Republic Services Inc (RSG) 2008 Q1 法說會逐字稿

Good morning, and welcome to the first-quarter conference call for investors in Republic Services. Republic is traded on the New York Stock Exchange under the symbol RSG. The 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 (technical difficulty) Republic's summary of quarterly earnings, and 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, Trey. And good morning and thank you for joining us today. This is Jim O'Connor, and I'd like to welcome everyone to Republic Services first-quarter conference call. Tod Holmes, our Chief Financial Officer, and Ed Lang, our Treasurer, are joining me as we discuss our first-quarter performance.

I'd like to take a moment and remind everyone that some of the information that we will discuss on today's call 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 recording of this conference call, you should be sensitive to the date of the original call, which is April 24, 2008.

Please note that this call is the property of Republic Services Inc. Any redistribution, retransmission, rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited.

During the first quarter we continued to deliver on our pricing initiatives and realized margin improvement. We believe the current pricing environment is sustainable across all lines of business.

Key results in the quarter were Republic had revenue growth of 1.8% to $779 million. We achieved internal growth of 3.7%, with 6.2% of price improvement and volume decline of 2.5%. Our first-quarter volume decline was affected by a slowdown in the residential housing construction activity and associated lower landfill volumes.

Price growth continues to be strong. Core price is up 4%. Pricing is the most important factor for covering rising costs and increasing operating margins and return on invested capital.

Within our Orlando business, our core price was up approximately 3.4% in the quarter. We continue to see sequential improvement in landfill pricing, particularly in our MSW volumes. As landfill and residential collection contracts renew, we are seeing consistent price increases and high levels of retention.

The biggest impact on volume growth was in our temporary rolloff business, which decreased approximately 15%. This decrease is due primarily to weak residential construction volumes and is similar to the trend we experienced during the second half of 2007. Additionally, residential construction-related C&D volumes are down at our landfills. Despite the net volume reductions, temporary rolloff pricing has remained stable.

We continue to adjust our workforce and capital spending to reflect lower activity in our temporary rolloff line of business, and the field has done an exceptional job in making those adjustments.

Operating margins in the first quarter improved 320 basis points to 18.2%. When 2007 results are adjusted for remediation expenses, operating margins are up 40 basis points. And we continue to remain focused on all of the cost components of our business to remain competitive in the marketplace.

Republic had a number of significant achievements in the quarter, including our free cash flow for the first quarter was $67 million. Our full-year guidance is $340 million to $350 million. During the quarter, we continued to return cash to our shareholders. In the first quarter we repurchased approximately 3.2 million shares of stock for $98 million. There's $288 million remaining under a current Board authorization. Share repurchase will continue to be the cornerstone of our cash return strategy to shareholders in 2008.

Since the inception of our share repurchase program in July 2000, we've repurchased over $2.2 billion of Republic stock, or 41% of its outstanding shares. Upon completion of the existing Board authorizations, our repurchase program will total $2.5 billion, or approximately 48% of our outstanding shares.

As always, we continue to utilize our return on investment pricing tools on contract renewals and municipal contracts. And at this time, I'd like to turn the call over to Tod Holmes, our Chief Financial Officer, for a financial review of the first quarter. Tod?

Thank you, Jim. I'll begin my review of the Company's financial results by discussing revenue. Again, as Jim indicated, first-quarter revenue rose 1.8% to $799 million from $766 million last year. Internal growth was 3.7%, which is in line and maybe slightly above our guidance for the full year. This is really led by price growth. Total price growth was up 6.2%, 4% increase from core price, a 1.1% increase from fuel surcharges and a 0.3% increase from environmental fees. Also, commodities continue to be strong and we had a 0.8% increase from commodities.

So, again, during the quarter we continued to benefit from our ongoing price increase strategy in all lines of business.

Our first-quarter volume declined 2.5%. This is slightly above our full-year guidance for this year. However, if you will recall from our last-quarter call, we'd indicated that we thought the volumes would be a little bit weaker in the beginning of the year versus the end of the year due to the declines of volumes throughout last year and the fact that they would -- those declines would anniversary out as we went into the latter part of this year.

Temperate rolloff volume, as Jim indicated, was down 15%; landfill volume down 5%. Commercial volume and residential volumes were both up low single digits.

Divestitures accounted for the remaining 1.9% reduction of our revenue. And if you will recall, we had sold in the fourth quarter of last year, our LETCO soils business in Texas. That is the primary impact there.

Now let me talk about our operating margins' first-quarter year-over-year change. Year-over-year operating margins increased by 320 basis points, as Jim indicated, from 15% to 18.2%. During the first quarter of 2007 we recorded a pretax charge of $22 million related estimated cost to comply with orders issued by the Ohio EPA and our Countywide landfill. Excluding this charge, our year-over-year operating margins increased by 40 basis points from 7.8% to 8.2%. This increase is despite substantial headwinds from fuel prices and is consistent with our guidance of expanding operating margins.

The key components for our year-over-year margin increase are as follows. Again, the Countywide charge was anniversaried out, so that was a positive 280 basis points. Pricing really affects a lot of these other factors, as well as some of our cost initiatives. Truck maintenance, positive 20 basis points; risk and health insurance, a -20 basis points; fuel, the big driver, a -140 basis points. Our disposal and subcontracting cost was a positive 130 basis points; labor, positive 30 basis points; DD&A, positive 30 basis points; and SG&A, a -30 basis points. For a total of 320 basis points positive.

Now let me comment on each of these components of year-over-year margin change. First, truck maintenance. Again, during the first quarter of 2008, our tools that are in place, particularly Dossier, which focuses on preventive truck maintenance, has allowed us to have a reduction in truck maintenance expense as a percentage of revenue.

Second, the risk (technical difficulty) insurance. Insurance expense during the first quarter was 6.1% of revenue, higher than the first quarter of 2007, and that was due to some one-time adverse development in a couple auto liability claims. We believe that these costs associated with our risk program will come back down here in the next quarters of this year, and that for the year, we expect something in the 5.5% to 6% of revenue for our risk and health insurance.

Third, fuel costs. Our average wholesale price per gallon increased substantially, from $2.44 in the first quarter of 2007 to $3.39 in the first quarter of 2008. Current fuel prices are approximately $3.96 a gallon. A couple things I might add -- we do have a hedge in place for a little over 10% of our fuel consumption. That was actually a benefit of 20 basis points, since that was put in at about $2.85 a gallon.

And then the other factor we have is prices were moving up in the quarter, and the month of March was certainly the highest price. Although we're quick to get our fuel surcharge, there is about a one-month delay. And had we had that April surcharge in place for the month of March, that would have been another 10 basis points (technical difficulty) basis points of benefit.

Fourth, our disposal and subcontracting costs. This is our largest cost category through which really the impact of improved pricing is clearly visible.

Fifth is labor. During the fourth quarter, we continued to benefit from productivity improvements, which contributed to our margin growth. One thing I would add about labor, both here and in SG&A, is we did go through a mandatory enrollment for all of our employees in the 401(k) plan. So, we've got probably another 10 to 15 basis points of expense due to higher participation in the 401(k) plan, both here in our direct operating labor and also in SG&A labor.

Sixth is DD&A. The decrease in DD&A as a percentage of revenue is primarily due to improved pricing. Finally, SG&A. First-quarter SG&A was 10.6% of revenue. This increase in SG&A is again due to higher equity compensation in the 401(k) expense that I talked about earlier. We believe going forward that SG&A should be in a range of 10% to 10.5% in fiscal 2008. And as we look ahead for all of 2008, we believe that operating margin in the 19% range is achievable.

Now let me talk about our first-quarter operating income, before depreciation, amortization, depletion and accretion. Year-over-year operating income before DD&A increased by $22 million or 11.1%, from $198 million in the first quarter of 2007 to $220 million, or 28.2%, in the first quarter of 2008.

Now I'll talk about our free cash flow. Free cash flow for the first quarter of 2008 was $67 million. This is based on cash provided by operating activities of $148 million, purchases of property and equipment of $82 million -- and let me talk about that in just a minute -- that is what we actually paid in cash, some of which was actually delivered last year and paid this year -- plus our proceeds from the sale of property of $1 million equals free cash flow of $67 million.

As you are aware, earlier this year Congress passed the Economic Stimulus Act of 2008. This Act allows companies to purchase new equipment and to deduct 50% of the cost of the equipment as bonus depreciation in their 2008 tax returns. We believe this will save Republic about $25 million in cash taxes during 2008, and therefore improve our cash flows. However, we anticipate increasing our capital expenditures as a prebuy for both 2008 and also 2009 trucks prior to the new diesel engine requirements that going to effect January 1 of 2010.

But the combination of all of these brings us still to the points that we feel very comfortable with our original cash flow guidance at or above the range of $340 million to $350 million.

I mentioned earlier the statement of cash flows purchases of property and equipment showed $82 million. We actually have, I think, a reconciliation in our 8-K, because in the first three months, what we actually took delivery of was $48 million in capital versus that $82 million in the statement of cash flows. This difference again represents property and equipment that the Company received during 2007, but was paid for in 2008. And again, this reclassification on the statement of cash flow from cash provided by operations to purchases of property and equipment.

Let me talk about our items impacting our cash balances. During the first quarter of 2008, as Jim indicated, we purchased 3.2 million shares. That is about 1.7% of our outstanding share count. For approximately $98 million, or $30.19 per share. And our remaining authorization at today's prices could allow us to purchase over 5% of our outstanding shares.

Our actual share count at March 31st, 2008 was 182.7 million shares.

Republic's balance sheet remains very strong. At March 31st, our accounts receivable balance was $307 million. Our days sales outstanding did go up from 34 days at December 31st to 35 days at March 31st. This is a function, we believe, of the economic times that we are in. Our net debt is $1,527,000,000, up from $1,450,000,000 at December 31st, and our net debt to total cap at December 31st was 55%.

Now I'll turn the call back to Jim O'Connor.

Thanks, Tod. Republic's EPS for the first quarter was $0.41, which is 46% improvement versus the first quarter of 2007. After adjusting for remediation expense and additional income taxes, the first-quarter EPS was up 11%. We'd like to reiterate our current earnings guidance for the year of $1.78 to $1.82 EPS for the full year of 2008.

With the passage of the Economic Stimulus Act earlier this year, Republic's cash flow will improve due to bonus [appreciation] resulting from higher deferred taxes. We provided 2008 cash flow guidance of $340 million to $350 million. The 2008 depreciation guidelines will increase free cash by approximately $25 million.

However, as Tod stated, we plan to increase our 2008 capital spending for commercial and residential collection vehicles for several reasons. There will be new engine standards beginning on January 1, 2010 that increase the cost of vehicles by $10,000 to $20,000 a unit. Therefore, making this investment before 2010 will lower future capital spending.

Additional vehicles purchased in 2008 will benefit from bonus depreciation. And by taking delivery before the new engine standards are implemented, we will minimize operating issues as manufacturers adopt to a new process. Our capital spending during the first six months of 2010 will be reduced to adjust for advance purchases.

We are maintaining our 2008 cash flow guidance at $340 million to $350 million, while possibly increasing our capital spending by up to $25 million. We will update cash flow guidance at the end of the second quarter, as we historically have done.

2008 business objectives continue to be focused on improving margins by achieving appropriate price increases to offset inflationary costs and business risk, improving our market position, standardizing significant business processes, maximizing the efficiency of service delivery and customer service and rationalizing our cost structure.

I'd like to thank all the employees of Republic Services for their dedication and hard work, which resulted in this strong performance in the first quarter. And operator, at this time, I'd like to open the call for questions.

Thank you. (OPERATOR INSTRUCTIONS) Scott Levine of JPMorgan.

Good morning, guys. Waste Connections mentioned on their call weather, and we saw a little bit of volatility in terms of weather in certain parts of the country. You didn't mention weather in your prepared comments. I know your footprint is in a lot of warmer-weather regions or tilted towards those markets. Did you see any unusual behavior there, was there any impact on the volumes that you could quantify?

Scott, we do have some seasonality, as you well know. Again, it predominantly resides in the Midwest and the Mid-Atlantic states. We have probably seen some impact there. Probably not to the same degree that some of our national competitors have. But it is a factor; it's just a little hard for us to sort all of that out when we look at the volumes changing from fall to winter quarters.

But just before I let you do a follow-up here, what I'd like to do is go back to some comments I have here, and I missed something, so bare with me, Scott.

I'd like to highlight that Republic continues to manage its business to adjust our costs and capital investment for the challenges of the slowing economy that we are experiencing. We continue to see pricing discipline in the industry, which is I think long overdue. And therefore, we can expect, I think, to deliver higher margins and returns in 2008, and we're comfortable with our earnings guidance, as I said in my comments, that we provided in February.

So I wanted to reiterate that, that even in light of the volume declines, we believe that we continue to see pricing to be rational, we continue to see margin improvement and we continue to see escalating free cash flow.

So, with that, Scott, I will give you an opportunity to do a follow-up.

Very well, thanks. I was hoping I could get a quick update on Countywide. I think we saw news items that the US EPA was getting involved here, so if you might be able to provide a little bit more clarity there.

Yes, we did sign a consent order in the last ten days with the US EPA, but pretty much following the same work elements that Ohio EPA had already outlined, with the addition that we may go to early closure of the 88 acres that are affected, or that are under remediation. It does not affect the currently active part of the facility. So, we don't anticipate at this time any additional remedial costs; we still believe that the charges that we took are appropriate and still represent the best engineering estimates to take us through remediation.

Great. Thanks, Jim.

Bill Fisher of Raymond James.

Good morning. Jim, just on the landfill volumes, just want to see if you can give any color on if you felt the declines there might moderate a bit as you move through the year. I think you had some noise last year in terms of some specific streams you pulled back on, or if there's any other permit expansions and things you might get.

As far as the volumes, I think some of the change in the receipt of special waste materials in the Detroit market area, those should anniversary out. Those were some sludges out of Toronto and sludges from the City of Detroit. We've also obviously stopped taking aluminum dross around the country. So we've seen some impact from that, but really not material in nature to the business.

As far as the landfill volumes, they have been predominantly affected by the construction and demolition dropping off. And they've also been affected really due -- some would probably relate it to the economy, but I think predominantly in the southeastern part of the United States, where we've seen extremely dry conditions and we haven't seen really much change in that in the first quarter, we've seen our unit rates be much lower. So our third-party deliveries would be a lot lower to our facilities.

Okay, and just following up on that. On the C&D side, I know you have a lot of collection-only business. Would the C&D mix and the landfills still be about the same as on the collection side or is there any difference there?

I think what you've seen, Bill, is as we went through last year, the C&D mix of our total business has continued to decline as that piece of the business has slowed down in the residential construction. So, I would say that both on the rolloff -- the temporary construction rolloff is a little bit smaller portion of our total revenue. In fact, I think you can see it in the 8-K, that the rolloff revenue is down, despite some positive pricing there, and probably a little bit of non-construction growth there.

I think that same factor holds true on the landfill site, where the C&D volumes are down. Now, a lot of those declines were coming as we moved through the sequential quarters last year. And I guess the question that remains for all of us is have we hit a trough here in terms of that slowdown. It's a little bit hard for us to see -- it's early in the year, certainly the wintertime seasonality is a much larger factor here in this first quarter than in the other quarter. So we are not really going to have a clear picture until we move out of the first-quarter seasonality and also maybe see where this economy takes us.

Corey Greendale of First Analysis.

Good morning. Kind of following up on that question, can you comment on monthly volume trends as the quarter progressed and into April? And are you starting to see any of your customers on the commercial side downsizing their service levels at all?

I think the reconnaissance from the field is our commercial business is still modestly growing, and we've not yet seen any trending in our customer base to lower service deliveries or frequencies. So that still pretty much remains intact.

As far as the volumes, I kind of go back to some of Tod's comments here. It's a little hard for us to sort out what is actually happening in the winter quarter with some of our volumes, and how much of it is just the seasonal impact. But I think it's a fair statement to say that we still see obviously continued decline over the prior year's quarter, and whether that's related to weather or not, it is a concern to us.

But again, I kind of keep coming back to the same issues again, Corey -- that the business is still able to show pricing growth, we're still able to show margin growth in light of the volume declines. And these are volume declines that are unrelated to activities in the market, other than lack of demand for either residential and/or commercial construction.

So, I continue to look at the margins expanding and I continue to look at the escalation of free cash flow or our ability to generate significant amounts of cash flow. And it is just really too hard for us to say what further headwind volume could produce as the year goes on. And our guidance, again, has been based always on the fourth quarter. And we did anticipate that the volumes would be a little weaker in the first quarter than in the second quarter, and then would start to anniversary out in the third and fourth. And I think we've been consistent there. So it's just a little hard to comment exactly on where all the volumes are going.

I would add one other thing, Scott, and that is that we need to remember this business is scalable. And so when we look at a change in business activity, we are able to reduce the number of hours, we're able to reduce the equipment by slowing down the replacement, we're able to move equipment, and therefore maintain -- maybe with a little bit of a lag effect -- maintain the productivity that we've had in the past, which is certainly a key element in maintaining and growing margins. And I think our field organization has done an excellent job of adjusting the economic conditions.

That is helpful. And the second question is on pricing. I saw that there was a benefit from an environmental fee again, that that had sort of drifted down over the last couple of quarters. Did you implement a new fee or upsize that fee, and should we expect that kind of benefit for the rest of the year?

And if I could cheat and sneak in a quick third one, Tod, could you just quickly run through all the margin impacts again? The numbers I got didn't add up to 320, so I just want to make sure I got them right.

Could we do this -- on the margin, could I just do it offline with you, since I've already done it once. And maybe you can just give me a quick call after the call and I'd be glad to do that.

Fine.

Okay.

As it relates to the environmental fee, we did increase the environmental fee effective January 1 of '08. We moved it from 2% to 3%. It is still lower than our other two national competitors. But we feel in light of the impacts that we are seeing from cost increases, monitoring expenses and cost to secure additional capacity, we thought that it was more than appropriate to do that. So that will remain in place.

Leone Young of Citi.

Good morning. I understand that, especially in this first quarter, it's difficult with volumes between seasonality and weather. But how about the third factor? Can you comment a little bit about what you are seeing in terms of competitive behavior on price? Not just the nationals, but perhaps some of your larger independents -- any change there with the worsening economy?

No, in fact -- I was out on the road with Ed Lang up in Boston and New York, I guess it was about two weeks ago, two or three weeks ago. We do have a couple of anomaly markets where we are seeing some price decrease from a couple of independents. But when I look at our larger markets and our larger urban markets and I look at our larger independents that really can actually -- could impact the market to some degree, they act very rational, and, in my opinion, have been holding the temporary construction prices to the historical levels that we've seen. So, I guess the answer to the question -- short answer is we still believe it is stable with a few isolated anomalies.

Great. And turning just to trends you are seeing in commercial construction, I know there is a lag in the garbage business, which is great. But in particular, what are you seeing in commercial construction in some of your key markets, like Florida and Las Vegas?

Well, I mean, again, most of -- we really haven't seen a whole lot of impact there. But I can tell you -- it's probably what gives rise to the question -- we have seen a number of projects cancelled, meaning that they are not coming out of the ground, and that we wouldn't anticipate volumes. So I would think we would probably start to see some impact from some of what we are hearing about in Florida and in Las Vegas and Southern California, probably in the latter part of '09, as some of the larger projects won't finish until that time.

(OPERATOR INSTRUCTIONS) Jonathan Ellis of Merrill Lynch.

Thank you and good morning, guys. Just -- I know you touched on landfill pricing, but wondering if you could walk through the magnitude of price growth in the commercial collection, residential collection and permit rolloff businesses.

When you look -- let's start with residential. It's predominately index priced, whether it's in our franchise business or whether it is in our contract residential municipal business. So I mean, it's going to trend at a CPI which is running right around 3%.

I'm sorry -- you mean on price on contract renewals in the municipal business, is what I meant to say.

Oh, contract renewals. The contract renewals have significantly outpaced the CPI. As we've been in renegotiating and/or rebidding franchises and/or municipal contracts, I think we were seeing pricing move anywhere from 5% to 10%, depending on the return expectation or the return delivery that we were achieving in the contract or the franchise. So pricing has escalated in those areas anywhere from five to low double digits.

Okay, great. Then just on the landfill side, can you update us on how far you are through working through the long-term disposal agreements and what type of price increases you are achieving on those contracts?

Sure. I think it was probably about six quarters ago we kind of brought up the fact that landfill pricing would move and will continue to escalate as these contracts anniversaried out. I'd say we've probably got another four quarters to go; we're probably about two-thirds of the way through them, and I think it's reflective in our pricing.

If you look over the lasts several years, we've moved pricing from approximately 2.5% to 2.8%, up now to a little over 3%, 3.4%. So, I think you are starting to see it materialize, and I think it will continue to grow. And again, when I was on the road two weeks ago, I think you should see landfill pricing move up towards the 4% range. And then -- now, whether it will move much higher than that will depend on the individual markets and demand. But at the end of the day, I think 4% to 5% would be somewhere where we settle in in the next 12 to 24 months.

At this time, we show no further questions.

Okay. Thank you, Trey. I appreciate it. And at this time, I'd like to remind everyone that this call is available for the next 24 hours by calling area code 203-369-3289. Additionally, a recording of the call will be available on Republic's website at republicservices.com. And I'd like again to thank all of you for spending time with us today. Please have a good day. And goodbye.