Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Covanta Holding Corporation (NYSE:CVA)

Q3 2012 Earnings Call

October 18, 2012, 8:30 a.m. ET

Executives

Alan Katz - VP, IR

Anthony J. Orlando - President and CEO

Sanjiv Khattri – CFO

Tom Bucks – CAO

Brad Helgeson - Treasurer

Analysts

Daniel Mannes - Avondale Partners, LLC

Ben Kallo - Robert W. Baird & Co.

Scott Levine - JPMorgan

Michael Hoffman – Wunderlich Securities

Gregg Orill - Barclays Capital

Al Kaschalk - Wedbush Securities Inc.

Smittipon Srethapramote - Morgan Stanley & Co. LLC

Operator

Good morning everyone, and welcome to the Covanta Holding Corporation's third quarter 2012 financial results conference call and webcast. This call is being tape and a replay will be available to listen to later this morning. For the replay, please call 877-344-7529, and use the replay conference ID Number 10019283. The webcast will also be archived on www.Covantaenergy.com. and can be replayed or downloaded as an MP3 file.

At this time for opening remarks and introductions, I'd like to turn the call over to Mr. Alan Katz, Covanta's Vice President of Investor Relations. Mr. Katz, please go ahead.

Alan Katz

Thank you, Amy and good morning. Welcome to Covanta's third quarter 2012 conference call.

The RR team had a busy quarter. We did two West Coast investor trips as well as our typical plant tours and investor meetings in the Tri-state area. I wanted to take this opportunity to tell everyone that we'll be starting a quarterly plant core program to give everyone a chance to see one of our facilities. It has been our experience seeing our operations is an important element of the investment thesis for Covanta. If you're interested, please reach out to me after the call and we can discuss the details. Or you can sign up on the IR section of our website, Covantaenergy.com.

Moving on, joining me on the call today will be Tony Orlando, our President and CEO, Sanjiv Khattri, our CFO, Tom Bucks, our Chief Accounting Officer, and Brad Helgeson, our Treasurer. We will provide an operational and business update, review our financial results, and then take your questions. During their prepared remarks, Tony and Sanjiv will be referencing certain slides that we prepared to supplement the audio portion of this call. Those slides can be accessed now or after the call on the investor relations section of the website. These prepared remarks should be listened to in conjunction with those slides.

Now on to the Safe Harbor. The following discussion may contain forward-looking statements and our actual results may differ materially from those expectations. Information regarding factors that could cause this differences can be found in the company's reports and registration statements filed with the SEC.

The content of this conference call contains time sensitive information that is only accurate as of the date of this live broadcast, October 18th, 2012. We do not assume any obligations to update our forward-looking information unless required by law. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Covanta is prohibited.

The information presented includes non-GAAP financial measures, reconciliations the most directly comparable GAAP measure, and management's reason for presenting such information is set forth in the press release that was issued last night as well as the slides posted on our website. Because these measures are not calculated in accordance with U.S. GAAP, these should not be considered in isolation from our financial statements prepared in accordance with U.S. GAAP.

It should also be noted that our computations of free-cash flow, adjusted EBITDA, and adjusted EPS may differ from similarly titled computations used by other companies.

With that, I'd like to turn the call over to our President and CEO, Tony Orlando.

Anthony J. Orlando

Thanks, Alan. Good morning everyone.

Let's begin with a quick summary of the quarter. For those of you using the web text, please turn to slide three.

Sanjiv will walk you through our financials, but generally, the third quarter results were in line with our expectations. Our organic growth initiatives were offset by challenging markets and maintenance timing.

Our operating track record continues to be strong and predictable. We completed the Honolulu expansion project and a third boiler is now in commercial operation. We renewed and negotiated several important contracts including a waste contract at our Essex facility and our Long Island Power contracts. And we maintained our focus on our organic growth initiatives.

We now order guidance toward the lower end of our original range primarily because energy and metal market declines. Notwithstanding this, we're still on track to grow our adjusted EBITDA for the full year and to achieve our initial guidance on all metrics. We're able to do this because we're executing on the challenging organic growth targets we set for ourselves at the beginning of the year to overcome lower debt service revenue and lower energy prices.

New projects in construction have been positive contributors. Special waste is growing nicely. And we're doing an excellent job maintaining our facilities while managing our costs. I'm also pleased with the work we're doing to recover more metal. Although we are a bit behind the aggressive timeline we originally set for ourselves in terms of new project installations. That will reduce the benefit we had initially planned on seeing in Q4, but we'll definitely get the benefit next year.

As I said in the past, we're intent on continuing to grow our bottom line not just this year, but also next year and in the years ahead.

Now let's turn to the business outlook. We'll start with waste on slide four.

Our review of the waste markets is essentially unchanged. The market remains very competitive. But our facility locations give us a competitive advantage. And we continue to do a good job contracting for long-term waste supply. About 75% of our waste revenue is under a contract for rest of this year and through at least 2013. The contracted nature of our waste re-mitigates the impact of spot market fluctuations. And gives us a significant amount of long-term visibility. We're constantly renewing and replacing these contracts when they come to an end. Some of these contracts are above market. Some are below market. Although it's fair to say that given current market conditions, we're seeing more contracts adjust down to market. We've been effectively offsetting these transitions with a combination of our typical contract and inflation adjustments, new long-term contracts to displace spot waste, and the expansion of our special waste business. Overall, our Q3 tip fee was up about 2% compared with 2011.

Let me highlight some of our new innovative contracts that meet our client's needs while enabling us to display spot waste. Over the past ten months, our New England team has signed seven new bundled service contracts for waste, recycling, and compost in Connecticut. The individual contracts are relatively small. But in aggregate, they're meaningful. In total, these contracts represent almost 100,000 tons of waste and 15,000 tons of recyclables with an average contract life of 4 years. These are good examples of situations where we can add value for our clients by managing their entire waste streams.

In addition to tip fee contract renewals and replacements, we're also continuing to find mutually beneficial solutions to transition service fee contracts to tip fee. During the quarter, we finalized our agreement to convert our Essex County facility in Newark, New Jersey from a service fee to a tip fee effective on January 1st. Overall, this is a positive contract for us. We can control the strategically located facility and our energy revenues increase giving us an added exposure to the energy market, which I'll describe further in just a moment.

However, I want to point out that this new contract will result in lower waste revenues and increased expenses. At today's market prices, the net benefit to our adjusted EBITDA will be modest next year and will grow over time.

We'll continue to move through the service fee contract transitions over the next several years. Remember, as discussed many times before, when we own the facility with a service fee contract, our municipal client pays debt service dollar for dollar. Thus when we pay off project debt, our debt service revenues declined. As has been the case in the last several years, in 2013, we'll have lower debt service pass-through billings with correspondingly lower debt service payments. This will be approximately a $15 million reduction next year.

Moving onto our energy portfolio, please turn to slide five. This quarter, natural gas and electricity markets recovered a bit primarily on increased demand due to weather and switching from coal to natural gas.

Full year average natural gas is now forecast to be about $2.75 per MMBTU versus the $3.00 price that we had discussed when we initially issued guidance in February of this year. Our rough rule of thumb has held to throughout the year. Again, that rule of thumb was that for every $1.00 move in natural gas prices, we'd see about a $10 to $15 million annualized impact to our 2012 adjusted EBITDA. These initial rule of thumb to $0.25 move in natural gas price from the time we issued our initial guidance causes a $3 to $4 decline in our adjusted EBITDA.

Moving on, we made progress this quarter in managing our longer term energy exposure by entering some additional contracts. In particular along with all of our Long Island communities, we entered into a long-term power purchase agreement or PPA with LIPA, the Long Island power authority. This is a five year contract with renewal options for another ten years. The contract is retroactive back to April. We'll be paid a similar price as we have been in the past with a fixed price for two years and a floor and ceiling price thereafter. This removes the potential volatility that had come along with selling at an avoided cost rate. This is a win/win contract moving over 600 megawatt hours from the exposed into the contracted bucket giving us visibility to our contract pricing while providing LIPO with clean renewable base load electricity and certainty around this aspect of their cost.

We also signed a one-year power contract with the city of Riverside, California for the output at our Stanislaus facility. This contract will run from December of 2012 to November of 2013 at a bundled rate per energy and renewable credits.

In 2013, our total economic energy output from our energy from waste facilities will be about 5.5 million megawatt hours. This is an increase of about 600,000 megawatt hours due to the Essex and Stanislaus tip fee contract transitions plus the Honolulu plant expansion and the new steam contract at Niagara.

So let me recap our energy outlook for next year. Our total economic output from the EFW facilities is expected to be about 5.5 million megawatt hours. Approximately 80% of this output is already contracted or hedged. And we plan to increase that to 85% by the start of the year. So our expectation for next year breaks down as follows. 3.7 million megawatt hours is contracted. 900,000 megawatt hours will be hedged. And 900,000 megawatt hours will be exposed to market.

I should point out that on our last call, I had discussed 2013 with about the same exposed output as we had started 2012. That would have been about 1.5 million megawatt hours. Now with the new LIPO contract in hand, we expect to enter the year with 900,000 megawatt hours on the spot market.

In total, we expect flat pricing in our EFW portfolio with an increase again of about that 600,000 megawatt hours. The price per megawatt hour will be flat notwithstanding the rising energy markets for three reasons. First, we have some above-market contracts transitioning to market next year. Second, our 2012 hedges placed in 2011 were at higher prices than the 2013 hedges we placed earlier this year. And third, the megawatts we added with the new contracts noted earlier are coming in at prices below our 2012 average price. Of course, the additional megawatts will substantially increase our total energy revenue next year. But remember, while the new contracts drive and the increased energy sales are all positive, the additional revenue will be partially offset by other contract changes that will reduce waste revenue and increase expenses.

Let's move onto metals on slide six. Year-over-year for the quarter, market prices were down about 15%. That caused in decline in our total quarterly metal revenue. But we're continuing to make progress maximizing the value of the metal that we recover. This quarter, we boosted the quality of our recovered metal at one of our larger plants by processing the metal through a shredder and an air classification system. By doing this, we removed impurities, which actually reduces the weight sold, but significantly increases the price with a net improvement in total metal revenue. So we continue doing good things that have enabled us to hold year-to-date metal revenue flat in the face of a 10% decline in the average HMS #1 price.

Unfortunately, the market continues to move against us. In October, HMS price was just set at $307, the lowest monthly number so far this year. We're expecting a small price improvement in the last two months of the year. Such that our full year 2012 expectation for HMS is about $365 compared with $410, which was the basis of our original 2012 guidance. At that time, we gave you a rough rule of thumb that a $50 movement in the HMS #1 index would be approximately a $10 million impact to our adjusted EBITDA. So we expect to see nearly a $10 million adverse impact on metal pricing this year.

The metal projects that we are pursuing continue to have an excellent return with any reasonable market price assumption. Short-term metal prices will continue to be volatile, but we're investing for the long term. We now have several metal recovery projects online. And several more that are currently being constructed. We'll get a little benefit from these projects in the fourth quarter. But as mentioned earlier, most of the benefit will be next year.

We aim to increase our metal recovery metal significantly by the end of 2013. Compared to our actual results in 2011, our 2013 target is to recover approximately 50,000 more tons of ferrous metal and approximately 10,000 more tons of non-ferrous metal. That's going to be a meaningful increase in metal volumes next year. Remember, the non-ferrous metal commands a much higher price. So the additional non-ferrous recovery will be the big driver for growth next year.

Looking ahead to 2013, I am confident in our additional metal recovery. But the market price is difficult to predict. Economic activity particularly in China will drive the price. If current market prices carry into 2013, it will erode the year-over-year benefit. But we still expect to see a meaningfully higher metal revenue.

Before I wrap up our metals discussion, I'd like to mention a JV that we announced in September with Tartech. This is 50/50 joint venture to recover and recycle metals from the ash that is currently in monofills. We've just started this relationship. And now we're working to develop projects with landfill owners including our clients. The development and construction will take some time. So it's not likely we'll see any benefit next year. But we're optimistic this will be beneficial in the long run. And I believe it's indicative of how our team is thinking outside the box to come up with ways to grow the business for the long term.

Speaking of growth, let me move on to slide seven so I can discuss our organic growth initiatives.

I just addressed metal recovery and so I won't repeat that. Moving to special waste, we continue to make great headway in this business. I mentioned earlier that the higher price we command in special waste is helping to overcome market pressure. Our special waste business is continuing to grow. And we signed on several new clients this past quarter.

Efficiency and productivity improvements are on track. I discussed a number of technological and process improvements over the past year. So I'll just say that between those improvements and some procurement initiatives that we have launched, we'll see some nice savings this year and next.

In terms of construction, we've essentially completed the construction of a third boiler at the Honolulu facility. And we're now operating it under our new long term O&M agreement. This project was on time and on budget.

Our Durham York project is on schedule. And we're well into the early stages of construction with the project nearly 25% complete at the end of the quarter. Construction was a positive contributor to our bottom line this quarter because of the good job we're doing with these projects.

Looking ahead to next year, we have plans in the works to continue investing in organic growth projects that will benefit 2013 and beyond.

Before I wrap up, I should mention that I don’t have anything new to report regarding our European development efforts. We're still waiting for the client to make their decision on the Merseyside waste procurement. It is frustrating to have to wait so long. But this is a large complex contract and a very important decision for the community. We remain hopeful that we'll be named as a preferred bidder, which will enable us to move forward with this excellent project.

Regarding the Dublin project, we're still in discussions for financing. But there's nothing further to report on this now.

Turning to slide eight, I'd like to offer a quick summary of 2012 and 2013 before passing the call to Sanjiv.

We continue to manage the business well. And despite the market conditions and challenges, we have a great deal of predictability and stability. Our third quarter results were in line with our expectations. And we're confident full-year results will be within our guidance ranges.

Looking ahead to next year, we are still in the process of establishing our budgets. And we'll provide guidance when we host the year-end earnings call. But I can tell you now the same thing I've told you in the past. We are intent on growing our bottom line. We grew adjusted EBITDA in 2010 and '11. We just updated 2012 guidance, which calls for growth this year. And we expect to grow EBITDA again next year. Yes, we have challenges to overcome. And the lower metal price doesn’t make it any easier. But energy prices finally seem to be moving our way. We're effectively managing the business and executing on our organic growth initiatives. I've got confidence our team will get the job done.

Furthermore, our free-cash flow will continue to be strong. And we will remain focused on capital allocation and shareholder returns. This gives us a very solid base. Plus we have upside potential if we can realize some of the larger growth opportunities or energy and metal prices move in our favor, which is likely to happen if the world economy picks up.

Now, I'll turn the call over to Sanjiv for his remarks.

Sanjiv Khattri – CFO

Thanks, Tony. Good morning, everybody and good afternoon to those of you calling in from Europe. This quarter has been filled with activity. As Tony described, the team made big progress on renewing or establishing several important contracts. The focus on organic growth and development continued. We overcame market headwinds while setting the business up for long term value creation.

My team has been active as well with the proposed project for refinancing lead by Brad our Treasurer. I’ll discuss that briefly before the end of my prepared remarks. We are also in the pick of better season, so [inaudible] sitting here with me is keeping all of us very busy.

As usual, let’s start with a quick overview of the financials. I’m on Slide 10, which lays out our Q3 2012 financial highlights. As Tony highlighted, the quarter came in generally aligned with what we discussed on our Q2 call with the exception of revenues was declined by about 5%.

Adjusted EBITDA was down slightly from last year. Free cash flow was up primarily on working capital timing and adjusted EPS was basically flat all as we had expected.

As usual, I’ll walk through the detailed financial [inaudible] waterfalls over the next few slides. Before we get into the numbers, I want to note that as always on Slide 20 in the Appendix, we include our more detailed family of the P&L including year-to-date metrics. We are happy to take any questions on this, of course.

Let’s get to work and dive into the details. Starting with revenue on Slide 11. Total revenue in the second quarter declined by $20 million year over year to $412 million. Energy pricing was up 8 million for the quarter, primarily due to two factors. Working in our favor was a retroactive energy revenue related to both our new LIPA contract, which Tony detailed earlier and several of our biomass plants. Working against us was the underlying market energy pricing compared with 2011.

A quick word on the retroactive energy payments. The LIPA amount was related to the effective date of the contract, which was in April. We signed the contract earlier this month for the third quarter revenues included the incremental revenues from Q2. On the script of the biomass plant, under certain contracts we get a higher per-unit price if we achieve cumulative production thresholds within the contract year. We achieved these thresholds in quarter three and were able to recognize the incremental revenue for the contact year to date.

The 8 million was more than offset by several negative drivers this quarter. The largest of them was the lower construction revenues. While total construction was lower year over year, a large driver of this was a positive piece of news. We completed construction on the Honolulu expansion project on time and on budget. All our construction was down 15 million versus last year but we expect construction in Q4 to be relatively flat year over year with the Durham project wrapping up.

In terms of our organic growth in initiatives and our energy from waste plants were offset by lower energy production at our biomass plants and slightly lower waste volumes. So we ended up with a negative [inaudible] impact in that category.

In terms of underlying waste volumes which grows some of this [inaudible], waste volumes were down a bit this quarter year over year, largely related to the exceptionally high volume availability last year. And if you recall, we had an impact of Hurricane Irene in the Northeast late August last year. This resulted in a very high [inaudible] last September.

In the Waste and Services contract transition and extensions to that degree, we were [inaudible] negative this quarter due primarily to the impact of the Hartford contract ending. The softness in Metals market pricing was over a 4-million impact in the quarter. We had total Metals revenue of 17 million this quarter versus 20 million last year. Year-to-date metal revenues accounted for $55 million, flat compared with the same period 2011 despite the significant decline in price.

Tony covered Metals in some detail, so no need for me to dwell further. Lastly, there was small impact due to a reduction in Debt Services revenues and the run off of our insurance business.

Moving on to Slide 12, Adjusted EBITDA was down 3% year over year to $150 million, consistent with what we shared with you last quarter. The benefit from the 8 million in energy revenue I just explained fell through to the bottom line. Our Organic Growth Initiative, including Special Waste, various operational improvements and then backed up construction this quarter were partially offset by the [inaudible] of Alternative Fuel Tax credits and the slightly lower waste I just mentioned resulting in a $3 million positive impact to adjusted EBITDA.

Waste and Service Contract addition and extensions were a negative 1 million primarily due to the Hartford contract ending and other minor transitions. Metal pricing was another 4 million negative with impact to revenue flowing through to the bottom line. Plant maintenance expense was up by 4 million this quarter due to timing but we expect fully year maintenance expense to be actually down year over year. And on the side, we continue to enjoy strong operating performance at our facilities.

Lastly, lower debt service pass through billings of 5 million were right in line with that expectations.

Turning to Slide 13, let’s discuss Q3 free cash flow. Now, free cash flow was up 4 million to $111 million this quarter compared with the third quarter of last year. As you can see from the waterfall, this was primarily due to the positive impact of working capital offset by the 3 million decline in adjusted EBITDA. Maintenance CapEx is on track with $67 million spent so far this year. Guidance on this line item is unchanged at the full-year range of 80 to $90 million.

As you know, going forward, free cash flow will continue to be impacted by construction-related working capital, especially as projects wind down and ramp up. The good news is that our operations underlying free cash flow remains very strong and continues to trend well.

A quick update on our growth capital spend. With minor details in some of the Metal projects as well as the [inaudible] team expansion project, we now expect 2012 total growth CapEx to be significantly less than the 50 million outlook we shared at the start of the year. Any projects that are executed in 2012 will be completed in 2013 as they remain very economically compelling.

As we have done in the past, Slides 22 and 23 in the Appendix provides the details using actual Q3 data of how Covanta consistently generates significant amounts of cash flow from relatively modest earnings. We continue to find these slides useful as we introduce the strong pre-cash flow story at Covanta to new investors.

Question-and-Answer Session

Operator

(Operator instructions). Our first question is from Daniel Mannes – Avondale Partners, LLC, go ahead sir.

Daniel Mannes – Avondale Partners, LLC

Hey, good morning everyone.

Sanjiv Khattri – CFO

Good morning Dan.

Anthony J. Orlando – President and CEO

Good morning.

Daniel Mannes – Avondale Partners, LLC

I was wondering, could we touch a little bit more on the Essex contract. Your indication, obviously you’re picking up a couple hundred thousand extra megawatts hours, you are going to have some incremental cost. Could you sort of walkthrough the economics of it in maybe a little more detail. Because you kind of indicated that 2013 wasn’t going to see much of a benefit, so how does it play out when this becomes a big benefit over a couple of years, what are you going to do that makes this very valuable?

Anthony J. Orlando – President and CEO

Well again, I think there are a couple of key aspects to this. It’s a great facility, in it’s a strategic location, and the transaction and the investment that we’re going to make, you know, secures this facility for us and for our clients for the long-term.

In terms of the energy exposure, I think we like that, you know this is again a good location in terms of energy output and we like having that additional energy exposure. We’re going to have the opportunity to invest in new metals project, which we’ve already got, you know, now underway. So overall it’s going to be a benefit for everybody involved. But it is – there’s a lot of moving parts and pieces to it, and of course I think you know us well enough by now Dan, I’m not going to get into the specific contract discussions, but suffice it to say, this is good for us and good for everybody involved.

Daniel Mannes – Avondale Partners, LLC

So, I can summarize, you mean the real upside here sounds like it’s going to be the ramp in power prices overtime, and then also the scrap metal as you put those systems in, which sounds like it’s probably a little bit later in ’13 or farther down the road?

Anthony J. Orlando – President and CEO

Yes, and there will also, I think some benefits on the waste side longer-term.

Daniel Mannes – Avondale Partners, LLC

And then real quick.

Sanjiv Khattri – CFO

Also Dan, I have one quick thing, the capital spending related to it, went through the same rigorous return on investment that Tony insist on, so the investment that we are making has a good – very good (NYSE:IRR).

Daniel Mannes – Avondale Partners, LLC

Sure. And then lastly, if you could give us a little more collar on the LIPA transaction. I know you’ve been working on that for a while, and I know you were burdened with some uncertainty on pricing under the old, you know, short-term of what it cost. Can you walk us through a little bit about the mechanism on pricing going forward and where this lofts in, and may be relative to what you were seeing before in the contract?

Anthony J. Orlando – President and CEO

Yes, sure Dan. Again this is certainly an important contract, I think again for everybody involved this is good for our municipal clients that are getting a share in the energy revenue. It’s good for us and it’s good for LIPA because it gives everybody some certainty.

In terms of the price, we are looking at a price that’s very similar to what we were getting historically. But, what we’ve done now is we’ve taken kind of that volatility off the table. We’ll get – there’s actually a fixed price for the first couple of years, and then after that there’s a floor and a ceiling on the price. So, in terms of, you know, when you look at our numbers year-over-year, you’re not going to see a big difference, because the price is very similar to what it was in the past. But what we’ve done is we’ve given ourselves some certainty there, you know, in an environment where their avoided cost was starting to move more frequently and moving downward more frequently, so.

Daniel Mannes – Avondale Partners, LLC

Got it, thanks a lot.

Sanjiv Khattri – CFO

Thanks Dan.

Operator

Our next question is from Ben Kallo – Roberts W. Baird & Co. Good ahead please.

Ben Kallo – Roberts W. Baird & Co.

Hi Tony, Hi Sanjiv.

Sanjiv Khattri – CFO

Good morning Ben, very early for you.

Ben Kallo – Roberts W. Baird & Co.

Very early. As far as the international growth goes, do you guys have a stop deadline where you wouldn’t go forward with any project? So if we don’t get Dublin going forward, if we don’t … So if we don’t get the U.K. going forward, when is that day?

Anthony J. Orlando – President and CEO

Look, I think we are constantly, you know, evaluating, assessing where we are and what we’re doing and what makes sense. You know, as long as we think it makes sense to continue, we will. You know, specifically with respect to Dublin, to the extent there is a deadline, its self-imposed by us and our client. So, as long as we are making progress and we both think it makes sense to pursue the project we will. We do continue to think that’s a good project for everyone involved, but the project finance markets do remain a challenge, so we’ll have to see how that plays out. When we have some news on it, you know obviously one way or the other we’ll let you know.

I would also note that in the meantime it’s really not a big drain on resources.

Ben Kallo – Roberts W. Baird & Co.

And so, you will know by the end of year and then following up to that, can you still have a dividend increase even if you fall through on this project next year?

Sanjiv Khattri – CFO

Again, when we laid out the dividend, the board was very clear that they wanted to have a dividend that had some good potential in it. Clearly as you have been very vocal about the resiliency of our cash flow, and again this is a decision the board will take, but I can’t imagine that with the strong emphasis that capital allocation is for the board that what will happen to the dividend, it has good potential. But I can’t really commit whether to [inaudible] As I said, the dividend was set so that it that it has growth potential.

Ben Kallo – Roberts W. Baird & Co.

I’ll just going to ask the question. How do you guys think about the political environment, meaningful at all?

Anthony J. Orlando – President and CEO

With respect to the presidential election?

Ben Kallo – Roberts W. Baird & Co.

Yes.

Anthony J. Orlando – President and CEO

Is that your question? Yeah, you know, look, obviously the political season right now is, you know, active and I guess if you’re in one of the swing states you’re probably seeing, you know more commercials than you’d care to. Here in New Jersey, I guess we don’t see many commercials. But, you know look, we’re prepared to work with whatever policies are set. We believe that, you know, waste disposal is necessary no matter who’s in office, and certainly everybody needs energy. I was happy to hear both candidates the other day, you know, firmly say that they’re in the “All in the above camp”. So, you know, I think it’s not going to be a significant driver on us one way or the other.

Ben Kallo – Roberts W. Baird & Co.

Thanks, good quarter.

Sanjiv Khattri – CFO

Thanks Ben.

Operator

Our next question is from Scott Levine – JP Morgan, go ahead.

Scott Levine – JPMorgan

Hi, good morning guys.

Sanjiv Khattri – CFO

Good morning Scott.

Anthony J. Orlando – President and CEO

Morning.

Scott Levine – JPMorgan

So, a question regarding the outlook for 2013. You know you were clear the expected EBITA to grow based on everything you see, and that you’re in the planning process right now. Your comments on free cash were more general. I was wondering if you had anything to add there? And if we were to think specifically about the things that are a greater swing factors with regard to the outlook for ’13, I was wondering if you could elaborate on what those are, and what types of things we should be looking for in order to develop more definitive thoughts on what 2013 and 2014 look like actually?

Anthony J. Orlando – President and CEO

Sure, this is Tony, I’ll take that Scott. So, you know, in terms of our outlook, as you said we do expect to grow. We’re still in the middle of our budget process, but we’re starting to get some fair bit of visibility there. So, we know what we have in front of us, we know what we got to get done and certainly there’s some challenges, but I think the team is up to it.

With respect to cash, you know, EBITA obviously gets a little more predictable. The cash flow has a – more swings potentially, particularly with the construction activity that we have going on in terms of working capital. But, it’s our goal to convert EBITA to cash, we’re a very cash focused company, and generally speaking the EBITA is a very good proxy for our cash generation. So, we would expect things to generally speaking move in tandem there.

In regard to what’s going to have an influence next year, I mean clearly the markets are meaningful. I described our energy hedging position and contracting position, and as I said, we’re looking to actually go into next year with a fever megawatts exposed. We still have some hedging to do this year, so we hope to kind of take advantage of the recent rise in energy prices when we put those hedges in place. But, you know, energy is actually going to have a slightly smaller impact next year, but it will clearly be a much bigger impact in 2014, ’15 and ’16, right, so our – while we’re trying to narrow down that volatility in the first year, we’re exposed to what we believe on a long-term basis is a nice position in terms of energy output, with the facilities that we have in great locations where we get paid for our fuel. So, we like that exposure long-term.

I think probably one of the biggest factors for next year will be metal prices. We know that that tends to be volatile. We know it’s going to be impacted by the economy in China and of course here in the states as well. What we can control and what we can do, we’re going to recover more metal, we know we’re going to do that. And so, even if the prices stay where they are now, we’re going to get more metal revenue, but it’s hard to say where that price is going to go. You know, if it bounces back up to where it was this year, you know, that’s going to be a really nice pickup for us next year. So, we just have to see on metal revenue.

I think those will be the two biggest factors. You know, the waste markets don’t tend to move all that quickly. And then of course it’s us focusing to capitalize on opportunities that we have in front of us, and finding ways to add to the bottom line.

Scott Levine – JPMorgan

Got it, and to be clear, I think you said Tony in your prepared comments that your recovery and your volumes on the metal side may be a little bit lower than we expected into Q4 by 2013 pretty much in line with what you guys were previously expecting, is that correct?

Anthony J. Orlando – President and CEO

Yes.

Sanjiv Khattri – CFO

Yes, that’s right Scott.

Scott Levine – JPMorgan

Great. And one follow-up, you know I believe someone asked about the election in the U.S. I guess I would ask you generally outside of, you know, Merseyside and Dublin, are there other reasons to be optimistic there could be additional growth opportunities, and maybe a little bit more collar regarding the overseas landscape and whether you see additional markets offering potential for additional project development?

Anthony J. Orlando – President and CEO

I think that there’s a couple things that give us some optimism there. We generally see regulatory and policy environment outside the U.S. that is very supportive of what we do. Certainly that’s the case in the U.K., that’s the case in Ireland, that’s the case in China where we’re focusing. We also see potentially some additional opportunities in Canada. So, generally speaking the regulatory environment and policies are supportive of avoiding putting waste in landfills, and that works to our advantage.

Having said that, we do want to be discipline and focused on pursuing the opportunities. They are fairly longtime framed as we know, and they’re not – they can be a significant cost. So, we want to have some success on what we have right in front of us before we start to kind of venture out into other opportunities, but they are there.

I would say the other area is technology development. I talked a bit about it on the last quarter. We announced a technology called “Clear Gas”, in the spring and this is a new technology that we’ve developed a gasify waste, which we believe can be competitive on a smaller scale. And so, it’s still in the early days there, but I think that long-term that’s going to open up some new doors for new opportunities for us on smaller scale projects.

Scott Levine – JPMorgan

Got it. One last one if we may. Sanjiv, I think you mentioned thought on the dividend and potential for growth. I mean if you just comment on capital returns policy in general, dividend versus buyback, you know, is there a bias one way versus the other [inaudible] remaining constant, or is it kind of an open mind with respect to future buyback activities?

Sanjiv Khattri – CFO

For a couple of givens. One, is that the company generates a lot of free cash flow, I think we’ve shown that, we’ve laid it out to you, we’ve shown you how we do it. So that’s fact one. The company has had a very consistent policy now that we invest our cash in growth capital, and whatever is left we get it down to the shareholder and that can be a mix of either stock buyback, and dividend. We’ve returned over $750 million dollars since we started this program. Bought back over 16% of the company. I expect that to continue, so I expect all the cash flow we generate either to go to growth, or to go to dividend, and stock buyback. I do believe that the board believes, Tony believes, that the dividend should be able to grow every year.

So, that’s our objective. We obviously have to look at what’s happening in the business and what the factors are, and then any funds that will be left, they well be candidate for stock buyback. So, you know, that’s sort of the mix and we think all three are very important.

Operator

As a reminder, would you kindly limit yourself to one question and one follow up. Our next question is from Michael Hoffman with Wunderlich Seucrities. Go ahead, please.

Michael Hoffman – Wunderlich Securities

So the challenge to get five questions in one.

Sanjiv Khattri – CFO

Michael, if anyone could, you can.

Michael Hoffman – Wunderlich Securities

So on the small G initiative, if we could, how much lower could metal prices go and you’ll still be flat in ’13 versus ’12 in revenues given the initiatives that, you know, the new developments to collect more, separate it, improve the quality?

Anthony Orlando – President and CEO

You know, they could actually dip a fair bit, as I mentioned earlier, you know, if prices stay where they are, which would be quite a bit below the average 2012 price, we still expect to have significant growth. You know, if they dip further, which again, it’s very hard to predict the metals market, you know, but that would really, I think, be reflecting of a real slowdown in the economy and I guess, you know, that’s, again, not out of the question but hopefully won’t be the case. So I think even if they dip quite a bit further, we’ll still have a pickup in total revenue.

Sanjiv Khattri – CFO

And more importantly, Michael, you and I have talked about this, we will have [inaudible] structure and improve quality and quantity long term that is going to pay off with a few dips here and there and we know it’s noisy, who cares.

Michael Hoffman – Wunderlich Securities

Yep, that’s kind of the nature of that question. And then on special A50, Tony, you’ve talked about a ’12 goal of about 50 million. Could you characterize where we are in that and then how do you think about what ‘13’s goals should be at least as far as the scope of the upward direction?

Anthony Orlando – President and CEO

Well, but we have to have our goals at a 50 million run rate by the end of the year. We feel good about that. And we both have set our goals to get double-digit growth on special waste, so that’s, you know, we’ve been doing that actually now for a little while and we would expect to continue doing that in the years ahead.

Michael Hoffman – Wunderlich Securities

And then if I could ask your indulgence, could I ask one question about Dublin?

Anthony Orlando – President and CEO

Yes.

Michael Hoffman – Wunderlich Securities

There’s a sovereign debt sort of issue at the moment, the Germans are smashing their teeth. If that clears and is in some level favorable, does that take a fairly significant hurdle out of the bank’s minds of do I want to lend Europe scenario?

Sanjiv Khattri

Brad, do you want to [inaudible]? Many of you know Brad, he’s our Treasurer. He is personally leading the charge on Dublin. Why don’t you tell us what’s going on?

Brad Helgeson – Treasurer

Yeah, Michael, let’s say that, you know, the situation not only from a macro and sovereign standpoint has improved over the last 12 months pretty clearly, so while I think that hasn’t necessarily manifested itself in banks rushing to re-enter Ireland, I think it has settled things down pretty clearly and I think net-net is positive for what we’re trying to do. Notwithstanding that, it is still difficult.

Michael Hoffman – Wunderlich Securities

Yes, I understand that, but it – that’s, I think, a clear data point that not everybody might have a grasp on. Thanks.

Sanjiv Khattri – CFO

Thanks, Michael.

Operator

Our next question is from Gregg Orill with Barclays, go ahead.

Greg Orill – Barclays Capital

Thanks a lot.

Sanjiv Khattri – CFO

Hi, Greg.

Greg Orill – Barclays Capital

Hi. Good morning. I was wondering if you could talk about the turn of capital through the stock buyback ongoing and how and whether that’s independent of the hearing on the Dublin and Merseyside opportunities and in the event that you don’t win one of those, how would that affect the buyback?

Sanjiv Khattri – CFO

You know, we’d be speculating on exactly what would happen, but as I responded to Scott’s question, [inaudible] a lot of free cash flow [inaudible] as growth capital dividends and stock buyback to the extent that we actually have a couple of big development opportunities like Merseyside or – and/or Dublin, then clearly that would be a big user on growth capital and we would have to look at our stock buyback program at that time. Obviously the dividend will stay and will continue to have growth potential but we’d have to revisit the level and the frequency of stock buyback and we will be very transparent with you, as you know, I take you through ever dollar, where it’s gone, so you can bookmark us.

To the extent that we are unsuccessful, again, we’d have to stand back, the board would have to look what are the growth opportunities that the company has. Tony mentioned some smaller opportunities. Tony mentioned Clear Gas, so we’d have to look at all of that, but to the extent that we stay consistent with our philosophy, which is the free cash flows, are they going to grow, or the stock buyback to the dividend, it’s hard to imagine a scenario under which stock buyback would not continue to be a very important element of that. And also, it really depends what else is going on, but this is something we’ve done and we will continue to do balancing the three, recognizing that the best use of our capital remains growth, but we want to be responsible in terms of how we chase the growth and we’re going to be responsible in terms of what growth we’ve chase and we’ll take it from there.

So I think you can rest assured that all three will be happening.

Greg Orill – Barclays Capital

Excellent. Are there any plans for an analyst day in the near future?

Sanjiv Khattri – CFO

We’ve been looking at that. We would seriously consider doing that in the near term. You know, we sort of look at what else is going on in the business. We feel that we made a lot of progress with our investor community by the very extensive recharge leading the quarter, the quality of our disclosures and you know, I think [inaudible] run a first-class outfit in terms of doing all of that. But you know, at the appropriate time, I think we’ll sit back and if it’s appropriate for us to have an analyst day, we will. That is – that’s going to be something, Greg, that we are looking at and obviously you guys will be the first ones to know once we decide.

Greg Orill – Barclays Capital

Thanks a lot, Sanjiv.

Operator

Our next question is from Al Kaschalk with Wedbush Securities. Go ahead, please.

Al Kaschalk - Wedbush Securities Inc.

Good morning. Just a follow up on two clarifications. First, Tony, on the metals project, I realize you said there was some delays. It doesn’t sound like anything structurally has changed, but could you elaborate or provide a little more color on that delay? Is it discretionary? Is it working on new partnerships, et cetera?

Anthony Orlando – President and CEO

Sure. Yeah, it’s actually pretty straightforward. You know, we set some pretty aggressive targets for ourselves with multiple projects in multiple locations and you know, while the permitting process for these recycling and metal recovery is a lot more straightforward than permitting a new facility, sometimes the permits still take longer than you think they will. And so for the – you know, most of it really has to do with permitting and in some cases planning, where you know, we are just – we want to make sure that we get a good system in that’s going to be most effective and as you can imagine, these are systems that we’re putting in kind of retrofitting existing units and so we want to make sure that we get it done that’s going to give us the most benefit long term and if that means it takes us a couple more months to design it, you know, we’ll take a couple months to make sure we get it right. So you know, it’s just a few month delay, it’s really not a big deal.

Al Kaschalk - Wedbush Securities Inc.

Very good. And then finally on – you said bundled services in your prepared remarks and to me that was something of a slight – I won’t say change, but incremental – is that market driven? In other words, competition wise, but if you’re able to go bundled then you can certainly secure recurring volume streams or can you talk a little bit about if that is, in fact, new or if that’s – what dynamics are happening there.

Anthony Orlando – President and CEO

Yes. I will, Al. It is actually a bit new and different for us. It’s something we started actually about a year ago, driven by markets and what our municipal clients wanted to see. We started – it does tend – I will say it does tend to be more prevalent in the Northeast, Connecticut and Massachusetts. I think we first started doing this on a pretty small scale, maybe a year and a half ago in Massachusetts and we found that it’s something that our municipal clients and customers like where effectively they can have one-stop shopping and so we’ve been really pitching that as a way to service those clients and it’s been successful, you know, as I mentioned in the script. We’ve rolled up quite a number of small-to-medium sized contracts, you know, typically about five years, by providing both the waste disposal service, but also providing them with composting and recycling services.

Al Kaschalk - Wedbush Securities Inc.

Do you outsource any part of that now or would that – is that something…

Anthony Orlando – President and CEO

We do work with partners on that too to handle some of that service for us.

Al Kaschalk - Wedbush Securities Inc.

Very good. Thank you.

Operator

Our next question is from Smitti Srethapramote with Morgan Stanley. Go ahead, please.

Smittipon Srethapramote - Morgan Stanley & Co. LLC

Hey, good morning. Good morning, Tony and Sanjiv. Just two quick questions. First, how much incremental revenues benefit do you expect from the Durham York project? And how does that margin compare to Honolulu?

Anthony Orlando – President and CEO

You know, the Durham facility is relatively small and I can’t recall the tons off the top of my head, but it is a facility that is owned by a municipal client so you know, we have significant revenue actually during the construction phase and you know, we’re seeing that kind of still ramp up and it will kind of – the construction will kind of peak sometime in the next few quarters and the construction completion is scheduled for late 2014. And then we’ll have an operating contract very similar to what we have as our other publically owned facilities where we operate an annual fixed fee and we make a margin on that service.

Sanjiv Khattri - CFO

And I also, Smitti, we’re new to the story, of very high-level H power was a [inaudible] million dollar construction project, give or take. Dunham York was a $250 million project, give or take. Both of them would be 20-year O&M contracts where we’ll have some variable upside based on our performance but basically a fixed service fee, both very little capital, obviously, an nice little cash stream, so both are very good from a term perspective and on a profitability perspective.

Smittipon Srethapramote - Morgan Stanley & Co. LLC

Thank you. And maybe just a quick follow up for Sanjiv. Can you quantify the expected impact from working capital and free cash flow in Q4?

Sanjiv Khattri – CFO

So you know, this is part of our – not embarrassing but you know, the whole impact of construction, working capital [inaudible], we had a long slide last quarter in Q2 . [Inaudible] because those payments are so lumpy and in some cases while the payables are also lumpy, they’re less so. So I think as I said earlier, we expect free cash flow to be mostly flat year over year adjusting for the construction working capital. However, I can’t – it depends on some of the milestones and because, you know, the payments are so chunky they can move the needle. Net-net, if I stand back, we are very confident that the 250 to 265 million free cash flow [inaudible] that we gave you is still very, very good. I mentioned to you earlier that maintenance CapEx is still in range between 80 to 90 million and cash flow from – so you can work backwards. We are confident that anyone volatility we have in the working capital will be captured within that range. So I think that’s sort of the best way to reassure you and you know, I know cash flow is really strong and you know, so that’s sort of a key part that’s – and frankly, the strongest part of the investment pieces is not just our high EBITDA margin but the strength of our cash flow.

Smittipon Srethapramote - Morgan Stanley & Co. LLC

Great. Thank you.

Operator

Our next question is a follow up from Ben Kallo with Robert Baird. Go ahead. It appears as those Mr. Kallo has removed himself from the question queue. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Orlando for any closing remarks.

Anthony Orlando – President and CEO

Well, thank you, everybody for joining us this morning. We look forward to finishing the year strong and talking with you in the future. Thank you.

Operator

This concludes our conference for today. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of 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.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts