美國廢棄物管理公司 (WM) 2005 Q2 法說會逐字稿

Good morning. My name is Angelic and I will be the conference operator today. At this time I would like to welcome everyone to the Waste Management second quarter 2005 earnings release conference call. [ Operator Instructions ] I would now like to turn the call over to Greg Nikkel, Director of Investor Relations. Mr. Nikkel, you may begin your conference.

Thank you Angelic, and sorry for the slight day in starting. But good morning to everyone and thank you for joining us. With me this morning are 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. David will begin with the review of the quarter and a summary of our plans to divest of certain operations and streamline our organization. He will also discuss our pricing and volume performance. Larry will review our operating costs and discuss our organization restructuring. Bob will review SG&A costs, other financial statement items, and our announced divestures. We will conclude with questions and answers. This call is being recorded and will be available 24-hours a day, beginning, approximately, 10:00 a.m. Eastern time today until 5:00 p.m. on August 11th. To hear a replay of the call, over the Internet, access the Waste Management Web site at www.WM.com. To hear a telephonic replay of the call dial 800-642-1687 and enter reservation code 7068485.

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, 2004, and in the Company's press release this morning. These risks and uncertainties could cause actual results to different materially from those described in the forward-looking statements. Additionally, during the course of the presentation, we will discuss free cash flow, margins on earnings, before interest and taxes, and margins on earnings before interest, taxes, depreciation and amortization, all of which are non-GAAP financial measures. We've defined and reconciled those items as part of the 8-K we filed today, which can be found on the Company's Web site www.WM.com. 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 28th, 2005, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited. Now, I'll turn the call over to Waste Management's CEO, David Steiner.

Thanks, Greg. Good morning to everybody on the call. I'll start by summarizing our quarterly results and our plan to improve performance by divesting of our underperforming and nonstrategic operations and streamlining our organization. I'll also review our pricing performance and other highlights and important points about the quarter. As you all saw in our press release this morning, there were a number of items relating to businesses, asset impairments and other unusual items. When we look at the quarter we back all of these items out and I'll do so in my remarks. When I do, I'll state that we're excluding AI-UI, or assets impairments and unusual item. We achieved a number of positive results during the quarter, that I'll detail for you in a moment.

First, though, I want to address our margin performance. Coming out of the the first quarter we expected we'd expand our margins on year-over-year basis. During April, we saw a year-over-year volume improvement in several critical areas of our business, particularly the highly seasonal roll-off and MSW line, consistent with our expectations for the year. As the second quarter progressed, we did not see these positive volume trends continue, as year-over-year volumes in those areas were flat to down. Even so, second quarter EBIT margins were flat year-over-year on a as reported basis. If you exclude the AI-UI in both years, our second quarter 2005 EBIT margins actually expanded by 10 business points-basis points, I'm sorry. . Certainly not where we want to be. But solid performance, given the cost-head wins that Larry will discuss. We fell short of our objective for higher year-over-year EBIDTA margins in the second quarter, due to much of the increase in our revenues occurring in low-margin business, and the weakness in roll-off, MSW and Special Waste volumes in May and June. However, we still would have shown slight EBIDTA margin improvement if you excluded the impact of higher fuel prices.

Also, I'd like to note despite these headwinds EBIT and EBIDTA margins at the 4 major U.S. solid waste groups combined expanded compared to last year after adjusting for AI-UI. While the 4 main groups had improved margin, the 3 other operating groups had lower year-over-year margins, negatively impacting the Company as a whole. Briefly, in Canada, we were ordered to divest of the Ridge Landfill, which had very good margins. We also had strike-related costs in the greater Toronto market area of about $3 million, and revenues from a low-margin transfer station construction project for the Region of Peel in Canada. At Wheelabrator it was primarily the timing of repair and maintenance costs of about $9 million. Recycling was impacted by more brokerage business, which is extremely low margin but requires little capital; by increased customer rebate levels due to more competition for the business; and by plant closure costs.

Before I review the second quarter in more detail, I want to expand on our plans to divest of under performing and nonstrategic businesses, which is consistent with the objective of improving margins and returns through the process of fixing or selling assets. So far, we've identified businesses with over $400 million in gross annual revenues. As we work through our analysis and other issues, we'd expect that amount to grow. Simply put, where we can't internalize volumes and we don't see a clear path to getting our margins and returns to acceptable levels, we will exit those operations. We also announced today our plan to streamline our organization. The move to simplify our management structure is natural progression in the maturation of our Company. You may have heard me say that the rubber meets the road in our business at the market area level. Through our system improvements and the appointment of Larry O'Donnell as our President and COO, we now have better visibility to our 56 market areas. We can now move beyond the stage of stabilizing the Company and rationalize our staff support.

I'll now review our second quarter results. Our total revenues grew by nearly 5%. And for the second straight quarter, our base business revenue growth from yield stood at 2.1%. If we were include the impact the fuel surcharge program, our internal revenue growth from yield would have been 3.1% during the second quarter. We saw continued pricing strength in our residential, commercial, and industrial lines of businesses. Yield for each of these lines of businesses improved by over 200 basis points for the second straight quarter. Importantly, new business pricing in our commercial line of business, one of the most important drivers of yield improvement, was up over 10% during the second quarter of this year. We raised average prices on our commercial customer base, by an average of 4.1%, and on our total collection customer-base by an average of 3.2%. Related to these price increases is the need to minimize any price roll-backs. The roll-back percentage on price increases stood at 11.4% for the quarter, which compares favorably to the 23.3% erosion result from the second quarter 2004.

Our 1% environmental cost recovery fee, which we began to implement in earnest at beginning of 2005, produced nearly $9 million in revenue during the second quarter. This compares to about $5 million in the first quarter, and is in line with our earlier projections. We also produced revenue growth due to yield improvements over 2% at our Wheelabrator operations and our transfer station. The revenue growth from yield on the municipal solid waste stream at our landfills was positive for the 7th straight quarter, and reached its highest level during that period of time. The yield on the construction and demolition material coming into our landfills was also positive during the second quarter. These improvements were partially offset by decline in yield for special waste, primarily due to highly competitive bidding for jobs. We continue to see very aggressive pricing on special waste jobs Nationwide and on MSW volumes in a number of states such as Virginia, Illinois, Michigan, Minnesota, and Wisconsin. We really haven't seen much evidence of our competitors broadly raising prices, especially in the MSW roll-off and commercial lines of business. To the extent we've seen them raise prices is only been in pockets.

We again saw that our disposable pricing study produced good results. The study now includes 24 individual landfills, 23 individual transfer stations, and disposal facilities in 4 market areas. To summarize the results of the study, we've raised prices generally on about 40 to 50% of the third party MSW and C&D volumes that these sites received from their existing customers. The average price increase on the tons were in the 6 to 9% range. We provide more detail in an 8-K that we released this morning. Based on these results, we expect to implement what we've learned at virtually all of our landfills and transfer stations by the end of this year.

Internal base revenue growth due to higher volumes increased by 120 basis points during the second quarter. The largest contributors to this were increased recycling brokerage volumes and pass-through revenues from the overall margins. Residential volumes fell in the East, due primarily to our disciplined pricing approach to bidding contracts. Clearly, our pricing program on the rebidding of residential contracts has helped us reduce lower margin business. Lower landfill volumes in the East, and lower collection volumes in the midwest are consistent with softening econo0mic data that we've seen in segments of those regions.

As I stated earlier, we saw positive volume trends during April that did not continue through the months of May and June. Through the first have of July our industrial hauls, commercial yards and special waste volumes are all down on year-over-year basis, which is obviously below our expectations. It is clear that our price increase program is more aggressive than those of our competitors, and we've lost volumes as a result. For example, our loss of volumes in the roll-off business, beginning in May, coincides with our previously announced 10% seasonal price increase in April. We certainly see a positive trade off between higher pricing and lower volumes. It is not uncommon for a price leader to see volumes decrease over the short term. But we believe that our current pricing program is the best long-term interest of our Company and our shareholders. To the extent that our loss of volumes is price related, we intend to stay the course on recovering our higher costs and improving our returns and margins.

With respect to our outlook the rest of the year, we have a lot of positive programs that are going to drive improved margins and financial performance. However, given recent volume trends and continued cost pressures we believe it's appropriate to expect us to perform at the lower end of the analysts current range with respect to EPS. Free cash flow, however, remains very strong at 314 million for the quarter and 734 million for the first half of the year. We still expect free cash flow to be between 1.1 and $1.2 billion for the year, excluding the severance costs related to our restructuring.

Overall, we're pleased with our second quarter results in a number of areas and very excited about what lies ahead. But our excitement is certainly tempered by the fact that hundreds of highly qualified people, our friends and our colleagues are leaving our business. These are people that helped us get this Company back on track and build this great organization. As we said, this is part of the natural maturation of our Company and we have to do what's best for the entire Company. But their hard work and their dedication to Waste Management will be long remembered and appreciated. And with that, I'd like to turn over the call to Larry O'Donnell, our President and Chief Operating Officer.

Thank you, David. Good morning to everyone on the call. I'm first going to detail our operating cost results for the for the quarter, and will then elaborate on our plans to streamline our organization. As David noted, we did see positive margin trends in many areas this quarter. That said, operating expenses in the second quarter of 2005 were $2 billion $173 million, or $133 million higher than in the 2004 quarter. As a percent of revenue, this is a 110 basis points increase in our operating cost margin from 65% of revenue to 66.1% of revenue. As I've done on previous calls, I will use basis points to detail the cost changes as a percentage of revenue, for each of the operating expense categories I'll be be discussing.

I'll begin my discussion by focusing on the impact that higher fuel costs and subcontractor costs had on our second quarter operating expenses. If costs had not increased in these two areas, we would have met the cost expectations for the quarter. I'll also discuss our plans to address these costs going forward. Direct fuel costs increased $32 million in the second quarter, compared to same quarter last year. Primarily due to diesel fuel prices being up by $0.54 per gallon compared to the second quarter of 2004. This resulted in about an 80 basis points increase in our operating costs. Subcontractor costs were up by about 30 basis points in the second quarter of this year, compared to the same quarter last year, with about $8 million or two thirds of the increase due to third party haulers passing through higher fuel costs in the form of billed surcharges or rate increases. The collective effect of higher fuel prices, either directly or indirectly from third-party haulers, caused 100 of 110 basis point increase in operating expenses this quarter.

To attack these costs, we have redesigned our fuel surcharge program as of July 1 to better capture the full effect that high fuel costs have on our business. We've received very few complaints from customers after including the new fuel surcharge on bills that went out after June 28th. Our previous fuel surcharge program recovered substantial portion of increased direct fuel costs. But over the last four consecutive quarters, we've noted that our indirect fuel costs, passed on to us from subcontractor haulers, had increased by over $25 million. Our new program is expected to close that gap. The new program is based on a more current fuel index that will eliminate the two-month lag between cost incurred and recovery that existed in the old fuel surcharge program.

Cost of goods sold increased by about 40 basis points during the second quarter of this year, compared to same quarter last year. There were two unique business transactions totaling over $9 million in cost of goods sold that accounted for about 30 basis points of the cost increase. Both projects involved pass through to the customer of actual costs we incurred. One project consists of our construction of a transfer station and recycling facility for the Region of Peel in Canada, which we will operate after construction is completed. The other project involves our purchase of engines and other related equipment that we, in turn, sold to a utility partner and two landfill gas to energy plants. I point these out, because as we said in the past, we are going to make good long term business decisions that may hurt margins in the short term. The remaining 10 basis point increase in costs of goods sold during the second quarter of this year, was due to the net effect of higher brokerage volumes, partially offset by lower commodity prices in our recycling operations. Collectively higher fuel costs and the increase in cost of good sold caused 140 basis points of the higher operating costs.

I'll now review the rest of the operating expense categories on which we collectively lowered operating costs by approximately 40 basis points. Our labor and benefits cost improved by about 20 basis points, quarter-over-quarter, due to productivity improvements in both the commercial and industrial segments of our business. Total maintenance and repair costs were essentially flat despite a 25 basis points increase at our Wheelabrator waste to energy segment due to the timing of outages for maintenance and repairs. A positive trend is that maintenance and repair costs in all other segments of our business fell collectively by about 20 basis points. This indicates that we're still improving in areas like fleet maintenance, which is the single, biggest component of our repair and maintenance spin. Maintenance cost per driver hour, which is the key measure of our collection fleet maintenance program, improved on a year-to-year basis. Another positive trend was that our total spend in dollars on collection fleet maintenance fell slightly during the second quarter of this year compared to same quarter last year. Our continued focus on safety resulted in lower risk management costs in the second quarter, when compared to 2004. For the second quarter of 2005, the combination of lower auto and general liability expenses and flat workers compensation costs resulted in about a 25 basis point decline in the risk management category. These savings are a direct result of the success we're having in creating a strong safety culture at Waste Management. Our total recordable incidents rate, which is a standard OSHA measure, improved over 13% from the same quarter last year, and is ahead of our 2005 plan year-to-date. In addition, the number of workers comp claims fallen by 21% this quarter, compared to same quarter of last year. We produced a number positive operating costs results in this year's second quarter, but we intend to continue to improve our operating performance.

More importantly, our re-organization plan that we announced today will make us a more efficient and competitive organization. We've simplified the management structure by reducing group and corporate staffing levels. This re-organization increases the responsibility and accountability of our market area general managers, streamlines business decisions, reduces costs and reflects the natural progression of our continued improvements in standardizing our business processes. During the past few years, as we stabilized our Company, the group and corporate staffs provided needed support. Now the Company has evolved. We've made great strides in the standardization and improvement of critical business processes to run our operations. We believe now is the time to streamline these functions and create a direct line of sight from top management to the market areas. Better enabling the market areas to concentrate on driving improvements and serving the customer.

As we've progressed, we've learned that a number of the support functions that have existed at the group and corporate level can now either be performed directly at the market area level or with a smaller and more expert staff at corporate level. The reduced corporate staff will have subject matter experts focused on supporting the market areas with improved tools, training and strategy development. These functional support staffs will not be constrained by group boundaries. But rather they'll be available to support all our market areas. Any new processes will be developed in conjunction with the field and the market areas will be fully responsible for their implementation. We're moving many of our strongest performers that had been at the group level back into the market areas where they can directly impact our day-to-day business. We not only accomplished one of David's and my top priorities of having the best people in the right places, but we also enabled them to be more nimble and operate more effectively.

We will maintain an important leadership organization led by our four group Senior Vice Presidents. These teams bring a great deal of industry and regional specific expertise to our organization. We've eliminated the Canadian group office, and the 4 Canadian market areas will now report to our other groups. This gives us a balanced span of control of 4 groups to support our 56 market areas. Our fifth group, consisting of recycling operations, has also been streamlined and more closely aligned with the hauling and collection operations to achieve greater operational efficiency. Our Wheelabrator waste energy operation remains our sixth operation group.

Due to streamline operating structure we will lower our cost structure. We expect to save about $70 million on annual bases as a result of these changes. More importantly, we expect to make better business decisions in all areas of performance as this new organization will be leaner, more nimble and overall better qualified to improve our operational performance. With that, I'll now turn the call over to Bob Simpson, our Chief Financial Officer.

Thank you, Larry. I'm going to begin with the review of the impact that tax settlements had on earnings. During the second quarter of this year, earnings increased $345 million due to the benefit from the settlement of federal income tax audits for the years 1997 through 2000. The increase in earnings was attributable to a reduction in income tax expense and there was no cash impact. Over the past year, we have settled over 10 years of open federal income tax audits through 2001.

Another one-time item impacting our income tax expense results from our decision to repatriate approximately $485 million of accumulated earnings and capital from Canadian subsidiaries. This is the being done in accordance with the American Jobs Creation Act of 2004, which allows companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate during 2005. Income tax expense increased $34 million in the second quarter of this year, as a result of this item. We currently have $115 million in Canada that we will repatriate immediately. We are reviewing our options regarding the best way to fund and repatriate the remaining balance of the $485 million, as well as the the optimal use of it within our current capital structure.

Our SG&A costs dropped $4 million to $313 million during the second quarter of 2005 versus the same quarter 2004. This $4 million year-over-year improvement was primarily due to a reduction in legal fees. SG&A costs, as a percent of revenue are 9.5%, a 60 basis points reduction year-over-year. This keeps us on track to achieve our expected full-year target of lowering SG&A costs to under 10% of revenue.

Depreciation and amortization was 10.5% of revenue in the second quarter of this year, compared with 11.1 in the prior year quarter. Interest expense $128 million in the second quarter, a $9 million increase from 2004. This increase is primarily the result of the higher interest rate environment in 2005 as well as a $5 million out of period correction of capitalized interest. Our effective tax rate for the second quarter of this year was a negative 71.3%, due, of course, to the effect of the tax audit settlements. Excluding the impact of these settlements, our full-year projection is 29.5%, which, as a result of the settlements, decreased from our previous full-year projection of 30.5%.

Total reported debt increased $45 million during the second quarter, compared with the end of march. Our debt to total capital ratio decreased to 57.6%, in line with our objective to be at or below 60%. We reduced the floating rate portion of our total debt portfolio to about 35% at the end of the quarter, compared with 38% at the end of the first quarter.

We, again, generated very strong cash flow during the quarter. Net cash from operations was $597 million, with capital expenditures of $310 million during the quarter. After considering $27 million in proceeds from divestitures, our free cash flow was $314 million. This is a 31.9% increase over last year's quarter. Cash interest payments are expected to be about $37 million lower; and cash tax payments are expected to be about $45 million, higher sequentially during the third quarter. We utilized our free cash flow to repurchase 188 million dollars in shares during the second quarter. $12 million of which was settled in July of this year. Combined with the $102 million spent on repurchases during the first quarter, our total for the year stands at $290 million. We still expect to spend between $600 and $700 million in share repurchases for the full year. Primarily as a result of this program, our diluted share count fell over 15 million shares compared to the end of the second quarter of 2004.

Let me close with some comments on the announcement of our plan to divest certain operations that represent over $400 million in revenue. These operations consist primarily of collection businesses and transfer stations and were selected as a result of our program of assessing our low margin or nonstrategic operations in determining whether to fix or divest of them. These decisions are based on a number of criteria, which include our strategic positioning within a marked, and our ability to increase the internalization of waste. A number of our financial characteristics are also reviewed including EBIT margins and return on capital. We continue to assess each of our operations under these criteria, and when nonstrategic operations are positioned to be divested they are added to the list. The announcement today again reflects our commitment to improving our financial performance and to aligning our actions with the interests of our shareholders. In summary, we are pleased with the results of the quarter and are excited about the potential of our new organizational structure. And with that, Angelic, lets open the lines for questions.

Thank you. [ Operator Instructions ] Your first question comes from the line of Lorraine Maikis of Merrill Lynch.

Thank you, good morning.

Morning.

You've spoken in the past about how you need the pricing increases to grow your margins. And then, this quarter, what we saw is pricing increase caused you to lose some more profitable waste then caused your margins to go down. I guess, can you just talk about the trade offs between these two metrics? How you look at it and what you expect to change going forward, or to maintain going forward to get these margins moving in the right direction?

Sure. Glad to. Well first off, I would say that the raising the prices and losing the volumes, for us, net-net had a positive effect. Remember what we said about the 4 solid waste groups actually showing EBIDTA and EBIT margin improvements year-over-year. So we think the trade off of higher price and lower volumes is working. Now, would we rather raise prices and not lose volumes? Absolutely. But when you're the price leader, you need to expect to lose some volumes in the initial stages of a pricing program. And so I don't think that that's unusual. Would we rather that it not happen? No doubt about it. But we are going to stay the course and we're not going to deviate from our program.

So then, you still plan to touch every landfill and by the end of the year with 6 plus % price increases?

Well, you know, the average price increase that we have in our landfill studies averages around 6 to 9%. It varies by market, by market. I can't tell you that the average would be 6%. But we certainly have every intention of raising landfill prices, particularly on MSW in each of our market areas by the end of the year.

Okay. Then just moving to the recycling business, I know that that acquisition was made in 2003 to try to improve the profitability of your recycling arm, I understand its a dilutive margin proposition, but could you maybe talk about the cash flow impact that you're seeing from that business?

Sure. We've often said, remember, how that business lines up. About 150 million of the $200 million in revenue is actual recycling processing. Fits right in with our recycling business and it took a step for us down the road of what we've been doing in the recycling business, which is consolidating facilities in order to increase through-put to increase margins. That other $50 million of the $200 million in revenue is brokerage business, which requires very little capital, but also has very thin margins. So from a cash flow perspective I'd say that its like we talked about with a lot of our long term decisions. We made the right decision. In the short term its going to affect our margins, but from a return on invested capital point of view its the right decision to make. .

Okay. Just finally, can you talk about your expectations for free cash flow in 2005 and if those have changed?

Yes. You know, as you can see, through the first two quarters of the year, free cash remains strong at over $700 million for the first six months of the year. Given that and given our outlook for the second half of the year, we still believe that we'll generate the 1.1 to $1.2 billion that we expected at the beginning of the year, and that we'll return it to the shareholders in the manner that we set forth at the beginning of the year.

Thank you.

Thank you.

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

Good morning.

Morning, Amanda.

First, on the volume losses that occurred, was it also at the landfill level or was it really primarily roll-off hauls? And where do you think those volumes have gone?

Yes. Obviously, the first thing that we have to address is the fact that in our last conference call we said we were going to see improved margins, or I guess what we -- technically what we said was that if we didn't see improved margins we weren't going to make our plan and we still expected to make our plan. So we said we expected to see improving margins in the second quarter. And remember what we said during the script about our April volumes? I think it is a fair question and I want to give you just a little bit of data, Amanda, to highlight what you're talking about as far as the volumes go. When you look at it in April, on the industrial haul side when we look at the April results, they were up 2.2% in April. But then when you go to May and remember that at the end of April we put in our 10% price increase. When you go to May you see the industrial volumes up 0.8% year-to-year. So you are still seeing some volume growth, but its flattening out a little bit. But then in June we actually saw year-to-year volume decreases. We saw the volumes down 0.6% in June. And then through July we see the volumes down 2.9% in our industrial hauls. On the MSW side, in April, when we gave our guidance for the second quarter, MSW volumes were up year-to-year 1.6%. In May they fell by 4.2%. Now, we didn't know at that time whether it was just late seasonality or whether we were seeing the effects of our price increase program, and we didn't see the financial results from that loss in volume until we closed the books in May. So we didn't see the financial results, really, until the mid-june time frame. Still, we aren't sure at that point in time if it's just a late seasonality or if our pricing program is having some effect. Then in June we saw MSW volumes down 2.5%, we see them down 2.9% through the first three weeks of July. It is very clear to us that when you listen to what other folks are out there talking about, as far as volumes go, and when we look at our own internal volumes, it's very clear to us that we're leading the pricing program and we are losing volumes as a result. You know I won't speculate as to where they're going, I'll leave that to others. But, it is clear we're that we're losing the volumes because we're out there leading the price increase program.

Were your third-party landfill volumes down in those test markets on the same kind of pattern?

If you look at the 8-K that gives you the volume changes. And you can see that in a couple of landfills we did lose the volume.

Okay. And, then, on the asset sales, is your inclination more to sell than to swap? And if you sell, what are you thinking of doing with the proceeds when you talk about reinvesting in what's not really a major growth business, would you look at debt pay downs for the proceeds? Or are you trying to find other businesses to grow?

Yeah. You know, when we talk reinvests the proceeds, we are talking about reinvesting the proceeds in buying private haulers like we have in the past, but we are also talking about using those proceeds to buy operations from the major competitors throughout the country, in which case we call them simultaneous buy-sell transactions, some people call them swaps. But, certainly, we would rather sell some of those operations to folks that we can then buy back accretive operations from. So when we talk about reinvesting proceeds, it's not just buying businesses from private companies throughout the country, but we do intend to talk with the major national and regional players to see their level of interest in these operations, and hopefully use some of the proceeds from selling it to them to buy operations back from them. So that would certainly be our first preference. Beyond that, we would then allocate that cash, consistent with our current cash flow allocation, capital allocation program, and we would also make sure that we maintain our investment grade rating.

In your new restructuring, how many layers are there now between Larry and the field? and do you think there's room for more headquarters or generally overhead cost cuts over time?

Amanda, this is Larry. Let me step back and go through the process we used in coming up with this restructuring. What we really did is pulled the Senior Vice Presidents from those groups together and we had a meeting with them; we also had the other Senior VPs here at the corporate office. And we said, look, we got 56 market areas, let's start from ground zero. What do we really need as a company to provide support to these 56 market areas? We've come a long way, we've standardized many of our business processes that we have out there. We've developed the tools. We've put in place IT systems. Now that we've done all of that, what do we now need to support these 56 business units? And we went by each function that we have here both in the group offices as well as at the corporate offices, and built each one of those support functions up from ground zero. And that's what -- where we were then left with the -- with how many people that then came out of our organization. When you look at it, the people that are leaving the organization, they come from a variety of locations, but primarily, group and corporate payroll. Although I would tell you most of those people were all involved one way or another in supporting our market areas. So it was really a way to go about looking at reducing the staff that we had on top of the market areas. The new structure we have now, instead of group offices with lots of people in those group offices reporting to those group Senior Vice Presidents, the 4 group Senior Vice Presidents now have two reports in their office. They also have the market area General Managers that report to them, but their support staff consists of a financial business partner and HR partner. That's it. The other support functions we've now built out of the corporate office and completely streamlined those support functions so that they, now, cover -- they aren't limited by, okay, if we are going to have one, we've got to have four or five of these, one in each group. We have a limited number of each one of these support functions in some cases teams, like a maintenance team, that is there and available to provide support to all 56 market areas. That's how we went about it. Does that explain? Did that--

That's very helpful, thank you.

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

I guess the frustration is we've got another cost-cutting program here that you've announced some head counts and this is one of many over the last several years. And like you to be in an underpromise/overdeliver kind of mode. When do we actually see the leverage of this stuff?

Well, Michael, when you say the leverage of this stuffer, I think you have -- stuff, I think you have to break it into its component units. Clearly you are seeing the effects of price increase program, both positively, through the increase in yields, and unfortunately a little more negatively than we anticipated through loss of volumes. When you talk about the cost programs, I think Larry can speak more to the particulars of those, but obviously that is an ongoing, everyday, today, tomorrow, next year, and years after that, you know, you're going to continue to see the benefits of those. So, I think you have to break it down to its component parts and obviously, those are the types of things we're working on everyday.

I -- the message about return on capital is, I think, absolutely, without question the right one. You know, there is three focuses.You can drive growth, cut costs and you can lower your capital tied up into low-return businesses and you've identified points of all of that. In your mind as you lay out milestones, where are you based on the beginning of your internally thinking about returns? And how fast will you make other adjustments to accelerate the pace of this return metric? Because, clearly, the market is not giving credit to the industry -- you're not the only ones doing it -- but the market is not giving credit to the industry for driving returns yet, even though, in fact, you shank your balance sheet. And your cash flow is pretty good.

Yes. And Michael, a lot of what we're doing depends on circumstances outside of our control -- the economy, how our competitors react to our price increase program, so we can control what we can control. And the one thing that quite frankly, we have been deficient in in the last couple of years, because you know we're working on day-to-day operational improvements, we've been a little bit deficient on making sure that we get out of those under performing assets that we have spread throughout North America. And at this point in time -- Larry talked about the restructuring, freeing up our market area General Managers to do what they're supposed to do, which is operational improvements and service to customer. ut it also frees up us at corporate staff. The last few years as we have spent time building tools and building processes. We're now freed up to do what we're supposed to do, which is go out and rationalize our operations. We will have people that will be dedicated to selling these operations. Does it take time? You're absolutely right. It's not going to happen overnight, but we've got to make sure that everyday we're in there plugging away and making improvements.

One last thing and I'll drop the issue. You made commitments last year about changing compensation to drive improvement returns.

Yes.

Do you think the employee base gets it?

On that question there's absolutely no doubt. And again, I'll go back to the re-organization of the line of sight. I've talked about it now for the last year and a half, which is -- you can't imagine how valuable it is to us to have a President and Chief Operating Officer. And obviously, having a President and Chief Operating Officer of someone of Larry's caliber adds into that. And what that does is that allows us to get that direct line of sight into those market areas. So, we spend a lot more time with those individual market area General Managers than we ever have in the past. So, there's no doubt that we get a better read for what they're thinking day-to-day, and they get a better read, more -- just as important -- on what we're thinking and the strategic direction we want them to head in. And I would say there's absolutely no doubt that when we talk to them they understand that.

You know, let me just give you an example of that, Michael. You know, I'm out in the field quite a bit and before we changed the compensation structure, almost everywhere I went, I heard requests for more capital, for a variety of things. And that always came up in any conversation I had. I will tell you since we've changed that compensation structure that people aren't talking it. They are not asking me for capital like that anymore. In fact, what you hear is people saying, "wow, you know, we've identified underperforming routes that we're going to get rid of and we're going to move these trucks over to a different market area". We never had that happening before. It has essentially changed the whole focus. People are really looking at where they have their capital invested, where they are getting the highest return on that capital, and if its not getting the return that they need to get to, they're figuring out where they need to deploy that capital in order to increase their returns. So I think absolutely it has had a positive impact.

Okay. Thank you.

Thanks, Michael.

Your next question comes from the line of Kevin Monroe of Thomas Weisel Partners.

Good morning.

Morning, Kevin.

I was wondering if you could quantify what percentage of your business doesn't meet your criteria? I know you have several criteria in terms of under performing or performing at adequate levels. You have identified this $400 million, but where are we in the stages of going through this?

Yes, its a little more complicated than just doing a financial analysis and, then, selling a business. You have to go in and look and see, are there buyers for the business? Are there contractual commitments that would allow us -- either would allow us or not allow us to sell the business? So there's a lot more analysis that we need to go through before we get to what the final number will be. So, you know, I hate to speculate as to what that number will be until we get through that analysis.

Okay. The next question would be n the $400 million that you've identified, is it fair to assume that if you divest all of that $400 million that would be a positive free cash flow event?

Obviously, the initial event, absolutely.

Other than just the proceeds? I mean, I would assume -- these operations burning cash?

Oh, well when we look at it, we look at it on a present value of future anticipated cash, and so we look at it based on what kind of capital we think we need to put into that business in order to sustain it. I will tell you we didn't look net-net -- maybe Bob's folks did, but we don't have the information here -- that net-net, the capital we invest would be more than the EBIT that we lose, or the EBIDTA that we lose.

Yeah, yeah, yeah.

I don't know we can truly answer that.

In a number of these operations in recent -- in the most recent quarters, we've cut back on capital spending just because they weren't able to meet our targets. We're putting the capital in markets and in business units that were generating better returns. So, Kevin, perhaps over the last three or four years that could be the case. I'm not sure that's the case today.

And, ultimately, to really summarize something I think David said earlier, I mean what we want to do is take the cash we get for this and redeploy it into something that will return -- will give us higher returns.

Right.

So, maybe not immediately, as you would see that, but pretty shortly there after that's our intention to employ it for a better return for the shareholders.

Thank you.

Thank you.

In your next question from the line of Leone Young of Citigroup.

Yes. Good morning.

Hi Leone.

Mathematically I'm having a little trouble reconciling your commentary on volumes with some of the trends we saw in the quarter. As I look at the press release, unless I'm reading it wrong, total disposal volumes were up 2.4% year-over-year. Which would be your more profitable volume. So I'm having trouble squaring that with the fact that you think the volumes increased on your overall 1.2% due to the lower volume recycling? And that you actually lost landfill volumes due to higher pricing?

Yeah. You know, when you look at the landfills you have to break it down again into its component parts, and what you have is MSW -- for the quarter, it was relatively flat. You had special waste down fairly dramatically, but really the increase that we saw on the disposal side came from C&D volumes. And so when we look at the numbers, obviously we'd rather get the growth in MSW, rather than C&D. And special waste, again, has been down consistently throughout the quarter.

Okay. Also in terms of your guidance, at the lower end now, I would assume that would include what you expect to save on the headcount reduction. But would you care to comment on what it incorporations and underlying volume trends?

Yes. It would exclude the charge, obviously, but it would include the benefits that we see coming forward.

And, you know, when you look at the volume trends, the interesting thing is that when you look at the volume trends in the second quarter, we, still, if we don't have fuel affect us, we still meet our expectations. So we're addressing that by putting a new fuel surcharge that's going to cover more of our added fuel costs. So we're pretty optimistic that the pricing program, the cost program, the fuel surcharge, are going to continue to bolster our bottom line. You know, what we do expect is that we won't see the same level of decrease in volumes that we saw in July. We don't expect to see roll-offs down 2.9% the rest of the year or MSW down 3% for the rest of the year.

I would also think, too, that some of what you're seeing is really geographically isolated? Because the other companies are really talking about strong volumes in the South, the Southeast, and the Southwest.

Well, I listen to the commentary and actually what I think they said they're stronger in the West and South and Southwest, but that they're strong across the entire country. And you know, that's consistent, frankly, with what we talked about, which is that we only see price increases in pockets. Some places we see it; most places we don't. And so that would be consistent with what we're seeing. Also, it is true that we believe that the industrial midwest and some of the states in the East are economically not recovering as fast as the states in the West and Southwest.

Okay. Thank you.

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

Hi, good morning.

Good morning.

My first question, David, relates to pricing. With this pricing, I think most of us assume obviously pricing can't work in every market, but hopefully it works in more markets than not. Or at least that's what I assume. And my question you is, in the areas that you lost volume, can you talk to the competitive dynamics of those markets? Were you, perhaps, too aggressive in markets where historically they're just very competitive and maybe don't even make sense to be in. In the first quarter we had great results, so we got a little aid -- ahead of ourselves?

No, I don't think so. Frankly, when it comes to pricing programs, we have quite a bit of experience in how pricing programs work. And at our Company when we first started our pricing program what we found was that if we talked about it at the Senior Management level that got us a certain level of pricing, about 0.5% of price. When you have a decentralized organization, what you find out is that some people are listening, most people aren't. So price increases occur in some places, they don't occur in others. So, what you have to do in order to get a truly sustained price increase program, is get down to the lower-levels of the organization and hold people accountable for the results. You know, until you -- until you walk in face-to-face with a Manager who is making his or her budget, but who is making his or her budget with negative 2% volume, or negative 2% price and positive 6% volume, until you go to that person and make sure that everyone understands that despite the fact they're making their numbers, they are making it in a manner that is going to, long term, hurt the Company because of increasing costs, until you go and make sure that folks understand that that's not good behavior, you just don't see sustained price increases. You know, that's what we've done. We've gone down to that lowest level and we've told people you are not succeeding if you're making your budget, but you're making you budget by lowering price in order to grab volume. That's not managing the business for the long-term, making your budget for the short-term. So you've got to have some discipline. You've got to have some determination. And until you do that, you're going to see exactly what we see, which is some places are going to listen, some places they aren't. And frankly, it is not -- it is not to do with economic conditions in a particular market area, its really to do with those individual managers and that's why you have to get down to those individual managers to make them understand what you're trying to accomplish.

Just to build a little -- just so I'm clear on what you just -- the answer you just gave to Leone in addressing the volume, so your expectation is that you'll lose volume for a little while, but then it should come back as others raise price after you? They will go after market share first, but then they will start to raise their prices? What's the expectation there?

You know, as we go about seeing cost increases in every one of our lines of business, we have to go out and get pricing to cover those increased costs, otherwise you are going to see what you've seen, which is margin deterioration. And those cost increases aren't particular to us, they are certainly throughout the industry. So we would expect that as others feel cost pressures, that ultimately they're going to have to go about raising their prices. I think that's a fair statement.

When you talk to the field people is there a sense out there that -- from your competition, whether it is the large nationals or it is some of the independents, do you think they're -- or do they think that the market in general is testing you to make -- to insure that you are committed to pricing in the longer term? Is there any sense of that?

Oh again, I will tell you that -- again, when we go back to the beginning of our pricing program, I can't tell you that every one of our market areas and General Managers acted rationally the way we would like them to act until we went down and trained them. Again, when we talk about price increases happening in pockets, there is really no overall pattern that we can see from our competition, national, regional and local, there really is no pattern that you can see that they are raising prices in some places and not others. It really depends on who that local market area General Manager is and that is hard to pattern. So when we go out and talk to our market areas folks, there are some markets -- certainly there are some markets where the economy is weak, and so they expect pricing to be a little harder to get. Places that we've talked about before, like Ohio and Michigan. But there are other places where what you're see is strong economies and our competition continuing to drop price. Places like Virginia, Minnesota, what you see is what we would look at as irrational behavior based on the market dynamics. So when we talk about price increases being in pockets, it's that kind of odd behavior, frankly, that we've got to look at and we've got to understand it. But we can't let it deviate us from our pricing program.

And then, sorry, one last question, quickly. On the -- you suggested that by the end of the year you would hope to raise prices at most of --at the -- the rest of your landfills. Should we assume thats evenly split between Q3 and Q4, or will it be more heavily weighted towards Q3 given seasonally its just a better time of year?

Yes. You know, as we talked about with the -- when we went through the pricing study, we're continually raising prices at landfills. We went about a disciplined approach through the landfill pricing study. But we continue to raise prices at our landfills. There's really no particular time table as to how we roll it out. So I think it would be fair to assume it would be rolled out fairly evenly throughout the third and fourth quarters.

Great. Thank you very much.

Thank you.

Your final question comes from Tom Ford of Lehman Brothers.

Good morning.

Morning, Tom.

Couple of questions. Number one, Larry, can you give me an exact example as to how the re-org makes you more nimble? I'm not really sure I understand exactly where the benefit comes from from moving bodies around.

Okay. Well, it isn't just moving bodies, it's also having some people -- and good people, I might add, -- leave our Company. What you had is as we built up staffs at the -- at the corporate and group levels, as we were building tools and creating -- first of all, determining what our best practices were, then designing programs, and then going out and implementing those programs throughout our market areas, you had several layers of people that were going through all of that. You had people at the corporate office that were at the highest level designing the programs. Then they would reach out into the group offices and work with those people to try to get them on board, and then the group people would go out and work with the market area people and there would be filters in what was going on, and eventually it would get out to the market areas. We worked through all that process, we got the business processes standardized in the areas that we were focused on. And now -- then what you had after you got them in, is lots of people still at each one of those levels, all requesting data, requesting information, and the poor folks at the market areas were getting bombarded by questions and requests for data and analysis from all over the place. And I'll just call it bureaucracy for lack of a better term. What makes us more efficient is we don't have all of those people anymore. What we are going to do is, people are going to have defined roles and responsibilities. Everybody knows that what their job is, what the focus is, and we're eliminating all of these other layers of boy I sure would like to have this analysis. What about this analysis? In a lot of cases market areas getting requests for analysis that they had just completed for somebody else. But they wanted it in a different manner. So that's what makes this more nimble and more efficient.

Okay. Dave, just curious from the volume numbers that you gave us, if I go back to these, the roll-off business was getting worse, right? Straight through?

Right.

But it seemed like the MSW was stabilizing in the last couple -- last two months. Did you guys make any changes or anything? In terms of what was done, that caused that MSW to -- its still down, but it is not down as much.

Yes. And Tom, I think the short answer to that is no. We didn't make any dramatic changes and obviously there is seasonality, there was -- we heard from a lot of our market areas that there was a late Spring and so the May volumes were probably affected by weather. Remember you had a lot of severe rain storms in the South and through the East in May. My guess is that the improvement from May to June and, then it is deteriorated slightly in July. So, you know, that's certainly not something that we can be overly optimistic about, but my guess is the more late-spring phenomenon than anything that we've done on that our competitors have done.

Okay. Does the performance as you progress through quarter, does that make you think -- I assume you guys are always rethinking it and you've got this re-org here. The re-org to me sounds like it's just stripping out layers of bureaucracy that were built in with the initiatives. What I'm curious about is, does the performance in the quarter, and you guys saying that you need to be more nimble, does this make you rethink the structure at all in terms of things, decision-making made at corporate, as opposed to decision making that, maybe, needs to be made much close to the customer?

Sure. You know, when we went through the re-organization that's exactly -- we had a two-day meeting with the entire senior leadership team and that's exactly the type of things that we started to discuss. We also have put some performance, what we call performance leadership teams against some of the issues that we talked about, that Larry talked about. And they're going to come back to us in the next 45 days with some suggestions on how we can streamline further. So, that -- that will absolutely be an ongoing process. It is the ultimate result from this restructuring that we with make better decisions. You know, I can't tell you that we have that structure in place today, because it will be a living and breathing organization. But I can tell you that coming out of the other side, we'll do just that. We will make better decisions, folks will understand the strategy better. You know, it all goes back -- when I talked about the pricing program, and the need to actually go down and face-to-face and meet with that local manager to make them understand what you're trying to accomplish as a Company, that just doesn't apply to pricing, that applies to everything we do. That applies to safety, that applies to maintenance, that applies to all of the things we are a trying to accomplish, and that's what this structure allows us to do. It allows us to get down there and have face-to-face conversations with those market area General Managers in our case. Have face-to-face conversations about how they can improve, to provide the mentoring and coaching that they need to improve, and, ultimately, to understand what they're doing in those market areas so that we can make sure we have the right people in the right place. So, that is absolutely where the restructuring will lead us.

Great. Okay. Some other questions here. Larry, you talked about the surcharge? I was just wondering -- I think if my math is right, your fuel surcharge in the second quarter was about a point of internal growth?

Right.

About right.

What would it be under the new methodology? Do you have an idea of what they would be?

We can do the roughly calculations because we have -- we have a amount that we believe the new fuel surcharge will contain.

Essentially it would pick up that part of the fuel costs that was in the subcontractor line.

So that would be -- that was, like, $8 million, right?

$8 million, correct.

Right.

Instead of 32 then, you would be looking at something more like 40?

That's the way I would look at it.

Okay. Great. Okay. Bob, you mentioned the fact that, and Dave, you did, too, about [Roick] changing people's focal points and what have you in decision making. I'm just wondering, it is not a huge number, but CapEx does seem like its running somewhat light relative to last year. Your volume performance is also light as you guys have talked about, why isn't the CapEx budget down?

Well, we're continuing -- we're not going to pull it back, but we are going to let the field operate through it, using our -- the mind set created by our new incentive programs. I have to tell you that in our conversations with the market areas, as Larry indicated they're take a much harder look at their capital needs as they go through the year, and we very well may end up below budget, Tom, when all is said and done.

Okay.

We're not going to mandate that from here, we are going to let them work through that themselves.

Remember, Tom, that the bulk of our capital is spent at the landfills, and we are absolutely not going to cut back on that, because we need those -- we need those ex-- cell build-outs to take in volume, and on the truck side you generally are buying trucks fairly well in advance. And so, there's only so many places that you can tweak CapEx. And also remember that when you got the new rules coming in on the diesel engines, that we do want to buy trucks. You know, I would look at it as not that we are going to reduce our capital spending, necessarily. I would look at it that we're going to probably -- well, we will certainly reallocate our capital spending to where we are a putting it into our more profitable markets.

Okay. And just one last question is, I don't know if -- I think this might -- you might have been asked this before. I don't know if you can -- kind of tough question. But, if you look at the divestures that you announced, which is great by the way, and just wondering, number one, was any of that reclassified to like discontinued or something in the quarter? And then secondly, can you give me an idea of the base that has been reviewed so far? That the -- that -- that that revenue would correlate to?

Tom, none of it is reclassified to discontinued ops at this point in time. We will, of course, take a good look at that in the third quarter as we work forward. But at this point none of it has been. When the 10-Q is filed later today or first thing in the morning you'll see that and will see that clearly. And, we have -- we continue to look at all of the underperforming -- all of our operations, Tom, so I can't tell you that there's some portion that we haven't looked at yet. We continue to look at all of it.

Okay. Thanks very much.

Thanks, Tom.

There are no further questions. Are there any closing remarks?

Yes. Thank you all for joining us this morning. Obviously, we'll be seeing many of you as we go out on the road the next few weeks and we look forward to spending time with you. Thank you for joining us.

Thank you for participating in today's Waste Management second quarter 2005 earnings release conference call. This call will be available for replay beginning at 12:00 PM Eastern standard time today through 11:59 PM Eastern standard time on August 11th, 2005. The conference id number for the replay is 7068485. Again, the conference id number for the replay is 7068485. The number to dial for the replay is 1-800-642-1687, or 706-645-9291. This concludes the conference. You may now disconnect.