Good afternoon, welcome to the Republic Services second quarter 2018 investor conference call. Republic Services is traded on the New York Stock Exchange under the symbol RSG. All participants in today's call will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Nicole Giandinoto, Senior Vice President of Investor Relations and Treasurer. Please go ahead.
Good afternoon, thank you for joining us. I would like to welcome everyone to Republic Services second quarter 2018 conference call. Don Slager, our 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 July 26th, 2018. Please note that this call is the property of Republic Services.
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 a GAAP reconciliation table and a discussion of business activities, along with a recording of this call, are all available on Republic's website at republicservices.com. Also included in our press release are unaudited supplemental schedules that include a pro forma view of second quarter 2017 revenue and costs, had we adopted the new revenue recognition standard as of January 1st, 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.
Thanks, Nicole. Good afternoon, everyone, and thank you for joining us today. We are pleased with our strong second quarter results. The team sustained the momentum built in the first quarter by executing our business plan, advancing our multi-year initiatives, and capitalizing on strong solid waste trends. As a result, we continued to grow both price and volume, effectively managed our costs, and despite a $0.10 headwind from recycling, delivered double-digit growth in both earnings and free cash flow. Additional second quarter highlights include adjusted EPS of $0.73, an increase of 20%. Adjusted free cash flow of $323 million, an increase of 173%. Core price was 3.6% and average yield was 2.1%, both in line with our expectations. Average yield was strongest in our small container and large container businesses.
The majority of these customers are in open markets where we can leverage increases in demand for service, our enhanced product offerings, and our digital platform. We have converted almost 25% or $590 million of our CPI-based contracts to a waste-related index or a fixed rate increase of 3% or greater for the annual price adjustment. These waste indices are more closely aligned with our cost structure and have historically run higher than CPI. Volumes during the quarter increased 60 basis points. Excluding the impact of non-regrettable losses and a difficult special waste comparison in the prior year, volume growth would have been 1.4%. The solid waste business contributed 50 basis points of EBITDA margin expansion. We maintained customer defection of less than 7% for the second quarter in a row. We invested $56 million in tuck-in acquisitions in the second quarter, plus an additional $42 million in July.
This brings our year-to-date investment to $123 million. In February, we guided to over $150 million of investment for the full year. Our pipeline continues to be robust, we now expect investment to invest approximately $200 million in tuck-in acquisitions for the full year. Finally, we continued our practice of increasing cash returns to our shareholders. During the quarter, we returned $328 million to our shareholders through dividends and share repurchases. Additionally, our board approved a 9% increase in our quarterly dividend. This is consistent with our historical practice of raising the dividend in the mid to high single-digit range. The annualized dividend is now $1.50 per share. Next, I'd like to make a few comments on recycling. At this time, China's actions continue to create a supply-demand imbalance for recovered paper.
This unprecedented imbalance is causing commodity prices to remain low and processing costs to increase as mills become more selective in the quality of material they buy. While this situation is painful in the near term, we believe these market conditions will serve as the catalyst needed to transform recycling into a durable, sustainable business model, a model in which companies can continue to invest for the benefit of their communities without undue risk. The Republic team is taking action. We are working diligently to both minimize the near-term impact of these headwinds and accelerate efforts to shift our municipal customers to a fee-based pricing model with a more equitable risk-sharing arrangement. First, in the open market, we are raising prices to cover higher processing costs resulting from stricter contamination requirements. Second, in the restricted market, our sales team is meeting face-to-face with our 1,000-plus municipal recycling customers.
We are requesting an immediate price increase and adoption of a new pricing structure at or before contract renewal. This structure includes a fee to collect the material, plus a net processing fee that factors in processing costs, contamination levels, and commodity prices. Of the customers we've met with to date, 10% have already agreed to an incremental price increase within the next six months, and another 60% are reviewing and approving price adjustments or considering implementing the new pricing structure by the next contract cycle. Typically, negotiations with staff and city council approvals take months to obtain, so we are extremely pleased with the initial results of these concentrated efforts over the past 90 days. To support our initiatives to increase prices and transition to a new pricing structure, we are leveraging the current environment to drive awareness and change among our customers and consumers.
We are hosting webcasts, presenting to state and local officials, and conducting interviews with local and national media. Additionally, we are meeting with municipal solid waste directors and consultants to review the new pricing model and explain why it must be included in future RFPs. Finally, we are leveraging technology to increase productivity, reduce costs, and improve the quality of material recovered at our processing centers. Our customers have told us repeatedly that recycling is important to them, and they are demonstrating their willingness to pay. Although it will take time, with their help, we can ensure recycling is sustainable for generations to come. Next, turning to our full-year guidance. Despite a recycling headwind of approximately $0.30 versus the prior year, we are reiterating our full-year EPS and free cash flow guidance. Growth in the solid waste business is more than offsetting the headwind from recycling.
In fact, even if you remove the benefit from tax reform, we still expect to see mid- to high single-digit growth in earnings and free cash flow despite the recycling headwind. Looking forward, the immediate actions we are taking in the recycling business will not only benefit the remainder of 2018, but will also generate positive momentum heading into next year. The current macro indicators that impact our business continue to remain favorable. We believe this will lead to an increasingly supportive pricing environment and continued volume growth in the future. Now I'll turn the call over to Chuck, who's going to discuss our financial results in greater detail. Chuck?
Thanks, Don. Second quarter revenue was approximately $2.5 billion, an increase of $94 million, or 3.9% over the prior year. The increase in revenue includes internal growth of 2.1% and acquisitions of 1.8%. The components of internal growth are as follows. Average yield increased 2.1% and was in line with our expectations. Average yield in the collection business was 2.4%, which includes 2.6% in the small container business, 2.5% in the large container business, and 2% in the residential business. Average yield in the post-collection business was 1.5%, which includes landfill MSW of 2%. The majority of our third-party landfill MSW business is with municipal customers that have contracts containing pricing restrictions. Total core price, which measures price increases less rollbacks, was 3.6%. Core price consisted of 4.4% in the open market and 2.3% in the restricted portion of our business.
The second component of internal growth is total volume, which increased 60 basis points over the prior year. Volumes in our large container business increased 2.5%, and volumes in the small container business were essentially flat as expected. Small container volumes included an 80 basis point impact from intentionally shedding certain work performed on behalf of brokers, which we view as non-regrettable. Excluding these losses, small container volumes would have increased 80 basis points. Volumes decreased 2.8% in the residential business. The decrease was expected based upon our strategic decision not to renew certain contracts that fell below our return criteria. The post-collection business, made up of third-party landfill and transfer station volumes, increased 1.3%. Landfill volume was essentially flat. Growth in MSW and C&D was offset by a decrease in special waste. More specifically, landfill MSW volume increased 1.8%, and C&D volume increased 8.3%.
Special waste volume decreased 4.5% due to a difficult comp in the prior year. The third component of internal growth is fuel recovery fees, which increased 60 basis points. The increase relates to a rise in the cost of fuel. The average price per gallon of diesel fuel increased to $3.19 in the second quarter from $2.55 in the prior year, an increase of 25%. The current average diesel price is $3.22 per gallon. The next component, energy services revenue, increased 20 basis points. This is primarily due to an increase in drilling activity in the Permian Basin, where we continue to be well-positioned. The final component of internal growth is recycling, processing, and commodity revenue, which decreased 1.4%. The decrease in revenue primarily relates to lower recycled commodity prices and tons sold.
Excluding glass and organics, average commodity prices decreased 42% to $91 per ton in the second quarter, down from $157 per ton in the prior year. As Don discussed earlier, recycling continues to be a headwind, but it's important to note that recycling processing in commodity revenue represents less than 5% of Republic's total revenue. Beginning in Q4 of this year and into 2019, we expect the recycling headwind to decrease as the prior comps become easier. I will discuss changes in margin. In the second quarter, adjusted EBITDA margin decreased 180 basis points to 27.4% versus 29.2% in the prior year. This included 50 basis points of expansion from the solid waste business, which was more than offset by a 190-basis point headwind from recycling and a 40-basis point headwind from increasing fuel prices during the quarter. Our fuel recovery fee lags changes in diesel prices.
In a rising fuel price environment, we face a temporary headwind. In the second quarter, SG&A expense as a percentage of revenue was 10%. For the full year, we expect SG&A as a percentage of revenue to be approximately 10.4%. Second quarter 2018 interest expense was $97 million, which included $10 million of non-cash amortization. Our adjusted effective tax rate was 24.7%, which was lower than expected due to the resolution of an open tax matter. The lower tax rate provided a $0.01 benefit to EPS relative to the prior year. In the second half of the year, we expect our effective tax rate to be approximately 24% due to tax planning opportunities. Second quarter adjusted EPS was $0.73, an increase of $0.12 or 20% over the prior year. EPS included a $0.12 benefit from tax reform, which was offset by a $0.10 headwind from recycling.
Adjusted free cash flow for the first half of the year was $679 million, an increase of 89% versus the prior year. The growth in free cash flow was due to solid growth in EBITDA and a favorable benefit from the timing of working capital, which we expect to partially reverse in the second half of the year. We returned $320 million of cash to our shareholders through dividends and share repurchases. This included 3.2 million shares repurchased for approximately $215 million. Finally, as Don mentioned earlier, we are reaffirming our full year 2018 EPS and free cash flow guidance ranges. If recycled commodities remain at July levels of approximately $95 per ton, we expect to be at the low end of our guidance ranges. At this time, operator, I'd like to open the call for questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. In the interest of time, we ask that you limit yourself to one question and one follow-up question today. If your question has been answered and you would like to withdraw, you may do so by pressing star then two. If you are using a speakerphone, please pick up your handset before pressing the keys. Our first question today will come from Hamzah Mazari with Macquarie Capital. Please go ahead.
Good afternoon. The first question is just around M&A. Don, you're sort of raising the tuck-ins that you're doing. Historically, I think you said $100 million tuck-ins. Today, it's running a lot higher. Just curious what the pipeline overall looks like and at what point do you run into sort of antitrust? I guess you're $10 billion in revenue today. Can you get to $15 billion before that's an issue? Just maybe size up your pipeline longer term.
Well, look, if you think about the industry being $60 billion, what did we say, $30 billion of it is still in the hands of private entrepreneurs?
35%.
There's a big chunk out there. The issue really comes to, you've heard me say this before, most likely, we're not incenting people to sell their businesses. We're buying good quality businesses from good quality operators. People are getting to a place in the life cycle of their business where selling the company is an option. That may be because of their life plan, their succession plan, their age, you name it. It's been a good, robust pipeline. We think the pipeline remains robust into next year. We think we continue to deploy, call it that $100 million-$150 million a year for several years at least, because that's the sort of the timetable or the sales cycle of the pipeline we look at. As far as your antitrust question, when you think about this business, it still remains a local business.
When we think about having a first or second market position, which we do across 95% of our revenue, and having a first market position, it may start with the fact that you're vertically integrated, but it may mean you only have a market share of 25% or 30%. There's plenty of room to grow our share of a market through tuck-in acquisitions for quite a few years to come.
Great. Just a follow-up question on recycling. The actions you're taking are very encouraging. I guess it revolves mostly around contract renegotiations, just curious whether you think you have to spend capital in the recycling business today, or maybe at a later stage, or maybe that's off the table. Maybe for Chuck, is the recycling headwind $0.30 that's baked into the guidance? Thank you.
All right. I'll start and let Chuck finish up. I think you asked three questions there, Hamzah. The first one is, look, and I may have to say it a couple more times on this call because I'm sure it's on everyone's mind, but, I said it in the prepared remarks. This issue that we're facing right now emanating from China, while it's really painful in 2018, it really is overall a good thing. I'm really optimistic about this serving as the catalyst needed to actually change to fix the business. As we said before, recycling is a product our customers want to buy. It's a growing part of the waste stream. It's a business we want to be in because we want to be a good partner to our customers.
The fact is, our customers are voting with their wallets, and they are paying more for recycling. We've been very effective raising prices in the open market and recycling without losing volume. It's the contractual nature of the municipal business and contracts that are sort of five years on average and the nature of municipal budgets and sort of the political aspect of too many decision-makers in the process that slow us down there. The good news is, individuals, consumers want to recycle, staff wants to recycle, and certainly city councils and mayors don't want to give up recycling. We think there's a lot of room here to finally fix the business. I said in my remarks, we've talked to the lion's share of our 1,100 customers already, and we're getting good results. We've already renegotiated some contracts with new pricing ahead of the contract date.
We have a lot of customers already taking our advice and thinking about new ways to do things. We frankly have a handful of customers who've kind of scoffed at it. We'll have to reassess whether we like that partnership or not. Partnership is a two-way street. We're making a lot of progress. There's a lot of room for pricing here, and we're going to really use this opportunity to fix this business. The one point I'll make too is when we break this down to the absolute lowest common denominator, a household, a household is paying on average in the country $25 a month for twice-a-week service, once trash, once recycling. Let's say that's $20 on trash and $5 on recycling. That $5 needs to be $10 or $12.
We're not talking about an amount of money that breaks the bank for an individual ratepayer, and that's what lawmakers, city councils, those are people need to understand. I think the average citizen who wants to recycle and do good things for the environment will be more than willing to do that to make this right. That's the road we're going down. As far as CapEx, we will invest some CapEx. These won't be new facilities. These will be some advanced technology. We've already invested some CapEx in sorting equipment, some robotics, things like that. We'll continue to do that, but that won't be a material change in our capital spending, Hamzah. I'll turn it over to Chuck.
Oh, yeah. Hamzah, in terms of your question, so in our guide right now is $0.30-$0.32 of headwind associated with the recycling business. The good news is that that's being offset by the solid waste business. The solid waste business continues to perform very well.
Great. Thank you.
Our next question comes from Brian Maguire with Goldman Sachs. Please go ahead.
Hi, good afternoon.
Brian.
Just a question on cost inflation. I think we're seeing just general labor tightness, obviously trucking drivers, more of a long-haul situation, but just kind of general inflation out there. Some others in the industry have suggested you're kind of seeing 4%-5% rates. Wondering if you can kind of validate what you're seeing and then kind of related to that, as we exit this year and go into next year, what sort of a yield net pricing do you think you need to keep margins flat in the current environment?
Okay. Again, a multifaceted question. Let's start with labor. We are seeing some increases in labor costs, in direct labor, and let's start with the good news, right? That is a result of a strong economy. The underlying factor here is a strong economy. A strong economy helps our business be from a growth perspective. The fact that there is some labor increase also drives some inflation across the board, and we've always said a little inflation is good for us. Remember, we've got a big chunk of business still, even though we're making a big dent in that restricted market, we still have some business that escalates with CPI. The fact that there's a little more inflation, that will come back to us through CPI pricing as well.
As it relates to labor for us, we are, in some markets, in select markets, raising some wages and frankly, rethinking some of our pay plans. Here's the thing, we're focused on being an employer of choice, being a great place to work, attracting the best of brightest people. We're going to continue to do that. We believe in market pay. The backdrop to that is our turnover is low. It's dramatically lower than general industry. It's lower than trucking by a long shot. In the waste space, we think our turnover is lower than anybody's. Specifically drivers and techs, in fact, our tech turnover went down year-over-year.
Again, when we talk about employee engagement and do the right thing by people and being that great place to work, we're really serious about it, and that's one of the things I think that's helped us offset some of these pressures in the labor market. We'll see a little pressure there, and then as it relates to some of the long-haul waste transfer business, we'll see a little pressure there. The fact is, if those are structural changes, that allows us room to price, right? These type of things affect all companies. They don't just affect one company. We think they'll affect us less because of our focus on people and talent and turnover, and work environment. We'll use the opportunity for pricing, and we'll gain the advantage from how it affects CPI. All there is, there's a delay, right?
Mm-hmm. Right.
We're being responsive. We'll see more price in the second half of the year. Our RPM process, which you know is we don't just price once a year all at the same time. We price throughout the year. We've got still four buckets of price through the remainder of the year that we can lever up on in the open market. We'll do that to start to make up for it, and we'll push for pricing that looks more like a 3% yield, frankly. That's the conversations we're having internally.
Okay, great. This is very helpful. One on recycling, this is maybe a little bit of a bigger picture one, not trying to get too much into the ins and outs of China and what's going on. A lot of commodity markets, when you see a demand shock like we've seen from China, prices reset lower like we've seen. There's oftentimes a supply response. Recycling seems very different. Sort of the future you're portraying is one where really there won't be much change in supply. Everyone wants to do the right thing. My question is sort of, is there a place to put all of this material if China follows through on some of its proposals? Today, are you able to actually place all these tons somewhere in the world, albeit at a lower price and not a great margin?
Maybe you can kind of also just comment on how much you're actually exporting to China today that you would have to move to other markets if they did truly come out of the market.
Yeah. To use easy math, we're still about 60% domestic and about 40% that we export, right? Again, that's general math. Don't hold me to those exact numbers, but use 60/40, make the discussion easy. We've moved material away from China. We're virtually sending nothing to China today. We're still very closely in contact with our partners in China, who have had to shut down capacity because there's no inflow of material. They, I think, would agree with us, the demand for packaging is not lessening. In fact, most people you talk to, if not all people you talk to, believe that two things are true. The demand for paper packaging is going to continue to increase. If people continue to use virgin fiber pulp, the price for pulp is going to continue to increase, and then we get into this nice supply and demand economy again.
The fact that we've been able to move paper pretty easily to other markets, it says a lot about our team and our capability and the fact that packaging demand remains. Just in the big macro picture, the fact that you can argue where and how much, but sort of an expanding economy of people who want to buy goods and services, right? You want to call it a middle class or an emerging class in markets globally. I think those macro trends continue, so the demand will be there. The supply, I think, when we talk to customers, they want to recycle.
In the open market, the fact that we've aggressively raised prices on recycling and haven't lost customers because frankly, people are saying, "Hey, I'm okay paying just about as much for recycling as I do for trash because I've got to carry it out to my dumpster anyways.
Might as well feel good about doing something for the environment. I'm oversimplifying, that's generally the vibe that we're getting from our customers. We're going to continue to be a good partner. This is going to be a slow go as we continue to turn contracts over. The supply-demand economy is global, so it's going to take time. There are going to be other investments in domestic mills. These Chinese mills are going to look for other ways to clean up the paper, whether there's a lot of ideas on the table. This will take a few years to work out. In the meantime, as I said, and I'll say it over and over again, this in the long term is a good thing. We at Republic Services run the business for the long term.
We don't get excited about something that's temporary in nature that makes our quarter hard or our year hard. This is going to be a good thing when we're all said and done, and it'll take a little time to sort out. We're being very opportunistic and very optimistic.
Okay. Thanks very much.
Our next question is from Noah Kaye with Oppenheimer. Please go ahead.
Good afternoon. Thanks for taking the questions. If we could start with volume. It's been a couple of quarters of positive volume here, and 1Q was particularly strong. As we get into the back half, obviously, the special waste comps get tougher, and I'm looking at your kind of original volume guidance for the year. I'm just wondering, and maybe it's something we should all be aware of as we go into the back half, how should we expect kind of those headline volumes to trend over the course of 2H? Will they kind of go flat or even negative? Just how to think about that so we're modeling appropriately.
Yeah, Noah, probably a little negative in the second half of the year. Right now, we had guided to 0 to 25 basis points of volume growth for the year. Right now, we're thinking we're going to be at or slightly above that 25 basis points.
Noah, I just would add to that, as Chuck mentioned, we might be flat to slightly negative in the back half, but if you exclude that difficult solid waste or, excuse me, special waste comp and the non-regrettable losses, we'd be looking at, for the second half volume growth, pretty similar to the first half.
That's a great point. Yeah, you should focus on that because that's the underlying trend in the business. I think it also demonstrates the sort of internal discipline that we use when determining what business we're going to do and what business we're not going to do.
Right. We're still in the sort of underlying 1%-2% volume growth environment. That should be understood when we're looking at these headline metrics.
Absolutely.
Second question. $700 million of buybacks for the year is very strong. It does imply a bit of a deceleration from 1H. I guess there will be more spend on this targeted M&A in the backup. Anything else to read into there just in terms of how you're lining up the balance sheet?
No, it's really the M&A. Obviously, $50 million more than what we had anticipated, also a little bit more in terms of CapEx. About $20 million is what we're anticipating, and that's really due to fund the growth that we're seeing in the business. Those are the moving items.
Yeah. Actually, it looks like you increased your assumption of operating cash flow for the year, you actually have that little higher CapEx to offset that. Your OCF is moving up from your original guide. Is that right?
Right. Yeah, that's correct. Right on.
Right. Okay, thank you very much.
Our next question is from Tyler Brown with Raymond James. Please go ahead.
Hey, good afternoon.
Hey, Tyler.
Hey, Tyler. Hey, Chuck. Can we maybe walk from the 29.2 to the 27.4, the EBITDA margins, maybe with a little bit more color here. I get the positive 50 from solid waste, the 190 from recycling, which I'm assuming includes dilution from ReCommunity and the 40 basis point fuel math. SG&A was an 80 basis point tailwind. Does that imply that core solid waste margins were down even ex fuel, which quite frankly is debatable whether that should be in there or not?
Well, keep in mind that the fuel, there's a lag on the fuel, right? In a rising fuel environment, we get a little bit of a headwind associated with that. Obviously, that reverses when fuel goes in the opposite direction when it decreases. What Don had talked about is that we're beginning to see a little bit more wage inflation in the core business, and that's happening in select markets. That is actually eating into a little bit of that SG&A benefit, Tyler, that we saw down below operating expenses. Once again, that's something that we're aware of and something that the pricing team is going to take into consideration second half of this year and into 2019 as we develop our pricing strategy.
Okay. It sounds like core solid waste is very solid. You're converting more to higher CPI. CPI is improving. All indications are is the open market remains very rational. Why are we seeing price decelerate specifically in the restricted, but I guess frankly in both, decelerate sequentially? I get the lack of the fee from last year in the restricted piece, again, why the decel sequentially?
On the restricted piece, we anniversary a significant price increase with a very large municipal customer, you see a little bit of a price decrease there sequentially. Once again, that's going to pick up in the second half of the year. Right? I would say in the open market, the core price continues to be very strong. This is the 20th quarter in a row that we've seen core price at 4% or higher in the open market. We continue to perform very well there.
Yeah, Tyler, as Chuck said, I'm sure a lot of our Republic leaders are listening. A lot of our field leaders, general managers, and sales managers are listening. They know the pricing is going to be picking up in the second half. We're going to recoup some of this recycling. We're going to take advantage of a growing market. I said, defection is down, sub 7, almost as low as 6% the second quarter in a row. We've got more room to price in the market. We've got a reason to price with the recycling issues in China and with some of this labor cost. CPI is going to pick up, right? Because we're going to start to see those second-half resets, it'll start to come back.
Did I hear you, Don, talk about 3% yields in the back half, or was that more an aspirational comment?
Yeah, that's not the back half. That's where we think we can go, right? We've been there before. That's not a number we've never seen. It's in this kind of a growing economy with a strong CPI, with good organic growth. That does impact market behavior, and we think we can get back there.
Okay, going back to one of the prior questions, there is a lot of inflation in the system. It's not just labor, but whether it's transportation, et cetera. Big picture, 2.1% yield is probably not enough in this inflationary environment, even excluding recycling, to really get sustainable solid waste margin expansion. Would you agree with that?
Yeah. With inflationary environment, we've got to be north of that. You heard the conversation earlier, we're going to be. That's where we've got to go.
Okay, just my last one here. Chuck, maybe a tax rate for next year. I know there's some moving pieces here this year.
Yeah. For now, the statutory tax rate's going to be a little over 27%. Without giving guidance, right now that's kind of our best guesstimate, maybe a little bit less than that.
Sorry, 27?
Twenty-seven, right.
Okay. All right, thank you.
Our next question comes from Michael Hoffman with Stifel. Please go ahead.
Thank you, Don, Chuck, Nicole, for taking my question. There's a little bit of a wind-up in this one because I'm trying to flesh out something that I think is being missed. If I started with your original outlook for the components of the bottom end of the range, $3.05 in February. I look at where you are today at $3.05. My math says you've got almost 35% improvement sequentially in the performance of the solid waste business inside that forecast.
Yeah, there is an improvement in the solid waste business, Michael. I'm trying to think of the easiest way to explain this. Let me do it this way. Original guidance to $3.05-$3.10, right? A recycling headwind right now, we're saying is going to be about $0.26, right? Improvement in the solid waste business above and beyond what was in the original guidance of $0.10, then you've got $0.04 from the CNG tax credit, then another $0.12 from the tax rate. That's what gets you back to the $3.05-$3.10. To your point, the solid waste portion of the business is performing better than we originally expected.
Okay. You said that really fast, all that. Just so I make sure we have the numbers correct. There's $0.12 from tax reform for the whole year?
No, it's not from tax reform.
From tax rate. Yeah.
The benefit from tax reform, and this is important, that was already included in the $3.05-$3.10. That was already included in our original guidance. The remaining $0.12 in tax rate, that's other tax opportunities that we were able to take advantage of this year.
Right. Okay. What I was trying to do is bridge the 243 that you finished that compares to the 305. What I concluded, if I took the headwind from recycling, added back tax reform, and then looked at what solid waste was, there is a clear sequential improvement versus where you started the year.
Absolutely. Think about it this way. The solid waste piece of the business is up 16% from where we thought it would be.
Okay
In our original guidance.
Okay. Since the last 10 people asked 45 questions, can I ask one more?
Sure, Michael. Even though you had a big wind-up.
Yeah. How much capital do you have tied up in recycling, and what does the revenue margin mix need to look like to generate a reasonable return on that capital?
Here's what I would say, is that right now, we're getting a decent return on recycling, but it's not where it needs to be. We need something a little bit higher, and that's why we're focused on all these different action items, the pricing, and also on taking costs out of the system. Obviously the headwind that we're seeing with commodity prices, $160 million roughly year-over-year, it's huge, but we are very confident that we have the action items in place and the people in place to fix this portion of the business, and we will get an appropriate return on the business.
Okay, just so I understand, you are generating a positive return on capital in that business as bad as it is?
I would say that the return on capital is positive, but it's not where it needs to be. Remember, we've talked about this before, I think on this call. There are three ways that we deal through with recycling, right? One is where we go out and collect it in the open market with our small container, large container business, where we're negotiating really directly with customers, one-on-one kind of negotiations with proprietors and decision-makers. In that business, we have been raising prices over the last couple of years and here more recently, very effectively. When I say customers have voted with their wallets, those customers have said, "I want to continue to recycle, even though recycling now costs almost as much as trash removal," for those customers. That has then been a good business for us.
We have a lane, if you will, where waste or recycled material comes to our facilities that we don't collect. We've been pretty effective in getting that business converted, there's more work to do, but those customers have been open to the conversation, and we're moving that business. The last is this big municipal piece, right? As I said in my comments, the actual rate payer is paying very little per month for recycling. The idea of doubling or tripling their rate is minuscule in the scheme of things. It's a cup of designer coffee. I'm not a coffee drinker, but it's not that much compared to what they pay for cable, for internet, for all of their other sort of habits. Trash and recycling is sort of a necessary service, and recycling is something they want to do.
When you aggregate that spend to 10,000 residents, then the decision-maker gets nervous, right? Because it becomes a big dollar amount. We've got to continue to break it down to the lowest denominator, and those are the conversations we're having because the consumer, ultimately the voter, wants to recycle, and they want a company like Republic Services that's a good partner that will do a good job for them. We're only going to invest in recycling where the returns are warranted and where the construct of the contract is fair and reasonable and equitable. We're going to, along the way, find partners. There are great partners, and we're going to, along the way, find partners who we're going to have to reevaluate the value of their partnership because they don't want to understand this. That's where we're at.
That's okay because this business will sort of work through that. Again, it's a good opportunity. It's a stinker right now in 2018, but the strength of solid waste is overtaking it. There'll be headwind in 2019 and 2020 as we start to climb out of it. I mean, tailwind.
Okay. Thank you.
Next question comes from Michael Feniger with Bank of America. Please go ahead.
Yeah. Thanks, guys. I believe you were originally expecting underlying EBITDA margin expanding 10 to 30 basis points for the year. What's your new expectations for that now? I don't know if you guys I know we see the EPS guide, but just what is the first half? I think you did $1.39 of adjusted EBITDA. What's the expectation in the back half? I was hoping you guys could help just kind of bridge that and how much of that is Q3 versus Q4.
Yeah. For the year, we're expecting the EBITDA margin to be about 28%. Just to put that in context for you, what we're expecting right now is solid waste margin expansion of 60 to 80 basis points, and then recycling being a headwind about 120 to 140 basis points. We are obviously expecting the margins to improve in the back half of the year, once again, on the back of the continued strength in the solid waste business.
Is that more I'm sorry, is that more like fourth quarter weighted?
It actually goes down Q3 to Q4, steps down a little bit, as you would expect because of the seasonality in the business.
Okay. I guess just my last question would be, you mentioned volumes, underlying volumes of 1%-2% range. Can we be thinking about, with the economy the way it's been progressing and the momentum, could we be thinking 2019 is closer to that 2% range? Just on the average yield discussion, we were talking about 3%. I mean, is there room for the pricing? Is it just to cover the rising costs, or is there room for that price-cost dynamic to inflect higher in 2019?
All right. First of all, this is not our 2019 guidance call.
Okay. All right.
Look, first on the growth. The underlying growth 1%-2%, we think that's realistic. Give us a little time to see how the rest of the year comes in and how things sort of normalize. The underlying fundamentals, again, population growth, household formation, all the things we look at still indicate there's room to run. You know that we're well-situated across our markets with strong position. We get our fair share of the growth along the way. We've got high confidence in that. We'll talk finer point in 2019 when we get to that juncture, right? On pricing, especially hear this, right? We've seen 3% and 3.5% yield in the past when the economy's been strong. We're enjoying one of the strongest economies we've seen in a long time.
We've got a really great story to tell, and the economy and the solid waste business is what is overcoming this struggle with recycling. We're going to fix that too. My point about 3% price, as Tyler said, that is aspirational, but it's very doable. This is a conversation we're having today in the building. We're talking with our revenue management team, and we're talking with our operating team, and we're having those conversations because the market will allow it, the value we provide will allow it, and there are some structural changes that we take a fairness approach with customers that we can go ask for it legitimately. Again, CPI, the almost $600 million now of the restricted book now is converted. We're not done yet. We're going to hit $600 million, then we're going to take on $700 million.
CPI by itself is on the rise. All these things are good factors. I mean, the fact that the underlying solid waste business is strong, a good economy, operationally we're solid. The fact that we've got this great workforce and low turnover. We got a ton of other metrics that we watch that we don't share with you, obviously, that all tell us a really good story. We're going to continue to build on the success, then we're going to turn this recycling thing around, and it's going to be a happy day. More to come. These things start to anniversary into 2019 and help us build a strong 2019. That wasn't guidance. Good job.
Thank you.
Thanks, Scott. Our next question comes from Jeffrey Silber with BMO Capital Markets. Please go ahead.
Hey, guys. It's Henry Chen. Good afternoon, calling for Jeff. Just to follow up on some of the points you were making, I'm just curious how you're thinking about the overall capacity of the business. If volume growth picks up, are you kind of prepared, at least given the wage inflation, to ramp up hiring? I'm just kind of curious with your increase in CapEx, does that sort of suggest you need to sort of invest in new improvements to make things more efficient given the wage inflation? Just however you're thinking about capacity for the business. Thanks.
Well, first of all, as far as CapEx goes, we've always guided, CapEx is 10% of revenue. When revenue's growing, as volume's growing, deploying CapEx to capture that volume, that's the best way our owners would like us to see us deploy cash, right? We do that very effectively. There's not latent capacity in the business because the business has been growing for some time now. As it relates to the staffing model, again, we have low turnover. We've held the line very well year-over-year. Some of this wage inflation that we talk about is in select markets, but we're handling that well. In fact, our time to fill open positions is actually down year-over-year. Again, we track a lot of really cool metrics here. Our people are doing a great job of attracting good people.
We've got great training programs to bring people into the pipeline. I think we're poised to, again, handle the growth that comes at us. Remember, solid waste, that 1%-2% organic growth, we're not talking about light speed here, but when you factor in a very nice steady diet of 1%-2% volume, price in excess of inflation, the model sings a very nice song. We're going to continue to build on the great cash flow. As someone always likes to say, follow the cash. Look at the cash flow of the business. We're very happy with what we're doing in the underlying business. Frankly, we're very certain that this is the moment when the waste industry is going to fix this recycling thing for good.
Yeah. Got it. Okay. That's helpful. Thanks so much.
This will conclude our question and answer session. I would like to turn it back to Mr. Slager for any closing remarks.
Thank you, Austin. In closing, I think as I just said, we are very pleased with our second quarter performance. Strong, solid waste fundamentals together with relentless operational execution, I love when the team is relentless, resulted in a double-digit growth in both earnings and free cash flow. Despite the recycling headwinds, we are reiterating our original guidance, which represented 20% growth in earnings and free cash flow per share versus the prior year. We will continue to manage the business to create long-term value, and remain focused on executing our strategy of profitable growth through differentiation. I'd like to thank the entire Republic team, all the employees for their hard work, commitment, and dedication to operational excellence and creating this thing we call The Republic Way. Thanks, everybody. Thank you for spending time with us today. Have a good evening, and please be safe out there.
Ladies and gentlemen, this concludes the conference call. Thank you for attending today's presentation. You may now disconnect.