Republic Services Inc (RSG) 2004 Q1 法說會逐字稿

Good morning and welcome to the first quarter 2004 conference call for investors in Republic Services. Your host this morning is Republic Chairman and CEO, Jim O'Connor. Today's call is being recorded and all participants are in a listen only mode. There will be a question-and-answer session following the Republic summary of quarterly earnings. I will provide you with specific instructions for questions later in the call. At this time it is my pleasure to turn the call over to Mr. O'Connor and thank you for using Sprint. Go ahead, Sir.

Thank you, Scott. Good morning and thank you for joining us. This is Jim O'Connor, and I would like to welcome everyone to Republic Services' first quarter conference call. This morning, Tod Holmes, our Chief Financial Officer, and Ed Lang, our Treasurer, are joining me as we discuss our first quarter performance.

I would like to take a moment to remind everyone that some of the information we will discuss with you today contains forward-looking statements which involve risks and uncertainties and may be materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations.

Additionally, the material we discuss today is time sensitive. If in the future you have listened to a rebroadcast or a recording of this conference call, you should be sensitive to the date of the original call which is April 29th, 2004. Please note that this call is the property of Republic Services Inc. 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 our operations are performing within our expectations. During the first quarter total revenue was $637 million. This was an improvement of $43 million or 7.2 percent compared to the first quarter of 2003. Internal growth was 6.2 percent with 2.9 percent from price and 3.3 percent from volume. This is the strongest level of internal growth we have achieved since the second quarter of 2000. Our pricing initiative is successful and will continue to be successful for the balance of the year. Republic's employees continue to demonstrate the discipline and the commitment required to successfully raise prices.

Republic earned 36 cents per share in the first quarter compared to 33 cents in the first quarter of '03. We generated $153 million of free cash flow in the first quarter and we continued to return cash to our shareholders. In addition to our quarterly dividend, we repurchased 3 1/2 million shares for approximately $93 million.

Based on our strong cash flow performance, our Board of Directors has increased the repurchase authorization for 2004 by 75 million, bringing the total '04 authorization to 275 million. In addition, Republic will increase its dividend by 100 percent to 48 cents per share on an annual basis, beginning with the October dividend.

And we continue to maintain the strongest credit profile in the solid waste industry. As previously announced, we will repay a $225 million note which matures May 15th of this year.

During April, we acquired a construction and demolition landfill in Virginia that will improve our competitive position in a market with good growth opportunities. In addition this acquisition will improve our internalization rate by 1 percent over the next twelve months. Our field operations continue to achieve the best days outstanding sales performance in the industry. We maintain DSO at 35 days.

And in January, Forbes Magazine recognized Republic as one of the 15 best managed companies in the services supply industry product sector. Republic is the only company in the solid waste industry to achieve this does distinction. Now I'll turn the call over to Tod Holmes, our Chief Financial Officer, to go through our first quarter financial review.

I'll begin my review of the Company's financial results just briefly going over first quarter revenue again. First quarter 2004 revenues Jim indicated grew 7.2 percent from -- to 537 million, excuse me -- 637 million from 594 million last year.

Our internal growth from the core business, core operations, is 5.8 percent. 2.3 percent from price and 3.5 percent from volumes.

As we mentioned during our last conference call, during the latter part of 2003, Republic initiated a price increase strategy. During the first quarter of 2004, we continued to realize the benefit of this initiative through higher core price growth.

Our core volume growth comes from all lines of business including our residential collection businesses where we have been awarded a number of new municipal contracts. Keep in mind that some these contracts anniversary late in 2004, so our core growth going forward from that date is set down.

Core volume growth during the quarter also came from landfills and transfer stations where we have recently opened new sites and secured new contracts. Volumes from our commercial and industrial and landfill businesses are also up. The remaining 1.4 percent of revenue growth comes from commodities, non-core businesses, state taxes fuel surcharges and acquisitions.

Next, I'll discuss changes in our sequential margins. Sequentially, our first quarter operating margins increased by 60 basis points. The key components of our increase in sequential margins are as follows. Fuel was actually a negative 30 basis points. Disposal cost and third party hauling cost was a positive 40 basis points, DD&A was a positive 50 basis points, SG&A sequentially was unchanged for a net and margin improvement of 60 basis points.

Fuel. During the first quarter of 2004, fuel prices were up from the fourth quarter. Average price per gallon increased about 10 percent for diesel from about $1.37 in the fourth quarter to $1.51 in the first quarter.

Second, disposal cost and third party hauling costs. During the first quarter the Company experienced lower disposal costs and third party hauling due to seasonally lower volumes at its transfer stations and in its residential collection operations.

Third, DD&A. During the first quarter of 2004, the Company completed its annual review of actual and projected costs associated with capping, closure and postclosure of its landfills in accordance with State and Financial Accounting Standards No. 143. You'll recall this was a pronouncement that was put out in 2003.

As a result of this review, the Company recorded a $2.6 million reduction and landfill amortization during the quarter. This reduction is due to the reversal of contractor profits and projected inflation actually came in a little bit lower than the model we forecasted. This was included in the Company's previous cost estimates during 2003 as required by the statement.

In addition, the Company experienced lower depletion due to seasonally lower landfill volumes.

Finally, SG&A. Sequentially, SG&A remained constant at 9.8 percent of revenue. During the first quarter of 2004, the Company successfully recovered bad debts that were previously fully reserved and as a result the Company lowered its bad debt expense and allowance for doubtful accounts during the quarter. This decrease in bad debt expense was offset by sequentially higher compensation costs, resulting from full bonus accruals for the new fiscal year.

Now I'll turn my attention to the year-over-year operating margins. Operating margins year-over-year decreased by 40 basis points from the first quarter of 2003 to the first quarter of 2004. Key components of a margin decrease are as follows. Risk and health insurance was a negative 80 basis points; fuel was a negative 10 basis points; commodity price increases was a positive 20 basis points; post (indiscernible) negative 20 basis points; disposal costs third party hauling cost and revenue mix was a negative 60 basis points; DD&A was a positive 50 basis points, and SG&A was a positive 60 basis points for a net decrease in margin, again, of 40 basis points.

Now I'll briefly comment on these components of year-over-year margin.

First, risk and health insurance. During the first quarter of 2004, insurance expense was approximately 6.9 percent of revenue or approximately 80 basis points higher than last year. And I might add that this 6.9 percent is consistent with what we saw in the fourth quarter. We expect self-insurance to be in the range of 6 1/2 percent during the second quarter of 2004 and in the range of 6 to 6 1/2 percent in the second half of 2004. This improvement is based upon many actions that are already in place such as a change in our health insurance administrator from Signa to Blue Cross and Blue Shield.

We believe the strength of the Blue Cross and Blue Shield network allows us to secure greater group discounts from doctors and hospitals for the benefit of both our employees and the Company.

Second, fuel. Fuel prices were higher during the first quarter of 2004 versus 2003. The average price per gallon of diesel increased about 6 percent from $1.43 in 2003 to $1.51 in the first quarter of 2004.

Third, commodities. During the first quarter of 2004, commodity prices increased by approximately 13 percent per ton from $54 in 2003 to $61 in 2004. However, as we said in the past, the portion of increases in commodity prices is offset by increased cost related to rebates or tip fees that we pay people to bring clean commodities into our facilities.

Fourth, host fees. During the first quarter of 2004 we experienced an increase in host fees due to higher year-over-year landfill volumes.

Fifth, disposal. Third party hauling costs and revenue mix. During the first quarter of 2004, we experienced an increase in transfer station volumes and third party transportation costs. Disposal cost also increased because of an increase in residential and industrial volumes and higher cost disposal markets.

Sixth, DD&A. As I previously mentioned during the first quarter of 2004, the Company recorded a $2.6 million reduction in landfill amortization in connection with statement of Financial Accounting Standards No. 143 and, again, this reduction is due to primarily the contractor profit that -- since we have people on-site -- we go ahead to perform many of the services ourselves and, therefore, that cost is not necessary.

Finally, SG&A. Decrease in SG&A as a percentage of revenue is primarily due lower bad debt expense but it's also due to the leveraging of the Company's cost structure over a higher revenue base.

Operating income before DD&A. Year-over-year, the operating income before depreciation, amortization, depletion and accretion increased by $6 million or 3.6 percent from 165 million in the first quarter of 2003 to 171 million in the first quarter of 2004.

Next, I will discuss free cash flow. Our definition of free cash flow is very straight forward. It's cash provided by operating activities of the statement of cash flows less purchases of property and equipment plus the proceeds from the sale of equipment. Again all of this is presented in the Company's consolidated statement of cash flows. Using our definition of free cash flow for the first quarter of 2004, we had $153 million. This is based upon cash provided by operating activities of $190 million, less purchases of property and equipment of 39 million plus the proceeds from the sale of equipment of 2 million.

Please keep in mind that our cash flow is historically high during the first quarter because of the timing of tax (ph) payments and capital expenditures. The Company is very comfortable. We feel that we are on track to achieve our free cash flow target of $340 million for the year.

Now how are we going to use this cash flow? Again during the first quarter of 2004, we paid about 1.4 million for businesses with run rate of 1.4 million. More importantly we repurchased 3.5 million shares of our common stock, as Jim had indicated, for $93 million. This was done at an average price of $26.24 per share. From the inception of our stock repurchase program through March of 2004, we repurchased approximately 16 percent of our common stock or 29.1 million shares for about $577 million at an average price of just under $20 a share.

As of March 2004, we have $173 million remaining under the increased share repurchase program and we expect upon completion of these programs to have repurchased approximately 6 percent of our outstanding shares during 2004. Even after the substantial repurchase of shares our cash available at March 31st, 2004 to pay off the $225 million of public debt maturing in May of 2004 and to fund future internal growth, acquisitions, dividends and share repurchases is approximately $490 million.

Again, our balance sheet remains very strong. At March 31st, our accounts receivable balance was $250 million and our day sales outstanding was 35 days. We continue to lead the industry in managing our accounts receivable and our net debt is $1,020,000,000 at March 31st. That's down from $1,075,000,000 at December 31st, 2003.

Consistent with our cash flow performance and previous guidance, our debt to total capital at March 31st is 35 percent. And we continue to remain committed to maintaining our investment grade rating. Now I'll turn the call back over to Jim.

Thank you, Tod. Before taking your questions I'd like to reconfirm our guidance for 2004. We expect 2004 EPS of $1.50 to $1.55. As we discussed in previous calls 47 to 48 percent of our earnings are achieved in the first half of the year and, again, while we are a penny above first quarter First Call consensus, we still think it's prudent to be within that range. We expect to generate $340 million of free cash flow -- again, consistent with our original guidance -- and capital spending is expected to be approximately $275 million -- again, consistent with our original guidance for the year.

At this time I would like to ask the operator to open the call up for questions.

+++ q-and-a.

(OPERATOR INSTRUCTIONS)

Amanda Tepper of J.P. Morgan.

Why -- can you just address why you want to keep your leverage where it is, given the outlook and the cash flow? I understand wanting to stay investment grade, but probably you could be investment grade with much higher leverage than where you are now so what's the outlook? Is it thinking that there's going to be acquisition targets down the road or just keeping powder dry to continue to up the buyback or what's the thought?

I think it's all of what you've just mentioned. You answered your own question. But you know, again, we continue to look for opportunities. We're continuing to buy. We mentioned we bought a construction and demolition facility in April. We continue to have a strong pipeline for acquisitions. Again, it's just that the potential candidates aren't sellers today. And then again I think we do see some other opportunities depending on the changing interest environment that may cause opportunities to afford themselves to us. So that's the reason to keep the balance sheet and, Tod, do you have anything you want to add to that?

Well, Amanda, with this increase for the share repurchase 275 million and the doubling of the dividend essentially what we're doing is taking the cash flow, the substantial cash flows the Company is generating, and returning that to the shareholder on a current basis. And the Board looks at that every quarter. It's something that Jim and the Board are very cognizant of and focused on. We do listen to our shareholders and certainly one of the things that we have heard is while they appreciated the dividend they felt it was very modest and hence the substantial increase.

So we will continue to focus on that and look at how we will return the cash. I think the general view is the cash flow off the P&L is available to return to the shareholders. The return now is almost 8 percent. You got 6 percent in the share repurchase and 1.7 percent in the dividend. And then the balance sheet is available as Jim indicated to look for opportunities and provide us with a tremendous amount of flexibility which I think is the unique aspect of Republic Services in this industry.

The balance sheet differentiates us and it gives us flexibility. And we don't need to be like everyone else.

Could you just give, then, as a follow-up a little more color on the acquisition pipeline? Because there were other players a lot smaller than you doing acquisitions these days, I'm assuming that don't meet your return criteria. What are you looking for these days and why are you optimistic that it will get better if rates rise?

Again I think as it gets tighter to reinvest in your business I think it will drive people to the marketplace and, again, the population of companies that we continue to talk to, private companies that we talk to, just today aren't ready. And but, again, the criteria -- we've always had the discipline built into the criteria, the financial criteria, that is. And we're not going to deviate from that but, again, I think we see opportunities out there and we see some substantial opportunities out there over the next 18 to 24 months and therefore, we think it's prudent to keep the balance sheet where it's at.

Trip Rodgers with UBS.

Can you talk about your internal growth guidance? Has that changed particularly regarding volumes?

I think that in the first quarter I mentioned the core business volume growth was 3 1/2 percent. Actually this is, in some respects, a little bit like the retail business. We have an extra day in the first quarter of 2004 due to leap year. And so when you look at half of our revenues which are the transfer disposal and then the rolloff construction activity and industrial activity, we picked up more volumes. That was worth about 80 basis points in volume growth.

So you normalize that outwards at about 2.7 percent. Now that these contracts that we spoke to were worth about 110 basis points so that kind of gets us down to a core growth of about 160 basis points. I think where we are today, while we're not moving guidance up at this point in time, we are cautiously optimistic. We are seeing an uptick. We are seeing business activity pretty good and so I would expect that the core volume growth that we would have would be higher than the 1 percent guidance that we gave for the full year. Sequentially, it will step down but it will definitely be above the guidance we gave and that's why as Jim said earlier, come July mid-year we will revisit the complete guidance for the Company and give everybody an update.

I think we're cautious at this point. We want to see what happens with the seasonal uptick here in the second quarter to make sure that it's very real.

Lorraine Maikis with Merrill Lynch.

Thank you. Good morning. Just wanted to ask about the pricing environment. I know you had initially said 2 percent pricing was a little bit better. Can we expect that trend to continue through the year?

I think the pricing program continues on through the second quarter and obviously we continue to look at it in the field monthly. But we do -- we do see it continuing. We do see us again staying. Right now we're staying with our original guidance but I think we are re-reviewing some of our accounts as it relates to fuel surcharge as fuel continues to escalate and again I think we will see this pretty much hold for the balance of the year.

And in terms of the competitive landscape out there, have you generally been able to pass through this pricing with a proper level of retention?

Yeah, the retention has been extremely good I think which, again, speaks to the rationale within the sector. So I think if -- this could be a very good sign I think for the industry to loosen up the pricing and to get some of the benefits from the consolidation that has occurred over the last five or six years.

Tom Ford with Lehman Brothers.

Just had a question for you, Jim. Can you talk a little bit more about you had referenced some development programs that had been going forward. I just was wondering if you could give a little bit more color?

Well we continue to develop opportunities to have outreach from our landfills and that's one of Mike Cordesman, the President and Chief Operating Officer's -- one of his primary goals for this year is to identify those opportunities. So we do have a number of development projects but they are in various stages and, again, for me to identify any of those at this particular time I think would be premature.

But we do. We are investing monies there and it is a big focus for us this year.

Could you talk about the order of magnitude what you think in terms of potential -- obviously not near term but a year or two down the road, what you think you can contribute?

It's hard to tell. A lot of these development projects are at various stages. Some are in the process of zoning, some are even in stages earlier than that where we're starting to develop market research. So to give you an indication of what the impacts will be, Tom, are really premature. They are in their formative stages and as soon as they available, trust me, we will be the first ones out on the street telling you what the benefits are.

Bill Fisher with Raymond James.

This thought on the pricing. What are you seeing at all on the landfill pricing and how is any special (indiscernible) mix affecting that?

Landfill pricing has still been -- we haven't been extremely successful there but we have moved out a little bit. It's for all practical purposes about flat. But we are starting to see some movement there and I think -- I think we will as the year goes on.

I think to add to that, Bill, while net is flat what we see is, in some markets the event pricing tends to be competitive and so we've seen some decreases there offset by some decreases -- excuse me -- some increases in the continual MSW reoccurring revenue stream. But net net it reverses downward trend and is neutral and we think we are positioned to start to get some positives here.

Corey Greendale with First Analysis.

Question about the free cash flow which was nice in the quarter. I know at some point this year you were expecting I believe you're expecting a refund from the IRS. Was that a contributor in the quarter?

Yes it was we actually I think our working capital was a positive $54 million. Now there's a number of components in there. The lion's share of it was we filed for a quick refund and while I thought it was going to come in the second quarter it actually came in the first quarter so that was a key driver. You know, you look at this 153 million or target (ph) of 340 and, typically, in this business, capital spending -- normalized capital spending for us would be 70 million a quarter. We spent 38 so you have to normalize that and then taxes, again, typically we tend to pay most of our cash taxes in the second half of the year. Maybe a little bit in the second quarter. So it's taxes, capital spending and I think good working capital management along with this quick tax refund. But I want to reemphasize the $340 million cash flow number is something that we feel very comfortable with.

Michael Hoffman with FBR.

The Board of Directors each quarter obviously reviews the issue the balance sheet and what you're doing with the cash. Can you talk a little bit about the criteria that they are using that would lead them to change their view on keeping the powder dry? And then can you talk about what you think the market looks like from a container utilization standpoint? Are we getting to a place where excess capacity is starting to be absorbed if we're seeing this economic volume recovering?

Let me take the latter part of that. We are and I think that that's a positive sign. Maybe you're a little premature to say that we are in full recovery but we are starting to deplete the inventories that we have on-site which is also giving rise to some temporary pricing flexibility. But it's still relatively small. Not anywhere near the drop-off or recovery of the drop-off in price that we talked about in previous calls that being approximately 20 percent. But we are starting to deplete it. The price is starting to move, so I think we are starting to see some positive signs and I think over the next several months will tell the story.

Todd, you want to... ?

Sure. On the board discussion and the criteria we actually use although we don't use a lot of consultants we use an outside firm called LEK to help us in the evaluation of the Company and, therefore, at what price we should be buying back our stock. And we look at it and say there's a value somewhere probably in the mid 30s. As a result of that, the share repurchase program is appropriate. I think the Board views it as a strategy that should be applied in a consistent fashion, that we shouldn't necessarily go into the marketplace with a huge Dutch (ph) auction, allow people that may be our timing and their presence in our stock to take advantage of it. They've want to continually return volume to the long-term investors in the Company. So the share repurchase is a key component. Certainly at the prices today -- they're around $28 a share, they feel there's a value capture there but in addition to that this view towards the dividend and the fact that with strong sustainable cash flows not only should we have these share repurchase but also be stepping up the dividend. We're up above the S&P 500 and I think we've established a pattern as we did in the share repurchases of annually visiting that and moving it up.

I think it's consistent with the Company's looking to be consistent and predictable and not take necessarily aggressive movements in either direction. And I think this is consistent and I think it's predictable and I think it adds a sense of security to the portfolios of the people who like the profile of Republic Services.

We do get out and talk to our shareholders on a regular basis and certainly the Board has that feedback so the actions of the Board I believe are reflective of what our current owners are asking us to do, not what maybe prospective owners or other interested parties might be asking.

Leone Young with Citigroup Smith Barney.

Nice quarter. Most of my questions have been answered but if I could just ask you some direction perhaps on DD&A, given the change in the first quarter? And also I I apologize but I did not catch the net debt number.

The net debt was 1,020,000,000. 1-0-2-0. And in terms of your other question was ... ? I'm sorry.

You had lower DD&A.

Okay the direction of the DD&A. Well once a year it's just a quirk of this FAS 143 with the contractor profit in there and so once a year what we do is take a look at the past year's activity in terms of closure/ postclosure, look at the estimated cost versus the actual cost and then true it up. So on an ongoing basis, we have probably higher amortization costs than we would ultimately realize. We get to the end of the year and at either the fourth quarter or the first quarter we will true it up. So I would expect amortization of the next three quarters to be consistent with what we saw in the fourth quarter and, again, you also get some seasonal uptick there and then after the year is closed we will go back and take a look at the contractor profit and take that out. And on a one year lag basis realize that benefit. Does that answer your question?

Kevin Monroe with Thomas Weisel Partners.

Given some of the cost increases that you guys continue to try to overcome, are you confident that you will get year-over-year improvement in EBITDA margin this year and is it more a factor of easy comps? Or is it more a factor of pricing or something else?

I'll let you make the decision whether or not the comps are easy, I sure don't think they are but at the end of the day I think that was the reason to put the pricing strategy in place. And it continued to move out that revenue, that particular competitor component other revenue initiative just to stem some of the head winds from fuel and insurance. So we were tired of seeing and so was our field declining margins and I think you can see that we've -- I think we've curtailed most of that and we should see some improvement assuming the economy continues to move forward in the latter part of this year.

I would add to that, that in addition to price, a number of the initiatives that we have have taken hold and are driving the margins. Certainly on the labor side the initiatives that we have have allowed our labor costs to be consistent and not be an issue or a factor in terms of our margins. On the risk side the actions that we have taken, give us a great deal of confidence that we'll pick up the sequential improvement from first to second quarter and more importantly from the first half of this year to the next half. So it's price. But it's also staying focused on the cost side, the margins, I think, have hit a trough and we're bouncing back up in terms of improving margins.

At this time we have no more questions.

Thank you, Scott. I'd like to thank, first of all, all the members of the Republic team for their dedication and support and we look forward to continued success in 2004. I'd like to thank all of you for spending time with us today and a replay of this call is available by calling area code 402-220-2491. Passcode is 23000738 and, additionally, this call will be archived on Republic Services' web site at www.RepublicServices.com. And thank you very much. Have a good day.