Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the quarter and nine months ended December 31, 2019 (fiscal 2020 Q3), not 2018 Q3 as stated in the request metadata. Comparative figures are for the periods ended December 31, 2018. Financial amounts below are in millions of dollars unless noted.
Business context and reporting period
ADS designs, manufactures and sells water-management products, including corrugated plastic pipe. Its reporting segments are Pipe, Infiltrator Water Technologies (IWT), International, and Allied Products & Other. ADS acquired IWT on July 31, 2019; its results are included from that date. The company notes that sales are generally seasonal, with construction activity affected by weather.
Financial results and liquidity
| Metric | Three months ended Dec. 31, 2019 | Three months ended Dec. 31, 2018 | Nine months ended Dec. 31, 2019 | Nine months ended Dec. 31, 2018 |
|---|---|---|---|---|
| Net sales | $393.4 | $318.1 | $1,303.0 | $1,112.5 |
| Gross profit | $123.4 | $72.4 | $207.7 | $267.5 |
| Income (loss) from operations | $41.0 | $24.9 | $(102.1) | $122.7 |
| Net income (loss) | $23.7 | $16.6 | $(195.3) | $79.6 |
| Adjusted EBITDA (non-GAAP) | $91.3 | $48.4 | $289.8 | $195.1 |
| Adjusted EBITDA margin (non-GAAP) | 23.2% | 15.2% | 22.2% | 17.5% |
- Quarterly sales rose 23.7%; IWT contributed $58.5 of external sales. Management attributed growth in legacy businesses to U.S. construction and agriculture demand, while International sales were slightly lower year over year.
- Quarterly gross margin was 31.4%, versus 22.8%; operating margin was 10.4%, versus 7.8%. Quarterly net income attributable to ADS was $23.3, or $0.28 per diluted share, versus $15.8, or $0.25 per share.
- Nine-month reported results include $246.8 of noncash ESOP special-dividend compensation, including $168.6 in cost of goods sold and $78.1 in selling, general and administrative expenses. The charge drove the reported net loss; it should not be mistaken for ordinary operating performance. The company also reported $22.6 of acquisition transaction costs and $33.2 of deferred financing cost write-offs, as well as a $4.2 debt prepayment penalty.
- Nine-month operating cash flow was $296.3, capital expenditures were $46.3, and free cash flow (non-GAAP) was $250.0. The filing attributes improved operating cash flow to profitability and working-capital changes.
- At December 31, cash was $98.3 and working capital was $303.7. Debt obligations were $1,001.7 and finance lease obligations were $70.0; net debt, including finance leases and less cash, was $970.9. Management reported a 3.0x leverage ratio.
- Revolver availability was $341.5 after $8.5 of letters of credit; total stated liquidity, including cash, was $439.8. Management believes cash, available facilities and operating cash flow will meet expected needs for at least 12 months.
Material changes versus comparable periods
- The July acquisition added a new business and substantially expanded assets, goodwill and intangibles. Preliminary consideration transferred was $1,147.2; the preliminary allocation included $565.1 of goodwill and $485.0 of identifiable intangible assets. Valuations remained subject to adjustment during the measurement period.
- Quarterly sales growth reflected IWT and increases in Pipe and Allied Products & Other. For the nine months, International sales fell 10.0%, primarily from lower International Pipe volume.
- The company raised acquisition financing, issued $350.0 of 5.0% senior notes due 2027, completed a $293.6 net common-stock offering, and established a $700.0 term loan and $350.0 revolving facility. These transactions materially increased debt and interest expense compared with the prior year.
- The company paid a $1.00-per-share special dividend and quarterly dividends in June 2019. The ESOP used some proceeds to repay its loan, triggering the large noncash compensation charge. The September stock offering issued 10.35 million shares.
Outlook, risks and unusual items
- No specific sales or earnings guidance is provided in the filing. ADS expected fiscal 2020 capital expenditures of approximately $75–$85 and said it expected to fund them from operating cash flow.
- The debt facilities are secured by substantially all company assets and include restrictive covenants. A financial maintenance test applies if revolving-credit exposure exceeds specified levels; ADS reported covenant compliance at December 31, 2019. Variable-rate debt exposes the company to interest-rate risk.
- Management highlights acquisition integration, realizing synergies, employee retention and potential unexpected costs or liabilities as risks. IWT results in the period are only for the post-acquisition period, so reported growth is not a like-for-like comparison.
- An internal investigation into ADS Mexicana management conduct and product compliance is ongoing. The company accrued its current estimate of probable losses, which it said was not material, but could not determine maximum future exposure, which could be material.
- Management concluded that a previously identified material weakness in internal control over financial reporting remained present at December 31, 2019; disclosure controls and procedures were therefore not effective. The filing also identifies remediation of controls, including at ADS Mexicana, as a risk.
- Other key risks include resin and raw-material prices, construction-market cyclicality and weather, competition, international and joint-venture operations, product warranties, legal matters, and the company’s ability to service and refinance its increased debt.
Important facts for investors to verify
- Confirm the reporting-period mismatch: this is a December 31, 2019 filing, not a 2018 Q3 filing.
- Assess underlying performance separately from the $246.8 ESOP charge, acquisition costs, inventory step-up and debt-extinguishment expenses; review the company’s non-GAAP reconciliations and limitations.
- Track IWT integration, final purchase-price allocation, realized synergies and comparable organic growth as full-period results become available.
- Review debt maturities, interest-rate exposure, covenant headroom, cash generation and the implications of the $970.9 net debt measure.
- Monitor the ADS Mexicana investigation and any developments affecting potential product, warranty or legal liabilities.
- Follow remediation of the material weakness and the expected effect of ESOP preferred-share conversion, which the filing says could increase common shares outstanding by about 28% after conversion.