Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The filing provided is for the quarter and nine months ended December 31, 2020 (fiscal 2021 third quarter), not 2019 Q3 as stated in the request. Comparisons below are with the corresponding 2019 periods. Dollar amounts are in millions unless noted.
Business context and reporting period
ADS designs, manufactures and markets water-management products for construction, infrastructure, agriculture and septic-wastewater applications. Its reportable segments are Pipe, Infiltrator Water Technologies (IWT), and International, with Allied Products & Other also reported. The quarter’s results reflect demand growth across U.S. construction and agriculture markets. ADS notes that sales are typically stronger in the first and second fiscal quarters due to seasonal construction activity.
Financial results
| Metric | Three months ended Dec. 31, 2020 | Three months ended Dec. 31, 2019 | Nine months ended Dec. 31, 2020 | Nine months ended Dec. 31, 2019 |
|---|---|---|---|---|
| Net sales | $486.1 | $393.4 | $1,539.0 | $1,303.0 |
| Gross profit | $168.5 | $123.4 | $562.9 | $207.7 |
| Gross margin | 34.7% | 31.4% | 36.6% | 15.9% |
| Operating income (loss) | $83.0 | $41.0 | $311.6 | $(102.1) |
| Net income (loss) attributable to ADS | $53.8 | $23.3 | $204.5 | $(195.5) |
| Diluted earnings (loss) per share | $0.62 | $0.28 | $2.38 | $(3.31) |
| Adjusted EBITDA and margin | $138.9; 28.6% | $91.3; 23.2% | $472.4; 30.7% | $289.8; 22.2% |
Quarterly sales rose 23.6%; management attributed growth to higher volume across Pipe, IWT and Allied Products, along with pricing and product mix in certain businesses. Gross profit increased 36.6%, supported by volume, favorable pricing and material costs, and operational improvements. Year-to-date sales rose 18.1%; the comparison is affected by IWT having been acquired on July 31, 2019, so the prior-year period included only part of its results. The prior-year nine-month result also included $246.8 million of ESOP special-dividend compensation expense, including $168.6 million in cost of goods sold and $78.1 million in selling, general and administrative expense. This makes the year-to-date profit improvement less comparable to underlying operating trends.
For the nine months, cash provided by operating activities was $448.8 million, capital expenditures were $57.7 million, and company-defined free cash flow was $391.1 million. Cash ended at $224.0 million. Working capital was $386.0 million, down from $428.0 million at March 31, 2020. ADS reported total debt and finance lease obligations of $843.8 million and net debt of $619.8 million at December 31, 2020; its leverage ratio, defined as trailing-twelve-month Adjusted EBITDA divided by net debt, was 1.1x.
Debt included $443.0 million outstanding under the term loan and $350.0 million of 5.0% senior notes due 2027; there were no revolver borrowings. The $350.0 million revolving facility had $339.0 million available after $11.0 million of letters of credit. ADS reported $563.0 million of liquidity, including cash, and said it expected cash, operating cash flow and available borrowing capacity to cover requirements for at least the next twelve months. It repaid $205.3 million of term-loan debt and $100.0 million of revolver debt during the nine months.
Material changes, outlook and risks
- Quarterly operating income increased to $83.0 million from $41.0 million. Interest expense declined to $8.4 million from $13.2 million, primarily due to lower debt levels.
- For the nine months, interest expense declined to $27.8 million from $70.8 million; the prior period included $33.2 million of deferred financing cost write-offs and a $4.2 million debt prepayment penalty, as well as higher debt.
- ADS anticipates fiscal 2021 capital expenditures of approximately $80–$90 million, expected to be funded from operating cash flow. No broader earnings or sales guidance is stated in the provided filing text.
- COVID-19 remained a significant uncertainty. Facilities were operating as essential businesses, but ADS warned that reduced operations or temporary facility closures could occur and that pandemic effects on business and markets remained uncertain.
- ADS began a fiscal 2021 restructuring plan involving headcount reductions and cost elimination. It recorded $1.9 million of plan expenses for the nine months and said it had no current estimate of additional costs or an expected completion date.
- Management and the audit committee’s control disclosure is material: a previously identified material weakness in internal control over financial reporting remained present at December 31, 2020, and the CEO and CFO concluded disclosure controls and procedures were not effective.
- ADS disclosed an internal investigation concerning ADS Mexicana management conduct and product compliance with Mexican laws. It accrued its current estimate of probable losses, described as not material, but said maximum future losses could not be determined and could be material.
- Other key risks include resin and raw-material price and availability, construction-market cyclicality and seasonality, competition, acquisition integration and benefit realization, weather, international and joint-venture exposure, indebtedness, and interest-rate changes. A 1% rate increase on variable-rate debt was estimated to raise annual interest expense by about $6.0 million based on borrowings at December 31, 2020.
- ADS guaranteed 50% of certain South American joint-venture debt; its maximum potential obligation was $11.0 million, with $10.1 million of outstanding principal and letters of credit at period end. The company stated it did not expect required contributions related to the arrangement.
Important facts for investors to verify
- Confirm the intended reporting period: the supplied filing is fiscal 2021 Q3, not 2019 Q3.
- Review the reconciliation and assumptions behind non-GAAP Adjusted EBITDA, free cash flow and leverage, and assess how recurring the adjustments are.
- Separate underlying year-over-year performance from the prior-year ESOP special-dividend charge and the partial-period IWT acquisition comparison.
- Track remediation of the material weakness and any related disclosure-control developments.
- Monitor COVID-19 effects, restructuring costs, raw-material pricing and the expected $80–$90 million fiscal 2021 capital program.
- Assess the potential exposure from the ADS Mexicana investigation and the South American joint-venture guarantee.
- Consider potential dilution from ESOP preferred shares: ADS said conversion following repayment of the ESOP loan, expected no later than March 2023, could increase common shares outstanding by approximately 24%.