Waste Management Inc (WM) — Q4 2018 Earnings Call Transcript

Thank you, Sia. Good morning, everyone, and thank you for joining us for our fourth quarter 2018 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; John Morris, Executive Vice President and Chief Operating Officer; and Devina Rankin, Senior Vice President and Chief Financial Officer. You'll hear prepared comments from each of them today. Jim will cover high-level financials and provide a strategic update. John will cover an operating overview. And Devina will cover details of the financials including guidance for 2019. Before we get started, please note that we have filed the Form 8-K this morning that includes the earnings press release and is available on our website at www.wm.com. Form 8-K, the press release, and the schedule to the press release include important information. During the call, you will hear forward-looking statements, which are based on current expectations, projections or opinions about future periods. Such statements are subject to the risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K. Jim and Devina will discuss our results in the areas of yield and volume, which unless otherwise stated, are more specifically referenced to internal revenue growth or IRG from yield or volume. All fourth quarter volume results discussed are on a workday-adjusted basis. During the call, Jim and Devina will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share, and then also address operating EBITDA, which is income from operations before depreciation and amortization, and operating EBITDA margin. Any comparisons unless otherwise stated will be with the fourth quarter of 2017. Net income, effective tax rate, EPS, income from operations, and operating EBITDA for both the fourth quarter and full-year of 2018 and 2017 have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations. These adjusted measures in addition to free cash flow are non-GAAP measures. Please refer to the earnings press release notes and schedules, which can be found on the Company's website, at www.wm.com, for reconciliations to the most comparable GAAP measures and additional information about the use of our non-GAAP measures. This call is being recorded and will be available 24 hours a day beginning approximately 1 p.m. Eastern Time today until 5 p.m. Eastern Time on February 28. To hear a replay of the call over the internet, access the Waste Management website, at www.wm.com. To hear a telephonic replay of the call, dial 855-859-2056 and enter reservation code 6496795. Time-sensitive information provided during today's call, which is occurring on February 14, 2019, will no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited. Now, I'll turn the call over to Waste Management's President and CEO, Jim Fish.

Thanks, Ed. And thank you all for joining us this morning. At this time last year, I was telling you that 2017 was arguably the best year we've seen. I'm pleased to report that 2018 results were even better. Through our continued focus on customer experience, cost management, and price discipline, to name a few, we had a great year. For the year, the business produced a record high in operating EBITDA, which is the best reflection of the health of our business. We grew operating EBITDA by more than 5%, in spite of the strongest recycling headwinds we've seen in over a decade. Overall, in 2018, we produced $4.20 of EPS, another year of double-digit improvement. Devina will cover our 2019 guidance in more detail, but we are forecasting another record year in operating EBITDA this year with our growth rate expected to be about 5%. Included in our 2019 forecast is our expectation that the strong recycling headwinds from last year will turn into a tailwind, thanks to our focused efforts on reducing operating costs in our plants and charging fees for contamination. To the extent that Waste Management is a good proxy for the overall U.S. economy, our 2019 guidance of another record year in operating EBITDA clearly demonstrates the strength of our own business and of the economy as a whole. As we mentioned, our operating EBITDA is the best reflection of the health of our business, and our strong growth translated into the strongest free cash flow we've seen ever, with the exception of 2014 when we sold our waste energy business. We allocated close to 90% of that free cash flow to shareholder returns, growing our dividend for the 15th consecutive year and spending $1 billion on share repurchases. We also spent $466 million on acquisitions, an indicator of the active M&A environment we’re in and our ability to complete transactions at our targeted returns. In 2018, we continued to focus on our people, disposal optimization, technology, and profitable growth, all about delivering exceptional customer service. Our strong 2018 results validate that our execution on our focused differentiation and continuous cost improvement strategies drive strong growth in our business, and we expect further progress in 2019. Our strategic direction in 2019 will look very much like 2018, as we move forward with a cultural transformation that places Waste Management employees at the head of the class in terms of focus and importance. In December, we announced the hiring of our Chief Human Resources Officer, Tamla Oates-Forney, who was formerly an HR executive at GE. Tamla is moving forward quickly in putting world-class processes in place, upgrading talents, and helping to direct this valuable cultural shift at Waste Management. Similarly, after only 15 months under the leadership of Nikolaj Sjoqvist, our new digital team is beginning to show how our investment in operating, customer-facing, and back-office technologies, as we migrate towards more agile cloud-based systems, can serve to differentiate Waste Management going forward and propel profitable growth. Lastly, on the strategic front, our 2019 sustainability forum, which was held two weeks ago in conjunction with the Waste Management Phoenix Open, broke all previous forum attendance records and built on our message of sustainability, which is collectively good for the environment, good for our customers, and good for our investors. That's best demonstrated by the shift in our fleet from higher cost, higher emission diesel trucks to quieter, much cleaner burning, lower cost CNG trucks. To complement and aid the shift towards sustainability and benefit from the geographic breadth of our landfill assets, Waste Management is investing in higher return energy plants at our landfills in 2019 and beyond. This investment provides an avenue to close the loop between our renewable energy plants and CNG fleet, creating favorable returns for the Company. Our strategic focus on people, technology, and growth to a superior customer experience is moving Waste Management from a leader in the waste business to being a leader in the Fortune 250. That was no better acknowledged than with our recent recognition by Fortune as one of the world's most admired companies. Finally, as part of our strategic growth plan, we will continue to invest in acquisitions that surpass our return criteria and create value for our shareholders. Our pipeline looks robust, and there are plenty of opportunities to invest in acquisitions at a rate similar to what we achieved in 2018. So, in 2019, we expect another year of above-average M&A activity. To that point, you may have seen that we recently received Hart-Scott-Rodino antitrust clearance to proceed with the acquisition of landfill assets in West Texas. We will be buying these assets at an operating EBITDA multiple well below our trading multiple, and we’re excited to integrate this core Waste Management service offering. We hope to close in March and we will provide additional details once the deal is closed. In summary, our hardworking employees made 2018 a very successful year, and we expect to see strong growth again in 2019. We will continue to make investments in our employees, technology, and capital equipment this year to further grow our business, improve customer service, and generate strong returns. We are confident that these investments will position us well for 2019 and into the future. And with that, I'll turn the call over to John and Devina to discuss our results and our 2019 guidance in more detail.

Thanks, Jim, and good morning. We're very pleased with our fourth quarter results, as we executed extremely well on our core price disciplined growth strategies. Our industry-leading organic revenue growth continued to drive strong income from operations and operating EBITDA growth, both grew 7% in the fourth quarter. Throughout 2018, and particularly in the second half of the year, we've been very focused on our pricing programs to overcome inflationary cost pressures and grow margins. As we continue to experience cost pressures in 2019, particularly labor, transportation, and landfill operating costs, we will ensure that these increases are being passed along to our customers so that we can continue to generate appropriate returns and grow margins. This strategy is best demonstrated by our collection line of business. We generated strong growth in 2018 and expect that trend to continue into 2019. As we think about the year ahead in our collection line of business, we expect to see the benefit from our investments in people, fleet, and technology. First, as Jim mentioned, focusing on our people is the most important priority in 2019. Last year, we invested a portion of our tax savings in our employees, and this year, in addition to upgrading and automating our fleet, we will continue to invest in our employees through proactive wage increases, facility improvements, and additional training at our driver and technician training facility, which will open in the first half of this year. In regard to fleet investments, 2018 truck purchases and further fleet investments planned in 2019 are beginning to drive meaningful improvement in our maintenance costs. By the end of 2019, we expect to have over 60% of our routed vehicles running on natural gas, and we know there is a significant maintenance savings with natural gas compared to diesel trucks as they age. 2018 proved to be another solid year with respect to our efforts around continuous improvement and modernizing the work environment for our employees. We believe the steps we’re taking to move towards an automated fleet will continue to drive not only safety performance, which is paramount but also meaningful efficiency and employee retention. This was again validated with several recent contracts that we were able to convert from the traditional rear-load model to an automated sizeable service offering. We recognized almost immediate improvement in all of those critical elements of our performance. We are also advancing our fleet strategy through partnerships with the truck manufacturers to implement the same safety technology we have in many of our cars today. We are looking to implement features like lane departure warnings, brake assist, and collision detection, which are worthwhile for enhanced safety alone, and they have the added benefit of making our operations more efficient as we avoid lost time and costs associated with incidents. Finally, the use of technology is important to the continued growth of our collection business. We've been collecting and using data from the technology on our vehicles to anticipate and respond to our customer’s growth and needs. This is translating into lower customer churn, volume growth above U.S. economic levels, and it's creating value for our customers and shareholders. Looking at our disposal network, as we have discussed, we have the best positioned assets in North America but we are seeing cost pressures from our third-party haulers at our transfer stations and higher landfill operating costs. We’re focused on disposal pricing opportunities that will continue to create healthy margin in a rising cost environment. In addition, we look to continue to make technology investments, like our pilot with Caterpillar for remote-operated equipment, that will continue to increase the returns in these valuable assets. Turning to recycling, we performed well in the fourth quarter as a direct result of our continued focus on improving operating costs, restructuring our municipal contracts, and successfully battling contamination. In 2019, we will look to continue to improve in recycling by investing in the MRF of the future to further enhance operating costs and optimizing our plans by being thoughtful about meeting our customers' requirements. In addition, we will continue making progress on reducing contamination, assessing fees to cover our cost of service, and reduce our costs of managing materials. Last week, we closed on an above average amount of acquisitions in 2018, and as Jim mentioned, the pipeline looks strong for 2019. Integrating these acquisitions is a key priority for our operating teams to ensure we manage cost, extract the value of these transactions, and deliver superior service to our customers. I'm excited about the future opportunity for Waste Management, as we believe that focusing on our people, optimizing our disposal network, better using technology, and growing our business will provide strong returns for many years to come. I'll now turn the call over to Devina to further discuss our financial results and 2019 outlook.

Thanks, John, and good morning, everyone. Our fourth quarter results were in many ways the strongest we saw all year, allowing us to close our 2018 on a strong note as we either met or exceeded all expectations. I'm going to start by reviewing those results in detail and then turn to our outlook for 2019. Our top two financial priorities are growing operating EBITDA and leveraging that growth to convert more earnings to free cash flow. In 2018, we delivered on each of those priorities. Operating EBITDA in the fourth quarter grew on a year-over-year basis by more than 7%. For the full year, operating EBITDA was $4,216 million, over a 5% increase from the prior year and in line with our original guidance, in spite of a recycling headwind that was far greater than we could have predicted. We converted every dollar of operating EBITDA growth into incremental free cash flow in 2018, growing free cash flow to $2,084 million, that's an increase of over $300 million or almost 18%. This is higher than expected as the strong performance in the traditional solid waste business was supplemented by the sale of over $200 million of non-strategic businesses and assets over the course of the year. While these proceeds are always a part of our free cash flow measure, in 2018, the amount was over $100 million more than we expected. So, as we normalize for this difference, the result is free cash flow of about $1,975 million, right in the middle of the guidance range that we gave at the end of the third quarter. These results highlight the value of our balanced execution of disciplined pricing and targeted volume growth. In the fourth quarter, organic revenue growth in our collection and disposal business was 5.8%. Achieving this result in the fourth quarter of 2018 is particularly impressive on the volume front when you consider the year-over-year comparisons we were facing given 2017 hurricanes volumes. Our notable volume performance has been driven by our commercial collection business, and our focus on customer progress has reduced our churn to 8.6%, which is over a 100 basis-point improvement from the prior year. We have also seen service increases continue to outpace service decreases, making this the sixth consecutive year for us to achieve that result. And we are happy to see momentum on that front build. In the landfill business, volume growth has been driven by strong C&D and special waste volumes, both of which grew by double digits in the fourth quarter. As we have discussed on prior calls, the California wildfire volume contributed to the increase in our C&D volumes, which we expect to continue into 2019. We never like to see events like this occur, but we have positioned ourselves particularly well as a strong community partner for those devastated by the fires and, as a result, expect that we will continue to see significant fire volumes into 2019. However, given the magnitude and uncertainty inherent in this effort, we have not specifically considered these volumes in our 2019 outlook. Turning now to cost and margins. In 2018, our operating expenses as a percentage of revenue were about 62% for both the fourth quarter and the full year. There were a number of variables that impacted the comparability of operating margins in 2018, but when we isolate the impact of the revenue accounting change, the special benefits we paid to our frontline employees and recycling, we are pleased with our operating expense margins improving for the year in spite of higher third-party transportation and labor costs. These results tell us that we are growing in the right ways, executing our pricing programs to cover cost increases, and creating incremental margin, and continuing to operate more efficiently. In 2018, our SG&A costs as a percentage of revenue were 9.6% for the fourth quarter and 9.7% for the full year. This is the first time since 2005 that full-year SG&A as a percentage of revenue has been below 10%. In fact, when you compare our 2018 SG&A costs to 2012, you'll see that dollars spent on SG&A have actually come down, which is a testament to the hard work our team has done to manage our spending even in a strong growth environment. Together, these results drove more than 50 basis points of operating EBITDA margin expansion in the fourth quarter of 2018, and 50 basis points of operating margin expansion for the full year. As we think about guidance and outlook for 2019, we see the strong performance from 2018 as a foundation for continued earnings and cash flow growth. We project that our operating EBITDA will increase to $4.4 billion to $4.45 billion in 2019, growing again at about 5%, with this growth fueled by our focus on delivering industry-leading organic revenue growth. We expect core price of greater than 4%, yields of greater than 2% in collection and disposal, and total company volume growth of around 2%. We expect our strong operating EBITDA growth to drive free cash flow of between $2,025 million and $2,075 million, an increase of approximately 7% after adjusting for the above-average asset sales in 2018 and normalizing for tax planning benefit that won't repeat. We project capital expenditures required to support our business to be between $1.65 billion and $1.75 billion in the year ahead. We will continue our long-standing commitment to our shareholders of using excess free cash flow to pay dividends, prioritize well-priced acquisitions and investments that will bolster our long-term organic growth, and repurchase shares. Adjusted EPS for the year is expected to be between $4.28 and $4.38. Our 2019 guidance is based on an effective tax rate of 24%, which is almost 2 percentage points higher than what we saw in 2018. Normalizing for that as well as 2018 benefit from fuel tax credit that we are not counting on in setting our 2019 guidance, this represents EPS growth of about 7% for 2019. We are all very pleased with the strong financial performance we accomplished in 2018 and are particularly proud of the commitments we made and will continue to make in the years ahead in building the best team in the industry. Jim, John, and I can't thank the Waste Management team enough for the fantastic year they delivered. With that, Sia, let's open the line for questions.

Hey, guys. Good morning. Thanks for taking my questions. Can we just talk about the SG&A? Obviously, it's a great year in 2018. So, I was wondering how we're thinking about SG&A as a percentage of sales going into ‘19?

Sure. So, you're right. 2018’s SG&A performance was fantastic and definitely a result of focused and dedicated attention to controllable costs. When we think about the baseline, what you'll see is that we’re ensuring that we manage our baseline cost so that we can invest in the future. And so, thinking about 2019 you'll see an increase in SG&A as a percentage of revenue to about that 10% level that we think is the right level for us long-term. And that increased SG&A is going to be dedicated towards the two strategic priorities that Jim discussed, and that's continued investment in technology and people.

I would like to add to what Devina mentioned by highlighting that this is not just a trend for one year; it has been ongoing since 2012. I discussed this when I was CFO back in 2012, and Devina has continued to build upon it. This issue is persistent and has been developing since before 2018.

And on the pricing, guys, I mean, core pricing was strong in the fourth quarter, 5.6%; you're guiding it to be up 4%; I think ‘18 was up over 5% for the full year, even 2017 was up close to 5%. I'm just curious how you're seeing that pricing playing out, at least the momentum there, and how we should think about that as we go to the second half of the year?

I agree with you, Michael, that core price is an important topic. Yield is more complex due to its mix component, but core price truly reflects the price increases we’re passing on to our customers. You highlighted some figures from 2018, with core price at 5.3% and 5.6% in the fourth quarter, which is impressive. Looking at the early signs in January, the core price, yield, and volumes were all excellent. We are optimistic about this trend continuing. We believe we are in a very favorable position for achieving strong prices alongside increased volumes, and we don't foresee any compromise between the two.

Understood. Lastly, you may have mentioned this, but I believe we discussed a potential uplift in EBITDA of $40 to $50 million if prices stayed flat. This was a few months ago, and we have seen prices decline since then. Can you clarify what assumptions are included in the 2019 guidance concerning recycling?

Yes, it's a bit challenging to predict the exact figure because it involves several factors. We have our operating costs, which John talked about, and the contamination fees, along with the influence of commodity prices. We maintain our previous comments that recycling will benefit us in 2019. However, it's hard to determine the exact impact right now due to the ongoing decline in commodity prices. Nonetheless, we are confident about the anticipated benefit from our actions related to contamination fees, which only began in the second quarter and increased throughout the year. Therefore, we expect the first quarter to provide a significant boost from these fees and the reduced operating costs, although the impact will lessen as we progress through 2019.

If you think about it, there is considerable variability in the recycling line of business. The important takeaway is that Waste Management has effectively managed to ensure that fluctuations in commodity prices will no longer dictate our earnings outlook for that division. We are transitioning to a model that emphasizes fee-for-service and focuses on achieving returns from our deployed assets, while leveraging technology to decrease costs over time. These will be our main priorities. Additionally, if we look at our projections for average commodity prices, we saw averages in the $65 to $70 range for the full-year in 2018, and we anticipated being around $70 in 2019. However, we are already observing softer levels early in 2019. This is why we are cautious about providing a specific number that aligns with what we shared at the end of Q3.

I think, Devina, what I would add is the beginning of the year was certainly volatile, and it’s reflected in our OpEx through Q2, but we've seen steady improvement in the last couple of quarters in our OpEx. And if you look at our results for Q4 in recycling despite kind of flattish commodity prices from Q3 to Q4, we showed improvement. So, I think it validates what Jim and Devina were talking about, Michael.

Hi, Jim. It was great to see you golfing in Phoenix. I didn't witness your game, but it was certainly relevant to discuss the real waste initiatives you have going on there, which seem to be gaining significant traction with both consumers and the industry. Clearly, you are making substantial investments in areas like the future materials recovery facility and recycling, as well as CNG vehicles. I'm curious about your perspective on these investments overall. Do you see them as mostly defensive measures to maintain current profitability in the industry and protect your market share, or do you view them as proactive investments that could create new business opportunities in the future that aren't available today?

My golf game improved this year compared to last, which makes me happy. As for your question, we're approaching this as an offensive strategy. I've consistently mentioned that sustainability must be both environmentally and economically viable for it to succeed. That's our primary goal. Regarding our investments, our venture group led by Chuck Boettcher is exploring opportunities to enhance the backend of recycling plants, particularly concerning the large amounts of waste plastics produced. We charge fees for contamination up front, but we're looking for investments that yield strong returns while also addressing some of the waste plastics generated. From a sustainability perspective, achieving both economic and environmental benefits would be ideal. Chuck and his team are searching globally for solutions, and I'm optimistic that we'll discover ways to enhance the sustainability of our recycling model, while still addressing contamination issues and continuing to charge fees. We're also focused on developing the next generation of recycling plants to lower operating costs.

I noticed some of your comments from the prepared remarks mentioned you might be increasing your capital expenditures. It seems like it might be related to methane recovery at the landfills in 2019. Could you provide more details on that? The rise in capital expenditures doesn’t appear to be significant, but it is slightly higher than the already elevated levels from 2018. I'm curious if this increase is related to ongoing fleet modernization or the new initiatives you're discussing regarding sustainability and environmental aspects.

Right. You’re correct. Last year, when looking at capital expenditures as a percentage of revenue, it was 11.4% in 2018, and this year it might be around 10.9%. However, it's important to note that our guidance does not include capital or EBITDA for the renewable energy plants. These plants are essential for us to complete our strategy. We have made significant investments in natural gas trucks, which will constitute over 60% of our fleet by the end of the year. Natural gas trucks have advantages such as lower maintenance costs, making them beneficial for us. The expansion of our natural gas fleet enables us to optimize the benefits from the credits available through the establishment of these plants. I mention that these are not included in the CapEx or EBITDA guidance due to the timing involved. Constructing these plants requires 12 to 14 months. When we evaluate our capital projects, if we choose to go ahead with a renewable energy plant, we anticipate strong returns, typically within three to four years. Therefore, they represent very attractive investments. However, it’s crucial for investors to understand the timing factor involved, as we do not align these investments on a calendar year basis due to the construction duration. Capital expenditures occur at the outset.

And I would add on the normal capital number to your point that it being elevated from kind of those historical norms of the 10%, really has to do with the growth that we’re seeing in the solid waste business. We've invested in the fleet and we're also investing in additional airspace at the landfills. I mentioned CNG and special waste volumes, both being up double digits. And so, constructing airspace to keep up with that growth is something that we’re committed to. And so, those are the main drivers of the elevated spend that in a growth economy and a growth environment for our business we’re certainly seeing that as a worthwhile investment.

Okay. Last one for me. Jim, I think you mentioned you got some regulatory clearance in March; you're closing some landfill assets in West Texas. I recognize that was kind of a hole in the portfolio out in the Permian for you guys. But, I'm just wondering with the decline in oil prices, why now is the right time to be investing in there? And do you feel like you got the appropriate multiple on those businesses, given where oil prices are now?

Yes. We feel really good. As I mentioned in my script, we feel really good about the multiple that we’re buying this at. And we really didn't have a presence in the Permian basin, which if you are going to be in that energy services space in the United States, that's the big void. That's the one you have to be in. And so, this is something we've been looking at for a while, and this one, we really felt like was the right fit for us. So, we will give more details on the financial side of it, once we close this, but we’re excited about the strategic value of this, and we’re certainly excited about the multiple that we're getting it at.

My question is around capital allocation. I realize you have a $1.5 billion authorization. But just any thoughts as to how to think about the pace of buybacks in ‘19 and as well as any kind of updated thoughts on how you're thinking about large M&A, either in solid waste or outside solid waste?

Sure. So, I'll start, Hamzah, good morning, and then turn it over to Jim to talk a little bit more about the M&A landscape. But as he mentioned during his prepared remarks, if you look at 2018, we spent over $450 million on acquisitions, and at the same time bought back $1 billion of our stock. In 2019, we expect that M&A spending could be in the $200 million to $400 million range on that core solid waste tuck-in spend where you are more accustomed to seeing that be more in the $100 million to $200 million range for us. So, when we think about that level, we're planning share repurchases of about $800 million for 2019. And should we see a different outcome on the M&A side, we will flex that as appropriate to maintain a strong balance sheet.

Yes. And regarding M&A, as Devina mentioned, we typically engage in several smaller tuck-in acquisitions that offer exciting synergies. These opportunities align well with our core business. In the case of Petro Waste, we are looking at something fundamental to our operations due to its landfill assets, even though it’s in an area we wouldn’t usually operate in for energy reasons, like West Texas. This is why we had to acquire it at a price significantly below our trading multiple since it lacks the synergies associated with tuck-in acquisitions. However, we are confident about that multiple. Furthermore, when it comes to tuck-ins, we believe in acquiring them at multiples that we can effectively reduce by 2, 3, or even 4 turns through the realization of synergies.

Are you considering the cyclicality of your business in a different way? If there were to be a slowdown, how do you assess the cyclicality and defensive characteristics of your business, especially in light of unexpected events like the 10% drop in volumes during the 2009 recession?

Yes. I would say we do think about it. We've discussed what might happen if the economy declines; there has been considerable talk about that recently, but it seems to have lessened. We've mentioned several times that a recession is inevitable at some point, though the timing is uncertain. The recession in 2009 was unique because it was heavily influenced by the housing market. Our business in relation to housing has not yet recovered to its 2009 levels. When we examine indicators that might suggest a recession is approaching, we find our volume numbers in the commercial collection business, our special waste sector—which is a solid indicator of the industrial economy—and our construction and demolition volumes at our landfill to be the most relevant. Currently, all of these indicators look strong. While we are typically a lagging indicator, these metrics are somewhat leading and they all appear robust right now. This trend has also continued into January, where our volume numbers remain strong across those measures. Therefore, we are attentive to this situation and want to ensure we are not caught by surprise by an economic downturn. This is why we focus on efficiency and cost control. The positive news is that we are not experiencing the softening that has been discussed over recent months.

And from a defensive nature, Hamzah, I mean, it's a very good point anytime it's made about our industry and our business. There's a great deal of discipline in the industry today. But I think last time around, maybe we weren't always good at it. So, we can certainly flex down our capital expenditures. You've seen us flex our SG&A costs. And we would be well-positioned to do those things that we saw from softness in the volume environment going forward.

Great, just a follow-up question and I'll turn it over. On customer churn, could you remind us how you're calculating churn? Is it on a dollar basis, is it something different? And then, is there any more room to improve that further? Thanks.

I think there is an opportunity for you to share your thoughts.

Yes, I wanted to mention that we are examining our customer situation from both perspectives, including customer count. While we've discussed the structural factors involved, you can observe that year-over-year—even in a growth environment—one of the reasons for our growth is the improvement in our services. This is reflected in our churn rate, which has decreased both year-over-year and quarter-over-quarter.

And I'd say, your last point there, Hamzah, I still think we have some opportunity. You asked a question and rightly so, over the last few quarters. And I still think we have some opportunity. We were really happy with the improvement and we finished at 8.6%. But, look, I think we can get down below 8%. And then where we go from there is more aspirational. But, I think structurally, I think the business can certainly be below 8%.

Hey, Devina, couple of modeling questions. But, what are your expectations for total revenue growth in ‘19? So, basically, what I'm driving at is, what is your assumption for the net benefit from M&A in ‘19? It looks like you had quite a bit of action at the end of the year including maybe some divestitures.

Right. So, both acquisition activity and divestiture activity were a little elevated for us in 2018. The net impact to revenue in the year was about $65 million to revenue rollover, and we expect to be about the same, and then with incremental acquisitions I would say that it's about a 1% increase in revenue. And if you add that to the 2% yield plus guide and about 2% volume, it'd be around the 5% mark.

Okay. And to be clear, is Petro Waste in that guidance?

No. It's not specifically included in the guide.

Okay. That's helpful.

Acquisition growth in the $200 million to $400 million range was included in the guide. So, you can think about Petro being a piece of that puzzle potentially. But, we're going to wait until after the first quarter to revisit the total M&A guide for the year, beyond the $200 million to $400 million.

And then, I just want to make sure we all have it. But, how big of a headwind in Q1 specifically will the CNG tax credit and recycling be in terms of EBITDA or EPS?

So, the CNG tax credit was $28 million in operating expense benefit in Q1 of last year; it didn’t show up in cash flow until the second quarter. From a recycling business perspective, we actually expect some upside from recycling, though with the softness in commodity prices we've discussed, it's hard to predict how much that will be.

And then, Jim, just a bigger picture question, but it seems like the solid waste market is really affording maybe 4% to 5% organic growth. You're looking at call it 2 plus 2 in ‘19, which is obviously very healthy. But, conceptually, is 2 plus 2 a function of your go-to-market strategy, or is it a function of what the market is affording? I mean, obviously, volumes require capital, the airspace, etc. Maybe why not turn up the pricing dial and turn down the volume dial, particularly in an inflationary environment?

Tyler, I want to clarify that our projections of 2 and 2 for a total of 4 are quite similar to what we provided last year, which was also 2 and 2 and 4% on core price. It's not significantly different from what we outlined in 2017, where we reported 4% core price, 2% yield, and 1% volume. Overall, this trend is consistent with what we've communicated over the past few years. While our performance in 2018 may suggest some potential for improvement, we want to be cautious with our guidance on the top line considering discussions around the macroeconomic environment, which may indicate a softer outlook. We aren't currently experiencing that softness, but we intended to take a conservative approach with our guidance, although we acknowledge that there could be some upside.

I think the one area that we've talked about and we're going to continue to talk about and focus is post-collection pricing, both landfill and transfer station. You heard us all talk about some of the pressures we’re seeing from our third-party transporters and all the pressure on the network to be able to move volumes. I think if you look at the results you're going to see that our focus on the core price side and the transfer and landfill piece has improved. But, as Jim mentioned, I think that's the one opportunity there, particularly as we see the volumes improvement, and we’re trying to mitigate some of these cost pressures that we’re facing.

And Tyler, I would add that I really don’t think for us in this environment we view price and volume at all as a trade-off. We see the incremental volumes that we’re achieving in the marketplace providing better flow-through than our existing business, and that's important. And so as long as we continue to see EBITDA margin on incremental volume exceed our existing margins, and we can control the capital at a reasonable level and see return on invested capital grow at the same time, we’re going to continue to see volume growth as a good addition to the price discipline that we bring to the market.

And maybe lastly, Devina, if I walk down the EBITDA to free cash flow waterfall, so I start with EBITDA add in stock comp, maybe take out closure, post-closure, cash interest, cash taxes, all the CapEx, it still feels like you need a little bit of a working capital benefit to get to the free cash flow guidance. Am I right there?

We anticipate a slight repeat of the working capital benefit that we experienced in 2018 in the upcoming year. However, I agree with your assessment. I want to highlight that we had a $75 million tax planning benefit in 2018 that will not occur again. This represents a minor challenge, particularly when considering the interest and tax aspects for 2019. Nevertheless, this has been factored into our guidance, reinforcing your point about working capital. We expect to see some advantages there.

So, you know, that the volume guidance of 2%, as you said that that doesn't contemplate or include the fires, and obviously you're coming off a tough comp year-over-year including some large new contracts that you talked about. Any large new contracts or items that you would call out as drivers for the volume growth this year?

I think the one that we spoke about which we just about anniversaried is the city of Los Angeles, obviously that was a big implementation for us and drove a lot of the puts and takes in our volume last year. But outside of that, there's not one that I would call out.

John, we may see a little bit of impact positively in ‘19 with respect to the city of Los Angeles was the start-up cost side. So, while the top line may not show much due to the anniversaring, we did see some start-up costs that really persisted through a big part of last year, and that should start to mitigate.

We should start to lap that.

Understood, thanks. And then, I guess, I wanted to follow up on Devina’s previous comment that you're seeing the EBITDA margin on new volumes exceeding additional volume. I guess, if we look at the revenue guide and EBITDA guide, if we’re doing our math right, it kind of assumes flattish EBITDA margins year-over-year. So, I guess the question is, should we be seeing higher operating leverage at this point? Is there anything you can do to get margin expansion in ‘19 considering that we don't have the recycling headwind, and it is a very healthy environment for growth?

Yes. I think it’s a great point, Noah. And when we look at the guidance for 2019, what I think is important to point out is that we do expect solid waste margins to improve by about 50 basis points. And in 2018, we saw the same results; they were just muddied up a little by the impact of hourly bonus as well as the recycling line of business that you mentioned. And so, when we strip away all of that, we generated 50 basis points of solid waste margin expansion in 2018. We expect to do the same in 2019. Where you're going to have an offset on the EBITDA line is the incremental SG&A dollars that we expect to invest in technology and people. And so, the solid waste business is performing exceptionally well, and we're getting the right leverage also with that incremental volume.

Noah, it's John. I would probably revisit or add to that. One area we're clearly focused on has a lot to do with the cost pressures and transportation pressures that I mentioned earlier is on landfill and post-collection pricing and making sure that we're recognizing all the pressures that we're seeing through the transfer and landfill networks to make sure that we're overcoming those cost pressures.

And perhaps a finer point as well that’s worth mentioning is we actually are seeing increases in our recycling volumes. A lot of those increased recycling volumes are in our brokerage business. And so that does mute the margin expansion of the overall business a little as well.

Right. So, that shift to brokerage is, as you said in the past, it's about a 5% EBITDA margin business, so that will have an impact as well. All right. This is very helpful color. Thank you.

I know, it's tough on the recycling to give a number on the anticipated tailwind for ‘19. But perhaps just assuming a stable underlying commodity price environment, I'm trying to get a sense for what portion of the benefit is coming from the contamination fees relative to the operating costs. And maybe if you can provide some context on how far through the portfolio you guys have worked through on the contamination fees, and perhaps on a percentage basis, how much those operating costs have come down over the last year or so?

Let me start by detailing the contamination fees, which we’ve categorized into a few different areas. One of these is municipal contracts, which I previously mentioned. We are making progress there, as these contracts tend to have a longer cycle. We expect to see gains from this direction heading into 2019 and beyond. The initial phases were somewhat easier to manage, although the volumes weren’t as large. This involves ensuring that our commercial customers provide us with the materials we expect and that the contamination levels of materials received do not exceed what we can process. There are three key focus areas related to this. I noted earlier that our operating expenses from a Material Recovery Facility standpoint peaked in Q2, which isn’t surprising given the significant market volatility at that time. Since then, we've likely reduced our operating cost per ton by about 4% to 5%. In Q3 and Q4, we stabilized revenues while continuing to show improvements. The overall performance of the MRFs at our recycling plants indicates that our efforts to manage contamination are contributing significantly to these enhancements.

And Sean, the original estimate we provided for the tailwind was around $40 million to $50 million. We always mentioned that this assumes commodity prices remain flat from their previous levels. They have decreased somewhat, which makes us hesitant to provide a specific number. However, it's safe to say it will be a tailwind; we just can't pinpoint exactly what that will be. If prices stabilize from here, I would estimate we're looking at a figure in the $20 to $30 million range. But again, there's uncertainty as prices might rise back to where they were a couple of months ago. The initial number we discussed, based on flat commodity pricing at the end of the third quarter, was $40 to $50 million. If prices do return to those levels, we should see ourselves falling within that range, along with the ongoing efforts on contamination fees with municipalities and a heightened focus on operating costs.

Sean, this is probably the toughest quarter to call just because this is generally a volatile market from a commodity standpoint with what’s generally going on overseas.

Thank you. Jim, it sounds like you might have a cold as well. Devina, am I right that the SG&A swing for investing in Nikolaj’s projects is around $100 million?

That's about right. Yes.

And just to follow up on the last one. So, typical three-year paybacks, way to think about that and mid-teens unlevered IRR, and that's the way to think about the sort of leverage on that?

Yes. That's a great way to think about it.

Okay. And then, on free cash flow, I get you sell things periodically. That's the swing in the numbers. If I strip that out over the last three years, and I look at the sustainable growth between them, like ‘17 to ‘18 you are up 12%, but ‘18 to ‘19 you're up sort of mid-5s. Is it appropriate for me to sort of smooth those two numbers and say that we can talk about a 6% to 8% sustainable free cash flow growth rate under the current business climate?

That's where we are. Yes. We definitely are happy that if you normalize ‘17 to ‘18 for taxes and interests and the proceeds from divestitures and do the same for ‘18 to ‘19, we're in about a 7% annual growth environment.

I think one of the questions you've all had is how our EBITDA, which is a significant factor, is translating into cash and free cash flow. Looking at the years 2017, 2018, and 2019, we're quite pleased with the results. In 2017, the figure was 42.2; in 2018, if we adjust for some one-time tax planning and normalize for divestitures—which we will always have—it's around 45.1. For 2019, our guidance is 46.3. This indicates an annual growth in conversion ratio of about 90 to 120 basis points. Not too long ago, that number started with a 3 and was in the mid-3s. Now we are on a path where it starts with a 5, and we're really pleased with the conversion rate from EBITDA, which was 5% last year and around 5% this year, to cash.

And then, to do this waterfall bridge differently on your EBITDA $4,216 million, midpoint 4,425, that's 209. But, I got to factor in there, there is a $100 million of the SG&A. So, the solid waste and recycling is really up 300 something, is that the way to think about that?

That's exactly right.

That's why, Michael, it's pretty straightforward to mention things like bonuses or recycling benefits. However, as we all know, there are many factors that influence the EBITDA number. Our main focus is the overall growth, which increased by 5% last year and is expected to grow another 5% this year. This was twice the economic growth last year, and it could potentially be as much as 2.5 times. We're very pleased with the EBITDA growth, as we believe it's the best indicator of the health of the business.

And to that last bit, Devina, what's the number for 2018 when you talk about the solid waste business? So, that when you make that statement, the solid waste business, what is that revenue number?

The revenue number? We’ll have to get back to you, Michael. And we've got good information in the tables, but we’ll clarify how we’re thinking about that. So when we look at the solid waste business in the 2018 relative to 2017, we saw over $300 million of EBITDA growth in that business, which makes sense because the $210 million of EBITDA growth that we talked about had that $90 million of headwind from the recycling line of business. It was really a stellar performance.

Okay. That's part of what I was trying to convey, but it's difficult for people to recognize the margin expansion in that business considering the way it's presented. Perhaps some clarification on that would be beneficial.

Okay. We’ll take that into consideration.

And then, one last thing for you, Jim. I'm assuming these renewable energy projects, as you experience in CNG credits, come and they go, so they are good returns on capital, not counting on the RINs are there forever? Yes, that's correct. There is some volatility in the RINs, but we believe they are strong investments for us, which is why we are interested in them. They are accessible to us not only because of our landfill gas but also due to the CNG conversion we are implementing over several years.

Good morning. It’s Henry Chien calling for Jeff. I wanted to ask about the volume guidance for 2019 in relation to some comments, suggesting there is a slight shift towards commercial and construction and demolition. I'm curious about how you perceive the sensitivity of that number and volume growth to various sectors of the economy. For instance, if housing starts strengthen or weaken, or how the industrial economy is performing, will there be any changes in the sensitivity of that volume as you look ahead this year?

Yes, Henry, I believe Devina mentioned this earlier. When we examine our special waste and construction and demolition pipelines, we saw strong performance in 2018, and we still observe positive health in those areas. Both Jim and Devina remarked on the commercial line of business. The service increases compared to decreases serve as a reliable indicator along with our other sales activities. While we are keeping an eye on potential risks, the short-term outlook remains strong. In fact, as Devina pointed out, the ratios of service increases to decreases have improved as the year progresses. We have not yet noticed any softening in those categories.

And we certainly take into consideration a lot of attention in our business is paid to housing starts and new business formation. And so, those two data points are important to us. We're a lot less directly tied to housing than we were with the last downturn. And that's valuable for us in thinking about the confidence we have in achieving that 2% margin growth in the year.

I would also add, Henry, when you look at the tables in the back on MSW line, if you net out some of the one-time things, we really look at that as being about a 3.5% to 3.7% increase in volume when you kind of normalize it for some one-time issues. So, all our volume fronts look pretty consistent and strong as we sit here.

Great. Thank you. So, to conclude, first, I do understand Ron Mittelstaedt was not on his call this morning due to a family emergency. And Ron is a friend of mine. And I just want to say to Ron that we're thinking about him. He's definitely in our thoughts and prayers this morning. Regarding the business, the last few years and we've talked about it this morning, but the last few years and our expectations for this year really demonstrate our consistency in managing our business. And we're producing what we consider to be excellent growth in all of our financial and operational metrics and very solid returns to shareholders, and I could not be more proud of this team for doing that. Thank you all for joining us this morning, and we will talk to you next quarter.