Republic Services Inc Class A RSG
Q4 2009 Earnings Call Transcript

Transcript Call Date 02/11/2010

Operator: Good afternoon, and welcome to the Fourth Quarter 2009 Conference Call for Investors in Republic Services. Republic Services is traded on the New York Stock Exchange under the symbol RSG.

Your host this afternoon is Republic's Chairman and CEO, Mr. Jim O'Connor. Today's call is being recorded and all participants are in listen-only mode. There will be a question-and-answer session following Republic's summary of quarterly earnings. (Operator Instructions).

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

James E. O'Connor - Chairman and CEO: Good afternoon. Welcome everyone and thank you for joining us this afternoon. This is Jim O'Connor and I'd like to welcome everyone to Republic Services’ fourth quarter conference call.

Don Slager, our President and Chief Operating Officer; Tod Holmes, our Chief Financial Officer and Ed Lang, our Treasurer are joining me as we discuss our fourth quarter performance.

I'd like to take a moment to remind everyone that some of the information that we 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 our actual results to differ materially from expectations.

Additionally, the material we discuss today is time sensitive. If in the future you listen to a rebroadcast or a recording of this conference call, you should be sensitive to the date of the original call, which is February 11, 2010.

Please note that this call is the property of Republic Services Incorporated. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited.

I'm pleased to report that we exceeded our original guidance for earnings per share, free cash flow, merger synergies and EBITDA margins. This solid performance was achieved during the significant economic downturn and the integration of two large solid waste companies.

We believe we are well positioned for strong results in 2010, due to our pricing discipline, cost controls, realization of merger synergies and a commitment to improve return on invested capital. Let me give you some of the financial highlights for the full year.

Revenue $8.2 billion, net income adjusted for a pre-merger or for merger-related and debt refinancing expenses $565 million or $1.48 per share. Full year EBITDA margins were 30.6%. This strong performance highlights the ability of our field organization to maintain pricing discipline and implement cost controls, while working through the integration process.

Core price for the full year was 3%. We continue to use our return on investment pricing tool to be sure all business activity meets our requirements. Volumes declined to 9.5% in 2009 due to the weak economic conditions, particularly in the construction business.

Full year adjusted free cash flow was $746 million or $1.96 per share, which is 132% of adjusted book earnings. Again, free cash flow is the best measurement of the quality of earnings.

Our Board has approved $0.19 per share dividend payable April 15, 2010. During the fourth quarter, we issued $600 million of 12 year notes with a coupon of 5.25% and called approximately $1.1 billion of existing debt. This debt called was retired with the 12-year note issuance, bank borrowing and cash.

Total debt reduction in 2009 was $740 million. We continue to look for – we continue to look at liability management opportunities to realize future reductions in interest expense. I also want to provide some information on our integration.

During 2009, our integration schedule and subsequent financial savings ran ahead of plan. The target of $150 million is one year ahead of schedule. We expect run rate synergies achieved by the end of 2010 to be $165 million to $175 million and our management team will continue to identify further margin improvement opportunities going into 2011.

We realized $115 million of those synergies that I just mentioned during 2009. We expect to realize $40 million to $45 million of additional synergies during 2010. Our field organization under Don's leadership has far exceeded expectations regarding the amount and the timeliness of the synergies achieved.

So now I'd like to have Don Slager, our President and Chief Operating Officer, talk to those achievements.

Donald W. Slager - President and COO: Thanks, Jim. 2009 was the year of great accomplishments for Republic, not only did we hit our $150 million synergy target in half the time expected, we are developing a single business culture that is focused on customer service, safety and improving return on invested capital.

I'd like to highlight a number of our achievements in the integration process. First, in our overlap markets, which represent approximately one-third of our revenue base, we have eliminated 70 routes through our optimization tools used to enhance labor productivity.

We have redirected approximately 13,000 tons of waste per day within our transfer station and landfill network. All divisions are utilizing the same billing and operating system which is vital to driving further productivity initiatives.

Looking at information technology which is key to our long-term success, many of our large scale conversions are behind us and our detailed planning efforts completed in 2008 provided the foundation for solid execution. In Q4, we moved all human resource and payroll systems to a single platform, which was fully operational for the first payroll in January 2010.

Additionally, we converted 63% of our divisions to a common billing and operating system and as I've said, we completed 100% in overlap markets. We expect to finish the remaining conversions by the end of Q3 2010.

Over 70,000 hours of training has been delivered to enhance the capability of our people. We will continue to make this investment in training to extract the value from the systems and processes implemented.

I also want to comment on the overall performance of operations in 2009. We had some outstanding successes, especially in the area of safety and productivity. Our accident and injury frequency decreased again in 2009, with 30% fewer claims than the previous year.

Collection productivity improved despite a decrease in route density due to the weaker economy. We've continued our progress toward automated collection in our residential business.

In 2009, we converted more than 200 routes to automated collection service and plan to convert an additional 200 routes in 2010. By the end of 2010, we expect our residential system to be approximately 50% automated.

I'd like to thank all of our field management and various integration teams for their ongoing efforts to achieve the most successful merger in the solid waste industry, while maintaining a focus on excellent customer service.

I'll now turn the call over to Todd for a recap of our fourth quarter financial performance.

Tod C. Holmes - EVP and CFO: Okay. Thanks, Don. Fourth quarter 2009 revenue as reported rose by 61% to $2 billion from $1.240 billion last year. This increase of $755 million relates primarily to the merger with Allied on December 5th of last year.

Since we are measuring the performance of the operations on a combined company basis, the remainder of my comments assume the companies merged on January 1st of 2008, therefore the prior year combined company financial data is included and can be referenced in my comments, it can be found on our website.

On a combined company basis, there was a year-over-year decline in Q4 internal growth of 8.7%. Now, this consists of core pricing growth of a positive 2.5%. Again, this quarter we see core pricing improvements in all line of business including collection at a positive 3%. Industrial pricing of 2.7 was less than other lines of business, however, because temporary work had price increases less than average.

The total landfill price of 1.1% includes MSW landfill pricing of 3.1%, which is consistent with prior quarters. This, however, was partially offset by relatively flat construction and demolition pricing and lower special waste type event price to work.

Price increases to our index-based customers were pressured by lower CPI which is simply a function of contractual terms. And again, approximately 50% of our revenue are tied to index-based pricing. Price increases to other customers remained strong. This would be the non-index-based 50% of our customer base and again consistent with prior quarters.

Commodity revenue increased by about 0.7%. We saw commodity prices up 37% to an average of $103 per ton in the current quarter from $75 per ton in the fourth quarter of 2008. Q4 (MERS) commodity volume of 421,000 tons reflects a 2% decrease from the prior year and also Q4 average price increased $8 a ton from $95 in the third quarter of 2009 with prices actually ending the month of December higher than the average for the quarter.

Now our fuel recovery fee actually decreased 2.2%. The reduction in fuel recovery fees relates to a decrease in fuel cost. The average price per gallon of diesel decreased to $2.74 in the fourth quarter from $2.97 in the fourth quarter of 2008 or approximately 8% lower. Current fuel prices are very close to that at $2.78 per gallon.

Our volumes were down 9.7%. This also includes a decline of 100 basis points from the impact of hurricane Ike in the prior year, so excluding hurricane Ike, the volume loss was actually 8.7%, which is a sequential improvement of about 140 basis points for a little over 10% volume loss in the third quarter. So, a little bit better than the third quarter.

Residential and commercial volumes experienced low to mid-single digit declines, volume loss was most significant again in the industrial and landfill lines of our business, which experienced mid teen year-over-year volume declines. Both the reflection of the week economy and also some weather related issues across the country late in the fourth quarter of 2009.

Now, let me turn to our fourth quarter year-over-year margins. Similar to internal growth, I will discuss fourth quarter year-over-year margins as if the companies had merged on January 1, 2008. Let me again remind you that we posted this combined financial data on our website.

Fourth quarter 2009 EBITDA margin excluding divestiture loss, restructuring charges and cost to achieve synergies and remediation charges, was 29.4% in the fourth quarter of ’09 compared to a combined margin of 26% in the prior year. This represents an improvement of 340 basis points.

In the fourth quarter of 2008, we had included the results of the DOJ divestitures that generally carried higher margins than the Company average because of the concentration of landfills and commercial collection assets that had to be sold. The impact of these divestitures resulted in a year-over-year decrease and EBITDA margin of approximately 30 basis points.

Now, let me talk about some of the more significant changes in cost as a percentage of revenue. First fuel. Fuel expense improved 10 basis points primarily due to an 8% decrease in the cost of fuel as I mentioned earlier. Again, average diesel prices decreased to $2.74 in the fourth quarter of 2009 compared to $2.97 in the fourth quarter of 2008 and again, current prices are fairly close to the fourth quarter ’09 at $2.78 gallon.

More than offsetting the decrease in fuel cost was a decrease in related fuel recovery fee revenue resulting in a net decrease in EBITDA margin of 100 basis points. And I would remind everybody that those recovery fees lag by one month, either going down or going up.

Second, cost of goods sold. The 20 basis point increase in expense relates to increases in rebates to customers for volume delivered to (our MERS). Cost of goods sold (that are MERS) increased approximately 10% to an average of $27 a ton from about $24 a ton in the prior year. Commodity revenue increases more than offset this increase in cost resulting in an increased spread of approximately $26 per ton. The net impact was a favorable 40 basis point improvement on EBITDA margin.

Third, labor. The 10 basis point improvement in margin relates to a 70 basis point benefit from finalizing actuarial assumptions associated with the new combined health and welfare plans and this is partially offset by cost increasing as a percentage of revenue in the post collection business. Again, we merged both of our health plan mid-year in 2009. Labor is relatively fixed in the post collection line of business and does not decrease fortunately with volumes.

Fourth, disposal expense. Disposal expense decreased in absolute dollars, but increased by 50 basis points as a percentage of revenue. These variable costs decreased in the collection business as volumes declined, but we are not impacted by changes in the post collection business where they are relatively fixed. Therefore, as post collection revenues decreased as a result of volume loss, these costs increased as a percentage of total revenue.

Next, transportation and sub-contract expense, the 140 basis point improvement in margin results from four factors. First, synergy related cost reductions from redirecting waste streams to our more efficient disposal network; second, internalizing national accounts collection work that was historically sub-contracted before the merger; third, impact of volume mix depending on changes in volume in the business and then fourth would be lower fuel surcharges.

Finally, let me talk about SG&A. The 250 basis point improvement in margin for SG&A relates to the following. 170 basis point increase, primarily associated with one-time items in Q4 2008, including conforming bad debt policies of $19.6 million and then also a year-over-year reduction in legal settlements of about $14.6 million. Additionally, there were favorable actuarial adjustments to our health and welfare benefits in the current year of about $4.4 million and again, we combine both plans on July 1st, and then ended up in the latter part of the year getting a better track record of combined experience and an actuarial update based on that combined experience. The second SG&A item is 60 basis points increase realized from synergy related headcount and overhead reductions as a result of the merger.

Now, let me bring it all together there. Again, 340 basis points of EBITDA margin expansion and it can be summarized as follows. First, is the impact of divestitures was negative 30 basis points. Second, the net fuel impact was a negative 100 basis points. Third, the net commodity was a positive 40 basis points. Fourth, the actuarial adjustments to health and welfare plans and that’s both in the direct labor as well as in SG&A was a positive 90 basis positive. Fifth, the impact of conforming bad debt policies in the prior year and the change in legal adjustments in the prior was a positive 150 basis points. Sixth, the realization of synergies a positive 140 basis points. And finally seventh, and this is really at the heart of our business, price increase and cost controls partially offset by fixed cost and lower volumes. We had a positive 50 basis points there, really in the core of our business.

Depreciation, amortization and accretion increased by 130 basis points also year-over-year. Of this increase, 90 basis points relates to increased non-cash expenses associated with purchase accounting valuations of Allied assets and liability in connection with the merger. Again, we had to put a substantial amount value which was formally in goodwill and not amortized in the landfill airspace to be amortized. The remaining 40 basis point variance relates to this fixed cost relative to lower revenue.

Now, let me talk briefly about our interest expense. The Company recorded non-cash interest expense of $41 million in the fourth quarter of 2009. This arises primarily from amortization on Allied debt that was recorded at a significant discount.

We also recorded a $102 million loss or $0.17 per share related to premiums paid and non-cash write-offs of discounts and fees associated with the recently completed note refinancing and tender. And again, these refinancings have a very quick payback probably in the range of two to three years. So, we are taking advantage of these favorable interest rate environment.

Now, I will turn the call over to our Treasurer, Ed Lang to further discuss financing initiatives. Ed?

Edward A. Lang, III - SVP and Treasurer: Thanks, Tod. During the fourth quarter, we continued to execute our liability management strategies by calling approximately 1.1 billion of existing debt that would have been repaid over the next four years. We used cash investments, a new 12-year note for $600 million at a coupon of 5.25% and bank borrowings to retire the called debt. As Todd mentioned, this high coupon debt – because this was high coupon debt that was called, the average cash payback period is less than two years.

Republic has three benefits from this refinancing effort. First, lower cash interest expense; second, extinguishment of the debt discount, associated with these maturities, as you remember the debt discount was a result of the purchase accounting required at merger close; and third, extending debt maturities.

The negative impact of the cash premium and the extinguishment of the discount was $0.17 of EPS. The 2010 EPS benefit of this refinancing is approximately $0.07 of EPS.

Republic issued another call of debt maturing in 2014 earlier this week. For planning purposes, we have assumed that we can refinance this debt at existing rates and included this positive $0.01 EPS impact in our guidance. There will be one-time costs of approximately $52 million or $0.08 of EPS to retire this maturity.

Of this charge only $9 million relates to cash premiums paid and $43 million relates to a non-cash write-off of the debt discount. We will continue to take advantage of other liability management opportunities, since credit markets remain attractive.

In 2010, we expect total interest expense to be in a range of $500 million to $515 million with non-cash interest of approximately $100 million. This excludes any premiums paid or discounts written-off in connection with early extinguishments.

I will now discuss free cash flow. Year-to-date adjusted free cash flow was $746 million, which consisted of cash provided by operating activities of $1.4 billion, less property and equipment received of $862 million, plus proceeds from the sale of property of $32 million, plus merger-related expenditures net of tax of $75 million, plus divestiture-related tax payments of $105 million and this equals the adjusted free cash flow of $746 million. We define adjusted free cash flow based on CapEx received during the period. We have included a reconciliation of the timing difference between CapEx received versus paid on page 13 of our 8-K filing.

Now, I'll talk about our balance sheet. At December 31st, our accounts receivable balance was $865.1 million and our days sales outstanding was 39 or 24 days net of deferred revenue.

Reported debt was approximately $7 billion at December 31st. During 2009, total debt was reduced by $740 million and excess credit availability under our bank facility is approximately $800 million.

Now, I'll turn the call back to Jim.

James E. O'Connor - Chairman and CEO: Thank you, Ed. During 2010, we will be focused on the same performance metrics in order to deliver higher return on invested capital and improved margin performance. 2010 financial guidance, which is based on economic conditions and commodity values, remain consistent with levels exiting the fourth quarter of 2009.

Our financial guidance then for 2010. We anticipate that our full year adjusted EPS will be in a range $1.63 to $1.67. We expect internal price growth to be 2% to 2.5% and volume declines of 3% to 4%.

Our pricing is impacted by the lower CPI statistics since approximately 50% our revenue is index priced. Some of our contracts use a trailing 12-month average to reset pricing. Others use a single month-over-month to reset. We do expect commodity prices to be positive this year.

Our adjusted cash flow guidance is $700 million to $725 million. This guidance assumes the termination of bonus depreciation expense. If bonus depreciation is extended into 2010, adjusted free cash low would be $750 to $775 million. Our planned capital received is $775 million.

Anticipated full year EITDA margin is 31% before integration costs. We expect to achieve $165 million to $175 million of run rate merger synergies by year end and anticipate further opportunities in 2011. We expect our effective tax rate to be approximately 42%.

Now before going to Q&A, I'd like to comment on the exceptional performance of our entire organization. Don and I have recently concluded the annual planning process and we were impressed with our field organization’s ability to adjust to the merger integration process and the economic environment. We identified opportunities to further expand margins over the next two to three years, including opportunities in procurement national accounts and route optimization.

We will build on everything we’ve learned during the past year and take advantage of the revenue growth opportunities and the operating leverage that exists in our business, when the economy recovers.

Our success in working as a single team has allowed us to execute the most successful integration in the solid waste industry. Our detailed planning efforts laid the groundwork for the only large waste industry integration that has delivered shareholder value and exceeded synergy guidance, both in terms of financial performance and the timing of completion.

As we look back at 2009, it was a very challenging year, due to the historically weak economy. However, the Republic team overcame the weak business environment, successfully integrated two large companies and are now on track to achieve record financial performance in the coming year. I'm confident in the operating leverage that exists in our broad business platform and look forward to continued improvement in 2010.

So, with that, operator, I'd like to open the call for questions.

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