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Republic Services Inc
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Good afternoon and welcome to the Republic Services Third Quarter 2018 Investor Conference Call. Republic Services is traded on the New York Stock Exchange under the symbol RSG. All participants in today's call will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.
I would now like to turn the conference over to Nicole Giandinoto, Senior Vice President of Investor Relations and Treasurer. Please go ahead.
Good afternoon and thank you for joining us. I would like to welcome everyone to Republic Services third quarter 2018 conference call. Don Slager, our President and 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 the actual results to differ materially from expectations. The material 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 October 25, 2018.
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.
Also included in our press release are Unaudited Supplemental Schedules that include a pro forma view of third quarter 2017 revenue and cost, had we adopted the new revenue recognition standard as of January 1, 2017. During today's call, all references to changes versus the prior year are based on the 2017 pro forma figures, which are comparable to the 2018 results.
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, Nicole. Good afternoon, everyone, and thank you for joining us. We are very pleased with our strong third quarter results. The team sustained the momentum built in the first half of the year by capitalizing on strong solid waste trends to drive both price and underlying volume growth, advancing our multi-year initiatives to provide an improved customer experience, in addition to safer and more efficient operations, and executing our plans to mitigate recycling headwinds in the short-term and advance our long-term strategy to transform our recycling business.
As a result, in the third quarter, we delivered double-digit growth in both earnings and free cash flow per share, despite an $0.08 headwind from recycling, invested an additional $53 million in value-enhancing acquisitions, bringing our year-to-date total investment to $133 million, and returned approximately $200 million to shareholders through dividends and share repurchases.
During the quarter, we continued to see solid revenue and EBITDA growth in our collection and disposal businesses, as well as energy services. Together, they contributed 80 basis points of margin expansion. The pricing environment continued to be favorable in the third quarter. Core price was 3.9% and increased 30 basis points from the second quarter.
In the open market, core price increased 20 basis points sequentially to 4.6%. In the restricted market, core price increased 50 basis points sequentially to 2.8%. This is the highest restricted core price we've achieved in nearly 10 years.
Improving the customer experience continues to be a critical part of our overall business strategy. We achieve this by developing and offering products that are designed to meet our customers' wants and needs and delivering superior service. Doing so helps us retain our customers for a longer period of time and earn a price increase each year.
In turn, we successfully raised prices while maintaining our customer defection rate below 7% for a third consecutive quarter.
Additionally, we continue to convert our CPI-based contracts to an alternative pricing mechanism. We now have 25% of our CPI-based contracts representing $625 million, transitioned to a waste-related index or fixed rate increase of 3% or greater for the annual price adjustment. These waste indices are more closely aligned with our cost structure and continue to run higher than CPI.
We also continued to see strong underlying volume growth in our collection and disposal businesses in the third quarter. Excluding the impact of non-regrettable losses and a difficult special waste comp, total volume increased 1% over the prior year. We believe the current economic backdrop, including solid consumer sentiment readings, supports continued top-line growth.
Next, our energy service business continues to perform well. In the third quarter, total energy services revenues increased 30% over the prior year. Our recycling business also improved in the third quarter. We successfully increased prices and reduced our operating cost by 3.5% sequentially.
As we expected, current market conditions are serving as a catalyst to transform our recycling business into a more durable, economically sustainable business, one where companies can continue to invest for the benefit of their communities without undue risk.
Our team has been working diligently to execute our short-term plans to mitigate recycling headwinds, as well as advance our longer-term plans to transform our recycling business.
In the open market, we continue to see new recycling service at 90% to 100% of the price of solid waste, demonstrating our customers' willingness to pay. We rolled out a recycling processing fee to our recycling collection customers to cover higher processing costs. And this fee contributed 25 basis points to total revenue growth.
In the restricted market, we successfully negotiated price increases with a portion of our municipal processing customers, with an annualized benefit of $6 million. These will go into effect in the fourth quarter.
We also continued to secure immediate price increases from many of our municipal collection customers. These price increases contributed approximately 10 basis points to average yield. Additionally, we transitioned some of our municipal collection customers to a new pricing model, including multiple municipalities in Texas, Illinois and Iowa.
Finally, we continued to leverage technology to increase productivity, reduce costs and improve the quality of material recovered at our processing centers. As a result, we sequentially improved our year-over-year cost headwinds by $0.01.
I'm extremely pleased with the results our team has been able to deliver thus far. Although it will take time, with help from our customers and consumers, we can ensure recycling is sustainable for generations to come.
Turning to our full-year 2018 guidance. On the second quarter earnings call, we advised that we expected to be at the lower end of our EPS and free cash flow guidance ranges. Given the strength of the business, we now expect EPS to be near the midpoint of the guidance range and free cash flow to be near the upper end of the guidance range, despite a recycling headwind of approximately $0.30 versus the prior year.
With that, I'll now turn the call over to Chuck to discuss our third quarter financial results in greater detail. Chuck?
Thanks, Don. Third quarter revenue was approximately $2.6 billion, an increase of $102 million or 4.1% over the prior year. The increase in revenue includes internal growth of 2.2% and acquisitions of 1.9%.
The components of internal growth are as follows. First, average yield increased 2.4% and was in line with our expectations. Average yield in the collection business was 2.8%, which includes 3% in the small container business, 3% in the large container business and 2.3% in the residential business.
Average yield in the post collection business was 1.7%, which includes landfill MSW of 2.2%. The majority of our third-party landfill MSW business is with municipal customers that have contracts containing pricing restrictions.
Total core price, which measures price increases less rollbacks, was 3.9% and increased 30 basis points from the second quarter. Core price in the open market was 4.6% and core price in the restricted portion of our business was 2.8%.
The second component of internal growth is total volume, which decreased 10 basis points over the prior year. Volume in our large container business increased 60 basis points and volume in the small container business decreased 30 basis points.
Small container volume included a 90-basis-point impact from intentionally shedding certain work performed on behalf of brokers, which we view as non-regrettable. Excluding these losses, small container volume would have increased 60 basis points.
Volume in our residential business decreased 2.9%. The decrease was expected based upon our strategic decision not to renew certain contracts that fell below our return criteria. The post collection business made up of third-party landfill and transportation volume increased 2.4%. Landfill volume increased 2.3%.
Growth in MSW and special waste volume was partially offset by an anticipated decrease in C&D volume. More specifically, landfill MSW volume increased 3%. Landfill special waste volume increased 3.9%, despite a difficult comp in the prior year. C&D volume decreased 60 basis points versus the prior year due to a difficult comp. In the prior year, C&D volume increased substantially due to hurricane-related clean-up efforts in the South.
The third component of internal growth is fuel recovery fees, which increased 80 basis points. The increase relates to a rise in the cost of fuel. The average price per gallon of diesel fuel increased to $3.24 in the third quarter from $2.63 in the prior year, an increase of 23%. The current average diesel price is up $0.14 from September levels.
The next component, energy services revenue, increased 10 basis points. This is primarily due to an increase in drilling activity in the Permian Basin where we continue to be well-positioned.
The final component of internal growth is recycling, processing and commodity revenue, which decreased 1%. The decrease in revenue primarily relates to a decrease in the number of tons sold and lower recycle commodity prices, which was partially offset by the new recycling processing fee rolled out to our recycling collection customers to cover higher processing costs.
The recycling processing fee contributed an incremental 25 basis points of pricing. It's important to note that our average yield of 2.4% does not include the 25-basis-point benefit from the recycling processing fee.
Excluding glass/organics, average commodity prices decreased 37% to $106 per ton in the third quarter, down from $167 per ton in the prior year. In the fourth quarter, we expect the headwind from lower recycle commodity prices to decrease as the prior-year comp becomes easier.
Next I will discuss changes in margin. In the third quarter, adjusted EBITDA margin decreased 70 basis points to 28.4% from 29.1% in the prior year. This included 80 basis points of expansion from the solid waste business, including collection, disposal and energy services, which was more than offset by a 150-basis-point headwind from recycling.
Keep in mind, following 28 quarters of low CPI, we are now just beginning to see the margin benefit from higher CPI in conversions to the water, sewer, trash index.
In the third quarter, SG&A expense as a percentage of revenue was 10.2%. For the full year, we expect SG&A as a percentage of revenue to be approximately 10.4%.
Third quarter 2018 interest expense was $95 million, which included $10 million of non-cash amortization. Keep in mind, 17% of our debt portfolio has a variable interest rate. Therefore every 100-basis-point increase in variable rates will increase annual interest expense by approximately $15 million.
Our all-in adjusted effective tax rate in the third quarter was 23.6% and in line with our expectations. In the fourth quarter, we expect our all-in effective tax rate to be approximately 23.5%. Third quarter adjusted EPS was $0.82, an increase of $0.15 or 22% over the prior year. EPS included a $0.12 benefit from tax reform, which was partially offset by an $0.08 headwind from recycling.
Adjusted free cash flow through the first three quarters was $968 million, an increase of 60% versus the prior year. The growth in free cash flow was due to an increase in EBITDA, lower cash taxes primarily due to tax reform, and the timing of tax payments. During the quarter, we returned $203 million of cash to our shareholders through dividends and share repurchases.
Now, I'll turn the call back over to Don to discuss our preliminary outlook for 2019.
Thank you, Chuck. Given the predictability and consistency of our business, similar to prior years, we are providing a preliminary outlook for next year. We are currently midway through our annual planning process. Based on our initial reviews and assuming current business and economic conditions continue, we project the following for 2019: Adjusted EPS of $3.23 to $3.28 and adjusted free cash flow of $1.125 billion to $1.175 billion. This represents mid- to high-single-digit growth in EPS and free cash flow per share despite rising interest rate environment.
Also contemplated in our outlook is a tax rate headwind of approximately $0.16 and an incremental $50 million capital investment of tax reform savings back into the business for the benefit of our front-line employees. Excluding the impact of taxes and tax reinvestment, our outlook includes double-digit growth in both earnings and free cash flow per share.
We will achieve these results in 2019 by securing price increases in excess of our cost inflation, growing volume for the seventh straight year, executing on our profitable growth through differentiation strategy to enhance the customer experience and drive additional operating leverage in the business; continuing to transition our municipal recycling customers to a more durable fee-based pricing model, including a fee that fully acknowledges the cost to collect and process the material with a more equitable risk sharing arrangement; effectively deploying capital to fund profitable organic growth and value-enhancing acquisitions; and consistently and efficiently returning cash to our shareholders through dividends and share repurchases. Similar to prior years, we will provide detailed financial guidance for 2019 in February of next year.
In summary, our 2018 performance, along with a favorable economic backdrop, position us well for continued growth in 2019. Next year, as we anniversary the headwinds from recycling, we expect our results to demonstrate the strength and operating leverage of our business. This includes strong top-line growth, 30 basis points to 50 basis points of EBITDA margin expansion, and double-digit growth in EPS and free cash flow per share.
At this time, operator, I would like to open the call to questions.
Thank you, Mr. Slager. The first question will come from Tyler Brown of Raymond James. Please go ahead.
Hey. Good afternoon.
Hey, Tyler.
Hi, Tyler.
Hey. Yeah, nice quarter. So I appreciate the early look into 2019. You mentioned the 30 basis points to 50 basis points of margin expansion next year. That's very solid. But I am a little curious about how we get there. So, first, is there any assumption of a margin benefit from, say, recycling, be it a processing fee or commodities?
And then, given what's going on the unit cost inflation side of the equation, what kind of average yield do you think you need to achieve to overcome that heightened inflation? I mean, do you need north of a 3% yield to get there?
What an ironic question that was, Tyler. So, look, let me start with a really strong performance here as we end the year, right? So we're really happy with the quarter. Again, the underlying fundamentals of the business of strong volume/price, and we pulled through some of the highest prices we've seen in years, right? So, that price is going to continue and build and we'll have certain things that start to anniversary in our favour.
We're already having impact from our efforts to change the recycling model here in this year and we'll have more impact in Q4. Those will start to come to bear throughout the year. And again, we have 1,100 contracts we talk to, municipal contracts. We've already converted quite a few of them to a new model. We are still talking to over 40% of them today is to move in that direction. So there's a lot of that good happening.
As far as the commodity value, we have that flat into next year, right? So, if that comes back, we sort of get the automatic benefit. You've heard me say before, I hope it doesn't come back. I hope it just stays right where it is, because that's how we'll fix this recycling model.
And we don't want any of our people sort of getting weak in the knees. We need to push through to a new model that gives us predictable consistent returns in that business and then shares the upside with customers, if they do a good job and a responsible job with the contamination. So we're going to continue to push that.
We're getting benefit in maintenance. We're getting benefit in some of the labor activity. We've got a lot of good things happening underlying the business that are starting to now show up, and that's how we get the margin expansion. It's just good old-fashioned blocking, tackling. Pricing continued to be strong, and a good economic backdrop in solid waste.
Okay. And then maybe coming back a little bit to the pricing. So I know next year the CPI look-back is going to benefit 2019 mathematically. But I'm just curious if you can talk about how quickly you can push through on the open market side, maybe talk about how Capture plays a role in that? And maybe how quickly you can pivot in the open market side?
As it relates to recycling or just solid waste?
Just solid waste pricing
Well, again, Capture is the tool we use to really, one, make our sales team more efficient, make the selling experience better for customers, but also keep some level of centralized control over the process. So Capture is a real-time tool.
So as we see the opportunity and the pricing flexibility, markets change, we're able to really act quickly with the pricing that we move into the marketplace. And of course, when we price our open market customers, we use this RPM process, where we're only pricing a segment of the customers per month. So we've got the ability to kind of accelerate/decelerate depending on what we're seeing in the market.
So that's the tool we use. And again, if you look at the pricing that we're getting now, I think it was on the last call you asked me some similar question. Don, are you going to need pricing that looks more like 3% to start to offset some of the inflationary pressures that we're seeing in, for instance, long-haul trucking or leachate? And my answer to you was, yes, we're going to have to move pricing north from where it is today.
And you can see now just in the last few months, our efforts, moving pricing in the right direction sequentially. So we're going to continue, as I said in my comments, to get pricing over normal inflation costs, net of productivity. And we're prepared to do that. Our people are good at it. We've got the systems in place to do it. And we're confident we can do that with the good economic backdrop we have.
Okay. Good. I'll turn it over. Good stuff. Thank you.
The next question will be from Hamzah Mazari of Macquarie Capital. Please go ahead.
Good afternoon. My first question is just around how you guys think about your U.S. housing exposure versus others in the sector. It feels like legacy Republic had more exposure because of Sunbelt states. But then you also have a slide in your deck that others do not, signifying sort of a correlation to single-family housing starts. So do you guys have more exposure? Or is that just a coincidence that you guys talk about it more?
Well, I'll let Chuck give you some numbers on this. But I think we had a lot of exposure when the bubble burst, because of the overcapacity that was built out in places like Florida and Arizona and Las Vegas. And those are markets that we're very dense in. Of course, we don't have that problem today. Frankly, today there's more sort of a supply shortage.
Yeah.
Right? So we're on the other end of it. So I still think this steady growth in housing is still good for the business. I'd much prefer sort of a steady improvement than a sudden improvement.
And if the market continues to move toward the all-time average of 1.5 million [housing starts], even the 1.4 million, we're sub that today. So I think we're well positioned and right in the way of the growth. And so the growth will come to us. As far as having more than anybody else, I don't know that that's true.
Yeah. I don't think that that's true either. When we talk about housing starts, we're really talking about that as a proxy for consumer sentiment, how the consumers really feel about the economy. The consumers are really the ones that drive GDP. They're really the ones that drive the growth in the business.
So we look at housing right now, it's still strong, it's 1.2 million units and that's up 6.6% over the prior year. So we still see good growth in housing. Even if it stays kind of at 1.2 million or creeps up a little bit from there, that still tells us that the consumer feels very good about the economy. And if they feel good about the economy, they're going to spend more money and that's going to generate waste, which is good for us.
And remember, Hamzah, we lag these changes, right? So if there's something moving there that is of any sort of material impact to the business, I think we'll see it coming a long way off.
Right. Makes sense. And my follow-up question is just around how to think about M&A as you look into 2019. You talked about $200 million this year. It feels like the last time you did below $100 million was in 2016. So, just maybe walk us through, is $200 million the right number to look at in 2019? And is that just solid waste or are you looking at energy as well? Thank you.
Well, thanks. Well, look, I think overall I would tell you that the pipeline is robust. We're not giving exact guidance on M&A for next year, but I think you could say it's certainly going to be north of $150 million in 2019 based on what we know today. That that pipeline builds over time. So we've got a good group of people that wake up every day and think about this. We've got a number of interesting acquisition candidates in the pipeline today. So we'll see good progress continue. And again, the good news is we're still paying a reasonable amount for these deals on a multiple basis post synergy. So I think we'll see a continued benefit from acquisitions still and well into 2019.
Great. Thank you.
The next question will be from Brian Maguire of Goldman Sachs. Please go ahead.
Hi. Good afternoon.
Hi, Brian.
Hi, Brian.
Thanks for the yearly color on 2019 guidance. Just to try and tease out a little bit some of the components, I know it's still early, but the 30 basis points to 50 basis points of margin expansion, I just wanted to make sure I have the right starting point. I think you were previously talking about a 28.0% for 2018. Is that still what you're looking for? And so we should think about it being like a 28.3%, a 28.5% next year, is that right?
That's right, Brian.
You're right.
That's right.
Okay. So, just want to make sure I have the right starting point there. Yeah. And then based on your comments around the tax impact next year and assuming even if acquisitions contribute only half the growth that they did this year, it seems to imply yield price plus volumes are maybe up 3%. My math might be off a little bit, but seems like somewhere in that ballpark.
It seems still lower than what others are talking about. We have one guy talking about 3% plus 3% this morning. Others are doing more like 2% plus 2% in this environment. Just wondering if you think about 2019, we're talking about price maybe having to get almost up to 3% just to offset inflation. Does that leave us much for volume growth? And if not, is there anything you guys are looking at in the 2019 that would cause you to think we're not going to see a pickup in volume growth?
Well, all right. Well, look, we're not giving a detailed guidance for 2019. We've given our preliminary outlook. Again, based on what we're seeing in the business today, again, strong economic backdrop, we still think there's room to run here, good execution in our initiatives, already good progress in restructuring and revamping this recycling business, really strong pricing, strongest in years.
As Chuck said, we're starting now see the benefit of the compounding benefit of rolling over with the new alternative index starting to take place. Higher CPI, we think that continues to fuel progress into 2019. Remember, when it comes to volume, we've got a little bit of our business to shed still with the brokered business. We're not afraid to walk away from bad contracts with municipalities. So we talked about non-regrettable losses, so that'll still be part of our 2019 story, right?
But, again, we're starting from a strong position here in ending Q3 and already in Q4. So I gave you a lot of color, but we think the volume and the pricing traction that we're seeing will continue into 2019.
Okay. Yeah. I think that broker component continuing is probably what I was missing initially, but that makes sense. Okay. I appreciate it. Thanks.
Yeah. And I would just add, we're talking about the 28% margin here in 2018. If not for this recycling headwind, we'd be at 29.5% for 2018, okay? So we would have been sort of a stone's throw from that 30% goal we set for ourselves. And then our friends in China can then kind of put us back on our heels a little bit. But we're standing up and we're going right back at it again and all these things we've got, they're making progress for us in 2018, they're going to bode well for us in 2019. We're going to march right back to a better margin.
Thank you. The next question will come from Noah Kaye of Oppenheimer. Please go ahead.
Hey. Good afternoon. Appreciate you calling out the 25 bps revenue growth from recycling processing fees. You're clearly making a lot of progress there. So, first, can you remind us of the magnitude of the EBITDA impact you're expecting from recycling this fiscal year and what kind of tailwind you might be able to generate in the recycling line of business in 2019 as a result of these initiatives?
Yeah. So what we're expecting this year is 140 basis points of compression from recycling in 2018. And obviously, we'll get a little bit of a benefit associated with the actions that we've already put into place in Q3.
So, if we just talk about the annual value of the Q3 actions, it's about $40 million, that's the annual value. So, about $20 million of a rollover benefit in 2019. And I need to point out that that doesn't include any of the actions that we expect to be able to take here in Q4.
Great. Next, I think you mentioned a $0.16 tax rate headwind for next year. Does that imply the tax rate going back to 27% or 28%, what's the right number?
Yeah, going back to 27%.
Okay. Great. And then if I could just take one more crack at what I think a couple others have been trying to get at. It looks like you'll probably get 1%, maybe 1.5% growth from M&A next year. You're moving past the impacts of rev rec.
So, underlying volume growth in particular, I think a lot of people are focused on that. You're coming off of kind of an easy headline comp this year. So, any reason why underlying volume growth rate, you can't be in that 1% to 2% range?
Well, again, this is not guidance, right? But let's just talk about the predictability of the business, that's the hallmark of the business, right? Other than sort of these sort of anomalies like China's actions or things like that, or the housing bubble reaching 3 million units or whatever heck it did and bursting years ago, generally speaking, things do not always move pretty slow.
So, when you've got good traction and momentum, you've got the underlying fundamentals we have, they tend to sort of stay with you for a period of time. And as I said, I think it was to Hamzah, because we lag, we still sort of see these other big changes coming. So, think about that predictability. We also tell people, right, that the business grows with household formation, population growth, business formation. We see that continuing, right?
We also tell people that, look, on average the business can grow sort of through this cycle sort of 1.5% to 2% organic volume, right? Now we have some takeaways from that because we've got some business we're shedding in a non-regrettable way. So I didn't just give you guidance. I just gave you general backdrop of this business. Pricing, we generally are able to price ahead of inflation. Now we ran into a problem when CPI went away from us and now we're getting our grip back on that.
So, as I said in my comments, we're going to price ahead of inflation in 2019. So, that pricing historically has been 2.5% to, in some cases, 3%. Now that sort of varies a little bit by line of business, by market vertical. But those are sort of generalities that underscore the strength, the predictability in this business, and that's what we're seeing now.
We're seeing some of that CPI anomaly sort of going, again, in our rear-view mirror. We're making a great deal of headway in this China situation. And while it's just a lot of hard work, it's all stuff we know how to do and we're already getting the benefit. It's showing up in the numbers now and that's what gives you confidence into 2019.
Thanks very much for the color, Don. I appreciate it.
The next question will be from Jeff Silber of BMO Capital Markets. Please go ahead.
Thank you so much. I know there's been some discussion in the industry, and I know we heard from one of your competitors this morning about some increasing third-party costs, transportation-related, labor-related. Can you address that? I'm assuming that's something you're seeing. How you're able to push that through in terms of price increases to your customers?
Yeah. Sure. We are seeing some of that. Again, we generally don't handle our own waste transfer trucking. So we generally hire a third-party to move waste from our transfer stations to our landfills. The long-haul trucking companies are experiencing a great deal of cost increase and labor shortage and turnover. That's kind of coming into that space a little bit.
We're doing a much better job with our own drivers, with our own front-line workforce, because we've spent a lot of time trying to work on creating a great work environment, employee engagement and the rest of it.
But we are seeing that coming and we're building that into our cost inflation model. We're building that into our pricing assumptions. We're building that into our go-forward planning when it comes to renewing large contracts and so forth.
Okay. Great. And my follow-up question, I just want to confirm something I thought I heard you say. But if we take out the recycling headwinds that you've seen this year and just look at your core business, margins are up on a year-over-year basis. I know there's some noise in terms of the revenue recognition, but I just want to confirm that that's the case.
Yeah. Yeah. Margins would be up anywhere from 60 basis points to 80 basis points during the year. And obviously, that's being masked this year because of recycling. But when we guide to 30 basis points to 50 basis points EBITDA margin expansion, that's where you truly see how the solid waste piece of the business is growing.
Okay. Fantastic. Thanks so much.
The next question will be from Michael Feniger of Bank of America. Please go ahead.
Hey, guys. Yeah. Thanks for taking my question. I just want to ask a quick question on you had a nice jump in the restricted pricing, up 50 bps. When we kind of think about the open, I mean you're kind of at this 4.5% mark the last three quarters. Should we be thinking next year that's kind of the ceiling on the pricing gains in the open market? And where you're getting most of the leverage is really on that restricted because of the CPI? Is that kind of how to think about it? Is there like a limit on the pricing gains base that we're seeing in the open market right now?
Yeah. You could think about it that way. I mean, we're going to continue to explore price elasticity by market, by market vertical, whether it's large container, small container, what have you. We're going to continue to do that. Our tools allow us to do that, our people are really good at it.
We are, again, seeing the benefit now of the rolling over of moving restricted business to a more credible and appropriate index. That's certainly going to give us a lot of help as we go through time. And even though CPI is starting to look a little more like normal, we're not going to relax and go back to CPI.
We are moving forward to change contracts over time to water, sewer, trash or a fixed 3% or greater. That's still our model. That's still what we're aiming at. Just like I said, if China changes its tune, if recycling gets better, we're still going to continue to change the model to something that's durable. We're going to take this volatility out of the business.
So again, I'm not giving detailed pricing guidance by market vertical today. But again, the underlying strength, the results we're getting today, you can kind of model those into next year and get a pretty good handle on it I think.
Makes sense. And then on the internal cost inflation, we're kind of thinking about next year. I mean, I know the rule of thumb I believe used to be around 2.5% and then you guys would get 50 bps of productivity. I mean, how is that framework kind of changing into next year? And can you still get that 50 bps of productivity gains?
Yeah. So what we've said historically is cost inflation at about 2% to 2.25% and that's net of the productivity gains that you spoke of.
As we look now and then into 2019, we're thinking that costs are probably going to trend up closer to 2.5%. And once again, that's net of the productivity gains. And that's why getting the price increase that Don had talked about is so important. And that's what allows us to get the EBITDA margin expansion in 2019.
Right. We've always said, we can't offset normal inflation through productivity. There's just not that much sloppiness in our business. So while we get better every year across many different functions and capabilities, there's not so much sloppiness to overcome inflation. So we just have to adjust pricing to do that.
And when there are real broad-based legitimate things happening in labor or with trucking and those kind of things, we're able to go to customers and get it done. And our contracts, the markets allow us typically to do that.
And again, with CPI now being something that we're getting in our hand or at least when it's improving and we're changing the index, that can help us get that.
Great. Thanks.
The next question will be from Michael Hoffman of Stifel. Please go ahead.
Hi. Thank you for taking the questions. One housekeeping, what's the share count you're using for the per share guidance?
For 2018, Michael, or for 2019?
2019.
For 2019, we're going to have to get back to you on that, Michael, I don't have it in front of me.
Okay. And then, you really helped bring a little clarity to all of this hand-wringing around what the price environment is supposed to be next year. You're at 2.4%, 2.5% second half of this year. You're going to put pricing initiatives in the fourth quarter on an open market basis. CPI is trending at up 40 basis points this year. So it would be reasonable to think that I take the trend out of the second half of this year and it progressively gets better all year long and that's the way to think about it, right?
In 2019.
Yeah. The trend for 2019, yeah, that's right, Michael.
Yeah. Okay. And then...
Yeah. But we're never just sitting still, right? So there's always something happening in the market with our tools, with the way we're adjusting pricing, with our fees, with whatever, there's always something new happening that ultimately rolls into the pricing format, right? And the reality is that some of these inflationary costs are beyond our control that we have to overcome.
And then as you said, CPI, and every time we're successful in getting a new contract rolled over with a new index, every time we're successful convincing a new recycling customer to go to a fee-based structure, each one of those things just keeps rolling into the business, right, and ultimately moving that number up through time.
Okay. And then the volume question, everybody keeps wringing our hands about as well. When you shook away all the noise of regrettable losses and contracts you chose to walk away from, this year you had a positive volume that I would assume that's something in that 1.5%, 2-ish range.
Well, above 1%.
It was underlying...
Above 1%.
Above 1%.
And better next year.
Right. So, that's where I was going. Okay. That's all I needed. Thanks.
Thank you, Michael.
Hey, Michael. Just on your share question, what I would tell you is think about it in how we've always talked about it. We first invest in CapEx and M&A. And then from there, we return the remainder of the cash to our shareholders through dividends and share repurchase. So I would just kind of think through that as you're modeling it and we'll get more detailed guidance in February.
All right. Well, you tend to buy back 2% to 3%. So I was assuming I was going to just reduce the number on a rolling basis 2%.
Yeah. I think that's a good...
Yeah, that's fair. That's fair.
...starting point.
Okay.
The next question will be from Corey Greendale of First Analysis. Please go ahead.
Hey. Good afternoon. I think, Don, you've been pretty articulate about how you're thinking about pricing. But maybe just a little bit on landfill pricing, and I know a lot of that is locked up under long-term contracts, but just given – well, it sounds like a good environment overall. Do you expect any sort of inflecting on that in 2019 or thinking about that any differently?
Well, I should like to expect more landfill pricing, but here's the deal. Most of our landfill volume, besides all the volume that Republic brings to its own landfills, comes from municipalities. So, that restricted price is getting restricted generally to CPI, except for those contracts that we've begun to move to a different index.
The unrestricted volume looks more like a 3% to 4% price increase. So we're going to continue to move that up. I'm a little disappointed that it hasn't been able to move up faster. But as we've shared with you before, I mean we've been pretty straightforward on the cost of these landfills, the cost of leachate, the scarcity of the asset. And we continue to move pricing up and unfortunately that dislocated some volume to other landfills that have been willing to take on all that cost and liability for less than we are. So it's still something that I think over time has more room for upside. That's really not baked into our 2019 guide or 2019 preliminary outlook.
Got it. And my follow-up is I think hopefully pretty easy question which is just can you remind me the consolidation of the service centers, is that totally a 2018 cost benefit or is there some benefit in 2019? And just can you quantify what it is in 2018, if there isn't anything in 2019?
No we pretty much got it done, right? It's pretty much behind us.
Yeah. It's 2018.
Yeah.
So, just in terms of roughly what the benefit is in 2018 versus 2017?
Yeah. It's the SG&A improvement, that's the primary improvement year-over-year, so call it 20 basis points to 30 basis points.
Okay. Great. Thank you.
Thank you. And at this time, there appear to be no further questions. Mr. Slager, I'll turn the call back over to you for your closing remarks.
Well, thank you, Denise. In closing, I would like to thank all Republic employees for their hard work, commitment and dedication to operational excellence in creating the Republic Way. And you could all do me one favor and go to recyclingsimplified.com, so everyone can learn how to recycle responsibly. Tell all your friends to be friendly to the planet, it'll change your life. Thank you for spending time with us today. Have a good evening.
Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending this presentation. At this time, you may disconnect your lines.