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Good afternoon. My name is Deirdre, and I will be your conference operator today. At this time, I would like to welcome everyone to the Stericycle third quarter 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.
Thank you. I will now turn the call over to our host, Ms. Jennifer Koenig, Vice President of Corporate Communications and Investor Relations. Ma'am, you may begin your conference.
Good afternoon and thank you for joining Stericycle's third quarter 2018 earnings call. This afternoon's discussion will feature Charlie Alutto, Chief Executive Officer, Dan Ginnetti, Chief Financial Officer, and Cindy Miller, Chief Operating Officer.
The discussion this afternoon includes forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those described in the forward-looking statements. Factors that could cause these actual results to differ are discussed in the Safe Harbor statement in our earnings press release and in greater detail within the Risk Factors section in Stericycle's filings with the U.S. Securities and Exchange Commission.
Past performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate future trends or results. To the extent permitted under applicable law, we make no commitment to disclose any subsequent revision to forward-looking statements.
On the call, we will discuss non-GAAP financial measures. For additional information and reconciliation to the most comparable GAAP measures, please refer to the footnotes and schedules in our earnings press release, which can be found on Stericycle's Investor Relations website.
Finally, the prepared comments for today's call correspond to our third quarter earnings presentation, which is also available on the Investor Relations website. Throughout the call, we will be referencing specific slides from the presentation.
I will now turn the call over to Charlie Alutto.
Thank you, Jennifer. Welcome, everyone, to our third quarter 2018 earnings conference call.
We are pleased to report that both our Regulated Waste and Compliance Services and Secure Information Destruction businesses exceeded our expectations in the quarter. Once again, our core businesses have met or exceeded expectations. This performance was offset by C&RS, which experienced further challenges. As a result, adjusted EBITDA and adjusted EPS were in line with our expectations. In the quarter, we continued to make progress executing on our business transformation and the implementation of the new ERP system.
Before we review our quarterly results in more detail, I'd like to highlight a few recent developments. First, Cindy Miller joined Stericycle as President and Chief Operating Officer on October 1. Cindy comes to our company following an impressive 30-year career of global leadership in transportation, logistics, and operations at UPS. She'll be leading the Global Medical Waste and Hazardous Waste and Secure Information Destruction businesses as well as the execution of our business transformation. We are excited to have an executive with Cindy's strong track record of driving growth and innovation joining our team during this important and transformational time.
Focusing on the business transformation, as reflected on slide 8, Stericycle has realized year-to-date adjusted EBITDA benefits from business transformation initiatives of $39.8 million. The recurring impact of these year-to-date initiatives is projected to deliver $57.1 million in run rate benefits for 2018. These completed initiatives combined with our fourth quarter initiatives place us on track to deliver our goal of $60 million to $65 million for full year 2018. Expenses for business transformation were $21 million in the third quarter and totaled $64.9 million for the year. Capital expenditure payments for business transformation were $4.5 million in the quarter and $8.2 million for the year. Importantly, we remain within budget and on track to achieve our business transformation milestones.
We also completed the detailed design of the ERP system. This included hosting workshops to map our end-to-end future stay processes. We have now begun the build phase of our ERP. We remain confident in our ability to reduce the 450-plus information technology and operating systems to approximately 50 and reduce our financial systems from 65 down to one global financial system. As a reminder, in 2019, we will be focusing on building, testing, and training for the new ERP system. In 2020, we expect to deploy the ERP system in the U.S. and Canada and then continue to roll out internationally in 2021.
The business transformation EBITDA benefits we expect to achieve in 2019 will come from the tailwind of initiatives implemented in 2018. The majority of the expected benefits from our business transformation initiatives that will drive our long-term growth rates will materialize following the ERP deployment beginning in 2020.
Another aspect of business transformation is portfolio rationalization. In the quarter, we completed the divestiture of the non-core U.S. Clean Room service. We continue to explore strategic alternatives for C&RS and evaluate other non-core service lines and geographies.
And now for the first time, I'd like to turn the call over to Cindy for a review of our performance in the quarter. Cindy, welcome to the Stericycle team.
Thanks, Charlie. I appreciate the warm welcome, and I'm very excited to join Stericycle during such an important and evolutionary time.
As reflected on slide 11, total revenues for the third quarter were $854.9 million, a decrease of 3.2% from Q3 2017. Strength in Secure Information Destruction and other core services was offset by a further reduction in C&RS recall revenue resulting from smaller events, as well as expected declines in the SQ Medical Waste business, foreign exchange, and divestitures. When adjusted for Manufacturing and Industrial Services, revenues were $775.8 million, down 2.6%. As compared to the same quarter last year, acquisitions contributed $7.7 million to revenues, and divestitures reduced revenues by $10.4 million.
Revenues for each of our service lines in the third quarter were as follows: Regulated Waste and Compliance Services, $476.6 million; Secure Information Destruction Services, $227.6 million; Communication & Related Services, $71.6 million; and Manufacturing and Industrial Services, $79.1 million.
This quarter we closed four tuck-in acquisitions, all in the U.S. Three were Secure Information Destruction businesses and one was Medical Waste. These acquisitions contributed revenues of approximately $0.4 million in the quarter and projected annualized revenues of $4.8 million. We also completed the previously-announced divestiture of the U.S. Clean Room Service business. This divestiture reduced revenues in the quarter by $1.5 million, with a projected annualized revenue impact of approximately $9 million.
Regulated Waste and Compliance Services revenues came in above our expectations, and we are encouraged by the trends we see across the business. In the quarter, healthcare and hazardous waste and our programs for unused pharmaceuticals and controlled substances continued to have strong growth. In addition, our SQ Medical Waste business came in above our expectation due to slightly less discounting in the quarter.
Secure Information Destruction Services exceeded our expectation. Organic revenue growth in the quarter was 9.1%, or 4.7% when adjusted for recycled paper pricing. Overachievement was driven by continued expansion of recurring services in the U.S. and by growth in the UK in response to the newly implemented GDPR privacy regulations.
Communication & Related Services revenues declined due to the continuation of smaller recall events. We managed more events in Q3 2018 compared to the prior year. However, the events involved a smaller number of units and significantly lower revenue per event. While we are disappointed in the overall results, our market position remains very strong, and the business is well positioned to support global brands as future recall events occur.
Although Manufacturing and Industrial Services revenues were down, organic revenues when adjusted for divestitures and foreign exchange were up 6.8%.
Dan will now discuss our financial performance for the third quarter in greater detail.
Thanks, Cindy.
Looking at slide 13, the results for the third quarter were as follows. Quarterly revenues were $854.9 million and adjusted EBITDA was $183.9 million. Both were driven by growth in Secure Information Destruction and other core services and offset by decline in C&RS, Latin America, and divestitures.
GAAP EPS was $0.20 due to business transformation charges and other adjusting items. Adjusted EPS was $1.03 versus our midpoint guidance of $1.00. As you will see on slide 14, the bridge between guidance and actual results includes the following: $0.05 from the performance of operations, including SOP paper favorability; $0.01 from lower depreciation expense; and $0.02 from the purchase of the mandatory preferred convertible shares. These were offset by $0.05 in C&RS.
As-reported cash flow from operations was negative $141.1 million in the quarter, which includes the $295 million SQ settlement payment. Excluding the settlement payment, cash flow from operations was $153.9 million. CapEx was $32.9 million, or 3.8% of revenues. Free cash flow was negative $174 million in the quarter, which again includes the SQ settlement payment. Excluding the settlement, free cash flow was $121 million.
Our debt-to-adjusted EBITDA ratio under the amended debt agreement was 3.58 times at the end of the quarter, inclusive of the settlement payment. The unused portion of the revolver was $466.8 million at the end of the third quarter.
And in the quarter, we repurchased 50,000 shares of mandatory preferred convertible for $2.5 million. At the end of the quarter, we have authorization to purchase 2.4 million common shares. As a reminder, the mandatory preferred convertible stock converted on September 14. There is no impact on the reported adjusted EPS, as we have been using the if-converted method. Our DSO was 63 days.
I will now turn it back to Charlie, who will provide an update on Stericycle's 2018 full-year guidance.
Thanks, Dan.
Now for our updated guidance for 2018, which is included on slide 17, please keep in mind that these are forward-looking statements. Our guidance is based on currently known items and does not include future items such as acquisitions, divestitures, or adjusted litigation matters.
Following the close of the third quarter, we believe annual revenues for 2018 will be in the range of $3.44 billion to $3.52 billion using foreign exchange rates at the end of the third quarter. The worldwide revenue guidance for each of our service lines is, Regulated Waste and Compliance Services is expected to be in the range of $1.91 billion to $1.93 billion. Secure Information Destruction Services is expected to be in the range of $900 million to $920 million. Communication & Related Services is expected be in the range of $310 million to $330 million depending on recall revenues. Manufacturing and Industrial Services is expected to be in the range of $320 million to $340 million.
We believe adjusted EBITDA will be in the range of $736 million to $756 million. We expect adjusted EPS will be in the range of $4.31 to $4.41, using a share count of 90.5 million shares. This reflects an adjusted tax rate of approximately 25.5% to 26%.
On slide 19, we present a revised 2018 adjusted EPS guidance bridge. Strength of operations, including paper pricing, contributed $0.03. Lower depreciation expense and share repurchases from Q3 contributed an additional $0.03. These were offset by $0.04 in Latin America from lower revenue in Brazil, cost pressures from a temporary plant closure and foreign exchange, and $0.11 from C&RS, which includes $0.05 from the Q3 actual results and $0.06 from the lower recall revenues we expect will continue through year end.
We believe cash flow from operations will be in the range of $160 million to $195 million, which includes the payment for SQ settlement. We expect CapEx to be between $145 million to $160 million, and free cash flow will be between zero to $50 million.
In closing, we remain confident in the fundamentals of our business. Key trends, including a large aging population and heightened focus on information security, continue to drive growth in our markets. Additionally, our strong leadership position, the benefits of our business transformation, and the expected efficiencies from our new ERP system will provide Stericycle with a robust long-term growth platform. Our team is excited about the future and committed to our customers, our core values, and our business transformation.
We'll now answer your questions. Deirdre, you can now open the line for Q&A.
And our first question comes from Sean Dodge with Jefferies.
Good afternoon, thanks for taking the questions. Maybe starting with CRS, Charlie, you told us last quarter that's up for sale. Any update you can provide on that process? And then having another tough quarter, everyone should know the recall business is inherently lumpy. Maybe you can talk about any impact, if at all, that potentially has on your ability to sell the business and what you'd hope to get for it.
Sure, Sean. We touched on our last call that we're seeking strategic alternatives for the C&RS business. Yes, not great that it's during a time that we're down and we know and you've followed the stock for a long time. And that has been an unpredictable business for us.
I think we're encouraged by couple of things there. The number of recall events, if you look year over year, is actually up by 25%, and we continue to get a 98% reoccurring rate from our customers, meaning that when a customer uses our recall platform, has another recall event, and it might even be a smaller recall event, they come back to us. So we're encouraged by that.
We all know that this is an unpredictable business. The average revenue per recall, I think Cindy discussed it in her comments, was down something like 70% when we look at it year over year. So this is more of a matter that we're not losing any competitive deals out there. It's just the size of the recall event is significantly lower. The fundamentals of the business are still there. We're still a market leader. Yes, it's not perfect timing with respect to the results, but it is an ongoing process as we go through this portfolio rationalization and looking at alternatives for this business.
Okay, that's helpful. Thank you. And then Cindy mentioned slightly less discounting in the quarter. I've heard the checks, some people talk about getting checks in late August, so having that behind us without any obvious impact on that is encouraging. Can you give us a sense of the run rate you're running at now? And then is there anything you're seeing incrementally there that maybe gives you more or less confidence that this is something you can put behind you sometime mid to late 2019?
Sean, I think you had a couple of questions there. I'm going to touch on discounting. I'll let Cindy touch on the fact that checks were mailed in this last quarter. SQ discounting actually came in slightly better than expected. In order of magnitude, which I think was your question, it was about $1 million less in discounting than we had anticipated for the quarter. We're really encouraged. We know it's only one quarter, so we don't want to say that for the rest of the year we feel confident. Certainly, I think our estimate that we gave out, we'd have discounting of about $120 million to $130 million through 2019. We're sticking with that even though we had a slightly better quarter. I think we're encouraged about some of those strategic initiatives that we put in for SQ. We'll continue to evaluate them for the year.
I will turn it over to Cindy to talk about anything that came out from the checks that we mailed.
Thank you, Charlie. Sean, what we've seen is obviously checks went out, and we were prepared. We anticipated calls. We needed to be prepared in order to handle any of the customers' questions that they may have had. And for the calls that we did get, they were smaller in number than we had anticipated. The majority of them were concerned about normal things. They were focused on the actual nature of the check and just making sure that they were valid, and had some questions surrounding that. So I think the group did a great job in handling their concerns, and we feel very comfortable with the responses that we've given up to this point in time.
Okay, that's great color, thank you.
Thanks, Sean.
And our next question comes from Nick Speakout (sic) [Nick Hiller] with William Blair.
Hey, guys. Nick here in for Ryan. If we can go back to the C&RS EPS guidance bridge, that $0.06 for the rest of the year, because it's so volatile, is that coming just from you think volume is basically going to be decreased? Is there anything else there you can provide color on?
Let me take you through that, Nick. Obviously, we saw lower volume in Q3. That is really – we saw more calls but the volume was about 70% down from the normal sizes we saw a year ago. When we looked at it in Q2 and we saw a disruption there, is was really one quarter, and we came off a strong quarter. And so we only adjusted really for the recall event in the quarter plus a little bit more.
In Q3, we've added a little bit more on the line of sight. We saw the results of Q3. And it being a month into it and not having line of sight of any large recall events, we thought it was prudent to adjust Q4 for the volume that we're at now. It's really two things. It's the lower – the smaller size. Plus, without having any large recall events that have tails that would bleed in Q4, that's not happening. So as a result of that, we thought it very responsible not just for Q3 but the run rate of the volume going through the balance of the year.
Got you. And then on that, with the sale process, if you can, provide a little bit more color on how that's going and whether or not you might be losing some focus or if there's disruption there after the announcement of the sale.
As I mentioned before, it is an ongoing process, Nick. I think the disruption is a good question. Obviously, the team is focused on running the business day to day, but they are also looking at strategic alternatives. To say that there's no distraction there I don't think would be fair.
But again, if you look at the last eight quarters, we had more events this quarter than any quarter we've had. So we're winning events. The team is focused on winning events. Events are up 25%, year over year. It's just that they are a lot smaller events, and they're 70% less from a revenue per event size than they were year over year. So I think the distraction, I think it's human nature to be distracted a little bit by it. But based on the number of events that we won in the quarter, I think the team is doing a good job of trying to focus on maintaining and increasing their market.
Got you, thanks. I'm good here. I'll jump back in.
Thanks.
Thanks, guys.
And our next question comes from Gary Bisbee of Bank of America Merrill Lynch.
Hey, Gary, welcome back.
Thank you, it's good to be back. I guess one follow-up, just quick one on the CR&S business, we've heard a lot about recall. We know that's volatile. What's going on in the patient communications portion of that? If I go back 18 months to the Investor Day you had, there was a story at the time of cross-selling that, of leveraging the new technology to try to grow that. Has that changed as well, or has this really been more just the recall volatility in the last few quarters?
Let me take that one on. I want to give you visibility on what we talked about last quarter. I know you weren't on the call, but you would have followed it. Last quarter we did say that there was a reduction in volume on those calls. I will say that that has stabilized now in Q3. We think that's stabilized in Q4 as well. We have gone on the LiveAnswer platform, as we spoke about that on that Investor Day in New York; it was 18 months or two years ago. We have not converted all the customers onto that new platform. We want to be careful about putting existing customers on new technology. So that continues to be an opportunity, we think, for the business. And obviously, as automation grows, including our automation, that does take away a little bit from the call volume on the LiveAnswer, or what you call the patient communications side of that business.
Okay, thanks. And then if I just take a step back, one of the challenges I think you faced in the last few years is the international build-out has comes with substantially lower margins than the U.S. business. And obviously hazardous waste has had much lower margins as well, but I don't think you've given a real update on where haz margins are or really just what the strategy is from here over the next few years to improve the profitability of international and of hazardous waste.
Can you give us some thoughts on how we should think about – I know the ERP probably helps, and clearly pruning the portfolio is something you've said you're still evaluating. But is there anything else that's the key driver over a several-year window to improve those businesses? Thank you.
Yes, I'll give you some color there. I think if you look at our results over the last 18 months, we've incrementally improved the EBITDA margins of our international operations. That's come with Secure Information Destruction internationally, efficiencies across some of our geographies.
Our hazardous waste business – just for everybody, our hazardous waste business now internationally, predominately from Latin America. We did the divestiture of the UK hazardous waste business. And actually the Latin America hazardous waste business had a really good quarter. That's one of the reasons we had a strong M&I number for the Q3 results.
I think you touched on it, Gary. I talked about it earlier on. We have 450-plus systems, 65 financial systems. A lot of that has to do with our international operations. Long term, once we get on a global ERP and we've implemented that international, it will drive both in SG&A savings and a cost to revenue efficiencies.
And then lastly, we're looking at the portfolio. We've made decisions like South Africa shredding, patient transport, UK haz waste operations. The UK haz waste operations and the patient transport business have a very, very low EBITDA margin. So we continue to look at the portfolio with respect to the financial performance as well.
And our next question comes from David Manthey with Baird.
Hey, good afternoon.
Hi, David.
First off, if pricing is stabilizing and the maximum of customer churn is probably behind you, is there any reason to believe that RWCS shouldn't start to see growth or even moderate growth at some point in the next few quarters here?
Listen, we're encouraged by Q3. SQ discounting was better than we had anticipated. I think we want to wait another quarter or two. I think the initiatives that we implemented are starting to take impact. I don't think we want to declare victory there yet. I think you have to remember, though, we've got discounting that's still occurring in the business. Although it's better than we anticipated, it's still occurring. And we had anticipated that to continue through at least – an elevated amount through the second half of – through the first half of 2019. So I think realistically looking at it, our goal along with it is to start to see growth in that beginning in 2020. That's still the goal, and this is a long-term opportunity for us to turn around this business. So we'll see.
Again, we're encouraged by Q3, but I think it's going to be another quarter or so that we want to see those results continue before we get definitive on that. But the plan all along was 2020 growth, and we feel better about that today than we did just three months ago.
And, Charlie, you've been saying it's better than your expectations, but is it getting better? Is the rate of change going the other direction now?
The way I say it's getting better is that we have a discounting that we hadn't anticipated, remember that $40 million to $45 million for the year. And then we have estimates for what that will be each quarter, David. So it came in lower than we anticipated. So it is getting better. Discounting is lower than we thought. Our churn rate is better and trending in the right direction. So that's what I mean by better. I think we've added a lot. We talked about that $30 million investment, and I think Cindy maybe can touch on that to give some color on that as well. We're encouraged, again, good quarter, but again, this is a long-term journey for us, so we don't want to get out ahead of ourselves on that.
Yeah. And, David...
Just so I don't misquote you, Charlie, you're not saying that discounting is getting better. You're saying it's getting better than you thought it was going to be, but we don't know what you thought it was.
Yes, that's correct. It is getting – we had a number that we thought we were going to discount, and we discounted $1 million less in Q3.
Is it still getting worse quarter to quarter or not?
No. No, it is not. No.
Okay, that's what I was getting at. Thank you.
No, I get it. Yes. I got you, David.
And, David, this is Cindy. Just a little bit of follow-up, Charlie had mentioned some of the investment. Just a general overview of a couple of things that we also think is very positive, it was laid out earlier this year that we've been focused on a number of initiatives for strengthening, really strengthening the relationships and improving the long-term performance of the business.
And just an update, we're seeing the positive results from limiting or forgoing some of the price increases to specific customers, and I think that plays specifically to what Charlie was just mentioning. We also talked about changing the account management sales model and getting engaged a little bit more, one on one with some of the field customers, and we're seeing some very positive results from that.
But then I think the other investment that we had talked about was additional marketing investments. And early on, which I think these are indicators that I think would predict maybe some future opportunity, we're seeing some measurable traction in brand promotion and in some of our digital channel work. So when you look at that macro level, we think that that's also very encouraging when we take everything into consideration.
Okay. Thanks. Could I...
Thanks, David.
And our next question comes from Michael Hoffman with Stifel.
Hi, thank you all for taking...
Hey, Michael.
How are you doing, Charlie?
Good.
Cindy, welcome on board. Let me lead with, so you've been there what, three weeks, a month? What's the first impressions? What are the things that you think you bring that will make an impact? And how do we see and measure those since you're coming in on the perimeter of understanding what KPIs are? What are the KPIs we're going to be looking for as a result of your being there?
I think – and, Michael, thank you for the welcome, just a couple of things. First, I'd been attracted originally to the industry because I believe my background is pretty well suited to help Stericycle maintain market leadership position. When we talk about reaping benefits from an ERP and reaping benefits from a business transformation, we're talking about getting the results expected from synergies and productivities and anything else that comes from technology. And I think that that certainly is something that I've been raised on for the last 30 years. So I think that falls right in line.
And then I think just some overall observations. I think the team of course has been very welcoming and supportive. I'm very pleased to see that there's just a feeling of openness to change, and I get the feeling of folks being eager to engage with me, which I'm excited about. And referencing business transformation and that whole ERP and business transformation effort, it's a very strong team, and I think they've got extensive and pretty diverse business experience backgrounds.
I've taken a look at initial plans and designs. I think they're very comprehensive, quite thorough. And I'm very confident coming into this with four weeks under my belt, I feel very confident in our ability to deliver the plan results that are out there. So it's an honor to be part of the Stericycle team, and I look forward to helping contribute in any way that I can.
Okay. Charlie, the $40 million to $45 million target for this year, what's the year-to-date run rate of the $40 million to $45 million?
Yeah, I would say that we're tracking according to plan, so it would be three-quarters of that, less maybe about $1 million or $2 million from the slightly better quarter that we had. I don't have the exact number. I can follow up with you and get the exact number, Michael.
So take the mid...
So we had staged it to happen in quarterly increments. And again, Q3 came in slightly better. Q1 and Q2 came in as expected. So year to date, we're trending a little bit better than we thought by about $1 million.
Right. So I take $42.5 million, multiply it by 75%, subtract $1 million, and I get about where it would be?
That's correct.
Okay. So in light of that, when I think of the underlying – you gave an interesting table, Table 1-C, called Disaggregated Revenue Changes, and you show this $42.6 million year-to-date organic growth. If I do that math and take out the three-quarters number and then think about paper and adjust for that and so on and so forth, I can back away pieces and I come away – this is a complicated way to get there – but there's organic growth in everything else in medical waste.
So let me give you some of the things that we've given you before. If you think about regulated waste and compliance of revenues and you take out the SQ pricing, and we still have a little bit of overhang from the patient transport exit, at the end of the day, Michael, we're roughly at about 2% growth in that segment. And then if you look at – our M&I number came in probably better than we had expected as well. We were on the high end of the range, on the higher end of the range for the year, and certainly exceeded our expectations for the quarter. A lot of that is being driven by international.
And of course Secure Information Destruction had a great quarter, where we continued to be at the high end of the range where we thought we were going to be from a year ago. So there's a lot of growth in the business. We're still struggling, obviously, still dealing with SQ pricing, but there is growth in the underlying business.
Michael, just to add, and it appears you're looking at the disaggregated revenues, and keep in mind within that to get down to an organic growth, we're taking out things like acquisitions, divestitures, and foreign exchange. But remember, when we're talking about that, we still have in comparable to 2017 that includes those patient transportation contracts that we're exiting as well, and those have been a headwind and continue to be through this quarter. Now in Q4, you'll begin to see those fall off, so that doesn't get captured in there. It does affect the organic growth. And once those are fully behind us and in the rearview mirror, you'll see an improvement there. That comparable improves.
Okay, Dan. I think you might have just confused me, but let me repeat back to make sure. The $42.6 million, which is just the organic, is just organic, the $34.6 million would include the impact of selling South Africa and patient trans and the Clean Room business.
Yeah. Michael. I didn't want to confuse you. So yes, if you recall, in patient transportation, we divested a portion of that, and we retained a certain number of contracts that we had carved out that we ran throughout. Those were not divested, and so those contracts that remained will remain within our organic growth as those are coming off. So that's why I tried to give highlights of that.
So that's what you're referring to. And if my memory serves, that was about $15 million , $20 million?
Yes, that's correct.
So the $42.6 million also reflects that you're winding down those organically.
That's correct.
That's correct.
Okay. So the rest of the organic growth that's overcoming that is that much better. Okay.
Yeah. Yeah.
All right, I'll move on. The convert contribution in FY 2018 year to date to the earnings per share year-over-year change, what is that number so we all make sure we think about that when we start building 2019?
I think what you're referring to is the repos that we did, I believe, of the mandatory preferred convertible I think is what you're asking.
Yes.
And that was $0.19 for the year in total. We had guided to $0.17. It was an additional $0.02 in the quarter.
Okay. And then you made a point of telling us that you have an open authorization. So given where the stock is sitting, are you prepared to be in the market and buy stock?
Yes, Michael. Share repos does remain a part of our capital allocation strategy. Obviously, debt reduction is very important to me at this point in time as we are investing in the future state of our company. And we're devoting a certain amount of cash to being able to invest in our business transformation and our ERP system. We do need to continue to delever from the point of where we are today, but we will continue to do acquisitions and we'll continue to consider repo as a part of our capital allocation strategy and remain opportunistic when the opportunity exists and when we're comfortable with the cash flow that we have.
I think right now the priority is on debt reduction.
Debt reduction, yes.
To get the leverage down, Michael, and then we'll be opportunistic on the common shares as well.
And our next question comes from Hamzah Mazari with Macquarie Capital.
Good evening, Hamzah.
Good evening. How are you doing? My first question is if you just step back from medical waste, we realize we've had these re-pricings due to – forget about self-inflicted, but maybe the market structure change with hospital acquisition, but maybe frame for us. What is the barrier to entry in this business today going forward? And then if you look at technology, we cover the solid waste business. Disposal tends to be a barrier to entry. I think you can build an autoclave for $25,000 now or $50,000. So just help us frame barrier to entry in this business. Clearly, it's had an impact on the stock. So maybe help us understand that. Thank you.
Yeah, I think you're building a very small autoclave for $25,000 or $50,000, maybe in a doctor's office to do instruments. It's more expensive than that. You've got boilers to operate the units. You've got material handling. So there's a lot more that goes into it than just the units. You have the permits to get the autoclave.
As I have always explained to folks, I think when you think about medical waste, I hear people say, low barrier to entry or high barrier to entry, and they're both right. On the hospital side of the business, it's a higher barrier to entry because a portion of the hospital waste has to be incinerated, and hospitals generally won't do business with somebody that doesn't have their own disposal or access to incineration. So from that aspect, the barrier to entry to get into the hospital business is going to be higher.
On the SQ business, the barrier to entry has always been small. You don't even have to – to your point, Hamzah, if you want to debate the cost of an autoclave, you don't even really need an autoclave. You can go out, you can get permits for a truck, and you can go and you can bring waste to a third party to treat that waste. And most of the SQ waste that a small hauler would pick up from does not have to be incinerated, so it can go to an autoclave.
The real barrier to entry there is route density. You start out, everybody has a contract. Stericycle has a contract. Most of our competitors have contracts, so the barrier to entry is building that route density, and it takes you a long time, one account at a time, to build that local route density. So I think that is somewhat of a barrier to entry for the SQ customer.
And, Hamzah, I would add to that. One of the other barriers to entry is really that intangible direct customer relationship we have and the breadth of services that we have. The vast majority of our customers use us for multiple services, and they enjoy the fact that we can help them with – yes, if you're thinking about a hospital, with not just their medical waste needs but their hazardous needs, their pharmaceutical needs. We have resources inside the hospital helping service. We can handle their Secure Information Destruction. Even in the SQ, we can handle their compliance needs as well. And I would tell you that the more services we have in, really we're solidifying that relationship with the customers. And that's a big barrier to entry because of the breadth of services we can do versus our competitors.
Great. And then maybe I missed this, but can we frame again in terms of med waste pricing? We called out $130 million headwind. How much is remaining now in Q4 next year? And then once this headwind is behind us, is this a CPI-plus business? We see a lot of labor inflation. We see the solid waste guys pricing pretty aggressively. Just for investors, how much pricing headwind do we have left? And then is this a business with pricing power?
I think elevated like we're saying, it's elevated discount, and we think there's another $20 million to $30 million in pricing that gets us through the middle of next year, 2019. We do think it's a CPI-plus type of business, where we can get better than CPI-like increases. There's always going to be some pricing in the business, Hamzah. We've talked about this. We have hundreds of thousands of customers in the SQ space. Those customers, some are price-sensitive, and there's always a level of discounting and churn in the market given the large number of customers we have. But we think, though, that once we get through this, we can price and get price in the CPI-plus range.
And our next question comes from Scott Schneeberger with Oppenheimer.
Thanks. Good evening, everyone.
Hi, Scott.
Hey. Could we speak a little bit about the guidance for cash from ops and CapEx? It looks like both were decreased. Could you get a little bit into drivers there? Thanks.
Thanks, I'll take that one, Scott. So you'll remember, obviously we started the year at $330 million to $400 million in free cash flow. At that time, we did not consider and did not know if we would be making a settlement payment. Last quarter, we did announce that we would be making that settlement payment, and then we had a few other puts and takes. In our revised guidance going into this quarter for the full year was a midpoint of $43 million.
We are, and you saw in our CapEx numbers, we're trending a little bit less then where we had anticipated we would be for the full year, although we do expect a higher quarter in Q4. But we're lowering our CapEx expectations by about $10 million. With this C&RS challenge in Q3 as well as an expectation that it's going to continue for the balance of the year, we adjusted out about $11 million on our EBITDA from there.
And then you'll remember when we're talking about unknown one-time adjusting items, we did not and don't have the ability to forecast or give guidance to those. And we did see about $17 million in cash for our Q3 related to legal and regulatory compliance. And so because we don't forecast that, that would come out of that. Take those across the midpoint of our guidance, it would be about $25 million.
Certainly we had a very strong quarter and we're pleased with the quarter. We had an improvement of our DSO of about two days. But just to make sure that we don't assume Q4 is going to be a replication of Q3, we thought – we were very pleased to implement a new purchase order system, which is part of our future state. We're very excited to have that. It did slow down outflows of cash in Q3, which gave us a little bit of a benefit. We expect that will flip a little bit next quarter. But that was a great step in our company to work towards our remediation of material weaknesses and advance the future state of our systems.
Thanks, Dan. that was helpful. I remember talking about legal last quarter. And so is this the remnants? Are we done? Is there a lot more trickle in the fourth quarter? Is there trickle into next year on these unique one-time items like legal? And then how should we think about the CapEx budget next year considering you were a little lower than expected this year?
Thanks, Scott. Let me take both of them. We did have higher legal expenses through the first three quarters. We do anticipate that those legal expenses will be lower in Q4. It's unpredictable. As you know, we're going through the FCPA investigation as well, so it's unpredictable. But again, we're going to manage those as diligently as possible. I think to your point, though, we do anticipate that those will be lower in Q4.
As far as CapEx, we've always run 3.5% to 4% to revenue. I think cumulatively for the year we're at 3.7%, so we're right in the middle of it. We do anticipate Q4 will be higher than Q3 in capital for the line of sight that we have and the projects that are committed to close and get paid in the quarter. But again, I think 3.5% to 4% is a good anticipation with respect to CapEx for next year.
Remember also, next year we'll have some CapEx devoted to the future state of our business transformation. That could bring it up a little bit. That's an expectation that we put out there, but it will be up, but it shouldn't be dramatically up. And I think as we're operating south of the 4% of our revenue, it's a realistic number.
All right. Thanks, I appreciate it. I will turn it over.
Thanks, Scott.
And our next question comes from Isaac Ro with Goldman Sachs.
Good afternoon, guys, thank you.
Hi, Isaac.
I wanted to just maybe – by the way, thanks for putting that bridge on the free cash flow guidance this quarter. That was helpful. If I look at that bridge, two items, one was the $17 million reduction in title litigation and the rest. Could you maybe just give us a sense of, the extent to which is new versus last quarter? What was it? Why was that? And then on the EBITDA, the $11 million and change, if we consider the fact that you've got a little bit of a tailwind from paper pricing, what was the actual underlying reduction in EBITDA for a little bit of context?
Let me take that, I believe your question was what was the litigation change from Q3 to Q4? Most of that had to do with the ongoing FCPA investigation that is winding down, but that continued in Q3. So I think that was your question of what was the amount in Q3 over Q2.
And then with respect to SOP on the impact of paper pricing, I'll let Dan answer that one. Just so everybody knows, it's at an elevated level. The market remains strong for SOP 37. The Chinese ban on mixed paper and contaminated paper coming into that market has helped elevate SOP 37. Although most of our paper stays in U.S., it does have an impact on pricing. We started the year with a range of $135 to $165 a ton. Our current guidance is for a year range of $185 to $195 a ton.
I'll touch on the EBITDA impact. You saw that we did bring the midpoint when you look at that in our press release of the EBITDA guidance that you gave, the midpoint came down by about $17 million. When you tax-effect that, that's about $11 million in cash. Some of the big movers in that, as you saw, we had some temporary impacts in Latin America. That was probably about $4 million of our change in guidance. Foreign exchange continues to be a headwind. That's only about $1 million, but EBIT flows through. The combination of – about $13 million comes from C&RS. Obviously, with the reduction of that, you have to maintain a certain staffing level to be able to handle the increased number of events that we're having, even though they're happening at a smaller amount. That's about $13 million there.
SOP is going to contribute to the midpoint of the guidance of about $6 million to EBITDA. And then you did see, as we refine our ranges going into Q4, we came off the top a little bit, and that squeezes it down to about $4 million out of EBITDA. So as you're thinking about Q4 from an EPS standpoint, I think you would get to about an $89 million to a $99 million based off the adjustments of those things on the EBITDA.
Great, thank you. And then just to follow up, I noticed on slide 22, you guys gave us ranges for your long-term goals for revenue and earnings growth rates and all that. And correct me if I'm wrong, I think that's the first time you guys have gone into that level of detail on all those items. So it would be helpful to know what led to your reasoning to commit to those ranges, and then maybe just clarify the periods. Over that five-year period, what's the start and end year period for those ranges? And as part of that, can we assume that we might get a little more detail in the fourth quarter call or on a rolling basis? Thank you.
Actually those numbers have been out there when we introduced business transformation earlier this year, so that's not the first time, I think we've always had it on a slide. We now put it on a closing slide as well. A lot of those benefits come after ERP is implemented. Dan can add a little more color to that.
Yeah. Again, we shared those on a graph when we rolled out the business transformation, and those are the five-year graphs. Obviously, the majority of the plan is reliant on implementing our ERP systems. Just to remind you, in 2019 we'll be focusing on building, testing, and training on the ERP. In 2020, we expect to deploy the ERP system in the U.S. and Canada, and they continue that rollout in 2021.
The majority of the BT EBITDA that you're going to see savings in 2019 comes from a tailwind of initiatives that we've completed in 2018. The long-term EBITDA growth rate that you're seeing out there and all of the long-term growth rates really would be following the ERP implementation. So you're going to see a bit of a spike up in 2020, 2021, and 2022. And that was really as we communicated it; that 2018 and 2019 is really that build, test, train, prepare ourselves. We try to capture those BT initiatives that we're on track for. But again, the spike up in those growth rates and getting within those really is a 2020 and beyond event once we deploy.
Okay, got it. Thank you, guys.
Thanks, Isaac.
And we have a question from Hamzah Mazari with Macquarie Capital.
Thank you. I just had a follow-up. Thank you, was one, if you guys divest assets, more material assets, does the ERP cost go down? I guess it was $275 million to $300 million. That was one.
And then two, I know Cindy just joined, and I know she didn't deal with the restructuring plan, but does the restructuring plan change also that you have a new COO now? Just those two questions. Thank you.
Yeah, I'll take the first one. It depends on what assets we're selling. Obviously, we early on made the decision that C&RS, we were going to probably do something strategic with that. We didn't put a lot of time, effort or cost into building ERP for that. We're looking at the mega-processes that we're building. Certainly, if we divested some assets, I think it derisks the implementation, Hamzah. That's how I look at it. I don't know how significantly, it depends on, again, what we divest and what kind of impact it would have on the cost and the savings. We'll get to that when and if we divest of assets.
But if we do divest, there's one thing for certain, I think it derisks the implementation because it would be not updating a system, an operating system or a financial system. So we'll look at that as we make decisions on whether or not an asset stays in the portfolio. Certainly, ERP is one lens we put on that. On the restructuring, Cindy, any thoughts on that?
Yeah, Hamzah, thanks for the question. One of the things that I'm most excited about is getting a chance to get into and join the company to help with the continued restructuring. I don't think the restructuring is not going to change at all, I just think that it provides me an opportunity to engage with the team to a greater detail to then help the teams and the field operations really drive the synergies and the efficiencies and the productivity results that we should get from all of the work that the team is doing. So I think it's been great for me to get here on the beginning, not to change things, but to help support and augment field engagement as we go forward.
That's great. Thank you for taking my questions last minute. I appreciate it.
Thanks, Hamzah, no problem.
And we have a question from Michael Hoffman with Stifel.
Thank you. The follow-up would be to just tease out the other guy's question about the $850 million to $1 billion. Just to be clear, there are two pieces to that. Business transformation has a component, ERP. Am I right? The business transformation if I take the low end it's probably about $650 million of $850 million. ERP is about $200 million. If you think about the peak year in business transformation, we're probably somewhere between $125 million to $150 million in annualized savings, and the ERP is probably $75 million to $100 million, and that essentially comes out of SG&A?
I think if you look at business transformation, we refer it internally to Pay the Way, and you think about that as the $60 million $65 million that we'll incur over five – which will reoccur over a five-year period. So if we just took $60 million, if you want, and you'd say that's $300 million. And then so I would say the majority of the savings is actually coming from the implementation of the ERP. A majority of that obviously is some back office and shared savings and being on obviously a lot fewer systems.
I don't think we've broken out SG&A, cost of revenue at this point. Obviously, SG&A is an important component when we think about ERP, but we think there are benefits in cost of revenue as well, and part of the ERP is routing inefficiencies in the marketplace.
So if you just did the simple math, Michael, on the $60 million to $65 million, yes, we're going to have some tailwind into 2019 on that as well. And you can almost do the math on that because we put a table out there. I believe it was on slide 9. It's the BT slide that actually tells you each quarter, so you can do the tailwind yourself. So you take that tailwind times four, and you'd probably get to a number that's around $400 million-plus related to business transformation, and the rest ERP. Hopefully that helps out. You got it?
It was slide 8.
Slide 8, I'm sorry. Slide 8 gives you – it's a good breakdown now of when those savings occurred so you can do this tailwind on what's going to happen in 2019.
All right. If I take that approach, $400 million and $450 million, how do you think about roughly that $450 million splits between OpEx and SG&A?
It's really early to tell on that. I would lean more heavily on the SG&A. It's really taking our end-to-end processes. It's being able to consolidate our systems, our IT, improving IT processes and flows, being able to remediate our material weaknesses and take out some of that manual transactional level of work that we do. But certainly a big part of this is being able to optimize the routing and our billing out of the field and how it flows through.
And then one of things we haven't added to this, but certainly the ERP offers us data analytics like we've never enjoyed in this company and to be able to have real-time feedback and daily revenue recognition. Cindy can probably talk about the advantages of being a truly metrics-driven organization and what that's done for her career and being able to drive efficiencies in operation.
Thanks, Dan. Michael, I think one of the things that we look at when we talk about data analytics and any of the routing optimizations that we have, there's a tremendous opportunity for us to take a look across the businesses and across all the various routes that we have out there, to take a look and see how we can get even greater density, how we can reduce miles, how we can get more predictive in when we need to make particular pickups for accounts, because right now they all run independent with real no crossover visibility between the two, or between any of them that are routed in on the road.
And I think having daily visibility to that so that we can maximize, we can get more predictive, I think the savings, whether it's in fuel savings, whether it's in vehicles, whether it's in miles, bringing down overtime, better utilization of our drivers, there's a tremendous amount of opportunity that having real-time day-to-day engagement will make just a huge difference on how we manage this business moving forward.
Okay, thank you very much.
Thanks, Michael.
And we have no further questions at this time.
Thank you, operator. In closing, I want to thank each and every member of our worldwide team. Our Regulated Waste and Compliance Services and Secure Information Destruction businesses exceeded our expectations for the latest quarter and are on track to deliver solid performance in 2018. In addition, the team continues to work together to ensure that our business transformation remains on track and on budget. Your work and dedication is truly appreciated and provides for a bright and successful future at Stericycle. Thank you, everyone. Have a great evening.
This does conclude today's conference call. Thank you for your participation, you may now disconnect.