Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period note: The supplied filing covers the three and six months ended September 30, 2017—the company’s fiscal second quarter and first half of fiscal 2018. This conflicts with the request metadata of “2016 Q2.” Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate.
Business context
ADS designs, manufactures and markets thermoplastic corrugated pipe and related water-management products, primarily in North and South America and Europe. It reports Domestic and International segments. Results are seasonal, with construction activity and sales generally higher in the first half of the fiscal year. On August 1, 2017, ADS acquired DURASLOT, Inc., a linear surface-drain manufacturer, for approximately $2.3 million.
Financial performance
| Metric | Three months ended Sept. 30, 2017 | Year-over-year change | Six months ended Sept. 30, 2017 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $401.0 million | +11.2% | $759.4 million | +5.7% |
| Gross profit | $89.8 million | −0.8% | $176.5 million | −5.7% |
| Gross margin | 22.4% | 25.1% prior year | 23.2% | 26.0% prior year |
| Operating income | $34.4 million | −20.4% | $65.9 million | −16.2% |
| Net income | $18.0 million | −26.0% | $36.4 million | −16.6% |
| Net income attributable to ADS | $17.9 million | — | $35.6 million | — |
| Basic and diluted EPS | $0.29 | $0.38 prior year | $0.57 basic; $0.57 diluted | $0.68 basic; $0.67 diluted prior year |
| Adjusted EBITDA (non-GAAP) | $66.9 million | +$1.3 million | $127.2 million | −7.4% |
Second-quarter Domestic sales rose 12.9%, primarily on higher pipe volume; International sales were nearly flat. For the six-month period, Domestic sales rose 7.5%, while International sales fell 6.2%. Higher material, labor and overhead costs pressured gross profit; International gross profit was particularly weak, falling 43.5% in the quarter and 36.4% for the half year.
Operating results also included $5.1 million of asset-disposal and exit costs in the quarter and $8.5 million for the half year. The filing reports quarterly and half-year cash dividends of $0.07 and $0.14 per common share, respectively.
Cash flow, liquidity and debt
- Six-month operating cash flow was $28.4 million, versus $45.6 million a year earlier. The filing attributes the decline principally to the timing of receivable collections, partly offset by lower inventories.
- Capital expenditures were $27.0 million, compared with $23.8 million. Free cash flow, a non-GAAP measure defined as operating cash flow less capital expenditures, was $1.4 million, versus $21.8 million.
- Cash at September 30 was $11.2 million. Working capital was $285.8 million, up from $184.8 million at March 31, 2017, primarily reflecting seasonal receivables and lower inventory.
- Reported liquidity was $353.1 million, including cash, $278.9 million available under the U.S. revolving facility after letters of credit, and $50.0 million available under the senior-note shelf. Management said available liquidity and operating cash generation were expected to cover requirements for at least the next twelve months.
- Debt principal was $388.3 million at September 30, including $258.1 million drawn on the revolving facility and $125.0 million of senior notes. Capital lease obligations were an additional $82.9 million on the balance sheet. The company reported compliance with debt covenants.
- In June 2017, ADS amended its credit agreement to provide a $550 million revolving facility, expiring June 2022, and issued $75 million of seven-year senior notes at 3.53%. The revolving facility’s average interest rate was 3.21% at quarter-end. A $100 million, five-year interest-rate swap was put in place.
Material changes, outlook and risks
- Restructuring: ADS began closing three underutilized plants, reducing headcount and eliminating nonessential costs. Six-month restructuring charges were $7.0 million, and a $2.8 million severance liability remained at September 30. The filing describes the charges as one-time but does not quantify expected savings.
- Capital spending outlook: Management anticipated fiscal 2018 capital expenditures of approximately $50–$55 million. The filing provides no specific revenue or earnings guidance.
- Controls and reporting: Management concluded disclosure controls were not effective at September 30 because previously reported material weaknesses remained. Remediation was ongoing across the control environment, leases, inventory, journal entries and reconciliations, ADS Mexicana controls, and revenue cut-off. The company could not say when remediation would be complete.
- Legal and regulatory matters: A shareholder securities class action had been dismissed and affirmed on appeal, but a rehearing petition was pending. The SEC Enforcement Division’s formal investigation into accounting practices continued; ADS said an unfavorable resolution was reasonably possible, losses could be material, and the loss range could not be estimated.
- Key operating and financial risks: Management identified raw-material price and availability, construction-market cyclicality and seasonality, weather, competition, international and joint-venture operations, customer concentration, indebtedness and liquidity, and the possibility of further accounting adjustments or restatements.
- Other items: The six-month effective tax rate was 38.7%, including a $1.0 million discrete tax benefit. A 1% increase in rates on variable-rate debt was estimated to increase annual interest expense by about $1.6 million at quarter-end borrowings.
Most important facts for investors to verify
- Confirm the period: the filing is for September 30, 2017, not 2016 Q2.
- Track whether revenue growth translates into margin and earnings recovery, especially given higher input costs and weak International gross profit.
- Monitor seasonal receivable collections, operating cash flow and free cash flow, alongside planned capital spending.
- Review debt, borrowing availability, covenant headroom and interest-rate exposure as borrowing needs change.
- Assess progress in remediating material weaknesses and any developments or estimated exposure from the SEC investigation.
- Determine whether restructuring produces savings sufficient to offset its charges; the filing does not quantify expected savings.