Good morning. And welcome to the Advanced Drainage Systems' Third Fiscal Quarter 2018 Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mike Higgins, Director of Investor Relations and Business Strategy. Please go ahead.

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 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, the press release we issued earlier this morning is posted on the Investor Relations section of our Web site. 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 Web site. With that, I'll turn the call over to Scott Barbour.

Thank you, Mike, and good morning, everyone. We executed the fundamentals of our business well this quarter, which help to drive solid top line growth and margin expansion. We posted net sales growth of 9% in both our domestic and international businesses, and drove 280 basis points of margin improvements this quarter. Our sales team work to get ahead of resin cost increases with our price increases. Their efforts in addition to favorable product mix help drive the margin improvement this quarter. We will continue to focus on the fundamentals of the business and drive execution in sales, operations and logistics. This is our path to driving sustainable improvements in our company. I recently spent several days at regional sales meetings discussing strategies for growth and profitability improvement. There are a couple of themes I would like to share with you. First, our sales team is very excited about our HP product line, which posted double-digit gains again this quarter with strong market penetration in key states. HP pipe is the tip sphere for ADS and capturing market share in large diameter applications against concrete pipe. We will continue to invest in this product and our capacity to produce it to ensure that we fully seize this opportunity. Second, from what our team is seeing in the marketplace, the activity out there is very good. When our team meets with project managers, engineers and contractors, they are excited about the level of project activity and we are well positioned to capitalize on these market tailwinds. I’ve led some sales meeting, excited by the momentum of the business. I believe there is great focus with the organization around solid execution. I will continue to drive down mindset with an eye on sales growth, margin expansion and free cash flow generation. Next,…

Thanks, Scott. Moving to slide five, our domestic construction market sales grew 12% in the quarter, further strengthening our conviction in our market conversion strategy. We generated double-digit growth in each of our end markets, as well as in our HP product line and Ally products. The 9% international net sales growth in the quarter was also driven by our conversion strategy in the Canadian construction market, as well as 37% growth in Ally products. We generated adjusted EBITDA growth of 29%, representing margin improvement of 280 basis points. The improvement was primarily driven by the key items we mentioned on our last call. Most importantly, we were able to achieve price increases ahead of our material cost increases. We also achieved volume growth, both domestically and internationally with favorable product mix. And finally, we executed on our previously announced restructuring actions of which we realized about $3 million of benefit during the quarter. As Scott said, we are pleased with this performance but far from satisfied. We believe there is a lot of room to run with our SPP and productivity initiatives, which should drive sustainable margin improvement over time. Moving to slide six, through nine months we generated $104 million of free cash flow, an increase of $24 million compared to last year, primarily due to working capital improvements and strong year-to-date net sales. For the full year, we expect our free cash flow to be north of $90 million, a significant improvement from last year. On slide seven, we outline the impact from U.S. tax reform on our financials in the period. In the third quarter, we recorded a $16.8 million benefit to our income tax expense, which is composed of three items. The largest component is a $14.7 million one-time benefit to income taxes from the…

We'll now begin the question-and-answer session [Operator Instructions]. Our first question comes from Ryan Connors with Boenning & Scattergood. Please go ahead.

I wanted to actually peel down on something you mentioned a little bit and that is the selling expense related to the HP products. And I know that selling expense did seem to jump in the quarter, and I wasn't sure that was related to that or not. So if you could just talk about that in the quarter itself. And then on a go forward basis. How structuring incentives and so forth around selling of those new products will impact that line item?

So what you saw in that selling expense line item is just a result of the top line growth that we've experienced, that 9% that Scott and I both spoke to. So that's just what came through as a result of commissions and the higher sales growth in the quarter.

And are those incentive structures any different than the incentive structures or selling incentives on the more traditional HDPE products or are those more or less the same, otherwise does the mix shift towards HP?

Same.

That is same, okay…

Yes, we understand the question and they are the same. This is a volume, sales volume driven item.

And my other question was, and I might have missed, I apologize if I did. I had to hop off for a brief minute. But any update on the ag market. I know there have been some talk about that being a headwind a couple of quarters ago now. Just curious what the update is there and anything you can provide.

So I would say that ag market is pretty stable right now. We believe we hit a lower end of what has been happening, and it's kind of moving along sideways, I would say. That's particularly true in the U.S., maybe a little more challenged in Canada. But volume wise, price wise it's moving just sideways. I would say the downdraft related to volume in that market, we've experienced majority of the pain.

And then also apologize if I missed this too. But, did you mention the tax rate we should be assuming going forward?

So in that 30% to 32% range should be what you assume.

Our next question comes from Nishu Sood with Deutsche Bank. Please go ahead.

So solid performance on improving the margin in the face of last quarter's headwinds from the storm activity in the Gulf. Just curious if you could walk us through the moving parts behind the 70 basis points increase in gross margins? Specifically qualifying what was there from price increases, raw material cost and then on other parts of SPP initiatives?

Again, solid performance on the top line growth, Ally products being up significantly, was part of that HP as well. So again starting with volume, solid growth there and that mix Ally the pipe really helped out. On the pricing side of the house, you hit on it got in front of the resin cost up, so mid-single digit price increases there. That led to when you look at that slide five and the bridge there, those would be the biggest pieces. When you look at the period cost for manufacturing and transportation, a lot of that again is a result of the higher sales and some of those products that have to travel over a little bit greater distances than others. So diesel being up year-over-year, common carrier rates, those are some of the things you see in our period cost that led to that margin expansion year-over-year.

And then I guess just going more on the -- thinking about the input cost versus pricing. So last quarter you talked on a bit of weakness from temporary timing gaps between suppliers increasing cost a bit more aggressively than you guys were. You talked about responsible price increases. Just curious as to how the trends went to this quarter, have they coupled up again, should we may be anticipate a bit of -- maybe this quarter was a bit higher than next quarter as these trends catch-up and I guess re-couple? Thanks for the time.

So I think, when we spoke previously, it was -- we received resin cost increases. It takes 30 to 60 days for our pricing to catch-up. And I would say in the quarter just completed, you saw that catch-up of pricing occur. I would say as we move through this quarter and what's going on right now is resin prices are, I recall, stubbornly sticky at what we experienced last quarter. So we think our pricing and our resin inputs are relatively lined up well. Now, we have some elements that bounce around and then we try to manage those and will continue to do that. But in aggregate, I would say, they are in that state that you’ve described as coupled.

And our next question is from Scott Schrier with Citi. Please go ahead.

Just want to follow up on that last question. I just wanted to confirm. So, based on the timing differences you have between pushing the price ahead of the resin, you would say that you had a little bit of a positive margin impact in the quarter that could potentially moderate a little bit as we as we go forward and the price versus cost kind of moderate -- or couples.

I think that’s an accurate description. I would say, however, that we continue to do a good job of holding on to price. There are other things we do for customers, particularly around logistics and transportation that we need to be adequately paid for. So, we -- that's a theme going through our discussions with customers and with our sales teams right now. So, we're going to be very mindful, prudent, maybe even aggressive in making sure that we’re paid for not only the product we produce but the services we provide in that logistics and transportation. And we will -- that should manifest itself and us being able to hang on to the pricing that we achieved. It won’t be there forever but kind of that’s our game plan right now, as we look forward over the next period of time here.

Got it. And then, moving on to your domestic end markets, obviously had that double-digit growth out pacing the market. I know you mentioned the mid single digit pricing increase. But I just want to see if you can give a little bit more color on the material conversion. Obviously, infrastructure at 14% based on what the market is doing, seems like whether it's quite a bit more of acceptance with some of your HP products. So, I just want to see if you can give a little bit color around the material conversion in the market place.

That’s a good question. And I would say that -- the color I would add is even if you strip out pricing effects, we’re -- our conversion from concrete to our products is ahead -- on or ahead of that kind of 2 points a year, 1.5 to 2 points a year conversion. And you see it manifesting itself in that infrastructure where we have the HP pipe which is our polypropylene product firmly aimed at that market in the larger diameters. So, that -- you kind of nailed it. That’s the color; that’s the place for us to grow and take advantage of the tailwinds there. I would also additional, in infrastructure, I know the bill is going to be announced here, maybe this week or Monday or something like that. And we don’t think we’ve fully seen the effects of that. We do where we are seeing those effects is where our market share model has worked and works well, where we get the approvals with the various agencies and Departments of Transportation. We work on acceptance within the professional engineer community, servicing those agencies. We have great coverage locally and then, we track these projects and win. And what you see in that infrastructure line is that happening in states that have some of these private public partnerships already in gear and are expanding their infrastructure spending. That’s what that is. That is not the effect of any type of national legislation that we might be seeing, which will take a little longer to dial out.

One more, I just want to ask a little bit about the comments about kind of turning up your M&A spend and how you're looking at that into next year? Just curious, if you can talk about, is there a sweet spot for size range? Is this more Allied Products related? And based on conversations, how are you getting a sense for seller expectations or a potential multiple that you might be facing in the coming years?

I think it’s fair to say that Allied Products would be a very fruitful area for us to look more expansively. We are going to stay in the storm water kind of section of our market pretty much. That will be the focus of that kind of program through the strategic and qualitative and financial lens. I would expect that sellers would have increased expectations, somewhat driven by the tax reform and lower tax rates and all that kind of stuff. And market that I think has some tailwinds from -- we have shown here it to you today we are doing pretty well, better than the market but it's clearly market that is healthy right now. So, we will be very mindful of what those multiples would be and very much in lockstep with our Board of Directors and their kind of guidance on that.

[Operator Instructions] Our next question is from Mike Halloran with Baird. Please go ahead.

Could you just provide an update on how you are thinking about some of the strategic internal initiatives as we sit here today, whether on the network optimization, the logistic side or maybe even a higher level view on -- since you have come on board as CEO, how the allocation of priority has changed or not changed? And if there is any focal points perhaps you can share?

So, we have I think really upped our skills and tools to manage our network of plants and our production planning and sales and operations planning processes. And we’ve seen some really positive ways that’s manifested itself in just the operation of our business and what I would call the velocity of our inventory, and our ability to do very detailed production planning, which is really important for us to do and helps us to optimize our kind of transportation costs and things like that. So, we’ve got a full-court press on that. And we will continue to invest in people, in tools and processors just strengthen our execution in that area. That has also highlighted opportunities for us to put in capacity in certain areas of the country for HP pipe in particular that would further strengthen our customer service and our footprint to serve some really important local markets where HP has gotten a good foothold, in particular. Third, I would say, as we've been through that we've also seen opportunities in what I call our logistics and transportation activities, which are high customer service activities, and we do a lot of great things for our customers there. But, we can do it better, we can be more efficient, we can put in new metrics that I think will drive better performance internally around that service. And maybe most importantly, I want to make sure that we are adequately compensated for that performance -- for performing that service. So, Mike, you kind of asked -- what have you really latched on to and kind of driven in different directions over the last five or six months, I would say those three things. You probably heard me say this, we're highly relevant in the market, and that's a great place to be. I think the way we were able to go out and get this pricing done was very effective, and we saw that real early, we jumped on that. It’s obviously paying some benefits for us now. And we're building upon that with these other three areas, as far as kind of what I would call really immediate attention and impact that we're trying to have.

And then, just on the demand side, sequentially through the quarter, it sounds like things were pretty stable through -- pretty healthy or pretty consistent. Is that true, on one hand? And on the other hand, you commented on whether potentially being a swing factor in the first fourth quarter here. Is that different than normal though, or is that just your way of saying, hey, look, we just know weather can swing things around a little bit but for now we're pretty comfortable with what we're seeing?

So, to answer your second question is -- I called it with our Board of Directors, local lore or legend in the Company is, is that March is a really big swing month, and that makes sense. March weather in the Midwest and Northeast, which is we're really strong, it can be highly, highly durable and swing stuff around. That said, we're doing pretty well in the Sunbelt, in the Southeast and out West. And we talk and work very hard to make sure we're maximizing what's going on in those areas that don't have that weather variability. Now, I am not going into local legends. So, March is highly variable and we got to pay attention to that. Your first part was sequentially how things were going. We feel pretty good. Our backlog is up year-over-year, double -- kind of nice double digits. We have a good book to bill ratio in December, which is very unusual but good in January, really good during the first couple of days of February. So, I'd say market pace is really kind of on the right side of the line versus decent, if you will.

Our next question is from Mike Dahl with Barclays. Please go ahead.

I just wanted to go back to the discussion around the SPP initiatives. And you've mentioned in the opening remarks the desire to accelerate some of the investments using, in part, the benefits from what you'll see in terms of lower taxes. I just wanted to get a little more color on -- of the details you just kind of went through on what you've been working on, which specifically are things that you think you can lean into more aggressively in the near-term in terms of pulling that forward?

So, what we'll do is lean into making sure that we have the right capacity in the right regions, particularly to support the HP product. And we will, what Scott has talked about, some investments are kind of moved to the left, on the chart. And we are particularly aggressively at getting those kind of investments done. And that is part and parcel with optimizing our network in reducing our kind of intra-network transportation costs, and taking up our customer service by really kind of having the right product built in the right plant for the right customer that is within that geographic zones. And again, we've invested in some really nice tools to do that. We're integrating them into our sales and operations plan very aggressively. And we think that we will continue to get better and better and better at that. And that helps us expand our margins, at the end of the day, expand our margins and take care of our customers better.

Can you help us just size up both from an operating expense and a CapEx standpoint, kind of what we should be thinking in terms of costs associated with these? And then, any thoughts on framing up the benefits in terms of magnitude on that top line and margin side and that you ultimately see from these initiatives?

So, I think on that side of the house, again, a lot of what we're talking about here is kind of that CapEx investment was a little bit of OpEx investment. But like we said in the script, Mike, there will be a lot more of that coming up as we go through our 2019 guidance on our year-end call. But, that's what we’re framing up now and we’ll give you a lot more flavor for that coming up.

Last one on my side, just the tax rate 30, 32. Just give us a bridge on -- it's a bit more elevated than we would have thought, just the bridge on kind of why it's not coming down more. I know there is some ESOP stuff, but just help us understand that a little bit.

No problem. So, our effective tax rate usually runs in the low 40s, so somewhere 40% and 42%. So, the rate, as we are looking at here provisionally, would come down by about 10 basis points, if you will, 10 points from that. That would be the 14% reduction in the statutory rate from 35% to 21%. And then, the manufacturing credit, domestic manufacturing credit goes away, and that's about 3 points that goes the other way. So, that’s kind of how you bridge at a top level the 40 to 42 we have today to the 30 to 32 range we have provided.

And our next question is a follow-up from Nishu Sood with Deutsche Bank.

Just a quick one. So, the homebuilders have been accelerating land development investments over the last two quarters. Just curious how is that translated into that portion of the business, and what was the annual year-over-year growth for the quarter there?

So, while Mr. Higgins kind of looks up where that number is, let me give you the color around that is when you do see those land developments or around a city where people are developing big neighborhoods and stuff like that there is two elements of that. There is the kind of the public ways or roads that enter there, call that outside the development; again there is the inside of the development storm water stuff that needs to be done. And we can participate in both of those. We usually participate higher in the ones kind of within the neighborhood. And one of these sales meeting we were talking about the other day, I mean, this particular sales win in the Midwest been very successful around the suburbs or small cities around the metropolitan area there. So that’s a good place for us to hunt. The tertiary or derivative is, you have strip shopping centers and McDonald and all those things that go in which you pipe and lot of Allied Products, particularly our StormTech products. So, that’s a good cycle for us, good cycle where we get kind of three bites at the apple, the public, the private pipe inside the development, and then developments or strip shopping centers or accessories that -- services that are needed around those developments. So, what’s the number?

It’s high double-digit.

Tim, I think if you look at what Scott was talking about, new residential construction subdivision development for the quarter, we are up high double digits; and for the nine months, we're up mid double digits. And really, if you then look at it geographically, seeing pretty good growth across most of the country, obviously with strong growth areas in the South and West, which you would expect with the demographics that are occurring there.

[Operator Instructions]

In closing, we're pleased with our performance this quarter. The top line reflects the strength of our underlying markets and our continued success in executing our diverse conversion strategy through the growth of our pipe products as well as our solutions strategy through the growth of our Allied Products. We’ve demonstrated our commitment to expanding our margins and will continue to focus on the fundamentals of our business and driving execution across all aspects of our operations as we progress through the remainder of fiscal 2018 and beyond. Thank you again for joining us today and we look forward to speaking with many of you very soon. Operator, that concludes our call.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.