Waste Industries USA Inc. Q3 2007 Earnings Conference Call Transcript

Waste Industries USA Incorporated Q3 2007 Earnings Conference Call Transcript

Waste Industries USA Inc. (WWIN)

Q3 2007 Earnings Conference Call

October 31, 2007, 2:00 pm ET

Executives

Carol Dalton - Investor Relations

Jim Perry - President and CEO

Steve Grissom - Vice President and CFO

Harry Habets - Chief Operating Officer

Analysts

Scott Levine - JP Morgan

Presentation

Operator

Good day, everyone. And welcome to today's Waste Industries USA Third Quarter 2007 Earnings Results Conference Call. Today's call is being recorded.

And now for opening remarks and introductions, I would like to turn the conference over to the President and Chief Executive Officer, Mr. Jim Perry. Please go ahead, sir.

Jim Perry

Thank you, [April]. And good afternoon, everyone. Thank you for joining us today to discuss our performance for the third quarter. In just a moment, you will hear from Steve Grissom, our Chief Financial Officer, followed by Harry Habets, our Chief Operating Officer.

By way of introductions today, we have in the room with us Lonnie Poole, Chairman and Founder of Waste Industries, Ven Poole, who's our Vice President of Corporate Development, Mike Durham stepped in today, Mike is Vice President of Administration and Support Services, and a new visitor today, Scott Poole joins us, Scott is a major shareholder in our company.

Before I turn you over to Carol for the customary Safe Harbor statement, let me lead with a opening statement that we've prepared. As Waste Industries has reported, a group of investors of which I am one has delivered a proposal to the company to take the company private by acquiring all of the outstanding shares of Waste Industries stock.

A Special Committee of the Board of Directors is reviewing the proposal with the assistance of its financial advisor, JP Morgan Securities. The proposal audit is included as an exhibit to Waste Industries Form 8-K filed with the SEC on October 24 to report the receipt of the proposal and you are directed to the Form 8-K for information regarding the proposal.

Waste Industries will issue further announcements regarding the proposal when and as appropriate. Neither I nor any other Waste Industries employees on this call will address the proposal or respond to questions about it.

So with that, Carol would you read the customary Safe Harbor statement and then we will proceed with our quarterly performance.

Carol Dalton

Thank you, Jim. Forward-looking statements made herein are made only as of the date of this conference call and the company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statement is contained in the companies SEC filings.

Such filings include but are not limited to the company's 10-K for the year-ended December 31, 2006. Copies of these filings are available on our website at www.wasteindustries.com or may be obtained by contacting the company or the SEC. Jim?

Jim Perry

Thank you very much, Carol. We were pleased with our operating results for the quarter. Total revenues increased 4.6% to $88.6 million while income from continuing operations increased to $6.9 million, as compared to $3.9 million a year ago.

We were especially pleased to see our operating margin improve from 13.1% to 15.2% quarter-over-quarter. We achieved an EBITDA margin of 23.2% and we earned $0.49 per share from continuing operations.

CapEx for the quarter was $12.5 million and our free cash flow through September 30 was $26.1 million. Debt to total capitalization declined to 49.6%, compared to 51.9% for the same period in 2006.

We believe our performance for the quarter reflects results in a number of key areas. First and foremost, our people continue to find ways to improve productivity, collecting and disposing of about 3% more waste per employee for the quarter than in last 2006.

Two, we continue to improve the internationalization of waste we collect into our landfills. In the third quarter we internalized 27.2% of our waste volume compared to 23.6% a year ago and our disposal cost for the quarter was 17.1% of total collection service revenues, compared to 18.3% in the third quarter of 2006.

Three, our balanced revenue mix continues to be strength. For example, while we experienced along with other companies a volume decline in roll off revenues for the quarter during the same period we expensed nice gains in our residential, commercial and landfill areas and Steve will cover those in just a moment.

Also, our growth strategy has continued to focus on selective acquisitions and targeted municipal work. Companywide year-to-date through the third quarter we have acquired seven operations with annual revenues of about $14.6 million and five of these companies were in the allowed market and in the third quarter we secured about $1 million per year of net new municipal contract revenues.

In the area of fuel, fuel usage increased about 3.7% for the quarter while overall fuel costs increased about 4.2% for the same period. The average price per gallon per diesel fuel increased to $2.78 per gallon.

However over the past several weeks we've experienced pricing in excess of $3.10 per gallon and on the last US Department of Energy index that we received October 29, for the lower Atlanta region -- Atlantic region was, that index $3.09 per gallon, compared to $3.02 for the prior week so we've seen a run-up in fuel cost over the last week to 10 days.

In the area of price and volume we achieved an improvement of pricing of about 1.3% for the quarter. We continue to be pleased with pricing for our residential work, which now makes up nearly 24% of our revenue mix and year-to-date this segment has experienced revenue growth of about 12%.

During the quarter the number of hauls for temporary or construction type work declined about 4.5% on the same-store basis but the good news is that revenue per haul improved about 8%. Same trends held true for hauls from our more permanent work.

As I reported on our last call while roll off hauling activity has been soft in some markets we continue to have operations where activity is quite robust. Mild weather has been a plus as existing construction products have been able to meet or exceed their contract schedules.

Revenues for our front end or commercial work was another black spot for the quarter with volume increasing about 3%, accompanied by positive pricing of about 1%. A few words about our Wake County landfill operating contract.

Construction on the first 26-acre sale is going well, there again the weather for the summer and during the fall has been good and we are ahead of schedule. The landfill and synthetic liner has been installed and we anticipate this site will be ready to accept waste as originally scheduled in the first quarter of 2008.

Total capital required to start up this project is still in the $11 million to $12 million range. Before I turn you over to Steve and Harry, to give you more detail on our performance for the quarter and year-to-date, let me summarize where I believe we're at.

I believe our operating fundamentals are well institutionalized in all of our operations and that Harry and his team continue to find ways to improve both productivity and service in delivering cost.

I believe our focus on strengthening routes in designed markets through acquisitions has proven to be a sound strategy and one that we will continue to pursue.

I believe internalizing more of our waste volume and effectively managing our overall disposal cost remained critical to offset public costs that are beyond our control. And finally and probably most important, I believe our performance reflects the hard work of our men and women who met the challenge of the hottest summer on record as they continue to deliver outstanding and great service to those we serve.

And with that, let me turn you over to Steve for further details about the quarter.

Steve Grissom

Thanks, Jim. Let's first review the year-over-year results for the third quarter beginning with revenue. Service revenues for the quarter increased 4.5% to $88.2 million. Internal growth was 1.3% all of which was pricing and acquisition growth was 3.2% for total service revenue growth of 4.5%.

The rate of pricing growth declined from the prior period levels but the volume is breakeven after experiencing several quarters of year-over-year volume declines. With the exception of temporary roll off all other collection lines and disposals experienced positive growth versus last year.

In the prior years third quarter we lost some very high volume but low price municipal roll off work. In addition, we instituted some significant residential price increases in Q3 last year. Looking ahead to Q4, we expect to show positive overall internal volume growth for the first time since the first quarter of 2006.

Now for detail on the operating margin development, the operating margin of 15.2% is 210 basis points higher than the third quarter last year. This is the sixth consecutive quarter of year-over-year operating margin expansion.

As a percentage of revenue operations costs was favorable at 170 basis points, depreciation and amortization was favorable at 140 basis points, SG&A cost was unfavorable 70 basis points and gains from sale of equipment and fixed assets were 30 basis points unfavorable to prior year.

The annual accounting adjustment for landfill capping, closure and post-closure costs in accordance with Statement of Financial Accounting Standards Number 143 was calculated for the third quarter as we do each year and this resulted in approximately $1.4 million of reduced amortization expense from lower than expected capping costs.

But higher accretion expense of approximately $0.2 million and this item was included in operations cost. This net effect of $1.2 million positively impacted the operating margin by 130 basis points.

Moving on to operations costs, the 170 basis points reduction versus the prior year quarter was impacted by the following items and once again leading the favorable category is disposal cost of 130 basis points.

We have lower labor costs of 40 basis points, there were lower reduced casualty insurance and workers compensation cost of about 40 basis points and we also had reduced fuel costs of 30 basis points versus last year.

The primary unfavorable items are increased repairs and maintenance costs of 30 basis points, higher medical claims of 20 basis points and landfill closure and accretion costs, landfill closure accretion costs, excuse me, of 20 basis points.

Our disposal posts as a percentage of revenue continues to decline and reflects the 360 basis points improvement in the year-over-year internalization rate, which is now up to 27.2%.

Sequentially, operating cost increased 90 basis points from the Q2 levels. Costs driving the sequential increase are higher labor costs of 30 basis points, increased disposal and transfer costs of 30 basis points and we also had higher repairs and maintenance again 30 basis points and higher fuel costs of 20 basis points. The one favorable in the sequential comparison is the casualty and workers compensation insurance, so that was favorable at 20 basis points.

Our SG&A cost for the quarter were $1.1 million higher year-over-year and as a percentage of revenue increased 70 basis points. Approximately $0.8 million of this unfavorable variance is due to the collection of a previously reserved municipal customer account in the third quarter of 2006. The remaining $0.3 million of unfavorable variance is due to higher payroll expense and medical claims.

Moving on to depreciation and amortization, the year-over-year expense was $0.8 million lower or a reduction of 140 basis points and is due primarily to the lower landfill amortization expense for the quarter of approximately $1.4 million and this was as a result of our annual landfill accounting adjustment.

In the third quarter we completed the annual evaluation of all landfill sites with the assistance of an outside engineering firm. We analyzed the asset retirement obligations and capping and closure liabilities per the guidelines of the FAS 143 Accounting Standard.

The analysis revealed that the cost of two capping events at the Samson County MSW landfill should be reduced and because both these events are deemed full air space capacity. The FAS 143 guidelines require that any cost adjustment to this capping events run through the current period P&L. Thus the favorable $1.4 million impact in the quarter.

One of the measures of cash flow for the company which is operating income before depreciation, amortization and accretion increased 9% year-over-year to 23.5% of revenue, compared to 22.5% of revenue for the prior year quarter.

Next, let's discuss our free cash flow, third quarter free cash flow is $6.1 million. This is based upon cash provided by operating activities of $18 million, less purchases of property, equipment and landfill construction of $12.4 million plus proceeds from sale of equipment of $0.5 million, year-to-date free cash flow is $26.1 million.

Our total bank debt of $157 million outstanding at the end of Q3 is the same level as year-end '06 and you've heard that the debt to capitalization ratio is 49.6%. At this time, the weighted average cost of our debt is approximately 6.6%. So again, another very good quarter of improving margins.

And now, I'll turn over to Harry to throw a color on operations.

Harry Habets

Thanks a lot, Steve. As you can tell we're having a good year in spite of a somewhat challenging Q3. Not only has diesel fuel climbed to all time highs, but chassis, engine and truck body replacement part costs are also at an all time high. I will highlight a few of the initiatives under way that will improve our results in Q4 and 2008.

While our folks have delivered terrific financial results so far this year it has not been at the expense of safety. Workers comp frequency is on track to be down for the fifth year in a row, while our vehicle accident frequency is down over 10% from 2006. Not only is the frequency of accidents and injuries down, so is the severity.

As you heard earlier, we finished 2006 with a 22% internationalization rate and in Q3 we enjoyed a 27.2% internationalization rate. The primary drivers we completed four more acquisitions on the West side of Atlanta this year. And of course are internalizing the disposal of the Grady Road landfill.

Mid year, we based collection operations at our North Carolina landfills, Red Rock, C&D landfill and Samson landfill in order to direct haul more volume to our landfills, as a result we're able to avoid unnecessary transfer station costs and realize a higher disposal rate.

To really get an appreciation for our overall M&A and business development strategy the past couple years, the following metrics speaks volumes, no part intended. We internalized 43% more tonnage in Q3 '07 than we did in Q3 '04, which was the period just before we embarked on the Atlanta strategy, and in Q3 '07 our landfills received record volumes.

Earlier this year we started a new productivity initiative for our maintenance facilities. Our three pilot locations are excited about the early results. We're getting more work done with the same crew and enjoying the benefits of a just in time inventory control system. And we will be refining the processes and software, and rolling this out to all of our operating locations over the next 12 months.

In early 2006, we decided that by Q3 of '07 that more of our organic growth would have to come from volume as opposed to price. So we went ahead and we strengthened our sales force and we twicked the commission plan to encourage new profitable work. And we are a much more opportunistic today than we were in early '06, and as expected in Q3 we saw the positive volume impact of a more proactive sales effort on our commercial profit center, which is also our most profitable.

We are just about finished integrating the acquisitions that we completed on the west side of Atlanta, and in South Carolina and in North Carolina earlier this year. The start up costs associated with six municipal contracts and two major reroutes will also soon be behind us. And we expect that our cost of operations as a percent of revenue will show good improvement in Q4 and that all of the synergy benefits will be realized in Q1 '08.

Now some color on the Atlanta market. One of the major companies we'll call them Brand X is going after volume by lowering its disposal prices even further. Our YTD Atlanta C&D landfill volume is up 32% over last year, however in Q3 volumes were down 17% from Q2. And the primary reason is the housing construction collapse that started in August, however in an attempt to lure business away from us Brand X just lowered their C&D disposal rates by 25%.

Unfortunately we are much user friendly than Brand X's landfill next door and we don't plan on losing many customers. Brand X is apparently also desperate for MSW volume. They recently left over $3.50 a ton on the table chasing a municipal disposal bid in the Atlanta area.

Now how does this impact our business in Atlanta? Grady Road Landfill's volume is not at risk from this price competition as almost all of its tonnage is on our trucks. We are growing a profitable collection company out in the Western suburbs of Atlanta that is internalizing over 93% of its waste to Grady Road Landfill.

Unlike safeguard C&D landfills which gets 95% of its volume from the 150 plus mom and pop roll off companies in Atlanta, our Grady Road Landfill success is not dependent upon third party haulers.

Our routing efficiency initiatives and their success is best -- and their success is best exemplified by the following stat. At the end of Q1 '07 we had 869 collection vehicles and at the end of Q4 we will only have 764 collection vehicles.

Now, in order to be the low cost service provider we're also focused on reducing our customer transaction cost. In Q3, we began the new E-Bill payment website and convenience pay process including the 800 interactive voice response system and we're also using a new print vendor.

Now the project will result in annual savings of over 400,000 and it's basically the result of reduced credit card processing fees of 2.5% to 3%. We're saving two to three days of bank float time so we get the funds quicker and we've instituted a toll free interactive voice response system for our customers to easily make credit card payments with and this also improves our CSR's productivity as it was taking them four to six minutes to process a payment under the old I-pay X system.

Now we're also moving as many of our customers as possible to E-Billing to avoid the cost of paper bills, postage and manual processing of payments. A little more color on the business, the housing side of the construction and demolition business. It is very soft but fortunately in the Southeast most of the housing C&D hauling it migrated away from roll off service some years ago.

It's going to dump trucks a lot of manual laborers going in and sweeping the homes so the impact of the housing construction slowdown to Waste Industries was minimal. At the few branches where residential construction contractors are still using roll off service, obviously business is down but we have right sized the fleet and the workforce.

Most of our branches provide C&D roll off collection service to the commercial construction market and for the most part the commercial construction market is still very strong. The biggest impact the housing slowdown has had is on the volumes at our C&D landfills. Although other than safeguard landfill in Atlanta, we have not seen a volume decrease anywhere else Q2 to Q3. It's more a case of how much more could we have had if housing construction was as strong as it was last year.

Now, the numbers alone do not tell the full story of our accomplishments so far this year for as we were achieving record results we were also strengthening our organization and building long-term value of our company, and we offer full credit for this excellent performance to the people of Waste Industries. Back to you, Jim?

Jim Perry

Good job, Steve and Harry as always. I give a lot of detail about the performance of the company and different market situations.

So with that, let me turn it over for Q&A and see what other questions we might answer. April?

Questions-and-Answers Session

Operator

(Operator Instructions) We'll first hear from Scott Levine of JP Morgan.

Scott Levine - JP Morgan

Good afternoon.

Jim Perry

Good afternoon, Scott.

Scott Levine - JP Morgan

You know, it looks like the pricing metrics slipped a little bit. Harry you gave some commentary about some competition in Atlanta. You know, anecdotally have you seen any major shift in pricing behavior on the part of either your large publicly traded competitors or larger independents and then as a third class smaller mom and pops, any appreciable change in behavior from anyone?

Harry Habets

Well, Brand X is one of the major players and so Brand X in the Atlanta market at least on the disposal end of it is obviously lowering their rates. But Brand X collection operations every place else in our footprint they seem to be enjoying the pricing climate that's out there today.

So, I've not really seen a lot of price competition other than from the mom and pop roll off companies along the coast that are going, whose business has been interrupted by this housing meltdown.

Jim Perry

Yes. Scott, I would echo that. I think in general the pricing environment is still fairly stable and you have pockets like Harry suggests on the coast where the smaller independents are dealing with a substantial drop in volume and there may be where you experience more of the pricing deterioration, but in general it's important to note that throughout our markets the pricing has been fairly stable and we think it looks stable in the foreseeable future.

Steve Grissom

Hi, Scott. This is Steve. Because we're anniversarying on that Q3, I gave a little color on that. You know, that Q3 was a significant quarter last year in which we lost some very low price business.

That is the real reason that the pricing slipped, we didn't drop any prices to meet competition. It's simply that we lost the low price contract last year in third quarter and now we're anniversarying on that.

Harry Habets

And when we lost high volume low priced work it gave everyone the impression that we were really jacking up rates when we weren't.

Steve Grissom

Yes. And the dynamics have changed in this Q3 between the price and the volume. The volume on previous quarters was in the 2% to 3%, you know, perhaps 2.5% negative for several quarters and now volume has gotten to a breakeven, prices dropped down from the previous 3% to 4% levels on the calculation method but internal growth is up, you know, we've doubled internal growth of the Q3.

Harry Habets

And the really important stat is our commercial truckload business volume is actually adding volume, our salespeople are adding business organic growth.

Scott Levine - JP Morgan

Yes. So it sounds like the trends going forward here as well on the volume side with going into positive territory this is more of a comp issue than anything else?

Steve Grissom

Yes. Absolutely believe that, yes.

Scott Levine - JP Morgan

Got it. Okay. And then one last one I guess on the municipalities, are you seeing change in their behavior, we had the Supreme Court ruling earlier in the year regarding flow control?

Are you seeing any change in behavior on the part of the municipalities, I think your footprint maybe looking to take advantage of that ruling anyway?

Harry Habets

Yes. I mean, definitely -- in Virginia. It's definitely exploring it.

Jim Perry

I think most of the markets they are now adjusting on what the impact is and how to position themselves going forward, I believe this is a personal opinion that there will be some adjustments to how they think about the collection and disposal of waste.

And in general we'll contract for the service in order to recognize revenues off of fees and so fourth on the surface as opposed to actually buying the trucks and doing it themselves, that's a personal opinion.

Scott Levine - JP Morgan

Great. Thanks, guys.

Jim Perry

Yes.

Operator

(Operator Instructions) There are no questions. Mr. Perry, I'll turn the conference back over to you for any additional or closing comments.

Jim Perry

Well, thank you very much, April. And thank you for everybody who joined us today to hear about another great quarter for our company and for those of you who might have been keeping score as I have for the last 30 plus years, this concludes our 131st consecutive profitable quarter, which I'm very proud and again, as Harry said earlier, it's a testimonial to the men and women who do a good job in good times and not so good times.

So thank you again for joining us today. And thank you for your support -- continued support of our company. Have a good day.

Operator

That does conclude today's teleconference. Thank you all for your participation. You may now disconnect

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.