Advanced Drainage Systems, Inc. — FY2020 Form 10-K
Period clarification: The filing is for the fiscal year ended March 31, 2020, not fiscal 2018. Fiscal Q4 ended March 31, 2020; the filing also reports full-year results.
Business context and reporting period
ADS manufactures thermoplastic pipe and water-management products. It completed its acquisition of Infiltrator Water Technologies (IWT), a septic systems and tank supplier, on July 31, 2019. Fiscal 2020 therefore includes about eight months of IWT operations; comparisons with fiscal 2019 are not fully like-for-like.
Financial and operating performance
| Metric | FY2020 | FY2019 |
|---|---|---|
| Net sales | $1,673.8 million | $1,384.7 million |
| Gross profit / margin | $316.5 million / 18.9% | $327.0 million / 23.6% |
| Operating income (loss) / margin | $(95.3) million / (5.7)% | $129.4 million / 9.3% |
| Net income (loss) | $(191.8) million | $81.5 million |
| Adjusted EBITDA / margin | $361.9 million / 21.6% | $232.0 million / 16.8% |
| Cash from operations | $306.2 million | $151.7 million |
| Capital expenditures / free cash flow | $67.7 million / $238.5 million | $43.4 million / $108.3 million |
Sales increased 20.9%; reported growth included $169.3 million of IWT external sales. Domestic pipe sales rose 9.9%, Allied Products & Other sales rose 13.5%, and International sales declined 7.5%. The filing attributes stronger legacy performance primarily to sales volume, pricing and material-cost benefits.
FY2020 reported results included $246.8 million of non-cash ESOP special-dividend compensation expense, allocated between cost of goods sold ($168.6 million) and SG&A ($78.1 million). Excluding this expense, gross profit was $485.1 million; the company’s defined organic gross profit, which also excludes IWT, was $404.1 million, up 23.6%. Adjusted EBITDA is a non-GAAP measure and includes multiple adjustments.
At March 31, 2020, cash was $174.2 million, working capital $428.0 million, and total debt excluding finance leases approximately $1.100 billion. Including finance leases, reported total debt was $1.162 billion; net debt was $988.0 million and management’s leverage ratio was 2.7x. Revolver availability was $241.5 million after $100 million drawn and $8.5 million of letters of credit, for stated total liquidity of $415.7 million. The company reported compliance with debt covenants.
Fiscal Q4 net sales were $370.8 million, gross profit $108.8 million, net income $3.5 million and net income attributable to ADS $2.3 million. Q4 figures are unaudited.
Material changes versus prior year
- The IWT acquisition expanded the business and increased goodwill and intangible assets; goodwill was $597.8 million, including $495.8 million assigned to IWT.
- Debt rose substantially to fund the acquisition. Financing included a $350 million 5.0% senior-note issuance due 2027, a $700 million term loan, and a $350 million revolving facility; the company also issued $293.6 million net proceeds in common stock.
- Operating cash flow more than doubled, supported by working-capital changes, including improved receivables collections, faster inventory turns and extended payables terms.
- Interest expense increased to $82.7 million, including $33.2 million of deferred financing cost write-offs and a $4.2 million prepayment penalty associated with refinancing.
- The company declared a $1.00-per-share special dividend in addition to quarterly dividends; total declared dividends were $1.36 per share. The special dividend triggered the substantial non-cash ESOP compensation charge.
Outlook, commentary, risks and unusual items
- Management said COVID-19’s effects on revenue, results, liquidity and cash flows could not be reliably estimated. It reported project delays, customer retail closures and temporary factory shutdowns in the affected segment, while manufacturing facilities generally operated as essential businesses. No quantified revenue or earnings guidance is provided in the supplied filing text.
- Management expected fiscal 2021 capital expenditures of approximately $60–65 million and stated that cash, revolver availability and operating cash flow should meet needs for at least 12 months.
- COVID-19-related costs included $4.8 million of accrued pandemic pay for hourly employees; payment was deferred. ADS also deferred its share of Social Security payroll taxes under the CARES Act, with repayment due in 2021 and 2022.
- Goodwill impairment is a notable sensitivity: the IWT reporting unit’s estimated fair value exceeded carrying value by less than 20%; management stated a 150-basis-point increase in the discount rate would put fair value below carrying value. Worse-than-forecast COVID-19 effects could also prompt an impairment assessment.
- Management identified a material weakness in internal control over financial reporting at consolidated joint venture ADS Mexicana, related to its control environment and an internal investigation into management conduct and product compliance. Management and the auditor concluded ICFR was ineffective as of March 31, 2020; remediation remained ongoing. The auditor nevertheless gave an unqualified opinion on the financial statements.
- The ADS Mexicana investigation’s estimated probable losses were described as not material, but the company could not estimate maximum potential future losses, which could be material. The company also guaranteed 50% of certain South American joint-venture debt; its exposure on outstanding debt was about $4.7 million, with a stated maximum potential obligation of $11 million.
- Other key risks include resin-price and supply volatility, construction and agriculture cyclicality, seasonality and weather, customer concentration, acquisition integration, leverage and variable interest rates. The two largest customers represented 24.3% of FY2020 sales.
Most important facts for investors to verify
- Separate underlying operating trends from acquisition contributions and the $246.8 million ESOP compensation charge; review the company’s non-GAAP reconciliations.
- Track IWT integration, realized synergies and performance against acquisition assumptions, particularly the IWT goodwill valuation and impairment cushion.
- Monitor debt, interest costs, liquidity, leverage and covenant headroom as COVID-19 effects and demand evolve.
- Follow remediation and independent testing of the ADS Mexicana material weakness, and any developments in the investigation or related potential liabilities.
- Assess subsequent-period customer demand, resin costs and pass-through pricing, cash conversion, and the continuing impact of COVID-19.