QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2022
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, Ohio43026
(Address of Principal Executive Offices, Including Zip Code)
(614) 658-0050
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
WMS
New York Stock Exchange
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 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 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 January 26, 2023, the registrant had 81,233,409 shares of common stock outstanding, which excludes 183,617 shares of unvested restricted common stock. The shares of common stock trade on the New York Stock Exchange under the ticker symbol “WMS.”
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 innovative water management solutions in the stormwater and onsite septic waste water industries, providing superior drainage solutions for use in the construction and agriculture marketplace. ADS’s products are used across a broad range of end markets and applications, including non-residential, infrastructure and agriculture applications.
The Company is managed and reports results of operations in three reportable segments: Pipe, Infiltrator Water Technologies Ultimate Holdings, Inc ("Infiltrator") and International. The Company also reports the results of its Allied Products and all other business segments as Allied Products and Other.
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, 2022 was derived from audited financial statements included in the Annual Report on Form 10-K for the year ended March 31, 2022 (“Fiscal 2022 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 December 31, 2022 and the results of operations for the three and nine months ended December 31, 2022 and cash flows for the nine months ended December 31, 2022. 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 2022 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 income of unconsolidated affiliates in the Condensed Consolidated Statements of Operations. All intercompany balances and transactions have been eliminated in consolidation.
Recent Accounting Guidance
There have been no new accounting pronouncements issued or adopted since the filing of the Fiscal 2022 Form 10-K that have significance, or potential significance, to the Condensed Consolidated Financial Statements.
2.ACQUISITIONS
Acquisition of Cultec - On April 29, 2022, the Company completed its acquisition of Cultec, Inc. (“Cultec”). Cultec was a family-owned technology leader in the stormwater and onsite septic wastewater industries. The acquisition of Cultec expands the Company’s portfolio of innovative water management solutions in the stormwater and onsite septic wastewater industries. The total fair value of consideration transferred was $48.0 million.
The following table summarizes the consideration transferred and the preliminary purchase price allocation of assets acquired and liabilities assumed. The purchase price allocation for assets acquired and liabilities assumed is preliminary and will be finalized when valuations are complete and final assessments of the fair value of acquired assets and assumed liabilities are completed. Such finalization may result in material changes from the preliminary purchase price allocation. The Company's estimates and assumptions are subject to change during the measurement
period (up to one year from the closing date), as the Company continues to finalize the valuations of assets acquired and liabilities assumed.
(Amounts in thousands)
Initial Amount
Increase to Purchase Price
Updated Amount
Accounts receivable
$
5,957
$
—
$
5,957
Inventory
4,469
—
4,469
Intangible assets
31,400
—
31,400
Goodwill
9,660
518
10,178
Property, plant and equipment
1,986
—
1,986
Accounts payable
(5,539)
—
(5,539)
Accrued expenses
(75)
—
(75)
Other liabilities
(366)
—
(366)
Total fair value of consideration transferred
$
47,492
$
518
$
48,010
The preliminary goodwill of $10.2 million represents the excess of consideration transferred over the preliminary fair value of assets acquired and liabilities assumed and is attributable to expected operating efficiencies. The goodwill is deductible for income tax purposes and is assigned to Allied Products & Other.
The preliminary purchase price excludes transaction costs. During the nine months ended December 31, 2022, the Company incurred $1.5 million of transaction costs related to the acquisition such as legal, accounting, valuation and other professional services. These costs are included in selling, general and administrative expenses in the Consolidated Statements of Operations and Consolidated Statements of Comprehensive Income.
The identifiable intangible assets recorded in connection with the closing of the acquisition of Cultec are based on preliminary valuations including customer relationships, patents and developed technology and tradename and trademarks totaling $31.4 million.
(Amounts in thousands)
Preliminary fair value
Customer relationships
$
12,400
Patents and developed technology
16,200
Tradename and trademarks
2,800
Total identifiable intangible assets
$
31,400
The Company has excluded certain disclosures required under ASC 805, Business Combinations as they are not material to the financial statements.
3.REVENUE RECOGNITION
Revenue Disaggregation - The Company disaggregates net sales by Domestic, International and Infiltrator and further disaggregates Domestic and International by product type, consistent with its reportable segment disclosure. This disaggregation level best depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. Refer to “Note 12. Business Segments Information” for the Company’s disaggregation of Net sales by reportable segment.
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 following table presents the balance of the Company’s contract asset and liability as of the periods presented:
Nature of the Company’s Leases - The Company has operating and finance leases for plants, yards, corporate offices, tractors, trailers and other equipment. The Company’s leases have remaining terms of less than one year to 28 years. A portion of the Company’s yard leases include an option to extend the leases for up to five years. The Company has included renewal options which are reasonably certain to be exercised in its right-of-use assets and lease liabilities.
5.INVENTORIES
Inventories as of the periods presented consisted of the following:
December 31, 2022
March 31, 2022
(In thousands)
Raw materials
$
123,722
$
156,050
Finished goods
335,307
338,274
Total inventories
$
459,029
$
494,324
6.NET INCOME PER SHARE AND STOCKHOLDERS' EQUITY
Employee Stock Ownership Plan ("ESOP") - As previously disclosed in the Fiscal 2022 Form 10-K, in April 2022 all currently outstanding 15.6 million shares of Preferred Stock held by the ESOP were converted into 12.0 million shares of the Company’s redeemable common stock at the Conversion rate of 0.7692. The Company’s 401(k) retirement plan (“KSOP”) holds these shares of common stock. When participants sell or forfeit these shares, the shares are no longer subject to the put option of the Internal Revenue Code and are no longer required to be classified in mezzanine equity.
Net Income per Share - For the three and nine months ended December 31, 2021, the Company was required to apply the two-class method to compute both basic and diluted net income per share. Holders of redeemable convertible preferred stock participated in dividends on an as-converted basis when declared on common stock. As a result, redeemable convertible preferred stock met the definition of participating securities. 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. The Company was not required to apply the two-class method to compute net income per share for the three and nine months ended December 31, 2022 as the redeemable common stock and common stock have the same rights to earnings available to common stockholders.
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:
Three Months Ended December 31,
Nine Months Ended December 31,
(In thousands, except per share data)
2022
2021
2022
2021
NET INCOME PER SHARE—BASIC:
Net income attributable to ADS
$
82,040
$
73,678
$
421,193
$
225,024
Adjustments for:
Dividends to participating securities
—
(1,357)
—
(4,633)
Net income available to common stockholders and participating securities
82,040
72,321
421,193
220,391
Undistributed income allocated to participating securities
—
(9,457)
—
(30,870)
Net income available to common stockholders – Basic
$
82,040
$
62,864
$
421,193
$
189,521
Weighted average number of common shares outstanding – Basic
82,067
71,267
82,891
71,087
Net income per common share – Basic
$
1.00
$
0.88
$
5.08
$
2.67
NET INCOME PER SHARE—DILUTED:
Net income available to common stockholders – Diluted
$
82,040
$
62,864
$
421,193
$
189,521
Weighted average number of common shares outstanding – Basic
82,067
71,267
82,891
71,087
Assumed restricted stock
114
236
131
245
Assumed exercise of stock options
626
854
702
904
Assumed performance units
180
432
256
516
Weighted average number of common shares outstanding – Diluted
82,987
72,789
83,980
72,752
Net income per common share – Diluted
$
0.99
$
0.86
$
5.02
$
2.61
Potentially dilutive securities excluded as anti-dilutive
42
12,271
45
13,240
Stockholders’ Equity – During the three and nine months ended December 31, 2022, the Company repurchased 1.9 million and 3.8 million shares, respectively, of common stock at a cost of $179.9 million and $375.0 million, respectively.
7.RELATED PARTY TRANSACTIONS
ADS Mexicana - ADS conducts business in Mexico and Central America through its joint venture ADS Mexicana, 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.
On June 6, 2022, the Company and ADS Mexicana amended the Intercompany Revolving Credit Promissory Note (the “Intercompany Note”) with a borrowing capacity of $9.5 million. The Intercompany Note matures on June 8, 2027. 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 Secured Overnight Financing Rate (“SOFR”) plus an applicable margin based on the Leverage Ratio. As of December 31, 2022 and March 31, 2022, there were no borrowings and $1.5 million of borrowings, respectively, outstanding 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. ADS owns 50% of the South American Joint Venture. ADS is the guarantor of 50% of the South American Joint Venture’s credit arrangement, 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 December 31, 2022. The maximum borrowings permitted under the South American Joint Venture’s credit facility are $22.0 million. The Company does not anticipate any required contributions related to the balance of this credit arrangement. As of December 31, 2022 and March 31, 2022, the outstanding principal balances of the credit facility including letters of credit were $6.3 million and $9.9 million, respectively. As of December 31, 2022, there were no U.S. dollar denominated loans. The weighted average interest rate as of December 31, 2022 was 11.5% on Chilean peso denominated loans.
Long-term debt as of the periods presented consisted of the following:
December 31, 2022
March 31, 2022
(In thousands)
Term Loan Facility
$
429,000
$
434,250
Senior Notes due 2027
350,000
350,000
Senior Notes due 2030
500,000
—
Revolving Credit Facility
—
114,300
Equipment Financing
20,955
31,254
Total
1,299,955
929,804
Unamortized debt issuance costs
(12,314)
(1,648)
Current maturities
(15,601)
(19,451)
Long-term debt obligations
$
1,272,040
$
908,705
Senior Secured Credit Facilities – In July 2019, the Company entered into the credit agreement (the “Base Credit Agreement”) by and among the Company, as borrower, Barclays Bank PLC, as administrative agent, the several lenders from time to time party thereto. In September 2019, the Company amended the Base Credit Agreement (as amended the “Senior Secured Credit Facility”). The Senior Secured Credit Facility provides for a term loan facility in an initial aggregate principal amount of $700 million (the “Term Loan Facility”), a revolving credit facility in an initial aggregate principal amount of up to $350 million (the “Revolving Credit Facility”), a letter of credit sub-facility in the initial aggregate available amount of up to $50 million, as a sublimit of such Revolving Credit Facility (the “L/C Facility”) and a swing line sub-facility in the aggregate available amount of up to $50 million, as a sublimit of the Revolving Credit Facility (together with the Term Loan Facility, the Revolving Credit Facility and the L/C Facility, the “Senior Secured Credit Facility”).
In May 2022, the Company entered into a Second Amendment (the "Second Amendment") to the Company's Base Credit Agreement with Barclays Bank PLC, as administrative agent under the Term Loan Facility, PNC Bank, National Association, as new administrative agent under the Revolving Credit Facility. Among other things, the Second Amendment (i) amended the Base Credit Agreement by increasing the Revolving Credit Facility (the "Amended Revolving Credit Facility") from $350 million to $600 million (including an increase of the sub-limit for the swing-line sub-facility from $50 million to $60 million), (ii) extended the maturity date of the Revolving Credit Facility to May 26, 2027, (iii) revised the “applicable margin” to provide an additional step-down to 175 basis points (for Term Benchmark based loans) and 75 basis points (for base rate loans) in the event the consolidated senior secured net leverage ratio is less than 2.00 to 1.00, and (iv) reset the “incremental amount” and the investment basket in non-guarantors and joint ventures. The Second Amendment also revises the reference interest rate from LIBOR to SOFR for both the Amended Revolving Credit Facility and the Term Loan Facility. Letters of credit outstanding at December 31, 2022 and March 31, 2022 amounted to $9.7 million and $9.2 million, respectively, and reduced the availability of the Revolving Credit Facility.
Senior Notes due 2027 – OnSeptember 23, 2019, the Company issued $350.0 million aggregate principal amount of 5.0% Senior Notes due 2027 (the “2027 Notes”) pursuant to an Indenture, dated September 23, 2019 (the “2027 Indenture”), among the Company, the guarantors party thereto (the “Guarantors”) and U.S. Bank National Association, as Trustee (the “Trustee”). The 2027 Notes are guaranteed by each of the Company’s present and future direct and indirect wholly owned domestic subsidiaries that is a guarantor under the Company's Senior Secured Credit Facility. The 2027 Notes were offered and sold either to persons reasonably believed to be “qualified institutional buyers” pursuant to Rule 144A under the Securities Act of 1933 (the “Securities Act”) or to persons outside the United States under Regulation S of the Securities Act.
Senior Notes due 2030 – On June 9, 2022, the Company issued $500.0 million aggregate principal amount of 6.375% Senior Notes due 2030 (the “2030 Notes”) pursuant to an Indenture, dated June 9, 2022 (the "2030 Indenture"), among the Company, the Guarantors and the Trustee. The 2030 Notes were offered and sold either to persons reasonably believed to be “qualified institutional buyers” pursuant to Rule 144A under the Securities Act or to persons outside the United States under Regulation S of the Securities Act.
Interest on the 2030 Notes will be payable semi-annually in cash in arrears on January 15 and July 15 of each year, commencing on January 15, 2023, at a rate of 6.375% per annum. The 2030 Notes will mature on July 15, 2030.
The Company used a portion of the net proceeds from the offering of the 2030 Notes to repay in full the outstanding borrowings under its Revolving Credit Facility and will use the remainder for general corporate purposes. The deferred financing costs associated with the 2030 Notes totaled $9.0 million and are recorded as a direct reduction from the carrying amount of the related debt.
The Company may redeem the 2030 Notes, in whole or in part, at any time on or after July 15, 2025 at certain specified redemption prices set forth in the 2030 Indenture. In addition, at any time prior to July 15, 2025, the Company may redeem the 2030 Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the 2030 Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date plus an applicable “make-whole” premium. At any time prior to July 15, 2025, the Company may also redeem up to 40% of the aggregate principal amount of 2030 Notes issued under the Indenture with net cash proceeds of certain equity offerings at a redemption price equal to 106.375% of the principal amount of the 2030 Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date.
The 2030 Indenture contains customary events of default, including, among other things, payment default, failure to comply with covenants or agreements contained in the 2030 Indenture or the 2030 Notes and certain provisions related to bankruptcy events. The 2030 Indenture also contains customary negative covenants.
Equipment Financing – In November 2021, the Company purchased material handling equipment, trucks and trailers previously leased under a master lease agreement and classified as finance leases. The purchase was funded with debt through the Master Lease Agreement and Interim Funding Schedule with Fifth Third. The assets acquired are titled to the Company and included in Property, plant and equipment, net on the Company's Condensed Consolidated Balance Sheet. The equipment financing had an initial term of between 12 and 84 months, based on the life of the equipment, and bears a weighted average interest of 1.5% as of December 31, 2022. The current portion of the equipment financing is $8.6 million, and the long-term portion is $12.3 million at December 31, 2022.
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. The following table presents the carrying and fair value of the Company’s 2027 Notes, 2030 Notes and Equipment Financing for the periods presented:
December 31, 2022
March 31, 2022
Fair Value
Carrying Value
Fair Value
Carrying Value
(In thousands)
Senior Notes due 2027
$
328,577
$
350,000
$
349,902
$
350,000
Senior Notes due 2030
486,570
500,000
—
—
Equipment Financing
19,981
20,955
29,302
31,254
Total fair value
$
835,128
$
870,955
$
379,204
$
381,254
The fair values of the 2027 Notes and 2030 Notes were determined based on quoted market data for the Company’s 2027 Notes and 2030 Notes, respectively. The fair value of the Equipment Financing 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 categorization of the framework used to evaluate the 2027 Notes, 2030 Notes and Equipment Financing are considered Level 2. The Company believes the carrying amount on the remaining long-term debt, including the Term Loan Facility and Revolving Credit Facility, is not materially different from its fair value as the interest rates and terms of the borrowings are similar to currently available borrowings.
9.COMMITMENTS AND CONTINGENCIES
Purchase Commitments - The Company has historically secured supplies of resin raw material by agreeing to purchase quantities during a future given period at a fixed price. These purchase contracts typically ranged from 1 to 12 months and occur in the ordinary course of business. The Company also enters into equipment purchase contracts with manufacturers. The Company does not have any outstanding purchase commitments with fixed price and quantity as of December 31, 2022.
Litigation and Other Proceedings – 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 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.
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 one-time charges, as well as the occurrence of discrete events. For the three months ended December 31, 2022 and 2021, the Company utilized an effective tax rate of 24.0% and 28.1%, respectively, to calculate its provision for income taxes. For the nine months ended December 31, 2022 and 2021, the Company utilized an effective tax rate of 23.4% and 26.6%, respectively, to calculate its provision for income taxes. State and local income taxes increased the effective rate for the three and nine months ended December 31, 2022 and 2021. The Company’s ESOP also increased the effective rate for three and nine months ended December 31, 2021, which no longer impacts the effective tax rate after the repayment of the ESOP loan and the allocation of the remaining unallocated shares of Preferred Stock in the prior year. Additionally, discrete income tax benefits related to the stock-based compensation windfall decreased the rate for the three months ended December 31, 2022 and nine months ended December 31, 2022 and 2021.
11.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, performance-based restricted stock units 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 periods presented:
Three Months Ended December 31,
Nine Months Ended December 31,
2022
2021
2022
2021
(In thousands)
Component of income before income taxes:
Cost of goods sold
$
743
$
700
$
2,175
$
2,019
Selling, general and administrative expenses
5,436
5,542
17,737
16,492
Total stock-based compensation expense
$
6,179
$
6,242
$
19,912
$
18,511
The following table summarizes stock-based compensation expense by award type for the periods presented:
Three Months Ended December 31,
Nine Months Ended December 31,
2022
2021
2022
2021
(In thousands)
Stock-based compensation expense:
Stock Options
$
1,035
$
793
$
3,316
$
2,406
Restricted Stock
1,754
1,480
5,480
4,359
Performance-based Restricted Stock Units
2,827
3,471
9,619
10,432
Non-Employee Directors
563
498
1,497
1,314
Total stock-based compensation expense
$
6,179
$
6,242
$
19,912
$
18,511
2017 Omnibus Incentive 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 5.0 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.
Restricted Stock – During the three and nine months ended December 31, 2022, the Company granted less than 0.1 million and 0.1 million shares, respectively of restricted stock with a grant date fair value of $0.1 million and $11.9 million, respectively.
Performance-based Restricted Stock Units ("Performance Units") – During the nine months ended December 31, 2022, the Company granted 0.1 million performance share units at a grant date fair value of $6.6 million.
Options – During the nine months ended December 31, 2022, the Company granted 0.1 million nonqualified stock options under the 2017 Incentive Plan with a grant date fair value of $5.5 million. The Company estimates the fair value of stock options using a Black-Scholes option-pricing model. The following table summarizes the assumptions used to estimate the fair value of stock-options during the period presented:
Nine Months Ended December 31, 2022
Common stock price
$99.29
Expected stock price volatility
41.1%
Risk-free interest rate
2.9%
Weighted-average expected option life (years)
6
Dividend yield
0.48%
12.BUSINESS SEGMENTS INFORMATION
The Company operates its business in three distinct reportable segments: “Pipe”, “International” and “Infiltrator.” “Allied Products & Other” represents the Company’s Allied Products and all other business segments. The Chief Operating Decision Maker (the “CODM”) evaluates segment reporting based on Net Sales and Segment Adjusted Gross Profit. The Company calculated Segment Adjusted Gross Profit as Net sales less Costs of goods sold, depreciation and amortization, stock-based compensation and non-cash charges. A measure of assets is not applicable, as segment assets are not regularly reviewed by the CODM for evaluating performance or allocating resources.
Pipe – The Pipe segment manufactures and markets high performance thermoplastic corrugated pipe throughout the United States. The Company maintains and serves these markets through product distribution relationships with many of the largest national and independent waterworks distributors, buying groups and co-ops, major national retailers as well as an extensive network of hundreds of small to medium-sized distributors across the United States.
Products include single wall pipe, N-12 HDPE pipe sold into the Storm sewer, Infrastructure and Agriculture markets, High Performance polypropylene pipe sold into the Storm sewer, Infrastructure and sanitary sewer markets. Products are designed primarily for storm water management in the construction and infrastructure marketplace across a broad range of end markets and applications, including non-residential, residential, agriculture and infrastructure. Products are manufactured using HDPE and polypropylene plastic material.
Infiltrator – Infiltrator is a leading national provider of plastic leach field chambers and systems, septic tanks and accessories, primarily for use in residential applications. Infiltrator products are used in onsite septic wastewater treatment systems in the United States and Canada.
International – The International segment manufactures and markets pipe and allied products in certain regions outside of the United States, including Company owned facilities in Canada, subsidiaries that distribute to Europe and the Middle East, exports and through the Company’s joint ventures with local partners in Mexico and South America. The Company’s Mexican joint venture, ADS Mexicana, primarily serves the Mexican and Central American markets, while its South American Joint Venture, Tigre-ADS, is the primary channel to serve the South American markets. The Company’s International product lines include single wall pipe, N-12 HDPE pipe, high performance PP pipe and certain geographies also sell our broad line of Allied Products.
Allied Products & Other – Allied Products and Other manufactures and markets products throughout the United States. Products include StormTech, Nyloplast, ARC Septic Chambers, Inserta Tee, BaySaver filters and water quality structures, Fittings, Cultec and FleXstorm. The Company maintains and serves these markets through product distribution relationships with many of the largest national and independent waterworks distributors, major national retailers as well as an extensive network of hundreds of small to medium-sized distributors across the United States. The Company also sells through a broad variety of buying groups and co-ops in the United States. The Company aggregates operating segments within the Allied Products & Other segment disclosure. None of the operating segments within the Allied Products & Other businesses segment disclosure exceeds the quantitative thresholds for separate segment reporting.
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:
The following sets forth certain financial information attributable to the reportable segments for the periods presented:
Three Months Ended December 31,
Nine Months Ended December 31,
2022
2021
2022
2021
(In thousands)
Segment Adjusted Gross Profit
Pipe
$
106,279
$
92,066
$
421,011
$
258,681
Infiltrator
46,497
60,546
193,569
178,795
International
13,342
13,240
51,456
49,695
Allied Products & Other
78,401
72,785
293,472
204,063
Intersegment Eliminations
714
(44)
329
1,421
Total
$
245,233
$
238,593
$
959,837
$
692,655
Depreciation and Amortization
Pipe
$
12,754
$
12,534
$
38,754
$
36,595
Infiltrator
5,120
3,551
15,014
10,362
International
1,369
1,403
4,023
4,151
Allied Products & Other(a)
16,603
17,349
49,555
52,579
Total
$
35,846
$
34,837
$
107,346
$
103,687
Capital Expenditures
Pipe
$
28,268
$
18,657
$
75,565
$
41,296
Infiltrator
12,810
15,614
33,856
50,774
International
2,366
735
4,393
2,249
Allied Products & Other(a)
7,869
1,597
13,044
6,048
Total
$
51,313
$
36,603
$
126,858
$
100,367
(a)Includes depreciation, amortization and capital expenditures not allocated to a reportable segment. The amortization expense of Infiltrator intangible assets acquired is included in Allied Products & Other.
Reconciliation of Gross Profit to Segment Adjusted Gross Profit
Three Months Ended December 31,
Nine Months Ended December 31,
2022
2021
2022
2021
(In thousands)
Reconciliation of Segment Adjusted Gross Profit:
Total Gross Profit
$
223,917
$
208,977
$
895,987
$
610,155
Depreciation and Amortization
20,573
18,042
61,675
52,824
ESOP and stock-based compensation expense
743
11,574
2,175
29,676
Total Segment Adjusted Gross Profit
$
245,233
$
238,593
$
959,837
$
692,655
13.SUBSEQUENT EVENTS
Common Stock Dividend - During the fourth quarter of fiscal 2023, the Company declared a quarterly cash dividend of $0.12 per share of common stock. The dividend is payable on March 15, 2023 to stockholders of record at the close of business on March 1, 2023.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise indicates or requires, as used in this Quarterly Report on Form 10-Q ("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. We consolidate our joint ventures for purposes of GAAP, except for our South American Joint Venture.
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, 2023 refers to fiscal 2023, which is the period from April 1, 2022 to March 31, 2023.
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 Form 10-Q and with the audited Consolidated Financial Statements included in our Fiscal 2022 Form 10-K, as filed with the Securities and Exchange Commission (the “SEC”) on May 19, 2022. 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.”
Overview
ADS is the leading manufacturer of innovative water management solutions in the stormwater and onsite septic wastewater industries, providing superior drainage solutions for use in the construction and agriculture marketplaces. Our innovative products, for which we hold many patents, are used across a broad range of end markets and applications, including non-residential, infrastructure and agriculture applications. We have established a leading position in many of these end markets by leveraging our national sales and distribution platform, industry-acclaimed engineering support, overall product breadth and scale plus manufacturing excellence.
Executive Summary
Third Quarter Fiscal 2023 Results
•Net sales decreased 8.4% to $655.2 million
•Net income increased 11.7% to $83.2 million
•Adjusted EBITDA, a non-GAAP measure, decreased 3.6% to $169.7 million
Net sales decreased $60.2 million, or 8.4%, to $655.2 million, as compared to $715.4 million in the prior year quarter. Domestic pipe sales decreased $24.3 million, or 6.1%, to $375.7 million. Domestic allied products & other sales increased $1.6 million, or 1.1%, to $149.0 million. Infiltrator sales decreased $44.8 million, or 30.1%, to $103.9 million. The decrease in domestic net sales was driven by sales in the U.S. construction end markets. International sales increased $3.1 million, or 5.6%, to $59.0 million, driven by growth in the Canadian and Mexican businesses.
Gross profit increased $14.9 million, or 7.1%, to $223.9 million as compared to $209.0 million in the prior year. The increase in gross profit is primarily due to the favorable pricing on pipe, onsite septic and allied products as well as favorable material cost. This increase was partially offset by a decrease in volume, inflationary cost pressures and higher manufacturing costs.
Adjusted EBITDA, a non-GAAP measure, decreased $6.4 million, or 3.6%, to $169.7 million, as compared to $176.2 million in the prior year. The decrease is primarily due to the factors mentioned above, as well as an increase in selling, general and administrative expenses. As a percentage of Net sales, Adjusted EBITDA was 25.9% as compared to 24.6% in the prior year.
Year-to-date Fiscal 2023 Results
•Net sales increased 17.3% to $2,453.6 million
•Net income increased 86.5% to $425.0 million
•Adjusted EBITDA, a non-GAAP measure, increased 44.2% to $732.0 million
Net sales increased $362.4 million, or 17.3%, to $2,453.6 million, as compared to $2,091.1 million in the prior year quarter. Domestic pipe sales increased $243.0 million, or 21.0%, to $1,401.6 million. Domestic allied products & other sales increased $129.9 million, or 30.9%, to $550.2 million. Infiltrator sales decreased $0.4 million, or 0.1%, to $420.9 million. The increase in domestic net sales was driven by double-digit sales growth in the U.S. construction end markets.
International sales increased $19.2 million, or 10.4%, to $203.9 million, driven by strong sales growth in the Canadian, Mexican and Exports businesses.
Gross profit increased $285.8 million, or 46.8%, to $896.0 million as compared to $610.2 million in the prior year. The increase in gross profit is primarily due to the favorable pricing on pipe, onsite septic and allied products as well as favorable material cost. This increase was partially offset by a decrease in volume, inflationary cost pressures and higher manufacturing costs.
Adjusted EBITDA, a non-GAAP measure, increased $224.4 million, or 44.2%, to $732.0 million, as compared to $507.5 million in the prior year. The increase is primarily due to the factors mentioned above. As a percentage of Net sales, Adjusted EBITDA was 29.8% as compared to 24.3% in the prior year.
Results of Operations
Comparison of the Three Months Ended December 31, 2022 to the Three Months Ended December 31, 2021
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 periods presented. We believe this presentation is useful to investors in comparing historical results.
For the Three Months Ended December 31,
2022
2021
Consolidated Statements of Operations data:
(In thousands)
Net sales
$
655,167
100.0
%
$
715,357
100.0
%
Cost of goods sold
431,250
65.8
506,380
70.8
Gross profit
223,917
34.2
208,977
29.2
Selling, general and administrative
85,936
13.1
80,059
11.2
(Gain) loss on disposal of assets and costs from exit and disposal activities
(348)
(0.1)
3,466
0.5
Intangible amortization
13,842
2.1
15,138
2.1
Income from operations
124,487
19.0
110,314
15.4
Interest expense
20,001
3.1
8,756
1.2
Derivative gains and other income, net
(4,125)
(0.6)
(979)
(0.1)
Income before income taxes
108,611
16.6
102,537
14.3
Income tax expense
26,068
4.0
28,792
4.0
Equity in net income of unconsolidated affiliates
(639)
(0.1)
(717)
(0.1)
Net income
83,182
12.7
74,462
10.4
Less: net income attributable to noncontrolling interest
1,142
0.2
784
0.1
Net income attributable to ADS
$
82,040
12.5
%
$
73,678
10.3
%
Net sales - The following table presents Net sales to external customers by reportable segment for the three months ended December 31, 2022 and 2021.
(Amounts in thousands)
2022
2021
$ Variance
% Variance
Pipe
$
364,880
$
396,695
$
(31,815)
(8.0)
%
Infiltrator
88,934
122,363
(33,429)
(27.3)
International
53,646
50,143
3,503
7.0
Allied Products & Other
147,707
146,156
1,551
1.1
Total Consolidated
$
655,167
$
715,357
$
(60,190)
(8.4)
%
Our consolidated Net sales for the three months ended December 31, 2022 decreased by $60.2 million, or 8.4%, compared to the same period in fiscal 2022. The decrease in Net sales was primarily a result of decreases in our Infiltrator segment and in our domestic Pipe segment.
Our Pipe and Infiltrator segments experienced decreased sales primarily due to lower volume offset by improved pricing/mix of products sold. The increase in our International segment was driven by growth in the Canadian and Mexican
businesses. Growth in Allied Products & Other was driven mainly by the acquisition of Cultec partially offset by volume decreases.
Cost of goods sold and Gross profit - The following table presents gross profit by reportable segment for the three months ended December 31, 2022 and 2021.
(Amounts in thousands)
2022
2021
$ Variance
% Variance
Pipe
$
92,816
$
68,717
$
24,099
35.1
%
Infiltrator
41,345
56,871
(15,526)
(27.3)
International
11,881
11,816
65
0.6
Allied Products & Other
77,161
71,617
5,544
7.7
Intersegment eliminations
714
(44)
758
(1,722.7)
Total gross profit
$
223,917
$
208,977
$
14,940
7.1
%
Our consolidated Cost of goods sold for the three months ended December 31, 2022 decreased by $75.1 million, or 14.8%, and our consolidated Gross profit increased by $14.9 million, or 7.1%, compared to the same period in fiscal 2022. The increase in our gross profit was primarily due to improved pricing as well as favorable material cost partially offset by a decrease in volume, inflationary cost pressures along with higher manufacturing costs.
Selling, general and administrative expenses
Three Months Ended December 31,
(Amounts in thousands)
2022
2021
Selling, general and administrative expenses
$
85,936
$
80,059
% of Net sales
13.1
%
11.2
%
Selling, general and administrative expenses for three months ended December 31, 2022 increased $5.9 million from the same period in fiscal 2022 and as a percentage of sales, increased by 1.9%. The increase in Selling, general and administrative expenses is the result of increased headcount.
(Gain) loss on disposal of assets and costs from exit and disposal activities - The change in (Gain) loss on disposal of assets and costs from exit and disposal activities is primarily due to asset disposals in fiscal 2022.
Intangible amortization - Intangible amortization decreased $1.3 million due to the accelerated method of amortization for customer relationships.
Interest expense - Interest expense increased $11.2 million in the three months ended December 31, 2022 compared to the same period in the previous fiscal year. The increase was primarily due to increased average debt levels.
Derivative gains and other income, net - Derivative gains and other income increased by $3.1 million for the three months ended December 31, 2022 compared to the same period in the previous fiscal year primarily due to interest income.
Income tax expense - The following table presents the effective tax rates for the three months ended December 31, 2022 and 2021.
Three Months Ended December 31,
2022
2021
Effective tax rate
24.0
%
28.1
%
The change in the effective tax rate for the three months ended December 31, 2022 was primarily related to the transition of the Company’s Employee Stock Ownership Plan (“ESOP”) and the repayment of the ESOP loan in the prior year. See “Note 10. Income Taxes” for additional information.
Equity in net income of unconsolidated affiliates - The Equity in net income of unconsolidated affiliates decreased for the three months ended December 31, 2022 as compared to the same period in the previous fiscal year.
Net income attributable to noncontrolling interest - Net income attributable to noncontrolling interest increased for three months ended December 31, 2022 due to an increase in net income at our ADS Mexicana joint venture.
Comparison of the Nine Months Ended December 31, 2022 to the Nine Months Ended December 31, 2021
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 periods presented. We believe this presentation is useful to investors in comparing historical results.
For the Nine Months Ended December 31,
2022
2021
Consolidated Statements of Operations data:
(In thousands)
Net sales
$
2,453,562
100.0
%
$
2,091,128
100.0
%
Cost of goods sold
1,557,575
63.5
1,480,973
70.8
Gross profit
895,987
36.5
610,155
29.2
Selling, general and administrative
261,095
10.6
230,231
11.0
(Gain) loss on disposal of assets and costs from exit and disposal activities
(147)
—
2,554
0.1
Intangible amortization
41,360
1.7
46,229
2.2
Income from operations
593,679
24.2
331,141
15.8
Interest expense
49,334
2.0
25,100
1.2
Derivative gains and other income, net
(5,632)
(0.2)
(2,791)
(0.1)
Income before income taxes
549,977
22.4
308,832
14.8
Income tax expense
128,641
5.2
82,063
3.9
Equity in net income of unconsolidated affiliates
(3,705)
(0.2)
(1,128)
(0.1)
Net income
425,041
17.3
227,897
10.9
Less: net income attributable to noncontrolling interest
3,848
0.2
2,873
0.1
Net income attributable to ADS
$
421,193
17.2
%
$
225,024
10.8
%
Net sales - The following table presents Net sales to external customers by reportable segment for the nine months ended December 31, 2022 and 2021.
(Amounts in thousands)
2022
2021
$ Variance
% Variance
Pipe
$
1,370,071
$
1,150,655
$
219,416
19.1
%
Infiltrator
354,603
353,567
1,036
0.3
International
185,425
170,999
14,426
8.4
Allied Products & Other
543,463
415,907
127,556
30.7
Total Consolidated
$
2,453,562
$
2,091,128
$
362,434
17.3
%
Our consolidated Net sales for the nine months ended December 31, 2022 increased by $362.4 million, or 17.3%, compared to the same period in fiscal 2022. The increase in Net sales was primarily a result of growth in our domestic Pipe segment and Allied Products & Other.
Our Pipe and Infiltrator segments experienced growth primarily through improved pricing/mix of products sold partially offset by volume decreases. The increase in our International segment was driven by growth in the Canadian and Mexican businesses. Growth in Allied Products & Other was driven mainly by improved price/mix of products offerings and the acquisition of Cultec partially offset by volume decreases.
Cost of goods sold and Gross profit - The following table presents gross profit by reportable segment for the nine months ended December 31, 2022 and 2021.
(Amounts in thousands)
2022
2021
$ Variance
% Variance
Pipe
$
380,199
$
194,644
$
185,555
95.3
%
Infiltrator
178,438
168,090
10,348
6.2
International
47,253
45,512
1,741
3.8
Allied Products & Other
289,768
200,488
89,280
44.5
Intersegment eliminations
329
1,421
(1,092)
(76.8)
Total gross profit
$
895,987
$
610,155
$
285,832
46.8
%
Our consolidated Cost of goods sold for the nine months ended December 31, 2022 increased by $76.6 million, or 5.2%, and our consolidated Gross profit increased by $285.8 million, or 46.8%, compared to the same period in fiscal 2022. The increase in our gross profit was due to an increase in net sales from improved pricing partially offset by a decrease in volume, inflationary cost pressures and higher manufacturing costs.
Selling, general and administrative expenses
Nine Months Ended December 31,
(Amounts in thousands)
2022
2021
Selling, general and administrative expenses
$
261,095
$
230,231
% of Net sales
10.6
%
11.0
%
Selling, general and administrative expenses for nine months ended December 31, 2022 increased $30.9 million from the same period in fiscal 2022 and as a percentage of sales, decreased by 0.4%. The increase in Selling, general and administrative expenses is the result of increased headcount to support business growth.
(Gain) loss on disposal of assets and costs from exit and disposal activities - The change in (Gain) loss on disposal of assets and costs from exit and disposal activities is primarily due to asset disposals in fiscal 2022.
Intangible amortization - Intangible amortization decreased $4.9 million due to the accelerated method of amortization for customer relationships.
Interest expense - Interest expense increased $24.2 million in the nine months ended December 31, 2022 compared to the same period in the previous fiscal year. The increase was primarily due to increased average debt levels.
Derivative gains and other income, net - Derivative gains and other income increased by $2.8 million for the nine months ended December 31, 2022 compared to the same period in the previous fiscal year primarily due to increased interest income.
Income tax expense - The following table presents the effective tax rates for the nine months ended December 31, 2022 and 2021.
Nine Months Ended December 31,
2022
2021
Effective tax rate
23.4
%
26.6
%
The change in the effective tax rate for the nine months ended December 31, 2022 was primarily related to the transition of the Company’s ESOP and the repayment of the ESOP loan in the prior year. See “Note 10. Income Taxes” for additional information.
Equity in net income of unconsolidated affiliates - The Equity in net income of unconsolidated affiliates increased for the nine months ended December 31, 2022 as compared to the same period in the previous fiscal year due to an increase in the current period income at our South American Joint Venture.
Net income attributable to noncontrolling interest - Net income attributable to noncontrolling interest increased for nine months ended December 31, 2022 due to an increase in net income at our ADS Mexicana joint venture.
Adjusted EBITDA and Adjusted EBITDA Margin - Adjusted EBITDA and Adjusted EBITDA Margin, which are non-GAAP financial measures, have been presented in this Form 10-Q as supplemental measures of financial performance that are not required by, or presented in accordance with GAAP and should not be considered as alternatives to net income as measures of financial performance or cash flows from operations or any other performance measure derived in accordance with GAAP. We calculate Adjusted EBITDA as net income (loss) before interest, income taxes, depreciation and amortization, stock-based compensation expense, non-cash charges and certain other expenses. We calculate Adjusted EBITDA Margin as Adjusted EBITDA divided by net sales.
Adjusted EBITDA and Adjusted EBITDA Margin are included in this Form 10-Q because they are key metrics used by management and our board of directors to assess our consolidated financial performance. These non-GAAP financial measures are 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 these non-GAAP financial measures to supplement GAAP measures of performance to evaluate the effectiveness of our consolidated business strategies, to make budgeting decisions and to compare our performance against that of other peer companies using similar measures. We use Adjusted EBITDA Margin to evaluate our ability to generate profitable sales.
Adjusted EBITDA and Adjusted EBITDA Margin contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs, cash expenditures to replace assets being depreciated and amortized and interest expense, or the cash requirements necessary to service interest on principal payments on our indebtedness. In evaluating Adjusted EBITDA and Adjusted EBITDA Margin, 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. Management compensates for these limitations by relying on our GAAP results and using non-GAAP measures on a supplemental basis.
The following table presents a reconciliation of Adjusted EBITDA to Net income, the most comparable GAAP measure, for each of the periods presented.
Three Months Ended December 31,
Nine Months Ended December 31,
2022
2021
2022
2021
(In thousands)
(In thousands)
Net income
$
83,182
$
74,462
$
425,041
$
227,897
Depreciation and amortization
35,846
34,837
107,346
103,687
Interest expense
20,001
8,756
49,334
25,100
Income tax expense
26,068
28,792
128,641
82,063
EBITDA
165,097
146,847
710,362
438,747
(Gain) loss on disposal of assets and costs from exit and disposal activities
(348)
3,466
(147)
2,554
Stock-based compensation expense
6,179
6,242
19,912
18,511
ESOP compensation expense
—
17,221
—
43,389
Transaction costs(a)
1,334
2,145
3,417
3,022
Other adjustments(b)
(2,525)
234
(1,562)
1,318
Adjusted EBITDA
$
169,737
$
176,155
$
731,982
$
507,541
Adjusted EBITDA Margin
25.9
%
24.6
%
29.8
%
24.3
%
(a)Represents expenses recorded related to legal, accounting and other professional fees incurred in connection with business or asset acquisitions and dispositions.
(b)Includes derivative fair value adjustments, foreign currency transaction (gains) losses, interest income, the proportionate share of interest, income taxes, depreciation and amortization related to the South American Joint Venture, which is accounted for under the equity method of accounting and executive retirement expense.
Liquidity and Capital Resources
Historically we have funded our operations through internally generated cash flow supplemented by debt financings, equity issuance and finance and operating leases. These sources have been sufficient historically to fund our primary liquidity requirements, including working capital, capital expenditures, debt service and dividend payments for our common stock. 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.
The following table presents key liquidity metrics utilized by management. The table includes the non-GAAP measure, Free Cash Flow, which is further discussed and defined below, and Leverage ratio which is calculated as net debt divided by the trailing twelve months Adjusted EBITDA.
Nine Months Ended December 31,
(Amounts in thousands)
2022
2021
Net cash provided by operating activities
$
660,438
$
193,847
Capital expenditures
(126,858)
(100,367)
Free Cash Flow
533,580
93,480
Total debt (debt and finance lease obligations)
1,308,768
Cash
426,690
Net debt (total debt less cash)
882,078
Leverage Ratio
1.0
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 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 summarizes our available liquidity for the period presented.
(Amounts in thousands)
December 31, 2022
Revolver capacity
$
600,000
Less: outstanding borrowings
—
Less: letters of credit
(9,650)
Revolver available liquidity
$
590,350
In addition to the available liquidity above, we have the ability to borrow up to $1.3 billion under our Senior Secured Credit Facility, subject to leverage ratio restrictions.
Working Capital and Cash Flows
As of December 31, 2022, we had $1,017.1 million in liquidity, including $426.7 million of cash, $590.4 million in borrowings available under our Revolving Credit Agreement, net of outstanding letters of credit. We believe that our cash on hand, together with the availability of borrowings under our Credit Agreement and other financing arrangements and cash generated from operations, will be sufficient to meet our working capital requirements, anticipated capital expenditures, and scheduled principal and interest payments on our indebtedness for at least the next twelve months.
Working Capital - Working capital increased to $787.1 million as of December 31, 2022, from $480.7 million as of March 31, 2022. The increase in working capital is primarily due to increased cash from the issuance of our 2030 Notes and a decrease in accounts payable and other accrued liabilities partially offset by a decrease in accounts receivable and inventory due to seasonality.
Operating Cash Flows –Cash flows from operating activities increased $466.6 million during the nine months ended December 31, 2022 primarily driven by operating income and changes in net working capital.
Investing Cash Flows - Cash flows used in investing activities during the nine months ended December 31, 2022 increased by $24.8 million compared to the same period in fiscal 2022. The increase in cash used in investing activities was primarily due to capital expenditures.
Capital expenditures totaled $126.9 million and $100.4 million for the nine months ended December 31, 2022 and 2021, respectively. Our capital expenditures for the nine months ended December 31, 2022 were used primarily to support facility expansions, equipment replacements and technology improvement initiatives.
We currently anticipate that we will make capital expenditures of approximately $175 million in fiscal year 2023, including approximately $80 million of open orders as of December 31, 2022. Such capital expenditures are expected to be financed using funds generated by operations.
Financing Cash Flows - During the nine months ended December 31, 2022, cash provided by financing activities included the issuance of $500.0 million of 2030 Notes and proceeds of $123.2 million on our revolving credit facilities. Cash used in financing activities during the nine months ended December 31, 2022 included repurchase of common stock of $375.0 million, payments of $237.5 million on our revolving credit facilities, $30.1 million of dividend payments, and $28.7 million for shares withheld for tax purposes.
During the nine months ended December 31, 2021, cash used included the repurchase of common stock of $292.0 million, repayment of $124.6 million on the Revolving Credit Facility, $13.1 million of shares withheld for tax purposes, $27.8 million of dividend payments and payments on our finance lease obligations of $49.4 million. Cash provided by financing activities included proceeds of $258.1 million on the Revolving Credit Facility.
Cash held by Foreign Subsidiaries - As of December 31, 2022, we had $33.2 million in cash that was held by our foreign subsidiaries, including $23.3 million held by our Canadian subsidiaries. We continue to evaluate our strategy regarding foreign cash, but our earnings in foreign subsidiaries still remain indefinitely reinvested, except for Canada. We plan to repatriate earnings from Canada and believe that there will be no additional tax costs associated with the repatriation of such earnings other than any potential non-U.S. withholding taxes.
Financing Transactions
Senior Secured Credit Facility - In July 2019, the Company entered into the Base Credit Agreement by and among the Company, as borrower, Barclays Bank PLC, as administrative agent, the several lenders from time to time party thereto. In September 2019, the Company amended the Base Credit Agreement. In May 2022, the Company entered into a Second Amendment to the Company’s Base Credit Agreement. The Senior Secured Credit Facility provides the Term Loan Facility in an initial aggregate principal amount of $700 million, the Revolving Credit Facility in an initial aggregate principal amount of up to $600 million, the L/C Facility in the initial aggregate available amount of up to $60 million, as a sublimit of such Revolving Credit Facility and a swing line sub-facility in the aggregate available amount of up to $50 million, as a sublimit of the Revolving Credit Facility. As of December 31, 2022, the outstanding principal drawn on Term Loan Facility was $429.0 million and there were no borrowings on the Revolving Credit Facility. The Company had $590.4 million available to be drawn on the Revolving Credit Facility, net of $9.7 million of outstanding letters of credit.
ADS Mexicana Revolving Credit Facility - The Company and ADS Mexicana amended its Intercompany Revolving Credit Promissory Note (the “Intercompany Note”) with a capacity of $9.5 million on June 6, 2022. The Intercompany Note matures on June 8, 2027. 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 December 31, 2022 and March 31, 2022, there were no borrowings and $1.5 million of borrowings, respectively, outstanding under the Intercompany Note.
Issuance of Senior Notes due 2027 - On September 23, 2019, the Company issued $350.0 million aggregate principal amount of its 2027 Notes, pursuant to the 2027 Indenture among the Company, the Guarantors and the Trustee. The 2027 Notes are guaranteed by each of the Company’s present and future direct and indirect wholly owned domestic subsidiaries that is a guarantor under the Company's Senior Secured Credit Facility. The 2027 Notes were offered and sold either to persons reasonably believed to be “qualified institutional buyers” pursuant to Rule 144A under the Securities Act or to persons outside the United States under Regulation S of the Securities Act. The Company may redeem the 2027 Notes, in whole or in part, at any time on or after September 30, 2022 at established redemption prices.
Interest on the 2027 Notes is payable semi-annually in cash in arrears on March 31 and September 30 of each year, commencing on March 31, 2020, at a rate of 5.000% per annum. The 2027 Notes will mature on September 30, 2027. The Company used the majority of the net proceeds from the offering of the 2027 Notes for the repayment of $300.0 million of
its outstanding borrowings under the Company’s Base Credit Agreement. The 2027 Indenture contains customary events of default, including, among other things, payment default, failure to comply with covenants or agreements contained in the 2027 Indenture or the 2027 Notes and certain provisions related to bankruptcy events. The 2027 Indenture also contains customary negative covenants.
Issuance of Senior Notes Due 2030 – On June 9, 2022 the Company issued $500.0 million aggregate principal amount of 6.375% 2030 Notes pursuant to an Indenture, dated June 9, 2022 (the "2030 Indenture"), among the Company, the Guarantors and the Trustee. The 2030 Notes were offered and sold either to persons reasonably believed to be “qualified institutional buyers” pursuant to the Securities Act or to persons outside the United States under Regulation S of the Securities Act.
Interest on the 2030 Notes is payable semi-annually in cash in arrears on January 15 and July 15 of each year, commencing on January 15, 2023, at a rate of 6.375% per annum. The 2030 Notes will mature on July 15, 2030. The Company used the majority of the net proceeds from the offering of the 2030 Notes to repay in full the outstanding borrowings under its Revolving Credit Facility and the remainder for general corporate purposes. The deferred financing costs associated with the 2030 Notes totaled $9.0 million and are recorded as a direct reduction from the carrying amount of the related debt.
The Company may redeem the 2030 Notes, in whole or in part, at any time on or after July 15, 2025 at certain specified redemption prices set forth in the 2030 Indenture. In addition, at any time prior to July 15, 2025, the Company may redeem the 2030 Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the 2030 Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date plus an applicable “make-whole” premium. At any time prior to July 15, 2025, the Company may also redeem up to 40% of the aggregate principal amount of 2030 Notes issued under the Indenture with net cash proceeds of certain equity offerings at a redemption price equal to 106.375% of the principal amount of the 2030 Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date.
The 2030 Indenture contains customary events of default, including, among other things, payment default, failure to comply with covenants or agreements contained in the 2030 Indenture or the 2030 Notes and certain provisions related to bankruptcy events. The 2030 Indenture also contains customary negative covenants.
Equipment Financing – In November 2021, the Company purchased material handling equipment, trucks and trailers previously leased under a master lease agreement and classified as finance leases. The purchase was funded with debt through the Master Lease Agreement and Interim Funding Schedule with Fifth Third. The assets acquired are titled to the Company and included in Property, plant and equipment, net on the Company's Condensed Consolidated Balance Sheet. The equipment financing has a balance of $21.0 million and had an initial term of between 12 and 84 months, based on the life of the equipment. The equipment financing bears a weighted average interest of 1.5% as of December 31, 2022.
Covenant Compliance - The Senior Secured Credit Facility requires, if the aggregate amount of outstanding exposure under the Revolving Facility exceeds $210.0 million at the end of any fiscal quarter, the Company to maintain a consolidated senior secured net leverage ratio (commencing with the fiscal quarter ending March 31, 2020) not to exceed 4.25 to 1.00 for any four consecutive fiscal quarter periods.
The Senior Secured Credit Facility also includes other covenants, including negative covenants that, subject to certain exceptions, limit the Company’s and its restricted subsidiaries’ (as defined in the Credit Agreement) ability to, among other things: (i) incur additional debt, including guarantees; (ii) create liens upon any of their property; (iii) enter into any merger, consolidation or amalgamation, liquidate, wind up or dissolve, or dispose of all or substantially all of their property or business; (iv) dispose of assets; (v) pay subordinated debt; (vi) make certain investments; (vii) enter into swap agreements; (viii) engage in transactions with affiliates; (ix) engage in new lines of business; (x) modify certain material contractual obligations, organizational documents, accounting policies or fiscal year; or (xi) create or permit restrictions on the ability of any subsidiary of any Loan Party (as defined in the Senior Secured Credit Facility) to pay dividends or make distributions to the Company or any of its subsidiaries.
The Senior Secured Credit Facility also contains customary provisions requiring the following mandatory prepayments (subject to certain exceptions and limitations): (i) annual prepayments (beginning with the fiscal year ending March 31, 2021) with a percentage of excess cash flow (as defined in the Senior Secured Credit Facility); (ii) 100% of the net cash proceeds from any non-ordinary course sale of assets and certain casualty or condemnation events; and (iii) 100% of the net cash proceeds of indebtedness not permitted to be incurred under the Senior Secured Credit Facility. For further information, see “Note 11. Debt” to the Consolidated Financial Statements in our Fiscal 2022 Form 10-K. We are in compliance with our debt covenants as of December 31, 2022.
Excluding the guarantees of 50% of certain debt of our unconsolidated South American Joint Venture as further discussed in “Note 7. Related Party Transactions” to the Condensed Consolidated Financial Statements, we do not have any other off-balance sheet arrangements. As of December 31, 2022, our South American Joint Venture had approximately $6.3 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
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 2022 Form 10-K, except as disclosed in "Note 1. Background and Summary of Significant Accounting Policies.”
Forward-Looking Statements
This 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 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;
•the risks related to the COVID-19 pandemic or other pandemics in the future;
•disruption or volatility in general business and economic conditions in the markets in which we operate;
•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;
•uncertainties surrounding the integration and realization of anticipated benefits of acquisitions and similar transactions;
•the effect of any claims, litigation, investigations or proceedings, including those described under “Item 1. Legal Proceedings” of this Form 10-Q;
•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 supply purchasing and customer credit policies;
•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;
•the risks associated with our current levels of indebtedness, including borrowings under our existing credit agreement and outstanding indebtedness under our existing senior notes; and
•other risks and uncertainties, including those listed under “Item 1A. Risk Factors.” in the Fiscal 2022 Form 10-K.
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.
Item 3. 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 Fiscal 2022 Form 10-K except as disclosed below.
Interest Rate Risk - We are subject to interest rate risk associated with our bank debt. Changes in interest rates impact the fair value of our fixed-rate debt, but there is no impact to earnings and cash flow. Alternatively, changes in interest rates do not affect the fair value of our variable-rate debt, but they do affect future earnings and cash flow. The Revolving Credit Facility and the Term Loan Facility bear variable interest rates. The Revolving Credit Facility and the Term Loan Facility bear interest either at SOFR or the Prime Rate, at our option, plus applicable pricing margins. A 1.0% increase in interest rates on our variable-rate debt would increase our annual forecasted interest expense by approximately $4.2 million based on our borrowings as of December 31, 2022. Assuming the Revolving Credit Facility is fully drawn, each 1.0% increase or decrease in the applicable interest rate would change our interest expense by approximately $10.2 million, for the twelve months ended December 31, 2022.
Item 4. Controls and Procedures
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 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 the evaluation of our disclosure controls and procedures, our CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
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 December 31, 2022 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
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 have a material adverse impact on the Company’s financial position or results of operations.
Please see “Note 9. Commitments and Contingencies,” of the Condensed Consolidated Financial Statements of this Form 10-Q for more information regarding legal proceedings.
Item 1A. Risk Factors
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 2022 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 2022 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 Form 10-Q.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
In February 2022, our Board of Directors authorized a $1.0 billion common stock repurchase program. Repurchase of common stock will be made in accordance with applicable securities laws. During the three months ended December 31, 2022, the Company repurchased 1.9 million shares of common stock at a cost of $179.9 million. As of December 31, 2022, approximately $625.0 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.
The following table provides information with respect to repurchases of our common stock by us and our “affiliated purchasers” (as defined by Rule 10b-18(a)(3) under the Exchange Act) during the three months ended December 31, 2022:
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plan
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
The cover page for the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2022, has been formatted in Inline XBRL and contained in Exhibit 101.
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: February 2, 2023
ADVANCED DRAINAGE SYSTEMS, INC.
By:
/s/ D. Scott Barbour
D. Scott Barbour
President and Chief Executive Officer
(Principal Executive Officer)
By:
/s/ Scott A. Cottrill
Scott A. Cottrill
Executive Vice President, Chief Financial Officer and Secretary
(Principal Financial Officer)
By:
/s/ Tim A. Makowski
Tim A. Makowski
Vice President, Controller, and Chief Accounting Officer
