Earnings Call: Q1 2022

Aug 5, 2021

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. At this time, all participants are in listen only mode. Later, we will conduct a question and answer 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 these names, 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 Various factors, including those discussed in our press release and the risk factors identified in our Form 10 ks 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 ks submitted to the SEC. We will make a replay of this conference All available via webcast on the company website. With that said, I'll turn the call over to Scott Barker. Thanks, Mike, and good morning, everyone. Thank you for joining us on today's call. We achieved a record $669,000,000 of sales in the 1st quarter, 32% growth over last year. Growth was split fairly evenly, weighted a little bit more to favorable pricing and volume growth. Demand remains strong at both ADS and 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 ABS and Infiltrators' scale position in Material Procurement and Recycling Operations, we procure material at the best possible cost and availability. Moving to profitability. Our adjusted EBITDA increased 4% on a dollar basis, 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 We hit the Gulf region in February of 2021. In the Q1, our material cost per pound increased significantly compared to the prior year. Additionally, in the Q2, 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 We continue to raise prices in line with these material increases as well as reprice quotes over 30 days old to ensure We are covering the sequentially higher costs. Material availability has improved since our last call. It It comes at a price, but we are doing what it takes to get 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 Q2 due to the COVID-nineteen pandemic, making the Q1 year over year comparison more pronounced than usual. Within transportation, there are 3 major factors driving additional costs. 1, we have a shortage of available drivers for our fleet requiring us to utilize more common carrier than normal to service our customers. Number 2, common carrier rates are up over 50% year on year. And number 3, we're removing more materials throughout the network to get it into the right location so we can meet customer demand. While 3 of our largest cost components, materials, labor and transportation have a lot of moving parts, We are responding with the following programs. To address the labor issues within manufacturing, we are focused on simplifying the manufacturing for new employees, including focusing production and decreasing SKUs, reducing changeovers and Deployed Centralized Scheduling Techniques. We have also consolidated inventory of some key products to fewer locations for vendor visibility Order Management, again, simplifying the task and providing better visibility. The management time is focused on a handful of locations where we have the most issues, Particularly with labor and capacity. We have created dedicated transportation lanes and 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 manufacturing and transportation labor hiring, which has improved both the applicant flow and the onboarding process. Where possible, we have 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 high production line this month in the Midwest to increase capacity and we have also made aggressive investments in the StormTech business to increase production capacity. We saw capital spending increase year over year in the Q1 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 1st 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 while we are very proud of the sales volume and pricing power, there are work items, particularly with labor and transportation, which we will have to grind through and continue to improve. While some of these work items are inflationary and potentially transitory, others are operational that need to be worked through systematically. In 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. Allocating that throughout our larger manufacturing network is our task now. The ABS 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 alike very quickly in May June. And given this environment, we expect our profitability going forward to look different quarter to quarter this year, more or less 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 Q1 fiscal 2022 financial performance. There are some key points that I want to hit on from 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 leaffield products. Consolidated adjusted EBITDA increased 4 point 5% to $167,000,000 resulting in an adjusted EBITDA margin of 24.9% in the quarter, down from 31.4% in the Q1 of fiscal 2021. Scott discussed in detail the actions we have taken around the largest drivers of the margin compression: Materials, labor and transportation inflation as well as 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 have issued 2 more price increases since the end of our fiscal Q1, 1 in July and another just last week. We will hit the full run rate of the announced price increases today and our fiscal Q3. From an SG and A perspective, the first quarter results contain approximately $2,000,000 of wages, travel, medical and other that were not incurred last year due to the COVID-nineteen pandemic. In addition, commission expense increased in line with the sales growth we experienced in the Q1 year over year. In summary, we have good line of sight to the costs 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 will play out as we move past this unique period of higher inflation. Moving to Slide 7. We generated $79,000,000 of free cash flow this quarter compared to $124,000,000 in the prior year, primarily driven by increased capital spending and working capital. The impact from working capital was primarily due to higher material costs moving through 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 $15,000,000 increase and capital expenditures we experienced in the Q1. For the full year, we continue to expect between $130,000,000 $150,000,000 in capital expenditures, our largest investments being to support future growth, followed by our productivity and automation initiatives. Further, as part of our disciplined capital deployment strategy, we repurchased 1,100,000 shares of our common stock for a total of $115,000,000 in the Q1, leaving $177,000,000 remaining under existing authorization as of June 30. Our trailing 12 month leverage ratio was 1.2x and we ended the quarter with $480,000,000 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 $2,500,000,000 to 2,600,000,000 dollars representing growth of 26% to 31% over the prior year. Our adjusted EBITDA This is unchanged at a range of $635,000,000 to $665,000,000 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 line. Your first question comes from the line of Michael Halloran with Baird. Good morning, everyone. Good morning. So let's start on demand side. Maybe just talk about sequential 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 So on visibilitysustainability on the demand side, certainly feels like you're very confident. Just like to hear A little more details on it. So good morning, Mike. This is Scott Barbour. And So 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 They were double digit. And if I don't hear our customers, Either at the distribution or contractor level talk about demand destruction. 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? A sense for where the how those pressure points lined out? Well, probably Scott Sienna, don't take this one. But the one that really came on hard and fast was the transportation. It was really kind of complicated to unwind as we got into mid June. Number 1, we're having to run more on common carrier fleet than our fleet than we've traditionally done, and that's because of a driver shortage versus our planet. And that shortage was driven by retirements, difficulty in hiring, I mean, all things that we got to go work on. That one and then the rate at which it costs us to get common carrier. And we have pretty good relationships and And contractual type of things with these folks, but it was just that that we came on hard. And then I don't know what happened in June in the country, but the movement of labor An ability to attract labor just really changed from, let's call it, April, May to June, July timeframe. 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. It's worth the price increase timing. Scott, you want to Scott has 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, staying in front of it, we've been again in the market with True 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 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 it's our line of sight and as we look forward through the year, That's why we are confident in getting that revenue guidance up to the level that we're talking to and staying in front Not just material costs, which again sequentially month over month continue to go up, but as well as these labor inefficiencies as well as transportation costs. And a lot of that we'll see coming in, in the second half. 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 3rd 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 could continue and that can make it more challenging to push it out. But And that's why when I think about a typical cadence to the year on margins, fiscal 1, Q2, Q3, your peak quarter's 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. Okay. All right. I'll leave it there and get back in queue. Thanks, guys. Thank you. Thanks, Glenn. Your next question comes from the line of Matthew Bouley with Barclays. Hey, good morning, everyone. Thanks for taking the questions. 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 2022? Thank you. So I did go through a kind of our focus list of operational things that we're working. And a lot of those are designed to 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 turnover 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 three kind of parts of our business, water in Canada and the agriculture region, 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 to 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 nonresident that are Turning underneath. A lot of transportation things, the move to another region where we're We've got a 3PL partnership for their retail deliveries 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 And snap my fingers, but it takes a lot of time to plan for past teams to kind of get those in 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, but 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 It's 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. This trucking and driver availability and all that, I don't think that's a totally short term issue. I think that one's going to We have to continue to work at this. 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 We were 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 Set 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 what you'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've 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? Thank you. So I think our FY 2018 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 me at that same time. I was kind of fighting to 1 front war In that one, 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'm 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. We'll have to balance that against some other things, Certainly, that's our go to. Yes. I would say it's not a question of holding on to margins, Matt, as you Fertilize it, it's more of the magnitude of the ability to expand margins in that scenario. In their 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 get some of it back. But from a margin Expansion perspective, the playbook, we know how to work that. We'll continue to do that. Got it. Great. Well, that's really helpful color, guys. Thank you and best of luck in the next quarter. Thanks. Thanks, Matt. Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Hey, good morning, guys. Hey, Josh. Good morning. So just on the markets themselves, because I think we could probably talk about inflation all day. 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 non resi 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 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. Like, 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 is really good territory for us, bounced back really quite strong. So I think we're up in every region. And the agriculture business also remains very strong. The only place that we can was the sales to the do it yourself kind Hi, Shannon, 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 pull forward To build these warehouses, we remain very bullish on residential. We had our Board of Directors at Infiltrator for the last 3 days 2 days, 2 and a half days. And that is going great, Gunz, 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 this Capital investment, these productivity initiatives are so important because everything we build right now, we can move out the door Quick. It goes on the truck. It goes on the truck. Got it. And then I guess just sort of related to that point, given that You guys are pretty busy, a little bottlenecked, 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 You've 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. You know, it's not pervasive in every territory or every contract or something like that, but definitely it's early times with lengthened more than we'd like. There's no doubt that if that gives us a chance for a concrete alternative in that, I don't think it's going to damage our share gains story long term, but you're correct. I mean, it's under A little stressed right now. But that said, we got to service our customers in the ones that have been loyal to us And that you're kind of that core customer base. So I think every one of our regional managers Yes. It has been I would say talk to us about I have an account I've been trying to gain for several years. This is the opportunity to do it. In some cases, we've had to take a pass 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, I'm afraid you see that, but Really good activity. We question whether there are enough contractors out there to install anything on order in the industry or with us In particular, but until we ship it, they can put it in. Got it. Appreciate all the color. Best of luck, guys. Thank you, Your next question comes from the line of Garik Shmois with Loop Capital. Hi, thanks for having me on. First off, just on the cost 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 to 2Q, are you anticipating to add the labor capacity costs for the rest of the year? Yes. I would hey, Gary, Scott here. I would say, basically our guidance assumes that the level The labor inefficiencies, transportation costs and headwinds, that they stay with us. So we've kind of assumed that that higher cost basis kind of 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 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 out of some labor, transportation, etcetera, and make sure that we can go get that value and that return. So it's all in. When we look at it for all of the remaining year in that light. Okay, got it. Just wanted to 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 Hey, Hugh. Rationalization, some of the transportation inflation. 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's timing issues. That's a good question. This is Scott B. And the pipe Part of our business is the most transportation intensive of all those product lines. 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 Weight drain issues, difficulty in getting labor, all these kinds of things, although that's been at all locations in front of us. But I don't think this is the case. We saw it first in pipe and it spreads to the others. That's not what's happened. You just what you're seeing in there is just the transportation intensity of that pipe manufacturing and that pipe network. Great. Thanks for that and best of luck. Okay. Thanks. Thanks, Gary. And your next question comes from the line of Michael Halloran with Baird. Hey, thanks for taking a couple more questions. So, bought some stock back on the quarter. Obviously the internal investment 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 and A? And then Also on the M and A side, just some thoughts of what the actionability in the pipeline looks like. So we've got a lot of capital ramping up and that remains our number one priority And because obviously we need that. We have a couple of actionable things we're working on right now In the M and A pipeline, they'll develop as they develop, but we love them both. There are Once we get through with 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 and A, What does the market look like at that point? How do you feel about to go forward? Is everything doing like we said we were going to get a dime? And we'll make another decision on that one. 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 capabilities of the company. So that's how we talk about it internally with the Board, Mike. Yes. And I think that point that Scott I 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 productivity and automation initiatives that we have. So a lot of that investment remains our number one, followed by M and A. And then to Scott's point, we'll decide 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. Good. That was the only one I had. Thank you. Appreciate it. Thanks, Mike. There are no further questions in queue at Time, presenters, are there any closing remarks? Thank you all very much for joining us today. We appreciate the quality of questions and insights that you all have in the company. We are clearly thrilled with the sales And the volume and the pricing side of it, we're operating very well in several parts. There's some other things we have 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.