Advanced Drainage Systems Inc (WMS) 2016 Q4 法說會逐字稿

Good morning, and welcome to the Advanced Drainage Systems FY16 results conference call.

(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 FY16. Scott will then provide more detail on our financial results for this past year, as well as our guidance for FY17 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' FY16 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 FY16.

Overall, our top-line performance this past year was strong, generating 9.3% growth, or 6.2% organic growth in net sales to $1.29 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 FY16 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 FY15, 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 costs. We believe that raw material costs will continue to remain favorable in FY17, as costs moderate and additional resin production capacity comes online.

Turning to slide 5, we once again generated above-market growth in FY16. This was particularly evident in our core construction markets, where we significantly out-paced 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 FY16, 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 out-perform 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 costs. 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 over time.

Now I'll turn the call over to Scott Cottrill to discuss the details of our results this year, as well as our FY17 guidance. Scott?

Thank you, Joe. On slide 7, we provide a detailed summary of our financial results for FY16. 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 head winds 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 re-statement-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 FY17, we anticipate that there will be an additional $9 million of re-statement-related costs to support the accelerated process of filing our three 10-Qs and annual report on Form 10-K for FY16, all within a three- to four-month period of time. We're also treating these as one-time costs, and have excluded them from our FY17 adjusted EBITDA guidance.

Beyond the $28 million in re-statement-related expenses, which are non-recurring, G&A increased $15 million during FY16. The increase related primarily to the Ideal and BaySaver acquisitions, additional bonus expense, and costs related to the financial transformation project. As it relates to the additional bonus expense, you may recall that we did not pay bonuses in FY15, which makes the FY16 bonuses fully incremental on a year-over-year basis.

On slide 8, I'd like to briefly highlight our top-line performance by geography. For FY16, 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 FY16 by quarter on slide 9, 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, respectively. 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 to 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 agricultural 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 FY16, 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 up side to our free cash flow in FY17, due to increased earnings, lower re-statement-related costs, and continued working capital improvements.

During the year we re-paid $50 million in debt, which brought our leverage ratio down to 2.4 times. We also had $45 million in capital expenditures, which included investing in our HP and N12 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 out $15 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 FY17, we are 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 plan 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 opportunities. We have a long history in being active in the M&A markets, and will continue to evaluate opportunities that complement our product and solutions 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 FY17 guidance, which we have highlighted on slide 13. We are expecting net sales to be in the range of $1.33 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 FY17. 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 a relatively weak start to FY16. 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 FY16.

Furthermore, the incremental benefit from favorable resin prices will be lower on a year-over-year basis in the second half of FY17 as a result of the favorable resin prices we experienced in the second half of FY16. 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 FY16, and have throughout our history.

Favorable growth in our domestic construction markets will be somewhat offset by continued softness in the agriculture end market, which we expect will decline by 5% to 12% in FY17. We are also expecting the second-half 2016 weakness in our international markets to persist in FY17, largely driven by challenging market conditions in Mexico, as well as softness in Canada tied to the weaker agriculture 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 FY17. 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 FY17. 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 our 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 traditional materials in the construction markets 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 FY17 sales. This brings us to our FY17 net sales guidance range of $1.33 billion to $1.38 billion.

Lastly, on slide 16, we provided a bridge to further detail what is driving our adjusted EBITDA expectations for FY17. We're expecting incremental growth of approximately $35 million to $45 million to our 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 FY16 10-Qs and FY16 annual report on Form 10-K, all within 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 FY17.

Lastly, we anticipate getting a slightly favorable impact from our diesel and resin hedges, as well as operational efficiencies. This brings us to our FY17 adjusted EBITDA expectations of $205 million to $230 million. Overall, we are excited about our prospects in FY17, and believe we are positioned well to have another successful year.

As we previously communicated on our call on March 30, we have dedicated significant time and resources to the completion of the FY15 audit and re-statement, along with the preparation and filing of the three quarterly filings for FY16. As a result, we are unable to file our FY16 form 10-K within the prescribed due date, which was May 31. We intend to file the FY16 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 a 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 FY17 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)

Rob Hansen, Deutsche Bank.

Thanks. I just wanted to ask a little bit about the weather pull-forward. I think you mentioned around $15 million in 4Q may have been pulled forward there.

What have sales done in April and May? Has that definitely have come through? You had some very strong end market numbers exiting March, and now we're obviously in June now. I wanted to see how that has played out here?

Yes, Rob, Mike Higgins. I would say in terms of that, what we have recently given -- or we gave today on guidance, we're comfortable with where that is, and what we're seeing so far. 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 Chlapaty. One of the things, it's so difficult to quantify what the pull-forward, 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 into March, they had other business that was projected or on the books to begin in April. Will the season slow down earlier because of that? That's a question right now we just can't answer.

You haven't necessarily seen a slow-down yet?

No. I would say we've seen what we've expected to see.

Got it, okay. Then I wanted to ask about the EBITDA to free cash flow conversion. I think in the past few years it's been in that 20% to 30% range, and then last year 48%.

What's changed compared to the prior years? Is it just all in the margins? What's changed there? What changed since you gave us that initial guidance of free cash flow and that $40 million-ish range at the end -- in the last call?

Rob, this is Scott. I'd say the biggest change from FY15 was in working capital. Again, the way we look at working capital is receivable inventory and payables. In FY15, we had a use of cash there close to $20 million, and in FY16 we generated -- obviously a lot of that was driven by the lower resin cost and inventory of about $15 million net-net overall. Inventory was much greater than that, but working capital in total was about a $15 million source of funds.

I think for the strong performance versus what we indicated at the end of March, quite honestly a little bit of that was visibility, a little bit of that was still in the middle of the throes of the re-statement, and wanting to be conservative as we were finishing that up. Again, very happy with the conversion that we've seen there. Again, on the working capital side, we would expect as we go into FY17 for us to be positive on the working capital side, as well.

What is the right level of conversion to free cash flow from EBITDA going forward? Additionally, how do you think about -- you used to have operating leases, right? That would come through net income, and therefore the operating line. Now that's down below in financing. It's kind of -- maybe it distorts the free cash flow picture a little bit compared to historically. How do you think about it in that way, as well?

On your second point, all of the periods have been re-stated, and they're all consistently presented. To your point, that payment of the capital leases is now treated as a financing or a re-payment of debt, if you will. It's out of our free cash flow definition, but that's the same for every period. It's not like we've just done that for 2016 and 2017.

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%. As we grow sales, we're going to need a little bit of additional working capital to support that additional growth. That being said, in a lower resin cost environment you'll have a positive going the other way. That's how I'd think about working capital. We project that will be slightly positive to us, net-net in FY17.

On the CapEx, which is the other key piece to this, will be up around $5 million to $10 million based on our guidance in FY17 versus FY16. Again, $32 million. We're going to have that EBITDA growth. Some of that will be eaten into by additional CapEx. I believe working capital both on supporting the growth in sales, but then favorably based on lower resin costs, I think that will net-net prove out to be a slight source of funds. We should have pretty good conversion of that incremental EBITDA into incremental cash flow.

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

(Operator Instructions)

Mike Halloran, Robert Baird.

Good morning, everyone.

Good morning.

I appreciate the additional color you gave on how the year-over-year growth rates track through FY17, but could we talk about that in terms of the sequential pattern? You just mentioned that we won't know the full impact of whether or not weather was really pulled forward demand or not until you get later in the year. 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 did you build in a little bit of cushion as you went to the back part, just in case weather did pull some demand forward?

No, it represents a pretty consistent pattern with what we've seen. Usually the first half of the year is around 60% of -- due to seasonality of our total sales. We would expect to see that same pattern here as we go into FY17.

On the hedging side, what's the actual number from a hedging loss perspective that's embedded in this? I know you're saying it's a modest positive year over year. I think it was what, about $15 million of a loss in FY16? Maybe help us with that in FY17, and whether you're expecting any of those losses to carry through into FY18 if prices hold steady?

Yes, I think you're right. FY15 was the impact. In FY16, right now we project the number was about $12 million going in to FY17. 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. As you talk about FY18, there's not an overhang there. 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 over to Management for any closing remarks.

Yes, this is Joe Chlapaty. In summary, we are pleased with our results for FY16, 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 FY17 to continue our legacy of out-performing the overall market by driving conversion opportunities from traditional materials, as well as generating significant operating leverage over time. 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.