Mike Higgins - Director, IR & Business Strategy Joe Chlapaty - Chairman & CEO Scott Cottrill - CFO Ron Vitarelli - Co-COO.

Mike Halloran - Robert W. Baird Robert Wetenhall - RBC Capital Markets.

Good morning and welcome to Advanced Drainage Systems' Fourth Quarter and Fiscal Year 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. 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 provide highlights for the fourth quarter and fiscal year 2017.

Scott will then provide more detail on the financial results for the quarter and year, as well as our guidance for fiscal 2018 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 because of various factors, including those discussed at our press release and the risk factors identified in our Form 10-K 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, everyone. Welcome to ADS's fourth quarter and fiscal year 2017 earnings conference call. We'd like to thank all of you for joining us. I'm pleased to share with you a summary of our highlights during the quarter and year including our market conversion performance.

Following my comments, I will turn the call over to Scott to discuss the financials in further details, as well as our outlook for fiscal 2018. We finished the year delivering solid topline performance due to strong demand in the Southeast and favorable weather conditions in the Midwest United States.

Our fourth fiscal quarter 2017 net sales came in essentially flat compared to the prior year with 1% domestic roll being offset by a 13% decline in international sales. These results were particularly impressive given the 19% year-over-year growth we posted in our fourth quarter last year.

Our adjusted EBITDA was $13 million for the quarter compared to $22 million in the prior year. The pressure on our adjusted EBITDA this quarter was due to the timing of absorption cost related to production and transportation expenses in addition to higher SG&A.

That said, we fully expect our margins to return to more normal seasonal patterns in fiscal 2018 as our production increases to support anticipated growth.

We also continue to generate favorable cash flow which provides us with additional avenues with shareholder value creation including investments and growth and operational improvements, as well as cash returns to shareholders which Scott will expand on in just a moment.

On a full year basis, we generated net sales of $1.260 billion and adjusted EBITDA of $193 million, both of which were equal to or better than our previously communicated guidance range.

Considering the challenging market dynamics we faced this past year, we were pleased with our overall performance as we continued our long track record of market conversion which is detailed on Slide 6.

During fiscal 2017 we delivered above market growth and fall [ph] the non-residential and new residential construction markets as sales outpaced their respective end markets by an estimated 300 basis points.

Sales growth in these two end markets were driven by continued strong performance of our HP pipe and allied products underscoring market adoption of ADS's innovation and complete package of broader management solutions and products. The infrastructure market was mixed throughout fiscal 2017.

However, we remain encouraged by the renewed national focus on America's ageing infrastructure.

We feel very good about our position in this market over the long-term as we expect to benefit from increased spending and adoption of our newly released HPXR product line which is designed to address a $1 billion market opportunity in large diameter storm water applications.

Finally, the Ag market declined 22% this year and was challenged as farm incomes decline for the third consecutive year after reaching a record high in 2013. In summary, despite the challenging market environment in fiscal 2017 we are confident in our ability to continue generating above market growth and healthy profitability going forward.

We are the leading player in an industry with a large addressable opportunity across diverse construction markets. We are entering fiscal 2018 with renewed focus on driving strategic growth, operational excellence and commercial excellence which we believe will create additional shareholder value.

Now, I'll turn the call over to Scott to discuss our financial performance and our fiscal 2018 guidance.

Scott?.

Thank you, Joe. Let's now shift to our Q4 financial performance on Slide 7. As Joe mentioned, we finished the year with strong topline performance. Sales through our domestic construction markets exceeded our expectations with 2% growth in the quarter driven by a 3% increase in the non-residential markets.

Non-residential sales were driven by both pipe and allied product growth, including our HP product which continues to grow double-digits in the quarter. The residential market ended the quarter flat, similar to previous quarters, a 5% decline in retail sales offset new residential construction market growth of 8%.

That said, we believe the overall housing market will remain healthy and well positioned for growth in fiscal 2018. The infrastructure market has remained mixed as Joe mentioned.

We are optimistic about potential increases in infrastructure funding in fiscal '18, particularly at the state level and long-term we will continue to expand our position in this attractive end market. On the international front, the decline we've been experiencing in Mexico throughout fiscal '17 showed signs of stabilization this quarter.

While sales were down in the fourth quarter on a year-over-year basis, it was far less of a decline than we experienced throughout the year. In Canada, the return of a more normal winter as compared to last year has significant impact on results which were down 24%.

Our gross margin was 16.1% for the quarter, 410 basis points lower as compared to the same period last year. Our adjusted EBITDA margin was 5.1% for the quarter driven by headwinds from higher inventory absorption and increased SG&A.

The higher inventory absorption cost were result of low production volume in the third quarter when we adjusted production levels to meet the lower demand experienced during the year which impacted gross profit and adjusted EBITDA by approximately $4 million to $5 million in this quarter.

Moving to Slide 8, on an annual basis our overall topline performance came in at $1.260 billion, about 2.6% lower than fiscal 2016 and slightly above our updated guidance range. Our domestic construction markets grew 3% during the year which was offset by declines in agriculture, international and retail markets.

On a product level, our allied products grew 3% this year, partially offsetting the 5% decline in pipe sales. Strong allied product sales reflect our position as a complete solutions provider for the water management industry.

Our gross margin increased 140 basis points to 23.5% as compared to 22.1% last year, primarily due to lower resin cost and effective price management.

And finally, our adjusted EBITDA increased 3% to $193 million and our adjusted EBITDA margin improved 90 basis points to 15.4%, primarily due to the same factors impacting our gross margin, partially offset by higher G&A expenses.

We experienced the favorable cost environment in fiscal 2017 and we were able to hold on to the majority of our cost savings through disciplined pricing practices. We believe the resin cost environment will remain stable in fiscal 2018 with slight headwinds in the first half of the year being offset by favorability during the second half.

Before moving on to our free cash flow performance, I'd like to take a second to address our G&A expenses as outlined on Slide 9. As you can see, our G&A expense had numerous moving parts this year. The biggest items of the fluctuations in share based compensation and restatement cost.

Excluding these two items and the other EBITDA adjustments listed on the slide, the higher G&A expense is primarily due to an increase in headcount and professional fees. Going into fiscal 2018, we are targeting SG&A to be in the mid-teens as a percent of sales.

Turning to Slide 10, we generated $57 million of free cash flow this year, a decrease of $33 million when compared to the prior year. This decrease in free cash flow is primarily attributed to an increase in cash required for working capital.

In fiscal '17 we launched a project to optimize our manufacturing and distribution network and resulted in higher inventory levels on our balance sheet and drove the majority of the increase in cash used for working capital.

We used the winter months to build specific high demand inventory for our upcoming selling season, positioning ourselves to have the right products, at the right plant, at the right time to meet customer needs as quickly and efficiently as possible. This is, and was part of our superior performance program which I will get into in just a minute.

Lastly, we ended the year with net debt of $422 million and CapEx of $47 million. In fiscal 2018, we expect capital expenditures to be approximately $55 million to $60 million. On Slide 11, we shift our focus to fiscal 2018 expectations.

We anticipate mid-single digit sales growth in our domestic construction markets based on underlying market growth of low to mid-single digits. Our domestic construction market growth expectation is supported by healthy non-residential and new residential construction markets.

We also expect our agricultural market revenue to decline low to mid-single digits based on continued weakness in farmers income and crop prices during fiscal '18. And finally, we expect to grow our sales in our international markets by low to mid-single digits based on market growth of low single digits.

Turning to Slide 12; we provide our fiscal 2018 outlook. We expect net sales to be in the range of $1.275 billion to $1.325 billion, representing growth of 1% to 5% and adjusted EBITDA to be in the range of $200 million to $220 million which represents an adjusted EBITDA margin of 15.7% to 16.6% based on the sales levels.

The margin improvement year-over-year is expected to be driven by favorable demand and operational improvements. Turning to the next slide, many of you have heard us talk about our strategic pillars focused on strategic growth, operational excellence and commercial excellence.

Some of these initiatives such as our conversion strategy and bolt-on acquisitions are not new.

However, we are implementing a broader spectrum of initiatives, what we call are superior performance program or SPP aimed at further driving our growth and competitive advantage in the industry as well as accelerate margin expansion and profitability overtime.

We continue to review every aspect of how we can operate more efficiently, including optimizing our footprint, accelerating new product development and introduction; and implementing continuous improvement and lean manufacturing among many other initiatives.

Our fiscal 2018 budget anticipates a modest net benefit to our adjusted EBITDA for these initiatives with incremental benefits being partially offset by higher associated cost to implement. Finally, you're all familiar with our capital structure and deployment priorities which we have outlined on Slide 14 and updated for fiscal 2018 objectives.

Our capital spending for fiscal 2018 is focused on supporting growth and certain product lines in geographies, as well as our SBP [ph] productivity and efficiency initiatives and continuing our quarterly dividend program which we increased this quarter.

We continue to evaluate numerous M&A opportunities and remain committed to a disciplined process to ensure we create long term shareholder value. Lastly, we will continue to evaluate opportunistic share buy backs under our current repurchase authorization in the future. Now, we'll be happy to take questions. Operator, please open the line..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Robert Wetenhall with RBC Capital Markets. Please go ahead..

Hey. Good morning, gentlemen. This is actually Tim Flores [ph] on for Bob. Thanks for taking my questions..

Sure..

I like to talk about your HPXR75 product line.

You talked about the market size, but I was just wondering what has been the response of customers so far and what's the potential for taking market share in that category?.

This is Joe Chlapaty. We really are very excited about this product line and we've been very disciplined in how we go to market with it. As we have gone out and had a number of installations go in, the product is performing at or above expectations.

We are focusing right now on speeding up or accelerating our capability of producing this pipe at more locations and we believe that the -- when I say installers, the folks who have purchased this product, the site developers are very excited about it and it is our goal to increase capacity earlier than we had anticipated and we believe this is going to be a very strong growth opportunity for us.

We're very excited about it..

Thank you. And just to follow up, moving on to M&A. In the press release you mentioned that you plan to execute both on acquisitions in fiscal year '18.

Is there any region or product category that you're specifically targeting?.

I guess what I'd answer that is the fact that our allied products would be that sweet spot. It continues to grow out our portfolio under the WMS brand, if you will - higher margin, water quality would be a good example of that. Those are the kind of areas that we're targeting and emphasizing..

Retention-detention business has been very strong for us and our storm tech product line continues to grow at double digit rates.

We're looking to perhaps integrate additional opportunities in that arena, but the allied products, as Scott said, are doing very well and it's not only the absolute dollars there, but the pull-along effect that's having on our based pipe business..

Perfect. Thanks and good luck..

Thank you..

Thank you..

The next question comes from Mike Halloran with Robert Baird. Please go ahead..

Good morning, everyone. Let's start on the revenue side first.

Maybe you can talk about the cadence through the quarter and through the first couple of months here of the fiscal first quarter? Obviously while there was a modest tail in the first quarter, but maybe just talk about the cadence as you see it in the market place under construction businesses as you worked through the first five months this year..

Yes. Again, we had a very good quarter from a sales perspective. It wasn't just March, started in February. So Q4 again was above our guidance range and very favorable performance.

The only thing related to Q1, which we won't get into a lot of detail on that, but when you look at what we're seeing, there's nothing that we're seeing in there that the business activity that we expected and as part of our '18 guidance all appears to be holding true to form based on what we see today..

Yes, that makes sense.

Sorry?.

I was just going to say that the guidance we've given for the year, we are taking business at the pace that we believe we'll meet that guidance..

Okay. That makes sense. Great. And then on the cost side, the margin side, I think the most number of questions I'm getting right now is just trying to understand that bridge on the margin from this quarter which is a little more pressure going into next year.

If you could talk about a few of the line items this year versus next year, first on the absorption side, could you just go a little bit more on the detail on what exactly happened there and whether that should then be normalized by the timing in to the first quarter here?.

Yes. On the absorption side, basically when you look at fiscal '17 starting in June and in Q2 and in Q3, we have lower performance on the top line than what we'd expected going into the year. We had to readjust our production plans, if you will, and our plans to kind of match that new reality.

So as you do that and we lowered our production in Q3, especially after Q2 validated that the markets were going to come in a little bit south of what we expected going into the year, well, you have the class structure that you had in place, but you've got lower production.

So lower number of units being produced, so you got higher cost being associated with those units. So at the end of December, our Q3, the inventory levels that you have are at a higher cost level than what we had anticipated and what we have had last year.

That then spills over using your DSI or your turns, you end up realizing that higher cost that was in your inventory at December 31, you end up realizing that in Q4 in Jan, Feb and March.

There might be a little over that that will spill over into '18, but there's nothing in that that changes anything in our guidance and we fully factored that into the numbers that are in here..

Our production volumes in the fourth fiscal quarter obviously as sales generation were strong, we were ramping up production in the fourth quarter, not only from the stand point of sales, but also our optimization program to make sure that we had inventory in appropriate locations to minimize inner plant freight cost..

That makes sense. I think that's a good segment on the transportation cost. Obviously last couple of quarters that has been a headwind. Makes sense, right? Some rising cost, but also mixed with that being lower mix to your portfolio.

So how do the transportation cost lever as we go into next year? Is it pretty stable versus the fourth quarter rate? Obviously you got to move up and down for whatever the revenue numbers look like, but is the fourth quarter the right way to think about going forward?.

Roughly. You've got some of the SPP [ph] initiatives that are targeted in that area, particularly around network optimization as to reducing that inner plant freight that we have. If we can have the inventory at the right place, then we don't have to be shipping it from one location to another. We have some benefit baked into there for the year.

Obviously, there's cost to rule out all these things with the new BI and software tools and everything else that we're doing. But roughly that rate because of the inflationary pressures you have on salaries, wages and so forth, I think roughly that would be the right way to think to with some nominal benefit from SPP to offset some of that..

The benefit we're going to have is we have opened and are now producing at our new Missouri plant, Harrisonville Missouri and we believe as the year progresses and we increase our production there, that's going to have a meaningful impact, a positive impact on our freight cost..

So then, the [indiscernible] price cost side obviously said slight headwind in the front part of the year. Maybe you could just talk through that resin prices from a weakened track? It looked like it's down a little bit more than that. Obviously you don't have as much visibility to non-virgin [ph] side.

So maybe you could talk about some of the puts and takes if there's any hedging going on and how it's only slight in the front half and a little bit better on the back half..

Resin costs are tracking the way we've anticipated. If you take a look and break down our non-virgin cost versus the virgin, we did experience in the fourth quarter some increases in material cost. Our anticipation is that they will start to head down and that we're looking for the year.

I would say overall lower cost in fiscal '18, then '17 and it's a case of timing to some degree, but equally important, we're seeing favorable pricing conditions in the non-virgin arena, especially in the [indiscernible] prices for post-consumer materials..

Okay. So the non-virgin is mitigating some of the near term resin pricing headwinds on the virgin and then as you work through the year, you're expecting the virgin come down a little bit.

The pricing side from an industry perspective, how do you guys feel there from your price to the market place?.

The pricing on a year-over-year basis, we assume will be relatively flat on an overall basis. That being said, we expect Mexico will be down a little bit more year-over-year especially in the first half of the year and then you've got some puts and takes within the other markets. But overall, flat is our assumption..

Good. I appreciate all the color, guys. Thanks..

Okay, Mike..

[Operator Instructions] Our next question comes from Robert Wetenhall with RBC Capital Markets. Please go ahead..

Hey, good morning, gentlemen.

How is everybody?.

We're good, Robert.

How are you?.

Good morning..

I'm great. Thanks..

Are you in New York or you're in Florida?.

No. I'm sitting in the lobby of Fidelity [ph] right now..

Okay..

If you guys would be here with me, it would be more fun. Hey, just want to ask you for a second. You got the buyback program in place for $50 million. You're paying at dividends, you're evaluating some acquisitions. The business is on solid footing.

What are your thoughts through 2018 fiscal year-over-year where we go directionally with capital allocation? What's the longer more strategic thought process behind it? How should we be thinking about where you're going to use your free cash flow?.

Yes. Hey, Bob. Scott here. Think about it as to supporting organic growth initiatives as our primary focus for that. That's not only through CapEx, but innovation.

So organic growth, especially in those high profit, high growth areas like HPXR75, those are the types of areas that we're looking at as we continue to try to build out those suite of products.

Innovation, we've talked about XR 75, but when you look at what we're doing and some of the things we're working on, what are quality in some of the other areas, those are areas that we get really excited about. It's not static. It constantly changes, so we're going to make sure we got the bandwidth to fund those.

Obviously M&A is that second tier which we've got our funnel as we referred to it or our pipeline.

There's constantly ins and outs as you move through that, so we want to make sure we've got the flexibility to be able to jump in at the right opportunity and don't want to be in the position where we're constrained, where we can't take advantage of one of those opportunities. Those will be the first two and they're constantly evolving.

We're reassessing. New things are coming in at all times. The dividend, we just went up another penny, $0.04 [ph] a year on that, so the dividend would be the next line of thinking there. And then the share repurchased the opportunistic. That is absolutely a tool in the tool chest and we'll use that as the circumstances dictate.

But our primary focus right now and strong bias is on organic growth..

Bob, this is Joe. Go ahead, Bob..

Just on the M&A's side, if you are looking at stock to say, broadly speaking what the pipeline looks like, what dollar size the transaction you'd be happy to buy right now and is there any product categories like storm weather management that you're more focused on? How should we just be thinking about that and what you want to do with the platform?.

Again, I would say directionally and targeting, we're going to aim at areas that complement our strengths and where we can use our national footprint and our distribution relationships to leverage. We've been very successful in the past. That would be our priority.

And again, allied products, whether that's our storm tech chambers, water quality - those are kind of the areas of focus. As to size and so forth, I don't want to get into that little detail. We're more looking at obviously strategic ones first.

We've got a bunch of financial criteria and hurdle rates that it needs to meet that we'd be looking at, but it's more of a reasonable multiple for the business and how that meets our strategic goals - not only in the next year or two, but over the next three to five years..

Got it..

There is after-review going on now for potential acquisitions. You never know when those are going to occur. They become a discussion, a negotiation and an analysis, but there is activity going on in that arena.

I might add that we are so excited about our allied products and the new HP pipe that we're being cautious in terms of share buy back because we could see ourselves investing some meaningful dollars in the organic growth opportunities and initiatives.

And what we've decided to do is the board is going to take a revised look in August that our next board meeting of where our share purchase program goes into strategy involved with that..

Got it. That's encouraging. Awesome. Just on the market stuff, it seems like Mexico and agricultural segment has been a bit of a headwind in fiscal 2017.

At what point do you think these markets just have bottomed out and start to inflect positively? Because it seems like your core business is doing really well and you just have a little bit of drag coming out of last year with these other markets which were slightly softer.

Do these markets inflect? I'm just curious, you would think cyclically, at some point, they got to bounce back?.

Yes. I'll take Mexico that Mike talked Ag. But in Mexico, we were still down year-over-year in Q4, but nowhere near the level we have been year-to-date. There's some pricing cluster there that we're going to turn the corner on as we go through fiscal '18. You can see the public versus private market changing.

We've run in new leadership team down there, a new general manager, a new staff, a new team, hiring folks, go to market strategies - things were very optimistic about down there, so I think you're going to see that below single-digit growth that we talked to.

Mike, you want to hit on Ag?.

Yes. Bob, with regards to Ag, you're absolutely right. There has been a headwind over the past couple of years. We think it's at a bottom. We don't see the type of significant decline that has occurred over the past year.

But with that said, we continue to look at what assets we have deployed in that market and if we do see softness, we'll move those assets to higher growth areas to utilize them better.

We did that this past year with mothballing a couple of plants that were dedicated to that market and putting those assets to use in other facilities, specifically in the south and southeast where we're seeing very strong growth that we need to have the capacity..

Got it.

And so did your fiscal '18 guide contemplate kind of continued softness potentially in these markets with continued strength in the core business?.

It does, yes. If you looked at the international, what we're talking about is a low to mid-single digit type growth there. Agriculture is a mid-single type decline with growth in our core domestic construction markets..

Got it. And just one final question and I might have missed it. Sorry. I just jumped on late.

Any update on the succession planning and thoughts on process and timing?.

This is Joe, Bob. It's proceeding as according to plan and the committee that is doing that work has developed a profile of the type of person we want and we're gathering candidate names and as we stated in the press release that went out, that every confidence we'll have is then placed by the end of the calendar year..

Good. I think you guys are doing a great job of managing the process in that very important and critical area. Best of luck for excellent 2018..

Yes. Thanks, Bob..

Thanks..

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Joe Chlapaty, CEO, for any closing remarks..

Thank you. In summary, we are well-positioned for growth in fiscal 2018. Our strong performance in our core construction markets is expected to continue. Driven by solid demand in our conversion strategies, particularly in our non-residential and new residential construction end markets.

We have been very pleased to see double digit growth of our HP pipe as well as solid growth in our key allied products, which we expect will continue in fiscal 2018.

We will continue to accelerate this growth through innovation such as our recently launched HPXR75 product line, as well as both on acquisitions that complement our product suite and geographic footprint.

Lastly, we are committed to improving our longer term margin profile through performance improvement initiatives focused on operational and customer excellence. Overall, we feel very good about our position in the markets we serve and our ability to continue driving above market growth and 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..