Earnings Call Transcript - WMS Q4 2025

Operator, Operator

Good morning, ladies and gentlemen and welcome to Advanced Drainage Systems Fourth Quarter of Fiscal Year 2025 Results Conference Call. My name is Tamika, 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, Michael Higgins, Vice President of Investor Relations and Corporate Strategy. Please go ahead, sir.

Michael Higgins, Vice President of Investor Relations and Corporate Strategy

Thank you. Good morning, everyone. I'm here with Scott Barbour, our President and CEO, Scott Cottrill, our CFO; and Craig Taylor, Executive Vice President, ADS and President of Infiltrator. 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 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 which speak only as of today. Lastly, a press release we issued 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'll now turn the call over to Scott Barbour.

Scott Barbour, President and CEO

Thank you, Mike, and good morning, everyone. I appreciate you joining us on today's call. We wrapped up fiscal 2025 with net sales of $2.9 billion, reflecting a 1% increase from the previous year. Notably, our domestic construction market sales rose by 3% as we achieve above-market performance through our material conversion strategy in the stormwater and on-site wastewater sectors. We experienced significant growth in Florida with double-digit increases in pipe, Allied products, and Infiltrator products. Texas also showed double-digit growth in Infiltrator products, along with gains in pipe and non-residential markets. From a product perspective, our water quality products and the Cultec retention/detention chambers we acquired in 2022 both saw double-digit growth. Additionally, both tank and active treatment products in Infiltrator also grew significantly. Craig Taylor will elaborate on these shortly. Regarding profitability, this year's adjusted EBITDA margin of 30.6% marks our second most profitable year ever, albeit slightly lower from peak levels due to challenges with pricing, material costs, and a tough economic environment affecting demand. The resilience of this year's profits stems in part from our focus on expanding more profitable segments, with Infiltrator and Allied products comprising a larger share of overall sales. Organic sales in these segments grew by 5% and 3% respectively, with on-site wastewater and Allied products representing a combined 44% of our revenue. We had planned to discuss the evolution of ADS' product mix at our Investor Day originally set for this June. However, given the current volatility in the industry, we believe a more opportune moment for in-depth discussions about our three-year outlook will be later this year when we have clearer visibility. Therefore, we will reschedule the Investor Day and inform you of the new date, which will be later this year. Now, I want to highlight our journey over the past decade as shown on Slide 5. From FY 2016 to FY 2025, we have strategically diversified our products, geography, and end markets to become a more profitable business. We concentrated on growing our higher-margin Allied products, which expanded at a 10% CAGR during this time, outpacing our core pipe business. Our presence in the residential market has strengthened through both our pipe business and Infiltrator products, leading to an 18% CAGR by focusing on relationships with large national homebuilders and securing approvals in fast-growing residential areas, mainly in the Southeast. This approach has yielded excellent results for the company. Additionally, our acquisition of Infiltrator boosted our residential exposure to 36% of total revenue, further accelerating growth and enhancing our margin profile. This diversification is crucial to our future strategy, which enhances profit resilience, supports ongoing margin expansion, and allows us to engage in various water management projects. Since FY 2016, we have transitioned from being a pipe manufacturer to a comprehensive water management solutions provider, and our profitability reflects this change. We are proud of our growth, diversification, and leadership in each segment. Moving on to Slide 6, this diversification has enhanced our total market opportunity by approximately $10 billion. We have a substantial addressable market and a long path ahead to execute our conversion strategy across all products. In the stormwater sector, where ADS leads the market, plastic pipe constitutes about 40% of the $5.5 billion market. In the Allied Products area, we hold about 10%, while in on-site wastewater, Infiltrator commands roughly one-third of the market. We see significant potential in these categories, supported by our proven strategy of gaining approvals and strengthening relationships in the field. Additionally, several long-term trends will propel growth in these markets, such as the under-investment in U.S. water infrastructure, the increasing severity of major storm events, and the residential construction shortfall we've frequently discussed. Studies, particularly from the American Society of Civil Engineers, indicate that existing water infrastructure is largely in poor condition and generally below modern standards. This trend presents an encouraging outlook for us, as it will drive investment in water management infrastructure across multiple products and regions. In the long term, we will continue to benefit from these growth trends by leveraging our strong portfolio, introducing new products, and pursuing acquisitions that enhance our market share across various projects. Our value proposition is outlined on the next slide. We offer a best-in-class portfolio of water management products and, uniquely, the capability to provide complete water management solutions on a national scale that are safer, more sustainable, quicker to install, and lower in installation cost. Our robust product lineup is backed by a proven go-to-market strategy that has consistently delivered market share growth, supported by our exceptional field team of 300 professionals. As we have enhanced our profitability and cash flow, we can reinvest strategically into new capacity, products, engineering capabilities, and customer service tools. Over the years, we have developed leading-edge design tools that facilitate product selection for customers in various ways, digitally, creating superior service offerings. We also maintain a fleet that delivers over 70% of our products, having modernized and improved our logistics significantly. Our customer experience enhancements, driven by investments over the past year, have led to delivery performance exceeding 90%, providing our clients with superior information and availability. Moreover, we launched our engineering and technology center about nine months ago, which is the most advanced stormwater facility globally, enabling faster development and launch of new products, as well as optimizing manufacturing processes. We’ve already seen excellent results from our recent investments. When we align our scale, best-in-class products, effective market strategy, and ability to reinvest, we clearly have a stronger position now compared to FY 2016 and against any of our competitors. I am proud of our team for navigating this challenging year and achieving significant progress in spite of a tough demand landscape and material cost pressures. We continue to excel in safety, reaching important milestones in our safety performance this year. We have much more to discuss, which we will address along with our three-year plan at the rescheduled Investor Day later this year. Scott Cottrill will now provide an outlook for FY 2026, and we remain confident in our capacity to achieve above-market growth in our core domestic construction areas while maintaining solid profitability, despite ongoing challenges in demand. Next, I’ll hand it over to Craig Taylor, President of our Infiltrator business, to review their fiscal 2025 performance.

Craig Taylor, President of Infiltrator

Thanks, Scott. I'm happy to be here today. Fiscal 2025 was another strong year at Infiltrator. We reported $560 million in sales, an increase of 15% over the prior year, including $46 million in record sales. On an organic basis, sales increased 5% driven by double-digit growth in both septic tanks and advanced treatment products. Tank sales increased 12%, driven by a material conversion and new product introduction. Just like ADS' material conversion strategy, Infiltrator plastic tanks are driving market conversion from the traditional concrete tank. In fiscal year 2025, we launched two new products to address market needs and to provide contractors with additional installation flexibility. Organic advanced treatment sales increased 33% compared to the prior year, primarily driven by market growth as well as the introduction of the ECOPOD-NX. This product is the next generation of advanced wastewater treatment technology designed to meet new regulations that require higher levels of nitrogen reduction to protect watersheds and the environment. Adjusted gross margins increased 50 basis points to 53.6%. This includes the impact of the Orenco acquisition. Organically, we expanded adjusted gross margin by 250 basis points, primarily driven by favorable pricing, manufacturing efficiencies, and material costs. Infiltrator's profitability today demonstrates the benefit from capital investments made in machinery and equipment over the last six years, most significantly, the highly automated advanced manufacturing facility opened in 2020. Since opening, Infiltrator's profitability has improved by 1,100 basis points. When the market slowed years ago, we were able to utilize the facility while we took older equipment offline for refurbishment. As we ramped back up, we achieved a 15% improvement in productivity and efficiency. In addition, our business continues to be very innovative. New products we have introduced in the past three years account for over 20% of our revenue. As we look at Orenco, we see an opportunity to grow revenue and improve the processes and efficiency in our manufacturing. We are targeting margin improvement of 1,000 basis points over the next three to five years and we are excited about the additional breadth this acquisition brings to our product line. The acquisition also gives us access to new applications. For example, the Primo's product assists homeowners converting through centralized wastewater systems by making the process lower cost and less disruptive. In addition, Orenco's advanced treatment product increases our exposure to the commercial systems where the Infiltrator products have a strong foothold in residential systems. All in, we are very proud of this year's accomplishments and excited about the future growth at Infiltrator as we continue to drive material conversion and capitalize on growth in the advanced treatment market. Now I'll turn the call over to Scott Cottrill.

Scott Cottrill, CFO

Thanks, Craig. In the fourth quarter, net sales decreased 6% overall as demand was impacted by higher interest rates, economic uncertainty, and unfavorable weather conditions. Recall, last year, we experienced favorable weather conditions that allowed for an early start to the spring selling season in both construction and agriculture. From a timing perspective, construction activity and agriculture accelerated by about six weeks this year compared to last year. Importantly, price costs remain in line with expectations and manufacturing and transportation costs were both favorable in the period. On Slide 10, we present our free cash flow and liquidity. As most of you know, one of the strategic advantages of the business is the consistency and quality of our cash flow generation. Even in a choppy and uncertain macro environment, we generated $581 million of cash from operations during fiscal 2025. The strong cash generation of the business gives us the flexibility to invest in production, capacity, and innovation to grow our position in the highly attractive stormwater and on-site wastewater markets. That's an envious position to be in and one we intend to optimize to continue driving long-term shareholder value. Capital spending increased 15% to $212 million in fiscal 2025 as we continue to invest in improving customer service through investments in technology and better order management processes, accelerating innovation in new products and new technologies that add to our stormwater and wastewater solutions packages. Increasing our production capacity in certain regions and certain products that have superior demand, profitability, and growth characteristics, debottlenecking and expanding our recycling operations such as our recycling facility in Cordele, Georgia as well as our material science and blending capabilities; and finally, increasing the safety, productivity, and efficiency of our manufacturing network. In addition, we upgraded our transportation assets, including refreshing the fleet and implementing the latest telematics and safety technology to improve superior delivery and customer service. Turning to capital allocation. Our priorities remain unchanged and rooted in our commitment to drive growth and create long-term shareholder value. First and foremost, we will continue to invest strategically in the core business for all of the reasons I just mentioned. A close second, the pursuit of acquisitions to grow our product offering and leadership in the stormwater and on-site wastewater markets. That said, we recently announced the acquisition of River Valley Pipe, a manufacturer of corrugated plastic pipe products serving the agricultural market in the Midwest. We will continue to focus on opportunities to expand our product offering and capacity. Our balance sheet and free cash flow profile gives us the ability to move decisively when the right opportunities emerge without needing to dilute shareholders or take on excessive leverage. We remain opportunistic in evaluating M&A that enhances our portfolio and aligns with our long-term strategy. We've also maintained a balanced approach to capital deployment returning $121 million in fiscal 2025 to shareholders through dividends and share repurchases. We have deliberately built and maintained a fortress balance sheet that provides us with the flexibility to navigate cycles as well as promptly act on opportunities. We closed the year with $1.1 billion in liquidity and a net leverage of 1.1 times. In addition, today, we announced a 13% increase in our annual dividend to $0.72 per share. Moving on to Slide 11. We present our fiscal 2026 guidance ranges. Based on our order book, backlog, and market trends, we expect revenue to be in the range of $2.825 billion and $2.975 billion and adjusted EBITDA to be in the range of $850 million to $910 million. These ranges result in an adjusted EBITDA margin of 30.1% to 30.6%, down 50 basis points to flat compared to this year's 30.6% margin. It is important to note that we do not expect any material impact from tariffs. Today's guidance reflects the end market outlook on Slide 12. We do not expect the non-residential or residential end markets to accelerate as both are under pressure from higher interest rates and economic uncertainty. We expect a non-residential end market to be flat to down low single digits, and the residential market to be down low to mid-single digits. The infrastructure market continues to benefit from IIJA funds and we expect that market to grow low single digits next year. Finally, both the agriculture and international end markets are expected to be down double digits in the year. Finally, the fiscal 2026 guidance at the midpoint includes the following key assumptions: for revenue, volume up low digits and pricing down low single digits. For profitability, price/cost should be neutral for the year as we expect lower material costs year-over-year to offset the impact of pricing I just noted. Manufacturing costs will be unfavorable due to fixed cost absorption, primarily in the first quarter. The higher costs are due to the lower production volume over the winter months due to the slower demand experienced in Q4 and as well as expected in fiscal 2026. Transportation costs are expected to be favorable year-over-year due to improved efficiency and route planning and SG&A costs are expected to be 14% of revenue for the year. We will remain focused on executing our long-term strategy to drive consistent long-term growth, margin expansion, and free cash flow generation in the large and attractive stormwater and on-site wastewater markets, the significant conversion opportunity. With that, I will open the line for questions.

Operator, Operator

Your first question is from Mike Halloran with Baird.

Mike Halloran, Analyst

First, Scott, I would like to clarify your recent comment regarding price and cost. How is pricing tracking sequentially? Have you noticed any additional pressure in that pricing comment? Are there any mix components influencing the pricing? I understand you expect to be price and cost neutral as we progress through the year due to those factors. I just want to get a better understanding of the pricing situation.

Scott Cottrill, CFO

Yes, Michael. Essentially, we're looking at pricing that is down by low single digits, but this is relative to the pricing effects that we didn't experience until the second quarter of this fiscal year. Therefore, the comment indicates that we'll continue to see challenges, particularly in the first quarter as we progress through the year. However, pricing should remain relatively stable throughout the year.

Mike Halloran, Analyst

Okay. That makes sense. So you're basically saying first quarter is where the pressure point is and then kind of static year-over-year once you lap that comp. Okay. That helps. And then the demand side of the equation, modestly positive volumes. I mean, it seems like you're embedding some sort of share gain potential within the context of that based on the end market commentary that you have on Slide 12. Maybe just talk about where you are expecting the share gains to come in and what are the catalysts for that on an in-store level by products, end markets, however you want to go after that?

Scott Cottrill, CFO

So Mike, this is Scott B. Yes, we are seeing share gains as we convert from traditional materials to plastic pipe, particularly with our polypropylene products in the larger diameter category. We have gained share in the residential segment, which we continue to expand through our sales efforts and the strength of our value proposition for early land development projects. While the market may experience varying growth levels and uncertainty, we have been steadily growing from a low starting point.

Operator, Operator

Your next question is from the line of Matthew Bouley with Barclays.

Matthew Bouley, Analyst

Good morning, everyone. Thank you for taking the questions. Just wanted to ask first about the cadence for the year, thinking about the top line. So a lot of great color there around some of the margin impacts in Q1. But just think about revenue. I mean I guess if I look at the fourth quarter, organic growth was maybe down 3% or so. Is Q1 shaping up similar to Q4, plus or minus? And kind of what I'm getting at is what's the implication to year-over-year growth as you think about the second half of the year within your guide? Thank you.

Scott Cottrill, CFO

Yes. I want to be careful to get too much, Matt into the quarters. But I will highlight, we do talk about 1H and 2H. And typically, the business will see 55% to 60% of the revenue in the first half of the year and 40% to 45%, obviously, in the second half. We expect to see that same dynamic this year. I think in the first quarter on a year-over-year basis, obviously, there is a little bit of upside opportunity given that some of that pull ahead that we saw last year that we mentioned. So a year-over-year comp. That's a little bit easier in the first quarter, but expect 55% to 60% of the revenue in the first half, consistent with what we normally generate and drive.

Scott Barbour, President and CEO

You've got to see real impact in the first quarter.

Matthew Bouley, Analyst

Okay. Got it. Great. That's helpful. Thanks for that guys. And then I wanted to maybe just step back, the Investor Day. I just wanted to ask a little bit more about the, I guess, the postponement there. Because I certainly hear you around the uncertain cycle. But obviously, you have a lot of great sort of non-cycle topics to point to as you went through in your prepared remarks. And you obviously just guided to 2026. So presumably, you have a starting point to think about a 3-year guide. So I guess what I'm asking is, are you just seeing the end market volatility to such a degree that you sort of lost the comfort, I guess, around putting out a longer-term outlook? Or, yes, I'm just trying to understand how these current market conditions are giving you that sort of pause there? Thank you.

Scott Barbour, President and CEO

This is Scott Barbour. Good question. I think it comes down to kind of two things, Matt. One was, just getting to FY 2026 kind of nailed down, yes, there was a lot going on over the last three months to try to nail down that. And then every time we got into what kind of assumptions to make on market growth and these other things to really nail down a three-year plan, we couldn't. We just didn't feel comfortable nailing down a three-year plan underneath those kind of conditions. I mean I know you all will hold me highly accountable to that plan, and I didn't want to have to give you such a big range, it didn't make sense. So that's why we postponed it. You're right. We have a lot of great things to talk about, but that felt like without a really solid economic three-year plan in front of you, we wouldn't accomplish what we wanted to accomplish with you. And I didn't want to waste your time on that. So I'd rather give you a really solid plan, take an extra couple of months to get it done, and that was my logic on that.

Operator, Operator

Your next question is from Bryan Blair with Oppenheimer.

Bryan Blair, Analyst

Thanks. Good morning. I want to circle back to order rates. I understand the framework for the full year guide and then appreciate all the moving parts there and how you're contemplating end market dynamics. Just curious what you're seeing on a run rate basis, you mentioned that the orders are positive year-to-date. Just curious how end markets are trending relative to the guidance framework that you have and maybe speak to potential catalysts for risk as we think about the full year progression.

Scott Barbour, President and CEO

Okay. This is Scott B. Order rates are currently positive and support the guidance we provided for both the first and second halves of the year. We are focused on a shift occurring from our fourth quarter to our first quarter due to seasonal factors and differing weather conditions this year compared to last. We believe the market is growing, but we want to navigate through the months of April, May, and June to better understand that impact. Particularly on the Infiltrator side, as the season begins, we expect ordering patterns to change starting in June. Craig is closely monitoring this, especially regarding our core leach field products, where we have good visibility into the market. We need to reach that reorder point to ensure that seasonal shifts are not misleading us, before we can confidently comment on the market's strength.

Bryan Blair, Analyst

I understand. Thank you for that detail. Can you provide an update on the Orenco integration and confirm if the target is a 1,000 basis points margin expansion? Additionally, could you discuss the strategic fit and anticipated financial contribution of River Valley Pipe? Thank you.

Scott Barbour, President and CEO

So Craig, why don't you talk about Orenco? He did, in fact, say that big of a number.

Craig Taylor, President of Infiltrator

Yes. The margin expansion is primarily driven by the growth I mentioned, which involves increasing revenue, integrating our commercial business with our operations, and enhancing our distribution channels while boosting our general on-site product. We are concentrating on this growth opportunity, leveraging our manufacturing efficiencies to improve operations, and this will aid margin expansion over the next few years. Therefore, we are looking at a three to five year outlook for that expansion.

Scott Barbour, President and CEO

No, I think the Infiltrator team consists of very skilled engineering and manufacturing professionals. They are currently in Oregon, implementing a solid plan on a rotating basis. As Craig mentioned, they have made significant progress in commercial integration and have opened new distribution channels, which are already showing benefits. It is an ambitious plan, and we are pleased with the progress made in the first seven months of working with the team in Oregon and Craig. Regarding River Valley, we have always aimed to increase our competitiveness in Illinois and Iowa, and River Valley has facilities in both states. This acquisition provides us an opportunity to capture market share and expand our operational footprint. We believe it's important to acquire such assets rather than allowing others to take ownership. For these reasons, acquiring River Valley is a strategic move for us. Additionally, we obtained a valuable customer base along with a product line that will complement our offerings in these regions, where we have aimed to strengthen our presence for many years. When this opportunity arose, I was determined to pursue it.

Operator, Operator

Your next question is from the line of John Lovallo with UBS.

John Lovallo, Analyst

Good morning, guys. Thanks for taking my questions. I wanted to go back to just kind of market growth and your forecast for internal growth. It seems like on a blended basis, you're expecting your end markets to be down kind of low single digits. And you're guiding roughly flat sales. If we back out Orenco and River Valley, I mean how much of this is organic sales versus kind of the inorganic portion? I mean I guess the point is it seems like the expectation is for only sort of modest outperformance versus the end markets this year.

Scott Cottrill, CFO

Yes, John, it's Scott C here. You're right. I mean, if you look at the end markets, you got to weigh the end markets based on about 45% of our business is non-res, 35% is res. So when you look at what we think those end markets are going to be down low to mid-single digits, roughly our guide would say organically at the midpoint, we're going to be flat on the volume side of the house. So again, we think that is still a really great example of conversion and continuing that trend. So that's the way we looked at it and the way we think it's going to play out based on what we know right now.

John Lovallo, Analyst

Okay. Got you. And then for the 2026 EBITDA margin of 30.3%, I mean it's down roughly 30 basis points year-over-year on sort of flattish sales. I guess a similar question. I mean how much of this decline is organic versus inorganic? And on the organic piece, is that dominantly focused on the first quarter where that price cost is going to be unfavorable?

Scott Cottrill, CFO

Yes. Right now, we need to keep in mind the absorption impact we discussed that will occur in the first quarter. When we estimate Orenco, we anticipate it will be about 50 basis points dilutive to our organic growth, compared to about 30 basis points in the first quarter of 2025. I view it as relatively flat year-over-year in terms of organic performance, with a bit more dilution from having Orenco for the full year due to its lower margin profile.

Operator, Operator

Your next question is from Garik Shmois with Loop Capital Partners.

Garik Shmois, Analyst

Hi. Thanks. Just wanted to follow up on the pricing piece, recognizing it's been stable for several quarters, but just with the market expected to again be down, just any additional maybe handholding us to your level of confidence that pricing will remain stable from this point forward in the softer market?

Scott Barbour, President and CEO

Yes. We manage this daily by examining participation, competitors, the nature of the job, and customer specifics. We've been analyzing this in detail for the last four quarters while seeking opportunities for price improvements. We appreciate this process as it provides us with good visibility, especially regarding the pipeline segment of the business, which is limited to specific geographies. We are confident that our processes and the analysis our managers conduct will continue to be effective tools for managing price and participation. We feel positive about the current situation. Competitors are always present, and that is simply a part of doing business every day.

Scott Cottrill, CFO

There are instances where we will be increasing prices in specific regions, products, or end markets. It's always a combination, and we need to maintain a balance. Additionally, we have the effects of past performance that we discussed, which will influence year-over-year comparisons. We consider all these factors to develop our outlook, which we expect to be relatively stable. It's important to account for all these elements when making our assessments.

Operator, Operator

Okay. That's helpful. And then just a follow-up is just on capital allocation and you're sitting at a pretty comfortable leverage ratio, and you have a slide in the deck that does talk to your capabilities in your balance sheet is quite attractive to accelerate your investments. So is there a scenario here? And I know you've made two acquisitions over the last several quarters, but is there an opportunity for you to ramp that up even further or go larger if the opportunity presents itself?

Scott Cottrill, CFO

Yes. I mean our growth algorithm is very compelling at growing above our end markets via the conversion story. The innovation and new products and then put this balance sheet to work through acquisitions to get incremental growth on top of that. We like what we've been able to do over the last 12, 18 months, going all the way back to fiscal 2020 for the Infiltrator acquisition that's been a grand plan not even a home run. So we look at that being at 1.1 times levered. We have a lot of opportunity to put this balance sheet to work. And we're actively looking at all options, including the engineering and technology center and innovation and what we can do there with new products. So again, very excited about that long-term shareholder value creation. And acquisitions will definitely be part of that.

Operator, Operator

Your next question is from the line of Jeff Hammond with KeyBanc Capital Markets.

Jeffrey Hammond, Analyst

Hi, good morning, guys.

Scott Cottrill, CFO

Hi, Jeff. Good morning.

Jeffrey Hammond, Analyst

It seems like the near-term orders are strong, but I'm curious about the longer-term outlook in the pipeline. Specifically, what trends are you noticing in residential land development? Additionally, are there any immediate indications of delays or deferrals in construction projects due to tariff issues, uncertainty, and rising costs?

Scott Barbour, President and CEO

We're not significantly impacted by tariffs as a company. Our main concern is the potential effect on demand and delays in construction projects. Over the past 60 days, we haven't observed a substantial number of projects being removed from consideration. Following last week's agreement to postpone actions with China for 90 days, we haven't seen many projects return either. People seem cautious given the uncertainty. What we do notice is a steady flow of orders and quotes, which has improved compared to last year. It's not exceptionally high, but it's stable. We expect this trend to continue for the remainder of the quarter, though predicting the second half of the year is challenging. It's unclear if these issues will be resolved in 90 days or how interest rates will fluctuate. The situation remains uncertain, so we will adopt a conservative approach in our forecasts. Overall, I haven't seen any drastic changes recently due to the various announcements.

Michael Higgins, Vice President of Investor Relations and Corporate Strategy

Yes. I think if you just look at go back to February, right, when we released our earnings and everybody thought the world was going to end because of all of these tariffs, it was creating a ton of certainty. And there's been a lot of moves since then. So the move, as Scott referenced, a week or so, 10 days ago with relation to China, everybody is feeling good about themselves. But again, that can change in another 60, 90, 120 days.

Scott Barbour, President and CEO

We believe we have a solid plan and strategy, as well as a strong market position to implement it. While we cannot control the end markets, we can manage how effectively we carry out our strategy of outperforming, growing Allied Products and Infiltrator faster than the pipe business, and maintaining good price-cost discipline.

Operator, Operator

Okay. Great. And then just back on the capital allocation question. So to ask it a different way, maybe. One, a lot of my companies are saying, 'Hey, it's tougher to get deals done in this environment, just given all the uncertainty.' Wondering if you're seeing any of that. And then I think your answer to the prior question was a lot more towards growth and external growth and just how you're thinking about buybacks because you highlighted a lot of great things about the business and the market doesn't seem to be appreciating it. And we just wanted to see when and if you want to lean in on buybacks.

Scott Cottrill, CFO

Our priorities remain unchanged. We are focused on reinvesting in the business. We plan to increase our capital expenditures, moving from about $212 million in fiscal 2025 to a projected $275 million in fiscal 2026. We aim to enhance innovation through our engineering technology center and new product developments. There are significant opportunities for internal investment. Regarding acquisitions, we are always exploring potential opportunities. Additionally, returning excess cash to our shareholders is a key part of our balanced capital allocation strategy. Last year, we returned $120 million through dividends and buybacks. We continually evaluate this based on the company's outlook, our working capital, cash flow, and the broader economic environment over the next six to eighteen months. This approach is both balanced and effective. We consider share buybacks after addressing our primary priorities. If we generate the expected cash and if other opportunities do not materialize as anticipated, we will consider re-entering the buyback market.

Scott Barbour, President and CEO

I would add one thing to that, which is we are still in a period of relative uncertainty and we want to have a very strong balance sheet if we're ever moving into those kind of times. But I think Scott is right. I mean it's excess cash beyond what we see for our needs and so we obviously see some needs out there with an appropriate level of conservatism.

Operator, Operator

Your next question is from the line of Trey Grooms with Stevens.

Trey Grooms, Analyst

Hey, good morning. Thanks for taking my question. So you guys did a great job in the quarter managing SG&A. How should we be thinking about the SG&A expense in 2026? And maybe if you could talk about some of the levers you're pulling or cost out you can tap if end markets remain subdued or maybe even decrease more than expected from here just kind of given the current level of uncertainty.

Scott Cottrill, CFO

Sure, Trey. So obviously, you've got the impact of Orenco coming in there. So that's part one. Craig did a good job highlighting the synergy program and some of the things that we're looking at there. On the internal basis, absolutely things that we're going to continue to invest in as we look to the long-term growth of the company. Obviously, when the top line is not growing and at the midpoint, it's flat year-over-year, that's tough, right? Because there are certain things you need to invest in and so forth. So right now, we've got a bunch of initiatives in place, a lot of things that we're looking at related to outside spend and things that we could do there through our procurement team as well as our team here and manage with our partners. So a lot of actions in flight that we're looking at to keep that manageable, if you will. So that's what I would tell you. Right now, that 14% of revenue is where it rolls up, but a lot of things in flight to mitigate such as we move through the year.

Trey Grooms, Analyst

Okay. Great. That's helpful. And then you mentioned just kind of geographically, if we could touch on that, strength in Florida, Infiltrator strong in Texas. Any other geographic puts and takes you could talk about as we look at your footprint?

Scott Barbour, President and CEO

So I think, Craig, you were pretty strong in the last year across all geographies. Both companies, both Infiltrator and ADS remain very focused with capacity and headcount, all those kind of things on the Southeast and the Atlantic Coast. And we haven't seen that slow down, Trey. I mean, those continue to be very, very good for us. Texas, we had a very good year with Infiltrator. These new tanks, I think, have done quite well there, and we've strengthened our distribution there. And we continue to believe Texas for the ADS side both pipe and Allied products to be a good opportunity for us to increase our market share and growth. It's not an easy market. It's competitive, but it continues to be a good one. Mike, can you think of any other geographies in particular? I mean, the core geographies have been going along at kind of a...

Michael Higgins, Vice President of Investor Relations and Corporate Strategy

Yes. I would say, Trey, Scott mentioned a handful of states, Florida, Texas, Carolinas, et cetera. We talk a lot about these priority states, and this was a year again where we saw it's a group of 15, 16 states, primarily concentrated in the lower half of the U.S. Again, we saw those states grow faster than the company average. And again, as we've told you guys many times, the states, we all know them, they're growing faster than the rest of the country. Our market shares are lower in those states. So they provide really good runway for growth, and they help offset some of the softness that we've seen in some of our other geographies that tend to be more mature like the Northeast, Ohio, some other places in the Midwest, et cetera. But it's that focus, a geographic focus on where those opportunities are, where we're really seeing kind of continued consistent strength despite end markets that were quite a bit softer this past year.

Operator, Operator

Your next question is from the line of Collin Merano with Deutsche Bank.

Collin Merano, Analyst

Good morning. Thank you for taking my question. I would like to explore the manufacturing and transportation aspects further. The first quarter showed favorable results for transportation in the fourth quarter. You mentioned that manufacturing is expected to become a challenge in the first quarter, while transportation is likely to remain positive through fiscal year 2026. Could you provide more insights on how we should view the trends in manufacturing and transportation?

Scott Barbour, President and CEO

Yes, Collin. This is Scott Barbour. Regarding logistics, we are implementing several strategies on the ADS side to reduce our mileage. This includes some planning techniques and approaches to market service that maintain our delivery performance. Additionally, Pat and Melissa are focusing on optimizing our asset mix internally and externally. There are numerous initiatives underway in logistics. We have also refreshed our fleet, significantly reducing its average age over the past 18 months, which will lower our repair and maintenance costs while improving our fuel efficiency. I believe this positive trend will continue throughout the year, reflecting the intentional strategies we've developed. In terms of manufacturing costs, we experienced benefits in the fourth quarter from improved efficiency and favorable absorption earlier in the calendar year. As you may recall, the absorption impacts our balance sheet and influences the P&L about three months later. Consequently, when we had to decrease volume starting in December and continuing through March due to solid inventories and delivery performance, we encountered some under-absorption, which is expected to affect us in the coming months. We are actively working to mitigate this under-absorption. The favorable absorption we saw earlier has shifted to unfavorable due to the timing of this under-absorption on the balance sheet. That said, our Infiltrator division is currently achieving excellent manufacturing costs in our pipe plants. The benefits of our investments, organizational developments, and actions taken from November through February will manifest later this year as those costs are reflected on our balance sheet. Overall, I believe we are on track with both our logistics and manufacturing costs.

Collin Merano, Analyst

Great. That's really encouraging commentary. And I guess just on the CapEx really quickly. You called out the step-up. Just given the step up, how are you guys thinking about free cash flow generation this year? And then how are you thinking about CapEx sort of in the medium term as you move beyond fiscal year 2026?

Scott Cottrill, CFO

Yes, we consistently evaluate cash flow from operations and aim for a minimum of 65%. We also monitor working capital as a percentage of sales, targeting 20% since our operation is build-to-stock. These are essential metrics we focus on to manage the business effectively. Currently, we aim for over 40% conversion of EBITDA to free cash flow. We plan to reinvest in the business as we believe it's the best and most rewarding use of our capital. We maintain these key performance indicators and benchmarks to ensure proper management. Thus, we are targeting over 40% of EBITDA for free cash flow and over 65% for cash flow from operations.

Scott Barbour, President and CEO

And I think you keep it in those guardrails and then we'll spend capital will be probably in this range $250 million, yes. We have some things coming up through the big year with a couple of big investments in facilities on the ADS side, there will be some investments in Infiltrator coming up. It will balance those as we go through the year, we push and take, but I was looking out three or five years.

Scott Cottrill, CFO

Yes. I think the other thing I would highlight there is the fact that to Scott's point, A big part of that $275 million is Infiltrator. So again, when you look at the margins and profitability of that business, where else would you rather have us put those funds to work. So that's really important. When you think of innovation in that engineering and technology center and those products, particularly in the Allied area that we see some of the early wins there as well out of the gate. There's some really exciting things to go in areas that are very profitable for the business, and that's how we're prioritizing. So it's not $275 million of CapEx, it's going to take five years for returns at a low margin, it's basically the other way around. It's spending in the areas that are high profitability and are going to add really greatly to that shareholder value over time.

Scott Barbour, President and CEO

We have addressed all the questions, and we thank everyone for participating in the call today. We will be in contact with many of you later today. This past year was filled with achievements, as I have mentioned, along with some frustrations and disappointments. However, we finished strong as we wrapped up the year. The team remained dedicated throughout. As we noted, we are on track with our guidance from April and May. We will keep moving forward and look forward to talking with all of you or seeing you soon. Thank you.

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.