Casella Waste Systems, Inc. (CWST) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Casella Waste Systems Fiscal Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As reminder, today's conference being recorded. I would now like to introduce our host for today, Mr. Joe Fusco. Sir, please go ahead.

Thank you for joining us this morning, and welcome. Our group for today's discussion includes John Casella, Chairman and Chief Executive Officer of Casella Waste Systems; Paul Larkin, our President and Chief Operating Officer; Ed Johnson, our Senior Vice President and Chief Financial Officer; and Ned Coletta, our Vice President of Finance and Investor Relations. Today, we'll be discussing our third quarter fiscal year 2012 results. These results were released yesterday afternoon. Along with a brief review of these results and an update on the company's activities and business environment, we'll be answering your questions a little later as well. But first, as you know, I must remind everyone that various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for the purposes of the SEC's Safe Harbor provisions. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in our prospectus and other SEC filings. In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and therefore, you should not rely on those forward-looking statements as representing our views as of any date subsequent to today. Also during this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the Financial Tables section of our earnings release, which was distributed yesterday afternoon and is available in the Investors section of our website at ir.casella.com. And now, I'll turn it over to John Casella, who will begin today's discussion.

Thanks, Joe. Good morning, and welcome to our Fiscal Year 2012 Third Quarter Conference Call. Our goal today is to discuss our third quarter results, discuss our outlook through the remainder of the year, and to update you on our midterm strategy. I will start with a brief strategic summary, and Ed Johnson will take us through the numbers. The third quarter was an interesting quarter with several important strategic developments and improvements in the core fundamentals of the operating business, partially offset by the continued stagnant economic environment and lower energy and commodity prices. Most of the core fundamentals of the business were positive in the quarter, higher year-over-year collection pricing, higher landfill volumes across all categories of waste, higher recycling of volumes driven by continued customer adoption of our Zero-Sort Recycling services, these positive operating results were muted by negative macroeconomic factors. With the sharp drop in natural gas prices in the late fall, energy prices were down over $30 per megawatt hour year-over-year in December and January at Maine energy. This decline in energy pricing negatively impacted operating income by $1.4 million year-over-year. In addition, recycling commodity prices also declined last quarter, with commodity prices down 13% year-over-year and down 25% from our second to third quarter, while our hedging strategies worked as expected and absorbed much of pricing pressure, the lower prices negatively impacted operating income by $700,000 year-over-year. Commodity prices have rebounded from the December lows but we expect negative year-over-year comparisons for the next couple of quarters. As a result of these macro headwinds, we've reduced our fiscal 2012 guidance. Over the past several weeks, we've been working with our management team to complete our budgeting process for fiscal 2013. Our primary goal remains the same, generate free cash flow of roughly $20 million…

Thank you, John. Good morning, everyone. On a consolidated basis, revenue was up $3 million for the quarter as compared to the same quarter last year. Operating cost were up $4.5 million, and SG&A declined by about $900,000. Adjusted EBITDA for the quarter came in at $22.2 million, slightly below last year. These numbers came in below our expectations for the quarter, so I'd like to take the time this morning to walk through each line of business, and not only provide a clear picture of what is happening currently, but a basis for how to view things going forward. Our shortfall is primarily in the landfills. Volumes coming into our landfills were up 13.5% this quarter versus the comparative quarter, with third-party volumes up 16.8% and internal volumes down 1.8%. The third-party increase includes about 4% from McKean, which we did not acquire until Q4 last year, another 4% from Southbridge, where we were allowed to begin ramping volumes during the quarter while our permit expansion to 300,000 tons per year was in the public capital phase, and about 5% from Chemung where we received the permit expansion late in the second quarter. The remainder was due to a great effort by our landfill sales team in a very difficult environment to reach further to capture volumes. My comment about the difficult environment in which our landfill sales team is operating refers to a continuing shortage of government-funded contaminated soil or other special materials that we've historically have received in the landfill. We mentioned this on the last call, our team has done a great job replacing this volume, and then some. However, most of this volume has been brought in on a T&D basis, transportation and disposal, as a package to the customer. As a result, even though…

[Operator Instructions] Our first question comes from the line of Scott Levine from JPMorgan.

First question, with regard to the sensitivity on the commodity side, it sounded like, frankly, the guidance revision was driven by the landfill cost and then Maine Energy here, but I don't know if you can or have provided maybe general rules of thumb on maybe EBITDA sensitivity to fluctuations in commodity cost, both on the recycled fiber side or just for the basket as a whole. And then also, for electricity prices at Maine Energy?

Well, as you know, Scott, we operate a slightly different model than most of our competitors, in that we share both the upside and downside swings of commodities with a lot of our customers. So we're kind of naturally hedged on about 50% of our commodity sales. And so the big swings don't affect us as much, but they do affect us some. The way we were looking at things going forward, you know that OCC prices bounced back a little bit in February, the Chinese mills have returned to the market after the new year downtime and are buying at a rapid rate now. So as we enter the low-generation months, we believe that prices will further rebound. Plastic's pricing has remained strong with demand bullied by the mild winter and increasing construction demand. So I'm not sure if that quite answers your question. One other piece that you may know is on a -- every $1 of swing, we only swing about $0.35 on the bottom line.

Got it. Is your -- basically, you're seeing improved commodity behavior in the markets, and your guidance as you've reset it, reflects conservative assumptions in your mind?

Yes.

Okay. And then turning to solid waste pricing, it sounds like the, I mean, total metric wasn't exactly in line with what we were looking for but it sounds like the collection pricing is behaving generally in line with your expectations, maybe an update on whether the pricing in general to the market is tracking in accordance with your plan?

We are tracking at about 2.6% collection price year-to-date, and we remain comfortable with that full year guidance so we are about where we thought we would be. The collection being up 2.1% in the quarter, as the percentage of revenues year-over-year, it is down from 3.4% in Q2, but Q2 benefited from higher price roll-off work coming from the storm. So we are pleased with our performance there, and we think we're on track on a full year.

Got it. One last one if I may. I think, as you pointed out, Ed, GreenFiber isn't captured in your EBITDA guidance. Is there any change in outlook, obviously, you've heard a lot of encouraging news about -- hopeful news about the housing market. But is there any change in the outlook you guys would have or point to in that business in particular?

Well, I think, there are some encouraging things at GreenFiber. Obviously, they had a tough year with -- we really do more not so much to construction, but the fact that we had a very warm winter. So they had a difficult retail season which didn't get them into the impairment bucket as far as their auditors requiring them to evaluate the goodwill position.

The other thing too is the management team there has done a tremendous job of rightsizing the business. They have taken the right actions in terms of taking capacity out while the market begins to improve. They're developing additional products that they're going to be introducing into the marketplace as well. So I think they clearly have done a great job in terms of managing the difficulty of the reality of the marketplace, and there's some bright things that lead into the future. But certainly, it's still an opportunity for us at some point in time as its non-core.

Our next question comes from the line of Corey Greendale of First Analysis.

I'll ask my complicated question first, just in case you want to look into it while I'm asking my other questions. But I realize tax treatment is always less than clear but -- and I was wondering if you could take a stab at what EPS would have been excluding the U.S. GreenFiber write-down?

Well, I mentioned, that was a $0.60 after tax swing per-share. So the $0.92 would have been $0.32.

Okay. Good. Sorry if I missed that. The second question is on special waste, it sounds like it's mostly market dynamics, but I was wondering if you could kind of just speak to whether you think there's any competitive issues going on there versus just the lack of volume in the market?

I think it's really the lack of volume in the market. I think it's a function of where we are economically, it's a function of both state, federal, municipal budgets in terms of being able to move forward with the normal cleanup work that we would see in the marketplace. I really don't think it's a function of the competitive marketplace, as much as it is just the macroeconomic view and the budget constraints that both state and federal government are wrestling with right now, Corey.

Okay. And given all the moving pieces, I was hoping you might be able to speak to just kind of underlying collection volume trends, whether you think it's getting better or worse, whether you think this 2013 is flat, positive or just your where your thoughts are on that?

I think that, clearly, things continue to be stable and moving in a slightly positive direction. I think that we're beginning to see a bit more activity than we have, we're seeing more from a permitting standpoint, we're seeing a bit more activity in terms of development projects. There's just been a couple of large development projects announced. So I think we're beginning to see signs, it's not really impacted us to date. But I think things are certainly, I believe, slightly positive in terms of what we're seeing from a potential development standpoint going out into next year.

Okay. And just one last quick one. On Southbridge and congratulations on getting that done by the way. That now that we -- you talked before about your thoughts on kind of what the EBITDA contribution is from that, but now that it's actually done, could you just remind us and give us your updated thoughts on what the incremental kind of annualized EBITDA contribution is, that you'd get up to 300,000?

Yes, Corey, it's Ned. We expect the facility to contribute around $3.5 million to $4 million of additional EBITDA from this next step up. And then as you're aware, after we operate one year, at the 300,000 ton level, we will have the ability to permit to the 405,000 ton level, which will give us another step up in EBITDA on the next 125,000 tons.

Yes, and that step up actually goes back to the January interconnect with the landfill gas-to-energy project. So we're in that year process from January -- starting January this year, once we operate for that year, after the landfill gas-to-energy facility was online which happened in January. So it'd be next January when we'll be able to apply for that step up to the -- pickup the additional 100,000 tons.

Okay. And from where we stand, now you think you'd get that $3.5 million to $4 million incremental, that first incremental step up by late spring, on an annualized basis?

Yes.

And our next question comes from the line of Michael Hoffman of Wunderlich.

Can we just follow-up on your comment, $1 equals $0.35, where is the $0.35 hitting, EBIT or EBITDA?

EBITDA.

EBITDA, okay. And then asset sales, so if there's a -- a different message here than from the past, it sounds like it's a when not an if. So can you talk a little bit about how quickly the when could happen on a Maine or a GreenFiber recycling bank -- RecycleBank and what are the barriers to the when?

Sure. I think, clearly, Michael, we're focused on those 3 non-core assets. And I think, we'll have some real specifics in terms of timing on the fourth quarter call, but we have had been working on those issues for a number of months now. And I think that we'll be able to get some real specifics on the fourth quarter call. But they're near-term events, not long-term events.

So near-term means in the calendar '12?

I think -- we'll give you the specifics on the fourth quarter call, but our goal would be to get as much of that done in calendar '12.

Okay. And then the Facebook IPO, does that have an impact on your ability to get RecycleBank sold sooner or later?

I think a positive IPO there in that space certainly should be helpful.

Okay. And then can you talk about sort of the thoughts about the balance sheet and the overall strategy towards moving the leverage ratio. I mean, at this juncture, it's coming from cash from ops. It looks like you'd add to that from the asset sales. But what's the timing of a bogey on the leverage ratio getting below 3% -- or 3x, I mean.

Mike, honestly, our main focus right now is the refi of the second lien notes because that helps our cash flow tremendously. And John mentioned, our primary target next year is to get the free cash flow to $20 million. And with that step, I think it opens the door for us to rapidly -- more rapidly address the balance sheet issue. But until we get those steps done, we've got to do those steps first.

Okay. And then on the opportunity to participate in shale plays, so what are you hearing in the state of New York about the timing of finally getting a set of regs that you can define whether drilling happens or not?

It's a great question. I think we've -- there has been some communication over the last month or so, from the Commissioner DEC Joe Martens, And they've got, I believe, somewhere in the vicinity of 15,000, 20,000 comments. So his best guess was it was going to take them probably about 8 to 12 months to get through those comments and have the response out on the street relative to the regulations that they're going to put in place. But it certainly seems that they're moving forward, and it certainly seems as though it's not a matter of whether, it's just a matter of when. I think they're thoughtfully going through those comments and they're going to thoughtful regulations in place, but it certainly looks at this point in time that, that timing could be 8 to 12 months, maybe a little bit longer than that.

So this is a calendar '13 contribution?

I would say that's correct, Michael.

Okay. And then how do you frame what's happening in Pennsylvania versus McKean at this point, in shale? How do you characterize what's happening there?

I think it's fair to say that with the price of natural gas, some of the drilling has stopped. There's still an awful lot of activity there because there's a lot of drilling that has to happen in order to protect the existing leases that are in place. So there's still significant amount of activity in our coupling of the water treatment which we're going to bring online in probably the summer of this year, bundling the water treatment along with the drill cuttings and solidification, which we're in permitting for right now. We believe that we'll be able to capture our fair share of the activity that's there. But clearly, with natural gas pricing where it is now, the amount of drilling has -- some folks have moved rigs, but there's still tremendous amount of activity there, and I think we'll begin to see that activity in the next year in New York as well.

Okay. And then it's my understanding that Montréal is facing about a 200,000 annual landfill shortage. So how are your assets positioned if you are to absorb any of that, if they can?

We have the capability at some of our facilities to handle Canadian waste. So that is -- that would be a net positive for us.

Okay. And then lastly, on Maine Energy, specifically. Am I correct there's a little bit of a bundling of what's going on with the landfill, as well as Maine before you can make that move and can you just...

Yes, I think there's a very fair perspective. There's a lot of interaction in terms of Maine Energy, with streams from Maine Energy going to the disposal facility. So strategically, we really need to look at what's right for the total system and what's right for the communities. But the facility does have impact on other facilities. So when you look at it, you have to look at it as a whole operation as opposed to just a waste energy plant in isolation.

So clearly, the permit expansion you got helps that but What has to happen, is there a discussion with the state or is it local or what...

There's other permitting activity that we need to go through there, that we're in the process of moving as we speak. So there's additional permitting that we need to do at those facilities. So that's an ongoing process and something that's in the works at this point.

And our next question comes from the line of Al Kaschalk of Wedbush Securities.

Just on Maine Energy. It sounds like the way you're framing this is that it's an asset up for sale now or exploring strategic alternatives versus in the past. But don't get too excited because of the nature of the permitting process and all the things that are just going to take some time realizing. So I guess the question in all that noise is, is 2012 calendar year a reasonable time to get something done there?

I think it is, yes. I think it is.

Okay. All right. And then back to the core business for a second. If I -- my question is this. It sounds like, operationally, all the comments are positive, for the most part x some of the commodities and recycling noise. But yet, I wonder if it's driving at the margin level that you have internally or is that for expectations? And with additional volume coming on and the struggles to maybe in certain markets, be competitive, do you feel like you're making steps forward operationally, on the margin, trying to get it back towards more industry or in line with the industry level?

Al, it's Paul. The -- our progress over the last year has been substantial on the pricing front. As we mentioned, we're comfortable on the full year basis that while there's pockets of resistance there, on a market-by-market basis, that we've been very successful with the pricing initiatives that we've undertaken. When you look back over the last couple of years, with our directly -- with our direct operating cost as a whole in the collection line of business, we have improved nicely over that period of time. When we look at the quarter's results, truthfully, they're not where we want them to be. We are improved, we improved slightly over last year, on a cost of ops. But we see continued opportunity there, I guess, is my point. And we're going to remain pretty vigilant in getting that return in key markets. Many are performing right where we need them to be, but there are a few and they're higher-volume facilities that we know we can do better, so that our focus here, in the last couple of months of this year and then into FY '13.

Paul, so do you -- if we assume the pricing level in the new, in the -- you're getting price, is this a question now of competition in the market that you need to defend volumes, therefore, there may be some price? Or is it a question that it's just the higher-priced waste isn't there in the market today, and it's not given maybe some added benefit to the recovery story that's underway?

I think that when you look at the special waste, Al, it just -- it really is a very high impact in terms of profitability at the disposal facility. So that, I think, is the driver in terms of the overall performance from a landfill perspective. That waste is very accretive to the landfill model and it's fundamentally just gone away.

Great. And then just my final question as I touch on special waste. Is the waste volume originating from government-type entities or is it industry? Or what sort of -- what have you seen historically? And then going forward, it's sort of a tough model to live on, right? With not only you, but others, to be dependent on government entities to drive some of that volume, is that fair?

I think, it's fair, but I think that the reality is a lot of that cleanup work where you're getting special waste soils and asbestos and other, is somewhat driven and has been historically, from a government perspective, some of it is driven from a private sector standpoint. But I think that there's a certain amount of that, that clearly has been -- clearly, has driven from a state and municipal government perspective. And it's always been that way. So I think that it will not improve until we really get our act together in Washington, obviously, and begin to wrestle with the overall fundamental deficits that we have.

I think, it also speaks to our strategy that we mentioned earlier around oil and gas. We recognize that, that may now always be there with special waste going forward. And the positive, we received a very positive response thus far, regarding both the water treatment, the prolification and the drill cutting into our Pennsylvania site. But then as we mentioned earlier, when New York does come online, we're well-positioned for that. So we are thinking past to this decline in BUD volumes, in other ways, to attract material into our sites.

And we also have a question from the line of John Zaro of Bourgeon Capital.

A couple of questions. One, and they're sort of interrelated, I'm assuming now that we have sort of come to more of a conclusion that these 3 assets are not really long-term assets for you, that while they have declined somewhat in value relative to what they're worth to Casella, and that they don't fit and obviously, in a very short-term, they're hurting you guys. That because of what's happened in the markets from the private equity side, that they're worth more to people on the outside? And sort of as a secondary to that, I'm assuming that you've had some interest from the outside on some of these assets? I've been working on them for a couple of months.

That's a fair perspective, John. There is interest in the assets and the -- as I said before, we're working on that and we'll be able to bring some clarity to it, obviously, on the fourth quarter call. But you're absolutely right, there is interest.

And we also have a question from the line of Michael Hoffman from Wunderlich.

Just quick follow-up on special waste and then the assets. Am I wrong in that there was a ton of federal stimulus money that flooded New England? And so some of the special waste activity got pulled forward, if you will, from -- if there was a normal buyout of it, it got pulled into the current period when that money was available, and so they've kind of done things early and we've got to work through that debt?

I would -- without -- I don't know if we've analyzed that, Michael. But without doing any analytical work, I think that there's probably some truth to that.

Okay. Well, we did look at it and it looked like New England got pulled just because they're all democratic state, they've got a lot of money. So...

Well, not all of them.

Okay. And then the other one is, can you make Maine Energy a discontinued op and get it out of the day-to-day numbers so that this does -- it doesn't make the problem go away, but at least clears up the financials?

Mike, I think the best thing for us to do is to try to execute our plan in terms of the strategic options that we have in front of us and then that issue will take care of itself.

And I see no further questions in the queue at this time. I'd like to turn the conference over to management for any final remarks.

I'd just like to thank everyone for your attention this morning and look forward to our fourth quarter call which is...

Mid-June.

Mid-June. Thank you very much. Have a great day, everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day.