Republic Services Inc (RSG) — Q1 2015 Earnings Call Transcript

Good afternoon. And thank you for joining us. This is Brian DelGhiaccio, and I would like to welcome everyone to Republic Services' first quarter 2015 conference call. Don Slager, our CEO, and Chuck Serianni, our CFO, are joining me as we discuss our performance. Before we get started, I would like to take a moment to remind everyone that some of the information we discuss on today's call contains forward-looking statements, which involve risks and uncertainties that may be materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations. 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 23, 2015. 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. 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 the recording of this call are 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 events are scheduled, the dates, times and presentations are posted on our website, along with instructions for listening to the live webcast of the event. With that, I would like to turn the call over to Don.

Thanks, Brian. Good afternoon, everyone, and thank you for joining us. We are pleased with our strong first quarter results which were in line with our expectations. The Republic team continues to execute on our long-term strategy designed to generate consistent earnings and cash flow growth, expand margins, and continually improve return on invested capital. Some of our financial highlights for the quarter include, first quarter EPS was $0.49, which included a $0.02 benefit from the timing of our Fuel Recovery Fee. We anticipated this benefit as part of our full year guidance provided in February. Adjusted free cash flow was $241 million, which was in line with our expectations. EBITDA margin was 28.9% and represents a 120 basis points improvement from the prior year. Approximately 90 basis points of the improvement relates to the net impact of fuel and recycled commodities. Core price in the first quarter was 3.7% and average yield was 2.1%. This is our highest level of average yield in over four years. First quarter volumes increased 1.9% with positive contribution from all of our collection and disposal lines of business. We returned $194 million total cash to our shareholders during the quarter. This includes 2.3 million shares repurchased for $95 million. We have $265 million remaining on our existing share repurchase authorization which we intend to complete during 2015. We continue to make progress on our multi-year initiatives that enable us to execute our strategy. These initiatives are designed to profitably grow our business, enhance the customer experience, improve productivity, and reduce costs. By the end of the first quarter, 15% of our fleet was operating on natural gas. 69% of our residential fleet was automated, and 64% of our fleet was certified under our One Fleet maintenance program. Additionally, all of our markets are now using our capture pricing tool. We have trained and implemented our priority based selling program in approximately 60% of our markets. We expect PBS to be fully implemented by the end of the year. And finally, over 700,000 customers are enrolled in our customer portal called My Resource. On February 13, we closed the acquisition of Tervita LLC. The assets provide a platform to expand our presence in the U.S. E&P waste sector, uniting an experienced, high-quality workforce with the Republic team. We are still early in the integration process, but it's going well and is expected. In summary, our strong performance in the first quarter was in line with our expectations and keeps us on track to achieve the full year guidance we provided in February. Consistent with prior practice, we will update our full year guidance on our Q2 earnings call in July. Before turning the call over to Chuck, I want to provide an update on our municipal business. We continue to educate municipalities and expand the use of indices published by the Bureau of Labor Statistics that align with our cost structure. These include the water and sewer and trash collection services index, and the garbage and trash collection index. During the quarter, we converted an additional $40 million of annual revenue, and now we have over 300 contracts representing $110 million of annual revenue using an alternative index. We are still early in the process but very encouraged by our initial success. We continue to offer high quality services and products to our municipal customers. But we must earn an appropriate return to deliver those services. Converting to alternative indices, together with actions we are taking to improve the performance of our municipal business, will take several years to realize the full impact given the long-term nature of these contracts. Chuck and Brian will now discuss our financial results. Chuck?

Thanks Don. First quarter 2015 revenue was approximately 2.2 billion, an increase of 92 million over the prior year. This 4.4% increase in revenue includes internal growth of 2.3% and acquisitions of 2.1%. The components of internal growth are average yield growth of 2.1%. Average yields in the collection business was 2.5%, which includes 4.1% yield in the industrial business, 3.2% yield in the commercial business, and 70 basis points in the residential business. Average yield in the post-collection business was 1%, which includes landfill MSW of 2%. Core price, which measures price increases and net rollbacks to our same-store customer base was 3.7%. Core price consisted of 4.8% in the open market and 1.8% in the restricted portion of our business. Our volumes increased 1.9% year-over-year. The collection business was positive 1.7%, primarily due to an increase in large container industrial volume. Growth in the industrial business was 3.9%, with relatively equal contribution from the permanent business and temporary C&D holes. Volume in the small container commercial business was up 0.8%, and residential volume was positive 1.1%. The post-collection business was up 3.9%, which is comprised of landfill growth of 4.2% and transfer volume growth of 3.3%. Within landfill, MSW was up 5%, C&D increased 10%, and special waste grew 3%. Next, fuel recovery fees decreased by 70 basis points. The change relates to the decline in the cost of fuel which decreased approximately $15 million compared to the prior year. The average price per gallon of diesel decreased to $2.92 in the first quarter from $3.96 in the prior year, a decrease of 26%. The current average diesel price is $2.78 per gallon. Currently, we recover approximately 80% of our total fuel costs through our fuel recovery fee program. Additionally, 20% of our diesel gallons are hedged using financial hedges. At current participation levels, a $0.20 per gallon change in diesel results in a $1 million change in operating income. We realized a $0.02 EPS benefit in the first quarter due to a timing difference between our fuel recovery fee revenue adjustment and fuel expense, which tends to lag by one to two months. We do not expect this benefit to continue in future quarters. Finally, commodity revenues decreased by 100 basis points. The decrease in commodity sales primarily relates to a decrease in recycled commodity prices. Commodity prices at our recycling facilities decreased 17% to an average price of $97 per ton in the first quarter, from a $117 per ton in the prior year. Current average commodity prices are approximately $96 per ton. First quarter recycling volume of 580,000 tons represents growth of approximately 4% from the prior year. Excluding acquisitions, volume was down 5% and below our expectations. This was primarily due to congestion at the West Coast ports. Cost of goods sold for recycled commodities decreased $3 million compared to the prior year, a decrease of 20 basis points as a percentage of revenue. Now I will discuss changes in margins. First quarter adjusted EBITDA margin was 28.9% compared to 27.7% in the prior year, an increase of 120 basis points. Most of the improvement relates to changes in net fuel and commodity which added 90 basis points. The remaining 30 basis points change primarily relates to reduction in risk insurance expense as a result of favorable claims development and continued improvement in safety-related performance. SG&A costs were 11% of revenue, an increase of 70 basis points compared to the prior year. This change includes acquisition-related costs and integration expenses associated with recent acquisitions which included approximately 30 basis points of expense during the quarter. I want to remind you that we provide a detailed schedule of our cost of operations and SG&A expenses in our 8-K filing. Brian will now discuss interest expense, free cash flow, and selected balance sheet data.

Thanks Chuck. First quarter 2015 interest expense was $89 million, which included $11 million of non-cash amortization. Our effective tax rate was 39.4%, which was consistent with our full year guidance. First quarter adjusted free cash flow was $241 million and in line with our expectations. Cash flow can vary quarter-to-quarter based on the timing of working capital. At March 31st, our accounts receivable balance was $930 million and days sales outstanding net of acquisitions was 38 days or 25 days net of deferred revenue. Reported debt was approximately $7.6 billion at March 31st and availability under our bank facility was approximately $1.7 billion. I will now turn the call back to Don.

Thank you, Brian. To conclude our first quarter results, I'm proud of how the Republic team continued to execute our strategy and our strong performance reflects their hard work. We will continue to deliver on our promises to our key stakeholders including our customers, communities, employees, and shareholders. At this time, operator, I’d like to open the call for questions.

Couple of questions for you on the pricing side, so the 2.1% yield is a nice improvement relative to last year. Can you talk about how you see the trajectory for the balance of the year because I believe in the second half there may be some negative impact of the reset of CPI? Do you think we can stay above this 2% level for the balance of the year?

No Alex, we’re sticking with our guidance as we said in our prepared remarks, we think that average yield should still be somewhere around the one-year guidance we gave. There are a couple of things happening in Q1; first of all, we’ve got a little softer quarter last year to compare to, so that kind of flows through our results here, you've got to keep that in mind. Q1 of last year was impacted negatively by weather and other things. We also have had increasingly better pricing on a consecutive basis over the last four or five quarters, and so as we get through the year the comps, the pricing are going to get a little more difficult because we have been improving average yield consistently. So that’s going to be coming up on us. And lastly, we’ve got a lot of pricing actions out there in Q1, specifically in and around recycling. As you know, we were hit pretty hard with commodity sale prices and we’ve taken some pretty serious actions for pricing in the field specifically in and around recycling customers, and that’s all showing up in that yield.

And then just on Tervita, now that we’re into '15, can you provide an update on what you expect the revenue contribution could be from Tervita in '15?

Yes, so we think it is just going to be right where we thought it would be for the most part, had a little tour itself for us, but again we've only owned it for six weeks. We’re really happy with the assets. We have seen, I know everyone sort of read about all of the rig count dropping faster than we expected. We’re seeing a little bit of softness, we anticipated some of that softness in our pro forma, in our budget and our guidance, and the place we're probably being seen the weakest part in net business is the solids control piece of the business, which is coming in a little softer than expected and that’s really got much more of a lower margin associated with it. So I think the real performance of that business is going to be pretty much on track with what we expected as far as cash flow and EPS.

Just wondering if you can maybe talk a little bit more on the commercial side, in terms of trends what you're seeing container waste is going to be like?

Yes, so the container waste is up a little bit, service increases are up but not dramatically. I would tell you what we’re seeing in the business is continuing a broad recovery. Again, we saw it first in the construction demolition and we've talked about that for a year. We’re starting to see a little bit of that improve in and around the commercial business and we’re seeing it frankly in some of our MSW at the landfill as well. So a broader recovery, pretty good solid recovery across all regions, but not a spike, just kind of a steady improvement.

Do you get any sense of slowing or pressure on the industrial side, if we think about domestically speaking the pull back in industrial production? Are you seeing any of that right at this point?

As Chuck said, we’ve got really solid performance both on the permanent side of our industrial business as well as on the temporary side, pretty strong performance. Now remember that we’re going to have some headwind as we go forward on a year-over-year basis because again we’ve been improving that segment of our business pretty consistently quarter-by-quarter. So it's going to be more difficult as we go through the recovery to maintain some of these high growth numbers because of the comps. I mean we would expect to continue to grow but just maybe not at the same rate.

That's great, appreciate the color.

Hey Don, so just, would love to get some color on Capture and PBS, so you know looks like you guys are virtually rolled out on Capture maybe PBS has got a little bit more to go, but it seems like you're getting some traction there, but any data points you could share around the impacts there and maybe through low churn or maybe that spread differential between lost and new business?

So, I won't give you the exact numbers, Tyler, but I can tell you that where we've rolled out Capture and where they've been at it the longest, the price per unit of new sales compared to last year are improving. The Capture also comes in handy and the PBS training comes in handy with retaining business, so reducing net churn from lost business and better negotiating skills with customers on potential reduction of rates when that's necessary, that's improving. So we're seeing impact maturing, which we expected, we're seeing higher rates on new business as expected, and we don't have it rolled out everywhere, as you'd imagine that the divisions that had it rolled out earliest have got better compliance and adoption rates, and it's the ones that have been through more recently that still need to work on that, but we're continuing to improve that, and by the end of the year, we'll be very solid across the entire company both with Capture and PBS will be rolled out, and of course we have enhanced our CRM tool, so those three things together make the sales organization much more effective, much more efficient, and much more professional. And we’ve got the controls in place that we need to further improve churn and new pricing and new sales as well.

Okay, perfect, that's a good color. So you know again, nice quarter here and it seems like again the pricing side maybe has got a little bit of momentum there but it still seems that maintenance and repair really hasn't seen a lot of leverage from One Fleet, maybe I'm missing it and that's very possible here but when would you expect kind of that unit cost inflation on the maintenance and repair side to maybe moderate or maybe even turn negative?

I'm going to let Chuck give you the numbers in a minute, but let me just give you the color again. You know at the divisions that have been in operation the longest, we've seen a reduction in some pretty important metrics. Lower engine cost per hour, we've seen better fleet reliability measured as less downtime. We've seen lower tech turnover; it's pretty hard to find diesel techs these days, so the maintenance shops that have One Fleet installed are better placed to work for those techs, all will be positive metrics. So we know it’s working, and I'll let Chuck talk a little bit about how some of the margins and mix have impacted what you're looking at.

So Tyler, you know it's important to note that the impact that net fuel and commodity has had on the margins overall. We said that it was a 90 basis point improvement in the EBITDA margin, but it has a similar impact in terms of the cost margins; the impact on labor is about 30 basis points. When you look at the impact of that revenue going away, and the impact on maintenance is probably about 10 basis points. The other thing I would note is that it also has had a negative impact on our SG&A as a percentage of revenue to the tune of about 20 basis points, so you're seeing that included in the numbers that you're looking at in our press release.

Okay, yes, that's great. And then Don if I can squeeze kind of a left field question here, but I am very curious about this, so there's been a lot of talk in some of the transportation rags about a Federal highway bill that may add a size and weight provision, which would allow for heavier trucks, and I'm just curious if you guys have ever looked at this or maybe contemplated any potential savings from any big changes on size and weights? I guess maybe thought of another way, do you guys typically cube out or weighed out your transfer trailers?

Yes, we generally weight out the transfer trailers, these are 52 foot trailers now, really mega capacity, so we work within the compliance of the current regulations for gross vehicle weight. Generally speaking, we max out the weight before we max out the space in the trailer and the same thing in our hauling fleet, our collection fleet. They can generally handle more weight than which is allowed under the regulation, so we live within the regulations today, we haven't looked a lot at what refining those would do for us. I don’t know where that bill stands or how much traction it's got but we haven’t spent a lot of time on that Tyler.

As left field, I was just curious, thank you.

A question for you on your residential business, if I just use the 552 million that you give in the release in terms of revenue, you're looking at about a 2.6% growth rate in that business and if my model is right that looks like it's the highest growth since the last cycle. Can you maybe just put some parameters around that growth, are you seeing any changes within the organic growth rates there or is it some of the small tuck-ins just starting to add up?

One thing Joe to remember too as well is that that's going to include acquisition growth as well, so when you think about things like, you know the Rainbow franchise and some of those things that we acquired, it's not just organic growth, it's also going to include acquisition growth as well.

Yes and that’s why I was asking if you could just flush out maybe the difference between organic and inorganic, I mean have you seen any sort of change in the growth rate for just the organic component?

I would say as far as unit growth within current contracts, we haven’t seen any real surge there. That business tends to be a little lumpy because these are generally in the residential business five-year contracts. We do have a couple of new contracts from organic growth in the mix today. But we budget every year for a little bit of new business and some lost business in that contractual base.

So it sounds like probably no inflection point from new home formation or anything like that though?

Not in the ordinary.

Relative to the SG&A, I think Chuck you called that earlier that there was some integration expense that was included in the SG&A. I'm curious what a decent run rate for the salary side is, should we expect about 30 basis points of headwind over the next couple of quarters? I know you’ve got some additional integration with Tervita. Is that a decent run rate?

We’ve stated -- we’ve got some continued headwinds with Tervita with acquisition-type costs. I think overall for the year we expect that SG&A as a percent of revenue is going to be a little bit in excess of 10%, but I would tell you that longer-term for the company we feel that 10% of revenue is a comfortable spot for us in terms of SG&A.

Yes, and the other thing to remember Joe is that the impact of lower fuel recovery fee and lower commodity prices doesn’t have a cost offset in SG&A. So as a percent of revenue, that gives us about a 20% increase as a result of the decline in those revenues.

I am trying to get my hands around your recent guidance in the middle of the year, but you got off to a pretty good start. There are a couple of numbers that I'm like, okay, this is going to do weird things in the second half of the year if I’m holding one and a half price, it feels like it’s got to walk itself up to some. And then you had a 2% to 2.5% revenue growth rate, but that was before Tervita, so I got to assume that number has got to change anyway, right? I'm struggling with -- you're not changing your outlook not even sort of being a little more optimistic about we feel really good about the outlook.

Yes, so let's say this, we feel good about what’s going on in the business I think our comments reflected that. We got some good things going on, our initiatives all have traction, we completed the rollout of Capture, we’re on track with their other major initiatives, we talked about some of the broader base recovery we’re seeing in MSW at the landfill, and commercial business starting to tick up a little bit, all that’s good. Tervita is going along fine, a little headwind there. Again, this was pretty much what we expected when we gave you guidance only two months ago. There are some anomalies, and remember that we even though we had to take a pretty big hit year-over-year in our guidance from standpoint of recyclables, we’ve actually -- they are actually weaker than we planned, and you see that there in the numbers. So we’ve got that as a headwind remaining on the year, and you don’t know what’s going to happen there just yet. So we still have to overcome three more quarters of a pretty tough recycling commodity market. We are getting traction in the programs. Remember, last Q1 was pretty weak with the adverse weather, so this quarter is a fairly easy comp. Again, we got the $0.02 from fuel that’s going to go away. So we had a good quarter and solid quarter, and we’ll take all the credit for that, but it's just too early to talk about year-end at this point. And again, as we get through the year remember we've been growing and improving price every quarter sequentially in the past four or five quarters, and so as we go through the year and comp the last year, those comps are getting a little tougher on year-over-year growth, so just keep that in mind.

Are you retaining more of the price that you're putting in the street this year than you were last year?

We are, we’ve gone out with a little more pricing in the open market, and we’ve also gone out pretty strong with price increases this year in the open market to our recycling customers because the market hasn’t held up. And remember this, we already know about what our price is going to be in our restricted base, that is what it is, and we’re trying to combat that with the new indices. And again having some pretty good traction there. So I can’t predict today what the open market is going to do into Q3 and Q4. I would like to think that it's going to hold up fine as it did in Q1, so we’re going to continue to maintain the kind of level of actions we’ve taken in Q1. We’re not going to relax our pricing position, and we’re going to continue to expect more from the tools. But lot of extra price you see there is coming from open market actions and a lot of it coming from the recycling business. And we can’t go back and price that again, that was sort of a one-time step up.

You got to clean up the difference between the commodity and what you're charging.

Thank you, Sheila. I would like to thank all Republic employees for their hard work, commitment, and dedication to operational excellence and creating the Republic way. Thank you for spending time with us today, and have a good evening.