Casella Waste Systems Inc Q1 FY2023 Earnings Call

Good day. And thank you for standing by. Welcome to the Casella Waste Systems, Incorporated's First Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Charlie Wohlhuter, Director of Investor Relations. Please go ahead, sir.

Thank you, Norma, and thank you, everyone, for joining us this morning. With us today are John Casella, Chairman and Chief Executive Officer of Casella Waste Systems; Ned Coletta, our President and Chief Financial Officer; Jason Mead, our Senior Vice President of Finance and Treasurer; and Sean Steves, our Senior Vice President and Chief Operating Officer of Solid Waste operations. Today we will be discussing our 2022 full-year and fourth quarter results. These results were released yesterday afternoon. Along with a brief review of those results and an update on the company's activities and business environment, we will be answering your questions, but first, I remind everyone that various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our most recent annual report on Form 10-K, which is on file with the SEC. In addition, any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our views change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to today. Also during this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. Reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures, to the extent they are available without unreasonable effort, are available in the appendix to our Investor slide presentation, which is available in the Investors section of our website.

Thanks, Charlie, and good morning, everyone. We are very happy to share with you our strong results to begin the year and the exciting announcement from earlier this week on the pending acquisition of select solid waste operations in adjacent markets. We are executing well against our key growth strategies and we look forward to our continued opportunity to grow the business from our expanding platform to further drive shareholder value. Before discussing the quarterly results, I'd like to provide some strategic views on this announcement while Ned will go into the financials. The Northeast continues to be the focal point for our company with great opportunity for future expansion. We recognize that continued execution of our growth plan requires us to expand our existing footprint in a disciplined manner. In mid-2021, we grew our geographic region through an acquisition in Connecticut where we are performing well and have successfully integrated. The pending acquisition of GFL's solid waste operations in Pennsylvania, Maryland, and Delaware provides meaningful scale to grow from, including the ability to introduce our resource management solutions to our new customers. Further, these operations and markets fit our business profile very well. Across nine collection operations, transfer stations, and a recycling facility, the business mix carries low exposure to the economic cycle, given the high concentration of residential subscription and commercial collection customers. This enhances our ability to remain nimble from an operating, pricing, and risk mitigation perspective. We estimate that approximately 5% to 7% of the GFL operations we intend to acquire are tied to construction and demolition activity. This helps to blend down our consolidated C&D exposure. In addition to the business, we have several talented team members with deep knowledge and experience in these operations and markets. This provides us with added confidence related to a successful transaction and integration. We believe these factors will result in a high degree of risk mitigation, which will support our ability to continue delivering long-term shareholder value. We look forward to welcoming new team members and providing excellent service to our new customers and communities after we close the transaction. Now, moving on into our performance in the quarter. As reported in yesterday's press release, we grew revenues by over 12% and adjusted EBITDA by over 11% in the quarter on a year-over-year basis. The results from our solid waste operations have positioned us strongly to start the year. In fact, solid waste adjusted EBITDA margins expanded over 220 basis points year-over-year for the quarter. This is a testament to our team's perseverance in managing through an inflationary period. Our continued investment into cost-reducing operating initiatives, coupled with focused pricing programs, helped drive performance in the quarter. Ongoing implementation of fleet automation, conversions, route optimization, and onboard computers are delivering increased efficiencies and safety improvements. Sean and his team continue to make great strides in improving our overall operations. From a pricing perspective, our year is off to a strong start, ahead of budgeted levels, given persistent inflation with solid waste price up 8.8%. Likewise, our floating fuel cost recovery fee program is fully offsetting the volatility in fuel-related expenses. While recycling commodity prices have improved modestly from late last year, they remain significantly down from the first quarter of 2022, presenting a headwind for consolidated performance as we expected. That said, our risk mitigation strategies, such as our floating SRA fee, have helped limit the negative financial impact. Overall, we are optimistic that our efforts within the first quarter will benefit our execution throughout the year. I'd like to provide a brief related to our key strategies and recent performance. An important element of our solid waste operations is our landfill assets and the focus we place on increasing returns through our operating programs and permitting initiatives. Reported prices for landfills increased to 10.9% year-over-year as we remain focused on offsetting inflation, including higher capital cost items at our disposal facilities and regulatory costs. As discussed in February during our fourth quarter 2022 earnings call, we experienced a timing shift in tonnages at our landfills, with year-end 2022 volume decline being more than offset by activity levels in January. While there has been slight moderation in volumes from January, we reported positive volume growth in the first quarter. Regarding permitting, our McKean rail project is underway, and I'm pleased to share that Sam and his team recently received all final solid waste permits for that development project. We can now focus on building the required offload infrastructure, with rail operations at the site anticipated to come online in the spring of 2024. The ability to accept waste by rail at McKean is one of our larger development projects in our near-term pipeline, increasing our ability to drive organic growth and internalization opportunities. This positions us well to serve our customers by providing increased disposal certainty and helping to meet their future needs with our safe, secure, and compliant outlet, given the supply-demand imbalance of disposal capacity in the Northeast. It's exciting to have all the activity from a permitting standpoint. As I mentioned, Sam and his team have done a terrific job of getting through that process on time as expected, and we look forward to constructing the infrastructure to bring that facility online in the spring of 2024. In our collection business, we're executing at a high level, similar to the strength of our disposal operations with solid waste collection operations improving year-over-year. This is a direct result of the focus and agility across our team to stay ahead of cost inflation through cost-reducing investments, operational initiatives, and pricing discipline. Sean and his team are driving costs out of the business and enhancing safety by making return-driven investments to increase our use of automated trucks, route optimization capabilities, and onboard technology. About 50% of our addressable collection fleet is automated, and 55% of our route trucks are equipped with onboard computers. In our Resource Solutions, we take great pride in our commitment to environmental stewardship, and our business model promotes this through the services we provide. Recycling has been at the core of the company for decades, and fortunately, our SRA fee and other risk mitigating features in our contracts have greatly limited the financial impact, which we expect will subside in upcoming quarters. We continue to invest in resource management offerings to help fulfill demand from our customers. Our approach ensures environmental and economic balance. We are currently installing new recycling equipment and technology at our Boston MRF, which is slated to be operational by mid-year. This is a great example of an investment that will increase recycling volume throughput, enhance the quality of our end product, improve operating efficiencies, and result in a safer operating environment. We’re excited that this project is on time, on budget, and we expect to have it operational by mid-year. Lastly, I'd like to highlight our capital allocation and growth strategy. Our acquisition pipeline remains robust with about $500 million of addressable opportunities and annualized revenues just above our current Northeast market footprint. As part of our diligent process related to the pending acquisition of the Mid-Atlantic solid waste operations from GFL, we identified opportunities in this market that nearly doubled the size of our current pipeline. This highlights the platform nature of these operations from which we can build over time. Together with our near-term development project pipeline of waste by rail services at McKean and the increased recycling throughput at our Boston MRF, we see a nice growth runway for organic and inorganic projects that meet our return criteria and will drive long-term shareholder value. And with that, I'll turn it over to Ned to walk through the financials.

Thanks, John, and good morning, everyone. Revenues in the first quarter were $262.6 million, up $28.6 million or 12.2% year-over-year, with 2.5% of the year-over-year change driven by acquisition activity and 9.7% driven by organic growth. Solid waste revenues were up 16.6% year-over-year, with price up 8.8%, acquisition growth of 1.8%, and our fuel cost recovery and other fees up 6.3%. Volumes were just slightly up. Revenues in the collection line of business were up 17.1% year-over-year, with price up 8.9% and volume slightly down. Revenues in the disposal line of business were up 19.3% year-over-year, with price up 9.3% and volumes up 6.4%. Landfill pricing was up 10.9% year-over-year. Our Resource Solutions revenues were up 1.2% year-over-year with 4% growth from acquisitions, 9.9% volume growth, and 9.5% growth from processing fees and other prices, offset by much lower commodity prices. Commodity prices were down roughly 52% year-over-year, driven by lower cardboard, mixed paper, metals, and plastics pricing. As you may remember, commodity prices hit a high point in April 2022 and declined roughly 70% through the remainder of the year, hitting a multiyear low in December 2022. Commodity prices have rebounded over 20% sequentially from December through March. Adjusted EBITDA was $50.7 million in the quarter, up $5.1 million or 11.2% year-over-year, with $4.7 million of the growth driven by improvements in our base business. Solid waste adjusted EBITDA was $49.5 million in the quarter, up $10.8 million year-over-year, with strength in both the collection and disposal lines of business. Resource Solutions adjusted EBITDA was $1.2 million in the quarter, down $5.5 million year-over-year, with negative performance driven by three major factors. Adjusted EBITDA was down $1.7 million due to lower commodity prices. As John mentioned, our risk mitigating commodity programs are working well to offset most of the significant decline in commodity prices. Unfortunately, these programs are not fully implemented in several newly acquired markets that had legacy contracts that do not allow us to pass the recycling risk back to customers. These markets accounted for 80% of the year-over-year adjusted EBITDA decline from commodities. Adjusted EBITDA was down $2.5 million at our Boston MRF as the facility was shut down during the quarter for a planned retrofit as we completed a full technology upgrade. Revenues were lower as we displaced volumes and incurred high costs due to transloading volumes to other facilities. Finally, adjusted EBITDA was down $1.3 million across the remainder of the Resource Solutions business due to higher disposal costs for biosolids, given severe capacity constraints, and lower project work for industrial customers. In the quarter, adjusted EBITDA margins were 19.3%. That was down 20 basis points year-over-year and better than our plan. Solid waste margins were 25.4% in the quarter, up 220 basis points year-over-year. Our pricing programs managed to cover the costs of inflation again in the quarter with solid waste prices as a percentage of total revenues up 6.3%, offset by roughly a 5.3% headwind from inflation excluding fuel. Further margin bridging items included a 50 basis point improvement from higher solid waste volumes and operational efficiencies, an 80 basis point headwind from the Boston MRF shutdown, a 35 basis point headwind from lower landfill gas to energy performance, a 30 basis point headwind from acquisition, and a 20 basis point headwind from recycling commodity prices. Our fuel recovery fee was effective in the quarter, fully recovering year-over-year increases in fuel and recapturing margin. Cost of operations in the quarter was up $17.8 million or down 80 basis points as a percentage of revenues. G&A costs in the quarter were up $5.9 million or up 90 basis points as a percentage of revenue, with the shift to a more conservative bad debt methodology driving over half of the increase as a percentage of revenues. Depreciation and amortization costs were up $4 million year-over-year, mainly driven by higher landfill amortization on higher volumes and a mix shift. As of March 31, we had $596.1 million of debt with $60.2 million in cash and liquidity of $332.5 million. Our consolidated net leverage ratio hit an all-time low at 2.06x, our average cash interest rate was approximately 3.7%, and we had fixed interest rates on approximately 73% of our debt. As expected, and as discussed on our fourth quarter earnings call, our adjusted free cash flow started the year light at only $2.2 million, with capital expenditures up $5 million year-over-year and working capital timing differences driving much of the variance. We expect these timing variances to resolve in the second to third quarters, and we are confident in hitting our full year adjusted free cash flow guidance range of $119 million to $125 million as our operating results started the year ahead of budget. The main negative timing difference is in a period where $3 million of accrued payables and $3 million of capital expenditures slipped from the fourth quarter to the first quarter, roughly $4.5 million of higher cash taxes as compared to 2022 as we step into higher state cash taxes, and approximately $3 million higher cash outflows for bonuses paid in March 2023. Given the strong start to 2023 and our continued visibility on pricing and operating programs, we have reaffirmed our guidance ranges for fiscal 2023. The guidance ranges have not been updated for the pending acquisition of select operations from GFL Environmental. As always, we'll update our guidance after completing any acquisitions. As John mentioned, we are excited about the pending acquisition of collection, transfer, and recycling operations in Pennsylvania, Delaware, and Maryland from GFL. As announced in our press release, we believe this acquisition is a great strategic fit. We expect the acquired operations to generate approximately $185 million of revenues and $43 million of EBITDA in the first twelve months of operations. We anticipate generating roughly $8 million of incremental annual synergies and benefits within three years through landfill internalization and fleet automation efficiencies. Furthermore, the structure of this transaction is favorable as we expect to yield over $130 million of cash tax savings over a multiyear period. We plan to pay for this acquisition through a combination of cash on hand, revolving credit facility borrowing, and from a planned new Term Loan A under our existing senior secured credit facility. We expect the transaction to close by the third quarter. I'd like to take a moment to thank the GFL team for their help during the diligence process and their continued assistance as we work collaboratively on integration planning. We look forward to welcoming GFL employees to our team in the coming months, and we also look forward to providing great service to the new customers in the Mid-Atlantic.

And our first question comes from the line of Stephanie Moore with Jefferies.

Hi. Good morning. Thank you for the question. I wanted to touch on post the pending acquisitions of the GFL assets and more so, the Mid-Atlantic region. And I think you noted that this almost doubles your total addressable market from an M&A standpoint. I wanted to think about how, assuming these deals close, you'll prioritize assets in your more legacy Northeast markets, and then more so in these markets. And what will be some of those determining factors for expanding further in this new market. Thank you.

Sure. Several years ago, we identified in our strategic planning that we want to look into adjacent markets for acquisition opportunities. Building a pipeline takes years as we build relationships with small business owners and look for opportunities. Luckily for us, we've been doing business in these markets for many years through our National Accounts Group, and we have a lot of deep relationships. Furthermore, we had a couple of great hires to our team over the last few years who have spent quite a bit of time in these markets, operating businesses, and acquiring businesses. So our pipeline has developed well over the last year plus. But this platform acquisition presents a great opportunity for us to have a platform across the region and then look to densify through great sales efforts and also tuck-in acquisitions. So regarding your specific question of where will we focus our energy, we continue to focus on both. As John mentioned, we have a solid platform and acquisition pipeline in the Northeast with excellent opportunities to drive vertical integration and synergy value. We're also advancing our pipeline in the Mid-Atlantic, and there will be a balance across both. We're not just shifting effort from one market to the other.

Yes. I also think it's important to note that from a business development perspective, we were working in the Mid-Atlantic, identifying opportunities, building a platform in terms of opportunities there for about a year prior to having the chance to look at the GFL assets. So we had a team in place focused on that market. This acquisition complements the work that we had started to do in adjacent markets. As we mentioned earlier, our expansion into Connecticut in 2021 has gone exceptionally well for us. So this represents another great platform to continue to grow across the entire Northeast.

Great. Thank you. And then just as a follow-up, maybe switching gears to volume performance. I was hoping you could discuss what you're seeing from a macro perspective and any potential slowdown in volumes as you move through the quarter or maybe in your C&D business. Would love to get your thoughts there. Thank you.

I think that we saw a little bit of softness at the end of the year, but on balance, we see a bit of activity without anything giving us pause. Keep in mind, we're in the lowest activity months of the year for us in the Northeast during the first quarter. Overall, the first quarter saw a slight increase in volume, so we don't see anything that raises concern at this point in time from a volume standpoint.

Yes. And, John, over the last decade, we have consciously re-blended our book of business. If you recall, back in 2008, about 18% of our revenues came from construction and demolition, whether it be in the collection line of business, transfer, or landfills. Today, that figure sits at around 10%. Additionally, with the GFL acquisition of select operations, they're even lower than us, sitting in the 5% range.

Right. Understand overall.

Yes. But yes, we're seeing some downs overall. That's the most economically sensitive part of any waste company, of course, is construction and demo activity. Through the first quarter, we saw a few ups and downs. We ended December with some weakness, but had a strong month in January and a decent month in February and March. In the Northeast, we always need to let the spring unfold before knowing the true trend, but today there is nothing significant in the metrics.

And our next question comes from the line of Tyler Brown with Raymond James.

Hey, good morning, guys. Ned, I've got to revisit the margin bridge if I could. I believe you mentioned a 50 basis point contribution from volume, negative 80 from the Boston, negative 35 from landfill gas, negative 30 from M&A, and negative 20 for commodities. However, if you add that all up, that's negative 110 or 115, and margins were only down 20. So if so, were core margins up, say, approximately 100 basis points? Is that what you're trying to convey?

Yes, I'm not sure if there's a mistake here. I'm adding it up myself because that should add up correctly. Yes, that's actually down 10 basis points. So if you factor in solid waste price, that was consolidated up 6.3% plus 50 basis points of margin expansion due to higher volume, yielding 6.8%. This is less 5.3%, less 80 basis points, less 30, plus 30, less 20. That's down 10 basis points. There are certainly some items affecting us, like the Boston MRF shutdown, which is almost done. This won’t persist into the future. We're still managing to get price ahead of inflation, and as you're aware, we have the flexibility in our book of business to course-correct if inflation rises again.

Okay, all right. But the Boston drag should dissipate soon.

Yes. We're investing both capital dollars and managing lower operating results here for about a quarter and a half while we complete that retrofit. Once we come back online, we are anticipating about $3 million to $3.5 million of better performance at the Boston MRF due to higher throughput and better operating efficiencies. We are utilizing a lot of technology at robotics, and we expect to accomplish more work with about 35% to 40% fewer people. This is a strong long-term investment in a market that genuinely requires sustainability and has a vast growth opportunity in the greater Boston area.

Okay, perfect. And I have a detailed question about the model, but this is the third or fourth quarter in a row that the surcharge and other contributions to IRG have been substantial. I mean, fuel was kind of flattened out year-over-year. What’s happening there? Is there a lag or is there something going on that I should understand? How to interpret that?

Yes, there’s a bit of a lag, but that line also contains our SRA fee. As fuel surcharges have declined, our SRA rate fee has risen due to historically low commodity prices. Jason can probably provide the mix for you, but you're seeing a countervailing trend there behind the scenes.

Okay, that is very constructive. That will clarify things. I'll connect offline with Jason on that. Regarding pricing, I know there was significant acceleration. One could argue that you may not have been as aggressive on price compared to others in the previous year. When we analyze Q1 pricing, do you think this is the peak or might we see acceleration in Q2 as well?

Last year, we probably came out of the gates a bit lower than we should have. We recognized a bit higher inflation in the business in late Q1, early Q2, leading to a second-round price uptick hitting a high point in June. Currently, we did extensive analytical work late in 2022, and we came into the market with a slightly higher price in January-February. You shouldn’t expect further climbs unless we see inflation trends become stronger, at which time we will also adjust prices again. One caveat is that landfill areas where inflation remains high, especially on capital items, will influence pricing.

Okay, that’s insightful. Earlier, I asked about the embedded unit cost inflation in the current guidance. Could you clarify that?

Yes. Let me pull up the accurate model. Do you happen to know that, Jason, off the top of your head?

I do. Our expectations for the first half of the year anticipate core and inflation across our business, excluding fuel, to be about 5.5% year-over-year and the second half closer to 5%. This blends around 5.25% over the year.

Okay. We're pretty close; it would be around 5.3% in Q1.

Yes. Okay, great. On the GFL assets, you provided excellent insights on why now, I’m very much looking forward to your new camouflage map, as I call it. There’s a lot to this deal, perhaps more than meets the eye from my perspective. Can you discuss the cash tax shielding benefits in this deal? How should we think about cash tax payments, excluding this deal, and how does it add longer-term value?

As most shareholders know, we've benefited from federal and state net operating losses over the years, which we used to offset much of our cash taxes. We now have roughly $52 million of federal NOLs and not many at the state level. We're stepping into a higher cash tax position. We aim to acquire businesses optimizing tax structures. The GFL acquisition offered a great opportunity because three of the operating units we’re acquiring are disregarded entity LLCs, treated much like an asset deal from the acquisition perspective. This provides an excellent tax basis step-up according to tax law, leading to depreciation and amortization of intangibles. This creates a substantial opportunity to offset cash taxes in year one and, indeed, throughout 15 years. This is a valuable aspect of the tax code driving value during acquisitions.

Yes, that’s extremely helpful. So it's a long-term benefit. John, you mentioned that this new platform opens up numerous M&A opportunities. Just to clarify, does this new platform essentially double your acquisition opportunities?

That’s accurate, Tyler. As I mentioned earlier, the business development team has been actively working in Pennsylvania to identify opportunities long before the GFL acquisition opportunity arose. We are indeed poised to double our acquisition opportunities, which is precisely correct.

Okay, perfect. One final question.

The new platform provides us with another significant growth opportunity going forward. Naturally, we'll have considerable work to do from an integration standpoint, and it must be executed effectively over the next 6 to 12 months. But long term, we expect significant growth opportunities in the Mid-Atlantic. So, it's quite exciting.

Great. Lastly, you mentioned cross-selling Resource Solutions as a potential benefit. Is that included in that $8 million of synergies or would that fall separately?

No, it’s not included. It’s a fantastic opportunity. Consider providing solutions to colleges, universities, municipalities, and industrial customers. These customers seek partners who help them meet their sustainability goals. Our entire Resource Solutions team will have terrific organic growth opportunities to provide those services across this customer base.

Next question comes from the line of Michael Hoffman with Stifel.

Hey, everybody. Good morning. John, I imagine there’s a whiteboard somewhere in Rutland where you’ve laid this all out. I see $185 million, $43 million in EBITDA. If I project five years out, what does that business look like?

It’s difficult to predict how substantial it can grow, Michael. However, we believe there’s tremendous value to be created. Tyler touched on this regarding Resource Solutions. We genuinely believe we have an excellent opportunity to significantly grow that entire book of business in this market. It’s a great opportunity with significant potential for business development as well. We foresee a robust portfolio of assets available to us, both from disposal stations, transfer stations, and the ability to utilize McKean. It’s indeed an exciting prospect.

Is it unreasonable to expect that $43 million can double in five years with a 15% CAGR?

Yes, we've been achieving growth in low double digits in EBITDA and mid to high double digits in free cash flow over the years. We aim to use this platform to sustain that trend. You're absolutely right; that’s the reason for pursuing this region. We won’t provide multi-year guidance yet on our projections for this, but your assumptions are quite valid.

Correct. Pennsylvania has unique flow control issues. Are there limits on what you can do due to the flow control?

Certainly, there are limits where communities are flow-controlled. It makes sense that there would be limits in those areas, but it's not universally applied across the entire platform.

Yes, you encounter flow control in Delaware, but from our standpoint, we perform phenomenally in collecting waste and recyclables. We deliver high returns in those operations and provide value there. This is not a negative aspect in our view. We have communities in the Northeast with flow control, and we’ve been operating effectively in those for years, providing excellent service and maintaining the right equipment for efficiency while cross-selling those services for high returns in those markets.

Has HHR been filed yet?

Yes, it was filed on the 21st of April.

So the 30-day clock has started, expected around late May. What might hold this up?

I don’t think there should be any issues since, as you noted, there’s no overlap, so that shouldn't be a concern with HHR.

We’re collaborating with the GFL team and aim for a late Q2 close.

Regarding the pricing dynamics, you had a window where disposal prices were exceeding collection. After the pandemic, collection started exceeding disposal again, but you’ve returned to disposal prices now being higher. Are we on a sustainable path regarding this difference?

Yes, it’s indeed necessary. As we discussed earlier, we're witnessing high inflation in disposal prices. The IWS folks introducing rail to Apex during the pandemic dampened volumes within the greater New York marketplace. They’re running at capacity these days, and we’re facingConstraints, especially regarding sludge disposal. The number of sites for that material is quite limited, creating weekly challenges. Expect some fluctuations as capacity increases or new outlets become available. That said, we're bringing McKean online for long-term stability from a waste disposal perspective.

Sounds good. Looking forward to seeing you all on Sunday in New Orleans.

Sounds good.

Sounds good. See you down there.

See you there.

The next question comes from the line of Sean Eastman with KeyBanc Capital Markets.

Hi, team. Thanks for taking my questions. Hope everybody's well. While we’ve covered many compelling positive aspects of this deal, I want to look at it from an alternative perspective. This deal has a different profile than what you’ve pursued recently. Your M&A strategy has worked exceptionally well. Can you share insights on the decision-making process around staying within that same lane versus jumping into a platform acquisition like this?

Sure, Sean. We've had great success growing within the Northeast and could have continued targeting significant opportunities over our current infrastructure. However, it’s apparent to us that to maintain growth, we required platform expansion. We began looking into adjacent markets for growth opportunities in 2021 after our step into Connecticut. The platform opportunity with GFL aligned perfectly with our ongoing business development endeavors in Pennsylvania, creating a long-term growth prospect and the potential for lasting value.

Does this mean you may enter a digestion mode from a perspective over the next 12 months, or can you maintain your traditional program?

Our traditional program will carry on alongside existing operations. We have a separate management team in place familiar with the Mid-Atlantic market, and we’re enthusiastic about their capabilities. We'll continue exploring opportunities in the Northeast as they become available.

I’d like to add that over the last few years, we have built an acquisition diligence team and integration resources. Those teams are well-prepared, and working with a professional organization like GFL makes this structured process a bit easier than purchasing smaller companies that often present challenges. We have a good amount of work ahead, but we’re dealing with a highly organized seller who assists us in preparing for integration.

It's essential to note we're going to continue addressing the existing opportunities we hold in New England and New York. These opportunities are substantial and active, so we will maintain our current momentum as we venture into the future. Our capabilities have positioned us well to accomplish this.

That’s very helpful. Finally, I’d like to ask if there are any notable updates from an inflation perspective.

No new developments. We continue to observe inflation across the same categories as previous periods, with the exception of labor costs coming down somewhat. Parts maintenance and third-party hauling remain our highest inflationary areas. On the capital side, some heavy equipment and truck costs have decreased slightly. Nonetheless, landfill construction costs continue to reflect high inflation. Overall, our internal numbers have dipped a bit, now around 5.3%, down from 5.9% internal inflation several quarters ago.

Our next question comes from Michael Feniger with Bank of America.

Yes, thanks. Regarding the GFL asset, I’m curious how to interpret the contract structures there. You have a unique mix with subscriptions while some competitors rely more on CPI-based contracts. Can you clarify if there are different contract structures in this new footprint we should note?

There’s substantial benefit to this acquisition as the mix mirrors attributes we appreciate in a business model. It has a favorable blend of subscription, residential, small can commercial, and industrial work. This is viewed positively overall. We see about 58% as small can and residential, with a large portion based on subscriptions, possibly 5% to 7% allocated to municipalities. Small can commercial accounts for about 30%, while industrials roll off around 4% to 5%, leaving just approximately 5% related to construction and demo. This mix is favorable to us, allowing effective management of pricing.

Great. The margins appear healthy in this new footprint. Can you comment on free cash flow conversion aspects? Will you need to invest significantly to bring this asset up to operational standards? How do you view CapEx needs for this new footprint?

Once we acquire the business, we will conduct further assessments. We plan on investing some capital in the first year, particularly in facility enhancements, but the fleet seems to be in good shape. On the free cash flow side, we discussed cash benefits earlier, driving near-term value. Generally, we don’t foresee significant capital outlays that could adversely affect free cash flow immediately.

Considering your current footprint, disposal network, and recognized capacity constraints over time, could you update us about the disposal side?

Pennsylvania presents significant disposal capacity. We foresee no immediate challenges in that regard, and we consider our McKean facility a safety net. We anticipate opportunities for rail transfer from that market down the line. Overall, there is substantial disposal capacity available in the market currently.

Thank you. I'm currently showing no further questions at this time. I would like to turn the call back over to Mr. John Casella, Chief Executive Officer, for closing remarks.

Thank you, operator, and thanks, everyone, for joining us this morning. We look forward to discussing our second-quarter 2023 earnings with you in late July. Thanks, everybody. Have a great day and a wonderful weekend.

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Have a wonderful day.