Republic Services, Inc. Q1 2008 Earnings Call Transcript

Apr.25.08 | About: Republic Services, (RSG)

Republic Services, Inc. (NYSE:RSG)

Q1 FY08 Earnings Call

April 24, 2008, 08:30 AM ET

Executives

Jim O'Connor - Chairman and CEO

Tod C. Holmes - Sr. VP and CFO

Analysts

Scott Levine - JP Morgan

William Fischer - Raymond James

Corey Greendale - First Analysis

Leone Young - Citigroup

Jonathan Ellis - Merrill Lynch

Operator

Good morning and welcome to the First Quarter Conference Call for Investors in Republic Services. Republic is traded on the New York Stock Exchange under the symbol RSG. Your host this morning is Republic Chairman and CEO Jim O'Connor. Today's call is being recorded and all participants are in the listen-only mode. There will be a question-and-answer session [technical difficulty] Republic summary of quarterly earnings and I will provide you with specific instructions for questions later in the call.

At this time, it is my pleasure to turn the call over to Mr. O'Connor. Good morning, Mr. O'Connor.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Fray and good morning and thank you for joining us today. This is Jim O'Connor and I would like to welcome everyone to Republic services first quarter conference call. Tod Holmes, our Chief Financial Officer and Ed Lang, our Treasurer are joining me as we discuss our first quarter performance.

I would like to take a moment to remind everyone that some of the information that we will discuss on today's call contains forward-looking statements, which involve risks and uncertainties and maybe materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations.

Additionally, the material that we discuss today is time sensitive. If in the future you listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call which is April 24, 2008. Please note that this call is the property of Republic Services Incorporated. Any redistribution, retransmission, rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited.

During the first quarter, we continue to deliver on our pricing initiatives and realized margin improvement. We believe the current pricing environment is sustainable across all lines of business. Key results in the quarter were republic had revenue growth of 1.8% to $779 million. We achieved internal growth of 3.7% with 6.2% of price improvement and volume decline of 2.5%. Our first quarter volume decline was affected by a slowdown in the residential housing construction activity and associated lower landfill volumes.

Price growth continues to be strong. Core price is up 4%. Pricing is the most important factor for recovering rising costs and increasing operating margins and return on invested capital.

Within our landfill business, our core price was up approximately 3.4% in the quarter. We continue to see sequential improvement in landfill pricing particularly in our MSW volumes. As landfill and residential collection contracts renew, we are seeing consistent price increase and high levels of retention.

The biggest impact on volume growth was in our temporary roll-off business which decreased approximately 15%. This decrease is due primarily to weak residential construction volumes and is similar to the trend we experienced during the second half of 2007.

Additionally residential construction related C&D volumes are down at our landfills. Despite the net volume reductions temporary roll-off pricing has remained stable. We continue to adjust our workforce and capital spending to reflect lower activity in our temporary roll-off line of business and the field has done an exceptional job in making those adjustments.

Operating margins in the first quarter improved 320 basis points to 18.2%. When 2007 results are adjusted for remediation expenses, operating margins are up 40 basis points. And we continue to remain focused on all of the class components of our business to remain competitive in the marketplace. Republic had a number of significant achievements in the quarter including; our free cash flow for the first quarter was $67 million; our full-year guidance is $340 million to $350 million.

During the quarter, we continue to return cash to our shareholders. In the first quarter, we repurchased approximately 3.2 million shares of stock for $98 million. There's $288 million remaining under a current board authorization. Share repurchase will continue to be the corner stone of our cash return strategy to shareholders in 2008. Since the inception of our share repurchase program in July 2000, we've repurchased over $2.2 billion of Republic stock or 41% of its outstanding shares. Upon completion of the existing board authorization, our repurchase program will total $2.5 billion or approximately 48% of our outstanding shares.

As always, we continue to utilize our return on investment pricing tools, on contract renewals and municipal contracts. And at this time, I would like to turn call over to Tod Holmes, our Chief Financial Officer for a review -- financial review of the first quarter. Tod?

Tod C. Holmes - Senior Vice President and Chief Financial Officer

Thank you Jim. I'll begin my review with the company's financial results by discussing revenue. Again, as Jim indicated, first quarter revenue rose 1.8% to $799 million from $766 million last year. Internal growth was 3.7% which is in line and maybe slightly above our guidance for the full year. This is really led by price growth, total price growth was up 6.2%, 4% increase from core price, a 1.1% increase from fuels surcharges and 0.3% increase from environmental fees. Also commodities continue to be strong and we had 0.8% increase from commodities.

So, again during the quarter, we continue to benefit from our ongoing price increase strategy in all lines of business. Our first quarter volume declined 2.5%. This is slightly above our full year guidance for this year. However if you will recall from our last quarter call we'd indicated that we thought the volumes would be a little bit weaker in the beginning of the year versus the end of the year due to the declines of volumes throughout last year and the fact that they would have -- those declines would anniversary out as we went into the latter part of this year.

Temporarily roll-off volume as Jim indicated was down 15%, landfill volume down 5%. Commercial volume and residential volumes were both up low single digits. Divestitures accounted for the remaining 1.9% reduction of our revenue. And if you will recall we have sold in the fourth quarter of last year our LETCO soils business in Texas; that's the primary impact there.

Now let me talk about our operating margins, first quarter year-over-year change. Year-over-year operating margins increased by 320 basis points as Jim indicated from 15% to 18.2%.

During the first quarter 2007, we recorded a pre-tax charge of $22 million related estimated cost to comply with orders issued by the OHIO EPA and our Countywide landfill. Excluding this charge, our year-over-year operating margins increased by 40 basis points from 7.8% to 8.2%. This increase is despite headwinds... substantial headwinds from fuel prices and is consistent with our guidance of expanding operating margins.

The key components for our year-over-year margin increase are as follows. Again the Countywide charge was anniversaried out so that was a positive 280 basis points. Pricing really affects a lot of these other factors as well as some of our cost initiatives. Truck maintenance positive 20 basis points, risk and health insurance a negative 20 basis points, Fuel, the big driver, a negative 140 basis points. Our disposal in sub-contracting cost was a positive 130 basis points, labor at positive 30 basis points, DD&A positive 30 basis points, and SG&A a negative 30 basis points for a total 320 basis points positive.

Now, let me comment on each of these components of year-over-year margin change. First, truck maintenance, again during the first quarter of 2008 our accruals that are in place particularly Dossier which focuses on truck -- preventive truck maintenance, has allowed us to have a reduction in truck maintenance expense as a percentage of revenue. Second, the risk in insurance, insurance expense during the first quarter was 6.1% of revenue higher than the first quarter of 2007 and that was due to some one-time adverse development on a couple auto liability claims.

We believe that these costs associated with our risk program will comeback down here in the next quarters of this year and that for the year we expect something in the 5.5% to 6% of revenue for our risk and health insurance.

Third, fuel costs. Our average wholesale price per gallon increased substantially from 2.44 in the first quarter of 2007 to 3.39 in the first quarter of 2008. Current fuel prices are approximately 30... $3.96 a gallon. A couple of things I might add, we do have a hedge in place for a little over 10% of our fuel consumption. That was actually a benefit of 20 basis points since that was put in at about 2.85 a gallon. And then the other factor we have is prices were moving up in the quarter and the month of March was certainly at the highest price. We... although we were quick to get our fuel surcharge, there's about a one-month delay and had -- we had that April surcharge in place for the month of March that would have been another 10 basis points of benefit.

Fourth, our disposal and subcontracting costs. This is our largest cost category through which really the impact of improved pricing is clearly visible. Fifth is labor. During the fourth quarter we continue to benefit from productivity improvements which contributed to our margin growth. One thing I would add about labor both here and in SG&A as we did go through a mandatory enrollment for all of our employees in the 401-K plan. So, and we've got probably another 10 to 15 basis points of an expense due to higher participation in the 401-K plan, both here in and our direct operating labor and also in SG&A labor.

Sixth, is DD&A. The decrease in DD&A is a percentage of revenue is primarily due to improved pricing. Finally SG&A. First quarter SG&A was 10.6% of revenue. This increase in SG&A is again due to higher equity compensation in the 401-K expense that I talked about earlier. We believe going forward that SG&A should be in a range of 10 and a -- 10% to 10.5% fiscal 2008. And as we look ahead for all of 2008, we believe that operating margin in the 19% range is achievable.

Now let me talk about our first quarter operating income before depreciation, amortization, depletion and accretion. Year-over-year operating income before DD&A increased by $22 million or 11.1% from $198 million in the first quarter of 2007 to $220 million or 28.2% in the first quarter of 2008.

Now I'll talk about our free cash flow. Free cash flow for the first quarter of 2008 was 16... $67 million. This is based on cash provided by operating activities of $148 million. Purchases of property and equipment of $82 million and let me talk about that in just a minute, as that's what we actually paid in cash some of which was actually delivered last year and paid this year. Plus our proceeds from the sale of property of 1 million equals free cash flow of 67 million.

As you are aware earlier this year congress passed the Economic Stimulus Act of 2008. This act allows companies to purchase new equipment and to deduct 50% of the cost of the equipment as bonus depreciation in their 2008 tax returns. We believe this will save Republic about $25 million in cash taxes during 2008, and therefore improve our cash flows. However, if we anticipate increasing our truck capital expenditures is a pre-buy for both 2008 and also 2009 trucks prior to the new diesel engine requirements that go into effect January 1st of 2010. But the combination of all of these brings us still to the point that we feel very comfortable with our original cash flow guidance at or above the range of $340 million to $350 million.

And I mentioned earlier that the statement of cash flows, purchases of property and equipment showed $82 million. We actually have, I think, a reconciliation in our 8-K because in the first three months what we actually took delivery of was $48 million of capital versus that $82 million in the statement of cash flows.

This difference again represents property and equipment that the company received during 2007 but was paid for in 2008. And again this reclassification on the statement of cash flow from cash provided by operations to purchase of property and equipment.

Let me talk now about our items impacting our cash balances. During the first quarter of 2008 as Jim indicated we purchased 3.2 million shares. That's about 1.7% of our outstanding share account for approximately $98 million or $30.19 per share and our remaining authorization at today's prices could allow us to purchase over 5% of our outstanding shares. Our actual share account at March 31st 2008 was 182.7 million shares.

Republic's balance sheet remains very strong. At March 31st, our account receivable balance was $307 million. Our days sales outstanding did go up from 34 days at December 31st to 35 days at March 31st. This is a function we believe of the economic times that we are in. Our net debt is $1.527 billion up from $1.450 billion at December 31st and our net debt to total cap at December 31st was 55%.

Now, I will turn the call back to Jim O'Connor.

Jim O'Connor - Chairman and Chief Executive Officer

Thanks Tod. Republic's EPS for the first quarter was $0.41, which is 46% improvement versus the first quarter of 2007. After adjusting for remediation expense and additional income taxes, the first quarter EPS was up 11%. We would like to reiterate our current earnings guidance for the year of $1.78 to $1.82 EPS for the full year 2008. With the passage of the Economic Stimulus Act earlier this year, Republic's cash flow will improve due to bonus appreciation resulting from higher deferred taxes. We provided 2008 cash flow guidance of $340 million to $350 million. The 2008 depreciation guidelines will increase free cash by approximately $25 million.

However, as Tod stated, we plan to increase our 2008 capital spending for commercial and residential collection vehicles for several reasons. There will be new engine standards beginning in January 1st 2010. That increased the cost of vehicles by $10,000 to $20,000 a unit. Therefore making this investment before 2010 will lower future capital spending.

Additional vehicles purchased in 2008 will benefit from bonus depreciation. And by taking delivery before the new engine standards are implemented, we will minimize operating issues as manufacturers adopt to a new process. Our capital spending during the first six months of 2010 will be reduced to adjust for advance purchases.

We are maintaining our 2008 cash flow guidance at $340 million to $350 million while possibly increasing our capital spending by up to $25 million. We will update cash flow guidance at the end of the second quarter as we historically have done. 2008 business objectives continue to be focused and improving margins by achieving appropriate price increases to offset inflationary costs and business risk.

Improving our market positions, standardizing significant business processes, maximizing the efficiency of service delivery and customer service and rationalizing our cost structure. I would like to thank all the employees of Republic Services for their dedication and hard work which resulted in this strong performance in the first quarter.

And operator at this time, I would like to open the call for questions.

Question And Answer

Operator

Thank you. At this time we are ready to begin the question and answer session. [Operator Instructions]. First question does come from Scott Levine of JP Morgan. You may ask your question.

Scott Levine - JP Morgan

Good morning guys.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Scott.

Scott Levine - JP Morgan

Waste Connections mentioned on your call weather and we saw a little bit of volatility in terms of weather in certain parts of the country; didn't mention weather in your prepared comments. Now your footprint is in lot of warmer weather regions or tilted towards those markets. Did you see any unusual behavior there; was there any impact on the volumes that you could quantify?

Jim O'Connor - Chairman and Chief Executive Officer

Scott we do have some seasonality as you well know. I mean again it predominately resides in the mid-west, in the Mid-Atlantic States. We probably seeing some impact there. Probably not to the same degree that some of our national competitors have. But it is a factor. It's just a little hard for us to sort all of that that out when we look at the volumes changing from the fall to winter quarters.

But just before I'd like you to do a follow-up here. What I'd like to do is go back to some comments I have here and I missed something so bear with me Scott. I'd like to highlight that Republic continues to manage its business to adjust our cost and capital investment but the challenges of the slowing economy that we are experiencing, we continue to see a pricing discipline in the industry which is I think long over due. And therefore we can expect I think to deliver higher margins and returns in 2008 and we are comfortable with our earnings guidance as I said in my comments that we provided in February.

So I want to reiterate that that even in light of the volume declines we believe that we continue to see pricing to be rational, we continue to see margin improvement and we continue to see escalating free cash flow. So with that Scott, I will give you an opportunity to do a follow up.

Scott Levine - JP Morgan

Very well, thanks. I was hoping whether I'd would get a quick update on Countywide. I think we saw news items at the US EPA was getting involved here. I was hoping like you could provide a little bit more clarity there.

Jim O'Connor - Chairman and Chief Executive Officer

Yeah. We did sign a consent order in the last 10 days with US EPA. But pretty much following the same work elements that Ohio EPA has already outlined with the addition that we may go to early closure of the 88 acres that are affected or -- that are under remediation. It does not affect the currently active part of the facility. So we don't anticipate it this time; any additional remedial costs. We still believe that the charges that we took are appropriate and still represent the best engineering estimates to talk us through remediation.

Scott Levine - JP Morgan

Great. Thanks Jim.

Jim O'Connor - Chairman and Chief Executive Officer

Thank you.

Operator

Bill Fischer of Raymond James, you may ask your question.

William Fischer - Raymond James

Yes. Good morning.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Bill.

William Fischer - Raymond James

Yeah. Jim, just on the landfill volumes, just want to see if you can give any color on... if you thought that declines there might moderate a bit as you move through the year. I think you had some noise last year in terms of some specific strange pull back on or if there's any other permanent expansions and things you might get?

Jim O'Connor - Chairman and Chief Executive Officer

Well as far as the volumes, I mean I think some of the change in the receipt of special waste materials in the Detroit market area, those should anniversary out; those were some sludges out of Toronto and sludges from the city of Detroit. We've also obviously stopped taking aluminum draws [ph] around the country. So, we've seen some impact from that but, in... really not material in nature to the business.

As far as the landfill volumes that are predominantly effected by the construction in demolition being dropping off and they have also been affected really due... somewhat probably related to the economy but, I think predominantly in the southeastern part of the United States where we seen extremely dry conditions and we haven't seen really much change in that, in the first quarter, we've seen our unit rates be much lower, so our third party deliveries would be a lot lower to our facilities.

William Fischer - Raymond James

Okay, and just following-up kind of on the C&D side, you have lot of collection only businesses. With the C&D mix and the landfills, still be about the same as on the collection side or is there any difference there?

Jim O'Connor - Chairman and Chief Executive Officer

Well, I think what you have seen Bill is as we went through the last year, the C&D mix of our total business has continued to decline as that piece of the business has slowed down in the residential construction. So, I would say that both on the roll-off, the temporary construction roll-off is a little bit smaller portion of our total revenue effect, I think you can see it in the 8-K that the roll-off revenue is down despite some positive pricing there, and probably a little bit of non-construction growth there. And I think that same factor holds true on the landfill side where the C&D volumes are down.

Now a lot of those declines were coming as we move through the sequential quarters last year and I guess the question that remains for all of us is how we hit a trough here and in terms of that slowdown, it's a little bit hard for us to see it's early in the year, it's... certainly the winter time and seasonality is a much larger factor here in this first quarter than in the other quarter. So we are not really going to have a clear picture until we move out of the first quarter seasonality and also maybe see where this economy takes us.

Operator

Corey Greendale of First Analysis. You may ask your question.

Corey Greendale - First Analysis

Hi, good morning.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Corey.

Corey Greendale - First Analysis

Kind of following up on that question, could you comment on monthly volume trends as the quarter progressed and into April and are you starting to see any of your customers on the commercial side downsizing their service levels at all?

Jim O'Connor - Chairman and Chief Executive Officer

Well I don't... I think the reconnaissance from the field is our commercial business is still modestly growing and we've not yet seen any -- any trend in our customer base to lower service deliveries or frequencies. So that still pretty much remains intact. As far as the volumes, I kind of go back to some of Tod's comments here. It's a little hard for us to sort out what's actually happening in the winter quarter with some of our volumes and how much of it is just the seasonal impact. But I think it's a fair statement to say that... look we still see obviously continued decline over the prior years quarter, and whether that's related to weather or not it is a concern to us.

But, again I kind of keep coming back to the same issues again Corey that the business is still able to show pricing growth. We are still able to show margin growth in light of the volume declines and these are volume declines that are unrelated to activities in the market other than lack of demand for either residential and/or commercial construction. So, I continue to look at the margins expanding and I continue to look at the escalation of free cash flow or our ability to generate significant amounts of cash flow and it's just really too hard for us to say what further headwind volume could produce as the year goes on and our guidance again has been based always on the fourth quarter and we did anticipate that the volumes would be a little weaker in the first quarter and in the second quarter and then we would start anniversary out in the third and fourth, and I think we've been consistent there. So, it's just a little harder to comment exactly on where all the volumes are going. I did one of the things Scott and that is we need to remember this business is scalable.

And so when we look at a change in business activity we are able to reduce the number of hours, we are able to reduce the equipment by slowing down the replacement. We are able to move equipment and therefore maintain... maybe with a little bit of a lag affect maintain the productivity that we've had in the past which is certainly a key element in maintaining and growing margins. And I think our field organization has done an excellent job of adjusting the economic conditions.

Corey Greendale - First Analysis

That's helpful. And second question is on pricing. I saw that there was a benefit from an environmental fee again, that had sort of drifted down over the last couple of quarters. Did you implement a new fee or upsize that fee and should we expect that kind of benefit for the rest of the year and if I could cheat and sneak in a quick third one. Tom could you just quickly run through all the margin impacts. Again I... the numbers I got didn't add up to 320, so I just want to make sure that I got them right?

Jim O'Connor - Chairman and Chief Executive Officer

Could we do this on the margin, could I just do it offline with you since I... I've already done it once, and maybe you can just give me a quick call after the call and I'll glad to do that.

Corey Greendale - First Analysis

Fine.

Jim O'Connor - Chairman and Chief Executive Officer

Okay. As it relates to the environmental fee, we did increase the environmental fee effective January 1st of '08. We moved here from 2% to 3%. It's still lower than our other two national competitors. But we feel that in light of the impacts that we were seeing from cost increases, monitoring expenses, and cost of secure... additional capacity we thought that it was more than appropriate to do that. So, that will remain in place.

Operator

Leone Young of Citi. You may ask your question.

Leone Young - Citigroup

Yeah, good morning.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Leone.

Leone Young - Citigroup

I understand that especially in this first quarter it's difficult with volumes between seasonality and weather but how about the third factor. Can you comment a little bit about what you are seeing in terms of competitive behavior on price, not just the national but perhaps some of your larger independents; any change there with worsening economy?

Jim O'Connor - Chairman and Chief Executive Officer

No. In fact, again... we look at... I was out on the road with Ed Lang up in Boston and New York. I guess it was, Ed, what about two weeks ago, two or three weeks ago. We do have a couple of anomaly markets that -- where we are seeing some price decrease from a couple of independents. But when I look at our larger markets and our larger urban markets and I look at our larger independents that really can actually have... could impact the market to some degree. They act very rational and in my opinion have been holding the temporary construction prices to the historical levels that we have seen. So I guess the answer to the question... short answer is we still believe it's stable with a few fuel isolated anomalies.

Leone Young - Citigroup

Great. And turning just to turns you are seeing in commercial construction. I know there's a lag in the garbage business which is great. But in particular what are you seeing in commercial constructions in some of your key markets like Florida and Las Vegas?

Jim O'Connor - Chairman and Chief Executive Officer

Well, I mean... again, most of the... we really haven't seen a whole lot of impact there. But I mean I can tell you this it's probably what gives rise to the question. We do... we have seen a number projects canceled meaning that they are not coming out of the ground and that we wouldn't anticipate volume. So I would think we'd probably start to see some impact from some of what we are hearing about in Florida and in Las Vegas and Southern California probably in the latter part of '09 as some of the larger projects won't finish until that time.

Operator

[Operator Instructions]. Our next question does come from Jonathan Ellis of Merrill Lynch. You may ask your question.

Jonathan Ellis - Merrill Lynch

Thank you and good morning guys.

Jim O'Connor - Chairman and Chief Executive Officer

Good morning Jonathan.

Jonathan Ellis - Merrill Lynch

Just... I know you touched on landfill pricing but wondering if you could walk through a magnitude of price growth in the commercial collection, residential collections and permit roll-off businesses.

Jim O'Connor - Chairman and Chief Executive Officer

I mean when you look at... let's start with residential. It's predominantly indexed priced, whether it's in our franchise of business or whether it's in our contract residential municipal business. So, I mean there it's going to trend to the CPI which is running in right around 3%.

Jonathan Ellis - Merrill Lynch

I am sorry, I guess, you mean on price on contract renewals in the municipal business is what I meant to say?

Jim O'Connor - Chairman and Chief Executive Officer

Contract renewals? Okay.

Jonathan Ellis - Merrill Lynch

Yes.

Jim O'Connor - Chairman and Chief Executive Officer

Well the contract renewals have significantly outpaced the CPI. As we have been in renegotiating and/or rebidding, our franchises and/or municipal contracts, I think we are starting... we were seeing pricing move anywhere from 5% to 10% depending on the return expectation or the return delivery that we were achieving in the contract or the franchise. Our pricing has escalated in those areas anywhere from 5% to low double digits.

Jonathan Ellis - Merrill Lynch

Okay, great. And then just on the landfill side, can you update us on how far you are through working through the long-term disposal agreements and what type of price increases you are achieving on those contracts?

Jim O'Connor - Chairman and Chief Executive Officer

Sure. I think it was probably about six quarters ago we've kind of brought up the fact that landfill pricing would move and we'll continue to escalate as these contracting anniversaried out. I'd say we have probably got another four quarters to go, we are probably about 2/3rd of the way through them and I think it's reflected in our pricing. If you look over the last several years, we've moved pricing from approximately 2.5% to 2.8% up now to a little over 3%, 3.4%.

So, I mean... I think you are starting to see it materialize and I think it will continue to grow. And again when I was on the road two weeks ago, I think you should see landfill pricings move up towards the 4% range. And then now whether it will move much higher than that will depend on... will return on the individual markets and the demand. But at the end of the day, I think, 4% to 5% would be somewhere where we settle in the next 12 to 24 months.

Operator

At this time, we show no further questions.

Jim O'Connor - Chairman and Chief Executive Officer

Okay. Thank you Fray, I appreciate it. And at this I would like to remind everyone that this call is available for the next 24 hours by calling area code 203-369-3289. Additionally a recording of the call will be available on Republic's website at republicservices.com. And I'd like again to thank all of you for spending time with us today. Please have a good day, and good bye.

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