Advanced Drainage Systems, Inc.

Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' second quarter fiscal 2022 results conference call. My name is May, 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. please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. 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.

Thank you, and good morning, everyone. With me today, 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 that, I'll turn the call over to Scott Barber.

Thank you, Mike, and good morning. Thank you, everybody, for joining us on today's call. We achieved a record $706 million in sales in the second quarter, an increase of 30% compared to the same period last year. Sales growth was primarily driven by pricing at both ADS and NippleTrader across our geographies and our end markets. Our volume was down slightly in the second quarter, primarily due to the retail business within the ADS residential end market, which had a difficult comparison relative to last year when we experienced record shipping levels in the retail category at the height of the COVID-19 pandemic. Excluding retail, the ADS construction market sales volume was up slightly despite constraints within our manufacturing and transportation operations. Infiltrator sales increased 38%, primarily due to favorable pricing, as well as a slight volume increase with strong growth in the southeast and southern regions of the United States. Additionally, international sales for the total company increased 29% this quarter, with double-digit growth in our Canadian and Mexican businesses. Our backlog and pace of orders remain favorable, as well as our ability to capture price in the market, which gives us confidence in the updated sales targets we issued today. The price increases we implemented in the second quarter will hit their full run rate in the fiscal third quarter, and we have obtained some additional pricing on certain products and in certain end markets to cover the continued inflationary cost pressures. Overall, the demand environment remains favorable, and our leading indicators point to continued strength as we work through the high levels of backlog in our order book. From my perspective, we must continue to work down the backlogs at both ADS and infiltrator, manage through the customary weather and seasonal impacts in the second half of the fiscal year, and continue to leverage the self-help programs that are creating additional production capacity. In addition, we are focused on installing and ramping up new equipment coming online, which will add some production capability in the second half of the year and additional capacity as we enter fiscal 2023 this coming April. Moving to profitability, our adjusted EBITDA decreased 5% this quarter. Favorable pricing issued over the past year covered inflationary cost pressure on materials and diesel. However, labor shortages in both manufacturing and transportation impacted our profitability. This was particularly evident within our transportation business, where we had to ship more deliveries to third-party logistics services, a cost premium compared to our internal fleet. In addition, the year-over-year cost for third-party logistics services is up significantly. Within the manufacturing organization, we were unable to consistently operate all the production lines we wanted to run due to labor shortages. Importantly, though, the programs we discussed on our last call around SKU reduction, process simplification, inventory consolidation, and sourcing product from Mexico are working, resulting in improved daily production rates as we progress through the second fiscal quarter and into October. Availability of raw materials was more problematic in the first part of the quarter, but improved month to month. Material costs remained elevated, and as expected, the second quarter had the largest gap between high material prices this year and historically low prices of last year. Importantly, we were able to maintain the amount of adjusted EBITDA generated as the infiltrator business in the second quarter. Infiltrator products are primarily produced at a single manufacturing location and less transportation sensitive than the ADS products. While Infiltrator faced similar headwinds from labor and transportation, the impact on profitability was less pronounced. Overall, the first half of this fiscal year has largely played out as we expected. As discussed on our first quarter call, we're going to see the year-over-year improvement in adjusted EBITDA in the back half of this fiscal year. We will realize the full run rate of price increases in the third quarter, as well as the benefits from our self-help initiatives. Though this year has been challenging, we remain confident in our ability to identify and execute the right programs to expand our margins over time. Finally, our year-to-date capital spending more than doubled in the first half of this fiscal year. We were making investments to increase capacity, with some having an impact in Q4 for infiltrator and the ADS pipe manufacturing. We started up our production line in the Midwest at the end of the first quarter to help increase capacity, and we also made investments in the storm tech business to increase production capacities and infiltrator. New injection molding processes, presses are starting up now. with additional presses coming online in the fourth quarter to support the growing on-site septic business. These new investments also include automation that will help offset the impact from the labor shortages. Importantly, once our approved capital investments are up and running, we expect capacity will increase by double digit at both ADS and Infiltrator, which will allow us to continue to meet the robust demand environment through the back half of this fiscal year and beyond. All that said, core drivers of our business remain strong. We will continue to systematically work our self-help programs, particularly on the labor and transportation, that improve both production and our service levels to customers. And as we move through this unique period with record demand, significant inflation and labor challenges, we are confident the programs we are working will benefit our business for many years to come. With that, I'll turn it over to Scott Cottrell to further discuss the financial results. Thanks, Scott. On slide five, we present our second quarter fiscal 2022 financial performance. From a top-line perspective, we generated significant growth year-over-year, driven by both ADS and Infiltrator. Legacy ADS pipe products grew 31%, Allied products sales grew 19%, and Infiltrator sales increased 38%, with double-digit sales growth in both tanks and lease-filled products. We continue to demonstrate our pricing power with significant year-to-date price increases across each of our segments. As Scott mentioned, during the second quarter, strength in our construction market sales partially were offset by constraints within manufacturing and transportation, as well as weakness in our retail and market, which was impacted by tough comparisons year-over-year. Consolidated adjusted EBITDA decreased 5% to $165 million, resulting in an adjusted EBITDA margin of 23.3% in the quarter. We knew this quarter would be our most challenging from a year-over-year comp perspective, given the low input costs and high demand environment we experienced last year. Importantly, we have good line of sight into the costs impacting our business and have taken actions to mitigate them in the back half of this year. These efforts have already contributed to margin improvement on a sequential basis throughout this second quarter. The long-term fundamentals of our business remain intact, and we are on track to hit the double-digit growth in our adjusted EBITDA guidance for the fiscal year. Moving to slide six, we generated $31 million of free cash flow year-to-date. In addition to the growth-oriented capital investments Scott outlined, Working capital was a significant use of cash here to date as we purchased raw materials and built inventory at a much higher cost compared to last year in order to support the demand we are experiencing. We continue to make progress on our working capital initiatives, most recently working to extend our payment terms with some of our largest suppliers. As a percent of sales, working capital was 22% as compared to 20% in the same period last year. From a capital deployment perspective, we remain committed to efficient and disciplined capital allocation to drive shareholder value. Our first priority for capital deployment remains investing organically in the growth of the business, as we view this as the highest return and lowest risk use of our available capital. To that end, we've spent more than two times the amount as last year at this time, primarily on these type of growth initiatives. For the full year, we continue to expect between $130 million and $150 million in capital expenditures, with the largest investments focused on future growth, followed by our productivity and automation initiatives. In addition, we continue to work an active M&A pipeline focused on staying close to the core, including regional pipe capacity, allied products that fit our solutions package, and recycling capacity to support the future growth of the business. We are committed to a strong balance sheet, financial flexibility, and returning excess cash to our shareholders, as demonstrated by the $312 million returned to shareholders year to date through share buybacks and dividends. We completed our share repurchase program in the second quarter, purchasing a total of 2.6 million shares year to date. Finally, our trailing 12-month leverage ratio was 1.7 times remaining below our targeted leverage of two to three times that we've previously communicated finally on slide seven we have updated our fiscal 2022 guidance based on our performance and pricing actions taken to date order activity backlog and current market trends we currently expect net sales to be in the range of 2.55 billion to 2.65 billion representing growth of 29% to 34% over the prior year. Our adjusted EBITDA guidance is unchanged at a range of $635 million to $665 million, representing growth of 12% to 17% over last year. The increase in our revenue guidance today is due primarily to the continued strength in orders and our backlog, as well as the impact of favorable pricing that we've introduced to the market to date. With that, I'll open the call for questions. Operator, please open the line.