Republic Services, Inc.
Q2 2011 Earnings Call Transcript

Published: 28 Jul 2011

[Operator:]

Good afternoon, and welcome to the Second Quarter Conference Call for Investors in Republic Services. Republic Services is traded on the New York Stock Exchange under the symbol RSG. Your hosts for this afternoon's call are Don Slager, President and CEO; Tod Holmes, CFO; and Ed Lang, Republic's Senior Vice President and Treasurer. Today's call is being recorded. [Operator Instructions] At this time, it is my pleasure to turn the call over to Mr. Ed Lang. Good afternoon, Mr. Lang.

[Edward Lang:]

Thank you, Holly. Welcome, good afternoon, and thank you for joining us. This is Ed Lang, and I would like to welcome everyone to Republic Services' Second Quarter 2011 Conference Call. Don Slager, our CEO; and Tod Holmes, our CFO, are joining me as we discuss our second quarter performance. Before we get started, I would like to take a moment to remind everyone that some of the information that we 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 July 28, 2011. 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 expressed written consent of Republic Services is strictly prohibited. With that, I would like to turn the call over to Don.

[Donald Slager:]

Thanks, Ed. Based on our second quarter performance, Republic Services is on track to achieve record levels of earnings and free cash flow. Financial and operational highlights include

[Tod Holmes:]

Thanks, Don. Our second quarter 2011 revenue, as Don indicated, was approximately $2.1 billion. The change in revenue from the prior period includes the following

[Edward Lang:]

Thanks, Tod. Q2 2011 interest expense of $111 million includes $18 million of noncash amortization. As we continue to refinance our debt, the portion related to the allied debt discount of $5 million will decline. On May 2, Republic issued $1.85 billion of long-term debt to refinance existing maturities. The newly issued debt consists of

[Donald Slager:]

Thanks, Ed. Before we get to Q&A. I would like to update our guidance for 2011. We are reaffirming our adjusted EPS guidance of $1.86 to $1.89. This reflects earnings growth of approximately 10% compared to 2010. We expect adjusted free cash flow will be $875 million to $900 million. We are maintaining this guidance, although we are increasing capital spending to take advantage of bonus depreciation. This increase is primarily a pull forward of 2012 truck capital. At our next board meeting in October, we expect our board will approve a new share repurchase authorization for 2012. At this time, operator, I would like to open the call to questions.

[Operator:]

[Operator Instructions] And our first question comes from Hamzah Mazari with Credit Suisse.

[Christopher Parkinson:]

This is Chris Parkinson on behalf of Hamzah. Just very quickly, on the pricing front, can you comment on what you see in terms of rollbacks and any further price discounting by regional players that you maybe didn't see in the first quarter? And then also, how do you think about pricing on a sequential basis in the back half?

[Donald Slager:]

Yes. I'll let Tod take the second half of that question on the sequential price for the second half. This is Don, by the way. We have -- since we talked about it on the first quarter call, we are seeing some pressure on the municipal contracts that are rolling through. We have done some surprise rollbacks, some reextensions of business and flat rates to extend that business going forward. We have been taking a very strong approach in protecting our current business. And when competitors are calling, we're fiercely defending that business. We've got a great business with good, strong margins and cash flow. So job one of Republic is to protect the cash flow we have and then grow the cash flow from there. So we have seen some competitive activity out there. It's probably not too unusual, based on the fact that the economy has been -- has long and deep and a downward trend that it's been. So we've -- we're holding our own. And we think there are better days ahead. As far as pricing goes, we're still in the marketplace every month, effectively pricing our open market business. As Tod said in his comments, our open market MSW price and the landfill is 4 -- between 4% and 5% in the quarter. So we're very actively in the market every month in the open market, raising prices and very effectively defending our business accordingly.

[Tod Holmes:]

Yes. On the second half, well I would add to Don that if we look at our collection business, all lines of our collection business on a unit basis, our revenue per unit is up. And as Don indicated, we're protecting both existing business and keeping it at good returns. And the business that we acquire is also at good returns. As Don said earlier, we're using our ROI pricing model. If we look at the first half of the year, our pricing was about 1%. If we look at the second half of the year, what we're saying today is there will be a modest step-up in pricing, and we believe it's in the range of 1% to 1.5%. This is primarily coming from the higher CPI environment, the anniversary-ing of lower CPI from prior years. So as we look ahead to '12, we would expect to see further step-ups to the CPI, and it's just inherent in our base of business.

[Christopher Parkinson:]

Perfect. And then also on the volume front, could you just quickly remind us on any areas where you're seeing greater-than-expected volume losses? And whether or not you're seeing others gaining share? Or is it largely economic driven? And then also if there's any weather impact during the quarter?

[Donald Slager:]

I think that was 3 questions.

[Christopher Parkinson:]

Sorry, my apologies.

[Tod Holmes:]

That's fine.

[Donald Slager:]

Yes, I don't know that I would name any one area that we're losing share in a great pace or any one person. We think that the larger companies tend to be more active in the pricing environment, trying to increase the returns of their business. We've seen more activity, frankly, from some of the small haulers, who are maybe living for today or are looking for an exit strategy at some point in the business. So that's probably not much different than it's been, historically in the waste business. But you have had an economic downturn here that's lasted very long, and you don't see any organic growth in the market really happening and that causes some strange behavior at times. But we'll weather this storm and we'll continue to price, and we'll see our way through it.

[Tod Holmes:]

And to your question, first of all, weather, there really is no weather impact for us. I mean there's been events that have occurred, whether it's flooding or tornadoes, but net-net, it really hasn't impacted our business much, one way or another. I think it kind of comes back to what Don talked about with the economy being weak for so long.

[Operator:]

The next question I'm showing comes from Scott Levine with JP Morgan.

[Scott Levine:]

So I'm looking at the assumptions behind the guidance you initially provided in February. I mean, it looks like price, you guys are looking at 1% to 1.5% for the year, it's kind of coming in line maybe towards the lower end, but within the range. Obviously, recycle commodities are doing better than you guys initially expected. And you guys are initially looking at volumes being flat to slightly up. Should we assume after the first half of the year that it's a bit lower? Maybe you can comment with regard to your views on how the macro side of things has played out in the second quarter.

[Donald Slager:]

Yes. So we're still looking for volumes to be flat to slightly up. As we said, pricing maybe, like you said a little softer, but still in the range. And then as far as the economy goes, a bright spot, as I said in my notes. It's 5 sequential quarters of volume improvement in the collection lines of business. So we're creeping forward in the right direction, maybe not as fast as we'd hoped at first, but directionally, we're still good. And then, a bright spot for us in Q2 was we gained some speed through the quarter of -- in the roll-off halls and units. And so May was a little softer. And then we kind of picked up some speed in June there. So it -- we're looking at that to hold up for us. We saw probably, geographically, a little more improvement in the south part of our company than maybe we'd expected because for so long, the south and the west had been weaker than the Midwest and in the east. The south is making a little bit comeback there.

[Tod Holmes:]

Scott, I would add, when you look at a price and the volume side of the equation, the net result of what's happening there shows up in the margins. We've got strong margins. If it weren't for fuel, we would probably be at or above our target now. You could also maybe net against that commodity prices. But we're basically on track with where we thought we would be from a margin standpoint, which I think indicates that the other components of pricing and volume components of our business, while it's a tough economy, are still pretty good.

[Donald Slager:]

Yes, and that we've got a great operating team. They're out there, really doing a great job, controlling unit costs and getting productivity. So we're holding up pretty well.

[Scott Levine:]

Got it. Maybe to follow up on fuel, Tod, now that you mentioned that. Can you remind us whether you have any hedges on or whether your thoughts are maybe in terms of hedging out some of that exposure with synergy prices remaining as high as they are?

[Edward Lang:]

Scott, this is Ed. We have a small amount of our fuel hedged in for '11 and '12, but it's less than 5% of our total exposure. And the average rate that we have for the hedge this year is $3.66. It's a little bit lower than that for the small amount we have hedged in '12. We are looking at the energy markets, but unfortunately, given almost this day-to-day volatility in the pricing, it puts a -- makes some of the cost of the hedging fairly expensive as far as the -- how it gets priced out because of the market volatility. But it is something we continue to look at, and we will try to be opportunistic, if there is an opportunity for further hedging for '12 and '13.

[Donald Slager:]

And in the meantime, this recovered fee works pretty well for us, we talked about before as a natural hedge.

[Operator:]

The next question comes from Al Kaschalk with Wedbush Securities.

[Albert Kaschalk:]

First, the easy question, I guess in my view. On special volumes, could you talk about -- last year, I may have missed what the event was and then if it was also a part of the Gulf or -- and then this year, what are you seeing in terms of special volumes that may be helping to drive...

[Donald Slager:]

Yes, we really don't have much from the Gulf issue last year in special waste. And we did a couple of big jobs. We talked about the military base job in the West Coast, the pesticide contaminated soil then a large regulatory clean-up in. . .

[Tod Holmes:]

We had a refinery in the Midwest in the second quarter, also in the Central region.

[Donald Slager:]

That's right.

[Tod Holmes:]

Al, if you were to look at last year's special waste volumes, our second quarter, we had kind of a peak in special waste volume activity in the second quarter of last year. And then we had another -- and this was because of a refinery cleanup project in the Midwest, I think. And then there were some other -- the other things that Don mentioned on the West Coast were also a factor. And then in the fourth quarter, we had an even larger peak, and that was due to the Camp Pendleton in Southern California and Tronics, which was a clean-up EPA-mandated in Las Vegas. So as we look at our volumes this year, I think the difference is, we believe we will meet or exceed the total volumes for last year, but we're doing it with a broader base of smaller jobs, which is actually a good thing. It shows maybe the purse strings are loosening up a little bit with some of these companies for some discretionary spending.

[Donald Slager:]

Right. Al, you know that special waste volumes by quarter, always very lumpy. So you've got to walk through that, as Tod did. We feel pretty strong about the volume side of things, and pricing is holding up well in special waste. So that does bode well for the economy, we think.

[Albert Kaschalk:]

Right, okay. And then my follow-up, if I may, Don. Given now the so-called honeymoon's over 6 months into it, I was wondering if you could just maybe take a step back and give us an update on the CEO chair there, and specifically maybe some of the markets you're doing your multiyear plan on? And how you're feeling about some of these goals you've set out, trying to stay away from the quarterly numbers for a second.

[Donald Slager:]

Yes, well we feel really good about the goals for the year. We feel good about some of the major initiatives that we set out. A couple of them are maybe moving a little slower than we'd like. We're just as committed to them as we've been, I think they have real value. The organization is operating very well. The team, we've got a top-quality team here. So all things are go, and I'm actually feeling pretty good about it. So I didn't know the honeymoon was over yet.

[Albert Kaschalk:]

Could you comment about maybe the industry segment of recycling and how you are evaluating that? Have you made any decisions in terms of whether you're accelerating or just progressing, as prices remain high here at a couple of the...

[Donald Slager:]

So what I would tell everyone is when we think about our company, it's 243 marketplaces. Yes, we're in 40 states, in Puerto Rico. And we're organizing 4 regions, 28 areas. But what's really important about the business is the 243 markets are all uniquely different. And so when we think about how we're going to improve the business on a day-to-day operating side, we think about how we do maintenance or how we do safety or how we move toward automation. Those things are very similar everywhere across those 243 markets. But when you think about how we invest and grow the business, those markets are very uniquely different, and they're different because they're different competitors, different asset structure, different market dynamics, different regulations and so forth. So as it relates to recycling, when we talk about the investments we're making in recycling, they're not everywhere, because the tons aren't moving in the same way everywhere. So what we've done, the team's done here is evaluated 243 markets. We've identified 25 markets, about 10%. And we think we need to develop more capability in, in and around recycling because we think the market would benefit and the customers are willing to pay for recycling. They're interested in recycling so there's some customer demand. So what we've done in our original plan this year is we set aside about $25 million to invest in about 5 markets to begin to move that business forward. And we may, by the end of the year, invest a little more than $25 million. But we're doing it very, very, very cautiously, if you will, making sure that we're learning along the way in how we're going to do with it best. And we've prioritized the markets accordingly. So we're excited about it, the team's actively involved in it. And we're convinced that in some of those markets, the ton is evolving, and there is more recycling and diversion possible. It's not happening very rapidly, but it's important for us to be in that space. And so we're trying to bring all the solutions we need due to our customers through that. So I have a long answer to your question, but we're engaged in it. We're excited about it, and it's right smack in the core of what we do. We look at it like we own the waste stream today, and we want to own it tomorrow even as it changes.

[Operator:]

Michael Hoffman with WSI.

[Michael Hoffman:]

We'll be looking for the book signing on how to run a garbage company. On the free cash flow, just so I'm clear, the $875 million to $900 million, I realized is just what you gave before, but the language of excluding legacy tax benefits, what do you think the upside is from that in the remainder of the year? And on that gain, there's a fair amount of working capital use in the first half that swings to the second half. Where's the flexion up in the model and the cash from op side that would create some upside to this outlook on free cash flow?

[Tod Holmes:]

Well again, we're comfortable with the $875 million to $900 million, and there's 2 offsetting items. We've got a greater capital spend because we're pulling forward some of the capital to capture bonus depreciation. There's a tax shelter associated with that. Also we closed out some of our open tax issues. And so we're going to get a favorable benefit from our cash taxes. So those 2 are kind of neutral. So even though CapEx is going up, the cash tax is going to offset that. You asked about the first quarter working capital. Typically, what happens is we end up with a fair bit of capital spend at the end of the year, which moves up our accounts payable. So you'll see a reversal from the first half to the second half of the year working capital, and we're very, very comfortable with the cash flow guidance we've given, staying within that range, despite the fact that we're going to spend a little bit more this year with the pull-forward truck capital.

[Michael Hoffman:]

Okay. And then, the second question. So interest rates, probably, never be as low as they are today, probably in our business lifetimes. And the group has other public companies, but has underperformed. And there's some pretty cheap valuations out there. Is there another big transaction in Republic's horizon?

[Donald Slager:]

Yes. Michael, we look at everything that's out there, large and small. And we're doing a great job today having successfully integrated 2 very large successful companies. We're very proud of the team and their ability. They're very good at what they do. And again I think people would tell you that a lot of folks thought it could be done. I think we've really shined in the process, so we know we can integrate businesses. And we're doing a good job today on tuck-ins and bolt-ons. For a long time there, we were busy integrating the big business. And now we're reengaged out there in small tuck-ins, and we're pretty excited about our area of presence, are bubbling up some really good local opportunities so we can fill out some of the, sort of the missing pieces, if you will, in various markets. And so we're always open to ideas and looking at anything that's out in the market that fits our profile.

[Operator:]

Corey Greendale with First Analysis.

[Corey Greendale:]

Question. First, Scott Levine actually asked this question, but I wanted just to clarify the answer. Do you still think that for the full year volume will be at least flat?

[Tod Holmes:]

Full year, I think, because of where we were in the first half of the year, the full year number would be slightly negative. But the second half, again, we think we're going to exit the year positive.

[Donald Slager:]

Exit speed is important here, so we're moving through the year, and I think we're setting ourselves up a pretty good spot for '12.

[Corey Greendale:]

Understand. The second question I had is, I understand in terms of incremental returns that you're doing exactly the -- what makes sense in terms of pricing. From a bigger picture perspective, I think there's been this thought that the -- just taking kind of a big picture view, that from a gain theory perspective that if you start to see larger companies be more aggressive in pricing downward that, that's kind of obliges others to do the same, and you wind up in more of an aggressive negative pricing spiral. So can you just speak philosophically about why you think we're not at the beginning stages of something like that occurring again?

[Donald Slager:]

Yes, I will talk to you about that. First, take a look -- I'll just remind you. Look at our EBITDA margins, 31-plus percent. So I think that reflects a lot of things about our company. One, certainly the asset base we have and operating capability of our people, but we watch very keenly, pricing and the return on our business. And so we're pretty proud of that margin. And I think there's some folks who'd like to have that. As far as pricing goes, again, there is no organic growth in the marketplace. And so when you took your first economics class in high school, it's kind of supply/demand and you get that, right? It's been really long, really deep. So some of the smaller folks out there in the marketplace, get a little twitchy, and they start doing some silly things. And you can only stand by and watch it for so long. There's a couple of things going on simultaneously at Republic Services, and we've talked about this before. First, we are steadily, consistently, continuously pricing our business. So in the open market, we are every month in the market, pricing our business in all lines of business in the open market in every geography in the company. And we call it ratable pricing. And we go through the year constantly through levering up and down, if you will, depending on the market dynamic, but pricing consistently in the marketplace. So we haven't stopped that practice. When -- sometime last year, we started talking about defending the business more staunchly, and we had the team out there using ROI tools, knowing what our cash costs are and defending a very good business space. So we might have been more willing to walk away from this business 2 years before that. And then we start to defend business, say business at a lower rate in some cases. It's going to show up on our price metric. We didn't lose the volume, we keep the volume at a lower price per unit even though it's profitable, and there's good cash flow associated with it. As an owner of our business, you want us to do that. You want us to protect that cash flow, and we do it very well, probably better than we ever have. But that's going to show up in what we report as price, right, Cory? So the third thing we're doing out there is we're selling, right? And we're out there in the marketplace and we're looking for new opportunities as well. And we may -- we're going to compete vigorously with everybody in the marketplace, just like we always have. And there are some markets where we're losing share to 1 or 2 smaller competitors, and we may be more aggressive in a couple of those cases because we can't just stand idly by. So we have not changed our pricing strategy or focus. We have not changed our return focus, but we're simultaneously pricing, saving business and competing in the marketplace. Now when you do all the math of all the mix by type and line of business and geography and the saving and the churn, that's putting some pressure on the price metric. But the activity and the philosophy and the strategy has not changed. But there's a lot of mix and math that caused those numbers to be what they are. Now full circle back to the first statement I made

[Tod Holmes:]

To the concern that you stated, I don't think we see a dramatic shift in the marketplace at all. We view the marketplace as being fairly stable. It's just a question of a long, slow, flat economy.

[Corey Greendale:]

Yes, I understand that. And I'm sure, you said all that before, but I still think it's helpful to hear it again.

[Operator:]

Bill Fisher with Raymond James.

[William Fisher:]

Just quickly on -- Tod, I think you mentioned the landfill lines are down 1.8%. Does that exclude Toronto, do you know?

[Tod Holmes:]

Yes, that would exclude Toronto.

[William Fisher:]

Okay. And you mentioned some color on regional via roll-off and the South was doing better. I was just curious on some other markets like California, something that has been probably more down or if any of those are getting kind of less bad, if you will, as you move through the quarter?

[Donald Slager:]

Yes, we're getting -- I'll use your term, Bill, we're getting less bad everywhere as it relates to volume. So it's a broad brush. I just highlighted the South because they've probably picked up a little bit quicker than the other 3.

[William Fisher:]

Okay, great. And just actually quickly, do you have -- if that has a tax rate or something for the second half that moves around a little bit?

[Tod Holmes:]

Yes, we're expecting our second half effective tax rate to be approximately 41%.

[Operator:]

Thank you. That is all the time we have for questions today. I'll now turn the call over to Mr. Don Slager for his closing remarks.

[Donald Slager:]

In closing, thanks, operator. I would like to thank the entire Republic team for their efforts and resulting performance in the second quarter. We remain, as always, focused on the business fundamentals required for our continued success. As a reminder, a recording of this call is available through August 5, 2011, by calling [phone]. Additionally, I want to point out that our SEC filings, our earnings press release, which includes GAAP reconciliation tables and a discussion of business activities along with a recording of this call, are all available on Republic's website at republicservices.com. And finally, I want to remind you that Republic's management team routinely participates in investor conferences. When presentations are scheduled, the dates and times are posted on our website along with instructions for listening to the live webcast of the event. Thanks, everyone, for spending time with us today. Have a good evening.

[Operator:]

Ladies and gentlemen, this concludes the Republic Services conference call for today. Thank you for participating. You may now disconnect.