Republic Services Inc (RSG) 2007 Q2 法說會逐字稿

Good morning and welcome to second 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. And good morning to you and thank you for joining us. This is Jim O'Connor and I would like to welcome everyone to Republic Services second quarter conference call. This morning Tod Holmes, our Chief Financial Officer, and Ed Lang, our Treasurer, are joining me as we discuss our second 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 our 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 July 27, 2007. 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.

During the second quarter we continued to deliver on pricing initiatives and margin improvement. We believe the current pricing environment is sustainable. Key results in the quarter were -- Republic had revenue growth of 3.7% to $808 million. We achieved internal growth of 4.1% with 5.2% of price improvement and a negative 1.1% volume growth. Our second quarter volume growth comparison was impacted by a slowdown in the residential housing construction activity. Revenue from our construction and demolition business was down approximately 1%. The biggest impact was in temporary roll-off business, where residential construction volumes decreased approximately 10% to 15%. We are still experiencing low single-digit growth in our commercial construction and permanent roll-off volumes.

Despite the net volume reductions, temporary roll-off pricing has remained stable. Operating margins for the quarter improved 170 basis points to 18.9%. Within our Orlando business our core price was up approximately 3% in the quarter. We continue to see sequential improvement in landfill pricing. However, disposal pricing for some Midwest markets and Canadian waste are not improving. This will be a focus for Republic Services in the third quarter. We are focused on all components of our cost structure to ensure that we remain competitive in our marketplaces. Republic has had a number of significant achievements including our free cash flow for the second quarter, which was $143 million.

During the quarter we continued to return cash, free cash to our shareholders. In the second quarter we repurchased approximately 3.1 million shares of our stock for $94 million. Republic has approximately $84 million remaining under the existing authorization for share repurchase. Since the inception of our share repurchase program in July 2000, we have repurchased approximately $2 billion of Republic stock or 38% of the outstanding shares. Our earnings per share for the second quarter was $0.45, which is a 28% improvement versus the second quarter of 2006. Now at this time I would turn the call over to Tod Holmes, our Chief Financial Officer, for a review of our financial -- for the financial review of the second quarter.

Thank you, Jim. I will begin my review of the Company's financial results by discussing first the second quarter revenue. Second quarter revenue arose 3.7% to $808 million from $780 million last year. This represents internal growth of 4.1%. Total price growth was 5.2%, 4% coming from core price, 0.001% from fuel surcharges, 0.003% from environmental fees and 0.008% of a percent from commodities. During the quarter Republic continued to benefit from our ongoing price increase strategy in all lines of business. Securing price increases to provide adequate returns on our substantial investments remains a key initiative for Republic in both the intermediate and longer term. Total volume was negative. It was negative 1.1%. This is an improvement over the first quarter. Core volume was negative by 0.9% and non-core volume was negative by 0.2%. Acquisitions accounted for the remaining negative 0.004% change in our revenue. Got a few small divestitures that occurred over the last twelve months that caused that.

Let me talk briefly about provisions for income taxes. During the three months ended June 30, 2007, Republic resolved various matters that effectively closed our 2001 to 2004 tax years and as a result we recorded a $5 million reduction in income taxes. This had a benefit to our second quarter earnings per share of about 2.5%. If we look at our year-to-date effective tax rate, it is just over 38% and we would expect the Company's effective tax rate to be approximately 38.5% for the full year. Associated with this closure of the '01 to '04 tax years was an additional payment to the Internal Revenue Service which was already accrued and provided for in the Company's books, hence our noncash taxes will be a little bit less than we had originally forecast. Second quarter year-over-year operating margins improved substantially. Year-over-year the operating margins increased by 170 basis points from 17.2% to 18.9%.

Key components of our year-over-year margin change are as follows -- truck maintenance, positive 20 basis points; health and risk insurance was a negative 10 basis points; fuel was positive 10 basis points; labor was a positive 20 basis points; and disposal and subcontracting costs were a positive 130 basis points for a total benefit of 170 basis points. I will comment briefly on the factors driving these individual components improvement. First truck maintenance. During the second quarter of '07 we continued to focus on cost saving initiatives in the maintenance area, both for our trucks and our landfill equipment. That combined with better pricing resulted in a percentage reduction in truck maintenance. Second, risk and health insurance. Insurance expense during the second quarter 2007 was 5.8% of revenue. This is higher than the second quarter of '06 and most of this is being driven by higher medical costs. We continue to believe that risk and health insurance as a percentage of revenue will be approximately 5.5% for the remainder of 2007.

Third, fuel. Our average wholesale price per gallon decreased from $2.73 in the second quarter of '06 to $2.69 in the second quarter of '07. Current fuel prices are approximately $2.76 per gallon, so the third quarter should be similar to the second. Fourth, labor. During the second quarter we continued to benefit from productivity improvements, which again contributed to our margin growth. Fifth, our disposal and subcontracting costs. This is our largest cost category through which the impact of improved pricing is clearly visible. Also, we had a small benefit, maybe about 30 basis points, due to dry weather, particularly in the southeast, which helped reduce the disposal waste in our containers, particularly in the small container commercial collection business. Finally, SG&A. During the first quarter of 2007 we reduced our allowance for doubtful accounts by approximately $4 million to reflect the Company's continued success in managing our accounts receivable.

Republic's days sales outstanding continue to be the lowest in the industry and this reduction in bad debt expense in the SG&A area was offset by some higher incentive compensation costs. Republic believes that SG&A as a percentage of revenue will be approximately 10% for fiscal 2007. Now let me turn my attention to the second quarter operating income before depreciation, amortization, depletion and accretion. Year-over-year operating income before DD&A increased by $22 million or 10.4%, from $212 million or 27.2% in the second quarter of '06 to $234 million or 29% in the second quarter of 2007. Again, that's 180 basis point improvement. Next, I will discuss free cash flow. Free cash flow for the second quarter, as Jim indicated, was $143 million. This is based on cash provided by operating activities of $210 million, purchases of property and equipment of $69 million, plus the proceeds from the sale of equipment that we're retiring of $2 million to net to the $143 million.

Free cash flow for the six months ended June 30, 2007, was $199 million. Again based on cash from operating activities of $309 million less purchases of property and equipment of $113 million plus proceeds of $3 million yields to $199. Again, Republic has increased its guidance for 2007 on free cash flow and we expect it to be in the range of $320 million to $325 million, a little bit more than 100% of net income. Items impacting cash balances. During the second quarter we purchased 3.1 million shares at an average price of $29.95 per share. The actual share count of Republic at June 30, 2007, was 190.9 million shares. Republic's balance sheet remains very strong. At June 30th our accounts receivable balance was $312 million, days sales outstanding was 35 days. Our net debt is $1.409 billion down from $1.430 billion at December 31st. Consistent with our cash flow performance in previous guidance, our net debt to total capital at June 30, 2007, is 50% and Republic, as we've always said, remains committed to a solid investment grade rating. Now I will turn the call back over to Jim.

Thank you, Tod. Based on our strong performance year-to-date, we are raising our financial guidance for 2007. EPS guidance on an as-reported basis is $1.52 to $1.55. Without the impact of our Ohio remediation costs, EPS is expected to be $1.59 to $1.62. Free cash is expected to be $320 million to $325 million. Due to lower capital requirements related to our roll-off business, our capital expenditures will be reduced to $295 million from $310 million. Internal price growth, excluding commodities, is expected to be approximately 4.5%. Volumes for the full year will be down approximately 1.5%. As a result of our strong performance and continued confidence in the sustainability of our pricing initiatives, our Board of Directors has decided to increase the annual dividend by 60% and pay $0.17 per quarter beginning this October. At current prices this represents a yield of 2.2%, which exceeds the S&P 500 average dividend yield.

An additional $250 million has been approved for share repurchase through December of '08. As previously discussed, our 2007 business objectives are centered on -- improving margins by achieving appropriate price increases to offset inflationary costs and business risks; continue to improve our market positions; standardizing significant business processes; and rationalizing our cost structure. I would like to thank all the employees of Republic Services for their dedication and hard work which resulted in this strong performance in the second quarter. Operator, at this time I would like to open the call for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Corey Greendale with first analyst. Please go ahead.

Hi. Good morning.

Good morning, Corey.

First question. Jim, obviously your comments in the release about the sustainability of price increases is pretty bullish. Can you just give some sense as to first of all why -- what's leading to your bullishness as far as like what pricing could be like multiple years out. And secondly, when you say sustainable, how far above inflation do you think you can sustain pricing or how many points of price, however you're looking at that?

I think we've consistently said that if we could improve our pricing in the marketplace by 100 to 150 basis points above the CPI, that we would be able to expand our margins and we're still confident with that. And with the market reaction to price that we've seen in the last three quarters, we feel that it is sustainable. And we feel that we have not even yet achieved adequate pricing on our landfills yet and adequate returns on go forward capital. So I think when we look at that we believe that, barring some economic downturn that we can't forecast, that these pricing initiatives are -- are working and we believe that they're sustainable for the intermediate term.

Great. And on the volume side, as I am looking at it, the negative 1.5% guidance for the full year would suggest that the volume declines a bit more in the second half than it did in Q2. Was there anything in Q2 that was kind of one-time or special waste or anything that would have made that at a little bit better run rate than the second half?

No, I don't think so. We're still seeing a decline in the residential construction business, but all other lines of our business are growing at either 1% to 2%. Our commercial small container business, our industrial roll-off permanent business, and our residential business. So other than the impacts on landfill from construction and demolition and our temporary business, we're still seeing a pretty strong growth factor in the rest of our lines of business.

Thank you.

Thank you. Our next question comes from Jagdeep Ghuman with Credit Suisse. Please go ahead.

Good morning.

Good morning.

Jim, I was wondering, you made the comment on landfill pricing that the Midwest and Canadian pricing wasn't improving to the extent you would like to see. Why is that and how are you going to address that?

I think we're going to, once again, be the pricing leader in the marketplaces. When we analyze the Canadian waste streams, there are independent transfer stations that exist in the Toronto area that are actually probably doing better on a margin basis than we are, so shame on us. Our disposal rates there are extremely low. I think the market, I would say, is somewhere between $10 and $13 a ton. And to get adequate returns it probably needs to be upwards to $20. For people making the money, the Canadian waste streams are the independent transfer operators and they are leveraging us against our competition. And I think that's about to change, at least from our perspective. In the Midwest, it is really mostly pressures from competitive landfills in Kentucky. And again our focus, we'll be there to step out and be the price leaders in that market.

Gosh, understood. Okay. Also on the CapEx reduction, can you comment a little bit as far as the buckets in which those reductions are coming? Are we talking about just less landfill equipment or how are you addressing that?

It is predominately our industrial collection business related to residential construction, related to the residential construction slowdown. We're slowing the replacement capital in that particular area.

Got you. All right. Thank you very much.

Thank you.

Thank you. Our next question comes from Scott Levine with JPMorgan. Please go ahead.

Good morning.

Hi, Scott, how are you?

Good. Regarding the margin expansion. Pricing is 50 to 70 basis points above what the high-end of what you guided to the beginning of the year, but the margin expansion is considerably higher as well. Is the upside to the margins really a reflection of the pricing upside, the fact that the revenues more price driven, or is there something on the cost side that's also contributing to the upside of margins versus your initial expectations?

Scott, I think it is really the primarily the price that's driving it. I did mention on the disposal side that we did see maybe about 20 or 30 -- well, 30 basis points. As we look at our containers, the weight per container yard in our small container system is a little bit lighter than we expected or than it traditionally is, so that was a little bit of a benefit. But for the most part it is driven by the pricing and again we see it across the board.

Now, I don't want to minimize the importance of some of the cost initiatives that we have that may offset some of the the inflation in the other lines, like the truck maintenance or routes smart productivity improvement there. And even in the disposal line, our disposal optimization tool provides some benefit as we look at alternative transfer stations and picking the lowest cash costs disposal network. So those are all certainly drivers, but the real key here is price and I think that our guidance at the beginning of the year we were thinking maybe around 50 or 60 basis points of margin expansion. Obviously, we're kind of where Jim was earlier when he was saying 100 to 150 basis points of price above CPI puts us in a position where we think that we'll perform at that level for the full year.

Very well. One on the dividend as well here. You've been talking about the dividend and this kind of takes you up to a 2% plus, 2.3% yield at current levels. The mix of buyback versus dividend is kind of where you want to be and you look to maintain this mix of buyback versus dividend going forward or are you looking to size dividend anymore than you are with this move here?

Our approach always has been and it remains the share repurchase is a cornerstone for our program. So the majority of the cash will go back to the owners of the business through the share repurchase. Again, we feel that while the industry is starting to get price, we're not getting the returns that we need to yet on our landfills, so we're in the early innings of the pricing story. We're going to continue to strive for better returns. That means that when we look at the value of the business we think that it is mispriced and there is a substantial value capture in the share repurchase program.

Now, turning to the dividend, our dividend payout was very, very low given the quality and consistency of our cash flows. So we're up around 40% or so in terms of a dividend payout ratio, which is -- it could be higher, but it is not because we think there is more value in the share repurchase. But we are certainly above the S&P 500 yield and, I think, as you look ahead you will see us move to a dividend strategy which is probably low double-digit, something maybe in the teens, in terms of dividend growth corresponding to the growth in our free cash flow.

I think it really speaks to the sustainability of our cash flows and I think the environment and the sustainability of the pricing environment.

Thank you. Our next question comes from Jonathan Ellis with Merrill Lynch. Please go ahead.

Thanks, good morning, guys.

Good morning, Jonathan.

Just to clarify, in terms of the EPS guidance, you mentioned $1.59 to $1.62 excluding the Countywide charges earlier in the year. I am just trying to understand, does that include the one-time items this quarter related to taxes and also the reversal of doubtful account allowances?

Again, when you look at the taxes, and I misspoke earlier and I need to clarify that, the impact on the quarter I said was 2.5%. It was $0.025 cents. If you look at our effective tax rate year-to-date, it is just over 38%. So we had a higher tax in the first quarter, a little bit lower tax in the second quarter, and for the full year the effective tax rate is very close to the guidance that we set forth at the beginning of the year. So I don't think that when you look at that full year guidance taxes is an anomaly or a pickup. It is really what we started out with. This improvement, set aside Countywide, we've overcome Countywide in that $0.07 charge. Actually it is probably more like $0.08 if you consider the additional amortization that we're incurring because we cut back the air space a little bit. But if you look at it, that $0.10 or $0.11 above our initial guidance is all coming from the operating line. There aren't any one-time items there. Now, we do have about $0.015 or so of benefit from our allowance for bad debts, and again, I think that really reflects the performance of this Company and the leadership of this Company in managing its working capital.

Okay, great. And I guess I was hoping can you talk a little bit about pricing across the serve markets this quarter, what you saw in residential, commercial? You did talk about industrial earlier. Then also on the landfill side maybe talk about what's going on with contract pricing.

In general, our pricing is pretty evenly spread across the country. And pretty evenly spread across all lines of business, other than our residential, our residential construction roll-off business, which has remained flat and which I think that's a pretty good indicator, too, of the marketplace and the sustainability of pricing. If you went back to the last recession, you would have seen that those prices decline 10% to 15%, so I think that's all -- also holds up the pricing initiatives in the marketplace and the strategy. As far as the annuity streams of revenue, commercial, residential, we're up about 5%. Again, I think we're seeing it from all of our -- all of those lines of business pretty much evenly throughout the country.

(OPERATOR INSTRUCTIONS) Our next question comes from Leone Young with Citigroup. Please go ahead.

Yes, good morning and congratulations on your quarter.

Thank you.

First of all, I was just wondering on the cash flow. Tod, your cash -- your Company's cash flow from operations was very strong. Was there anything unusual in the cash from operations that we should be aware of?

Well, when you look at the second quarter, I think a little bit of it is the timing. We're year-to-date $200 million and our target is about $320 million, $325 million now. So timing of CapEx in the second quarter, you'll have more landfill capital spent here in probably the next four months, July through October. So there is a little bit of timing there that causes the second quarter cash flow to be a little bit higher. I might mention, if you do the simple math, we've guided down our CapEx by $15 million. There is probably at least $5 million of cash flow from the higher earnings, so you would think that we would move our guidance up by $20 million from the initial guidance of $315 million and we only moved it up by about $10 million. The difference there, again, is in the working capital in the tax area where we did pay out a little bit of cash to close out the '01 to '04 audit years.

Great. And also, Jim, it is apparent that the majors are really holding the line on temporary roll-off pricing. Can you comment at all on the independents' behavior in that line?

I think we're seeing the major independents, the ones that actually can impact the volume, holding the price, too. So all in all I think we're in pretty good position here to come out of this downturn. Hopefully it won't last much longer.

Thank you. Our next question is from Brian Butler with FBR. Please go ahead.

Operator, this will be the last question.

Okay. Good morning.

Good morning.

Just to kind of followup on that last one on the roll-off and what you're seeing from the private. What different this time around? You're seeing stable pricing on weak volumes. Is it a matter of just the privates are parking these containers or is there something else occurring in the market that allows them to put them somewhere else?

No, I think what we're seeing here is the major national companies and regional companies holding the line. I think they're setting the pricing atmosphere in the markets for temporary construction business. And where the independents can impact the construction business is on smaller jobs. With the strength in the commercial construction market and the demand for quality service, again, I think that's what's holding up the volumes for the national companies.

Great. And then my second question just on as we face potentially a higher interest rate environment, can you just kind of remind everyone kind of where you stand and what kind of impact we can see if interest rates do go up?

I will start it out and then flip it over to Ed Lang. We are about 60% fixed in our debt. And really most of our floating debt is the industrial revenue bonds that we have, which is a low cost debt. And if you look at the Company, if interest rates go up, we might see a little bit of an increase there, but you look at the cash needs for the Company and the cash flows of the Company and we don't necessarily see our debt going up dramatically, so there is not necessarily a need for us to go to the capital markets to do a bond issue. We're going to the capital markets for industrial revenue bond funds. Do you want to add anything, Ed?

Not much. Obviously we look at our year-end debt levels being pretty close to where they are now. And even with -- if there is an increase in short-term interest rates, given as Tod mentioned, most of the floating rate debt being weekly tax exempt floaters, there is minimal impact on us.

Thank you, operator, and I would like to remind everyone that the recording of this call is available today and tomorrow by calling area code 402-220-6436. Additionally, a recording of the call will be available on Republic's website at republicservices.com. Thank you for spending time with us today. Have a good day.

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