Republic Services Inc (RSG) 2003 Q3 法說會逐字稿

Good morning and welcome to the Republic Services third quarter conference call for investors listed on the Stock Exchange as ticker RSG your host is Jim O'Connor. You are in listen only until the question-and-answer session. This call is being recorded. Go ahead please.

Good morning and thank you for joining us. This is Jim O'Connor, I'd like to welcome everyone to Republic Services third quarter conference call. This morning Todd Holmes, our Chief Financial Officer and Ed Lang, our Treasurer, are joining us.

Some of the information that we will discuss with you today 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 expectations.

Additionally the material we will discuss with you today is time-sensitive. If in the future you listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call, which is November 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 consent of Republic Services is strictly prohibited.

Although Republic has experienced the impact of a slow economic environment and higher insurance and hire fuel costs we remain on track to generate free cash flow of at least $240 million. We will continue to employ this free cash to enhance shareholder value. The recent actions we have taken include ,our board of directors as of our last meeting allocated an additional $25 million for share repurchase in 2003. Our total share repurchase in 2003 will be $175 million. As of 9-30, we have repurchased approximately $135 million of stock, or 6.4 million shares. The board also approved an authorization to repurchase $200 million of stock in 2004.

At today's price level, this represents approximately 6% of our outstanding shares. Republic paid its first dividend on October 15th. We will look at the current payout level in the future to determine if our cash low profile can support a higher yield. Republic will still have significant amounts of excess cash after share repurchase and dividend payouts. Therefore, we have also decided that in May '04 we will retire $225 million of maturing note. After retiring the note, our next debt maturity will be 2009.

Republic is focused on providing value for both equity and fixed income investors, our business generates high levels of predictable free cash, which allows us to support these efforts. I would like to highlight a number of other items before turning the call over the over to Tod Holmes.

Revenue increased 6.3% to $648 million. Internal growth represented 3.9% with is price increases of 1.5% and volume growth of 2.4%. Earnings per share in the third quarter was 28 cents. This included a $24 million pretax increase in insurance accruals, or 9 cents a share. Our net debt to total capitalization at the end of the third quarter was 36%. In July, we renewed a $300 million, 364 day credit facility. We repurchased approximately 2.1 million shares in the quarter, for $48.7 million. Share repurchase will continue to be the cornerstone for enhancing shareholder value. Republic acquired $6.9 million of revenue in the quarter for $14 million.

Year to date we have acquired $18.4 in annual run rate revenue for $31.9 million. Our current acquisition pipeline represents approximately $50 million in annual revenue.

During the quarter we've seen an increase in Activity, related to our event driven businesses-- industrial collection and special waste disposal. But it's too early to state that this is a sustainable increase in these lines of revenue. However, in order to ensure that we are prepared to maximize our returns if there is an acceleration in the general economic conditions we are reviewing our pricing strategies in all markets.

Our intent is to implement a broad based pricing initiative in markets that are not limited to index pricing. This represents about 50% of our revenue base. During 2003, we achieved average price increases of 1.5% to 2%. Our plan for 2004 is to achieve average price increases of 2% to 2.5%. We'll implement this program to increase prices on this segment of our revenue during the first quarter. We believe as an industry that we have not realized the full benefit of the significant investment in fixed assets during this economic slow down and margin expansion will only occur with a broad based increase in pricing.

I'd like to thank the dedicated employees of Republic for their efforts. Our company is focused on generating higher levels of free cash flow and improving return of invested capital. Now I'd like to turn the call over to Tod for our financial review.

Thank you Jim. I'll begin with third quarter revenue. Third quarter revenue for 2003 rose 6.3% to $648 million from approximately $610 million last year. Internal growth from core operations is 3.9%. 1.7% from core price and 2.2% from core volume. Our core volume growth comes primarily from the residential businesses where we've been awarded a number of new municipal contracts in the past year, and also our landfills and transfer stations, where we've recently opened new sites and secured new contracts.

Volumes in our commercial business are holding steady, and industrial volumes are up. The remaining 2.4% of revenue growth comes from commodities, non-core businesses, state taxes, fuel surcharges and acquisitions. Next, I'll discuss changes in our sequential operating margins. Sequentially, our third quarter operating margins decreased by 430 basis points. The additional $24 million of self-insurance expense we announced in September, and recorded during the third quarter of 2003 accounted for 380 basis points of this decline.

The key components of our decrease in sequential margins are as follows. Risk and health insurance, 410 basis points, labor, 10 basis point, DD&A, 20 basis points, SG&A, a 10 basis point improvement for a net of 430 basis points.

First, risk and health insurance. During the third quarter of 2003, we recorded the additional expense I previously mentioned of $24 million on a pretax basis, or 9 cents per share. This related to existing claims. This increase in self-insurance is attributable to various changes in estimates as a result of continued negative trends, through the company's current policy year, based on recent actual claims experience, expected claims development, and medical cost inflation.

Excluding the additional expense we recorded during the third quarter, our insurance expense is approximately 6.7% of revenue, or approximately 30 basis points greater than the second quarter. We expect self-insurance to range from 6.5% to 7% of revenue through mid 2004, when we should begin to see the benefits of our safety program initiatives. And in the range of 6% to 6.5% thereafter. Second, labor. Pay raises, which had been deferred since March 2003 went into effect in August, resulting in higher sequential labor cost.

Third, DD&A. During the third quarter of 2003, the company experienced higher DD&A as a percentage of revenue due to seasonally higher landfill volumes.

Finally SG&A, sequentially SG&A decreased by 10 basis points, from 9.7% to 9.6% of revenue due primarily to the leveraging of existing cost on an increasing revenue base.

Operating income before amortization, depletion and accretion. This is the financial metric formerly known as EBITDA. In response to recent guidance from the Securities & Exchange Commission regarding the disclosure of nonGAAP financial measures, the company will no longer use the acronym EBITDA. Instead, we will now use the phrase operating income before depreciation, amortization, depletion and accretion. Please keep in mind that this is a change in name only, and it's not a change in the manner in which the company calculates this financial measure.

Sequential operating income before DD&A, decreased by $23.8 million or 13.5%, from $176 million during the second quarter of 2003 to $152.2 million during the third quarter. This decrease is attributable [entirely] to the additional self-insurance expense recorded during the quarter.

Year-over-year operating margin. Before I talk to you about year-over-year margins, I want to emphasize that the entire company is focused on cost controls, especially risk and insurance cost. I'm confident that we'll see substantial improvement in these costs in the next 6 to 9 months. However, as Jim indicated, if this industry expects to maintain and improve both its earnings and its margins in 2004, then we must secure greater price increases.

A primary focus of our 2004 business planning process, which is ongoing as we speak, is a broad-based customer priced pricing initiative. We will know by April of 2004 if this industry is willing to seek price increases to recover higher cost or rather, is focused on gathering up market share at the expense of earnings.

Now, for year-over-year margins. Operating margins decreased by 590 basis points from the third quarter of 2002 to the third quarter of 2003. The additional $24 million self-insurance expense we recorded in the third quarter of 2003 accounted for 390 basis points of this margin decline. The key components of our margin decrease are as follows. Risk and health insurance, 490 basis points. Commodity pricing, 30 base points. Fuel, 20 basis points, termination of a lease operating facility in August 2002, 20 base point benefit, waste taxes, 30 basis points, the economy, third party hauling and revenue mix, 70 basis points, the adoption of statement of financial accounting standards 143, negative 10 basis points. DD&A was a positive 10 basis points, SG&A was a positive 30 basis points. For a net of 590 basis points.

Now, let me briefly comment on the components of this year-over-year margin change. First, risk and health insurance. As I previously mentioned during third quarter, we recorded additional self-insurance expense of $24 million. We also experienced higher health care costs and insurance premiums during 2003. Second, commodities. During the third quarter of 2003, commodity prices decreased by approximately 13% from $61 per ton in 2002, which represents the peak of commodity prices, to $53 per ton in 2003.

Third, fume. During the third quarter of 2003 fuel prices were up from the prior year. Our average price per gallon increased about 2% from $1.29 to $1.32.

Fourth, operating lease facility. The company repaid its operating lease facility during the third quarter of 2002.

Fifth, waste taxes. During the third quarter of 2003, we continued to experience taxes levied on landfill volumes on certain states that were passed through to customers at no margins.

Sixth, the economy. During the third quarter of 2003, volume and pricing in our event business continued to be impacted by the economic slow down. We also experienced an increase in cost associated with the long haul transport of waste by third party vendors. Furthermore we generated more revenue from our residential line of business and our transfer stations, which traditionally have lower margins.

Seventh, statement of financial accounting standards 143. The company’s cost of operations improved by 120 basis points, as a result of the adoption of SFAS 143. This improvement however was offset by an 80 basis point increase in landfill amortization, and 50 basis points of greater accretion expense.

Eighth, DD&A. The increase in DD&A resulting from the adoption of SFAS 143 as previously discussed, the termination of the company's operating lease facility in August of 2002, and normal capital expenditures was offset by increased revenue.

Finally, SG&A. The decrease in SG&A is primarily attributable to leveraging existing costs on an increasing revenue base.

Now, for year-over-year operating income before depreciation, amortization, depletion and accretion. Again, the financial metric formerly known as EBITDA. Year-over-year operating income before depreciation, amortization, depletion and accretion decreased by $19.4 million or 11.3% from $171.6 million in the third quarter of 2002 to $152.2 million in the third quarter of 2003. All of this decrease was due to the additional insurance accruals.

Now, AOL discuss our year-to-date operating margins. Year-to-date operating margins decreased by 310 basis points from 19.4% to 16.3%. The additional self-insurance expense reported during the third quarter caused year-to-date margins to decrease by about 140 basis points. 190 basis points of the 310 basis point decline is attributable to increased insurance cost. 70 basis points relates to the economy, third-party hauling and revenue mix. 30 basis points of this decline relates to higher fuel cost. 50 basis points relates to waste taxes. 10 basis points relates to hire amortization and accretion cost associated with the adoption of SFAS 143, and that's net of a related 110-basis point improvement in operating cost.

The remaining decline of [40] basis points relates to higher depreciation and depletion expense. These declines were partially offset by a 30 basis point improvement in operating cost related to repaying the synthetic lease, and a 40 basis point improvement in SG&A cost, and a 10 basis point improvement in commodity prices.

Next I'll discuss free cash flow. As we have said in the past, one of the most attractive aspects of this business is its ability to generate free cash flow. We believe that strong sustainable cash flow is indicative of a high quality of earnings. For 2003, our definition of free cash flow is cash provided by operating activities, less purchase of property and equipment, plus proceeds from the sale of equipment, as presented in the company's consolidated statement of cash flows.

Using this definition for free cash flow, the third quarter of 2003 was $88 million. This is based upon cash provided by operating activities of $180 million, less purchases of property and equipment of $93 million, plus proceeds from the sale of equipment of $1 million. That equals free cash flow of $88 million for the quarter.

Free cash flow for the nine months ended September 30th, 2003, was $255 million. This is based upon cash provided by operating activities of $432 million, plus purchases of property and equipment of $181 million, plus the proceeds from the sale of equipment of $4 million. Again, that's equal to free cash flow of $255 million.

Please keep in mind that our free cash flow is historically high during the first three quarters of the year, because of the timing of capital expenditures and tax payments. If we normalize our free cash flow for our expected annual capital expenditures and tax payments, it would be reduced by $18 million and $50 million respectively.

This results in a normalized free cash flow of $187 million for the nine months. Given our year-to-date results, I feel very confident that our free cash flow for year will be at the upper end of our range of $240 million to $250 million. Now, let's talk about the uses of our cash flow. During the third quarter of 2003 we paid $14.1 million for businesses, with a run rate of $6.9 million and purchased $2.1 million shares of stock for approximately $48.7 million. I might add that at the end of the quarter, our share count is 159.1 million shares.

From the inception of our stock repurchase program through September 30th, 2003, we've repurchased over 13% of our common stock, or 23.6 million shares, for approximately $435 million, or about $18.46 per share.

During 2003, we anticipate repurchasing approximately 5% of our outstanding stock. Even after the substantial repurchase of shares during 2003, our balance of unrestricted cash available at September 30th, to fund future internal growth, acquisitions, dividends and share repurchases is approximately $125 million.

Our balance sheet remains very strong. At September 30th, our accounts receivable balance was $266 million, and our days sales outstanding was 37 days. Republic continues to lead the industry in managing working capital. Our net debt is $1 billion 54 million of which $1.05 billion is public debt and $433 million is tax exempt financing at favor rates. Consistent with our cash flow performance in previous guidance our net debt to total capital at September 30th, 2003, is 36%. And as Jim indicated, we remain committed to maintaining our investment-grade rating. Now I'll turn the call back over to Jim O'Connor.

Thank you, Tod. Operator, you can open up the lines for questions.

(Operator instructions) Our first question comes from Amanda Tepper from J.P. Morgan. You have the floor.

Good morning.

Good morning Amanda.

The obvious question is to get a little more detail on your pricing and why you think you'll be able to get more pricing next year. Let's take a scenario where there is no change in the underlying fundamental market. If you got -- you said 1.5 to 2% this year and you're aiming for 2% to 2.5% next year in your competitive markets, how are you going to go about it?

It is an internal discipline, something that's needed by the sector. 2% to 2.5% even under the economic conditions we are experiencing today is not substantial. And anything less than that we will not be able to maintain margins. And we're committed to maintaining or improving the margins in '04 no matter what the economic conditions are.

And at some point in time this industry needs to step out, all right, and better mirror, other industries that I've talked about in public before, and that's the aggregate business. There is not a rationale that exists within pricing totally within our sector. I think the sector's committed to it. But we're committed in the first quarter to move price out.

In the first quarter. Does -- is what Allied is talking about with their landfills giving you more confidence that you can do that? Is this any of these markets that you're aiming?

No, this is a broad-based, across all of the geographies that we service, on a component of our revenue which is about 50% of our total revenue, about $1.2 billion worth of revenue.

Okay.

This is going to be very broad-based and we're going to move it out and we're going to do it you know, conscious of the types of accounts that exist within that part of our revenue base. But we're going to move price out. I mean, you guys are always looking at our margins and our ability to increase margins. And we are we are serious about it and we think it's about time that we move price out. And we're going to move it out.

Okay. And then you did give a little bit of commentary that you're starting to see some firming in industrial lines. Can you give a little bit more color on that?

Sequentially we've seen you know third quarter is usually our strongest quarter. Sequentially we've seen some improvements on our volumes on our temporary collection business and special waste business. But again, I think-- I don't want to necessarily say that that is sustainable as I did in my comments. We would hope it is a good sign but at this particular stage I just don't want to say that it appears to be an indication that the economy is significantly getting better.

Are you seeing anything notable on bids for special waste business?

Nothing substantial other than I think we're seeing more activity, meaning that again, some of the discretionary spending by industry may be loosening a little bit.

Okay, great. Thank you very much.

You're welcome.

Next question is from Lorraine Maikis from Merrill Lynch. You have the floor.

Good morning. What was your internalization rate in the quarter?

54%.

Okay. And then could you just talk a little bit about the increase in transfer and disposal revenues, what's been driving that? Are there particular projects in your transfer and disposal network that you're working on?

Well, I wouldn't say that it's anything that's -- you know, unique to the quarter. It's a trend that we saw in previous quarters. Certainly we have volumes coming in from Canada. We have developed, particularly up in the Midwest and in Southern Indiana, some additional transfer stations or had acquired some properties, I think in the Carolinas also.

So what we're doing is building out our network a little bit more to move our transfer capabilities, our internalization up a little bit.

But those cost too, Tod, I think. I mean, they're experiencing the same thing our industry is experiencing.

Higher fuel cost.

Higher insurance costs, right. While we've held the line with a number of our subcontractors, I mean, those pressures are real pressures to them as they are to us and we're going to have to start recognizing those in forms of compensation to our subcontractors.

So I think we're starting to see some of that. Again, which gives rise to why, in the first quarter of '04, we're going to need to get substantially more price than we've got in the past. And again one of the reasons we're committed to take at least the component of our revenue base that's not restricted to index pricing or contracts and we'll price out in those particular -- in that particular segment of our business.

And this pricing increase program includes both collection and landfills?

Yes.

This is broad based across all lines of business. It The billion two would encompass industrial residential collection as well as transfer and disposal.

Thank you.

We do want to remind everyone that we do limit ourselves to two questions. The next question comes today from Brad Coltman from Deutsche Banc securities.

Pricing volume, starting to see a pickup on the industrial side yet you're not that confident about the sustainability. But irregardless, you're still going to be putting through a price increase in the first quarter. If that's correct, I'm just wondering what's so magical about the first quarter and why not rollout the pricing earlier this year?

This year, when you look at your customers Brad and the notification that you need to give to your customer base, it's something that we're building in our business planning process that's ongoing as we speak.

So we're laying the foundation or the groundwork in the fourth quarter. We will be providing that notification and actually securing the price increases and seeing it in the first quarter. It's just really a question of planning it and rolling it out.

It's not something you just, you know, you just do by pulling a trigger. It takes some planning.

Okay. Then my second question will be, I just wonder if you could share with us some thoughts at the board level, what they were thinking in terms of why increasing the share repurchase program versus not coming out with a larger dividend?

Valuation is the key. The board looks at the valuation of the company, and I think we spoke about it on -- in the July call. That the discounted cash flow valuation of the company is substantially above where the stock is trading. And the board believes that the share repurchase is the best way to deliver that value to the shareholders. So next year you're going to see about 6% in terms of share repurchase returned to the shareholders. 1% for the dividend. But I want to remind everyone that we have the capacity to increase the dividend, and it's certainly something that we will be looking at next year.

Is there a targeted growth rate for the dividend?

No.

Okay, thank you.

Next question is from Bill Fisher from Raymond James.

Good morning.

Good morning Bill.

Tod you mentioned your unrestricted cash was $127 million. Do you have what the IRB cash was at the end of the quarter?

I think it's about 140. I don't have it offhand here, Bill.

I guess the follow-up on that is, is that something you see coming down next year on funding your capex?

Yes, we do. You know, again, this cash that's restricted for industrial revenue bonds, and I think we probably raised you know, $50 million or $70 million of industrial revenue bond money so far this year.

It's essentially prefunding for our capital spending and we look at about an 18 to 24-month time horizon for the utilization of those funds. So as we move through next year that balance will be drawn down next year. We will, however, continue to seek industrial bond funds where it's appropriate.

Our next question is from Tom Ford Lehman Brothers. You have the floor.

Good morning guys.

Good morning Tom.

Hey Tod, continuing on I was just curious about one thing in the quarter. Was the sequential step-down in the interest expense line?

Okay.

I mean, it seemed to hold relatively stable from -- well, let's put it this way, you saw a nice step down from the first to the second quarter, and then it seemed like it stepped down quite a bit more into the third. And I was just curious if you could just, you know, talk to that. ,Anything notable there?

No, I think the key there is the cash that this business generates, and the cash balances that we're building up some higher interest income on that cash. Offhand I think that's probably the key.

Okay. And then Jim, going back to your commentary about pricing.

Yes, sir.

Obviously it's positive that you're kind of taking this -- you're stepping out here. But did I hear you correctly that you need about a low twos range just to keep kind of flat on the margin line?

Yes, I think you know to improve or maintain, we need in excess of two.

Okay.

Tom, in excess of two, you know, we should turn the corner and start to improve our margins. The other variable in here is what's going on in the cost side.

Right.

The fact that this past year we have seen that ramp-up in fuel cost, we had seen the ramp-up in insurance, and we think that the fuel is behind us. We looked at the insurance. We feel that we should turn the corner mid '04 on the insurance and those costs should start to come down. They will definitely level off here. And so as a result, with that being a constant above 2% we should start to see some movement in margins.

And any just, real quickly, any last thought, because you talked about two of the big drivers. What about the labor side? Have you seen any -- other than Chicago, have you guys seen any data points out there either a plus or a minus?

No. But I mean I think, you know, it's like -- whether it's Los Angeles or Chicago, I mean all of those contracts that were significantly above the cost of living, settlement above the cost of living, are going to have ramifications in the near future on all the labor contracts that we're going to sell across the country.

And I would have liked to have seen them, just as my competitors would have, a better deal in the Chicago market. And I think we picked a good market to take a stance. And I would like to have seen a better result. But again, I think it was a good result. But it will have impact on labor in future quarters.

Great, thanks a lot.

The next question is from Corey Greendale (ph) with First Analysts. You have you the floor.

Good morning.

Good morning Corey.

I wanted to ask about the historical pricing. The 1.9% is better than what you've been getting for a while. I just wanted to ask for a little more detail on what's driving that. Are things going a little better in the large markets? Or are the CPI coming in better? Or any of the drivers, driving that upwards historically?

Yeah, it's really pretty consistent here Corey. It's 1.5 historically, we saw it move up to 1.7. And then on top of that we had 20 basis points of fuel surcharge. That difference is of maybe 1.5 to 1.7, that 20 basis points is due to the timing sequentially of our franchise contracts where, in July, those have their annual CPI renewal.

It's not a huge dollar amount but certainly you get a little bit of a sequential step-up. So that's what that is. And we don't really -- we haven't seen anything substantial one way or another, aside from that.

Okay. The 20 basis point impact of the fuel surcharge, is that about the impact that there was in the first and second quarter also?

The first and second quarter I think was probably about 30 basis points. Third quarter was 20 basis points.

Thank you.

Next question is from Leon Young with Smith Barney. You have the floor.

Good morning Leone.

First of all with the special waste, with the slight increase in activity has there been stabilization of pricing or is it too early for that?

This will sound sarcastic, it is already so low one would say it's already stabilized.

Well, that's good to hear in that regard. And also if you could give us a little update on Michigan and you know, some of the state legislative activities there.

Well, again, the county -- state legislation I guess there are a number of bills that are moving. But none of which we -- we see as impacting our business or impacting the Canadian waste flow to Michigan.

Wayne County did try to impose some restrictions, and we were successful along with the association in securing a temporary injunction. And we think that any discriminatory tax passed either by a county or a state will meet with the same resolution that we received from the courts on this injunction, and that is that, you know, they won't stand the test of the Commerce Act. So we don't really see any liability here.

Terrific, thank you.

Thanks.

The next question is from Trip Rogers of UBS. You have the floor.

Good morning. Just want to talk about the strength you saw in industrial in the quarter. You're already through one quarter -- one month in the fourth quarter. Is that something we see that largely year-over-year change, is there any kind of pent up volumes you sell in the fourth quarter that you realized? Just trying to get a feel for how that trend's going next quarter.

No. I mean I think we're -- again, remember the demographics of our revenue. It's in the Sun Belt, and we've seen some pickups in those areas. But again, it's hard to distinguish what we're looking at in what is normally a better quarter than the others, and that's the third quarter.

And as far as the month of October goes, it appears that it's somewhat holding, but again, not in all areas. You know, in the Midwest and again the Mid Atlantic, we're starting to see some seasonal drop off but nothing significant.

It's clearly some incremental strengthening but not any pent-up demand that's being unleashed and coming at us in a wave.

Okay. And separately, net debt continues to decline as a percentage to capital, is there a minimum level you're going to try to keep that above? I know you are retiring some debt next year as well.

We look at the net debt basis, so retirement moves some off the balance sheet, doesn't change that metric. We don't necessarily target a net debt. I think the more relevant measures are debt coverage and interest coverage ratios using EBITDA which of course is not sanctioned by the S.E.C. anymore but the credit rating agencies continue to use it.

But our focus is there. I think more importantly than targeting a metric is really how much cash do we have and what can we do with that cash to deliver the best value to our long-term shareholders. And at this point you know the board has sent a very strong signal that the share repurchase program, we believe has been successful and continues to be the cornerstone for this cash flow strategy.

That coupled with acquisitions where we see them and then of course at some point if the stock price moves up, focusing more on dividends. But certainly, we have the capacity to have a $200 million share repurchase program and step up the dividend at some point.

Great, thanks a lot.

Next question is from Kevin Monroe with Thomas Weisel Partners. Have you the floor.

Good morning.

Good morning Kevin.

Just wondering if you could speak qualitatively on potential impact on free cash flow if your pricing strategy negatively impacts your volumes in 2004? If you see deterioration?

I don't think there is that much of an impact on the cash flow. I think to the contrary, if we get the additional pricing, and this industry starts to get rational about pricing and get some decent returns on its investment for a change, we'll see our cash flow start to step up.

But the capital side of this business is pretty well fixed. We don't think this is a pricing strategy that would cause us to dramatically lose volumes. Hopefully, what we've got is a rational sector and people realize that they need to go after pricing to cover declining margins. But our cash flow is in the range of 90% to 100% of net income. And I think it will stay there or maybe slightly above that.

Okay.

Well, Kevin, I'll give you an editorial comment here.

Sure.

We talk a lot about pricing in this sector. And I guess it's about time we do it. And as Tod said in his comments, if we're going to improve margins, and they're going to be broad-based, it's going to have to come from responsible pricing. So I guess we're just going to have to -- we'll have to see whether this -- whether the sector is conscious of margin improvement, and -- or not.

Okay, thank you.

Next question is from Stewart Scharf from Standard & Poor's. You have the floor.

Firstly, do you have a target for internalization for this year and for '04?

Internalization Stewart is really a measure of how well a business is integrated. So that percentage is something that is the function of the markets you're in. I think we've talked about that in the past. For example, here in Florida a lot of our volumes go into municipally controlled incinerators and are not part of the internalization metric.

Our goal has been to continue to look at each individual market to make sure we're well positioned, that we have a strong competitive position, and if that leads to some internalization that will slowly occur over time that's fine. We are not trying to dramatically improve our assets just to drive internalization.

The short answer is, we'll see a gradual improvement in internalization in the future but we don't have a target number.

Okay. Regarding the pricing, if the pricing doesn't stick and you don't get your targets of say two, 2.5%, do you have an alternative strategy for improving margins, any restructuring type of plan?

Well, I feel very positive that that -- it will stick. And I feel very positive that the methodology that we're going to employ during the first quarter to secure it is a good one, and one that we have been successful since we've gone public in securing positive price every quarter.

So I don't see any reason why at this particular time I would say we wouldn't be successful. We feel very comfortable and very confident and we think that's a reasonable range for pricing.

And certainly on the cost side, we have a number of initiatives that are ongoing, particularly in the safety and insurance area, which I spoke of earlier? You know, we do expect to see improving margins in the second half of next year.

But again, as Jim has always said after 20-some years in the business, this business is all about making sure that your costs are under control, you're not going to necessarily drive tremendous margin improvement out of the cost side of your structure. You need to make sure the costs are rational so you can compete effectively.

But this is a very heavily fixed investment, fixed-base type of business where the real driver of margins comes from pricing and modest pricing over a number of years will deliver expanding margins.

Okay, thank you.

Next question is from Steve Cole (ph) from Matador Capital.

Two questions, I want to make sure I'm clear on this. The 58% of revenues, where your speaking that the price increase was applicable for, does that include (inaudible) business and spot contracts that are coming off during the year?

Yeah, that is -- the way we're looking at this, is we've got a component of our revenue that's in the franchise municipal contract.

Yes.

Segment the revenue that way, then we have permanent business, again running across all lines, that we've contracted some price increase -- to a price increase with or no price increase with, okay? And then we have a permanent component of our revenue base that is unrestricted that we have discretion over and that's the $1.2 billion.

And so what we're doing is, you know, going for a price increase on that $1.2 billion above and beyond what we would get out of the contractual or franchise piece of our business.

Okay. And one quick follow-up on --

Excuse me Steve, the blend is this 2% to 2.5% that we're spending of for the entire company.

The blend is the both components?

Right.

Last question on municipal contracts, you spoke Tod earlier about obviously you benefited from new contracts. Could you speak to the rollover effect as we look towards Q4, more importantly to 2004, don't we have a couple of contracts that are kicking in that will help going forward or can you --

It goes both way. We have contracts kicking in in November and again in January. But we've also got contracts that you know, started at the beginning, fourth quarter of last year beginning of in year that roll off. So, I think there's an equilibrium there. Maybe over the long term that might slow down a little bit as a driver of our volume growth.

Thank you very much.

Okay, one more question operator.

Last question is from Aldo Mazzaferro (ph) of Goldman Sachs.

Good morning. I wonder if you could give us a feeling best you think right now what the inflation might be in the biggest cost items next year?

It's hard to predict the economy, we did this two or three years ago when we were going to have this V-shaped recovery. Inflation is a recovery of that.

We look at the medical cost and the insurance cost and we believe that those costs without any actions on our own, would be going up in the, 10%, 15% range, certainly solid double-digit range. We looked at our labor cost which is probably in the 2% 3% range.

And then I think the fuel is probably mostly behind us, unless we get some sort of geopolitical risk. I think those are the key components of the cost structure that would be volatile that we would be looking to try to recover in our pricing. And again, in this 1.5% to 2% range, absent some extraordinarily great increase in some of those costs like we see in this past year, we think we ought to be able to maintain margins. And then above that 2% range start to improve the margins, stabilize them and then improve them.

Right. And in terms of capex, and DD&A for next year, do you have a forecast?

Aldo, we don't give guidance at this point. On our January call after we complete our business planning process, we will go ahead and give detailed guidance in terms of the earnings expectation and the cash flow expectations along with the components of cash flow.

Okay.

But I will add if you look back over the past three or four years you'll see that we've got a very stable asset base. We have invested a tremendous amount in this business. So, our capital spending--we would not see it go up dramatically.

Thank you.

Thank you. I want to thank all of you for spending time with you today. A replay is available by calling 402-220-2491. The pass code is 19565101. Additionally, this call will be archived on Republic Services Website at www.republicservices.com.

Thank you again for joining us and have a great day.