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 session. To ask a question during the session, please press star one on your telephone. 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 will 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, 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 are covering 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 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 the 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 three major factors driving additional costs.
One, we have a shortage of available drivers for our fleet, requiring us to utilize more common carrier than normal to service our customers. Number two, common carrier rates are up over 50% year-on-year. Number three, we're moving more material throughout the network to get it into the right location so we can meet customer demand. While three 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 process for new employees, including focusing production and decreasing SKUs, reducing changeovers, and deploying centralized scheduling techniques. We have 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 have 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 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 pipe 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 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 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 items, 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 and 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. Propagating it 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. A 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 and June.
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 six, we present our first quarter fiscal 2022 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. 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've issued two 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 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 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 seven. 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 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 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 investments being to support future growth, followed by our productivity and automation initiatives. Further, as part of our disciplined capital deployment strategy, we repurchased 1.1 million shares of our common stock for a total of $115 million in the first quarter, leaving $177 million remaining under existing authorization as of June 30th. Our trailing 12-month leverage ratio was 1.2 x, and we ended the quarter with $480 million of liquidity.
Finally, on slide eight, 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-$2.6 billion, representing growth of 26%-31% over the prior year. Our adjusted EBITDA guidance is unchanged at a range of $635 million-$665 million, representing growth of 12%-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.
Ladies and gentlemen, at this time, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that is star one. We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Michael Halloran with Baird.
Good morning, everyone.
Good morning.
Let's start on the 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 on visibility/sustainability on the demand side. Certainly feels like you're very confident. Just like to hear a little more details on it.
Good morning, Mike. This is Scott Barbour. All of our segments are up. The retail is a little weaker. Our order rate in the core non-residential, residential, Infiltrator, agriculture businesses on a pound volume basis remains double digit. 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. We're pretty confident in that kind of rolling forward and being able to execute on this backlog.
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 materialized and 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 how those pressure points lined out?
Scott and probably Scott, seeing how loaded I take this in, 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 a driver shortage versus our plan. That shortage was driven by retirement, difficulty in hiring. I mean, all things that we got to go work on. I think that one, and then the rate at which it costs us to get common carrier. We have pretty good relationships and contractual type of things with these folks, but it was just that we came on hard.
I don't know what happens 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 to June, July time frame. 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's been working that very hard.
Yeah, I'd say for the quarter, Mike, it's basically one of those items that we stayed in front of it. Again, from an incremental margin perspective on that, obviously dilutive from a margin perspective, but again, from a dollar perspective, stayed in front of it. We've been, again, in the market with two price increases since the end of the quarter, as we mentioned.
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 quarters at least. That's why we're getting the pricing into the market.
Which has a lag effect.
Yes. As 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 of 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. A lot of that we'll see coming in in the second half.
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 could continue, and that could make it more challenging, push that out. Is that a fair way to think about it?
No, you got it. Spot on. That is the right way to think about it.
That's why when I think about a typical cadence of the year on margins, fiscal one, Q2, Q3 are 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.
Okay. All right. I'll leave it there and get back in queue. Thanks, guys.
Thank you.
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. 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 as, 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.
I did go through kind of our focused list of operational things that we're working. 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. The new hires do tend to turnover faster. That's all designed to kind of get throughput up, which will give us better productivity per labor hour. That's an important thing, mainly that additional capacity. I'd also add to that we've done this and we've exercised many of these techniques in those three kind of parts of our business, Florida, Canada, and the agriculture region, and they work very well.
Getting those replicated in our network is what we're really working on, particularly in a couple of places where we've got to 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 non-resident that are churning underneath. A lot of the transportation things, the move to another region where we're done a 3PL partnership for their retail deliveries and freed up fleet capacity for trade deliveries. We're now doing that in two 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, a lot of time to get those into place .
Those are all kind of permanent things, permanent improvements we can make. 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. 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 gonna be one we have to continue to work against. I hope that was helpful, a little color underneath those.
Yeah, very much. That is exactly what I was looking for and certainly understood what you are saying there around common carrier trucking and all that. 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 what you are saying around common carriers, that may take a little longer. If we ever get to materials at least flattening out or deflating, how you think about price in that scenario? You have 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? Thank you.
I think our FY 2018, the 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. My transportation and my labor moving on me at that same time, I was kind of fighting a one-front war in that one. We held on to that, and we largely built upon that over the last couple of years, last three 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. We'll have to balance that against our share gain activities. We'll have to balance that against some other things. Right. Certainly, that's our go-to.
Yeah. I would say it's not a question of holding on to margins, Matt, as you verbalize it. It's more of the magnitude of the ability to expand margins in that scenario.
Build our programs back.
Exactly. It's going to be all of the CI and lean initiatives that Scott went through, plus the pricing. Again, as you've said over the years, you know the playbook. This is unprecedented times and price increases.
We will get some of it back. From a margin expansion perspective, the playbook, we know how to work that.
Yeah. 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.
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, it's pretty much all we do all earnings season. 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 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?
Yeah. That is all intact. The crescent remains very strong. In addition, New England, the Northeast, the Northwest, which are really good territories for us, bounced back really quite strong. I think we're up in every region. The 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. We remain very bullish on the 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 two and a half days, and man, that is going great guns, as well as the pipe business that services the residential at ADS.
That horizontal construction that follows that residential remains strong. We're in a position now across our product lines where we build and ship. That's why this 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 on a truck.
Got it. 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. Is there anything in terms 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 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 times issue is definitely there. It's not pervasive in every territory or every contract or something like that, but definitely, our lead times have lengthened more than we like. There's no doubt that that gives a chance for a concrete alternative in that. I don't think it's going to damage our share gain story long term. You're correct. It's under a little stress right now. That said, we got to service our customers and the ones that have been loyal to us and that are kind of that core customer base. I think every one of our regional managers has been in, 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, 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. We're still seeing really strong demand. Yeah, on the fringe, you see that, but really good activity.
We question whether there are enough contractors out there to install everything on order in the industry.
Exactly
With us in particular, but I'm told we ship it, they can put it in.
Got it. Appreciate all the color. Best of luck, guys.
Thank you, Josh.
Ladies and gentlemen, again, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that is star one. We'll pause for a moment to compile the Q&A roster. Again, that is star one. 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? How should they end up pacing as the year progresses? Is this kind of isolated to 2Q, or are you anticipating to add the labor and capacity costs throughout the rest of the year?
Yeah. Hey, Garik. Scott here. I would say, basically, our guidance assumes that the level of the labor inefficiencies, transportation costs, and headwinds, that they stay with us. 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 two subsequent price increases afterwards. 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 and that return. It's all in when we look at it for all of the remaining year in that light.
Okay. Got it. 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. I think you've cited a couple of factors that may be specific to pipe. I just wanted to be clear on that, with respect to the SKU 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 they're a timing issue. That's a good question. This is Scott B. 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. That kind of makes sense to it. Those products saw rises in transportation costs, they were easier to kind of see and offset with the pricing. The pipe network is also spread out for that reason. The production tends to be a little bit more localized, you run into those localized wage grade issues, difficulty in getting labor, all these kind of things. Although that's been at all locations in the crisis.
I don't think this is a case of we saw it first in pipe and it spreads to the others. That's not what's happened. 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 the rest of the year.
Okay, thanks.
Thanks, Garik.
Your next question comes from the line of Michael Halloran with Baird.
Thanks for taking a couple more questions. 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. How are you guys thinking about balancing the external usage of capital at this point, buyback versus M&A? Also on the M&A side, just some thoughts of what the actionability in the pipeline looks like.
We've got a lot of capital raise it up , and that remains our number one priority, because obviously we need that. We have a couple actionable things we're working on right now in the M&A pipeline. They'll develop as they develop. We love them both. 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 the go forward? Is everything doing like we said we were going to get it done? We'll make another decision on that one. We felt 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 a reasonable timeframe, and we remain very confident in the cash-generating capabilities of the company.
That's how we talked about it internally with the Board, Mike.
Yeah. 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 and that order book and backlog that we have there. As well, those productivity and automation initiatives that we have. A lot of that investment remains our number pne, followed by M&A. 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.
Good.
That was the only one I had. Thank you. Appreciate it.
Thanks, Mike.
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, and we appreciate the quality of questions and insights that you all have in the company. We have 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. We'll continue to kind of work through those. A little bit different cadence and profitability this year versus last year. I think still building out the right place. 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.