Forterra, Inc.
Q2 2017 Earnings Call Transcript

Published: 10 Aug 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 Forterra, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode and later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Matt Brown, Executive Vice President and Chief Financial Officer. Sir, you may begin.

[Matt Brown:]

Thank you, and good morning, everyone. Welcome to Forterra's Q2 2017 earnings conference call. Joining me on the call today is Jeff Bradley, our Chief Executive Officer. Presentation slides to accompany this call are available on the Investors section of our website. Turning to Slide 2 of the presentation, before I turn the call over to Jeff, I would like to point out that Forterra intends to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please be reminded that our comments today may include forward-looking statements which are subject to risks and uncertainties and actual results may differ materially from those indicated or implied by such statements. These risks are described in detail in the Company's SEC filings including our annual report on Form 10-K. The Company does not undertake any duty to update such forward-looking statements. Additionally, we will refer to certain non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures and other related information, including a discussion of why we consider these measures are useful, in both our earnings release and at the end of our Q2 2017 earnings presentation that is available on our website. Now, I'd like to turn the call over to Jeff Bradley, our Chief Executive Officer to give an update on our business.

[Jeff Bradley:]

Good morning, everybody and thank you for joining us. This quarter was a little more challenging than we anticipated. But I continue to be very excited about the long-term outlook for the business. Along with the implementation of the many initiatives we have underway, that will drive cost lower and margins higher. We had growth in revenue and shipments in both the water and drainage businesses in the quarter, versus the second quarter of last year in spite of the higher than expected rainfall and the impact of Tropical Storm Cindy in June. Excluding the impact of the adverse weather, we believe our results would have been within the range I gave on the last call. As I discussed on our last call, we implemented multiple price increases across the country in the first half of the year. We are seeing positive momentum across majority of the markets in which we operate both in drainage and water segments that are offsetting the few areas with pricing weakness due to competitive factors. The strategic cost-cutting initiatives I talked about on the last call are also now starting to kick in and we believe they will significantly lower our cost in 2018 and beyond. The residential and the commercial outlook remains strong and the key economic indicators support expectations for continued growth. I want to walk you through the key factors that impacted our results for the quarter and talk more about what we are seeing in the business. We expect to see increasing highway infrastructure spending and deployment of FAST Act dollars as we head into 2018 based on our analysis of track projects and consistent with the broader market expectations. However, in Q2, we experienced lower than expected growth of FAST Act related work on infrastructure spend. The slowdown in highway infrastructure work in the quarter is consistent with the broader U.S. national results released by the Census Bureau. Turning to the municipal water project spending, a key demand driver for our water segment. We along with the broader market are expecting growth in 2018, but we have experienced limited demand in Q2, which unfortunately we believe will persist into the second half of this year. In our drainage segment, however sales price was up compared to Q1 of 2017, but declined compared to Q2 of last year. As I mentioned on the last call, we’ve implemented successful price increases in almost all of our regions. However, versus our expectations, average pricing was negatively impacted by a few key factors including mix, and increased competition in a few of our key markets. Even with the impact of Tropical Storm Cindy, and the carryover effect of the first quarter rainfall, California to push shipments beyond the second quarter and the impact is softer infrastructure demand; we generated organic growth in net sales and volume in drainage as compared to Q2 of last year. On the cost side of drainage, our per unit raw material cost and labor costs were down on a sequential quarter basis, but higher than in Q2 of last year and higher than we expected. We are actively addressing these issues with the procurement initiatives that I’ve discussed last quarter. We’ve also completed a management reorganization and launched post-Cindy initiatives in our drainage business, which will result in a more streamlined structure and lower costs. I will touch on these more in detail shortly. Turning to the water segment results for Q2. Lower than expected shipments driven by previously described excessive rains and the impact of softer than expected meeting demand was a key factor in our results falling lower expectations. Had nothing for the rain impact, we believe we would have experienced growth versus Q2 of last year in the water segment. However, selling prices for ductile iron pipes were lower than we had expected and a bit below the first quarter of 2017. The March price increase in DIP that I mentioned on the last call and that we expected we begin to contribute the results starting in the third quarter would not broadly accepted by the market due to ongoing competitive factors. However, on a positive note, our average DIP prices trended upwards throughout the second quarter. We instituted another price increase in June that is already driving the lift in prices as we get into the fourth quarter of this year, at the same time the water team is aggressively managing other operating costs to strengthen margins. Let me now discuss steps to move the business ahead. We have well over a $100 million in annual spend for freight and over $400 million in annual spend on raw materials. Prior to undertaking our most recent cost initiatives, we were not taking full advantage of the national scope and scale of our business. The most part of procurement was handled on a local basis. We have now centralized this and are starting to see savings. Several of the contracts have already been executed. We believe that the benefit of our procurement focus initiatives has the potential to deliver significant savings next year and beyond consistent with our previous expectations. We anticipate that many of the new lower price contracts we have already have in place will begin to contribute savings to the bottom-line in the back half of this year. Beyond the procurement initiatives, that I discussed, we also recently reorganized the management structure in our drainage business with a focus on increasing accountability on a plant-by-plant basis, streamlining our cost structure and improving profitability. Specifically, we have repositioned key leaders throughout the segment and in some cases put new leadership in place. Importantly, this allows us to implement labor productivity and management solutions at the plants while being able to capitalize on opportunities to optimize our operational footprint without impacting customer service and quality. On the back of this new structure, organic growth volume and momentum in pricing, we are driving cost out of every element of the business to increase margins that will favorably impact our business next quarter and beyond. On the corporate front, our external consultants have largely completed their work on our cost savings initiatives and we expect SG&A to be much lower in the second half of this year. While our expectations for the remainder of this year include cost associated with external accounts that are assisting us with our material weakness remediation efforts and SOX compliance work, the heavy lifting associated with our major initiatives is largely done. Now let me give you an update on the sale of the U.S. pressure pipe business we announced back in June. We closed the sale on July 31, and we used the proceeds of about $23 million to pay down our revolver. We expect this transaction to be immediately accretive to our earnings, margins and cash flows. As part of the deal, we are also able to bolster our position in the large and growing Houston drainage market through the acquisition of assets from a Houston area Drainage pipe and products plant. The demand outlook remains firm against the backdrop of the healthy economic environment. We are actively working to lower our costs and enhance our margins going forward. In addition to the cost savings initiatives that I have discussed today, we remained committed to executing on our growth initiatives, specifically our storm water business, cross-selling initiatives, and our strategic accounts initiatives. We continue to make progress on these organic growth initiatives, which we expect to contribute meaningful growth for our business over the next few years. Matt?

[Matt Brown:]

Thanks, Jeff. Turning to Page 3 of our presentation, I will briefly discuss our consolidated results, then move to our segment results. Net sales increased by 14.4% due to acquisition, while gross profit as a percentage of sales declined to 17.3% from 21.8% in Q2 2016, due primarily to lower average sales prices and higher cost of goods sold. SG&A as a percentage of sales increased to 15.4% from 15.0% in Q2 2016, due primarily to higher consulting costs. In addition to transaction costs that were added back for the purposes of calculating adjusted EBITDA, we incurred other professional fees in Q2 2017 of $9.1 million, compared to $4.3 million in Q2 2016. These fees include cost associated with our SOX compliance projects and consultants utilized to evaluate our cost savings initiatives in procurement and SG&A. As Jeff mentioned, the work of our strategic consultants focused on the procurement and SG&A initiatives was largely completed by the end of June as we expected. While we continue to utilize outside consultants in the back half of 2017, including our – work we expect these costs to be substantially lower than the cost incurred in the first half of 2017. Before turning to our segment results, as compared to Q2 2016, I want to provide a quick bridge of our performance relative to the net income and adjusted EBITDA guidance ranges, we provided on the Q1 earnings call. Roughly half of the underperformance was in drainage and half of miss within water. In the drainage segment, rainy weather, weaker pricing and higher cost including freight and labor, each represented about one-third of segment underperformance. In the water segment, approximately two-thirds of the underperformance is due to lower than expected volumes in ductile iron pricing, ductile iron price due to weather and the balance is due to lower than expected average sales prices in DIP. These negative factors are partially offset by a positive variance relative to expectations in the U.S. concrete and steel pressure pipe business. To be clear, the U.S. pressure pipe business still resulted in EBITDA – in adjusted EBITDA losses for the quarter, they were just lower than we had expected. Turning to next page of the presentation, which summarizes the results for the drainage segment of our business, sales increased approximately 15.2% equally the benefit of net sales from acquisitions of $27.7 million. Excluding the benefit of net sales from acquisitions, we had organic net sales growth of about 1% reflecting growth in shipments, partially offset by a decline in average sales prices. The lower average sales price in Q2 2017 as compared to Q2 2016 was driven by pricing declines in a few key markets, partially offset by price gains in our other stronger markets. EBITDA margin for the drainage segment was 18.1%, and adjusted EBITDA margin was 18.3%, down from 24.5% and 25.1% respectively in Q2 2016. The key reasons for the decline consistent with our commentary in the last quarter includes the following. One, we had a decline in the average sales prices of our products that was driven primarily by increased competition in a few specific markets. The pricing weakness accounted for approximately half of the margin decline as compared to Q2 2016. Next, our cost of goods sold were higher than the same quarter last year reflecting the impact of higher freight, labor and raw materials. As Jeff discussed, we’ve responded swiftly to these rising costs including with the recent organizational restructuring, plant level labor management actions, and the procurement cost savings initiatives that we have outlined. These higher costs accounted for the balance of the margin declines as compared to Q2 2016. Turning to next page of the presentation that summarizes the results for the water pipe and products segment of our business. Net sales of $215.2 million grew 13.7% due to the full quarter results from the DIP FAB and fittings business in Q2 of 2017, as compared to only a partial quarter in Q2 2016. Excluding the benefits of net sales from acquisitions of $28.4 million, net sales declined by about 1.3%, primarily due to a decline of organic volumes and average sales prices in the ductile iron pipe portion of the segment. We reported EBITDA margin of 8.3% and an adjusted EBITDA margin of 13.8% for the water segment, down from 17.2% and 22.0% respectively in Q2 2016. The divested U.S. concrete and steel pressure pipe assets generated EBITDA and adjusted EBITDA losses of $8.6 million and $1.1 million respectively on net sales of $34.2 million, compared to positive EBITDA and adjusted EBITDA of $7.3 million and $1.3 million respectively on net sales of $23.1 million in Q2 of 2016. The comparison between Q2 2017 and Q2 2016 for the water segment was also impacted by strong EBITDA margin results for the Canadian concrete and steel pressure pipe in Q2 2016 associated with a large contract that wrapped up lately in Q2 in 2016. The absence of the favorable results in this contract led to about 250 basis points decline in our EBITDA and adjusted EBITDA margins for the water segment in Q2 2017 as compared to Q2 2016. In addition, to the approximately 100 basis point decline in EBITDA and adjusted EBITDA margins related to the U.S. concrete and steel pressure pipe business. The balance of the declines in the EBITDA and adjusted EBITDA margin for the water segment of about 450 basis points is due primarily to the impact of a lower average sales price for ductile iron pipes and higher average scrap price. As summarized in the earnings presentation, about 100 basis points of the decline is driven by lower average sales prices and about 300 basis points of the decline was driven by higher scrap costs with the balance of the decline is to a modest decline in shipments. Now I want to turn to our expectations for the remainder of 2017. On the drainage side of the business, we expected average sales prices in the third quarter of 2017 will be similar to those realized in the third quarter of 2016 reflecting the benefits in the recently announced pricing actions. However, we expect to continue to face cost pressures in the third quarter of 2017 as compared to the third quarter of 2016. On the water side of the business, we expect that prices in DIP will improve in the third quarter of 2017, as compared to our Q2 2017 average. Based on the recent trends and the most recently announced price increases, we expect that our average sales price in DIP in the third quarter of 2017 will be in line with the average in the third quarter of 2016. However, we anticipate that higher scrap cost may negatively impact our margins as compared to third quarter of 2016. Another factor that will influence margins in water in the third quarter is the tough year-over-year comparison in the Canadian concrete and steel pressure pipe business. The third quarter of 2016 benefited from a large pressure pipe project in Canada wrapped up in the fourth quarter of 2016 consistent with the trend in Q2 2017, compared to Q2 2016, we expect that our margin in the third quarter of 2017 in the Canadian pressure pipe business will be impacted by a similar level as in Q2 2017 due to the soft year-over-year comparables. On the corporate front, we expect that cost will be lower in Q3 as compared to Q2 2017 and likely more in line with our Q1 2017 corporate costs. This reflects the benefit of reduced professional fees in support of the surge initiatives as compared to Q2, but incorporates the continued use of an outside accounting firm to assist this software implementation among other ongoing initiatives. Consistent with Jeff’s commentary, we expect to see lower corporate cost heading into 2018 as we work to get these initiatives underway, which is largely completed actually in 2017. As a result, we anticipate that our EBITDA and adjusted EBITDA margins in the third quarter of 2017 will be lower than the third quarter of 2016 levels, which were 16.5% and 18.2% respectively. Based on this commentary, we are providing net income and adjusted EBITDA guidance range of $1 million to $7 million and $55 million to $65 million respectively for the third quarter of 2017. We expect that the factors we describe that influence expectations for the third quarter of 2017 will also impact our results in the fourth quarter of 2017. As Jeff discussed, we are very focused on executing on our cost savings initiatives and we expect these initiatives will begin to materially benefit our results in 2018 and beyond. However, given the significantly lower expectations for 2017, we are reassessing the timetable to achieve our previous commentary with regard to pathway to achieving a 400 basis point increase in income from operations, EBITDA and adjusted EBITDA, as a percentage of sales as compared to our results in fiscal year 2016. While we expect to see the benefit of our initiatives in 2018 and beyond and believe that there are further opportunities for us to reduce our cost and increase our margins, the increased market uncertainty reflected on our expectations for the third quarter of 2017 reduces our visibility to remain confident in shooting the previously communicated margin target by 2019. However, I want to be clear that we have not lowered our expectations with regard to the anticipated benefits of our initiatives. We just recognize that this is going to take more time than we originally anticipated. We remain confident that these initiatives scheduled with the disposition of the U.S. concrete and steel pressure pipe business will support margin expansion in consistent with our previous expectations. I also want to provide a brief update on our capital structure and liquidity. As of June 30, we had $80 million drawn on our $300 million ABL revolving credit facility. Just June 30th, we have paid down an additional $55 million of the ABL facility and the balance currently stands at $25 million drawn. Regarding capital allocation, we expect our CapEx needs to remain relatively low with maintenance CapEx approximating by a 2.5% of sales and no major growth investment plans through the year end. Including the benefit of the net proceeds from the sale of the U.S. concrete and steel pressure pipe business, the anticipated positive cash flows from working capital in the second half of 2017, we expect to end the year with no borrowings on our ABL facility and with the cash surplus headed into our seasonal increase in working capital during Q1 of 2018. With that, I’d now like to turn the call back over to the operator to open up the line for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Bob Wetenhall of RBC. Your line is open.

[Robert Wetenhall:]

Good morning everyone.

[Jeff Bradley:]

Good morning, Bob.

[Matt Brown:]

Good morning, Bob.

[Robert Wetenhall:]

This is clearly a very disappointing quarter and I appreciate the color that you provided about the pricing environment seems a little challenging. Obviously, the entire sector has been adversely impacted by heavy rainfall which affected volumes and I think, Jeff did a good job of touching on the impact of higher scrap cost in the DIP business. I think it’s more constructive means of time to talk about the outlook and I was just going to ask Jeff, you did $12 million of EBITDA in the first quarter, you reported $46 million in the second quarter, the midpoint of your guidance is $60 million for the third quarter and I was wondering of $25 million sounds like a reasonable estimate for the fourth quarter. So, when we are looking out, is it reasonable to underwrite 2017 on a full year basis in the range of $120 million to $150 million?

[Jeff Bradley:]

Yes, Bob. I mean, at this point, that sounds like a reasonable look at the second half. I know we missed the first quarter that’s behind us, we missed the second quarter. What really gave me optimism in the second quarter is, had it not been for this except that rain and the storm, we would have been in the range that I talked about. Overall, the fundamentals we are seeing for the second half are stronger than we saw for the first half in a lot of areas. We are seeing on the water side, we are seeing pricing starting to lift. We have now another increase. In the last call I talked about a March increase that we implemented, we just did not get the traction on the March increase that we were expecting. We are getting traction on the June increase as evidenced by the orders we are booking, we booked in July and the orders we booked – or we are booking in August. The challenging side of that business is the muni, municipal spending, we really believe, actually last year we believed it would come back this year. We got into – we got through the first quarter and thought for sure we were going to start seeing it second quarter and balance of the year, we just haven’t seen that yet. Still feel good about the resi numbers. On the drainage side, we have a lot more pockets of strength and we have pockets of weakness. Specifically, we continue to strength in Texas in the Midwest, in Nashville, California and Denver. What’s impacted there, what we talked about, we had some cost issues related to labor and freight and all of those markets I’ve talked about labor has been tight, which has impacted the labor numbers. But, again, we’ve got a lot of great things going on. So, the procurement issue that we spend money on has really seen as my expectations, I think the expectations of everybody in the company, we are going to have a fantastic return on investment. The numbers, the costs are now starting to flow through, but this is in a small way, we will see a very little dip in Q3, a little bit more in Q4 but we’ll see a significant impact as we get into next year. So, excited about that and that will more than mitigate some of the cost challenges we had in drainage this quarter. We are seeing markets like Houston that in the past year or so, softened up doing very well, Houston is growing. The other markets I mentioned are strong. Residential is strong. The other disappointing or I guess, really surprise and a disappointment on the drainage side is FAST Act dollars. One of the big themes on the roadshow that we and I think everybody else is really excited about was the work that was coming out from the FAST Act. Unfortunately, we just haven’t seen that much work. I talked from the first call about the velocity of which we were seeing from Q4 to Q1 in FAST Act work and that was all through. But we really saw a leveling off in the second quarter. So, that also missed on our expectations. We are tracking about $85 million to $90 million of projects right now. And we are feeling good about that, but we just don’t know when they are going to hit. So I think to be conservative. We should probably push that more into next year. So, just to sum everything up with all that I just said, the positives far out way the negatives as we looked at the business as we look ahead to the future. I think it’s a long-winded answer.

[Robert Wetenhall:]

Guys, can you give me the dollar impact in the quarter for both segments between weather pricing and input cost inflation from an EBITDA perspective?

[Matt Brown:]

Yes, Bob, it’s Matt. So, we kind of broke that out in fractional terms in the script and I can translate that just always for you, since it’s really just a matter of doing the math. The delta between our actual results for the quarter of $46.5 million and $55 million, which was the midpoint of the guidance range we’ve given for Q2 is $8.5 million. So, there were some negative factors there. There were also a positive factor. Actually, if we take the positive factor out of the equations first, we had about $4 million of outperformance action in the U.S. pressure pipe business. And then we had about $12.5 million or so of negative performance relative to expectations from the main two segments that we still have. So, basically to break that down for you, we said that drainage and water are each about half of the underperformance. So you had basically underperformance of $12.5 million offset by overperformance of $4 million in U.S. pressure pipes. So it’s basically $12.5 million of breaking down between the two main segments. So about six and a quarter each for drainage and water. So for drainage, we said that, that’s divided up a third, a third, a third with pricing volume and cost respectively. So that equates to about $2 million for each of those factors. Now, with respect to water, essentially there is six and a quarter million dollars of underperformance can be divided up two-thirds volume and one-third price and now it’s pretty much all on the DIP part of the business. So, that gets you to about $4 million of volume underperformance in water, because that $2 million of price underperformance. Most of the volume performance is due to…

[Robert Wetenhall:]

Let me ask you this way, Matt. Is weather about $4 million bucks headwind in the quarter and is pricing at about $3 million, and then as COGS inflation like $1 million to $2 million, I am not looking it by segment, I am looking at a consolidated?

[Matt Brown:]

Yes, on a consolidated basis, if you take those together, I would say weather is around $4 million of the impact, so that’s in the volume piece. Most of the volume piece on a consolidated basis versus $6 million total would be weather. So, $4 million is a good estimate for that. If you take the price together on a consolidated basis, that was about a $2 million impact. And then, finally, cost which on the drainage segment by the way, but on a consolidated basis as well will be about $2 million.

[Robert Wetenhall:]

Got it. And just like you did last quarter which was extremely helpful. Can you just refresh and maybe Jeff, you can jump in too interest expense, full year expectations, CapEx, cash taxes, net working capital, and any other information about your update to debt repayment? I know you have the Royal acquisition outflow in there in the brick assets sale tax. So there is a couple items I hope you have given us kind of a view on from a cash flow perspective of sources and uses, we’ll make our own assumptions about EBITDA, just trying to see the other side of the picture?

[Matt Brown:]

Sure, so, if you look at the – what I would call recurring items for cash flow, interest, things like that, they total to a little bit less than $146 million and you have another for the full year that is, then you have another $30 million plus or so one-time item. So we break that down for you. The ongoing items would be interest around $55 million. You’ve had term loan amortization of around $12 million for the full year. Cash taxes recurring would be about $10 million that’s essentially income taxes, CRA payment around $4 million for the year, CapEx $45 million and then finally an increase in working capital of around $20 million, that gets you to around $145 million. So, the non-recurring items would be a one-time cash tax payment of $20 million to be paid related to the Brick separation which occurred last year so we paid actually in Q2 of this year. Then we acquired Royal – the Royal acquisition which was $35.5 million. And then finally, we did the divestiture of the pressure pipe business where we generated the same $23 million in cash. So these other three one-time items as an outflow on a net basis of about $33 million.

[Robert Wetenhall:]

Got it. That’s extremely helpful. And Jeff, it unfortunate that the weather was as severe as it was in the quarter obviously, affected the rest of the sector as well. It sounds like your tone about the pricing environment going into the back half of the year is rather constructive . Can you just talk about what you are seeing in terms of competitive pricing pressures and managing raw material cost and just you also touched on a consulting investment – investments in consultants. What’s the return on that as we look into next year? Thanks and good luck with the back half of the year.

[Jeff Bradley:]

Thanks, Bob. In terms of pricing, yes, we are optimistic about what we are seeing. Let me just break it down on the water business. As I said, we were expecting a lift from our March increase which we really didn’t see. We put through a June increase in water I am talking specifically, ductile iron pipes, with the order inflow in July and the orders coming in, in August, we are seeing pricing lifting in DIP. We are seeing increased scrap prices as well. Just to remind everybody, our ductile iron pipe business, we consume roughly 400,000 tons of scrap or similar to a mini mill for those you that know the steel business and we melt the scrap down to make our pipes. So, scrap is a very material input cost. So we are tracking scrap as well. On the drainage side, as I said, we are seeing a lot more positive. As we look around the country and drainage is really a regional business. We are seeing not to repeat, but we are seeing positive pricing in our key markets, markets like Texas and Nashville, Denver, California, the Midwest. We’re still challenged in the Southeast and Florida and really the challenge there is just been the weather. And I was on the phone with our General Manager at Denver just yesterday and Denver is a great market for us, you know the acquisition we made about a year ago, that he said, he said, Jeff, the business out here is strong. He said, bidding activity is up, pricing is good, he said, had a knock in for weather, I am going to ship a lot more. I’ve got a lot of material in the yards to get out, but they’ve had weather issue there. That’s really just a resounding issue in certain parts of the country like Denver, California, and Southeast. The business is there. The pricing is good. It’s got delays in jobs because of the rains, and also just to remind everybody, our business everything is underground. So, you have a heavy rainfall for a couple of days and the sun is out and everybody feels good, but our business is underground. So that ground has saturated the contractors still can’t dig. So we are going to have – in this business you have more of a prolonged effect at times due to rain. On the procurement side, Bob, yes, we had a lot of cost. I talked about in Q1 and Q2, we are going to see a fantastic ROI on that. Those lower costs are coming in now, but really the biggest effect will be as we get into next year, and that’s pretty much across the board. It’s raw materials outside of scrap because scrap price every month it’s raw materials, it’s freight, it’s labor, it’s MRO and what we’ve done is of course, really taken advantage of the scale of this business and scale this company and just going to see great results. Thank you. Next.

[Robert Wetenhall:]

You bet. Good luck.

[Operator:]

Thank you. And our next question comes from the line of Ian Zaffino of Oppenheimer & Company. Your line is open.

[Ian Zaffino:]

Hi, thank you. I just wanted to maybe get into little bit of the drainage business and I know there is a decline in sales price. Was that, localized to certain regions? What were the dynamics there? Is it just that you are not getting enough volume through? Or is it just too much capacity? And just give us a little bit more detail on that? Thanks.

[Jeff Bradley:]

Sure, Ian. It is the first point, it’s not capacity, it’s not volume. There are certain markets where pricing has been under pressure. And for competitive reasons, there are a lot of people listening to this call, I’d rather not disclose all those areas, but as I said, we’ve got more pluses than minuses. But, they are spot on. There has been some particularly areas and we are coming up with ideas and ways to get around that. The good news is, volumes are very good, demand is good. We don’t see increasing supply and at the end of the day, when you have strong demand without an increase in supply, ultimately you are going to have higher price.

[Ian Zaffino:]

Okay. So, how much of the portfolio is being hurt by pricing pressure versus the other that’s not?

[Jeff Bradley:]

Are you talking the whole business, Ian?

[Ian Zaffino:]

Just in the drainage pipe business.

[Jeff Bradley:]

How much of the portfolio? What exactly do you mean by that?

[Ian Zaffino:]

I am just trying to get a sense of how localized the pricing pressure is and that, is it just a small market that has…

[Jeff Bradley:]

Percentage of the business?

[Ian Zaffino:]

Yes, or maybe, any type of detail you give, because I am just trying to get a sense of – I am trying actually, kind of it the thesis of the story or that you are able to push pricing? And so, I am wondering if there is just one or two markets that are completely or way down and are skewing the price increases in the other markets. I guess, that’s what I am trying to get actually.

[Jeff Bradley:]

The answer is, yes. But I’d rather not get you the rest of the answer. But you are spot on it’s one or two and no more than two, yes. But I will tell you without really showing everybody, our playbook, we have a solution and we are starting to see a positive outcome. And that’s really all I can share with you, but yes, have they not had the pricing pressure in these one or two areas, you would have seen an overall lift at our average selling price, which goes back to my point that the majority of the markets that we serve are strong, pricing-wise, demand-wise, it’s just a couple large markets that are impacting us. So, yes, you are spot on.

[Ian Zaffino:]

Right, and that…

[Jeff Bradley:]

Ian one last piece of that, okay. We did have a rain impact in two particular higher than average priced markets that impacted us as well and these are markets that we traditionally would not have planned for excessive rain. We had a lot of inventory in the quarter that should have and would have shipped, that didn’t shipped. So if you couple that getting all that stuff out that higher priced stuff, the higher priced material, so, free kept inside coupling that with the one or two markets that have dragged us, it would have been a very different story, which gets to the fundamentals in this business remains very strong. We got a couple pockets that were weather impacted that will take care of itself and then the other situation I talked about, I really can’t show our hand, but we’ve got a solution for that as well and we are starting to see the benefit. So, I know, we’ve missed, but as I said when I opened up the call, I still remain very optimistic about the business, about this industry, we’ll get this year behind us and really excited about everything we are seeing for next year.

[Ian Zaffino:]

Right, so in the healthy markets, it was up, what is that? Low single-digits?

[Jeff Bradley:]

I didn’t say what the percentage growth was in the healthy markets. I don’t think, no.

[Ian Zaffino:]

Okay, all right. I mean, I think what’s happening here is, the thesis of the story is being questioned and I think any color you could give us that supports the thesis is helpful and that’s I guess, I am trying to get at so.

[Jeff Bradley:]

All right.

[Ian Zaffino:]

Go ahead.

[Jeff Bradley:]

So, I mean, I tried to do that with I think, you were spot on as I said, there were a couple no more than two markets that ended up where pricing was impacted more than anything. And we are actively working to turn that around and we are seeing results. So that will support our thesis. We had a couple other markets where we had high price materials that didn’t get out because of weather, which I touched on. So the thesis is intact. We just had some couple significant one-time events this quarter as I just talked about that really impacted us, but the thesis is still intact.

[Ian Zaffino:]

Okay, and then, just turning to the demand side and I know, in the roadshow we talked about or you guys talked about the FAST Act that you are trying to see some spending from the FAST Act. Did that, I guess, dry up or did that money never come out and then, is there – are you hearing anything as far as when some of that money maybe released and as we look into 2018 whether or not we should kind of build some of that in our assumptions or maybe just assume 2018 is going to just be flat organic year?

[Jeff Bradley:]

It’s a great point. So let’s go back to the roadshow. As we were talking about FAST Act, we really didn’t have a lot of work out there yet. I talked about we are going to see traction in the – I’ll call it the poor state first, states like Louisiana and Mississippi, and we saw a little bit of work coming out there in the fourth quarter as we had our fourth quarter call, I talked about that. Then on the last call, I talked about a significant increase off of, what was a low number in the fourth quarter on FAST Act. So we were pretty excited about the velocity of change we were seeing. And, we use that optimism really to forecast the balance of the year, we thought the balance of the year was going to continue to increase like that. Unfortunately, that hasn’t happened. The second quarter FAST Act work was higher than the first quarter but not that much higher. So we’ve done as much investigated work as we can and we’ve learned there are lot of large projects around the country that have not come out to bid yet. So that’s one factor. And the second factor is, we are tracking as I said, about $85 million worth of projects right now. I can tell you that, the work in the first quarter and the second quarter was nowhere near that amount. So, we are optimistic about the projects we are tracking and we are optimistic about the fact that, multiple people have told us that there is a fair amount of large work out there that’s being worked on now that has not been playing out for bids. So, based on that, I am optimistic about next year, but I am not willing to put a number on it yet, or an estimate on it yet. But I absolutely believe that next year will be better than this year. I mean, let’s face it. There is an awful lot of money out there.

[Ian Zaffino:]

Okay, great. Thank you very much.

[Jeff Bradley:]

You are welcome.

[Operator:]

Thank you. And our next question comes from the line of Michael Dahl of Barclays. Your line is open.

[Matthew Bouley:]

Hi this is Matthew Bouley on for Mike today. Thank you for taking my questions. I wanted to ask about the third quarter guidance. Would you be able to outline which areas across price, competitive dynamics, timing of shipments, just where specifically do you have higher degrees of confidence and where do you feel the visibility is still limited? Because, I think given the second quarter results, it would be helpful if you could just outline the risks and sensitivities around the guide? Thank you.

[Jeff Bradley:]

Right, let me take. Let Matt and I both answer that. We don’t have our July profitability numbers in yet. We have revenue. We have shipments. We have ASP for July. We have obviously, revenue and shipments for August. But we still don’t have any EBITDA numbers yet. So, we’ve looked at what’s already come in, in terms of orders or backlog what has shipped and what we expect to ship the balance of this month and next month taking into account, weather, we are taking a strong look at weather that some of these areas where we’ve been hit hard by weather. We are looking at that, especially the Southeast. So, we are putting all that into the equation to come up with our number.

[Matt Brown:]

Yes, I would just add to that, in terms of, is that be with the risks are there, if you look forward to Q3 and the rest of the year, I would say, of course, it’s always, you could have weather – but in addition to input cost would be another area of risk, how to say, is a risk what we put out.

[Matthew Bouley:]

Okay, got it. Thank you for that. The second question, I had I wanted to ask about the acquisition of the drainage assets in Houston. Just how should we think about the competitive environment in Houston as a result of that and if you could comment on the pricing in that market specifically? Thank you.

[Jeff Bradley:]

Right, we – I mean, we typically don’t give pricing within a market. But let me just share what I can about Houston. We had a pretty big or there was pretty big exit in the oil and gas industry out of Houston and we are really seeing a turnaround there. Residential business is strong, which means people are moving there, there are jobs there. We are seeing volume growth. We’ll have volume growth this year over last year. I think we increased probably in 2015. We are getting back to those numbers. So we are pretty optimistic and all I can tell you at a high level, when you look at the basic economics, if you have – and I’ve said this before, if you have no new supply, and you have increasing demand in any market or any business, typically that’s going to yield a higher price. So, Texas is a great market overall, North Texas, Central Texas, Houston, I been here now for a couple years and I am just blown away by the amount of stuff that’s consumed in this state. So, we are bullish on Houston. We are bullish on the rest of the state actually.

[Matthew Bouley:]

Okay, thank you very much.

[Jeff Bradley:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Scott Schrier of Citi. Your line is open.

[Scott Schrier:]

Hi, good morning. I want to look across your portfolio, on both businesses, when you look at the markets that you’ve seen with the various competitive dynamics, when you evaluate it, are there any markets where you look out pricing and demand and realized the ramp up before you can get some adequate returns on invested capital might be some time where it might be better for the company to divest some of those markets? And use that money to pay down some debt and just focus on some of the markets that might be a little better structured?

[Jeff Bradley:]

Sure and that’s, yes, we are doing that all the time. We are constantly looking at that and we took that action in the water business. We divested ourselves of the concrete steel and pressure pipe business. That business required a lot of working capital, it’s a highly engineered business. It was a very competitive business and to your point, we thought we could get a much better return on capital by investing those dollars in other things. So, we have taken that step. As we sit here today, we don’t see that anywhere else, but let me just tell you about one other thing that we are doing and again, we are constantly doing this too. We are constantly looking at cost. We mentioned the reorganization in the drainage business. One of the things that’s coming out of that is, we got a lot of locations. We’ve got north of 70 drainage pipe and product plants. What we are doing now is running this analysis where if we have plants that are close to each other and we can drive higher efficiencies by operating one plant versus two and then you got to analyze the potential increase in freight, we are doing that and we are probably going to idle a couple plants. That’s not going to impact our volumes. It’s just going to lower our cost by putting more business into a single plant even with the potential increase in added freight expense. So that analysis is going on right now. That kind of answers your question.

[Scott Schrier:]

Yes. And then, I wanted to ask you more on the price increases in the drainage segment and we are seeing from the suppliers the aggregates and cement producers, they’ve been pushing price pretty consistently and one of the thesis is around cement, as it gets tight and we are going to see a steeper ramp up in price and that – I am just curious, when you look at the pricing power, you have across that business. Do you have a path to push all of that placing through or will it be difficult for some time and we might get squeezed on the margins. At what point do you start to be able to push pricing in excess of the material cost increases on the drainage side?

[Jeff Bradley:]

Right. So, again, we are looking at that all the time. We have successfully passed through ten price increases across the country on the drainage side. First of all, the drainage business is a very regional business. You have regions where you have lot of competitors. You have regions where you don’t have as many competitors, but drainage is a very regional business and, where you are going to get prices in your strongest markets. We and in general, this drainage business we don’t wait for raw materials to increase to take advantage of an opportunity to raise price. I’ve talked about that in the past. So, the goal is, obviously, to have our prices outtake our costs. Over time, I think we’ve done a pretty good job on the drainage side. One of the things that’s really going to help us that I have talked about, I am not going to beat at the depth again, it’s a procurement initiative and I am not going to get specific into products. What I can tell you that we are going to have – we have had a very positive success rate on the cost reductions that we’ve been able to get across the raw materials in drainage. Not really going to have a major impact till next year. So, between lower costs, and those costs are going to impact all of our regions by the way. Those cost reductions are really not regional. Those cost reductions will be across the footprint and we will continue to push price where we can. We have announced additional increase in drainage for the second half of the year. We don’t always get every increase, but we typically get more than half. So, look for additional price in second half and lower cost as we get through the second half and lower cost as we get into next year.

[Scott Schrier:]

And lastly, I wanted to touch on your comments on the muni water environment. And how you haven’t really seen the ramp up in spending. At this point, how do you get comfort in municipalities in their ability and willingness to invest in their water plans and when do you expect that that investment would pick up?

[Jeff Bradley:]

Right. So, I guess, the one positive thing that’s going to fuel municipal spending is residential. We continue to see really good resi numbers. I mean, ultimately, the municipalities are going to have to invest. The private side has been strong, but the municipalities are going to have to invest. I mean, as we came to Texas. For instance, I know Texas is an representative of the country and you would see water towers across the landscape and again, that’s the result of the resi growth. So, longer term, we see it happening eventually, I mean, it has to. The muni spending has to come, because it’s needed. We’ve talked about the state of the infrastructure. The question is, to your point, when is it going to happen? I think to be conservative, we are probably going to push it into next year. The other thing is, ultimately, the states and the towns and the cities are going to have to increase their rates. So right now, we are actually pushing that muni into next year.

[Scott Schrier:]

Got it. I think the argument on the municipal water spending, especially because it’s resi-focused as the fact that we’ve had good residential growth and housing starts for the past couple years and that on its own has it really been enough to push that muni spending? So that’s the concern that we see there, I am just trying to get some clarification on it.

[Jeff Bradley:]

Totally agreed with you. What we are thinking is, as resi continues to increase and there are more people and more homes, that’s got to be putting a lot of pressure on the muni business. So, we know it’s got to happen. The question is when.

[Scott Schrier:]

Got it. Thanks.

[Jeff Bradley:]

For sure, you are right. I mean, it’s got to happen.

[Scott Schrier:]

Great. Thank you and good luck.

[Jeff Bradley:]

Thanks.

[Operator:]

Thank you. Our next question comes from Rohit Seth of SunTrust. Your line is open.

[Rohit Seth:]

Hey, thanks for taking my question. My first question is on your construction pipeline and maybe help you can help me square away some of the datapoints that I have available to me with what you got. I am seeing construction starts and water supply assumes down 28% on an LTM basis, I mean, these numbers were pretty good in 2016. But, obviously here deteriorating pretty substantially and then, sewer and waste disposal down 21% on an LTM basis, highway and street down 7%. This is a forward-looking indicator, so, these are all deteriorating and then, in the PPI, I am seeing, ductile iron pipe having improved from where it was earlier in the year. Is we are treating again in the latest data point in June and that’s on an easy compare. So curious, what datapoints you are looking at to get that sense that things are moving in the right direction or will move in the right direction? And then, my second question is on your bank covenants. You had talked about that the last quarter EBITDA is moving lower from here and just curious how those covenants will limit your capital allocation options going forward? Thanks.

[Jeff Bradley:]

Okay, let me take the first part of the question. We are not seeing the dramatic fall-off that you mentioned. Again, I’ve talked a lot about the markets. And the water business is a regional business as well. We are just not seeing that, again not to beat a dead horse, but really the only slowing or the only softness on the water side and the sewage side, that we are seeing is on the muni side. So, we are just not seeing that kind of fall off and we look at, again, what do we look at, we look at our backlog. And by the way we have some sewer on the drainage side as well. But we look at our backlogs, our backlogs are strong. Typically, our drainage backlog is going to go out – let’s call it four plus months, the water backlog is going to way out three plus months. So, but at the end of the day, we definitely, need the muni business to lift and grow.

[Matt Brown:]

And, Seth, to the second part of your question, about the bank covenants and capital allocation, so just to refresh everyone the bank covenants. The debt instruments we have in place or the term loan and the ABL facility. On the term loans, there are no financial covenants, no maintenance covenants, just in current covenants. So it’s covenant light. On the ABL facility, the only covenant, financial covenant as it springing covenants such that, if our availability on the revolver gets below essentially 30% of the borrowing base, which equates to the $30 million, then we would have to comply with the same sort of coverage ratio and then on 1.0 times. So, at this point, given the amount of debt we pay down, we only have $25 million drawn on the revolver, I think the availability of $259 million after letters of credit, that are drawn on that so, that are outstanding on that. So, we got a plenty of liquidity, so we are nowhere near tripping that covenant. And we expect to pay down the revolver to zero before the end of the year and start generating a lot of cash. So no covenant or liquidity concerns that we are aware of. In terms of capital allocation, we mentioned this in the last call as well that, we’ve been very acquisitive over the last couple of years. You will not see that level of acquisition activity for the rest of this year going into next year. The focus will be more on internal initiatives, cost-cutting and then delevering, I want to say delevering at this point, I really need to paying down the revolver. But I don’t see it’s paying down term loan and what we assess that next year, but going into early next year, there is a large increase in working capital that as the seasonal playing, that we want to make sure we have enough liquidity going into that. So, that’s how we keep capital allocation at this point. And as far as CapEx goes, I should mention, we have to scale that back as well, that’s under control in terms of the maintenance level of CapEx being pretty modest for the business at around 2.5% of revenue. That equates to around $40 million. We expect to spend around $45 million total for this year. And probably similar going forward as well.

[Rohit Seth:]

And is that CapEx, your maintenance CapEx if things are – I mean, are you able to keep your assets in good shape and is that enough to sustain that going forward for several years at that level?

[Matt Brown:]

Yes, it is.

[Rohit Seth:]

And then, back on the construction starts, are these metrics representative of your entire product portfolio? I am sure you look at on the right construction starts.

[Jeff Bradley:]

You are talking construction starts?

[Rohit Seth:]

Yes, from Dodge.

[Jeff Bradley:]

Sure, we look at all that data. And we are constantly doing a bottoms-up look from across the country. Just to remind you, our drainage business is pretty much across the U.S. but not in the Northeast. The water business is pretty much across the country.

[Rohit Seth:]

I guess, what I am getting at, sorry, I guess, what I am getting at is, do you want to draw wrong conclusions looking at this data, is this pointing to a certain segment of your business and not the entire business? Do you understand what I am saying?

[Jeff Bradley:]

Yes. Again, we are looking at our order inflow across the company coming from all the regions and just to remind you, when we look at our drainage business, we are looking at commercial, residential, and infrastructure. The water business we are looking more at the residential and the muni business and we are just not seeing the fall-off that you are mentioning.

[Rohit Seth:]

All right. Thank you very much.

[Jeff Bradley:]

Sure. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Nishu Sood of Deutsche Bank. Your line is open.

[Nishu Sood:]

Thank you. With the deterioration in performance in the first half, just the kind of scale of it and I think you’ve posted a good job of laying out some of the margin drivers year-over-year in 2Q. Investors are going to be looking for whether there is something systemic here. Whether there is some root cause, obviously that’s going to cause problems on such a widespread basis. I mean, you obviously have gone through a lot of the details. I think, what’s your thought process there? Or how would you guide us to think about that? I mean, when you have a performance erosion that this dramatic, I mean, it’s a natural question that comes up, so really I was interested to get your thoughts on that please.

[Jeff Bradley:]

I mean, we don’t have a systemic problem at all. We talk –in the last call, we gave guidance for the quarter. I think $50 million to $60 million of EBITDA. Unfortunately, we didn’t take into account the excessive rains and the profitable storm that hit the Southeast, I think I laid out the things we did not account for and on top of that, I laid out the optimism. And, people might say, well, you missed the first quarter, you missed the second quarter and how can you remain optimistic? We remained very optimistic. We remain optimistic about the balance of this year. I think we’ve given conservative guidance numbers. But this is a great business. It’s a great industry. We see a lot of growth ahead of us and muni is going to come back I mean, without muni is a – probably it’s going to have issues. So, we are very optimistic. We see continued growth in residential around the country. Commercial business is good. I think when you look at all of the things we’ve done in this business in the past, couple of years, we are constantly looking to get better. We are never standing still. We just did a major reorg of the drainage business, which is going to take out costs and make the business stronger. So we are doing a lot of things. We are not just sitting around. And we will take advantage of the markets we are in. So, Nishu, I guess, to really answer your question, there are no systemic issues. I am not going to make excuses. We are going to continue run the business as smart as we can run it. Continue to look for ways to drive shareholder value. So, and all things are pointing to a 2018 being much better than a 2017.

[Nishu Sood:]

Got it. Got it. Okay. And on the guidance, so, kind of rounded numbers, your EBITDA margin and I am comparing the pro formas, 1Q, your EBITDA margin was down about 10% year-over-year. When you gave us look forward into 2Q, the implied improvement in year-over-year EBITDA margin was around 200 BPS. So I think you expect it to be down 800, 750, something like that, BPS. The result was actually down again 10% or 1000 BPS or so. Your look forward into 3Q actually implies a faster rate of improvement than when you looked from 1Q into 2Q. So, I just wanted to understand the drivers of that, that implies a higher level of confidence that the kind of issues are being addressed at this point, compared to three months ago. What’s the main driver of that?

[Matt Brown:]

There are couple things, Nishu. One is, of course the consultants are pretty much out in terms of impact of corporate costs. So that will, the amount we are spending on professional fees will go down by approximately 50% going from Q2 to Q3. The another factor is that, Q3 last year was a - I would say impacted by rain as well. So it’s a little bit easier comps. Now the other factor I would say is that, we have confidence now and that we are seeing price increases sticking, particularly in the water side of the business, where we didn’t see that in Q2. So I will see those are the biggest factors going into Q3 that gives us a little more confidence.

[Nishu Sood:]

Got it. Got it. And then, finally, on the price increases, for prices to be level which is what I think you mentioned, prices to be level on a year-over-year basis in 3Q and you know, obviously, there has been quite a bit of discussion about the price increases. And so, appreciate those details and if they are going to stick, as you just mentioned, what is the risk of volume loss of those price increases? Because obviously the amount of the price increases implied is probably significant. Does the competitive environment allow for that level of price increase without some sort of volume give up?

[Jeff Bradley:]

We weigh all that. I mean, we are looking and at the end of the day, we manage the company for earnings. That’s what we are looking at. And there are different strategies in all of our markets. So, if it means, we have to give up price in a particular state, area, city, to get pricing up overall, we look at, we analyze it. So we are looking all those things and the dynamics in every market are different. I am not going to share the playbook with you on all the different markets we serve, but, I just want to share the confidence that we are looking at all that. Our goal is to drive earnings and drive volumes. Top-line growth is going to drive bottom-line growth. We understand that and we can face what we are saying on the orders that are coming in. We can bake volumes on our backlogs. As I said, we are optimizing our footprint on the drainage side, looking at consolidating a couple plants, which is going to drive efficiency. But we are, Nishu, we are always looking at that stuff. And we are operating as smart as we can. The big change in the drainage business is, we have gone to a General Manager structure which we didn’t have before in our region. So, now we have somebody that owns the P&L for that region. These are our best guys. I’ve traveled with a couple of them. We put this change through July 1st and I’ve been thrilled with all the things that I am seeing the way these guys are thinking about the pricing and the markets and costs. And so, it’s going to play out really, really well for us. It’s a great point though.

[Nishu Sood:]

Okay. All right. Thank you

[Jeff Bradley:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Jerry Revich of Goldman Sachs. Your line is open.

[Benjamin Burud:]

Hi, this is Ben Burud on for Jerry Revich. Good morning.

[Jeff Bradley:]

Hey, Ben.

[Matt Brown:]

Good morning, Ben.

[Benjamin Burud:]

So, just wanted to start in ductile iron. I believe you guys have about 50% share there. Can you kind of talk about why you haven’t been able to really push through the steel contemplation when you have this kind of position in the market?

[Jeff Bradley:]

Well, I mean, we have competitors, it doesn’t matter what’s your share is, you are competing with people. So, share really doesn’t play into it. We compete with people across the country. As I said, we are seeing – we are starting to see prices lifting. And that’s a result of the June price increase that we instituted.

[Benjamin Burud:]

All right. And then, over the course of the call, you guys have obviously expressed the amount of optimism you have, heading into next year, on the cost side of things, can you kind of get a little more granular on to what you see changing as we head into next year?

[Jeff Bradley:]

You mean, on the cost side?

[Benjamin Burud:]

Yes.

[Jeff Bradley:]

Sure. So, again, we breakdown the businesses. We’ve had this very successful procurement initiatives. We’ve had outside help on this. And we have what’s called a way one and a way two. The way one is going to yield – is a significant amount of money and this isn’t just pie-in-the-sky numbers. These are real numbers. I've seen everything. We are tracking everything. So, I am very optimistic about that. On the drainage side, I am really optimistic about the new management structure in drainage. The things these guys are looking at, plant optimization, driving cost out within their operations. So that’s a big part of my optimism. On the drainage – on the water side, we’ve done a really good job in operating efficiencies. We’ve got a great operating guy that’s running that business. So, I mean, overall, you are right, I am optimistic about the year.

[Benjamin Burud:]

Got it. Thank you.

[Jeff Bradley:]

All right. Thanks, Ben.

[Operator:]

Thank you. And at this time, there are no further questions. I would like to turn the conference back over to CEO, Jeff Bradley for closing remarks.

[Jeff Bradley:]

Sure. Thank you very much everybody. We really appreciate your interest. I think it’s clear we are enthusiastic. We are optimistic about what we are seeing in front of us and we look forward to talking to you all in the next call. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everybody, have a great day.