Republic Services, Inc. (RSG) Q2 2016 Earnings Report, Transcript and Summary

Welcome to the Republic Services Second Quarter 2016 Investor Conference Call. Republic Services is traded on the New York Stock Exchange under the symbol, RSG. [Operator Instructions]. I would now like to turn the conference over to Brian DelGhiaccio, Senior Vice President of Finance.

Good afternoon and thank you for joining us. I would like to welcome everyone to Republic Services' second quarter 2016 conference call. Don Slager, our CEO and Chuck Serianni, our CFO, are joining me as we discuss our performance. I would like to take a moment to remind everyone that some of the information we discuss on today's call contains forward-looking statements which involve 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. The material that we discuss today is time-sensitive. If in the future, you listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call which is July 28, 2016. Please note that this call is the property of Republic Services Inc. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Republic Services is strictly prohibited. I want to point out that our SEC filings, our earnings press release which includes GAAP reconciliation tables and a discussion of business activities, along with the recording of this call, are all available on Republic's website at republicservices.com. And finally, I want to remind you that Republic's management team routinely participates in investor conferences. When events are scheduled, the dates, times and presentations are posted on our website. With that, I would like to turn the call over to Don.

Thanks, Brian. Good afternoon everyone and thank you for joining us. We're pleased with our second quarter results which were in line with our expectations and keep us well-positioned to achieve our full-year financial guidance. We continue to realize the benefits of executing our strategy of probable growth through differentiation which allows us to attract and retain high-value customers, build the best team, increase profitability and create long term value. During the second quarter, adjusted EPS was $0.55. EPS improved from the prior year, even with a $0.02 increase in the effective tax rate. Excluding the increases in taxes, EPS grew approximately 6%. Adjusted free cash flow grew 5% to $177 million and was in line with our expectations. Core price was 3.1% and average yield was 2%. We expect the average yield to remain relatively consistent with our second quarter performance for the remainder of the year. We continue to see the highest level of average yield in our small container commercial business. The majority of these customers are on open markets, where we can a leverage an increase in demand for service our enhanced product offerings and our digital platform. Second quarter volumes grew increased -- second quarter volumes increased50 basis points. As expected, volume growth moderated from the first quarter but remain positive. We continue to expect volume growth of approximately 1% for the year, consistent with our guidance. Cost of operations improved 20 basis points to 61.3% of revenue, from 61.5% in the prior year. There was a sequential improvement in most cost categories, including labor, maintenance and landfill operating costs. Adjusted EBITDA margin was consistent with the prior year at 28.3% of revenue. We incurred approximately $5 million of legal settlement costs during the quarter which impacted EBITDA margin by 20 basis points and reduced EPS by approximately $0.01. We saw EBITDA margin improvement in all lines of business, with the exception of residential. Pricing in the residential business continues to be impacted by below CPI environment. We launched and priced a tender transaction and new debt issuance which will reduce annual interest cost by $17 million or approximately $0.03 of EPS. These deals closed in early July. As part of our efficient capital allocation strategy, we returned approximately $400 million total cash to our shareholders, since the beginning of the year. This includes 4.2 million shares repurchased for $194 million. Additionally, our Board recently raised the quarterly dividend by approximately 7%. The annualized dividend is now $1.28 per share. Regarding our revenue enhancing and customer-facing initiatives, first, we now have approximately $340 million in annual revenue that uses a Waste Related Index for the annual price adjustment. These Waste Indices are more closely aligned with our cost structure and have consistently run higher than CPI. Additionally, we move $25 million annual revenue to a fixed rate increase of 3% or greater. We made these changes for customers that want more certainty around future rate increases and we're confident that we can manage our cost structure at or below this level. Second, approximately 1.6 million customers are enrolled in our customer portal and mobile app, up 60% from the prior year. These tools significantly enhance our customer interaction and connectivity. Third, our eCommerce platform now has the capability for customers to purchase temporary large container and residential subscription services online. This addresses the evolving needs of our customers' buying preferences and provides a lower cost sales channel. Approximately 15% of residential subscription sales are coming through our eCommerce platform. And finally, we opened our second Customer Resource Center located in Phoenix. We expect to open our last Customer Resource Center in Indianapolis later this year. Regarding our fleet-based productivity and cost savings initiatives 17% of our total fleet now operates on natural gas; 73% of our residential fleet is currently automated; and 85% of our total fleet has been certified under our OneFleet Standardized Maintenance Program, up from 70% a year ago. We recently completed the final wave of our OneFleet implementations and expect the entire fleet will be certified by mid-2017. Recent recycled commodity prices have trended above the prior year by approximately $5 to $10 per ton. If prices remain at these levels for the balance of the year, we would expect to achieve the higher end of our EPS and free cash flow guidance ranges. When assessing other macro conditions, we continue to see a gradual improvement in the fundamentals that impact our business which was the premise for our 2016 business plan. Chuck will now discuss our financial results. Chuck?

Thanks, Don. Second quarter 2016 revenue was approximately $2.4 billion, an increase of $39 million or 1.7% over the prior year. This 1.7% increase in revenue includes internal growth of 1.3% and acquisitions of 40 basis points. The components of internal growth are as follows, first, total average yield growth of 2%; average yield in the collection business was 2.3% which includes 3.7% yield in the small container business ; 1.9% yield in the large container business; and 1.2% yield in the residential business. Average yield in the post-collection business was 1.1% which includes landfill MSW of 1.6%, a majority of our third-party landfill MSW business is with municipal customers that have contracts that contain pricing restrictions. Total core price which measures price increases less rollbacks, was 3.1%. Core price consisted of 4.1% in the open market and 1.5% in the restricted portion of our business. Second, our total volumes increased 50 basis points which was in line with our expectations. Volume growth moderated during the second quarter, mostly due to the mild winter conditions which favorably impacted our first quarter performance. Volumes in the collections business increased 30 basis points which included 2.9% increase from the large container business, a 10 basis point decline from the small container business and a 1.4% decline from the residential business. Within our large container business, temporary C&D hauls were up 6.5% and recurring hauls were up 2.1%. Temporary C&D hauls remain strong and continue to reflect an increase in construction-related activity. There was a 50 basis point impact to small container volume from not renewing select national accounts customers and shedding certain work performed on behalf of brokers. We view these losses as non-regrettable. Our residential volume decline of 1.4% was due to not renewing certain contracts that did not meet our return criteria. These losses were known and contemplated in our full-year volume guidance. The post-collection business, made up of third-party landfill and transfer station volumes, increased 1.5%. Landfill volume increased 1.6% which consisted of MSW volume growth of 2.2% and C&D of 13.8%, partially offset by decline in landfill special waste of 1.1%. The decline in special waste relates to large event-driven volumes in the prior dear year that did not repeat. Third, fuel recovery fees decreased 1%. The change primarily relates to the decline in the cost of fuel. The average price per gallon of diesel decreased $2.30 in the second quarter from $2.85 in the prior year, a decrease of 19%. The current average diesel price is $2.38 per gallon. We recover approximately 80% of our total fuel costs through our fuel recovery fee program. Additionally, 20% of our diesel gallons are hedged using financial hedges. Next, energy services revenue decreased 50 basis points. The decrease in energy services revenue primarily relates to a year-over-year decrease in drilling activity, resulting from a decline in the price of oil. Finally, commodity revenue increased 30 basis points. The increase in commodity revenue primarily relates to an increase in processing fees charged to third parties. This increase results from our initiative to transition to fee-based recycling model. Excluding glass and organics, average commodity prices increased 3% to $116 per ton in the second quarter, from $113 per ton in the prior year. Second quarter total recycling volume of 648,000 tons was consistent with the prior year. Cost of goods sold for recycled commodities was flat versus prior year. Now I will discuss changes in margin. Second quarter adjusted EBITDA margin was 28.3% and consistent with the prior year. Total cost of operations decreased to 61.3% from 61.5% in the prior year, resulting in 20 basis points of margin expansion. Sequentially, the year-over-year change in labor improved 30 basis points and maintenance improved 40 basis points. We expect maintenance expense, as a percentage of revenue, will be below prior-year levels as we exit the year. SG&A expenses were 10.4% of revenue compared to 10.2% in the prior year. The 20 basis point increase was due to settling certain legal matters from prior years. On a full-year basis, we expect SG&A expenses of 10.5% of revenue which represents a 30-basis point improvement from 2015. When looking at the detailed cost line items, as a percentage of revenue, there is an impact from the decrease in fuel recovery fees. For example, the 1% decline in fuel recovery fee revenue resulted in an increase in labor expense of 20 basis points and repairs and maintenance expense of 10 basis points. I want to remind you that we provide a detailed schedule of cost of operations and SG&A expenses in our 8-K filing. Second quarter 2016 interest expense was $92 million which included $12 million of non-cash amortization. As Don mentioned, we recently completed several financing transactions. First, we refinanced our $1 billion credit facility that was maturing in May of 2017. Second, we tendered $575 million of debt with coupons ranging from 5.7% to 7.4%. And finally, we issued $500 million of 10-year senior notes with a 2.9% coupon. As a result of these transactions, we expect to save approximately $17 million in annual interest expense or approximately $0.03 of EPS. Our effective tax rate was approximately 38%. The lower tax rate in the second quarter resulted in a $0.01 EPS benefit from settling of federal tax matter. We expect an effective tax rate of approximately 39.5% for the remainder of the year. Second quarter adjusted free cash flow was $177 million and year-to-date adjusted free cash flow was $337 million. Both were in line with our expectations. We expect free cash flow generation will be weighted to the second half of the year due to the timing of capital expenditures and working capital. We remain comfortable with our full-year adjusted free cash flow guidance of $820 million to, $840 million. Now I will turn the call back over to Don.

Thanks, Chuck. To conclude, our second quarter results were consistent with our expectations and they keep us on track to achieve our full-year guidance. I'm proud of how the Republic team continued to execute our strategy of profitable growth through differentiation. And our performance continues to reflect our hard work. We will continue to deliver on our promises to our key stakeholders, including our customers, communities, employees and shareholders. At this time in the call, I would like to open the call to questions.

[Operator Instructions]. Our first question comes from Tyler Brown of Raymond James. Please go ahead.

Core pricing did decelerate a little bit but yield has held steady. I think the spread between the two is about as small as we've seen in some time. I know one of your competitors has talked about must improved churn. I'm just curious if you're experiencing the same and can you talk a little bit about how PBS and Capture might be helping out there?

Certainly, what we're seeing here is a benefit from PBS and from Capture and that's what's allowed us to decrease our churn by about 30 basis points sequentially. The other thing that we have in here, Tyler is the fact that we're very much focused on ensuring that we're charging for all the services that we performed and that would include things like delivery fees and extra pick-ups. So that's really the focus that we have placed on these new tools and charging for the services has really allowed us to drive down that churn.

Tyler this is Don. As you know PBS is fully rolled out. Capture has now been rolled out for some time. The adoption rates, utilization rates of those tools are very high. We've got great training programs in place to re-trained new hires. It's been really a great success for us. There is a lot of pull in the organization for those tools, professionalizing the sales team. As a backdrop to what Chuck said, defection has remained low at 7% and now we've had that low for a long time. Churn is improving, as Chuck said. The underlying fundamentals of small container business are strong. So just all around, a good steady business and really good execution by the sales organization. And year over year, another stat we like to look at cost or price of new sales compared to price of new sales from last year is also up and that's, again due to the new tools that we've got out there.

Chuck, this is a bigger picture question, but margins have been hanging around this 28% range for, I'd say, the past couple of years. I know publicly, you guys have talked about that there is really nothing structurally that precludes you from getting back to, say, that 30% margin profile. I know there's lots of internal initiatives but what are the real key levers to getting back to that range? Is it really about bending the cost curve or do you guys need some exogenous help from, say, CPI commodities? Is that what's going to help you get there?

I think when we think about it longer term, we will need to be successful in terms of switching our customers from CPI to some other pricing index which we're very much focused in on. Obviously, a little bit of a tailwind from commodity pricing would help us also. But we're beginning to see margin expansion, right? So we had gross margin expansion during the quarter, 20 basis points, as I mentioned. The other thing is that we still feel comfortable saying that we're going to have gross -- our EBITDA margin expansion during the year. Part of that is going to come from just our continuing -- continual focus on cost, including maintenance and labor and also we're going to get a little bit of a benefit from the reversal of the workday. So we feel really good about the progress that we're making this year in terms of the cost side of the equation and we feel good about being able to get back to those 30% margins.

Remember, last time, we were north of 30% Tyler and given the size 31ish, we had better recycling commodity prices. We did not have the CPI environments. Those are two important macro things that you pointed out. But we're now seeing benefits coming through the P&L from the OneFleet initiative that is fully rolled out, as I said. We'll certify everybody by this time next year; that's starting to pay dividends. We will see the benefit start to happen next year in 2018 from the benefit of the reorg net of the CRC consolidations. Those start to roll in. Those are, I think, costs that will easily be able to achieve, based on what we have seen so far so there's a lot of good things in the works and again, there's always that next wave of initiatives that we haven't talked about yet.

Our next question comes from Noah Kaye of Oppenheimer. Please go ahead.

Maybe we just start with the recycling part of the business? First of all, can you just remind us how far you are through that process of reworking the contracts? And how long you think that will take? And I think there's second part of that question be it -- I think recently, in particular, you put in place some pretty state-of-the-art automation on some of the recycling facilities. To what extent are you seeing that in a higher automation level helping you on the margin profile and helping the economics along? Thanks.

So let me start by just reminding everybody that the recycling business really is unique based on individual markets. So while on one hand, we continue to make strong investments in recycling. And we're very much committed to helping our customers do the right thing for the planet and to meet their sustainability goals. That only works for us in markets where customers are willing to pay for the service and where we've got a density and participation to make it work. So I say very often, that sustainability doesn't work without profitability and those are a couple of key issues. Customers really need to value it and we need to have density and participation to make it work. So while we made some great state-of-the-art investments, as you pointed out. We have won some awards, frankly, for some of our innovation in and around recycling. At the same time, we've also had to close some low-volume facilities that were antiquated and where we don't have enough participation to make recycling work. It can't work as a loss leader. So how far are we in the process of really reinventing or reimagining recycling? Again you think about our business being only about 10% of revenues in recycling. It's, again, you think about our business being only about 10% of revenues in recycling. One of the most volatile parts of our business has been as we just spoke to Tyler about the commodity pricing environment. While it's starting to move up a little bit. It started out very low in the year. Maybe it's going to come back even stronger in the second half, we will have to see. But two components of recycling, one, is processing where we take in material to our facilities from third parties and then one is collection. On the processing side, about 40% of the volume we take in on processing we've adjusted or have favorable terms so where those customers who actually share in the risk and the upside of the material and the market prices. So those are good contracts. The remaining 18% of those customers in the processing side of our business are -- the remaining customer are going to come due for renegotiation over the 18 months. So over the next 18 months, we will negotiate to get to fairer terms there. And then on the collection side, that really resides primarily in our residential municipal business and we're working with our municipal partners to help understand this issue and we're renegotiating contracts as we go through time. Those contracts tend to be longer term so I would say we're just still very in early -- in the very early innings with that. But most of the -- that dialogue is met with practical solutions and people understand that it's got to work for both sides of the partnership so we're just going to continue to work through it and continue to invest where it makes sense.

I'd like to ask you a question on the relationship between increasing customer profitability and some of the technology initiatives that you're adopting and you mentioned that you've seen good progress on customer churn continuing to trend lower. I would also think with some of the early events that telematics and raw optimization technologies that you've got; it's becoming easier to pinpoint the types of accounts that will improve raw density and integrate profitability so to what extent should we continue to expect that to be a tailwind for you, as basically a secular technology benefit?

Well, just to be clear, we have been using route-based tech -- computer-based technology for routing for a long time, right? GPS-type systems and geocoding, that's not new technology for us. We will continue to improve the utilization of those systems but that's not going to be a big lever for us to pull. We're going to just get incrementally better year-on-year and continue to improve as the tools improved. But we've been using those tools for a long time so I don't want to leave you the impression that our routes aren't highly efficient or densely routed because that's one of the reasons our margins are 28% because the density model of our business.

Our next question comes from Andrew Buscaglia of Credit Suisse. Please go ahead.

Can you just talk about -- I thought your topline was a little bit -- just a touch less than I was expecting and if you break it down, it looks like I think expectations might have been a little bit high from Q1 with -- on the volume side but they were pretty much in line, although there were some interesting puts and takes when you start breaking down the volume. Can you just talk about each or the ones that -- highlight the ones that met your expectations or maybe were a little bit lighter? I know there's a lot going on with comps and --

Yes, we'll tag team this. Let's start off by setting the context, right? We had a pretty strong volume growth rate in Q1 but we reminded everybody that, that was just kind of a strange comp year over year. We had a very mild winter compared with a very tough winter the year before and we said to everybody that, look, our guidance for volume has been for the year was 0.5% to 1%. And we're saying now that our volume growth is going to be about 1%, right? So it really is in line in total and -- as far as an exit speed this year, with what we expected, frankly, maybe even to the high end of that.

What I would add to that also is that we did see, as I mentioned before, we did see a step-down in residential volumes and that's because of certain contracts that we did not renew because they didn't meet our return criteria so keep that in mind also. The other thing is that you've got a 50 basis point sequential decline in volume, just due to the additional work day so that's obviously something that's driving the topline in a pretty significant manner. But as Don mentioned, we still remain comfortable with our guidance of hitting about 1% for the year in volume guidance which, as you mentioned, is that the upper end of our original guidance range.

So obviously, a lot of this recovery has been led by our C&D business which continues to perform for us. We mentioned that churn rates are good. We mentioned, I think, defections stayed low. We're seeing container weights increase slightly. We're seeing service increases versus decreases continue to be incrementally favorable. So all those underlying things that point to -- continue to strengthen and fundamentals are there and we're also just being smart about pricing. I guess the last thing is and we mentioned it in the comments is we have walked away from some broker business and we have determined that, that broker model hasn't really favored the Company. And so we have intentionally shed some of that business over the last couple of quarters so that -- you net that out, obviously, the numbers are quite a bit more favorable.

And can you talk a little bit just looking at the top line as well. It looks like the tuck-in was a little bit lower than normal. Just curious what you're seeing in the private market. It sounds like things have quieted down with that. You also may have had some divestitures in there, so--?

We were a little slow out of the gate this year but we're confident that we will intelligently spend $100 million or so in and around tuck-ins. again/We're focused primarily in on tuck ins because of the return profile of those. And as you know, these things are kind of lumpy. But we've got a good pipeline and we've got a number of deals that we're working on now that we think will come through for the second half of the year and we will be right where we said we would be.

Our next question comes from Corey Greendale of First Analysis. Please go ahead.

First question I had is actually on the special waste environment. We do this survey every quarter and it -- the results of the survey said everything was strong but special waste looked a little weak. I don't know if it's just a quirk in our survey so wondering what you were seeing?

For us, Q2 is, again, from a comp perspective a little tougher for us because we had a pretty large job last year on the West Coast that did not repeat and again, you know that again, a big job like that, you've got to throw off your year-over-year comparison. Our first half special waste was -- remained about 3% above our three-year average so overall, we're still trending in -- we think in a good way. So remember, too, that a portion of our special waste is manufacturing related, that manufacturing waste is reccurring while you stream and those continue to be very stable and strong. And then the event business, similarly related to land clearing and construction, tends to be sporadic. That's what we're seeing. It's not that unusual that we would see these kind of movements. So we're -- I know overall construction remains pretty positive for us. So we think over the long term, we're still in pretty good shape there.

Okay and then I actually had a question on recycling. The -- as you have done some restructuring in that business, I imagine we've all been focused on what happens when commodity prices are down; now it's actually trending up. Is there a formula you can give us? I think in the K, you've given us a formula each $10 per ton change. Does X to revenue and operating income, how that formula changes as you've restructured those contracts?

I think the formula is basically the same so for every $10 change in commodity prices for our basket of commodities it has about $0.03 in EPS impact on the business.

And you all see that changing -- sorry?

Well, it will change as we continue to change the contract. So what we'll do, Corey, is when we make enough progress, we'll reevaluate it and we'll update then -- probably and hopefully by the time we get to guidance next year, we'll have a new view of that.

I'm going to ask One real last quick one if you'll let me which is Chuck, can you give us-- which quarter do you expect the reversal of the extra day to hit?

It's going to hit in the fourth quarter.

Our next question comes from Joe Box of KeyBanc Capital Markets. Please go ahead.

So I appreciate the comments earlier that you guys have narrowed the gap between core price and yield and maybe I'm reading into the a bit much but when you look at core price, your open market component in Q2 was 4.1%; that's down from where it was that in 1Q and it's down from I think it was 4.8% last year. I guess I would have thought that, that this lever would have been pulled a little bit harder given the restricted component is down on CPI. Is there anything that we can point to that would maybe explain some of the moderation or is it just tough comps?

I think we need to keep in mind that core price includes the anniversarying of recycling collection prices that we pushed real hard in Q1 of last year. So because those anniversaried, we had a little bit of a headwind in core price but as we mentioned before, even though we had that headwind, we were able to keep average yield consistent at 2%.

And Joe, our expectation is with, one, our focus on price and our internal controls around price and then our tools and Tyler mentioned synergy -- our Capture and PBS so with our tools, we keep a very close eye on that. We're rewarding salespeople for selling intelligently so we think and plus the market the general market has been strong. Growth has been there and our whole strategy around growth differentiation. We think our value proposition to our customers continues to improve, right? All of that directionally says that we think we're going to continue to experience decent pricing in the open market because we will earn it and we can help offset some of these costs that we just can't normally offset through productivity so nothing has really changed in our MO or in the overall structure of the market.

So then it's fair to say then that some of your bigger open market classes or products like commercial and landfill are good probably seeing similar, if not better core pricing?

Well, remember on landfill, specifically MSW, most of the waste that comes in is municipal under long term contracts. We have very little open market MSW coming into our landfills any more, just because we have priced those assets according to what a realistic return is for running a landfill. So but we do see decent pricing across the board.

And then Don, just a question for you on some of the customer-facing initiatives that you alluded, the eCommerce in the release. I certainly get that this is aimed at reducing churn and if you do that, you guys could boost revenue and margins. So I'm curious, have you started to see the meaningful reduction in churn from the systems. And I guess more generally, when you guys think about pursuing a project like this, how do you measure the returns associated with it and what's your expected payback period?

Well, two things, right? The rollout of click-to-buy or eCommerce tools, right? We -- as I said in my commentary, we're already seeing very high percentage of new business coming through in those markets where we rolled it out. So the return comes from the fact that, that new business shows up with a lower cost of acquisition because basically people are self-serving, right? They are shopping online; they're making the business -- the buying choice without having the interface with a live human being knocking on doors. And then secondly, those online purchases tend to be and have been at a higher than average price because the convenience of shopping online has value. On top of that, those purchases have come with, frankly, a higher degree of contract compliance where customers are opting in for -- to a service agreement because of the convenience of everything. So all of those things have value and now that the tools are proven, they are really user friendly and now they are rolled out almost across all of our markets. We have to just continue to push participation and the payback will be there. And frankly, if you look around the consumerism, that's where it is today. And we've been probably a little late to the game as an industry but I think as an industry, we're probably ahead of many of the other people out there and certainly smaller competitors who don't have the capability or the resources to do this and that's, of course, part of our differentiation strategy, right? We've got to meet customers where they want to be, they want to do business they want do business, so overall, it's just one more slice of how we're going to compete in the market? How we're going to grow revenue intelligently and how we're going to do it ultimately at a lower cost to acquire.

Our next question comes from Michael Feniger of Bank of America. Please go ahead.

So on the volume side, did that -- do you see any -- of the underlying volume, did you see any discernible trends through the quarter and is it on track through July?

Yes, I would say that we're on track. We're exactly where we thought we be. I actually -- as we said before, we're at the high end of our guidance right now. So we feel very comfortable with the volume growth we've seen in the velocity that we have for the rest of the year.

Okay and was there anything specific, any region or were there any slowdown as you went through the quarter?

No, this is Don. I would say it's very broad-based across geographies, across most lines of business. So again, it's a -- we talk about the fundamentals being strong. We talk about the fact that we're still mid-cycle in the recovery. All of those things are pointing in the right direction. So we think it's a solid quarter and as Chuck said, we're reiterating guidance. We're saying that we think we'll l perform to the high end of that, as long as commodities hold up and the volume side as well. So we're pretty pleased with how the business is performing today and the economy is cooperating.

Just my last question, I think restricted pricing was 1.5%. Is this the bottom that we should see with how we've been seeing CPI trend or is this going to take another step lower in the second half of the year?

Yes, this is pretty much the bottom right now in terms of restrictive pricing. Obviously, we've got a little bit of a CPI headwind in the second half of the year but that's already contemplated in our guidance. But the should be close to the bottom right now.

Yes, because what you will see probably sequentially, Mike, right, is that as we -- the majority of our price resets right around the second half of the year, right? So you're going to start picking up the 2015 CPI environment in the restricted pricing in the second half of 2016 and into the first half of 2017. But the one thing obviously is that we're going to maintain this 2% average yield and the way we're going to do that is with a little bit better pricing in the open market. Chuck talked about some of the recycling collection pricing that we did last year Q2 that anniversaried to bring it more in line with what we charged on the solid waste side and we're going to see more of that in the second half of this year to offset the CPI headwind, right?

And on top of that we're also going to continue to convert people to the alternative indices and we're also going to deal with the -- some of the pricing that we have today in and around the recycling to make that fair for us. That's going to continue to happen through this cycle and then as we've always said, a little bit of inflation is good and if we see some of that come through that, at some point, will help us well.

But also remember, right, we've been managing in this low CPI environment for quite a long time now and I think we've done it pretty effectively. So If you think about the number of years we've -- what's it, 1.6% average CPI?

1.1% over the last verdict.

We maintained our margins. We continue to produce strong free cash so this business is built to withstand it and I think there's upside on the horizon. So --

Our next question comes from Michael Hoffman of Stifel. Please go ahead.

This is Brian Butler in for Michael today. The first question, just on the margins. In the first half, on EBITDA margins, first and second quarters it was down, I think around 40 or 50 basis points and when you think about getting to the midpoint or the high end of your guidance, that means there's about another 120 -- 100 to 120 basis points in the second half. How should we think about that from a waiting perspective in third and fourth quarters? Was that more back-end weighted to the fourth quarter where you see much stronger margins or is it going to be more even?

So right now, keep in mind that here in the second quarter, the EBITDA margins were 28.3%, right? So consistent with last year, had a little bit of a headwind as we had mentioned in those margins because those legal settlements that we had talked about. So if you back those out, you're close to that 28.5% that we had guided to for the year. In the back half of the year, we continue to see strong EBITDA margins. keep in mind that work day that I had talked about will also benefit the margins in the fourth quarter of the year so right now, we still feel very comfortable with our EBITDA margin guidance.

And we have said, our operating costs are improving, right? We think that continues through the second half; again, this legal settlement doesn't repeat. Those are the things that will continue to pull that EBITDA margin up through the end of the year.

Brian, you are probably going to see a heavier weighting to Q4 than Q3 again because of the workday that Chuck mentioned, we're going to get a benefit from that but also we have an easier comp in the fourth quarter from the EBITDA margin performance in the prior year so most of it will be weighted to Q4.

Okay and what was the benefit from the day? Did you guys give that?

Well, just think of it this way is that in the first quarter when we actually had one extra day, it was about 50 basis point drag on margin so think of something similar in Q4 but obviously flipping the other way.

Okay. And then I just on a follow-up question, when you talked a little bit on the service upgrades looking better, can you give a little bit more color on those trends on the commercial side of the business and are you seeing any recessionary signs for many of the commercial customers?

No, the trends are just moderately incrementally better but nothing negative.

We continue to get strong price on the small container piece of the business, once again for the quarter, it was 3.7% for the quarter.

Our next question comes from Misha Levental of Wedbush. Please go ahead.

Just wanted to turn to the residential side for a second and the contracts you decided not to renew, I get the reason for shedding unprofitable volumes but just wondering what happens to these volumes? And where do the volumes go and how much capacity do you guys have left to shed?

Well, I guess, I won't share with you what we think we have to shed because frankly, we go into this thinking that as contracts come up for renewals, that because of our relationships, because of our great service, because of all the work we're doing to improve the customer interfaces, we think we'll be able to extend the business. But this issue of having some contract losses is just the nature of our business for as long as we have been doing this. The point I'm pointing to it is that we had this little CPI environment for many years. We've taken it on the chin with certain customers and we get to a point of renegotiation and we have to express to a customer that when we entered into this agreement five or 10 years ago, we expected to see a 3% or 3.25% price increase as we modeled in old CPI. Instead, we have seen 1.6% or less price increase and our costs are going up at 2% or 2.25%. If a customer's not willing to understand the cost model and thinks that we're going to take another price reduction to go forward and it doesn't meet our return criteria, even though we may love the customer and enjoy being good citizen and good part of the community, we've got to have a return that's appropriate. So this is just business. Right now we're just pointing out that we expected to lose some of those contracts in Q2. That's why we saw the -- one of the reasons we saw the reduction from 2% volume growth in Q1 to 0.5%. I don't want to blow it out of proportion, it's just part of the business but it gets a little lumpy and when it happens, we've got to point it out. But at the same time, we're having a lot of other successes in extending business and improving our work and our value, building strong relationships. Bringing the better service and the differentiation model that we talk about so overall, net-net of net, directionally, the economy has been good to us. The Company is growing, our people are executing, the initiatives are deployed and we're seeing the benefits in the numbers. The quarter is performing right in line with where we thought we would be. And we're, again, saying that we're on top of our guidance and we expect it to hit at the upper end if we continue with just the same pricing -- or in commodity sales. So don't blow that out of proportion.

Okay. And just turning really quick to -- of the refinancing that you guys accomplished, is there any additional room or opportunity for additional refinancings down the road or what's the state of affairs over there?

This is Brian. The reality of it is that we start seeing a number of maturities coming due beginning in 2018, right? So I think we've got maturities every year from 2018 through 2023 so that's the more likely scenario, as those maturities come to term, you will see us then obviously issue new debt at the market rates at that point in time.

At this time, there appear to be no further questions. Mr. Slager, I will turn the call back over to you for closing remarks.

Thank you, Nicole. I would like to thank all Republic employees for their hard work, commitment and dedication to operational excellence and creating the Republic way. Thank you all for spending time with us today. Have a good evening and be safe out there.

Ladies and gentlemen, this concludes the conference call. Thank you for attending. You may now disconnect.