Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the quarter ended December 31, 2018 (the third quarter of fiscal 2019), not 2017 Q3. It compares the three and nine months ended December 31, 2018 with the same periods in 2017. Amounts below are in U.S. dollars; financial statement figures are unaudited.
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, generally stronger in the first and second fiscal quarters; weather can delay construction activity.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2018 | Prior-year quarter | Nine months ended Dec. 31, 2018 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $318.1 million | $320.8 million | $1,112.5 million | $1,080.2 million |
| Gross profit / margin | $72.4 million / 22.8% | $77.8 million / 24.3% | $267.5 million / 24.0% | $254.4 million / 23.5% |
| Operating income / margin | $24.9 million / 7.8% | $27.2 million / 8.5% | $122.7 million / 11.0% | $93.1 million / 8.6% |
| Net income attributable to ADS | $15.8 million | $32.1 million | $76.8 million | $67.7 million |
| Diluted EPS | $0.25 | $0.51 | $1.20 | $1.08 |
| Segment Adjusted EBITDA | $48.4 million | $56.0 million | $195.1 million | $183.2 million |
For the nine months, operating cash flow was $148.0 million (versus $138.9 million), capital expenditures were $31.1 million (versus $35.1 million), and free cash flow, a non-GAAP measure, was $116.9 million (versus $103.8 million). Cash at December 31 was $19.8 million. Working capital was $236.3 million, compared with $237.2 million at March 31, 2018.
At December 31, gross debt principal was $229.4 million, including $126.5 million drawn on the U.S. revolving facility and $100.0 million of senior notes. The filing reports $414.9 million available under the revolving facility, net of letters of credit, and $75.0 million available under the senior-note shelf; total reported liquidity was $509.7 million, including cash. The company said available liquidity and operating cash flow should cover anticipated needs for at least twelve months and reported compliance with debt covenants. Capital lease obligations totaled $86.9 million, current and long-term combined.
Material changes versus prior comparable periods
- Quarterly sales declined 0.8%; nine-month sales increased 3.0%. In the quarter, Domestic sales rose 0.8%, while International sales fell 11.4%. For the nine months, Domestic and International sales grew 2.6% and 5.7%, respectively.
- Quarterly gross profit fell 7.0%, with margin declining 1.5 percentage points. ADS cited higher Domestic material and transportation costs, partly offset by lower labor and overhead costs. Nine-month gross profit increased 5.1% and margin improved 0.5 percentage points.
- Quarterly net income attributable to ADS fell to $15.8 million from $32.1 million. The prior-year quarter included a $7.4 million income tax benefit, while the current quarter recorded $2.5 million tax expense. Nine-month net income attributable to ADS rose 13.4%.
- Nine-month Segment Adjusted EBITDA increased 6.5%. Lower restructuring costs and reduced general and administrative expenses contributed to improved year-to-date operating results.
- Debt principal declined from $300.8 million at March 31, 2018 to $229.4 million at December 31, 2018. During the nine months, ADS paid down $25 million of senior notes and had net repayments on its revolving facility.
Outlook, commentary, risks and unusual items
- ADS anticipates fiscal 2019 capital expenditures of approximately $40–$50 million, primarily for facility expansions, equipment, recycled-resin initiatives and technology. It did not provide earnings or revenue guidance in the supplied filing.
- The fiscal 2018 restructuring plan continues through fiscal 2019. ADS has no estimated completion date or total cost estimate; nine-month fiscal 2019 restructuring expense was $1.5 million. Management cautioned that restructuring costs are one-time expenses and do not indicate future costs or savings.
- Management began incurring professional fees for strategic growth and operational improvement initiatives in the quarter. These include market assessments, acquisition strategy and manufacturing-network reviews.
- Quarterly results included a $1.8 million discrete tax benefit from releasing tax reserves; the nine-month effective tax rate was 26.6%, versus 18.6% a year earlier. Tax Act accounting was finalized during the quarter, with no material adjustments to prior provisional amounts.
- ADS acquired the remaining 35% of BaySaver for $8.8 million, making it wholly owned. It also exchanged its Tigre-ADS USA interest in April 2018 for release from existing debt guarantees.
- A shareholder securities class action, previously dismissed and affirmed on appeal, returned to the District Court after a November 2018 motion seeking relief from final judgment and leave to amend. ADS opposed the motion; the company said an unfavorable outcome is reasonably possible, could be material, and cannot currently be estimated. The SEC investigation was settled in July 2018; the $1.0 million penalty was paid.
- Key risks include resin and transportation cost volatility, construction-market cyclicality and weather, competition, international and joint-venture exposures, leverage, interest and foreign-exchange movements, and potential further financial-statement revisions. ADS guarantees 50% of the South American joint venture’s facility; its maximum potential obligation was $11.0 million. The filing also notes a $23.5 million committed resin-purchase cost for January–December 2019.
- The filing states that disclosure controls were effective as of December 31, 2018 and that there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the reporting-period mismatch: the supplied document is fiscal 2019 Q3, despite the request specifying 2017 Q3.
- Assess whether the quarterly gross-margin decline and higher material and transportation costs persist, and compare performance by segment.
- Review the full debt agreements, covenant headroom, interest-rate exposure and the distinction between committed borrowing capacity and cash on hand.
- Track restructuring costs and realized savings, planned capital expenditures, and whether the strategic initiatives produce measurable returns.
- Monitor the shareholder litigation motion and any subsequent estimate or disclosure of potential losses.
- Consider potential dilution from the ESOP preferred shares: the filing says conversion could increase common shares outstanding by approximately 31%, with conversion expected after repayment of the ESOP loan no later than March 2023.