Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The supplied metadata says “2018 Q2,” but this filing covers the quarter and six months ended September 30, 2019—ADS fiscal 2020 Q2 and first half. Comparisons below are against the corresponding 2018 periods. Amounts are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context and reporting period
ADS designs, manufactures and markets thermoplastic pipe and water-management products in the Americas and Europe. On July 31, 2019, it acquired Infiltrator Water Technologies, a provider of septic wastewater products. Infiltrator’s results are included from the acquisition date; its purchase accounting remains preliminary. The business is seasonal, with construction activity generally stronger in the first half of the fiscal year.
Key financial metrics
| Metric | Three months ended Sep. 30, 2019 | Six months ended Sep. 30, 2019 |
|---|---|---|
| Net sales | $495.9 million; +22.0% | $909.6 million; +14.5% |
| Gross profit / margin | $146.5 million / 29.5% | $84.4 million / 9.3% |
| Operating income (loss) | $57.2 million | $(143.1) million |
| Net income (loss) | $8.5 million; ADS-attributable $7.6 million | $(219.0) million; ADS-attributable $(218.8) million |
| Diluted EPS | $0.10 | $(3.86) |
| Adjusted EBITDA (non-GAAP) | $118.2 million; margin 23.8% | $198.5 million; margin 21.8% |
| Operating cash flow / free cash flow (non-GAAP) | Not separately reported for the quarter | $171.7 million / $146.1 million |
Quarterly sales growth reflected higher U.S. pipe and Allied Products & Other sales and $52.7 million of external Infiltrator sales; International sales declined 13.6%. For the six-month comparison, gross profit was heavily affected by a $246.8 million non-cash ESOP special-dividend compensation charge, including $168.6 million in cost of goods sold and $78.1 million in selling, general and administrative expenses. Excluding that charge, management reported gross profit growth, but the filing’s adjusted measures are non-GAAP.
At September 30, cash was $54.2 million, current assets $564.2 million and current liabilities $241.3 million. ADS reported $395.7 million of liquidity, including $341.5 million of available revolving credit after letters of credit. Total debt was $1.052 billion, excluding finance leases; total finance lease liabilities were $75.3 million. Reported long-term debt was $1.043 billion. The company said it was in compliance with debt covenants.
Six-month investing cash outflow was $1.114 billion, primarily reflecting $1.089 billion paid for the Infiltrator acquisition, net of acquired cash. Financing cash inflow was $988.1 million. Capital expenditures were $25.6 million; the company anticipated fiscal 2020 capital expenditures of approximately $85–$100 million.
Material changes versus comparable periods
- Quarterly sales increased $89.4 million; quarterly net income fell from $29.4 million to $8.5 million. Gross margin rose to 29.5% from 23.5%, with management citing sales mix and favorable material costs.
- Six-month sales increased $115.2 million, but results shifted from $63.0 million net income to a $219.0 million net loss, chiefly because of the ESOP special-dividend charge and acquisition-related financing and expenses.
- Quarterly interest expense rose to $52.3 million from $4.5 million. The six-month amount was $57.6 million versus $8.3 million; management attributed much of the increase to $33.2 million of deferred financing cost write-offs, a $4.2 million prepayment penalty, higher debt and interest-rate changes.
- ADS completed an underwritten offering of 10.35 million shares, receiving $293.6 million net, and issued $350 million of 5.0% senior notes due 2027. These transactions and new secured borrowings financed the acquisition and refinanced prior debt, materially increasing debt and common shares outstanding.
- Reported goodwill rose to $669.8 million and net intangible assets to $501.6 million, principally reflecting the acquisition. The preliminary allocation included $567.0 million goodwill and $475.0 million identifiable intangible assets.
Outlook, risks and unusual items
- Management stated that cash, operating cash generation and committed borrowing availability should cover working capital, planned capital expenditures, debt service and preferred dividends for at least the next 12 months. No sales or earnings guidance was provided in the supplied filing text.
- Management cited strong U.S. construction and agriculture end markets, while International sales were weaker, particularly in Mexico and Canada. Resin costs, construction cyclicality, weather and seasonality may affect results.
- Acquisition risks include integration challenges, retention of key staff, realization of expected synergies and possible changes to preliminary purchase accounting. Infiltrator contributed $52.7 million of sales and $6.9 million of pretax income after acquisition.
- Debt risks include substantial leverage, variable-rate exposure, restrictive covenants and refinancing or cash-flow risks. The $350 million notes bear 5.0% interest and mature in 2027; the $700 million term loan matures in 2026. The secured facility includes a leverage covenant triggered under specified revolving-credit usage conditions.
- An internal investigation into ADS Mexicana management conduct and product compliance resulted in an accrual for estimated probable losses. The company said the accrual was not material but could not quantify maximum potential future losses, which could be material.
- Management said a previously identified material weakness in internal control over financial reporting remained present at September 30, 2019; CEO and CFO concluded disclosure controls were not effective. The filing also identifies risks related to acquisition integration and the control environment at ADS Mexicana.
- The prior stockholder securities class action was concluded after the court denied the plaintiff’s motion and no appeal was filed. Other ordinary-course proceedings were not believed by the company to have a material adverse effect.
Important facts for investors to verify
- Reconcile the reporting-period metadata: this is a September 30, 2019 filing, not a 2018 Q2 filing.
- Track the final Infiltrator purchase-price allocation, integration costs, realized synergies and acquired-business performance.
- Assess underlying profitability separately from the ESOP special-dividend charge, acquisition transaction costs and debt-extinguishment charges; review the company’s non-GAAP reconciliations.
- Monitor debt levels, interest expense, variable-rate exposure, covenant headroom, liquidity and the effect of new share issuance and potential ESOP share conversion.
- Follow remediation of the material weakness and updates on the ADS Mexicana investigation and possible product-related liabilities.
- Confirm whether fiscal 2020 capital expenditures remain within the stated $85–$100 million estimate and whether operating cash flow supports planned investment and debt service.