Republic Services Inc (RSG) 2002 Q4 法說會逐字稿

Thank you for holding and welcome to the fourth quarter and year-end 2002 results for Republic Services Incorporated hosted by CEO Jim O'Connor. We will be in a listen-only mode for the first portion of the conference. We will have a question and answer session, and I will give instructions at that time. Mr. O'Connor, I turn the conference call to you.

Good morning and thank you for joining us. I'd like to welcome everyone to Republic Services' fourth quarter conference call. This morning, Todd Holmes, our Chief Financial Officer, and Ed Lang, our Treasurer, are joining me as we discuss the fourth quarter and year end performance.

I'd like to take a moment to remind everyone that some of the information we'll discuss with you contain forward-looking statements which involve risks and uncertainties and may be materially different from actual results. Our S.E.C. filings discuss factors that could cause actual results to differ materially from expectation. Additionally the material we will discuss with you today is time sensitive. If in the future you listen to a rebroadcast or a recording of this conference call, you should be sensitive to the date of the original call, which is February 4th, 2003. Please note that this call is the property of Republic Services, Incorporated. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited.

I'm pleased to report to you today that Republic Services has outperformed revenue, earnings, and cash flow expectations for the quarter and the full year. This strong performance during a weak economy attests to the quality of all our employees and the investments we've made in our business. We are focused on continual improvement in the quality of operations. And free cash flow generation in order to create greater value for our shareholders.

A year ago we stated the objectives for 2002. We expected the internal growth to be 1 ½% to 2% percent with 1% to 1 ½% from price and ½% to 1% in volume. Our actual internal growth from core operations was 3% with 1.4% from price and 1.6% from volume. We were able to exceed our expectations because we were able to secure additional long-term franchises and municipal contracts. And also benefits from our geographic mix of our business being in higher growth markets.

Because of the weak economy, we that thought net income would be flat or down slightly and earnings per share would be $1.37 to $1.39. At the time of our second quarters earning call we raised the EPS guidance to $1.39 to $1.41. And we revised -- we exceeded our revised guidance by earning $1.42 for the full year.

After the change for goodwill accounting, we gave guidance that we would generate $147m of free cash flow before the benefit of deferred taxes and other non-cash adjustments. During the second quarter call we raised the guidance to $155m. For the full year, we exceeded this revised guidance by $44m and generated $199m of free cash flow. Our ability to generate predictable levels of significant free cash flow is the best measurement of the quality of our earnings.

We had forecasted capital expenditures of $240m in 2002. Our actual capital expenditures were $259m. We raised our cap ex budget in order to meet the equipment requirements of our new franchise and municipal contracts. We also opened two new disposal facilities and one transfer station. Republic has the youngest fleet in the industry and our continued investment in our business is key to the quality service and managing our costs.

Our plan for utilizing free cash flow includes repurchasing $125m in our stock. Our Board of Directors increased their authorization by $25m to $150m during the third quarter. We completed this authorization by purchasing 7.9m shares of Republic stock during 2002. Since we first instituted a share repurchase, we have purchased over 17m shares or approximately 10% of our outstanding shares.

In addition to the accomplishments I've just discussed during 2002, we had other significant achievements. We acquired $57m in annual run rate revenue. We remain committed to growing our business through acquisitions. But keep in mind we have a disciplined approach to evaluating these opportunities. And this process assures us we will achieve appropriate returns on invested capital.

In addition we improved our returns by divesting $20m in revenue and markets and lines of business in which we did not have a strong competitive position. Currently $10m in annual revenue in deals that have been signed and accepted. In addition, there is approximately $50m in our acquisition pipeline.

During 2002, we completed the installation of a new general ledger system throughout Republic. This standard accounting platform will allow us to achieve greater efficiencies in our purchasing and accounts payable functions. About 24 months ago, we began to roll out revenue enhancement and cost reduction initiatives. Included in this process were a number of management information tools, such as broad optimization, customer relationship management and a maintenance tracking software system. We've seen positive results in our margin performance as a result of these initiatives and expect to see continued improvement.

We will continue to provide enhancements to our core Systems. And, most importantly, provide ongoing training to be ensured that we are achieving the greatest return from these investments in software and management tools. In July, we renewed our multiyear and 364-day bank credit facilities. Republic has no borrowing outstanding under these facilities. The company has no debt maturities until 2004. And we remain the only company in the solid waste industry to have an investment grade rating from all major agencies.

And now I'd like to turn the call over Tod Holmes, our Chief Financial Officer, to give us his presentation and financial results for 2002.

Thank you, Jim. Let me remind everybody that an online recording will be available at our website, www.republicservices.com. I'll begin my review of the company's financial results with free cash flow. As we've said in the past, one of the most attractive aspects of this business is its ability to generate substantial amounts of free cash. We believe that a strong, sustainable cash flow is indicative of high quality earnings.

For 2002, we used a very simple definition of free cash flow. It is net income plus depreciation, depletion and amortization, less capital expenditures, plus or minus net changes and working capital. Keep in mind that our statements of cash flow show even greater cash generating capabilities as they include other common components of free cash flow that are excluded by our simple definition, such as non-cash taxes and proceeds from equipment sales.

Beginning in 2003, we will use a revised definition of free cash flow, which is much closer to the financial statements. It includes cash provided by operating activities, less purchases of property and equipment, plus proceeds from the sale of equipment as presented in the company's consolidated statement of cash flows.

Our focus on free cash flow continues to provide financial benefits. As of December 31st, 2002, our accounts receivable will decrease to $239m. And our day sales outstanding improved to 36 days, which is down from 37 days at September 30th, 2002, and 38 days at December 31st, 2001. Using our simple definition, free cash flow for the fourth quarter of 2001 was negative $11m. This is based on net income of $58m plus D D&A of $52m, less capital spending of $96m, less an estimated decrease in working capital of approximately $25m. And again that's free cash flow negative at $11m in the quarter.

Using our simple definition, free cash flow for December 31 ended 2002 was $199m. This is based on net income of $236m plus DD& A of $199m less capital spending of $259m, plus an estimated working capital. This benefit arises from improved accounts receivable, and closure/post closure accruals of positive $23m. So that's $199m for the year. Again, note that this $199m is based on our simple definition of free cash.

Free cash flow under our new definition which more closely ties to our financial statements including deferred taxes from ongoing operations of $45m. Plus proceeds from the sale of equipment of approximately $15m. This results in annual free cash flow of $259m.

How did we use this cash? We used it for business acquisitions and share repurchases. During 2002, we paid $56m for businesses with a run rate revenue of $57m. During the fourth quarter of 2002, we purchased 600,000 shares of our common stock for approximately $11.6m at about $20.29 per share. This brings the total shares of our common stock we purchased in 2002 to about 7.9 million shares for approximately $150m with an average price of about $18.86 per share. Even after this substantial repurchase of shares during 2002. Our balance of unrestricted cash available at December 31st, 2002, to fund further internal growth, acquisitions, and share repurchases, is approximately $141m.

Next, I'll discuss our fourth quarter revenue. Fourth quarter 2002 revenue rose 7.4% to $605m from $563m last year. Internal growth from core operations is 4.4% with 1.6% from price and 2.8% from volume. Our core volume growth comes primarily from residential collection business where we've been awarded a number of new municipal contracts and franchises in early 2002. Volumes from our commercial business are holding steady and is expected. Due to the weak economy, volumes from our industrial construction and event businesses are down year over year. The remaining 3% of revenue growth comes from commodities, non-core businesses, state taxes, and acquisitions.

Next, I'll discuss our changes in sequential operating margins. Sequentially, our fourth quarter operating margins decreased by 80 basis points, which is expected based upon the normal seasonal trends in our business. The key components of our sequential margins are as Follows. Commodities is a negative 40 basis points; seasonality and revenue mix is a negative 70 basis points; fuel is a negative 20 basis points; the termination of our operating lease facility was a positive 20 basis points; D D&A is a positive 10 basis points; and SG&A is a positive 20 basis points. Giving us sequentially a negative 830 basis points.

First commodities. During the fourth quarter commodity volumes decreased slightly and commodity prices trended downward approximately 20% from the prior quarter. Our third quarter 2002 average price was about $65 per ton compared with $50 per ton in the fourth quarter of 2002.

Second, seasonality and revenue mix. During the fourth quarter we experienced lower landfill, transfer station, and industrial revenue volumes due to normal seasonality.

Third, fuel. During the fourth quarter of 2002, fuel prices increased by about 4% or 5% per gallon from $1.25 to $1.30. Fuel prices in early January were about $1.43 per gallon or 10% higher than those experienced during the fourth quarter of 2002.

Our fourth quarter operating lease facility. Again our company repaid this during the fourth quarter.

Fifth, D D&A. During the fourth quarter, the company experienced sequential decrease in D D&A expense primarily due to lower sequential landfill volumes.

Six, SG&A. Sequentially, SG&A decreased from 20 basis points from 9.9% to 9.7% in the fourth quarter. This due to lower bad debt expense and the normal annual true-up of bonus accruals. We continue to believe that SG&A in the range of 10% is appropriate for our existing business platform given the current economic conditions.

EBITDA Sequentially, EBITDA decreased by $6.7m or 90 basis points from $171m or 28.1% during the third quarter to $165m or 27.2% in the fourth quarter. Again, this decrease is the result of a normal seasonal nature of our business.

Year-over-year operating margin. Operating margins increased by 190 basis points from the fourth quarter of 2001 to the fourth quarter of 2002. In accordance with the statement of financial accounting standards number 142, the company ceased amortizing goodwill effective January 1st, 2002. This change in accounting improved margins by 200 basis points. Therefore, our actual margins, excluding this decline by 10 basis points.

The key components of this decrease are as follows. First, operating improvements, positive 30 basis points for the year; insurance and risk -- health and risk was a negative 20 basis points. Fuel was a negative 10 basis points. The termination of our operating lease facility was a positive 50 basis points. Benefit of higher commodity prices was a positive 60 basis points. The economy, primarily lower industrial construction Activity, was a negative 50 basis points, with a mix of business being a negative 40 basis points. Depreciation and depletion was a negative 100 basis points. And SG&A was a positive 70 basis points, netting to a total for the year of a negative 10 basis points.

Now, let me briefly comment on these components of year-over-year margin change. First, operating improvements. As Jim previously mentioned, during the fourth quarter we continued to benefit from the revenue and productivity initiatives that we put in place during 2001. And we have seen the benefit of these initiatives throughout the entire year of 2002.

Second, insurance. During the fourth quarter of 2001, as we said earlier, we saw a tightening in the insurance markets. This continued in 2002 as we saw double-digit increases in both risk and health insurance.

Third, fuel. During the fourth quarter of 2002, fuel prices were up from the prior year. Our average price per gallon increased about 4% from $1.25 in the fourth quarter of ’01 to about $1.30 in the fourth quarter of '02.

Fourth, the operating lease facility. Again the company repaid this lease facility during the third quarter.

Fifth, commodities. Commodities increased 25% from the fourth quarter last year. Our fourth quarter 2002 average price, as I said earlier, was $50 per ton compared to $40 per ton in the in the fourth quarter of '01.

Six, the economy. During the second half of 2001, we began to experience a downward trend in our event business which is comprised of industrial and construction roll off in landfill operations. During the fourth quarter of 2002, volumes and pricings in this event business continued to be negatively impacted by the economic slowdown.

Seventh, our mix of business. During the fourth quarter, we generated more revenue from our non-core business, our residential collection business, and our transfer stations. Which all have lower margins typically. In addition, we experienced an increase in taxes levied on landfill volumes in certain states that were passed through to customers at no margin. And that was a cost of at 20 basis points in margins, although no impact on a dollar basis.

Eight, depreciation and depletion. Depreciation and depletion expense also increased by approximately 100 basis points, primarily due to capital expenditures and acquisitions. And finally, SG&A. This SG&A is primarily attributable to lower bad debt expense and lower labor costs.

Our year-over-year EBITDA improved 80 basis points from $149m or 26.4% in the fourth quarter of 2001 to $165m or 27.2% in the fourth quarter of 2002.

Our year-to-date revenue. Annual revenue rose 4.8% to $2.365b from $2.257b last year. Internal growth from our core business for the year as Jim indicated was 3%. 1.4 from price, 1.6 from volume. The remaining the 1.8% of revenue growth came from commodities, non-core businesses, state taxes, and acquisitions.

Now, let me discuss our year-to-date operating margins. Year-to-date, our operating margins increased by 80 basis points from 18.4% in 2001 to 19.2% in 2002. 180 basis points of this improvement came from change in goodwill accounting. Therefore, our actual margins declined by 100 basis points. This margin decline was marginally offset by operating improvements from our company-wide initiatives as we previously discussed of 30 basis points. A decrease in fuel costs of 30 basis points and the termination of the operating lease facility of 30 basis points. And an increase in commodity prices of 40 basis points.

Approximately 70 basis points of our year-to-date margin decline was attributable to increased insurance costs. An additional 70 basis points decline is due to increased depreciation and depletion. 40 basis points of the decline is due to the slowdown in our event business resulting from the economy. And 30 basis points is due to the revenue new mix, primarily higher non-core residential transfer station revenues at lower margins. And 20 basis points is due to a higher subcontractor cost.

Despite a difficult economy, our EBITDA increased year-over-year by $22.6m or 4% from $631m during 2001 to $653.5m for the year ended December 31st, 2002.

Our balance sheet remains very strong. At December 31st, our accounts receivable balance was $239m. And as I previously stated, our day sales outstanding was 36 days. During the 2002, we reduced our net debt by $86m to $1.150b at December 31st, 2002.

Approximately $1.050b of our debt at December 31st is long-term public debt. And approximately $380m is tax exempt financing at favorable interest rates.

Consistent with our cash flow performance and previous guidance, our debt total to capital December 31, 2002 is 38%. We remain committed, as Jim indicated, to maintaining our investment grade rating. And as of December 31st, 2002, we had $141m in unrestricted cash.

Consistent with our focus on free cash flow, we maintained a disciplined approach on our capital expenditures. Capital expenditures for the fourth quarter were $96m, consisting of $49m for replacement capital, $28m for internal growth, and $19m for infrastructure. Capital expenditures for the year with $259m with about $131m for replacement capital, $85m for internal growth, and $43m for infrastructure.

SFAS No. 143 -- before I turn the call back to Jim, I want to briefly comment on statement of financial accounting standards No. 143. Which is accounting for asset retirement obligations, which the waste industry is required to implement during 2003. The waste industry, as many of you already know, has already accounted for costs associated with asset retirement obligations using life cycle accounting. This accounting standard will have no cash impact on the way we account for closure and post closure costs at our land fills. The methodology we used to implement 143 is based upon meetings with major industry participants and their respective auditors in the past two months. We believe that our methodology will be consistent with that used by other large players in the industry. And will provide greater clarity in reporting to users of our financial information.

Under SFAS 143, we will continue to accrue for post closure costs as air space is consumed in each landfill. Which is consistent with traditional life cycle accounting. However, closure costs will be accrued as air space is consumed in each capping event. And let me just briefly explain that a capping event consists of installing synthetic and natural layers on top of the waste. And it occurs periodically throughout the operating life of the landfill. A capping event generally encompasses several cells or portions of the landfill -- excuse me -- portions of cells within a landfill. Just to give you a simple example, a 150 to 200-acre land fill with 30 years of life could typically have about 10 capping events over its life. Although the number of cells would be much greater than that.

We estimate the cost of adopting 143 to be 3 cents per share in fiscal 2003. This consists of a benefit the company receives from discounting closure and post-closure costs that we have not done previously. This benefit is offset by higher estimated future costs which the company must assume are provided by third parties. The company has historically performed, and will continue to perform in the future, certain closure/post-closure functions using internal resources.

However, SFAS 143 does not allow the company to use its lower cost internal resources in developing closure and post-closure accruals. The benefit of discounting is also offset by the Inclusion of gas systems in the company's depletion rates. Starting in 2003, the company will include the cost of gas systems and sale development costs and closure-post closure expense for all land fills where the need for such systems sometime during the future is considered probable. This methodology is consistent with that used by other companies in the waste industry.

And I want to stress that 143 is a non-cash accounting change. And I believe that what we will see is greater consistency in reporting in the industry as a result of the cooperation that we've seen with both our auditors and the other firms in the industry.

Now let me turn the call back over to Jim.

Thanks, Tod. I will briefly outline our expectations for 2003 before taking your questions.

Our most important objective is to maintain our strong free cash flow performance in 2003. Based on feedback from our investors, we will define free cash flow as cash provided by operations, less capital expenditures. We expect to generate free cash flow that is equal to 90% of our net income in 2003.

And as you know, our board has authorized a $150m share repurchase for 2003. We expect to earn $1.49 to $1.51 per share before the impact of SFAS 143. We expect the accounting change will reduce the earnings by 3 cents a share, to so the estimate earnings per share will be $1.46 to $1.48. We are anticipating capital expenditures of $260m for the full year.

We believe that internal growth of the company will be in the area of 2 to 3% with equal contributions from price and volume. We still have not seen an economic recovery in our customer base tied to manufacturing, commercial, and industrial construction. Until there is a more broad-based recovery, we cannot expect a stronger top-line growth and anymore significant margin improvement.

Based on our continued investment in our asset base, cost initiatives and training programs, we believe that we will be well positioned to realize top-line growth and significant margin improvement once the economy improves. In fact, we see margins returning to the area of 20 to 21% on the operating income side. EBITDA margins will be upwards to 30 to 31%. EPS growing that low double digits, and the top-line growth to be in the area of 5 to 7%. Much as we experienced back in 1999.

I'd like to thank all of the employees for their strong performance in 2002, and we are excited about our opportunities to execute in 2003. Operator, we'll now take questions.

If you'd like to ask a question, please press star 1 on your touch-tone telephone, and you will be placed in the queue until your name is read. You will be limited to one question and one follow up. The first question is with Amanda Tepper from JP Morgan.

Good morning.

Good morning, Jim, Ed, and Tod. How you doing?

Great.

Want to talk about your '03 guidance, of course. Because I understand, Jim, what you're saying about what your margins would look like when the economy gets better. But given the flat economy you've assumed, looking at my model -- looks like you're telling us you're going to have margin erosion next year in EBITDA basis. And the flat economy of about 50 basis points, which is more than I would have thought given the strategic initiatives you've been doing. So where is this erosion coming from? How much are you offsetting? What's your guidance there?

Actually, Amanda, what we see is margins holding consistent with 2002 somewhere in the 19.2, 19.3 range.

I'm talking EBITDA margins.

Okay. Operating income, I think, is going to drive the EPS number. And looking at that, we feel that while we have some increased costs, the increased pricing that we should be able to get in the 1% to 1 1/2% range should offset with the increased cost with the possible exception of some of the higher insurance costs. And there again, we would believe that that would be offset by the cost improvement efforts that we have.

Again for all of 2003, we saw a benefit of about 30 basis points from all those initiatives. And we've got a number of them that continue on into 2003, and we'd fully expect that benefit to offset higher insurance. I don't want to get into a lot of modeling here on the call, but one thing I would suggest people look at is the actual share count and the jumping off point for the share count. Because I think sometimes we overlook the treasury stock method for options and, you know, end up with maybe too low a share count that could skew the EPS numbers.

Okay.

Amanda, too, I think some of the driver there on margins. When you look at our business base, we've got about 30, 35% of our business base in long-term franchises. And we've had a change in the CPI here. So some of that is reflected in our pricing guides. But, again, that's causing some change in our margins on a go-forward basis.

Okay. This is a follow-up. Can you give me maybe one or two highlights from the initiatives where you're doing where you got those 30 basis points? I guess I was thinking that would be accelerating this year. So is the routing and maintenance and the safety joint venture of those kicking in where you thought? Where are you getting the biggest bang for the buck there?

I think where we're seeing most of the impact in '02 was in our maintenance performance. And again, we introduced a tracking system, as you well know. We're starting to get some benefits from that not only in reduced maintenance and better scheduling, but in better use of our capital expenditures as far as targeting assets to be replaced. The other thing is that's also helping us in scheduling our manpower and hours in our shops. We’re getting much more productive and a much better impact from just scheduling work hours around when the routes are running. And when we're scheduling to do preventative maintenance.

So most of 2002 was coming from those initiatives in maintenance. One of the other maintenance initiatives was our tire program. We're looking to have the tire impact, which is a major expense in our maintenance program, of probably anywhere from $5 to $10 per wheel position. Keep in mind most our trucks have 10 wheel positions.

Our routing initiatives, while we went through the last 18 months with a relatively simplistic approach -- which is a benchmarking process as you know -- we've now moved much more sophisticated broad optimization program in the fourth quarter where we got done the identification process. We locked in on route smart. We signed up with route smart. We are rolling out in Fairfax, Virginia, our third division. And by the end of the second half of -- by the end of the first half of the year, we should have 25 of our largest operating divisions on route smart.

Okay. Great. Thank you.

Thank you.

The next question is from Bill Fisher.

We've got a lot of static there.

Can you hear me, Jim?

I can hear you now.

I just had one question on the disposal and transfer revenues. I think they were up, like, 9%. Year-over-year, about $18m. I think you mentioned taxes were about $2m. Can you touch on some of the things that have been driving that, and the outlook there?

Well, obviously, we continue to try to expand our market areas with additional transfer capabilities and the recruitment of volumes into the station. As you well know, those transfer stations produce at relatively no margins. They exist to feed our landfill structure. The additional volumes that we've been able to get in are at significantly less price. And again, it's predominantly in the area of special waste, which is again bench driven.

I think, Bill, as you look forward into 2003, is somewhat risky. And some of these events we don't see reoccurring. While we were able to secure a significant amount of special events, we see those starting to dissipate in the later part of the year. Which gives rise to some part of the forecasting in 2003.

Do you get either the [rump key] internalization or some of the Carolina projects? Have you gotten all the benefit of that in the fourth quarter?

No. Again, the union county facility in South Carolina, which is an MSW facility, we still haven't applied all of the logistics we had in mind when we developed that site. And that is to move waste from the Winston, Salem, area and the Charlotte area. The Winston-Salem area into [Uwarry], a county just outside of Charlotte, and that’s [inaudible]. And then the Charlotte waste into our union county facility as well as picking up some materials in the Greenville/Spartanburg areas.

So, no, we haven’t. That facility right now is up around the 600-ton-a- day mark. And we're projecting to take the site over the course of the year to the 900 to 1,000-ton mark. As far as the other facilities that are opened up. Our Greenville facility, which is a construction and demolition facility which is relatively small and sevens the local marketplace.

I think, Bill, the advantages that we've had have been predominantly in the event special waste business. But, again, at a price to us. We've seen a decline in the pricing, which is consistent with our prior calls of anywhere from 15 to 25% to secure that additional volume. Do you have anything you want to add to that, Tod?

Well, just the sites that we have, particularly in South Carolina. As Jim indicated, they will ramp up some in 2003 and also in 2004. And we looked at these as longer-term assets that kind of go to what Jim was saying earlier in terms of the economic rebound. You get a stronger economy, and the site will be more valuable not just from a volume standpoint but a greater pricing flexibility. So over the course of 24 months or so, we should continue to see the benefits of those sites.

Just one follow-up on that. Do you see any pickup on Toronto in '03? I know it's lower gate rate stuff, but should that pick up at all?

Toronto -- yeah, I think it's public information. There's about an extra 450,000 tons a year coming into Toronto. The one thing everyone needs to recognize is to go from Toronto to the Detroit area -- a lot of the costs are actually in transportation. So you really need to look to the Toronto -- or, excuse me -- the Detroit market in terms of pricing that work.

Okay. Great. Thank you.

Thank you.

OPERATOR The next question is from Leone Young with Salomon Smith Barney. Go ahead, please.

Yeah, good morning. I understand you don't want to get into a whole lot of modeling questions. But like Amanda, I can't get down to $1.50 without declining margins. Tod, you mentioned some items below the line, like shares perhaps. Any other anomalies below the line? Higher tax rates?

I don't think there are necessarily anomalies. I think it's how people modeled the share account. The other thing might be the interest expense. I just draw your attention to our interest expense in the fourth quarter, which was probably a little bit higher. Our capitalized interest has come down a little bit.

Again, that's non-cash. But to the extent we have fewer landfill development and transfer station construction projects, we're not capitalizing interest on those development projects.

The other thing is interest income. We had pretty good interest rates in the first half of the year. Now I think that we're investing short term at about 1.3%. So we viewed that -- although our cash balances are greater, the increase in cash doesn't offset the decline in rates there. So interest expense might be another area that people need to look at in their models.

Obviously, after the call, we'll be available. Ed will be available to help on the models, but --

I was asking half-way modeling and half-way theoretical. But as a follow-up to that, Jim. As we look at your internal growth in the fourth quarter, and yet your forecast is really calling for no pickup, or deterioration. I understand you want to be conservative. It worked well for you last year. I wondered if there's anything you see out there that would be driving down your internal growth.

No. Keeping in mind one thing, as you look into going into next year. A lot of the municipal contracts that we gathered up and the long-term franchises that we gathered up were in the first quarter of '02. For the most part they're anniversary now in the early parts of '03. So that's what gives rise to some of that.

As far as what's on the horizon,. We've got a pipeline of municipal opportunities available much like our competitors. But again we don't see many changes in the economy. When we look at the broader indexes from the Department of Commerce and nonresidential construction, third and fourth quarter decreased 9.3%. The industrial production declined on an annual basis from Fed statistics 2.4%.

So I guess you could say we're conservative and it worked well for us, but I don't look at it as being conservative. When you look at what we performed at in 2002, we were only off the guidance by 2%. I think that's pretty good. I think most people doing forecasting are putting performers out for acquisitions. At least I know in my business, if we performed within a 2% variance range, that's pretty good. I don't see it being conservative and I don’t see much changing the economy.

So as far as the margins go, I think our margins -- we'll be able to maintain our margins. And I think the modeling that you guys need to work on with Tod and Ed can be accomplished in the next couple of weeks.

Fair enough, Jim. Thanks.

Thank you.

The next question is from Mark Farano from First Analysis. Go ahead, please .

Good morning.

Good morning, Mark.

I'm talking about the free cash flow. You mentioned a figure, I think $259m for '02 under the classic definition you're adopting now. And just backing into what your guidance is for '03. It looks like you're forecasting, either down or possibly flat free cash flow '03 to '02. Could you comment on that as well as the dynamics behind that?

Sure. I think the greatest dynamic there, Mark, is our accounts receivable. Again, our organization continues to amaze me in their ability to collect cash efficiently. And also we're holding the bad debts down. So that really gave rise to a lot of this benefit this year. And I think that as we look to next year, we're not anticipating that reoccurring. We're anticipating maintaining the day sales where we are.

The other factor which nobody really sees or touches on much is in the tax area. Back in September of 2001, the government initiated this 30% bonus depreciation. And that goes from -- for assets acquired, it's trucks and equipment, it's not for real property or land fills -- it's trucks and equipment acquired after September 11th, 2001. What happens if you model this out, you get a benefit in -- a little bit of a benefit in 2001. You get a greater benefit in 2002.

And then it starts to reverse itself because you're getting -- for your 2002 assets, about 50% of your total depreciation in the year 2002. And in 2003 it's a lot less, even though you're getting a new benefit from new assets in 2003. We looked at this benefit in '02 and estimated it to be about $15m. In '03, that benefit is about $10m, and in '04 -- I'm not sure, we haven't modeled out that far -- but I expect it to be slightly positive or neutral. So I think deferred taxes are another factor there.

And then my follow-up question would be -- it looks like you are assuming roughly flat capital expenditures year over year. And I think as you commented, the '02 cap ex included some growth cap ex. Can you give us a sense of -- does your '03 projection kind of assume a certain win rate on the municipal work you're bidding on, or just give us a sense of that?

I think you need to look at the revenue assumption of 1% to 1 1/2%. We have -- as we look to our 2003 capital, reduced the amount of capital, I think, by about $15m for our internal growth assumption. And one of the issues with looking at internal growth capital is the mix of that capital. I mean, to the extent it's land films or compactors, there's more capital per dollar or revenue than maybe small container work.

The other thing I want to point out is if you look at this business over about a three-year period, if you went back to 2000, our capital spending was $267m. And for '03, we're saying $260m. And if you look at revenue growth, thinking we come in at maybe 3 or 4% higher than where we are this year, in that same 3 year period where capital has gone down 3%, our revenue has gone up about 15 or 16%.

So while we continue to reinvest in the business, we are positioning ourselves to be more efficient in the use of our capital.

Mark, maybe just one follow-up there. In the middle part of last year, we restructured our sales and marketing programs. And brought on a Vice President of sales and marketing. And over the course of the third and fourth quarter, we've been out -- Gary Sullivan, myself, and Mike Cordesman -- have been out to our seven or eight largest competitive markets.

And at the conclusion of those initial reviews, we decided to restructure or reorganize the majority of those marketplaces from a sales and marketing perspective. And we did that. And all of that work was effectuated in December. So some of the growth that is in here, some of the capital that is in here, and maybe some of the growth that's not in here yet is going to be coming from that reorganization of our divisional sales staffs and our most competitive markets. So, one, there's probably some upside here as far as internal growth. And, two, I think we're probably forecasting some of that on the capital side.

Okay. Thanks a lot.

Thank you.

The next question is from [Trip] Rogers with UBS Warburg. Go ahead, please.

Good morning, Trip.

Talk about -- regarding your guidance -- what you're assuming as far as fuel costs as well as commodity prices.

Fuel was at the October levels. I think right now with the fuel we're experiencing in January is about 10 to 15% higher. So, I mean, even with -- I know a lot of people are concerned that we're very conservative in our '03 guidance here. But we have some head wind here already, with fuel being up and commodity prices being down from where they were. Again, we used, for budget and forecast purposes in our internal processes, October levels.

And if you look at the full year, what we expect year-over-year for fuel on a full-year basis is about flat. Now, depending on how the political events unfold this year, we could see some substantial volatility. But we -- while we might see higher fuel prices in the first quarter of this year or maybe into the second quarter, we believe that will be offset by lower prices in the second half of the year. So year-over-year, it should net out.

Any commodity prices?

I think that's a similar situation there.

All right. Then looking at -- regarding 14. Can you talk about the discount rates you're now using and what your total obligation does under 143?

Well, we're still in the process of finalizing this. You need to understand that 143 is effective January 1st. And the disclosures will be completed and available in our first-quarter queue. So while we have put some very detailed models together and done an extensive amount of work, we have not had our auditors sign off on this yet. I think from a discounting standpoint, you can probably look at something in the 2 to 3% rate for inflation, probably in the middle of that range, and our risk-free cost of capital is probably about 6 to 7%.

Great. Thanks a lot.

OPERATOR The next question is from Carey Callaghan with Goldman Sachs. Go ahead, please.

Good morning, guys. To follow up on the FAS 143. Am I right in understanding there's potentially a cumulative charge associated with prior periods? And when would you come out with that?

That's correct. This is a change in accounting principle. And as a result Of that, what we have to do is in our first quarter disclosure. You will see a cumulative adjustment for the effect of that change on that portion of the air space or closure/post closure that's already been consumed. The air space has been filled up as of December 31st, 2002.

So while we have an idea of that, again, we have not audited that or had that audited, and I can't disclose that at this time. There will be a cumulative impact, we expect, although it certainly wouldn't materially alter our equity or balance sheet positions.

Okay. And that --

But, I'm sorry, that's a one-line item that you will see on the income statement.

I see. Looks like you spent about 37% of your total cap ex in the fourth quarter. Should we expect similar kind of seasonality to your cap ex over the course of the year in '03?

Yeah, I think that's probably fairly typical. You get the first part of the year while you're doing replacement for vehicles and maybe some containers and whatever growth capital you have. The construction products for landfills and for facilities -- the few facilities we have -- typically occur in the summer months. Probably more in the third and fourth quarter. So I think that's a normal, seasonal event.

And just lastly, for Jim. In your conversations with municipalities across the country, it looks like there's a looming budget cries at the state and local level in fiscal year '04. Are any of them talking about potentially divesting up or selling disposal assets you guys might be interested in?

There's some preliminary indication that there are some communities looking at doing that. We're talking to a number of them. But, again, these are long-term discussions, early on in a number of cases. And in a number of cases, they're intertwined with union activity that causes these things to take on a protracted negotiating period. All in all, I don't really see a lot coming right now. the reality is, there is a squeeze out there. We are getting some additional inquiries. Hopefully, that will present some upside to us in the latter part of 2003. But, again, I don't think it's enough to substantially impact what we're forecasting.

Right, I was actually thinking in the beyond years -- '04, et cetera. Any particular parts of the country? Is that more out west that you're seeing that? I know California's got a huge budget problem.

No. You know, I think -- again --

Okay. So it's something that's in a number of different states?

Yeah, it's pretty much across the board. We haven't seen any particular area where we're getting more opportunities or more lead generations.

Okay. Thank you.

Thanks.

OPERATOR The next question is from Kevin Monroe with Thomas Wiesel Partners. Go ahead, please.

Morning.

Morning Kevin .

You talked about how you initiated 24 months ago your cost savings initiatives. Can you quantify how much cost you've driven out on a per-year bases? And can you also maybe give a net number what that cost savings has been offset by in terms of insurance or your health costs?

Let me give it to Tod here.

Yeah, we've covered that in our margin discussions. It's approximately 30 basis points. You look at 30 basis points, at roughly $2.5b, you're talking roughly $7m or so of cost improvement. And as we look out in future years, we think we have similar opportunities. But this isn't the type of business that you're going to see -- unless you haven't managed your cost to begin with, you're not going to see a dramatic, 100 or 200 basis point improvement. It's a gradual improvement if you want to make sure that those cost improvements are sustainable. So looking ahead, I think it's probably somewhere in that range, which is probably the pressure we see for margins on insurance in '03.

That's basically a wash. And just quickly on FAS 143. Where's that incremental cost being carried? Is it in cost of goods sold or DD&A?

What happens is closure/post closure costs currently are in the cost of operations. And you might recall in our annual report, we actually showed kind of the cash and non-cash components because it really is a non-cash expense. And then you spend capital to close sites. That's all going down below the line in DD&A in 2003. So it goes from cost of options to DD&A.

So more than the incremental 3 cents is going into D D&A?

That's true. And again you can look at our financial disclosures and you can see there's probably about $20m a year that goes in there. But then there's probably about $10m or so the past year or two that's gone out.

As closure spending.

Okay. Thanks.

Next question is from Brad Goldman with Deutsche Bank Securities. Go ahead, please.

Can you hear me?

Yes, we can, Brad.

Just wand to touch on the acquisition opportunities mentioned. That’s $10m signed. Do you expect that to be completed in the fourth quarter?

Yes. In fact it's going to be closing in the next several weeks.

Is that and any other opportunities in the pipeline included in your guidance?

No, that would be all upside.

And I know we're getting towards the end here. But is there anything you're seeing with respect to the other companies in terms of swaps or divestures?

Well, we continue to talk to Allied and Waste Management. We had some activity, as you know, in the fourth quarter with both of them. So we continued to have those discussions and we would anticipate on doing a limited amount with both companies in the first half of the year.

Okay. And then with $140m in cash and expectations of generating free cash of somewhere around $200m. I know about $150m of that will go for share purchases and a little more for acquisitions. Still looks like you're going to have a pretty solid cash position with that scenario. Update us what your thoughts are with regards to the dividends. I know you discussed it in the third quarter and decided to wait. In the event the Congress doesn't pass the double taxation issue, what are the odds you that you guys will actually institute a policy?

I hate to give odds out, Brad. But quarterly, we discussed what our cash strategy is. As you well know, we had a special board meeting last year to develop a plan. We continued to discuss it. We discussed it at last week's board meeting. And we continue to revisit the dividend issue.

I think regardless of what the administration does, we will continue to revisit that. And you're right. We have a signature amount of cash. And unless there are some acquisition opportunities in the first half of the year unrelated to the pipeline that we currently have, something more significant, we would probably seriously consider that in the latter part of the year.

Okay. Thank you.

OPERATOR The next question is from Lorraine Maikis with Merrill Lynch. Go ahead.

Could you discuss the portion of volume growth in 2002 that would be event driven?

How much of our volume growth was event driven in 2002? Is that your question, Lorraine?

Yes.

Lorraine, I think the bulk of our volume growth came from these municipal contracts that you saw in the first half of the year. I guess what I would draw people's attention to is the AK. If you look at the last page, it actually shows revenue. And you can see our residential revenue year-over-year is up about $60m, which is over 2%. So the lion’s share of the revenue is right there.

On the landfill transfer station side -- that revenue has also gone up by about $50m. Some of that is the new sites, and then some of that would also be -- some of the special waste jobs that Jim was talking about. Kind of a combination of those two.

Okay. And then with many of these residential contracts anniversarying in the first half and maybe a drop-off in special event waste. Can you just walk us through where you're getting this 1% to 1 1/2% volume increase in '03?

Well, I think I think 1% to 1 1/2% is a normal type of rate excluding these residential contracts. We'll get a little bit of it in the first quarter until it anniversary's out. And then it should drop off in the in the first quarter. What we'll see in the balance of the year is a function of where we're positioned in the United States. We still see growth in those areas of the country that are more focused on a service economy. In the southwest and in the west. It's really in the industrial sectors of the countries where we're seeing this decline in our industrial revenue.

Okay. And your internalization rate for the quarter?

53%. It's unchanged.

Thank you.

Michael Hoffman with FBR has the next question.

Tod, at the risk of beating dead horse. I wanted to understand the comments about the margin issue. You've had a successful cost cutting. But the reason the margins is are not expanding in '02 is that they're offset by insurance and fuel. And as you look in to '03. Despite the fact you raise prices, and you will cut costs, you still expect extraordinary cost increases like fuel, potentially, or insurance that would offset. So, all in all, it's a wash?

Well, Mike, I think you need to look at the pricing levels that we're at in this economy. And pricing, you know, in the range of 1 ½% essentially pulls us neutral. It offsets the inflationary costs. Our employees are getting, normal wage increases. Some of our suppliers may be passing on some cost increases. And while we try to manage those supplier-types of cost increases, there's still an organic type of cost increase embedded in the business that I think the 1 1/2% price offsets, and that should be pretty much neutral. So what you're talking about is what's happening in the margin or on the edge, and that is really commodities, fuel, and insurance.

And again, we think fuel is pretty much neutral, although it might spike in the first half and be lower the second half. Commodities -- that's a similar type of assumption. So you've got our cost improvement initiates which we think should continue in the range of about 30 basis points with the higher insurance offsetting it.

Okay. That's what I thought you were making the comment on. I just wanted to make sure I got that right.

I know you've asked not to get in too much details on Models. But you've said things that may be needed to be clarified for all of us in one audience. Your interest rate is running at what level, so we get that right?

It’s running effectively a little bit under 6%, , at about 5 3/4 on a net basis.

You're suggesting some costs in cost of goods sold are now coming down to D&A in addition to FAS 143.

That is 143. That's what's coming down to cost of goods sold. And in the order of magnitude. Look to closure/post closure to costs. It's about $20m a year. And that might be a little bit high because we're having to discount that now. But somewhere in that range.

You said you had like SG&A to be about 10%. I'm assuming that's a goal, because you're not quite there yet. You're a little bit higher. Is that a targeted goal you're going to get to or is it a wish?

No, I think it's a reality. We're at 9.7% in the fourth quarter. And what we said is This goes back to the discussions we seem to get into with our competitors where everyone is trying to understand what is going on in in the industry. We've got a cost structure from an SG&A standpoint that is very much under control. We don't have a very large corporate office. We have a few functional specialists. Our regional structures are defined as are our areas.

And we're very comfortable with 10%. We were 10.1 for the year, 9.7 in the fourth quarter, 9.9 in the third quarter. And what's going the going to drive it? Well maybe a little bit in terms of some bad debts may move up or some litigation costs or other things that may be a function of the economy.

Again, we've always talked about putting the structure that we any is appropriate to manage the company. We have that. And any future growth, we can leverage often of that number. So if anything, we'd see a better economy, as a margin percent with the margin improving. But as far as headcount goes, we don't see any changes in our headcount. Nor do we plan any headcount reduction at this stage.

Last two items, just to get a starting point. What's the right tax rate we would should be using? And what's the beginning year share count?

Good questions. The tax rate is 38%, and the beginning of the year share count is 163.7m shares. That's actual shares as of 12/31. To that you need to consider treasury stock method and all the others things we talked about.

Shooting from the hip, adds about how much?

Shooting from the hip for what?

Treasury piece to get the adjustment.

Probably 1 1/2 to 2 million shares.

Okay. Thanks.

Operator, we'll take one more call.

Okay the last question is from Allen [Zavice] (ph) from Credit Suisse First Boston. Go ahead, please.

On the FAS 143, could you give a little more detail on -- I think it was always perceived that using the discount method you would get a benefit to the EP. And it seems like the new adoption of the new landfill gas systems is offsetting that. Could you give us the two pieces? How much that new handling of the lamed fill gas system is costing in terms of EPS? And how much the rest of winds up netting out to that 3 cents impact?

I'm not going to give you specific numbers for where we are currently because, again, we've not finalized this with our auditors. But go back to the discussions that we had two years ago or three years ago on us discounting versus other companies not discounting. And we said that we thought that discounting benefit was in the range of about 2 cents.

Now, what we've done is -- on the gas side, we've looked to the other companies, and what we've said is we will strive for conformity with the other two large players in the industry so that you get greater comparability or consistency. That's the reason for that. The other thing, in the same vein of consistency, is that we looked at this thing from a life cycle accounting standpoint. I think, theoretically, that might be a slightly preferable approach. And you might see some of the smaller companies doing that. We felt that we were better off having consistency, particularly with our auditors who as you know, audited one of the other large companies who talked to the FCC. So there we're striving for the closure event approach, which might introduce a little bit of volatility into the mix.

The final point is the point I made earlier about third-party costs. You know, this pronouncement has this artificial assumption in there that all our costs need to have third party contractors with the overhead and profit in there. And that's not the economic reality of how we run our business. So I take everybody back to the fact that 143 is non-cash. it doesn't really affect the gash-generating capability of any of these businesses. And as a result of 143, I think you've got an industry that has come together very nicely. And you will have greater consistency in reporting.

And the last question. Could you explain why, after a couple of years of being consistent, you're changing your primary measure of cash flow?

Yes, it's very simple: We have been understating -- and we've had a number of our shareholders say to us to please use something that reflects your financial statements rather than this simplistic approach. By excluding the non-cash taxes, by excluding the proceeds from equipment sales, we've understated the true cash capabilities of this business. And what we want to do is make sure everyone understands, for comparability, clearly what this business is generating from cash. Because that is all the true value of an industry like this where the businesses grow at a much slower rate.

True, but that always has been the case. Any other particular reason about doing it now?

No, there's no particular reason. We've been talking about it you know for a number of Months. And felt that with the new year, it was the appropriate time to bring it out. And again it's always been in the face of the financial statement.

What we're talking about is off the statement of cash flow. So you take cash flows from operation also. That sub totaled in the cash flow statement less, just below it, there you have your capital spending. And I want to emphasize that it's capital spending less proceeds from asset sales. It has nothing to do with when we sell a business. It's just the trucks and containers and Caterpillar equipment that is fully depreciated that we sell off.

Great. Thank you.

So it's as reported.

Thanks Allen, and thanks to all of you for spending time with us today. Replay of this call is available today by calling area code (402)220-2491. The pass code is 15128070. Again, thanks for joining us and have a great day.