Jul 25, 2008
Operator
Good morning, and welcome to the Second 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's Chairman and CEO, Jim O'Connor. Today's call is being recorded, and all participants are in a listen-only mode.
There will be a question-and-answer session following the Republic's 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.
James O'Connor
Good morning, and thank you all for joining us. This is Jim O'Connor and I would like to welcome everyone to Republic Services second quarter conference call.
Tod Holmes, our Chief Financial Officer and Ed Lang, our Treasurer are joining me as we discuss our second quarter performance. I would 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 involves risks and uncertainties, and may be 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 the conference call, you should be sensitive to the date of the original call, which is July 25, 2008. 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. Yesterday, Waste Management filed an 8-K regarding their intent to acquire Republic Services.
As we stated in our response, we believe our merger with Allied Waste is in the best interest of our stockholders because it creates significant value generating opportunities. I will have no further comment regarding Waste Management's proposal, including in the Q&A portion of this call.
During the second quarter, we continue to deliver on our pricing initiative, which has offset significantly higher fuel costs. We believe current pricing environment is sustainable across all lines of business.
Key results in the quarter, Republic had revenue growth of 2.4%, to $828 million. We achieved internal growth of 3.9%, with 7% of price improvement and volume decline of 3.1%.
Our second quarter volume decline was affected by the slow down in residential housing construction activity. C&D volumes in our temporary roll-off business and third party C& D volumes at our transfer stations and landfills continue to be weak.
Price growth continues to be strong. Core prices up 4.1%.
Pricing is the most important factor for covering rising costs and improving return on investor capital. Within our landfill, our core price was up approximately 3.7% in the quarter.
We continue to see sequential improvement in landfill pricing, particularly in our MSW volumes. The landfill business is capital intensive and requires continued focus on pricing in order to achieve appropriate risk adjusted returns.
As landfill and residential contracts renew, we are seeing consistent price increases at high levels of retention and we continue to utilize our return on investment pricing tools, on renewals and franchises, and municipal contracts. The biggest impact on our volume was in our temporary roll-off business which decreased approximately 16%.
The decrease is primarily due to the weakening of the residential construction volumes and is similar to the trend we have experienced during the past three quarter. Additionally, construction related landfill volumes are down 16%.
Despite the net volume reductions, temporary roll-off pricing has remained stable. We continued to adjust our work force and capital spending to reflect lower activity in our temporary roll-off line of business.
By making these adjustments we have maintained our labor productivity. Operating margins, adjusted for the remediation expenses for the second quarter were 18.6.
Yield cost increased 220 basis points compared to the second quarter of 2007. We remain focused on all the components of our cost structure to be sure we remain competitive in our market places.
Republic's had a number of significant achievements in the quarter. Our free cash flow, for the second quarter was $82 million.
We believe our full year cash flow performance will be at the high end of our guidance of $340 million to $350 million, excluding merger related costs. During the quarter, we continued to return our cash to our shareholders.
In the second quarter, we repurchased approximately 1.3 million shares of stock for $41 million. Republic discontinued the share repurchase program during the second quarter, when it appeared that we would come to an agreement in our merger negotiations with Allied Waste.
Our Board has approved a 12% increase in our quarterly dividend, beginning in October. The new quarterly dividend is $0.19 per share.
We've increased our dividend every year, since we initiated the dividend five years ago. And, at this time, I'd like to turn the call over to Tod Holmes, for a financial review of the second quarter.
Tod?
Tod C. Holmes
Thank you, Jim. I'll begin the review of the company's financial results by discussing revenue.
Second quarter 2008 revenue rose by 2.4%, greater than $28 million from $808 million last year. And as Jim indicated internal growth was a positive 3.9%.
Our total price was 7%, with a 4.1% increase from core price, a 1.9% increase from fuel surcharges, a 0.4% increase for environment fees, and a 0.6% increase from commodity improvement. During the quarter, Republic continues to benefit from its ongoing price increase strategy, and discipline in all lines of the business.
Second quarter core volume, declined 3.4%, while the land fill volume was down 5%, and temporary roll off volume was down 16%. Divestitures and non-core operations accounting for the remaining 1.2% reduction in our revenue, and primarily relate to our divestiture of Levco [ph] business in the fourth quarter of 2007.
Second year... excuse me, second quarter year-over-year operating margins, what we see here year-over-year operating margins decreased by 440 basis points from 18.9% to 14.5%.
However, this is due to a unique circumstance. During the second quarter of 2008, we recorded a pre-tax charge of $34 million related to estimated cost complied [ph] with orders issued by the Ohio and U.S.
EPAs, and refunds to environmental conditions at out Countywide land fill. Excluding this charge, operating margins for the second quarter were 18.6%.
Peak components of our year-over-year operating margin change are as follows. The charge associated with Countywide, negative 410 basis points.
Our truck maintenance improved positive 20 basis points. Higher fuel costs were a negative 220 basis point impact on margin for the quarter.
Disposal and subcontracting costs, positive 80 basis points; our labor, positive 60 basis points; land fill operating costs, excluding Countywide positive, 50 basis points; our DD&A, positive 30 basis points; and SG&A, a negative 50 basis points for a total of negative 444 basis points. Now, let briefly comment on the components of these margin change.
First truck maintenance, again, during the second quarter of 2008, the company's continued to focus on preventative maintenance and cost saving initiatives, and improved pricing resulted in a reduction in truck maintenance expense as a percentage of revenue. Next is fuel, Republic's average wholesale price per gallon increased from $2.69 a gallon in the second quarter of '07, to $4.23 in the second quarter of 2008.
And current fuel prices are approximately $4.56 per gallons for Republic. Third, our disposable and subcontracting costs, again this is our largest cost category for which the impact of improved pricing is clearly visible.
Next and fourth is labor. During the second quarter, we continued to benefit from productivity improvements, which contributed to our margin growth, and it's particularly important to note, in the roll-off construction area, we're able to maintain our productivity, despite the housing slowdown.
Now fifth, land fill and operating costs, lower land fill volumes, and continued focus on cost savings helped reduce land fill operating expense. Sixth, DD&A.
The decrease in DD&A as a percentage of revenue is again primarily due to improved pricing. And finally SG&A; year-over-year SG&A as a percentage of revenue was unchanged at 9.9%, excluding the Countywide charge.
We had also a $4 million reduction in our allowance for doubtful accounts, which is a benefit in the second quarter of 2007. And that was a function of the excellent account receivable working capital management that our entire field organization delivers.
Despite a year-to-date 200 basis point increase in fuel expense, we continue to believe that operating margins in fiscal 2008 will be at or slightly higher than those of the prior year, excluding the remediation charge at Countywide and the increase in fuel expense. Year-over-year gross operating profit increased by 220 basis points from 28.4% to 30.6%.
Next I'll discuss our free cash flow. Again as Jim indicated, free cash flow for the second quarter was $82 million.
This is based on cash from operating activities of a $164 million, less the purchases of property and equipment, we paid in cash of $84 million plus proceeds from the sale of old equipment of $2 million, for a net of $82 million free cash flow. For the six months ended June 30 free cash flow was $149 billion...
$149 million excuse me. Cash from operation was $311, purchases of property and equipment was $65 million...
$165 million and we received $3 million from the proceeds of the sales of equipment. As you are aware, earlier this year Congress passed the Economic Stimulus Act of 2008.
This act allows companies to purchase new equipment and deduct an additional 50% of the cost of equipment in the 2008 tax returns. We believe this will save Republic approximately $25 million of cash during 2008.
However, we currently anticipate increasing our current capital expenditures in 2008, to pre-buy 2008 and 2009 trucks, prior to new diesel engine requirements effective January 1, 2010. Therefore we remain comfortable with our cash flow guidance of $350 million, which is at the high end of our range from our original guidance for cash flows.
And again, this guidance excludes merger related costs. And let me talk just briefly about items that impact cash balances.
During the second quarter, Jim indicated we repurchased $1.3 million shares for about $41 million or about $30 at may be $0.03 a share. Republic's actual share count on June 30, 2008 was 181.9 million shares.
And as Jim indicated in June, after announcing our agreement to merge with Allied, we suspended the share repurchase program. Republic's balance sheet remains very strong.
At June 30 accounts receivable was $320 million, day sales outstanding was 35 days, which is consistent with the second quarter of last year, despite a weakening economic environment. Republic's net debt is $1.5 billion, which is up slightly from 1.45 billion at December 31, and our net debt to total capital at June 30 is 54%.
Now, let me turn the call back over to Jim.
James E. O'Connor
Thank you Tod. Republic's CPS for the second quarter was $0.46 excluding remediation cost, which is 2% improvement versus the second quarter of 2007.
We would like to reiterate our current earnings guidance of the $1.78 to a $1.82 of earnings per share for the full year 2008, excluding remediation costs. We provided 2008 cash flow guidance of $340 million to $350 million and as Tod said we believe that will be at the high end of this guidance, even though we will increase our capital spending for collection vehicles to take advantage of bonus depreciation.
We also expect operating margins to be at or above the full year 2007 results, excluding remediation costs. Again, 2008 business objectives continue to be focused on improving margins by achieving appropriate price increases to offset inflationary costs and business risks, improving our market position, standardizing significant business processes, maximizing efficiency of service delivery and customer service and rationalizing our cost structure.
On June 22nd Republic signed a definite merger agreement with Allied Waste. This agreement was signed after an extensive and cooperative due diligence process, that identified the benefits and the risks associated with this transaction.
This thoughtful process, clearly, identified a $150 million in tangible near-term synergies that can be delivered to Republic and Allied shareholders. Last week, 40 key managers met in Florida to begin the process of developing integration plans, along with extracting synergies of a $150 million.
I have instructed our combined teams to complete this process by October first. Our companies have the best management team in the industry, scalable systems and a commitment to meet and exceed expectations.
I'd like to thank the managers from Allied Waste and Republic, who participated in the planning process, and will continue to participate in the planning process for their hard work and commitment. We have received strong support from this transaction from investors who trust us over the years.
Due to its financial discipline, due to our financial discipline, best-in-class information technology, and strong management team, Republic has provided the highest total return to shareholders during the past 10 years of the three largest companies. I'm committed to bringing the same discipline to Republic Services post merger.
Recently, Republic Services celebrated its 10 year anniversary as a publicly traded company. I want to thank all the Republic employees who have contributed to the effort of making Republic the best performing company in the solid waste industry.
With that operator, at this time, I'd like to open the call for questions. Question And Answer
Operator
Thank you. [Operator Instructions].
All participants will be allowed one question and one follow-up question. [Operator Instructions].
Bill Fisher of Raymond James, you may ask your question.
William Fisher
Hi, good morning.
James E. O'Connor
Good morning, Bill.
William Fisher
Hey, I've two unrelated questions. First on the franchise business, kind of when during the year do you get the bulk of the annual increases, and how have they been this year.
And a feel where it is, if you look to '09, what kind of increases would you expect to get, built into that?
James E. O'Connor
Yes, well, Las Vegas being a large component of our franchise we're at July 1, we received 3%. And we'd anticipate, right now, looking at the CPI, if you annualize it out, it's approximately running 4% or little just north of 4%.
So, in the case of, lets say, Las Vegas specifically, we would get adjusted next July, based on the change from December to December, December of '07 to December of '08, probably at the run rate we are looking at, a little north of 4%.
William Fisher
Okay, great. And then, I don't think you can touch on this or not but on a DoJ process with Allied, can you just touch on getting approval, where you're on that process.
And touch on the steps that would take to... related to the West's vision?
James E. O'Connor
As soon as we announced the transaction, we filed simultaneously with that announcement with the Department of Justice. We have been having regular meetings with them.
I think, we went through a very thoughtful process, during [ph] getting prepared for the announcement day in that filing. We believe that we've been very forthright in our filing on markets.
And, I think, that's when the feedback that we've got from the Department of Justice like this [ph] are. We did receive on July 23, a request for second...
a request for additional information, which is statutory. So, it's nothing out of the ordinary.
And it's as we expected it. So, we see the process moving just as we expected it right now.
And we'd anticipate closing some time in the fourth quarter. But again, I think, the important part here is, is that the integration planning build that we're going through, is looking for day one readiness October 1.
Just in case, we get an early release from the Department of Justice.
Operator
Jonathan Ellis, of Merrill Lynch, you may ask your question.
Jonathan Ellis
Thanks. Good morning guys.
James E. O'Connor
Good morning, Jonathan.
Jonathan Ellis
I wanted to know a little bit more about volumes. You mentioned that residential construction volumes are down about 16%, which I believe was very consistent with the year average decline last quarter.
Yet, overall volumes were down 3.4% this quarter versus only being down 2.5% last quarter. What can you attribute the incremental weakness to your volumes?
Tod C. Holmes
Well, I think, some of it is, last year as we were moving through the year, we had a pretty strong second quarter. So, I think as we looked at...
I think that's probably some of the noise in there. As we look ahead, our guidance for the full year is about 3%, and as you will recall, the second half of last year, we saw continued weakness, particularly in the housing sector and we believe that the comparables become easier particularly in the latter part of the year.
James E. O'Connor
Latter part of the third quarter and the fourth quarter.
Tod C. Holmes
About our commercial business, we've had modest growth in commercial, residential, we had a contract in Houston that basically we lost on June 30 of last year. That anniversary is out, excluding that, we have modest growth there.
So the other aspects of the business are holding up from a volume standpoint, it's really isolated to this temporary roll-off activity.
Jonathan Ellis
Great and my follow up question on the landfill contracts, could you update us on what portion of the contract rate base has been re-priced at this point, and what kind of the average price increase you're achieving on those contracts?
James E. O'Connor
Jonathan, I think...again I think a number... I think probably about a year and half ago we talk to landfill pricing starting to move, because some of these contracts were anniversaried out and the market appeared to be much rational as it relates to disposal.
Again, I think we probably get about another three or four quarters to run. I think you can see as the pricing has improved over the last two years from probably a little as 2% now to 3.7%, that the cost for that is really these contracts were anniversaring out and our ability to secure additional price increases at that time.
But I think I said this when we were out on the road the last week or two, but I think I've consistent here in saying that landfill pricing is probably going to move up I mean barring inflation and the other cost. Probably it will be escalating more so than our pricing and our collection business, because it's lagged for so long.
So I think you'll continue to see pricing improvement here through '09.
Operator
Corey Greendale, of First Analysis, you may ask your question.
Corey Greendale
Hi good morning.
James O'Connor
Good morning, Corey.
Corey Greendale
First of all I wanted to ask you on the hauling side in competitive markets whether you're starting to see more customer push back up prices on fuel surcharges given how tough things are in general and if you could in any way take a stab at what percent of volume loss in the quarter might have been competitive versus economics?
James O'Connor
Again, I don't think that...I mean there may be some economic impact, but it's not material to what we're seeing. When we look at retention rates, our retention rates are still stable and so I guess what I would say to you is we are not seeing very much I see push back at all and again the pricing environment out there is pretty good and again when you look at the lack of returns this business has got over the course of the last five, or six, or seven years, I think the pricing that we're getting right now is very reasonable pricing.
Corey Greendale
Okay. And then on the volume front, I think it's sounds like its fair to say things are going to bump along the bottom, but can you just talk about the trend monthly as you went to the quarter and into kind of real time whether things are getting better, worse, or indifferent?
James O'Connor
I think we're seeing pretty much the same thing we saw in the earlier quarter and again I think that's what giving rise to us looking at the balance of the year and saying that we think we should see the volume starting anniversary, so I guess...I guess if one wants to draw conclusion from that statement that we would say that may be we're at the bottom.
Operator
Our last question does come from Leone Young of Citi. You may ask your question.
Leone Young
Yes, good morning.
James O'Connor
Good morning Leone.
Leone Young
It's encouraging the here that the commercial business still stays face up slightly. Can you talk a little bit more about what you're seeing then in terms of service opportunities [ph] or lost business.
It sounds like there has been no significant deterioration given the economy?
Unidentified Company Representative
Yes, there hasn't been any of that we can see. We've looked at our commercial small container volumes, which are in terms of volume or at close to 1% increase in volumes, which has historically been low in relation to a better economy, but still growing.
And we see comparable trends in our other permanent annuity kinds of work, barring adjustments for contract such as a city of Houston. So, again I think we feel pretty good about it right now.
That's not to say that, we can predict where the economy is really at, and where it is going, but at the end of day based on what see in our business, we feel pretty good about it.
Leone Young
And, given the high fuel cost, have you seen any change in terms of the independents behavior, with regard to price?
James O'Connor
No. I think again when you look at the retention rates you know at our business, and we look at some of the ways we track the available organic growth in the markets and then we look at the price were able to secure.
I would say that the again we're not seeing any independent impact. When you even at the temporary roll-up volumes were the real pressure at, still reports stable pricing and based on our cognizance with the field, we don't believe that we've lost any of the opportunities and we don't believe there has been substantial change in market share so again we feel very confident that the we going to be rewarded and we are confident that we will be able to meet our earnings guidance.
Operator
Brian Butler of FDR you may ask your question.
Brian Butler
Good morning guys.
James O'Connor
Good morning Brian.
Brian Butler
Just one question, just on the expenses. Were they associated with the Allied Republic merger talks in the second quarter and do you have any idea of kind of what's the right way to think about those kind of expenses, in the third and the fourth quarter?
James E. O'Connor
Sure. We haven't obviously, incurred expenses associated with due diligence.
And also, obviously some legal costs, particularly, with our work in Washington with the Justice Department. So, right now, we have a small amount that's on the balance sheet.
Essentially under, I guess, its pronouncement 141, we would capitalize those costs upon consummation of the merger. However, if for some reason we didn't merge prior to year-end, they will be expensed.
But, at this point there is a very small amount on the balance sheet, and there is nothing in our results.
Brian Butler
Okay. Thank you very much.
James E. O'Connor
Thank you, Brian [ph].
Operator
Scott Levine of JPMorgan, you may ask your question.
Scott Levine
Good morning.
James E. O'Connor
Good morning, Scott.
Scott Levine
Regarding volumes, could you talk to maybe any differences, you're seeing across geographies, either from a cyclical standpoint. Or due to the comp being different, maybe, in different parts of the country, and also, maybe the differences, what you're seeing in the franchise versus your competitive market?
James E. O'Connor
Well, I mean, most of our franchise work is in the areas that have been hardest impacted by the residential housing market. So, Florida continuous to be very weak, Nevada and Southern California.
Parts of the economy where we see, still housing remaining not strong, as I'll say, strong as it relates to several years ago. But, the Carolinas are specifically in Charlotte, we still see some strength, and Texas.
Scott Levine
Okay. And a follow-up on CapEx, from the high-end of the guidance, your free cash flow, last couple of years we seen you guys that's lowered your CapEx, budget when volumes have come in a little bit lower than expectations.
Do you think you have some additional room... headroom there, or have you already factored in some reductions maybe outside of your planned fleet purchases?
James E. O'Connor
Well, I mean, I think what we've done, what we're... when we tell you that we're moving up our capital spend guidance, basically, if you go through the really the math of it.
The first thing we've done is we've taken the original guidance with I think, was what 325 for capital. So, yes--
Tod C. Holmes
Yes.
James E. O'Connor
325, we have reduced it, for what we're seeing in the cyclical component of our business, which would be our industrial collection business, and some related disposal capital spend. And let's say that number roughly is about $10 million.
So, now you're down to 315. And then, so, the balance between that and our new guidance really is the pre-purchase of trucks, in the balance of '08 and '09, to beat the new engines that'll come out in 2010.
So, it's going to be predominantly related to that. And again, there are two benefits here.
The bonus depreciation, as well as the savings and the trucks that would probably have price escalation anywhere from $7,000 to $15,000 per unit, are related to the engine changes. So, that kind of gives you a rundown on the capital.
Could we've taken it up, if we had to? Yes.
But, we don't see any reason too. Tod, do you have anything you want to add to that?
Tod C. Holmes
No, I, my guess... the only thing I'd say again is we've got a fleet age is about six and a half years, and so, what we are doing in the short-term is, maybe, getting a slightly younger fleet.
And as we've looked at it, particularly in the due diligence with Allied, at our fleet age and Allied's fleet age, while their fleet age maybe seven a half years or so. We think there is a relevant range of the age, it's not a specific age, that's appropriate.
And it depends on how the equipment is being maintained. So, as we put this business together, there may actually be an opportunity from the capital standpoint, to allow our fleet age to go from six and a half to seven years, and still maintain our maintenance costs, and the improvement that we've achieved in maintenance cost over the past number of years.
James E. O'Connor
Yes, let me just expand on that, just for a second, so everybody understands it. It has nothing really to do, necessarily with the merger as such.
I think, internally Republic has put at lengthening the life cycle of their trucks, because we've already gone through almost a full cycle. When you look at when we instituted our maintenance programs and the age of the company now, and the replacement cycle, we're now to a point where a lot of the old equipment that wasn't well maintained, prior to acquisition, has pretty much gone through the fleet.
And we've... it's been replaced, and the new trucks have been maintained under our new maintenance program.
And so, some of the thought process prior to even the merger, was that possibly... that the economy life cycle replacement, may move up a half year.
So, that... it has nothing do with the merger.
But, it will obviously, would come at an opportune time, if we believe that was the case because we could then funnel that capital, into the Allied assets. So, again, I think, it just is a...
the timing was right. But it had nothing do with the merger.
If we lengthened the life cycle of the truck, it's related to our internal information.
Operator
At this time we see no further questions.
James E. O'Connor
Okay. Operator, thank you very much.
And I'd like to thank all of you for participating. I'd like to remind everyone that a recording of this call is available, for the next 24 hours, by calling area code 203-369-0486.
And additionally, a recording of the call would available on Republic's website at rebuplicservices.com. And I'd like to thank all of you for joining us today.
And have a great day.