Mike Higgins - Director of Investor Relations and Business Strategy Joseph Chlapaty - Chairman of the Board, President and Chief Executive Officer Scott Cottrill - Chief Financial Officer, Executive Vice President and Treasurer.

Marshall Mentz - RBC Capital Markets Ryan O'Donnell - Robert W. Baird & Co. Timothy Daley - Deutsche Bank.

Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' First Quarter Fiscal 2018 Results Conference Call. My name is Robert and I am your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a Q&A session, a question-and-answer session.

[Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Mike Higgins, Director of Investor Relations and Business Strategy. Please go ahead..

Thank you and good morning. With me today, I have Joe Chlapaty, our Chairman and CEO; and Scott Cottrill, our CFO. On today's call, Joe will provide highlights from our first quarter of fiscal 2018.

Scott will then provide additional detail on the financial results, as well as an update on our outlook for the full year, before we open up the call for 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 in 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, in 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 our first quarter fiscal 2018 earnings call. Thank you all for joining us today. I'd like begin with a few remarks about our performance by key end-markets.

Domestic construction, which is our largest end-market, had a good start to the year, generating mid-single-digit net sales growth for the quarter. Our performance was driven by both the success of our ongoing conversion strategy as well as continued strong performance of our HP product family and key Allied products.

Our performance in the domestic construction market this quarter was particularly impressive, given the 8% growth we experienced in the first quarter of last year.

With the strength of our backlog and solid demand in both non-residential and new residential construction, we anticipate the domestic construction markets will continue to drive above-market growth throughout fiscal 2018. On the other hand, our domestic Ag and international markets performed below our expectations, both declined 13% this quarter.

The international sales decline was concentrated in Canada, where we faced a weaker than anticipated demand in our Ag market, primarily driven by weather. While we're off to a slower start, we expect both Ag and international to improve from Q1 performance throughout the year.

Collectively these factors contributed to consolidated net sales being essentially flat in the quarter. In terms of adjusted EBITDA, we generated $60 million this quarter, which is lower than the year-ago period due to increased material cost, pricing headwinds in our domestic and Canadian Ag markets and Mexico, as well as higher G&A expenses.

It is worth noting that in the first quarter of last year we generated record adjusted EBITDA of $72 million, representing 34% growth in the prior year, driven largely by favorable material cost and strong non-residential construction market demand.

As we discussed on our last call, we expected resin cost to be a headwind through the first half of this year, which will be partially offset by favorability in the second half.

The improving cost environment, coupled with our conviction in the strength of our end markets for the balance of the year, gives us confidence in our guidance for fiscal 2018. Additionally, last year the portion of our adjusted EBITDA generated in the first quarter was higher than we anticipated for this year.

We continue to make progress on implementing our superior performance program initiatives, aimed at further driving our growth and competitive advantage in the industry, as well as accelerating margin expansion and profitability over time.

With that said, we are taking further action to reduce our overall cost structure and improve margins in light of the softness in the Ag markets, which Scott will expand upon in a moment. Finally, I would like to tough on a few updates to our capital deployment this quarter.

I am pleased to announce that we invested $8 million or approximately 15% of our share repurchase authorization and buying back 400,000 shares in the quarter, consistent with our stated capital allocation policy to engage in opportunistic share repurchases.

We also announced the acquisition of DURASLOT this morning, broadening our Allied Products portfolio and offering future growth opportunities as we leverage our national footprint, as well as our sales and engineering teams to increase the market presence of this product line.

In summary, from a top-line perspective, our core domestic construction markets are off to a solid start this year. I am pleased to see our continued success in generating above-market growth, through our conversion strategies and by offering the industry's only complete package of water management solutions and products.

We are taking action to improve our cost structure and continuing to implement our SPP initiatives to drive margin expansion over the long term. With that, I'll turn the call over to Scott to discuss the financials in more detail..

Thank you, Joe. On Slide 5, we provide a summary of our performance during the quarter. Key takeaways include, first, we experienced solid growth in our core domestic construction markets, despite a tough comparison to the prior year.

And you may recall, we had double-digit growth in our non-residential market, which contributed to 8% overall growth we experienced in our domestic construction markets. Second, we experienced lower year-over-year pricing primarily concentrated in our domestic and Canadian Ag market as well as in Mexico.

Third, we had higher raw material costs during the quarter than last year. Last year's resin cost were the lowest we have experienced in the last couple of years. Making the year-over-year comparison that much more difficult. While our domestic construction sales grew 4% in the quarter, which we believe outpaced the overall market.

Our Ag sales were weaker than we anticipated. We are therefore taking actions to reduce our cost structure and improve efficiencies to address this market weakness. We are also accelerating some of our SPP initiatives primarily those related some operational excellence, and network optimization, which we began last year.

That said, our gross margin came in at 24.2%, 280 basis points lower than the prior year impacted by the items I just mentioned as well as higher operational costs. With respect to the inventory absorption cost issues we faced in the fourth quarter, the impact was nominal in Q1 of this year.

These factors in addition to an increase in G&A expense contributed to 330 basis points decline and our adjusted EBITDA margin, which came in at 16.8%. Moving to Slide 6, I'll spend a minute reviewing our G&A expenses.

The largest items impacting G&A expense are $7.7 million decrease in restatement related costs, and $7 million decrease in stock-based compensation expense. Due to recent change in accounting rules and modification to our stock award agreements, we are once again utilizing the equity method of accounting for stock compensation.

This change will allow us to value grants at the grant date and amortize expense over the life of the grant, which will significantly reduce the volatility around our stock comp expense going forward. These decreases were partially offset by increased professional fees, salaries and related benefits.

The increase in professional fees included cost of approximately $1.6 million related to our SPP initiatives during the quarter. Moving to Slide 7, in the first quarter of fiscal 2018, our free cash flow with the use of cash of $35 million, as compared to use of $13 million in the prior year.

The increase in the use of cash was primarily related to the decrease in our adjusted EBITDA, increased working capital requirements as well as an increase in capital expenditures related to the same period last year. Additionally, in the first quarter of fiscal 2018, we amended our revolving credit facility and our private Shell facility.

We increase the revolving credit facility to $550 million from $425 million and the Shell facility to $175 million from $100 million. Moving to Slide 8, during the first quarter, we've repurchased 400,000 shares of our common stock representing approximately 15% of our authorization. This leads about $42 million remaining under our current program.

We will continue to consider opportunistic share repurchases as part of our capital deployment plan to create shareholder value. Slide 9, highlights our end market expectations for fiscal year 2018. Our domestic construction market outlook remains unchanged.

We expect the domestic markets to grow low to mid single-digit and expect our sales in those markets to grow mid-single-digit. Importantly, we still expect to execute on conversion strategy of top line growth that outpaces the market.

We now believe the Ag market will be down mid-single-digit compared to our previous outlook of low to mid single-digit declines for the year. And we believe our international end markets will be up low-single-digit as compared to low to mid single-digit growth we initially expected.

Moving to Slide 10, we are maintaining our previously communicated estimates for fiscal 2018. Our expectation for net sales is to be in the range of $1.275 billion to $1.325 billion. And adjusted EBITDA is to be in the range of $200 million to $220 million.

With respect to adjusted EBITDA, as mentioned previously we are continuing our operational excellence and network optimization initiatives that began last year, and taking actions to improve our margin performance, and to better align our cost structure given the current conditions in our Ag market.

We are committed to taking a balanced approach to managing both our top line as well as margin improvement, and we'll continue to review all areas of the business to drive efficiency and reduce our cost. To this point, we are currently in the process of shutting down underutilized facilities, reducing our headcount and cutting out nonessential costs.

We expect these initiatives to have a favorable benefit to our adjusted EBITDA of $5 million to $10 million over the remainder of fiscal 2018. Lastly, I'd like to spend a few minutes on our SPP initiatives.

We continue to make progress implementing a more formalized and processed driven approach to executing on our key initiatives that are aim to driving further growth and competitive advantages.

We also continue to inspect and reevaluate every aspect of how we operate to see how we can do such more efficiently including optimizing our network footprint, accelerating new product development as well as expanding our focus on continuous improvement and lean manufacturing among many others. Now, we'll be happy to take your questions.

Operator, please open the line..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bob Wetenhall of RBC Capital Markets. Go ahead, sir..

Good morning, guys, this is actually Marshall Mentz on for Bob, how are you all doing?.

Great.

How are you?.

So you talked about making up potentially $5 million to $10 million of EBITDA through the operational initiatives that you're undergoing to address kind of, I guess, a weaker than anticipated demand in some of your end-markets.

Is it fair to say that, that fully represents your shortfall in the first quarter here and what you see in the balance of the year? Or is part of that also your DURASLOT acquisition, maybe kind of expand on the acquisition and how that fits into your guidance range?.

This is Joe Chlapaty. Let me begin and give you kind of an overview to that question, as an answer. And then, I'll let Scott and Mike to take over. Be mindful that as - or if you take a look at our performance in fiscal 2017, which was last year, we were somewhat frontend loaded in our first quarter and our performance decelerated through the year.

As we were planning for this year we anticipated, which is coming to fruition, a kind of a reversal of that approach, where we are going to - we believe we'll see strength in our performance accelerate as the year progresses. And much of this will be selection of improving material costs, which we are experiencing.

And as we've noted in the comments that we made, our end-markets outside of Ag are robust right now. And our order and shipping activities is quite strong. So we believe that as we go through quarters two, three and four, we will accelerate our performance and improve to the point that we will meet our guidance.

There is no DURASLOT activity included in there and - the SPP initiatives are a factor, but that's not just the thing that's going to carry us through the year..

And the only thing I'll add to that is the fact that, as we can talk to our network optimization and rationalizing our footprint, as we look at areas of our business that aren't performing up to our expectations, then we've got the process now to go look at that in the data and the information to go take the action.

So when we talk about these restructuring actions, it's basically focused on taking out some of that investment or infrastructure that we have to support those markets that aren't growing. If you look at where we have made investments and it's in the construction markets.

And those are the markets that we continue to see growth, in our HP product line and in some of the others. So that's, well, how I would talk to that. And then, DURASLOT is not a material component of that.

And it's mostly just those restructuring actions, but I would say it is, yes, it is a response to what we've seen in the quarter and as we look forward. But it's also just a continuation of our network optimization processes..

Very helpful, and I agree and I think there is a lot of noise in the first quarter given how well you all performed last year.

The pricing headwinds that you highlighted, are those isolated to your agricultural markets in Mexico? And how should we think about the price/cost interplay during the balance for the year?.

Yes. So to answer your first question is yes. It's isolated to Ag and international. I think again as you look at our material cost, they were up 5% percent year to year. But if you look at the mix of that, our polypropylene was up 23% and that goes into our HP product line, which again, great mix, HP was up 17% year-over-year.

So again, as we look through our purchasing and our cost, that spike in cost was mostly in that February through April time period. And we'll see those costs kind of impact Q2, but then come down through Q3 and Q4.

On the pricing side, again, as we quote jobs, we're taking that into account and upping our price in regions, geographies, as well as on HP based on the polypropylene increase as well, as we go forward..

I might add that, material cost, both in the form of high-density polyethylene and polypropylene are moving down as we speak. And the impact of the capacity additions that we've talked about several times are taking place and accelerating.

And we believe that will be the direction going forward, not just for the balance of this year, but looking out several years..

I guess, finally just one more. Do you have any additional detail on the uptake of HPXR 75? I know you all have been excited about that in the past. And maybe just how that is going, and how receptive customers have been to that in the market..

Yeah, well, we have sold the HP 75 and the [reactor from contractor's obsolesce] [ph]. What we have been doing is refining our manufacturing processes to enable us to produce the product in more locations, so that we can minimize freight cost. And we've done some refining of our manufacturing process.

And we got little reticent to push too hard until we felt we had the inventory in place that meet market demand. But we were excited about this product line. And it really is an extension of HP. I mean, you got our high density N-12, you've got the HP product line, now the XR 75.

And we believe it's going to perform the same way going forward in that trajectory as the HP product line and it will have a pull along effect of the standard HP and the HDP product.

So we remain very optimistic and we've had the good success with those installations that have gone in and as we build inventory in that product line, we'll be accelerating the intensity of our marketing and sales efforts..

Thank you and good luck during balance of the year..

Thank you..

Thank you..

The next question comes from Ryan O'Donnell of Baird. Please go ahead..

Good morning, guys. This is Ryan on for Mike..

Hey, Ryan..

Hi, Ryan..

So I just wanted to kind of piggy back on some of those margin questions, so specifically on the G&A, I think that's kind of the piece surprised us a little bit this quarter.

Maybe just talk about how that kind of trends through the year from, called a normalized $23 million this quarter back toward maybe something in the mid to high teens over time? And then how the cost saves kind of flow in and materialize as well through the year?.

Hey, Ryan. This is Scott. The thing to look at on the G&A side of the hose is, if you remember last year, April through September, we are pretty much related to restatement. So we had Deloitte, PwC, KPMG, but pretty much all of those professional fees were geared toward restatement related activity, so those all got at it back.

When you look at October through March, we pivoted to kind of normal operations, normal accounting controls, auditing type of work. We have still the one residual restatement related item related to share-based comp that took us all the way to January to get our 10-K filed. So the cost for G&A that hit EBITDA last year are very much backend loaded.

We still had the audit fee for the full year, but the audit fee was recognized in October through March. So we got a back half comparison that's going to be a lot easier than a front half comp, so just to highlight that for you.

That being said, the G&A costs were a couple of million dollars higher than we would have expected, that's - some of that - all of that is timing of the services that related thereto. Some of the firms did some extra work in the first quarter than what we have budgeted that they would have done.

So again, the salaries were in line with what we expected, and I would say on the professional fees largely other than some of those timing expectations. But we are very much going to be a headwind first half, and then second half will be a tailwind based on the phasing last year..

Okay, great. Is there any way to size that through the year whether it's kind of all in as reported basis or kind of excluding some of those items that you call out on the bridge to get down to the $23 million this quarter.

Is there any way to size the full year G&A expectations that you guys are projecting right now?.

Because of the noise on year-over-year basis, Ryan, as we talked about at the end of last year, and again SG&A, looking at that as a percent of sales is not the way to look at it. But to frame up and model it out, using that mid-double-digit kind of number is where we expect SG&A to be this year as a percent of sales.

That's the best way to look at it this year..

Okay. And then last one for me on the demand side, could you talk about it sounds like the front log is improving.

How did your sales rate in orders track month-by-month through the quarter? And how are we looking kind of - for next quarter and then into the back half of your fiscal year?.

This is Joe Chlapaty again. We are experiencing robust orders right now and shipping activity, in fact, I believe it's through - it's July or June.

Through July, our order backlog and revenue compared to last July is up 9% over the year, so over the sweet spot of our season and our activity is, where we have hoped it is, and it's accelerated definitely from the first quarter..

Okay. Thanks a lot guys..

Thanks, Ryan..

The next question comes from Nishu Sood of Deutsche Bank. Please go ahead..

Hey, this is actually, Tim Daley on for Nishu. Thanks for the question. So I just wanted to dig into your market outlook for 2018. So last quarter, you were giving the international market low- to mid-single-digits versus a low-single-digit market. Now you're expecting low-single-digits versus a low-single-digit market.

Is that a - does that mean essentially you're losing share in the international? And is that a deliberate pullback, because of the recent weakness or is that more of just a natural drift?.

No, I don't think is losing share, I think, it's just a factor of kind of what we're seeing on the pricing side of the house. When we talk international, Canada - Canada was really down significantly in the first quarter a lot of that was given - was due to Ag as well as pricing. In Mexico, the in weather - in Mexico it was pricing.

And so as we look to that first quarter performance, and where we expected it to go through the end of the year, it won't be - absolutely, won't be as bigger headwind as what we saw in the first quarter.

But as we look at where we ended up the first quarter to have kind of those expanded growth projections in there in the ranges we initially went out with, we thought it's prudent to just take those back a notch. But in Mexico, for example, they're out with price increases this quarter. They will be out with price increases next quarter.

So again actions being taken that we feel very confident that - will hit those guidance - those new guidance ranges that we gave for the end market?.

Okay. That makes sense. And then, I guess, you were mentioning incremental focus within Ag and international, I believe on cost savings due to the disappointing pricing.

So I'm just thinking now that is - your expectation for the growth has been slightly tapped down, will these cost savings effectively be enough to offset the loss in operating leverage due to the lower volume growth expectations? Thank you..

Yes, Tim. This is Scott. Yes, absolutely, we hope so and that's why we're taking the actions on both, in all three of those levers, right. It's not only just looking at our footprint, but it's our headcount, it's our nonessential expenses.

So I would say, we've talked about network optimization, and looking at rationalizing and optimizing our footprint since last year, and this just falls right in line with that.

So when we see the market demand and what we saw in the first quarter, when we project out through the rest of the year, we look at our capacity utilization - it's well - we took the plans off the shelf and if do well. So we were ready as a management team to take the actions.

We think appropriate to manage that margin so that we hit our margin goals and targets that we set for ourselves..

Be mindful that, we are allocating or putting our production equipment into those markets that are strong. And I think that has been one of the key initiatives that we talked about as we went into the performance improvement systems upgrade, and so that's a result of this.

And we believe was through some of the equipment changes we've made and through the inventory levels that we've provided there we were able to take production capacity out of certain locations mainly in the agricultural Midwest and move that equipment towards more needed. So it's a reflection of what the Ag economy is doing right now.

But be mindful, if you had some kind of resurgence in that, we could be right back there with the same opportunity to take advantage of that. So we haven't abandoned the market or we haven't lost any share in the market, we're just doing the prudent thing and putting our assets where there's growth and there's demand..

Understood. So kind of more of a reloading, I guess, since the….

Exactly..

All right, thank you..

Right..

[Operator Instructions] The next question will again come from this Nishu Sood of Deutsche Bank. Please go ahead..

Hey, sorry, I just wanted to follow up on the DURASLOT acquisition just - I guess, what - I know obviously it seems like it's a much more of, I guess, kind of spot solution to the tricky problems in drainage, rather than a kind of holistic approach of a product.

So I was just trying to figure out, what percent of I guess your revenues touch DURASLOT? And I guess what margin gains could you get out of the vertical integration of this product?.

Yeah, Tim, excuse me, this is Mike Higgins. The revenue is modest. The key thing with - so the way to look at the DURASLOT acquisition, are these things that we've been successful with in the past.

And that's a product that has either a local or a small regional scope, we're able to take that product and then leverage it across our national sales force or engineering force or distribution network and our manufacturing network to grow it in size and scale.

A lot of the Allied products that we sell i.e., StormTech, Nyloplast and Serdity [ph] collects storm, those product lines. Those are products that have started as very modest revenue things and have grown obviously to become a significant part of our business. So that's what we see with DURASLOT right now. It has a very local or regional focus.

And we anticipate expanding that to more a national presence to further the market penetration of that product..

We also believe there are meaningful opportunities to reduce the cost of manufacturing that product and without a lot of cost additions in ADS, because of the number of plants we have, where we manufacture fabricated fittings and we can slide this into those same facilities with no incremental cost.

And so make the product available on a national basis which it hasn't been to a large degree and at the same time take cost out of the product..

It's very helpful. Thank you for the questions..

Thanks, Tim..

[Operator Instructions] Okay. As there are no more questions, this will conclude our question-and-answer session. I would now like to turn the conference back over to Joe Chlapaty for any closing remarks..

In summary, we edged the first quarter position for growth in fiscal 2018. Our performance in our core construction markets is expected to continue to drive growth throughout the remainder of this year, driven by solid demand, continued success of our conversion strategies, as well as strong growth of our HP product family and key Allied products.

In fact, we are exploring expansion opportunities for HP product family in order to meet the demand we are seeing in the marketplace. We will also look to accelerate our growth through innovation, as well as bolt-on acquisitions that complement our product suite and geographic footprint, such as our DURASLOT acquisition announced this morning.

Lastly, we are committed to improving our margin profile through performance improvement initiatives, focused on operational and customer excellence, as well as near-term steps to reduce our cost structure to better align with the current conditions in our agricultural markets.

Overall, we feel 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..