&A or more organic?

John, this is Mark Sturgeon. I think for ADS in those markets, I think we have capacity to grow fairly significantly in Canada and Mexico and South America, just as we do in this country. Those are more, again, a conversion story, gaining share from other products.

In terms of looking at acquisition potential, potential acquisitions, just as we do in the US, we are constantly looking for opportunities that would add to synergies in our strategies going forward at this point.

We are looking at things. We certainly have nothing to announce, but we feel we are positioned to grow those markets. The outlook, as we had said earlier, for Canada and Mexico and really South America we feel is on the upside going forward for us.

Got it. Joe, just a quick follow-up on the freight topic that you brought up. Do you pass freight costs on to your customers, or do you price your products shipped?

Well, what we do is we have a baseline delivery cost that we incur. As fuel prices escalated, we had a fuel surcharge that we were passing on to our customers, as a separate component from the pricing dynamics of our pipe and Allied Products.

But in adding to that, we run millions and millions of miles, and the reduction in fuel prices will have a fairly significant impact on our bottom line.

Keep in mind, John, that there are significant -- there is a lot of volume, but what we call nontrade miles, where we are moving equipment and we are interplanting things. So you can understand the impact of lower fuel costs on those nonbillable miles, so to speak.

Got it. Thanks, guys.

Rob Hansen, Deutsche Bank.

Thank you. Yes, the first question I had was just on your sales guidance. You narrowed it a little bit, and I guess that's primarily because of the agricultural business; and correct me if I'm wrong. But there was no EBITDA impact.

So I just want to understand the puts and takes there. Does the agricultural business not have as much of an impact on the bottom line there? I wanted to get your thoughts on that.

Yes, I would say -- this is Mark again, Rob -- we adjusted our guidance on the high end slightly because that second quarter, with the fact that not as much summer drainage work got done, the fields were -- there was less set-aside land, and farmers just didn't do as much summer drainage work. Right now our order volume and demand is good there; it is going to be weather dependent, on how long the agricultural season goes in.

But our margins, as you saw, were a little bit better than what we had originally forecasted, and we are showing some optimism on our international markets. So all in all at this point, we did not think it was prudent to change that guidance.

Okay. Then when you -- so what exactly were the volumes down in agriculture? I guess what I am taking away from this is it's generally a lower-margin product, so it is not as much -- so your margins should actually improve as it becomes a lower portion of your business. Is that correct?

When -- we are filing our 10-Q on Friday and there are specifics in that document that will give the exact percentage of decline in the agricultural markets, so I think you will directly get your answer there. For the quarter, agricultural sales were actually down in dollars 11.7%, so that was the impact of what it was for the second quarter.

We were actually up 4.8% in the first quarter. So after 6 months it is just down 5.7%; but it did have an impact in that quarter.

That's very helpful. The last question I had was just, what are you guys seeing for October volumes? Any comments on that would be extremely helpful.

I would say as we have gone through October and entered in November our order activity remains very solid. At this point we are experiencing some recovery in the agricultural area. It was a little bit soft as we left from September into October because of the late harvest, but so far this month the weather has been favorable and we appear to be recovering some of the agricultural business that did not occur in the second fiscal quarter.

Order volume remains very solid. And what we are pleased with is the breadth in the geographic dispersion of order volume, which has meaningfully improved in what we call our Sunbelt States. If you go to the Carolinas, Georgia, Florida, Phoenix, those are showing meaningful improvement compared to the prior year; and that just spells well for us in the winter, because those areas obviously are not as weather-dependent to ship product.

In addition to that, Rob, our Allied Product business, which obviously had an impact very positively on our earnings, all the different products that we provide to give that total solution to providers, had a very solid, strong growth really across-the-board for the first 6 months. That activity and the outlook for those really remains the same.

And the commercial construction markets, nonresidential -- you saw the growth we had in the infrastructure with some of our new products -- those markets and the activity there remains very consistent.

All right. Thank you very much, guys.

(Operator Instructions) Bob Wetenhall, RBC Capital Markets.

Hey, Joe, Mark; good morning. Hey, just wanted to ask you, thinking forward in the next two or three quarters, with the EBITDA growth do you think the margin expansion story is going to be more on the gross margin line? Or do you think it is more about leveraging SG&A cost?

Yes, Bob; this is Mark. I think it's a combination of both. I think, as we've said several times, as the market opportunities expand and with some of our new products, both pipe and Allied Products, we are being aggressive as a Company with the support of our Board to add salespeople, engineers, and to go and try to further gain penetration. So in spite of doing that, from a bottom-line standpoint we still picked up 20 basis points on our leverage of SG&A to sales.

We are going to continue to do that and really stay aggressive. That -- we do think as the sales line growth, the dynamics that we had for the quarter going forward should be very similar. So we are anticipating both that we should get additional leverage on our SG&A line as we are able to grow the top line, which will ultimately fall down to the guidance that we have given on adjusted EBITDA of 50 to 100 basis points type of growth on our EBITDA margins for the year and anticipation going forward.

That's a good story. That's nice to see. Any big DoT wins or jobs coming up, either way, that you have visibility into?

Well, let me just say this, Bob, that the very positive impact of the high-performance product line is generating above-anticipated infrastructure sales. So we see that continuing.

And we are experiencing that type of activity, again, in a number of these Sunbelt plants, which I think bodes well as we get into the traditional cyclical downturn in winter.

Okay. Okay; that makes sense. A final question. Your balance sheet is in great shape; you got leverage where you want it; your guidance is very consistent with what you said at the time of the IPO. You obviously have low CapEx, and you are going to generate a lot of free cash flow.

Thinking about calendar 2015 and 2016, you are going to be cash rich. You're going to be underlevered. What do you do with all that extra money?

Well, I think what this does for us, Bob, very positively, it allows us to be more aggressive on growing the business. So we are strategically looking at new opportunities for growth both in terms of geographies, people, new products, looking at acquisitions.

And as we had noted previously, we will reinstitute our dividend program. And to the degree that we don't absorb the cash in these other growth initiatives, we will return it to our shareholders.

Great answer, guys, and nice quarter. Good luck.

Thanks a lot.

Thank you.

At this time I'm showing no additional questions. I would like to turn the conference call back over for any closing remarks.

Okay. This is Joe Chlapaty again. We are very pleased with our second-quarter results and are proud of our success during the 3 months as a publicly traded company. The diversity of our end markets and growth opportunities for both our pipe and Allied Products differentiates ADS from other building products companies.

We remain focused on our strategic growth initiatives and execution in gaining market share from traditional materials and taking full advantage of recovering end markets. We are confident that we are well positioned to continue delivering above-market growth as well as operating leverage over time.

I want to 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.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.