Casella Waste Systems, Inc. (CWST) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, welcome to Casella Waste Systems First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. Now I'll turn the conference over to Joe Fusco. Please begin.

Thank you for joining us this morning and welcome. With us today are John Casella, Chairman and Chief Executive Officer of Casella Waste Systems; 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 fiscal year 2013 first quarter results. These results were released yesterday afternoon. Along with a brief review of these result and an update on the company's activities and business environment, we'll be answering your questions as well a little later. 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 on the Financial Tables section of our earnings release, which was distributed yesterday afternoon and is also 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. John?

Thanks, Joe. Good morning, everyone, and welcome to our fiscal year 2013 first quarter conference call. Our goal today is to discuss our first quarter results and to update you on our midterm strategy. I will start with a brief overview and then Ed Johnson will take us through the numbers. Our first quarter was quite challenging. We faced and continued to face significant headwinds from significantly lower recycling commodity prices, decline in special waste volumes at our Western New York landfills and a weak roll-off collection environment. Despite these headwinds, our core solid waste operating assets continued to perform well in a stagnant economic environment. Furthermore, the steps we have taken to realign operations and reduce our cost structure positions us well to maintaining operating performance in this tough environment and to provide positive operating leverage as cyclical revenues return. Recycling prices fell 24% year-over-year in a quarter with all classes of commodities down, this drop in recycling commodity prices negatively impacted adjusted EBITDA by $2 million year-over-year in the first quarter. Prices fell further into August, with fiber prices down $10 to $15 per ton sequentially from July. The Yellow Sheet was released late yesterday and showed further weakening of fiber pricing from August to September, with prices down another $15 to $20 per ton. This weakness in fiber prices is mostly directly related to robust inventories at domestic mills and the slow Chinese economy. On a positive note, plastic prices were up in August and metal prices have stabilized. Given the current weakness and forecasted uncertainty for commodity pricing, we reduced our recycling business forecast for the remainder of our fiscal year to roughly 15% below our first quarter pricing. This reduction is reflected in the guidance that we issued. Special waste volumes at our Western New…

Thank you, John. Good morning, everyone. As John mentioned, a few weeks ago, we announced some significant overhead cost cuts on a realignment of some of our management and sales activities. We also announced the downward revision to our guidance, net of the cost savings, resulting from lower special waste tons into our landfills and lower commodity prices. With everything that's going on in the numbers, I thought it would be good to go into a little more detail on the quarter and the related guidance revisions than I usually do. Consolidated revenue for the first quarter came in at $121.2 million as compared to $127.2 million in the first quarter last year. The $6 million decline is primarily resulting from less disposal revenue, down $3.2 million; recycling commodity prices, down $2.5 million; and brokered revenue, down $1.2 million, offset by revenue growth in other areas. Disposal revenue was affected by several factors: an early spring, which pulled normal spring roll-off work into April; special waste, primarily from government-funded projects; and drill cuttings. Overall, disposal tonnages were down 3.6% or 42,000 tons. I think it's meaningful to look at each region separately to reflect how our long-term strategy is playing out. In the Eastern region, where we operate the Southbridge Landfill and Massachusetts Juniper Ridge and the Maine Energy burn plant in Maine and have a landfill closure project in Worcester, our tonnage was up 30% or 114,000 tons and revenue was up 13.1% or $1.6 million. This is primarily due to the volume increase to our permit for Southbridge that we received in Q3 of last fiscal year and our success in securing contaminated soil loads for the closure project in Worcester. An additional 105,000-ton permit increase for Southbridge is on track for late third quarter this fiscal year…

[Operator Instructions] First question is from Michael Hoffman of Wunderlich Securities.

Could you talk a little bit about the capital spending in the quarter? It was up year-over-year. Seems -- I just, help us understand how that flows through to the guidance on capital spending for the year? Where are we sort of timing wise?

Yes, I'd be happy to. That's a good question because it is a little different than in prior years and the reason is because -- there it appears different -- the reason is because of the early spring and the ability to get into the landfill construction a little earlier than we have in the past. So we -- our CapEx for the quarter was $16.4 million compared to $14.8 million last year, but our full-year target is almost 20% less for the year this year than it was last year, of course, excluding anything that might happen around Maine Energy. But we came in at $50.7 million -- or we came in at $59.2 million last year. We're going to be around $50.7 million this year.

Okay. So some of that seasonal spending that --

Just an opportunity to move that construction up, Michael, because of the warm weather. It's a timing issue.

Right. Because normally, that's in the second quarter. So that's -- for some of that, so we would just even that out more is what I'm hearing for 1Q and 2Q capital spending.

Yes. I mean, actually, we're -- the way we do our forecast is we put the bulk of the remaining in the second quarter, but it never works out that way. It usually pushes into the third but...

Okay, okay. And then with regards to next steps at Maine Energy, you got your purchase and sale agreement. Have you submitted your permit requests already to the state of Maine?

I believe they have gone in, yes. If they have not, Michael, they're prepared, and we'll be going in very shortly.

And once that's submitted, what's the -- I mean I'm assuming it's fairly bureaucratic. What sort of the process look like?

I think that process is at least probably a 90-day process. And as you know, it's difficult to predict because when you get into that process, certainly in a lot of cases, it'll take longer. But I think we do have the support, obviously, of the communities for what we're trying to get done. So it's likely that we should go through the process in an orderly fashion.

And what's plan B, if it just takes longer and longer? But you've come up against closing dates and decommissioning dates.

Well, I think that plan B is, there is really no plan B. I think that at this point in time, we're fully expecting to get through the process. I think we always have the opportunity to shut the facility down at any point so -- or to sell the facility. So -- I mean those options are certainly on the table to -- if for whatever reason it didn't go through, we could potentially sell the facility to someone else or shut the facility down.

Well, maybe I didn't ask it very clearly. Let's say this process just takes longer for the state to approve your Juniper modification --

We'll just keep operating the facility.

Okay. That's -- so that's what the plan B is. So that -- it stays open until we get an approval.

Absolutely, and for some reason, if something happened, we could sell the facility to someone else, for that matter as well. But we would continue to operate the facility through the period of time that it takes to get through the process.

Okay. And then just on a mechanical question, if you get this permit live, does that allow the auditor to let you treat this as discontinued ops at that point?

No, it doesn't work out that way because there's a -- in GAAP, you have to consider what happens to the revenue. And since we would still control most of the tons that now go into Maine Energy and we would reallocate those other facilities, hopefully Juniper Ridge, they won't allow disc ops treatment.

Okay. And then lastly, on the balance sheet and the second lien, can you walk us through a little bit of the thought process of your decision-making process? What are the triggers that are saying, "We can't do it right now but we would," of refinancing?

A few comments on that, because I've been asked that quite a bit. I -- the -- we talked about in the last call our disappointment, really, that the market did move and we were looking at a significant negative MPV transaction to refinance the second lien notes. But I -- maybe I didn't make it clear then, but I need to make it clear now that we always had the option to do it. I mean the markets were there. There wasn't any issue, except the economics of it, for us. So we continue to look at ways to either get it closer, get it to something that -- that's not such a hit for us to take now or just have it all arranged to take care of it next July when those notes are callable at par.

Okay. And then in the context of that negative economic analysis, what are we looking at as far as the cost aspect of that now versus waiting until July?

Well, this -- I mean the big hurdle is the $10 million call premium and being able to recapture as much of that in interest savings as we can for the rest of the year.

Our next question is from Scott Levine of JPMorgan.

So it sounds, from an internal perspective, pricing has been a strategic priority of yours over the last year or so -- and although the pricing metric you guys posted is a bit lower than we expected on a total company basis, the comments suggest that throughout the non-cyclical portions of your business, that you're achieving the types of increases that you're targeting. I was hoping you could provide maybe a little bit more color on how your pricing initiatives are tracking according to plan. And if we continue to see the type of challenging macro environment you guys are guiding to and seeing right now, do you see risk that some of those pricing targets end up coming down going forward? Or is it really more a function of internal initiatives on your part and the environment is accommodating at this point?

Yes. I was hesitant to get into too much detail because it gets a little complicated. But if you recall, when we put in this pricing initiative originally, our long-term goal was to spread the price increases evenly through 12 months of the year. So that we were managing, as a core process, our customer profitability and picking every month who we were going to raise. Well, when we initiated the program, we had not had price for -- we had not gotten price in the 2 years prior. So we had some pent-up adjustments to make. We had some underwater customers that either were going to flush out or be raised. So we didn't really spread it evenly last year as much as we are this year. And so in the first quarter of last year, we had more price increase activity than normal. And now we're trying, instead of increasing those customers again in that first quarter, we're spreading them a little bit more for the year to get to our long-term strategy there. So then to answer your question about where we are on plan, the 1.7% for the commercial and residential was very close to plan. So we're pretty happy with the process and how it's working. The only thing that went off plan was the temporary roll-off, which is, as I said, priced dynamically based on the demand in the market as those prices change, depending on whether our equipment is being utilized or not. So when May fell off, we had to lower price to get the boxes out.

Yes, now that makes perfect sense. It sounds like the majority of the business, particularly the non-cyclical portion, is pouring[ph] close to where you expect it to be.

Yes.

Okay. And then, not to get ahead of ourselves here, you just announced the restructuring program. But say these headwinds continue and it looks like from our calculation, your leverage is -- your debt to EBITDA is pushing 5X here. If the environment remains challenging, commodities seem[ph] to fall off, it sounds like the refi and the second lien's likely a longer-term event than initially conceived, do you have like additional capacity to manage and flex down costs or to manage free cash flow? Or does your strategy and your decision on your course of action with some of these alternatives to delever change depending on how the operating environment flexes? Or do you have enough flexibility in your operating strategy to mitigate against some of those -- some of the headwinds that we're seeing intensify the last few months or so?

Well, that's a good question. Yes, we do have some flexibility. The main thing that we're focused on right now is getting through the Maine Energy divestiture. That has a pretty significant effect on our numbers. And the other thing is the, which is longer term, the put-or-pay contract coming up in Peabody, which really distorts our numbers. And with those 2 events, which are on schedule, we don't see any real long-term issues here. But if we continue to have headwinds, then yes, we will start taking a look at certain operations where we could cut costs. In this case, I'm not talking about headcount. I'm talking about reducing our exposure in certain areas of the business.

Understood. One last 1, and John as well, you mentioned GreenFiber is doing a bit better. We have seen pretty strong improvement in some of the building products areas. Maybe talk about the willingness to sell that business timing wise and/or when we could expect to see volumes improve. I know you've talked about some of the management aspects and the EBITDA trends. But is that what you guys -- I think you've talked about considering a divestiture once the market's coming back. Is it coming back as the leading indicators suggest that the markets that it serves are improving?

I think it's a fair question. There's no question that the housing market is improving, albeit slightly but it's certainly improving and it seems as though it's going to continue to improve on a go-forward basis. At least, that's certainly what all of the projections are at this point in time. As Ed said before, the management team's done a good job of rightsizing the business for the revenues. They also introduced a new product called Orcatherm[ph] into the marketplace as well this month, which is a pretty exciting product that is being rolled out in 260 Home Depot stores. So they -- not only have they done the right thing from a cost standpoint in terms of rightsizing the business, but they've continued to innovate by putting new products in the market. We're seeing that OSB and engineered wood is beginning to move. And usually, that's a -- it's a 3-year -- excuse me, 3-months lag from an insulation standpoint when you really begin to see insulation. So I think there's a possibility that could be monetized this year. But I think, again, it simply depends on whether or not that housing market continues to improve, and we continue to see things really come off the bottom, as they've started to, over the last couple of months.

Our next question is from Bill Fisher of Raymond James.

Could you just touch on some of the factors that might drive the landfill volumes up or down sequentially in the October quarter, whether you have any seasonality, expansions, projects or just something that, factors to think about on that front?

For the 1 thing, we do. At the end of the year, we're going to be expanding the permit at Southbridge, and we don't think that we're going to be in a position, based on where we are with regard to the existing permitted expansion to 300,000 tons. We're confident that we won't have any difficulty filling the -- that facility once we get that permit to expand. So that's 1 factor that would be at the end of fiscal year, probably in the third or fourth quarter. And other -- other activity, usually, we begin to see real activity before winter in terms of volumes. We usually see second quarter volumes usually are strong. So from a seasonal standpoint, second quarter is normally strong from a volume perspective.

Okay, great. And just a follow-up on the other questions on the refinancing. Basically, if you have the -- if you get the Juniper change, the Southridge expansion, the cost saves, I mean just kind of walk through it. It seems like your April quarter might have a lot better free cash metrics to it, and you'd only be a quarter away from saving $10 million on the call premium. So I mean, is it kind of wait it to make it better off or just to wait until all those factors are in place?

Well, my view of it, and some investors have even reached this conclusion that basically because of the economic headwinds, our whole plan on cash flow and because of Maine Energy and the complications with it, our whole plan on cash flow just really got pushed a year from where it was a year ago. We were expecting a big cash flow this year. Now that's not going to happen, so -- but we're now -- we've now got things built in that really are independent of economic situations despite the cash flows next year. So I think you're right on what you're saying.

Our next question is from Corey Greendale of First Analysis.

This is actually David Warner for Corey. I noticed that you put in your fuel surcharge price component in this quarter's numbers. Could you just give a -- an update as to how that program is working, what's been the recent impact of fuel surcharges and how you expect that component of price to trend in the next few quarters?

This is Ned, David. Just -- we put the component back into our statistics for the quarter after removing it for a year. If you look back to last year, in the March-April time frame, we had decided that our fuel, oil and environmental recovery feeds had reached a very high percentage. It was upwards of 20% when fuel was in high $3.90, $4 a gallon. And we really instated that program back in 2004 when diesel, if you can imagine, was $1.25 a gallon. So it really become a bit decoupled in certain ways, and we wanted to put that into permanent price so our customers can better understand what the true cost structure was. We reset our index where diesel started at $4.09 a gallon. So we really haven't gone above the threshold that much. But anything above $4.09 a gallon diesel, we start to float with the fuel recovery fee again. There are some customers who have fixed fuel recovery fees, typically some municipal or larger contracts. So we put the statistic back in this quarter, so we could have our investors start tracking it again as it's floating again and we're 1 year past when we rolled it into permanent price.

Our next question is from Al Kaschalk of Wedbush Securities.

I just want to follow up here on 2 questions on and drill down on 1 in particular. It seems like the business in general is struggling to spit off or generate free cash flow. And to the questions earlier about -- I forget where the covenant is on the debt to EBITDA but [indiscernible] we're pushing hard to those levels and the items that are in the pipeline to generate proceeds to pay down debt don't[ph] seem to be meaningful. And so I guess the question is, is how much room and time frame on that room do we have on covenant?

As you know, back in April, we worked closely with our banks to reset covenants. And then, of course, we've come into this year and we ended up because of market conditions having to push the second lien refi, which had an effect. And we've also experienced the shortage in the commodity prices and the tonnage. So we work closely with our banks. We -- right now, our forecast -- the low end of our forecast would put us very close to our interest coverage covenant. But the banks are aware of that and we're working very closely with them. So I'm not overly concerned about it, and we work with them on a monthly basis so --

Are you able to share with us what that ratio is? I'm sorry if I should have that, but I don't recall.

Yes. For this quarter, Al, we'll have this in our Q, which will be filed later today. Our total debt-to-EBITDA covenant will come at 4.96x against a covenant requirement of 5.25x max. And the senior funded covenant will come in at 2.95x against a 3.25x max, and interest coverage will come at 2.35x against a 2.15x minimum.

Okay, all right. And then -- so the cost cuts, one could argue maybe timing but have you done enough? And hear me out on this, please. If you look at the contribution on EBITDA margins on the disposal and recycling side of your businesses, those are generating I would say 90% of the EBITDA you posted in the quarter and the balance of revenue, call it $80 million, is generating very little, if not maybe even breakeven. So are there more -- [indiscernible] that you've used like non-core assets there that need to be shed? Or is it a dynamic where volumes and pricing just aren't getting to the level where they need to be?

I think it's a little bit of both. I think we have some assets that we're reviewing currently, Al. And I think that, clearly, we'll continue to review those assets that are not performing at a level that is -- that we expect. And so I think there's a possibility that there could be more assets that we will take a hard look at. So I think it's a combination of both.

Is the collection business specifically healthy?

Yes, it is. I think we have other ancillary businesses that we're looking at that on a go-forward basis, just probably will not make sense.

And, so they gave you a [indiscernible] that didn't specify healthy. What are you defining as healthy for the business plan, John?

Well, I mean, it's something that's above our cost of capital, returns that are above our cost of capital. We've got some facilities that we -- some assets that we're looking at on the basis of return, it's doing those reviews and certainly that's the -- that's really the basis that we're looking at those assets.

Again, just back to the debt on EBITDA [indiscernible], obviously, [indiscernible] and the denominator here seems to be a struggle to drive to the upper end. And again, I appreciate the headwinds that you have. But it just sound like there's a component here that we're missing in terms of driving that dollar level higher.

Yes. I think there's a couple of things that affect that ratio. When you , and I'm sure you have looked at our return on net assets and that's the thing I'm looking at right now throughout the footprint of our asset pool, you see things like Southbridge where we have a lot of money invested. But the real profitability of Southbridge starts clicking in when the permits increase. So that's happening now. So Southbridge looks a lot healthier than it did a year ago, and it's going to look a lot healthier next year than it does now. We have some other assets, which aren't in that situation where they're producing just a minimal return on our asset investment, and those are the ones we're focused on right now.

My -- I guess the question is right, is it the market -- as you get the permit expansion, is there any guarantee that you get the volume? And if you don't get the volume and we're still in the -- or you got to compete for the volume, pardon me --

Well, that's the nice thing about where Southbridge is. Because not only is it a market that has shrinking capacity, we have not had much problem filling the volume that we just got in the increase. But it's also on a market where we're taking out capacity with Maine Energy. So some of that waste will end up in Southbridge with the permit increase. And then we have a put-or-pay expiring in December 2014, which is the real home run because that allows us to internalize the volume in the Southbridge. And at that point, we'll actually have to push some waste out into the market.

Our next question is from John Zaro of Bourgeon Capital.

My concern, and it's sort of along -- I guess, everyone's concern is that you've had so many successes of trying to clean up parts of the company, including the -- selling the energy business a couple of years ago. But we're still kind of in the same place because, a, the economy is not recovered and we still have this big fear of this debt overhang, which troubles some analysts and many investors. So I guess the question is, isn't it just sort of better to get some of the stuff out of the way? In other words, if you wait, and I realize that this is sort of a toss-up, but if you wait until next year and the economy is worse and or rates are worse, your debt cost of refinancing could be substantially higher.

I think that's a very --

I mean substantially higher, we're at historically all-time records. And the market hasn't moved that far away from where you were going to price it in June. I mean --

I think that's a real factor in the analysis in terms of whether or not you go forward and do that refinancing now. There's market risk in terms of where the market goes is a big factor, John. I think that's exactly right. That's why we continue to work on it now to try to find the right -- the right formula in terms of refinancing the balance sheet. That's why we said we're -- we continue to work on that now because market risk is significant. No one knows where the market's going to be in the next 12 months and certainly, the markets are fairly good right now. So that's -- that is indeed a factor.

I mean because I sort of scratch my head every once in a while when you guys say, "Oh well, the market moved away from us." It really -- I mean, yes, it may have moved 25 basis points. But it hasn't really moved, and it's trading at record lows.

Yes. It wasn't just that the market moved away, but our credit rating went down as well and it put us into a different bucket.

That bucket has a huge market need for product. So there's always demand for that. And I guess the other thing too is that and I'm -- I sort of -- and I reminded of the fact that we looked at -- we theoretically have already looked at all these different properties and what has -- 2 years ago, we talked about what is -- what are the returns on capital and what projects weren't earning return to the capital. So again, I go back to the fact of -- maybe it is just time to say, "Well, you know what, let's just sell some of this crap and move on, because we're still sitting at $4.74." [indiscernible] maybe worth $10 and the rest of it may be worth $5 or $6. The fact of the matter is the world is different -- dramatically different.

John, I totally agree with you. We -- but these aren't like things you just call somebody and sell tomorrow. These are things that require a significant lead time to get the right buyer and to do the right analysis to make sure we're doing the right thing. So we are working on that diligently now.

Okay. And then the other thing is, did you move the date of the close of Maine to December from November, for anything other than it gave you more flexibility?

No. I think that we're of the mindset that we'll go through that process. The facility will continue to operate until we get through the process. I think that it took us a little bit longer to get the purchase and sales agreement done. But with that done, I think we're in the process now. And other than that, John, there was no other reason why we moved it other than just the ordinary process of going through and getting negotiations done. And the facility will continue to operate until we get done what we need to have done from a permit standpoint so --

My understanding is, is that the way the agreement is written is that you guys have the choice of whether you want to close it, whether you get that permit or not. Is that --

No, we would continue to operate the facility if we didn't get that permit. It is our choice and I think that we have the capability to bring that waste to other facilities, which is 1 of the reasons why it's a good thing to be taking capacity out of the marketplace. But we'll continue to operate the facility until we are able to get done what we need to have done from a permitting standpoint. And I think at this point in time, we're of the mindset that we should be able to get through that process. But we do have other options because of the amount of capacity that we have.

[Operator Instructions] We have a follow-up question from Michael Hoffman of Wunderlich Securities.

There seems to be some concern that the EBITDA can't improve if nothing gets better. So bear with me if I walk through this waterfall of events. But if 10 -- if fiscal '13 is 101 and '14 fiscal, things that are known are the incremental rollover of the first permit expansion at Southbridge, then the new permit expansion, that's got to be somewhere in the $3 million to $5 million of the incremental EBITDA in cash. It's clearly Maine Energy. I know you're not talking about it, but you've talked about impact to EBITDA on an annual basis of greater than $3 million or something at least in that range. There's 6 to 8. And then the refi, if it was done next July would at least be 6 to 8 of cash. So right there, you're talking about $17 million, $20 million cash improvement in '14. And those are all new. And then in '15, you get a follow-on rollover of Southbridge of the last permit mod, the increments from the refi and the put-or-pay. Again, I got another $7 million of EBITDA plus another $2 million to $4 million of free cash from the rollover. Those -- am I right about those? Those are all there, just time has to go by.

Yes. The only hesitation I have there is, make sure you know that the put-or-pay expires in December '14. So we don't get the full benefit in fiscal '15. The full benefit goes to fiscal '16.

Okay, fair enough. So then I got to carry on into '16. So I have 3 years of high visibility on incremental improvements of EBITDA and all you really have to do is show up and fog a mirror.

Yes, and --

That's a fair perspective.

Okay. So this isn't any -- it's not dire unless the bottom falls out of the wall[ph]?

Yes. And I -- I'd like to point out also is we've reduced our forecast to current realities. But we're not sitting on our hands as far as finding new sources of special waste and finding other solutions in our market. We just aren't in the position to promise something that hasn't materialized. So we have a pretty full pipeline of things we're working on. And should any of those materialize, then we've got some upside. But I think your analysis of just going through what's already on the books, what's going to happen, just the timing issue, is a very good one.

We're showing no further questions at this time. I'd like to turn the call over to management for any closing remarks.

Thank you, all, for attending this morning. Our next earnings release and conference call will be in early December when we'll report our second quarter fiscal year 2013 results. Thank you, everyone, and have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.