UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 001-36557
ADVANCED DRAINAGE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware
51-0105665
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
4640 Trueman Boulevard, Hilliard, Ohio 43026
(Address of Principal Executive Offices, Including Zip Code)
(614) 658-0050
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
Smaller Reporting Company
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 31, 2018, the registrant had 57,137,277 shares of common stock outstanding. The shares of common stock trade on the New York Stock Exchange under the ticker symbol “WMS.” In addition, as of October 31, 2018, 300,876 shares of unvested restricted common stock were outstanding and 22,808,013 shares of ESOP, preferred stock, convertible into 17,543,923 shares of common stock, were outstanding. As of October 31, 2018, 74,982,076 shares of common stock were outstanding, inclusive of outstanding shares of unvested restricted common stock and on an as-converted basis with respect to the outstanding shares of ESOP preferred stock.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
Page
Condensed Consolidated Balance Sheets as of September 30, 2018 and March 31, 2018
1
Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2018 and 2017
2
Condensed Consolidated Statements of Comprehensive Income for the three and six months ended September 30, 2018 and 2017
3
Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2018 and 2017
4
Condensed Consolidated Statements of Stockholders’ Equity and Mezzanine Equity for the six months ended September 30, 2018 and 2017
5
Notes to the Condensed Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
36
Item 4.
Controls and Procedures
PART II. OTHER INFORMATION
Legal Proceedings
38
Item 1A.
Risk Factors
Unregistered Sale of Equity Securities
39
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
40
Signatures
41
i
Table of Contents
ADVANCED DRAINAGE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (In thousands, except par value)
September 30,
2018
March 31,
ASSETS
Current assets:
Cash
$
17,612
17,587
Receivables (less allowance for doubtful accounts of $7,174 and
$6,826, respectively)
236,968
171,961
Inventories
247,161
263,792
Other current assets
7,219
5,113
Total current assets
508,960
458,453
Property, plant and equipment, net
402,238
399,381
Other assets:
Goodwill
103,002
103,017
Intangible assets, net
40,693
44,437
Other assets
39,342
37,954
Total assets
1,094,235
1,043,242
LIABILITIES, MEZZANINE EQUITY AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of debt obligations
26,395
26,848
Current maturities of capital lease obligations
22,970
22,007
Accounts payable
95,861
105,521
Other accrued liabilities
65,116
60,560
Accrued income taxes
10,455
6,307
Total current liabilities
220,797
221,243
Long-term debt obligations (less unamortized debt issuance costs of $2,641 and $3,028,
respectively)
252,524
270,900
Long-term capital lease obligations
62,283
59,963
Deferred tax liabilities
35,750
32,304
Other liabilities
24,721
25,023
Total liabilities
596,075
609,433
Commitments and contingencies (see Note 10)
Mezzanine equity:
Redeemable convertible preferred stock: $0.01 par value; 47,070 shares authorized;
44,170 shares issued; 22,810 and 23,300 shares outstanding, respectively
285,117
291,247
Deferred compensation – unearned ESOP shares
(185,376
)
(190,168
Redeemable noncontrolling interest in subsidiaries
8,968
8,471
Total mezzanine equity
108,709
109,550
Stockholders’ equity:
Common stock; $0.01 par value: 1,000,000 shares authorized; 57,525 shares issued;
57,084 and 56,476 shares outstanding, respectively
11,433
11,426
Paid-in capital
381,475
364,908
Common stock in treasury, at cost
(9,035
(8,277
Accumulated other comprehensive loss
(22,843
(21,247
Retained earnings (deficit)
11,631
(39,214
Total ADS stockholders’ equity
372,661
307,596
Noncontrolling interest in subsidiaries
16,790
16,663
Total stockholders’ equity
389,451
324,259
Total liabilities, mezzanine equity and stockholders’ equity
See accompanying Notes to Condensed Consolidated Financial Statements.
- 1 -
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands, except per share data)
Three Months Ended
Six Months Ended
2017
Net sales
406,555
401,049
794,402
759,408
Cost of goods sold
311,182
311,248
599,338
582,868
Gross profit
95,373
89,801
195,064
176,540
Operating expenses:
Selling
24,731
24,346
48,896
47,445
General and administrative
21,584
23,887
42,966
50,563
Loss on disposal of assets and costs from exit and
disposal activities
324
5,121
1,428
8,544
Intangible amortization
1,985
2,015
3,969
4,059
Income from operations
46,749
34,432
97,805
65,929
Other expense:
Interest expense
4,531
5,055
8,333
9,534
Derivative loss (gains) and other expense (income), net
94
(2,539
(720
(3,493
Income before income taxes
42,124
31,916
90,192
59,888
Income tax expense
12,194
13,437
26,478
23,183
Equity in net loss of unconsolidated affiliates
558
520
691
272
Net income
29,372
17,959
63,023
36,433
Less: net income attributable to noncontrolling interest
702
96
2,073
828
Net income attributable to ADS
28,670
17,863
60,950
35,605
Weighted average common shares outstanding:
Basic
56,929
55,269
56,776
55,286
Diluted
57,558
55,893
57,374
55,953
Net income per share:
0.45
0.29
0.97
0.57
0.96
Cash dividends declared per share
0.08
0.07
0.16
0.14
- 2 -
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)
Currency translation gain (loss)
2,837
2,558
(1,975
5,985
Comprehensive income
32,209
20,517
61,048
42,418
Less: other comprehensive gain (loss) attributable to
noncontrolling interest
996
(239
(379
612
Total comprehensive income attributable to ADS
30,511
20,660
59,354
40,978
- 3 -
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
35,363
37,941
Deferred income taxes
3,221
(801
Loss on disposal of assets and costs from exit and disposal activities
ESOP and stock-based compensation
11,760
8,709
Amortization of deferred financing charges
387
550
Fair market value adjustments to derivatives
(901
(590
Other operating activities
(1,342
12,078
Changes in working capital:
Receivables
(64,649
(111,463
16,378
46,205
Prepaid expenses and other current assets
(2,116
256
Accounts payable, accrued expenses, and other liabilities
(5,082
(9,745
Net cash provided by operating activities
58,161
28,389
Cash Flows from Investing Activities
Capital expenditures
(19,299
(27,035
Cash paid for acquisitions, net of cash acquired
—
(1,990
Other investing activities
429
(411
Net cash used in investing activities
(18,870
(29,436
Cash Flows from Financing Activities
Proceeds from Revolving Credit Facility
250,100
335,950
Payments on Revolving Credit Facility
(243,400
(273,650
Payments on Term Loan
(72,500
Proceeds from Senior Notes
75,000
Payments on Senior Notes
(25,000
Debt issuance costs
(2,268
Payments of notes, mortgages and other debt
(465
(1,450
Payments on capital lease obligations
(11,619
(12,217
Cash dividends paid
(11,618
(8,673
Proceeds from exercise of stock options
3,473
100
Repurchase of common stock
(7,947
Other financing activities
(561
(1,171
Net cash (used in) provided by financing activities
(39,090
6,174
Effect of exchange rate changes on cash
(176
(394
Net change in cash
25
4,733
Cash at beginning of period
6,450
Cash at end of period
11,183
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes
18,331
22,169
Cash paid for interest
8,032
9,424
Non-cash operating, investing and financing activities:
Acquisition of property, plant and equipment under capital lease and incurred
lease obligations
11,860
15,196
Balance in accounts payable for the acquisition of property, plant and equipment
3,152
1,375
Payable recorded for business acquisition
300
- 4 -
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND MEZZANINE EQUITY
Common
Stock
Paid
-In
Stock in
Treasury
Accumulated
Other
Compreh-ensive
Retained (Deficit)
Total
ADS
Stock-
holders’
Non-
controlling
Interest in
Redeemable
Convertible
Preferred Stock
Deferred
Compensation -
Unearned
ESOP Shares
Mezzanine
Shares
Amount
Capital
Loss
Earnings
Equity
Subsidiaries
Balance at April 1, 2017
153,560
12,393
755,787
98,222
(436,984
(24,815
(83,678
222,703
14,907
237,610
24,225
302,814
15,863
(198,216
8,227
112,825
373
35,978
455
Other comprehensive income
5,373
Redeemable convertible
preferred stock dividends
(888
Common stock dividends
($0.14 per share)
(7,785
Allocation of ESOP shares to
participants for compensation
1,185
(322
4,024
Exercise of common stock
options
58
(2
42
Restricted stock awards
1,060
(78
349
1,409
Reclassification of liability-
classified awards
13,714
Equity classified stock-based
compensation expense before
related tax effects
2,093
ESOP distribution in
common stock
4,651
1,753
6,404
(512
(6,404
Common stock repurchases
400
Balance at September 30, 2017
778,548
98,148
(442,787
(19,442
(56,746
271,966
15,892
287,858
23,713
296,410
15,541
(194,192
8,682
110,900
Balance at April 1, 2018
56,889
413
23,300
15,219
1,241
62,191
832
Other comprehensive loss
(1,596
(975
($0.16 per share)
(9,130
Dividend paid to
holder
(735
(335
Allocation of ESOP shares
to participants for
compensation
3,597
(383
4,792
242
26
(704
2,771
19
1,803
(54
1,750
1,568
375
6,126
6,130
(490
(6,130
Balance at September 30, 2018
57,525
441
22,810
14,836
- 5 -
Advanced Drainage Systems, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1.
BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business - Advanced Drainage Systems, Inc. and subsidiaries (collectively referred to as “ADS” or the “Company”), incorporated in Delaware, designs, manufactures and markets high performance thermoplastic corrugated pipe and related water management products, primarily in North and South America and Europe. ADS’s broad product line includes corrugated high density polyethylene (or “HDPE”) pipe, polypropylene (or “PP”) pipe and related water management products.
The Company is managed based primarily on the geographies in which it operates and reports results of operations in two reportable segments: Domestic and International.
Historically, sales of the Company’s products have been higher in the first and second quarters of each fiscal year due to favorable weather and longer daylight conditions accelerating construction activity during these periods. Seasonal variations in operating results may also be impacted by inclement weather conditions, such as cold or wet weather, which can delay projects.
Basis of Presentation - The Company prepares its Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Condensed Consolidated Balance Sheet as of March 31, 2018 was derived from audited financial statements included in the Annual Report on Form 10-K for the year ended March 31, 2018 (“Fiscal 2018 Form 10-K”). The accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments, of a normal recurring nature, necessary to present fairly its financial position as of September 30, 2018 and the results of operations and cash flows for the three and six months ended September 30, 2018. The interim Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements, including the notes thereto, filed in the Company’s Fiscal 2018 Form 10-K.
Principles of Consolidation - The Condensed Consolidated Financial Statements include the Company, its wholly-owned subsidiaries, its majority-owned subsidiaries and variable interest entities (“VIEs”) of which the Company is the primary beneficiary. The Company uses the equity method of accounting for equity investments where it exercises significant influence but does not hold a controlling financial interest. Such investments are recorded in Other assets in the Condensed Consolidated Balance Sheets and the related equity earnings from these investments are included in Equity in net loss of unconsolidated affiliates in the Condensed Consolidated Statements of Operations. All intercompany balances and transactions have been eliminated in consolidation.
Recent Accounting Guidance
Recently Adopted Accounting Guidance
Cloud Computing - On August 29, 2018, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update (“ASU”) to provide guidance on implementation costs incurred in a cloud computing arrangement (“CCA”) that is a service contract. The ASU, which was released in response to a consensus reached by the EITF at its June 2018 meeting, aligns the accounting for such costs with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, the ASU includes in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply CCA guidance to determine which implementation costs should be capitalized in such a CCA. The Company adopted this update effective July 1, 2018 on a prospective basis. The new standard did not have a material impact on the Condensed Consolidated Financial Statements.
Revenue Recognition - In May 2014, the FASB issued an ASU which amends the guidance for revenue recognition. This amendment contains principles that will require an entity to recognize revenue to depict the transfer of goods and services to customers at an amount that an entity expects to be entitled to in exchange
- 6 -
for goods or services. The amendment sets forth a new revenue recognition model that requires identifying the contract, identifying the performance obligations and recognizing the revenue upon satisfaction of performance obligations. In August 2015, the FASB issued an additional ASU that deferred the effective date of the new revenue standard for public entities to periods beginning after December 15, 2017, with early adoption permitted but not earlier than the original effective date of periods beginning after December 15, 2016. There have also been various additional ASUs issued by the FASB in 2016 that further amend this new revenue standard. The updated standard permits the use of either the retrospective or cumulative effect transition method. The Company adopted these standards on April 1, 2018 using the modified retrospective transition method. See “Note 3. Revenue Recognition” for further information on the adoption of the revenue recognition ASUs.
Cash Flow Classification - In August 2016, the FASB issued an ASU which provides amended guidance on the classification of certain cash receipts and cash payments in the statement of cash flows, including related to debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance and distributions received from equity method investees. This update is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, and early adoption is permitted. This amended guidance must be applied retrospectively to all periods presented, but may be applied prospectively if retrospective application would be impracticable. The Company adopted this update effective April 1, 2018 using the retrospective method. The new standard did not have a material impact on the Condensed Consolidated Financial Statements.
Goodwill Impairment - In January 2017, the FASB issued an ASU which removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, under the standards update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments are effective for annual periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company adopted this update effective April 1, 2018. The new standard did not have an impact on the Condensed Consolidated Financial Statements.
Definition of a Business - In January 2017, the FASB issued an ASU to clarify the definition of a business. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The amendments are intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments provide a more robust framework to use in determining when a set of assets and activities is a business. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company adopted this update effective April 1, 2018. The new standard did not have an impact on the Condensed Consolidated Financial Statements.
Stock-Based Compensation - In May 2017, the FASB issued an ASU to clarify when modification accounting should be applied for changes to the terms or conditions of share-based payment awards. The amendments clarify that modification accounting guidance should only be applied if there is a change to the value, vesting conditions, or award classification and would not be required if the changes are considered non-substantive. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company adopted this update effective April 1, 2018. The new standard did not have an impact on the Condensed Consolidated Financial Statements.
Recent Accounting Guidance Not Yet Adopted
Leases - In February 2016, the FASB issued an ASU which amends the guidance for leases. This standard contains principles that will require an entity to recognize most leases on the balance sheet by recording a right-of-use asset and a lease liability, unless the lease is a short-term lease that has an accounting lease term
- 7 -
of twelve months or less. The standard also contains other changes to the current lease guidance that may result in changes to how entities determine which contractual arrangements qualify as a lease, the accounting for executory costs, such as property taxes and insurance, as well as which lease origination costs will be capitalizable. This standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. Early adoption of this standard is permitted. The standard allows the use of the modified retrospective transition method, whereby the new guidance will be applied at the beginning of the earliest period presented in the financial statements of the period of adoption. The modified retrospective transition approach includes certain practical expedients that entities may elect to apply in transition. In July 2018, the FASB amended ASC 842 to provide another transition method, allowing a cumulative effect adjustment to the opening balance of retained earnings during the period of adoption. The Company expects to adopt this standard effective April 1, 2019. The Company has implemented a new software solution to improve the process of tracking and accounting for leases under the current and new standards. The Company has not yet determined whether to apply any of the available practical expedients. The Company is in the process of reviewing contracts under the new standard to determine the impact the new standard will have on the Condensed Consolidated Financial Statements.
Measurement of Credit Losses - In June 2016, the FASB issued an ASU which provides amended guidance on the measurement of credit losses on financial instruments, including trade receivables. This standard requires the use of an impairment model referred to as the current expected credit loss model. This standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those years, and early adoption is permitted for fiscal years beginning after December 15, 2018. The Company expects to adopt this standard effective April 1, 2020. The Company is currently evaluating the impact of this standard on the Condensed Consolidated Financial Statements.
Hedge Accounting – In August 2017, the FASB issued an ASU which expands an entity’s ability to apply hedge accounting for non-financial and financial risk components and provides a simplified approach for fair value hedging of interest rate risk. The standard also refines how entities assess hedge effectiveness. This standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those years, and early adoption is permitted. The Company expects to adopt this standard effective April 1, 2019. The Company is currently evaluating the impact of this standard on the Condensed Consolidated Financial Statements.
Fair Value Measurement – In August 2018, the FASB issued an ASU that is intended to improve the effectiveness of disclosures in notes to financial statements. The standard removes, modifies and adds certain disclosure requirements related to fair value measurements. This standard is effective for fiscal years beginning after December 15, 2019. The standard requires the use of the retrospective transition method for specific amendments within the ASU and the prospective treatment of other amendments. Early adoption is permitted. The Company expects to adopt this standard effective April 1, 2020. The Company is currently evaluating the impact of this standard on the Condensed Consolidated Financial Statements.
With the exception of the pronouncements described above, there have been no new accounting pronouncements issued or adopted since the filing of the Fiscal 2018 Form 10-K that have significance, or potential significance, to the Condensed Consolidated Financial Statements.
2.
LOSS ON DISPOSAL OF ASSETS AND COSTS FROM EXIT AND DISPOSAL ACTIVITIES
In fiscal 2018, the Company initiated restructuring activities (the “2018 Restructuring Plan”), which will continue throughout fiscal 2019, including closing underutilized manufacturing facilities, reducing headcount, optimizing product offerings and eliminating nonessential costs, designed to improve the Company’s cost structure. The Company closed one and three manufacturing facilities in the six months ended September 30, 2018 and 2017, respectively. As additional restructuring opportunities may be identified, the Company does not have an estimated completion date or expected total cost estimate for the 2018 Restructuring Plan.
- 8 -
The following table summarizes the activity included in Loss on disposal of assets and costs from exit and disposal activities recorded during the three and six months ended September 30, 2018 and 2017:
(In thousands)
Accelerated depreciation
430
1,520
3,561
Plant severance
118
186
83
827
Corporate severance
2,577
Product optimization
303
Other restructuring activities
171
202
Total 2018 Restructuring Plan activities
1,022
4,283
1,018
6,965
(Gain) loss on other disposals and partial disposals of property, plant and equipment
(698
838
410
1,579
Total loss on disposal of assets and costs from exit and disposal activities
Approximately $0.7 million of the Total 2018 Restructuring Plan activities related to the Domestic reporting segment for the three and six months ended September 30, 2018, respectively. Approximately $4.3 million and $7.0 million of the Total 2018 restructuring Plan activities related to the Domestic reporting segment for the three and six months ended September 30, 2017, respectively. There was $0.3 million of the Total 2018 Restructuring Plan activities related to the International reporting segment for the three and six months ended September 30, 2018 and 2017, respectively. There were no 2018 Restructuring Plan activities related to the International reporting segment for the three and six months ended September 30, 2017, respectively.
A reconciliation of the beginning and ending amounts of restructuring liability related to the 2018 Restructuring Plan at September 30, 2018 and 2017 is as follows:
(Amounts in thousands)
Balance at the beginning of the period
3,901
Expenses
214
Non-cash expenses
59
3,404
Payments
(1,867
(580
Balance at the end of the period
2,307
2,824
As of September 30, 2018 and March 31, 2018, the Company had $0.4 million and $0.5 million of long-term severance liability related to the restructuring activities recorded in other liabilities in the Condensed Consolidated Balance Sheet. The current portion of the restructuring liability is recorded in Other accrued liabilities in the Condensed Consolidated Balance Sheet.
3.
REVENUE RECOGNITION
On April 1, 2018, the Company adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606”), and all related amendments using the modified retrospective transition method. The adoption of ASC 606 did not impact the opening retained earnings balance or cause a material shift in the amount or timing of revenue recognition. Results for reporting periods beginning after April 1, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in a consistent manner with historical accounting policies.
- 9 -
The Company generates revenue by selling pipe and related water management products primarily to distributors, retailers, buying groups and co-operative buying groups. Products are shipped predominately by the Company’s internal fleet, and the Company does not provide any additional revenue generating services after product delivery. Payment terms and conditions vary by contract.
Revenue is recognized at the point in-time obligations under the terms of a contract with a customer are satisfied, which generally occurs upon the transfer of control of the promised goods. In substantially all of the Company’s contracts with customers, control is transferred to the customer upon delivery. The Company recognizes revenue in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Revenue is presented in the Condensed Consolidated Statements of Operations net of allowances for returns, rebates, discounts, and taxes collected concurrently with revenue-producing activities.
Refer to “Note 13. Business Segments Information” for the Company’s disaggregation of Net sales by reportable segment. The disclosure of Net sales by reportable segment is aligned by geographical region and product type and best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.
Significant Judgments - The Company’s performance obligation under contracts with customers is to sell and deliver pipe and related water management products. The Company’s contracts with customers may contain multiple performance obligations by promising to deliver multiple products to the customer. For these contracts, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis.
The Company’s products are generally sold with a right of return, and the Company may provide credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize. Variable consideration is estimated at contract inception and updated at the end of each reporting period as additional information becomes available and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur.
Contract Balances - The Company recognizes a contract asset representing the Company’s right to recover products upon the receipt of returned products and a contract liability for the customer refund. The adoption of this standard resulted in the Company recording a contract asset for estimated inventory returns. On April 1, 2018, the estimated inventory returns resulted in a $0.6 million decrease in Receivables, net and a $0.6 million increase in Other current assets on the Company’s Consolidated Balance Sheets. The following table presents the balance of the Company’s contract asset and liability as of September 30, 2018 and April 1, 2018:
April 1,
Contract asset - product returns
988
577
Refund liability
2,249
1,468
Practical Expedients and Exemptions - The Company expenses incremental costs to obtain a contract (e.g. sales commissions) when incurred as the amortization period would have been one year or less. These costs are recorded within selling expenses on the Condensed Consolidated Statements of Operations.
The Company has elected the accounting policy election permitted by ASC 606 to account for shipping and handling costs as activities to fulfill the promise to transfer the goods when these activities are performed after a customer obtains control of the goods. Revenue will be recognized at the point of shipment.
The Company has elected the accounting policy to exclude from the transaction price all sales taxes that are assessed by a governmental authority and that are imposed on and concurrent with a specific revenue-
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producing transaction and collected by the Company from a customer, for example, sales, use, value added, and some excise taxes.
Further, the Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
4.
INVENTORIES
Inventories as of the periods presented consisted of the following:
Raw materials
53,540
54,909
Finished goods
193,621
208,883
Total inventories
There were no work-in-process inventories as of the periods presented.
5.
FAIR VALUE MEASUREMENT
When applying fair value principles in the valuation of assets and liabilities, the Company is required to maximize the use of quoted market prices and minimize the use of unobservable inputs. The Company has not changed its valuation techniques used in measuring the fair value of any financial assets or liabilities during the fiscal periods presented. The fair value estimates take into consideration the credit risk of both the Company and its counterparties.
When active market quotes are not available for financial assets and liabilities, ADS uses industry standard valuation models. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including credit risk, interest rate curves, foreign currency rates and forward and spot prices for currencies. In circumstances where market-based observable inputs are not available, management judgment is used to develop assumptions to estimate fair value. Generally, the fair value of Level 3 instruments is estimated as the net present value of expected future cash flows based on internal and external inputs.
Recurring Fair Value Measurements - The assets and liabilities carried at fair value as of the periods presented were as follows:
September 30, 2018
Level 1
Level 2
Level 3
Assets:
Derivative assets – diesel fuel contracts
698
Interest rate swaps
3,844
Total assets at fair value on a recurring basis
4,542
Liabilities:
Derivative liabilities – diesel fuel contracts
360
Contingent consideration for acquisitions
325
Total liabilities at fair value on a recurring basis
685
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March 31, 2018
596
2,801
3,397
Derivative liability - diesel fuel contracts
116
578
694
For the three and six months ended September 30, 2018 and 2017, respectively, there were no transfers in or out of Levels 1, 2 or 3.
Valuation of Contingent Consideration for Acquisitions - The fair values of the contingent consideration payables for acquisitions were calculated based on a discounted cash flow model, whereby the probability-weighted future payment value is discounted to the present value using a market discount rate. The method used to price these liabilities is considered Level 3, due to the subjective nature of the unobservable inputs used to determine the fair value. Changes in the fair value of recurring fair value measurements using significant unobservable inputs (Level 3) for the periods presented were as follows:
460
858
1,348
Change in fair value
7
9
32
Payments of contingent consideration liability
(142
(129
(262
(645
735
Valuation of Debt - The carrying amounts of current financial assets and liabilities approximate fair value because of the immediate or short-term maturity of these items, or in the case of derivative instruments, because they are recorded at fair value. The carrying and fair value of the Company’s Senior Notes (discussed in “Note 12. Debt” in the Company’s Fiscal 2018 Form 10-K) were $100.0 million and $95.8 million, respectively, as of September 30, 2018 and $125.0 million and $122.3 million, respectively, at March 31, 2018. The fair value of the Senior Notes was determined based on a comparison of the interest rate and terms of such borrowings to the rates and terms of similar debt available for the period. The Company believes the carrying amount on the remaining long-term debt, including the Secured Bank Term Loans, is not materially different from its fair value as the interest rates and terms of the borrowings are similar to currently available borrowings. The categorization of the framework used to evaluate this debt is considered Level 2.
6.
DERIVATIVE TRANSACTIONS
The Company uses interest rate swaps, commodity options in the form of collars and swaps, and foreign currency forward contracts to manage its various exposures to interest rate, commodity price fluctuations and foreign currency exchange rate fluctuations. For the interest rate swap executed on June 28, 2017, gains and losses resulting from the difference between the spot rate and applicable base rate is recorded in Interest expense. For collars, commodity swaps and foreign currency forward contracts, contract settlement gains and losses are recorded in the Condensed Consolidated Statements of Operations in Derivative gains and other income, net.
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Gains and losses related to mark-to-market adjustments for changes in fair value of the derivative contracts are also recorded in the Condensed Consolidated Statements of Operations in Derivative gains and other income, net.
The Company recorded net losses and net (gains) on mark-to-market adjustments for changes in the fair value of derivatives contracts as well as net losses and net (gains) on the settlement of derivative contracts as follows:
Diesel fuel option collars
154
(678
142
(402
(430
(103
(1,043
(188
Total net unrealized mark-to-market gains
(276
(781
(266
(53
(574
(1
Foreign exchange forward contracts
(39
(90
(67
(92
Total net realized gains
(372
(755
A summary of the fair value of derivatives is included in “Note 5. Fair Value Measurement.”
7.NET INCOME PER SHARE AND STOCKHOLDERS’ EQUITY
The Company is required to apply the two-class method to compute both basic and diluted net income per share. The two-class method is an earnings allocation formula that treats participating securities as having rights to earnings that would otherwise have been available to common stockholders.
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The following table presents information necessary to calculate net income per share for the periods presented, as well as potentially dilutive securities excluded from the weighted average number of diluted common shares outstanding because their inclusion would have been anti-dilutive:
(In thousands, except per share data)
NET INCOME PER SHARE—BASIC:
Adjustments for:
Dividends to redeemable convertible preferred
stockholders
(478
(470
(959
Dividends paid to unvested restricted stockholders
(15
(16
(30
(35
Net income available to common stockholders and
participating securities
28,177
17,377
59,945
34,611
Undistributed income allocated to participating
securities
(2,310
(1,397
(5,022
(2,830
Net income available to common stockholders –
25,867
15,980
54,923
31,781
Weighted average number of common shares
outstanding – Basic
Net income per common share – Basic
NET INCOME PER SHARE—DILUTED:
Assumed exercise of stock options
629
624
598
667
outstanding – Diluted
Net income per common share – Diluted
Potentially dilutive securities excluded as
anti-dilutive
6,303
6,211
6,229
6,349
Stockholders’ Equity –During the six months ended September 30, 2017, the Company repurchased 0.4 million shares of common stock at a cost of $7.9 million. The Company did not repurchase any shares of common stock during the three or six months ended September 30, 2018. The repurchases were made under the Board of Directors’ authorization in February 2017 to repurchase up to $50 million of ADS common stock in accordance with applicable securities laws. As of September 30, 2018, approximately $42.1 million of common stock may be repurchased under the authorization. The repurchase program does not obligate the Company to acquire any particular amount of common stock, and may be suspended or terminated at any time at the Company’s discretion.
8.
RELATED PARTY TRANSACTIONS
ADS Mexicana - ADS conducts business in Mexico and Central America through its joint venture ADS Mexicana, S.A. de C.V. (together with its affiliate ADS Corporativo, S.A. de C.V., “ADS Mexicana”). ADS owns 51% of the outstanding stock of ADS Mexicana and consolidates ADS Mexicana for financial reporting purposes.
ADS Mexicana’s Revolving Credit Facility expired on June 22, 2018 and was replaced by an Intercompany Revolving Credit Promissory Note (the “Intercompany Note”) with a borrowing capacity of $12.0 million. The Intercompany Note matures on June 22, 2022. The other joint venture partner indemnifies the Company for 49% of any unpaid borrowing. The interest rates under the Intercompany Note are determined by certain
- 14 -
base rates or London Interbank Offered Rate (“LIBOR”) plus an applicable margin based on the Leverage Ratio. As of September 30, 2018, there were no borrowings under the Intercompany Note.
South American Joint Venture - The Tuberias Tigre – ADS Limitada joint venture (the “South American Joint Venture”) manufactures and sells HDPE corrugated pipe in certain South American markets. The South American Joint Venture operates within Argentina, which on July 1, was identified for high inflationary accounting. The Company has determined the effect of a change in the exchange rate under high inflationary accounting is not expected to have a material effect on the Company’s results in any interim or annual period. ADS owns 50% of the South American Joint Venture. The Company has concluded that it is appropriate to account for these investments using the equity method, whereby the Company’s share of the income or loss of the joint venture is reported in the Condensed Consolidated Statements of Operations under Equity in net loss (income) of unconsolidated affiliates and the Company’s investment in the joint venture is included in Other assets in the Condensed Consolidated Balance Sheets. ADS is the guarantor of 50% of the South American Joint Venture’s credit facility, and the debt guarantee is shared equally with the joint venture partner. The Company’s maximum potential obligation under this guarantee is $11.0 million as of September 30, 2018. The maximum borrowings permitted under the South American Joint Venture’s credit facility are $22.0 million. This credit facility allows borrowings in either Chilean pesos or US dollars at a fixed interest rate determined at inception of each draw on the facility. The guarantee of the South American Joint Venture’s debt expires on December 31, 2020. ADS does not anticipate any required contributions related to the balance of this credit facility. As of September 30, 2018 and March 31, 2018, the outstanding principal balances of the credit facility including letters of credit were $13.2 million and $14.5 million, respectively. As of September 30, 2018, there were no U.S. dollar denominated loans. The weighted average interest rate as of September 30, 2018 was 5.6% on Chilean peso denominated loans.
ADS and the South American Joint Venture have shared services arrangements in order to execute the joint venture services. In addition, the South American Joint Venture has entered into agreements for pipe sales to ADS and its other related parties, which totaled zero and $0.6 million for the three and six months ended September 30, 2018, respectively, and $0.2 million and $0.8 million for the three and six months ended September 30, 2017, respectively. ADS pipe sales to the South American Joint Venture were $0.4 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and $0.6 million and $0.2 million for the six months ended September 30, 2018 and 2017, respectively.
BaySaver - BaySaver Technologies LLC (“BaySaver”) is a joint venture that was established to produce and distribute water quality filters and separators used in the removal of sediment and pollution from storm water. ADS owns 65% of the outstanding stock of BaySaver and consolidates its interest in BaySaver.
ADS and BaySaver have entered into shared services arrangements in order to execute the joint venture services. Included within these arrangements are the lease of a plant and adjacent yard used to conduct business and operating expenses related to the leased facility.
Tigre-ADS USA - Tigre-ADS USA was a joint venture established to manufacture and sell polyvinyl chloride (“PVC”) fittings for waterworks, plumbing, and HVAC applications primarily in the United States and Canadian markets. In April 2018, the Company and the joint venture partner agreed to exchange the Company’s shares of Tigre-ADS USA for a release from the existing debt guarantees. Following the exchange, the Company no longer has an ownership interest in Tigre-ADS USA.
ADS purchased $0.7 million and $0.5 million of Tigre-ADS USA manufactured products for use in the production of ADS products during the three months ended September 30, 2018 and 2017, respectively, and $1.2 million and $1.1 million during the six months ended September 30, 2018 and 2017, respectively.
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9.
DEBT
Long-term debt as of the periods presented consisted of the following:
Secured Bank Term Loans:
Revolving Credit Facility — ADS
178,200
171,500
Revolving Credit Facility — ADS Mexicana
Senior Notes payable
100,000
125,000
Industrial revenue bonds
475
940
Equipment financing
2,885
3,336
281,560
300,776
Unamortized debt issuance costs
(2,641
(3,028
Current maturities
(26,395
(26,848
Long-term debt obligation
Letters of credit outstanding at September 30, 2018 and March 31, 2018 amounted to $8.5 million and $13.0 million, respectively, and reduce the availability of the Revolving Credit Facilities.
Events Related to the Secured Bank Term Loans - On June 22, 2018, the Company’s $12.0 million Revolving Credit Facility – ADS Mexicana matured. At June 22, 2018, there were no borrowings under the Revolving Credit Facility – ADS Mexicana. Refer to “Note 8. Related Party Transactions” for additional information on the Intercompany Note which replaced the Revolving Credit Facility – ADS Mexicana.
Fiscal 2019 Amendment to the Secured Bank Term Loans – On July 9, 2018, the Company amended the Second Amended and Restated Credit Agreement (the “Credit Agreement”) and the Second Amended and Restated Private Shelf Agreement (the “Private Shelf Agreement”) to amend the definition of Consolidated EBITDA and changed the timing of the quarterly rate adjustments. In addition, the amendment to the Credit Agreement clarified the process of a transition to replace LIBOR which is being phased out.
10.
COMMITMENTS AND CONTINGENCIES
Purchase Commitments – The Company secures supplies of resin raw material by agreeing to purchase quantities during a future given period at a fixed price. These purchase contracts typically range from 1 to 12 months and occur in the ordinary course of business. Under such non-cancelable purchase contracts in place at September 30, 2018, the Company has agreed to purchase resin over the period October 2018 through December 2018 at a committed purchase cost of $4.4 million.
Litigation and Other Proceedings – As previously disclosed in the Company’s Fiscal 2018 Form 10-K, the Company’s historical accounting practices were the subject of an investigation by SEC’s Division of Enforcement (the “Enforcement Division”), which began in August 2015. That matter was resolved on July 10, 2018 via a settlement between the Company and the SEC. Pursuant to the settlement, the Company consented to the entry of an administrative order without admitting or denying the findings therein. The order required the Company to cease and desist from committing or causing any violations and any future violations of certain provisions of the federal securities laws and the rules promulgated thereunder and to pay a civil monetary penalty of $1.0 million, which payment has been made. The Company previously accrued an expense for the penalty amount during Fiscal 2018.
The Company is involved from time to time in various legal proceedings that arise in the ordinary course of business, including but not limited to commercial disputes, environmental matters, employee related claims, intellectual property disputes and litigation in connection with transactions including acquisitions and divestitures. The Company does not believe that such litigation, claims, and administrative proceedings will
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have a material adverse impact on the Company’s financial position or results of operations. The Company records a liability when a loss is considered probable, and the amount can be reasonably estimated.
11.
INCOME TAXES
The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017. The Tax Act significantly revises the future ongoing U.S. corporate income tax by, among other things, lowering the U.S. corporate income tax rate from 35% to 21%, full expensing on qualified property, eliminates the domestic manufacturing deduction and implements a territorial tax system. The 21% U.S. corporate income tax rate was effective January 1, 2018.
The Company has recognized the provisional tax impacts related to revaluation of deferred tax assets and liabilities and deemed repatriated earnings and included these amounts in its financial statements for the year ended March 31, 2018. The ultimate impact may differ from these provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Act. During the three months ended September 30, 2018, the Company did not make any adjustments to its provisional amounts included in its Consolidated Financial Statements for the year ended March 31, 2018. The accounting is expected to be finalized in conjunction with the filing of the fiscal 2018 U.S. corporate income tax return, no later than the close of third quarter fiscal 2019.
The Company’s effective tax rate will vary based on a variety of factors, including overall profitability, the geographical mix of income before taxes and related tax rates in jurisdictions where it operates and other onetime charges, as well as discrete events. For the three months ended September 30, 2018 and 2017, the Company utilized an effective tax rate of 28.9% and 42.1%, respectively, to calculate its provision for income taxes. For the six months ended September 30, 2018 and 2017, the Company utilized an effective tax rate of 29.4% and 38.7%, respectively, to calculate its provision for income taxes. These rates are higher than the federal statutory rate primarily due to state and local income taxes and our Employee Stock Ownership Plan (“ESOP”). In addition, the effective tax rate for the six months ended September 30, 2017 differed from the federal statutory rate due to the favorable impact of a $1.0 million discrete income tax benefit related to the release of tax reserves recorded during the three months ended June 30, 2017.
12.
STOCK-BASED COMPENSATION
ADS has several programs for stock-based payments to employees and non-employee members of its Board of Directors, including stock options and restricted stock. Equity-classified restricted stock awards are measured based on the grant-date estimated fair value of each award. The Company accounts for all restricted stock granted to Directors as equity-classified awards. The Company recognized stock-based compensation expense in the following line items of the Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2018 and 2017:
Component of income before income taxes:
82
45
144
90
Selling expenses
50
27
86
52
General and administrative expenses
1,680
1,738
3,141
3,358
Total stock-based compensation expense
1,812
1,810
3,371
3,500
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The following table summarizes stock-based compensation expense by award type for the three and six months ended September 30, 2018 and 2017:
Stock-based compensation expense:
Equity-classified Stock Options
795
1,009
Restricted Stock
763
1,306
728
Non-Employee Directors
254
497
679
2017 Omnibus Plan
On May 24, 2017, the Board of Directors approved the 2017 Omnibus Incentive Plan (the “2017 Incentive Plan”) which was approved by the Company’s stockholders on July 17, 2017. The 2017 Incentive Plan provides for the issuance of a maximum of 3.5 million shares of the Company’s common stock for awards made thereunder, which awards may consist of stock options, restricted stock, restricted stock units, stock appreciation rights, phantom stock, cash-based awards, performance awards (which may take the form of performance cash, performance units or performance shares) or other stock-based awards.
During the three months ended September 30, 2018, the Company granted 0.1 million shares of restricted stock to non-employee directors with a grant date fair value of $1.1 million. During the six months ended September 30, 2018, the Company granted 0.1 million shares of restricted stock with a grant date fair value of $3.4 million.Performance Units - In addition, during the six months ended September 30, 2018, the Company granted 0.1 million performance units, subject to performance and services conditions. The grant date fair value of the performance units was $2.8 million, based on the market price of the Company’s common stock at the date of the grant. For the performance units, 50% of the award is based upon the achievement of certain levels of Return on Invested Capital for the performance period and 50% is based upon the achievement of certain levels of Free Cash Flow for the performance period. The performance units have a 3-year performance period from April 1, 2018 through March 31, 2021. The performance units, and any accrued dividend equivalents, will be settled in shares of the Company’s common stock, if the applicable performance and service conditions are satisfied.
Options – During the three months ended September 30, 2018, the Company did not grant any stock options under the 2017 Incentive Plan. During the six months ended September 30, 2018, the Company granted 0.2 million nonqualified stock options under the 2017 Incentive Plan. The grant date fair value of the nonqualified stock options was $1.9 million. The Company estimates the fair value of stock options using a Black-Scholes option-pricing model. The following table summarizes the assumptions used in estimate the fair value of stock-options during the six months ended September 30, 2018:
Common stock price
$25.75
Expected stock price volatility
30.5%
Risk-free interest rate
2.9%
Weighted-average expected option life (years)
6.0
Dividend yield
1.2%
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13.
BUSINESS SEGMENTS INFORMATION
The Company operates its business in two distinct operating and reportable segments based on the markets it serves: “Domestic” and “International.” The Chief Operating Decision Maker (“CODM”) evaluates segment reporting based on Net sales and Segment Adjusted EBITDA. The Company calculates Segment Adjusted EBITDA as net income or loss before interest, income taxes, depreciation and amortization, stock-based compensation expense, non-cash charges and certain other expenses. Beginning April 1, 2018, the Company revised its allocation of allowances for returns, rebates, and discounts between Pipe and Allied Products for segment reporting purposes. Prior to April 1, 2018, the Company allocated substantially all returns, rebates, and discounts to Pipe net sales. These changes did not impact the Company’s previously reported consolidated financial results. The prior period segment results and related disclosures have been recast to conform to the current year presentation under the new allocation methodology. The following table sets forth reportable segment information with respect to the amount of Net sales contributed by each class of similar products for the periods presented:
Domestic
Pipe
249,324
256,175
491,350
484,798
Allied Products
101,945
95,709
202,417
186,583
Total domestic
351,269
351,884
693,767
671,381
International
44,008
38,375
78,456
68,329
11,278
10,790
22,179
19,698
Total international
49,165
100,635
88,027
Total Net sales
The following sets forth certain additional financial information attributable to the reportable segments for the periods presented:
For the three months ended September 30, 2018
Segment Adjusted EBITDA
64,539
6,982
71,521
4,434
97
11,518
676
15,638
1,898
17,536
11,610
815
12,425
For the three months ended September 30, 2017
63,473
3,411
66,884
4,971
84
12,185
1,252
17,658
2,062
19,720
437
8,673
9,086
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For the six months ended September 30, 2018
133,371
13,293
146,664
8,191
24,775
1,703
31,591
3,772
17,491
1,808
19,299
For the six months ended September 30, 2017
118,562
8,667
127,229
9,356
178
21,700
1,483
33,921
4,020
Equity in net loss (income) of unconsolidated affiliates
655
25,781
1,254
27,035
The following sets forth certain additional financial information attributable to the reportable segments as of the periods presented:
Investments in unconsolidated affiliates
10,254
12,343
Total identifiable assets
963,860
904,718
144,109
142,822
Eliminations
(13,734
(4,298
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The following reconciles net income to segment adjusted EBITDA for the periods presented:
For the Three Months Ended September 30,
Reconciliation of Segment Adjusted EBITDA:
26,617
2,755
16,932
1,027
Segment EBITDA
58,207
5,426
51,746
4,425
Derivative fair value adjustments
Foreign currency transaction gains (losses)
818
(1,579
(Gain) loss on disposal of assets and costs from exit
and disposal activities
(137
461
4,994
127
Unconsolidated affiliates interest, tax, depreciation
and amortization(a)
271
277
438
Contingent consideration remeasurement
(9
Stock-based compensation expense
ESOP deferred stock-based compensation
4,368
2,595
Executive retirement expense
894
Restatement-related costs(b)
35
1,042
Transaction costs(c)
890
For the Six Months Ended September 30,
57,206
5,817
32,082
4,351
121,763
11,434
97,059
10,032
647
(2,448
Loss on disposal of assets and costs from exit
872
556
8,313
231
650
571
852
(7
8,389
5,209
Executive retirement (benefit) expense
(278
909
Restatement-related (benefit) costs(b)
(1,196
2,502
315
1,057
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(a)
Includes the proportional share of interest, income taxes, depreciation and amortization related to the South American Joint Venture and the former Tigre-ADS USA joint venture, which are accounted for under the equity method of accounting.
(b)
Represents expenses recorded related to legal, accounting and other professional fees incurred in connection with the restatement of the prior period financial statements as reflected in the fiscal year 2015 Form 10-K and fiscal year 2016 Form 10-K/A. The benefit recognized in fiscal 2019 is the result of insurance proceeds received in fiscal 2019.
(c)
Represents expenses recorded related to legal, accounting and other professional fees incurred in connection with the debt refinancing and potential asset acquisitions and dispositions.
14.
SUBSEQUENT EVENTS
Dividends on Common Stock- During the third quarter of fiscal 2019, the Company declared a quarterly cash dividend of $0.08 per share of common stock. The dividend is payable on December 14, 2018 to stockholders of record at the close of business on November 30, 2018.
Acquisition of BaySaver – During the third quarter of fiscal 2019, the Company acquired the remaining 35% ownership interest in BaySaver for a purchase price of $8.8 million. After the transaction, BaySaver will be a wholly-owned subsidiary of the Company.
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Unless the context otherwise indicates or requires, as used in this Quarterly Report on Form 10-Q, the terms “we,” “our,” “us,” “ADS” and the “Company” refer to Advanced Drainage Systems, Inc. and its directly- and indirectly-owned subsidiaries as a combined entity, except where it is clear that the terms mean only Advanced Drainage Systems, Inc. exclusive of its subsidiaries.
Our fiscal year begins on April 1 and ends on March 31. Unless otherwise noted, references to “year” pertain to our fiscal year. For example, 2019 refers to fiscal 2019, which is the period from April 1, 2018 to March 31, 2019.
The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our Condensed Consolidated Financial Statements and related footnotes included elsewhere in this Quarterly Report on Form 10-Q and with the audited Consolidated Financial Statements included in our Fiscal 2018 Form 10-K, as filed with the Securities and Exchange Commission (the “SEC”) on May 30, 2018. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in the forward-looking statements. For more information, see the section below entitled “Forward Looking Statements.”
We consolidate all of our joint ventures for purposes of GAAP, except for our South American Joint Venture and our former joint venture, Tigre-ADS USA.
Overview
We are the leading manufacturer of high performance thermoplastic corrugated pipe, providing a comprehensive suite of water management products and superior drainage solutions for use in the underground construction and infrastructure marketplace. Our innovative products are used across a broad range of end markets and applications, including non-residential, residential, agriculture and infrastructure applications. We have established a leading position in many of these end markets by leveraging our national sales and distribution platform, our overall product breadth and scale and our manufacturing excellence. In the United States, our national footprint combined with our strong local presence and broad product offering make us the leader in an otherwise highly fragmented sector comprised of many smaller competitors. We believe the markets we serve in the United States represent approximately $11 billion of annual revenue opportunity. In addition, we believe the increasing acceptance of thermoplastic pipe products in international markets represents an attractive growth opportunity.
Our products are generally lighter, more durable, more cost effective and easier to install than comparable alternatives made with traditional materials. Following our entrance into the non-residential construction market with the introduction of N-12 corrugated polyethylene pipe in the late 1980s, our pipe products have been displacing products made with traditional materials, such as reinforced concrete, corrugated steel and polyvinyl chloride (“PVC”), across an ever expanding range of end markets. This has allowed us to consistently gain market share and achieve above-market growth throughout economic cycles. We expect to continue to drive conversion to our products from traditional materials as contractors, civil design engineers and municipal agencies increasingly acknowledge the superior physical attributes and compelling value proposition of our thermoplastic products. In addition, we believe that overall demand for our products will benefit as the regulatory environment continues to evolve.
Our broad product line includes HDPE pipe, PP pipe and related water management products. Building on our core drainage businesses, we have aggressively pursued attractive ancillary product categories such as storm and septic chambers, PVC drainage structures, fittings and filters, and water quality filters and separators. We refer to these ancillary product categories as Allied Products. Given the scope of our overall sales and distribution platform, we have been able to drive growth within our Allied Products and believe there are significant growth opportunities going forward.
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Restructuring Activities
In fiscal 2018, we initiated restructuring activities designed to improve our cost structure, including closing underutilized manufacturing facilities, reducing headcount and eliminating nonessential costs. These activities will continue throughout fiscal 2019. The Company closed one and three manufacturing facilities in the six months ended September 30, 2018 and 2017, respectively. The following table summarizes the restructuring activity included in Loss on disposal of assets and costs from exit and disposal activities recorded during the three and six months ended September 30, 2018 and 2017:
(in thousands)
Total restructuring activities
The following table summarizes the line items of the Condensed Consolidated Statements of Operations where the expenses above would have been recorded to absent of a restructuring program:
2,264
4,946
1,390
The restructuring costs above represent one-time expenses and are not indicative of expected costs or cost savings in future periods.
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Results of Operations
Three Months Ended September 30, 2018 Compared With Three Months Ended September 30, 2017
The following table summarizes our operating results as a percentage of net sales that have been derived from our Condensed Consolidated Financial Statements for the three months ended September 30, 2018 and 2017. We believe this presentation is useful to investors in comparing historical results.
Consolidated Statements of Operations data:
100.0
%
76.5
77.6
23.5
22.4
6.1
5.3
0.1
1.3
0.5
11.5
8.6
1.1
-
(0.6
10.4
7.9
3.0
3.4
7.2
4.5
0.2
7.1
Net sales - Net sales were $406.6 million in the three months ended September 30, 2018, increasing $5.5 million, or 1.4%, over the comparable period in fiscal 2018.
$ Variance
% Variance
(6,851
(2.7
%)
6,236
6.5
(615
(0.2
5,633
14.7
488
6,121
12.4
Total net sales
5,506
1.4
Domestic net sales decreased $0.6 million, or 0.2%, in the three months ended September 30, 2018, over the comparable period in the previous fiscal year. Our domestic pipe sales decreased by $6.9 million, or 2.7%, which was primarily attributable to a $19.8 million decrease in pipe volume. This decrease was offset by price increases and changes in product mix of $15.2 million. Allied Product sales increased $6.2 million, or 6.5%, led by our storm chambers and structures product lines.
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International net sales increased $6.1 million, or 12.4%, in the three months ended September 30, 2018 over the comparable period in the previous fiscal year. Our international pipe sales increased by $5.6 million, or 14.7%, which was primarily attributable to volume, price increases and changes in product mix of $1.2 million. The increase was also attributable to the increased Allied Product sales of $0.5 million.
Cost of goods sold and Gross profit - Cost of goods sold decreased by $0.1 million, or 0.0%, and gross profit increased by $5.6 million, or 6.2%, in the three months ended September 30, 2018 over the comparable period in the previous fiscal year.
Gross Profit
84,785
83,708
1,077
10,588
6,093
4,495
73.8
Total gross profit
5,572
6.2
The increase in domestic gross profit of $1.1 million, or 1.3%, was primarily due to decreased labor and overhead costs of $1.8 million. This increase was offset by the gross profit impact of the decreased sales discussed above and increased material and transportation costs.
International gross profit increased $4.5 million, or 73.8%, in the three months ended September 30, 2018 compared to the same period in the previous fiscal year, primarily due to the gross profit impact of the net sales increase discussed above. In addition, we implemented cost containment measures to mitigate increasing material costs.
Selling expenses - As a percentage of net sales, selling expenses were relatively flat at 6.1% in the three months ended September 30, 2018 and 2017.
General and administrative expenses - General and administrative expenses for the three months ended September 30, 2018 decreased $2.3 million from the prior year period. The decrease was primarily due to a decrease in professional and legal fees $0.5 million.
Loss on disposal of assets and costs from exit and disposal activities – In the three months ended September 30, 2018, we recorded $1.0 million of expense related to restructuring activities, including closing one underutilized manufacturing facility. In addition, we recorded a gain on other disposals and partial disposals of property, plant and equipment of approximately $0.7 million. See “Note 2. Loss on Disposal of Assets and Costs from Exit and Disposal Activities” for additional discussion.
Intangible amortization - Intangible amortization remained relatively flat as a percentage of net sales.
Interest expense - Interest expense decreased $0.5 million in the three months ended September 30, 2018 compared to the same period in the previous fiscal year, primarily due to a $0.4 million unrealized gain on the interest rate swap.
Derivative losses (gains) and other expense (income), net - Derivative gains and other income decreased by $2.6 million for the three months ended September 30, 2018 compared to the same period in the previous fiscal year. The decrease is primarily due to changes in realized foreign currency gains and losses.
Income tax expense - For the three months ended September 30, 2018 and 2017, the effective tax rates were 28.9% and 42.1%, respectively. The decrease in the effective tax rate was primarily due to impact of the Tax Cuts and Jobs Act (the “Tax Act”).
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Equity in net loss of unconsolidated affiliates - Equity in net loss of unconsolidated affiliates represents our proportionate share of income or loss attributed to our unconsolidated joint venture in which we have significant influence, but not control, over operations. The Equity in net loss of unconsolidated affiliates increased by $0.1 million for the three months ended September 30, 2018 as compared to the same period in the previous fiscal year. The increase in loss from the South American Joint Venture was offset by the Tigre-ADS USA disposal in April 2018.
Net income attributable to noncontrolling interest - Net income attributable to noncontrolling interest increased by $0.6 million for the three months ended September 30, 2018 compared to the same period in the previous fiscal year.
Six Months Ended September 30, 2018 Compared With Six Months Ended September 30, 2017
The following table summarizes our operating results as a percentage of net sales that have been derived from our Condensed Consolidated Financial Statements for the six months ended September 30, 2018 and 2017. We believe this presentation is useful to investors in comparing historical results
75.4
76.8
24.6
23.2
5.4
6.7
12.3
8.7
1.0
(0.1
(0.5
11.4
3.3
3.1
0.0
4.8
0.3
7.7
4.7
Net sales - Net sales were $794.4 million in the six months ended September 30, 2018, increasing $35.0 million, or 4.6%, over the comparable period in the previous fiscal year.
6,552
15,834
8.5
22,386
10,127
14.8
2,481
12.6
12,608
14.3
34,994
4.6
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Domestic net sales increased $22.4 million, or 3.3%, in the six months ended September 30, 2018, over the comparable period in the previous fiscal year. Our domestic pipe sales increased by $6.6 million, or 1.4%, which was primarily attributable to price increases and changes in product mix of $31.9 million. The increase in pipe is offset by a $22.9 million decrease in pipe volume. Allied Product sales increased $15.8 million, or 8.5%, led by our storm chambers and structures product lines.
International net sales increased $12.6 million, or 14.3%, in the six months ended September 30, 2018 over the comparable period in the previous fiscal year. International pipe sales increased by $10.1 million, or 14.8%, which is attributable to price increases, changes in product mix and an increase in pipe volume. In addition, Allied Products sales increased $2.5 million, or 12.6%.
Cost of goods sold and Gross profit - Cost of goods sold increased by $16.5 million, or 2.8%, and gross profit increased by $18.5 million, or 10.5%, in the six months ended September 30, 2018 over the comparable period in the previous fiscal year.
176,220
164,034
12,186
7.4
18,844
12,506
6,338
50.7
18,524
10.5
The increase in domestic gross profit of $12.2 million, or 7.4%, due to the gross profit impact of the net sales increase discussed above and a decrease in labor and overhead costs of $6.4 million. These increases were offset by an increase in material and transportation costs of $13.5 million.
International gross profit increased $6.3 million, or 50.7%, in the six months ended September 30, 2018 compared to the same period in the previous fiscal year, primarily due to the gross profit impact of the net sales increase discussed above offset by an increase in material and transportation costs.
Selling expenses - As a percentage of net sales, selling expenses remained flat at 6.2% in the six months ended September 30, 2018 and 2017.
General and administrative expenses - General and administrative expenses for the six months ended September 30, 2018 decreased $7.6 million from the prior year period. The decrease was primarily due to a decrease in professional and legal fees, including insurance proceeds, of $5.1 million.
Loss on disposal of assets and costs from exit and disposal activities - In the six months ended September 30, 2018, we recorded $1.0 million of expense related to restructuring activities, including closing one underutilized manufacturing facility. In addition, we recorded a loss on other disposals and partial disposals of property, plant and equipment of approximately $0.4 million. See “Note 2. Loss on Disposal of Assets and Costs from Exit and Disposal Activities” for additional discussion.
Intangible amortization - Intangible amortization remained flat as a percentage of net sales.
Interest expense - Interest expense decreased $1.2 million in the six months ended September 30, 2018 compared to the same period in the previous fiscal year, primarily due to a $1.0 million unrealized gain on the interest rate swap.
Derivative losses (gains) and other expense (income), net - Derivative gains and other income, net decreased by $2.8 million for the six months ended September 30, 2018 compared to the same period in the previous fiscal year. The decrease is primarily due to changes in realized foreign currency gains and losses.
Income tax expense – For the six months ended September 30, 2018 and 2017, the Company had effective tax rates of 29.4% and 38.7%, respectively. The decrease in the effective tax rate was primarily due to impact of the Tax Act.
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Equity in net loss of unconsolidated affiliates - Equity in net loss of unconsolidated affiliates represents our proportionate share of income or loss attributed to our unconsolidated joint venture in which we have significant influence, but not control, over operations. The Equity in net loss of unconsolidated affiliates increased to a $0.7 million loss for the six months ended September 30, 2018 from a $0.3 million loss for the six months ended September 30, 2017.
Net income attributable to noncontrolling interest - Net income attributable to noncontrolling interest increased from net income of $0.8 million for the six months ended September 30, 2017 to net income of $2.1 million for the six months ended September 30, 2018. The change is primarily attributable to fluctuations in the profitability of ADS Mexicana.
Non-GAAP Financial Measures
In addition to financial results reported in accordance with GAAP, we have provided the following non-GAAP financial measures: Adjusted EBITDA and Free Cash Flow. These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with GAAP. However, these measures are not intended to be a substitute for those reported in accordance with GAAP. These measures may be different from non-GAAP financial measures used by other companies, even when similar terms are used to identify such measures.
Adjusted EBITDA - Adjusted EBITDA, a non-GAAP financial measure, has been presented in this Quarterly Report on Form 10-Q as a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We calculate adjusted EBITDA as net income before interest, income taxes, depreciation and amortization, stock-based compensation expense, non-cash charges and certain other expenses.
Adjusted EBITDA is included in this Quarterly Report on Form 10-Q because it is a key metric used by management and our Board of Directors to assess our financial performance. Adjusted EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. In addition to covenant compliance and executive performance evaluations, we use adjusted EBITDA to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions and to compare our performance against that of other peer companies using similar measures.
Adjusted EBITDA is not a GAAP measure of our financial performance and should not be considered as an alternative to net income as a measure of financial performance or cash flows from operations or any other performance measure derived in accordance with GAAP, and it should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Adjusted EBITDA contains certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized. In evaluating adjusted EBITDA, you should be aware that in the future we will incur expenses that are the same as or similar to some of the adjustments in this presentation, such as stock-based compensation expense, derivative fair value adjustments, and foreign currency transaction losses. Our presentation of adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by relying on our GAAP results in addition to using adjusted EBITDA as a supplemental measurement. Our measure of adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.
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The following table presents a reconciliation of Adjusted EBITDA to Net income, the most comparable GAAP measure, for each of the periods indicated.
EBITDA
63,633
56,171
133,197
107,091
Foreign currency transaction losses (gains)
715
1,423
Executive retirement expense (benefit)
Restatement-related costs (benefit)(b)
65
321
Adjusted EBITDA
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Free Cash Flow - Free cash flow is a non-GAAP financial measure that comprises cash flow from operations less capital expenditures. Free cash flow is a measure used by management and our Board of Directors to assess our ability to generate cash. Accordingly, free cash flow has been presented in this Quarterly Report on Form 10-Q as a supplemental measure of liquidity that is not required by, or presented in accordance with GAAP, because management believes that free cash flow provides useful information to investors and others in understanding and evaluating our ability to generate cash flow from operations after capital expenditures.
Free cash flow is not a GAAP measure of our liquidity and should not be considered as an alternative to cash flow from operating activities as a measure of liquidity or any other liquidity measure derived in accordance with GAAP. Our measure of free cash flow is not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.
The following table presents a reconciliation of free cash flow to Cash flow from operating activities, the most comparable GAAP measure, for each of the periods indicated.
Cash flow from operating activities
Free Cash Flow
38,862
1,354
Liquidity and Capital Resources
Our primary liquidity requirements are working capital, capital expenditures, debt service, and dividend payments for our convertible preferred stock and common stock. We have historically funded, and expect to continue to fund, our operations primarily through internally generated cash flow, debt financings, equity issuance and capital and operating leases. From time to time, we may explore additional financing methods and other means to raise capital. There can be no assurance that any additional financing will be available to us on acceptable terms or at all.
As of September 30, 2018, we had $12.0 million in cash that was held by our foreign subsidiaries. Prior to the Tax Act, our intent was to indefinitely reinvest our earnings in foreign subsidiaries with the exception of cash dividends paid by our ADS Mexicana joint venture. As a result of the Tax Act, we continue to evaluate our strategy with our foreign cash, but we still intend to indefinitely reinvest our earnings in foreign subsidiaries.
Working Capital and Cash Flows
As of September 30, 2018, we had $455.9 million in liquidity, including $17.6 million of cash, $363.3 million in borrowings available under our Revolving Credit Facility net of $8.5 million of outstanding letters of credit, and $75.0 million under the Senior Notes, described below. We believe that our cash on hand, together with the availability of borrowings under our Revolving Credit Facility and other financing arrangements and cash generated from operations, will be sufficient to meet our working capital requirements, anticipated capital expenditures, scheduled principal and interest payments on our indebtedness and the dividend payment requirement for our convertible preferred stock for at least the next twelve months.
Working Capital - Working capital increased to $288.2 million as of September 30, 2018, from $237.2 million as of March 31, 2018. The increased in working capital is primarily due to an increase in accounts receivables of $65.0 million due to the seasonality of operations offset by a $16.6 million decrease in inventory.
Operating Cash Flows - Cash flows provided by operating activities for the six months ended September 30, 2018 was $58.2 million as compared with cash provided by operating activities of $28.4 million for the six months ended September 30, 2017. Cash flows from operating activities during the six months ended September 30, 2018 was primarily impacted by increased income from continuing operations and changes in working capital.
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Investing Cash Flows - During the six months ended September 30, 2018 and 2017, cash used for investing activities was $18.9 million and $29.4 million, respectively. The decrease in cash used for investing activities was primarily due to decreases in capital expenditures and purchases of property, plant and equipment through financing. Our capital expenditures for the six months ended September 30, 2018 were used primarily for new equipment and facility expansions and upgrades.
Financing Cash Flows - During the six months ended September 30, 2018, cash used for financing activities was $39.1 million due to payments on our Senior Notes, payments on our capital lease obligations and dividends paid offset by net borrowings on our Revolving Credit Facility. During the six months ended September 30, 2017, cash provided by financing activities was $6.2 million, due to increased borrowings on our Senior Notes and Revolving Credit Facility associated with the debt refinancing, partially offset by increased repayments on our Revolving Credit facility and Term Loan, and $7.9 million of repurchases of our common stock under the stock repurchase program.
Capital Expenditures
Capital expenditures totaled $19.3 million and $27.0 million for the six months ended September 30, 2018 and 2017, respectively. Our capital expenditures for the six months ended September 30, 2018 were used primarily to support facility expansions, equipment replacements, our recycled resin initiatives and technology.
We currently anticipate that we will make capital expenditures of approximately $50 to $60 million in fiscal year 2019. Such capital expenditures are expected to be financed using funds generated by operations. As of September 30, 2018, there were no material contractual obligations or commitments related to these planned capital expenditures.
Employee Stock Ownership Plan (“ESOP”)
The Company established the Advanced Drainage Systems, Inc. ESOP (the “ESOP” or the “Plan”) effective April 1, 1993 to enable eligible employees to acquire stock ownership in ADS in the form of redeemable convertible preferred shares. The Plan was funded by an existing tax-qualified profit-sharing retirement plan, as well as a 30-year term loan from ADS. Within 30 days following the repayment of the ESOP loan, which will occur no later than March 2023, the shares of redeemable convertible preferred stock owned by the ESOP will be converted into shares of the Company’s common stock.
The Company is obligated to make contributions to the Plan, which, when aggregated with the Plan’s dividends, equal the amount necessary to enable the Plan to make its regularly scheduled payments of principal and interest due on its term loan to ADS. Compensation expense is recognized based upon the average annual fair value of the shares during the period which ADS receives payments on the term loan, and the number of ESOP shares allocated to participant accounts.
As disclosed in “Note 15. Employee Benefit Plans” to the Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of our Fiscal 2018 Form 10-K, redeemable convertible preferred stock can convert to common stock upon retirement, disability, death, or vested terminations over the life of the Plan. As stated above, within 30 days following the repayment of the ESOP loan, all redeemable convertible preferred stock will be converted to common stock, which will be no later than March 2023.
The ESOP’s conversion of redeemable convertible preferred stock into common stock will have a meaningful impact on the Company’s net income, net income per share and common shares outstanding. The outstanding shares of common stock would be 31% greater after conversion.
Impact on Net Income – Following the repayment of the ESOP loan discussed above, the Company will no longer be required to apply the two-class method to determine Net income per share. In addition, the Company would not be required to recognize the fair value of ESOP deferred compensation attributable to the shares of redeemable convertible preferred shares allocated.
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The impact of the ESOP on net income includes the fair value of ESOP deferred compensation attributable to the shares of redeemable convertible preferred stock allocated to employee ESOP accounts during the applicable period, which is a non-cash charge to our earnings and not deductible for income tax purposes.
Impact on Common Stock Outstanding – The repayment of the ESOP loan and related conversion of redeemable convertible preferred shares will have an impact on the number of common shares outstanding. As shares are converted, the number of common shares outstanding will increase.
(Shares in millions)
Weighted average common shares outstanding
56.9
55.3
56.8
Conversion of redeemable convertible shares
17.7
18.4
17.8
18.5
Financing Transactions
Secured Bank Term Loans - On June 22, 2017, we entered into a Second Amended and Restated Credit Agreement with PNC, which amends and restates the original agreement dated as of June 12, 2013, to provide us a $550 million Revolving Credit Facility, which is more fully described in our Fiscal 2018 Form 10-K.
As of September 30, 2018, the outstanding principal drawn on the Revolving Credit Facility was $178.2 million, with $363.3 million available to be drawn on the U.S. facility, net of $8.5 million of outstanding letters of credit.
ADS Mexicana Revolving Credit Facility - On June 22, 2018, the Company’s $12.0 million Revolving Credit Facility – ADS Mexicana matured. At June 22, 2018, there were no borrowings under the Revolving Credit Facility – ADS Mexicana.
ADS Mexicana’s Revolving Credit Facility was replaced by an Intercompany Revolving Credit Promissory Note (the “Intercompany Note”) with a capacity of $12.0 million. The Intercompany Note matures on June 22, 2022. The Intercompany Note indemnifies the ADS Mexicana joint venture partner for 49% of any unpaid borrowing. The interest rates under the Intercompany Note are determined by certain base rates or LIBOR rates plus an applicable margin based on the Leverage Ratio. As of September 30, 2018 there were no borrowings under the Intercompany Note.
Fiscal 2019 Amendment to the Secured Bank Term Loans – On July 9, 2018, the Company amended the Second Amended and Restated Credit (the “Credit Agreement”) and the Second Amended and Restated Private Shelf Agreement (the “Private Shelf Agreement”) to amend the definition of Consolidated EBITDA and changed the timing of the quarterly rate adjustments. In addition, the amendment to the Credit Agreement clarified the process of a transition to replace LIBOR which is being phased out.
Senior Notes - On December 11, 2009, we entered into a private shelf agreement with Prudential Investment Management Inc., or Prudential, which agreement, as amended and restated on September 24, 2010 and subsequently further amended, provides for the issuance by us of senior secured promissory notes to Prudential or its affiliates from time to time in the aggregate principal amount up to $100 million. On June 22, 2017, we entered into the Second Amended and Restated Private Shelf Agreement with Prudential, which amends and restates the agreement dated as of September 24, 2010, to provide for the issuance of secured senior notes to Prudential or its affiliates from time to time in the aggregate principal amount of up to $175 million, which is more fully described in
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our Fiscal 2018 Form 10-K. We have $75 million available for issuance of senior notes under the private shelf agreement. At September 30, 2018, the outstanding principal balance on these notes was $100 million.
Covenant Compliance
Our outstanding debt agreements and instruments contain various restrictive covenants including, but not limited to, limitations on additional indebtedness and capital distributions, including dividend payments. The two primary debt covenants of the amended ADS Revolving Credit Facility and Senior Notes include a Leverage Ratio and an Interest Coverage Ratio maintenance covenant. For any relevant period of determination, the Leverage Ratio is calculated by dividing Total Consolidated Indebtedness (funded debt plus guarantees) by Consolidated EBITDA, as defined by the credit facility. The current upper limit is 4.0 times (or 4.25 as of the date of any acquisitions permitted under the amended agreement for which the aggregate consideration is $100.0 million or greater). The Interest Coverage Ratio is calculated by dividing the sum of Consolidated EBITDA by consolidated interest expense. The current minimum ratio is 3.0 times.
For further information, see “Note 12. Debt” to the Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of our Fiscal 2018 Form 10-K. We were in compliance with our debt covenants as of September 30, 2018.
Off-Balance Sheet Arrangements
Excluding the guarantees of 50% of certain debt of our unconsolidated South American Joint Venture as further discussed in “Note 8. Related Party Transactions” to the Condensed Consolidated Financial Statements, we do not have any other off-balance sheet arrangements. As of September 30, 2018, our South American Joint Venture had approximately $13.2 million of outstanding debt subject to our guarantees. We do not believe that this guarantee will have a current or future effect on our financial condition, results of operations, liquidity, or capital resources.
Critical Accounting Policies and Estimates
With the exception of the accounting pronouncements adopted during fiscal 2018 discussed in “Note 1. Background and Summary of Significant Accounting Policies” and “Note 3. Revenue Recognition,” there have been no changes in critical accounting policies from those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Fiscal 2018 Form 10-K.
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Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Form 10-Q”) includes forward-looking statements. Some of the forward-looking statements can be identified by the use of terms such as “believes,” “expects,” “may,” “will,” “would,” “should,” “could,” “seeks,” “predict,” “potential,” “continue,” “intends,” “plans,” “projects,” “estimates,” “anticipates” or other comparable terms. These forward-looking statements include all matters that are not related to present facts or current conditions or that are not historical facts. They appear in a number of places throughout this Form 10-Q and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our consolidated results of operations, financial condition, liquidity, prospects, growth strategies, and the industries in which we operate and include, without limitation, statements relating to our future performance.
Forward-looking statements are subject to known and unknown risks and uncertainties, many of which are beyond our control. We caution you that forward-looking statements are not guarantees of future performance and that our actual consolidated results of operations, financial condition, liquidity and industry development may differ materially from those made in or suggested by the forward-looking statements contained in this Quarterly Report on Form 10-Q. In addition, even if our actual consolidated results of operations, financial condition, liquidity and industry development are consistent with the forward-looking statements contained in this Form 10-Q, those results or developments may not be indicative of results or developments in subsequent periods. A number of important factors could cause actual results to differ materially from those contained in or implied by the forward-looking statements, including those reflected in forward-looking statements relating to our operations and business, the risks and uncertainties discussed in this Form 10-Q (including under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), and those described from time to time in our other filings with the SEC. Factors that could cause actual results to differ from those reflected in forward-looking statements relating to our operations and business include:
•
fluctuations in the price and availability of resins and other raw materials and our ability to pass any increased costs of raw materials on to our customers in a timely manner;
volatility in general business and economic conditions in the markets in which we operate, including without limitation, factors relating to availability of credit, interest rates, fluctuations in capital and business and consumer confidence;
cyclicality and seasonality of the non-residential and residential construction markets and infrastructure spending;
the risks of increasing competition in our existing and future markets, including competition from both manufacturers of high performance thermoplastic corrugated pipe and manufacturers of products using alternative materials;
our ability to continue to convert current demand for concrete, steel and polyvinyl chloride (“PVC”) pipe products into demand for our high performance thermoplastic corrugated pipe and Allied Products;
the effect of weather or seasonality;
the loss of any of our significant customers;
the risks of doing business internationally;
the risks of conducting a portion of our operations through joint ventures;
our ability to expand into new geographic or product markets;
our ability to achieve the acquisition component of our growth strategy;
the risk associated with manufacturing processes;
our ability to manage our assets;
the risks associated with our product warranties;
our ability to manage our supply purchasing and customer credit policies;
the risks associated with our self-insured programs;
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our ability to control labor costs and to attract, train and retain highly-qualified employees and key personnel;
our ability to protect our intellectual property rights;
changes in laws and regulations, including environmental laws and regulations;
our ability to project product mix;
the risks associated with our current levels of indebtedness;
fluctuations in our effective tax rate, including from the recently enacted Tax Cuts and Jobs Act;
changes to our operating results, cash flows and financial condition attributable to the recently enacted Tax Cuts and Jobs Act;
our ability to meet future capital requirements and fund our liquidity needs;
the risk that information may arise that would require the Company to make adjustments or revisions or to restate further the financial statements and other financial data for certain prior periods and any future periods;
any delay in the filing of any filings with the SEC;
the review of potential weaknesses or deficiencies in the Company’s disclosure controls and procedures, and discovering further weaknesses of which we are not currently aware or which have not been detected; and
additional uncertainties related to accounting issues generally.
All forward-looking statements are made only as of the date of this report and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking statements to reflect future events or developments. Comparisons of results for current and any prior periods are not intended to express any future trends, or indications of future performance, unless expressed as such, and should only be viewed as historical data.
Quantitative and Qualitative Disclosures about Market Risk
We are subject to various market risks, primarily related to changes in interest rates, credit, raw material supply prices and, to a lesser extent, foreign currency exchange rates. Our financial position, results of operations or cash flows may be negatively impacted in the event of adverse movements in the respective market rates or prices in each of these risk categories. Our exposure in each category is limited to those risks that arise in the normal course of business, as we do not engage in speculative, non-operating transactions. Our exposure to market risk has not materially changed from what we previously disclosed in Part II. Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” of our Annual Report on Form 10-K for the fiscal year ended March 31, 2018.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) are responsible for evaluating the effectiveness of our disclosure controls and procedures as defined in the Securities Exchange Act of 1934, as amended (the “Exchange Act”) rules 13a-15(e) and 15d-15(e). The Company’s disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on those material weaknesses, and the evaluation of our disclosure controls and
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procedures, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2018.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act that occurred during the three months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
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As previously disclosed in the Company’s Fiscal 2018 Form 10-K, the Company’s historical accounting practices were the subject of an investigation by SEC’s Division of Enforcement (the “Enforcement Division”), which began in August 2015. That matter was resolved on July 10, 2018 via a settlement between the Company and the SEC. Pursuant to the settlement, the Company consented to the entry of an administrative order without admitting or denying the findings therein. The order required the Company to cease and desist from committing or causing any violations and any future violations of certain provisions of the federal securities laws and the rules promulgated thereunder and to pay a civil monetary penalty of $1.0 million, which payment has been made. The Company previously accrued an expense for the penalty amount during Fiscal 2018.
Please see “Note 10. Commitments and Contingencies,” of the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for more information regarding legal proceedings.
Important risk factors that could affect our operations and financial performance, or that could cause results or events to differ from current expectations, are described in “Part I, Item 1A — Risk Factors” of our Fiscal 2018 Form 10-K. These factors are further supplemented by those discussed in “Part II, Item 7A — Quantitative and Qualitative Disclosures about Market Risk” of our Fiscal 2018 Form 10-K and in “Part I, Item 3 — Quantitative and Qualitative Disclosures about Market Risk” and “Part II, Item 1 — Legal Proceedings” of this Quarterly Report on Form 10-Q.
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In February 2017, our Board of Directors authorized the repurchase of up to $50 million of our common stock. Repurchases of common stock will be made in accordance with applicable securities laws. We did not repurchase any shares of common stock during the three months ended September 30, 2018. As of September 30, 2018, approximately $42.1 million of common stock may be repurchased under the authorization. The stock repurchase program does not obligate us to acquire any particular amount of common stock, and may be suspended or terminated at any time at our discretion.
None.
Not applicable.
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The following exhibits are filed herewith or incorporated herein by reference.
Exhibit
Number
Exhibit Description
10.1*
10.2*
First Amendment to Second Amended and Restated Credit Agreement, dated as of July 9, 2018.
Amendment No. 1 to Second Amended and Restated Private Shelf Agreement, dated as of July 9, 2018.
31.1*
Certification of President and Chief Executive Officer of Advanced Drainage Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Executive Vice President and Chief Financial Officer of Advanced Drainage Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Principal Executive Officer of Advanced Drainage Systems, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Certification of Principal Financial Officer of Advanced Drainage Systems, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*
XBRL Instance Document.
101.SCH*
XBRL Taxonomy Extension Schema.
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase.
101.DEF*
XBRL Taxonomy Extension Definition Linkbase.
101.LAB*
XBRL Taxonomy Extension Label Linkbase.
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase.
* Filed herewith
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 8, 2018
By:
/s/ D. Scott Barbour
D. Scott Barbour
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Scott A. Cottrill
Scott A. Cottrill
Executive Vice President, Chief Financial Officer and Secretary
(Principal Financial Officer)
/s/ Tim A. Makowski
Tim A. Makowski
Vice President, Controller, and Chief Accounting Officer
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