Advanced Drainage Systems, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the three months ended June 30, 2017 (fiscal 2018 Q1), not 2016 Q1. Comparative figures are for the three months ended June 30, 2016. Amounts are in U.S. dollars; financial figures below are in millions unless stated otherwise.
Business context and reporting period
ADS designs, manufactures and markets thermoplastic corrugated pipe and related water-management products. It reports Domestic and International segments. Results are seasonal, with construction activity typically stronger in the first half of the fiscal year. The filing is unaudited and should be read with the company’s fiscal 2017 Form 10-K.
Key financial results
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $358.4 | $357.6 |
| Gross profit / margin | $86.7 / 24.2% | $96.6 / 27.0% |
| Operating income / margin | $31.5 / 8.8% | $35.5 / 9.9% |
| Net income | $18.5 | $19.4 |
| Net income attributable to ADS | $17.7 | $18.3 |
| GAAP diluted EPS | $0.28 | $0.29 |
| Adjusted EBITDA (non-GAAP) | $60.3 | $71.8 |
| Operating cash flow | $(16.5) | $(0.1) |
| Capital expenditures | $17.9 | $12.6 |
| Free cash flow (non-GAAP) | $(34.5) | $(12.7) |
Cash was $8.7 at June 30, 2017. Working capital was $267.0, compared with $184.8 at March 31, 2017. Total debt obligations, excluding capital leases, were $408.6, versus $350.4 at fiscal year-end; capital lease obligations totaled $83.5. ADS reported $319.5 of liquidity, comprising cash, available revolving-credit capacity and unused senior-note capacity, and stated it expected available resources and operating cash flow to cover needs for at least 12 months. The company reported compliance with debt covenants at quarter-end.
Material changes versus prior comparable period
- Sales were nearly flat, up 0.2%. Domestic sales increased 2.2%, while International sales declined 13.3%.
- Gross profit fell 10.2%; gross margin contracted 2.8 percentage points. Management attributed the domestic decline chiefly to higher material costs ($4.5) and labor and overhead costs ($1.4); international weakness reflected lower sales and mix/pricing.
- Adjusted EBITDA declined 15.9%. Net income attributable to ADS fell 2.9%, while diluted EPS decreased by $0.01.
- Operating cash use increased substantially, mainly reflecting the timing of receivable collections; receivables increased $46.5 from March 31. Capital spending also rose.
- Domestic Allied Products sales grew 4.3%; International pipe and Allied Products sales declined 13.4% and 12.9%, respectively.
Outlook, commentary, risks and unusual items
- No revenue or earnings guidance is provided. ADS anticipates fiscal 2018 capital expenditures of approximately $55–$60 million, expected to be funded with operating cash.
- Two manufacturing facilities are scheduled to close in fiscal 2018. The quarter included $3.4 of disposal and exit costs, including about $2.0 of accelerated depreciation and $0.6 of severance.
- A June refinancing expanded the revolving credit facility to $550 million, with a June 2022 expiration. ADS issued $75 million of seven-year senior notes at 3.53%; total senior notes outstanding were $150 million. A $100 million five-year interest-rate swap was entered into to mitigate rate volatility.
- Cash from operations and capital spending were affected by seasonal working-capital needs. The company cited raw-material price and availability, construction cyclicality and seasonality, weather, competition, international and joint-venture exposure, and indebtedness among its risks. A 1 percentage-point increase in rates on variable-rate debt was estimated to raise annual interest expense by about $1.5 million at quarter-end borrowings.
- The SEC Enforcement Division’s formal investigation into accounting practices remained ongoing. ADS said an unfavorable resolution was reasonably possible, losses could be material, and it could not estimate a range. A securities class action had been dismissed with prejudice, but the plaintiff’s appeal was pending.
- Management said previously identified material weaknesses in internal control over financial reporting remained present at June 30; disclosure controls and procedures were therefore deemed ineffective. Remediation efforts continued.
- The quarter’s effective tax rate was 34.8%, versus 42.1%, with a $1.0 discrete tax benefit related to release of tax reserves. Lower reported stock-compensation expense partly reflects modification of awards and reclassification from liability to equity classification; prior-year expense included liability-award mark-to-market effects. Restatement-related costs were also lower, although investigation- and litigation-related costs continued.
- On August 1, 2017, after quarter-end, ADS acquired DURASLOT, Inc. for $2.3 million. A $0.07-per-share quarterly dividend was declared, payable September 15, 2017.
Most important facts for investors to verify
- Progress and potential financial consequences of the SEC investigation, related litigation appeal, and remediation of material weaknesses.
- Whether margins and adjusted EBITDA stabilize after higher material costs and weaker International sales; assess the drivers and persistence of the reported cost changes.
- Receivables collection, seasonal working-capital requirements, and cash generation relative to the $55–$60 million fiscal-year capital-spending plan.
- Debt, interest-rate exposure, covenant headroom and liquidity following the refinancing; note the filing does not provide a clear covenant headroom calculation.
- Costs and operational effects of the two facility closures, and integration or contribution from the post-quarter DURASLOT acquisition.