Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the unaudited quarter ended June 30, 2019 (fiscal 2020 first quarter), not 2018 Q1 as stated in the request metadata. Unless otherwise noted, figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Business context and reporting period
ADS designs, manufactures and markets thermoplastic corrugated pipe and related water-management products. It reports Domestic and International segments. Sales are seasonal, typically stronger in the first half of its fiscal year, and can be affected by weather and construction activity.
Financial results and liquidity
| Metric | Quarter ended June 30, 2019 | Prior-year quarter |
|---|---|---|
| Net sales | $413.7 million | $387.8 million |
| Gross profit (margin) | $(62.2) million (negative 15.0%) | $99.7 million (25.7%) |
| Operating income (loss) | $(200.3) million | $51.1 million |
| Net income (loss) attributable to ADS | $(226.4) million | $32.3 million |
| Diluted earnings (loss) per share | $(4.06) | $0.51 |
| Adjusted EBITDA, non-GAAP | $80.3 million | $75.1 million |
| Operating cash flow | $62.8 million | $9.8 million |
| Free cash flow, non-GAAP | $53.1 million | $3.0 million |
- Revenue rose 6.7%. Domestic sales increased 9.3% to $374.4 million; International sales declined 13.3% to $39.3 million, primarily reflecting lower international pipe volume.
- The reported loss was driven chiefly by $246.8 million of non-cash ESOP special-dividend compensation expense: $168.6 million was recorded in cost of goods sold and $78.1 million in selling, general and administrative expenses. The charge substantially distorts reported margins and earnings. Adjusted EBITDA, which excludes this charge and other adjustments, increased about 6.9%; it is a non-GAAP measure, not a substitute for GAAP results.
- The effective tax rate was negative 10.9%, versus 29.7% a year earlier. A $60.7 million discrete tax expense associated with the ESOP dividend-related share allocation materially affected the rate.
- Operating cash flow increased year over year; management cited working-capital changes. Inventory fell $34.3 million from March 31, while receivables rose $44.8 million. Capital expenditures were $9.7 million.
- At June 30, cash was $9.4 million and working capital was $236.7 million. Gross debt obligations were approximately $258.4 million, excluding $79.1 million of finance lease liabilities. The company reported $469.8 million of liquidity under its then-existing arrangements, including cash and available borrowing capacity.
- Total assets were $1.068 billion. Total current liabilities were $244.0 million.
Material changes and unusual items
- The Board approved a $1.00-per-share special cash dividend and a $0.09 quarterly dividend, paid June 14; the filing reports total dividend payments of $81.6 million. ESOP-held dividend proceeds were used to repay $12.0 million of the ESOP loan, resulting in allocation of approximately 11.6 million preferred shares to participants and the related compensation charge.
- Domestic pipe sales increased 8.3% and Domestic Allied Products sales increased 11.7%. International pipe sales declined 15.0% and International Allied Products declined 7.8%.
- ADS adopted the new lease standard on April 1, 2019, recording $13.3 million of additional lease liabilities and corresponding right-of-use assets; adoption did not affect reported earnings or cash flows.
- On July 31, 2019, after quarter-end, ADS completed its acquisition of Infiltrator Water Technologies for preliminary net cash consideration of $1.080 billion. Preliminary purchase accounting included $578.7 million of goodwill and $475.0 million of intangible assets; valuations remain subject to adjustment.
- The acquisition and refinancing were funded through new senior secured facilities providing for a term loan of up to $1.3 billion and a revolving facility of up to $350 million. These facilities replaced the former PNC credit agreement and Senior Notes and also funded repayment of Infiltrator debt and transaction costs. The term loan matures in seven years and the revolver in five years. The agreement is secured by liens on substantially all of the company’s and certain guarantors’ assets, and includes financial and other covenants.
Outlook, risks and contingencies
- Management expects fiscal 2020 capital expenditures of approximately $55 million to $65 million, primarily for expansions, equipment, recycled-resin initiatives and technology; it expects to fund these from operating cash flow.
- Management stated that cash, financing availability and operating cash flow should meet working-capital, capital expenditure, debt-service and preferred-dividend needs for at least the next 12 months. This statement predates the acquisition financing and should be considered alongside the substantially larger post-acquisition debt burden.
- Key risks include integrating Infiltrator and achieving anticipated synergies; increased leverage and compliance with new credit covenants; construction-market cyclicality and seasonality; weather; resin and other input costs; competition; international and joint-venture risks; and the ability to pass cost increases to customers.
- ADS disclosed that a previously identified material weakness in internal control over financial reporting remained unresolved as of June 30, 2019. Management concluded disclosure controls and procedures were not effective as of that date.
- An internal investigation into ADS Mexicana management conduct and certain product compliance matters was ongoing. The company accrued an estimate of probable losses that it described as not material, but said maximum potential future losses could be material and could not be estimated.
- A shareholder securities lawsuit’s renewed motion was denied in July 2019. The company nevertheless said an unfavorable outcome remained reasonably possible, that potential losses could be material, and that it could not estimate a loss range.
- The filing reports compliance with debt covenants as of June 30, 2019. It also identifies a South American joint-venture debt guarantee with a maximum potential obligation of $11.0 million.
Important facts for investors to verify
- Post-acquisition debt balances, borrowing costs, covenant headroom and liquidity after the Infiltrator transaction and refinancing.
- Final acquisition purchase-price allocation, Infiltrator’s contribution to consolidated results, and whether anticipated synergies and integration benefits are realized.
- Progress in remediating the material weakness in financial reporting controls, including controls at ADS Mexicana.
- Developments in the ADS Mexicana investigation and any resulting product, warranty, regulatory or legal exposure.
- Underlying operating performance and cash generation apart from the unusual ESOP compensation charge, including international sales trends and working-capital movements.
- The eventual effect of ESOP preferred-share conversion on common shares outstanding and per-share results.