Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems' First Quarter Fiscal Year 2022 Financial Earnings Results Conference Call. My name is Tiffany, and I am your operator for today's call. [Operator Instructions].

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. .

Good morning. 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 said, I'll turn the call over to Scott Barbour. .

Thanks, Mike, and good morning, everyone. Thank you for joining us on today's call. We achieved a record $669 million of sales in the first quarter, 32% growth over last year. Growth was split fairly evenly, weighted a little bit more to favorable pricing than volume growth. .

Demand remained strong at both ADS and in Infiltrator throughout our end markets and geographic footprint. In addition, international sales increased 82% this quarter with growth in our Canadian, Mexican and exports businesses. .

Our backlog and pace of orders remain favorable as well as our ability to capture price in the market, giving us confidence in the updated sales targets we issued today. .

We have issued several price increases since late last year to cover inflationary cost pressure, and we'll continue to use our leading market position in that respect as well as ADS and Infiltrator's scale position in material procurement and recycling operations to procure material at the best possible cost and availability. .

Moving to profitability. Our adjusted EBITDA increased 4% on a dollar basis given -- again, driven by the favorable pricing and strong volume growth. The price increases we issued over the last 10 months largely covered the inflationary pressure on materials and diesel.

There are additional headwinds related to driver availability, an increase in the use of common carrier and an increase in common carrier rates that we are working to offset. .

We remain confident in our ability to identify and execute the right mitigation programs and expand our margins over time. Material prices started to rise in October 2020, increasing more significantly as a result of the winter storms that hit the Gulf region in February of 2021. .

In the first quarter, our material cost per pound increased significantly compared to the prior year. Additionally, in the second quarter, we will experience the largest gap between historically high material prices this year and historically low material prices of last year. .

The price increases we pushed into the market are largely covering material, and we continue to raise prices in line with these material increases as well as reprice quotes over 30 days old to ensure we're recovering the sequentially higher cost. .

Material availability has improved since our last call. It comes at a price, but we are doing what it takes to give materials out to our facilities so we can support customer needs, including incurring additional transportation costs and shuffling production scheduling more than we have in the past. .

We remain committed to meeting our customers' demand and have efforts underway to ensure we continue to do so. Across the market, attracting and retaining manufacturing labor and drivers is difficult right now. We've had to increase the pay rate in many locations to help mitigate this issue, both starting pay as well as raises for current employees.

In addition, last year, we delayed all manufacturing merit increases until the second quarter due to the COVID-19 pandemic, making the first quarter year-over-year comparison more pronounced than usual. .

Within transportation, there are 3 major factors driving additional costs. One, we have a shortage of available drivers for our fleet, requiring us to utilize more common carriers than normal to service our customers. .

Number two, common carrier rates are up over 50% year-on-year. And number three, we're moving more material throughout the network to get it into the right locations so we can meet customer demand. .

While 3 of our largest cost components, materials, labor and transportation, have a lot of moving parts, we're responding with the following programs.

To address the labor issues within manufacturing, we are focused on simplifying the manufacturing process for new employees, including focusing production and decreasing SKUs, reducing changeovers and deploy centralized scheduling techniques. .

We've also consolidated inventory of some key products to fewer locations for better visibility and order management, again, simplifying the task and providing better visibility. .

Management time is focused on a handful of locations where we have the most issues, particularly with labor and capacity. We've created dedicated transportation lanes and are deploying route planning techniques to help with the transportation labor shortage.

As well, we've expanded the use of 3PL partnerships for retail to an additional region which freed up ADS fleet capacity for trade deliveries. .

More broadly, on labor, we have added recruiting process outsourcing partnerships for our manufactured and transportation labor hiring, which has improved both the applicant flow and the onboarding process. Where possible, we've increased pipe imports from our Mexican and Canadian operations to further supplement supply and availability in the U.S. .

Finally, we are making capital investments to increase capacity with some having an impact in Q4 for Infiltrator and the ADS pipe manufacturing. We started up a pipe production line this month in the Midwest to increase capacity, and we've also made aggressive investments in the strong tech business to increase production capacity.

We saw capital spending increasing year-over-year in the first quarter, and this will continue as we invest in the long-term potential of both businesses. .

All that said, the momentum underpinning the core drivers of our business remains strong. Infiltrator maintained the high levels of profitability in the first quarter, despite similar challenges around materials, labor and transportation. .

The international businesses also performed very well with double-digit revenue and EBITDA growth in each of those businesses.

The domestic pipe business is large and complex, and while we are very proud of the sales volume and pricing power, there are work guidance, particularly with labor and transportation, which we'll have to grind through and continue to improve. .

While some of these work items are inflationary and potentially transitory, others are operational that needs to be worked through systematically. And the areas where we started implementing programs using these techniques, namely the agriculture business, Canada and Florida, we've seen positive results over the years. .

However, throughout our larger manufacturing network is our task now. The ADS legacy and Infiltrator businesses combined to have their best sales quarter in our history. The combination of the highest demand we've seen in our history across all regions simultaneously, in an environment with labor and driver shortages and rapid inflation. .

This all came on us and our industry like very quickly in May and June. And given this environment, we expect our profitability going forward to look different quarter-to-quarter this year, more like the seasonality in fiscal 2018 when we made the majority of our profitability dollar growth in the back half of the year. .

With that, I'll turn the call over to Scott Cottrill to further discuss our financial results. .

Thanks, Scott. On Slide 6, we present our first quarter fiscal 2020 financial performance. There are some key points that I want to hit on from a results perspective. Obviously, from a top line perspective, we had significant growth year-over-year, driven by both pricing and volume. .

Legacy ADS pipe products grew 42% and Allied Products sales grew 13%. Infiltrator sales increased 24% with double-digit sales growth in both tanks and leach field products. Consolidated adjusted EBITDA increased 4.5% to $167 million resulting in an adjusted EBITDA margin of 24.9% in the quarter, down from 31.4% in the first quarter of fiscal 2021. .

materials, labor and transportation inflation as well as the labor availability. Material costs are at the highest levels in recent memory and have continued to increase sequentially month-to-month throughout this year. .

We've issued 2 more price increases since the end of our fiscal first quarter, one in July and another just last week. We will hit the full run rate of the announced price increases that today in our fiscal third quarter. .

From an SG&A perspective, the first quarter results contain approximately $2 million of wages, travel, medical and other expenses that were not incurred last year due to the COVID-19 pandemic. In addition, commission expense increased in line with the sales growth we experienced in the first quarter year-over-year. .

In summary, we have good line of sight to the cost impacting us and have actions in place to offset such as we move through the year. Based on the timing of these actions, we expect to see most of this improvement in the second half of our fiscal year.

The long-term fundamentals of the business are still intact, and we will play out -- and will play out as we move past this unique period of higher inflation. .

Moving to Slide 7. We generated $79 million of free cash flow this quarter compared to $124 million in the prior year, primarily driven by increased capital spending and working capital. The impact from working capital was primarily due to the higher material costs moving to the balance sheet as compared to the year ago period.

We continue to make progress on our working capital initiatives. And during the quarter, working capital decreased to approximately 19% of sales, down from 21% of sales last year. .

Our first priority for capital deployment remains investing organically in the growth of the business, as demonstrated by the $15 million increase in capital expenditures we experienced in the first quarter. .

For the full year, we continue to expect between $130 million and $150 million in capital expenditures, our largest investment being to support future growth, followed by our productivity and automation initiatives. .

Further, as part of our disciplined capital deployment strategy, we repurchased 1.1 million shares of our common stock for a total of $115 million in the first quarter, leaving $177 million remaining under our existing authorization as of June 30. .

Our trailing 12-month leverage ratio was 1.2x, and we ended the quarter with $480 million of liquidity. Finally, on Slide 8, we have updated our fiscal 2022 guidance.

Based on our performance to date, pricing actions taken, order activity, backlog and current market trends, we currently expect net sales to be in the range of $2.5 billion to $2.6 billion, representing growth of 26% to 31% 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 is due primarily to pricing that we've introduced into the market to date to offset the additional inflationary cost pressures we've discussed on the call today. .

With that, I'll open the call for questions. Operator, please open the lines. .

[Operator Instructions] Your first question comes from the line of Michael Halloran with Baird. .

So let's start on the demand side. Maybe just talk about sequentials through the quarter, what that visibility looks like moving forward across the various industries you serve? And what your client base is saying? And any kind of thoughts on visibility/sustainability on the demand side? It certainly feels like you're very confident.

I'd just like to hear a little more detail on it. .

Mike, this is Scott Barbour. And all of our segments are up. The retail is a little weaker, but our order rate in the core nonresidential, residential, Infiltrator agriculture businesses on a pound volume basis remains double digit. .

And it's -- I don't hear our customers, either the distribution or contractor level, talk about demand disruption. What they talk about is availability of product. So we're pretty confident in that kind of rolling forward and being able to execute on this backlog. .

And then let's talk on the flip side of the coin then. Obviously, the leverage was a challenge in the quarter.

Could you try to bucket out for us how much of this was just the price cost lag that's materializing given the rapid inflation? How much is all the network repositioning that you need to do to make sure you're meeting the customer demand? How much is the transportation piece? Could you just give us some directional sense for where the -- how those pressure points lined out?.

Well, maybe, probably Scott, see how well you can take this one, but the one that really came on hard and fast was the transportation. And it was really kind of complicated to unwind as we got into May and June.

Number one, we're having to run more on common carrier fleet than our fleet than we've traditionally done, and that's because of the driver shortage versus our plan. .

And that shortage was driven by retirements, difficulty in hiring. I mean all things that we got to go work on, right, that one and then the rate at which it costs us to get a common carrier. And we have pretty good relationships and contractual type of things with these folks. But it was just a -- that we came on hard. .

And then I don't know what happened in June in the country, but the movement of labor and ability to attract labor just really changed from, let's call it, that April, May into June, July time frame. And we've done things. It's gotten a little bit better here recently, but it was a big digestion that came on us there in that period of time. .

As far as the price increase timing, Scott, do you want -- Scott's been working that very hard. .

Yes, I think for the quarter, Mike, it's basically one of those items that we stayed in front of it. But again, from an incremental margin perspective on that, obviously dilutive from a margin perspective. But again, from a dollar perspective, stayed in front of us. .

We've been, again, in the market with 2 price increases since the end of the quarter, as we mentioned. So yes, we got the labor issue on both the manufacturing and transportation side of the house. We've got the common carrier usage and common carrier rates. That's all still coming at us as we go through the next couple of quarters at least.

And that's why we're getting the pricing into the market. So... .

Which has a lag effect. .

Yes.

So out line of sight as we look forward through the year, that's why we're confident in getting that revenue guidance up to the level that we're talking to and staying in front of not just material cost, which again sequentially month over month continues to go up, but as well as the labor inefficiencies as well as transportation cost and a lot of that we'll see coming in, in the second half.

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So to be clear here, then the price increases that you're putting through in the marketplace are designed to cover all of these inflationary pressures you just suggested.

And that's why when you hit the third quarter -- fiscal third quarter, plus or minus, you should start seeing a lot more favorability in terms of the cumulative price cost metrics and what those margin metrics might look like just as the catch-up starts materializing based on what we know right now.

Obviously, inflation can continue and that can make it more challenging to push that out. But is that a fair way to... .

You got it spot on. That is the right way to think about it. .

And that's why when I think about a typical cadence to the year-end margins, fiscal 1Q, 2Q, your peak quarters revenue tends to fade a little bit.

That's why we might see a different relative margin cadence through the year than we might normally see?.

Absolutely. Correct. .

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

Following up on the last one because it sounds like the price expectation is there in terms of covering these cost issues. But Scott B, at the top, you mentioned a few sort of operational changes you're making beyond price.

I'm curious if you could maybe expand on that a little bit? And kind of what you see is -- I don't know if you can quantify anything, but anything around the ability for some of these operational changes you're making to offset the cost issues as well and kind of what might be the lasting impact of some of those changes as we think about '22?.

So I did go through kind of our focus list of operational things that we're working.

And A lot of those are designed and try to make it simpler, reduce SKUs, reduce changeovers even more than we already have, to increase throughput, make it easier as we go through a pretty significant hiring and some turnover that the new hires do tend to turn over faster. .

And so that's all designed to kind of get throughput up, which will give us better productivity per labor hour. And that's an important thing, mainly that additional capacity.

I'd also add to that, that we've done this, and we've exercised many of these techniques in those 3 kind of parts of our business, one in Canada in the agriculture region, and they work very well. .

And getting those replicated in our network is what we're really working on, particularly in a couple of places where we've got kind of get focused. Those are lasting initiatives, Matthew, I mean, those things will be there forever as well as many of the other kind of procurement activities that we do in nonresi and churning underneath. .

A lot of the transportation things the move to another region where we've done a 3PL partnership for their retail delivery and freed up fleet capacity for trade deliveries, we're now doing that in 2 regions very successfully, again, lasting impact, replicate that in other regions as we go through. .

I wish we could do it all at once. It's not like [ fingers ], but it takes a lot of time and planning for team to kind of get those into place. So those are all kind of permanent things, permanent improvements we can make. Now, we'll have to use those to offset the wage increases that we've seen beyond the normal in the future. .

I don't think that's a transitory type of thing. I think the material will flatten out and go back down, but the timing of that is very unknown to us or anyone, I think. So those might -- that one might be a bit more transitory as the common carrier rate piece. .

But this trucking and driver availability and all that, I don't think that's a totally short-term issue. I think that one is going to be when we have to continue to work against. So I hope that was helpful a little color underneath those. .

Yes, very much. That's exactly what I was looking for. And certainly understood around what you're saying there around common carriers and trucking and all that.

So if I think back a few years when -- after the, for example, the hurricanes in Texas and you saw a big spike in materials in the subsequent months, and you guys were able to largely offset that with price. .

If you can kind of educate us on some of the history? In this scenario, if we ever get to the other side of all this, and again, I hear we're saying around common carriers that, that may take a little longer.

But if we ever get the materials at least flattening out or deflating, how you think about price in that scenario? You've taken multiple price increases and you got more to come.

To what degree are you able to kind of hold on to margin in a scenario where you eventually get deflation?.

So look -- I think FY '18 and fall of 2017, hurricane hits, we get pricing up, very impactful in our second half, and we had a very good second half, made the year. I think a little different. I didn't have my transportation and my labor moving on that same time out. It was kind of fighting at one front war in that one. .

And we held on to that and we largely built upon that over the last couple of years -- last 3 years, I'd say very successfully. We're doing some models on the impact of if we can hold on to 90% of that, 80% of that, 70% of that. .

I don't think we're going to be able to hold on to all of it as successfully as we did in the past. But I like our chances of holding on to the vast majority of it as we go forward. .

Now, we'll have to balance that against our share gain activities, plus balance that against some other things. But certainly, that's our go to. .

Yes. I would say it's not a question of holding on to margins, Matt, as you verbalized it, it's more of the magnitude of the ability to expand margins in that scenario. So... .

Build our programs back. .

Exactly. So I mean it's going to be in all of the CI and lean initiatives that Scott went through plus the pricing. And then again, as you've said over the years, you know the playbook. But this is unprecedented times and price increases, we will give some of it back. But from a margin expansion perspective, the playbook, yes, we know how to work that. .

Yes, we'll continue to do that. .

Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley. .

So just on the markets themselves because I think we could probably talk about inflation all day and it feels like from maybe some of your peers out there, pretty much all we do all earnings season.

But the -- Scott, if I go back to last year, you guys held up a lot better than kind of the rest of the nonresi-facing market with the share gains, the kind of bias to the crescent more horizontal construction. I think we're seeing the broader market kind of bounce back a little bit more.

Is that something you guys are seeing? Is there any kind of lapping effect of maybe some of those areas of strength from last year like warehouse and data center that are kind of moderating the volume growth, can you just sort of contextualize how your markets are sort of bouncing back maybe relative to the census data?.

Yes. So that is all intact. I mean the crescent remains very strong. In addition, New England, the Northeast, the Northwest, which are really good territory for us bounced back really quite strong. So I think we're up in every region. .

And agriculture business also remains very strong. The only place that weakened was the sales to the do-it-yourself kind of channel, which is understandable given how much it was up last year and we were glad to have it last year. .

So we remain very bullish on that warehouse. You guys see the data just like we do, tremendous construction, pulled forward to build these warehouses. We remain very bullish on residential. We had our Board of Directors at Infiltrator for the last 2 days, 2.5 days.

And that is going great guns as well as the pipe business, the services, the residential at ADS, that horizontal construction that follows that residential remains strong. .

And we're in a position now across our product lines where we build and ship. And so that's why there's capital investment. These productivity initiatives are so important because everything we build right now, we can't move out the door quick... .

It goes on a truck. .

It goes a truck. .

Got it.

And then I guess just sort of related to that point, given that you guys are pretty busy little bottlenecks, presumably with kind of the more concrete-based alternatives out there, I would imagine that capacity is sort of a little bit more fungible or maybe flexible, like is there anything in terms of kind of that share gain or selling in the story to the right folks that has gotten delayed at all as a function of, "Hey, we're just -- we're too busy as the contractors," or "Hey, you guys have longer than normal lead times" that is sort of throwing that off a little bit here in the short term?.

I think the lead time issue is definitely there. It's not pervasive in every territory or every contract or something like that. But definitely, is only times it lengthen more than we'd like. There's no doubt that, that gives us a chance for a concrete alternative in that. .

I don't think it's going to damage our share gain story long term. But you're correct, I mean it's under a little stress right now. But that said, we got to service our customers in the ones that have been loyal to us and that they're kind of that core customer base. .

So I think every one of our regional managers has been, I would say, talk to us about, "I have an account that I've been trying to gain for several years, this is the opportunity to do it?" In some cases, we've had to pick the past and that hurts no doubt. But fundamentally, it's not going to damage our story, I don't believe. .

When you look at the -- Josh, when you look at the strength of the order book and the order activity that we've seen as well, the quoting, the coming through our digital design tools. And to Scott's point, the lead times are going out. So we're still seeing really, really strong demand. And yes, on the [ fringe ], you see that. But really good activity.

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We question whether there are enough contractors out there to install everything on order in the industry. .

Exactly. .

Or with us, in particular, but until we ship it, they can put it. .

[Operator Instructions] Your next question comes from the line of Garik Shmois with Loop Capital. .

First off, just on the costs that you're adding with respect to labor and capacity, I guess, just to be clear, are these costs contemplated in your guidance? And how should they end up pacing as the year progresses? Is this kind of isolated it's 2Q or you anticipating to add the labor capacity cost for the balance of the year?.

Yes. Garik, Scott here. I would say, basically, our guidance assumes that the level of the labor, inefficiencies, transportation costs and headwinds they stay with us. So we've kind of assumed that, that higher cost bases kind is with us for a while.

And hence, the need, desire and actions we took related to pricing, both at the end of our fiscal Q1 as well as the 2 subsequent pricing increases afterwards. .

So again, when we look at pricing, absolutely material costs are one of the first things we look at, but it's the value proposition, it's what's coming at us on labor, transportation, et cetera, and make sure that we can go get that value in that return/so it's all in. When we look at it further for all of the remaining year in that line. .

Okay. Got it. And then just wanted to drill down by segment a little bit more. Obviously, it looks like the margin pressure in the quarter was the most pronounced in pipe. Some of the other businesses actually held in reasonably well compared to last year. So I think you cited a couple of factors that may be specific to pipe.

I just wanted to be clear on that with respect to the rationalization, some of the transportation inflation. .

I just want to be clear that those headwinds are more specific to pipe? Or should we anticipate that maybe some of the margin headwinds that hit pipe are just coming for some of the other divisions.

It's just a timing issue?.

I don't think there are timing issues. That's a good question, so it's Scott B. And the pipe part of our business is the most transportation-intensive of all those product lines. If you think about it, you ship a lot of [ air ]. There's less dollars per load than on an Infiltrator product or an allied product. So that kind of makes sense to it. .

Those products saw rises in transportation costs, but they were easier to kind of see and offset with the pricing. And the pipe network is also spread out for that reason. The production tends to be a little bit more localized.

So you run into those localized wage rate issues, difficulty getting labor, all these kinds of things, although that's been at all locations [indiscernible]. .

But I don't think this is a case -- we saw first in pipe and it spreads to the others, that's not what's happening. You just -- what you're seeing in there is just the transportation intensity of that pipe manufacturing in that pipe network. .

And your next question comes from the line of Michael Halloran with Baird. .

So I bought some stock back on the quarter. Obviously, the internal investment side is priority one and ramping CapEx, trying to manage the network appropriately. And I certainly understand that.

But how are you guys thinking about balancing the external usage of capital at this point, buyback versus M&A? And then, also on the M&A side, just some thoughts of what the actionability in the pipeline looks like?.

So we've got a lot of capital [ raise it up ] and that remains our #1 priority and -- because obviously, we need that. We have a couple of actionable things we're working on right now in the M&A pipeline. They'll develop as they develop, but we love them both. .

There are -- once we get through this tranche, we'll go back and have another discussion on the share buyback with our Board of Directors, and we'll make an assessment kind of the organic M&A, what does the market look like at that point? How do we feel about to go forward? Is everything doing like we said we were going to get it done? And we'll make another decision on that one.

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But we felt that the buyback was a good use of cash because it was kind of building up on our balance sheet. We had plenty of liquidity to do anything we saw in the reasonable timeframe, and we remain very confident in the cash-generating capabilities of the company. So that's how we talked about it internally with the Board, Mike. .

And I think that point that Scott hit on during the opening comments, we're still making a lot of investments from a capital expenditure, organic investment, if you will, perspective, to stay in front of that great growth in that order book and backlog that we have there. But as well as those productivity and automation initiatives that we have. .

So a lot of that investment remains our #1 followed by M&A. And then to Scott's point, we'll decide on the kind of distribution side of that part as to what our opportunities look like and what our forecast looks like as we move forward. .

There are no further questions in queue at this time.

Presenters, are there any closing remarks?.

Thank you all very much for joining us today. We appreciate the quality of your questions and insights that you all have in the company. We have -- clearly, thrilled with the sales and the volume and the [ question ] side of it. We're operating very well in several parts. There are some other things we had to go work on, but that's what we do.

And we'll continue to kind of work through those a little bit different cadence and profitability this year versus last year, but I think still building on the right place. So we appreciate it and look forward to speaking with you all again soon. .

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now disconnect..