Waste Connections, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Financial amounts below are in U.S. dollars; figures are in millions unless stated otherwise. The filing was signed August 5, 2016.
Business context and comparability
Waste Connections provides solid-waste collection, transfer, disposal and recycling services in the U.S. and Canada, as well as exploration and production (E&P) waste services and intermodal services. On June 1, 2016, it completed its all-stock acquisition of Progressive Waste. The statements are the historical results of Old Waste Connections, with Progressive Waste’s results included only from the acquisition date. Accordingly, reported year-over-year comparisons are not like-for-like; acquired operations contributed $174.0 million of Q2 revenue and $25.6 million of pre-tax earnings in June.
The transaction was accounted for as a reverse merger using acquisition accounting. Consideration, including assumed debt and net of acquired cash, was $5.17 billion; preliminary goodwill recorded was $2.86 billion. Former Old Waste Connections shareholders owned approximately 70% of the combined company and former Progressive Waste shareholders approximately 30%. The combined company began trading as Waste Connections, Inc. (WCN) on the NYSE and TSX on June 1.
Financial results and liquidity
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $727.6 | $531.3 | $1,242.3 | $1,037.4 |
| Operating income | $63.5 | $110.0 | $154.5 | $211.9 |
| Operating margin | 8.7% | 20.7% | 12.4% | 20.4% |
| Net income attributable to Waste Connections | $27.5 | $57.4 | $72.3 | $109.2 |
| Diluted EPS | $0.20 | $0.46 | $0.55 | $0.88 |
| Adjusted EBITDA (non-GAAP) | $233.6 | $177.7 | $403.3 | $346.0 |
| Adjusted net income (non-GAAP) | $93.2 | $61.6 | $148.4 | $118.2 |
| Adjusted diluted EPS (non-GAAP) | $0.66 | $0.50 | $1.12 | $0.95 |
Q2 revenue increased 37.0%; six-month revenue increased 19.8%. Growth reflected acquisitions, customer price increases and stronger solid-waste volumes, partly offset by steep E&P weakness. Despite higher revenue, reported operating income and GAAP earnings declined as acquisition-related expenses and higher operating, depreciation and amortization costs weighed on results. Q2 SG&A was $152.7 million, including acquisition costs, severance, excise taxes and equity compensation. The filing’s non-GAAP adjusted results exclude specified acquisition and other items and should not be treated as GAAP results.
For the six months, operating cash flow was $259.6 million, versus $319.2 million; capital expenditures were $112.1 million, versus $102.2 million. Cash flow from operations less capital expenditures was $147.6 million. Adjusted free cash flow, a non-GAAP measure including adjustments such as transaction and severance costs, was $234.4 million versus $220.1 million. Cash and equivalents were $55.6 million at June 30. Working capital was positive $49.4 million, compared with a $15.8 million deficit at year-end 2015.
At June 30, total long-term debt before debt issuance costs was $3.78 billion. The company had $457.0 million drawn on its revolving facility, a $1.64 billion term loan and $825 million of legacy senior notes, alongside $750 million of newly issued senior notes. The new credit facility matures in June 2021; reported availability under the revolver was $845.9 million. The company stated it was in compliance with applicable credit covenants. A one-percentage-point rise in interest rates on unhedged floating-rate debt would reduce annual pre-tax income by approximately $17.4 million.
Material changes and management commentary
- Reported revenue growth was substantially acquisition-driven. Excluding the Progressive Waste contribution, management cited core price increases and improved solid-waste collection, transfer-station and landfill volumes; lower diesel prices reduced fuel surcharges.
- E&P revenue at operations owned and fully operated in both comparable periods fell $25.0 million in Q2 and $63.1 million in the first half, reflecting lower oil prices and reduced drilling and production activity. Management expected 2016 E&P segment revenue to decline 40%–50% from 2015.
- Q2 cost of operations rose to 57.2% of revenue from 56.0%; SG&A rose to 21.0% from 10.8%. Management attributed much of the SG&A increase to acquisition, severance, excise-tax and equity-compensation costs. Q2 corporate segment EBITDA included a $75.9 million loss, versus $2.8 million of income a year earlier.
- Acquisition and integration charges included $31.6 million of Progressive Waste transaction costs for the first half, $19.4 million of severance, $14.3 million of excise taxes on executive equity awards, and related equity-compensation charges. The acquisition also expanded the company’s geographic reporting structure and operations in Canada and the Southern U.S.
- Management expected approximately $325 million of 2016 capital expenditures for the existing business. It said cash, operating cash generation and credit facilities should provide adequate funds for working capital and other needs for the foreseeable future, while warning that capital-market disruption could impair borrowing access.
Outlook, risks and contingencies
- Management cited seasonal fluctuations, typically lower activity in the first and fourth quarters, and estimated a 12%–15% difference between highest and lowest quarters. Winter weather can raise labor and disposal costs.
- Key risks include acquisition integration and realization of expected synergies; leverage and refinancing; permitting or expansion of landfill capacity; environmental regulation and remediation; fuel, labor and recyclable-commodity prices; competition and contract retention; and the continuing downturn in E&P activity. The company warned that further E&P weakness could lead to impairment charges; E&P assets included $915.5 million of property and equipment, $77.3 million of goodwill and $21.5 million of indefinite-lived intangible assets.
- Landfill closure, capping and post-closure liabilities were $236.8 million on the balance sheet. The filing separately disclosed estimated future expenditures of $1.456 billion in current dollars; those estimates extend largely beyond five years and are subject to assumptions.
- A subsidiary is among more than 100 potentially responsible parties at the Lower Duwamish Waterway Superfund site. EPA estimated site-wide cleanup costs of about $342 million, but the company could not determine its share or the likelihood or outcome of allocation and settlement. A related natural-resource-damages assessment also had no estimable company exposure.
- The company said a complaint concerning the environmental review process for a proposed Chiquita Canyon Landfill expansion was not expected to impair its ability to obtain approval, though the process could be affected by future developments.
- After quarter-end, the board approved a normal-course issuer bid for up to 8,770,732 shares, subject to regulatory approval; TSX approval was received August 3, 2016. The company also declared a $0.145-per-share quarterly dividend payable August 15, 2016. These are not commitments to repurchase shares or maintain future dividends.
Important facts for investors to verify
- Separate acquisition-related growth and one-time integration charges from ongoing organic growth and operating costs; note that Progressive Waste is included in reported results only from June 1.
- Track E&P demand and revenue against management’s stated 40%–50% full-year 2016 decline expectation, and assess related impairment exposure.
- Review debt, floating-rate exposure, covenant headroom and the assumptions behind reported revolver availability following the acquisition financing.
- Assess the quality and repeatability of adjusted EBITDA, adjusted net income and adjusted free cash flow, including their exclusions, alongside GAAP earnings and operating cash flow.
- Monitor landfill permitting and closure estimates, the Lower Duwamish allocation and potential natural-resource claims, and the timing and funding of planned capital expenditures and share repurchases.