Republic Services Inc (RSG) 2008 Q3 法說會逐字稿

Good morning and welcome to the third quarter conference call for investors in Republic Services. Republic is traded in the New York Stock Exchange under the symbol RSG. Your host this morning is Republic's 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, sir.

Good morning. And good morning to all of you and thank you for joining us. This is Jim O'Connor and I would like to welcome everyone to Republic Services' third quarter conference call. 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 will discuss on today's call contains forward-looking statements which involves risk and uncertainties and may be materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations. Additionally, the material that we discuss with you 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 October 31, 2008.

Please note that this call is the property of Republic Services ,Inc. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited. On today's call I will review with you our views on the pending merger with Allied Waste Industries, but first I want to review the third quarter results where we continue to see margin improvement. Republic had revenue growth of 3.4% to $834 million. We achieved internal growth of 4.2%, with 7.3% of price improvement and volume decline of 3.1%. Our third quarter volume decline was affected by the slowdown in construction activity. C&D volumes in our temporary roll-off business and third-party C&D volumes at our transfer station and landfill continue to be weak. Price growth continues to be strong. Core pricing is up 3.8%.

Pricing improvement is the most important factor in covering rising costs and improving return on invested capital. Within our landfill business our core price was also up approximately 3.4% in the quarter. Pricing for MSW landfill volumes was up 4.2%. The landfill business is very capital intense and requires continued focus on pricing in order to achieve appropriate risk adjusted returns. And we, again, continue to utilize our return on investment pricing on all renewals of franchise and municipal contracts. The biggest impact on our volume growth was in our temporary roll-off business, which decreased approximately 15%. This decrease is due primarily to weak residential construction volumes and is similar to the trend we had experienced during the past three quarters. Additionally, construction related landfill volumes are down 19%. Despite the net volume reductions, temporary roll-off pricing has remained stable.

We have continued to adjust our workforce and our capital spending to reflect lower business activity. By making these adjustments, we have maintained our labor productivity. Operating margins for the third quarter were 20%. Fuel costs increased approximately 180 basis points compared to the third quarter of 2007. EBITDA margins in the third quarter was 29.9%. Although the economy is weakening, the basic fundamentals and operating disciplines of our business are intact. Our current stock price reflects valuation multiples that are very low -- at the very lowest levels and do not recognize our ability to generate high levels of predictable free cash flow in our business today and further after the closing of the merger with Allied Waste. We remain focused on all the cost components of our business to ensure that we remain competitive in our marketplaces.

Republic has a number of significant achievements in the quarter, including our free cash flow for the third quarter was $95 million. We believe our full cash -- our full year cash flow performance will be within the range of our guidance of $340 million to $350 million, excluding merger-related costs. We began paying a higher dividend in October. The quarterly dividend is $0.19 per share, which is a 12% increase. We have increased our dividend every year since we initiated it five years ago. We will continue the $0.19 quarterly dividend after the merger closing. And at this time, I would like to turn the call over to Tod Holmes, our Chief Financial Officer, for a review of our financial performance in the third quarter. Tod.

Thank you, Jim. I will begin my review of the Company's financial results by discussing revenue. Again third quarter 2008 revenue rose by 3.4% to $834 million from $806 million last year. That is an internal growth rate of 4.2%. Total price was 7.3% with 3.8% coming from core price, 2.8% from fuel surcharges, 0.4% from environmental fees, and 0.3% from commodities. During the quarter, we continued to benefit from our ongoing price increase strategy in all lines of business. Our third quarter core volume did decline 3.3%. This was driven primarily by landfill volume, which was down 2%, and temporary roll-off volume related to construction industry, which is down 15%. Divestitures and non-core operations accounted for the remaining 0.6% reduction in our revenue. That was primarily divestiture of our LETCO business in the fourth quarter of last year.

Our third quarter year-over-year operating margin. Year-over-year operating margins increased by 410 basis points from 15.9% to 20%. During the third quarter of 2008, we recorded $3.2 million of costs associated with our merger with Allied. Excluding these costs, our operating margins for the third quarter would have been 20.4%. The key components to our year-over-year operating margin improvement are as follows -- The Countywide landfill cost that we incurred last year 410 basis point improvement; truck maintenance positive 40 basis points; higher fuel costs this year negative 180 basis points; risk and health insurance positive 90 basis points; disposal and subcontracting costs a positive 80 basis points; labor a positive 50 basis points; DD&A positive 20 basis points; SG&A a negative 60 basis points; and our integration costs a negative 40 basis points. So that totals 410 basis point improvement.

Let me briefly comment on the components of our third quarter year-over-year margin change. First, truck maintenance. During the third quarter of 2008, we continued to focus on cost savings initiatives and improved pricing results -- improved pricing resulted in a reduction in truck maintenance expense. Second, fuel. Our average wholesale price per gallon increased from $2.76 in the third quarter of '07 to $4.13 in the third quarter of '08. Current fuel prices have come down. They are currently at about $3.21 per gallon. Third, the risk and health insurance costs. Our insurance expense during the third quarter 2008 was 4.7% of revenue, which was lower than the prior year due to favorable settlement of older claims in the auto and general liability lines of coverage. Fourth, disposal and subcontracting costs. This is our largest cost category through which the impact of improved pricing is clearly visible.

Fifth, labor. During the quarter, we continue to benefit from productivity improvements and pricing, which contributed to the margin growth here. Sixth, DD&A. The decrease in DD&A as a percentage of revenue is primarily due to improved pricing. And finally, SG&A. Excluding the integration costs, SG&A as a percentage of revenue for the third quarter of 2008 would have been 9.9%. This is a range which we feel is appropriate in the longer term for Republic as a standalone Company. The increases in year-over-year SG&A as a percentage of revenue is due to an increase in bad debt expense during the third quarter of 2008 and a decrease in incentive compensation expense during the third quarter of 2007. Now our third quarter income before depreciation, amortization, depletion and accretion.

Excluding the remediation charge at the Countywide landfill in the third quarter of 2007 and excluding the integration cost during 2008 for the Allied merger, our year-over-year income before DD&A increased by 40 basis points from 29.8% to 30.2%. Next I will discuss free cash flow. Free cash flow for the third quarter of 2008 was $67 million. This is based upon cash provided by operating activities of $163 million, less purchases of property and equipment of $99 million, plus proceeds from the sale of property of $3 million for a free cash flow of -- excuse me of $67 million. Free cash flow for the nine months ended September 30th was $216 million. This based upon cash provided by operating activities of $474 million, less purchases of property and equipment of $264 million, plus proceeds from the sale of property of $6 million for the $216 million free cash flow.

Now I might point out that during the third quarter of 2008, we made $28 million in cash payments for costs attributable to our merger with Allied, of which $3.2 million flowed through the P&L. The majority of these costs have been capitalized and, excluding these payments, free cash flow for the three and nine months ended September 30, 2008 would have been about $95 million and $244 million respectively. We continue to believe that our free cash flow guidance of $340 million to $350 million for fiscal 2008 is appropriate. And, again, this guidance excludes merger related cash expenditures. Republic's balance sheet remains very strong. At September 30th, our accounts receivable balance was $326 million and our day sales outstanding was 35 days. Net debt was $1.460 billion, which is up from $1.450 billion at December, '07, and our net debt to total capital at September 30, 2008 is 53%.

In June, after announcing our merger with Allied, Republic suspended its share repurchase program. Our actual share count at September 30, 2008 was 182.2 million shares. Now I will turn the call over to Ed Lang for an update on financing related to the merger.

Thanks, Tod. I would like to provide an update on our financing plans. In order to meet the long-term liquidity needs of Republic Services post merger, we set out the following objectives. First, obtain investment grade ratings. Second, arrange for $2.75 billion of bank facility capacity for letters of credit and short-term borrowing requirements. And third, secure additional surety bond capacity at attractive rates available to investment grade companies. Last June, prior to the announcement of the merger, we met with Standard & Poor's and Moody's to review the proposed transaction. After our announcement, both agencies issued press releases indicating investment grade status. In July, we began the bank facility syndication by selecting Bank of America and JPMorgan as co-leads.

In order to secure the $2.75 billion of bank capacity required, we amended Republic's existing $1 billion facility and syndicated a new $1.75 billion facility. We signed this documentation and it went effective in mid-September. All financing for the merger that is required is in place. At the same time we began working with major providers of surety bonds to address the increased requirements of Republic post merger. We were able to secure incremental capacity at rates significantly lower than Allied's current costs. The ability to secure investment grade status was vital to our success. As far as debt maturities, Republic has only one matured debt maturity in 2009, approximately $100 million due in May of next year. The Company has no debt maturities in 2010. The maturity in May of '09 will be repaid with free cash flow from operations. Jim will now provide additional information on Republic and the merger process.

Thanks, Ed. Republic's EPS for the third quarter was $0.48. This was a record level of earnings per share. We would like to reiterate our current earnings guidance of $1.78 to $1.82 of earnings per share for the full year 2008, excluding remediation and merger costs. We provided 2008 cash flow guidance of $340 million to $350 million and believe that we will be within the ranges even though we will increase our capital spending for collection vehicles to take advantage of bonus depreciation. I would like now to give you an update on our merger with Allied. I am extremely pleased to report that this process remains on track to meet our original guidance of closing before year-end. Only two events need to occur before closing, a successful shareholder vote on November 14th and the signing of a final agreement with the Department of Justice. We expect to conclude the process with the Department of Justice in early December.

All the cash received from divestitures will be used for debt reduction. We will reduce debt by over $2 billion during the first three years of the merger. As Ed mentioned, all required financing is in place and there is no need to look to debt capital markets until 2011. As discussed previously, our organizations came together after the merger was announced and formed an integration team that has equal participation from Republic and Allied. These teams developed a detailed integration plan that ranges from day one through 2010. As part of the planning process, our integration teams have documented synergy savings and the timing for realizing these benefits. And I am very confident that the $150 million in near-term synergies have been identified and we have greater clarity in definition and that we will realize the benefits of these synergies in the second half of 2010.

Our integration teams have identified additional savings that have been placed in what we call the parking lot and we will realize some of these savings in the latter part of the first three years. Our IT organization has completed a detailed systems review and all systems for the new organization have been selected. A conversion plan has been finalized and will be completed in a timely manner. Both companies have significant experience in a major system implementation and internal and external resources have been allocated to this project. We named more than 100 executives for the new Republic Services at corporate, region and area levels. All these individuals have participated in the integration planning and training. In addition, Don Slager and I have visited all four region offices to rollout post merger operational strategies within the last week. And let me go on to tell you that there is a lot of enthusiasm amongst our top management.

We concluded a day session where we transferred and looked for the field to come back and add a sense of realism to our plans, in addition to additional challenges to exceed the plans. That evening we had a dinner and I think whatever cultural issues that we may have anticipated, I think Don and I would both attest to that the teams came together very quickly and there was a lot of enthusiasm. And I think it's reflected in some of the stories that were told at dinner that night. So it is a great team of people. We will complete the corporate office staffing and the field staffing within the next 10 to 14 days. I would also like thank all the employees at Republic and Allied for their efforts in this integration planning process. We announced the merger on June 23rd. Many investors were concerned about the integration risks and the failures that occurred in previous transactions. The primary reasons for these failures were lack of planning and financial strength. This is not the case in Republic and Allied's merger.

We've spent over 20,000 man hours on integration planning and we have received investment grade ratings on a pro forma basis. We are well positioned for a successful transaction. At this time, operator, I'd like to open the call to questions.

(OPERATOR INSTRUCTIONS)

I guess in light of today's economy and the results of our quarter, it looks pretty good. Operator, do you have any questions yet coming in.

Yes, the first question is from David Feinberg of Goldman Sachs. Hello, David.

Hi, can you hear me?

I sure can.

Great. So first question. I wanted to know what impact, if any, there might there be from the class-action settlement that you announced yesterday as well to financials and to cash flow.

It is immaterial. I am going to let Tod -- David Barclay, our General Counsel, is here with us. Do you want to talk to that at all?

Yes. No, this was settled on the basis of just a few additional disclosures that were contained in our 8K and there will be a modest fee award likely within the next three to four weeks.

And that -- just so I understand, that fee award goes to the shareholders. Is that true?

No, there is not a monetary settlement. The fees will be going to the plaintiff's counsel in the case.

Understood. And then turning to the broad economy and then I will hand it over. Republic has a nice footprint in the Sun Belt of the United States, which unfortunately has felt the brunt of the slowdown earlier than the other parts of the economy. As we here at Goldman, and I think more broadly, are looking for a broader based US slowdown in '09 thought that maybe you can give us some insight in terms of how you expect perhaps your volume growth to play out and/or your pricing strategies based on your experience operating in some of these markets that were hardest hit by the housing downturn.

Sure. David, this is Tod. I think that we have been through a couple economic cycles here in this business in the early '90s and 2001, 2002, and typically what you will see, and it depends if this one is deeper and longer than those cycles, but typically what you see is probably four to six quarters of negative volumes. So, we would -- we would look for 2009 to be a soft year from a volume standpoint, but again, historically, the volume declines have been primarily in the construction area, both residential which we have seen this past year and maybe in the future commercial construction. And then in -- in some of the other landfall related volumes associated with construction.

The other business tends to maybe flatten out a little bit. On the margin side typically what we will see is an uptick in bad debt expense from a 20, 30, 40 basis point range to maybe a 40 to 70 basis point range. The margins might come under a little bit of pressure. But again the equipment on this business, it is on wheels. We can move it around. There is a strong replacement cycle that you can slow down as well, obviously, the growth capital. Typically the cash flows hold up quite well.

And I think the pricing is a discipline and a discipline that is imbedded in the Republic management team and process. We don't see any reason why we wouldn't continue along with pricing guidance in the area of 50 to 100 basis points.

Above CPI.

Okay.

Thank you very much.

Thanks.

The next question is from Corey Greendale from First Analysis.

Thanks.

Good morning, Corey.

Jim, your comment is right, that doesn't mean there aren't questions. Congratulations on holding up well through the downturn, regardless

Thank you.

The first question I had was also on the pricing. So I know that you guys are being disciplined on pricing. What -- what -- how would you give us confidence that the same will be true of smaller competitors and that if they start to get more aggressive on price, that won't mean that you will start to lose increasingly profitable volumes if the downturn continues?

Well, I mean I think it is -- it -- again, when we are focused on returns and cash value creation, we are talking about continuous improvement in contribution. And inflation is starting to set in. We saw fuel -- we have seen fuel most recently kind of pull back here a little bit, but for the most part, I think the independents are feeling the same cost pressures that we are. So, I don't -- I really don't anticipate a lot of pricing pressure there. If we would have seen it, I think we would have seen a lot of it already in the temporary construction business. I think the larger independents, as I said, are probably much more rational. They are looking at how hard it is to recover pricing, as we are. And we have elected to take a position that -- that we are going to hold the pricing, even if it means loss of some volume. And I think what we have seen in the larger urban markets that the independent sector has pretty much followed that and it is reflected in our retention rates and our pricing.

Okay. And could you help us think through what the potential impact could be of commodity prices falling? Waste talked about that on their call. I know you are not as exposed as they are, but if it could have a noticeable impact on the P&L?

I think what -- we are seeing similar impacts. The current pricing for fiber today, OCC and OMP, is in the $40 to $60 a ton range and if you went to the early parts of '08, we are somewhere up around the $130 to $160 range. So there has been a significant drop-off. If you look at these prices running through the third quarter, we are looking at an earnings impact in the third quarter of probably about $0.025 to $0.03.

Fourth quarter.

I'm sorry, the fourth quarter, $0.025 to $0.03. Again, when you lose that much price, even though the volumes of fiber within Republic are relatively small, I think our total production on an annual basis is about -- what did we say.

200,000 tons a year of fiber.

200,000 tons of fiber. We are going to see some impact and obviously if that continues on we will see impact next year. I think the positive for us is that we recognize that going into a weakening economy that we could see some -- some stress on the commodity prices and we hedged our commodities where we weren't -- we didn't have floors already. So when you look at our overall fiber that we have produced, we have got about over half of it is either protected by floor pricing, which is in a range of about $75 to $85 a ton, and we've got a good component hedged now. So over half of our volume is protected with hedge and floors.

The next question is from Jonathan Ellis from Merrill Lynch.

Thanks and good morning, guys. I wanted to just talk briefly about landfill pricing. You mentioned, I think, first off that pricing was at 3.4% this quarter. It seems like there is a slight deceleration from last quarter. I think last quarter pricing was up 3.7%. I wanted -- I was hoping you could shed some light on the deceleration there. And just in addition to that, if MSW pricing was up, I think you said over 4%, where was the weakness that offset that to get to a blended average of 3.4%.

Well, I think a lot of it really comes from the mix of MSW with the construction volume, the non-MSW. The MSW volume was about -- I think I said earlier about 4.1% or 4.2%. So we still see for reoccurring revenue streams on the landfill pricing holding up pretty well. C&D volume was actually up about 2% from a pricing standpoint. I think that's what you are seeing in that sequential slight step down.

Okay. And just on the -- in overall pricing, a slight sequential deceleration to 3.8% from over 4% last quarter. My understanding is given the concentration of your municipal agreements that have resets around July 1st, typically you get either core pricing that holds flat to accelerate slightly between 2Q and 3Q. Can you just help us understand what the resets were in those contracts this year and perhaps what they may look like for next year.

I think the resets this year, which were typically either July 1st through September 30th, were probably around 3% or so. What we've got right now this year on a year-to-date basis is CPI that is running at about 4.5%. So while in the past we had talked about how Republic, because of its heavy franchise business, was a little bit slower in getting price as, for example, fuel and inflation was moving up, we are probably at -- well, maybe we are at an inflection point and so December of this year, if pricing in the fourth quarter holds, we will have over a 4% CPI that will go into many of these contracts next summer. So certainly that is something that is going to benefit the Company in 2009.

Next question

The next question is from Scott Levine from JPMorgan.

Good morning.

Good morning, Scott, how are you?

I am well, how are you?

Pretty good.

On fuel. Have you guys adopted any new hedges there and remind us what hedges you do have in place and whether you guys would be thinking with the recent pullback of hedging out more of your fuel exposure in the franchise markets or elsewhere?

Scott, this is Ed. The only hedging we have done this year is related to specific contract renewals where those communities did not want to include a fuel surcharge. So we locked in the fuel costs into the -- those contracts through a financial transaction. So this year about 10% of our total fuel risk was hedged. Next year it will step up to about 13% or 14% and that is the impact of the hedges we put in place specific to certain contract renewals that occurred in 2008.

And, Scott, we continue to evaluate our position there. We are very well aware of where crude is at today and we have had significant internal discussions as to what our policy going forward should be as it relates to hedging.

Got it. And one last one on -- on management philosophy. You guys have -- my perception has been that you employed a decentralized model in the past. Do you view any changes to your philosophy given the merger with Allied, given the changes to the business on a pro forma bases. Anything along those lines?

No. In fact, actually there have been a lot of questions along those lines and I think -- I can speak for Republic and I think I can speak for Allied that at the end of the day we are more alike than not. And decentralization is something we practice, where it is appropriate to practice. A particular function should be centralized, they are centralized, such as procurement of capital assets or treasury functions. I look at it and I kind of say, look it, decentralization in my mind relates to the field organization being able to make market decisions, all right, relating to the customer base. There is a lot of other things that we are looking to standardize and streamline through a number of best practices that Allied has already got in place and that Republic has been practicing. At the end of the day they are very much alike and I don't really see much change in the way we conduct our business or the philosophy as it relates to decentralization.

There are no further questions at this time.

Thank you, operator. I would like to remind everyone that a recording of this call is available for the next 24 hours by calling area code 203-369-1806. Additionally, a recording of the call will be available on Republic's website at republicservices.com. Again, thank you all for spending time with us today. Have a great day? Thanks.

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