Advanced Drainage Systems, Inc. (NYSE:WMS) Q2 2024 Earnings Call Transcript

Advanced Drainage Systems, Inc. (NYSE:WMS) Q2 2024 Earnings Call Transcript November 3, 2023

Operator: Good morning, ladies and gentlemen and welcome to Advanced Drainage Systems Second Quarter of Fiscal Year 2024 Results Conference Call. My name is Christina and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Thank you. 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.

Mike Higgins: Good morning, everyone. Thanks for joining us. Here 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, 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. I’ll now turn the call over to Scott Barbour.

Scott Barbour: Thank you, Mike and good morning, everyone. Thank you all for joining us on today’s call. As a pure-play water company focused on stormwater in the legacy ADS business and on-site septic wastewater, Infiltrator, we play a crucial role in developing sustainable water management solutions to protect and manage water, the world’s most precious resource, safeguarding our environment and communities. Over the last several years, we have been experiencing a secular trend whereby large scale, water-related climate events are increasing in frequency, duration and intensity. What was once a 100-year storm event is now happening far more often. In the second quarter alone, we saw severe storms and flooding impact the eastern half of the United States, as well as a hurricane in the Southeast.

These severe water events caused billions of dollars in physical damage and asset destruction while also displacing people and disrupting businesses, degrading quality of life in communities. Stormwater infrastructure in the United States is often inadequate to accommodate such large quantities of water in very short time periods, which poses a critical challenge as these events become more common. At ADS, we engineer solutions to mitigate the impact of these water-related climate events for the millions of people affected, building resilient communities in the face of changing weather patterns, whether it be flood mitigation, nitrogen removal, water quality improvement or water conservation, we remain focused on the ADS brand promise. Our region is water, by providing clean management – water management solutions to communities and delivering unparalleled service to customers.

The secular trend of larger and more frequent water events, combined with the success of our conversion strategy, gives us confidence in the future of ADS and the investments we are making in the business to drive growth and profitability over the long-term. This morning, we announced the construction of a new manufacturing facility in Lake Wales, Florida, which will break ground in 2024. Florida is the second largest state for overall construction spending and remains a priority state for the company, built on a 100-acre plot of land, this new state-of-the-art facility is designed for the future workforce, promoting safety, efficient flow of materials and traffic and incorporating the most advanced automation technology for manufacturing corrugated thermoplastic pipe.

This facility will complement the two existing manufacturing facilities we have located in Winter Garden and Sebring, helping the company to meet current and future customer demand and giving us the flexibility to expand as we continue to penetrate this market through our conversion strategy and superior go-to-market execution. Since the Florida DOT approved the use of corrugated thermoplastic pipe for stormwater in 2014, we have executed well on conversion and growth, increasing the ADS pipe sales in the state by over 6x. The Lake Wales investment will help us further penetrate the attractive Florida market as well as open capacity in the Southeastern United States, where there are large and attractive markets like Georgia, the Carolinas and Virginia.

This Florida playbook is also the foundation for our conversion strategy in Texas, where we intend to capitalize on the November 2022 Texas DOT approval of corrugated thermoplastic pipe for use in infrastructure projects, accelerating the growth in this important market. Similar to Florida, the public approval in Texas comes on the back of an already strong business foundation and we expect this to serve as a force multiplier for conversion and growth over time. We are also investing in an engineering and technology center in Hilliard, Ohio, which will be the world’s most advanced stormwater engineering, research and development facility. Construction is well underway and remains on track for completion in 2024. This facility will bring product design, material science and manufacturing technology under one roof, which will increase our pace of innovation and importantly, help us incorporate more recycled material into our products.

This facility plays a key role in enabling ADS to meet our goal to consume 1 billion pounds of recycled material annually by fiscal 2032. In September, we issued the fiscal 2023 sustainability report and I encourage you to go to our website to read it. There’s a lot of important information in this report on the progress we have made on the sustainability front. This report also aligns to the United Nations’ Sustainable Development Goals, as ADS became a signatory to the UN Global Compact in August. Now moving to the second quarter results. We saw better-than-expected performance in the Infiltrator business and Allied Products portfolio continue in the second quarter. Despite domestic demand headwinds from higher interest rates, credit tightening and economic uncertainty, demand and pricing for the ADS pipe portfolio continued to perform in line with expectations.

While non-residential and residential market weakness continued in the second quarter, infrastructure activity remained consistent overall. And we are starting to see pickup on locally funded projects such as those at the municipal and county level as well in airport activity. From a margin perspective, we once again demonstrated the resilience of the business model through the 180-basis point expansion in adjusted EBITDA margin to 31.6%, despite a lower demand environment. This marks the seventh quarter in a row of year-over-year margin expansion. The margin performance this quarter reflected – benefited from sales mix and previous investments in the business including automation, more efficient production lines and tooling, effective management of price/cost and continuous improvement within the operations.

Transportation costs are trending favorably but the slow demand environment is resulting in higher manufacturing cost driven by under absorption of fixed costs as well as an increase in manufacturing engineering personnel that execute the capital investments. This morning, we updated our guidance to reflect the better-than-expected demand in margin performance in the Infiltrator business and Allied Products portfolio in the first half of the year. Demand and price for the pipe business remained unchanged from previous guidance and we expect demand in the second half of the year to remain consistent with the plan we laid out in May. We will continue to pursue growth opportunities through new products, attractive markets and partnerships, building out our portfolio and executing well so we can service customers’ needs and enable communities to solve their stormwater and on-site septic wastewater issues.

One thing is certain, the demand for stormwater and on-site septic wastewater products will persist and the secular tailwinds for water management will only increase. In summary, we had a solid first half of fiscal 2024. We feel confident in our ability to deliver on our commitments this year, expanding margins despite the slow demand environment. ADS’ value proposition, solutions package, conversion strategy and unique sustainability position in water and recycling remain highly relevant and we are committed to being a leader in sustainable water management solutions. We will continue to manage cost and production but importantly, we are managing this business for the eventual recovery in the residential and nonresidential end markets where we look to continue to gain share due to superior products, capabilities and commitment to service at both ADS and Infiltrator.

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

Scott Cottrill: Thank you, Scott. In the second quarter, we reported revenue of $780 million, a decrease of 12%, primarily due to lower volume. Adjusted EBITDA was $246 million, a decrease of 6%. We were able to partially offset the decrease in sales volume with favorable price/cost management. The team has done an excellent job managing pricing on a local basis and results in the second quarter were in line with expectations. Material costs were favorable year-over-year in the quarter, though we expect price/cost favorability to flatten out in the second half of the year. In addition, this quarter, we continued to see higher manufacturing costs year-over-year, primarily due to lower absorption of fixed costs as well as the increased investments we have made in engineering, quality and safety.

On Slide 8, we present free cash flow. We generated $376 million of free cash flow in the first half of fiscal 2024 compared to $361 million in the prior year, an increase of 4%. Year-to-date, working capital management has resulted in better conversion adjusted – of adjusted EBITDA to cash flow from operations. Capital spending increased 9% to $83 million in the first half of fiscal 2024, as we continue to make investments to increase automation, grow manufacturing and recycling capacity and increase productivity as well as build our new world-class engineering and technology center, here in Hilliard, Ohio. Our first priority for capital deployment remains investing organically in the business, which we view as the lowest risk, highest return use of capital.

We continue to expect to spend between $200 million and $225 million on capital expenditures this year, inclusive of this year’s initial spending for the new manufacturing facility in Florida, announced earlier today. Our second priority is acquisitions that are close to the core while being open to adjacencies that will provide for future platforms for consistent growth as well as expansion of our addressable markets. Third, we will continue to buy back shares under the current share repurchase program. In the first half of the year, we repurchased 1 million shares for approximately $102 million, leaving $316 million remaining under the existing authorization at the end of the second quarter. Year-to-date adjusted earnings per diluted share decreased 6% to $3.78.

Importantly, the share buyback program has resulted in 7% fewer shares outstanding compared to last year, partially offsetting the impact of lower net income on earnings per share. And lastly, we remain committed to the quarterly dividend paid to shareholders of $0.14 per quarter, a 17% increase versus last year. Moving onto Slide 9, we present our updated fiscal 2024 guidance ranges. We raised the bottom of the revenue guidance, which is now expected to be between $2.7 billion and $2.8 billion. We also increased the adjusted EBITDA guidance, which is now expected to be in the range of $800 million to $850 million. Today’s updated guidance is driven by the better-than-expected demand and margin performance in the first half of the year. Our second half sales expectations remain unchanged and we continue to expect revenue to be roughly flat to down 10%, on a year-over-year basis.

We expect normal seasonal patterns with 55% to 60% of revenue coming in the first half of this year and 40% to 45% coming in the second half. We believe the implied second half margins and our revised guidance are prudent given the challenging end market demand that we have been discussing throughout the year due to the higher interest rate environment as well as tighter lending standards. The revised guidance also includes the impact of accelerating certain customer service and order management initiatives into the second half of this year, given our better-than-expected results year-to-date, further strengthening our position as a supplier of choice, both now and into the future. We remain focused on executing on our plan and investing in the business for long-term growth, margin expansion and free cash flow generation.

With that, I will open the call for questions. Operator, please open the line.

See also Billionaire Michael Platt’s Top 10 Stock Picks and 30 Cities With the Highest Homelessness Problem.

Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Michael Halloran with Baird. Your line is open.

Unidentified Analyst: Hey, good morning, everybody. You’ve got Paz [ph] on for Mike. Quick one for you. If we take a look at your residential performance, can we maybe parse out what you’re seeing across legacy pipe and Infiltrator? I know that you said Infiltrator is performing a little bit ahead of expectations but can you maybe parse out what you’re seeing from a fundamental demand perspective, given that they sit a little bit different places in the build cycle?

Scott Barbour: Yes. This is Scott Barbour. So we would tell you that Infiltrator is stronger than in that latter half of the build cycle and I think they’re benefiting from kind of completions of homes catching up with starts here over the last six months, let’s say, because they’ve had a very strong first half relative to expectations. And I think we’ve probably got the right mix geographically and home type there. On the front end, that land acquisition piece where the pipe business plays is weaker for sure. And we really haven’t seen it pick up. In addition, in that residential, I think Mike Higgins has buried the multifamily, which has not been very, very good either. So we’re really pleased with how the Infiltrator business has unfolded this year.

And they’ve done a great job of managing their cost, being ready for this better-than-expected demand. They’re still down year-over-year but it’s a lot better than we thought it was going to be. And I was there – we were there two weeks ago. And many of you went to the Building 7 where we have the new equipment and automation and it was just awesome, how that facility is performing.

Unidentified Analyst: Yes. Thank you. That’s super helpful color. Maybe digging a little bit deeper on the automation investments. Can you maybe remind us the varying degrees of automation across the different facilities, how much room there is to go? And maybe kind of remind us on some of the level of sophistication, just so we can maybe get an idea of maybe the opportunity set?

Scott Barbour: Yes. There is a long way to go. And if you think about just Infiltrator, I mean, our most – Building 7, what do we have three or four buildings down there that are doing production, a couple of buildings doing material handling and warehousing but kind of really – two of those facilities are really automated. The Building 7 that you all saw highly, highly automated, not quite as much in the other building. And then the initial building that we have down there, not very automated at all. And then through our pipe factories, big, big network. We have some good automation projects really in flight, well in flight and operating, I would call it, three facilities with the maxi coiler and then the other two with the end-of-line automation.

So there’s a long way to go there. We announced today, the Lake Wales, we will use our best ideas, the way we’re thinking about things for the future in that facility from an automation standpoint because we believe that, that’s the manufacturing workforce of the future and this will dictate really how much you can make or the pounds that you can produce in those kind of facilities will be your level of automation because you’re not going to be able to get the labor that you once were able to get in many of these communities.

Mike Higgins: Hi Paz, this is Mike Higgins. I think another way to think about it is, it’s still pretty immature on the ADS side. So lots of opportunity to go there, a much broader network. And then on the Infiltrator campus, where maybe the kind of heavy lift initial kind of automation is in place in a lot of spots and their focus is move to, okay, how can we automate further the downstream activities to mitigate those challenges around hiring and then also to eliminate tasks that might provide a safety risk and make those roles and those jobs a lot safer.