Earnings Transcript for SRCL - Q2 Fiscal Year 2023

Operator: Hello, everyone, and welcome to the Q2 2023 Stericycle Earnings Conference Call. My name is Nadia, and I'll be coordinating your call today. [Operator Instructions]. I will now hand over to your host, Andrew Ellis, Vice President, Investor Relations, Enterprise Finance to begin. Andrew, please go ahead.

Andrew Ellis : Good morning, and thank you for joining Stericycle's 2023 Second Quarter Earnings Call. On the call today will be Cindy Miller, our Chief Executive Officer; and Janet Zelenka, our Chief Financial Officer and Chief Information Officer. The discussion today includes forward-looking statements that involve risks and uncertainties. When we use words such as believes, expects, anticipates, estimates, may, plan, will, goal or similar expressions, we are making forward-looking statements. Forward-looking statements are prospective in nature and are not based on historical facts, but rather on current expectations and projections of our management about future events and are, therefore, subject to risks and uncertainties. Our actual results could differ significantly from those described in such forward-looking statements. Factors that could cause our actual results to differ are discussed in the safe harbor statement in our earnings press release and in greater detail within the risk factors in our filings with the U.S. Securities and Exchange Commission. Our past financial performance should not be considered a reliable indicator of our future performance, and investors should not use historical results to anticipate future results or trends. We disclaim any obligation to update or revise any forward-looking statements other than in accordance with legal and regulatory obligations. On the call, we will discuss non-GAAP financial measures. For additional information and reconciliation to the most comparable U.S. GAAP measures, please refer to the schedules in our earnings press release, which can be found on Stericycle's Investor Relations website at investors.stericycle.com. The prepared comments for today's call correspond to an earnings presentation, which is also available at Stericycle's Investor Relations website. Throughout the call, we will reference specific slides from the presentation. This call is being recorded, and a replay will be available approximately 1 hour after the end of the conference call today until August 24, 2023. A replay of the webcast will be available on Stericycle's Investor Relations website. Time-sensitive information provided during today's call, which is occurring on July 27, 2023 may no longer be accurate at the time of a replay. Any redistribution, transmission or rebroadcast of this call in any form without the express written consent of Stericycle is prohibited. I'll now turn the call over to Cindy.

Cindy Miller : Thank you, Andrew. Good morning, everyone, and welcome to today's call. 4 years ago, the leadership team set this organization on a path focused on 5 key business priorities, which include

Janet Zelenka : Thank you, Cindy. I will start by summarizing our second quarter results. As noted on Slide 5, revenues in the second quarter were $669.5 million compared to $679.8 million in the second quarter of 2022. Excluding the net impact of divestitures of $24 million and unfavorable foreign exchange rates of $1.2 million, organic revenues increased $14.9 million. Of this increase, Regulated Waste and Compliance Services' organic revenue growth was $19.7 million, while Secure Information Destruction organic revenues declined $4.8 million. As noted on Slide 6, Regulated Waste and Compliance Services' revenues were $444.7 million compared to $448.4 million in the second quarter of 2022. Excluding the impact of divestitures and foreign exchange rates, organic revenues increased 4.7% in the second quarter. In North America, Regulated Waste and Compliance Services' organic revenues increased $16.8 million or 4.8%, mainly driven by our 3 pricing levers, which include pricing in existing contracts, new customer pricing and surcharges and fees. We are also pleased with the year-over-year positive growth in core medical waste collected, which contributed to roughly 1/3 of the organic revenue growth. International Regulated Waste and Compliance Services' organic revenues increased $2.9 million or 3.9%, mainly driven by our pricing levers, partially offset by lower waste volumes compared to the second quarter of 2022. International waste volumes have been impacted by hospital and nursing staffing shortages and intermittent strikes throughout Europe. In the case of the United Kingdom, it was recently reported that the NHS' medical procedures backlog has increased over 200% since 2020 to more than 7.4 million patients needing medical procedures. Secure Information Destruction revenues were $224.8 million compared to $231.4 million in the second quarter of 2022. Excluding the impact of foreign exchange rates, organic revenues decreased 2.1%. In North America, Secure Information Destruction organic revenues declined $3.3 million or 1.6% compared to the second quarter of 2022, mainly due to the decline in fuel surcharges. In the second quarter, recycling paper revenues were down approximately 4% or $8.1 million due to lower SOP, paper pricing and lower tonnage. The lower SOP recycling revenue was mostly offset by our recycling recovery surcharge, mainly due to the change in the rate table beginning in June 2022. Service revenue was up approximately 2.4% or $4.9 million, mainly driven by pricing levers, which includes the expansion of the recycling recovery surcharge. As a reminder, we have been working to add SOP surcharges to customer service contracts as we continue to renew contracts and win new business. These surcharges are now included in approximately 60% of North America customer contracts and are anticipated to offset approximately 60% of paper price volatility at current review rate. Our service revenue growth was partially offset by lower index fuel and environmental surcharges, which have declined as fuel prices have come down year-over-year. In International, Secure Information Destruction organic revenues decreased $1.5 million or 5.4% compared to the second quarter of 2022, mainly due to lower recycling revenue and fuel and environmental surcharges. Loss from operations in the second quarter was $24 million compared to income from operations of $38.1 million in the second quarter of 2022. The $62.1 million decrease was mainly due to 2023 net divestiture losses of $54.2 million, higher incentive and stock-based compensation of $9.7 million and higher fleet costs of $4.9 million, partially offset by lower bad debt expense of $8.9 million. Although we saw a decline in fuel costs, it roughly mirrored the decline in fuel and environmental surcharges. Net loss was $49.5 million or $0.54 diluted loss per share compared to net income of $10.5 million or $0.11 diluted earnings per share in the second quarter of 2022. The $60 million decrease was mainly due to lower income from operations of $62.1 million, as I just explained. Cash flow from operations for the 6 months ended June 30, 2023, was an inflow of $154.9 million compared to an outflow of $18.4 million in the same period of 2022. The year-over-year increase of $173.3 million was mainly driven by lower FCPA settlement payments of $67.6 million; accounts receivable improvements of $52.1 million, mainly due to an improvement in days sales outstanding; higher cash generated from operating income of $23.3 million; lower annual incentive compensation payments of $22.3 million; and other working capital improvements of $8 million. Adjusted income from operations was $76 million or 11.4% as a percentage of revenues, down from $82 million or 12.1% as a percentage of revenues in the second quarter of 2022. Adjusted income from operations decreased 70 basis points as a percentage of revenues due to the following

Cindy Miller : Thank you, Janet. The second quarter continues to highlight the strength of our team's ability to execute against our key business priorities while maintaining our ability to achieve our full year guidance. Our team is excited to build on our momentum of our key business priorities as we look forward to the deployment of the ERP to our U.S. Regulated Waste and Compliance Services business in the third quarter. As always, I'd like to thank our customers, team members and the communities we serve and our shareholders for their continued trust in having Stericycle protect what matters. Operator, please open the line for Q&A.

Operator: [Operator Instructions]. Our first question today goes to Sean Dodge of RBC Capital Markets.

Sean Dodge : Yes. And congratulations on the great progress with the leverage ratio. I want to start on the ERP, Cindy. Yes, you said you expect to have the U.S. Regulated Waste Systems all transitioned over by, it sounds like September. If we think about the potential for disruption to the business from this, if all this goes well, by the time we get to October, are the big risks with that pretty much behind you at that point?

Cindy Miller: Yes. I think it's very insightful, Sean. A couple of things that we will have when we get ready to share an update in October, we will have gone through a billing cycle or more. We'll be able to do some comparisons to make sure that we're on track in terms of trends and any of the data that we can analyze. So I think those are very big ones. And then I think after that, you still have the nuances of, do all the -- how is it going with all the handheld operations? And how are all the scales transmitting all the material and the data that we need to keep track of for regulatory and compliance reasons? So there's a myriad of things. I just mentioned 2 kind of very simple buckets. But I think we're going to get a really good feel because what you talked about was disruption. And in terms of disruption, automatically, we're going to look at making sure

Sean Dodge : Okay. Great. And then on the margins and all the pricing actions you all have taken over the last couple of years with the service recovery fee, the shifting of the SOP table, are those all now fully reflected in what we’re seeing here in Q2? Or are there more levers you pull in or some leg benefits still out there from the – I guess as we think about margins into the back half of the year, is there any more lift you expect to get from these pricing actions on a sequential basis?

Cindy Miller: I think the lift that we’ve gotten is pretty much at steady state. I think we would look to provide additional lift if we saw conditions worsen, if anything else had happened. I think we are seeing some relief in portions of the business where costs are becoming more, I want to say, normalized. However, as we called out in an area like fleet, we are still seeing cost pressures being up with reference to maintenance, vehicle repairs. When we return any of our rental vehicles, the fees for returning some of those vehicles have been increased quite a bit. So for us, I think we stay pretty close to it. I don’t foresee anything else that would be added in terms of any changes. However, all of those are dictated by what we see in the marketplace, and I know Fed just raised yesterday. So we’ll see if that drives anything else. Just as a latest update, Sean, just so you know, the last time we changed the scarf fee, the regulated waste fee was in October of last year. And then the last adjustment that we’ve made on the recycling surcharge was March of this year, just as a reference point for moving forward, but I don’t see anything else at this time.

Operator: And the next question goes to David Manthey of Baird.

David Manthey : Yes. Thank you. Good morning. First question related to the question that was just asked, after the inefficiencies that you experienced with the SID ERP rollout, have you factored in any type of disruption or any efficiencies or anything in RWCS in the current 2023 guidance that you've given us?

Janet Zelenka: Yes. David, the guidance that we put out for the year reflected that we were going to go through this. And so that meant that we weren't going to be able to drive significant productivity improvements in the second half of the year as -- in the RWCS space as they will actually be taken off for training, they're actually doing that now, and that will ramp up in this quarter for the go live. Secure Information Destruction will continue to drive operational efficiencies, but that will be offset by what we plan for just this productivity, if you will, from putting an ERP in. And I think you can see that our guidance and outlook for the year is pretty reasonable, and that is reflected in the sales growth as well. So the short answer is yes, we plan for some of that.

David Manthey : Okay. And then, Janet, further, based on the free cash flow guidance you've given us in the past and you've sort of given us some thoughts around the magnitude of operating margin improvement that you ultimately might expect in the business, can you give us an idea of what you might be thinking about in year 1 after this? You come out the other side? And again, based on the opportunity that you see out there, BlueSky in addition to the experience that you had and sort of the cadence of improvement coming out of the SID improvement trajectory after you implemented the ERP there. Any thoughts you can give us on that?

Janet Zelenka: So we still remain committed to our long-term guidance, which included the 13% to 17% adjusted improvement that we -- that is reflected in improved margin improvement. And what will happen is Secure Information Destruction continues we'll get some momentum into next year as they continue to find opportunities through using the platform to generate productivity improvements from fleet to route to idle time to all the measures that we can see while RWCS will learn the platform and then it will start probably towards the second half of the year to be able to leverage it. So the advantage of sequencing the 2 businesses is one can keep moving and driving on the improvements while the other is taking on the new work and learning it and then can move into driving improvement.

Operator: Our next question goes to Scott Schneeberger of Oppenheimer.

Scott Schneeberger : I'll echo the congratulations on reducing the financial leverage. You mentioned, I think it was Netherlands and United Emirates divestitures in the quarter. Could you just give us an update on where you are on the portfolio optimization process. It seems like you're announcing a few weeks each quarter now. They don't sound too material in size, but I'm just curious how much more meaningful proceeds perhaps can be derived there?

Cindy Miller: Yes. Scott, great question. Portfolio optimization remains one of our key priorities. I'm -- I think we've got about 17 -- well, the dental business will be 18 divestitures in the last little bit. The joint venture in the UAE will be, if you will, 19, although certainly different than the others because it's a joint venture. But in essence, kind of pulling out of business, pulling out of operations. But along that same time period, we've had an acquisition, too. So for us, I think if you take a look at the discipline that we've had fiscally in terms of improving the balance sheet, if you take a look at the position that we're in, in terms of overall debt, I think portfolio optimization for us continues to be looking at markets where we believe we have the opportunity to grow at the margins that we believe a company of our size and the value that we can bring would be meaningful. So I think the long answer that I gave you is really, in portfolio optimization, we continue to look from a divestiture perspective as well as a potential acquisition perspective as we've done before and we'll see where that leads.

Operator: And the next question goes to Tobey Sommer of Truist Securities.

Jack Wilson: This is Jack Wilson on for Tobey Summer. Can you give me a little more color around sort of the organic revenue decline in Secure Information Destruction?

Cindy Miller: Sure. I think one of the things that I think we need to really take a look at is I like to look at Secure Information more in terms of first half of the year versus last year, first half of the year, simply because things, I think, have the potential to get skewed. Last year, first half, it was early 2022, record inflation, driver shortages, supply chain issues, and we were still dealing, believe it or not, with Omicron with 14-day quarantines if anybody was exposed to anybody that had COVID. And if you recall, Q1 of last year was probably one of the most difficult operating quarters we've ever had. And when you take a transactional business that says you only get paid if you actually make a stop, you've got some difficulties there when you're already in a driver shortage to begin with, and then you have a lot of drivers out based off of different CDC rules. So as a result, Q1 of this year, Shred saw -- our Secure Information Destruction business in North America grew 13.4% over the prior year. So as you can see, that was a pretty big number. What ended up happening and what we believe is we then accelerated, started to get drivers back, put drivers in seats, had ramp-up time to get drivers ready to go, and we made up for an awful lot of those stops in Q2 of last year. So what we're seeing right now is the overall comparison this quarter versus last quarter. We are showing in North America a decline -- a modest decline of 1.6% and -- but I think it's just coming off of that comparison. So our ability to reaffirm guidance this year believes that the fundamentals of what we're seeing in the Shred business still continues to be what we think is good. So for us, it's not a quarter story. We're continuing to monitor the overall business, and we like the position that we're in.

Janet Zelenka: I just would add that we also have the dynamic of a fuel surcharge that is mostly in the shredded business. And as fuel costs came down, it worked as it should in that index came down at revenue, but costs came down in the core business as well and our cost of revenue. So it sort of did what it was supposed to do at the EBIT level, and we're still okay. So that's a top line dynamic that doesn't filter down to the bottom line.

Operator: [Operator Instructions] Our next question goes to you Brian Butler of Stifel.

Brian Butler : First question, just on the Secure Information Destruction business, did the stops increase? And are you seeing a meaningful shift between on-site shred versus off-site?

Cindy Miller: Yes. I think on-site versus off-site, we've been making steady progress. And I think it's pretty much been not as -- we made more progress earlier than where we are right now in terms of -- when we purchased the business back in 2015, there was a tremendous amount of shredding on a customer site, which is very difficult, specialized vehicles, a lot of vehicle issues, high maintenance with not as much being brought back to facilities. Over the course of the last several years, there's been a marked effort to now -- the majority of the volume that we pick up is processed back in our facility as opposed to with the specialized vehicles on site. So for me, I think we're in a really good position there. We constantly look to improve that. But I think that's a real good dynamic for us. And in reference, in terms of SOPs, just remember, we continue to win new business, we continue to drive our sales efforts in that space. And I think, unfortunately, we've got 2 quarters with different dynamics in a transactional business for some odd comparisons. But I think overall, we take a look internally at where we are for stops. And I think in terms of how we are trending towards our plan and how that plan fits into our 3% to 5% growth -- organic revenue growth for the company, we're reaffirming guidance which means we believe we're on track.

Brian Butler : Okay. And then shifting back to the ERP. Can you remind us what the duplicative IT costs are? Is there any more cost to be eliminated once the ERP is fully rolled out? And how does that, I guess, flow through the business over the next -- whether that be 6 or 12 months?

Janet Zelenka: Yes, you're right. We are maintaining and we put into full operation, which was about $50 million to $60 million of costs that slipped into our normal operating expenses in August of 2021 for the new system, while maintaining the legacy system of which RWCS is on globally. And that costs around $20 million to $30 million of legacy costs in IT and some other related areas. That is the cost that has the opportunity to go away once we're fully deployed, but we also need to modernize international before we can achieve that. So we're well on our path for that, and we have started to work on the international space, but it needs to come off globally before we can really turn that legacy system over. And that is factored into our long-term guidance as we thought through on the savings that we will achieve on IT costs.

Operator: And we have a follow-up question from Scott Schneeberger of Oppenheimer.

Scott Schneeberger : Cindy, with fleet cost being an issue here, and I wanted to hone in on the use of rentals a little bit. What percent of vehicles are you -- it sounds like you're fleeting up a bit and fleet modernizing, but use of rentals, where are you now as maybe a percent of your fleet and usage on a given day. And where are you looking to take that as a goal?

Cindy Miller: Yes. That's pretty keen, a good insight, Scott. So for us, we've had -- we've been in the rental business. I think most of last year -- second half of last year, we talked an awful lot about the supply chain being far behind and the actual receiving of our vehicle requests really being delayed. So as a result, you want to continue, you continue to grow, you continue to see organic growth, you've got to be able to service your customers. And rentals not just of tractors, but then also trailers, you've got a rent in order for that growth in terms of your ability to hold on to your trailers and a lot of the other power units. So since the beginning of this year, we've really been modeling an opportunity as vehicles and the fleet orders have started to come in. We've been, this year, going on some pretty massive vehicle returns, so returning those rentals that we have. And what we have seen are some pretty high -- some pretty exponentially high return costs for each vehicle. It used to be a set amount that was quite reasonable. And in some instances, we've seen it be 200% more in terms of an increase. So as you return more, which is a good thing because you're going to get a new vehicle order come in, you're going to have a vehicle that's more modernized and it's better equipped and designed for the job that our frontline drivers do. However, you do take a hit in terms of the rental. So your question is how many do we have? I can tell you, by the end of summer, we're estimating to have 80% of our fleet order completed. Now that's a much better position than we've been in quite some time. We've had -- we've been waiting on quite a few vehicles. So for us, I think we're winding down the last bit of our rental returns on the trailers as well as on the power equipment. But I think the overall fleet strategy, Sean, I think -- or I'm sorry, Scott, the overall strategy that we have is we eventually want to even get out of the leasing business because right now, we've talked before about our fleet strategy has been leasing. I think a longer-term push for us will be to a point where we continue to be fiscally responsible, have some strength in our balance sheet. We're looking for reasons to invest as we continue to generate cash. I think our long-term momentum to be able to start to buy some of the fleet and buy the trailers so that we can really take advantage of that on our balance sheet. I think that's the future of where we'd like to get to.

Operator: And we have a follow-up from Jack Wilson of Truist Securities.

Jack Wilson: So could you just maybe walk through a little bit of the moving parts of achieving full year EPS guidance with sort of the ERP system and the new fleet dynamics?

Janet Zelenka: So we have a fairly stable year. But if you look at where we delivered the first half, it kind of is in line with the first half guidance. If you split the guidance in 2, in the second half is kind of in the same boat. The -- you'll probably see some uptick in the fourth quarter just as we get through the ERP and we continue to drive productivity in shred, but -- we are going into an ERP. So the precision of being able to do a quarterly precision on what's going to happen is a little tougher, but we're really confident in the second year and the guidance for the full year that we put out.

Operator: We have no further questions. I'll now hand back to Cindy for any closing comments.

Cindy Miller : Thank you, Nadia. So for everyone listening to the call, I just want to share that we -- as always, we appreciate your interest in Stericycle and your shared excitement in our future. So thank you very much. We'll talk to you all soon.

Operator: Thank you. This now concludes today's call. Thank you all for joining. You may now disconnect your lines.