Waste Connections, Inc. Q2 FY2022 Earnings Call

Greetings, and welcome to the Waste Connections Second Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded Wednesday, August 3, 2022. I would now like to turn the conference over to Worthing Jackman, President and Chief Executive Officer. Please go ahead.

Terrific. Thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our second quarter results and increased outlook for 2022 and to provide a detailed outlook for the third quarter. I am joined this morning by Mary Anne Whitney, our CFO. As noted in our earnings release, accelerated solid waste pricing and E&P waste activity drove a top to bottom leap in the second quarter. Solid waste pricing growth of 8.8% in Q2 enabled us to overcome increased inflationary pressures during the period and deliver adjusted EBITDA margin in line with our outlook and flat year-over-year, excluding the margin dilutive impact from acquisitions completed since the prior year period. Our outperformance in the first half of 2022, expected further sequential increases within solid waste pricing growth, continuing strength in E&P waste activity, and acquisitions closed year-to-date position us to increase our full year outlook for revenue, adjusted EBITDA, and adjusted free cash flow and provide another reflection of our culture of accountability in a challenging operating environment. As anticipated, acquisition activity is pacing well above average. We have signed to close approximately $470 million in annualized revenue so far this year, and our pipeline remains quite robust. As such, we believe we are well positioned for double-digit revenue growth in 2023, along with margin expansion from continuing solid waste pricing strength and rollover contribution from acquisitions already signed or closed year-to-date. Additional acquisitions expected to close later this year and early next would provide further growth. Before we get into much more detail, let me turn the call over to Mary Anne for our forward-looking disclaimer and other housekeeping items.

Thank you, Worthing, and good morning. The discussion during today's call includes forward-looking statements made pursuant to the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995 including forward-looking information within the meaning of applicable Canadian securities laws. Actual results could differ materially from those made in such forward-looking statements due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement included in our August 2 earnings release and in greater detail in Waste Connections filings with the U.S. Securities and Exchange Commission and the Securities Commissions or similar regulatory authorities in Canada. You should not place undue reliance on forward-looking statements as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances that may change after today's date. On the call, we will discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both the dollar basis and per diluted share, and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non-GAAP measures to the most comparable GAAP measures. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations. Other companies may calculate these non-GAAP measures differently. I will now turn the call back over to Worthing.

Thank you, Mary Anne. We are extremely pleased with our performance in the first half of the year, led by strong execution and continued pricing implementation to address macro challenges. In the second quarter, as cost pressures persisted, we once again delivered pricing above our outlook, and we positioned ourselves for another sequential increase in Q3 to drive higher pricing in the second half of the year. Total Q2 price of 8.8% from 7.2% in core price plus 160 basis points in fuel and material surcharges was 30 basis points above the high end of our outlook. Total pricing ranged from almost 5% in our mostly exclusive market Western region to between 9.5% and 10.5% in our competitive regions, up 170 basis points sequentially from Q1. Our Q2 pricing reflected a 90 basis point sequential increase in core pricing, along with an 80 basis point uptick in fuel and material surcharges. Moreover, we are set up for a 100 basis point sequential increase in pricing growth in Q3 to almost 10%, primarily from higher core pricing as we recognize the full quarterly impact of increases already put in place during Q2 and early Q3. The advantage of continued acceleration of core pricing through the back half of 2022 is not only the potential for margin improvement to the extent that cost pressures abate, but also the setup for 2023, given our higher focus on core pricing, which we retain versus surcharges. Underlying volumes were up slightly in Q2, about as expected on reported volumes down about 70 basis points, with a year-over-year decrease attributable to the expiration of 2 poor-quality municipal contracts noted in earlier periods. Looking at year-over-year results in the second quarter on a same-store basis, commercial collection revenue was up about 14%, mostly due to price. Roll-off revenue was up about 11% on revenue per pull, up about 8.5%, and daily pools, up about 2.5% on increases in all regions. Most notably, our Central region was up about 5%. The landfill revenue was up 2.5% with average rates per ton up 6.5% and tons down about 3.8% on the toughest quarterly comparison from 2021. Year-to-date, tons are about flat year-over-year as we maintain our focus on the quality of revenue across all lines of business. Looking at Q2 revenues from recovered commodities that include recycled commodities, landfill gas, and renewable energy credits, or RINs, excluding acquisitions, collectively, they were up about 14% year-over-year due to higher values for both recycled commodities and RINs, resulting in a margin tailwind in the period of about 20 basis points. Commodity values were slightly below Q1, with average prices for OCC, or old corrugated containers of about $158 per ton and RINs averaging about $320 in Q2. RINs have actually ticked up a bit from recent lows and are currently about $2.85. Looking at a few of our sustainability-related projects under development. As noted last quarter, we have 2 greenfield recycling facilities and 2 renewable gas facilities under development, all of which are progressing and on track for completion by late 2023. The 2 recycling facilities will enable us to internalize the processing of recyclables that we are already collecting, thus having an attractive payback as we avoid third-party processing fees, and the RNG projects provide for beneficial reuse of landfill gas already being captured also with compelling returns. And finally, looking at E&P waste activity, we reported $50.4 million of E&P waste revenue in the second quarter, up 24% sequentially from Q1 and up 62% year-over-year, a margin tailwind of about 40 basis points in the quarter. Increases in drilling activity in multiple basins, led by the Permian, have driven a step-up in quarterly E&P waste revenue of over 40% since year-end 2021 from about $35 million of revenue to our current quarterly run rate of about $50 million in revenue. Moving to acquisition activity. As noted earlier, we've already closed 12 acquisitions year-to-date with annualized revenue of approximately $245 million, about 2 times the level of what we would consider average for a full year. These transactions are all in solid waste and include West Coast franchises as well as new market entries and tuck-ins spread across competitive markets in the U.S. and in Canada, with another $225 million in annualized revenues in both franchise and competitive markets expected to close during the third quarter, subject to customary closing conditions. Our activity already exceeds last year's outsized levels and sets us up for over 3% in rollover acquisition contribution next year. Our pipeline remains quite robust for additional acquisitions expected to close later this year or early next, driven by continued above-average levels of interest from high-quality private company sellers. The strength of our balance sheet with leverage of about 2.5x on a net debt-to-EBITDA basis provides for continued flexibility during periods of outsized acquisition activity like the ones we've been experiencing, along with optionality around the return of capital to shareholders, which we've already demonstrated through share repurchases completed year-to-date, along with another expected double-digit percentage annual increase in our cash dividend later this year. Our focus remains, as always, on value creation and replicating the success achieved over 25 years through disciplined capital allocation, market selection, and an intentional culture to drive differentiated, predictable results. We believe that the challenges of the current environment highlight the importance of this approach more than ever as we continue to execute through varying economic cycles. Now I'd like to pass the call to Mary Anne to review more in-depth the financial highlights of the second quarter and our increased outlook for 2022 and to provide a detailed outlook for Q3. I will then wrap up before heading into Q&A.

Thank you, Worthing. In the second quarter, revenue was $1.816 billion, about $30 million above our outlook and up $282 million or 18.4% year-over-year. Organic growth was over 9% in the quarter, and acquisitions completed since the year-ago period contributed about $144 million of revenue in the quarter or about $141 million net of divestitures. Adjusted EBITDA for Q2, as reconciled in our earnings release, was $567 million, about $10 million above our outlook and up about $82 million or 16.9% year-over-year. Adjusted EBITDA margin of 31.2% of revenue was in line with the margin outlook we've provided for the period, as we successfully overcame the continued escalation of cost pressures during the quarter. This included an incremental impact of 60 basis points from higher rates for fuel and third-party logistics compared to our Q2 outlook, resulting in a year-over-year margin impact of 170 basis points combined from those 2 items. Looking at the other margin drivers in Q2, the strength of solid waste pricing, which exceeded the high end of the range we provided in May, drove underlying solid waste collection, transfer, and disposal margin expansion of 110 basis points, excluding fuel and third-party logistics. This was bolstered by a 60 basis point combined margin benefit from higher E&P waste, recycled commodity values, and RINs. Excluding the margin dilutive impact from acquisitions completed since the year-ago period, adjusted EBITDA margin was flat year-over-year as expected. To reiterate, normalizing for acquisitions, we delivered flat year-over-year margins in the face of inflationary pressures, which accelerated during the quarter to 40-year highs. Moreover, year-to-date, we've delivered adjusted free cash flow of over $638 million or 18.4% of revenue, up 9% year-over-year in spite of capital expenditures up $100 million or 36% year-over-year. As such, we are well positioned to increase our full year outlook for adjusted free cash flow to up almost 15% year-over-year. I will now review our updated outlook for the full year and provide our outlook for the third quarter of 2022. Before I do, we'd like to remind everyone once again that actual results may vary significantly based on risks and uncertainties outlined in our safe harbor statement and filings we've made with the SEC and the Securities Commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook assumes no significant change in underlying economic trends. It also excludes any impact from additional acquisitions that may close during the remainder of the year and expensing of transaction-related items during the period. Looking first at our updated outlook for the full year as provided in our reconciled earnings release, revenue for 2022 is now estimated at approximately $7.125 billion or $215 million above our initial outlook with primary drivers, including higher solid waste price-driven organic growth, plus about $100 million from acquisitions completed since our initial outlook in February. Adjusted EBITDA for the full year is now estimated at approximately $2.19 billion or about 30.7% of revenue, down about 50 basis points from our initial outlook as follows. 40 basis points reflects the impact of incremental price increases to overcome higher inflationary pressures, including over 100 basis points from higher fuel and third-party logistics as compared to our original outlook, and 10 basis points is from the margin dilutive impact of acquisitions completed since February. We are increasing our outlook for adjusted free cash flow to $1.160 billion, with CapEx unchanged at $850 million. Turning next to our outlook for Q3. Revenue in Q3 is estimated to be approximately $1.865 billion. We expect price plus volume growth for solid waste of about 9%, including total price of 9.5% to 10% with core price of over 8%. Reported volumes will continue to reflect the 80 basis point impact from expired contracts. E&P waste revenue is expected in line with Q2 levels, and recovered commodity values are expected to remain largely in line with current levels, which, as Worthing noted, are down 15% to 20% from Q2. Adjusted EBITDA in Q3 is estimated at approximately $581 million or 31.2% of revenue. This reflects an expected 40 basis point margin dilutive impact from acquisitions already completed, continued underlying solid waste margin expansion from price-led organic growth, along with headwinds from fuel and third-party logistics, similar to Q2. Upside would come from any improvements in commodity-related revenues, higher E&P waste activity, acquisitions completed prior to quarter end, or easing of cost pressures given the magnitude of core-focused price increases already in place. Depreciation and amortization expense for the third quarter is estimated at about 12.3% of revenue, including amortization of intangibles of about $38.5 million or about $0.11 per diluted share net of tax. Interest expense net of interest income is estimated at approximately $47.5 million. And finally, our effective tax rate in Q3 is estimated at about 22.5%, subject to some variability. And now let me turn the call back over to Worthing for some final remarks before Q&A.

Thank you, Mary Anne. We are very pleased to raise our outlook for the full year, especially given the tough macro environment and rising inflation. We are positioned for significant margin expansion in solid waste as rising prices offset inflationary pressures, and we are already prepared for expected double-digit revenue growth in 2023, along with margin growth from ongoing solid waste pricing strength and contributions from acquisitions completed so far this year. As mentioned earlier, we anticipate additional acquisitions closing later this year and early next year, which will contribute to further growth when we share our formal outlook in February. With our focus on core pricing, we expect the potential for significant underlying margin expansion to alleviate some pressures. We are grateful for our over 20,000 employees who are effectively navigating the challenges of ongoing labor constraints, increased core pricing, and supply chain issues while fulfilling our commitments to customers and communities. We appreciate your time today, and I will now hand the call over to the operator to begin the Q&A session.

Our first question comes from Noah Kaye with Oppenheimer.

I think the story really has to start here with price in terms of your commentary for next year double-digit revenue growth. Obviously, that implies that core price will continue to be elevated into next year. So can you just help us get some confidence around that at this point? How much of that is really coming from the restricted side? How much of it from some of these incremental pricing initiatives? How do we unpack that?

That's a great question because, as you know, in restricted markets, there's a lag in the catch-up, and you'll see that next year. Look, as we already look at 2023, we're already positioned for at least 5% pricing without any other pricing actions to be taken. And that breaks down to at least 6% as we see it in our franchise markets that, along with the rollover pricing and competitive markets that's already been implemented, again, has us positioned for 5% price at a minimum next year before any other actions are taken in competitive markets. Our expectations, as we look ahead, we do think that inflationary pressures have peaked, that they will moderate, and may average closer to 5% or so next year. I don't think we'll know until another 12 months, if it breaks below 5%. But again, even if the average is 5% next year without any other pricing actions, we're already set up to recover that. And obviously, I would expect those, if the deflationary environment is 5%, that you'll see us do total pricing of at least 7% next year. And again, as you've seen this year, the vast majority of that will be core pricing.

Very helpful, Worthing. And then as you talk about potential for margin expansion next year, I'd just like to understand what you're seeing in terms of the trends right now in the cost structure. We can set fuel aside for a second, talk about some of the other components of solid waste. Where do you have a sense that those cost pressures may have been peak and starting to decelerate? How do we think about the real leverage potential in the business heading into next year?

I believe cost pressure has two dimensions. One is the actual cost pressure, and the other is the timing of when we notice it. As we progress through the first half of this year, we've clearly mentioned the impact of fuel and third-party logistics, which other companies have also noted. While firms like ours may have had price contracts with vendors, the reality in this environment is about whether you want the service. I don't mean to sound overly philosophical, but the uncertainties we faced are now clearer. The most intense pressures are behind us, and we have already adjusted pricing to recoup those costs. Unless those costs surge by another 25%, which seems unlikely given that third-party logistics costs are decreasing, we have a known cost structure and have implemented pricing to address it. Currently, we are mainly observing the typical rate of inflation, particularly in wages, which peaked back in the first quarter. We believe we are moving past that peak unless an unexpected shock occurs in the system.

To elaborate on that and add to Worthing's point, we've observed a peak in employee growth that rose from 3.5% to 4% last year, ending at 7%, and starting this year at 8%. It has since moderated to around 6% to 6.5%, which is encouraging. However, in the second quarter, this was offset by rising fuel costs and related expenses, leading to a 60 basis point incremental drag from fuel and third-party logistics in Q2. Overall, when we consider inflationary pressures in the business, we are still experiencing high single-digit increases, similar to what we noted in Q1, although it may be moderating slightly.

Many companies focused on the fuel environment have implemented surcharges that account for nearly half of their total pricing. These surcharges have risen significantly as fuel prices have increased, and we can expect the opposite effect as fuel prices begin to decline, as we are currently observing.

Yes. That's very helpful. Thanks for filling some of the known unknowns, and I guess we'll go worry about the unknown unknowns.

Our next question comes from Hamzah Mazari with Jefferies.

I wanted to follow up on pricing. Specifically, I would like to know your perspective on what type of pricing will be sustainable once inflation decreases. Additionally, when you decide to raise prices, how do you determine whether to categorize that increase as a surcharge or as part of the core price? I understand that core prices tend to be more stable. Could you share any internal strategies you have for maintaining sustainable pricing as inflation eases? I'm also aware that your franchise business has its own dynamics, which may limit your control in this area.

Sure. To address your question about our pricing strategy, we are primarily focused on core pricing. While some of our markets still utilize fuel and material surcharges due to historical reasons, 85% of our reported price comes from core pricing. Our approach is centered on recovering cost pressures, including fuel and logistics. Historically, our pricing has averaged a spread over CPI of about 150 basis points over the last 15 years. We expect to revert to that normalized spread versus inflation over time, which is our goal each year. This year has been unique due to rapid cost escalations. However, we anticipate benefits from the lagging CPI increases in the following year, particularly in 40% of our business. Just to clarify, we're still implementing price increases of around 4.5% to 5% in our West Coast region. Looking ahead to next year, we expect these increases to continue growing sequentially due to the inflationary impacts from the previous year.

Could you remind us how much unionized labor you have? Do you have less unionized labor compared to some of your larger peers, and is that a challenge for you currently? It seems like your labor inflation is higher than most. Is that due to having less unionized labor? Additionally, will this situation change if inflation decreases? I'm interested in your exposure to unionized labor and whether it's a challenge for you.

Well, I'll see it as a headwind for us because we have kind of the lowest percent of unionized labor among the big 3. I mean we're about 20% overall, but in the U.S., we're much less than that because Canada has a much higher percentage of unionized labor, just endemic to the market. But no, I'd say look as the other companies face resets on their union contracts, their headwinds are in front of them, number one. Number two, I'd say on the nonunion side, and on the union side, simply put, our employees deserve pay raises. They are operating and living in a high inflationary environment; if we have very high expectations on their daily performance, especially around safety and risk, then they deserve to be paid and rewarded. It's not about just constraining what our people make. Our people should get paid a lot of money for doing a difficult job in this environment. Again, we see savings I mentioned risk, for example. I mean we are 80 to 100 basis points below in total cost of risk. Wages can be higher, but if you're getting quality people, you see the payback in other areas of the P&L. I don't begrudge anything our folks are getting from wage increases.

Our next question comes from Jerry Revich with Goldman Sachs.

Mary Anne, I wonder if you could just expand on the third quarter margin outlook. So excellent operating momentum exiting the quarter. Normal seasonality is for margins to be up call it, 40 basis points Q3 versus Q2. And based on the outlook, we're looking for flat margins sequentially. Can you just expand on that? I think half of that headwind is the recycled price impact, but I'm wondering if you could just unpack the other moving pieces there sequentially?

Sure. That's a great question, Jerry. You're correct that the sequential comparison looks a bit different, largely due to the decline in recycled commodity values and RINs. Additionally, not only are we seeing these values decrease, but that also makes for tougher comparisons with the previous year, which is why it appears different on a comparative basis. Last year, we were able to achieve margin expansion in Q3 despite increasing cost pressures. So, the comparisons play a role in this, along with the fact that recycled commodity values increased throughout last year, which highlights the decrease in values for Q3 of this year.

As we've noted, I mean, there are a handful of items that would be additive to that margin to the extent they play out. We're already starting to see fuel crack a little bit as we move through Q3. We've seen RINs now pick up a little bit over the last 2 weeks. So anyway, there's a basket of items that would be additive to that depending upon how the quarter plays out.

When I just think about it more broadly, second half of this year versus first half and similar year-over-year margin guidance implied in all those quarters, what's different is in the first half of the year, there was the assist from recycled commodities and RINs, and it tells you that we're getting better underlying solid waste margin expansion in the back half of the year. That's what we're guiding to. You'd expect that as we've layered in more price.

Super. And then just to follow the breadcrumbs on 2023 that you folks have laid out price cost tailwind of about 2 points versus 1.5 in a normal year. So just to tease that out, it sounds like that would suggest margin expansion opportunity of about 80 basis points versus the 40 or so that you have done historically. Is that how you folks are thinking about '23 from a planning standpoint as we sit here today?

If we consider it from a planning perspective, we wouldn't set guidance that high. Therefore, you should expect to see an opportunity for margin expansion increasing as inflationary pressures ease. The best chance for margin expansion typically occurs when inflation is in the 2% to 3% range. We'll need to observe how inflation pressures subside and how margins are affected by acquisitions before we assign our leading margins to all new acquisitions; it's prudent to wait and assess the revenue those will generate. Internally, we believe that's likely not too far off.

Super. And then lastly, utility deals for landfill gas have really accelerated since your last quarter's call, Kinder Morgan has acquired an asset, longer-term offtake agreements are being struck. Can you just update us on how you're seeing the offtake market evolving as you get ready to bring online the additional landfill gas plants? Are you seeing pricing in the call it, mid-20s for longer-term agreements playing out at this point?

Sure. So just to update more broadly on how active we are in R&D facilities. I think that's indicative of how encouraged we are about the underlying fundamentals of those projects. So to give you an update, in addition to the 2 that we've already talked about, that Worthing said, we're on track. We have a total of 4 including those 2, which are either under construction or equipment has been ordered, and then an additional 6 in development for a total of 10 projects at various stages of development, including under construction, that we think will come online in the next 2 to 5 years. Just from those projects alone, it really puts us on track to achieve the targets we laid out of increasing that beneficiary use by about 40%. So those projects, as we've said, have strong fundamentals really over a broad range of outcomes on RINs. We just think that longer term, it is a nice opportunity, and we'll continue to add those projects, as opportunities present themselves.

And Mary Anne, can you comment on the uptake market? Is that developing?

We are encouraged by the level of demand and interest we are seeing. This strong interest is driving many projects in this space, as the fundamentals for the business are solid.

Super, I leave it there. Our next question is from Michael Hoffman with Stifel.

Mary Anne, you came into the year with, if I remember correctly, nearly 50% of your fuel hedged. What's the plan at this point going into '23? And how have the hedges helped buffer some of this pressure?

Sure. So you're right. We have about 50% hedged in '22, and we've got about 25% hedged in '23. We certainly look for opportunities to increase that just to get better visibility, but also like to be opportunistic if when opportunities present themselves. As we think about the need for continuing to get price, part of it is the fact that fuel will be an incremental pressure as those hedges roll off, which benefited us this year.

Okay. And then specifically to the timing of when your CPI resets. Is there a mix issue around the calendar year? Or is it pretty much weighted July 1?

To clarify, when we discuss those resets, we are referring to the 12 months prior to that date. Therefore, the impact at the midpoint of 2022 is based on the consumer price indices from the preceding 12 months. There may be some variability if a reset uses a slightly different metric. We aim to provide an overarching view; when we say they are all linked to consumer price indices, we recognize there are actual differences in how price increases are calculated from market to market. It serves as a good guide for understanding it. I wouldn’t recommend diving into more detail than that at this moment.

Yes. I asked the question poorly, clearly. The timing of when it happens, I get the lagging 12-month aspect and picking them, it's predominantly weighted to that portion of the revenues, that reset would be on July 1 predominantly?

The majority of our price increases are implemented in January, with some occurring in July, and we have a clear understanding of these. That is why when we communicate our guidance in February, we have already executed most of the price increases. By April, we typically have a solid understanding, with about 80% completed or confirmed by that time. I do not anticipate next year being any different.

Okay. When I consider the pace of mergers and acquisitions, it has been exceptional. Is it maintaining this pace, or are we beginning to see a peak? We've been discussing that things would eventually settle into a more normal level, yet it continues to remain strong. What is the outlook regarding the pace, the pipeline, and the ongoing conversations?

Sure. Every year I have been surprised by how strong the pace in the pipeline continues to be, as we highlighted in this call. We thought beating 400 last year would be challenging, yet we have exceeded that figure in just seven months. The discussions remain very strong, and it's important to emphasize that this isn't confined to one region; it spans both the U.S. and Canada. Clearly, the pace remains high, and we're fortunate to have the balance sheet to capitalize on that.

And expectation, whether it's 400 or 425 going into next year, it's not slowing down as far as the level of activity.

So again, the pace remains the same. Now whether we transact on at all, whether they all survive diligence, it's a different issue. But no, it's again, we're still turning down probably 7 or 8 deals for every 1 or 2 that we're pursuing.

And have valuations come in with some of the macro pressures that are happening in the market? Or are we still sort of asked about the same valuation parameters?

I'd say the valuations for gold-plated companies really haven't changed much over the years, but maybe 1 or 2 turns over the years because, again, our assumed long-term cost of capital inputs haven't changed much over the past 25 years. We don't change our inputs just because money was free over the past 3 or 4 years. When you're looking at gold-plated companies with solid cash flows, that's driving the valuation. Obviously, when you get to coastal deals, whether it be on the East Coast and Northeast or whether it be in the West Coast, when real estate is involved, as I pointed out on a couple of other calls, the real estate component of it can be uniquely high and drive on appearances, the multiple a little bit higher because in some cases, real estate is 25% to 35% of the purchase price almost. It's unique to a couple of geographies.

Okay. And then lastly, just to follow through on the underlying cost of inflation within the business. It's peaked and it's trending down gradually, is the message, and we've come off the high in the first quarter, and it's slightly ebbing its way down.

Yes, that's what it feels like. Again, we haven't baked that into our outlook because I look at it in the rearview mirror versus anticipating it continuing. But as you know, there are pundits on both sides of the argument on recession or not recession, etc. It's out there. In my view, it's always wait 18 months and they can look back with better clarity.

Right. Well, the fundamentals of your business would suggest that if there is one, your business is doing fine regardless.

Absolutely, because, again, this is an industry that is very resilient, especially in difficult economies. Again, the fact is with the vast majority of our revenue under fixed pay systems, price is always more important than volume. This industry has shown itself in the Great Recession and the recession before that. Again, if there are some weak times on the horizon, this industry will do quite well.

And then last one for me. The supply chain issues, have they started to ease at all? Or is it still just tight for trucks predominantly?

We haven't seen an easing of them. I mean, we still expect a number of our units to get pushed into next year. Obviously, by keeping our CapEx the same, we found a way to backfill and source some other CapEx to replace it. Yellow iron, in some cases, we've already been put on notice that could be 12 or 18-month lead times. We're well past when we've already placed our orders for yellow iron for next year because it's critical to get ahead of that.

Our next question comes from Sean Eastman with KeyBanc Capital Markets.

Great update here. I don't want to diminish your response with this question. However, as we observe the industry, everyone is seeing significant pricing. Many also have clear pricing visibility for 2023. Given this unique operating environment, what would you say are the key points of differentiation in the WCN model that you would want to highlight to investors?

Well, sure. First off, I think the model has remained unchanged, which is leading price, leading margin, leading free cash flow conversion. That's remained consistent throughout the years. But again, as we pointed out earlier in the call, what clearly differentiates us from the others is also our approach to price. To have 85% of our price this year core versus 50% as some others have, that makes a big difference as you play this out on a multi-year basis. Again, as you see cost pressures abate as we've talked about, there's core sticks. But that's not easy. I mean, this isn't a push-the-button-type business where we can sit here and essentially control price. Pricing is a local market-by-market implementation. It's not easy. It takes salespeople; it takes top-performing. It's an account-by-account analysis. This continues culturally to be a huge differentiation in how we approach price and where we think it's most important to drive it. Again, that's locally. It takes a lot of training and development to support and defend it. It takes a lot of investment in business acumen to understand the need for price and why that's important. When you wrap up the overall market model that we approach, the financial results that go with the investment in human capital, and more importantly, a recognition of the importance of core price versus just letting a computer track the DOE index to put pricing on an invoice that compounds itself on a year-over-year basis.

That's really helpful perspective, Worthing. I appreciate that. And maybe just 1 for Mary Anne, clarification on the updated guidance. So EBITDA guidance is up nicely. Free cash flow guidance is up, but maybe it feels like there's a cushion in there? And is the operating cash flow guidance actually a little bit lower? I just noticed that and wanted to get a little bit of clarity.

Sure. Our free cash flow guidance has increased by about $10 million, which represents a 15% rise compared to last year, and we consider this a significant achievement. Regarding CFFO, as you mentioned, the adjustments made in the first half of the year affected CFFO, and we have disclosed these in the reconciliation. The GAAP measure for CFFO appears to be slightly lower, but the adjustments are the reason for the impact on what's reported in CFFO. The main factors include the acquisition and an accrued liability that we settled right after closing. This affected cash flow overall; however, it should not change the adjusted basis for CFFO. I recommend considering that both CFFO and free cash flow have increased compared to our original guidance, without any changes to Capital Expenditures.

Got it. Perfect. I'll leave it there.

Our next question comes from Kevin Chiang with CIBC.

This is Jessica for Kevin. Just one question. So I guess, when we look back over the past 10 years, it does feel like the waste sector has come out of challenging periods in a stronger position. Exiting the financial crisis, we saw a greater focus on pricing discipline. As you look at the impact of the pandemic and now headwinds from inflation, I was wondering if you're seeing any structural positive changes occurring within the broader waste sector? And I guess specifically what you guys are seeing?

I think there was a bit of a disruption in your question, but I believe you've observed the fundamental changes in the waste industry. It's more about the rest of the industry adapting. We saw this trend leading into the Great Recession, where the emphasis was on maintaining prices, even if volumes fluctuated with the economic conditions. The idea was that by keeping prices steady, as volumes returned, they would align at higher pricing levels, which would be beneficial in the long run. We didn't witness such discipline during the minor recession in 2003-2004. The need for this discipline and the necessity of price increases have become clear. The industry has learned valuable lessons, particularly reinforced during the Great Recession, and this discipline is still in effect today. As the sector experiences some reduction in cost pressures, the potential for margin expansion also grows as inflation decreases.

Our next question comes from Kyle White with Deutsche Bank.

I kind of want to follow up a little bit on that and also on the pricing story. Obviously, that's the positive story across all the majors in waste. But curious if you're seeing any kind of potential slippage on pricing at that local level from some of the smaller competitors just given the uncertainties or a potential slowdown in the economy going forward. Any kind of slippage there as maybe some of those smaller players look to ensure they keep volumes?

Yes, it varies by market. In some areas, there are always competitors attempting a low-price strategy. However, those who have pursued that strategy typically face challenges, as we saw when recycling prices fell five years ago, forcing low-price players to raise their prices to recover. Now, with the impacts of COVID, high inflation, and labor shortages, companies that have maintained low pricing over the last two years are struggling significantly. Some are even exiting the market entirely because it’s untenable to operate with low prices when wages are rising substantially. Additionally, low pricing cannot absorb increases in fuel costs. If a business has relied on a high single-digit margin, they've likely fallen into negative territory over the past couple of years due to these pressures. Running this business can either be manageable or extremely taxing. This current period is particularly tough for those aiming to compete on price, especially with the uncertainties surrounding costs. Many of those competitors may have lost about 30% of their drivers because they haven't adapted to the realities of compensating drivers appropriately.

I assume that this also relates to the M&A environment by attracting more sellers to the market due to overall fatigue. However, I wanted to focus on the exploration and production business. You've had another impressive year-over-year improvement. Why shouldn’t we anticipate continued increases on a sequential basis as we move into the second half, especially considering the current oil prices and the rising rig count?

Sure. Well, what I would say, Kyle, is we're certainly encouraged by the cadence of activity, and we did see, as you pointed out, we saw the sequential increase Q2 over Q1. Maybe that means that there's more to come in Q3; we'd rather let that be upside. So we guided to basically in line with Q2.

But to your point, I mean, to the extent that the majors increase their CapEx budgets as they move into next year, I think there's an expectation that they will. We ought to continue to see sequential movement in that as we move through '23.

And our next question comes from Toni Kaplan with Morgan Stanley.

This is Hillary for Tony. So we talked earlier about whether there's a debate of we’re in a recession or not. So I guess have you seen any change in client behavior or activity like, what kind of activity or behavior are you seeing the most room depending on the segment?

Things have been, again, as I said before, fairly stable this year. If you look at the commercial side, our numbers are up nicely year-over-year. Some of that might, frankly, just be market share taking from some folks that haven't been able to service their own commercial accounts, and we've been able to step in and do that. Nothing notable both up and down. I would say on special waste, we talked about how that was down in Q2. Obviously, we had a strong start to the year in Q1. But we've seen some of those special waste jobs be pushed as logistics budgets and logistics costs have blown the budget that they originally had for those jobs. As those logistics costs come back down, we ought to see the special waste side of it start picking up again as it relates to jobs in our market areas. But no, it's been fairly steady as you go.

What I would add to that would just be that if you think about the most cyclical component of the business, we talked about roll-offs holding, for instance, being pretty steady, up a couple of points across all of our regions. We really haven't seen a material change in that level of activity. To put it in perspective for you, that piece of the business, construction-driven between roll-off and construction demolition debris at our landfills represent less than 10% of the overall mix of revenue, just to give you some perspective. We haven't seen any material change there.

Got it. As a follow-up, could you discuss your M&A activity regarding any potential targets or developments in recycling businesses?

Obviously, with some companies that we buy, they may be collection and transfer and recycling. Recycling facilities may come with acquisitions. When it comes to greenfield sites, obviously, we've talked about the 2 that we're constructing right now, 1 in Illinois and 1 in Colorado. Away from that, there are many multiple upgrades happening from an automation standpoint and optical sorting standpoint across other facilities. But no, we're not looking at any particular single recycling focused type company. Recycling does come with the assets that we're buying.

Mr. Jackman, there are no further questions at this time. I'll turn the call back to you for closing remarks.

Perfect. Well, if there are no further questions, on behalf of our entire management team and over 21,000 employees, we appreciate your listening to and interest in the call today. Mary Anne and Joe Box are available today to answer any direct questions that we did not cover that we're allowed to answer on the Reg FD, Reg G and applicable securities laws in Canada. Thank you again. We look forward to seeing you at upcoming investor conferences or hearing from you on our next earnings call.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.