美國廢棄物管理公司 (WM) 2004 Q2 法說會逐字稿

Good morning, be my name is Angelic, and I'll be your conference facilitator today. At this time I'd like to welcome, everyone to the Waste Management second quarter 2004 earnings release 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 period. If you'd like to ask a question during this time simply press star, then the No. 1 on your telephone keypad. If you would like to withdraw your question press the # key. Thank you. I'd now like to turn the call over to Cherie Rice, Vice President Finance and Treasurer. Ms. Rice, you may begin.

Thank you, Angelic. Good morning, everyone. And thank you for joining us. With me this morning are Maury Myers, Chairman of the Board; David Steiner, Chief Executive Officer; Larry O'Donnell, President and Chief Operating Officer; Bob Simpson, Senior Vice President and Chief Financial Officer; and Greg Nicholas, Director of Investor Relations. David will start things off with a review of the quarter and a detailed look at price and volume trends and activity. Larry will delve into operating costs, our improvement initiatives and recent management changes, then Bob will review the financial statements in detail and cover a few related topics. After that we'll open the lines for questions and answers. This call is being recorded and will be available 24 hours a day beginning approximately at 1 P.M. Central Time today until 1 P.M. on August 12th. To hear a replay of the call over the Internet access the Waste Management website at www.wm.com. To hear a telephonic replay of the call dial 800-642-1687 and enter reservation code 8357030.

As is our custom I will remind you that during the course of this presentation we will be providing estimates, projections, and other forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 and Section 21-E of the Securities and Exchange Act of 1934. These forward-looking statements are subject to a number of risks and uncertainties which are described in detail in Waste Management's annual report on Form 10-K for the year ended December 31, 2003, and in the Company's Press Release this morning. The risks and uncertainties could cause actual results to differ materially from those described in the forward-looking statements.

Additionally, during the course of the presentation, we will discuss free cash flow, a non-GAAP financial measure. Waste Management defines free cash flow as net cash provided by operating activities, less capital expenditures, plus proceeds from divestitures of businesses net of cash divested and other sales of assets. The Company includes this discussion because the amount of cash produced by non-financing activities that is available for use, such as acquisitions, share repurchase, debt reduction, and the payment of dividends is important to the Company's capital allocation process, and its goal of providing returns to its shareholders. For the same reason the company believes investors are interested in this measure.

As I stated earlier this call will be available for replay for a two-week period. Time sensitive information given during the course of today's call, which is occurring on July 29, 2004, may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of the Waste Management is prohibited. Now, I will turn the call over to Waste Management's CEO, David Steiner.

Thanks, Cherie. And welcome to all our conference call and webcast participants. I will start out this morning by reviewing the key performance drivers of Waste Management's second quarter. As noted in our Press Release, volumes were very strong this quarter continuing the trend we'd seen in March and April and discussed on the first quarter conference call. Internal revenue growth from volumes on base business was 2.5%. After 3 years of negative volume growth we're very encouraged to be seeing significant growth in our volumes once again. We think that this growth is evidence of a growing economy, our sales force effectiveness program, and our improved service offering. Our total average yield change was 40 basis points positive in the second quarter. We're still obtaining good price increases on our existing customer base. By that measure, we obtain a 2.7% price increase over the last year on our collection customer base and a 3.7% price increase on just the commercial customer base. However, our yield calculation takes into account the effect of lowering price to an existing customer in response to a competitor's offering to save the account, the impact of business churn, and changes in business mix.

The yield pressures are strongest in the Midwest and the South. Both these business areas had negative change in yield in the quarter while our other 2 groups the East and the West each had increased yield in the range of 1.5% in the quarter. The Midwest continues to see very competitive prices in Michigan, Indiana, and Illinois, as well as in the Denver market. Average yield change on our commercial customers has experienced erosion in these market areas as competitors continue to offer very low prices. The Midwest also has negative yield change in the special waste business as prices on one-time jobs continue to be bid lower to secure volumes. The South has very different issues. The negative change in yield for the quarter there is driven primarily by mix in the hazardous waste business and by changes in a number of residential contracts. Despite continued price competition we're working on a number of fronts to drive Waste Management's total yield higher.

In the Midwest, for example, as we've seen roll-off poles increase we've raised our average rate per pole on temporary roll-off business by $25 in many markets and by as much as $50 in some or a 10% to 20% increase. We believe we've been able to do this in part, as a result of our same-day service guarantees. We've also tested a new environmental fee at several of our landfills and transfer stations across the country. In October we plan to implement the fee on all our landfill and transfer customers where contracts permit. The fee is currently a $1 or 2 per load and the impact isn't huge, but if we're successful with it across our customer base, we estimate it will increase annual revenue and income from operations by $15 million.

In the collection business, we've had the most success raising prices when the corporate pricing department sent customer by customer data with price recommendations to the field. We've recently sent out to all of our market areas the same type of data on landfill customers. The market area managers now have a report that clearly shows how each customer's price has changed over the past 12 months. Whether up, down, or not at all. Next, the corporate team will work with the field on specific price increase plans by customer. The primary change we're working toward in our pricing approach is to price business to meet our return on capital goal. In order to create value for our shareholders we must earn a return on capital that's higher than our weighted average cost of capital. I will note that our MSW Business has had positive change in yield for each of the past 3 quarters, and the yield change has been growing each quarter, evidence that many of our sites have already been increasing prices. We need to see that same type of pricing improvement in other waste streams.

On the commercial side, I spoke earlier of how we've been successful raising prices to existing customers. In order to fully understand commercial pricing -- commercial market pricing dynamics we conducted a customer cancellation study in 10 major markets. Our goal was to determine what kind of prices were being offered by our competitors to entice our customers to switch service providers. And the results were very interesting. In those cases where the customer chose to tell us with a price they were quoted, the average quoted rate was more than 27% lower than our existing price. On the average, we were able to save these customers from defecting at a rate 10.5% higher than the rate they were offered by the competitor. We believe we were able to do this as a result of our service machine process and the better service we provide to our customers. We did learn that some of our markets do a better job of saving customers at a higher rate than other markets.

Unfortunately, in some markets we found that our people just immediately matched the competitor's price. We also analyzed the rates at which we're currently selling new business in those same markets and found that our average selling rate, while lower than our median rate, is 18% higher than our competitor's quotes. Of course, that wasn't the case in every market and we identified that in 3 of the 10 markets we need to increase our rates for new business to hit our targets. So we learned facts that will help us to improve our sales and retention efforts, and as a result of the study we're developing new reports that will give each of our markets this type of data on a weekly basis. This is just one example of the type of pricing data we have been gathering, and we'll continue to gather and analyze customer and pricing data in all parts of our business. These efforts are directed at giving us at the corporate office the kind of information we need to implement a disciplined pricing program. We believe that any successful pricing program needs to be executed at the field level, but monitored and supplemented at the corporate level.

Getting back to reviewing our total revenues for the quarter, the 7% year-over-year increase is comprised of the following components. Volume growth of 2.5% or $71 million. Almost 60% of this volume growth or $42 million came from the most cyclical parts of our business, roll-off and landfill. These lines of business represent only 30% of our net revenues, meaning they grew at a much higher rate than the remainder of the business. This is clearly an effect of an improving economy. $67 million or 230 basis points of the total revenue growth is net growth from acquisitions less a few divestitures. Higher recycling commodity prices produced $42 million or 140 basis points of the increase of our total revenues. When you isolate this at just the recycling business the yield in 5% over second quarter 2003.

Pricing growth on our base business was $11 million or 40 basis points of the increase. If you include the $8 million in fuel surge the total yield increase on base business was actually 70 basis points. And $4 million or 10 basis points came from the changes in Canadian foreign currency exchange. Our diluted earnings-per-share of 37 cents highlights our continued growth and solid improvement over the 30 cents reported for the prior year periods. But we clearly have areas where our performance can and should be better. Total cost is one. Our objective is to improve our cost as percent of revenue year-over-year. As compared to second quarter 2003, operating costs were flat as a percent of revenue and SG&A improved by about 20 basis points. So our total cost improved but not enough. We need to drop more of the increased revenues to the bottom line.

Our most significant cost control challenges in the quarter were recycling costs of goods sold, subcontractor costs, disposal costs, and fuel. Larry will cover these costs in more detail in a few minutes. We also believe that while commercial tons are increasing in many cases the associated revenues will appear later when larger and additional containers are ordered and when new business locations are established. So we expect to see margins improve in future quarters as our volumes continue to increase across the various segments of our business, and we continue to focus on cost. Acquisitions have obviously been an important part of our revenue in recent quarters. Our plan for this year is to spend about $250 million on tuck and acquisitions. In the first half of the year, total consideration paid has been $100 million. Acquired revenues to date are $84 million. We do continue to see attractive candidates with businesses that tuck in well to our existing operations. And purchase price multiples are still in a reasonable range.

Finally now that we're halfway through the year and have a better view on economic conditions we updated certain items in our 2004 guidance in our Press Release this morning. Our most important goal, free cash flow is now estimated to be at the high-end of our 900 million to a $1billion original goal. Likewise we project cash flow from operations to be toward the higher-end of the 2.1 billion to $2.2 billion range. We had a strong first half of the year, and we'll continue to drive generation of free cash flow. Capital expenditures which we originally estimated at 1.15 to $1.25 billion are now estimated at 1.25 to $1.3 billion. The higher range is due to 2 sets of circumstances. First of all, our volume growth has been higher than we expected. And to meet demand we'll need to stand at the high-end of our original range. Second, large parcels of land adjacent to key landfills and important markets have come up for sale and we expect to buy some of these partials this year. With the additional acreage at these sites we believe we'll be able to significantly extend these landfill lives.

Due to sustained volume growth through the first half of the year, we now estimate that full-year revenues will be in the range of 12.2 to $12.3 billion versus our original projection of 11.9 to $12 billion. At mid-year, our assessment is that progress is being made and we're well on our way to meet our original goals. Nonetheless, challenges abound such as the competitive pricing atmosphere. We'll continue to focus on pricing our business to meet return on capital goals and at the same time bring new tools and metrics to our operating units to reduce costs. We've been waiting for an improving economy for 3 years. And now that it's upon us we need to ensure that we leverage the better economy to drive higher shareholder value and returns on our investment. Now, I'll turn the call over to Larry O'Donnell to cover further operational details with you.

Thank you, Dave. And good morning to everyone. Overall, operating expenses were $2,040,000,000 or $134 million higher than in the 2003 quarter. Consistent with the volume increases we experienced in the quarter. As a percent of revenue, year-over-year operating expenses were essentially flat at 65%. Compared to the first quarter of this year, this is a 130 basis point improvement in operating expenses on a percent of revenue basis. Clearly, higher volumes and favorable business conditions drove our revenue growth. Most of this year's second quarter operating expense dollar increase is directly related to the increased activity due to this revenue growth which is similar to the pattern we saw in the first quarter of this year.

We did expect more of this increased revenue to fall to the bottom line and we have identified about $35 million of costs in the second quarter that increased disproportionally faster than the increase in revenue. Had these costs risen in proportion to the revenue increases we would have seen a 110 basis point improvement in our EBITDA margin in the second quarter. These costs were in the areas of third-party disposal, third-party transportation, disposal fees and taxes and fuel. I will discuss these costs further in a moment, as well as our plans to bring more of this increased revenue to the bottom line in the future. We continue to make good progress on our operational improvement initiatives. The focus in the second half of 2004 will be to better leverage our cost structure to help us expand operating margins.

Turning now to the more significant changes within our operating cost structure as compared to last year, I will begin with those items that grew disproportionately faster than the revenue growth. Subcontractor cost increased by $30 million over the second quarter last year. This increase is mainly driven by increased third-party transportation costs associated with the higher volumes hauled from transfer stations to our landfills. These costs grew disproportionally faster than revenues by about $19 million. About $5 million of the $19 million increase is due to the redirection of waste to more distant landfills primarily in the East and higher third-party transportation rates primarily in the East. Certainly our ability to begin barging operations out of New York City to our Virginia landfills will ease some of this cost pressure. We now have the permits on the Virginia side, and we are continuing our efforts to obtain the necessary permits on the New York City side. In addition, delays in receiving landfill expansion permits particularly in Pennsylvania, has caused us to redirect waste to more distant landfills increasing transportation costs. We've recently received several expansion permits that help alleviate the situation which I will discuss shortly. We've also raised prices at our New York City transfer stations anywhere from $8 to $20 per ton to help recover this additional costs.

Another component of the increase in subcontractor costs is the increased transportation on special waste jobs. We incurred about $7 million of increased transportation from special waste jobs over what we saw in Q2 last year, which is all a pass through cost with zero margins. Third-party disposal and transfer costs grew by $26 million over the second quarter last year due to higher volumes in the effective acquisitions. These costs grew disproportionately faster than revenues by about $9 million. Contributing to this increase was the redirection of waste to more distant landfills primarily in the East as I just outlined. We have recently received approval for expansion at our Granby Landfill in Massachusetts where tonnage had been severely restricted since the beginning of the year. Sale construction is now underway and we expect to begin bringing tonnage into the new cell late this year. We are also about to complete the sale construction at our Tully Town Land fill in Eastern Pennsylvania. We had to significantly reduce the tonnage coming into that landfill as we awaited the expansion permit and divert that volume to more distant landfills. We expect the Tully Town cell construction to be completed in the fourth quarter of this year.

Fuel costs increases contributed $16 million to the year-over-year increases to operating expenses in the quarter as the average price of diesel rose 24 cents per gallon. Fuel would have increased about $4 million if it had increased at the same pace as revenues. Therefore, $12 million of this increase relates to expense growth at a faster pace than revenue which negatively impacted our operating expense margins. We received $8 million from our fuel surcharge program during the second quarter covering about 66% of the increase in price. This leaves $4 million of excess cost related to increased fuel prices that was not covered by the fuel surcharge program. The final item contributing to the $35 million of excess cost we have identified in the quarter was higher disposal fees and taxes which increased by $8 million compared to the same quarter last year primarily due to volume. This increase was disproportionately higher than the revenues increased by about $3 million due to one-time settlements of old franchise and host fee disputes in California dating back to the mid '90s. Another item of operating costs that had a negative impact on operating margins was cost of goods sold which increased $31 million in the second quarter compared to the same quarter last year. The majority of this increase, about $29 million, consists of the recycling rebates we passed back to customers.

An area of continued focus for us is labor cost management. Salaries and wages are $26 million higher versus the same quarter last year. This increase is attributable to several factors including year-over-year wage increases, increased overtime expense caused by higher volumes, and the additional labor associated with acquired businesses. We have developed a new information tool that will we'll be rolling out in the third quarter to assist district managers and route managers to track unit costs by line of business and productivity on a weekly basis in our hauling operations. Productivity in the collection line of business increased 1.2% for the first half of the year compared to the same period last year. As I did during our last conference call, I'd like to highlight the results of some of our ongoing productivity and cost improvement initiatives which are showing positive results.

Overall, maintenance and repair costs fell $3 million in the second quarter compared to the same quarter last year, even with the increased activity we saw during the quarter. For the second quarter, maintenance costs per driver hour fell to $11.28, a 61 cent per hour decrease from the same quarter last year. On a year-to-date basis, we have reduced maintenance costs per driver hour 46 cents to $11.46. This rate decrease has saved us $12 million year-to-date in collection fleet maintenance costs over what we would have spent had the maintenance cost per driver hours stayed the same as last year. Our goal for the year is to save $27 million through this program and to average $11.32 per hour for the year. Total insurance and benefits costs in the second quarter which include health care, worker's compensation, and risk management have risen $1 million compared to last year. This is only a 5/10ths of 1% cost increase and is particularly gratifying given the increased business activity during the quarter and the increases other companies are reporting in health care and insurance costs.

This relatively low increase is evidence that our safety in worker's compensation programs are taking firm hold and dampening cost increases. We continued our progress in the second quarter of improving our total recordable injury rate, a standard OSHA measure reducing it another 18% from the prior year quarter. Lost work days have fallen 38% since the beginning of the year, and the number of employees absent due to injury has fallen nearly 37% for the first half of the year compared to the same period last year. Despite the significant progress, we are not yet where we want to be. Prevention of injuries and accidents remains a top priority. And our programs are designed to target zero as the only acceptable goal. We believe that this sustained reduction in casualty frequency and severity should lead to reduced claim costs and reduced premiums in time. Turning to our waste routing optimization initiatives. We realized $16 million in cost savings in the quarter moving us more than halfway to the full year objective of $44 million in savings. Our procurement program also showed good results in the quarter providing $13 million in new incremental operating expense savings. Year-to-date results are $24 million compared to a full year target of $44 million.

Before I turn the call over to Bob Simpson, I'd like to discuss the recently announced senior management changes and the realignment of several markets. Rich [Valogo] formerly Senior Vice President of the Eastern Group will now serve as Senior Vice President, Business Development and Corporate Strategy. And will be responsible for leading the overall business development efforts in other key strategic and growth initiatives. Rich will utilize his 31 years of industry experience to provide a longer-term view of our business development and strategy. He'll work on acquisitions and divestitures, landfill and transfer station development, disposal and volume exchanges to help us operate more efficiently and long-term corporate strategy. He will report to Dave Steiner in his new position.

Jim [Travasin] has assumed Richard's role in the Eastern Group and will report directly to me. Jim's diverse tenure at Waste Management spans 25 years of operating and sales experience. Jim was most recently Senior Vice President of Sales and Marketing where he spearheaded initiatives to increase our sales force effectiveness and to improve customer service to our broad customer base. We view both of these leaders as having a unique set of skills to apply to their new positions. The market realignment we announced consisted of moving the Ohio operations to the Midwest Group and the Kentucky operations to the Southern Group. These operations were previously in the Eastern Group. Now, I'll turn the call over to Bob Simpson who will update you on our SG&A costs and other financial results.

Thanks, Larry. This quarter's comparison of SG&A costs to the second quarter of last year's is favorable of percent of revenue 10.1% versus 10.3%. Although, it is higher in total dollars this year by $16 million this is consistent with our goal for SG&A to be 10.5% of revenue or better for the full year. In terms of the year-to-year dollar change there are 2 primary drivers. First of all, in the second quarter of 2003, we had a favorable litigation settlement that lowered our SG&A in the quarter by about $11 million. The remaining increase is largely driven by higher commissions paid to our sales force and a number of one-time items that we do not expect to recur in coming quarters. Depreciation and amortization was 11.1% of revenue in the second quarter of both years. This is consistent with our expectation which is that depreciation and amortization should generally be close to 11% of revenue for the full year. Interest expense net of interest income was about $6 million higher than in the second quarter of last year with interest expense up $9 million. There were several items impacting interest expense year-to-year and I will review a few of them of the key items that drove the increase.

First, nearly 3 million was a result of the accounting changes required by implementation of SIN-46 whereby we consolidated the 2 Wheel Abrator Special purpose entities effective December 31, 2003. Second, as we discussed on our first quarter conference call, early in the year we've made an investment in a facility producing synthetic fuel that results in Section 29, tax credits. During the second quarter we made a second investment, with these investments we have taken on additional debt and the associated interest cost was $2 million in the quarter. Finally, letter of credit fees related to the increased LC capacity in 2003 increased $2.5 million.

On the next line of the income statement is 24 million of equity losses and unconsolidated entities. That is primarily comprised of $26 million of losses resulting from the two investments in the synthetic fuel plants. In the second quarter this loss is offset by $35 million of income tax reductions and credits. After also considering the $2 million interest expense, related to these investments, the result is a net after-tax benefit of about $7 million in the quarter. You may recall that the initial synthetic fuel investment resulted in a negative impact of nearly .5 in cent in EPS in the first quarter. In the second quarter these investments translate to about a penny of EPS benefit. For the full year, we anticipate the benefit from these 2 investments to be approximately 3 cents per share. The tax revision in the quarter is at an effective tax rate of approximately 27.4%, due to the positive impact of the two synthetic fuel investments and a $6.6 million tax benefit related to favorable audit settlements. With a new synthetic fuel facility investment, we now project a 30.85 effective tax rate for the rest of the year excluding the benefits of favorable audit settlements. We do expect to close several other tax audits in the coming quarters that may result in associated tax benefits. That covers the income statement.

Now on to the balance sheet and cash flow. Due to the sequential increase in revenues receivables increased over $100 million in the quarter and, therefore, was a use of working capital. Note that our day sales outstanding were up about 1/3 of the day to 47.2 days over the course of the quarter adding a little to the use of working capital. Total debt decreased by nearly $300 million in the quarter, largely as a result of our paying off the $350 million of senior notes that were due in April and May. During the quarter we added $88 million of new tax exempt issuances and took on $36 million of debt related to our second synthetic fuel investment. Debt to total capital at the end of the year was 60.2% in line with our goal of being at about 60%. The floating rate portion of our total debt portfolio was 37% at the end of the quarter. We started repurchasing common stock a few days after our last earnings announcement and continued repurchasing daily until late July. During the second quarter we repurchased approximately 3 million shares in open market purchases at an average price of $28.89, and a total cost of $89 million. Our full year repurchases are still expected to be in the 400 to $500 million range, and we plan to be in the market making repurchases through the remainder of the year.

On June 25th we paid our second quarterly dividend of the year to our common stockholders. Clearly Waste Management remains committed to returning a large portion of our free cash flow directly to our shareholders in the form of both share repurchases and dividends. Speaking of cash flow and as Dave mentioned we now expect free cash flow this year to be at the high-end of our original range of $900 million to $1 billion. Through June we have produced $549 million of free cash flow over halfway to that goal. Of course, we only spent about 40% of our projected capital for the year which is about on par with our normal capital spending patterns. With business levels generally expected to be more robust in the second half of the year than the first year we anticipate offsetting much of the higher capital expenditures with higher net operating cash during the remainder of the year.

2004 is off to a solid start and we have identified important issues to tackle in the second-half of the year. We must obtain higher yields by continuing to drive price increases to our existing customers, by holding the line on price roll backs, and by selling our services to new customers at higher prices. We need to leverage our fixed cost structure and we must manage our variable costs to best take advantage of the growing volumes. We have seen margin expansion in the first half of the year and in combination all these actions will expand our margins at a much faster pace. Our leadership team has been positioning the company to a solid environment where industry volumes are growing and now we need to capitalize on those plans. And with that Angelic let's open the line for questions.

Thank you. As a reminder if you would like to ask a question please press star, then the No. 1 on your telephone keypad. To withdraw your question press the # key. Your first comes from Michael Hoffman of Friedman, Billings, and Ramsey.

Good morning, congratulations. You talk about the strength of the economy, have you started seeing service upgrades in the commercial side of the business?

Oh, I think, Michael, what we've seen is obviously that we have seen commercial volumes increase, but I don't know that we're able to say that we've seen a significant change in service levels.

And do you anticipate or as you look forward and see some of the increasing activity both in incremental seasonal and the ongoing economic that that service upgrades should start happening soon?

We would certainly expect that. I mean, you know, if you look past history as an indicator you would expect that that would be the case.

All right, thanks.

Certainly.

Okay. Your next question comes from Amanda Tepper of J.P. Morgan.

Good morning.

Morning.

With your volumes up, do you have any sense whether you might be gaining share in some of your markets or do you think it's the rising tide is lifting your boat the same more or less as everybody else?

I would expect that the rising tide is lifting the boat of everybody, but remember, what we've done is we've tried to differentiate ourselves from our competitors with our service machine offering. And we think over the long-term absolutely that will lead to greater share. But I don't think that at this point in time we're able to say that there's been a significant shift.

Okay. And then it was interesting when you talked about your 10 market pricing study. Did you identify what buckets of competitors were coming in at 20% below your prevailing evaluating prices? Was it more independents or more other major public waste companies?

We did characterize that by company. And I will tell you that both independents and the majors had very similar patterns. You know, there were slight variations in the amount. But the pattern was consistent and the pattern was that the price offering was dramatically below where our current price was.

Did you study landfill prices in those markets or just collections?

We studied landfill prices not in those 10 particular markets. What we've down done as we talk about in the call we went out to markets and studied landfill pricing, not from a competitive point of view, but from a "where are we" point of view, what have we done with our specific customers over the last year to 3 years. But we didn't do that same type of study, no.

And what was the cost of this study and whether will be the cost be of rolling out the new pricing reports you talk about across the Company?

The cost is very minimal. We did it all internally. It's just part of what our people do for their every day jobs so there is no incremental cost to produce that. I mean, obviously it takes their time away from something else, but those were done internally. We don't need to develop any new computer systems to generate the reports so there's really no incremental cost from that.

Okay. And then finally when you were talking about operating costs, there were a lot of different pieces that Larry was going through that were up and down. One of them was salaries. I just want to make sure I got that clear. And then he mentioned overtime being up because of volumes and, you know, aren't you working to staff better so that it's not overtime and maybe a little hiring is necessary? So if you could just comment on the salary piece.

The number that I gave you was salaries were up about $26 million and if you just look at, you know, as a percent of revenue, it looks to us that labor was in line with the revenue growth. We are seeing increases in overtime as the volumes go up. And, you know, we are right now looking for more drivers in many of our markets so that we can add drivers in and reduce that overtime. We're also as I mentioned, rolling out a new tool to help our route managers and our district managers to better manage both overtime and productivity. So that on a weekly and hopefully daily basis which is our goal they'll know exactly where they are, what their targets ought to be, and help manage our labor costs.

Are you having any difficulty hiring new drivers or is the hourly price going up a little bit?

In some cases, in some markets we are having a hard time finding qualified drivers, yes.

Okay. Thank you.

Thanks, Amanda.

Your next question comes from Thomas Ford of Lehman Brothers.

Yeah, good morning.

Good morning, Tom.

Just a few questions for you. Dave, you mentioned the impact of land investments on CapEx.

Yes.

I'm just curious about that uptick in the CapEx. Is it mostly that or is it the growth or could you break it down?

Sure. I mean, remember where we were on our original range. And what we're saying is that because of the uptick in volumes we will spends at the higher end of that original range. So as far as growth capital goes we thought we were well-positioned going into the year to not have to blow through our original budget to meet growth and we found that to be true. But we're going to be able to stay at in that range but the higher-end of that range. And so the incremental CapEx is truly long-term investments that we're making in our landfills to acquire land around those landfills so that we can get expansion.

Okay. And Larry touched on quite a bit in terms of disposal initiatives and what have you in the Northeast, New England and sort of New York, Pennsylvania area. I mean, it certainly seems like you guys are -- there's an element of momentum there in terms of development? I was curious as to, you know, is this something that continues in terms of addressing in other markets, and then also it seemed like your internalization rate ticked up year-over-year. Was that reflecting that?

Well Tom, we've talked about it the impact of fresh kills closing as we then began redirecting all that waste throughout the Northeast. You know, put pressure on a lot of our land films throughout the Northeast and that's when we then saw some issues at least having delays in getting permit expansions in some of those locations which then caused us to redirect the waste even further landfills. This has been an area of focus for us certainly we've talked about barging out of New York City. That's something that we continue to be focused on. It is taking us longer to get those permits in New York City than we had hoped. But it's an area that we continue to pursue. And once we get that in place it is going to have a positive impact on what we're doing there.

And the internalization rate year-over-year?

Increased slightly. We can give you that exact number.

That's fine, I just was wondering is that reflective of the fact that some these initiatives are starting to occur and be incrementally --?

Oh, clearly clearly. You know, it's not, again -- it's not a change that we thought was significant enough to mention and we also did internalize some waste that we brought to a large third-party competitor in Chicago. So we've been doing everything we can to get that internalization rate up.

And then just lastly. You talked a lot about initiatives and the fact that, I guess the way I would put it is, that you want to see better incremental margins on that new dollar of revenue. If I look sort of the normal seasonal trend from 2Q to 3Q in terms of gross margins, is it something that's going to notably influence in looking to this third quarter? Or do you think that it's more of something that you're working on it now and over time you realize incremental benefits?

Well, there are pieces of it that are longer-term and there are pieces of it that are short-term. When Larry talked about the labor management tool that we're getting out to the field we would expect for that to bear fruit immediately. When he talked about the landfill expansions in the East those go on more toward the end of the third quarter and the fourth quarter. So there are some that are going to be short-term, some that will be longer term. But I think, Tom, that it's safe to say, what we've been saying all along, is that we expect margin expansion year-over-year. So we would expect to see that in the third quarter.

Okay. Great thanks very much.

Your next question comes from Leone Young of Smith Barney.

Yeah, good morning.

Good morning, Leone.

First of all, on your landfill price increase program, you're saying you're sort of into the first stages of it. The next stage is for corporate and field to work together. And I was wondering if you could elaborate a little bit on the timing when we can possibly see some of these things roll out?

Sure. Yeah, we talked about, it's the same thing with our fuel surcharge program. If you look at the fuel surcharge program you could call that part of our pricing program because that's a way for us to recover increased costs. And that was .3% this quarter. So if you looked at that way the yield would be .7%. We look at the environmental management fee the same way. That's still only a buck or two per load, but that's something that we've got in place now. We've rolled out to a number of landfills and tested at the landfills it's been very successful. And we're going to roll it out throughout the country. The rest of what we've talked about from landfill pricing, we have going on as we speak. You know, Leone, that landfill pricing is so market area specific that it's difficult to say when everything's going to take hold. I think what we would say is that in order for it to take hold what we believe the industry needs to do in addition to looking at landfill, return on capital, is that they need to have the visibility down through their system so they can make sure those prices are increasing, and they have to have consistency in their pricing increases. We've been raising prices for the last 3 years and if you are going to continue to raise prices as an industry, you've got to have all the industry players acting consistently. You can't have one party that when they need cash or when they see volumes decrease because of price increase, they cut and run and go change their prices back to cutting price to get volume. We've continued to raise price. We're going to continue to raise price. We would certainly hope that the industry follows along with us. But you'll begin to see that through the third quarter. But you'll really see the big benefits of the landfill price increases I believe in 2005.

All right. And Bob, if I could ask you, you've given us a lower tax rate expectation that's great. What about the items of below the line that are related to that? Should we assume that they stay constant with the second-quarter levels then?

The interest expense, Leone, will be constant with the second quarter. It's a $2 million impact of the synthetic fuels investment and interest expense should be constant. The other income and expense items will be up a little bit about $28 million would be about the number for that.

$28 million?

Yeah.

Thank you very much.

Your next question comes from Corey Greendale of First Analysis.

Hi, good morning.

Hi, Corey

Just a couple of specific questions. Dave, I think in your commentary about the region you mentioned something about changes in municipal contracts in the South. Could you -- if I got that right -- could you just talk about what those changes were, and how widespread they were?

They weren't particularly widespread, but primarily that was a move towards more recycle-only contracts which as you know were at a lower margin. So it's really a mix issue on the residential side.

Okay. And that was pretty well isolated to the South?

Yes. As we talked about we got good -- we got about 1.5% yield in the East and the Midwest, and the West.

Okay. My other question was with these, yield initiatives coming in, could you just talk a bit about how, if it is, the comp structure at the operational level is tied to that and whether there's any potential changes in the comp structure as you continue with that?

Sure. You know, with the way we incentive advise our folks down to the lowest level is three-fold. We have a portion of it that's based on financial returns and those financial returns are EBITDA and return on capital employee. That accounts for 70% of the bonus with each of them accounting for 35%, an equal weight on EBITDA and return on capital employees. So when we talk about pricing based on return on capital employed, we have that metric down through our system and our folks are looking at that when they make pricing decisions. And then of the third piece is a personal piece that accounts for a 30% of the bonus and that would be specific matters that tie into a particular job so that. For example, you know, Bob Simpson's job would include a metric on DSOs. But when you get into our sales group, those metrics would be things like the price rollbacks, and the customer retention, and the customer churn. So they're very specific to that particular job function. And then at our cancellation desks, we have an incentive program for our CSRs to save the business at as high a rate as they can. In other words, they don't get compensated just because they save x% of the business. They get compensated based on the amount of dollars that they save. So they are compensated and are incentivized to save business at a higher rate. Now, we talked about those 10 market areas where in some cases we haven't done as a good a job. So we're going back in and making sure that we have the right compensation structure in place and we fully expect to improve that retention pricing.

And the comp structure as you just outlined how long has it been in place that way?

Oh, that's been in place since Maury came in, since shortly after Maury came in.

Okay. Good. Thanks a lot Dave.

Hey Dave let me mention on thing. Leone asked about below the line items and when talking about interest expense I was focusing on the synthetic fuels transactions. With respect to interest expense itself we expect it closer going forward to the first-quarter levels than the second-quarter levels. And then on to the next caller.

Your next question comes from Brad Coltman of Longbow Research.

You talked a little bit before about, I think it was you were referring to the Midwest and Southwest respect to yields. I was wondering if you could just maybe expand upon that a little bit, and then talk about with respect to volumes, what kind of activity you're seeing?

Sure, the South is sort of just a one-time vaguerly on price. I think what we're saying is that the South is not so much that we're seeing competitive pricing although, we are in some markets. It's more of a mix issue in the South in the commercial and in the residential line. Where we're really seeing price competition continues to be the Midwest. It's the same thing we've been talking about the last 2 quarters Illinois, Indiana, the Denver market area, you know, Ohio, in through Ohio, that's where we're really seeing severe pricing competition. On volumes we saw volumes increase sort of in the seasonal pattern that we would expect, but at a higher, obviously a higher rate than we would expect year-over-year, which we think is a sign of an improving economy. And we continue to see those volumes remain strong through July.

Are you not seeing improving volumes in the Midwest specifically?

We are actually are seeing improving volumes in the Midwest and we talked about it from a roll-off pole perspective. But as we've seen volumes go up we've raised prices at the landfill, but very specifically in the roll-off sector we've seen very strong activity in the Midwest and we've raised prices 10 to 20% accordingly.

Okay. I guess I'm just confused if you are seeing increase roll-off poles in the Midwest why are you also saying that the pricing is very competitive?

It's primarily in the Midwest, Brad, it's the same story that we get throughout the country. There are pockets that we talked about, you know, 3 of those 10 markets where we weren't selling at a high enough price. But frankly, you know that our yield number includes the rollback of pricing. So it's not so much that we aren't getting good price on new guess business. It's much more that we are getting our customers attacked by competitors, like I said at a 27 to 30% reduction to our price. So that's what -- when we talked about the commercial base we said it was 2.7% --

Yeah.

-- price increase for the quarter with a net yield being .4%. The primary reason for that is because competitors continue to offer very low prices to our customers.

Okay. Thank you.

Your next question comes from Bill Fisher of Raymond James.

Good morning. Just a couple things. Back on the 27% figure you mentioned is that just on the commercial side or on roll-off or primarily commercial?

The study was just on the commercial side.

And then just a quick thing for Cherie, do you have the splits on the roll-off residential collection revenue?

Just the revenue itself? Yeah, let's see here. Let's see. Residential was about 31.5% of the total collection, commercial 37.5%, roll-off 29%, and other was about 2%.

Great. Thank you.

Certainly.

Your next question comes from Jamie Cook from SFSB.

Hi, good morning, guys.

Good morning, Jamie.

Hi, just a clarification, when I look at your guidance you raise your revenue numbers to 12.2 to 12.3 billion and you suggest more volume which makes sense. More volume I guess than yield. But my question is when you had your guidance before I think you said no volume, 1% yield. So, you know, just to be clear I'm assuming you're backing away from the 1% yield you thought you would get?

Well, I think given our performance in the first quarter and the second quarter it would be hard for us to see such dramatic turn in pricing that we will get to our 1% yield. Having said that, we are in there fighting every day for price increases.

Okay. Great, thanks, guys.

Certainly.

Your last question comes from Lorraine Maikis of Merrill Lynch.

Thank you. Could you discuss the decisions surrounding the rollback of pricing versus just losing the customer?

Sure. You know, when we put our pricing systems in place, we've talked about our discipline pricing approach. And when we put our pricing systems in place we now have the ability to look at each of our customers, not only on a margin perspective with respect to that customer, but what type of customer it is. So is it a customer that has high density waste or low density waste? Is it a customer that's in a high density area or a low density area? So there are a lot of factors that go into place to determine what the floor pricing would be for any particular customer of ours throughout the country. So when the call comes in from a customer that they've got a lower price from a competitor, they have floor pricing right in front of them. They know what the price is that they can go to and still retain the customer at a profit level that we're comfortable with. Having said that, again what I talked about earlier is that we don't want people to go straight to floor pricing. We want them to try to save the customer to the extent they can at the highest price they can. Another thing that comes into play there is whether the customer has a contract. We've done a lot of work getting our customers under contract so that we can make sure that we're able to retain those customers at a higher price. And then the second piece is what I talked about earlier on our incentive plan where we incentivize those customer service reps to save those customers at the highest price they can.

Okay. And then in terms of EBITDA margins when things really do turn, I know 30 is a number that's been thrown out a number of times. I think we've had some structural changes in the business since then, but would you be willing to venture an estimate where you think EBITDA margins will go once your pricing program is on target?

Sure. If you take those structural changes into account, which we think is about 150 to 200 basis points of structural changes. We still think that our target should be to have 30% EBITDA margins, but we aren't predictors of the future so we haven't tried to put a time frame on that. What we've said is that what we expect out of ourselves and what we expect out of our management team, is sequentially improving margins year-over-year. And, you know, that's what we're going to be driving to. Obviously, we are able to get to 30% margins a lot quicker if price and volume pick up. But if price and volume don't pick up we're still going to expect expanding margins from our management team.

Thank you.

Thank you. And with that I will say thank you for joining us. We'll see many of you in the weeks ahead at our various investor and conference meetings. And we look forward to seeing and spending some time with each of you. Thank you for joining us.

This concludes the Waste Management second quarter 2004 earnings release. You may all disconnect.