Republic Services Inc (RSG) 2006 Q3 法說會逐字稿

Good morning and welcome to the third-quarter conference call for investors for 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 a listen-only mode. There will be questions and answers sessions following Republic's summary of quarterly earnings. I will provide you with specific instructions for questions later on 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 to all of you and thank you for joining us. This is Jim O'Connor and I'd 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 that 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 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 October 30, 2006. Please note that this call is the property of Republic Services, Incorporated. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited.

Republic's performance in the third quarter and year-to-date has continued to exceed expectations, specifically the third quarter. Republic had revenue growth of 7.8% to $787 million. We achieved strong internal growth of 7.5% with 5.5% of price improvement and 2% volume growth.

Although collection pricing is still the leading overall price growth, we are achieving price growth in our landfill network. Landfill pricing increased by 1.8% in the third quarter.

Our industrial collection business continued to grow in the third quarter. Within the temporary rolloff business, our residential activity is weaker. However, this is being partially offset by increased activity from commercial construction. Pricing for the temporary rolloff is stable, which reflects the pricing discipline within the industry.

We expanded operating margins by 60 basis points to 17%. Our pricing discipline was the key driver to our success in this quarter. As we have discussed in previous calls, we expect to realize operating margin expansion for the full year 2006.

We are achieving price increases in excess of inflation and the general economy, which is important for margin expansion. Several factors which will result in further margin improvement include the following, one we will continue to see positive results from our safety programs. Republic has included safety performance as a metric in its incentive compensation programs. Second, assuming fuel costs stay at current levels, our margins will continue to expand in the fourth quarter. And third, utilization of decision support tools will assist in improving our cost structure and our competitive position in the marketplaces.

Our free cash flow in the third quarter was $99 million. During the quarter, we continued to return cash flow to our shareholders. In the third quarter, we repurchased 2.3 million shares of stock for $91.9 million. Year-to-date, Republic has repurchased over 10.4 million shares for $418 million. As of September 30, we have $74 million remaining under a 2006 Board authorization for share repurchase and we will execute by year-end.

Since the inception of our share repurchase program in July 2000, we have bought approximately 62 million shares of Republic stock for $1.7 billion. Our earnings per share for the third quarter was $0.58, which was an increase of 29% compared to the third quarter 2005. Without the tax benefit that we recorded in this quarter, Republic's earnings per share would have been $0.54.

At this time, I'll turn the call over to Tod Holmes, our Chief Financial Officer, for a review of our financial third-quarter results.

Thank you, Jim. I will begin my review of the Company's financial results by discussing third-quarter revenue. Third-quarter 2006 revenue, as Jim indicated, rose 7.8% to $787 million from $730 million last year. Internal growth of 7.5%, of which 5.7% was from four operations. 3.8% from core price and 1.9% from core volume. Our 1.9% core volume growth would have been approximately 50 basis points higher if we did not have one less workday during the quarter.

Core volume growth also includes 90 basis points or about $6.9 million of revenue associated with Republic assuming from a subcontractor the responsibility for hauling Toronto waste earlier this year. There is very little profit in this contract. Therefore, excluding this contract, comparable operating margin would have been 15 basis points higher during the quarter.

Our core volume growth comes from all lines of business, including residential, commercial, industrial and landfill businesses. Total price growth of 5.5% with 3.8% from core price, 1.4% from fuel surcharges and 0.3 of 1% from environmental fees.

During the quarter, we continued to benefit from our ongoing price increase strategy in all lines of business. Pricing will remain the key initiative throughout the remainder of 2006 and into 2007. Acquisitions and taxes accounted for the remaining 0.3 of 1% growth in revenue.

We did have one unusual item in the quarter and that is our provision for income taxes. During the three months ended September 30, 2006, we recorded a $5.1 million net income tax benefit in our provision for income taxes. Approximately 1/3 of this benefit resulted from the completion of an IRS audit for the Company's 1998 through 2000 tax years. This is the first series of tax years that the Company has closed out with the Internal Revenue Service and I think our tax group has done a good job of managing this area.

The remaining difference resulted from an increase in the tax benefit we received in 2003 related to our change in landfill tax depreciation methods and hence, we received an additional benefit there.

Now let me turn our attention to the third-quarter year-over-year operating margin. Year-over-year operating margins increased by 60 basis points, as Jim indicated, from 16.4% to 17%. The key components of our year-over-year margin change are as follows, fuel was a -50 basis points; landfill operating expenses was a -30 basis points; insurance was a +60 basis points; labor, disposal and subcontracting costs, a +100 basis points; DD&A, a +10 basis points; SG&A, a -30 basis points for a total margin expansion of 60 basis points.

Now I'll briefly comment on these components of year-over-year margin change. First, fuel. Fuel was approximately 6% of revenue during the third quarter of 2006. Our average wholesale price per gallon increased about 14% from $2.40 a gallon in the third quarter of '05 to $2.81 in the third quarter of '06. Current fuel prices are approximately $2.40 per gallon, which should allow us to improve our margin sequentially into the fourth quarter.

Second, landfill operating expense. During the third quarter of 2006, the Company incurred additional costs at one of its active landfills associated with remediation for waste that was deposited during the mid-1990s. We do not expect these costs to reoccur in future periods.

Third, risk and health insurance. Insurance expense during the third quarter of 2006 was lower than the third quarter of 2005 due to favorable claims development.

Fourth, labor, disposal and subcontracting costs. This is our largest cost category through which the impact of improved pricing was clearly visible. Improved pricing in all lines of businesses, change in mix of revenue and continued focus on productivity improvements resulted in a margin benefit. This benefit was partially offset by higher subcontractor costs due to higher fuel.

Fifth, DD&A. The decrease in DD&A as a percentage of revenue is due to higher year-over-year revenue.

Finally, SG&A. During the third quarter of 2006, the Company experienced higher costs associated with stock options, 401(k) and incentive compensation programs. These increases in costs were partially offset by higher year-over-year revenue. We believe that SG&A as a percentage of revenue will be approximately in the 10% range for fiscal year 2006.

Now without the one-time additional remediation costs, our third-quarter margin expansion is 30 basis points. Overall, we believe that the Company could experience modest margin expansion in the range of 20 to 30 basis points for fiscal 2006 as a result of better pricing and continued focus on cost control, assuming no major changes in fuel prices.

Our third-quarter operating income before depreciation, amortization, depletion and accretion. Year-over-year, operating income before DD&A increased by $19 million or 40 basis points or 9.7% from $195.3 million or 26.8% in the third quarter of '05 to $214.3 million or 27.2% in third quarter of '06.

Next, I will discuss free cash flow. Free cash flow for the third quarter 2006 was $99 million. This is based on cash provided by operations of $154 million, less purchases of property and equipment of $64 million, plus the proceeds from the sale of property of $9 million. Again, that is equal to free cash flow of $99 million.

Free cash flow for the nine months ended September 30, 2006 was $76 million. This, based upon cash provided by operating activities of $301 million, less purchases of property and equipment of $242 million, plus the proceeds from the sale of property and equipment of $17 million, gives us a year-to-date cash flow of $76 million.

I would like to remind everybody that our free cash flow for the nine months ended September 30 was impacted by $83 million of federal income tax payments related to 2005. These tax payments were deferred until February 2006 as a result of Hurricane Katrina and also $60 million of payments for fiscal 2005 capital and other expenditures.

We continue to believe that our original guidance of $315 million for net capital spending is appropriate. After normalizing for these items, free cash flow for the nine months ended September 30, 2006 was $219 million. We believe our normalized free cash flow for 2006 should be at the upper end of our guidance, which is now $280 million to $290 million.

Items impacting cash balances. During the third quarter of 2006, as Jim indicated, we purchased 2.3 million shares of common stock for approximately $92 million at $39.42 a piece. Our actual sharecount at September 30 was 131.3 million shares.

Republic's balance sheet remains very strong. At September 30, our accounts receivable balance was $312 million and our days sales outstanding was 35 days. Net debt is $1.509 billion, which is up from $1.173 billion at December 31, 2005. Consistent with our cash flow performance and previous guidance, our net debt to total cap at September 30 is 51%. Now, I will go ahead and turn the call back to Jim O'Connor.

Thank you, Tod. Based on our strong performance year-to-date, we are raising our 2006 full-year EPS guidance to $2.03 to $2.06. This guidance includes the tax benefit reported in the third quarter. These one-time benefits will contribute approximately $0.04 of earnings per share this year. We expect our 2006 free cash flow to be at the upper end of our guidance of $280 million to $290 million.

Republic's Board of Directors has approved a new share repurchase authorization for 2007 for $250 million. We will continue to be committed to returning to all access free cash flow to our shareholders through share repurchase and dividends. By the end of 2007, total cash returned through share repurchase will exceed $2 billion.

As we enter our 2007 financial planning, we will be focused on the very same priorities that we did in '06 -- higher return on capital and improved free cash flow. We will achieve these objectives through our pricing initiatives, improved customer service, safety awareness, cost containment and continually evaluating our market position to identify and improve underperforming lines of business.

At this time, I would like to thank all the Republic Services' employees for their dedication and hard work, which resulted in record financial performance in the quarter and year-to-date. At this time, operator, we will open the line for questions.

(OPERATOR INSTRUCTIONS). Jamie Cook, Credit Suisse First Boston.

Congratulations on a nice quarter.

Thank you.

Jim, could you talk a little bit about what the trends you are seeing in the market? There's a lot of concerns out there that the economy is slowing, whether you -- when we look at your guidance for the fourth quarter, whether you are assuming any slowdown in the economy and then as you look out to 2007, how that could change the way you approach pricing?

Well, we see the general economy to still be relatively strong. The residential construction market, we are obviously starting to see some decline as all of the statistics point to, but we are still seeing a very strong commercial construction market pretty much as I said in my comments offsetting most of the loss.

The most important thing I think coming from all of that, because we can't control the economic factors, but we can control the pricing, that the pricing has maintained flat to yet still increasing in the temporary construction line of business. So I think that is a good sign.

As it reflects '07, we've just started really our '07 planning process, but there is no reason to believe that we will see any deterioration in price at this stage and that will continue along with the same pricing discipline that we executed in 2006.

Jonathan Ellis, Merrill Lynch.

A quick question just below the operating line. I noticed there looked like a $3.3 million benefit in other income this quarter. I am just wondering if you could give us some color around that.

Sure, Jonathan. We had a sale on a piece of property that was surplus property. So that resulted in -- actually it was in our cash flow statement also. I think cash proceeds of about $8 million. Along with that came a gain below the line.

Okay. So that $3.3 million -- I assume then almost all of that is from the gain?

Yes, it is primarily that gain on the property.

Great. And then maybe we could just talk a little bit about landfill pricing and more specifically I am wondering, Jim, if you could speak to any differences you saw in pricing in some of the competitive urban markets versus some of your franchise or mid-sized markets?

The larger, urban markets -- we're continuing to move price up as we have contracts expiring. Like I said in previous calls, to move pricing significantly in our landfills, it will take us anywhere from 8 to 10 more quarters, but the 1.8% price that we are seeing from landfills in the third quarter is predominantly from most of our facilities and I think predominately from our larger urban markets.

We were successful in moving and having some price success in Denver and some of our Michigan facilities, as well as moving price up in a number of facilities in the Southeast.

Bill Fisher, Raymond James.

Tod, just a clarification on that. I think you mentioned a remediation expense. Did you say there was a 30 basis point hit or how did that impact --?

Yes, I need to correct that. Thank you for bringing that up. We actually had 60 basis points of margin expansion in the quarter. That remediation was a 30 basis point hit and so without that, that will not occur in the fourth quarter. Our margins would have expanded 90 basis points in this third quarter.

Great. Just on CapEx, I know you haven't done the budget yet for next year, but if the volume growth is a bit slower and I assume you did a little bit of pre-buy this year, if you take out some of the other lumpy things, could CapEx be soft or be flat at all next year or how do you look at that?

Well, I think we are a little bit early here in our business planning process, so it is premature. One thing I would say is while there is a little bit of inflation in the CapEx, we would expect our DD&A to continue to grow in the next year or so on a cash flow basis. I think that CapEx would not be a headwind for us.

Kevin Monroe, Thomas Weisel.

I think I know the answer to this question, but, Tod, on your --?

We need a softball, Kevin. Throw us a softball.

Tod, on the fourth quarter, you were indicating that you see a sequential improvement in fourth quarter margins versus third quarter. Is that because --?

Year-over-year margin improvement. There is a little bit of seasonality in the fourth quarter.

Yes, I wanted to clarify that. But even with this remediation project not happening in the fourth quarter, you still --?

I think the wildcard in there is really fuel, what happens to fuel in the fourth quarter. As I indicated, it's down around $2.40 a gallon now. So that may give us some benefit. But the more important thing is when we look year-over-year, we believe that given the pricing environment that we are in, we should be in a 20 to 30 basis points margin expansion for the full year and we should be set up for 2007 for continued margin expansion.

Which is consistent with our original guidance at the beginning of the year that we were going to in '06 show margin improvement. So we are still giving guidance to that effect and we still think it is within that range of 20 to 40 basis points.

Corey Greendale, First Analysis.

On the price side, it looks like core price growth accelerated sequentially. I am guessing that was largely higher CPI increases rolling. But can you comment on that and what you are seeing in pricing in competitive markets on the collection side compared to last quarter?

Well, I think what we are seeing is we are seeing some of the CPI from our municipal work rolling in, which is giving rise to some of that 50 basis point improvement sequentially over the second quarter on core pricing. And I think we are just getting -- the tools that we have, we are getting better at utilizing. We are looking at utilizing other tools as it relates to pricing and that is from our routing tools as to locating stops that are possibly not profitable, putting them through our ROIC models again, and again, I think we are moving the discipline to the next level. I think that is what is the balance of the 50 basis points other than the CPIs rolling in from our franchise and municipal contracts.

And a second question is looking at the transfer and disposal revenue, the sequential comparison again. Last quarter, that was up 11% year-over-year. This quarter, it is up 6% year-over-year. So if you look at that 5.6 decline, would you say that is driven primarily by the slower residential construction or is there anything else you would point to?

I think it would be the slower construction. Again, it is growing. It is just growing at a little bit of a slower rate. So we see some flattening coming from the residential, but certainly on the commercial side, the American Institute of Architects has some of the strongest statistics out there since the mid-'90s in terms of commercial and industrial construction. A lot of that coming in the South, which is really our strong geography. So we feel that while there is a little bit of softening there, we have got this strength in commercial construction.

One thing I would indicate and this maybe goes back to what Bill I think was asking earlier, someone was asking about CapEx. We are a business that is very flexible in terms of its asset base. So if one market slows down, we are able to move assets to another market that is maybe not too far away and in the longer run, we can slow down and speed up our replacement capital and our internal growth capital. So the cash flows in this business, if there is a slowdown in a segment of the business, the cash flows in that segment should still hold up very well. But again, we are very positive at this point.

Leone Young, Citigroup.

If you looked at that landfill price increase a year ago compared to the 1.8, 1.9 you just talked about, what would that have been, Jim?

Less than 1%, Leone.

And then just a housekeeping question maybe for Tod or Ed in terms of -- you gave us the net debt number, but I was wondering if you would share the cash and restricted cash?

Let me just grab the balance sheet here and take a look at that. The cash is $49 million and the restricted cash is $208 million.

Great. And finally you obviously had some strength in the industrial area ex the temporary rolloff. Anything that stands out there?

No, I think this is just -- again, within some of the franchise markets, especially in the southwestern part of the United States, I think what we are seeing is the commercial -- I mean the industrial permanent component of our collection business escalating because we are starting to see the infrastructure follow the residential growth. So I think we're going to continue to see that well into '07.

Scott Levine, JPMorgan.

Tod, I think you mentioned the Southeast being strong from a commercial construction standpoint. I was hoping you could give us a little bit more regional color regarding economic conditions throughout your footprint. Everything pretty much the same or any of the places stand out upside or downside from a relative standpoint?

I think as we look at it, more the northern states and the eastern states seem to be a little bit softer. Obviously you have the auto industry, which causes operations in those cities that are heavily dependent on that industry to be a little bit softer, but aside from that, it seems fairly good. I would go back to the Beige Book and some of the comments that are made there. Obviously our business reflects a lot of what they are saying.

One more. With regard to the buyback here, you had an aggressive buyback in the first half this year. I was hoping you might be able to share some thoughts on how you plan to go about implementing the buyback and whether there is a particular price you're looking at in terms of being opportunistic? Any thoughts in terms of your behavioral layout?

Sure. Basically stay the course is our approach. We are fairly consistent. The business spins off substantial amounts of cash, so we are in the market on a steady basis. Obviously if there is higher volumes, we are in the market a little bit more than we would be during say a holiday period when the volumes slow down, but it is really more of a dollar cost averaging approach and I think our cash flow strategy, as we have said before, while share repurchase is a cornerstone to it, as the cash flow grows, our view is to grow the dividend, which it is right now only about a 30% payout ratio. So I think while we have got about a 1.7% yield on it, we see substantial opportunity there over the next couple of years to move that up.

Operator, we will take two more questions.

Brian Butler, Friedman, Billings, Ramsey.

A question just on the pricing for new business, I don't know if you mentioned this or not. Is new business being added at higher prices?

Yes. We traditionally -- as we raise our commercial or permanent component of our business, we adjust our pricelist accordingly. So yes, they are moving up at about the same percentages as we are achieving or as we are reporting in the third quarter.

Okay. Are you seeing any pressures there? For the most part, are the privates as well as the other public companies following that?

I think right now the reconnaissance from the field is most of our pricing has been very successful and we are continuing to experience organic growth at the pricing level that we are selling at. So I would say that the market is still pretty rational.

Steve Kohl, Matador Capital.

Good morning, guys. Good quarter. I wanted to talk a little bit about the landfill price increase. I know you've mentioned, Jim, in the past that it takes a number of quarters to roll everybody in. I think you said 8 to 10 fully given contractual obligations and what have you. What have you moved if you look at this increment from 1% to 1.8% or thereabouts over the last year? What rate are you moving it to get up to that level? Are we seeing it at 4% or 5% across the base so you are able to move it to that?

Yes. Where we have had some pricing inflexibility has been in the 4% to 5% range. I think it is consistent with what we talked about in the second quarter when we talked to some of the prices that we have been able to get in our landfills and particularly Colorado and Michigan where we did see ranges of 4%, maybe just a little north of 5% and that is where the contribution is coming from.

But again it is just not coming from those two areas. We are starting to see the volumes that are coming available to be price increased and as those come about, we're looking at those same ranges in terms of price. I think special waste is still somewhat weak. I don't think we have seen a tremendous movement in special waste pricing and I would look for that to probably change some time in '07.

Do you see, as you look out, Jim, to -- if we're at 1.8 now, should we expect kind of just a gradual sloping of this line over the next several years in terms of order of magnitude on the landfill site?

Yes, Steve, that is what I -- I would think that we would see it move may be 20 or 30 basis points in each year until we get up to about that 3% range, which would be sustainable. Obviously that discounts whatever may be happening as far as inflation goes and assuming that those things are relatively stagnant and our cost side is stagnant.

Great. Thank you very much.

Okay, thank you, operator. At this time, I will bring the call to an end. I would like to remind everyone that a recording of this call is available today and tomorrow by calling 203-369-1464. Additionally, a recording of the call will be available on Republic's website at republicservices.com and before I end the call, we do have a contract dispute with the Teamsters in Orange County and I would like to thank all of the management personnel that are participating in that work stoppage and further, just to let the people know that are on the call, this is not material to the Company's financial reporting nor will it be material in the fourth quarter. But I do want to take the opportunity to thank the people who have given up their time and sacrificed their time away from their family to respond to this work stoppage in Orange County. Again, thank all of you for spending time with us today and have a good day. Thank you.

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