Mike Higgins - Director, IR & Business Strategies Scott Barbour - President & CEO Scott Cottrill - CFO.

Nish Damodara - Baird Scott Schrier - Citi Tim Daley - Deutsche Bank.

At this time I would like to welcome everyone to the Advanced Drainage Systems' First Quarter and Fiscal 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Mike Higgins, Director of Investor Relations and Business Strategies, you may begin your conference..

Thank you and good morning. With me today I have Scott Barbour, our President and CEO; and Scott Cottrill, our CFO.

I would also like to remind you that we will discuss forward-looking statements as the 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, 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 Scott Barbour..

Thanks, Mike, and good morning, everyone. We had a strong first quarter in both sales and earnings. We saw healthy activity in the domestic construction markets where our sales increased 10%. This strength extended across both the non-residential and residential end markets.

Key markets such as Texas, Florida and Carolina has also performed well in the quarter and our activity is up, low double-digits compared to the prior year. In the non-residential market, our sales increased and each region did growth of large diameter HP pipe in our N-12 pipe products, as well as Allied Products.

The residential end market continues to be supported by strength in housing starts, especially as multi-family housing has returned to growth which is a water management solutions market for ADS. In general, ADS is benefiting from the strong residential development and associated [indiscernible] development.

Importantly, the success of our complete water management solution strategy continue to drive strong growth of our Allied Products including double-digit growth this quarter of StormTech for retention detention systems and Nyloplast for storm water capture.

We also saw impressive growth of our newer Allied Products including the Duraslot product line for the channel drain market which we recently acquired and our Barracuda separated water quality product, which we recently developed and introduced.

In our agricultural end market on seasonably cold temperatures in the West Spring and the Midwest, delayed the spring selling season this past quarter. We also believe the agriculture market is being impacted by the ongoing trade rhetoric. While we are not directly impacted by the U.S.

China tariffs, we could say it's the second order impact as farmers contend with the potential of a shrinking export market and depressed crop prices. An increase in sales in Mexico and Canada drove strong performance in our international business this quarter.

We are particularly encouraged by the strength of our business in Mexico where we are seeing growth in our N-12 product line as well as improved profitability as we incorporate recycled plastic into the manufacturing process. In Canada, growth continues to be driven by our team's solid executions in the construction end markets.

Moving to profitability, we are pleased to report year-over-year margin expansion for our third consecutive quarter.

While we continue to see inflationary pressures in transportation labor and material cost, favorable pricing, our team's disciplined execution, defined mitigation plans and the growing demand for our water management solutions have helped keep our margins on target plan.

Our mitigation plans have been heavily focused on transportation and logistics activities. For example, we are leveraging our own transportation assets to minimize the impact of high third party freight cost which remained at year-over-year headwind due to capacity constraints in cost increases.

We have also implemented new freight policies which help to ensure we are fairly paid for the transportation and distribution services we provide. This include implementing increased order minimums, building diesel fuel cost and do pricing in a new way and encouraging customer pick-ups among other actions.

We kicked off these actions in the fourth quarter of fiscal 2018 and are encouraged by the additional traction we are seeing in the marketplace. We also continue to focus on securing favorable pricing to cover resident cost, which remained at post-hurricane elevated levels.

Lastly, we see the benefit of our restructuring and manufacturing efficiency initiatives. In summary, we are very pleased with our first quarter financial performance, but as always, there's more work to do. The domestic construction market remains healthy with a solid pace of construction activity, expect it to continue throughout this fiscal year.

We will continue to focus on servicing our customers safely and on time, reducing our cost, driving efficiency throughout our business and executing on the fundamentals to ensure we are delivering the best results possible. I also want to share that our Green Line Polymers recycling subsidiary recently hit a milestone.

In June, they surpassed the one billion pound mark of reprocessed plastic or the equivalent of 500,000 tons. We continue to lead our industry in manufacturing products that are environmentally friendly and we are more committed than ever to our core mission as advancing sustainable business solutions.

I'd like to thank the passionate and dedicated employees who supports these efforts as we continue to seek out new ways of increasing the use of recycled plastic in our products. Lastly, we are planning to host ADS' first Investor Day in New York City on November 15.

We hope to see many of you there and look forward to sharing a more in-depth discussion of our business strategy and superior performance planned initiatives. With that, I will turn the call over to Scott Cottrill for a review of the financials..

Thank you, Scott. Moving to Slide 5. Net sales increased 8% to $388 million. Domestic net sales increased 7% to $342 million with growth in both pipe and Allied Products. Pipe sales growth was driven by both N-12 and HP where we had favorable price and volume in the quarter.

As Scott mentioned, growth in our Allied Product sales was driven by StormTech and Nyloplast, both of which grew double digits and continue to be integral to our water management solutions package. International net sales grew 17% driven by strong pipe sales in Mexico where we saw robust growth of our N-12 pipe products.

We also had 22% growth in Allied Products, which was large from StormTech sales in Canada where we continue to execute our complete water management solution strategy and increase our share in the construction markets.

Adjusted EBITDA increased 25% to $75.1 million, leading the margin improvement of 260 basis points to 19.4% this quarter as compared to 16.8% in the prior year. The strong profitability was driven primarily by volume growth in Allied Products and favorable pricing during the period.

Additionally, the benefits of our restructuring actions and SPP initiatives helped to offset the inflationary pressure that Scott mentioned earlier. Moving to Slide 6, we had a significant improvement in our cash flow provided by operating activities in the quarter driven by both better operating results and improvements in working capital.

As we mentioned on our last call, our working capital initiatives for fiscal 2019 include increasing inventory terms and more closely aligning our customer and supplier payment terms. So far, this initiatives have paid off and while we are still on early innings of our roll out, we are pleased with our results today.

Regarding capital spending, we plan to deploy between $60 million and $70 million in capital this year. This includes a number of projects that have gone through a robust approval process including plant improvements, new production lines and tooling to support high growth products and high demand regions.

This will reduce our manufacturing freight and material cost and allow us to service our customers more efficiently. We are also increasing our recycling capacity at our Green Line Polymers facilities where we sell processed recycled plastics. We're going to increase that capacity to capture additional cost benefits from using recycled material.

These improvements will also reduce the cost of converting the recycled plastic into usable material and improve our production efficiency. These organic investments remain our top priority for capital spending. We also expect contribution from these investments will largely benefit our fiscal 2020 results and beyond.

On Slide 7, we provide updated financial targets for fiscal 2019. Based on our order backlog and current market trends, we are maintaining the previously communicated range for net sales of $1.375 billion to $1.425 billion representing a year-over-year growth of 3% to 7%.

For adjusted EBITDA, we are raising the low end of our guidance range by $5 million and now expect adjusted EBITDA to be in the range of $225 million to $240 million, representing growth of 7% to 14%. These ranges represent an adjusted EBITDA margin of 16.4% to 16.8% or margin expansion of 60 to 100 basis points.

Our guidance contemplates more difficult comps as we move into the third and fourth quarter. As you may recall, our fiscal third quarter 2018 adjusted EBITDA was favorably impacted by the price increase we took ahead of material cost increases resulting from the hurricanes last summer.

The price increase took effect in the third quarter while the impact of the material cost increase did not meaningfully hit our P&L until the fourth quarter of last year. Today, we continue to hold on to favorable pricing in the marketplace as the cost of resin remains elevated.

However, as we approach the anniversary of the initial price increase, the year-over-year comparisons will start to flatten out. Turning to Slide 8, we provide our market outlook. Overall we expect current market trends to continue.

We expect domestic construction markets to grow at low to mid-single digits in fiscal 2019 supported by healthy demand in each of our end markets.

We are experiencing healthy demands in our non-residential and residential end market and though the infrastructure market was not as robust during the first quarter, we believe this is related to the timing of projects and not the help of the market itself.

Internationally, we expect low to mid-single digit growth supported by the Canadian construction markets and Mexico. With that, we'll be happy to take your questions. Operator, please open the line..

Thank you. [Operator Instructions] And our first question comes from the line of Nish Damodara with Baird. Your line is open..

Good morning, everybody. On demand side, it looks like the year is developing pretty nicely.

I was hoping you can just give us a little color about how things are tracked sequentially from fiscal Q1 and into fiscal Q2, and also if you could give us a quick update on the main acceleration you might be seeing your guys conversion trends? That will be great..

This is Scott Barbour. I would say that as your question, kind of sequentially how things are going in the order rates. I would say they're very consistent. I think we said they're kind of low double digits in order rates and I think that has been very consistent throughout first quarter, our first quarter into what we're seeing right now.

I think our demand side is being pretty consistent line of sight. So certainly do the end of the calendar year and into next year. I feel pretty good about that, too. The demand side I think is in good shape. On the conversion, I think you're talking about conversion from competing materials to plastic pipe [ph].

I think last year, we felt like there was a couple of points of conversion, maybe two points above what we were normally doing. We try to do one point of market conversion year. I think we ran that two and-a-half to three.

And some of the numbers we looked at as of yesterday with our Board, I think were in that range of conversion from competing materials. So I think that story or that strategy remains very consistent, that initiative remains at the very top of our list along with our solutions in Allied Product strategy for growth.

And I would tell you that probably stronger today, than it was 12 months ago, given the penetration in the market of our HP polypropylene-based product..

Got it. Thanks. That's really good color. Just a follow on the margin side, expansion is really pretty impressive in the quarter. It looks like a big chunk that was out performance on that price mix materials bucket.

Could you give us a sense for how sustainable that is on a go-forward basis and any commentary around any of you guys resident and [ph] material's outlook would be great..

This is Scott Barbour again and I think Scott Cottrill will hop in here, too. But I think we got on top of this pricing pretty effectively post-hurricane last year. That has created a really nice spread for us between as the elevated resin prices flow through our P&L.

We continue to look at that and manage that very closely and well and I think the comparisons for us as Scott Cottrill said will be pretty nice here through the first two quarters. That will flatten out some to the third to fourth. We're going to go work that.

We have a lot of different things in motion around that, so I think it will change as we get to the back half of the year. It's not reflective of any change in pricing that were doing the market, it's just how the things are flowing through our P&L, if you will.

The other thing I would say about the pricing element and sustainability of it is we're looking at more than just resin when we are looking at our pricing.

We are looking at how competitive materials are pricing, inflationary pleasures that they are seeing some common to us like transportation and labor, some not common to us because they have different inputs like steel or cement and things like that.

I think we've seen opportunities with respect to that kind of dynamic to get our price enough in the market. It's a very regional thing. You don't get it in any every single region. You got to really look at that on a very granular and regional level, which we do.

But we're really committed to working our pricing in a manner that allows us to continue to convert and keep that story going and conversions from competing materials and be responsible, relative to kind of protecting our margins. We're going to play both sides of that game.

Cottrill, anything?.

No, I think Scott did a great job with that. As it plays out specially on the polypropylene side, we're seeing a little bit of the polyethylene go up. But it's a story of two halves.

When you look at the second half of this year versus last year, we'll see -- at least we predict that we'll see that polyethylene come in a little bit favorable at the last year, but polypropylene is going to stay up a lot higher than where it was last year.

Those are items that we're managing last year and hence the comment about some of the comps as we get to the second half of the year and get flattening out a little bit..

Great. That's very helpful. If you guys don't mind me just making one more in here. Free cash looks pretty strong on the quarter, it's really above normal seasonality and with the leverage reaching pretty low levels here, I think 175 [ph] in the deck.

Just give us an update on how you guys are thinking about your M&A pipeline and how actionable it is today..

Again, it's one of those things we've talked about on these calls to develop a more proactive -- if you will -- pipeline for our M&A, we've always got targets that were thinking that are in various levels of pipeline, of that funnel. It's active. There's always things that we're looking at different levels within there.

Obviously we look at the multiple and we have a disciplined process to make sure that we hit our strategic and our financial objectives and targets that we have in place, but it's active. And from a capital allocation, capital deployment standpoint, it's one of the those areas that we really want to emphasize as we move through the share..

We've had quite a bit of discussion with our Board of Directors on this over the -- we just met this week and there's a lot of conversation outside of the board meetings around that. Very high on our agenda is how we go forward with that part of our capital allocation strategy.

I think the internal capital has come together nicely over the last nine months and the spending is a little down on the chart, but that's going to catch up here. There's really some timing issues in that, but this next leg around the acquisition piece is certainly the next part of the strategy coming together.

Very active, with Cottrill and I, in a lot of different conversations with our board have to structure that process and accelerate it..

Scott has a good point and that's favorable cash flow. We're very pleased with it, but after that is timing when it comes to our CapEx favorability and our tax favorability. The other piece of that would be the working capital and EBITDA performance running through our cash flow..

[Operator Instructions] Our next question comes from the line of Scott Schrier from Citi. Your line is open..

Just wanted to start off with the guidance. You talked about it on the last question. Your sales were flat, obviously it seems like you've gotten some more confidence in your margins especially after Q1.

I'm curious, is that due to just better cost outs than you previously thought and is the guidance just due to this quarter's performance/ Or is there any anticipated improvement throughout the year relative to your prior expectations?.

Good morning, this is Scott Barbour. We feel the need to identify all the Scotts. I would say that raising the bottom end, to me is the confidence we have in the execution of our plan for this year. Like any time you are going late through the year, you're always kind of worried about something that comes and hits you that you don't see.

But everything we see right now, we got a good line of sight on, it's working and more and more confidence in our plan today..

Got it. And then a follow up. A little bit more on the material conversion. It still looks good, but maybe it's tailed up about a little bit. I'm curious if one, maybe with higher resident cost and you having to push pricing takes it away in some people's eyes.

Some of that, the benefits of the material conversion theme and more on that I guess was infrastructure due to timing coming in a little lower. I was wondering if you could talk a little bit about that Senate Bill 3121 which seems like it would really open the doors from the water infrastructure perspective from material conversion..

Okay. So the material conversion piece is not slowing down. I think we're on a really good pace with our material conversion.

The relative segments I think we're growing faster than our competitors that we kind of see numbers on which in the storm water market, I can structure an activity which is pure storm water is up 10% year over year on the quarter.

I wouldn't back off at all on the success of that material conversion strategy and relatively unimpacted by resident price moves and our price moves because our competing products have had price moves, too. That said, it's always regional, Scott.

What you see in North Carolina might be very different than what you're seeing in California because you have different competitive dynamics, different jobs in those things, but in aggregate, we're very confident in our conversion story. The Senate Bill is the Transportation Bill. It's the one that gives equal thing for all materials.

That in general is good for us because it's an open competition type of an arrangement where any equivalent material could be used in those products and actually, we have people that have been working in conjunction with I think it's the Chemical Institute or the chemical guys, the resin guys trade arm along with our trade arm, the Plastic Pipe Institute to promote what we would call that open competition among materials in the Transportation Bill.

We will be highly in favor of that.

There was a third piece that you packed in there?.

No. I think you hit the major point. I really wanted to get at and I definitely appreciate the color on that senate bill. It seems like a real positive for material conversion. Thanks for time to answer my questions and good luck..

Our next question comes from the line of Matt Bouley from Barclays. Your line is open..

Good morning. This is actually Marshall [ph] on for Matt. Thanks for taking the questions and congrats for the quarter. Just a quick clarification first on your market outlook. It looks like you lifted your international outlook.

It's not completely apparent where the offset is, but I imagine agriculture came in a little weaker than anticipated?.

Yes, Marshall, that's spot-on. And again, we say market perform there. Again, when we look at our agriculture market being down 17%, it's one of those things that once you missed that spring, kind of planting season, it's unlike construction where you can make it up the next month or to. Once they plant, they plant. So you've missed it.

Your weakness in Ag [ph] is being offset by strength in international..

And then on the last call, you highlighted the few regions that you wanted to invest for growth just based on underlying economic factors. I think Texas, Florida and the West. If you could provide any additional color on what you're doing to address those markets or better-serve those markets..

This is Scott Barbour. In Florida, we continue to have very good success with Florida. Driven by our conversion strategy by the way of substituting for alternative materials and very good approvals and acceptance working that state. Great coverage, a really good team down there. Very well, well-run team. We saw a lot of success in Florida.

We also did some things in Florida this past year to try to increase our production and more effectively move our product in the logistics and transportation. We saw a lot of good results from that in the first quarter.

I would say a complete story, still work to do, but the initiatives that we undertook in Florida starting last fall, I think it paid off big for us. Texas had a good quarter. Again, a really solid team in Texas. We're trying some new initiatives there around gaining approvals and what I would call lobbying activities in the state.

We're very, very encouraged by the pace in which that program is progressing. I still think the best days are ahead of us in Texas and in terms of our sales. We're doing pretty well right now, but I think we could do better in the future. If we can recreate in Texas market share-wise what we're doing in Florida, we're going to like that picture a lot.

In California, a little slower quite frankly. We've added a lot of feet on the street there. We like our team. I think we need to give them a bit of time to mature in the region.

There are some work that we have to do -- we, meaning Cottrill and I, the corporate people, to probably get some assets and distribution points better situated to serve particularly the Southern California market. It's a different type of beast in that market. It's from a transportation logistics thing and we're working to kind of tweak that.

But in general, lots of focus by me and the team here in Ohio on those markets and very pleased with the initiatives that we got in flight there, some are yet kind of fully bloom, but I have every reason to believe they will..

Our next question comes from the line of Nishu Sood from Deutsche Bank. Your line is open..

Hi, this is actually Tim Daley on for Nishu. Thanks for the time. My first one is, Scott B, I think you mentioned some changes in the handling of transportation cost particularly in a way like it's charging customers for diesel fuel.

Could you just help us understand that a bit more and maybe kind of help break out hot much of the 50 basis points and manufacturing transportation bucket that was in the EBITDA bridge came from that quarter?.

I don't know if I can break out exactly like you asked there, but basically what we did, when we started looking at our logistics and transportation, as we went and said, 'look, we need to be fairly paid for the services we are providing' whether they be in kind of logistics, loading, unloading, delivery with our trucks and things like that.

I try to look at what were market rates for those types of activities and get that reflected in our quotation and pricing activities with our customers. And our sales force did a great job of kind of grabbing the bit on that with us and getting those kinds of things implemented.

What really shows up is offsetting inflationary pressures embedding now than that, manufacture transportation kind of thing. And relative to the diesel fuel, we simply went and went to a kind of standard industry way of building diesel fuel changes in price into the pricing of freight.

We have been a little less than what the market was doing there and I just brought it up to the market. Again, we have a lot of assets, a lot of people, a lot of activity doing logistics and transportation and I think it's only fair that we are paid adequately on a market based way for that service we provide our customers on.

I'm happy to provide it, love to provide it, but I just need to be paid fairly for doing it and that's what those initiatives were all around. And we started those back in November and December. By the time the team got in the market, we started really in February and March, so we kind of got and ramped up as we move into this year.

While not perfect, we can do better. Certainly accretive, but in the right direction and probably things that we work on every day. Scott Cottrill and I [indiscernible] it's like -- it has been 15 minutes since we've talked about transportation and logistics, something is wrong. So we constantly got that on our minds..

I do appreciate the color. And then just quickly, just a clarification, Scott C, I think you mentioned that the outlook for domestic construction, the man is consistent with recent trends. How should we think about that going into the rest of the year? I know you did mention that your line of sight into I guess fiscal year '20.

Should we take that results in Q1 on a year-over-year volumetric basis should carry through for the rest of the year? And thanks for the time and look forward to the Investor Day..

Yes, thank you. I think the comment is that the fact that when we look at our order rate and we look at the strength of the end markets.

We're very confident now that leads to our guidance ranges that we've got out there and as we extend that vision or view beyond and look at third party indicators and into season and data that we have as well as our sales force and our internal and again our order rates, we're very comfortable with that.

So again, when you look back at 10% growth in our construction end markets in the first quarter, it really tells you, the strength of the end markets, it tells you the strength of the ADS conversion story and our order rate activity plus all the independent third parties we look at.

We've very confident to what that leads for the remainder of the calendar and fiscal year. Very confident in the outlook..

[Operator Instructions] Our next question comes from the line of Scott Schrier from Citi. Your line is open..

Thanks for taking a follow-up. I'm curious if you could give a little bit more color and elaborate on the expansion of the recycling operation. I know you said it should benefit more in fiscal '20 and beyond.

I'm wondering if you could bracket maybe the order of magnitude of savings we can then expect from this?.

I think there's a couple of different benefits there. We see some things on the horizon that might drive additional use of recycled in our products, so we're getting ready for that. We've also got what we call optimized pellets, if you will, where you take our flank and making it in the pellets.

That optimized mix if you will is leading to better throughput and productivity on the operations side. So it's a little bit of capacity, it's a little bit of having more of these what we call 'palletizing lines'.

Again, when we talk to our GOP operations who take post-consumer bails and grind it and wash it and make it into flake, we then have these pelletizing lines that make it into these pellets that actually help us get a lot of productivity and throughput.

And now we're going the next step, if you will, and optimizing that blend and really creating the capacity for better throughput and productivity with our current operations of production lines. It's a little bit of capacity, as well as a little bit of the productivity side..

Okay, thanks..

This is Scott Barbour. I would like to stab one thing, but this is part of our superior performance initiatives.

We're committed to investing capital and executing programs that help us perform better and as Scott described, we're making these investments to get better throughput in our pipe extrusion assets, get better performance out of those which drives our conversion costs down, which drives our cost to goods sold down.

I mean we're trying to make really intelligent capital investments that have the right paybacks on the right time lines that are low risk. We know how to do this. We've been doing it for 10 years with these recycling assets.

Very, very solid program that will have a very quick low-risk high payout and that's what we're trying to do here over the next couple of years, is we step up that capital investment piece..

[Operator Instructions] We have no further questions in queue. I'll turn the call back over to Scott Barbour for closing remarks..

All right. Thank you. Again, I appreciate everyone joining us today in closing our financial results from the first quarter, have positioned us well for a solid fiscal 2019. We raised the low end of our adjusted EBITDA guidance range reflecting the confidence we have in our ability to meet our financial targets for the year.

We expect the demand on the construction markets to continue at a steady pace. We are currently experiencing and we expect ADS to outpace those markets with our conversion strategy. We will continue to focus on the fundamentals and drive improvements and profitability through operational excellence.

We look forward to speaking with many of you very soon as we look forward to another promising year. Operator, that concludes our call..

Thank you. This concludes today's conference call. You may now disconnect..