Advanced Drainage Systems, Inc.

Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' second quarter of fiscal year 2023 results conference call. My name is Jason, and I am your operator for today's call. Currently, all participants are placed in listen-only mode. Later, we will conduct a question and answer session. I would now like to turn the presentation over to our host for today's call, Mr. Mike Higgins, Vice President of Corporate Strategy and Investor Relations. Please go ahead.

Thank you, and good morning. 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, followed 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. 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. I'll now turn the call over to Scott Barber.

Thank you, Mike, and good morning. Thank you, everyone, for joining us on today's call. We achieved another very strong quarter of results with the second quarter sales of $884 million and adjusted EBITDA of $263 million. Importantly, this is the fourth quarter in a row that we have covered cost pressure through favorable pricing in the third quarter in a row of margin expansion. Sales growth of 25% was broad-based across geographies in both the construction and agriculture end markets. supported by continued strength in our priority states and allied products. The strongest volume growth occurred in the ADS residential and agriculture end markets. In the ADS agriculture business, we did a good job level loading deliveries, and that is shaping up for a fall season with year-over-year growth. The ADS residential business grew as home builders continued to develop land despite market uncertainty. We expect homebuilder land development to continue on previously acquired land. And over the long term, the lack of available home supply will continue to drive growth in this market. ADS participation in the residential market is still early in the material conversion story. So despite the pullback, residential remains a large growth opportunity for the company. What we see being on the land development side is the sales are choppy. Some areas remain strong, like the Atlantic Coast, the Southeast, and Texas. In other areas, like the Northeast, sales, orders, and project identification are beginning to slow. We are focusing business development efforts in those geographies where land development is continuing. In addition, we continue to develop programs with national and regional home builders where the ADS value proposition of faster, safer installation, fewer trucks to deliver the required linear feed to the job site, better installed cost, and sustainability is a proven winner. Infiltrator revenue increased 3% this quarter. The septic tank business grew double digit as plastic tanks continue to gain market share against traditional materials, and we add distribution points. We are still working down that backlog, leveraging the new capacity investments that have come online this year. In the leach field products, backlog is normalized and lead times are now customary with historical performance that infiltrator customers expect. The better lead times as well as residential market uncertainty led to distributor destocking over the second half of the second quarter as our distribution partners are less concerned about product availability and lead time. It is important to note The impact of destocking is larger in the infiltrator business when compared to the ADS business because on-site septic products are delivered from distributor stocks, whereas the ADS products are delivered directly to the job site by ADS trucks. Both companies are well-positioned to maintain price and leverage the material conversion story to drive above-market results. In Florida, Hurricane Ian impacted sales in the central and southwestern parts of the state. As the threat of the hurricane became more significant during the last week of the quarter, shipment volume in these portions of Florida decreased 70% and are slowly rebounding. Other portions of Florida are normal in terms of shipments. This is important to note since Florida is the largest state in terms of sales for the company. We expect contractors in southwest Florida to prioritize recovery efforts in the near term as opposed to the stormwater project installations as we move through the fiscal Q3. Importantly, ADS employees were minimally impacted and the ADS Florida facilities were back up and running with minimal downtime and raw material supply was not disrupted. If I take a step back and look at how the second quarter played out, overall sales volume was strong and according to plan in July and August. The first week of September started slowly. The second and third weeks strengthened to July and August pace. In the fourth week of September, when it became apparent that Hurricane Ian would hit Florida, shipments slowed down considerably. So we did see an overall volume degradation in September after a good first two months of the quarter. October shipments are on pace with September. Let me provide some more details and context on this demand inflection that we are in the midst of right now. First, there is variability by geography. We had difficult year-over-year comparisons in areas like the Northeast and Northwest where activity was elevated last year due to reopening. We believe that particularly in regions like the Northeast and Pacific Northwest, which had more dramatic pauses during the pandemic, that one and a half years of activity was compressed into a 12-month period that began in the second half of 2021 through late this summer. In other areas like the Atlantic coast and the southeast, including Florida, construction activity remains favorable and on track. Second, the destocking of the leach field chambers and infiltrator distribution was more dramatic and quicker than we anticipated in this past quarter. We believe that we are approaching the end of the destocking impact at Infiltrator as of the end of October. Next, we have been systematically working down backlog levels at both ADS and Infiltrator, and in most products and geographies, the backlog is now in a normal position. The normalized backlog and the shorter lead times we can provide due to the result of the capacity that we put in place has resulted in a slower order pace and less inventory bills at infiltrator distributors. In addition, customers are uncertain about market conditions in a rising interest rate environment, and this has slowed order rates for products that are stocked by distribution. As we move into the second half of the year, we are seeing a market inflection point. Demand is uncertain and interest rates continue to rise. Additionally, we are seeing a normal seasonal pattern of activity, more like pre-pandemic conditions. We adjusted the second half revenue guidance and accordingly, and due to improvement in raw material costs, favorable pricing and cost control, we were able to hold adjusted EBITDA guidance. We will continue to manage costs and stay focused on investing in initiatives that provide ADS the greatest returns and support the growth programs. As such, we are moving forward with capital spending planned for fiscal 2023, especially in high-demand regions like Florida and the Southeast, and those high-return, high-growth areas of the company, such as recycling and infiltrator businesses. Finally, in October, we broke ground on our new industry-leading engineering and technology center in Hilliard, Ohio, near the ADS corporate headquarters. This expansion brings together, in one location, product development, material science, and manufacturing engineering into one world-class purpose-built facility. This engineering and technology center will be the most advanced stormwater engineering and material science center in the world, enabling our team of engineers, scientists, and technicians to design sustainable solutions that utilize recycled plastics to improve quality of life in communities across North America. We will also be utilizing LEED building techniques, supporting the ADS commitment to sustainability. Though demand is uncertain, we are making the necessary pivots to manage the business through this inflection point. We are leaning into areas of the business where demand remains strong, such as the residential land development, as well as the data center and warehouse construction. We expect price costs to remain favorable, particularly as inflationary pressures begin to level off. We will also continue investing in the business to ensure we exit the current environment in a stronger competitive position. We do this with confidence in the strength of both the ADS and infiltrator business models. The conversion story related to competing materials remains intact, and we have an extremely healthy balance sheet and cash generation profile. We are in a very good financial position to execute on what we need to do both organically and inorganically, should the right opportunities arise. With that, I'll turn the call over to Scott Cottrell to further discuss the financial results. Thanks, Scott. On slide five, we present our second quarter financial performance. From a top-line perspective, we generated 25% growth year-over-year, primarily driven by favorable pricing at both ADS and Infiltrator. Legacy ADS pipe products grew 28 percent, allied product sales grew 37 percent, and infiltrator sales increased 3 percent. Consolidated adjusted EBITDA increased 60 percent to $263 million, resulting in 650 basis points of margin expansion to 29.8 percent in the quarter. As Scott mentioned, favorable pricing continued to cover inflationary cost pressures related to labor, manufacturing, and transportation costs. From an input perspective, raw material costs have moderated sequentially but remain at historically elevated levels. We expect this favorability to continue as we move through the second half of this year. Moving to slide six, we generated $361 million of free cash flow year to date compared to $31 million in the prior year. Strong growth and adjusted EBITDA coupled with better working capital helped drive significant free cash flow generation and conversion, which was approximately 64% of our adjusted EBITDA year-to-date. Given the current market uncertainty, it is important to highlight the strength of our balance sheet and financial position. As of the end of the quarter, we had over $1 billion of liquidity, including nearly $460 million of cash. Our trailing 12-month adjusted EBITDA to debt ratio sat at one time, and we expect to convert over 50% of our adjusted EBITDA to free cash flow for the full year. In addition, we recently received an upgrade from S&P on our debt and credit rating. We remain committed to our leveraged targets of two to three times net debt to adjusted EBITDA, but we are currently focused on the low end of that range at this time given market conditions. Importantly, 68% of our outstanding debt is fixed rate debt and therefore not subject to further interest rate increases. Through September 30th, 2022, we repurchased 1.9 million shares through our share repurchase program for a total of $195 million. As of last Friday, October 28th, that number now stands at 2.1 million shares for $227 million, leaving $773 million remaining under our previously announced billion-dollar share repurchase program. Given our strong financial position, we plan to continue our balanced capital allocation strategy of investing in our business while also returning capital to shareholders through our dividend and share buyback program. Year to date, our capital spending has increased 19% to $76 million as we continue to invest in capacity, efficiency, and automation. For the full year, we now expect our capital spending to be around $175 million. Finally, on slide seven, we provide our updated fiscal 2023 guidance. Based on our order activity, backlog, and current market trends, we now estimate revenue growth of between 12 and 16 percent, or $3.1 billion to $3.2 billion. We are not changing guidance for adjusted EBITDA, which is expected to be in the range of $900 to $940 million, representing growth of 33 to 39 percent and translating to an adjusted EBITDA margin of 29.2% at the midpoint. We will continue to monitor the market and take actions as we deem appropriate to make sure we are right sized for the demand environment in front of us. An example of such is adjusting our future production schedules as needed to right size our inventory and better align such with our forecasted demand environment over the coming quarters. In addition to cost control measures like the inventory right sizing initiative I just mentioned, We also intend to continue investing in the business, ensuring that we exit a market slowdown in a stronger competitive position than when we entered it. With that, I'll open the call for questions. Operator, please open the line.