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Edited Transcript of RSG earnings conference call or presentation 7-Feb-19 10:00pm GMT

Q4 2018 Republic Services Inc Earnings Call

PHOENIX Feb 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Republic Services Inc earnings conference call or presentation Thursday, February 7, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Charles F. Serianni

Republic Services, Inc. - Executive VP & CFO

* Donald W. Slager

Republic Services, Inc. - President, CEO & Director

* Nicole Giandinoto

Republic Services, Inc. - Senior VP of IR & Treasurer

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Conference Call Participants

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* Brian P. Maguire

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Hamzah Mazari

Macquarie Research - Senior Analyst

* Michael Edward Hoffman

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research

* Michael J. Feniger

BofA Merrill Lynch, Research Division - VP

* Noah Duke Kaye

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

* Patrick Tyler Brown

Raymond James & Associates, Inc., Research Division - Research Analyst

* Sean D. Eastman

KeyBanc Capital Markets Inc., Research Division - Associate

* Sou Chien

BMO Capital Markets Equity Research - Analyst

* Steven Schwartz

First Analysis Securities Corporation, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Republic Services Fourth Quarter 2018 Investor Conference Call. Republic Services is traded on The New York Stock Exchange under the symbol RSG. (Operator Instructions) 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.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [2]

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Good afternoon, and thank you for joining us. I would like to welcome everyone to Republic Services' Fourth 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 actual results to differ materially from expectations. The material that we discuss today is time sensitive. If in the future, you listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call, which is February 7, 2019.

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 express 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 the 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 the pro forma view of fourth quarter 2017 revenue and costs 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 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.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [3]

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Thanks, Nicole. Good afternoon, everyone, and thank you for joining us. We are very pleased with our strong finish to 2018. Full year 2018 EPS was $3.09 and in line with our guidance range. Free cash flow was $1.2 billion and exceeded the upper end of our guidance range. Total acquisition investment was over $200 million. Total cash return to shareholders was $1.2 billion, and total shareholder return was 9% compared to the S&P 500's negative return of 4%.

The team delivered these results despite a $145 million headwind from the recycling business. We accomplished this by capitalizing on strong solid waste trends to drive both price and volume growth, strengthening our market position and improving route density through acquisitions, executing our plans to mitigate recycling headwinds in the short term while advancing our long-term strategy to transform the business, and efficiently returning cash to our shareholders.

Turning to fourth quarter highlights. We delivered double-digit growth in earnings per share, invested $87 million in value-enhancing acquisitions and divested $79 million of nonstrategic assets. We also returned $284 million to shareholders through dividends and share repurchases.

Throughout the fourth quarter, the pricing environment continued to be favorable. We achieved core price of 4.3% and average yield of 2.7%, our highest pricing level in nearly a decade. We also achieved an all-time low customer defection rate of sub-7%. We attribute these accomplishments to our laser focus on enhancing the customer experience and delivering superior service.

Additionally, we successfully converted 27% of our CPI-based contracts representing $660 million to a waste-related index or fixed rate increase of 3% or greater. These waste indices are more closely aligned with our cost structure and continue to run higher than CPI.

During the quarter, we also continued to see underlying volume growth in our collection and disposal businesses. Excluding the impact of non-regrettable losses and a difficult special waste comp, total volume increased 90 basis points over the prior year.

Our recycling business also improved in the fourth quarter. The team continued to tightly manage operating costs and increase recycling collection and processing fees. As expected, the current market conditions continue to serve us as a catalyst to transform recycling into a more durable and economically sustainable business. Additionally, we opened our first next-gen recycling processing center in Plano, Texas. We call it next gen because unlike a traditional processing center, where we primarily sort and remove items that are not recyclable, here, we are leveraging state-of-the-art technology to extract items that are recyclable. This positive sort configuration allows us to produce a higher-quality product with less labor.

The facility also includes a 5,000-square-foot learning resource center for the community, so residents can learn the proper way to recycle and reduce their environmental impact. Our partnership with the city of Plano is an example of our new recycling business model. We are paid an appropriate fee to process the material, and the majority of the commodity value is rebated back to the community. This contract structure enables us to invest in new technology while earning an appropriate return on our investment.

Lastly, given we operate one of the largest vocational fleets in the U.S., we are continuously evaluating innovative approaches and technologies to improve the performance, economics and environmental impact of our trucks. Earlier this week, Mack Trucks announced our partnership to design and test electrification in a fully integrated garbage truck with 0 diesel propulsion components. We are proud to be partnering with Mack and optimistic that this will result in a significant step towards an even cleaner, more efficient fleet.

With that, I'll now turn the call over to Chuck to discuss our fourth quarter financial results in greater detail.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [4]

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Thanks, Don. Fourth quarter revenue was approximately $2.5 billion, an increase of $65 million or 2.6% over the prior year. This increase includes internal growth of 2.3% and acquisitions of 30 basis points. The components of internal growth are as follows. First, average yield increased 2.7% and was the highest level we've seen since 2009. Average yields in the collection business was 3.4%, which included small container of 3.2%, large container of 4.5% and residential of 2.6%. In our post-collection business, average yield was 1.5%, which included landfill MSW of 2.1%. 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 4.3%. Core price in the open market was 5.1% and in the restricted portion of our business was 2.9%.

The second component of internal growth is total volume. As expected, total volume decreased 70 basis points over the prior year. Excluding the impact of non-regrettable losses and a difficult special waste comp, volume growth would have been 90 basis points. Volume in our small-container business decreased 80 basis points as anticipated. This includes a 130 basis point headwind from intentionally shedding certain work performed on behalf of brokers, which we view as nonregrettable. Excluding these losses, small-container volume would have increased 50 basis points. Volume in our large-container business increased 80 basis points. And volume in our residential business decreased 1.9% due to our strategic decision not to renew certain contracts that fell below our return criteria.

Next turning to landfill volume. Landfill MSW volume increased 7.2%, while special waste decreased 11.6% and C&D decreased 10.7%. The decrease in special waste and C&D volume was due to a difficult comp in the prior year. In 2017, both special waste and C&D volume grew over 30%.

The third component of internal growth is fuel recovery fees, which increased 70 basis points due to the rise in the cost of fuel. The average price per gallon of diesel fuel increased to $3.26 in the fourth quarter from $2.87 in the prior year, an increase of 14%. The current average diesel price is $2.97 per gallon.

The next component, energy services revenue, was flat versus the prior year, which was in line with our expectations. In the Permian Basin, where we are well positioned, drilling activity remains steady.

The final component of internal growth is recycling processing and commodity revenue, which decreased 40 basis points. The change in revenue primarily relates to a decrease in the number of tons sold and lower recycle commodity prices. This decrease was partially offset by the new recycling processing fee rolled out to our open-market recycling collection customers. This fee contributed 35 basis points of pricing. It's important to note that our average yield of 2.7% does not include this benefit. Excluding glass and organics, average commodity prices decreased 15% to $106 per ton in the fourth quarter, down from $125 per ton in the prior year.

Next, I will discuss changes in margin. In the fourth quarter, adjusted EBITDA margin decreased 80 basis points to 27.4% from 28.2% in the prior year. This included 10 basis points of margin expansion from the solid waste business, which was offset by a 40 basis point headwind from recycling and a 50 basis point headwind from 1 additional work day.

Fourth quarter 2018 interest expense was $96 million, which included $10 million of noncash amortization. Our all-in tax rate for the fourth quarter was 20%. This includes an adjusted effective tax rate of 12% and a noncash charge of approximately $30 million related to solar energy investments that qualified for tax credits.

Fourth quarter adjusted EPS was $0.80 and increased $0.19 or 31% versus the prior year. EPS included a $0.12 benefit from tax reform. Excluding this benefit, EPS would have increased 11%.

Adjusted free cash flow for the full year was $1.2 billion, and cash conversion was 42%. Free cash flow exceeded our expectations primarily due to better-than-anticipated improvements in working capital. During the year, we improved both DSO and DPO by approximately 2 days. This improvement provided a onetime benefit to free cash flow.

Looking ahead, I'd like to review the highlights of our 2019 financial guidance, which is consistent with the preliminary outlook we provided in October. For the year, we expected adjusted earnings per share to be in the range of $3.23 to $3.28. After normalizing for taxes, our guidance represents double-digit growth in earnings per share.

Next, we expect adjusted free cash flow of approximately $1.125 billion to $1.175 billion. Included in our free cash flow guidance is a working capital headwind of approximately $45 million and $50 million of incremental capital we are investing for the benefit of our frontline employees as a result of tax reform. Excluding these 2 items, our guidance represents high single-digit growth in free cash flow per share.

Total annual revenue growth is expected to be 4.25% to 4.75%. We expected adjusted EBITDA margin to expand by 30 to 50 basis points over 2018, demonstrating the operating leverage in our business. Furthermore, given the strength of our current pipeline, we anticipate investing approximately $200 million in tuck-in acquisitions. 2019 net capital expenditures are expected to be $1.2 billion. And finally, we expect to return $1.4 billion of total cash to shareholders through $500 million of dividends and $875 million of share repurchases.

I'll now turn the call back over to Don to make a few closing comments before going to Q&A.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [5]

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Thanks, Chuck. Our strong finish to the year positions us well for continued growth in 2019. We'll achieve this growth by securing price increases in excess of our cost inflation, growing volume for the seventh straight year, continuing to transform the recycling business by transitioning our municipal recycling customers to a more durable, fee-based pricing model and educating customers on what and how to recycle through our recycling simplified campaign. We'll be executing our strategy of profitable growth through differentiation to attract and retain the best people, enhance the customer experience and drive additional operating leverage through the use of technology; and finally, effectively deploying capital to fund profitable, organic growth, invest in value-enhancing acquisitions and consistently and efficiently, as always, returning cash to our shareholders through dividends and share repurchases.

At this time, operator, I'd like to open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question will be from Tyler Brown of Raymond James.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - Research Analyst [2]

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So I see in the guide that you're expecting 25 to 50 positive basis points on processing fees, commodity sales in the guide. So I think that the RISI data that came out yesterday showed a dip in fiber prices. Can you just give us some clarity? I guess, on the one hand, I surmise you've got continuing -- a push on processing fees, but it's a little unclear. Specifically, what are you kind of assuming, recycling prices in the guide?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [3]

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Yes, so the guide has -- is about $505. I know it's a little bit lower than that right now but if you think about sort of how this thing normally works through the cycle of the year, we feel that it'll bounce back through the middle of the year. And over time, we'll average it at the right rate. So [under price] in the number.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - Research Analyst [4]

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Okay, and Don, I know you probably dislike getting that question as much as I dislike asking it. So in that vein, do you think that, over time, Republic will really, for all intents and purposes, eventually inoculate itself from commodity price changes, really pushing the risk down to the waste generator? And if so, how long do you think that process might take?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [5]

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Well, I like your term inoculate, so that's -- we're all about that. So if you think about my comments, and we used our new contract with the city of Plano, right, that's an example of what we're doing. We believe the right way to do this is to get paid appropriately for the collection, to get paid appropriately for the processing. And I say appropriately, that means within a return that we can live with. And there is a function in the contract for contamination that the cities and communities have to bear that burden and, in the end, that they get the benefit of what's left over, which is the commodity value less contamination. That's fair. Again, we've made it increasingly easy for customers to recycle. We're committed to be a good environmental partner for those customers that want to do their part. But where customers don't want to be responsible, that's got to be on them. And so we're only making investments in recycling going forward that have a true sustainability from a profitability perspective, and that has to work just like I described. So we're having success. And to be frank, there's all kinds of customers, right? So we've had conversations with all of our 1,100 contracts. Some have immediately already agreed to new terms that work. Some have told us kind of, at this point, no way. And some have said, let me think about it. We're in the second and third round of talks. We are going to continue to push this. I think, frankly, any operator would have to be, I'm trying to think of a nice word, an idiot to sign up for recycling the old way when we've got this big, global, macro thing in front of us. So we did a great job. The team did a great job isolating the problem in '18. We've done a ton of great work in '18 that's going to anniversary and carry forward into '19, and the work continues. We're going to have more success in '19 than '18, and that's one of the reasons we've got the confidence. But we're going to change the model. And people tell us they want to recycle, and I'm kind of a broken record around here. You're going to have to give us -- every homeowner is going to have to pay us about $1 more a week, and they're going to have to give us about 2 minutes more a day of their good, responsible time. And if they don't want to do that, we'll be glad to provide trash service instead of recycling service because we're really good at that.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - Research Analyst [6]

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All right. Yes, that's really good. And then one last one just on the volume guide of 0 to 25 bps. So can you talk about some of the puts and takes there? I mean, I thought you were largely through the broker culling. I don't think special waste has any real big comps, and frankly, it just doesn't really feel like a 0-volume environment. So can you just talk about what's driving that outlook? Is that just conservatism? And -- or is there something more idiosyncratic?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [7]

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Yes, there is a headwind associated with the special waste that we have going from '18 back into '19. So that's part of the reason why that volume growth is more muted. And at the end of this year, we're going to be about halfway done with shedding of brokers. But if you extract that out of the equation, if you remove broker volumes and those event volumes, the volume growth is closer to 1% to 1.25%.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [8]

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And let me add to that. On top of that, we've got some strong price here, too, right? So we're being very intentional about where we can get pricing, and we understand the trade-off of price and volume. So for instance, in our temp roll-off business and so forth, you know how that works, Tyler. So if we can get an extra point of price because demand is there, we might see -- we might give -- let a little volume go for that purpose.

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Operator [9]

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The next question will be from Brian Maguire of Goldman Sachs.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [10]

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Just a question on just the interrelationship between the CapEx and volumes, because it seems like the CapEx will be up again, and I thought of, in the past, the model being a little bit more like 10% of sales. It looks like we're going to be in that 11% to 12% range, 10% of sales if we're getting roughly 1% volume growth. And totally appreciate walking away from some broker business and some residential business that doesn't meet your return hurdles. But I would have thought, with that would have come actually maybe some reductions in CapEx or shifting of trucks from less productive routes to more productive routes. So can you help me maybe understand where this CapEx is being spent and where that number could be heading over time? And in kind of a flat volume environment, why it should be so high?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [11]

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Yes. So keep in mind that included in that CapEx guide, there's $75 million of what we're calling spend associated with tax reform, and that's money, as I said, that we're going to put back into the business, benefiting the frontline employees. So if you -- Brian, if you pull that out of the equation, then what you end up with is CapEx that's closer to 10.5% of revenue, which is right in line with where -- what we've told The Street that we would be at kind of post rev recognition, which is, on a historical basis, is closer to 10%. So that's right in line with our -- what we believe our long-term average should be.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [12]

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And this will be the last year with that sort of outsized spend on employee stuff?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [13]

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Yes, we've got 1 more year, that being 2020, where we're going to -- we have about $100 million that we're going to spend doing the same thing. But keep in mind that we talked about this back when tax reform was first enacted going into Q4 2017.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [14]

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Got it. And then just one more for me just on -- tax rate in general in 4Q was a little bit lower than your guidance. I was wondering if you could help us with that. And then just thinking about the '19 guidance. I appreciate the EPS is kind of in line with what you outlined earlier, but it looks like the tax rate may be a little lower. Just a little confused on that. Maybe I'm reading that wrong, but it seemed like it was 24% versus, I think, 27% before. So just trying to understand the puts and takes there.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [15]

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Yes, so both in 2018 and again, in 2019, we're going to benefit from solar projects, these investments that we're making that come with tax credits that we're able to utilize in order to reduce our effective tax rate but also to reduce our cash taxes. So just to put that in context for you, 2018, our effective tax rate was 20.7%, and then we had certain noncash charges associated with those solar projects that are included below operating income, right? So if you think about those 2 items together, then the net tax rate, including both of those, averages closer to 22.8%. As we go into 2019, our effective tax rate is 24.2%, and then we have about 3.1% in noncash charges related to those solar projects. So once again, if you put those 2 together, you end up with a tax rate of about 27.3%.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [16]

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Got it. So you're -- in those noncash charges, you're going to include that in that EPS.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [17]

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That's included in our EPS guide, yes.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [18]

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Got it. Okay, so they net out to 27%. Okay, just checking on that.

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Operator [19]

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The next question will be from Hamzah Mazari of Macquarie.

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Hamzah Mazari, Macquarie Research - Senior Analyst [20]

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My question is just around the cost side, specifically, how you guys are managing labor cost inflation, labor shortage. What's baked into your guidance there? I realize employee turnover is lower for you because every driver wants to work for Don Slager. But just any thoughts in terms of cost inflation?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [21]

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Yes, so our overall inflation, we think, for '19 is kind of in that 2.5 range. Labor will be a little higher than that. We do have pockets where we've got some labor shortage just because maybe there's local economic issues. Our turnover is essentially flat year-over-year. It's up a little bit with the growing economy. That's to be expected. We're not sitting on our hands. We're still working hard to improve the work environment. Chuck mentioned some of the investments we're making in facilities and specifically around employee facilities, locker rooms, training rooms, et cetera. So there's some labor pressure with long-haul trucking, which will impact our costs in and around transporting waste from our transfer stations to our landfills. We're dealing with that. But we're also doing a great job in and around with our procurement team. They've got goals this year. There are some spend categories that we historically haven't looked at. So we'll dig into those, and we'll find some savings there as well. But the driver shortage, so to speak, isn't keeping us up at night. We're working hard to retain and attract the best people, and I think we're on a good track. Landfill ops is going to be another part of the story. The leachate expense is going to be about flat year-over-year to what it's been this year, and that really is related to leachate because of just changes in POTWs or public treatment works that are changing their technology and starting to raise prices on leachate disposal. That's something we can manage through, and it's something we can price for. But I think that's going to be something, again, that affects all people in our business. And so I think, more than likely, you'll see more companies turning to some kind of price action to recover some of those costs.

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Hamzah Mazari, Macquarie Research - Senior Analyst [22]

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Great. And just my follow-up question, on pricing, you guided 2.75%. It feels like that's the highest price since '09 or just prior to waste saw a downturn because you guys are late cycle. Anything different in this pricing environment that you see versus prior to the downturn? Clearly, there's a lot of changes in this space over the last, I don't know, 10 years or so. Any thoughts on how this pricing environment is different, Don?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [23]

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Well, I guess, I'll say this, look, when organic growth is decent to good, that sets up the industry for a better pricing environment. I've always said that. So when there's decent organic growth, pricing tends to be better. The overall increase in capital cost, capital intensity, complexity of the business, I think, gives people a reason to price that maybe they didn't have before. So that lifts us up a little bit. Certainly, CPI has moved in our favor, and we're derisking our CPI portfolio. I'm moving to alternative indices that work for us. So that's going to benefit us going forward. Moving to alternative index, we've said $660 million now of that book has been converted. The hard work we're doing in and around recycling with the question that Tyler asked, we're doing a lot of contract renegotiations and new pricing. That's going to help. We've got a recycling processing fee that we've implemented. That's going to add some lift. And some of these things aren't fully implemented yet, so we're -- we still got some time to run under them and have them build through '19 and frankly, anniversary into '20. So we think there's a fair amount of upside there. As it relates to just us pricing customers, we've got a lot better at it. We're smarter about it. Our overall defection is down sub-7%, which would tell you that -- again, that's the lowest in the history of the company. We're spending a lot of time on customer experience, and so I don't believe you can just raise a customer's price. I think you've got to raise a customer's willingness to pay. And so we're working on further improving our service levels, meeting our service commitments, improving our products, improving our fleet, certainly having the best people on the front lines of our business. All those things, I think, give us pricing power in the end, and those things, we're going to continue to work on. So again, as you said, Hamzah, best pricing in 10 years. Basically. It's been building through the last few quarters. We're pretty confident we can achieve these levels in '19.

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Operator [24]

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The next question will be from Noah Kaye of Oppenheimer.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [25]

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Great to hear about solar project and electric trucks. Always nice. I wanted to ask you about the outlooks. You're reiterating the components of the preliminary outlook you provided in November, and I think we shouldn't be surprised by that. Investors have some to expect that consistency from you. The final numbers look to be the same. But has anything changed in the last 3 months within your assumptions, whether it's on volume, price, M&A or the cost side? And I ask in light of what is still a very sort of dynamic macro situation.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [26]

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Well, what's changing the macro is, last year, we spent a lot of time wringing our hands over this China thing. We're no longer dependent on China. Our team's done a lot of work moving material to new ports, opening new lanes. All of our material that we collect is handled and recycled ethically. So we've overcome the operational hurdle of that, and now we're settling into sort of a new cost model. So we're working through that and I've already described what we're doing there. From a growth perspective, right, we've always said we grow with population growth. That drives housing formation, business formation. So when there's population growth and there's job growth and there's wage growth, that's good for waste generation, right? So as long as we see the same kind of housing start number and consumer sentiment and spending is good, we think that's enough for us to continue to grow into the future. So we feel good about that. Chuck described some of the capital spending. Our CapEx is very, very consistent, other than when we got the gift from the government with the tax reform. We decided to spend $100 million or so to improve our -- $200 million, I guess, to improve our customer -- or our employee facilities. And these are not offices for general managers and staff. This is for frontline, hard-working men and women who show up at 2 in the morning and drive garbage trucks and fix garbage trucks and work at landfills. So those are the people we're most concerned about improving their work environment. So we're spending real money for a really good cause. So -- but that's not a surprise because we told you about that. So again, as you said, the business is very, on one hand, slow moving, which is maybe a bad thing for you, but it's slow moving, which is a good thing for you because it makes it predictable. So it shouldn't be a surprise to anybody that our guidance is right on top of the preliminary outlook because we got a pretty good handle on our business. And then what will change in '19 going forward? How fast can we move on restructuring the recycling business? That's going to depend on customer sentiment. It's going to depend on how well the market adjusts. It'll depend on what other competitors do, frankly. But our resolve is greater than it's ever been, and we're making some really great headway and we're having great examples of where customers are taking a good common-sense approach. And again, I gave an example in my written remarks. So we feel good about the business. We've got a really solid team here, and we're off to a great start.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [27]

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And just to come back to the labor question, I was really struck by the labor and benefits line. Expenses were up just 3% year-over-year. Obviously, that's a significant improvement in your cost containment. Anything you would point to in terms of kind of an improved success containing those labor costs? Anything we could think about going forward? Because, obviously, we saw a lot of growth over the first 3 quarters of the year, and what you are sort of suggesting for '19 suggests kind of a deceleration of labor cost inflation.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [28]

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Well, look, I'll hand that to -- off -- kudos to our operating leadership. They're really labor-focused on productivity, on efficiency and safety. Employee engagement's a big deal around here, as I said. I think we're probably the only solid waste company that does a nationwide employee engagement survey every year. 85% of our employees respond, which is double that of a world-class company. Our employee engagement scores are high. Our people trust that if they give us their opinions, we'll listen and we'll respond. We really are genuinely in earnest trying to make this the best place to work, where the best people come to work, and I think that helps us a great deal. And that's just not a slogan. It's what we really think. So -- and again, our operating leaders echo that throughout the organization. So I think that's part of it. Again, every year, we get a little benefit from the things we do last year. So we can continue to automate the residential fleet. We continue to make improvements in other areas. One Fleet continues to pay off. That investment, we don't talk about One Fleet anymore, but it's part of what we do now all the time, and it makes us more reliable. Reliable trucks mean more efficient trucks. They mean more happier drivers. So we're just going to keep building on the Republic Way, and year-on-year-on-year, we get better at the things we launched 2 and 3 years ago. We launched new things, and while maybe not one of them by itself is a game changer, it's the combination and sort of the sum of the parts that really make a difference for us. So we're just going to continue to build on that. So appreciate the compliment, I think.

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Operator [29]

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And the next question will be from Sean Eastman of KeyBanc Capital Markets.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Associate [30]

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I just wanted to touch on the M&A front. The $200 million planned investment seems to indicate an above-normalized year again in 2019 that's expected. So just hoping to get an idea of the profile of the discussions underway with your targets. Is it the usual singles and doubles? Or is there a good probability we might see something towards the upper end of that range in terms of target size?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [31]

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Well, it all depends, right? So look, we wouldn't tell you $200 million unless we felt pretty strongly that we could deliver it, right? So we've got a great pipeline, and again, we've got a great development team. We've got a lot of good people in place now who've been in place for a while, who know the business. Again, we don't go around incenting sellers because these are good companies we buy. And if you got a really great company, you're not likely to sell it unless somebody pays you an arm and a leg for it. So when it comes time for you to be in that moment, where you reach your business life cycle or your personal plan comes to fruition and it's time to monetize your life's work or something else happens, some kind of a life event, that's when we buy good companies. And we've been able to keep our multiple really consistent over the year. We're not overpaying for deals. And there are a lot of really nice companies out there, some really -- some companies of all sizes that we'd love to someday have an opportunity to be part of our network. And our job is to know the owners, to know where they're at in the life cycle and to be able to write a check. And we've consistently done that. We've sort of built our momentum up over the last few years, and we've got the appetite to do very big deals. It's just a matter of whether or not it's their time. So it's kind of like when the seller's ready, we're ready. And we're very good at integrating businesses. And so we're, first and foremost, focused on tuck-ins because those are, again, lowest risk, quickest return, best returns. It doesn't mean we wouldn't look at a brand-new market. If we could go into a new market and have scale and vertical integration, or at least the opportunity to over time, we would look at that. But you'll see us kind of stay in our lane. And -- with most of the acquisition activity. We've done some good work in and around the E&P space, and there might be an opportunity or 2 there that we'd look at. But we're very diligent about the ROI in these deals. We always compare and contrast the better use of cash to buy more cash flow at the right multiple or buying in our own stock. We're very comfortable with the value of our company and what value we're going to create over the next 3 years. We always look at that intrinsic trade-off. So this is kind of our formula. It's been kind of a balanced approach of cash allocation, dividend, buyback, keeping a strong capital structure, keeping our debt where we think it needs to be and having plenty of powder to do more acquisitions.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Associate [32]

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Got it. I appreciate that. And the next one I have is just on the differentiation strategy. You guys were speaking to the customer experience, customer willingness to pay. I was just hoping maybe you could talk anecdotally about where you guys have been finding -- you're getting some additional pricing power through that strategy. I just want to understand that a bit better.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [33]

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Well, we've had a lot of effort. Our marketing groups put a lot of effort into gaining customer insight. We probably spend more money on customer insights than any of our competitors really in getting to know what they think, what they want and for us to prioritize those things. Some of them seem pretty obvious on the surface, and some of them don't. So there's a lot of learning there. We are -- we're looking at digital opportunities. We're looking at ways to make it easier to do business with the company. We do have a digital channel for subscription residential business that actually has worked quite well. And new business coming into that channel comes in at a higher price than if we were going door to door. So people are willing to pay for convenience and reliability. And so you'll hear us talk more and more about digital as we go through time, not only digital in the trucks, digital in the operations to make us safer and more efficient but digital as we connect more and more to customers. And we think customers want to pay for that and are willing to because it makes their lives easier. So we'll continue to do that. And job 1, though, is to get the garbage off the ground every day on the right day in the right hour, do it safely and be a good environmental partner, and we're pretty good at that too. So...

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Operator [34]

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And the next question will be from Michael Hoffman of Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [35]

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Don, can you share with us where in the business model we're going to see the effect of the operating leverage? Is this going to be mostly OpEx or will this be a mixture of OpEx and SG&A as we work through that 30 to 50 basis points of operating leverage?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [36]

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Yes, it's mostly going to be OpEx, right? I mean, just to say, we still have some SG&A savings on the horizon. But I will say, look, and you always hear me say this, Michael, I mean, we've got 2 constraints. One is cash. We're only going to put so much cash to work on initiatives every year, and the reason for that is we can only take on so much change at a time. We've got 35,000 employees. We're trying to lead them in a direction, and we've got to get all 35,000 people to buy into that plan. And so we can't overload them with too many new things. But there's benefit and then pricing, right? I mean, we're going to price to beat inflation. We had years and years where we couldn't do that and now we've got momentum on our side to do that as well. So -- but those things go hand in hand. Better operations mean happier customers, mean better pricing.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [37]

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And then on free cash flow, I appreciate the approximately about $225 million, $225 million in spending over 3 years, so sort of the $50 million, $75 million and $100 million to reinvest into the employee base. If I get to strip that away and working capital timing things, how do I think about, one, what's the baseline free cash flow I'm starting with? And what's the sustainable growth rate -- your thoughts about that sustainable growth rate of that cash flow?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [38]

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Okay, let me explain it this way, Michael. If you take our reported free cash flow for 2018, so $1,178,000,000 and then I would back out about $45 million from working capital, which we believe onetime in nature. And then tax reform capital investment that you mentioned of $50 million, you end up with $1,083,000,000 and that was -- that I would consider to be a baseline. So then if you look at that relative to the guide that we gave for '19, that's about a 6% growth in free cash flow year-over-year.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [39]

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Okay. That's what I was trying to get at, is that's probably a good sustainable number. If I'm talking about a 4% at the top, getting the 6% at the cash is kind of a good relationship.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [40]

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Yes, that's right.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [41]

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Okay. And then just one more thing from a -- or maybe there's 2 housekeeping. What's your share count in your EPS guidance? And -- go ahead, sorry.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [42]

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Yes, so the share count is -- for the end of the year is 323 million shares. And then we'd expect that to decrease by about 2.5% during 2019 because of this -- our executing on the share repurchase program.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [43]

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Okay. And then in the 4.25% to 4.75% for total growth. The 1% that's acquisition, is that all rollover?

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [44]

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Michael, it's both in year and rollover. So we do have a little bit of the $200 million that we're investing this year is going to benefit us this year.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [45]

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Right, so if those get done earlier, that's the upside to that number, is what I was kind of getting at.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [46]

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Sure.

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Operator [47]

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The next question will be from Jeff Silber of BMO Capital Markets.

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Sou Chien, BMO Capital Markets Equity Research - Analyst [48]

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It's Henry Chien calling for Jeff. Just wanted to follow up on that similar question prior on your cost structure and how you're thinking about -- beyond natural operating leverage, are there any areas in the business where -- I was just thinking of the technology that you mentioned earlier in your remarks -- that are opportunities that you could maybe make the sort of long-term margin structure higher?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [49]

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What's your definition of long term?

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Sou Chien, BMO Capital Markets Equity Research - Analyst [50]

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The next few years, so beyond next year.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [51]

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Okay. Look, there's a lot of upside left in the business, right? I mentioned just something like One Fleet, where we don't talk about it much anymore. Internally, we do quite a bit. Obviously, we measure everybody against the standards. But there'll be a moment when all new trucks come in -- every truck we have will have been sort of brought into life under the One Fleet banner, and we'll even have a better fleet situation than we have today, right? So that day is out there, but that is long term. Some of this technology, we're excited about this thing we've got going on with Mack on the EV, but too early to tell, right? But that's why we're spending time and effort on this because technology has a real place in the future. We talked a little bit about technology in our new Plano next-gen recycling facility. There's sort of some technology yet beyond that, sort of robotics and things like that, that we're testing. So I will tell you this. I think there's a lot of opportunity yet with our digital operations initiative, and digital platform is kind of our fifth pillar of our strategy. But what I wouldn't want you to do is sort of run away with that too soon because we're involved in the conversations. We're involved in pilots and tests. We're involved in evolving technology where we can. And as we get sort of the magic formula, we'll be talking more about it, and then at that point, we'll be layering it into future guidance. But it's more right now for you to know that there's upside here, and we're working on it. And there'll be a moment when it comes to realization, and we're going to have a lot of -- talk more about it.

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Operator [52]

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The next question will be from Steve Schwartz of First Analysis.

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Steven Schwartz, First Analysis Securities Corporation, Research Division - Analyst [53]

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If I could just continue on that question with respect to fuel recovery fees, it looks like you, in your prepared remarks, noted a pretty significant sequential decline in fuel costs here in the first quarter. And I know that typically there's a lag between your recovery of increasing cost, which is certainly something that I think you faced over the past several quarters. So as we look for 2019 and your cost versus those fees, can you give us some color there?

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [54]

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Well, let me start. Fuel recovery fee isn't, I don't think, frankly, much of a story by itself because the purpose of our fuel recovery fee is to create a fair and equitable vehicle to sort of derisk the fuel that at some times in our history has been pretty volatile. It's somewhat of a built-in hedge against fuel prices. So while it does go up and down and at times can play a little havoc with our margin because of the lag, net-net of net over the long term, it doesn't really do much for us. It doesn't help us. It doesn't hurt us. It just sort of negates and offsets the volatility. That's the mindset.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [55]

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Yes. And then what I would add to that is that we anticipate fuel being up in 2019. And that's really due to a couple of things. One is the CNG tax credit. So if you think about that had -- providing for us in 2018 a $0.03 benefit in OpEx and then a $0.01 benefit of tax, so that goes away. And then also, we had some hedges in place during 2018 that ended up rolling off. So because of that, we're expecting fuel to be a little bit higher in '19 than it was in '18.

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Steven Schwartz, First Analysis Securities Corporation, Research Division - Analyst [56]

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Okay. So in other words, that cost, you wouldn't expect any significant difference from the 25 basis points that you have built into your revenue guidance for fuel.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [57]

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Yes, that's correct. I mean, if you think about it, the 25 basis points that the revenue goes up, you'd have a corresponding cost increase, maybe a little bit more because the CNG tax credit isn't tied to the fuel recovery fee. And that's the only disconnect you might have in there.

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Steven Schwartz, First Analysis Securities Corporation, Research Division - Analyst [58]

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Okay. And then my second question, my follow-up is just, once again, an extension, I think, off the discussion that you had with Tyler on volume. Through 2018, essentially, your volume declined. So from a comp standpoint, going through 2019, do you expect your volume to kind of play out through the quarters, I guess, in opposite or in mirror to what happened in '18?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [59]

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Yes, I would say that it would be relatively close to what happened in '18. The only thing I would say that we would need to be cognizant of are some of the quarters where we had especially heavy special waste volumes and C&D volumes coming into our landfill. That could skew the numbers a little bit.

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Steven Schwartz, First Analysis Securities Corporation, Research Division - Analyst [60]

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Got. Yes, yes, the first quarter of '18.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [61]

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If you look back -- exactly.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [62]

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Yes. I think, yes. I'll just add some color to that. We have a good outlook for growth this year, and we've got a good handle on, again, our sales efforts with our good sales tools and a great sales team. We think we're winning our fair share of new business. And at the same time, we're going to maintain the discipline to walk away from some business. We do have some municipal contracts out there that, frankly, don't perform very well for us. We're the incumbent, so we know all the costs, and we know all the pressures. And when we're the incumbent and we know that there's no profit or not a reasonable return in these things, we're going to probably walk away from some contracts. That's baked into that number, right? So that's going to continue. That's no different than it was in '18. So you got to make sure you understand that. That's going on behind the scenes net of net. So we're looking for our teams to either bring these contracts back around to profitability or move the equipment and the assets into utilization in other parts of the business. So that's the [guide we have].

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Operator [63]

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The next question will be from Michael Feniger of Bank of America.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [64]

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Just can you help me with the 30 to 50 basis points margin expansion in 2019? Is this back-end loaded? Is there -- how should we think about the quarterly cadence with still pretty tough recycling comps in the first quarter?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [65]

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Yes, I would say that it's pretty well distributed throughout the entire year. You're right. We have a little bit of a headwind associated with the recycling in Q1. So we need to keep that in mind, but other than that, I would say it's pretty well evenly spread.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [66]

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Okay. And then...

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [67]

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Yes, Michael, so -- Michael, just to put a finer point on that, so you're exactly right. As Chuck mentioned, our most difficult commodity comp, we still have a little bit of a headwind in Q1 just because that was the highest-priced quarter of last year. And then when you look forward, as Don talks about pricing, the pricing momentum will build. As we go in and we renegotiate and we get more and more of our recycling municipal customers to agree to price increases, that will build. So you do see a little bit. Think about Q3 as kind of our strongest quarter, and that's kind of where you build up in expansion in Q3. And that's kind of how you can think about the distribution.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [68]

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Okay. That's helpful. And then did you say earlier in your comments that you had 10 basis points of margin expansion off solid waste in the quarter?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [69]

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That's right. That's right.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [70]

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Yes. I'm just curious. I mean, if you're talking about shedding non-regrettable contracts, walking away from some of these resi contracts, which we know can be low margin, seeing the best pricing in 10 years and with the mix of the business, wouldn't we -- would we expect that number to be higher at this point of the cycle?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [71]

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Keep a couple of things in mind. One is that we had a headwind associated with special waste, right? And the other one is that we had -- as we had talked about, a little bit higher cost from our landfill operating. So that's masking or diminishing that growth that we called out.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [72]

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Okay. And just lastly -- that makes sense. On the average yield, the 2.75%, like how much of that is just automatic -- from '18, is just automatic from the CPI uplift? And how much of that is pushing on the open side?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [73]

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Yes, about 10 to 15 basis points is coming off of CPI.

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Operator [74]

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And at this time, there appear to be no further questions. Mr. Slager, I'll turn the call back over to you for closing remarks.

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Donald W. Slager, Republic Services, Inc. - President, CEO & Director [75]

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Thank you, Denise. In closing, I would like to thank all Republic employees for their hard work, commitment and dedication to operational excellence and of course, creating the Republic Way. Additionally, I'd encourage everyone listening to this call to take a few minutes and visit recyclingsimplified.com. It'd be good for everyone to learn how and what to recycle this very day. We all have an opportunity to do our part to create a cleaner and healthier environment. Thanks, everybody, for spending time with us today and be safe out there. Have a good evening.

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Operator [76]

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Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.