美國廢棄物管理公司 (WM) 2005 Q3 法說會逐字稿

Good morning, my name is Janice and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Waste Management third quarter 2005 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press Star 1 on your telephone keypad. To withdraw your question, press the pound key. Now I would like to turn today's conference over to Mr. Greg Nikkel, Director of Investor Relations. Sir, you may begin your conference.

Thank you, Janice. Good morning, 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 start things off with a summary of the financial results for the quarter, and he will review the details of our revenue growth, including price and volume trends. Larry will discuss operating costs and the impact of the hurricanes on our operations. Bob will then cover the financial statements. We will conclude with questions and answers. This call is being recorded and will be available 24 hours a day beginning approximately 11:00 a.m. Central Time today, until 5:00 p.m. on November 10th. 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: 9843424.

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 statements-- 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, earnings per share growth after adjusting for certain one-time items, margins on earnings before interest and taxes after adjusting for certain one-time items, and margins on earnings before interest, taxes, depreciation and amortization after adjusting for certain one-time items, all of which are non-GAAP financial measures. We have defined and reconciled those items as part of the earnings press release and the relief 8-K filed today, which also can be found on the company's website at 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 October 27, 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 will turn the call over to Waste Management's CEO, David Steiner.

Thanks, Greg. Good morning from Houston! As we stated in the past, our goals at Waste Management are to increase earnings, margins, and cash flow on a consistent basis and to use our free cash flow for the benefit of our shareholders. In the third quarter we made good progress on all these fronts. We also talked about rationalizing our asset base, and we're moving forward on that effort. We expect to begin to close on some smaller transactions in the fourth quarter of this year with the bulk of our program being implemented over the next year.

As we noted in our press release this morning, there were a number of one-time items that we booked during the quarter. As I explain our performance for the quarter, you should note that I'll exclude the impact of those specific items. First, we'll discuss earnings. When we look at the quarter, without the one-time items, we show earnings of 45 cents per diluted share, a 12.5% increase above last year's third quarter. With respect to margins, we expect here at Waste Management to expand margins on a year-over-year basis. Based on the success of our Revenue Enhancement programs and our operational excellence initiatives, we achieved that goal in the third quarter.

EBIT margins expanded approximately 120 basis points to 15.3% in the third quarter 2005. On the same basis, year-over-year EBITDA margins increased by nearly 100 basis points to 25.6% in the third quarter of 2005. This margin expansion occurred even with the strong head winds from rapidly-escalating fuel prices during the third quarter of this year.

I'll discuss our cash flow and the return of cash to our shareholders, but first, I wanted to focus on our internal revenue growth on base business and the yield and the volume components of this growth. Total internal revenue growth for the quarter, excluding recycling commodity prices, fuel surcharges, and IPP electricity rate changes was 1.1% with 2.7% coming from positive yield and a negative 1.6% from volumes. Our base business revenue growth from yield of 2.7% was the primary reason for our improved margins in the quarter.

A robust pricing program offsets a certain level of decline in volume and we believe we had a good balance between pricing and volume this quarter. Revenue growth from yield was up in all collection lines and across all geographies. This yield performance is the highest level that we've reached in the period dating back to at least the beginning of 2000. Importantly, if we were to include the impact of our fuel surcharge program, our revenue growth from yield would have been 4.3% during the third quarter. This is an impressive performance by our field management and by a pricing excellence team that is by far the leader in our industry.

The primary driver behind the improved yield was the continued strength in our commercial and industrial lines of business. With the yield in the industrial line up 4.7% and the yield in the commercial line up 2.9%.

We previously noted a number of the pricing initiatives that continue to contribute to revenue growth from yield. These include: Higher new business pricing in our commercial and industrial lines of business; minimizing price roll-backs; and our 1% environmental cost recovery fee. We've also begun to implement a number of other revenue enhancement ideas, including container and activity fees, service activation and setup fees and late payment fees. Many of these types of fees are commonly utilized in other industries, and since they have service costs associated with them, it makes good sense for us to recover these costs from our customers. We expect to see positive results as we continue to roll these out across our business.

We're keeping in mind, however, that in this industry, the third quarter does have the highest volume of all quarters, and it remains to be seen how our volumes will be impacted in lower-demand quarters as a result of our pricing programs. We also expanded revenue from yield on the disposal side of our business. The revenue growth from yield on the municipal solid waste stream at our landfills was positive for the eighth straight quarter. And it reached its highest level in the span of the last eight quarters. The yield on the construction and demolition waste stream coming into our landfills was also positive during the quarter. These improvements were partially offset by a decline in yield for special waste, primarily due to continued competitive bidding for soil jobs.

As you know, we began a pricing study at a number of our landfills the beginning of this year. In the second quarter we expanded that study to include a number of transfer stations and essentially all the disposal facilities in four market areas. In the third quarter of this year, we did not see any significant loss of volume due to the price increases that we've implemented as part of the study. The success of these price increases is contributing to the yield improvements I noted for the MSW and C & D waste streams. During our last earnings conference call, I said we expected to implement what we learned from that study at virtually all of our landfills and transfer stations by the end of this year. Our pricing team is on schedule to do just that.

I'll now turn our attention to the volume component of our internal revenue growth, which, as I stated above, was negative 1.6% during the third quarter of this year. You'll remember that in last year's third quarter, we had significant hurricane cleanup volumes, which added $59 million in revenue to the revenue growth for that quarter. Absent the 2004 hurricane impact, our volumes actually grew about 25 basis points in the third quarter of this year.

During our second quarter 2005 conference call, we discussed the impact that our pricing program was having on our industrial and commercial volumes through the first three weeks of July. At the time, we stated that it was evident that we had lost some collection volumes as a result of our push to raise prices, and that continued in the third quarter. Internal revenue growth due to volume for our industrial, commercial, and residential lines of business was a combined negative .8% for the quarter.

We certainly believe that our price increase program is more aggressive than those of our competitors, and we lost some volumes as a result, particularly in places like the Midwest. But we continue to see a very positive tradeoff between higher pricing and lower volumes, an unmistakable sign of that is the 120 basis point EBIT margin improvements I noted earlier. With our lower volumes, we've also flexed down our variable costs to help us achieve margin improvement.

Residential volumes fell in the East and the Midwest due primarily to our disciplined pricing approach to municipal contracts. It's important to note that our pricing program on the rebidding of residential work has helped us to weed out lower-margin contracts. This reinforces our view that our current pricing program is in the best long-term interests 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 our margins. To round out the discussion of volume changes, higher disposal volumes for all waste streams entering our landfills led to revenue growth of 40 basis points in the third quarter.

Other volume contributors to higher revenues were an increase in recycling brokerage business and pass-through revenues from the transfer station construction project in Canada that we mentioned in the second quarter, both of which are very low-margin business and therefore dampened our otherwise positive margins. Another goal that we have at Waste Management is to produce substantial free cash flow that we can return to shareholders, and we delivered on that front in the third quarter.

Free cash flow was $385 million for the quarter, and reached $1.12 billion for the first nine months of the year. We also took a number of steps to return that cash to our shareholders this quarter; first, we repurchased $295 million in shares during the third quarter and made $111 million dividend payment; next, you may have noted we announced an increase in our 2006 dividend program by 10% to 88 cents per share per year. That keeps us in the top cortile of the dividend-paying companies in the S&P 500.

Finally, we were able to settle our on-going litigation costs relating to certain former officers of the old Waste Management in connection with their settlement with the SEC. Our portion of the total settlement fund for the case was $26.8 million, but we insisted that before we would participate, we had to be assured that the funds would go to our shareholders. Through the great work of our legal team, we did just that, and a total of $27.5 million will be distributed to our shareholders. It's a result that's good for our shareholders and good for the Company going forward, and it's a tribute to our great legal team, the court, and the SEC that we are able to achieve such a positive result.

So, overall, the margin expansion we saw in the quarter was gratifying, and it shows that our focus on revenue enhancement through improved yield and the continuation of our cost controls are producing improved earnings margin and cash flow results. Larry is now going to review for you our operating cost results and also provide an update on our operations in the hurricane-impacted areas.

Thank you, David, and good morning. I'm first going to discuss our operating costs results for the quarter, and we'll then give you an update on our operations in the areas impacted by hurricanes Katrina, Rita, and Wilma.

As David stated, we saw positive EBIT and EBITDA margin trends this quarter. Our operating costs performance was a key contributor to that improvement. Operating expenses in the third quarter of 2005 were $2.202 billion or $51 million higher than in the 2004 quarter. As a percent of revenue, this is a 50 basis point improvement in our operating cost results from 65.7% of revenue to 65.2% of revenue, which is reflective of our on-going efforts to control our operating expenses.

I'm pleased to see that we are making progress with our operational excellence program in spite of the significant increases we have seen in prices for fuel and lubricants. As I've done on previous calls, I'll use basis points to detail the cost changes as a percentage of revenue for each of the operating expense categories I'll be discussing.

Effectively, there were three cost categories that caused the 50 basis point improvement in operating expenses. Lower subcontractor costs caused about a 100 basis point reduction in operating expenses. Higher direct fuel costs resulted in about a 110 basis point increase in operating expenses. And lower transfer and disposal costs caused about a 50 basis point reduction in operating expenses.

Netting these three cost categories together explains 40 of the 50 basis points of improvement in operating expenses. The remaining 10 basis point improvement came from the aggregate effect of all other cost categories.

I'll now review in detail the changes in un-- subcontractor costs, fuel costs, and transfer and disposal costs. Subcontractor costs fell by about $26 million in the third quarter of this year compared to the same quarter last year. You will recall that as a result of the four hurricanes that struck Florida in the third quarter of 2004, we subcontracted approximately $46 million of of the work to third-party hauling companies. This work did not repeat in the third quarter of 2005, causing the decline in subcontractor costs.

Excluding subcontractor costs associated with the hurricanes last year, subcontractor costs increased by $20 million in the third quarter of this year compared to last year. About $15 million of this $20 million increase is due to higher indirect diesel fuel prices that subcontractors pass through to us this year. Direct fuel costs increased $40 million in the third quarter of 2005 compared to the same quarter last year, primarily due to diesel fuel prices rising about 75 cents per gallon. This resulted in a 110 basis point increase in our operating costs.

As we noted in our second quarter earnings conference call, we redesigned our fuel surcharge effective at the beginning of the third quarter in order to recover the increase in direct and indirect fuel prices. Our re-designed fuel surcharge did just that, producing about $50 million in revenue in the third quarter and covering almost all the increase in higher direct and indirect fuel costs.

The other significant change in operating costs was a 50 basis point reduction in the transfer and disposal costs that our collection companies pay to third-party landfills and transfer stations. This reduction correlates to the decline in collection volume and our exit from low-margin collection contracts in accounts where we typically don't internalize the volume. This also contributed to the increase in our internalization rate from 64.8% during the third quarter of 2004 to 66.3% in the third quarter of this year.

As I noted at the outset of my remarks, the net impact of all other cost categories was a 10 basis point reduction in operating expenses. These cost categories include labor and benefits, repair and maintenance, risk management, and landfill operating costs. In light of the inflationary pressures that exist in these areas, the collective 10 basis point cost improvement shows that our operational excellence program and productivity, maintenance, and safety are continuing to generate positive results. For instance, we continued our improvement in safety in the third quarter, with a 24% improvement in our OSHA injury rate and almost a 30% improvement in our Fleet accident rate.

Before I review the status of our operations in the hurricane-impacted areas, I want to update you on the benefits we are seeing from the organization restructuring we announced last quarter. Bob Simpson will update you on the cost savings we achieved during the third quarter, but I want to let you know that we are receiving positive feedback from our market areas about how they are operating more efficiently under the new structure. As a result of the progress we've made in standardizing our business processes, we were able to simplify our management structure. We essentially eliminated a layer from our functional support staff and created a direct line of sites from top management to our market areas.

Many of our support functions that existed at both the corporate and group levels to be performed directly at the market area level or with a smaller and more expert staff at the corporate level, our market area managers have told me that the change has been very positive has streamlined the decision process, and has better enabled them to focus on driving improvements and serving the customer. We continue to expect that the heightened responsibility and accountability of our market area general managers will lead to better business decisions and improved financial performance.

I also want to point out that we recently announced a better alignment of our recycling business with our hauling operations. To help accomplish this, we purchased the interest of our minority partners in recycle America alliance and changed its name to WM Recycle America. This will enable our hauling companies and our recycling operations to work together more closely to reduce costs, share resources, and better serve our customers. We remain committed to the recycling business and improving its profitability.

In today's press release, we noted the impact that hurricanes Katrina and Rita had on our third quarter results. I want to update you on our operational status in the areas impacted by these storms and our initial assessment of the impact of hurricane Wilma in Florida.

Just prior to the landfall of Katrina and Rita, we took steps to move much of our equipment to higher ground, such as to our landfills. This helped us avoid significant losses to our fleet. The first order of business in the immediate aftermath of the storms was the personal safety of our employees. We made efforts to contact each of our employees to determine what we could do to help them with financial, housing, and medical assistance.

Following that, we turned our attention to moving additional people and assets into the disaster areas to respond to the citizens and businesses that make up the communities we serve. Our efforts have enabled us to fully restore our Gulf Coast operations with the exception of the hardest-hit New Orleans area. We have mobilized several hundred additional employees, about 50 more trucks, and nearly 2,000 rolloff containers from other market areas around the country in order to respond to the disaster relief efforts.

We established an employee disaster relief fund to assist our employees who suffered personal losses from the storms. In New Orleans, many of our employees lost or have not been able to return to their homes. Hotels and housing are simply not available, so we built a camp to house and feed the hundreds of Waste Management employees we have working in the New Orleans area.

Our third quarter earnings reflected both the additional costs associated with these efforts as well as the lost revenues from the disruption of service immediately before and after the storms. As we look ahead to the fourth quarter of this year, it is important to distinguish between the New Orleans area and the other areas in Texas, Louisiana, and Mississippi impacted by these storms. Outside of New Orleans, our disaster response efforts have been very typical of what we've experienced in prior storms. We have moved in additional rolloff assets and people from all parts of the country and expect to see higher rolloff and disposal volumes in these areas. However, we expect the loss of revenues and increased costs of our response efforts in the New Orleans area to have a negative impact in the fourth quarter similar to what we saw in the third quarter.

While things are constantly changing along the Gulf Coast with the disaster relief efforts, including the arrival of new hurricanes, we currently estimate a negative earnings impact of about one penny per share in the fourth quarter from hurricanes Katrina and Rita.

Turning to the latest storm, hurricane Wilma, we are just now receiving the initial assessments from our Florida operations following its landfall earlier this week. We did incur some wind damage to our facilities, and some are still without power or phones but are running on generators. All of our collection operations are back up and running.

We have two [wheel abrator] facilities in Broward County. One continued to operate through the storm and the other was knocked off the grid when the power went down. Power to that facility was restored last night, and we are in the process of checking that facility out today and hope to be able to bring that facility back on-line later today or tomorrow.

As we've seen with prior storms, there can be an initial negative impact to financial results in the post-storm recovery and startup. Given that Wilma just occurred this week, it's simply too early for us to specifically know what that impact will be. Although the storms have had an initial negative impact on our financial results, I'm again very proud of how our company and our employees across the country have responded in this time of need.

Many of our employees across the country have volunteered to leave the comfort of their homes and families to help. We are certainly well-positioned to participate in the disaster relief efforts along the entire Gulf Coast. With that, I'll turn the call over to Bob Simpson, our Chief Financial Officer.

Thank you, Larry. I'm going to begin with the review of our third quarter 2005 SG&A costs. Our SG&A costs decreased $7 million to $309 million during the third quarter of 2005 compared with the third quarter of 2004. This improvement was primarily due to savings from our restructuring and a reduction in the legal fees. Combined, these savings more than offset the impact of normal annual salary and other cost increases.

Total SG&A costs as a percent of revenue are 9.2%, a 50 basis point reduction year-over-year. At 9.8% for the 9-month period, we are on track to achieve our expected full-year target of lowering SG&A costs to under 10% of revenue.

The restructuring generated about $14 million in SG&A savings during the third quarter. On an annualized basis, we still expect to save about $70 million from the restructuring with about 80% of that lowering SG&A costs and the remainder decreasing operating expenses. Depreciation and amortization was 10.9% of revenue in the third quarter of this year compared with 10.5% in the prior-year quarter.

I want to provide you some background on the accounting adjustments to amortization expense that we disclosed in our press release this morning. This was the primary reason for the year-over-year increase in depreciation and amortization. As many companies have done this year, we reviewed the agreements covering our leased assets, including all of our landfills that are under lease or operating contract.

We identified five landfills in which the lease periods or contract lives were shorter than the permitted or expected lives, but where the amortization periods were based on the longer permitted, or expected landfill life. Because of the amortization should be booked on the shorter of the lease period or the expected life, we recorded a non-cash charge of $22 million before tax as a accumulative catchup adjustment for these five sites. We do not expect this will have any future material impact on the Company's financial results.

Moving down the income statement, the $27 million restructuring charge is due to the reorganization we announced in July. Asset impairments and unusual items totalled $86 million for the third quarter. The two largest items impacting this were previously disclosed in separate forms 8-K filed during the third quarter. They are the $27 million Legacy litigation settlement charge and the $59 million impairment of revenue management software applications previously under development.

Interest expense was $125 million in the third quarter, a $13 million increase from 2004. This increase is the result of the higher interest rate environment in 2005. We have seen LIBOR rates increase by about 200 basis points year-over-year and the rates continue to increase. Total reported debt decreased by $89 million during the quarter to $8.342 billion.

The floating rate portion of our total debt portfolio was 36% at end of the quarter and our debt-to-total capital ratio was 57.7%, in line with our objective to be at or below 60%. Most of our floating rate debt will vary based on 90-day LIBOR rate and a 10% basis point change in these rates has an approximate $3 million impact on an annualized basis.

Interest income decreased $13 million to $8 million during the quarter of-- the third quarter of 2005. Interest income in the third quarter of 2004 included a $15 million of interest received on the tax audit settlement refund during that period. You will note that we recognized $43 million of one-time benefits as a reduction in our income tax expense primarily from the resolution of federal and state tax audits.

In addition, we realized a $13 million benefit from reducing our estimated effective tax rate for 2005 from 29.5% to 27.75%. This revision to our effective tax rate is the result of the third quarter charges we outlined in our press release. Our effective tax rate for the third quarter of this year was 5.1% due to these tax items.

Before I move onto our cash flow results, I want to update you on the potential impact of crude oil prices on our Section 29 tax credits. If the average price of oil exceeds the targeted threshold levels for the entire year, the Section 29 tax credits begin to phase out. The average price of oil did not exceed those thresholds during the first, second, and third quarters of this year. We estimate that our Section 29 credits will not begun to phase out unless oil prices average $67 a barrel for the fourth quarter of 2005. During 2005, we expect to receive about 11 cents per share in benefits related to our Section 29 tax credits.

Keep in mind that as we look ahead to 2006, the last published phase-out range that the IRS released is for 2004. Based on an inflation assumption of 3%, we project that the phaseout range in 2006 will begin at about $55 per barrel and will be fully phased out at about $68 per barrel. So, for example, if the average price was the mid-point of the assumed range, we would expect our earnings to be reduced by about 5.5 cents.

We again generated very strong cash flow during the quarter. Net cash from operations was $623 million with capital expenditures of $272 million during the quarter. Adding in the $34 million in net proceeds from divestitures and other assets sales, our free cash flow was $385 million, bringing the 9-month total to $1,120,000,000. For the fourth quarter of this year, we project our cash tax payments to be $100 million and our cash interest payments to be $165 million.

Our capital spending is typically at its highest levels during the fourth quarter of the year and projects to be approximately $500 million in this year's fourth quarter. We utilized our free cash flow to repurchase $295 million in shares during the third quarter. Combined with the $278 million spent on repurchases during the first half of the year, our total for the year stands at $573 million or about 20 million shares.

By the end of October, we expect our repurchases to total nearly $650 million for the first 10 months of the year. For the full year, we expect to repurchase near the upper end or to slightly exceed the previously-announced range of $600 to $700 million of shares repurchased.

In closing, we were pleased with our financial results showing progress in pricing, cost controls, margin improvements and cash flow generation. Even with the slower fourth and first quarters coming up, we intend to keep our focus on continuing progress in these areas. And with that, Janice, lets open up the line for questions.

Good morning.

Good morning.

So, you were very clear when Larry ran through what's happening on the cost side, but when you look at it from 50,000 feet, at the overall margin that you got in the expansion year-over-year, how much with you say was cost-cutting versus price actually starting to hit all the way down to your bottom line on an operating basis?

Well, you know, I think it's safe to say, Amanda, that from our point of view, we need to have both in order to continue to get margin expansion. I don't know that we've broken it out to say how much is price and how much is cost control, but suffice it to say that we've got to stay focused on both of those if we're going to continue to show margin improvement.

Okay. And then on the landfill pricing, you said that it looks like you're not really losing volumes with the price hikes up? Looks like your landfill volumes were up a little bit shy of 2%. So what kind of average price hikes have you had? And are you basically saying that now you're rolling it out to the whole company?

Yeah, sure. They've been similar to what we've talked about in the past quarters, you know that, 6 to 9% level, and we are rolling it out across all of our landfills. You know, what's going to be interesting to see, Amanda, is that you know that where we're rolling it out is on the gate rate and on the contracts as they roll over, and so the success of the landfill pricing program's a little bit more difficult to gauge than on the collections side because you really won't know if this industry is serious about landfill pricing until those three to five-year contracts on volume start coming up for renewal. And what we've seen is that the gate rates that are charged by our competitors haven't caused us to lose volume, but in situations where they've got current volume, they're very aggressive on pricing, and so you know, I think it's way too early to declare victory on the landfill pricing front.

Okay. And with all this nice cash flow you're generating and interest rates going up so much, are you going to be in a position, are you thinking about maybe repaying more debt for a while?

You know, we constantly look at the tradeoff between all the things that we can do with our capital, whether it's paying a dividend or buying back shares or paying down debt. We don't have any current plans to pay back debt other than possibly some of the debt associated so that we continue to maintain normalized net debt levels. We could pay back some debt in connection with the Canadian repaiteration of proceeds.

One thing you will see-- Amanda, this is Bob-- one thing you'll see at end of the year is our debt levels go up as we borrow in Canada to fund the dividend, the remaining dividend program we announced with respect to our Canadian operations. We announced that in the second quarter, but you'll also see in the-- toward the end of next year, we have some maturities coming due, and I think that's where you'll see any action in that area.

Okay, thank you very much.

Sure.

Your next question comes from the line of Tom Ford of Lehman Brothers.

Good morning.

Good morning Tom.

Just a couple questions here. Just starting with you, Bob did you say CapEx $500 million in 4Q?

Yeah, we think that's our current projection, Tom.

So that's about $100 million up year-over-year?

Yeah, about 80, I think.

Okay. Is there anything unusual in there, like I know that in the past you've done real estate purchases, things along those lines?

Well, there may be a little bit of that in there, Tom, but I think a lot of it is just due to some of the weather issues we've had in the East and in the Midwest, some construction just happened later in the year than we would have normally seen.

Okay. Okay, great, thanks, Bob. One question I had, Larry, it's interesting looking at your cost categories, the notable drivers. I think the one that really-- and I could be wrong, so correct me if I am-- the transfer disposal costs I think was really notably different from prior, and I'm just wondering about, do you guys have an idea about the revenue or something to give us an idea, you know, what changed company-wide to really drive that reduction?

Well, some of it I think is looking at, as we've talked about, looking at some of the municipal contracts and other areas where we're doing business where we don't internalize, and you know, we really have had an effort of where those things, where there not you know, as profitable as we would want them to be, either improving them or getting out of them, and as we've done that, what you've seen is we've actually gotten rid of some of those businesses, and then as a result, it has also had an impact of increasing our internalization rate.

Right. But you don't have an idea of like how much revenue, for instance, you've walked away from? I'm just trying to get a sense as to the underlying-- you know, I'm trying to connect some dots in terms of the underlying numbers that have resulted in this.

I don't have the total, but I can tell you there are, you know, we look at these as we bid these contracts, as they come up for renewal, and a lot of them are some residential contracts that we've looked at and we've put in a number that you know, we feel like if we can't turn them around, we're willing to walk away from them, and we've walked away from a number of those.

And Tom, the residential line of business had a $10 million reduction in volume in the quarter.

$10 million volume?

$10 million in volume in the residential line.

Okay. So then, because then that kind of' brings up my next question, Dave, which is, you know, you referenced the adjustment down in the volume growth, and I think sequentially it was down around a percent or so. I'm just curious about, you know, how you guys think about that in terms of-- because I know you've said you're comfortable that that mix of price and volume, you're comfortable with the way it is today, or at least what was reported for the third quarter. I'm just trying to understand: No. 1, how do you frame it internally; and then No. 2, you had given us some data points in the second quarter call about trends that were occurring in Q2. I'm just wondering about those data points and how they trended in the third quarter?

Sure. Yeah, please don't, don't misinterpret our comments to say that we were comfortable with the mix we saw in the second quarter, because obviously, we would much prefer that this industry follow us along in recovering our increases costs by raising prices such that we don't lose volume, so you know, we were, we were comfortable with that number, but we certainly believe that it could be better as our industry learns how to effectively price. But you know, the way we frame it internally, Tom, is really very simple, and I'm going to give you just an example because it's the area that we talk about the most, would be in the Midwest. And in the Midwest, the collection volume was down 3.9%, the price was up 3.5%. In the commercial line, it alone, the volume was down 2.7%, down 3.3% in the industrial line, but the pricing was up 2.5% in commercial and 4.6 in industrial.

Now, what's the net effect? The way we frame that internally is that we ask our folks to look at the net effect to what happened to their business, and what you saw in the Midwest is that the gross operating profit on the commercial line went up by 210 basis points and the gross operating profit in the industrial line went up by 330 basis points. And so, the way we framed it internally is that if you look at the tradeoff between price and volume, you'll see a dramatic benefit by continuing to raise price even if you lose volume, because it's not a one-for-one tradeoff. You can raise price 1% and suffer more than a 1% volume loss and still come out ahead of the game.

Right.

And what our folks are beginning to realize, you know, to put it simply, Tom, quite honestly, is that they can make more money by doing less work! If they can shed that unprofitable business, like what Larry was talking about on the residential line, and shed the unprofitable business on the industrial and the commercial customers, which you know, which as you can see, our competitors have taken as we've lost share. If we can continue to do that and continue to make more money doing it, that's what we've got to do. As volumes decline. (talking simultaneously).

That's great. I Appreciate it. One last question, Dave. You alluded to it, asset sales. You say that there will be some small transactions in the fourth quarter, but that it will pick up more so in 2006?

Yeah.

No. 1, do you know what the order of magnitude is in Q4? And No. 2, do you want to give us a hint as to the order of magnitude in 2006?

Well, you know, Tom, this is Bob and let me address that. I don't think we want to foreshadow that, because it's all negotiations, and sometimes they close at the end of the year, and sometimes they close right after the end of the year. So, we just don't want to be-- give you a projection that could be wrong only by a couple of days. But we expect-- the way that the [vesticher] program is working, we kind of' put the $400 million in revenue that we've already identified and we'll be adding to that, by the way, as the quarter goes on, and we've put them into two different processes. There are some that we've already identified potential buyers or buy/sell partners, which would be including our two major competitors, and those discussions are going on as we speak, and we may-- and those are the ones that are more likely to be able to close in the fourth quarter or early in the first quarter of next year.

With respect to the rest of it, we're putting it through a bid process, including a virtual data room. You may have seen an ad we put in the Waste News and the Wall Street Journal, signaling that this particular process-- in this process, the process is where you'll see a lot of our next [tronch] going in and again, that process will probably continue up to mid-next year. And so it will take a while to get through all of those.

And again, just to reiterate what we've said before, our preference is to swap or do buy/sell transactions than to just get cash. Our preference is to take the cash and buy businesses, operations that would be accretive to our current operations and as opposed to just take the cash and put it into our capital allocation plan, but that is what would happen with whatever we don't use to purchase other businesses. Long-winded answer, Tom, might have answered some other questions you might have.

That was helpful Bob. One thing real quick. Can you break the 400 down between the two [tronchs]?

We just don't want to do that Tom, at this point.

Okay, thanks.

Your next question comes from the line of Leone Young of Citigroup.

Hey, good morning. Thank you.

Good morning.

As we look into the fourth quarter, and again, I realize it's hard to be precise, but maybe some general help in terms of you know, last year in the fourth quarter you obviously had a hurricane impact as well. So as we think about volume, gross margin trends as we go into the fourth quarter, vis-a-vis what you experienced in the third quarter, maybe you could give us a general overall guidance?

Yeah, and you know, Leone, the fourth quarter, as you know, really begins the seasonality for us and the lower volumes that will start in November and December. You know, October is generally a very high-volume month followed by volume starting to tail off in November and December. And those volumes, we saw it two weeks ago when you had those huge rain events in the East. We saw how much the weather can impact volumes in the fourth quarter, and so a lot of it is driven by what's going to happen with the weather, but my bigger concern, quite honestly, for the fourth quarter, is that we haven't been through a full cycle with our price increase program. You know, this is really the first year that we've had three quarters in a row where we've been over 2% price.

And as the seasonality starts to kick in in the fourth quarter and the first quarter of next year and as that frees up capacity in our industry, how is this industry going to react? You know, traditionally this is an industry that, as soon as capacity frees up, it chases volume and uses price to do that, and I think that's the big question in the fourth quarter: How's this industry going to react as volumes start to come down at a time when we're pushing the pricing program? I can tell you that we have absolutely no intention of backing down on our pricing program as the volumes tail off to seasonality. So you know, that's what we see in the fourth quarter.

So far in October, the volumes have continued on the collection line to follow sort of the third quarter pattern. They're down year-to-year. Disposal volumes have been slightly up, and so you know, we're encouraged that we can keep the momentum going on increasing our margins year-over-year if we can get the industry to not react to the downturn in volumes.

But related to that, which was actually going to be my second question, is you know, due to the hurricanes, obviously you take the negative up front and then theoretically you get some positive in terms of both rolloff container usage, and disposal volumes, both of which are, as you said, vulnerable to seasonality. Do you actually-- I guess what I'm saying is do you expect that to be some offset? And particularly in the rolloff container market, are Katrina and Rita enough to tighten up that market.

Yeah, you know, they certainly will, and it's interesting. As we went through our reviews throughout the country, we heard a lot of our market areas and far off places saying that other folks, you know, small, local competitors, are sending cans down there because they're going down there to pick up volume. So it has dominoed throughout the country. So there's no doubt that will have some effect. From our point of view, it will have-- we will get more volumes out of those areas, but unlike any hurricane that has ever happened, we've never had to house, as Larry was talking about, we've never had to house a couple hundred employees so that they could go to work in the morning, so our cost structure has obviously changed in that area for the fourth quarter.

Great, thank you.

Sure.

Your next question comes from the line of Bill Fisher of Raymond James.

Good morning.

Good morning!

Just following up on Larry, when you were talking about the operating costs. It looks like if you take out the fuel and last year's, the hurricane subcontractor costs, your overall operating costs were up just only 2% or so, and you know, after being up about 5 or so in Q2, is that-- if you look forward and look at the taking out lower-margin business and the productivity and what not, is that type of a number growth-wise, you could carry forward into '06?

Well, right now we're in the process of working on our budgets for '06, but what I can tell you is we continue to be focused on improving our productivity. I think there's still plenty of room for us to do a better job. While we have seen productivity improvements, I think there's still lots of room to continue to improve from there. You'll look at our maintenance program. We continue to show improvement year-over-year in our maintenance costs per hour, and yet, I still know that we can do better as I look across, as we make our rounds around our market areas.

Some of them have done an unbelievable job and there's still lots of opportunity at others. You know, what I'm really pleased to see is even with the substantial increase we've seen in fuel, you know, significant increases in lubricants, parts, as steel prices went up, we've been able to continue to show improvement in our operating cost structure. And it's really going to be key as we go into these seasonal months, we've got to make sure we continue to flex down our labor costs. Year-over-year, we actually showed improvement in salary and wages, and that's a big indicator of how well we're flexing down our cost. So we'll continue to stay focused on those things. And as we build our budgets for '06, you know, we're going to plan on continuing to make improvements in each of those areas that we're focused on. I know that doesn't give you a specific number, but certainly I expect to continue to show improvement year-over-year.

Great, thanks. That helps a lot. .

Your next question comes from the line of Jamie Cook of CSFB.

Hi, good morning.

Good morning.

My first question, Dave, how many landfills did you raise prices at as of the end of the third quarter?

Well, you know, my guess is-- and quite honestly, this is only a guess-- that we raised prices at virtually all of our landfills by the end of the third quarter, because you know, when we talk about our landfills pricing study, some folks think that our price increase program at landfill is limited to that study, and it certainly isn't. We're raising prices everywhere we can to make sure we get the return on capital that we expect from the huge investment we have in those landfills. So I can't give you a specific number, but certainly the IRG information that we look at would lead us to believe that we're doing a pretty good job of raising prices across the board.

And then my next question, you spoke a little bit about during your prepared comments about the incremental ways you're trying to get revenues in terms of container fees, late payments, things like that. I guess, how many markets did you test in the fourth quarter and how should we see that progress going forward?

Yeah, that's a really good question, and I'm glad you brought it up, because it is the part of the pricing excellence program that we're pretty excited about going forward. We went in and did pilots in four market areas to understand the elasticity effect of the various fees and surcharges that we need to charge to recover for our increased costs. So you know, container delivery fees and things like that, where we incur a cost to deliver the container and we're not recovering that cost. So we went in and studied a number of fee and pricing structures in those four market areas, and we learned that there is a lot of room where we can charge fees for services delivered or charge other fees, like late fees, and we can do that without causing elasticity of demand.

And so we completed those pilots in the four market areas; we're in the process of rolling that out across the Company; and we will have that rolled out in the next 18 months. So you really haven't seen a dramatic effect from that part of the pricing program. You'll really start to see the dramatic effect of that pricing program mid-to-late next year.

And then have you done any studies internally to sort of quantify the impact-- how impactful this could be? Do you think it could be as large as the current pricing initiatives that you have implemented today?

Well, you know, it's all, it's all a matter of balance. At some point in time you put so many fees and surcharges in that it starts to have an effect on elasticity. So it might have an effect on what you can get on your normal price increases. So you know, we have seen some internal numbers, but you really have to watch how these things play out before you can start to see the true effect it's going to have on elasticity. So when you look at what we've done this year, bringing price up to 2.1% in the first quarter, now up to 2.7% in the fourth quarter, 4.3% if you add our fuel surcharge program in. You know, when you think about this industry and where it was two, three, four years ago, 4.3% price would have been unheard of. And so we certainly are charting new waters here.

What we need to do as a management team is make sure that we have the proper balance going forward. What I've told, and Larry has told our management out in the field, is that that proper balance right now, we want to be more focused on price than on getting volume, and we want to be more focused on losing low-margin volume, and so going forward, we expect it's like everything we do here, we expect to show improvement. What those numbers are I won't say because you just don't know how the industry is going to react, but certainly, we expect to continue to show improvement in our pricing program.

Great, thank you very much.

Thank you! .

Your next question comes from the line of Lorraine Maikis of Merrill Lynch.

Thank you. Good morning.

Good morning.

Can you detail out the one-cent hurricane impact for us and where on the P&L we can see those additional costs?

Yeah. The one-cent it was about, oh, I guess 5 to 6 million, about half of that being lost revenue and about half of that being increased cost.

Okay. And then just--

And I expect that breakdown to be roughly about the same, I guess, for the fourth quarter. It could change, but you know, but that's sort of how we came up with our number for the fourth quarter. We expect about the same impact.

Okay. And then that includes running the camp--

Correct.

Okay. In terms of the Section 29 tax credits, if we do lose some of those tax benefits, can we imply some sort of positive or I guess reduction in the other income because it becomes more economically feasible to run those facilities with higher oil prices?

Yeah, I think there would be a reduction in those costs. Those facilities are running, Lorraine, those costs are probably going to be the same. If the price of oil goes high enough, where you'll see a cost reduction is if we just stop running those facilities. If the price goes high enough, the benefit of creating the synthetic fuel just doesn't make sense, and so I don't think you'll see it until the price of oil gets much higher. Remember that half of our Section 29 credits come from those transactions we've talked about, those two transactions, but the other half comes from our own landfills. So it won't be a dollar-for-dollar offset.

Okay. And then finally, can you just talk about labor availability, particularly in the New Orleans area, and if you're having any trouble getting drivers or getting people to help you out down there?

Yeah. It has been very difficult, and you know, what you've seen in New Orleans, a number of areas, they're not even letting people in. So there are a number of our employees as well as, you know, I'm sure it's the same situation faced by other businesses down there, that evacuated and then you know, found other jobs elsewhere and simply are not going to return. That's one of the things that we've done by bringing in labor from outside New Orleans. At the same time, we've got some pretty significant recruitment efforts underway throughout the Gulf Coast. We've got ads in newspapers. We run spots on the radio. We've sent down several--

RV's?.

RV's, that have set up interview posts, you know, and they travel around throughout that area trying to seek additional, new employees. They can run the whole process right there from the RV. So we've got a lot of efforts underway that are generating new employees for us in the area. At the same time, you know, a lot of the business-- a lot of the contractors that are coming down there are also trying to hire employees, hire them away. The wage rates have gone up significantly in the area, and it's something we continue to, you know, track on a daily basis, and stay on top of. But it is a challenge.

Okay, and just one more follow-up on the hurricane. You said 5 to $6 million in the third quarter. Shouldn't we think about tripling that for the fourth quarter or are you offsetting some of that with higher disposal revenues in the area?

Yeah, that's what we're really looking at. We expect to see increased rolloff in disposal volumes as we progress further along in the recovery efforts, and then at the same time, we expect there will continue to be loss of revenue on the commercial side and the residential side. You know, there's some residential areas that our contracts have actually been suspended because you can't even go in there. So we'll continue to see the shortfall on the revenue on the residential and commercial side. Hopefully, the upside on rolloff and landfill, and then of course just the increased operating costs.

Thank you. .

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

Um, let's see if there's anything left. Do you have business interruption insurance?

Business interruption?

Yes.

We do, but not with respect to hauling companies. We do with respect to our landfill and transfer operations.

Okay. So the contracts being cancelled on you for [force-majuer] issues or what have you, you're not going to be able to recover any of that for through insurance?

We're looking at all of that now. In fact, there are issues, and even one of our facilities in New Orleans, for instance, was flooded, and there are always these issues as to what caused the damage: Was it flooding or was it wind storm? And so you know, we're working with the insurance companies on all our claims currently and don't have a good feel at this point as to where we'll be able to make recoveries or even the timing of those recoveries.

Okay. David, you have remained decidedly strong-willed about pricing on your side, but you left me with an impression that you're less than favorably disposed about your competitors.

Well, yeah, Michael--

Well, just to close on that, Allied Waste had its best pricing quarter in a long time, and Waste Connections commented that they are for the first time since this program initiated and where they're overlapping, they're seeing Allied Waste, Republic, all raise pricing.

Sure. And I'm not saying that it's not a better environment out there. Don't get me wrong. But you know, there is absolutely no doubt that we've lost volumes as we've raised price. We've been the pricing leader and we've lost volumes as a result. There's no doubt about that. And what we've seen is that-- and this is not just with respect to Allied or any particular company, it's across the board-- what we've seen is that, this is an industry as we've had conversations many times, this is an industry that was fueled by revenue growth.

And it is very difficult for folks in this industry, and I include our company in that mix, it's very difficult for folks to give up revenue, and so what we've seen is that there is some more rational pricing on the street; there is a little bit more new pricing business rationality in the industry, but we also continue to see that when folks are, have business, they get very aggressive to keep that business, and so they're very aggressively lowering prices on contracts that they currently have, or they're very aggressively going after big, large chunks of revenue. We've had this conversation many times that, this is an industry that it's hard to get out of that revenue mentality, so when you see big contracts come up, you see people make bids that might not be particularly rational, but are we seeing better pricing on the street? Absolutely. Do we think this company can work to improve the way that we go about pricing and recovering our costs? Absolutely. I can't control what the industry does. I can only control what we do. And I can tell you that we think we can still do a better job.

Okay. Following that line of thinking, can you frame for us that if you were able to push out these new fee arrangements that you're looking at across the business, what's the scope of that improvement in dollars?

Yeah, again, you know, we've started to lay out targets with the market areas as we go through and do the roll-out of the pricing excellence program with respect to these fees and charges. Again, we have not tried to put together an aggregate number, and obviously, when you push price on fees in one area, you have the potential of reducing it in others. So again, we've tried not to talk in specific numbers. We've tried to say we can do a better job, we need to show continuous improvement quarter-to-quarter, and that's what were going to stay focused on.

Larry or Bob Class 8 engine emission starts coming in '06, '07, do you spend more money in '06 to buy forward so you're not exposed to that engine change.

Yes,-- yes, we are planning to buy more trucks in in 06. We're putting the fleet plan together right now as part of the budget process, but we do intend to buy more trucks next year than we bought this year.

So a couple hundred more trucks, a thousand more trucks, two thousand more trucks?

I don't think a thousand more, but it will be, it will be more than what we bought this year. Our buy this year will probably end up somewhere between 16 and 1800 trucks, depending on what deliveries we get in Q4.

Okay. Are there enough slats on the manufacturing side to do this, because you're not the only ones thinking about this?

You're absolutely right, and we've been working for several months to secure, make sure we have those build slots that we need for next year.

Okay. On the SG&A, Bob should we take what you did in the fourth-- third quarter and carry it forward pretty comfortably or do you have some thoughts about lumpiness about that?

Im' not concerned about lumpiness on a year-over-year basis. On the quarter by quarter basis we'll have the normal seasonal adjustments, but I think you'll just continue to see us make progress in that area.

Okay. All right. And then on the asset sales side, one more slice of that onion. You have talked about in various forms that there's $3 billion in revenues performing at 10% margins or less, so that's obviously bigger than the $400 million you've initially put on the market. What the pace at which you would want to be out of that $3 billion, whether they're swaps or outright sales, but when you look ahead and think about dramatic improvements in return on capital, the fastest way you're going to do that is driving real pricing and get rid of low-margin business that consumes capital.

Michael, we absolutely agree with that, but a significant portion of the $300 million I expect we will-- or $3 billion, I will expect we will not dispose of because we think we can fix it. We use an example of a rather large market area where we just see the future turning in that market area based on some market dynamics as well as some of our own actions, and so we've decided to hold onto that particular business, and I think that-- and to develop it-- so I think of that $3 billion, a lot of it we'll end up keeping because we'll be able to fix. As with respect to that which we do not intend to keep, I think it will take a couple years to work through all of that.

Okay. So from this point, 24 months, we would be, you know, a more profitable with better discipline on the capital deployed?

I would expect so, yes.

And how quickly does the market get to measure that your returns on capital are trending in the right direction?

I would think quarterly, using a year-over-year basis. Dave talked about our goal is to show progress in earnings and margin improvement and cash flow and return on invested capital fits in there just as well.

So as your measured that today, base on the incentive comp plans put in at the beginning of the year, will people make bonuses off of improving returns on capital this year?

Well, remember that our return on incentive bonus plan is the long-term incentive plan. That's got a 3-year timeframe to it. And I think people this quarter will begin to see-- I'll call it the thermometer that it's the community chest, the United Way like thermometer starting to show red at the bottom of the range where you get paid. I think this quarter will certainly send a signal in that direction. We haven't done the math on that yet. All I think that does is create more and more incentive for people to push down in this direction.

Okay. So there's no impact to people's comp this year on a pure ROIC, but there is on an EBITDA versus capital deployed, isn't there?

Absolutely. Yeah, that's half of our financial portion of our annual incentive plan compensation is EBITDA minus CapEx at the market area level.

Okay, and based on that metric, do you expect people to make bonuses?

Well, I think so.

Okay.

And I can't tell you that that's going to be true in every case, but I think we're certainly seeing a lot more capital discipline as we get, as we go through the year. So I expect that people will make bonus in that category.

All right. And have you accrued for that?

Oh yeah, absolutely.

Okay. Very good.

All right, Michael. Thank you, Michael.

Thank you all for joining us. In summary, obviously we're very happy with the quarter we had. We think that what this shows is the strong power of a robust pricing program, but you know, one quarter does not a trend make, and we need to be focused on consistently showing improvement at Waste Management. And that's what this management team is focused on, and that's what we're going to be up to at Waste Management over the next few years. Thank you for joining us and we'll see you next quarter. .

Thank you for participating in today's Waste Management third quarter conference call.