Business context and reporting period
Period clarification: Although the request identifies “2019 Q1,” the supplied filing is Advanced Drainage Systems, Inc.’s unaudited Form 10-Q for the three months ended June 30, 2020—the first quarter of fiscal 2021. Comparative figures are for the three months ended June 30, 2019.
ADS designs, manufactures and markets water-management and drainage products. Its reporting segments are Pipe, Infiltrator Water Technologies, International, and Allied Products & Other. Infiltrator, acquired July 31, 2019, contributed to the current quarter but not the reported prior-year results. Sales are historically stronger in the first and second fiscal quarters.
Financial performance and liquidity
| Metric | Quarter ended June 30, 2020 | Comparable 2019 period |
|---|---|---|
| Net sales | $508.6 million | $413.7 million |
| Gross profit (margin) | $188.5 million (37.1%) | $(62.2) million ((15.0)%) |
| Operating income (margin) | $107.1 million (21.1%) | $(200.3) million ((48.4)%) |
| Net income (loss) attributable to ADS | $70.5 million; $0.83 per share | $(226.4) million; $(4.06) per share |
| Operating cash flow | $133.7 million | $62.8 million |
| Capital expenditures | $10.3 million | $9.7 million |
| Free cash flow (non-GAAP) | $123.4 million | $53.1 million |
| Adjusted EBITDA and margin (non-GAAP) | $159.5 million; 31.4% | $80.3 million; 19.4% |
Management reported sales growth of 22.9%, Adjusted EBITDA growth of 98.6%, operating cash-flow growth of 112.8%, and free-cash-flow growth of 132.4%. The prior-year loss was heavily affected by $246.8 million of ESOP special-dividend compensation, including $168.6 million in cost of goods sold and $78.1 million in SG&A. Consequently, the reported year-over-year earnings comparison is substantially affected by this unusual prior-period charge.
At June 30, 2020, cash was $235.2 million; current assets were $729.4 million and current liabilities $258.9 million. Working capital was $470.5 million. Debt obligations were $1.048 billion, and finance lease obligations totaled $60.2 million; reported total debt including finance leases was $1.106 billion. Net debt including finance leases was $870.4 million. The company had $289.0 million available on its revolver after borrowings and letters of credit, and reported total liquidity of $524.2 million. Management said cash, borrowing availability and operating cash flow should cover working capital, expected capital spending, debt service and preferred dividends for at least 12 months. It reported covenant compliance at quarter-end.
Quarter-end debt included a $646.5 million term loan, $350.0 million of 5.0% senior notes due 2027, and $50.0 million drawn on the $350 million revolver. ADS repaid the remaining $50.0 million revolver balance in July 2020. The balance sheet lists $29.6 million of accrued income taxes at June 30, up from $2.1 million at March 31.
Material changes versus the prior comparable period
- Infiltrator contributed $84.1 million of external sales and $42.0 million of Adjusted EBITDA. Excluding Infiltrator, management reported organic gross-profit growth of 35.4%, citing favorable material costs, operating efficiency and higher sales.
- Pipe sales rose 4.4%; Allied Products & Other sales rose 4.2%. International sales fell 8.9%, mainly due to lower pipe volumes and allied-product sales.
- Interest expense increased by $4.7 million to $10.0 million, primarily reflecting higher debt and acquisition financing.
- Intangible amortization rose to $18.0 million from $1.5 million, principally due to acquired Infiltrator intangible assets.
- Operating cash flow benefited from improved profitability and working capital. Inventory declined to $239.2 million from $282.4 million at March 31, while receivables increased to $241.8 million from $200.0 million.
Outlook, risks, contingencies and unusual items
- COVID-19: Facilities were operating as essential businesses, but ADS warned that the pandemic’s magnitude and duration remained uncertain and that reduced operations or temporary facility closures could occur. The quarter included $0.6 million of COVID-related costs in the Adjusted EBITDA reconciliation.
- Capital spending: Management described approximately $60–$65 million of anticipated capital expenditures, expected to be funded from operations. The filing labels this forecast “fiscal year 2020,” despite reporting first-quarter fiscal 2021; the intended forecast period is unclear from the supplied text.
- Restructuring: A fiscal 2021 plan reduced headcount and targeted nonessential costs. The quarter included $1.1 million of related expenses; ADS gave no estimate of additional costs or expected completion date.
- Internal controls: Management stated that a previously identified material weakness remained present at June 30, 2020 and that disclosure controls and procedures were not effective. The filing also cites remediation of controls related to ADS Mexicana.
- ADS Mexicana investigation: An internal investigation concerns management conduct and certain product compliance matters. ADS accrued its current estimate of probable losses, described as not material, but said maximum potential future losses could be material and could not be determined.
- Other contingencies: ADS guaranteed 50% of the South American joint venture’s debt; its maximum potential obligation was $11.0 million. The company said ordinary-course litigation was not expected to materially affect results or financial position.
- ESOP dilution: ESOP preferred shares are expected to convert to common shares after loan repayment, no later than March 2023. ADS estimated common shares outstanding would be 24% higher after conversion. Current-quarter EPS also reflects the two-class method and preferred dividends.
- Dividend: A quarterly common dividend of $0.09 per share was declared, payable September 15, 2020. No formal revenue or earnings guidance is stated in the supplied filing text.
Most important facts for investors to verify
- Confirm the period: this is a June 30, 2020 filing, not a 2019 Q1 filing.
- Assess underlying performance apart from the prior-year ESOP special-dividend charge and from Infiltrator’s acquisition contribution; review the filing’s non-GAAP reconciliations.
- Verify the intended fiscal year for the stated $60–$65 million capital-expenditure outlook.
- Monitor COVID-19 effects, acquisition integration, raw-material costs, construction-market cyclicality and the company’s leverage and interest expense.
- Track remediation of the material weakness and the possible outcomes of the ADS Mexicana investigation.
- Consider the potential share-count increase from ESOP conversion and related effects on per-share results.