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Edited Transcript of ADSW earnings conference call or presentation 2-Nov-17 1:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Advanced Disposal Services Inc Earnings Call

PONTE VEDRA Nov 6, 2017 (Thomson StreetEvents) -- Edited Transcript of Advanced Disposal Services Inc earnings conference call or presentation Thursday, November 2, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Matthew Nelson

Advanced Disposal Services, Inc. - VP of Finance & IR

* Richard Burke

Advanced Disposal Services, Inc. - Chairman & CEO

* Steven R. Carn

Advanced Disposal Services, Inc. - CFO, EVP and Treasurer

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Conference Call Participants

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* Andrew Edward Buscaglia

Crédit Suisse AG, Research Division - Senior Analyst

* Corey Adam Greendale

First Analysis Securities Corporation, Research Division - MD

* Hamzah Mazari

Macquarie Research - Senior Analyst

* Kyle White

Deutsche Bank AG, Research Division - Research Associate

* Michael Edward Hoffman

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Michael J. Feniger

BofA Merrill Lynch, Research Division - VP

* Noah Duke Kaye

Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst

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Presentation

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Operator [1]

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Good morning. My name is Jennifer, and I will be your operator today. At this time, I would like to welcome everyone to the Advanced Disposal Third Quarter 2017 Earnings Call. (Operator Instructions) Thank you. And I would like to turn the conference over to Matthew Nelson, Vice President of Finance and Investor Relations. Sir, you may begin.

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Matthew Nelson, Advanced Disposal Services, Inc. - VP of Finance & IR [2]

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Good morning, everyone. We would like to welcome you to the Advanced Disposal Q3 2017 Earnings Call. With me today is Richard Burke, our CEO; Steve Carn, our CFO; and other members of senior management.

We issued our press release yesterday with our results and trust that you have had the chance to review it. If you need a copy of the release, you may find it on our website or at www.sec.gov.

In today's earnings release and during the conference call, we are providing adjusted financial information, including adjusted EBITDA, adjusted free cash flow and adjusted net income, all of which are defined in our press release and exclude certain items that management believes are not indicative of our results of operations. This information is provided to enable you to make meaningful comparisons of the company's operating performance between years and to view the company's business from the same perspective as management.

The earnings release contains exhibits that reconcile the differences between the non-GAAP measures and the comparable financial measures calculated in accordance with U.S. GAAP.

Before we begin, I need to make certain cautionary remarks about forward-looking information. The management (technical difficulty) in the teleconference may contain certain forward-looking information intended to qualify for the safe harbors reliability established within the Private Securities Litigation Reform Act of 1995, including projections, estimates and descriptions of certain future events. Any such statements are based upon current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in those forward-looking statements. In this regard, we direct listeners to the cautionary statements contained in our financial filings with the Securities and Exchange Commission.

This call is being recorded and will be available 2 hours after the conclusion of the call for 30 days. Time-sensitive information provided during today's call may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Advanced Disposal is prohibited. I would now like to turn the call over to our CEO, Richard Burke.

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [3]

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Thanks, Matt. Good morning. And we want to thank everyone for joining us today.

Q3 represented another solid quarter for the company with strong financial results. I'll take you through the highlights and then Steve will walk you through some of the more detailed financial results. Starting with revenue, top line grew nearly 9% and represented the best quarterly growth rate in our company's history.

As we discussed on last quarter's call, we expected volume growth to improve in the second half of the year and that is exactly what we saw with organic volume, up 3.4% on a year-over-year basis, despite 1 fewer workday. This was driven by combination of strong disposal volume and improving growth trends in our commercial and roll-off business and largely cycling the impacts from our initiative in 2015 and '16 to rationalize some municipal contracts that didn't generate the proper long-term free cash flow returns for us. I'd also note that municipal wins continued to outpace losses year-to-date 2017.

Growth from acquisitions net of divestitures was another key driver and added 4.2% to top line growth. Year-to-date, we've completed one large vertically integrated acquisition through our first quarter purchase of CGS in Indiana and 12 additional tuck-in acquisitions. These transactions have strengthened our existing markets and in one instance allowed us to swap out of a market where we were at a disadvantage disposal position, while improving our position in an existing disposal-neutral market.

Our acquisition pipeline remains healthy and we will continue to pursue acquisition opportunities that fit our market selection criteria and can be purchased at reasonable multiples.

Average yield contributed 20 basis points to revenue growth and was muted compared to prior quarters, due in part to revenue mix impacts from special waste, volume and the cycling of an environmental fee increase that was put in place in July 2016.

Over the last 8 quarters, however, our pricing has averaged approximately 2% or 40 basis points better than CPI over that time period, as we remain committed to disciplined pricing over the long term. It's part of our DNA and an important piece of our strategy for offsetting inflationary pressures that we see in our business, while at the same time, generating value for our shareholders.

Finally, revenue from commodity sales did increase on a year-over-year basis and contributed 90 basis points to growth in the quarter. We did, however, see a sharp decline in commodity prices in late Q3 related to regulatory changes in China, including restrictions on import licenses.

While most of our collected recyclables are processed domestically, the ripple effect of Chinese regulatory changes have impacted the global supply and demand picture and put significant pressure on the U.S. market. We expect falling commodity prices will result in a $3 million reduction to EBITDA or an approximately $0.02 impact to EPS in the fourth quarter from our previous guidance given during our Q2 earnings call.

Turning to bottom line results. Adjusted EBITDA improved $3.2 million to our best ever quarterly result of $112.3 million, despite $3.7 million of headwinds from storm startup cost and other items that we would consider to be more one-time in nature. Without these cost pressures, adjusted EBITDA would have been an even stronger $116 million. Gains and profitable organic growth, strategic tuck-in acquisitions that strengthen our footprint in our existing markets and managing controllable costs are all key drivers in our improvement in the EBITDA during the quarter.

As we stated earlier this year, we are continuing to see some cost pressures related to third-party disposal cost, disposal facility cost and health insurance claims that Steve will discuss in more detail.

Additionally, we have had 2 major hurricane impact us during the quarter, including Hurricane Irma that was a direct hit to our South region, which (technical difficulty) 40% of the company's revenue and left heavy storm debris cleanup in many of our disposal-neutral markets.

We estimate that the net impact from these storms was a $1 million reduction in EBITDA in the quarter and will be a $2 million EBITDA impact for the full year 2017.

Looking at cash flows. We are extremely pleased to report that, both our year-to-date September 2017 cash from operations of $247.4 million and adjusted free cash flow of $111.6 million, exceeded our full-year 2016 totals of $237 million cash from operations and $94 million of adjusted free cash flow. While there are always ebbs and flows in these metrics related to the timing of working capital receipts and payments, along with CapEx requirements that can impact us in any particular quarter, generating improving cash flow over the long term is our most important financial responsibility to shareholders. So we are pleased that we've delivered on this metric.

Overall, our team continues to deliver on the commitments we have made to shareholders. We have expanded our operational footprint, continued to strengthen markets with tuck-in acquisitions, achieved some important new municipal wins, continued our disciplined pricing over the long term, strengthened our balance sheet and reduced our leverage.

We have also continued to make important changes to our Board of Directors as we mature as a public company, with the addition of Michael J. Hoffman, a 40-year veteran and longtime CEO of the Toro company as an independent (technical difficulty). Our board is now comprised of a majority of independent board members. And all committees are made up of fully independent members.

Looking at our full-year guidance, we are raising revenue to our a range of $1.49 billion to $1.505 billion from our Q2 forecast of $1.475 billion to $1.49 billion, led by expected year-over-year improvement in organic growth. We also are narrowing our adjusted free cash flow guidance to $121 million to $131 million. With regards to adjusted EBITDA guidance, we are revising our range to $416 million to $419 million, this is due in part to a falloff in commodity prices that we think will impact us by $3 million, compared to our previous guidance for commodity prices at the time of our Q2 earnings call.

Additionally, we are impacted by continued storm-related cleanup in Florida, where we operate largely in disposal-neutral markets. And some other near-term cost pressures such as healthcare, that we are structurally addressing in 2018, but are currently headwinds. That being said, while we don't plan on giving direct 2018 guidance at this time, our core business remains strong and growing.

With that, I will now turn the call over to Steve for a more detailed discussion of our financial performance.

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [4]

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Thanks, Richard, and good morning. Revenue for the third quarter of 2017 increased to $32.1 million or 8.9% to $392.7 million from $360.6 million for the third quarter 2016.

Adjusted net income increased $3.2 million to $13.9 million from $10.7 million in the prior year. And adjusted EPS was $0.16 in Q3 2017. Adjusted EBITDA for the third quarter increased $3.2 million or 2.9% to $112.3 million from $109.1 million in the prior year. A reconciliation of non-GAAP measures to the comparable GAAP measures can be found in our earnings release. We achieved strong top line revenue growth for the quarter of 8.9%, driven by acquisitions, net of divestitures accounting for 4.2% and strong organic volume growth of 3.4%, with total average price yield of 1.3%.

Looking at revenue growth in more detail, we achieved total price yield of 1.3% for the quarter, with 20 basis point average price yield, 90 basis points price growth from commodity sales and 20 basis points from fuel fee revenue. Average price yield for the quarter was expected to be down sequentially from Q2 and down over the prior year quarter, impacted by a tough prior-year environmental fee comp. In addition, we experienced a significant increase in lower price special waste dirt jobs, which resulted in 50 basis point headwind to overall organic price yield in the quarter. However, over the past 8 quarters, we have achieved average price yield of 1.9%, which is 40 basis points over CPI of 1.5% over the same period, delivering up on our longer-term target of 2% price yield.

Digging into price yield to the line of business, we continue to see increased yield in our residential business, benefiting from higher CPI contract resets, with residential business contributing 1.4% price growth for the quarter.

Roll-off in price growth was 1.7% for the quarter, we've continued pricing growth in the Midwest and South, moderated by lower pricing in the East, which was impacted by lower price project-based work in the current quarter compared to the prior year. Commercial price growth of 40 basis points for the quarter was moderated by our strategy to defend business. We have reduced year-to-date churn to 6% compared to 12% at year-end. Although, we continue to see some undisciplined competitors in certain primary markets.

Overall, landfill price yield was negative 2.5% to the line of business during the quarter, impacted by mix of business, with volume increases weighted to special waste dirt jobs with tough prior year comp as we fully anniversary the environmental fee increases in the prior year. We saw a 29% increase in special waste tons over the prior year quarter, where special waste dirt job generally priced lower than other disposal volumes. MSW and C&D pricing were slightly negative 60 basis points on a year-over-year basis for the quarter due to tough prior year comps.

Solid waste fundamentals remain strong with overall organic volume growth of 3.4% for the quarter or 4% adjusted for 1 less work day. Disposal revenue was up 3.6% for the quarter, driven by 18% increase in landfill tons on a year-over-year basis. Broken down by 10% increase in MSW tons, 21% increase in C&D tons and 29% increase in special waste tons.

Commercial roll-off revenue increased 1.2% for the quarter, (technical difficulty) increase in commercial cubic yards and an increase of 3% in roll-off balls. The company reduced churn and continues to see service increases outpace service decreases. These volume gains were offset by non-regrettable loss resi contract volume of 80 basis points, which will continue to moderate as we anniversary these losses.

Turning to our bottom line results. Adjusted EBITDA for the third quarter of 2017 increased $3.2 million or 2.9% to $112.3 million from $109.1 million for the third quarter 2016. Adjusted EBITDA margin for the quarter was 28.6% compared to 30.3% in the prior year, reflecting 170 basis point decrease in margin year-over-year. We experienced $3.7 million or 90 basis points of margin headwinds due to increased operating cost from hurricanes. Spike in fuel costs related to storm supply disruption, new muni contracts startup costs, acquisition integration cost, increased disposal leachate and sulfate treatment cost and an increase in healthcare cost, driven by the number and severity of claims and considered these cost somewhat outside the normal course of business.

Excluding the costs, adjusted EBITDA for the quarter would have been $116 million with margins of 29.5%. We have taken several actions to help moderate the impact in future periods some of these cost headwinds, by accelerating some landfill infrastructure CapEx to reduce leachate and sulfate treatment cost. And providing additional employee health plan options in 2018 to help moderate health insurance cost, while still providing high-quality benefits to our employees. In addition, as we cycle the residential startup cost and acquisition integration cost, we expect to start to materialize a higher distribution from the acquired revenue. In addition, we continued to experience the following headwinds in the third quarter, similar to what we saw in the front half of the year. We continued to see cost pressure on disposal expense due to higher container weights and acquisition volume resulting in 50 basis point negative impact on the margin for the third quarter. However, this margin headwind improved 50 basis points sequentially from Q2 as we continue to experience service increases outpacing decreases, but have not yet fully offset the increased waste. Second, 80 basis points margin headwind from bonus accrual timing compared to the prior year, increased consulting related to (inaudible) implementation of testing. Additional sales and call-center headcount driving net new business and lower churn and increased bad debt expense impacted by acquired businesses not yet on our payment standard and collection efforts disrupted by hurricanes in the South. These headwinds were offset by 50 basis point contribution from price growth and productivity gains in the quarter. Reviewing the results of operations, we achieved income of $29.7 million for the quarter compared to $39.6 million in the prior-year quarter. We have provided detailed schedules of our cost of operations and SG&A expenses in our 8-K filing. Our cost of operations, excluding accretion in Green Tree expenses as a percentage of revenue was 61.6% compared to 60.2% in the prior-year quarter. The 140 basis point increase in operating expenses as a percentage of revenue is primarily due to storm-related cost, higher disposal costs impacted by increased weights, increased landfill gas and sulfate treatment cost and increase in fuel cost. SG&A (inaudible) as a percentage of revenue was 10.6% compared to 9.9% in the prior-year quarter. Salary expense increased 60 basis points as a percentage of revenue due to stock compensation and bonus expense accrual timing compared to the prior year, and increased sales and call center headcount. In addition, SG&A was impacted by storm-related increase in bad debt expense and additional professional fees related to (inaudible) implementation and testing. Depreciation, depletion and amortization was 17.6% of revenue compared to 17.8% in the prior year. As a reminder, our D&A is approximately 6% higher due to the impact of GAAP purchase accounting on the legacy business. However, it has no impact on free cash flow generation. We generated solid cash flows from operations for the quarter of $74.6 million or 19% of revenue compared to the prior-year quarter of $87.3 million or 24.2% of revenue with adjusted free cash flow of $28.6 million compared to the prior year quarter of $37.8 million. Cash flows from operations and adjusted free cash flow for the third quarter were impacted by the timing of approximately $12 million of landfill tax payments, that occurred in the second quarter in the prior year. Year-to-date adjusted free cash flow increased $21 million or 23% to $111.6 million or 9.9% of revenue compared to $90.6 million or 8.6% in the prior year.

We continue to deliver strong free cash flow improvement, with year-to-date adjusted free cash flow as a percentage of EBITDA of 36% compared to 30% in the prior year. The company expended $51.9 million for CapEx or 13.2% as a percentage of revenue due to the timing of spend between quarters, with year-to-date adjusted CapEx of 11.5% of revenue. For the quarter, replacement maintenance CapEx was $38.7 million or 9.8% of revenue. Growth CapEx was $4.2 million or 1.1% of revenue. And CapEx spend related to acquisitions subsequent to closing was $1.5 million or 40 basis points of revenue. Infrastructure CapEx was $7.5 million or 1.9% of revenue, primarily related to landfill gas and leachate treatment infrastructure. Total funded debt at September 30, 2017, was approximately $2 billion with approximately $227 million of revolver availability. During the quarter, interest expense was $24.1 million, with cash paid interest of $16.2 million. Covenant leverage, defined as total funded debt to pro forma adjusted EBITDA, at September 30, '17, was 4.6x compared to 4.8x at year-end. LTM September 30, '17, EBITDA of $429.5 million includes $12.5 million or pro forma credit for full-year impact of acquisitions and new municipal contracts net of divestitures. We will now open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Corey Greendale with First Analysis.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [2]

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So a couple questions. First of all, on the yield. So I understand there is a mix impact, but as you walk through the lines of business, it sounded like commercial is relatively, modest and you talked about defending business. So can you -- philosophically, that sounds like it is sort of shifting toward volume over price, but can you just comment on that and how temporary you think that was or just what your philosophy is on volume versus price in that line of business?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [3]

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Yes, so Corey, thanks for the question. But let me start there is no strategy change at all here. Price trumps volume, that hasn't changed. I mean, from quarter-to-quarter, there'll be different lines of business, that will be affected differently. When we talk about commercial, I mean, we've been working around a strategy of easier to do business with and more relationship selling. So we have bumped up some of our sales force in different -- specially in the primary markets where we were probably getting hit the hardest on the commercial side. So more touches, more face-to-face with these commercial customers, longer-term contracts, getting them signed up in order to maintain density on the route. So by doing that, in the quarter, we sacrificed a bit of price on the commercial side. But if you look at year-to-date, on commercial it's more in the 1.4% to 1.5%, not the 40 basis points that we're seeing in commercial. So just want to make sure from a strategy standpoint, nobody thinks -- or you don't think we are not placing price above -- we're not placing volume above price. We will defend our core business, especially in primary markets, where we feel like that's the best strategy. But overall, big picture, we're still aspirationally pushing for 2% price, 2% volume, 1% to 2% deal, so grow the company 4% to 6% over the long term.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [4]

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And Richard, do you think given market conditions -- so the aspiration you've communicated clearly, do you think given market conditions you can get back, as I understand, you've got the anniversary and the environmental fee as a headwind, but do you think, you can back to that 2% price level in, kind of, a reasonable timeframe?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [5]

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I do, I do. I think it's going to ebb and flow and some quarters are going to be different than others. But I think, if we look at it -- I mean if you look at it over an 8 quarter period, we are at 1.9% now. So we're very close to the 2% on price. The mix issue was the big issue around price for us this quarter, especially when you look at the special waste, the dirt jobs.

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [6]

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So Corey, we'll get a little bit of a tailwind from the 26% of our revenue that's index based. For the quarter, Q3, its contribution to the line of business was 1.4%, if we look at Q3 '16 that was 40 basis points. So that will help as we go into the back half of the year and into next year. Remember, a large portion of our contracts reset in Q4. So we'll start to get that price benefit Q4 and into '18.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [7]

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And Steve, as -- I know you're probably -- you know, you said you're not going to get into 2018 guidance, but a lot of moving pieces on the margin, but kind of, given your thoughts on price, and you start to -- hopefully, you don't have the same hurricane impact next year. Do you think that as a baseline assumption, that -- and maybe let me back out the impact of commodity prices, that you can get EBITDA margin expansion in 2018?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [8]

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There's a number of things, certainly, like you say backing up commodities is, kind of, the wild card, we'll continue to pull the levers. A certain amount, there's about 90 basis points that we're considering, kind of, out of course. And we've done some things to some health insurance cost, we've added a plan, we'd expect to moderate some of those costs going into '18. We've put in -- we've spent some CapEx, about $4.2 million, that we'll spend for fiscal year '17 around leachate and sulfate infrastructure, which will help (technical difficulty) as we go into '18. We're working on looking at disposal pricings, so trying to get increases -- service level increases, so we'll start to moderate some of that. So there's a number of initiatives or actions that we've taken today that we would expect to help moderate some of that margin pressure that we've seen in the back half of this year in Q3.

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Corey Adam Greendale, First Analysis Securities Corporation, Research Division - MD [9]

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So I think what I'm hearing is, and correct me if I'm wrong, it'll be dependent on -- if you can get price in excess of CPI then excluding those kind of, nonrecurring things, you should see EBITDA margin expansion in 2018?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [10]

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Yes. And just thinking that a little bit about the pressure on price in the quarter. A large part of it was the mix -- the big slug of special waste, dirt that came in in the quarter, I mean, 190 basis points negative on a year-over-year basis. And it's actually 50 basis points to overall average yield. If you exclude that special waste, that dirt that came in from the price yield, we would have been at 70 basis points of price. And so you get another lift in Q4 from CPI resets on your 26% of your revenue, you continue to push service level increases, we would expect (inaudible) '17 to be in that 1% to 1.2% price. So we're -- you can't look at just the quarter and say that there is a pricing issue, I mean, this is more than 1 quarter business and we'll continue to push strategies to improve on pricing.

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Operator [11]

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And your next question comes from Kyle White with Deutsche Bank.

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Kyle White, Deutsche Bank AG, Research Division - Research Associate [12]

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Just wanted to parse out the drivers of the downward revision to EBITDA guidance, make sure I have them correct. Sounded like it was a $3 million impact from the storms, along with another $3 million related to commodity. And also some headwinds on health insurance and disposal, any color you can provide there?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [13]

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Yes. The first 7 was (inaudible) Disposal leachate, sulfate startup cost and storm of $1 million in the quarter. We expect to see another $1 million in the fourth quarter for the storm. So just looking at Q3 itself, there was $3.7 million of kind of unforeseen, kind of, cost headwinds. Again, we talked about, we're adding a health insurance plan, we expect to be able to moderate that and still provide good health plans to our employees. We've spent some CapEx in '17 related to decreasing cost related to leachate and sulfate disposal. The startup cost will go away. We'll get a higher contribution in '18, as we start to achieve some of the synergies in the -- on the $100 million that we spent on the acquisitions this year. And we certainly don't expect a 50 or 100 year storm again, but you never know and that's going to -- that will be $2 million that will turn around in '18 if we're in the normal, kind of, tropical season.

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Kyle White, Deutsche Bank AG, Research Division - Research Associate [14]

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Got you. And then on the CapEx, are you guys providing guidance, it sounds like a little bit of acceleration there, I know you also had some spin related to, I believe, it was a Polk County contract that you won, just curious what your expectation is for 2017 there?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [15]

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I think -- you know, again, our targets in that 10 to 12 in the near term, you know, we keep saying we'll be in that 11 to 12 just because of the timing of some of the self-instruction development and infrastructure we're putting into our landfills because (inaudible) you know, you're putting that front end in those landfills, so we'll continue that in that range.

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Kyle White, Deutsche Bank AG, Research Division - Research Associate [16]

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And final question is just on organic volume growth was pretty strong in the quarter, better than our expectations. As we look sequentially into Q4, should we expect even better growth as you lap more non-regrettable contracts, just trying to think about the volume there, how sticky it is versus, kind of, one-time?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [17]

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So let me just give you a breakdown between collection and disposal. So on the disposal side, 29% increase quarter-over-quarter (inaudible) I mean that was just a couple very large special waste jobs that popped that were also -- you got to understand special waste dirt jobs generally come in at a much lower price, we'll stockpile that dirt and we'll use it in the future for daily cover. So there's some operational savings even though you're taking in at a lower cost, but what it does is, it significantly impacts the, kind of, the yield in the quarter it comes in. You've got 21% popped in C&D. Some of that seasonality that -- you know, we won't see that big of a pop, we expect in Q4. In MSW tons, we're up 10%. And then you look at the collection side, where we're starting to be more aggressive keeping some good density business on our trucks that are, good margin business, we were up 2% on cubic yards, 3% on roll-off, we'll start to cycle through on the residential side. So we'll see good volume in Q4, but not as we did in Q3 because of the significant couple jobs that we had come in in the quarter. And generally, we see a downturn seasonality-wise with special waste jobs in Q4 as weather sets (technical difficulty).

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Operator [18]

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Your next question comes from Hamzah Mazari with Macquarie.

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Hamzah Mazari, Macquarie Research - Senior Analyst [19]

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The first question is, just if you could give us a sense of -- you talked about the cost associated with the hurricane, maybe just give us a sense of, as you look at rebuild activity, do you plan to benefit or do you view that as a net neutral? Or do you view that as a negative because margins are low in C&D and its disposal-neutral territory? Maybe just give us a sense of how investors should think about rebuild activity and the impact?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [20]

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Okay. Thanks for the question. So on the hurricane, first one, just to be clear when we said 2 hurricanes, so you've got Matthew, how -- we don't have operation in Texas, so how we were affected there? Was the refinery downturn and the pressure it put on fuel cost across our platform. So let's be clear about that. Hurricane Irma much more of -- less of a flood and more of a storm -- debris storm. Not as many blue tarps on roofs in Florida. More of it's about vegetative waste. So we're not seeing a big uptick in rebuilds like rebuilding a building or that. It wasn't that kind of storm. It was basically a wind storm, by the time it got to Florida, a lot of vegetative waste on the ground. Out of Palm Beach County alone is estimating 3.5 million cubic yards, on the ground over and above normal just in one county. And what's happening to us there, while that's adding cost without a lot of reoccurring or without a lot of new revenue is, we have these large municipal contracts, 7-, 10-year contract. They're good contract except when a storm shows up. But we are in those contracts. We have to pick up, let's say, 1 yard to 3 yards of storm debris a week as we go through. And because a lot of the storm debris collectors that are nationwide (technical difficulty) dispatched to Houston, they've been slow getting to Florida. So Florida still has a lot of vegetation, even 6 weeks later after the storm on the ground. So because our contracts require us to pick up 1 yard to 3 yards, we're doing it every week. So we're picking up increased volumes with very nominal increased revenue. Where you make money in a hurricane that's a wind type hurricane is owning the disposal sites. And unfortunately, that's not our model and not our platform in Florida. We are disposal-neutral here, expect for one C&D landfill and one small one in Ocala and one in Jacksonville. So that's why the storm hasn't had the same offsetting revenue that some of our peers have had with us.

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Hamzah Mazari, Macquarie Research - Senior Analyst [21]

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That's very helpful. And then just -- as you think about acquisitions over the next year, couple of years, at what point can you sort of just maintain leverage and still do deals. You talked about $100 million acquisition spend. Is that the right number to look at longer term or does that pick up as you guide into '18 and '19, keeping your balance sheet in mind.

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [22]

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No. This has been an exceptional year for deals. We have done 13 -- we've done 12 acquisitions and 1 market swap. So total of 13 deals. So it's been a very solid year. And these deals have been done in markets where we're building density or increasing volumes or in disposal-neutral where we've gotten stronger. So it's been an excellent deal year. But I think it's been an exceptional year, Hamzah, I still believe our comfort is more in that $30 million to $50 million range a year. So I would say this year is nearly twice the norm. We did start the year off with CGS, which was a $25 million to $30 million deal. So that was a large deal to come out of the chute with. But you have to be opportunistic and get them. But if I was running out '18, '19 and forward, I would look more towards $30 million to $50 million, not $100 million. I think it's this has been exceptional year. We will be opportunistic just like we were this year if the chunkier deals come along. But I think a normalized run-rate's closer to $30s million to $50 million.

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Hamzah Mazari, Macquarie Research - Senior Analyst [23]

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Got it. Just a follow up, I'll turn it over, maybe for Steve. You mentioned higher cost in the system and healthcare, higher third-party disposal, leachate, new contract startups. Just maybe give us a sense of how much of this is temporary, how much is structural? Do these go down after 2 quarters or do they stay with us for the entire year in 2018? I know each one is different, so maybe just you don't have to quantify just high-level does healthcare go down second half '18, how would third-party disposal cost evolve in the system?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [24]

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Yes, good question, Hamzah. So on healthcare, so we look at that we have added a couple of plans and made some enhancements to our health -- employee health insurance plans. Those will go into effect January 1, for us as far as employees are concerned, but there's a 90-day lag, typically in health insurance claims. So that lag will continue into the first quarter of '18. And then we'll start to see it moderate and start to get the benefit of the plans that we put in place. So that gives you some perspective there. On the startup cost, we'll start to cycle through those, really, end of Q1 and first part of Q2. Because that's where the heavy part of the acquisitions were done. So we'll cycle those. On the storm-related cost, those will cycle right way. And then on the leachate and sulfate, those should start to really cycle through in that Q2, Q3 timeframe, as we put that infrastructure in to help reduce cost related to the leachate and sulfate, we have done some pricing to some particular customers that are -- that have an impact on their waste streams that they're bringing to us. So that's kind of how we're thinking about that bucket of cost and the actions we have taken today. And how they will moderate into '18.

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Operator [25]

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Your next question comes from Michael Feniger with Bank of America, Merrill Lynch.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [26]

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First question. Just can you go into this higher container weight issue a little further. I know this hit you last quarter. Has your thoughts on this dynamic changed at all?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [27]

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No. We're still seeing increased container weights across the board and we have been able to offset a little bit through some pricing and service increases in service level. But we're looking at that and we'll continue to drive -- that's going to be longer term cycle. And it really has to do with more of our customers' decision, that their containers overflowing and they have to have an extra pickup or they have to increase the size of their container. So as you get a growing kind of economy, and we see our customers' business grow, we are a little bit of lag on the commercial side. On the [lag side] on the downside, economy we get a live -- we get kind of a plus because you're picking up more air, you're more productive. So we're just in that period, as the economy picks up and till we see those service-level increases really take off, we are going to have some of these kind of cost pressures.

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [28]

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And Michael, on the short-term as Steve said, this is a headwind, right? But in the long term, it speaks well for the economy. It speaks well that restaurant containers are full and other places, slight manufacturing are full. That will translate into service interval increases and we're seeing that. If you see the difference between second quarter and third quarter, which cut that in half, from 100 basis points to 50 basis points weight. So on that, we are being proactive and going out to our customers trying to -- with our enhanced outside sales presence to draw -- to drive up service increases or interval increases. And we're seeing that. But it is a slower grind but long term as Steve said, taking a customer from 2 times a week to 3 times, or 4 times a weeks to 6 times. Those become nice incremental yardage for us to pick up, that can be the most profitable component of the commercial rep.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [29]

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Okay. I was hoping you can also expand a little bit more on your customer care Center initiative. How that's progressing. The pricing pressure in some of these primary markets, I know you guys had a 2-year stretch where you really rationalized a lot of your contracts, left markets that were not attractive. But the pricing pressure in some of these primary markets, how do you better leverage that over time? Do you need to do acquisitions to build density there? Just trying to get a feel for that.

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [30]

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You know I think it's about a -- I don't know that there's any one magic bullet to your question, but what we're focused on is more of a relationship sale, relationship with that customer, where (inaudible) outside sales people are touching them. And if they're of a certain size that we've got inside sales people reaching out, that we are doing everything to make it easier for them to transact business from us, whether that's through e-commerce, paying online, whether that's getting their records online. Things that we can do to make the service delivery, seamless, easy and very easy to transact business, which we can parlay that into longer-term contracts that puts less pressure around churn. So that's our focus right now is especially in these primary markets, where we have more competition than we would in the secondary. We've put a big push in those markets to extend and lengthen contracts, especially on routes where we have great density. So we can get pretty granular here, down to the route, say all right, you are doing 125 lifts on this route. How do we protect those 125 routes? How -- what percentage of those customers can we get on long-term 3 to 5 years contracts? Short term, as we shown, you may give back a little price on that, but to get a longer new 3-year, new 5-year contract. And then take them off your competitors' hit list. We believe as we do this market by market, it makes sense. Especially in the primary markets, not so much in the secondary where we have less competition and just to remind you, 65% of our revenue is in the secondary market, we only have about 20% of our revenue in primary, but that's where this initiative is focused in the big cities.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [31]

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And just lastly, on the revenue mix issue with the special waste. Has that improved so far in the fourth quarter? Have you seen any changes so far in October?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [32]

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For special waste?

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [33]

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Yes. With the revenue mix I know you (inaudible) you had these large special ...

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [34]

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The biggest project we had, a large soil project in the Midwest is -- has concluded. It's over -- it ended the end of September. So and just by seasonality, you'll see our special waste volumes trade back off, come back down to normal. That'll take some of the pressure off price. I'm going to miss the dirt, especially the site we were able to take this dirt to is a site that operationally is challenging. We cover the waste every day with 6 inches of soil. So if we don't have dirt coming in, revenue producing dirt coming in, then we have to send an operator and another -- 2 operators and a dump truck driver to go dig organic dirt. So that's an operational cost, right? When we get these big soil jobs, we can take that soil, we can stockpile it on top of a site and then when we pull off that pile and if we can get 6 months or so, there is a longer-term operational savings at the site. So that's why we like dirt, but you'll see dirt really fall off November and December and probably won't pick up again until May.

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Operator [35]

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Your next question comes from the line of [Michael Ocean] with Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [36]

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It's Michael Hoffman, not your board member. Can you help -- I realize somebody asked something like this question previously. But I couldn't get all the numbers to add up, you had a $10 million -- $10.5 million delta between midpoint to midpoint on your EBITDA. Can you reconcile that $10.5 million?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [37]

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On the EBITDA?

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [38]

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Yes. And then I'm assuming you're detrimental on your free cash flow was at 50%, so that's why it's $0.50 on every dollar of EBITDA equals free cash (inaudible) 10 on EBITDA 5 on free cash. But can you help me what caused the $10 million? Storms, leachate, healthcare, other?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [39]

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It's really those buckets, Michael. So if you go back, just look at the quarter specific to Q3, it's health insurance. And remember if you go back to Q2 we said health insurance was an issue there. It's moderated, it's a little bit different and it's based on claims but we think that's going to be a $5 million headwind for the year but it was $0.5 million in the quarter. And if you look back at Q2 6 months, a fair amount there. But disposals, so leachate and sulfate treatment cost. Now we've spent the dollars to try to manage those costs. But we put some infrastructure in. So we put in some pretreatment facilities. So we can discharge it at a much cheaper rate. We have startup cost in the quarter of $800,000 and we have storm of $1 million we said it's going to be $2 million for the full year. So taking all that into account, plus a few of the other headwinds we talked around disposal cost. And then the recycling headwinds that we'll see in Q4, is really the factors -- the main factors of reducing kind of from the midpoint of 428 down to 418.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [40]

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Okay, so $2 million for storms, $1 million for leachate, $5 million for healthcare. That leaves me $2 million as sort of the recycling and other is the way to think about it?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [41]

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Yes, sir. I think that's ...

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [42]

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Okay. And you're basically, your decremental on your free cash to your EBITDA is $0.50 on the dollar? Is how that ...

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [43]

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I can walk you through some of it, Mike. So you got $10 million decrease in EBITDA, $1 million probably more in the range on CapEx than if you had said you look at the midpoint of our guidance in Q2. We're going to benefit a little bit (inaudible) post closure expense about $7 million and that has to do with some modification (inaudible) That we've gotten out of our closure activities we thought we were going to do for the year. And we're going to be a little more efficient from a tax standpoint because we did get some further tax simplification. So we'll gain about $3 million there. So 131, negative 10, negative 5 on CapEx, plus 7 on CPC and 3 on tax gives you kind of midpoint using the midpoint the detail gets you to 126.

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Operator [44]

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Your next question comes from Noah Kaye with Oppenheimer.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [45]

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To go from -- if I got my numbers right, 12% churn down to 6%. Not to overstate it, is a huge improvement. And I think you gave us some color why you chose to defend the business in certain primary markets to help build out kind of a longer-term base of density. But I guess kind of normalized, what is the right level of churn do you think to be able to get headline price at 50 bps over CPI?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [46]

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I think it's somewhere in the 8% to 10% range.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [47]

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Okay. You know going forward, if we see that churn rate start to bump up a little bit, that's perhaps an indicator that the price driven growth strategy kind of gets back to where you had previously indicated it would be. Is that a right way to think about it?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [48]

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It is. Look let's not lose sight of the fact that looking at price at 1 quarter, is a pretty narrow lens. You got to look at price over 8 quarters, because I think over a 2-year stretch it will really tell you if you're committed, if you're disciplined to price or not, 1 quarter doesn't tell the story. So the fact that we're 1.9% to 2% during the same period when CPI was 1.4%, 1.3%, that means we are running 60, 70 basis points north of CPI for the last 2 years. But back to your churn, again, defending our commercial business in primary market, we think matters and we think it's important especially when we're internalizing that waste into our landfills. So the initiative in the primary markets has been sign them up to long-term contracts, get our CPIs, get our price increases in years going forward, but it's a good time to stabilize those -- that base in those primary markets.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [49]

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Okay, that's helpful. And then on the M&A front, you talked about a normalized spend rate. But maybe if we could get an update on the pipeline. How is the deal opportunity set now? If it continues robust, we certainly don't want to inflate expectations. But is there any constraining factor preventing you from doing more than $30 million to $50 million?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [50]

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No. The only constraint, so the deal pipeline is good, it's good, it's strong, it looks a lot like it's really heavily weighted towards tuck-ins versus new platforms and we like those, because startup cost is less, integration is quicker. And by and large there in our vertically integrated markets. Or they're in disposal-neutral that we like. So the deal pipeline is good. I just think on a run-rate again, over 2 or 3 years we're going to average closer to that $30 million to $50 million. And that's not because the deal isn't there, it's because the deal doesn't hit our hurdles, right? It doesn't either fit in the market, it doesn't -- we don't make it on valuation or some of the deals we look at are poorly capitalized and when you take the purchase price plus the capital, you got to put out it doesn't make sense. So it's more about -- it's not the number of deals, it's more about having the right deals that fit our criteria.

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Operator [51]

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Your next question is from Andrew Buscaglia with Credit Suisse.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [52]

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Can you just talk about you touched on the impact of indirect impact of Harvey, having impact on fuel. And that's how you'll see that. Can you comment on that fuel fee revenue line going forward. If there -- if you expect some sort of impact near and long term?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [53]

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Yes, Andrew, good question. So in Q3 what we saw is about 14% spike on a year-over-year basis for the quarter, but particularly, what happened in September because of the supply disruption, particularly in the Southeast because the ports were closed, not only just for Harvey and Irma, for both. So we got both hit by supply disruption from Texas impact and Florida impact. But there's a lag to that, so it's hard to capture some of that, because it's set at a price. So we bill it in advance. And if you miss that spike in that published rate, you'll never get that. So a little bit of the fuel impact that be associated with the storm we'll never get back because it just wasn't the (technical difficulty) residential customers on your subscription base at a quarter in advance. So that's kind of the headwind that we saw around fuel related to Q3 and the storm impact to that.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [54]

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Okay, okay. So I guess going forward, it's not -- you're not going to see any potential even benefit from higher fuel ...

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [55]

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It came back down. It was a temporary spike. It's a little elevated still but not what was right before and right after the storm.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [56]

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Okay. And then I don't know if the comment you made on 26% of your revenue is changed to I believe you said higher index. What was that -- how fast is that growing and what was that last year?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [57]

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On that metric, as far as we got price yield in Q3 '17 at 1.4% to the line of business on the resi. Then last quarter Q3 '16, it was 40 basis points. So we're up 100 basis points on a quarter-over-quarter basis.

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Andrew Edward Buscaglia, Crédit Suisse AG, Research Division - Senior Analyst [58]

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Okay, got it. And then just on recycling I was surprised you guys have much smaller exposure I think versus your peers. Yet you're seeing a similar impact. How do you justify that going into Q4?

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Steven R. Carn, Advanced Disposal Services, Inc. - CFO, EVP and Treasurer [59]

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What -- I think it's 2 things. On a year-over-year comp, it's going to be less pronounced. Price was a little bit less in Q4 '16 compared to where we think it will land in Q4 '17. But from when we did our -- built our guidance number, it was a much bigger spread. So that's when we we're talking about the much larger number, that $3 million ...

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Operator [60]

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Your next question is from Kyle White with Deutsche Bank.

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Kyle White, Deutsche Bank AG, Research Division - Research Associate [61]

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I just had a quick follow-up question regarding the recycling, particularly on fiber and OCC. Understand it's a huge drop-off in prices in early October. I'm just curious what your guys are seeing today. Has that stabilized or are you still expecting -- sounds like you're expecting a little bit of a decline in Q4?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [62]

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No. So we dropped about 40% on OCC prices from September to October. That price resets at the beginning of every month. So we haven't seen anything since that initial drop. But the additional regulations that China is putting in place that is supposed to impact the recycling market won't take ahold until December. So we are only speculating on what that's going to do and talking to some of the people in the industry to the price of OCC but right now, we know we dropped 40% September to October, we are holding their we see what November and December brings.

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Kyle White, Deutsche Bank AG, Research Division - Research Associate [63]

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Okay, so to be clear your guidance assumes current pricing at October levels then?

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [64]

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Yes, sir.

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Operator [65]

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And we have no further questions in the queue at this time. And I would like to turn the call back over to Richard Burke for any closing remarks.

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Richard Burke, Advanced Disposal Services, Inc. - Chairman & CEO [66]

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Thank you. We're making great progress as an organization, and we are optimistic about what the future holds as we work to deliver on the promises we have made to our shareholders. By focusing on market selection, profitable organic growth, accretive acquisitions, pricing discipline, managing controllable cost and being disciplined with our capital investments, we expect to continue to drive ever improving free cash flow. We would also like to say -- take this opportunity to say a special thank you to our team -- to the Advanced Disposal team for pulling together during Hurricane Irma and helping each other to safely service our customers in the aftermath of the storm, the sacrifice and dedication the team showed is just an excellent example of our culture and our mission of every day, driven to deliver Service First. Safety Always. Thank you, everybody for their time. And hope you have a safe weekend. Take care.

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Operator [67]

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Thank you for your participation. This does conclude today's conference call. And you may now disconnect.