Waste Management, Inc.

Good morning, my name is Thea and I will be the conference operator today. At this time I would like to welcome everyone to the Waste Management fourth quarter and full year 2018 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you would like to ask a question at that time simply press star and the number one on your telephone keypad. If you would like to withdraw the question press the pound key. Thank you. At this time I would like to invite Ed Egel, Director of Investor Relations. Please go ahead sir.

Thank you Thea. Good morning everyone and thank you for joining us for our fourth quarter 2018 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer, John Morris, Executive Vice President and Chief Operating Officer and Javina Rankin, Senior Vice President and Chief Financial Officer. You will hear prepared comments from each of them today. Jim will cover high level financials and provide a strategic update. John will cover an operating overview and Javina will cover the details of the financials including guidance for 2019. Before we get started please note that we have filed a form 8K this morning that includes the earnings press release and is available on our website at .wm.com. Form 8K, the press release and the schedules for the press release include important information. During the call you will hear forward looking statements which are based on current expectations, projections or opinions about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today's press release and in our files with the SEC including our most recent form 10K. Jim and Javina will discuss our results in the areas of yield and volume which unless otherwise stated are more specifically references to internal revenue growth or IRG from yield or volume. All fourth quarter volume results discussed are on a workday adjusted basis. During the call Jim and Javina will discuss our earnings per diluted share which they may refer to as ETS or earnings per share and they will also address operating EBITDA which is income from operations before depreciation and amortization and operating EBITDA margin. Any comparisons unless otherwise stated will be with the fourth quarter of 2017. Net income, effective tax rate, ETS, income from operations, EBITDA for both the fourth quarter and full year of 2018 and 2017 have been adjusted to enhance comparability by excluding certain items that manager believes do not reflect a fundamental business performance or results of operations. These adjusted measures in addition to free cash flow are non-GAAP measures. Please refer to the earnings press release split note and schedules which can be found on the company's website at .wm.com for reconciliation to the most comparable GAAP measures and additional information about the use of our non-GAAP measures. This call is being recorded and will be available 24 hours a day beginning approximately 1pm Eastern time today until 5pm Eastern time on February 28th. To hear a replay of the call over the internet, access the Waste Management website at .wm.com. To hear a telephonic replay of the call, dial -859-2056 and enter reservation code 6496795. Time sensitive information provided during today's call which is occurring on February 14, 2019 will no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now, our turn to call over Waste Management President and CEO, Jim Fish.

Thanks Ed and thank you all for joining us this morning. At this time last year I was telling you that 2017 was arguably the best year we've seen. I'm pleased to report that 2018 results were even better. Through our continued focus on customer experience, our cost management and our price discipline, to name a few, we had a great year. For the year the business produced a record high in operating EBITDA which is the best reflection of the health of our business. We grew operating EBITDA by more than 5% in spite of the strongest recycling headwinds we've seen in over a decade. Overall in 2018 we produced $4.20 of EPS, another year of double digit improvements. Divina will cover our 2019 guidance in more detail, but we are forecasting another record year in operating EBITDA this year with our growth rate expected to be about 5%. Included in our 2019 forecast is our expectation that the strong recycling headwinds from last year will turn into a tailwind thanks to our focused efforts on reducing operating costs on our plants and charging fees for contamination. To the extent that waste management is a good proxy for the overall US economy, our 2019 guidance of another record year in operating EBITDA clearly demonstrates the strength of our own business and of the economy as a whole. As we mentioned, operating EBITDA is the best reflection of the health of our business and our strong growth translated into the strongest free cash flow we've seen ever with the exception of 2014 when we sold our waste energy business. We allocated close to 90% of that free cash flow to shareholder returns, growing our dividends for the 15th consecutive year and spending $1 billion on share of purchases. We also spent $466 million on acquisitions, an indicator of the active M&A environment we're in and our ability to complete transactions at our targeted returns. In 2018, we continue to focus on our people, disposal optimization, technology and profitable growth, all while delivering exceptional customer service. Our strong 2018 results validate that our execution on our focused differentiation and continuous cost improvement strategies drive strong growth in our business and we expect further progress in 2019. Our strategic direction in 2019 will look very much like 2018 as we move forward with a cultural transformation that places waste management employees at the head of the class in terms of focus and importance. In December, we announced the hiring of our Chief Human Resources Officer, Tamla Osforny, who was formerly an HR executive at GE. Tamla is moving forward quickly in putting world-class processes in place, upgrading talent and helping to direct this valuable cultural shift at waste management. Similarly, after only 15 months under the leadership of Nikolai Shokvist, our new digital team is beginning to show how our investment in operating, customer-facing and back-office technologies as we migrate towards more agile cloud-based systems can serve to differentiate waste management going forward and propel profitable growth. Lastly, on the strategic front, our 2019 Sustainability Forum, which was held two weeks ago in conjunction with the Waste Management Phoenix Open, broke all previous forum attendance records and built on our message of sustainability that is collectively good for the environment, good for our customers and good for our investors. That's best demonstrated by the shift in our fleet from higher cost, higher emission diesel trucks to quieter, much cleaner burning, lower cost CNG trucks. To complement and aid the shift towards sustainability and benefit from the geographic breadth of our landfill assets, waste management is investing in higher return energy plants at our landfills in 2019 and beyond. This investment provides an avenue to close the loop between our renewable energy plants and CNG fleet, creating favorable returns for the company. Our strategic focus on people, technology and growth through a superior customer experience is moving waste management from a leader in the waste business to being a leader in the Fortune 250. That was no better acknowledged than with our recent recognition by Fortune as one of the world's most admired companies. Finally, as part of our strategic growth plan, we will continue to invest in acquisitions that surpass our return criteria and create value for our shareholders. Our pipeline looks robust and there are plenty of opportunities to invest in acquisitions at a rate similar to what we achieved in 2018. So in 2019, we expect another year of above average M&A activity. To that point, you may have seen that we recently received our Scott Rodino antitrust clearance to proceed with the acquisition of landfill assets in West Texas. We will be buying these assets at an operating even though multiple well below our trading multiple and we're excited to make core waste management service offering. We hope to close in March and we will provide additional details once the deal is closed. In summary, our hardworking employees made 2018 a very successful year and we expect to see strong growth again in 2019. We will continue to make investments in our employees, in technology and in capital equipment this year to further grow our business, improve customer service and generate strong returns. We're confident that these investments will position us well for 2019 and into the future. And with that, I'll turn the call over to John and Davina to discuss our results and our 2019 guidance in more detail. Thanks Jim and good morning. We're very pleased with our fourth quarter results as we executed extremely well on our core price disciplines growth strategies. Our industry leading organic revenue growth continued to drive strong income from operations and operating EBITDA growth, both around 7% in the fourth quarter. Throughout 2018 and particularly in the second half of the year, we've been very focused on our pricing programs to overcome inflationary cost pressures and grow margins. As we continue to experience cost pressures in 2019, particularly labor, transportation and landfill operating costs, we will ensure that these increases are being passed along to our customers so that we can continue to generate appropriate returns and grow margins. The strategy is best demonstrated by our collection line of business. We generate strong growth in 2018 and expect that trend to continue into 2019. As we think about the year ahead in our collection line of business, we expect to see the benefit from our investments in people, fleet and technology. First, as Jim mentioned, focusing on our people is the most important priority in 2019. Last year we invested a portion of our tax savings in our employees and this year, in addition to upgrading and automating our fleet, we will continue to invest in our employees through proactive wage increases, facility improvements and additional training at our new driver and technician training facility, which will open in the first half of this year. In regard to fleet investment, 2018 truck purchases and further fleet investments planned in 2019 are beginning to drive meaningful improvement in our maintenance costs. By the end of 2019, we expect to have over 60% of our routed vehicles running our natural gas. And we know there is a significant maintenance savings with natural gases compared to diesel trucks as they age. 2018 proved to be another solid year with respect to our efforts around continuous improvement and modernizing the work environment for our employees. We believe the steps we're taking to move towards an automated fleet will continue to drive not only safety performance, which is paramount, but also the efficiency and employee retention. This was again validated with several recent contracts that we were able to convert from the traditional rear load model to an automated side load service offering. We recognize almost immediate improvement in all those critical elements of our performance. We're also advancing our fleet strategy through partnerships with the truck manufacturers to implement the same safety technology we have on many of our cars today. We're looking to implement features like lane departure warnings, brake assist and collision detection that are worthwhile for enhanced safety alone and that have the added benefit of making our operations more efficient as we avoid lost time and costs associated with incidents. Finally, the use of technology is important to the continued growth of our collection business. We've been collecting and using data from the technology on our vehicles to anticipate and respond to our customers' growth and needs. This is translating into lower customer turn, volume growth above U.S. economic levels and it's creating value for our customers and shareholders. Looking at our disposal network, as we've discussed, we have the best position assets in North America. We are seeing cost pressures from our third party haulers at our transfer stations and higher landfill operating costs. We're focused on disposal pricing opportunities that will continue to create healthy margin in a rising cost environment. In addition, we look to continue to make technology investments like our pilot with caterpillar for remote operated equipment that will continue to increase the returns on these valuable assets. Turning to recycling, we perform well in the fourth quarter as a direct result of our continued focus on improving operating costs, restructuring of municipal contracts and successfully battling contamination. In 2019, we will look to continue to improve on recycling by investing in the MER for the future to further improve operating costs and optimizing our plans by being thoughtful about meeting our customers' requirements. In addition, we will continue making progress on reducing contamination, assessing fees to cover our cost of service and reduce costs of managing materials. Lastly, we closed on an above average amount of acquisitions in 2018 and as Jim mentioned, the pipeline looks strong for 2019. Integrating these acquisitions is a key priority for our operating teams to ensure that we manage costs, extract the value of these transactions and deliver superior service to our customers. I'm excited about the future opportunity for waste management as we believe that focusing on our people, optimizing our disposal network, better using technology and growing our business will provide strong returns for many years to come. I'll now turn the call over to Davina to further discuss our financial results in 2019 Outlook.

Thanks, Dawn and good morning, everyone. Our fourth quarter results were in many ways the strongest we saw all year, allowing us to close out 2018 on a strong note as we either met or exceeded all expectations. I'm going to start by reviewing those results in detail and then turn to our Outlook for 2019. Our top two financial priorities are growing operating EBITDA and leveraging that growth to convert more earnings to free cash flow. In 2018, we delivered on each of those priorities. Operating EBITDA on the fourth quarter grew on a -over-year basis by more than 7%. For the full year, operating EBITDA was ,000,000, over a 5% increase from the prior year and in line with our original guidance by the recycling headwind that was far greater than we could have predicted. We converted every dollar of operating EBITDA growth into incremental free cash flow in 2018. Growing free cash flow to ,000,000. That's an increase of over ,000,000 or almost 18%. This is higher than expected as the strong performance in the traditional solid waste business was supplemented by the sale of over ,000,000 of non-strategic businesses and assets over the course of the year. While these proceeds are always a part of our free cash flow measure, in 2018 the amount was over ,000,000 more than we expected. And so as we normalized for this difference, the result is free cash flow of about ,000,000, right in the middle of the guidance range that we gave at the end of the third quarter. These results highlight the value of our balanced execution of discipline pricing and targeted volume growth. In the fourth quarter, organic revenue growth in our collection and disposal business was 5.8%. Achieving this result in the fourth quarter of 2018 is particularly impressive on the volume front. When you consider the -over-year comparisons we were facing given 2017 hurricane volumes, our notable volume performance has been driven by our commercial collection business. And our focus on customer service has reduced our turn to 8.6%, which is over a 100 basis point improvement from the prior year. We have also seen service increases continue to outpace service decreases, making this the sixth consecutive year for us to achieve that result. And we are happy to see momentum on that front build. In the landfill business, volume growth has been driven by strong C&D and special waste volumes, both of which grew by double digits in the fourth quarter. As we've discussed on prior calls, the California wildfire volumes contributed to the increase in our C&D volumes, which we expect to continue into 2019. We never like to see events like this occur, but we have positioned ourselves particularly well as a strong community partner for those devastated by the fires. And as a result, expect that we will continue to see significant fire volumes into 2019. However, given the magnitude and uncertainty inherent in this effort, we have not specifically considered these volumes in our 2019 outlook. Turning now to cost and margins, in 2018, our operating expenses as a percentage of revenue were about 62% for both the fourth quarter and the full year. There were a number of variables that impacted the comparability of operating margins in 2018. But when we isolate the impacts of the revenue accounting change, the special benefits we paid to our frontline employees and recycling, we are pleased that our operating expense margin improved for the year in spite of higher third-party transportation and labor costs. These results tell us that we are growing in the right ways, executing our pricing programs to cover cost increases and create incremental margins, and continuing to operate more efficiently. In 2018, our SDNA cost as a percentage of revenue were .6% for the fourth quarter and .7% for the full year. This is the first time since 2005 that full year SDNA as a percentage of revenue has been below 10%. In fact, when you compare our 2019 SDNA cost to 2012, you'll see that dollars spent on SDNA have actually come down. That's a testament to the hard work our team has done to manage our spending even in a strong growth environment. Together, these results drove more than 50 basis points of operating EVDOT margin expansion in the fourth quarter of 2018, and 60 basis points of operating margin expansion for the full year. As we think about guidance and outlook for 2019, we see the strong performance from 2018 as a foundation for continued earnings and cash flow growth. We project that our operating EVDOT will increase to $4.4 to $4.45 billion in 2019, growing again at about 5%, with this growth fueled by our focus on delivering industry-leading organic revenue growth. We expect core price of greater than 4%, yield of greater than 2% in collection and disposal, and total company volume growth of around 2%. We expect our strong operating EVDOT growth to drive free cash flow of between $2.25 billion and $2.75 billion, an increase of approximately 7% after adjusting for the above average asset sales in 2018 and normalizing for tax planning and benefits that won't repeat. We project capital expenditures required to support our business to be between $1.65 and $1.75 billion in the year ahead. We will continue our long-standing commitment to our shareholders of using excess free cash flow to pay dividends, prioritize well-priced acquisitions and investments that will bolster our long-term organic growth, and repurchase shares. Adjusted EPS for the year is expected to be between $4.28 and $4.38. Our 2019 guidance is based on an effective tax rate of 24%, which is almost 2% higher than what we saw in 2018. Normalizing for that, as well as the 2018 benefit from fuel tax credits that we are not counting on in setting our 2019 guidance, this represents EPS growth of about 7% for 2019. We are all very pleased with the strong financial performance we accomplished in 2018 and are particularly proud of the commitments we made and will continue to make in the years ahead in building the best team in the industry. Jim, John and I can't thank the Waste Management Team enough for the fantastic year they delivered. With that, Diaz, let's open the line for questions.

At this time, I would like to remind everyone that if you would like to ask a question, to press star followed by the number one on your telephone keypad. We'll pause for just a moment and file the Q&A roster. The first question will come from Michael Fenneger with Bank of America.

Hey guys, good morning. Thanks for taking my questions. Can we just talk about on the SG&A? Obviously, it was a great year in 2018. Talk about how we're thinking about SG&A

as a performance was fantastic and definitely a result of very focused and dedicated attention to controllable costs. When we think about the baseline, what you'll see is that we're ensuring that we manage our baseline costs so that we can invest in the future. Thinking about 2019, you'll see an increase in SG&A as a percentage of revenue to about that 10% level that we think is right level for us long term. That increased SG&A is going to be dedicated toward the two strategic priorities that Jim discussed. That's continued investment in technology and people.

Michael, this is Jim. The only thing I would say in adding to what Davina said is that this is not a one-year trend. This has been a continuing trend since 2012. It's something that I talked about when I was CFO way back in 2012. Davina has really taken the ball and has continued to run with it. This is something that's ongoing, but it's not something that just started to happen in 2018.

On the pricing, guys, you made core person was strong in the fourth quarter, 5.6%. You're guiding it to be up 4%. I think 2018 was up over 5% for the full year. Even 2017 was up close to 5%. I'm just curious how you're seeing that pricing playing out, at least the momentum there, and how we should think about that as we go to the second half of the year.

Yeah, look, I think you're right to talk about core price, Michael, because yield, it's a bit more complicated. It includes the mixed component to it. Core price is probably the best representation of what we're actually passing to our customers in terms of price increase. You mentioned a couple of numbers there in 2018. Core price was 5.3%, .6% in the fourth quarter, which is outstanding. Honestly, when I look at early indications in January, for the month, January was excellent in terms of core price, in terms of yield, and in terms of volume. We're encouraged to see that it's continuing. We think we're really in a sweet spot right now in terms of driving both strong price and accretive volumes and really no reason to see a trade-off between the two.

Understood. Lastly, you might have mentioned this, but I think we were talking about 40 to 50 million EBITDA uplift just if prices remain flat. This was a few months ago. Obviously, we saw prices take a dip down. Did you guys clarify what's actually baked into the 19 guide with recycling? Thanks.

Yes. It's a little bit of a -to-predict number because there's a couple of components to it. There's what we're doing on operating costs that John mentioned and what we're doing with contamination fees. Then, of course, there's the number, which is commodity prices. We're sticking with our prior comments that the recycling is going to be a tailwind for 19. The extent of the tailwind, honestly, is difficult to quantify right now because of this continued softening in commodity prices. But really, for the year, the reason we're sticking with our prior comments about the tailwind is because of our efforts that were solely driven by contamination fees. The contamination fees really didn't start until second quarter, and they continue to ramp up throughout the year. So first quarter, there should be certainly a tailwind from those and this reduced operating cost. Then, that's lessened as we get through 2019. Thank you.

If you think, Michael, just to add a little bit of color there, because there is so much variability that can happen in the recycling line of business, the key point there is that waste management's done a longer going to be the driver of how we think about the earnings profile of that business. Moving to a model that prioritizes fee for service and getting a return on the assets that we deploy and then using technology to reduce costs over time, those are going to be our priorities. I think that the one data point that I would add, if you look at our estimate for average commodity prices, we ended 2018 in the $65 to $70 range for the full year on average. We predicted that we would be at about $70 in 2019, and you guys know as well as I do that early in 2019, we are seeing levels that are softer than that. So that's why we're hesitant to specifically give you a number that confirms what we had told you at the end of Q3.

I think that, you know, what I would add is, the beginning of the year was certainly volatile and reflected in our OPEX through Q2, but we've seen steady improvement in the last couple quarters in our OPEX. And if you look at our results for Q4 and recycling, despite kind of flattish commodity prices Q3 to Q4, we showed improvement. So I think it validates what Jim and Davina were talking about,

Michael. The next question is from Brian McGuire with Goldman Sachs.

Hey, good morning, everyone. Good morning. Hey, Jim, it's good seeing you on the Golf Channel a couple weeks ago out in Phoenix. I didn't get to see how your game was, though, but it was obviously very topical talking about the zero waste initiative you've got there, and that's been, it seems like picking up a lot of steam and momentum, both with consumers and in the industry. And I see you guys are making a lot of investments there, MRF of the future and some of the, you know, a lot on the recycling side, a lot on the CNG vehicles. Just wondering, you know, how do you view these investments in general? Are they, you know, do you sort of view them as almost defensive to sort of sustain, you know, current profitability in the industry and, you know, protect some of the turf that waste guys have? Or, you know, can these be offensive, you know, sort of investments that lead to new lines of business down the road that don't really exist today?

Yeah, thanks, Brian. I actually, my golf game was a little better this year than last year, so I'm happy. But I, you know, regarding your question, we really are looking at this as being an offensive move. You know, what I've said all along about sustainability, and I said it at our forum this year, and spoke with Kevin Johnson at Starbucks this week about it. And my point is sustainability has to be both environmentally and economically sustainable for it to really work. And so that's our kind of upfront goal going in. When we think about the investments themselves, you know, our venture group is run by Chuck Becker, and Chuck's looking at is there something we can invest in that improves the back end of these recycle plants, for example? We have a lot of waste plastics that go out of the back end, and so we're charging fees on the front end, as we've said earlier, for contamination. But is there something we can invest in that produces really good returns, but also is able to handle some of these waste plastics out of the back end of the plant? From a sustainability standpoint, both, you know, economically and environmentally, that would be ideal. So that's what Chuck and his team are looking for, really, kind of around the world. And I think we'll find it. I think we'll find something that helps us improve the sustainability of our model, our recycling model, but doesn't concede if somebody's still going to contaminate their trash bin, we're still going to charge them fees, and we're still going to work on through our new recycle plant in the future, reducing operating costs.

Okay, great. I sort of tied in with that a little bit. I can't, I just wanted to tease out some of your comments from the preparer. I think you said you were maybe spending a little bit more CAPEX on, I think it maybe was methane recovery at the landfills in 2019. I just want to get a little bit more color on that. And just in general, you know, the step up in CAPEX doesn't seem like a huge amount, but it is a little bit higher from already elevated 2018 levels. Just wondering, you know, is that on continued fleet modernization or some of these new initiatives that you were just talking about on sustainability and then environmental things?

Right. So you're right. I mean, it's, well, last year actually on a percent of revenue, which is kind of how we look at CAPEX, on a percent of revenue of .4% of 2018. And middle of the range is 11%ish, maybe .9% this year. But keep in mind, that doesn't include, our guidance does not include capital or resulting even for these renewable energy plants. The renewable energy plants are a way for us to close the loop. You know, we've made a big investment in natural gas trucks, will be over 60% of our fleet at the end of the year will be C&G. They're cheaper from a maintenance standpoint. There's all a bunch of reasons why natural gas trucks are good for us. But what this allows us to do because now we have such a big natural gas fleet is really close the loop through the monetization of these range credits that are available to us by building these plants. The reason I say that there that it's not in either the CAPEX guidance or the EBITDA guidance is because there's a timing difference. It takes 12 to 14 months to build these plants. So when we go through our capital committee process, if we decide that we're going to build out a renewable energy plant, the paybacks on those are excellent. They're three to four years. So they're kind of no brainers in terms of investments. But we also have to investors have to recognize that there's a timing difference that we don't we don't attempt to match them on a calendar year with the return simply because you're looking at a 12 to 14 month construction period for the plant. And so the CAPEX obviously takes place up front.

And I would add on the normal capital number, your point about it being elevated from kind of those historical norms of the 10% really has to do with the growth that we're seeing in the solid waste business. We've invested in the fleet and we're also investing in additional airspace at the landfills. I mentioned C&D and special waste volumes both being at double digits. And so, you know, constructing airspace to keep up with that growth is something that we're committed to. And so those are the main drivers of the elevated spend. But in a growth economy and a growth environment for our business, we're certainly seeing that as a worthwhile investment.

Okay, last one for me. Jim, I think you mentioned your you got some regulatory clearance in March. You'll close on some landfill assets in West Texas. Yeah, I recognize that was kind of a hole in the portfolio out in the Permian for you guys. But I'm just wondering with, you know, the decline in oil prices, why now is the right time to be investing in there? And do you feel like you got, you know, the appropriate multiple on those businesses given where oil prices are now?

Yeah, we feel really good. As I mentioned in my script, we feel really good about the multiple that we're buying this at. And we really didn't have a presence in the Permian Basin, which if you're going to be in that energy services space in the United States, that's the big boy. That's the one you have to be in. And so this is something we've been looking at for a while. And this one we really felt like was a was the right fit for us. So we'll get more details on the financial side of it once it closes. But we're excited about the strategic value of this. And we're certainly excited about the multiple that we're getting in it.

Okay, thanks very much.

Yep.

The next question will come from Hamza, Missouri with Macquarie Capital.

Good morning. Thank you. My question is around capital allocation. I realize you have a 1.5 billion authorization, but just any thoughts as to how to think about the pace of buybacks in 19 and as well as, you know, any kind of update as how you're thinking about larger M&A, either in solid waste or outside solid waste?

Sure. So I'll start Hamza. Good morning. And then turn it over to Jim to talk a little bit more about the M&A landscape. But as he mentioned during his prepared remarks, you know, if you look at 2018, we spent over $450 million on acquisitions and at the same time, bought back a billion dollars worth of stock. In 2019, we expect that M&A spending could be in the $200 to $400 million range on that core solid waste tuck-in spend where you're more accustomed to seeing that being more in the $100 to $200 million range for us. So when we think about that level, we're planning share repurchases of about $800 million for 2019. And should we see a different outcome on the M&A side, we'll flex that as appropriate to maintain a strong balance sheet.

Yeah, and the Humps on the M&A front, really, as Dena said, I mean, we tend to do a handful, you know, probably several handfuls of these smaller tuck-in type acquisitions, where the benefits are really extracting synergies. And those are right down the middle of the fairway. And then we're looking at, as is the case with this with Petro Waste, looking at something that's core to us, because it is landfill assets, but it's also in a place that we wouldn't normally be otherwise, if we weren't in an energy space, we're not going to be out in the middle of West Texas, if we weren't doing this for energy purposes. So I think with respect to the latter, that's why we really had to buy that at well below our trading multiple, because it doesn't come with the synergies that a tuck-in comes with. But we feel good about that multiple. And then with respect to those tuck-ins, we always feel good about the fact that we buy those in multiple and then whittle them down to the tune of, you know, two, three, even four terms through synergy modernization.

Gotcha. And then just in terms of, are you thinking about cyclicality of this business differently, if things were to slow? I know 2009 volumes were down 10%. Nobody expected that. That was obviously a great recession. But how do you think about cyclicality of your business and defensive qualities if things do slow down?

Yeah, I mean, look, here's what I would say. We do think about it. We've talked a lot about what happens if the economy turns down. There have been a lot of chatter about that a bit earlier. It feels like that's tapered off a bit. We've said this, I think, many times, and that is that 2009, I mean, we all know there's a recession coming at some point. We just don't know when. And 2009 was a bit different than the normal recession because it was so driven by housing. And so our business really on the housing side has not returned to where it was in 2009. But when we look at the indicators that might lead us to believe that a recession is, you know, on the horizon, the best indicators for us are our volume numbers in our commercial collection business, our special waste business, which is a good indicator of the industrial economy, and our C&D volumes in our landfills. And really, all of those look strong right now. You know, we tend to be more of a lagging indicator than a leading indicator, but those tend to be somewhat leading. And all of those look strong right now. And that carries over into January. We looked at our volume numbers in January, and they were very strong on those measures as well. So we do focus on it. We want to make sure we're not caught off guard by a downturn in the economy, hence the real attention that we pay to efficiencies and cost control. But the good news is right now, we're not seeing that softening that's been talked about over the last few months.

And from a defensive nature, Hamza, I mean, it's a very good point. Anytime it's made about our business, there's a great deal of discipline in the industry today that, you know, I think last time around, maybe we weren't all as good at. So we can certainly flex down our capital expenditures. You've seen us flex our SDNA costs, and we would be well-positioned to do those things if we saw some softness in the volume environment going forward.

Great. Just a follow-up question, and I'll turn it over. On customer churn, could you remind us how you're calculating churn? Is it on a dollar basis? Is it something different? And then is there any more room to improve that for the fix?

I think there is room, John. That's what I was going to say. We're doing that on a customer. We look at it both ways, Hamza, what's reported there is on the customer account. Yeah, I mean, we've talked about how much of that is structural, but I think as you're seeing year over year, even in the growth environment, one of the ways we're getting that growth and that growth is that we've improved service, and you're seeing in our churn rate, which has come down year over year and quarter over quarter. And I'd say your last point there, Hamza, I still think we have some opportunity. You've asked the question, and rightly so, over the last few quarters, and I still think we have some opportunity. Now, we were really happy with the improvement we made, and we finished at 8.6 percent, but look, I think we can get down below 8 percent. And then where we go from there is more aspirational, but I think structural, I think the business can certainly be below 8 percent.

Great, thank you.

The next question is from Tyler Brown with Raymond James.

Hey, good morning. Hey, Davina, a couple modeling questions, but what are your expectations for total revenue growth in 19? So basically, what I'm driving at is what is your assumption for the net benefit from M&A in 19? It looks like you had quite a bit of action at the end of the year, including maybe some divestitures.

Right, so both acquisition activity and divestiture activity were a little elevated for us in 2018. The net impact to revenue in the year was about $65 million to revenue. Rollover, we expect to be about the same, and then with incremental acquisitions, I would say that it's about a 1 percent increase in revenue. And if you add that to the 2 percent yield plus guide and about 2 percent volume, it'd be around the 5 percent mark.

Okay, and to be clear, is Petro waste in that guidance?

No, it's not specifically included in the guide.

Okay, that's helpful. Acquisition growth

in the $200 to $400 million range was included in the guide. So you can think about Petro being a piece of that puzzle potentially, but we're going to wait until after the first quarter to revisit the total M&A guide for the year beyond the $200 to $400 million.

Okay, that's helpful. And then I just want to make sure we all have it, but how big of a headwind in Q1 specifically will the CNG tax credit and recycling be in terms of EBITDA or EPS?

So the CNG tax credit was $28 million in operating expense benefit in Q1 of last year. It didn't show up in cash flow until the second quarter. From a recycling business perspective, we actually expect some upside from recycling, though with the softness and commodity prices we've discussed, it's hard to predict how much that will be.

Okay, okay, that's helpful. And then Jim, this is a bigger picture question, but it seems like the solid waste market is really affording maybe 4 to 5% organic growth. You're looking at call it 2 plus 2 and 19, which is obviously very healthy, but conceptually is 2 plus 2 a function of your -to-market strategy or is it a function of what the market is affording? I mean, obviously volumes require capital, they eat up airspace, etc. Maybe why not turn up the pricing dial and turn down the volume dial, particularly in an inflationary environment?

Yeah, so here's what I tell you about the 2 and 2 for a total of 4 here is that it's very similar to what we gave last year. In fact, I think it was 2 and 2 and 4% on core price. And it's not that different from what we gave in 17, although it's higher on volume. I think in 17 we kind of gave 4% core price, 2% yield and 1% volume. So it's pretty consistent with what we've been giving over the last couple of years. Obviously, when you look at our 2018 performance on those metrics, you might say, well, there's some upside. And we wouldn't disagree with you on that. But we don't want to get over our skis too much. There has been, as I mentioned earlier, there has been some conversation with respect to the macroeconomic climate that things might be softer. Again, we're not seeing that. But for guidance purposes, we wanted to be a bit cautious when we gave our guidance on top line. But we do recognize that that could be a bit of a sign there. Ty, this is John. I think the one area that we've talked about, we're going to continue to talk about, focus is the post-collection pricing. Both landfill and transfer station, you've heard us all talk about some of the pressures we're seeing from our third party transporters and all the pressure on the network to be able to move volumes. I think if you look at the results, you're going to see that our focus on the core price side and the transfer and landfill piece is improved. But as Jim mentioned, I think that's still an opportunity there, particularly as we see the volumes improvement and we're trying to mitigate some of these cost pressures that we're facing.

And Tyler, I would add that I really don't think for us in this environment, we view price and volume at all as a tradeoff. We see the incremental volumes that we're achieving in the marketplace providing better flow through than our existing business and that's important. And so as long as we continue to see EBITDA margin on incremental volume exceed our existing margins and we can control the capital at a reasonable level and see return on invested capital grow at the same time, we're going to continue to see volume growth as a good addition to the price discipline that we bring to the market.

Okay, that's helpful. Maybe lastly, Daveen, if I walk down the EBITDA to free cash flow waterfall, so I start with EBITDA, addins.com, maybe take out closure post closure, cash interest, cash taxes, all the capex, it still feels like you need a little bit of a working capital benefit to get the free cash flow guidance. Am I right there?

We're expecting about a little bit of a repeat of the working capital benefit that we saw in 2018 and the year ahead. But other than that, yeah, I think we have it exactly right. The one thing that I would say is we have a $75 million, I think I mentioned in my prepared remarks, that we had a tax planning benefit in 2018 that won't repeat. So that does provide a little bit of a headwind if you look at the interest in tax piece of the equation in 2019, but that is included in our guidance. So that emphasizes your point on working capital. We expect to see some value there.

Okay, great. Thank you very much.

The next question is from Noah Kay with Oppenheimer.

Hi, good morning all. Thanks for taking my call. So, you know, the volume guidance of 2%, as you said, that doesn't contemplate or include the fires. And obviously, you're coming off the top comp year over year, including some large, you know, new contracts that you talked about. Any large new contracts or items that you would call out as drivers for the volume growth this year?

No, I think this is John Noah. I think the one that we spoke about, which we were just about anniversary, is the City of Los Angeles. Obviously, that was a big implementation for us and drove a lot of the puts and takes in our volume last year. But outside of that, there's not one that I would call out. You know, John, where we may see a little bit of impact positively in 2019 with respect to the City of Los Angeles was the startup cost side. So while the top line may not show much due to the anniversary, we did see some startup costs that really persisted through a big part of last year. And that should start to mitigate. We should start to lack that.

Understood. Thanks. And then I guess I want to follow up on the EBITDA margin on new volumes exceeding additional volume. I guess when we look at the revenue guide and EBITDA guide, if we're doing our math right, it kind of assumes flatish EBITDA margins year over year. So I guess the question is, should we be seeing higher operating leverage at this point? You know, is there anything you can do to get margin expansion in 2019, considering that we don't have the recycling headwind? And it is, you know, a very healthy environment for growth.

Yeah, I think it's a great point, Noah. And when we look at the guidance for 2019, what I think is important to point out is that we do expect solid waste margins to improve by about 50 basis points. And in 2018, we saw the same results. They were just muddied up a little by the impact of the hourly bonus, as well as the recycling line of business that you mentioned. And so when we strip away all of that, we generated 50 basis points of solid waste margin expansion in 2018. We expect to be the same in 2019. Where you're going to have an offset on the EBITDA line is the incremental S&A dollars that we expect to invest in technology and people. And so the solid waste business is performing exceptionally well, and we're getting the right leverage out of that incremental volume.

Noah, it's John, I would probably revisit or add to that, one area we're clearly focused on that has a lot to do with the cost pressures and transportation pressures that I mentioned earlier is on landfill and post collection pricing and making sure that we're recognizing all the pressures that we're seeing through the transfer and landfill network to make sure that we're overcoming those cost pressures.

And perhaps a finer point as well that worth mentioning is we actually are seeing increases in our recycling volumes. A lot of increased recycling volumes are in our brokerage business. And so that does mute the margin expansion of the overall business a little as well.

Right. So that shift to brokerage is, as you said in the past, it's about a 5% EBITDA margin business. So that's been having an impact as well. All right. That's a very helpful color. Thank you.

The next question is from Sean Eastman with KeyBank Capital Markets.

Good morning, everyone. Thanks for taking my questions. I know it's tough on the recycling to give a number on the anticipated tailwind for 19, but perhaps, you know, just assuming stable underlying commodity price environment, I'm trying to get a sense for what portion of the benefit is coming from the contamination fees relative to the operating costs. And maybe if you can provide some context on, you know, how far through the portfolio you guys have worked through on the contamination fees and perhaps on a percentage basis how much those operating costs have come down over the last year or so.

So let me start. This is John. Let me start with kind of the, we've kind of broken out this contamination fees in a couple of different buckets. One is municipal contracts, obviously, which I mentioned, and I would tell you we're hitting innings on there. As you might imagine, the contract cycle is longer there, so we're working our way through that. So that's where we expect to see the upside going into 19 and beyond. The first two phases were a little bit easier, if you will, to execute on, although the buckets weren't quite as big, which is making sure that our own internal customers, commercial customers, are giving us the material that we expect. And then lastly is making sure that when the material hits the floor that the contamination levels are not above what we can otherwise process. So there's three buckets around that. I mentioned earlier our OpEx from a MERF standpoint kind of peaked in Q2, which probably shouldn't come as a surprise to anyone because there was obviously a lot of volatility in the market at that point. And off the top of my head, we've probably come down about four or five percent in operating costs per ton since then. But if you look at Q3 and Q4, we've kind of stabilized revenues and we've continued to make improvements in the overall MERF performance at the recycling plant, suggest that what we're doing around contamination is driving a big piece of that improvement. And Sean, I think the original number we gave in terms of tailwind was 40 or 50 millionish, something like that. And we always qualified it by saying that assumes flat commodity prices from where they were. They have come down a bit, so they've softened a bit more. And that's why we're a bit hesitant to give a number. But I mean, suffice it to say it's going to be somewhere between it's going to be a tailwind. We just know exactly what it's going to be. If it flattens from here, if it said, all right, we're going to stay where we are now. We haven't, I don't know that we know the number, but I think it's probably in the 20 to 30 million dollar range would be my guess. But then again, I'm not sure it flattens here. It may return back up to where it was a couple of months ago. So that's why we're a little uncertain about it. But the number that we gave originally, assuming flat commodity pricing back at the end of the third quarter was 40 to 50 million. And if it does return to that, I think you'll see us kind of in that range with the things that John mentioned as well. Continue to work on kind of that phase three of contamination fees with the municipalities and then also an added focus on operating costs. Sean, this is probably the toughest quarter to call just because this is generally a volatile market from a commodity standpoint with what's generally going on overseas.

Makes sense. It's helpful. And the second question I have is, you know, you guys are talking a lot about technology. It's those investments are having a, you know, a visible impact on the SG&A line this year. You guys did mention a few initiatives, but I just want to make sure I understand exactly what the big technology goals are in terms of implementation for this year relative to those investments flowing through SG&A. You know, and whether there's some core sort of KPIs you guys are targeting or some sort of payback period on those investments. Just want to understand those dynamics.

Right. Yeah, so certainly Nick and his team are looking at, you know, once we make an investment in a, whether it's a customer facing technology, whether it is, you know, really a use of data and analytics, they do have a very prescriptive scoreboard, if you will, and they're looking to see what kind of returns we get for those. So we've recently rolled out a tool for our open market residential customers and it's showing really, really promising results. And so the payback on it is, we think, is very short. But it's, you know, open market residential was not a huge business for us. The big question will be what happens when we roll out a customer facing technology for one of our bigger lines of business like commercial? We wanted to, you know, walk before we ran and so that's why we chose to go with OMR first. It is very promising in terms of the results that it's generating. Once we move to some of our bigger lines of business such as commercial or roll-off, we expect that those will also have short paybacks on them, but we're in the process of kind of building those out right now. And then the use of data and analytics, largely for John's purposes right now. I mean, as you think about, he's talking about maintenance costs and how we use data and analytics to really help us with things like predictive maintenance. We're doing some pilots on that and those we think will definitely bear some fruit. And we do have a metric that we're using to gauge that.

Super helpful. I really appreciate your time, guys. Thank you.

Thank you. The next question is from Michael Hoffman with CFO.

Hey, thank you. Jim, you sound like you have a cold too. Oh, man, I

feel good.

Javina, am I correct? We're talking about $100 million is what the SG&A swing is for investing in Nikolai's projects.

That's about right, yes.

And just to follow up on the last one, so typical three-year payback is the way to think about that at mid-teens, unlevered IRR, that's the way to think about the sort of leverage on that?

Yeah, that's a great way to think about it.

Okay. And then on free cash flow, I get, you know, you sell things periodically, that's the swing in the numbers. If I strip that out of the last three years and I look at the sustainable growth between them, like 17 to 18, you're up 12 percent, but 18 to 19, you're up sort of mid-fives. Is it appropriate for me to sort of smooth those two numbers and say, you know, we can talk about a 6 to 8 percent sustainable free cash flow growth rate under the current business climate?

That's where we are, yeah. We definitely are happy that if you normalize 17 to 18 for taxes and interest and the proceeds from divestiture and do the same for 18 to 19, we're in about a 7 percent annual growth environment.

I think, Michael, you know, one of the questions that you've all had of us is, how is this, you know, your EBITDA, which is really the long pole in the tin, right? I mean, how is that converting to cash? How is it converting to free cash flow? And if we look at, you know, 17, 18, 19, 19, of course, as our guides, people look at that, we're pleased, very pleased with that. I mean, 17 was 42 to 18 if you strip out, you know, some of those one-time tax planning and normalize the divestiture. I mean, we're always going to have some divestitures in there, so I'm not saying take it out completely, but more of 100 million divestitures than the big year that we had this year. If you normalize 18, 45.1, and then when you look at our guidance for 19, 46.3. So somewhere between 90 to 120 basis points of annual growth and that conversion ratio, and by the way, remember, it wasn't too long ago that we're, that number started with a three and it was really the mid threes. So we're now on a path to something that starts with a five. We're really pleased with that conversion from EBITDA to, which is 5% last year, 5%ish this year, to cash.

Okay, excellent. That helps. And then to do this waterfall bridge differently on your EBITDA, 4216, midpoint 4425, that's 209, but I got to factor in there, there's 100 million of SG&A. So the solid waste and recycling is really up 300 something is the way to think about that.

That's exactly right.

Well, and that's why, Michael, we, you know, it's pretty easy to kind of say, hey, you know, and nobody has actually this morning, but it's easy to say, well, what about your, you know, your bonus? You know, why not add that? Or why not add your recycling? That's it. And there is, we all know there's a lot of puts and takes in the EBITDA number. And, you know, the, what we're really focused on is the big number itself, which is, you know, grew 5% last year, and will grow another 5% this year. That was two times the economy last year, two times GDP last year, and it couldn't be as much as two and a half times. So, so we're very pleased with the EBITDA growth, which in our minds is, that is the best indicator of the health of the business.

Right. And to that last bit, Davina, what's the number for 2018, when you talk about the solid waste business, so that when you make that statement, the solid waste business, what is that revenue number?

The revenue number? We'll have to get that to you, Michael. And we've got good information in the tables, but we'll clarify how we're thinking about that. But when we looked at the solid waste business in 2018, relative to 2017, we saw over $300 million of EBITDA growth in that business, which makes sense, because the $210 million of EBITDA growth that we talked about had that $90 million of headwind from the recycling line of business. It was really a stellar performance.

Okay. That's part of what I was trying to get at, but I also, it's hard for people to see the margin expansion in that business, given the way the data is provided, so maybe a little clarity on that would help.

Okay. We'll take that under consideration.

And then one last thing for you, Jim. I'm assuming these renewable energy projects, you know, as you experienced in CNG credits, come and they go. So they're good return on capital, not counting on the RINS are there forever.

Yeah, that's right. Yeah. I mean, look, the RINS are, you know, there is some volatility to those RINS, but we feel like they're really good investments for us, and so that's our interest in them. And they're made available to us because of the, not only our landfill gas, but also this CNG conversion that we're making over a period of years. Got it. Thank you so much. You're welcome. Thank

you. Feel better. The final question is from Jeff Silver with BMO.

Hey, guys. Morning. It's Henry Chen calling for Jeff. Good morning, Andrew. Hey, good morning. I wanted to ask about the volume guidance for 2019. Just in relation to some of the comments, that sounds like there's a little bit more skewed to commercial and C&D. I'm just curious, how are you thinking about the sort of sensitivity of that number and volume growth to different parts of the economy? So I just, you know, thinking if housing starts continuing to get weaker or stronger or any other, or the industrial economy and so forth, is there any kind of changes in the sensitivity of that volume as you look forward to this year?

Yeah, Henry, I think Davina mentioned it earlier. I think when you look at our special waste pipelines and our C&D pipelines, we obviously had a strong 2018, and we still see health in those pipelines. I think Jim and Davina both commented on the commercial line of business. We, you know, service increases versus decreases is certainly a good barometer along with our other sales activity. And while we're kind of looking out at the horizon to make sure we're not missing something, the short-term outlook is still strong. In fact, as Davina mentioned, the service increase and decrease ratio has actually improved as the year goes on. So we have not seen softening in those buckets as of yet.

And we certainly take into consideration, you know, a lot of attention in our business is paid to housing starts and new business formation. And so those two data points are important to us. We're a lot less directly tied to housing than we were with the last downturn. And that's valuable for us in thinking about the confidence we have in achieving that 2% volume growth in the year.

I would also add, Henry, when you look at, you know, we look at the tables in the back on the MSW volume, if you net out some of the one-time things, we really look at that as being about a .5% to .7% increase in volume when you kind of normalize it for some one-time issues. So all our volume fronts look pretty consistent and strong as we sit here.

Got it. Okay. That's very helpful. Thanks so much.

Are there no further questions? At this time, I would like to turn the conference back over to management for any closing comments.

Great. Thank you. So to conclude, first, I do understand that Ron Middlestadt was not on his call this morning due to a family emergency. And Ron's a friend of mine. And I just want to say to Ron that we're thinking about him. He is definitely in our thoughts and prayers this morning. Regarding the business, the last few years, and we've talked about it this morning, with the last few years and our expectations for this year, really demonstrate our consistency in managing our business. And we're producing what we consider the excellent growth in all of our financial and operational metrics and very solid returns to shareholders. And I could not be more proud of this team for doing that. Thank you all for joining us this morning. And we will talk to you next quarter.