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Edited Transcript of RSG earnings conference call or presentation 25-Jul-19 9:00pm GMT

Q2 2019 Republic Services Inc Earnings Call

PHOENIX Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Republic Services Inc earnings conference call or presentation Thursday, July 25, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian A. Bales

Republic Services, Inc. - Executive VP & Chief Development Officer

* Charles F. Serianni

Republic Services, Inc. - Executive VP & CFO

* Donald W. Slager

Republic Services, Inc. - CEO & Director

* Jon Vander Ark

Republic Services, Inc. - President

* 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

* Derek Spronck

RBC Capital Markets, LLC, Research Division - Analyst

* Jeffrey Marc Silber

BMO Capital Markets Equity Research - MD & Senior Equity 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

* Misha Emmanuel Levental

Wedbush Securities Inc., Research Division - Research Analyst

* Noah Duke Kaye

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

* Patrick Tyler Brown

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

* Sean D. Eastman

KeyBanc Capital Markets Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Republic Services Second Quarter 2019 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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Thank you, Allison. I would like to welcome everyone to Republic Services' Second Quarter 2019 Conference Call. Don Slager, our CEO; Jon Vander Ark, our President; 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 rerecording of this conference call, you should be sensitive to the date of the original call, which is July 25, 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 expressed written consent of Republic Services is strictly prohibited.

I want to point out that our SEC filings; our earnings press release, which includes GAAP reconciliation tables; and the discussion of business activities along with the recording of this call, are all available on Republic's website at republicservices.com.

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. - CEO & Director [3]

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Thanks, Nicole. Good afternoon, everyone, and thank you for joining us. We are extremely pleased with our second quarter results, which clearly demonstrate the underlying strengths of our business. During the quarter, we successfully priced in excess of our cost inflation, achieved EBITDA margin expansion of 50 basis points and increased earnings per share by 8%. We expect a strong momentum in the first half of the year to continue. As a result, we are reaffirming our original full-year EPS and free cash flow guidance provided in February despite continued declines in recycled commodity prices.

During the second quarter, commodity markets continue to be challenged. We overcame these headwinds by focusing our efforts on things we can control. In particular, transitioning to a more durable, economically sustainable recycling business model. As you'll hear from Jon, we are making good progress and seeing results. For example, the revenue and EBITDA impact of lower recycled commodity prices in the second quarter was $8 million. Because of the team's relentless efforts, we overcame this headwind and increased recycling revenue 6% versus the prior year.

In the second quarter, we invested $129 million in acquisitions to further enhance our leading market position and drive growth in free cash flow. Our current deal pipeline continues to be strong. As a result, we now expect to invest approximately $550 million in acquisitions this year. We estimate these acquisitions, net of divestitures, will provide 125 to 150 basis points of top line revenue growth in 2019.

During the quarter, we also continued our balanced approach of returning cash to shareholders. We returned $213 million through dividends and share repurchases. Additionally, our board approved an 8% increase in the quarterly dividend, in line with our 10-year dividend CAGR. The consistent growth in the dividend demonstrates the stability and predictability of our cash flow as well as our confidence in the future cash flow generation capabilities of our business. Through the consistent execution of our profitable growth through differentiation strategy, we have created a solid foundation for our business. We are leveraging this foundation to deliver results and increase long-term shareholder value. Our second quarter results clearly demonstrate this.

Next, turning to our people. In recent years, our efforts to create an environment that attracts and retains the best talent have been recognized by reputable third parties such as Barron's, Ethisphere and Glassdoor. Most recently, Republic Services was named to Forbes' list of best employers for women. I'd like to thank our team for their relentless efforts to create a more inclusive culture and an environment in which all individuals are welcome and valued.

Finally, we believe as we grow the business, so does our potential to drive change and positively impacts the environment and society overall. We know we can do more and are raising the bar through our latest long-term sustainability goals, which we announced last week. Through the pursuit of achievement -- and achievement of these goals, we will further enhance the foundation of our business and continue to create long-term value for our employees, our customers, communities and shareholders.

I'll now turn the call over to Jon to discuss our second quarter operating performance. Jon?

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Jon Vander Ark, Republic Services, Inc. - President [4]

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Thanks, Don. The pricing environment in the second quarter remained strong. Total core price was 4.6%, and average yield was 2.8%. Core price included open market pricing of 5.5% and restricted pricing of 3.1%. Our pricing continues to benefit from the use of our tablet-based pricing tool. Through this tool, we are monitoring price elasticity and adjusting accordingly.

Additionally, we are benefiting from the advancement of several other strategic initiatives. First, we continue to successfully convert customers from CPI-based pricing to a waste-related index or a 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. We have now converted $715 million or 29% of our $2.5 billion CPI-based book of business.

Next, we regularly reassess our landfill pricing to ensure we are covering the total lifetime cost of managing the waste we accept. Third, we are proactively renegotiating our municipal recycling collection contracts. We are ensuring they reflect the true cost of recycling and include a more equitable risk-sharing arrangement. We've now secured price increases from approximately 29% of our municipal recycling customers, up from 21% in the first quarter. And finally, we're increasing our customers' willingness to pay by providing superior service and leveraging technology to make it easier for them to do business with us.

Turning to volume. Total volume in the second quarter increased 10 basis points versus the prior year. Underlying volume growth was 80 basis points after normalizing the impact of intentionally shedding certain volumes. This included work performed on behalf of brokers and nonregrettable contract losses in our residential collection business.

During the quarter, recycled commodity prices continue to decline. Our average price per ton decreased 14% to $78 versus $91 in the prior year. This resulted in an approximately $8 million or $0.02 headwind versus the prior year.

We offset the impact of lower commodity prices through additional pricing and increased recycling revenue in the second quarter by 6% versus the prior year. Our ability to increase revenue and overcome these headwinds demonstrates that we are transforming the recycling business into a more durable, economically sustainable business model.

In our recycling processing business, we have now secured price increases on approximately 55% of our contracted volumes, up from 34% in the first quarter. In our collections business, as I mentioned earlier, we continue to proactively secure price increases and renegotiate our municipal contracts. Additionally, in the collection open market, our recycling processing charge is enabling us to recover our processing costs and minimize volatility from changes in recycled commodity prices. This chart -- this change contributed to an additional -- this charge contributed an additional 40 basis points of pricing not reflected in average yield. If included, average yield would have been 3.2%. These results demonstrate that our customers do value recycling and are willing to pay for the service.

Finally, our adjusted EBITDA margin in the second quarter was 27.9% and expanded 50 basis points versus the prior year. Strong pricing and solid cost controls enable us to more than offset a 20 basis point headwind from lower recycle commodity prices.

We saw good operating leverage in both labor and maintenance again this quarter. Both of these costs, as a percent of revenue, decreased versus the prior period. Labor expense is benefiting from our focus on process and routing efficiencies as well as our efforts to increase employee engagement. Turnover decreased versus the prior year for the second quarter in a row.

Maintenance expense continues to benefit from our One Fleet standardized maintenance program. Today, approximately 90% of our work orders are scheduled. This enables us to take the reliability of our fleet to the next level and further improve our already high customer service delivery rate of 99.9%. By providing even better service for our customers, we can further enhance customer loyalty and increase their willingness to pay.

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

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [5]

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Thanks, Jon. Second quarter revenue was approximately $2.6 billion, an increase of $88 million or 3.5% over the prior year. Revenue growth was primarily driven by strong pricing across our collection, disposal and recycling processing businesses. Our revenue growth came in at an incremental EBITDA margin of over 40%. SG&A expense as a percentage of total revenue was 10.1%. For the full year, we continue to expect SG&A expense to be approximately 10.4% of revenue.

During the quarter, we grew EBITDA dollars by 5% versus the prior year and expanded EBITDA margin by 50 basis points.

For the full year, we continue to expect approximately 30 basis points of EBITDA margin expansion, in line with our original guidance. Year-to-date adjusted free cash flow was $621 million and in line with our expectations. Cash flow generation in the first half of the year positions us well to achieve our original full year guidance.

At the end of the quarter, leverage was 3x and within our optimal range of 2.5 to 3x. Interest expense in the second quarter was $99 million and included $12 million of noncash amortization.

In the second quarter, relative to our expectations, cash-related expense was favorable by $0.01. Our adjusted effective tax rate was 24% and provided a $0.04 benefit. This was partially offset by a $0.03 cash-related headwind from a noncash charge of $12 million. For the full year, we expect an effective tax rate of approximately 23%, 100 basis points lower than our original guidance and a noncash charge of approximately $60 million, which is consistent with our original guidance.

Finally, as Don mentioned, we are reaffirming our original full year financial guidance provided in February, which included EPS of $3.23 to $3.28, and free cash flow of $1.125 billion to $1.175 billion. We're assuming current economic conditions continue and recycled commodity prices remain at current levels of approximately $75 per ton for the remainder of the year. Relative to our original guidance, the decline in recycled commodity prices has created a headwind of approximately $50 million or $0.11 of earnings. We are offsetting these commodity headwinds primarily through strong pricing and solid cost management.

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) Our first question today will come from Tyler Brown of Raymond James.

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

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Nice quarter. But, Chuck, so I don't want to dwell on the guidance too much, but it seems like there's quite a bit of movement here. So like if we look at this from a high level and, let's say, we started at the midpoint of $3.26, you're going to reduce that by some recycling prices, you add back some from incremental M&A. Maybe you take away some because you're doing less of a buyback because of that M&A and then maybe you're getting a few pennies back on the tax rate. But basically, is that -- are those the moving pieces? And if I do all of that math, is there really any change in the core trends is really my question?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [3]

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Yes, I think you've got the component pieces, Tyler. I mean you talked about the commodities being a little bit more of a headwind than we had originally anticipated. We continue to do good work in terms of recycling processing charges and improvements there. Certainly, cost control has been a good story for us. The other thing is pricing, and pricing is coming in a little bit stronger than we had originally guided to and we believe right now that, that's going to continue for the rest of the year.

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

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Okay. And then on the M&A side though, it sounds like you're raising the expectations there. That's correct, right?

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

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That's correct.

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

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So that would be a positive, and then maybe you're taking some of the capital from buybacks to the M&A. Is that correct?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [7]

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That's also correct. As you know, Tyler, as we've said you before, especially during midyear-type acquisitions, you spend a little bit of money to get things integrated. So there's not a ton of bottom line benefit in the first year, but great rollover benefit in the next year. But there'll be some benefit. And as we said in the comments, certainly going to drive some top line revenue growth from that as well.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - MD [8]

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Okay. Don, so $550 million, if I go back to my notes, that must be one of the strongest M&A years that we've seen in a long time, maybe outside of the Tervita year. But what's really driving the strength there? Are these chunkier deals? Are there just a lot of small tuck-ins?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [9]

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There's a couple of chunky ones in there. Again as we've always said to you, that, one, we're going to remain opportunistic, right? We're going to remain flexible with our balance sheet and keep our [debt and] leverage where it needs to be. We've got plenty of dry powder to do good deals at the right price. When it comes down to buying good cash flow, good, consistent, reliable cash flow at the right multiple, we'll do that in exchange of buying in shares. So that's always been our model, but we don't overpay, we don't overspend. If you take a look at what's happening under the hood with our ROI, we're driving that in the right direction, so you can see that these investments are paying off in the long run. And there are things that are well within our footprint and our ability and our team's core competence, so it's all good stuff, and we're going to continue to do it. $550 million will be an outsized year compared to the years passed. I think we started this year at $200 million and then boosted it to $300 million, $400 million, I guess, pretty quickly. So yes, $550 million is a good number for us, and we'll talk more about what we think the pipeline looks like when we see you in October for next year.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - MD [10]

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And so maybe my last one here. So, Don, just a bigger picture question. So we saw the release around the 2030 sustainability goal, so I appreciate all that. But I want to talk about 2 of the goals that were in there that I surmise both have a sustainable and maybe have a direct financial impact. So first, can you talk about some of the specific plans to cut the reportable injuries in half, just particularly given that it's kind of hung around these levels the last few years despite your side loader adoption? And then secondly, your employment engagement store -- scores, they have been slipping just a little bit, not a lot, but a little bit over the past couple of years. Can you talk about maybe why and then how you plan to get those up? But those 2 pieces, if you could.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [11]

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Yes, sure. First of all, I think, look, when you look at what's happening just above and beyond just engagement, all of the other sort of cultural impacts we're having, I think we're having a -- and Jon mentioned in his commentary a lower turnover now for the second quarter, right, that's 2 quarters in a row. So it's continued focus. And I would tell you that having turnover that's flattish to down in this economy is a much bigger story than we probably mentioned on the call, right? So the combination of some of the fleet reliability stuff that Jon and the team have delivered on, the focus on safety, leadership training, we've invested in frontline leadership training, we have all of our frontline supervisors coming through this building and some of them now come through for the second time. But we're seeing really good trends developed underneath, and those trends have to -- we have to continue. And again, these things -- this is a sort of a long-term aspirational goal, but we're very confident. Let me have Jon add what he thinks.

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Jon Vander Ark, Republic Services, Inc. - President [12]

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Yes. So on the safety piece, I think technology is going to be a huge play for us. You have cameras as the most immediate venture on that front. But then if you think longer term and you compare commercial vehicles to passenger cars, we are at the very early stages of a lot of technology that's already available on passenger cars and pushing very hard our vendors to build that into the equipment going forward, and they all have that in their product road maps. And things like active safety lane assist, all those things will help us become safer. And then engagement, we are rising -- our workforce are becoming digital natives and that will be increasing percentage of our workforce. And as we put technology and we don't think about that singularly, we think about making our customers' lives better. We also think about making our employees' lives better. And as we've done that, a lot of investments historically on the sales force, we've seen that with engagement scores with them. They're more engaged, they're more connected. Their lives are easier and better, and we think we're going to see the same thing in the operating side of the business as we roll more technology in that part of our workforce.

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Patrick Tyler Brown, Raymond James & Associates, Inc., Research Division - MD [13]

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Okay. Perfect, Jon. I know those are long-term goals, but I appreciate the color.

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Operator [14]

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Our next question will come from Brian Maguire of Goldman Sachs.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [15]

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Congrats on the progress on transforming the recycling business. Just a couple of questions. On the landfill side, it seems the volume growth was really strong there, up about 6%. Just wondering if there's any onetime kind of special waste benefits in there? Anything kind of unusual you would call out in that solid growth there?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [16]

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Yes. I think landfill has been very strong on both price and volume. So good sign of economy, and I think also good sign of our leadership in that area where we continue to raise prices on landfills. We know that these are expensive assets, hard to operate and own. And we want to think about the total life cycle of everything that we bring in and are pricing accordingly and also seeing the volume growth associated with that. So it's been a good story for us.

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

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There's nothing really there that's going to – it is a tough comp from last year or for next year. It's good, solid across the board.

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

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Okay. And then just sort of a little bit on the flip side, collection volume seemed like they -- and I understand you're shedding some broker business and some of this is not regrettable. But it seems like it slipped a little bit and continues to kind of underperform the industry a little bit. Just any comment you have on general trends there outside of the broker business?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [19]

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Well. No, I would say, there was one sizable loss, customer loss in the quarter, a large national account, with garbage that was just too heavy for the amount of price they wanted to pay, right? And so that does happen. We're going to continue to again have nonregrettable losses. And so nothing unusual, nothing's changed with, I think, the market and nothing's really changed with our strategies. Just timing is a little bit lumpy from time to time.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [20]

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Okay. And then just on the input costs. The one that seem like it tick back up again with just some of the disposal cost and our leachate's been kind of a problem for a lot in the industry. Just any color you can give on how those are trending into 3Q and the back half of the year? Should we expect sort of continued margin headwinds on leachate?

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

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Yes. I think you're right on the landfill operating, particularly, leachate, listen, we suffer from weather and we've had a couple of wet seasons that doesn't come out of the landfill immediately, but does over time. I think you'll see that trend, that cost, that trend move favorably going forward, Brian, while we continue to maintain a pretty robust pricing environment.

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Operator [22]

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The next question will come from Noah Kaye of Oppenheimer.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [23]

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Actually, if I could just follow up on the previous question. So you got about $10 million, it looks like, in price realization on the landfill, and I'm just applying the yield of growth to the landfill business. And the leachate costs also went up about $10 million. So obviously, getting 1.7% yield is better than it had been in the past. But in recent view of tightening disposal capacity and these cost pressures, could this be an area where maybe you can push price a little bit more and we can -- going to see a tick-up past the 2% range?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [24]

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Well, let me take a high level and Jon can give you some background. But if you look at the results in the quarter and you look at our landfill pricing trends and you'll look at, to your point, ultimate long-term scarcity and difficulty of owning and operating landfill business, yes, there -- pricing has been trending up in landfill space. And certainly, I believe there's more room for pricing in the landfill space. And then specifically, the cost of leachate, that's the kind of thing that has a real cost that ultimately will pass back through to the market, and the market is willing to pay for it because again these landfills are ultimately still few and far between. Jon?

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Jon Vander Ark, Republic Services, Inc. - President [25]

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Yes, let me add. There's a natural lag, right? The cost hits us immediately and we can't price immediately, where we price typically over a 30-, 60-, 90-day environment, sometimes a little bit longer depending on the contract. We are raising our environmental recovery fee because as we see cost increase, but we are going to price ahead of that cost.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [26]

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Okay. And roughly how much of that add in the recovery fee?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [27]

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Well, that's going to be a future period thing that we talk about. So stand by, and we'll talk about how that's impacting us in October when we talk about future rate.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [28]

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(inaudible) that are contemplated in the guidance.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [29]

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Yes.

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Noah Duke Kaye, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [30]

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I don't want to take away from what you did in this quarter. I mean your price -- your total price was ahead of your total operating cost inflation, which is impressive. And I think if we just look at some of these cost items, you held your maintenance flat year-over-year. And so I guess the question is, is that, that really from One Fleet? Is this kind of level of holding the line on maintenance and some of these items sustainable? How should we think about that.

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

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Well, think about some of the comments that Jon shared with you guys, scheduled maintenance is now 90%. That means unscheduled maintenance is 10%. So reactive maintenance now is -- we only spend a certain or very small amount of our time on reactive maintenance. So think about what that means to downtime, to driver satisfaction, to customer service, the safety and all implications. Not to mention just fleet cost, right? So that's been a long road for us to roll out One Fleet, but we started on the other end of that, but we were 20% scheduled. Now we're frankly over our goal of 80%. So that's now become a durable process in the company, right? So that's ongoing. You were saying some nice things about the price traction and the price consistency that we've got. Don't overlook the fact that in the restricted market, we've got over 3% price. So the team has been long working at turning around that restricted book of business, which is kind of the bane of my existence for a couple of years, right? And now we've got that book performing at 3% price. So it just goes to show you the way this business works. It takes time to get these things up and running. They've got long-term benefit. They do find their stride, and we tell you we're going to do something, we're going to do it. We've a couple of great examples here that all those things are coming to fruition.

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Operator [32]

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

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

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Just on -- I'm just curious, on the second half, could you just give us anything in terms of how we should be thinking Q3 versus Q4? I mean you definitely got the operating leverage in the second quarter, but margin of first half -- first half last year, it's still -- are still flat. So we're expecting similar leverage, it seems like, in the second half. Is there anything you kind of help parse through how we should think about the third quarter versus the fourth quarter?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [34]

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Yes. I think that we are expecting margin improvement in both the third and the fourth quarter, but most of that's going to come through in the fourth quarter. Keep in mind also that in the fourth quarter of last year, the margins were a little bit lower, they were 27.4%. So when we talk about that margin expansion for the second half of the year, like I said, a lot of that will come through Q4.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [35]

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And Chuck, just on the $550 million for acquisitions, how much is actually -- is baked into 2019? Clearly you must have some line of sight to be able to put that number out. How much is that is actually going to be baked in you think to 2019?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [36]

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In terms of the op income you mean?

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [37]

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Yes.

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

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Or it's the revenue. It -- so it's going to have a very little impact in terms of the margins. Obviously, it's going to improve the dollars, but very little impact on the margins just because of the ramp-up time, because of the time it takes to get the synergies out of these acquisitions. The true tailwind associated with those acquisitions will come in 2020.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [39]

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Okay. And just lastly, I know this is splitting hairs, but like average yield last quarter was highest in the decade, it ticked down a little bit. How do we think about that number in the back half? I mean I know comps gets a little tougher, but how do we think about that in the back half? And why don't we include the processing fee? I think that was taking you above 3%. Is that just because that, that number's just a quarter is not sustainable? Why don't we actually include that processing fee and some of the actionable recycling within that number?

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

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Yes, that processing fee actually fluctuates with the price of commodities. And so what we didn't want to do is introduce that volatility into our yield, right? In terms of the yield, it does tick up and down a little bit. There's a little bit of volatility associated with it. But as we think of the back half of the year, we think it's going to be relatively consistent.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [41]

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And so remember, in yield, there's always a little bit of a mix, right? There's mix geographically, there's mix by line of business by market vertical. That's always in the business, you're always going to have that. But remember, you're always getting the benefit because we're in this pricing environment, and we're in this pricing reset environment when it comes to pricing differently than CPI and also now repricing the book of business around recycling. So you're going to have that running out ahead of you. In other words, we're going to have this rollover benefit as we reprice contracts now with better contract structure and terms that we negotiated last year, this first quarter and second quarter. So as we keep anniversary new quarters, that's going to kind of -- they start catching up. So you're going to have that benefit out in the future. And one more point on RPC, that looks fair for customers, right? It's good for us because we don't have this crazy (inaudible) talk about that's what's real and is fair to customers and that helps us sell that to customers to try and -- so partnering with them and doing what's right for the environment and something they can get their mind around. Are you still there?

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Operator [42]

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Our next question will come from Jeff Silber of BMO Capital Markets.

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Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [43]

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In your prepared remarks, you pointed out that the incremental margin you got on the revenue growth, I think, were over 40%. You haven't seen those numbers in quite a while. I'm just curious how sustainable you think that is and where that might normalize over time?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [44]

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Okay. Well, I'm not sure what that was. But look, we told you for a long time that when the business is working sort of normally, that we do bring in new business in and around that 40% margin. So that's not new to us. Yes, it's been -- it hasn't been that high lately, but you've got a robust environment, right? So pricing strong, you've got -- consumer sentiment is good, consumer spending is good, all these things point in the right direction. You've got job growth, you've got wage growth, you got all these things that help the price around. You've got certain amount of volume growth that helps drive pricing up. So we've got the tools deployed. When you first introduced Capture -- how many years ago was that Jon?

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Jon Vander Ark, Republic Services, Inc. - President [45]

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Five?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [46]

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Yes, so we've got 5 years now of integrating that and making that sort of the way we do business, the adoption rates are just about 100%, right? So all of those things working in a good environment, and that's the result we get. So as we -- as long as you have that kind of a backdrop, that's what we'll have.

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Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [47]

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Okay. Great, that's helpful. And I know when we kind of look at the broader economy, you mentioned the consumer is very strong, but we're not seeing those kind of numbers on the industrial side or the commercial side as much. I'm just curious, from your exposure there, what are your customers telling you? Are you seeing the kind of weakness that we're seeing in some of the broader economic indicators?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [48]

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Well, we don't -- we've seen a little bit of softness in the Midwest, the Great Lakes and some of those areas. We're still seeing strong economies, east and west. So we've got a lot of good indication. Look, we look at special waste being strong, we think that's a great indicator of future projects. We see, again, more service increases than decreases. There's a lot of good data in our system that we track that still paints a pretty positive future. And when there's little softness here or there, that could be relating to a number of things, but we're not too concerned about that right now.

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Operator [49]

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The next question will come 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 [50]

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I just want to make sure that -- a point of clarity here. I mean you had 3.2% price increase yield in the landfill side of MSW, which is where the bulk of the leachate gets generated, that's expensive. So that's more than covering what you need to do and from a -- from the margin leverage of that all the way through the revenues of inflation. And you're getting pricing leverage on the part of the business that has the worst part of the leverage from leachate.

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

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Yes. So we're getting leverage on that piece of the business, Michael. You're right about that, but we need to get leverage on the entire landfill book. And as Jon mentioned, the leachate cost continue to rise, and we need to make sure that we're getting an appropriate return on that entire asset. So there's still some work to do there.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [52]

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Okay. On the revenues, the $550 million that you want to spend, you spent $180 million in the first half, that leaves $370 million. When you gave the number in the beginning, Don, and I'm going to ask you if you'd repeat it because I didn't write it down fast enough. What are you assuming in the current outlook that, that converts to in booked revenues in '19?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [53]

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Yes. 1.25% to 1.5% top line.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [54]

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Top line. And that -- and you have spent the whole $550 million? Can you share some thought or...

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [55]

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We'll give the remainder over the second half of the year.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [56]

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Yes. We haven't spent it all yet, but we'll spend it...

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [57]

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No, no. Yes, but the assumption in the 1.25%, 1.5% is the whole $550 million spend?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [58]

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Yes, right. So look, we have a pretty tight system here on deals in -- pipeline deals in process, deals under contract. So we've got a pretty idea where we are. So we have a high level of confidence in that delta or we wouldn't have given it to you.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [59]

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Okay. And no, no, I get that. I just wanted to understand. So what do you think the rollover into 2020 for acquisition? On January 1, you have in hand, what contributing related to the acquisition?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [60]

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Yes, revenue.

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

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I would say, think of the incremental growth on that, it's 50% that would roll in. Because if you think of the $550 million, we're about halfway through that. So you -- and half of that contributions are top line growth rollover.

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

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We're talking revenue. We're not giving you guidance on margin, and yes, that comes in October month.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [63]

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Just trying to understand what the revenue rollover is now.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [64]

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And this was my point earlier, right. I mean, especially when we're having kind of robust second half M&A activity, really nice rollover into next year, right? So that's a good thing to have.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [65]

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And with it comes operating leverage on that rollover, so it creates a momentum.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [66]

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Absolutely. Sure.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [67]

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So that's the point of this. Okay.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [68]

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Very much.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [69]

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All right. And then it's all solid waste?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [70]

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Yes, it's all -- it's not all solid waste, it's all waste. It's all environmental service, it's all industrial waste, it's all stuff that we kind of do now and stuff that we're good at, and it's all within our capability set. We spent a little bit of money this year on some things around E&D and environmental industrial stuff, so it's a basket of things, right, but nothing outside what I would call our core capability.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [71]

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Yes, okay. At expo, Brian offered out that you were looking at industrial liquids as an opportunity because, basically, you have a skill set there because you do so much leachate process. I think so that would fit into that bill as well that you might find...

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Donald W. Slager, Republic Services, Inc. - CEO & Director [72]

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Yes, look, I mean, here's the thing, right? When -- no different than when we first introduced you to the fact that we were going to invest in Tervita right now. Our timing wasn't the best on that deal, but it turned out to be pretty nice for us. It's delivered good returns for us. And what I told everybody then was, look, this is about what? What's it about? Transportation. It's trucking, it's material handling, it's disposal, it's engineering, it's land management, it's landfill expansion, it's environmental services, it's all the kind of things we do. We've taken that business. We've learned everything we need to know about it. We've expanded. We've made it a better business. And then what happens is that opens you up to some additional capability, right? So we're not going to go very far from what we do well because that doesn't make sense. And so we're slowly looking at other opportunities. The one you mentioned is an opportunity in the space, right? So just like how we say about M&A and solid waste, we look at everything. We take a look at how it lays over our capability and our footprint. And then we look at the cash returns and we compare the cash returns of that M&A and our capability to run it against the returns on buying back our stock, and it's kind of that simple. But just like we did a great job at Tervita, just like we're doing a great job turning the recycling business around. We've got capacity beyond just dumping 2 yarders and 4 yarders, right? We're really good at that by the way.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [73]

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Yes, you are pretty good at it. Last question for me, based on -- if the commodities all stay right where they are and all the things you're doing, will you, on a run rate basis, fully offset all of the headwinds including the first half incremental headwind going into next year that you'll -- that I don't -- we don't have to talk about recycling if the commodities stay right here as far as the headwind.

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Nicole Giandinoto, Republic Services, Inc. - Senior VP of IR & Treasurer [74]

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What I'd say, Michael, just to clarify. So in 2019, all of the year-over-year commodity headwinds that we're experiencing were more than offsetting through pricing. So we're improving the profitability of the recycling business, overall. If you -- as far as 2020 goes, we'll talk about that more in October.

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

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But having said that, if you listen -- if you re-read the prepared remarks, we're making progress on every front. In fact, we're making progress on moving those contracts, de-risking and again recycling is a many faceted business, but we're making progress on every front of recycling. So we're on a path, right, not only to sort of openly overcome a deficit we've created for ourself, but we're on a path to derisk the business to a point where we're not going to spend a lot of time talking about it anymore, right? We're going to grow it. We might shrink it a little bit here and there to grow it, but we're going to be able to grow it and run it and do a great job for customers and the environment without having to talk about all those crazy volatility that exists.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [76]

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Okay. So I -- that opened up one more question for me, sorry. So the Plano, Texas facility, that's sort of an example of opportunity where you'll lower labor because of the technology you're bringing to bear there.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [77]

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It's a combination of applying new technology and know-how with a customer who values recycling, is willing to pay and willing to take their fair share of the risk. It's a combination of all those things. So that may not be the case for every customer, but certainly it was from people in Plano. They valued it enough to come to the table and they were looking for a great partner and they found in us, right? So we're going to continue to push that model and the model works. Jon?

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Jon Vander Ark, Republic Services, Inc. - President [78]

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Yes. It allows us to do 2 things. We'll take out about half of the labor in a tight unemployment environment that becomes important because that sort of job can be a tough one to fill. It also helps us produce a better product, and technology produces a cleaner product on the end and, therefore, we think we're going to get little more from what we sell out of the back door of the facility.

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Operator [79]

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(Operator Instructions) Our next question will come from Sean Eastman of KeyBanc Capital Markets.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Associate [80]

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Compliments to the team on the first half. Really nice work.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [81]

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Thanks, Sean.

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Brian A. Bales, Republic Services, Inc. - Executive VP & Chief Development Officer [82]

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Thanks, Sean.

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Misha Emmanuel Levental, Wedbush Securities Inc., Research Division - Research Analyst [83]

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Yes, the first question for me is, just in light of the first half sort of price volume being ahead of expectations, and you guys are saying you're expecting that momentum to carry into the second half. I think we came into the year with a 2.75% average yield guide, and then a volume outlook of flat to up 25 bps. I'm just wondering, is that still the algorithm that we're trending to here, or is that not the way we should be modeling anymore?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [84]

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Yes, it's close. I would say that on the yield side, we're probably a little bit higher than the original guidance, maybe something a little bit closer to 3%. And then on the volume side, maybe a little bit lower than what we had originally guided to, maybe something slightly negative. So but net-net, it's good position here for the rest of the year.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Associate [85]

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Okay, that's helpful. And then next one is just on the acquisitions. $200 million to $550 million definitely not an insignificant change versus initial expectations. So just wanted to get a little bit more color on how you guys came that far. I mean is it just a function of timing or is there some sort of change in behavior in terms of your acquisition targets?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [86]

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Well, it's mostly timing, right? And we start the year, we've got a pretty good view of the pipeline, but then things develop over time. So remember, it went from $200 million to $400 million to $550 million. Is that fair?

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [87]

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$300 million.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [88]

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$300 million. So anyway, the point is we walked it up. And so we know what we know, we share what we know and we give you numbers that we're confident in and then as the world moves, we've been able to move it up. But some deals maybe move faster than we thought, and some deals came to market that weren't in the market when we first gave you guidance in February. Jon?

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Jon Vander Ark, Republic Services, Inc. - President [89]

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Yes, I think the team has done a great job. We've invested in resources and we've become a preferred buyer. And I would say, we've got a higher number of referrals to buy companies than we ever have because that's where employee engagement comes back. We treat the employees that we acquire with dignity and respect, and they understand this is a great place to work. And listen, owners care about money, but they don't care just about the money. They also care about legacy and how people are going to take care of the business that they built. And we've proven ourselves to be very good stewards of the business they're selling to us.

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Sean D. Eastman, KeyBanc Capital Markets Inc., Research Division - Associate [90]

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Okay, got it. That's helpful. And just last one for me, leverage at 3x. I think you guys said at the end of the quarter. I'm just wondering kind of later in the cycle, we're maybe at the higher end of the leverage target. Does this mean you guys sort of cool your jets a little bit at this point? Or just wondering how you guys are thinking about that.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [91]

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Well, look, we've kept our leverage at our target leverage now for I don't know how many quarters. But we do that very intentionally, right? So we continue to do the work continually through the year on the debt portfolio. We continue to do the work on what we think optimum leverage looks like. We continue to look at all the other outlooks that we should look at to understand our leverage, and we do that consistently and we have a lot of discussion in our board around that. We still think the target is that optimum is between 2.5% to 3% and could be more optimally 3%. So again, if -- when we're buying cash flow, right, we're growing the business, that obviously allows us to actually increase our absolute debt, but still maintain our leverage ratio, so it's just -- that's just math. So as long as we're buying really good cash flow at the right multiple, with right returns, we've got frankly a lot of dry powder to do that. So there really is no limit on us from that respect.

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Operator [92]

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The next question will come from Derek Spronck of RBC.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [93]

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Just first off, sorry to belabor the acquisition pipeline, but does that $550 million, make any assumptions around potential divestures of Advanced Disposals from the acquisition there?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [94]

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No, it does not.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [95]

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Okay. So that's -- Okay. In that -- I guess, it's still pretty early, but do you see that elevated potential M&A environment carrying forward into 2020 as it stands now? And then on top of that, the potential divestitures as well?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [96]

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Well, it's too early to talk about 2020. Again, we'll give you our preliminary outlook in October and we'll shore up that guidance in February. It's a robust pipeline, I would say that. And again, it's -- deal activity is usually driven by sort of seller situations and life-changing events and other things that occur. So there's nothing we're really doing to go out there and incent people to sell. It's all about being there with people already. And as Jon said, being the right kind of company the people want to sell to. And of course, maintaining our flexibility, financially to do deals and integrate those quickly.

So -- and then as far as the mandated divestitures from the big merger that's been announced, I think it's too early to talk about that, I think from what I know, they're still in separate request and they've got some work to do and they've publicly said what their target range is for divestitures. You can probably all imagine that we've got a pretty good handle on markets across these 48 states, and that when deals like that come to market, we're pretty good at assessing what opportunity might be there for us or where certain market positions might be something we're interested in. So there might be an opportunity there for us and others, and I'm sure my counterpart at Big Green Company in Houston has his phone ringing off the wall with people who want to buy those assets. So again (inaudible) for sure.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [97]

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Okay, that's great color. And how was the competition for these -- from the -- are the buyers that you're competing against for potential, some of the more attractive assets, have they remained relatively rational? Or is it pretty competitive in terms of acquisitions versus your peers there?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [98]

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I would say yes and yes, it's competitive and it's rational. In the end, there's always a mix, right? You may have to pay more for something that comes with real estate, a permit, a landfill sort of infrastructure, a platform-type acquisition in a new market, trying to expand into those can sort of come at a higher purchase price than a tuck-in. Tuck-ins come at a very nice value and they're very quick to turn around to producing cash flow and so on. But -- so competitive, yes and rational still, yes. There are issues -- there are times when maybe certain thing comes to market or maybe private equity comes into the program, things get a little squirrely then. So -- but you've seen by our pipeline of what we've done, we know we haven't chased deals. We've looked at just about every deal, large and small, that's come to market, and we haven't bought them all because sometimes, we're not the natural buyer. I think there's always a natural buyer who's got some type of leg up with synergy value, et cetera or market position that we don't have. So we're not always the natural buyer. We're not always willing to pay the going price. Maybe that somebody else does because of their current situation or willingness to believe in what they can do with the asset, and then there are -- sometimes there's a disruptor in there like private equity. But to look at what we're paying for deals now, last year, the year before that, all really pretty rational and that will be still our MO as we go forward.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [99]

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Okay, that's great. And then just one last one for myself if I could. Just on the restrictive markets and the move towards wastewater sewer index or is there a CPI plus type of index. Do you think you'll be able to continue to increase that book of business on your restricted side towards the new index? And what happens if a customer just says no? I mean, do you just revert back to the original pricing index and try again next time or do you walk away from a contract at that point?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [100]

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Well, first of all, there's something really great about being the incumbent, right? Because you've already made the capital investment. You know exactly the weight of the trash and the disposal cost and the cost of labor and all the situations that exist in the contract. So nobody knows the cost and the profitability of the contract you're in more than you do. So that's a good news. We're dealing with people that we already have in our book of business. So we get to know where we're at. If you look at the success that the team has had, that Jon spoke of in his comments, we add to that book every quarter. What do we have now, Jon? 7...?

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Jon Vander Ark, Republic Services, Inc. - President [101]

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729.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [102]

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Okay. So when we first went down that road, right, we thought it can't be done, it can't be done. And now here we are, a couple of years in, and we've converted basically 30% if it. So I think, frankly, when CPI is higher like it is now, it's actually easier to have the conversation with customers because you don't have big chasm between this 0.5% CPI and the 3% we need to get at. So if a customer flat-out doesn't want, can't, will not accept the fluctuation of an index, again, this is a government index, this is not a index we made up. It's got a lot of science behind it. It makes sense. If they won't accept that, then we negotiate for flat rates of 3% or better. It sounds sometimes those are 4% or better, depending. And if the customers just frankly flat-out doesn't make us a reasonable return, we cannot obviously keep that customer going forward in the current state. So we're returns-based seller, right? The Capture tool everything we do is based on the return, and this is a very capital-intensive business. So sometimes we got to go back in 3 or 4x to get it.

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Jon Vander Ark, Republic Services, Inc. - President [103]

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Yes. We have 2 things on our side. One, we're relentless, so we just keep asking; two, we're only asking for what's fair. We're asking for a reasonable increase that supports our cost increase for employees who live and work in the communities in which we're negotiating. So that argument, over time, resonates. We might not get it immediately because in local government, it takes time to get things done, but we keep asking and we're really pleased with our progress.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [104]

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And we do a really good job for customers, right. So -- and having said all of that, we're every now and then going to walk away from a piece of business because we just can't get there.

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Operator [105]

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The next question is a follow-up from Michael Feniger of Bank of America.

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Michael J. Feniger, BofA Merrill Lynch, Research Division - VP [106]

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Don, you mentioned some softness in the Midwest. Just to be clear, is that something that has transpired recently? Is that something you picked up in June or tracking that way in July? And Chuck, just on the volume side being slightly negative this year, I know you're doing a lot of intentional shedding. Is that just the intentional shedding portion of the brokerage business that you guys were talking about? Or was there something underlying of why that might be more negative than what you guys kind of were expecting at the beginning of the year?

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Donald W. Slager, Republic Services, Inc. - CEO & Director [107]

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Yes. I think the softness, I think, I would say even more of a slowdown or not meeting our growth expectations. Certain part of the construction, you see on the outside of Midwest, some of that's weather-related, right, and we've seen some of those markets kind of bounce back to our expectations too. So I wouldn't read too much into that right now.

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Charles F. Serianni, Republic Services, Inc. - Executive VP & CFO [108]

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Right. And in terms of the volume growth itself, we have walked away from some business. As Don mentioned, we're very returns-focused. So as our system begins to fill up, we're looking for where we can get the best returns, and we've demonstrated an ability to redeploy assets if certain customers aren't giving us an appropriate return on our work. So that's part of it also.

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Donald W. Slager, Republic Services, Inc. - CEO & Director [109]

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Yes. So overall, look, we think we're getting our fair share of the business. We've got great sales tools and pricing tools. We've got great pricing, internal controls working for our benefit. Again, building sight of a really strong and crystal-clear yield that we report and low churn and improving ROI. I mean those are the results of that kind of internal control environment that Chuck described, right? So -- and again as always, there's always a little bit of lumpiness in our business. You lose one big national account, and it does ding your revenue growth when you're a sole-growth business like us. If you net all this out, I mean, we're growing like we say that we typically do, it's population growth that drives growth in our business. And if you kind of net some of these things, we're right on top of that. So we're feeling pretty good about it.

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Operator [110]

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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. - CEO & Director [111]

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Thank you, Allison. In closing, we are extremely pleased with our second quarter performance, are well-positioned to achieve our original full year financial guidance. Our team's relentless focus on operational execution and passion for our customers enabled us to deliver these results. Thank you to everybody. We expanded EBITDA margins by 50 basis points and grew earnings per share by 8%. And then finally, we increased the quarterly dividend by 8% again, demonstrating our continued commitment to increase cash returns to shareholders and it also shows our confidence in the cash flow generating capabilities of this business. The team did a great job this year.

Thank you, everybody. Thank you, Republic team. Thank you for spending time with us today for those of you on the phone, have a good evening and be safe out there.

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Operator [112]

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Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation, you may now disconnect.