Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems Second Quarter Fiscal 2022 Results Conference Call. My name is May, and I am your operator for today's call. [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. .

Thank you, and good morning, everyone. 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'll turn the call over to Scott Barbour. .

Thank you, Mike, and good morning. Thank you, everybody, for joining us on today's call. We achieved a record $706 million in sales in the second quarter, an increase of 30% compared to the same period last year. Sales growth was primarily driven by pricing at both ADS and Infiltrator across our geographies and our end markets. .

Our volume was down slightly in the second quarter, primarily due to the retail business within the ADS residential end market, which had a difficult comparison relative to last year when we experienced record shipping levels in the retail category at the height of the COVID-19 pandemic. .

Excluding retail, the ADS construction market sales volume was up slightly despite constraints within our manufacturing and transportation operations. Infiltrator sales increased 38%, primarily due to favorable pricing as well as a slight volume increase with strong growth in the Southeast and Southern regions of the United States. .

Additionally, international sales for the total company increased 29% this quarter with double-digit growth in our Canadian and Mexican businesses. Our backlog and pace of orders remained favorable as well as our ability to capture price in the market, which gives us confidence in the updated sales targets we issued today. .

The price increases we implemented in the second quarter will hit their full run rate in the fiscal third quarter, and we have obtained some additional pricing on certain products and in certain end markets to cover the continued inflationary cost pressures. .

Overall, the demand environment remains favorable, and our leading indicators point to continued strength as we work through the high levels of backlog in our order book.

From my perspective, we must continue to work down the backlogs in both ADS and Infiltrator, managed through the customary weather and seasonal impacts in the second half of the fiscal year and continue to leverage the self-help programs that are creating additional production capacity. .

In addition, we are focused on installing and ramping up new equipment coming online, which will add some production capability in the second half of the year and additional capacity as we enter fiscal 2023 this coming April. .

Moving to profitability. Our adjusted EBITDA decreased 5% this quarter. Favorable pricing issued over the past year covered inflationary cost pressure on materials and diesel. However, labor shortages in both manufacturing and transportation impacted our profitability.

This was particularly evident within our transportation business, where we had to ship more deliveries to third-party logistics services, a cost premium compared to our internal fleet. In addition, the year-over-year cost for third-party logistics services is up significantly. .

Within the manufacturing organization, we were unable to consistently operate all the production lines we wanted to run due to labor shortages.

Importantly, though, the programs we discussed on our last call around SKU reduction, process simplification, inventory consolidation and sourcing products from Mexico are working, resulting in improved daily production rates as we progress through the second fiscal quarter and into October. .

Availability of raw materials was more problematic in the first part of the quarter, but improved month-to-month. Material costs remained elevated. And then as expected, the second quarter had the largest gap between high material prices this year and historically low prices of last year. .

Importantly, we were able to maintain the amount of adjusted EBITDA generated at the Infiltrator business in the second quarter. Infiltrator products are primarily produced at a single manufacturing location and less transportation sensitive than the ADS products.

While Infiltrator face similar headwinds from labor and transportation, the impact on profitability was less pronounced. .

Overall, the first half of this fiscal year has largely played out as we expected. As discussed on our first quarter call, we're going to see the year-over-year improvement in adjusted EBITDA in the back half of this fiscal year.

We will realize the full run rate of price increases in the third quarter as well as the benefits from our self-help initiatives. Though this year has been challenging, we remain confident in our ability to identify and execute the right programs to expand our margins over time. .

Finally, our year-to-date capital spending more than doubled in the first half of this fiscal year. We are making investments to increase capacity with some having an impact in Q4 for Infiltrator and the ADS pipe manufacturing.

We started up our production line in the Midwest at the end of the first quarter to help increase capacity, and we also made investments in the Storm Tech business to increase production capacities and Infiltrator. .

New injection molding processes -- presses are starting up now with additional presses coming online in the fourth quarter to support the growing on-site septic business. These new investments also include automation that will help offset the impact from the labor shortages. .

Importantly, once our improved capital investments are up and running, we expect capacity will increase by double digit at both ADS and Infiltrator, which will allow us to continue to meet the robust demand environment through the back half of this fiscal year and beyond. All that said, core drivers of our business remain strong.

We will continue to systematically work our self-help programs, particularly on the labor and transportation, that improve both production and our service levels to customers. .

And as we move through this unique period with record demand, significant inflation labor challenges, we are confident with the programs we are working will benefit our business for many years to come. With that, I'll turn it over to Scott Cottrill to further discuss the financial results. .

Thanks, Scott. On Slide 5, we present our second quarter fiscal 2022 financial performance. From a top line perspective, we generated significant growth year-over-year, driven by both ADS and Infiltrator. .

Legacy ADS pipe products grew 31%, Allied Products sales grew 19% and Infiltrator sales increased 38%, with double-digit sales growth in both tanks and lease field products. We continue to demonstrate our pricing power with significant year-to-date price increases across each of our segments. .

As Scott mentioned, during the second quarter, Strength in our construction market sales partially were offset by constraints within manufacturing and transportation as well as weakness in our retail end market, which was impacted by tough comparisons year-over-year. .

Consolidated adjusted EBITDA decreased 5% to $165 million, resulting in an adjusted EBITDA margin of 23.3% in the quarter. We knew this quarter would be our most challenging from a year-over-year comp perspective, given the low input cost and high demand environment we experienced last year.

Importantly, we have good line of sight into the cost impacting our business and have taken actions to mitigate them in the back half of this year. These efforts have already contributed to margin improvement on a sequential basis throughout the second quarter. .

The long-term fundamentals of our business remain intact, and we are on track to hit the double-digit growth in our adjusted EBITDA guidance for the fiscal year. .

Moving to Slide 6. We generated $31 million of free cash flow year-to-date. In addition to the growth-oriented capital investments Scott outlined, working capital was a significant use of cash year-to-date as we purchased raw materials and built inventory at a much higher cost compared to last year in order to support the demand we are experiencing. .

We continue to make progress on our working capital initiatives, most recently working to extend our payment terms with some of our largest suppliers. As a percent of sales, working capital was 22% as compared to 20% in the same period last year.

From a capital deployment perspective, we remain committed to efficient and disciplined capital allocation to drive shareholder value. Our first priority for capital deployment remains investing organically in the growth of the business, as we view this as the highest return and lowest risk use of our available capital. .

To that end, we have spent more than 2x the amount as last year at this time, primarily on these type of growth initiatives. .

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

In addition, we continue to work an active M&A pipeline, focus on staying close to the core, including regional pipe capacity, Allied Products that fit our solutions package and recycling capacity to support the future growth of the business..

We are committed to a strong balance sheet, financial flexibility and returning excess cash to our shareholders, as demonstrated by the $312 million returned to shareholders year-to-date through share buybacks and dividends. We completed our share repurchase program in the second quarter, purchasing a total of 2.6 million shares year-to-date. .

Finally, our trailing 12-month leverage ratio was 1.7x, remaining below our targeted leverage of 2 to 3x that we've previously communicated. Finally, on Slide 7, we have updated our fiscal 2022 guidance.

Based on our performance and pricing actions taken to date, order activity, backlog and current market trends, we currently expect net sales to be in the range of $2.55 billion to $2.65 billion, representing growth of 29% to 34% over the prior year.

Our adjusted EBITDA guidance is unchanged at a range of $635 million to $665 million, representing growth of 12% to 17% over last year. .

The increase in our revenue guidance today is due primarily to the continued strength in orders in our backlog as well as the impact of favorable pricing that we've introduced to the market to date. With that, I'll open the call for questions. Operator, please open the line. .

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

So let's talk through the moving pieces as we go to the back half of the fiscal year for you. Obviously, the guidance implies above normal seasonal -- above normal seasonal ramp and the EBITDA levels as you move to the back half of the year.

I'm hoping we can just talk about the components behind that because it seems like it's a combination of capacity coming online, being able to loosen some of the labor shortages and the impacts and then also price cost and price timing. .

So maybe we could start on the capacity piece first. And just to understand what levers you guys have pulled and what this could mean for demand as we move to the back half or at least the ability to service the demand in the back half. And if that question needs to have the labor piece embedded in it, certainly understand. .

Okay. I think of it in 3 components. This is Scott Barbour, by the way. I think of it in 3 components, for that back half to come together, for our plan, and we have good line of sight on it. It's -- let's call it, price material, capacity, as you described and then volume, just release of orders to go through there.

Price material, I think we've worked very hard on in the front half of both companies and I think you can see in this debt kind of moving along very, very nicely and per plan. .

Capacity, I would say, has gotten better as we've gone through the months. There is a labor component to that. And we're working to mitigate that. It's not fully mitigated. But I think if it kind of stays the way it is right now, we can get through that.

And the machinery that is coming online that we mentioned in this, where decisions made as long as a year ago, and that stuff is hitting the floor and ramping up nice impacts on both companies, but a little ahead of Infiltrator than on the pipe side. So that's good because that Infiltrator is a very profitable company.

There is a very good shipping pace to that distribution. .

So that capacity piece in the regions Scott went through more on the capital being spent now does have a nice impact in the second half. And for the first time, we also kind of revealed that it gives us, once ramped up, kind of nice double-digit increases in our capacity going forward. .

We've never really talked about that very much, but we thought it was important to begin, now that we see it coming online, getting in there.

And then probably the one that I think about the most is the volume release, price in good shape, capital spending capacity, coming online nicely and then the volume piece, which could be a lot of things that can go on on that volume release. .

The orders are there, the backlog is there. But you got to get people to release it and take shipments of the sites, which can be driven by seasonality, other supply chain issues or labor issues that the contractor might have. So some bit out of our control, but we're working it very, very hard and closely. .

We feel pretty good at to make sure we get everything shipped we can. A lot of moving pieces in there, kind of a long answer, but I hope that that's where you were headed. .

Well, it was a long question, too... .

Your typical multi-tiered question. .

Well, to get as much as possible, I guess. So the price cost piece then, Scott mentioned that your margin levels got better through the quarter.

As we get to the back half here, do you think you're above the curve in the third quarter or the fourth which one when it comes to not just mitigating the diesel and the resin or commodity inflation like you did this quarter, but also maybe getting on top of the transportation piece and major pieces? Or does that take a little bit more time?.

It takes a little bit more time. But I think that sequential improvement we saw intra-quarter is something that we plan on. .

Obviously, you've got some seasonality impacts and leverage impacts as we go. But that pricing piece of this and getting to that run rate later in as we go through this third quarter, I think it becomes extremely leveraging. And when we get into that fourth quarter, you see kind of that nice margin improvement on a year-over-year basis as well.

So I would say it continues to get better as we march through the back half with kind of that inflection point on a year-over-year basis by Q4. .

So the gross price is good?.

Yes. The leverage on the SG&A piece, we're going to continue to get. It's just some of the gross profit piece subscribing it. .

So in other words, sequential improvement in the margins through the back half of the year despite what are the kind of the normal seasonal factors given all those things you mentioned.

Is that fair?.

Directionally, yes. .

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

So I'm going to ask kind of a multipart question as well. And you know what, that's the price you pay. So on the -- your kind of volume and price situation. Obviously, we can sort of see how chunky price is this year. Scott, you mentioned where you're adding in a little bit more as well.

If we just take some of the historical bouts of inflation as maybe a proxy for what happens as resin rolls over, and it looks like it's starting to, how much of that do you think you end up retaining?.

I mean, obviously, the margins of the company have come up a lot over the last kind of 4, 5 years is using inflation as sort of a price umbrella and then retaining some of that as cost normalized, an outsized piece of that, a smaller piece, like just maybe help dimension out that piece of it, because I think we all can appreciate that, like maybe freights elevated and for a longer period of time, labor's probably elevated forever.

But there are some pieces that could be a little bit more temporary. .

We would agree with you, exactly agree with you on that. And I think as we look forward, we would expect to replicate prior performance on retaining price. And we won't retain 100% of it.

There are some markets that are more competitive than the others, either by segment or by region, and we'll certainly continue to execute this conversion story and share gain story that we want to do. .

But we will, I think, retain a good piece of this price. I mean every -- all people running industrial companies right now are asking this question to themselves, Josh, is how much of this can I keep as we go forward. And we're trying to work all kinds of different parts of our value proposition to do that. .

And you've heard me talk about this in the past. It's not just the product, it's the service we provide and it's the transportation services we provide. It's all that we do to help people design projects and things like that. So we'll look at our whole value proposition and work that piece very, very hard to that price retention piece. .

Got it. That's helpful. And then maybe just sort of a follow-up to that. Obviously, you guys are providing more of a premium product on, say, like the pipe side. There's labor avoidance. There's other reasons why that's like a more desirable outcome.

What is sort of the price differential you had to guess, kind of across your markets versus reinforced concrete? Is it still a discount? Or are you starting to come in to lock that there?.

I'd say it's more in last step today than perhaps where we were historically, Josh. And we look at this very closely in particular markets where we want to protect our market share or gain market share.

There's other markets where we probably given a bit back on our conversion story, intentionally because we didn't have the capacity in that region to service it when it came up. As you know, and we've discussed, it's really been in an availability game here. .

I mean, in the industry for the last 8 months -- 6 to 8 months. But I would tell you that, that advantage has probably collapsed some because of our escalation in price. But I think we also know very cleverly where that is and how to make in-game adjustments if necessary. .

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

I wanted to ask just around the sales guidance increase and recognizing the balance of that is coming from pricing. But I'm just wondering if you may be able to provide a little bit more color as to where that's coming from? It seems like it's pretty broad-based.

But any more color by segment as to where you're getting the incremental price more successfully. .

Got it. I think that -- this is Scott Barbour. And a couple of things. The pricing is very broad-based, and Infiltrator products and in the ADS products, there's kind of no segment that is untouched by this. It has probably been a little more aggressive on what I would call products that we stock versus products that are project-based.

Those tend to be -- that's a very normal behavior for some of our stuff, we're competing on projects every day. You got to make sure you're competitive. Some stuff goes into stock, add a distribution. That tends to be not as every day competitive. It's got to be in line, but a little different. .

So I think that's how we've described that environment. The agriculture is always a little more competitive also than the commercial businesses. .

Mike, I mean, would you add anything to that or... .

Yes. I agree with Scott, Garik. This is Mike Higgins. When we look at our end markets, the pricing increase on a year-over-year basis is really pretty consistent. And that's a bit by design. It's how we price. As Scott said before, it's pretty consistent across the products, and that translates to pretty consistent pricing in the end markets. .

There's no one place that stands out. It's probably 80% of the price is, I think, the right -- is maybe what you were trying to get at there. .

And geographically, we're seeing the incremental pricing gains that we would want to see as well. So it's not like one part of the country carrying it versus another. .

Great. That is what I was looking for. I wanted to follow up with the issue of capacity and your capacity that's coming online. Is that requiring incremental labor? And maybe more broadly, you touched a little bit on looking to ramp up labor, just given the the headwinds in manufacturing on the transportation side.

Can you expand a little bit more on that? Where are you in the hiring process?.

It's a really -- that's a very good question and the one we work on a lot. So let's take it in 2 pieces. I would say is, the Infiltrator capacity comes online, those are pretty automated manufacturing cells. So the labor that comes online there is pretty small. .

It's 10 people, 6 people, to ramp up a whole bunch of capacity. And then on site, in Kentucky, they're doing all kinds of other projects of automation, the freezed up labor and kind of net-net, you don't see big increases in headcount as they add what are very nice chunks of incremental capacity. .

In the pipe making business, we are trying to do a very similar thing. So the projects that Scott and I have been looking at and approving, that our Board has approved, come in installed with less heads needed than prior investments that would have been made.

So again, we're trying to replicate in the pipe business what the Infiltrator guys have done for many, many years is that each incremental capacity needs less incremental heads. .

So again, it's going to be in kind of the 10s and 20s type of people, which is not easy to go and get. But we also are doing a much better job on the pipe side of incremental ties on activities that are freeing up headcount. So worried about it, yes.

Made additional incremental capital to do automation and better material handling to try to minimize the impact of additional heads and recognizing the environment that we're in today and likely will be in for a while in terms of labor availability. .

There are no further audio questions at this time. Please continue. .

All right. Good questions, and we appreciate it today. When we were talking to you 90 days ago, we knew this was going to be a tough -- our toughest quarter. We had a lot of things in flight. We've made a lot of progress over those 90 days. .

I'd tell you, Scott and I believe, we ended up just a little bit better than we thought where we were going to for the quarter as a result of many of those initiatives, particularly in the operations and the logistics pieces.

People are working hard, really very, very hard here to service customers to get capacity up so that we can take advantage of this nice market that we have. .

Not lost on us that we're spending capital and need to do that well. We've done the buyback and done a lot of cash out the door here in the last quarter. But all things that we planned to do and including rebuilding of the balance sheet with some inventory. .

So lots of moving pieces, but playing out like we thought it would. We had a good meeting with our Board over the last several days. Tremendous support for them in the programs that we're running, both at Infiltrator and ADS. .

So we're -- we think we have really good alignment in the company right now and the task ahead of us for the remainder of this year and for the next couple of years, which we're pretty enthused about. So we appreciate your participation today and look forward to catching up with you all over the course of today and the next couple of weeks. Thanks. .

This concludes today's conference call. Thank you for participating. You may now disconnect..