Advanced Drainage Systems - Q2 2024

Transcript

Operator (participant)

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. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question again, press star one. 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 (VP of Corporate Strategy and Investor Relations)

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. A copy of the release has also been included in a Form 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 (President and CEO)

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 reason 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 ac 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 six times. 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 lbs 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 U.N. 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 costs, 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 and 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's 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 non-residential 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 (EVP, CFO and Secretary)

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 the 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 eight, 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 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 would 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. Lastly, we remain committed to the quarterly dividend paid to shareholders of $0.14 per quarter, a 17% increase versus last year. Moving on to 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-$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%-60% of revenue coming in the first half of this year and 40%-45% coming in the second half. We believe the implied second half margins in 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.

Operator (participant)

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star, then one on your telephone keypad, and we'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Michael Halloran with Baird. Your line is open.

Speaker 10

Hey, good morning, everybody. You've got Pez 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 (President and CEO)

Yeah. 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, there where the pipe business plays is weaker, for sure, and we really haven't seen that pick up. In addition, in that residential, I think Mike Higgins is buried to multifamily, which has not been very, very good either.

So we're really pleased, you know, with how the Infiltrator business has unfolded this year. And they've done a great job of, you know, managing, you know, their costs, 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 gonna be. And I was there. We were there two weeks ago, and many of you went to the Building Seven, where we have the new equipment and automation, and it was just awesome how that facility is performing.

Speaker 10

Yeah. Thank you. That's, that's super helpful color. Maybe, 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 [crosstalk] kind of get an idea of maybe the opportunity set?

Scott Barbour (President and CEO)

Yeah, there, there's a long way to go. And if you think about just Infiltrator, I mean, the, our most Building Seven, what do we have? 3 or 4 buildings down there that are doing production, a couple buildings doing material handling and warehousing. But kind of really, you know, two of those facilities are really automated. The Building Seven 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, you know, we have some good automation projects really in flight, well in flight and operating. I would call it 3 facilities, you know, 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, you know, 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, 'cause you're not gonna be able to get the labor that you once were able to get in many of these communities.

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Hey, Pez, this is Mike Higgins. I think another way to think about it is, it's still pretty immature on the ADS side. [crosstalk] So lots of opportunity to go there, a much broader network. And then on the Infiltrator campus, you know, where maybe the kind of heavy lift, initial kind of automation is in place in a lot of spots, and their focus has moved 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, you know, a safety risk and make those roles and those jobs a lot safer? [crosstalk]

Speaker 10

Yeah, fair, fair. I'll leave it there and pass it on.

Mike Higgins (VP of Corporate Strategy and Investor Relations)

All right.

Operator (participant)

Your next question comes from the line of Matthew Bouley with Barclays. Your line is open.

Matthew Bouley (Managing Director and Equity Research Analyst)

Hey, good morning, everyone. Thank you for taking the questions. So maybe picking up on where Scott C. left off at the end of the prepared remarks around the margins in the second half. I, I think you're guiding to something like 25% EBITDA margins in the second half, after you did 34% in the first half.

Scott Cottrill (EVP, CFO and Secretary)

Mm-hmm.

Matthew Bouley (Managing Director and Equity Research Analyst)

So obviously, that's a bit of a larger first half to second half margin decline than is normal for ADS. So, you know, I think you mentioned there might be some accelerating investments that you're looking at, perhaps building in some conservatism. Maybe just kind of touch on the bridge there and sort of what would lead to that larger than normal decline into the second half. Thank you.

Scott Cottrill (EVP, CFO and Secretary)

Yeah, yeah, Matt, Scott here. You, you, you nailed two of the biggest ones, right? It's, it's being prudent with our end market guidance, given kind of the what we see out there. I think on the gross margin side of the house, you'll kind of see relatively flat performance as you look at the guide to what we're used to seeing in that 1H, 2H degradation. The SG&A piece of this that talks to the investments we're making in engineering, customer service, order execution, we are taking advantage of a better than expected year to pull some of those investments forward. So those will come through SG&A. So you will see some of that headwind on a margin deterioration. You are absolutely correct. That 1H, 2H degradation is greater than what we normally historically experience, and those are the three key drivers of that.

Matthew Bouley (Managing Director and Equity Research Analyst)

Got it. Okay, that's perfect. Thank you for that. And secondly, price cost obviously was positive again in the quarter. I wanted to pick up on some of your comments that you said a few times that price is performing in line with expectations. So just kind of wanted to unpack that a little bit. You know, what were those expectations? How is price performing within that price cost bucket? You know, and are you finding opportunities to perhaps utilize price adjustments in any regions to perhaps, you know, win conversion to your products? Thank you.

Scott Cottrill (EVP, CFO and Secretary)

Yeah, I mean, it's a local game, as we keep talking, Matt, and as you know. So the team's done a great job. We talked about holding on to the majority, vast majority of the pricing that we've gotten into the market over the last couple of years. A lot of drivers for why ADS is able to do that, but what we're seeing is absolutely a realization of what we talked about. We never talked about holding on to all of it. Obviously, need to be aware of competitive environments, geographical issues, all those items come into play. But, we talked about holding on to the vast majority. We are holding on to the vast majority. That will continue and obviously, we've got the nice resin being lower on a year-over-year basis, which is, as you saw in our EBITDA bridge that we provide, it gives us a nice little, you know, acceleration of our performance, both on the margin as well as the EBITDA growth.

Matthew Bouley (Managing Director and Equity Research Analyst)

Great. All right, guys. Good luck.

Scott Cottrill (EVP, CFO and Secretary)

Thanks, Matt.

Operator (participant)

Your next question comes from the line of Garik Shmois with Loop Capital. Your line is open.

Garik Shmois (Managing Director and Equity Research Analyst)

Oh, hi, thanks for taking my question. Just, you know, higher level, just wondering on the, the non-res side, how, how bidding on projects and how your backlog was tracking over the course of the quarter?

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Yeah. So, I had a little bit of a hard time hearing you there, Garik, but I think you talked about kind of backlog and project activity in the non-residential end markets. You know, I would say you know, steady, right? You know, it's a challenging non-residential end market. There's pockets of different types of projects that you know, we've seen pretty good activity on. But, you know, I would say kind of the, the backlog is steady. Order activity through the quarter was, was good. We didn't see it deteriorate further.

You know, but with that said, you know, we still have another six months of the year that's left, and I think everybody's well aware of the challenges that exist around non-residential with higher interest rates, tightening credit standards, and you know, just general concern about kind of strength of the economy moving forward. But, you know, I think we feel good with where we are in that space. You know, obviously, it's again, very local and very geographic, so you see kind of pockets of strength and pockets of resilience, and then you see pockets that, you know, might be a little weaker. But, you know, it was encouraging that some of the geographies we saw weaker in the first quarter, specifically some of the states out west, have seen improved performance as we moved through Q2.

Garik Shmois (Managing Director and Equity Research Analyst)

Great. No, thanks for that. Just wanted to follow up on the plans to add capacity in Florida. Just wondering if you could provide a little bit more detail around how much incremental capacity does that represent? Is it gonna be displacing any older capacity, or is this all purely incremental? And then just maybe just the timing around the project, just given, you know, some of the macro headwinds and, you know, recognizing it's gonna take some time for the facility to come online, but just curious as to why now?

Scott Barbour (President and CEO)

So, Scott Barbour. A couple of things. One, it will not displace existing facilities. We have two really high-performing facilities in Winter Garden, Florida, and Sebring, Florida, that are doing a super job servicing that market, which is still a very, very strong market for us across all of our segments. So it is truly incremental capacity for us in that state, particularly around the work that is going really fast in the DOT work, and the residential work, and our polypropylene pipe, which is our highest performing tip of the spear pipe. We're not gonna disclose kind of number of lines or how many pounds we're gonna make or anything like that. At this point, we're gonna break ground, you know, early next year. We're closing on the property now.

We've been working on this for some time, and had to move through the different stages of kind of getting prepared to announce it. We're very excited about this. We need it in this region. It's a very strong region for us, as we've been talking about for... I've been here six years now, and I think we've been talking about this since the very beginning of how important the Crescent is, or that Southeast United States and these priority states, and we've done a great job of growing there. We were six times larger in Florida than we were 10 years ago when we got the massive approval for our pipe products to be installed in public works down there. And so we've done a good job in our existing facilities, meeting that demand, but we know that's gonna get better because we still understand we have room to grow in terms of penetration. And I would expect this capacity to start to come online in 2025, calendar 2025.

Garik Shmois (Managing Director and Equity Research Analyst)

Understood. Thanks for all that, and I'll pass it on.

Operator (participant)

Your next question-

Scott Barbour (President and CEO)

Sometimes you have to. No, go ahead.

Operator (participant)

Oh, go ahead, sir.

Scott Barbour (President and CEO)

So, you know, sometimes you have to invest, you know, now in periods like this, which we are doing, to be ready for when these markets recover. As the market recovers, it's too late. And, we were talking about Infiltrator a little earlier. You know, right after we bought Infiltrator in 2019, we approved within weeks, you know, I think it was $40 million or $60 million of capital, a lot of capital, which was all incremental. People were worried about the residential market and all that kind of stuff, and we needed that capacity, you know, over the last two or three years. And now that capacity is going full bore at great cost, and that's the performance you see there. So I just bring that up because, yeah, times are a little uncertain, there's no doubt about it.

But, you know, we have the capacity to continue to invest this capital to be ready for that upturn. And I think that's what, you know, one of the nice characteristics about the company is we've been able to develop this really good cash flow and can go deploy that capital. So as we think about this Florida investment, you know, this Infiltrator investment we made right after the acquisition is kind of how we're thinking about it. You know, to be ready for the upturn, to be ready for these next legs of penetration gain, to be ready for these next legs of market upturn. So go ahead with the question, please.

Operator (participant)

Your next question comes from the line of Joe Ahlersmeyer from Deutsche Bank. Your line is open.

Joe Ahlersmeyer (Equity Research Analyst)

Hey, everybody. Thanks for taking the question. I'd like to talk about long-term profitability in the context of the EBITDA bridge that we're seeing today. Hearing you talk about sort of net neutral price costs in the back half, seems to me like probably the positives and negatives have reduced in magnitude, meaning you're likely getting less deflation as we move through here, but there's also not a major giveback on price. And so moving into next year, we shouldn't really assume that that changes much necessarily. And then on the investment side, in manufacturing and the under absorption there, that seems to me like something that part of that is temporary as part of this investment, but also if the end markets are improving, you would get a better incrementals on volume through that manufacturing line. I'm just trying to model how you would get back down to 28%-29% long-term EBITDA margins, when in a year like this, you're guiding to nearly 30%, at the high end?

Scott Barbour (President and CEO)

Hey, Joe, Scott here. So we're not gonna get into talking fiscal 2025, or longer. I will tell you, though, the performance that we've had in the year-to-date through the first 6 months, absolutely exceeding our expectations, as Scott talked about during the prepared remarks. The EBITDA bridge is presented and shown for a reason, right? It shows you all the key drivers that we have. And as you look at that, you're right in looking at, you know, your assumption. Management's got our own view of it, and we'll share that when the time is right. But what does that volume picture look like as we turn the corner in the next year? Price cost, this company does. I don't know if anybody does a better job at managing price costs than what ADS does.

So we'll continue to look at that. Anything that you assume on the volume side that comes back whenever you assume it in the cycle or year, then you get some really nice fixed cost absorption that comes to that manufacturing line. And we'll always manage our SG&A costs to make sure that we're being competitive. To Scott's point, it's getting the capacity where it needs to be during kind of a downturn. It's also getting more efficient, more competitive when we come out of it as well, which is what you heard us talk about related to customer service, order execution, and so forth. So again, not gonna get into 2025. We did, at the Investor Day, give 28%-29% margins, as kind of a three-year look, as to where at the end of fiscal 2025 we expect to get. We'll obviously update that guide as we come out with guide related to next year in the May timeframe like we always do. But again, doesn't stop us from executing, and delivering, as much as we can based on the environment that's in front of us, so.

Joe Ahlersmeyer (Equity Research Analyst)

Yep. Yeah, I agree with you on the price cost. I think the numbers don't lie there. Maybe then back to fiscal 2024, what maybe is included at the high end of the sales range for residential? We've heard the builders talking about development spend. Just wondering what your assumptions are within your guide there for when you might see that, if it's not in, you know, fiscal 2024, is it the early part of 2025? Because it seems like, all signs point to increased land development spend into next year.

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Yeah. Hey, Joe, Mike Higgins. I think with regards to the residential, this kind of move or the positive optimism that the builders have been talking about further development, that's probably an FY 2025 impact for us. You know, that's not going to happen in FY 2024. As they kind of ramp and start to develop more land for more communities, more subdivisions, you know, we would expect to see that sometime in the next fiscal year, but not really counting on any of that for FY 2024.Yeah, I think that goes back to Scott's comment, what we're seeing at Infiltrator on the completion side. A lot of focus right now on getting caught up for some of the backlog from the starts over the last couple of years, and focusing on completions right now is what we're seeing versus land acquisition, land development, and starts.

Joe Ahlersmeyer (Equity Research Analyst)

All very encouraging. Thanks, everyone.

Operator (participant)

Your next question comes from the line of John Lovallo with UBS. Your line is open.

John Lovallo (Managing Director and Equity Research Analyst)

Good morning, guys. Thank you for taking my questions. First one on free cash flow conversion. You know, from EBITDA, it's running at around 70%-71%, I think, year to date, which is solid. I mean, how are you thinking about cash flow conversion in the second half of the year? And then as we move out into next year, how should we be thinking about sort of the incremental CapEx from some of these initiatives that you guys announced today?

Scott Barbour (President and CEO)

Yeah, cash flow from operations is absolutely where we start when we look at it. Obviously, it starts with EBITDA, but working capital management is the big driver there, John. And so I would say right now, as we look at it, we target a 20% working cap as part of sales, as a percent of sales. We'll continue to look at that. Right now, we're sub 18%, year to date. So again, we'll look at that and see where we need to be. We like where we're at inventory-wise, given this lower demand environment. We've done a great job looking at our variable costs, getting our labor where it needs to be, getting our inventories where it needs to be.

So I think we've done a really good job of getting ourselves where we needed to be, and you see that coming through the working capital, right? The receivables come off. The inventory is a great driver, a big driver of that working capital improvement in cash year-over-year. So those are the key drivers in that. I would say right now, we focus more on the free cash flow to EBITDA from a conversion perspective, and we always kind of target a 50% or greater is the way we look at it. That ties to your next part of your question on the CapEx side, $200-$225 this year does include the Engineering Technology Center. It does include some initial spending on the Lake Wales, Florida, manufacturing facility.

You'll see more of the Lake Wales facility, obviously, coming in, fiscal 2025. But we've consistently been talking about the fact that this heightened level of CapEx versus what we've previously spent is gonna be around for at least the next couple of years as we use the balance sheet, as we use our leverage, and liquidity to focus on what we believe is the lowest risk, highest return use of that capital. It's on our footprint, it's on productivity. It's also an innovation, and that's that Engineering and Technology Center. So again, you'll see elevated CapEx spend. It will kind of toggle a little bit toward the Lake Wales facility, from a magnitude mix perspective, but you'll see a lot still in that productivity, engineering and innovation side of the house as well.

John Lovallo (Managing Director and Equity Research Analyst)

That's good color. I appreciate it. And then, you know, I guess maybe zeroing in here on the non-resi business. Curious what you're seeing in sort of that, you know, core, low-rise, horizontal-type projects. Are those still pretty soft? And then, I guess, conversely, on the institutional business or the, you know, the non-spec side of the non-resi side, is that still pretty, you know, pretty solid?

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Yeah. Hey, John, Mike Higgins. I yeah, what you said is true. So things that are, you know, kind of, as we said, kind of more speculative in nature, you know, I think, you know, remain challenged, and you see things getting pushed to the right. You know, institutional, which we would consider schools and other educational facilities and hospitals and things of that nature, yeah, I would say that's been pretty resilient, and that's because a lot of that funding that typically goes to build those projects is more stable, right? It's tax-based, it's bond-based. So I think we've seen that become very resilient.

Then again, things that are, you know, we described as built for purpose, you know, our engineering and technology center, things that are financed off people's balance sheets, and they're not going to the market for financing, you know, those continue to move forward. But again, the bulk of what we sell into is in that kind of general purpose, commercial property. So, you know, as we've said before, around some of these mega projects, you know, we do see activity. You know, we're bidding, we're identifying projects, chasing specifications, shipping product on several of those right now.

Yeah. But also, you know, there's been news, obviously, out there that, you know, some of these announced projects or investments are being paused and getting pushed to the right. So, I still—like we say, it's, you know, we're battling through the non-res market, right? We're doing what we need to do, and that's kind of be present in market, have good project knowledge, get product specified, and take market share from traditional materials. So, you know, we still feel we're kind of performing better than market when you look at our results, but, you know, it remains a battle out there day to day on the non-residential side.

Scott Barbour (President and CEO)

I would say particularly in the Allied Products [crosstalk] where, which, which John have a very—this is Scott Barbour, have a very high, you know, focus on the non-residential job pursuit and market for us. And, you know, we're—we, we know how much the market's down, and we're, you know, having really great performance, both, you know, sales, profitability, order rate in our Allied Products. So I think that's kind of the power of the go-to-market that we have. It's, it's really manifesting itself there.

John Lovallo (Managing Director and Equity Research Analyst)

Got it. Thank you, guys. Appreciate the color.

Operator (participant)

Once again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets Inc. Your line is open.

David Tarantino (Assistant VP of Equity Research)

Hey, good morning, guys. This is David Tarantino on for Jeff. Maybe to be clear on some of the pricing commentary, it seems like it's coming in in line. Can we dig into the gross margins and pipe a little bit? Seems like it took a little bit more of a step back, uh, relative to the balance of the businesses. Is there anything to call out in the quarter and maybe moving forward?

Scott Barbour (President and CEO)

No, not, not really. I mean, pipe was very much in line with what we thought coming into it. Price cost dynamic is laid out. You know, we talked about the first quarter coming out a little bit better than what we'd expected. Q2, largely in line. So really nothing unusual. A little bit of timing of some of the costs in phasing, but there's nothing, nothing in there at all related to any kind of trends or anything there that we're concerned about at all.

David Tarantino (Assistant VP of Equity Research)

Great. And then maybe switching gears on just on infrastructure. Obviously, smaller part of the business today, but it appears you guys have somewhat of a renewed focus here. Can you maybe give us an update on what you're seeing flow from the recent stimulus packages? I mean, it seems like much of this has yet to show through yet.

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Yeah. Hey, David, Mike Higgins. Like we said in the prepared comments, I think we're starting to see some activity around that. I think what we're seeing is more kind of, at, at the local level, so think about counties or, or, or cities. We've seen good activity around airport projects as well. You know, these things, you know, take time, right? To get the, you know, the government has to get the infrastructure in place to kind of handle requests, disperse money. You know, that money then has to get to these local agencies. They have to then prioritize projects they want to do, get those projects to, to market, to bid, get awarded, and construction to start.

So, you know, I think long, you know, this is— I think we've said this many times, you know, this infrastructure bill is a long-term thing, and you're not, necessarily for us, we believe you're not gonna see, one year or a specific year see this huge boom or huge impact, but when you look back on it after five, seven, 10 years, cumulatively, it will add up to something significant.

David Tarantino (Assistant VP of Equity Research)

Great. Thank you.

Operator (participant)

And your next question comes from Trey Grooms with Stephens Inc. Your line is open.

Noah Merkousko (Senior Research Associate)

Hey, good morning. This is actually Noah Merkousko on for Trey, and thanks for taking my questions.

[crosstalk] I wanted to follow up on a question that was asked earlier on, I guess, thinking about sort of leverage on volume growth. You know, how should we be thinking about incremental margins in a scenario where you do have volume growth and maybe price cost is neutral?

Scott Barbour (President and CEO)

Yeah, the best way to start or think about that is we talk about incremental margins from volume alone being in that 30%-40% range. I think that's still kind of a good rule of thumb for right now. Obviously, you know, as a starting point, like anything else, you then have to take a step back and what's your assumption around pricing resin and some of the cost drivers. But again, 30%-40% is what I would tell you to start with.

Noah Merkousko (Senior Research Associate)

Got it. That's helpful.

Scott Barbour (President and CEO)

And again, the other thing I'll lay on top of that is, again, it's a rule of thumb, and it's a starting point, but you got to be really careful when you look at kind of the segments, the timing, especially when you're looking at volume coming on or volume coming off, because that can sway that one way or the other as well. So again, start with 30%-40% and then toggle it as you go.

Noah Merkousko (Senior Research Associate)

Understand. And then for my follow-up, you know, as we look at the sort of end markets in the back half of the year, this year you've had, you know, both non-res and res down, but residential has been less severe and the comps get easier in the back half. So would you expect that dynamic to reverse where maybe non-res outperforms res, even though they're probably or possibly both down?

Mike Higgins (VP of Corporate Strategy and Investor Relations)

Well, I think what you see with the res kind of performance is the strength of that Infiltrator business in the first half of the year. You know, I think, yeah, you're right. The comps, you know, should be easier in the back half of the year. You know, I think, I, you know, I don't want to speculate by the end market, but I think, you know, what you've seen kind of Q1 and then look at Q2, you know, there might be some compression there, but I don't think it's gonna be, I don't think it's gonna be significant.

Scott Barbour (President and CEO)

Yeah, the other color or context I would give you is our guide assumes flat to down 10%. And so I think that would be the takeaway after being down 13% in the first half. So that assumes that the comps get a little bit easier as we go. And again, res and non-res are 85% of the business, so those would be the key drivers.

Noah Merkousko (Senior Research Associate)

All right. That all makes sense. Thanks for taking my questions, and good luck with the rest of the year.

Scott Barbour (President and CEO)

Thanks.

Operator (participant)

There are no further questions at this time. I would like to turn the call back over to Scott Barbour.

Scott Barbour (President and CEO)

Okay, thank you very much, and we appreciate the questions. I look forward to the follow-ups today. We felt very good about the quarter, feel good about raising our guidance. I think we're being prudent in how we're looking at the rest of the year. We announced a big investment today. I think we've been kind of foreshadowing this in the capital spending we've been talking about in this level for the next couple of years. We're very excited about that, very excited about what's going on for us in the Southeast, and in Florida in particular, and Texas. And we continue to, you know, look for the long term and when these markets recover and be ready for that. So with that, we'll sign off. We appreciate it. You all have a great day. Bye-bye.

Operator (participant)

This concludes today's conference call. You may now disconnect.