Advanced Drainage Systems, Inc. Q1 FY2023 Earnings Call

Good morning, ladies and gentlemen. And welcome to Advanced Drainage Systems, First Quarter Fiscal 2023 Results Conference Call. My name is Brika, 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. 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. Sir, you may begin.

Thank you. Good morning, everyone. Thanks for joining us for our call today. With me today I have Scott Barbour, our President and CEO, and Scott Cottrill, our CFO. I would also like to remind you that we will discuss forward-looking statements. 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 8-K submitted to the SEC. We will make a replay of this conference call available via webcast on the company website. With that, I will turn the call over to Scott Barbour.

Thank you, Mike and good morning. Thank you for joining us on today's call. We achieved a record $914 million in sales in the first quarter, an increase of 37% compared to the same period last year. Sales growth was primarily driven by strong demand across our geographies and construction end markets, supported by continued strength in our priority states. We saw attractive volume growth in Allied Products, Infiltrator and within our residential end market, driven by share gains from our storm sewer pipe and on-site septic products. Pipe volume in our nonresidential and agriculture end markets started slower than anticipated due to a wet spring for agriculture, job site delays, production limitations and difficult comps relative to last year. However, volumes improved month-over-month through the end of June and into the second quarter. And working closely with our distribution partners, engineering partners and contractors to monitor market demand, we collectively remain bullish on activity through fiscal 2023. Infiltrator sales increased 31%, driven by favorable pricing and strong volumes of septic tanks and Storm Tech chambers. Growth was strong in the southern and western regions of the US. The new production equipment installed during the fourth quarter of fiscal year 2022 at both Infiltrator and ADS is producing at expected rates and helping to bring down elevated backlogs. Although housing growth has slowed from the previous levels, Infiltrator has a good line of sight for continued if somewhat moderated growth for the remainder of fiscal 2023, given its healthy backlog and the impact of new capacity additions that will accelerate share gains. Looking beyond Infiltrator into the legacy ADS residential business, performance was strong overall. ADS residential sales increased 62% compared to the first quarter of fiscal 2022. Growth was robust in both our residential segments with growth related to single-family and multifamily development increasing 75% year-over-year led by share gains against traditional materials, pricing, and demand in single-family subdivision development and multifamily development. Our retail segment increased 40%, primarily driven by pricing. We continue to see a strong pace of orders and sales in the residential end market and are closely watching our leading indicators with the uncertainty that exists with forward-looking housing construction. We also continued to see strong growth in our nonresidential end market. Revenue growth for the quarter was 47% and driven by strong sales of pipe and Allied Products specifically our Storm Tech and Nyloplast product lines. Project identification, quoting, and order activity remain positive in the horizontal low-rise type of non-residential projects we participate in, including warehouse, distribution centers, commercial, and institutional projects. Rounding out our topline performance, international sales increased 9% this quarter, driven by sales growth in our Mexican and exports businesses. Moving to profitability, our adjusted EBITDA increased 80% this quarter. Favorable pricing continued to cover inflationary cost pressures on transportation and labor as well as raw material costs, which have moderated, but remained elevated as compared to previous years. This is our third consecutive quarter dating back to Q3 of fiscal 2022 that we have covered inflationary cost increases and the second consecutive quarter where we have experienced year-over-year adjusted EBITDA margin improvement. Overall, our backlog and cadence of orders remain favorable as well as our ability to capture price in the market. While there is uncertainty around the current macroeconomic environment, especially in residential construction, the momentum we are seeing in project identification, quoting, book-to-bill and order trends gives us confidence in our ability to achieve the updated guidance we issued today. Now, I want to highlight some other recent announcements. The integration of our two recent acquisitions, Jet Polymer and Cultec, are progressing well. Integration activities remain on plan and both businesses are meeting expectations. As previously announced in May, Bob Kidder retired as Chairman of our Board of Directors effective as of our Annual Shareholder Meeting on July 21st, 2022. Bob Eversole was previously selected and announced as the new Chairman of our Board of Directors in May and was reelected as a Director at our Annual Shareholder Meeting. I'm excited to continue working with Bob as Chairman as we execute on the growth strategies of ADS. We also elected Kelly Gast to our Board of Directors at our Annual Meeting on July 21st, 2022. Kelly brings broad financial experience from her leadership positions at Bayer as well as business strategy and commercial expertise. Her capabilities strengthen our Board and we look forward to working closely with her going forward. Lastly, we issued our fiscal year 2022 sustainability report this week. Sustainability is a core part of ADS and we are pleased to share how we are furthering our commitment to reducing our environmental impact, enhancing the safety of our people, creating a diverse inclusive and equitable workforce, and improving the communities we touch in this report. With that, I will turn the call over to Scott Cottrill to further discuss our financial results.

Thanks Scott. On slide five, we present our first quarter for fiscal 2023 financial performance. From a topline perspective, we generated significant growth year-over-year across our business. Legacy ADS pipe products grew 36%, Allied Products sales grew 5.4%, and Infiltrator sales increased 31% with double-digit sales growth across our domestic construction end markets. Consolidated adjusted EBITDA increased 80% to $299 million, resulting in an adjusted EBITDA margin of 32.7% in the quarter. As Scott mentioned, favorable pricing continued to cover inflationary cost pressures related to our material input costs, transportation, and labor. As we do not expect these cost pressures to abate this year, we will continue to work all of the levers in our playbook in addition to pricing to improve efficiencies and optimize costs. From a resin perspective, costs have moderated a bit but they remain at elevated levels from a historical perspective. Price cost continues to be favorable due to the pricing actions we've already taken and as we move through the year, we expect price cost to remain favorable. Moving to slide six, we generated $214 million of free cash flow year-to-date compared to $79 million in the prior year. Strong growth in adjusted EBITDA coupled with improvements in working capital helped drive significant free cash flow generation, which was approximately 71% of our adjusted EBITDA for the quarter. Our year-to-date capital spending increased 42% to $36 million as we continue to make investments to grow capacity and increase the efficiency of our operations. From a capital allocation perspective, our priority remains focused on investing organically in the growth of our business to increase our competitive position and accelerate market share gains. For the full year, we continue to expect between $150 million and $180 million in capital expenditures with our largest investments focused on future growth followed by our productivity and automation initiatives. In addition, we are monitoring our acquisition pipeline to identify opportunities that fit within our solutions offering, strategically increase our pipe capacity and grow our recycling capability to support the growth of the business. Lastly, we continue to opportunistically buy back shares as part of our share repurchase program. In the first quarter, we purchased 800,000 shares for a total of $67 million. And as of this call that number now stands at approximately 1.4 million shares for $125 million total, leaving $875 million remaining on our previously announced $1 billion share repurchase program. From a balance sheet perspective in May we increased our revolving credit facility from $350 million to $600 million. And in June, we issued $500 million of six and three-eighths senior unsecured notes due in 2030. We issued a portion of the proceeds to repay the outstanding borrowings under our senior secured revolving credit facility. These actions provide us with flexibility and allow us to operate effectively in various economic conditions. Overall, our liquidity and leverage position remains strong with over $1 billion of liquidity and a trailing 12-month leverage ratio of 1.1 times. Moving on to slide 7. We are raising our fiscal year guidance for both revenue and adjusted EBITDA. Net sales are now expected to be in the range of $3.250 billion to $3.35 billion and adjusted EBITDA is expected to be in the range of $900 million to $940 million. While there is uncertainty in the market, particularly in residential construction, the strength we are seeing in our leading indicators including project identification, quoting, book-to-bill and order trends give us confidence in the updated guidance we are issuing today. Our updated guidance reflects the better-than-expected performance we delivered this quarter and anticipates that these favorable performance trends continue into the second quarter but leaves the second half expectations from our prior guidance unchanged for now. As always we will continue to monitor the market environment and our leading indicators and we'll make adjustments if any to our outlook as and when appropriate. With that, I will open the call for questions. Operator, please open the line.

Thank you. We will now begin the question-and-answer session. The first question we have comes from Matthew Bouley of Barclays. Your line is open, Matthew.

Hi. Good morning, everyone. Thanks for taking the questions. So a question on that I guess the last point you made there Scott C. The - sounds like the second half expectations haven't changed in your basically what you saw in Q1 and to-date in Q2 I don't want to put words in your mouth, but it sounds like that's the bulk of the change. Can you maybe sort of bridge from the prior guide to the new guide just in terms of the components around volume price over cost sort of what's coming in better than what you expected versus the prior guide? Thank you.

Yes, Matt. This is Scott. If you examine the EBITDA bridge in the earnings presentation for the first quarter, you'll see the trends we're observing. As we've mentioned, we have strong visibility looking out three or more months. When we assessed the guidance and performance, we considered the favorable trends from the first quarter, which continued through July and into the second quarter. We decided it was wise to maintain our expectations for the second half as initially outlined. So we are taking a wait-and-see approach. However, we are monitoring some very favorable trends. It’s also important to emphasize that we anticipate price costs to cover throughout the year, comparing quarter-over-quarter and year-over-year. We believe these dynamics will hold true. Keep in mind that the comparisons in the second half of the year become significantly more challenging as we continue to navigate labor, transportation, and manufacturing costs. Overall, we are observing very favorable trends and maintaining a perspective on the first and second halves of the year.

Got it. No that's really helpful. Thank you for that color. And second one just taking a step back on, sort of, the longer-term profitability. So now I mean you're guiding this year to 350 basis points of margin improvement at the midpoint and the long-term guide was, I believe, 400 to 500 basis points. So just given where the, I guess, starting point is this year, does that at all change sort of the longer-term view to margins? And/or is there any more perhaps price cost tailwind that is now showing up relative to what was in that prior long-term guide? Any kind of thoughts on that would be great. Thanks, everyone.

Yes, Matt, it's Scott here again. You're correct. If you recall from Investor Day, we outlined a three-year plan with an expected margin expansion of 400 to 500 basis points. We mentioned the possibility that this expansion could be more pronounced in the early stages rather than later on, and that's exactly what we're observing right now. Are we ready to announce that we might exceed those projections? We'll see as the year progresses and we provide guidance for the next year. But I want to emphasize that the management team is quite pleased with the performance trends we're witnessing, so I'll leave it at that.

Scott Barbour here, Matt. I would just say, it's the first quarter of the first year of that plan. So I'm kind of not ready to do that. But I do recall this conversation in the past where we said it would be front-end loaded potentially. Yes. And we kind of had some line of sight on that price cost, as we came out of last year. We didn't think it would be to this magnitude, but we did have an idea that we could front-end load that, which we view as good, front-end getting ahead of the plan.

Absolutely. All right. Well, thank you both and good luck in the next quarter.

Okay. Thanks.

Thanks.

Thank you, Matthew. The next question comes from Michael Halloran of Baird. Your line is open.

Hey, good morning, everyone.

Hey. Good morning.

So not to belabor the front half back half thing, because I certainly understand the messaging. But on the margin side, obviously, exceptional margins in the quarter. You run rate those margins out and you get something meaningfully ahead of where you are right now from a guide perspective. Certainly, understand the conservatism part. And so, maybe the way I'll just ask it is, is there anything in this quarter that you thought was one-time in nature, not sustainable, that shifts on a forward basis? I certainly understand all the price cost commentary you've been making, Scott. So is there anything else in there I should be thinking about?

Good morning, Michael, this is Scott Barbour. There was nothing unusual that happened this quarter. It was a good quarter, and I mentioned this in the commentary. As we progressed through the quarter, things improved. The volume increased, our leverage improved, and our performance, especially in deliveries, was significantly better than a year ago. However, there were no one-time events or major projects that we would highlight.

No, that makes sense. From a capacity perspective, you're doing more work at the Infiltrator campus right now. On the legacy side, do you think the capacity is meeting the underlying volume, or is there still some catch-up needed to move toward something more optimized? I also might have missed this, but were volumes positive in the quarter on the legacy side? Any thoughts on that?

So, Scott Barbour here, again. The work in Infiltrator is progressing well. The equipment there has had a significant impact on Allied products and Infiltrator tank sales. The new equipment in the legacy business is performing strongly. However, you are right that we need additional capacity beyond just the Southeast and the Eastern Seaboard, where most of the new pipe equipment has been utilized, to better align volumes with customer demand. I consider this as enhancing our peak capacity for pipe production, which is an area for improvement that will require further investment and presents potential for growth moving forward. Is that kind of what you were asking? Did I understand correctly?

Yes. I know, it was the tail-on added at the end. Remind me if volumes were positive in the quarter or not.

So pipe volume is positive in everything, but the retail shipments and agriculture shipments.

And the Allied Products.

And Allied Products is very positive.

Infiltrator and Allied were positive.

I mean, that small negative of $3.3 million in the bridge is really driven by a wet spring, which impacted agriculture in some northern markets of non-res and we saw that recover late in the quarter and in July.

Year-over-year comps so. We had a really good April last year.

Yes, April and May. And Michael, it's Mike Higgins. I go back to the comments made in the opening commentary. As we went through the quarter the year-over-year volume performance improved.

Right.

And we saw that trend continuing in the month we just completed July.

So that's a good segue to the next question then. So the leading indicators, that you guys talked about, obviously part of it is the trend you're seeing through this July time period. But maybe just a little more depth on, what you're seeing on the leading indicator side. Why the competency of the year is this? What you've booked already, customer conversations what distributors are saying? Any more detail on that would be great.

Scott Barbour here again. When we begin collaborating with a contractor or developer on a project, we view that as project formation. We then provide a quote for that job, take an order, and ship it within 30 to 60 days. All of these metrics have shown positive growth year-over-year. I'm currently referring to the pipe side, which is contributing to Allied Products, residential pipe, and nonresidential pipe. Additionally, we expect the agriculture segment to perform well. We have observed significant order increases in that area over the past 30 to 60 days, which should mature in October and November. At Infiltrator, the order pace has stabilized, and we still have a considerable backlog. We do not anticipate that will create any challenges until we enter the next fiscal year. We're monitoring the situation closely, but it's still too early to draw any conclusions. At this moment, we are very confident that the residential segment, related to starts and completions driving onsite septic, is progressing according to our plan and aligning well with our expectations.

Great, really appreciate it. Best quarter guys.

Thanks Mike.

Thanks.

Thank you. The next question comes from Josh Pokrzywinski of Morgan Stanley. You may proceed with your question, Josh.

Hi. Good morning guys.

Good morning, Josh.

Scott, can you provide your insights on how your pricing stands in the market? You seem to have less competition from others with similar resins and inputs. While your cost situation is favorable, it may appear different for competitors. Specifically, how do you view pricing in the pipe business? What is the current status and how has it changed over the last couple of quarters?

Our relative price for pipe products continues to increase. This is a result of the pricing strategy we began implementing last year, which included consistent price increases throughout the year. We had a price increase in March that has held, largely due to heightened diesel and transportation costs. We are still experiencing some benefits from that, but that will level off as we progress through the year. While we are not lowering prices, we are also not planning to raise them further unless necessary based on market conditions. We believe we remain very competitive with traditional materials. In the past, these competitors have been slower to adjust to their inflationary input costs, but they have started raising prices quite aggressively. This is beneficial for us, allowing us to maintain our pricing in the market or adjust as needed to cover costs. We have thoroughly evaluated our pricing position, and we feel confident about our current price levels and our competitiveness in the market to secure the business we aim for.

Got it. That's a good segue to my next question. Clearly, you are benefiting significantly right now from pricing, costs, and volume. Regarding the mix, what is the willingness to perhaps realize less margin benefit and focus on gaining more market share? How do you strike that balance? Are there any considerations you are currently exploring?

Yes, there is a toggle. We believe it is currently set appropriately, and we are making gains in areas where we have available capacity, particularly in our focus states. We haven't needed to adjust pricing significantly to achieve our goals. However, compared to last year, when we were sidelined in the agriculture market due to a lack of materials and capacity, our situation has improved. If we need to make adjustments to gain market share, we will, but we won't compromise our pricing and cost balance at this time.

I would add one comment. Yeah. I was going to add one comment to what Scott said. Yeah, I was going to say versus using pricing as a toggle I think what we've kind of learned through the demand environment with the strong demand in these inflationary cost pressures is you can get share by improving service and availability.

That's a good point.

Just as easily as you can with price. So, I think really what we've been focused on so far is let's not use price to do that. Let's just be better value proposition in the market versus who we're competing against.

Yeah, it makes sense to me.

That's clearly what we've done in agriculture. Clearly, what we've done there, where we like I said we really haven't had a toggle much, if at all. And use better inventory builds better quality of inventory our production planning processes our fleet guys are doing a great job right now upturning our fleet capacity and multiple runs in a day to service the agriculture market. I mean, it's astounding the number of trucks we're rolling every day right now. So that's a very good point, Mike.

Thank you. We now have the next question from the line of John Lovallo of UBS. Your line is open, John.

Hey, good morning guys. This is Spencer Kaufman on for John. Thank you for your questions. Maybe the first one just piggy backing off of Josh's question there You guys have obviously put through a tremendous amount of price into the market. I'm just curious, what your current realization on price increases is and what was this on a pre-COVID world? How much more price even do you guys think you can get? And what typically happens to price in a deflationary environment?

Go ahead Scott.

Yeah. So again, as you look at our EBITDA bridge and you see that volume again different – based on the different segments we have Allied and Infiltrator up pipe down. But still getting a lot of pricing year-over-year, we look at it sequentially as well as that year-over-year trend. So again, I'll answer the last part of your question first. When you go back and look, I've been here seven years, I've been in different resin environments resin going up, resin going down. ADS consistently holds that spread, if you will and holds that pricing. So I would tell you that, again, it's going to be market dynamics. We'll continue to look at it. And it's the value proposition. Everybody always defaults to resin, it's much more than that. It's transportation, it's labor, it's that value proposition and as Mike and Scott were just talking about that ability to serve and that availability of product in the right place at the right time. It's such a regional business that all matters so much. So when you talk about pricing and keeping it, it's much more than just talking about resin. So the history of the company proves out that, we can keep that pricing as we move forward and that spread if you will. And we're highly confident as we move forward. We talked in our prepared remarks about that price cost being favorable in the first quarter and the fact that, we see it being favorable as we move through the rest of the year. So a high confidence level there, again, it's a key part of our playbook, if you will, but we're also not letting up on productivity initiatives, Continuous Improvement initiatives, lean. The capacity that we've added, we always said that, Infiltrator was going to add that capacity first. And we've seen it really and Scott mentioned, it as well on the tanks, on the Storm Tech product that they make that goes into Allied Products. Having that inventory being out there to service the demand that, we've had we've really seen that come through in a powerful way. And that's one of those favorable trends that we mentioned that, we saw in the first quarter that, we're looking forward to as we go into Q2 and beyond.

Okay. Yeah that makes sense. And I appreciate the color there. Maybe for my follow-up any update on Texas in trying to improve your hold there?

Yeah. This is Scott Barbour, and we continue to make a lot of progress in Texas in a public approvals, I think our sales in Texas were up like 49% or something like that. So very strong quarter in Texas, we're not through the whole approval process yet. It's not a short process. But I would say that we feel very good about where we are. And ultimately we believe we will have a big win there.

Great. Thanks, and good luck, guys.

Thanks.

Thank you, John. We have no questions registered. So I would like to hand it back to Scott Barbour for some closing remarks.

All right. Thank you very much and we appreciate the questions today and everyone who participated. It was certainly a good quarter. Lots of hard work by the people in the company at ADS, Infiltrator, Cultec unbelievable kind of journey that we're going through together in this year. It's turning out different than last year, but a good start. I think we've given some very good guidance here and we look forward to the next time we all meet. Thank you.

Thank you. That does conclude today's call. Thank you all for joining. You may now.