Mike Higgins - Vice President, Corporate Strategy and Investor Relations Scott Barbour - President and Chief Executive Officer Scott Cottrill - Chief Financial Officer.

Ryan Connors - Boenning & Scattergood Kevin DeCesaris - Citi Matthew Bouley - Barclays Scott Schrier - Citi.

Good morning. My name is Devon and I will be your conference operator today. At this time, I would like to welcome everyone to ADS’ Second Quarter Fiscal Year 2019 Financial Results Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Vice President, Corporate Strategy and Investor Relations, Mike Higgins. Mr.

Higgins, 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.

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, 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 submitted to the SEC.

We will make a replay of this conference call available via webcast on the company website. With that, I will turn the call over to Scott Barbour..

Thanks, Mike and good morning to everyone. First, I would like to congratulate Mike Higgins on his recent promotion to Vice President. Well deserved and we were glad to make that recognition in the last couple of weeks.

Our top line performance this quarter reflects growth in our domestic, non-residential and residential construction end-markets, double-digit growth in international sales and strong performance from Allied Products. Net sales growth of 1.4% would have been stronger if not for two items.

First, recall that in the prior year, Hurricane Irma disrupted resin supply causing an increase in resin prices. This led to our corresponding price increase, which took effect October 1, 2017. Many of our customers placed and took orders ahead of this price increase, which accelerated $10 million to $15 million of demand into September of last year.

The second was the record rainfall in the Northeast, Mid-Atlantic, Midwest and Texas, which we estimate had a $10 million impact on our net sales. Absent these two items, net sales would have grown in the mid to high single-digits this quarter.

Importantly, in October, sales were back on track to our plan and we were able to recover sales in key markets, such as Texas and the Carolinas. Based on the markets today, the strength of our order activity, our backlog and the initiatives we have in place, we are reaffirming our guidance for fiscal 2019 today.

We continue to see strength in our domestic construction markets where sales increased 2% this quarter driven by growth in both the non-residential and residential end markets. As of the unusually wet September, our second quarter domestic construction sales were in line with or better than we reported in the first quarter.

Like most everyone else in our industry, we are carefully watching the market indicators. Based on the strength of our order activity, backlog and the overall demand, we continue to feel good about the health of our core construction end markets. The people we do business with remain busy and confident about future demand.

Our international business had a strong quarter, with a 12% increase in sales and more than double the prior year adjusted EBITDA. Mexico performed well, driven by growth of our N-12 product line and higher profitability due to the incorporation of recycled plastic into the manufacturing process.

In Canada, growth continues to be driven by our team’s solid execution in the construction end markets. Finally, our export business is growing nicely and increased sales 41% this quarter. Moving to profitability, we are pleased to report year-over-year margin expansion for the fourth consecutive quarter.

Favorable pricing, our team’s disciplined execution in defined cost containment plans and the growing demand for our water management solutions kept margins ahead of the prior year period. However, we continue to experience the impact of inflationary pressure on transportation, labor and material cost.

We are working very hard to stay ahead of these cost pressures, including two recent actions we have taken. First, we announced the closure of a plant on September 1 which will provide a modest benefit this year, with the majority coming in fiscal 2020.

Second, we announced a price increase on October 1 to offset higher material and transportation costs, which went into effect November 1. Transportation cost inflation was a headwind this quarter though we benefit from having our own transportation assets.

This puts us in a position to better control the cost inflation than those relying on third-party providers. While our transportation cost increased in the quarter, we estimate our cost is up about half the rate of what third-party providers are charging in the marketplace.

We are mitigating the inflation through initiatives around the efficiency and productivity of our fleet, changes in policy and effective management of diesel fuel costs through pricing and hedging strategies.

We are seeing good traction on these initiatives, and we’ll go into further detail on this as well as other margin expansion initiatives at our Investor Day next week. In summary, we are pleased with our results through the first half of fiscal 2019. There is always there is more work to do.

While we expect the domestic construction market activity will continue at a solid pace throughout this fiscal year, we will continue to focus on driving above market growth, servicing our customers safely and on time, reducing our cost and driving efficiency throughout our business.

We are focused on executing on the fundamentals to ensure we are delivering the best results possible. Before I turn the call over to Scott Cottrill, I would like to welcome a new member of our leadership team, Darin Harvey, who has joined us as our Executive Vice President of Supply Chain.

Darin has extensive experience in leading complex global supply chains, continuous improvement in lean manufacturing and will lead our logistics, procurement, manufacturing and supply chain processes. Finally, as many of you are aware, we are hosting our first Investor Day next week.

We plan to go through our 3-year financial plan and do a deep dive on our initiatives to drive sales growth, margin expansion and cash flow generation. We look forward to seeing many of you there. 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 1.4% to $407 million led primarily by our international business. Domestic net sales were flat to the prior year, coming in at $351 million. Domestic Allied Products grew 7% driven by strength in key products such as our Nyloplast catch basins.

The continued growth of our Allied Products underscores the success of our complete water management solution strategy. Domestic Pipe sales were down 3% due to a weak September and a difficult comparison period that Scott mentioned. International net sales grew 12% driven by strong sales growth in each region.

In Canada, growth was driven by favorable pricing and growth in our construction end-markets as we continued to duplicate our successful U.S. complete water management solution strategy and increase our share in that market.

Net sales in Mexico increased due to favorable pricing and volume growth of our N-12 product line and we also experienced nice growth in our exports business. Adjusted EBITDA increased 7% to $71.5 million leading the margin improvement of 90 basis points year-over-year.

This strong profitability was driven primarily by favorable pricing as well as a higher mix of Allied Products. Additionally, the benefits of our restructuring actions and SPP initiatives helped to offset the inflationary pressures in transportation, labor and material costs that Scott mentioned previously.

It is also worth noting that our net income increased over 60% this quarter as a result of the adjusted EBITDA drivers I just mentioned, lower restructuring and realignment costs and the benefit of a lower tax rate.

Moving to Slide 6, our cash flow from operating activities increased $30 million year-over-year on year-to-date increase of revenue of $35 million. This significant improvement was driven by better operating results and improvements in working capital.

Our working capital initiatives for fiscal 2019 include increasing inventory terms and more closely aligning our customer and supplier payment terms. While we are still in the early innings of rolling out most of these initiatives, we are pleased with our results today. Regarding capital spending, organic investments remain our top priority.

Our initiatives this year include plant improvements, new lines and additional tooling as well as investments in our Green Line Polymer recycling facilities. These initiatives will reduce our manufacturing, freight and material costs and allow us to service our customers more efficiently.

We currently expect our capital expenditures to be between $50 million and $60 million this year. On Slide 7, we are reaffirming our financial targets for fiscal 2019.

Based on order activity and current market trends, we anticipate net sales to be in the range of $1,375,000,000 to $1,425,000,000, representing year-over-year growth of between 3% and 7%. We are also reaffirming our adjusted EBITDA guidance 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 a margin expansion of 60 to 100 basis points. Our guidance contemplates more difficult comps as we move into the back half of the year.

We have reached the anniversary of our price increase in fiscal 2018, so the year-over-year impact from pricing will be less significant in the back half of fiscal 2019 as a result.

That being said, we continue to hold on to favorable pricing in the market and will continue to take actions to mitigate inflationary cost pressures we are experiencing in resin, labor and transportation costs. On Slide 8, we provide our market outlook.

We expect domestic construction markets to grow at low to mid-single digits in fiscal 2019, supported by healthy demand in the nonresidential and residential end markets. We also expect mid-single-digit growth internationally, supported by the Canadian construction markets, our Mexican operations as well as our Export business.

In summary, we remain confident in our outlook for the balance of the year and look forward to building on our strong first half performance. With that, we will be happy to take questions. Operator, please open the line..

[Operator Instructions] Your first question comes from the line of Ryan Connors with Boenning & Scattergood. Please go ahead. Your line is open..

Great. Thanks for taking my questions. I wanted to – I don’t know if I heard you right there towards the end, Scott. I think you talked about the latest price increase and potentially there being a pull-forward effect in the third quarter here.

Is it – did I hear that right or if not, can you address that?.

No. Basically, that last comment was referring to, if you remember last year, it referred to the fact that in September we announced a price increase as a result of the hurricane and the concern about the resins and the fact that, that price increase went into effect in Q3 and Q4.

So, the comps, on a year-over-year basis, become a lot more difficult, if you will..

Got it, okay.

And then what about the fact that if you had a price increase announced October 1 that went into effect November 1, would there be – was there some pull ahead into October then or that’s just not as much of the too short notice?.

No, it was nowhere near as dramatic as what we saw last year, so nothing significant to mention there..

You next question comes from the line of Scott Schrier with Citi. Please go ahead. Your line is open..

Hi, good morning. This is Kevin DeCesaris on for Scott. Can you quantify any weather impact on any markets you would want to point out? And can you just kind of elaborate on the confidence when you reaffirmed the guidance? Thank you..

So this is Scott Barbour. And I think I will give you kind of 30 seconds of the quarter where July and August were tracking very nicely and then the very wet weather, particularly in Texas, the Carolinas, the Midwest, the Upper Midwest with agricultural business, we saw that just drop off dramatically in September.

And then particularly in Texas and the Carolinas, we saw it bounce right back in October. And I think the number we have given is kind of was it $10 million to $15 million impact, $10 million impact in September from those weather events I talked about, not all that came back in October, but particularly Texas and Carolina came back nicely.

So, we kind of think our trajectory is basically the same as what we were anticipating as we were going through July and August.

I have used the term we kind of got blown to the side of the road a bit in September, but back on the road in October, but those were kind of significant events moving around between September and October between a year ago with the dramatic impacts of the hurricane had on our industry and then what happens here.

The other thing I would add is that our order rate that we saw in October was good. It was probably right lined maybe ahead of what we anticipated as we were moving into the quarter..

Your next question comes from the line of Matthew Bouley with Barclays. Please go ahead. Your line is open..

Good morning. Thank you for taking my question. I just wanted to follow-up on the price question. You have been clear that the guide embeds an expectation for flattening price and you just mentioned that the increase is not as great as last year’s, but I think it’s still incremental relative to the prior guide if that’s correct.

So does that suggest that there is still some conservatism in the guide at this point perhaps following the weather impacts or I mean to what degree, based on what we are seeing in HDPE and polypropylene today, I mean, to what degree are you assuming you can continue to realize price over cost in the second half relative to what you did in the first half? Thank you..

Yes, it’s a fair comment. The October price increase would be incremental to what we saw before. But remember, as you do a budget, you go down. There are a lot of moving pieces here. So as we look at what’s going on with some of our other cost pressures, especially on transportation we see those kind of going the other way.

So I would say right now, our commitment is to try to – not to try, but to stay in front of all these inflationary cost pressures, hence that October 1 increase. And so as we look down through our manufacturing and conversion, our absorption, we look through what our material costs.

Our material costs in the second half of last year really started hitting us in Q4, not Q3, just because it started going into our inventory and then it flushed through the income statement till we got to Q4.

This year, as we have talked about, our resin costs have stayed up and our polypropylene particularly is up 20%, north of 20% and we will see that here in Q3, Q4, so a lot of moving pieces. That being said, that’s why we went out with the October 1 price increase to stay in front of that and that’s why we are confident in reaffirming our guidance..

Okay. I appreciate that detail. Thank you for that. And then secondly, you mentioned in the prepared comments just kind of staying in front of the economic indicators and obviously, there is a lot of concerns out there probably more so on the residential side at this point.

But I guess what are you seeing particularly in the residential end market if you could split it out between your new residential exposure versus the retail demand trends? And then maybe even on the non-residential side, just have you seen any impacts from the interest rate environment there or caution around the tariffs, perhaps? Just kind of any additional color you guys have on the end market trends would be helpful? Thank you..

Okay. This is Scott Barbour. And I am going to start with the non-residential, that’s our biggest segment kind of we are most highly vectored to that.

And I would say that the people we do business with that we sit across from the table have a pretty healthy level of work and quotation activity and they remain kind of bullish as they are looking forward into the next year – the next calendar year.

And we like that, I mean, all of the engineering activity we are doing on projects and our sales calls, we have done a lot of – kind of a regional sales people through here over the last week. They remain pretty bullish on both our pipe and our allied product positioning in the U.S.

On the residential side, we tend to be a bit more vectored to the multifamily, because it’s a better solutions package for us. It’s more private development directed versus public works type of approvals. And I think we are really focused on making sure that we are identifying those projects and pursuing those projects.

We are also very focused on the, what I would call the Florida, Texas, California or I also refer to it as the crescent that starts in the Carolinas across the South and up to California. That’s where all of the major stuff is going on. And year-to-date, all those are in pretty good shape, so from a residential standpoint.

And we will continue to be focused on getting the right resources, the right engineering approvals that would support that residential, that multi-family and then the non-residential there. So I am very – I am watching it very hard. I get a lot of questions about that.

But I am confident that we will be well positioned for what the market presents to us and maybe even a little bit better than average given our vector on these geographies and the multi-family..

Alright. Thank you very much..

[Operator Instructions] Your next question comes from the line of Ryan Connors with Boenning & Scattergood. Please go ahead. Your line is open..

Thanks for taking the follow-up.

I wanted to actually sort of continue on the same line as the last question there, but just from a bigger picture standpoint, we don’t have the benefit – the company is recently public, so we don’t have the benefit of ever having seen how the business behaves in a recession and recessionary environment, so can you just give us your perspective on big picture, how things went in the last recession, whether – I know the conversion is obviously a big driver relative to market growth, but does that mean – could we expect the business to continue to grow in that type of environment or will it we be in a low beta decline last scenario, any perspective you can give on that would be really helpful?.

Okay. Ryan, this is Scott Barbour. And I wasn’t here either. I have been here just over 1 year. Cottrill, you are like 2 years, 3 years. Higgins was born here, so he probably has a perspective. But I will give you what I understand and what I anticipate and maybe Mike Higgins can add some color around that.

But our strategy, particularly around the core construction markets, is really built on converting from alternative materials and penetration with our water management solutions in Allied Products.

And what I have seen and when I look back to the data that we, even in a down market, we can usually perform a bit better than the market because we gain share through this material conversion strategy. I would add to that, this geographic focus we are having, even if those markets go down, we still should incrementally be growing there.

So I would like to – like we will target, we will manage, we will drive to do better than the market even if the market is down. Now if it’s down 10 and I am only down 8, you are still going to be critical. But that’s essentially how the company has tried to maneuver its way through prior downturns.

Would you add anything, Mike or Scott?.

I will just add a comment and Mike can add as well. I would say as well, these SPP superior performance initiatives that we have put in place and started 2 years, 3 years ago, they really provide the foundational format for any kind of – yes, to protect our margins and our cash flow.

So our commitment is on the top line absolutely, it’s that conversion strategy to grow above the market regardless of what the market throws at us. But it’s also to be nimble on our investments and our foundational and make sure that we can protect our margins and our cash flow.

So these SPP initiatives, all the way from network optimization to CI/Lean and so forth, they really provide us with some really great tools and allow us to be a lot more nimble as I look at it..

Ryan, this is Mike Higgins. The only thing I would add is, just kind of reiterate what Scott Barbour said earlier. I wouldn’t use kind of the past recession as an indicator just because of the dramatic kind of downturn we saw with construction and the ability to perform in that.

But just as we do outperform the market when the market grows, if there is a downturn in the market, we would expect our sales to still perform better than the market, maybe just not go down as much.

So I think Scott said before, there is a lot of areas that are experiencing strong growth where we have lower market share that we would focus our efforts on to mitigate some of that economic downturn..

And I guess also, this is Scott Barbour again. I also think, relative to the dramatic downturn after the global financial crisis and kind of a slow lift out of that, we are of the mind and we talk about this with our Board too that the amplitudes of the swings are, through this part, through the cycle that we are experiencing now are less dramatic.

And we just – when we talk to our customers and they would talk about looking through whatever noise is going on in – up to that 30,000 foot level, they see a lot of projects out there. They see – they don’t see any kind of re-compute but because of interest rate rises and stuff like that. Now they might be proven wrong in that.

But I think for what they see right now, I think they are – I think the businesses there are optimistic..

It’s very comprehensive and extremely helpful. So I appreciate your time..

You are welcome..

Your next question comes from the line of Scott Schrier with Citi. Please go ahead. Your line is open..

Hi. Thanks for taking the follow-up. Any commentary on the M&A market and are there any interesting Allied Products deals you see out there? Thank you..

So this is Scott Barbour. And we are – relative to kind of the acquisition activity, I mean many of you know, you have done the math, you have seen that we are paying down debt and kind of our capacity is in pretty good shape relative to our balance sheet.

The team has done a nice job managing that, Dean Bruno and our treasury team and also the working capital initiatives that we are working on.

That said, we – Scott Cottrill, Mike Higgins and I, we are really putting together a very disciplined process around identification of the targets, the screens we use to kind of get those to a level of interest that we will go through with our team and our Board and move into conversations. That process is – and staffing is being built as we speak.

We are increasingly spending time on that with our Board of Directors. I have been here 1 year, a little over 1 year, I think we have been trying to build what I would call the execution elements of our company’s strategy and now we are beginning to bolt on the – what I would call the acquisition elements of that strategy.

Joe Chlapaty, he knew everyone in the business and had relationships with these people. We kind of build that in a different way, because Joe has kind of – having built the industry, he knew the people in the industry and that gave him a much different capability to go out and reach into the market than what we have, Scott and I are having.

But we are actively working that. There will clearly be targets identified in what we call our storm water management solutions space, which will include Allied Products as long with – along with the other things we do that.

We are clearly looking in the markets we are in, the adjacent, the very close adjacencies that we have and at the beginning of that process..

Okay. Thank you very much. Good luck..

Okay. Thanks. And we will – by the way, we will talk about that more next week at the Investor Day in New York and we look forward to talking to that. But I want to characterize it as kind of building that process, building that capability, high level engagement between Mike, Scott, myself and our Board members..

[Operator Instructions] There are no further questions. I would like to turn the call back to Scott Barbour for closing remarks..

Okay. Thanks a lot. Thank you all, again for joining us today. In closing, financial results in the first half have positioned us well for a solid fiscal 2019. We reaffirmed our guidance ranges reflecting the confidence we have in our market position and our ability to drive above market growth.

We expect the demand in the construction markets to continue at a steady pace for the remainder of fiscal 2019 with its ADS outpacing these markets through our conversion strategy.

We will continue to focus on the fundamentals and drive improvements in profitability through operational excellence and we look forward to seeing many of you next week at our Investor Day. Operator, that concludes the call..

This concludes today’s conference call. You may now disconnect..