Waste Connections, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Dollar figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions. The filing reports the Progressive Waste acquisition, completed June 1, 2016, using reverse-merger accounting: historical results are those of Old Waste Connections, with acquired Progressive Waste results included from the acquisition date. Period comparisons therefore are not like-for-like.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1,084.9 million | $547.9 million | $2,327.2 million | $1,585.4 million |
| Operating income (loss) | $158.7 million | $(375.2) million | $313.1 million | $(163.3) million |
| Net income (loss) attributable to Waste Connections | $88.6 million | $(257.0) million | $160.9 million | $(147.8) million |
| Diluted EPS | $0.50 | $(2.08) | $1.10 | $(1.19) |
| Operating margin | 14.6% | (68.5)% | 13.5% | (10.3)% |
| Interest expense | $27.6 million | $16.4 million | $65.3 million | $47.4 million |
- Q3 cost of operations was 58.7% of revenue versus 54.9%; SG&A was 11.9% versus 10.9%. Management attributed pressure to acquired operations’ lower margins, higher employee benefits and weaker E&P revenue; lower diesel costs partly offset these factors.
- Q3 adjusted EBITDA, a non-GAAP measure, was $342.3 million versus $189.0 million; nine-month adjusted EBITDA was $745.6 million versus $535.0 million. Adjustments include acquisition-related transaction, severance, equity-compensation and synergy-bonus costs. The company cautions that non-GAAP measures are not substitutes for GAAP results.
- Nine-month operating cash flow was $538.8 million, compared with $463.3 million. Capital expenditures were $204.9 million, versus $168.4 million. Management’s adjusted free cash flow measure was $440.3 million versus $298.6 million, including specified add-backs and tax effects.
- Cash and equivalents were $119.3 million at September 30, 2016. Working capital was a surplus of $95.4 million, compared with a $15.8 million deficit at December 31, 2015.
- Debt and notes payable totaled $3.680 billion, including $1.638 billion under a term loan and $357.9 million drawn on the revolver. The new credit facility matures in June 2021; $956.7 million of revolver capacity was available, excluding outstanding letters of credit. The company reported compliance with applicable debt covenants.
- Total assets were $11.188 billion and total liabilities $5.566 billion. The balance-sheet increase from year-end chiefly reflects the acquisition; goodwill was $4.351 billion.
- Cash dividends paid in the first nine months totaled $61.0 million. The quarterly dividend was $0.145 per share during the period; in October the board raised it to $0.18 per share.
Material changes versus the prior comparable period
- Revenue rose 98.0% in Q3 and 46.8% year to date, largely due to acquisition inclusion. Progressive Waste contributed $513.1 million of Q3 revenue and $687.1 million from June 1 through September 30. Core customer price increases and solid-waste volume growth also contributed.
- Excluding acquisition growth, existing solid-waste operations benefited from price increases and higher collection, transfer and landfill volumes. E&P revenue at facilities owned and fully operated in both comparison periods fell $21.1 million in Q3 and $84.2 million year to date, reflecting lower oil and gas activity.
- Reported earnings turned positive, but the comparison is heavily affected by 2015 E&P impairment charges of $411.8 million for goodwill, $38.3 million for indefinite-lived intangibles and $63.9 million for property and equipment. 2016 impairments and other operating items were $7.7 million in Q3 and $4.6 million year to date, including E&P closures and a corporate aircraft lease termination.
- Interest expense increased as a result of acquisition financing, new notes, higher average borrowings and rates, partly offset by redemption of prior notes. The acquisition was financed with shares and assumed debt; the company issued 52.1 million shares as consideration and assumed $1.729 billion of debt.
- The company reorganized reporting into five geographic segments plus E&P, adding Canada and Southern after the acquisition. E&P segment EBITDA declined to $8.9 million in Q3 from $17.5 million and to $22.0 million year to date from $55.0 million.
Outlook, risks and unusual items
- Management expected 2016 E&P segment revenue to decline approximately 45% from 2015 levels because of reduced oil and gas exploration and production activity. It forecast approximately $335 million of 2016 capital expenditures for the existing business; $204.9 million had been spent through September.
- Management said cash, expected operating cash generation and credit availability should fund working capital and other cash needs for the foreseeable future, while noting that disruption in capital or credit markets could limit access to financing. No broader earnings or revenue guidance is provided in the supplied filing text.
- Principal risks include oil and gas price and activity volatility; acquisition integration and realization of expected synergies; leverage and interest-rate exposure; fuel and labor costs; competition and contract renewals; landfill permitting, capacity expansion and environmental regulation; weather seasonality; and potential impairments. The company estimated that a one-percentage-point increase in rates on its $1.641 billion of unhedged floating-rate debt would reduce annual pre-tax income by approximately $16.4 million.
- The company’s subsidiary NWCS is a potentially responsible party at the Lower Duwamish Waterway Superfund Site. The EPA estimated cleanup costs of about $342 million for the site as a whole, but the company could not determine its allocation, the likelihood of settlement, or potential natural-resource-damage liability. The company stated it could not reasonably determine the outcome.
- Landfill closure, capping and post-closure liabilities were $241.2 million at September 30, including acquired liabilities; estimated future expenditures were $1.456 billion in current dollars. The company estimated approximately 28 years of remaining landfill life based on permitted capacity, or 34 years including probable expansions.
- The filing identifies integration and transaction costs, severance, equity-award expense, excise taxes and synergy bonuses as significant acquisition-related items. The purchase-price allocation remained provisional in some areas.
- The company had an approved normal-course issuer bid allowing repurchase of up to 8,770,732 shares through August 7, 2017, but had made no repurchases through September 30, 2016.
Important facts for investors to verify
- Separate acquisition-driven growth from organic price, volume and margin performance; verify the eventual contribution and realized synergies from Progressive Waste.
- Track E&P activity, revenue and EBITDA against management’s expected approximately 45% full-year revenue decline, and monitor possible further impairment indicators.
- Review leverage, revolver availability, covenant headroom, variable-rate exposure and the company’s ability to service the increased debt.
- Monitor integration and restructuring costs, provisional acquisition accounting, and whether adjusted results reconcile consistently to GAAP performance.
- Follow the Lower Duwamish allocation and cleanup process, landfill capacity and permitting, and changes in closure and post-closure estimates.
- Confirm capital spending, cash conversion, dividend sustainability and any share repurchases against the company’s stated financing priorities.