Republic Services Inc (RSG) 2005 Q3 法說會逐字稿

Good morning and welcome to the third-quarter conference call for investors in Republic Services. Republic is traded on the New York Stock Exchange under the symbol RSG. Your host this morning is Republic Chairman and CEO Jim O'Connor. Today's call is being recorded and all participants are in the listen-only mode.

There will be a question-and-answer session following Republic's 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. Good morning, Mr. O'Connor.

Good morning, Melissa. Good morning and thank you for joining us. This is Jim O'Connor and I would like to welcome everyone to Republic Services' third-quarter conference call. This morning, Tod Holmes, our Chief Financial Officer, and Ed Lang, our Treasurer, are joining me as we discuss our third-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 involves risk 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 that we discuss 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 November 2, 2005.

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.

Before we get to our third-quarter results, I would like to take a minute to provide you with a quick update regarding Hurricane Wilma and the recovery efforts here in South Florida. As you know, our corporate office and field operations in South Florida were directly impacted by last week's hurricane. I am proud to report that following the storm, all of our corporate functions were able to maintain system access and our field operations in Broward, Miami Dade, Palm Beach counties quickly returned to full operations. Electrical power was restored to our corporate office late last week.

I'm especially pleased with our dedicated teams at our local divisions and the way that they were able to restore services to the municipalities and commercial customers throughout the South Florida area.

As a company that cares, we also took steps to ensure that our employees and families were safe. All last week, we provided emergency supplies and food to our people who were impacted by the storm. Our excellent performance during this difficult time demonstrated that we have an effective disaster planning program. I would like to thank all the members of our corporate staff who executed critical functions from off-site locations during the first days after the hurricane.

At this time, we are continuing to work with the impacted communities in South Florida to meet all of their solid waste needs.

Moving on to our third-quarter results. I'm pleased to report to you today that Republic continues to improve its financial performance as a result of our pricing discipline and the strategic initiatives. Although we are still facing high fuel costs, which we are mitigating through fuel surcharges and pricing initiatives, we have remained on track to meet the financial guidance that we have set on previous calls.

We have achieved a number of important financial objectives in the quarter. Republic earned $0.45 per share versus $0.41 in the third quarter of 2004. Our operating margins were 16.4 versus 16.7. This margin deterioration was the result of higher fuel costs. Fuel as a percent of revenue was up 130 basis points on a year-to-year basis. Most of our other costs either improved or are flat compared to the same period in 2004.

Year-to-date operating margins are 17%, which is consistent with the same period in 2004 and includes an increase in fuel of 100 basis points. We are on track to achieve our objective to maintain or improve operating margins in 2005 compared to 2004.

Total revenue growth was 4.3%. We are succeeding in our efforts to raise prices without dislocating volume. Total price growth in the third quarter was 4.2% and volume growth was 1.8%. This was offset by lower revenue in noncore operations and divestitures.

Now I would like to talk and give you an update on strategic objectives we discussed earlier this year. First, we continue to utilize our return on investment pricing model. In preparation for our annual business planning process, we have recently completed market reviews throughout our Company. This process helps prioritize capital spending for 2006 and market development efforts.

Second, we will continue to exit underperforming markets and lines of business. Our decision to enter or expand in a market is based on our return on invested capital objectives. We have recently agreed to execute a number of transactions that will enhance our return on invested capital and free cash flow performance.

We have decided to exit the environmental contracting business and sell ESI division, located in Kansas City, Missouri, to current management. This business has always been reported as noncore operations. And we are actively negotiating asset exchanges with Waste Management and Allied.

Finally, we continue to roll out our routing tools to our residential collection business. We have substantially completed roll-out to our commercial business. All of our cost initiatives are ongoing efforts.

Other highlights in the quarter. During the quarter, Republic generated $48 million of free cash flow. We are on track to meet our original guidance for free cash flow. We continue to return our excess cash to our shareholders. In the third quarter, we repurchased 3.1 million shares for $113.6 million. Year-to-date we have repurchased 13.3 million shares, which represents approximately 9% of the shares outstanding as of December 31, 2004. Since we initiated our share repurchase 5 years ago, we have repurchased over $1.2 billion of our stock.

Our internalization rate has hit 56%. The acquisition of a number of landfills the past year and the divestiture of collection operations have been key to our year-to-year improvement. Since the beginning of 2005, we have secured 5 landfill expansion permits in North Carolina, Wisconsin, Maryland, Colorado, and Indiana. Republic will continue to improve its vertical integration strategy. Since 1998, Republic has successfully obtained 25 landfill expansion permits.

Our marketing personnel continue to be successful in securing new franchise and municipal contracts within existing markets. All of those bids have met our return on investment capital criteria of 10 to 12%. Our internal volume growth has been enhanced in the fourth quarter of 2005 by $6.5 million, or 80 basis points, with the startup of new contracts. In addition, our volume growth in 2006 will be enhanced by at least $17.5 million with the rollover impact of these contracts. With these successful bids, our 2006 volume growth will be enhanced by at least 80 basis points.

After Tod's financial review, I will have final comments before question and answers. Now I would like to turn it over to Tod Holmes, our Chief Financial Officer.

Thank you, Jim. I will begin my review of the Company's financial results by discussing third-quarter revenue. As Jim indicated, the third-quarter revenue rose 4.3% to 730 million from approximately 700 million last year. Internal growth was 5%, of which 4.8 was from core operations, 3% price in core operations and 1.8% volume in core operations.

During the quarter, we continued to benefit from ongoing price increase strategy and sequentially, our pricing from second quarter to third quarter was up. Price remains a key initiative for 2005.

Our core volume growth comes from all lines of business including residential, commercial, industrial, and landfill businesses. The remaining 0.2% of internal growth comes from commodities, noncore businesses, fuel surcharges, and environmental fees.

Internal growth was partially offset by a 0.7% reduction in revenue due to the divestiture of western New York assets during the first quarter of 2005.

Next I will discuss changes in our sequential operating margins. Sequentially, our third-quarter operating margins decreased by 70 basis points. The key components of this decrease in sequential margins are as follows -- fuel, -60 basis points; risk and insurance, -20 basis points; disposal and subcontracting costs, positive 20 basis points; and DD&A -10 basis points.

Briefly, the components of the sequential margin change are as follows. First, fuel. Fuel was approximately 5.5% of revenue during the third quarter of 2005. A sample of our larger collection divisions indicates that our wholesale price per gallon increased about 22%, from $2.15 in the second quarter to about $2.62 in the third quarter.

Second, risk and health insurance. The slight increase in risk and health insurance is attributable to actual claims experienced during the quarter, and we would expect that on an ongoing basis, our risk and health insurance would be in the 5.5% range of revenue.

Third, disposal and subcontracting costs. During the quarter, we experienced lower sequential disposal and subcontracting costs due to better pricing and continuous focus on productivity improvements.

Fourth, DD&A. The sequential increase in DD&A is primarily due to depreciation on newly acquired trucks and equipment, much of which is associated with business that we have picked up through bidding.

Finally, SG&A. Sequentially, SG&A remained unchanged at 9.8%. A slight increase in bad debt expense was offset by seasonally higher revenue, and we continue to believe that the Company's SG&A as a percentage of revenue will be at or slightly below the 10% range.

Operating income before depreciation, amortization, depletion and accretion sequentially. Sequentially, operating income before DD&A decreased by 1.8 million, or 0.1%, from 197.1 million in the second quarter to 195.3 million in the third quarter.

Our third quarter year-over-year operating margin. The change in third quarter year-over-year operating margins is very straightforward. Operating margins decreased by 30 basis points from the third quarter of '04 to the third quarter of '05. Key components are as follows. Fuel, -130 basis points; insurance -20 basis points; and our labor disposal and subcontracting costs, a positive 120 basis points.

Now I will briefly comment on these year-over-year margin changes. First of all, fuel. Again, it was approximately 5.5% of revenue during the third quarter of '05, and the larger divisions indicated that wholesale prices per gallon increased about 48%, from $1.77 in the third quarter of '04 to $2.62 in the third quarter of '05. Currently, prices are approximately 5% higher than our average price during the third quarter as we go into the fourth quarter here.

Second, risk and health insurance. Again, insurance expense increased 20 basis points due to some unfavorable claims experience, which we do not expect to reoccur here in the fourth quarter.

Third, labor, disposal, and subcontracting costs. Improved pricing in our collection lines of business, a changing mix of revenue and continued focus on productivity improvements has resulted in this 120 basis point margin benefit.

Overall, we believe the Company will continue to experience modest margin expansion during 2005 as a result of better pricing, the continued focus on cost control -- this assumes no further increases in fuel prices -- and it should set us up for a strong position for 2006.

The third-quarter operating income before depreciation, amortization, depletion and accretion increased by $6.1 million, or 3.2%, from 189.2 million, or 27%, in the third quarter of '04 to 195.3 million, or 26.8%, in the third quarter of '05.

Next I will discuss free cash flow. Using our definition, free cash flow for the third quarter was $48 million. This is based upon cash provided by operating activities of 159 million less purchases of property and equipment of 113 million, plus $2 million arising from the proceeds of the sale of equipment. Again, that gave us 48 million of free cash in the quarter.

Free cash flow for the nine months ended September 30, 2005 was 252 million. Again, this is based upon cash provided by operating activities of 494 million less 250 million for the purchases of property and equipment, plus approximately 8 million from the proceeds of the sale of equipment. Please keep in mind that our free cash flow is historically high during the first nine months of the year because of timing of tax payments and capital expenditures.

We expect our full-year capital spending now to be approximately 330 million, or $15 million higher than our revised guidance at the end of the second quarter, this due to additional bids awarded during the quarter. As a result, we believe our free cash flow for 2005 will be consistent with our original guidance of approximately $260 million.

Items impacting our cash balances. Again, as Jim indicated, during the third quarter we purchased 3.1 million of shares of our common stock for approximately $113.6 million, or $36.10 a share. As of September 30, we had 323.9 million remaining under our existing share repurchase program. These repurchases and this authorization we would expect to continue through 2005 and also throughout 2006. Our actual share count at September 30, 2005 was 139.8 million shares.

Republic's balance sheet remains very strong. At September 30, our accounts receivable balance was 294 million and our Days Sales Outstanding was 36 days. Again, Republic continues to lead the industry in managing accounts receivable.

Our net debt is 1.252 billion, which is up from 1.020 billion at December 31, 2004, and this is the function of the increased share repurchase and the utilization of excess cash from the balance sheet to pursue that share repurchase program. Consistent with our cash flow performance and previous guidance, our net debt to total capital at September 30 was 44%. Republic does remain committed to maintaining our investment-grade rating.

Now I will turn the call back to Jim.

Thank you, Tod. Although we have the challenge of high fuel costs and other inflationary pressures, we are comfortable with the high end of our EPS guidance of $1.70 to $1.74. Our business continues to generate strong levels of free cash flow and we remain committed to returning cash flow to our shareholders through share repurchase and dividends.

I would like once again to congratulate all the members of the Republic team for the excellent performance they have represented in our results for the third quarter. Special thanks to all of our South Florida operations and our corporate staff for their performance after last week's hurricane. Now, operator, I would like to open the call to questions.

(OPERATOR INSTRUCTIONS) Michael Hoffman, Friedman, Billings, Ramsey.

Just one question -- follow-on (ph) seems challenging. So can you talk about your return on invested capital goals and will your folks get bonuses this year? And then why you're not getting 100% of your fuel exposure covered through your surcharges and how you are going to fix that.

Our individual performance, our field operations, for the most part, and the corporate operations are overachieving, and we have provided for the bonuses in the results that we reported today. So all of the accruals are reflected in the numbers that we have presented today, Michael.

As it relates to fuel charge, we are recovering -- where we have discretion in our customer count in our revenue, we are recovering about 80 to 90% of our fuel. But remember that the accounts that we have discretion over only represent about 60% or 65% of our total revenue. The balance of our revenue is coming from fuel surcharges.

Part of our fuel strategy here was to initiate a fuel hedge to help us recover or at least mitigate the costs of higher fuel on that particular component of our revenue that is index priced, that being predominantly our franchise work.

You are doing hedges or you are contemplating hedges?

No, we have a 10% fuel hedge in that runs through the end of year. And we have executed another 10% of our fuel hedge to be effective January 1.

Amanda Tepper, JPMorgan.

The volumes were a little weaker than we were looking for this quarter. Are you seeing any slowdown in the pipeline? And you're going to be facing some tougher comps next year. I'm wondering whether you think these slightly lighter volumes, aside from the new contracts that you won, are based on a slight deceleration in the macroenvironment out there, or you think it's a reaction to more aggressive pricing.

I'll let Jim talk to the business itself, but in terms of what we're seeing on the internal growth "decelerating," it is a function really of the rollover effect of last year's bids that we had won. So we had some contracts that gave us slightly higher internal growth in the first half of the year, and then as those anniversaried out, things that started up in the second or third quarter of last year, obviously that internal growth percentage would come down.

So we are on track in terms of where we think we are and we are replenishing the pipeline with the additional contracts that we won. Again, we've probably got 80 basis points of internal growth already on the books for next year. So I will let Jim talk to the business itself.

I think, again, we have always said we're not economists. But when you look general economic statistics, we can see that capacity utilization that the Fed reports is up. We can see that GDP continues to grow. Non-residential fixed investment increased 6.2% in the third quarter of 2005. The CPI is up, which is I guess reflecting a little bit of inflation setting in, but historically that has been good for our business. So in general, we really still see a relatively strong economy.

Okay. And then my follow-up would be on these new businesses that you're winning, some of your competitors are saying they are walking away from this type of franchise business, that they can't win it at a good ROIC. How are you able to continue to do that?

We continue to use the same metrics we always have, Amanda, and I think we've been very clear to tell the investment community that we're looking at return on investment at about 10 to 12%, similar internal rates of return. And I don't know if that is because of the amount of due diligence that we do, but at the end of day, we look at this as good work. Some may consider it to be lowering the price.

But again, we're looking at return on invested capital on a go-forward basis and on an average over a 5-year period or a contract term. So I don't know how to answer that question, to be perfectly honest with you, other than to tell you how we evaluate the businesses.

There are some bids that have come out from municipalities and we submitted a no bid because we look at the restrictions that they have in terms of CPI constraints or the inability to pass through fuel increases. And essentially our operations people in the field have realized that they are not going to meet the cost of capital and the hurdles that we have set forth. And we do not want to take on that risk. So there are no bid responses that we have put in.

Jamie Cook, First Boston.

I noticed the environmental surcharge in your press release today, and I guess what percentage of the customer base have you passed environmental surcharge along and how should we see that progress through the end of the year and into '06?

Again, similar to our fuel surcharge, we have had success in passing along to those customers that we have discretion over. Obviously, our franchise work, which is contract based, we have not been very successful in that particular area.

But again, I would say it represents a 1% charge of the revenue that is charged to the customer. And then you should see it probably somewhat mimicking the fuel surcharge, not in total dollars, but as it relates to coverage of that particular part of our revenue base.

Okay, and than as a follow-up question, in the more competitive markets, in the markets where you compete against some of the larger players, what percentage of landfills have you implemented a price increase or if you few could speak to whether you're seeing a more favorable pricing environment in those markets.

Again, I think we're seeing some marginal improvement in landfill pricing. I wouldn't say it's anything that excites me a whole lot. I think we still see a competitive atmosphere in the event business. But I think the atmosphere is getting better out there, and as long as we continue to see that, we will continue to aggressively pursue price at our landfills.

Lorraine Maikis, Merrill Lynch.

Just to follow up on Jamie's question, can you just give us an idea of what percentage of landfills you're passing pricing through to? And are you also including any type of fuel surcharge or environmental fee on the landfill tons?

I would say that probably -- again, I don't have these statistics right in front me, so I'll go out on a limb here to say we've got about probably a third of our disposal facilities where we have had some discretionary price increases on third-party volume. And for the most part what we are trying to do in most of our landfills across the country is pass along a component of fuel to our third-party customers.

Okay. And then just to follow up on the hurricanes in the fourth quarter, I know you guys have been spending some money to help your employees out. Do you have any idea of what the incremental volumes or extra costs associated with all of these activities will be?

Volume-wise, again, we don't have disposal capacity in South Florida. So I think what we're going to see here is probably higher labor costs associated with the collection of municipal solid waste. Most of the communities down here have already instructed their residents that the only thing that we will be picking up and that our competitors will be picking up in the South Florida communities will be municipal solid waste.

All of the vegetative waste will be handled by the federal emergency management group, and that is being stockpiled currently on the curbs. So I think we will see some volume, but predominantly, I think increased labor costs in South Florida. But again, I don't think it's going to be material to our fourth-quarter results, and we still feel confident with our guidance to the upper end of the range of $1.70 to $1.74.

Bill Fisher, Raymond James.

Jim, you mentioned the 5 landfill expansions you've gotten, I think, year-to-date. Are any of those where you're getting daily limit expansions, like the C&D site in Maryland, I think you were looking for one.

With that -- in some cases, we don't have ceilings on the facilities. But I think -- Mike Cordesman's here. He can better answer the facility that we have just north of Baltimore. Mike, do we have a ceiling on that facility?

No.

No. We don't have any facility on the site that's just north of Baltimore, Bill, that we were successful in securing permit. But the other facilities, I think all of the facilities are unrestricted, or to the best of my knowledge. Our facility in Colorado does not have a ceiling. We can take as much as we want there. Where were the other facilities, Mike?

South Carolina --

And Indiana.

Yes. And think all of those facilities don't have any particular volume restrictions. I guess looking at the information (indiscernible), Bill, our facility in Fort Wayne does not have any ceilings and Mallard Ridge, which is in southeastern Wisconsin, is unrestricted.

These expansions are really a function of time and duration, Bill. It is not that we're necessarily going to ramp up volumes in these sites. It just extends out the lives of the sites, with the possible exception of the Maryland C&D site.

I may have missed it, but Tod, did you mention on the ESI, I know you have composting in that other revenue line, but how much revenue ESI would have on a trailing basis?

Year-to-date, I think ESI's revenue was probably about $12 million. And last year, ESI's revenue was $23 million. So again, it is contract type of work -- some of the contracts had slowed down here and wound up during the second quarter of '05. So I think full-year revenue for ESI in 2005 is probably about $13 million.

But that certainly is of big component of this non-core revenue decline. I think it was actually down $7 million in the third quarter of '04 to the third quarter of '05 as these contracts have wound down, which is almost 100 basis points.

Corey Greendale, First Analysis.

First question. Jim, I know you're probably not going to get too specific, but I was hoping you could put just a little more parameters around the transactions with Allied and Waste and magnitude and whether we should be thinking of you as a net divester, a net acquirer or kind of net neutral at the moment?

You're right -- you're not going to get very much information out of me. These are relatively small transactions, and we would anticipate closure in the fourth quarter. I don't think they are materially going to impact us one way or the other and they are probably EBITDA neutral for the most part.

Okay, and then just following up, a price question. I would imagine you're beginning to benefit from higher CPI increases in contact markets. Can you just confirm that, and if you could give any sense of what kind of benefit you're getting just from that aspect of your business to core price growth?

The CPI is obviously starting to escalate. We are starting to see some inflation set in, predominately fuel. But again, I think we probably already received all of the CPIs that we are going to get this year. And we probably received them at 9/30 and July 1. So I think the further expansion there would be recovered in '06, the mid part to the latter part of '06.

We received CPI increases in the summertime here, in probably that 2.5 to 3.5% range, depending on the contract.

I think we're seeing the CPI being about 50 basis points higher than it was at this time last year.

Leone Young, Citigroup.

First of all, another question on the pricing environment, following up on that. You have talked before about the public competitors moving on pricing. What are you seeing out of the independents?

I think they're following suit for the most part. They may not be as aggressive as we are and they're probably trailing the national companies. But for the most part, I think we're seeing them move. Again, I think in our comments, that we've been able to raise prices with very little customer defection. That not only talks to our larger urban markets where we're competing against the national companies, but even some of our more rural markets, where we do have independents of some size that we're competing with. So overall, I would say that they are moving also.

Secondly, particularly in light of Waste Connections' recent move, can you comment on a little bit on how you are approaching options next year?

I'll let Tod do that.

We're certainly looking at a number of different alternatives regarding options, including the useful life of the options, stock options versus restricted stock, and also, obviously, what Waste Connections and a number of other companies have done, which is to look at the vesting of options this year so that in 2006 and subsequent years, the business is not burdened by an expense which is really a function of prior years' activity.

Stewart Scharf, Standard & Poor's Equity Group.

Can you talk a little about your safety program and how that is progressing?

I think it is reflected in our risk insurance expense. That is the best place for you to look at it. And in some of our other disclosures where we look at the overall health and risk insurance accruals and what we have actually paid out. That's what I would look at for the success of the programs.

But overall, while we are no longer utilizing the services of DuPont, they were a great help to getting us focused on safety and starting to change the culture within Republic Services. And I can say, I think unequivocally, that the culture has shifted. And just as recently as the other day, Mike Cordesman led a safety call, as he does every month, with the field, as well as a lot of other safety activity occurring out in the field. So all in all, the activity has been very good, I think, and the results are reflected in our expense to revenue ratio.

Okay. And do you have an estimate for '06 options, assuming everything stayed the way it is right now -- option expense?

I think somebody on the street had put out some estimates that was probably somewhere in the $0.06 range. Obviously, we would not endorse that.

One other thing on options. When you look at the number of options that we granted last year -- I think it was about 1.7 million shares -- so it is a little bit over 1% of the outstanding share count. This is a Company that, unlike other industries, does not grant a large percentage of options, so there is not a huge dilution of existing shareholders.

Thank you, operator. And at this time, I'd like to thank all of you for spending time with us morning. A replay of this call is available today by calling area code 402-220-9682. Ask for the Republic Services earning conference call. Additionally, this call be archived on Republic Services' website at www.republicservices.com. Again, thank you for joining us and have a good day.

Thank you. That concludes today's conference. You may disconnect at this time.