美國廢棄物管理公司 (WM) 2004 Q3 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Waste Management third quarter 2004 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. [Caller Instructions] Thank you. I will now turn the call over to Greg Nikkel, Vice President of Investor Relations. Sir, you may begin.

Thank you, operator. 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 Cherie Rice, Vice President of Finance and Treasurer. Maury will start things off with a few comments. David will follow with an overview of the quarter, a detailed look at price and volume trends and a discussion of our pricing strategy. Larry will delve into operating costs, including impacts related to the four hurricanes, the cost of fuel and increased commodity prices. Then Bob will review the financial statements in detail and cover a few related topics. This call is being recorded and will be available 24 hours a day beginning at approximately 1:00 p.m. central time today until 5:00 p.m. on November 11th. 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 1203104.

As is our custom, I will remind you that during the course of this presentations, 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. These 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 business, 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 uses 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 October 28th, 2004, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now I'll turn the call over to Waste Management's Chairman of the Board, Maury Myers.

Thanks, Greg. Well, my comments will be very short, this is my swan song. I'd like to just thank the investment community for your help and support from the early crisis days in the fall of 1999 to the present. I'd like to say that the best ideas that I have, I steal from other people and many of them I stole from you; and so I appreciate all of that and the advice and help that you've given along the way. This company's come a long way under this team, and I think that my greatest achievement here has been the assembling of a really outstanding management team and, of course, as result of a careful transition plan that we've worked since the spring of this year, Dave and Larry are here, they're in place. The entire senior management team is in place, and I'm confident that they'll take this company to the next level. So it's time for me to fade away and--on November 11th to be specific, and say Aloha. And with that I'll turn it over to Dave.

Thanks, Maury. Good morning from Houston to all of our conference call and webcast participants. We've got a lot to talk about this quarter, but overall I'm very pleased with our results. As you all know, we've focussed on cutting costs here at Waste Management through the economic downturn. Now that we see the economy back on track, it's time to focus on growth. We intend to grow by differentiating ourselves from our competition, providing service offerings closely related to our core business, by raising prices and through creative tuck-in acquisitions. We do not believe that growing through cutting prices is a good short-term or a long-term strategy and will not march down that path. At the same time, we'll continue to increase our productivity and reduce our cost structure where possible. We believe that a combination of growth, productivity improvements and continued cost cutting will reap strong benefits for our company and shareholders. Our third quarter results benefited from very strong momentum and revenue growth due to both higher yield and the continued positive trend in volumes. And then the settlement of several tax audits.

These factors contributed to the quarterly earnings of 52 cents per share that we announced earlier today. After adjusting for the favorable impact of the tax audit settlements, we earned 40 cents a share, compared to 35 cents per share in the prior year quarter; a 14% improvement. The four hurricanes in the quarter had a nominal effect on earnings. We estimate that they contributed approximately $5 million on a pretax basis as the additional revenues were largely offset by the associated subcontractor and mobilization costs. Larry will provide a full review of the impact of the hurricanes in his review of costs. So overall, we were pleased with our results as we continued to grow revenues and to control costs in a number of areas due to our operational initiatives. The quarter was not without its challenges. As we faced margin pressures due to the impact of the hurricanes, higher fuel costs and continued tough pricing in the midwest. We'll review these in detail with you during today's call.

Our revenue growth included an 80 basis point improvement in our total yield. This matches the highest level we've seen in the last 10 quarters. It also marks the 13th straight quarter in which our yield change has been positive. Pricing improvements in the industrial sector of our collection business were the single biggest contributor to the overall higher yield in our base business. We've previously discussed our focus on raising prices in the temporary rolloff segment of our business in response to higher construction demand, which is tied to the improving economy. Our third quarter industrial sector results demonstrate that our price increase efforts is paying off. Improved residential pricing and higher rates at our transfer stations also contributed to our higher yield. We achieved our 80 basis point improvement in yield in spite of the fact that we had a 1.8% decline in yield in the midwest. Competition remains fierce in the midwest and we must turn around our pricing in Illinois, Michigan, and Ohio.

As we've reported for several quarters now, we continue to have success in raising prices to our existing collection customers. Year-over-year, we implemented an average price increase of 3% across our collection customer base. For just the commercial segment of our customers, we've implemented a year-over-year average price increase of 4%. The yield on the municipal solid waste streams coming into our landfills continued the upward trend it has shown for the last four quarters. During this period, yield on MSW has been positive in every quarter and has improved sequentially from one quarter to the next. We attribute this positive performance to our emphasis on raising prices to increase our return on capital, the continuation of higher volumes due to economic growth, and the impact of our recently implemented environmental fees charged to gate rate customers. Unfortunately, we've not seen the same types of results in other landfill waste streams, especially special waste, due in large part to competitive pricing on project work. We're focused on increasing all landfill prices now and into 2005. And I'll discuss this further in a few moments.

Volumes remained strong during the third quarter and into the month of October. We've now seen eight months of sustained year-over-year improvement in our volume. Total revenue growth for the quarter was 9.3% and total internal revenue growth was 7.3%. Internal revenue growth from volumes on base business was up 4.5%. As noted in our press release, we gained about $59 million in revenue as a result of the hurricanes. Even after excluding the hurricane revenue from our totals, higher volumes still contributed 2.5% in growth during the quarter. Recycling commodity prices remain strong and contributed $43 million, or 150 basis points, of the increase in total revenue. Acquisitions, net of some small divestitures, added $53 million, or 180 basis points, to our higher revenues. Surcharges on fuel costs added $16 million, or 50 basis points, to revenues. And $8 million, or 20 basis points, came from the affects of Canadian foreign currency exchange rates.

Another bright spot during the quarter was our strong free cash flow. We generated $305 million in free cash flow during the quarter, bringing our total for the first nine months to $854 million. Given this strong performance, we expect to meet or beat our previously stated range of 900 million to $1billion for the full year. Two important uses of our free cash flow are share repurchases and dividend payments. We increased the level of our share repurchases in the quarter to $240 million and are on track to reach our updated full year range of 425 million to $500 million. This will conclude our three-year buyback program, during which we've already repurchased over 72 million shares, or 12% of the shares outstanding when we began the program in 2002. We paid our third consecutive quarterly dividend of 18.75 cents per share on September 24th, and declared our fourth quarter dividend of the same amount on October 12th. Through the first nine months of 2004, we've returned over $650 million to our shareholders through share repurchases and dividend payments.

On the strength and confidence in our continued ability to generate cash, we also announced today that our board of directors has approved a new three-year capital allocation program to begin in 2005. This is designed to return annually up to $1.2 billion to our shareholders. As part of the plan, we expect to increase our quarterly dividend payments to 80 cents per share on an annual basis. This is a five cent per share annual increase when compared to our expected 2004 payment. And at a $27 stock price, represents nearly a 3% dividend yield. The balance of the $1.2 billion annual program will be available to continue our share repurchases, although the amount of stock we repurchase will obviously depend on a number of factors, like cash acquisition costs and capital expenditures.

As I mentioned earlier, I want to discuss in more detail our 2005 program to further raise landfill prices. We will always believe that pricing decisions are local decisions, but a pricing strategy is a companywide decision. So we have our corporate and field pricing folks working on the pricing strategy for 2005. That strategy will include pricing initiatives on all of our lines of business. But we're also going to test an additional pricing program at some of our landfills. The program is designed to select a representative number of landfills and to implement different levels of price increases in order to test price elasticity. As the results on price and volume are received, we will then report them to you. We're in the process of finalizing selection criteria for our landfills and the other elements of the special program. We will include both MSW and C & D landfills in the study. For our pricing on all landfill waste streams, including MSW, C & D, and special waste pricing; we will ensure that pricing adequately reflects our focus on return on capital.

The number of landfill fills we choose will be large enough to effectively test our strategy but not so large that we would expect it to significantly impact our earnings as a result of losing some volumes; which could happen if our competition chooses to use this situation to gain market share. Many of you have heard me say that any successful pricing program needs three things, visibility, accountability and sustainability. We need visibility so that we can make sure that our pricing strategy is being implemented and so we can report the results of our strategy to our shareholders. We need accountability within our organization to implement the strategy. Accountability will come through two processes. First, we'll use our data to develop performance measurements for our field managers. Second, we will ensure that our compensation structure focuses on our goal of improving the return on capital of our landfill assets. Sustainability means that we're prepared to lose some volumes in order to gain pricing that reflects the strategic value of our assets. I'm convinced that one of the long-term keys to revenue growth at Waste Management is through pricing.

The win-win aspect of higher landfill prices is that they will make their way to the curb and have a positive effect on our collection revenues. During the economic downturn of 2001 through 2003, Maury demonstrated leadership in his approach to increase our overall level of pricing even at the risk of losing some volumes. So although our internal revenue growth numbers show that our approach has been successful, we've had 13 consecutive quarters in which we've shown improving yield; we can still do better. And as the economy has recovered in 2004, we saw the benefits in our third quarter yield gains. We plan to follow that same disciplined approach to pricing in 2005 and beyond. We will always be clear at Waste Management that a good portion of our growth will come from pricing.

One of my stated objectives for the Company is to achieve year-over-year margin improvement. We did not achieve that margin improvement during the third quarter. Income from operations before depreciation and amortization for the third quarter fell from 25.3% of revenues in 2003 to 24.7% of revenues in 2004, a drop of 60 basis points. This was caused primarily by the cleanup efforts of the hurricane and the further escalation of fuel prices, some of of which related to third party transporters applying fuel surcharges. Year-over-year margins would have improved without these factors. A sign that we're continuing to make progress in a number of operational areas. But with all the strong performance trends of the third quarter: strong free cash flow, strong pricing, and strong volume growth, I'm disappointed we couldn't show the year-over-year improvement I expect. You can be assured that we're working to address how to increase our margin and for some specific details about these efforts, I'll turn the call over to Larry.

Thank you, Dave. I'd like to begin my review of operating expenses by discussing how we responded to the four hurricanes in Florida and the overall financial impacts our efforts had on third quarter revenues, operating expenses, and earnings. Certainly our thoughts go out to all those that were affected by the hurricanes. As members of the communities we serve, we understand the tragic impact of the storms and we're doing all that we can to help the people of Florida to return their lives to normal. When I think about our response to the four storms, one of the things that comes to mind is something that Maury established early in his tenure, the concept of one Waste Management. I say that because our response has truly been a team effort. Employees in our southern group have worked tirelessly for what has now become months. In addition, other members of the Waste Management team, particularly employees of both the midwest and eastern groups, have made tremendous contributions to the effort.

Earlier this week, I spoke with one of our drivers, Mike Sullivan, from Philadelphia, who's been helping out in Florida for almost two months. He's been working six to seven days a week and has only seen his family twice during that time. And his absence from the Philadelphia market area means his co-workers are having to work harder to cover for him while he's helping out in Florida. This is just one example of how our employees are pulling together to help out the people in Florida. We also received tremendous support in Florida from our suppliers who helped with rental equipment, containers, and food for our families and employees. When the first hurricane hit, we began mobilizing, not only in the areas hit by the storm, but also in other parts of the country, moving spare trucks, containers and drivers to assist with the cleanup effort. In addition, when the storms knocked out power, we were able to use our new customer service information systems and processes to reroute calls from the Florida call centers to our other call centers around the country.

This enabled us to continue to handle customer service requests following the storms. Our team effort demonstrates how far we have come as a company over the last few years and the tremendous pride that our employees have in Waste Management and in pulling together to serve our community. From an overall financial perspective, the additional work from the hurricanes generated $59 million in revenue in the third quarter. We estimate the income from operations from the hurricane work to be approximately $5 million on a before tax basis. The majority of the $59 million in revenue was in our collection lines of business. The four hurricanes left so much to be cleaned up, a number municipalities, as well as the federal emergency management agency or FEMA, asked us to serve as general contractor for the clean up. We have served these communities for many, many years and we believe they turned to us because of the trust they have in our commitment to deliver results. Similarly, we've worked with FEMA on many other disaster cleanup efforts over the years and they understand our capability to handle these kinds of situations.

We did not experience a significant increase in our disposal revenues as a result of the cleanup efforts in the third quarter because we were directed by the various governmental agencies to utilize the local municipal disposal sites for disposal in many cases. The local municipal sites normally restrict their tonnage but they opened up their landfills to accept the hurricane debris so that the cleanup could be completed faster. In addition, much of the green waste was shredded or burned. Because of the sheer volume of the collection workload, we subcontracted a significant portion of the work to third party hauling companies. This was the primary reason for the relatively low operating income margin on the hurricane-related business as we spent $46 million in passthrough costs paid to subcontractor collection companies. This of course directly impacted our gross margins as well. The hurricane cleanup efforts did not materially affect our yield because we treated additional business as volumes in our internal revenue growth calculations.

Our revenues were typically based on collecting a relatively low fixed margin on the passthrough costs. We also incurred additional operating costs as a result of higher disposal-related costs at certain of our Florida landfills as a result of the storms. The large volumes of rain from the storms increased the amount from the landfills which had to be collected, pumped into trucks and disposed of properly. As you might imagine, it was a monumental effort by our landfill operators to keep the landfills operating in spite of the four hurricanes, as they constantly worked on the roads to keep them passable and on the side slopes of the open disposal cells to keep them from washing out and available for disposal. Finally, our collection operating costs increased as a result of mobilizing and preparing the extra crews, spare trucks and containers from other parts of the country, as I mentioned earlier. In addition to the subcontractor cost, we estimate the total operating, administrative and D&A costs associated with our hurricane cleanup efforts to be approximately $8 million.

To summarize, the financial impact of the hurricane cleanup efforts in the third quarter, external revenues of $59 million were reduced by $46 million in third party subcontractor and transportation costs, $7 million in operating costs an $1 million in SG&A and depreciation & amortization. As a percent of revenue, operating costs were at 90%, which is significantly higher than our companywide operating costs as a percent of revenue. As we look ahead, we estimate income from operations from hurricane cleanup work in the fourth quarter will be similar to what we saw in third quarter.

Now I'm going to review our overall operating expense results. Operating expenses were 2,151,000,00, or $210 million higher than in the third quarter of 2003. As a percent of revenue, third quarter operating expenses increased from 64 .8% in 2003 to 65.7% in 2004, an increase of 90 basis points. As I discussed earlier, the hurricane work was very low margin business, which had the effect of increasing our overall operating expenses as a percent of revenue. The effects of the hurricane cleanup efforts increased third quarter operating expenses by 44 basis points. In order to better assess our operational performance for the quarter, I think it's helpful to also understand the affect of higher fuel and recycling commodity prices on our operating expenses. I find that once I'm able it isolate the impact of those costs, I can get a better picture of our performance and operating expenses.

Fuel price increases contributed 21 million to the year-other-year increase in operating expenses in the third quarter as the average price of diesel rose by approximately 36 cents per gallon from the same quarter last year. And as diesel prices have increased, some third party transportation companies have begun surcharge programs, similar to what we've implemented with our customers. For the third quarter, third party haulers charged us approximately $5 million in fuel surcharges where we could identify a separate fuel charge. Adding those fuel surcharges to the fuel increases we incurred directly, high year fuel costs caused us a $26 million increase in our operating expenses. This does not include increased cost for fuel from subcontractors where they did not specifically identify the cost on their bill. We received $16 million from our fuel surcharge program during the third quarter, covering about 62% of the identified increase in fuel related costs and 76% of our direct fuel costs. This leaves $10 million of excess costs, which caused a 50 basis point increase in operating expenses and cost us a penny in earnings per share.

Higher commodity prices for recycling materials, such as cardboard, newspaper and aluminium that we collect and sell to third parties such as mills,create additional revenue and are generally profitable for us. However, we often pay rebates to our recycling customers that may float with commodity prices. So as commodity prices increase, our profits increase as well with no additional invested capital required. At the same time, the recycling rebates we pass back to our customers increase the cost of goods sold component of our operating costs, which squeezes our operating margins. In the third quarter, higher recycling commodity prices caused our revenue to increase by an additional $37 million, however, we also saw an increase of $27 million in cost of goods sold, attributable to increased recycling rebates we paid to our customers. The net effect of this was an 11 basis point increase in our operating cost as a percent of revenue. Eliminating the impacts of the hurricanes, higher fuel and recycling commodity prices, our operating expenses for the third quarter, as a percent of revenue, were approximately 64.7%, compared to 64.8% for the same quarter last year; or a 10 basis point improvement over last year. Frankly, we expect more improvement than what this adjusted figure shows.

Because we are in a period of significantly rising revenues, I'm going to address cost changes in terms of basis points after eliminating the impact of the hurricane, higher fuel costs and recycling commodity prices. I find that to be the clearest way to view changes in our operating cost structure and helps me manage our operating costs. Subcontractor costs increased 58 basis points in the third quarter of 2004 from the third quarter in 2003, excluding subcontractors used as part of the hurricane cleanup effort in Florida. Most of this was due to our use of third-party transporters on special waste event jobs in our western group. These types of long-haul jobs are profitable business, but the trucking portion is a passthrough cost with zero return and squeezes our operating margin. During our second quarter conference call, I discussed the higher transportation costs in our eastern group due to the shipping of higher volumes from transfer stations to more distance landfills. Our performance in the east has improved, as we've made progress on the cell construction and landfill expansion project I discussed last quarter.

Eliminating the costs associated with the Florida hurricanes, salaries and wages, including payroll taxes and contract direct labor costs improved by 14 basis points in the current quarter compared to 2003; as productivity improvements more than offset increases in absolute dollars. The higher dollar costs are due to annual merit raises, higher overtime to service increased volumes and labor associated with acquired businesses. We've been able to more than offset these higher rates through productivity improvements in all our labor intensive lines of business. As I've discussed with you on previous calls, improving productivity continues to be a big focus for us. As part of our operations score card process, we measure productivity in our commercial, residential and industrial lines of business and have developed new tools to help our route managers improve productivity. In the third quarter, we rolled out the new tool I mentioned to you on our call last quarter to assist our district managers and route managers and improve productivity. The tool tracks unit costs by line of business and productivity of each of our drivers on a daily and weekly basis in our hauling operation. Our waste routing optimization initiative is another one of the tools we use to improve our productivity.

We realized $19 million in additional cost savings in the third quarter through our waste route initiative, helping us to exceed our full year goal of $44 million in savings, ahead of schedule. Our waste route initiative has been focused on the commercial and residential lines of business. Productivity in both our commercial and residential lines of business was up over 1.6% year-over-year, while our industrial productivity was up by 0.4%.

Now turning to maintenance, reducing our maintenance cost continues to be an important initiative for us. Excluding Florida hurricane related costs, maintenance and repair cost improved 30 basis points during the third quarter compared to the same quarter last year. Just as I said about our labor costs, there is opportunity to further improve our maintenance costs. One of the key measures in our collection fleet maintenance is our maintenance cost per driver hour. We are saving money year-over-year from these programs. In fact, year-to-date, we've reduced truck maintenance costs to $11.63 per driver hour from $11.90 per driver hour for the same period in 2003 without any adjustment for the hurricane. While we continue to expect to see savings year-over-year from our maintenance program, our rate of savings will not be as great as we originally expected this year due to the cost we incurred as a result of hurricanes and placing old trucks back into service to handle additional volumes as well as increases in parts costs.

Another bright spot in our operating cost performance in the third quarter was a 21 basis point reduction in insurance and benefits costs. These costs include general liability, auto liability, healthcare, worker's compensation and risk management expenditures. We continue to make progress in our efforts to be a leader in safety with our mission to zero program. In the third quarter, we continued to improve our total recordable injury rate, a standard OSHA measure, reducing it another 17% from the prior year quarter, meeting our goal for the quarter. We also continue to show great progress in reducing the number of employees absent due to injury. 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 sustained reduction in casualty frequency and severity should lead to reduced claims costs and reduced premiums in time. Landfill costs outside of Florida increased operating expense margins by 13 basis points during the third quarter, compared to the same period last year. Due principally due to higher leachate and methane collection expenses.

Outside of the Florida area, portions of the south and the east experienced very wet weather due in part to the rainfall associated with the four hurricanes, which tends to increase our leachate collection expenses as I previously discussed. However, we did not attribute nor include those costs in the hurricane totals that I previously discussed. From an operational perspective, we accomplished a lot during the third quarter. We are proud of our efforts in responding to the four hurricanes and will continue to help the people in Florida recover. We have demonstrated our ability to respond to higher demand for months on end and are gratified that 2004 volumes are still strong compared to the past several years. This level of activity has challenged our operators, but they've show resiliency and have improved productivity in an number of areas. We've set high standards for our employees through our operations score card process and will raise the bar in order to realize the opportunities we have to increase our productivity and reduce our operating expenses. Now I'll turn the call over to Bob Simpson, who will review our SG&A costs and other financial results.

Thank you, Larry. I'm going to start my discussion with the review of the impact of recent tax audit settlements on earnings. For the past several years, we have been actively negotiating settlements involving tax returns from as far back as 1989. During the third quarter of this year, we settled federal income tax audits for several subsidiaries, increasing earnings by $71 million, or 12 cents per share. Through September of this year, we have made significant progress in settling open federal income tax audits and expect to close the remaining open audits over the next few quarters. We believe that we are adequately reserved for these audits. The $71 million in benefits included $62 million from a reduction in income tax expense, as well as interest income, after tax, of $9 million. We are entitled to a refund, including interest, of $28 million, however our free cash flow will not increase by the 28 million because we have are applying the refunds to balances due from other open tax audits. We are pleased to be finally getting through these tax audits.

I will now cover this quarter's SG&A costs. As a percent of revenue, this quarter's SG&A costs decreased to 9.7%, versus 9.9% in 2003; although they increased in total dollars by 19 million. As you may recall, our full year target is for SG&A costs to be 10.5% of revenue or lower. Through the first nine months of this year, SG&A costs are 10.2% of revenue, so we're -- so we are tracking well toward this objective. If we exclude the $59 million in revenues related to the hurricane cleanup, our SG&A costs would have been 9.8% of revenue, still below last year's 9.9%. There are several drivers of the year-over-year dollar change. Sales commissions have increased $3 million due to the higher volumes we generated this quarter. Professional fees increased by almost 10 million, or about 1cent per share; 3 million of which related to legacy lawsuits in which trials will likely be concluded this year, 4 million related to defense costs of former officers, and 3 million for Sarbanes-Oxley 404 efforts this quarter. Bad debt expenses have risen $5 million. This is in line with our significant revenue growth and compares to an unusually low amount from the third quarter of 2003.

Depreciation & amortization was 10.5% of revenue in the third quarter compared to 10.8% in the same quarter of 2003. This is consistent with our view that depreciation & amortization should generally be close to 11% of revenue for the full year. Third quarter interest expense decreased $2 million compared to the prior year due to the pay down of senior notes earlier this year. Interest income increased by $18 million to a total of $21 million in the third quarter of this year. This is primarily due to the interest received on tax audit settlement refunds that I discussed earlier. On the next line of the income statement is 27 million of equity losses on consolidated entities, which is related to the losses resulting from the two investments in synthetic fuel plants. In the third quarter, this loss is offset by $40 million of income tax reductions and credits. After accounting for the $2 million interest expense related to these investments, the result is a net aftertax benefit of about $10 million in the quarter.

Let me take a moment to recap the earnings per share impact of these investments. In the first quarter, they had a negative impact of about one half a cent per share. In the second quarter, these investments resulted in about a penny of EPS benefit. In the third quarter, we gained a little more than 1.5 cents per share. And in the fourth quarter, we estimate the benefit from these two investments to be approximately 1 cent per share. With regard to our effective tax rate, the combination of the tax audit settlements and our synthetic fuel investments lowered our rate for the quarter to 10.4%. After eliminating the impact of the tax audit settlements, we now project an effective tax rate of 30% for the year. The change from 30.85% we discussed last quarter is primarily due to section 29 credit from our fuel investments exceeding our estimates. That completes the review of the income statement.

Moving on to the balance sheet and the cash flow statement, receivables increased over 110 million in the quarter due to the sequential increase in revenues and an increase in our days sales outstanding. DSOs were up about two days over last quarter to 49.3, due in most part to two large receivables. First is about 45 million in hurricane-related receivables, some of which we expect will not be paid until 2005. This will result in a use of working capital as well as an impact on our days sales outstanding next quarter as well. Second, at quarter end we had about $20 million in receivables from a municipality and these were paid earlier this month. Total debt increased by 65 million during the quarter. The primary driver of this change was a $61 million increase in the fair value of our swap portfolio. Debt to total capital at the end of the quarter was 60%. This is essentially the same as it was at the end of the second quarter and is in line with our goal of approximately 60%.

The floating rate portion of our total debt portfolio is approximately 36% at the end of the quarter. On October 1, we used cash to repay -- cash on hand to repay 295 million of senior notes that were due. A couple of weeks ago we filed an 8-K noting that we had entered into a new five-year, $2.4 billion bank facility. This facility replaced our previous three and five-year agreements which, combined, had the same total capacity. A few things to note for you regarding our new agreement. Based on our current credit rating, the fully drawn rate we will be paying for letters of credit is 62.5 basis points as compared to 100 basis points on our prior facility. We believe that this substantial reduction in our rate is indicative of our improved credit profile over the past two years, as well as the bank's confidence in Waste Management's financial strength into the future. The tangible net worth covenant from our prior agreements has been completely eliminated. This substantially increases our flexibility to continue returning value to our shareholders through dividends and share repurchases.

Our capital expenditures through the end of the quarter were $837 million. The fourth quarter is historically our heaviest spending quarter for the capital, so we still expect to spend 1.25 to $1.3 billion for the year. And with $854 million in free cash flow generated through the first nine months of the year, we are still projecting to meet or exceed our full year target of 900 million to $1 billion. We now expect to spend under $250 million on acquisitions in 2004. That number does not include about $45 million we have spent already this year for land adjacent to landfills that is available for future expansion. These expenditures are treated as CapEx and account for our exceeding our original capital expenditure target of $1.25 billion. We repurchased quite a bit of stock during the third quarter, over 8.5 million shares, for a total cost of approximately $240 million. This puts our 2004 repurchases through the end of the quarter at $329 million, well on the way to our range of 425 to $500 million in repurchases for the full year.

In closing, we are very pleased with the level of free cash flow that we generated during the quarter. We are also on target to achieve our full year goal of lowering SG&A to less than 10 .5% of revenue, though we know there is still improvement that committee can make in this area. As Dave discussed, and as we said in our press release this morning, our board of directors has reaffirmed and expanded our commitment to returning a large portion of our free cash flow to our shareholders in the form of dividends and share repurchases. This demonstrates prospects for continued revenue growth from pricing, increased operating productivity and our ability to generate strong and consistent cash flows. Now, operator, we will open the line for questions.

Thank you. [Caller Instructions] We'll pause for just a moment to compile the Q&A roster. Your first question comes from Amanda Tepper.

Good morning.

Good morning.

And a big Aloha to Maury, we're all very jealous of where you're going and hope to join you some day.

Thanks, Amanda. Aloha

How is the board looking these days at the split between the dividend and the buy back? Because obviously you have the capacity to pay more of a dividend than the increase you announced today. How are you going to allocate that going forward?

Sure. You know, we've always said that our board takes the allocation of our substantial free cash flow very seriously. And we want to make sure that we -- when we do look at allocating cash flow, that we show the confidence in the sustainability of that cash flow by increasing the dividend. But I wouldn't expect us, Amanda, to go on the dividend above 50% of our available free cash flow. As can you see, with the program we've got right now, it is weighted a little bit more toward share repurchases than the dividend.

Okay. And then when you're talking about look at your margins without fuel and I understand that because it's been a big head wind, but ultimately I'm sure you're trying to get your EBITDA margins up, including whatever happens with fuel. Is pricing going to be the key to that or is there anything else you can do on the surcharge or cost side to get there?

Sure. Pricing is always going to be the cornerstone that we look at to truly increase our margins over time. But you know, we have to continue to maintain our cost cutting culture and, you know, with Larry in charge of the operating costs, I'm fully confident we will continue to do that.

Okay. And then this is just a knit accounting question. You changed your accounting this year of where you're recording the landfill tax revenues that you collect. Can you break that out for us?

Yeah, let us dig for that and we'll mention it a little farther down the call.

Okay. Thank you.

Thanks, Amanda.

Your next question comes from Michael Hoffman of Friedman, Billings, Ramsey.

Thank you very much. Talking about the cost controls, can you give a sense, Larry, about the the lag that you're experiencing in the latest initiatives, you know, if you start rolling out an incremental push, it's showing up how many months ahead in margin? And then the second question would be on the compensation system and, as you alluded to, David, return on invested capital is being a driver of your behavior in landfill pricing. What's your thoughts about changing the compensation system from an EBITDA growth model to one that's focusing on some component of a return on capital?

Well, I'll start on the cost side. You know, some of our initiatives were actually ahead of schedule. As I mentioned on waste route, we were actually -- our goal for the year was 44 million in savings and you know, we actually surpassed that this quarter. You know, with a total of so far this year of 48 million in savings. Our safety program is another one that we feel like we're right on track and, in fact, if you look at what we've done on our PRIR, we've actually been exceeding our goals each quarter so far this year. Maintenance, we were making very good progress up until this quarter.

We still are showing year-over-year improvement but you know, we got a little headwind this quarter with the hurricanes. And when I dig into those maintenance costs, you know, you look at where we were at the end of 2003 at $11.87 and by the way, that is -- those numbers that I'm using include labor -- and our goal was to drive that number down. We made progress in the first quarter getting it it down to 11.72. And when I look at where we are in the third quarter, all of our groups actually improved from where they were in the first quarter to the third quarter, except for two. And one is the west and it only increased two cents from where they were in the first quarter. In the south, you know, they were up $1 from where they were even in the second quarter. So you know, I just think that the activity that we had and the headwind due to trying get all those trucks going out there and ready for the -- to serve what we needed to do in the hurricane cleanup had a big impact. You know, that was probably the biggest component of it.

You know, following on that before David talks about the cost compensation system, are you confident that at this juncture, ex these these external one-time events that have occurred that you can't control, mother nature and what have you, that you are at least keeping pace with the inflation that's in your business? Or do you think you actually have gained the march on it and you're slightly ahead of it?

Well, I will say this, I've said all along that on the maintenance side, you know, our goal is to get down to a $10 average cost per hour. That continues to be our goal. We still have a number of market areas that are at or below that level, so I know that it's possible. And we're going to continue to chip away at it and, you know, the other big driver I think when you look at costs is just our improvement in productivity. That's a big area of focus for us. It will continue to be going forward. And we're showing improvement there, which is helping offset the rising rate of labor. So those are things that we'll continue to focus on and I believe we still have plenty of opportunity there to show more improvement.

Okay. I appreciate that answer, but it wasn't quite the question I asked. I mean, do you think you're only keeping track or are you ahead of inflation at this point?

I would say that we're probably barely behind -- you know, slightly behind or close to it.

Okay.

In our activities right now.

And based -- because you guys have improved the data you can collect now. So you've got a -- I would think a much better feel for the subtlties of this. Do you have, sort of, as you look forward, a sense of you know, this could break through, is it a quarter away, two quarters away or longer than that?

Well, at the end of the day, you know, we're beginning to see some increases in pricing that we're receiving. For instance, on fuel. Well, fuel of course, but outside of fuel, steel prices, which impacts, you know, our steel container prices, as well as our parts prices. And at the end of the day, as Dave mentioned, we've got to get price increases ourselves. We got to pass that along and impact our top line by increasing our prices ourselves.

Okay. Well, that's a great segue, Dave, to you about compensation.

Yeah, on compensation, Michael, you know we have a short-term and long-term component to our compensation. And the short-term component does include a return on capital metric. About 30% of that is personal, 70% is financial. And of the financial portion, a full 50% is a return on capital metric. On the long-term compensation, you know, as we now approach the expensing of stock options, we'll be looking at a number of alternatives to either supplement or replace the stock option program, and each of those programs will have an element of return on capital in them.

I believe you have a -- I could have the dates wrong, but a big meeting, area manager meeting coming up in November. You know is it a plan at that time to sort of embrace a change on how they should think about their compensation as it relates to price and price at the landfills?

No, we just -- we just had our folks in last week.

Okay.

And our next big meeting will be first quarter of next year. But, you know, you can be assured that as we look at making adjustments to the compensation program to refocus on return on capital; you can be absolutely assured that we will communicate that throughout the organization.

Okay. Thanks.

Thanks, Michael.

Your next question comes from Leone Young of Smith Barney.

Yeah, good morning. Could you talk a little bit about the strength in your landfill volumes? Based on your commentary, a lot of that wasn't coming from the hurricane, as I understand it. So maybe you could give us a little color there.

Sure. You know, when we look at landfill volumes, frankly, it sort of follows the same pattern that we saw in the second quarter. We saw continued increases in MSW and very strong increases in special waste and we continued to see extremely strong increases in C & D. So you know, what we saw through the quarter was that volumes year-over-year continued to be up in all three of those lines. But frankly, remember, at the beginning of the year from January to February to March, we really saw a big acceleration of the increase in volumes. What we're seeing now is still an increase, it's absolutely a year-over-year increase. But month-to-month we're not seeing the acceleration that we saw. And that's because you know, we saw most of the acceleration at the beginning of the year.

Also, as you choose these landfills that you are going to price more aggressively, what criteria are you using, are you using where you're strategically placed or where you feel that pricing, you know, is unacceptable? A little color on that would be great.

Yeah, sure. You know, we are in the process of finalizing criteria, but we are picking landfills in a variety of situations because we want to learn about the elasticity of pricing and we want to learn about how hard pricing is going to affect volume. So we're not going to pick a homogeneous set of landfills. So we, for example, won't pick landfills only where they meet specific criteria. We will look at landfills where we believe we can be successful because we haven't had big price increases over the last five years. And then beyond that, we're going to pick a diverse set of landfills so that we can truly understand what our price -- what effect our price increases have. It's exactly what I talked about with doing different levels of price increases. If you pick the same type of landfill and implement the exact same type of price increase, you're not going to learn anything from your pricing strategy. So as much as I can say is that we will pick a number of landfills using specific criteria that will, you know, will -- not a homogeneous set of landfills.

Just a quick last housekeeping question from Bob. As I understand it, then, in the fourth quarter you'd be looking at your tax rate to be about 30%. And are you assuming any changes in minority interest or equity? Would they be about the same as the third quarter?

I would expect those minority interests and the equity losses to be about the same and you've got the tax rate. That 30% is a full-year tax rate.

Great. Thank you.

Your next comes from Tom Ford with Lehman Brothers.

Yeah. Good morning.

Good morning.

Hey, Dave or Larry, last quarter you guys had broken down the pricing metric, you know, highlighting I think like the west and the south were somewhere around a percent and a half. With the other areas, the east and the midwest being the problem areas.

Yeah.

I was just wondering could you give us an update? I don't know if you have those numbers but can you just give us an update as to how things are trending on a region level?

Sure. You know, it is trending pretty much like it was in the second quarter. Pricing continues to be the strongest in the west. And you know, I don't think in the second quarter, Tom, we said pricing in the east was a problem because, frankly, pricing in the east has been frankly robust over the last few quarters. So when you look at it you'll see pricing in the west is very robust. Pricing in the east is good. Pricing in the south is not as robust as it is in the west. And pricing in the midwest is actually down.

Okay. And in terms of the midwest, just going back over that, the drivers there, is that still competitive work on the street, as well as on the disposal?

On the midwest you said?

Yeah.

Oh, on the midwest, the price -- the price problems in the midwest are throughout all the lines of business. And you know, Tom, when you understand the business, you can understand why that's the case because if you can't get landfill prices up, you're not going to be able to get collection prices up. And so it has been throughout the various lines of business, you know, the commercial pricing has been particularly troublesome, but we have continued to see decent volumes. So we believe because we're seeing decent volumes we do have an opportunity to raise price in the midwest.

Okay. In terms of your comments about the pricing initiatives, am I reading this wrong or -- I just want to make sure I understand this. I mean, to me it seemed like you were saying that this was going to be part roll out but part experimentation. So I'm just wondering if I'm thinking about 2005, is this potentially something material to the pricing performance in '05?

Yeah, well, let me clarify that because I tried to do just that in my script because I didn't want anyone to get the wrong impression. You know, we are absolutely looking at a pricing strategy, when we go through our budget process as we are right now, we're looking at a pricing strategy where we intend to raise prices across all lines of our business and across every business that which have in the United States. So you know, that's what we've been doing for the last, you know, five years and that's what we'll do next year. We will build into our budget a good amount of price increase at every market area or, you know, virtually every market area throughout our business.

Now, on top of that, what we're going to do is this special landfill program. And that's where we will pick enough landfills, such that we can understand some of the dynamics of pricing in those markets, extrapolate it, hopefully, to our other markets and then continue that pricing program throughout all of our market areas in the United States. So, we will be raising prices across the board, throughout the United States, where we can, you know, in the way that we have the past, which is very strategic and very targeted. But this will be an additional program that we're going to do at these other landfills.

Okay. And I appreciate all your commentary on the cost side. And you know, I was just looking at it from a broad perspective. I mean, if I exclude the hurricane impact out, I get EBIT growth up something like 5.7 on revenue growth of 7.3. And I guess, so-- I guess, you're talking about getting together with your folks in the field. I mean, what's the message that you send to them, you know, there in that sense? I mean, you know, we're really trying to drive the performance here in terms of realizing some leverage benefits. I mean, what is it -- or where do you see in the cost structure or the mix, where do you see that there's major opportunities for improvement?

Well, you know, as Larry said, we're looking at areas of improvement throughout the cost structure. But you know, we're going to continue saying it and it's what we've preach to our folks out in the field, which is we absolutely expect you all to improve the cost structure. But in order for us to really see the margin growth that we expect year-over-year, we have to go out and pass on our increased costs to our customers through price increases. So that's really the message we've been spreading.

And, Tom, this is Cherie, let me just add that part of what Larry went through, though, is that the fuel and commodity are helping that 7.3 revenue growth that you were talking about; but they're not adding anything to the EBITDA. I mean, fuel in fact is taking away. I mean, commodity might be adding some but not nearly as much proportionately as if it was just regular revenue growth.

And we also had some head wind from some of the subcontractor work that we have in the west. That also makes it a little harder to continue to show that same kind of growth.

Okay. Great. Thank you.

Thank you, Tom.

Your next question comes from Jamie Cook of Credit Suisse First Boston.

Hi. Good morning, guys.

Good morning.

Hi. My first question, I guess you know, when we look at pricing for 2005 and, you know, we're optimistic and we're hoping we can get pricing at the landfill; but, you know, when you look at what one of your largest competitors said in the second quarter. They said they went out and they tried to raise prices at the landfill and their competitors didn't respond so they lost volumes. And now they're sort of taking that back or I guess they're not being as aggressive at the landfill in terms of pricing. So how -- I mean, when you talk to the people at the field, how do you -- what's the balance between, you know, how much volume you will lose for price and how long do you wait, or if it doesn't happen within a couple of months do you guys just pull the price increase?

You know, we can't control what our competitors do, quite obviously, and -- but you know, in listening to what they said in the second quarter, I would say that I think what they said was they didn't lose volumes from raising prices. They lose volumes because a couple of their large customers took volume from their landfill and internalized into their own landfill. So it wasn't that they lost volume through pricing. I think they lost volume, what they said was they lost volume because of a natural tendency for other companies to want to internalize waste. So you know, we can't control what our competitors do. All we can control is what we do. And it's what I said in our opening comments.

In order for us to have a sustained -- or a successful pricing program, we need that visibility, accountability and sustainability. And when we say sustainability, we mean that if we-- remember that if you lose volumes by raising prices, it's exactly what we've seen in some of our market areas. Net effect to the bottom line has actually been positive because the price increase has more than more than made up for the volume decrease. So you know, when you go out and raise prices at the landfill, first off, the fact that you lose volume might not be negative, it can still be very positive. But if you assume that we're going to lose some volume that the price increase won't make up for, what we're going to do is we're going to continue down the road of raising prices.

And that's why when I talk about the number of landfills that we'll do this special pricing at next year, we do need to be careful recognizing that our shareholders expect us to perform. So we're going did it at a number of landfills to where it's sufficient for us to understand pricing better and sufficient for us to really see how pricing is working at some of our landfills. But not so dramatic a number of landfills that if we did lose volumes, it would have a material effect on our earnings. So in summary, you know, price increases are good even if they push out volume because many times they more than cover the volume decrease and we will not go out-- you know, like Maury's done for the last five years, we're not going to go out and do anything rash. We're going to do something very strategic to make sure that we can continue to perform currently but that longer term we can continue to get better pricing.

Okay, and then my second question, just to be clear, if we look at 2005, is there anyway -- I mean, you'll be very -- you know, strategic in which landfills you raise prices at. Is there anyway to gauge by the end of 25 do you expect to get to 50% of your landfills, to 80% of the landfills, are you there yet, you know, in terms of quantifying that?

Right. What we will do is we will report to you all periodically what happens. So after we take those actions in various markets we're going to let you know what the action was and what the reaction was as far as our volumes are concerned. And you know, obviously it's like anything else, as we go through the program in 2005, if we find that we're having great success, we will obviously continue to roll it out throughout the country. So we don't have any firm plans other than we're going to go test pricing and then as we see that pricing react one way or another, we will either expand the program or we will continue on with that program. But again, what I can tell you is that we aren't going to back down from that program.

Okay. Great. Thank you very much.

Dave, let me go on answer a question Amanda raised about the accounting for the mandated fees and taxes. In order to conform the presentation year-to-year, we changed the presentation of our last year-- Q3 of last year to conform to this year and the effect of that was to increase revenues by 20 and-- $20.5 million last year. So that they would be -- you could look at them on an apples to apples basis. That'll be further explained in our 10-Q which we expect to file by tomorrow. Alright back to you, operator.

Thank you. Your next question comes from Lorraine Maikis of Merrill Lynch.

Thank you. Just wanted to talk a little bit more about landfill pricing. And the timing surrounding these test markets, so to speak. I mean, do you intend to roll them out and give them a quarter to see how they perform or will this be a full-year process?

No, and Lorraine, remember what the idea here is is to learn something about landfill pricing. And to learn, you know, what various levels of price increases, what effect that has on our business and to find out if we can actually raise prices and either continue to maintain volumes or lose small enough volumes that the price increase more than makes up for it. So this program is not just about raising prices, it's also about learning what the market dynamics are. So as we gain that knowledge, we will then take that knowledge and roll it out to other market areas. And so it's -- it's -- you know, it's hard to say it's going to happen this day and this day because as we go through the program, we're going to continue to learn things about pricing. But from a timing perspective, we will absolutely start the program right at the beginning of the next year and the first time we will report to our shareholders what the results will be, I would expect to be at our first quarter conference call in mid-February.

Thanks. And then every market is different. And I think you eluded to that earlier on in the call. Do you think that you have landfills in similar enough markets to be able to extrapolate those results forward to your overall business nationwide?

Absolutely. Absolutely. We've got people here who's sole job is to understand pricing and they understand the market dynamics and they're the ones that can tell us, you know, when they think a market dynamic is similar to another one. So that's their job and, quite frankly, they do it very well.

And that's in your national pricing group?

That's in our pricing group here in Houston and in our pricing folks out in the field.

Thank you very much.

Your last question comes from Dana Richards of Argus.

Hi. Good morning. This is Dana Richardson from Argus. Obviously this year your -- the results of your tax audits have been very favorable. But in the remarks, it was mentioned that you were adequately reserved for any outcomes next year. Does that mean that you expect to have more of a negative outcome with the tax audits? Could you give us some kind of range of expectations for that?

It's really -- really we can't, Dana. You really can't predict until the audits are complete. Issues can be raised at the very end of the audit. I've had experience with that. So I think -- I think the best thing to do is say that we're adequately reserved and as the audits --as the results come along, we will make them very clear to you.

So you don't have any feeling about whether it's going to be positive or negative or you can't comment on that?

I really can't comment on it.

Okay. Thank you.

Thank you.

And, operator, before we say good-bye, I know a number of you on this phone call, as we've been traveling around the country, and as Maury's been traveling around the country for the last five years; a number of you all have gotten to know him personally and you all -- you all have benefited from his good company and his business acumen just like we here at Waste Management have benefited from those things. And so I'm certain that all of you all would join me in saying to Maury, Aloha and Mahalo-- which is Hawaiian for good-bye and thank you.

Aloha and mahalo to all of you as well, Dave. Thank you.

Operator, with that, we can wrap-up the call.

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