Good morning, ladies and gentlemen, and welcome to Advanced Drainage Systems Second Quarter of Fiscal Year 2023 Results Conference Call. My name is Jason, and I am your operator for today's call. Currently, all participants are placed in listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the presentation over to our host for today's call, Mr. Mike Higgins, Vice President of Corporate Strategy and Investor Relations. Please go ahead.

Thank you, and 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. 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 and 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.

Thank you, Mike, and good morning. Thank you, everyone, for joining us on today's call. We achieved another very strong quarter of results, with the second quarter sales of $884 million and adjusted EBITDA of $263 million. Importantly, this is the fourth quarter in a row that we have covered cost pressure through favorable pricing in the third quarter in a row of margin expansion. Sales growth of 25% was broad-based across geographies in both the construction and agriculture end markets, supported by continued strength in our priority states and Allied Products. The strongest volume growth occurred in the ADS residential and agricultural end markets. In the ADS agriculture business, we did a good job level loading deliveries, and that is shaping up for a fall season with year-over-year growth. The ADS residential business grew as homebuilders continue to develop land despite market uncertainty. We expect homebuilder land development to continue on previously acquired land and over the long-term, the lack of available home supply will continue to drive growth in this market. ADS participation in the residential market is still early in the material conversion story. So despite the pullback, residential remains a large growth opportunity for the company. What we see being on the land development side is that sales are choppy. Some areas remain strong like the Atlantic Coast, the Southeast and Texas. In the other areas like the Northeast, sales, orders and project identification are beginning to slow. We are focusing business development efforts in those geographies where land development is continuing. In addition, we continue to develop programs with national and regional homebuilders where the ADS value proposition, a faster, safer installation, fewer trucks to deliver the required linear feet to the job site, better installed cost, and sustainability is a proven winner. Infiltrator revenue…

Thanks, Scott. On Slide 5, we present our second quarter financial performance. From a top-line perspective, we generated 25% growth year-over-year, primarily driven by favorable pricing at both ADS and Infiltrator. Legacy ADS pipe products grew 28%, Allied Product sales grew 37%, and Infiltrator sales increased 3%. Consolidated adjusted EBITDA increased 60% to $263 million resulting in 650 basis points of margin expansion to 29.8% in the quarter. As Scott mentioned, favorable pricing continued to cover inflationary cost pressures related to labor, manufacturing and transportation costs. From an input perspective, raw material costs have moderated sequentially but remain at historically elevated levels. We expect this favorability to continue as we move through the second half of this year. Moving to Slide 6. We generated $361 million of free cash flow year-to-date compared to $31 million in the prior year. Strong growth in adjusted EBITDA, coupled with better working capital, helped drive significant free cash flow generation and conversion which was approximately 64% of our adjusted EBITDA year-to-date. Given the current market uncertainty, it is important to highlight the strength of our balance sheet and financial position. As of the end of the quarter, we had over $1 billion of liquidity, including nearly $460 million of cash. Our trailing 12-month adjusted EBITDA to debt ratio sat at 1x, and we expect to convert over 50% of our adjusted EBITDA to free cash flow for the full-year. In addition, we recently received an upgrade from S&P on our debt and credit rating. We remain committed to our leverage targets of 2x to 3x net debt to adjusted EBITDA, but we are currently focused on the low end of that range at this time given market conditions. Importantly, 68% of our outstanding debt is fixed rate debt and therefore, are not subject to…

[Operator Instructions]. Our first question is from Michael Halloran with Baird. Your line is now open.

So handful questions here. First, let's start on the inventory side. Obviously, that seems to have caught you guys off-guard a little bit as you work through the quarter. Was there -- how quickly were you able to react to it once you saw the challenges? And maybe provide some context for why you think that by the end of October, the inventory levels have worked themselves out. I think a lot of people are other kind of product categories that touch your markets are expecting that to last a little longer. So I think some comfort in understanding what you've done, what the levels look like, how they compare to normal and what kind of demand environment you're assuming and what you're calling the normal kind of run rate, would be super helpful.

All right. Mike, this is Scott Barbour. So I think your -- let's probably start with the Infiltrator inventory destocking, which is really focused on the leach field products. Recall that there's really two major product lines there, the bigger being the leach field, the newer one being the tank. And the tank really isn't experiencing that destocking. It's still in kind of that work off the backlog mode. And what we saw, I would say, kind of starting the mid-point in the quarter is inflection and the reduction of that backlog. In other words, it was getting steeper on the leach field products. It was started to be worked off very quickly. And then just not kind of a reorder point. What I mean by that is the demand of the leach field products started to kind of really wane as we got halfway through the quarter. And we have now gotten to this point where the lead time on the leach field products and the kind of open orders behind it, the backlog are in a way that's kind of what we saw pre-pandemic. That leads us to believe we're towards the end. We don't know that for sure, we need to continue to watch. But I believe around that particular product, which was the most dramatic in the quarter that what's in front of us is really kind of demand uncertainty by home completions and it starts the completions. We think the distribution inventory is kind of getting to the right level there. So we don't expect another big event of destocking, it will be more demand-driven. Did that kind of clear what you were asking around the inventory levels and destocking?

Yes. That was -- one question. What percentage loosely of your organization actually is beholden to these inventory pieces? Because a lot of your business just doesn't really have channel inventory.

Right, right. Mike, I mean, what's the figure we've given on, it's really the Infiltrator products that are mainly stopped.

Correct. Retail and the ADS --.

Retail and the ADS side, but that's kind of been lower for a while --

Yes. If you think about the ADS business, somewhere between 70% to 80% goes directly to a job site. With the Infiltrator business, pretty much all of that is going to go from an Infiltrator facility to a distributor's yard.

So you're thinking somewhere around 25% to 35% is what the piece of that would behold in the inventory then?

Yes, yes, in that neighborhood, yes --

It would be in that neighborhood depending on the season.

So that's helpful. So didn't see the gross -- yes, go ahead, sorry --

No, I was just going to kind of reiterate, Mike that we believe the bigger thing to kind of watch out for is demand-driven from here forward. If we think -- it didn't hit us faster than we thought, there's no doubt about that. I mean and -- but we believe we're more towards the end than we are at the beginning of that phenomenon at any of the stocking locations for particularly Infiltrator.

That's helpful. And then two more bucks to questions. First, on the commercial construction side of things. You mentioned some regional slowing. Is that mostly just alluding to Florida? And more broadly, could you just talk about what the trend line you're seeing is in any areas of concern on the commercial construction side outside of expectations for a slow recovery in that specific region Florida was hit by the hurricane?

Well, it's -- as we kind of peel it back and we look at the Northeast and the Pacific Northwest, those areas went down pretty hard in the pandemic. And so starting last summer until -- I mean last year until this summer, they were very elevated levels of activity. That appears to have been kind of worked through and now we've kind of come back into a more normal seasonal pattern there, which is below where we were a year ago, but compares well to pre-pandemic in terms of commercial demand in those regions. Florida, if you got to take aside the hurricane impact in Southwest Florida, I think things are going along pretty normal as we have seen over the last several quarters in terms of construction activity. But Southwest Florida is important. It's a high-growth part of the state, and we're going to -- we're going to feel some impact from that. But it will get worked off. These things do. There's no destruction of demand. It's just kind of pushed out for right now. If we look at quoting activity and project identification, things like that in the commercial space, it's above prior year. Not -- I mean it's not double-digit, but it's above prior year and kind of good healthy levels. We talked the warehouse business remains good for us, lots of projects in that funnel. I know there's a lot of concern about that, but that really remains pretty good. The data center piece, these onshoring projects, we have a lot of business development activity there. We've done a really nice job. We stood up that business development a couple of years ago. Before the pandemic, we layered the residential and the warehousing into that. Now we're layering into that these onshoring projects. And some are here in Ohio, some are in Texas. We see them across the country. So we get -- we're getting a lot of quote activity in that kind of space. That said, we're in this inflection point and how these things are going to impact us. But right now, that appears to be doing okay.

All right. Helpful for that. And then last question, didn't see gross margin commentary by kind of the usual three things in the press release today, the pipe, Allied, and Infiltrator. Any help on that side? And then when you look at the back half of the year margins, I think one of the Scott's alluded to normal sequential patterns from a seasonality perspective. And second half is always worse than the front half, at least in a normal year worse than the front half on the margin line. But just help provide some context to how much the price/cost capture you think you can maintain? And any help with how to think about what were really good first half margins in your ability to carry through that kind of goes through on a seasonally adjusted basis moving forward?

Yes, Mike, Scott Cottrill here. So I'll try to unpack a couple of those points. Sequential margin performance, as Scott and I said in the script, we see this year kind of returning to more of our normal sequential kind of seasonality patterns. So you're absolutely right. It will -- anywhere from 200 to 300 basis points or greater is normally kind of that deterioration from first half to second half margin performance just because of the winter months, the lower volume that absorption and leverage piece. So we'll see that again, and that's what you see in the second half. On the drivers of price/cost, yes, you'll see that now. Now we're starting to lap a lot of the pricing year-over-year. We're keeping it at these high-levels. But on a year-over-year basis, you'll see more of that resin benefit coming in on a year-over-year basis as we go through the second half, and that's been embedded in our guide. As to the margin performance in the quarter and year-to-date, those EBITDA bridges are in the earnings release, as you said. And then the margin piece of that by segment will be out as part of the 10-Q filing later today.

Our next question comes from Matthew Bouley with Barclays. Your line is now open.

Hey, good morning everyone. Thank you for taking the questions. If I could kind of zoom into the volume outlook within the guide. I think obviously, you're guiding to second half revenues, I guess, down 3% year-over-year. Curious if you can kind of unpack what the volume assumption is in that, if I take residential weakening, some kind of near-term destocking and Florida getting pushed to the right or activity in Florida. I'm curious if you can kind of size up the volume impacts from some of these kind of more discrete items. Thank you.

Hey, Matt, it's Scott here. So again, you're right. So a little bit of pricing benefit still second half year-over-year. It will be mostly a volume play, which is what we saw in all the key dynamics that Scott covered here a little bit ago via the script as well as answering Michael's question here a little bit ago as well. But you're going to see most of that impact, that volume impact on kind of that Infiltrator side of the house first, which is how we've always been talking about that's exactly what we're seeing. So you're going to see a lot of that. Allied is still going to be strong year-over-year. So we'll still see some nice volume growth as well as pricing there. On the pipe side, on the ADS legacy business, again, some of those dynamics that we talked about come into play there as well. But most of that volume coming off will be Infiltrator. And as Scott mentioned, we knew based on single-family housing starts and the lag times kind of -- it was coming at us. We just -- it happened probably about a quarter ahead of when we thought and the impact in September was pretty dramatic and pretty sudden. So leading to all the actions we talked about before. But it's fair to look at a lot of that volume as being Infiltrator related.

Got it. Okay. That's -- that's very helpful. And then, secondly, on the margin outlook. I just heard you saying and you said several times around that there's some raw material benefit starting to flow into the second half there. I mean, if I kind of just high-level, say, you took your revenue guide down by $150 million at the mid-point, but the EBITDA margin is -- or the EBITDA dollars are unchanged. What I'm trying to get to is, I guess, how much of the deflation that you're now starting to see is incorporated in that second half guide? And just sort of what are the expectations around -- I heard you say operational cost control, things like that. I'm just trying to get at how much of actual declines in raw material prices are included in that second half guide? Thanks.

Yes. Matt, the way I think about it is those decreases are embedded in our guide. Again, based on resin procured in the month of September, October, by the time that it goes from raw material and is converted into a pipe finished good product and then sold. That could be 90 days, if you will. So we have three months of visibility to those costs that are on our balance sheet today. So again, we've embedded that -- or considered that favorability as well as pricing. I mean it's really important to also look at kind of where our pricing has been and where we've gotten it to and the fact that sequentially, we expect to hold on to most of that as we've talked about in the past. But again, that resin and what we're currently procuring it at is included in our forecast and the guide that we went out with.

Got it. And then just on that point, can you kind of speak to the resin -- the resins themselves sort of to what degree have they come off peak, if you can give any color on that?

Not -- I mean, directionally, again, it's off sequentially as well as year-over-year. But again, the absolute level, when you go back historically and look over the last five-plus years or greater, it's still at a very elevated level as compared to historic levels that we've seen. But again, sequentially, year-over-year, it's providing a nice benefit and offset to some of the volume challenges that we're seeing. And again, we kind of knew that, but the magnitude of such -- to your point, helps us offset some of the volume declines that are coming at us that again came at us a little bit faster than we thought they would.

Our next question comes from Josh Pokrzywinski with Morgan Stanley. Your line is now open.

Just following up on the price/cost commentary. I mean, I guess, versus last quarter, you had a little bit less of a benefit in the EBITDA Bridge. I don't think the year-over-year comp was a lot better. And I sort of get that you have more deflation showing up in the second half, although I think the resin kind of downward trajectory has been fairly stable. So I guess maybe what I'm trying to say here is I would have thought there would have been more this quarter. Is there anything going on with either mix or price flowing back to the customer in some instances, like -- can you just talk about how -- how that has gone kind of at the customer level in terms of managing that price/cost? Does that change at all versus the last quarter? Or is it really just a function of more of the improvement on resins that we've seen is kind of times itself into next quarter and beyond rather than this one?

It's timing. Well, the only thing I'd say, Josh, looking at the EBITDA bridge, I mean, that price cost was $169 million favorable in the quarter. Again, when you look at the magnitude of what we saw in the first quarter, yes, it's not the same on a year-over-year basis, but that's because of the price increases that were lapping last year. So when you get to Q3, Q4 of this year, again, you're not going to have as much pricing benefit on a year-over-year basis. But what we're going to see is a nice resin benefit year-over-year that will be in that price/cost far and is embedded in our guidance. So that's the interesting thing when you look year-over-year. But when you look sequentially, which is, again, how we look at it, we're holding on to most of that pricing like we thought we would. Obviously, with some of our plastic pipe competitors in certain regions, we got to be smart about it. But again, we're holding on to most of that pricing. And we track that. We look at it monthly, weekly, daily and we're holding on to it. And then to some of the points we've talked about earlier, we're also starting to see on a procured basis, some really nice resin benefits that will start coming through the P&L here over the next couple of months.

Got it. And then I apologize if I missed this in some of the earlier comments. But on the kind of lost revenue or deferrals coming out of Florida with the hurricanes, over what timeframe are you expecting to catch-up on that? Obviously, not imminently, but like is this a two-quarter phenomenon? Is it really into next year? How do we think about the catch-up?

Hey, Josh, this is Mike Higgins. Yes, I'd say that of that area, talking Southwest Florida that was hit the hardest. That's -- you're probably looking at potentially a two to three quarter phenomenon. I mean, obviously, people have seen the damage of the devastation that occurred. So a lot of the activity clearly is shifting to that. So we'll see some sales related to that, but kind of your everyday kind of nonresidential, residential construction projects that we sell that those are going to get pushed for at least a couple of quarters. That's -- and that's coming from our guys on the ground talking to their customers, talking to our distribution down there.

Got it. And then I apologize if I could sneak in just one more. The way that you guys are sort of describing the end market environment right now, especially on the resi side, with maybe non-resi closely following in most end markets or most macro environments. How does that kind of 8% CAGR long-term target look today? Is that something that still feels kind of achievable over the next several years? Or does that need to come down if we have kind of a more pronounced slowdown here over the next, call it, 12 to 18 months?

Yes. I mean, obviously, if it's more pronounced, you got to look at things. But again, the long-term trajectory and value proposition and model that Scott talked about earlier, no change. So over the long term, absolutely, that growth trajectory, that material conversion story, all that holds true. So that -- the ADS model, the Infiltrator model, that conversion story is intact.

Yes. I think the way we talk about it, Josh, is, yes, clearly, there's something going on in the market. It's an inflection point, there's uncertainty, but our business model is not broken, right? The conversion story, the value proposition that we bring, we're still executing on that every day, and we'll be very resilient and we can pivot based on kind of where opportunities are presented in the end markets.

And you're if you're thinking -- Josh, this Scott Barbour. No, I was going to say this is Scott B. I think this is really -- we're in that period of inflection and you don't really know where it's going to end up. I mean we know there's something common, the depth or length of it, we don't know. We can read the signals and watch the Fed and all that other kind of stuff. But we just don't know yet. So we're not going to change our long-term growth plans around any of this until we get a better handle on what the depth and length of what we're entering is there. I mean I think as I tried to describe, I mean, we were saying along in July and August, September was a lot different than July and August. October is kind of been the same. We're trying to figure out exactly these different impacts of destocking, slowdown in core demand in the end market, all these things. And we'll sort it out and we won't know until we're past it, but we're going to stay on top of it every day. And this is not unlike when the pandemic began. When we -- there was a couple of months of sorting things out, making sure we were lined up right, then you go, and that's where we are.

Hey, Josh, the only thing I'd add to that, you heard Scott and myself mention it multiple times, but we're continuing to invest heavily in the business. Obviously, certain regions still need to be invested for growth, but a lot of automation and efficiency type of spend that's coming that way. And again, as we talk to it, our game plan here is to continue investing in these areas so that we're even more competitive when we come out of this downturn. And again, we've got the balance sheet to do that, and we see that as a great way to not only invest organically in the business, but again, we can be positioned for any kind of M&A opportunities that might come our way down the road as well.

Our next question comes from Garik Shmois with Loop Capital. Your line is now open.

Hi, thanks for taking my question. You kind of alluded to this a little bit on the pricing questions. But just curious if the pace of the competitive behavior has accelerated at all over the course of the last couple of months? Or is it more of a normal price -- pricing environment when you start to see resin costs start to come down?

Good question, Garik, this is Scott Barbour. So it differs by market. And I would say to you that in the regions of tight RCP, reinforced concrete pipe supply, high demand for that stuff, maybe a lot little like capacity in those products, pricing is very steady and maybe with some opportunities. In our more competitive markets like agriculture, some days, there's a daily fight. Other days, it's pretty steady. It's not anything that we don't experience in a normal course. And like Scott said, we're going to protect our market share, but it's not at any elevated level over normal. And I think that's what you're kind of asking, is there any unusual activity because of the decrease in material prices. And it's -- every now and then you see one, you see a hot one, but it hasn't been above what I would call normal type of activity.

Got it. That's helpful. Follow-up question is just on material conversion, just the pace of how that could look over the next several quarters? And just I don't know if you can wind back maybe in other periods of an economic slowdown, you've been able to maybe accelerate the pace of material conversion and maybe speak to the spread now between HDPE pipe pricing versus maybe some of the other competitive materials that are seeing some more inflationary pressures moving forward?

Yes, Garik, Mike Higgins. So to the first part, other periods where we've seen economic slowdown, I would say, it's more geography-based where you're able to kind of accelerate that share gain, right? So clearly, things become more competitive guys are looking to protect margins on a slowdown. So if you have a contractor who maybe you have on the edge of kind of converting to your product, you're able to kind of push him a little further because of that competitive need in an economic slowdown. So I would say the pace accelerates in certain geographies, maybe more than others. But I think we're running at a pretty good clip right now at conversion, specifically in the residential end markets. And I'm sorry; I forgot what the back half of your question was?

The installed cost?

Yes, I think where we've seen over this year, the kind of the spread, the total installed cost advantage of our products versus the traditional materials has come into that more normalized level kind of 15%, 20%, 25% versus concrete pipe, as they've had to kind of take prices up around inflationary pressures and demand constraint --supply constraints related to the demand. I think we've seen those geographies where there were some parity maybe evolving that advantage has come back in line with what we typically see.

Our next question comes from John Lovallo with UBS. Your line is now open.

Hey, guys. Good morning. This is actually Spencer Kaufman on for John. Thanks for fitting me in here. Maybe just the first one, given Amazon announcements on pausing warehouse distribution CapEx as a refer to the industry. How are you thinking about the sustainability of warehouse and distribution end markets? And sort of along the same lines, just given all the economic uncertainty out there, you mentioned that we're sort of in this inflection point right now. What type of visibility do you have into the entire business right now?

Why don't you take that one?

Yes, Spencer, Mike Higgins again. On the warehouse distribution center part of that question, I'd say broadly, overall, the activity level remains strong. Specifically on the coasts, there's a real kind of acute shortage of warehouse space there. So we still see pretty strong demand up the East Coast, up and down the West Coast. As far as the Amazon piece, I know that gets a lot of headlines, but they're roughly 15% of the market. So there's still a lot of other development, a lot of other activity that goes out there. So the market is not solely reliant kind of on Amazon. And kind of -- one of the kind of viewpoints that we have been here is Amazon typically overinvest early into things, and this might be one of those things that a pull back, right? So they overinvested in this type of space. They're kind of pulling back on that a little bit. And then the other thing we hear from other kind of real estate professionals or the real estate industry is when you pull a couple of those layers back, Amazon kind of subleasing some of the space out is older stock. So they're older buildings that they've been in. They're trying to consolidate, operations into these newer facilities that they've built which are much larger, heavily automated to deal with the labor challenges. And there's takers for that old stock that old warehouse space. So we feel pretty confident in that type of activity through the end of the fiscal year.

Okay. Thanks, Mike. I appreciate the color there. And my follow-up question, just on the raw material costs that are improving down both quarter-over-quarter and year-over-year, but still elevated how you guys are describing it. I mean when you couple that with just some of the demand weakness you're seeing? And how are you thinking about the price moving forward? I mean would it be unreasonable to see potentially some giveback here?

It's -- I think the giveback is just so localized that it's difficult for -- I think you guys do it. I mean it's pretty minimal within the context of how much price we've gotten over the past year. When we give -- when we have to give back price tends to be on one project and one very regional type of thing. It doesn't tend to be across one whole class of distribution or customers. And it tends -- it's very rifle -- rifle shot. And the experience of the company is those rifle shots don't kind of pile up into some kind of tsunami. We're pretty good at keeping them extremely localized. And we offset that with -- when we compete against reinforced concrete with our polypropylene or HP products that are a bit tighter in supply, higher demand environment that we're competing against those guys. And we also have the pricing that we do on our Allied Products, which tend to be highly, highly differentiated and highly, highly specified. You kind of roll all that together, Spencer, and we feel like it's a very manageable, very manageable variable for us.

And when you look at some of the other inflationary cost pressures, you look at -- it's not just all about resin, but when you look at labor, you look at transportation; those are all costs that are still with us at elevated levels. So -- so again, I understand the question, but again, not a big item as we look at it.

There are no further questions. I'll pass the call back over to Scott Barbour for closing remarks.

I really appreciate everyone's participation and the good questions today. We anticipated a lot of these lines of questions; we look forward to kind of the follow-ups. And I just conclude, our team continues to work extremely hard on execution. You guys know me, I mean; execution is the first thing we think about in our business all the time. That's going to be really important. It's always important. It's really important in times of inflection. We remain very focused on kind of our end markets and customers and those programs that we can drive growth. We'll manage through it. It's an inflection point in the market. There are a few things that we've got to continue to figure out, we feel good about kind of holding the EBITDA guidance and well-positioned on that and the cash flow generation of the business that I think gives us a lot of options on things that we can do in the future. So I appreciate it. I look forward to talking to you all soon or seeing you all. Thanks.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.