Advanced Drainage Systems, Inc.

Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' second quarter fiscal 2021 results conference call. My name is Laura, and I am your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. I would now like to turn the presentation over to your host for today's call, Mr. Mike Higgins, Vice President of Corporate Strategy and Investor Relations.

Good morning, everyone. Thank you for joining us today. With me here I have Scott Barber, our President and CEO, and Scott Cottrell, 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 8K submitted to the SEC. We will make a replay of this conference call available via webcast on the company website. With all of that said, I'll turn the call over to Scott Barber.

Thanks, Mike. Good morning, everyone. Thank you for joining us on today's call. We had a strong second quarter of fiscal 2021 with 10% net sales growth as demand and business activity remained favorable. I want to thank the ADS and Infiltrator employees for their execution and diligence in making that happen. I also appreciate our customers for working with us and new and imaginative ways to serve the construction markets. We generated strong performance in key growth states including Florida, the Carolinas, Tennessee, Georgia, and Utah, as well as more broadly across the south and southeast regions of the United States. As a whole, we benefited from our national presence and geographic exposure, as well as our increased residential exposure from Infiltrator and the focused homebuilder programs at ADS. Infiltrator once again exceeded revenue expectations with 63% sales growth in the second quarter. Infiltrator continues to see double-digit growth in tanks and leach field products, with particular strength in Florida, the Carolinas, Georgia, Tennessee, and Alabama. Recall that Infiltrator results are for two months of the prior year quarter, given the timing of the acquisition, which closed July 31, 2019. In the residential end market, legacy ADS sales increased 15% this quarter. We see favorable dynamics in new construction, repair, remodel, and onsite septic. Orders, backlog, and sales remain strong through the period with very limited impact from the slowdown in residential starts earlier this year. As a whole, we are well positioned for growth in the residential market. On the front end of the cycle, the ADS products and go-to-market strategy are positioned for the land development phase, whereas infiltrator products come in play towards the end of the cycle when construction is nearing completion. Additionally, both infiltrator and ADS have a repair and remodel component that is strong and growing, its home improvement activity, and existing home sales continue to rise. About one-third of the infiltrator sales are related to repair and remodel, and at ADS, the repair and remodel exposure is covered through our retail and national accounts. The company's exposure to the residential market has increased to 38% of domestic sales compared to 28% at this time last year. Sales in our non-residential end market were up modestly, led by strong growth in HP pipe and StormTech retention detention chambers, as we continue to benefit from our exposure to horizontal construction. We are tracking very closely to the segments of the non-residential market that continue to do well, such as data centers and warehouses, as well as geographies that are experiencing growth, like the southeast and Atlantic coast. Importantly, we believe ADS is well positioned to continue to grow above market due to our conversion strategy, national coverage, and water management solutions package. And given what we see in the market today, we believe the second half of the year will be similar to the market conditions we experienced in the first six months. Agriculture sales were down just slightly this quarter as we caught up to a tough comparison period. Still, the agriculture sales team has had a great first half of fiscal 2021 with sales up 14% year over year. In addition, the fall selling season is off to a great start as we continue to benefit from the programs we put in place around organizational changes, new product introductions, and improving execution in the agriculture market. International sales increased 3%, driven by double-digit growth in our Canadian business. Canada is doing well across both the construction and agriculture end markets. mexico on the other hand is not performing as well having been more significantly impacted by the covid 19 pandemic overall strong demand is causing some regional and product level constraints lead time and inventory levels are stretched as we get into this part of the season Based on this strong demand and our desire to more fully capitalize on opportunities in our core end markets, we are stepping up our capital investments, which we now expect will total between $80 and $90 million for this fiscal year. The focus of our investments will be to improve safety, increase capacity for future growth, and improve productivity. We will rebuild finished goods inventory in the second half of the year by level loading production at our facilities in our traditionally slow months, preparing both ADS and infiltrator for good customer service and normal lead times. This build will depend on our second half demand, ramping up new capital, and dealing with the COVID-19 related circumstances like employee retention, absenteeism, and local conditions. Frankly, this is consistent with the environment we've been managing since the pandemic hit. We are also making investments in talent, including the recent addition of a senior leader to accelerate new product introductions, marketing, and innovation. As highlighted in a press release this morning, we created a new product management and marketing organization to accelerate the development, launch, and marketing of new products to meet customer needs. I'm pleased to announce Brian King joined our organization in September to lead this effort as the Executive Vice President of Product Management and Marketing. Brian has 25 years of successful product management experience, and we're excited to have him join our team. Moving to our profitability results, we achieved another quarter of record adjusted EBITDA during the period. Adjusted EBITDA margin increased 820 basis points overall, with a 640 basis point increase in the legacy ADS business. This was driven by favorable material costs, leverage from the growth in pipe and alloy products, execution of our operational initiatives, and contributions from the proactive cost mitigation steps we took earlier this year. Infiltrator also achieved record profitability in the quarter due to strong demand, favorable material costs, contributions from our Synergy programs, and continued execution of their proven business model. The Synergy programs are right on track to achieve the run rate targets we've previously communicated. As we look ahead to the second half of the year, we are optimistic as our order book, project tracking, book-to-bill ratio, and backlog all remain positive. We expect the normal seasonal patterns to apply to the second half of our fiscal year as installation activity slows down in geographies with colder temperatures. We also have some profitability headwinds coming up in the third and the fourth quarters, including inflationary costs from materials and labor. We are working to offset these headwinds through pricing actions, operational productivity initiatives, and our synergy programs. In summary, we did a very good job executing this quarter. We're focused on safety, managing through the COVID-19 environment, servicing our customers, and driving these new levels of profitable performance. Though uncertainty still exists regarding the broader market environment, we are well-positioned to capitalize on residential development and horizontal construction while continuing to generate above-market growth through the execution of our material conversion and water management solution strategies. We remain focused on disciplined execution as we look to build off a very strong first half of our fiscal 2021. With that, I'll turn the call over to Scott Cottrell to further discuss our financial results. Thanks, Scott. On slide six, we present our second quarter fiscal 2021 financial performance. Net sales increased 10% with 4% growth in our legacy ADS business plus 63% growth in our infiltrator business. Sales growth in the legacy ADS business was led by 15% sales growth in the residential market, which remains robust. As Scott discussed, demand in our non-residential market remains stable, with pockets of strength in horizontal construction, data centers, and warehouses. Overall, sales were solid throughout the quarter, and this trend has continued through October. Sales grew at Infiltrator across their portfolio, driven especially by strength in their leach field and tank product lines. Infiltrator continues to benefit from the underlying strength in the repair and remodel market, as well as growth in single-family housing. This growth was further accelerated by their material conversion strategy. From a profitability standpoint, adjusted EBITDA increased $56 million, or 47%, compared to the prior year. Adjusted EBITDA for the legacy ADS business increased $33 million, or 35%, with strong performance from our sales, operations, procurement, and distribution teams. ADS is very well positioned to capitalize on the current stability in our end markets due to our market-leading position, national relationships, breadth of products and services, as well as our geographic and end market diversity. These attributes make us the premier partner and leader in the industry and led to the margin expansion and strong financial performance in the quarter. Infiltrators adjusted EBITDA increased $21 million, or 86%, benefiting from strong demand, favorable pricing, lower input costs, productivity improvements, as well as our Synergy programs. Moving to slide seven, our free cash flow increased $112 million to $257 million, as compared to $135 million in the first half of fiscal 2020. These impressive free cash flow results were driven by the strong sales growth and profitability we achieved in the first half of fiscal 2021, as well as execution on our working capital initiatives. Our working capital decreased to right around 20% of sales, down from 22% at this time last year. Further, our trailing 12-month pro forma leverage ratio is now one and a half times, slightly below our target range of two to three times leverage. We ended the quarter in a very favorable liquidity position as well, with $204 million of cash and $339 million available under our revolving credit facility, bringing our total liquidity to $543 million. The favorable changes we have made to our capital structure have also resulted in no significant debt maturities until 2026. While pleased with our conversion of adjusted EBITDA to free cash flow in the first half of this year, we will need to make strategic investments in working capital and CapEx during the second half of this year to position us to take full advantage of expected growth as well as to make the necessary investments to support our productivity initiatives at both the legacy ADS and infiltrator businesses. In addition, we continue to assess bolt-on acquisition opportunities through our disciplined acquisition process. Finally, on slide 8, we introduce our guidance for fiscal 2021. Based on our performance to date, order activity, backlog, and current market trends, we currently expect net sales to be in the range of $1,790,000,000 to $1,840,000,000, representing growth of 7% to 10% over last year. Adjusted EBITDA to be in the range of $495 million to $515 million, representing growth of 37% to 42% over last year. And we expect to convert our adjusted EBITDA to free cash flow at a rate of around 60% for the full year, driven by our strong results as well as the investments we just discussed. With that, I'll open the call for questions. Operator, please open the line.