Republic Services Inc (RSG) 2007 Q3 法說會逐字稿

Good morning, and welcome to the third quarter conference call for investors and 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 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, Dennis, and thank you. Good morning and thank you for joining us. This is Jim O'Connor and I would like to welcome everyone 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'd like to take a moment to remind everyone that some of the information that we 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 listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call, which is November 6th, 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 third quarter, we continued to deliver on our pricing initiative and margin improvement. Our performance exceeded our original expectations and we have increased earnings guidance twice this year. We believe the current pricing environment is sustainable and the key results for the quarter were Republic's revenue grew 2.4% to $806 million. We achieved internal growth of 2.9% with 4.9% of price improvement and negative 2% volume growth. Our third quarter volume growth comparison was impacted by slowdown in residential housing construction activity and lower landfill volumes. Price growth continues to be strong. Core price is up 4%. Price is the most important factor driving increased margins and increased return on invested capital. Within our landfill business, our core price was up approximately 3.2% in the quarter. We continue to see sequential improvement in landfill pricing. As landfill and residential collection contracts renew, we are seeing consistent price increases and a high level of retention.

The biggest impact on volume growth was in our temporary roll-off business where residential construction volumes decreased approximately 12% which is similar to the first half year performance. In addition, residential construction related to C&D and special waste volumes were down at our land fills. 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 excluding environmental remediation costs improved 310 basis points to 20%. This is the first time our margins have been at this level since the fourth quarter of 2000. We are focused on all components of our cost structure to be sure we remain competitive in our marketplace.

Republic's had a number of significant achievements in the quarter. Our free cash flow for the second quarter was $60 million. During the quarter, we continued to return cash to our shareholders. In the third quarter we repurchased 4.2 million shares of stock for $127 million. Republic has approximately $207 million remaining under the existing authorization for share repurchase as of September 30th. Since the inception of our share repurchase program in July 2000, we have repurchased approximately $2.1 billion of Republic stock or 40% of our outstanding shares. During the third quarter, we extended two existing South Florida franchise agreements for up to five years at higher pricing. We continue to utilize our return on investment pricing tool on all renewals of franchises and municipal contracts. And at this time, now, I'd like to turn the call over to Tod Holmes for our financial review of the third quarter.

Thank you, Jim. I'll begin my review of the Company's financial results by discussing third quarter revenue. As Jim indicated, third quarter revenue rose 2.4% to $806 million from $787 million last year with internal growth of 2.9%. Total price was 4.9%, with 4% coming from core price, a decrease of 10 basis points or 0.10% from fuel surcharges and an increase from environmental fees of 0.10% and an increase from commodities of 0.90%. During the quarter, we continued to benefit from our ongoing price increase strategy in all lines of business. We have been successful in 2007, securing price increases that provide adequate returns on our substantial investments and we believe that this trend will continue in the fourth quarter and also throughout 2008. Our total volume declined 2%, core volume was down 1.9%, and non-core volume was down 0.10%. Divestitures accounted for the remaining 0.50% reduction in our revenue.

Third quarter year-over-year margin, year-over-year operating margins decreased by 100 basis points from 16.9% to 15.9%. However, during the third quarter of 2007, we reported a pretax charge of $32.9 million, or 410 basis points related to an increase in cost to remediate landfills in Ohio and California. The charge increased cost of operations by 390 basis points and DD&A by 20 basis points. Excluding this charge, year-over-year operating margins increased by 310 basis points from 16.9% to 20%. The key components of our year-over-year margin increase, excluding the landfill charge, are as follows. Truck maintenance, positive 10 basis points. Health and risk insurance, negative 50 basis points. Fuel, a positive 10 basis points. Landfill operating cost, a positive 50 basis points. Disposal and subcontracting costs, positive 160 basis points. Labor, a positive 40 basis points. DD&A, a positive 30 basis points and SG&A, a positive 60 basis points for a total improvement of 310 basis points.

Now, I'll briefly comment on the components of these year-over-year margin change. First, truck maintenance. During the third quarter of 2007, continued focus on cost savings initiatives coupled with improved pricing resulted in a modest reduction in truck maintenance expense. Second, risk and health insurance. Insurance expense during the third quarter of 2007 was 5.6% of revenue, which was higher in the third quarter of 2006, due primarily to higher medical costs. We continue to believe that risk and health insurance costs as a percentage of revenue will be in a range of approximately 5.5 to 6%. Third, fuel. Our average wholesale price per gallon decreased from $2.80 in the third quarter of '06 to $2.76 in the third quarter of '07. Current fuel prices, however, are approximately $3.16 per gallon. So we will have a little fourth quarter headwind from fuel.

Fourth, landfill operating expenses. During the third quarter, we benefited from lower year-over-year landfill operating costs due to lower C&D volumes and improved pricing. Also, during the third quarter of 2006, we were beginning to see some higher costs at our Countywide facility. The fifth is disposal and subcontracting costs. And this is the largest cost category from which the impact of improved pricing is clearly visible. Also dry weather, particularly in the Southeast, helped to lower disposal costs by about 40 basis points. Sixth, labor cost. During the third quarter, we continued to benefit from modest productivity improvements which coupled with improved pricing contributed to our margin growth. Seventh, DD&A. The decrease in DD&A as a percentage of revenue is due to higher year-over-year revenue and improved pricing.

And finally, SG&A. Third quarter SG&A was 9.5% of revenue. This decrease in SG&A is due to lower incentive compensation expense, which is about 50 basis points. We believe that SG&A as a percentage of revenue will be approximately 10% for fiscal 2007. Looking ahead, as Jim had indicated earlier, we believe that margin expansion for fiscal 2007 should be in the range of 180 to 190 basis points.

Now let's turn our attention to the third quarter operating income before depreciation, amortization, depletion and accretion. Excluding the landfill remediation charges, the year-over-year operating income before DD&A increased by $28 million, an increase of 13.1% from $214 million or 27.2% in the third quarter of '06 to $242 million or a 30% margin in the third quarter of 2007. The last time we achieved 30% EBITDA margins was in the fourth quarter of 2000.

Next I'll discuss free cash flow. Free cash flow for the third quarter of 2007 was $60 million. This is based on cash provided by operating activities of $127 million, less purchases of property and equipment of $69 million, plus the proceeds from the sale of property and equipment of $2 million. And that yields the $60 million of free cash flow. Our free cash flow for the nine months ended September 30th, 2007 was $259 million. This is based upon cash provided by operating activities of $470 million, less purchases of property and equipment of $216 million, plus proceeds from the sale of property of $5 million, yielding $259 million of free cash flow. For the nine months ended September 30th, 2007, the Company actually took delivery of $184 million of capital. The statement of cash flow shows purchases of property and equipment of 3 -- excuse, me $216 million. This difference represents property and equipment that the Company received during 2006 but was paid for during 2007. Hence, there's a slight difference between what you see on the statement of cash flows and what you see or will see in our 10-Q in the detail for MD&A on the equipment. This reclassification on the statement of cash flows from cash provided by operating activities to the purchase of the property and equipment. So free cash flow does not change.

We believe that free cash flow for 2007 will be in the range of $320 million to $325 million, which again, was our increased guidance that we gave in July of 2007. Items impacting cash balances. During the third quarter of 2007, we purchased 4.2 million shares of our common stock for approximately $127 million or $30.30 a share. Actual share count at September 30th, 2007, was 187.1 million shares. Republic's balance sheet remains very strong. At September 30th our accounts receivable balance was $320 million, and our days sales outstanding was 36 days. Net debt is $1.525 billion which is up modestly from $1.430 billion at December 31st, 2006 and our net debt to total capital at September 30th, 2007 is 54%. Now I'll turn the call back over to Jim O'Connor.

Thank you, Tod. As you know, we've taken charges twice this year related to environmental remediation costs. At our Countywide facility in Ohio, Republic is in compliance with the findings and orders set by the Ohio EPA. We are in full compliance with the existing permits and licenses issued to operate the facility today. Our Countywide facility has experienced higher leachate disposal costs as well as a modification to the site designed to isolate the area experiencing a reaction that generates high temperatures. We have seen settlement, leachate volume and heat subsiding in this area of the landfill. But not as quickly as we saw in laboratory work on the materials disposed of at the facility and had forecasted earlier. Our internal and external landfill engineers have concluded a thorough analysis of the future remediation requirements and reviewed this information with local officials. We believe the additional reserve that we have booked will cover all future costs. We expect this process to continue for the next 12 to 18 months.

In California, the accrual is related to higher leachate costs that will occur until a new on-site treatment facility is operational in 2009. There will be no further accruals related to this site. From a cash flow perspective, approximately $21 million of the $55 million in landfill charges will be spent in 2007. We will spend approximately $18 million in 2008 and the remaining $16 million will be spent in 2009 and after. Republic's as reported earnings per share for the third quarter was $0.35. Excluding environmental remediation costs, EPS was $0.46 which is an 18% improvement versus the third quarter of 2006. Our updated EPS guidance for the full year is $1.65 to $1.66, a 19% improvement versus the full year 2006, excluding the remediation charges recognized this year. We are on track to deliver 180 to 190 basis points of margin improvement to operating margins. This is consistent with our original guidance and demonstrates the impact of improved pricing on margins and returns. As previously discussed our 2007 business objectives are centered on improving margins by achieving appropriate price increases to offset inflationary costs and business risks, improving our market position, standardizing significant business processes and rationalizing our cost structure. I'd like to thank all of the employees of Republic Services for their dedication and hard work, which has resulted in another strong performance. Operator, at this time, I'd like to open the line for questions.

Thank you. We will now begin the question-and-answer session. (OPERATOR INSTRUCTIONS) Please limit yourself to one question and one follow-up question. One moment, please for the first question. Thank you. Our first question comes from Jagdeep Ghuman with Credit Suisse. You may ask your question.

Good morning.

Good morning.

Just wondering, can you touch upon on the fuel cost recovery side, what percent of your revenue base has some sort of fuel recovery clause built in, in terms of contracts?

Outside of our municipal contracts and franchises, we've got about -- this is approximately, about 60% of our revenue we have discretion over. Now some of that 60% obviously we have some contracts on that wouldn't allow us necessarily to pass it through, but it's a small percentage. So of that portion of our revenue, we have a high penetration of fuel surcharge recovery. I would say probably somewhere around 90%.

Okay. And within the municipal and franchise side it's basically built in via CPI escalator.

Most -- the majority of them are built into the index that adjusts the price within the contracts. We do have and have been successful over the last year or year-and-a-half in amending some of our franchise agreements for fuel surcharge pass-throughs.

Thank you. Our next question comes from Scott Levine with JPMorgan. You may ask your question.

Good morning.

Good morning, Scott.

Regarding the quarter, could you comment on what the volume environment wound up looking like as the quarter progressed? Were things fairly even moving through the quarter into October or was there any appreciable change?

No, I think we've seen a -- year-over-year we're still seeing the same sorts of impacts from the residential construction business. We're seeing temporary volumes off anywhere from 10 to 15%. We're seeing I think in the third quarter comps, probably we're seeing probably the largest impact resulting from our Florida operations where we have seen significant impacts on the construction business. But again, all reported within that 10 to 15% drop. But the majority of it is being experienced in Florida. C&D volumes at landfills are down a comparable percentage on a year-over-year basis third quarter. We're down about 12% or so. But again, we've not seen anything, so I guess when we look at it, we would say that the economy is still pretty resilient on our other lines of business and we're experiencing growth. And sequentially, quarter to quarter on C&D landfill volumes in our landfills, we're seeing it to be relatively flat.

Okay. One follow-up on landfill pricing. Sounds like you're encouraged by what we're seeing there as well. I was wondering if you comment a little bit more in detail regarding some of the markets you flagged as focal areas in the Midwest, perhaps some of the more competitive urban markets you mentioned in the last call.

Yeah, we still haven't seen much movement in the Canadian waste pricing. I mean, when we look at pricing in Toronto, the independent transfer stations in Toronto have a huge spread over transportation and disposal into the U.S. And we've been trying to eat away at some of that, because again, these are risk assets and there's a lack of volume available to -- in Canada for these kinds of wastes. So we haven't seen much price movement there. We've been trying to move it up in this quarter, got a little bit of resistance. The other market was in our eastern Kentucky operations, predominantly in Louisville and we have yet to see much landfill pricing movement in that particular market.

Thank you. Our next question comes from Bill Fisher with Raymond James. You may ask your question.

Good morning.

Good morning, Bill.

Jim, just following up on the landfill volumes. As you look out the next few quarters or so on a year-over-year basis, do you start hitting easier comps on the C&D side, do you anniversary some of the moves I think you made on special waste, or just what are some of the moving parts there, basically does that become less of a drag?

I think it will become less of a drag as we get into '08. Obviously, unless the economy takes another downturn. We're starting to see it flatten out, and maybe even see some modification into the fourth quarter of this year or some lowering of that into the fourth quarter. But I think yes, we'll see the comps get better next year.

Okay. And just a follow-up for Tod, actually, do you have a sense of where the growth or new cap spending will be on '07 and basically if the volume stays soft, if you see CapEx being the same or lower in '08? Or how do we kind of think about that?

We're not going to comment on '08. We're in the process of putting together our 2008 business plan. But I would say that our 2007 capital spending is similar to what we said in our July call, which is in that range of about $295 million to $300 million.

Our next question comes from Corey Greendale with First Analysis. You may ask your question.

Good morning. Question for Tod. I was hoping you could elaborate a little more on what helped SG&A in the quarter and whether this dollar amount is a good run rate to use going forward?

Well, again, in our notes I think we talked about a 10% run rate on the go-forward basis. Obviously, when we took this charge, it had an impact on incentive compensation for the Company. So there's probably about 50 basis points, 50 to 60 basis points of impact in SG&A as a result of the reduction in the accrual for incentive compensation.

Okay. And Jim, on the cash, uses of cash side, you've already done more on repurchases than at least I'd been expecting for the year. Can you just talk a little bit about maybe first of all, would you still do more in Q4 potentially? And second of all, any meaningful change in kind of the thoughts about uses of cash?

We're going to go into the market on an opportunistic basis. Basically, Corey, we accelerated the purchasing as well as the section 16 officers bought stock when the market got pressure I think in early August and the stock dropped into the $28 to $29 range. So we're going to continue to be opportunistic in our approach to buying and Tod and Ed Lang meet or converse every morning to determine what our position is in the market today. We completed every share repurchase and we've got through '08 to do that, so we're going to continue to look t the market and again, buy accordingly.

You know, I think the broader question, what do we do with the cash in terms of the cash strategy. It's essentially unchanged from what we had articulated and what the board had directed us towards in July, which was share repurchase continues to be the cornerstone for cash distribution strategy, although we would obviously move the dividend up. So we continue to believe that in today's market at these stock prices, given the margin expansion that we have seen and the opportunity we believe in the sector, the share repurchase should capture substantial value for our shareholders.

Thank you. Our next question comes from Jonathan Ellis with Merrill Lynch. You may ask your question.

Thank you. Good morning, guys.

Good morning, Jonathan.

Just want to talk about overall pricing. I think last quarter you had talked about expectations for 4.5% core price growth for the full year 2007. Wondering if you could talk a little bit about your expectations now and if that's changed at all with the factors around that deviation.

I think maybe we weren't clear, Jonathan. I thought that 4.5% was total, but what we're seeing in price is very consistent with what we have seen in prior quarters. And again, our view -- I think as we've always articulated and as we're seeing is to try to move pricing out somewhere around 100 basis points above CPI. And we're able to do a little bit more than that currently and, of course, we have a little bit of a benefit from commodities stepping up this year in the total price at least. But I would say that certainly that 4% range is -- on the core price is achievable.

I think right now we're experiencing a CPI of 2.8%, so we're 120 basis points above that on the core business and I think it's evident in what we have earlier said, that we can expand margins and we are expanding margins absent the charge, 180 to 190 basis points and are still on track to do that.

Great. And then my other question is can you just talk specifically about the commercial collection market, either in absolute terms where pricing is now or maybe directionally how its fared versus where it was last quarter?

First of all, in terms of the volume of that business, it's continuing to grow modestly. I would say in that 1 to 2% range. When you look at the pricing side of the equation, we're receiving mid single digit types of increases and we're holding the business. We don't see any change in our defection. So as we move forward, we think that's the appropriate place to be.

I mean, I think the key part to that is that we're getting price and the defection rates are flat. So again -- and they've been flat for the last I think six or seven quarters. So that tells me that the market is accepting the prices and the sector is still strong, looking still to move price out.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from Leone Young with Citi. You may ask your question.

Good morning. Nice quarter.

Thank you.

Obviously, the gross margin was very strong and as you talked about due to price. But as you look at that gross margin, is there anything in there that you would consider somewhat unsustainable, besides fuel?

Well, I think we talked about the SG&A in the quarter. So you know, certainly year-to-date, the SG&A is appropriate. The quarter SG&A was, again, probably about a 50 to 60 basis point benefit. The other point that I would make would be on our disposal side and we articulated this I believe in July and continue to see it. The drought down here in the Southeast part of the country is giving us a benefit in disposal, about 40 basis points. So I think those are the two unique items that we've got when we look at the margins.

And as a follow-up to that, if oil prices stay or diesel prices stay where they are, do you have a ballpark sense of how that could pressure margins in the fourth quarter?

Obviously they're moving up. There will be some pressure. But I don't think they're going to be material. We've got the recovery but the recovery is mostly dollar for dollar. You know, we're staying right on top of that, Leone. We're going to still stay with our forecast of improving the margins upwards to 150 to 200 basis points, right in that range.

Thank you. Our next question comes from Marshall Reid with Banc of America. You may ask your question.

Good morning.

Good morning, Marshall.

You talked about renewing contracts at higher prices. Can you just talk about maybe what kind of price increases you're seeing on renewals and I assume also you guys are out bidding for new business. How does pricing compare on new business?

Well, I mean, obviously when we're out looking at new business in a competitive marketplaces, say in our commercial industrial lines, we're moving our pricing up as we're moving pricing out. So I mean, -- so when we look at same store sales or price lists, year-over-year, we're moving those prices up as we're moving price out in the marketplace. So that would be one part of my response. As we get into the municipal and franchise markets, we're able to renegotiate price increases because I think when you look at the expectations within the sector for higher returns and better pricing, the market's moving up. The contracts we renewed had anywhere from high single digit to low double-digit price increases, only because the surrounding marketplaces had moved up. So again, when you look at return expectations, we're seeing returns in bidding -- in bids upwards to anywhere from 17 to 19% returns on average over the -- on average over the term of the contract.

I think another factor is fuel. So depending on where -- when that contract was originally bid, and the terms for fuel escalation, most of the contracts had just a CPI in there. They needed to be reset for the much higher fuel cost that we see today than we saw four, five years ago. So that's also been a factor moving the price up.

Okay. Just a follow-up on temporary roll-off. You mentioned price is stable. How sustainable is that, given volume losses and a market, say, like Florida, and is it possible you guys are losing a little share by holding the line on price in temporary roll-off?

We don't believe we are, I mean from our field reconnaissance it says we're not. I think those are probably better questions asked of our competitors than us. I mean, based on our reconnaissance, we would say no. And is it sustainable? As I've said when we've been out seeing investors and been out to conferences, if there was going to be an impact, we would have seen it by now. And the volume decrease here that we're experiencing today is just as strong as the commercial decrease we saw back in 2001. So there has been no move to market share.

And we've had isolated blips, but again it's the nature of our business, but nothing material or nothing universally across the Company, so we feel, yes, it is sustainable. Again, that depends on how bad the rest of the economy may get, if anybody breaks ranks. But I just don't see that happening. It's too hard to recuperate the price. We've had now almost six years to start to recuperate temporary roll-off prices. And I think we're not about to -- wanting, want to give those up as this particular stage.

Our last question today comes from Brian Butler with FBR. You may ask your question.

Good morning.

Good morning, Brian.

Just on the C&D volumes, especially I guess on the residential side. Can you put it in kind of a historical perspective, kind of where the levels are. Are we back to kind of 2005 levels or somewhere in between, just help me out with that.

You mean on the pricing or a volume standpoint?

Really on the volume, on the volume side.

Well, our business has grown steadily and dramatically over a two or three-year period so I would think that our volumes are still -- particularly with commercial construction being so strong -- holding up above where they were two or three years ago. And I would think that the same sort of situation applies on a unit pricing basis, because of, again, the higher fuel costs, the higher steel costs that goes into the containers and the trucks and the equipment.

Okay. And then just a follow-up on the acquisition kind of market, are you seeing any more or less competition for assets out there and could you comment on -- possibly on what kind of valuations you're seeing there? Is it starting to look less expensive? More expensive?

During the quarter, we may have bought a few million dollars worth of work. There's really not much on the market. And so it's a little hard to get a sense of what the pricing is. But again, I mean, we're going to stick to our pricing disciplines and the financial criterion that we've set for ourselves five to six years ago on return on investment and internal rate of return. So but no, we don't see the multiples coming down. The ones that we are talking to, they're right in that 5.5 to 7 range, depending on whether it's a fully integrated asset or a tuck-in.

Okay operator, I think that will conclude today's call. I would like to thank everyone for joining us today. I'd like to remind everyone that a recording of this call is available today and tomorrow by calling 203-369-0082. Additionally a recording of the call will be available on Republic's website at republicservices.com. Thank you for spending time with us today and have a great day.

Thank you. At this time, that does conclude today's conference. All parties may disconnect.