美國廢棄物管理公司 (WM) 2006 Q3 法說會逐字稿

Good morning, my name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2006 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. [OPERATOR INSTRUCTIONS]

I will now turn the call over to Mr. Greg Nikkel, Director of Investor Relations. You may now begin your conference, sir.

Thank you Kate. 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, and Bob Simpson, Senior Vice President and Chief Financial Officer. David will start things off with a summary of financial results for the quarter, her and review the details of our revenue growth including price and volume trends, and provide an update on our 2006 earnings and free cash flow guidance. Larry will discuss operating costs and other related topics. Bob will then cover the financial statements with an update on our Section 45K tax credits. We will conclude with questions and answers.

This call is being recorded and will be available 24 hour a day beginning approximately noon central time today until 5:00 p.m. on November 8th. 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 7044631.

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 27A of the Securities Act of 1933, and Section 21E of the Securities and Exchange Commission 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, 2005, and in the Company's press release this morning.

These risks and uncertainties could cause actual results to differ materially from those described in the forward-looking statements. Additionally, during the course of the presentation, we will discuss free cash flow, which is a non-GAAP financial measure. We will also discuss adjusted earnings growth, earnings per share growth, earnings per share projections, and income from operations as a percent of revenue adjusted for certain one-time items, which are also non-GAAP financial measures.

We have adjusted these measures for certain one-time items which occurred in the third quarter of 2006, and the third quarter of 2005. David's and Bob's comments on these non-GAAP financial measures will be on an as-adjusted basis.

We have defined and reconciled those items as part of the earnings press release or the release 8-K filed today, which 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 25, 2006, may no longer be accurate at the time of a replay, any redistribution, retransmission, or rebroadcast of this call in any form without the expression written consent of Waste Management is prohibited.

Now I will turn the call over to Waste Management CEO, David Steiner.

Thanks Greg. Good morning to everyone on the call. On behalf of the nearly 50,000 employees of Waste Management, I am very pleased to state that we again accomplished our primary goals of increasing our earnings and operating margins, and producing strong cash flow that we have returned to our shareholders. This marks the fifth straight quarter in which we have achieved these objectives.

When we look at earnings for the quarter, adjusting for the items we noted in our price press release, we earned $0.55 per share in this year's third quarter. This is a 22% increase compared to the adjusted $0.45 per share we earned in the third quarter of 2005. If we ignore the incremental $0.04 that we got from tax credits in the third quarter, the quarter was $0.51.

With respect to margins, our goal remains to expand income from operations as a percent of revenue on a year-over-year basis. We accomplished that for the fifth consecutive quarter. As a percent of revenue, income from operations as-adjusted increased 150 basis points to 16.8% during the third quarter of this year. As for our cash flow performance, we produced $431 million in free cash flow during the third quarter, bringing our year-to-date 2006 total to over $1.2 billion through September 30th, which we have returned to shareholders through our share repurchase and dividend programs.

I will start my detailed discussion by reviewing the yield and volume components of our internal revenue growth on base business. Total internal revenue growth from yield on base business was 3.6% during the third quarter of 2006. If we include the 0.9% benefit from our fuel surcharge program, our yield increased to a total of 4.5%.

We experienced revenue growth from yield across our four geographic operating groups, and in our Wheelabrator and Recycle America units. Our internal revenue growth from yield was most pronounced in our three collection lines of business. Combined the revenue growth from yield in the industrial, commercial, and residential lines of our collection business was 4.8% this quarter, which excludes the benefit of our fuel surcharge.

Pricing in the industrial or roll-off line of business led the way, with internal revenue growth from yield reaching 5.5% in the third quarter of the year. This is comparable to the level it has been for the last four quarters, and demonstrates that we are maintaining pricing momentum in our collection operations. Another great example of that momentum is our revenue growth from yield for our commercial line of business which stood at 4.4% this quarter, the highest level we have achieved dating back to at least 2002.

These results are due to the continued achievements of our field operating managers, in conjunction with our pricing excellence team. A key component of our success in growing revenue from yield has been new business pricing. During the third quarter, we added new commercial business at a higher average dollar rate per yard, than the average dollar rate per yard of business we lost. We also added new roll-off hauls, at a higher rate per pull, than the rate per pull of lost business. In other words, we are selling new business at higher rates than the business we lose. In both lines of business, it shows how our focus on new business pricing has paid off for our shareholders despite some volume loss.

Turning to the disposal side of our business, we grew revenue due to yield on our landfills, transfer stations, and waste energy facilities. The internal revenue growth from yield was 2.9% for the primary streams coming into our landfills, which is the highest level we have achieved, since implementing the improved pricing practices following our 2005 landfill pricing study.

I will now turn our attention to the volume components of our internal revenue growth, which as we stated in our press release was a negative 1.8% during the third quarter of this year. About half of this decrease is attributable to nearly one less work day during the quarter, and to lower volumes for noncore revenues.

During the third quarter of 2005, we had revenue from a recycling construction project, which is now complete. Those one-time revenues are classified as volume and did not repeat in 2006. So when we look at our core solid waste business, the overall volume loss was only about 0.9 of 1%.

The reduction in revenue due to volume loss was driven by lower volumes in our collection lines of business. The volume loss in the collection side of the business is an expected result of our pricing programs. Again, we are doing a better job of moving out unprofitable customers, and replacing them with profitable customers through higher new business pricing. So the volume loss in our commercial and industrial businesses has been more than offset by the higher rates we are generating in those areas. That strategy contributed to our 150 basis point improvement in EBIT margins.

Also we have been very pro active in rebuilding residential and national account collection work at higher rates, to increase our returns in those areas. This has been a win/win situation. If we keep the work, we are improving our profitability and return on invested capital, through the recognition of higher yields. And if we lose the business, we are in effect extracting ourselves from underperforming accounts, at which time we will flex down our operating costs, and redeploy our assets to more profitable accounts. In short, this approach is by choice and by design.

By examining our results for the last five quarters, it is clear to us that it is working well. We simply refuse to take on residential business or national accounts at rates that provide an unacceptable return. On the national account side, during 2006, we have lost business with annualized revenue of nearly $50 million, but with average margins of only about 5%.

Residential and national account contracts are also very capital intensive, so return on invested capital on underperforming contracts is not acceptable. We have held the line on bids for residential business and national accounts. Our new management team in national accounts is committed to providing better returns and increased profitability, even if it means losing some underperforming work.

I am completely confident that our strategy is the right strategy, and I am certain that our national accounts management is the best in our industry, so again, we expect to see improved performance despite lower volumes. Our improved performance is once again evidenced by the fact that our margins, earnings, and cash, continue to increase despite lower volumes. Volume growth also continued at our landfills across the three major waste streams of MSW, C&D, and Special Waste.

It is a tribute to our nearly 50,000 employees that I can say that this is the best quarter we have had in my six years at Waste Management. It's very clear to my me that our field organization and corporate staff are working together to execute our game plan, but certainly more work lies ahead, and we will need to work even harder to continue our success. As we enter the fourth quarter, there are several year-over-year factors to consider as we project fourth quarter and full year results.

For the fourth quarter of 2005, we pointed out that our earnings included $0.01 per share from hurricane-related cleanup work, and $0.02 per share in benefits due primarily to landfill capping adjustments. We also had unusually mild weather in the fourth quarter of 2005. We earned about $0.03 per share from our section 45K tax credits during the fourth quarter of 2005. We expect those credits to generate only $0.01 per share in this year's fourth quarter.

Taking into consideration those factors, our strong operating results in the first nine months, led us to increase our full year 2006 earnings expectations to an adjusted range of $1.78 to $1.81 per diluted share. Approximately an 18 to 20% year-over-year increase in adjusted earnings, and we expect free cash flow to meet or exceed our guidance of 1.2 to $1.3 billion.

So as we begin to look back on 2006, we are extremely proud of our accomplishments, and believe we are poised to continue our success in 2007 and beyond. We are very confident that our pricing and operational programs combined with the finest people and assets in the industry, is the platform that will enable us to continue to produce outstanding results.

With that, I am going to turn the call over to Larry, who will review our operating cost results for you.

Thank you David, and good morning to everyone on the call. I will begin my remarks this morning with a review of our operating cost results for the quarter. In summary, we again produced excellent operating results in the third quarter of this year. Operating expenses were $2.181 billion, or $21 million lower than in the third quarter of 2005, which is a 1% year-over-year decrease in operating costs on an absolute dollar basis.

This outstanding performance is the result of our dedicated employees' continued focus on operational excellence. Our success in flexing down operating costs as we shed lower margin volumes, the impact of the divestiture of lower margin operations, and nearly one less work day in the third quarter of this year.

As I have done on previous calls, I will now review the details of our operational performance in a number of our cost categories, using basis point changes as a percent of revenue in my explanations. As a percent of revenue, total operating expenses declined from 65.2% in the third quarter of 2005, to 63.4% in the third quarter of 2006. This 180 basis point improvement marks the fifth consecutive quarter in which we have improved our year-over-year results.

As a percent of revenue, and in actual dollars, we lowered operating costs in 7 of the 10 cost categories that we break out in our financial statements. The three exceptions were in the categories that we would expect to be higher. Those being fuel costs, subcontractor costs, and landfill operating costs. We are very pleased with these results.

As a percent of revenue, labor and related benefits costs improved 40 basis points. For the third straight quarter, we have reduced in actual dollars year-over-year group insurance and healthcare benefits costs. We are even more pleased with this result when we compare it with published reports, that state that average healthcare premiums have risen at over twice the rate of inflation.

Our productivity improvements in all three of our collection lines of business also contributed to this cost reduction. Our route managers and district managers have reduced labor hours by nearly 600,000 hours so far this year, compared to the same period last year, through the use of our labor management tools. This is in addition to the labor hours we estimate that we eliminated due to divestitures or lost volumes, due to our pricing activities, and is the result of our focus on driving productivity improvement throughout all our operations.

Transfer and disposal expenses, which include those costs from our collection, that our collection companies pay to third-party landfills and transfer stations, improved by nearly 40 basis points as a percent of revenue in the third quarter of 2006. This progress reflects our continued focus on improving or exiting low margin collection businesses where we don't internalize the volume.

We have reduced our maintenance costs by over 30 basis points as percentage of revenue, due to the lower maintenance expenditure at our Waste Energy facilities, as well as in our collection fleet. We have underspent our maintenance budget at our Waste Energy facilities by about $9 million year-to-date, largely due to the timing of preventative maintenance projects. We expect to complete those projects and spend those amounts in the fourth quarter.

In the area of collection fleet maintenance, we continue to see overall inflation of about 5% in the cost of lubes and parts, in addition to normal wage increases. We reduced our collection fleet maintenance spend by more than $3 million in the third quarter, compared to the same quarter last year, with every one of our operating groups contributing to the savings.

As we near completion of the roll-out of our Compass maintenance information system into all of our fleet maintenance shops, we are now able to perform detailed analysis of specific truck systems, such as hydraulics and brakes. We can then establish improvement targets for underperforming locations, compared with peer locations that perform similar work. I continue to believe that there is even more than opportunity to further reduce our maintenance costs through our improved information systems and preventive maintenance processes.

We again saw a reduction in our year-over-year risk management costs, due to lower Workers' Compensation costs. This produced over a 20 basis point reduction in our overall risk management cost as a percent of revenue. This directly correlates to our strong culture of safety, and our string of year-over-year improvements in our total recordable injury rate, which is an OSHA safety measure. On a year-over-year comparison, we improved in this area for the 23rd consecutive quarter. We are continuing our progress to become world class in safety.

Cost of goods sold as a percent of revenue improved by nearly 30 basis points, due primarily to the impact of divestitures within our recycling business, and lower recycling volumes. This category also benefited from the absence of pass-through costs related to the recycling construction project completed in the third quarter of 2005, which we discussed on previous calls.

Subcontractor costs increased by almost 10 basis points as a percent of revenue in the third quarter. This increase was caused by the higher estimated fuel costs passed on to us by third-party haulers. Absent that, our subcontractor costs in actual dollars declined year-over-year, as the loss of volumes through divestitures, or as a result of our pricing efforts, reduced our use of subcontractor haulers.

Our direct diesel fuel costs caused a 30 basis point increase in operating expense as a percent of revenue. Although fuel costs began to fall during the month of September, they were still higher by an average of $0.36 per gallon for the entire quarter compared to 2005. Although this negatively affected our operating margins, it did not lower earnings, because the increase in revenues from our fuel surcharge program fully covered the impact of both higher direct fuel costs, and higher fuel costs passed on to us by our subcontractor haulers.

In the other cost category, we lowered operating expenses as a percent of revenue by about 50 basis points in the third quarter of this year. There were a number of factors causing this decline, among which was a reduction in rental expenses and supplies, as well as insurance recoveries related to damage from last year's hurricanes.

As I stated at the beginning of my remarks, the third quarter marks the fifth straight quarter in which we have reduced year-over-year operating expenses as a percent of revenue. This demonstrates that our field managers have been successful in flexing down costs as we shed lower margin volumes, and as they continue to make progress on our pricing and operational excellence programs.

These efforts led to the year-over-year reduction in operating costs in actual dollars and as a percent of revenue, which we achieved in spite of higher fuel costs, and other inflationary pressures. This is the first time that we have accomplished this since 2002. These strong results show that we are focused on the right things, and we remain committed to showing continued and sustainable improvement.

With that, I'll turn the call over to Bob.

Thank you, Larry. I am going to begin with a review of the impact that falling crude oil prices had on our Section 45K tax credits and our earnings. As a reminder, we earn these credits from our landfill gas projects, and from our investments in two coal-based synthetic fuel partnerships.

The ability to earn these credits is tied to the expected average crude oil price form the full year. As of the end of the second quarter of this year, we estimated that 78% of the Section 45K tax credits would be phased out. This was based on crude oil pricing information as of June 30, 2006. Because of the high crude oil prices, the operations of the two synthetic fuel plants were suspended in May. At the 78% phaseout level, we recorded only a $0.02 per share benefit in the first half of 2006.

Crude oil prices fell sharply during the latter part of the third quarter of this year, resulting in the recommencement of operations of the synthetic fuel plants, and a reduction in the estimated phaseout of 35%. This estimate is based on the average actual crude oil price for the first nine months of the year, and the average oil futures price for the last three months of the year.

As a result of the phaseout percentage declining to 35%, we expect our effective tax rate to be approximately 36% for the full year and for the fourth quarter, excluding the nonrecurring tax benefits noted in our quarterly earnings releases this year. Based on the 35% phaseout level, we recorded a benefit of approximately $0.05 per diluted share during the third quarter, which includes a $0.02 benefit for additional tax credits we now expect for the first two quarters of the year. This brings the total benefit from section 45K tax credits and the operation of the the two synthetic fuel plants for the first nine months of the year to $0.07 per share.

During the fourth quarter of this year, we estimate that the phaseout will remain at 35%. Our share of the costs in the fourth quarter will be $18 million, which is reflected in the income statement line item titled 'Equity and Net Losses of Unconsolidated Entities.' As a result, we project that we will earn $0.01 per share during the fourth quarter of this year from our section 45K tax credits, bringing our total benefit for the full year to $0.08 per share. The full year earnings guidance we have provided includes this $0.08 per share benefit. We have included a chart in our schedules attached to our press release that lays this out.

I will now turn my attention to our SG&A expense performance during the quarter. Our SG&A costs increased $35 million to $344 million during the third quarter of 2006 versus the same quarter of 2005. This year-over-year increase was primarily due to increases in incentive plan accruals, sales and marketing activities, and in the revenue management system project costs.

SG&A costs as a percent of revenue were 10% during the third quarter of this year, or about 80 basis points higher compared with last year's third quarter results. We expect our full year SG&A costs to be about 10.2% of revenue, excluding the unclaimed property charge we reported in the first quarter of this year.

Depreciation and amortization decreased $29 million in the third quarter of 2006, compared with 2005. You may recall that we booked $22 million in additional amortization expense in the third quarter of 2005, related to an accounting adjustment to align the site lives of 5 landfills with the underlying lease agreements or operating contracts. This explains nearly all of the year-over-year decrease. Depreciation and amortization was 9.9% of revenue in the third quarter of this year, compared with 10.9% in the prior year quarter.

Moving down the income statement, the $19 million expense in the line item related to divestitures, asset impairments, and unusual items, is primarily related to businesses on our divestiture list. Interest expense was $138 million in the third quarter, a $13 million increase from 2005. This increase is primarily the result of the higher interest rate environment in 2006, where we have seen average LIBOR rates increase by about 150 basis points.

Interest income increased $16 million, to $24 million in the third quarter of this year, due to an increase in our cash balances, the higher interest rate environment, and interest resulting from tax audit settlements. Total reported debt increased by $42 million during the quarter, compared with the end of June. Our debt to total capital ratio increased 40 basis points to 58.4%, still in-line with our objective to be around 60%. Subsequent to the end of the third quarter, we have reduced our debt through the retirement of $300 million in senior notes.

We utilized our cash on hand to pay off this debt when it matured on October 16th. The floating rate portion of our total debt portfolio stood at 35% at the end of the quarter, the same level as at the end of the second quarter. We produced strong free cash flow during the quarter. Net cash from operations was $745 million, with capital expenditures of $357 million during the quarter. After adding $43 million in net proceeds from divestitures and sales of assets, our free cash flow was $431 million.

For the full year, we expect to meet or exceed our targeted range of 1.2 to $1.3 billion of free cash flow. Among these factors affecting free cash flow in the fourth quarter are divestiture proceeds and higher capital expenditures. We expect to meet our 2006 goal of selling most of the underperforming operations we have discussed on previous calls. We also expect sequential capital expenditures to increase significantly in the fourth quarter of the year, due in part to the additional capital we will spend on trucks, chassis, and engines.

Cash [tax] payments were $166 million during the third quarter, and we expect them to be $140 million in the fourth quarter. The fourth quarter payments reflect the benefit of the Section 45K tax credits, partially offset by the impact of higher earnings, and tax gains from divestitures completed through the end of the third quarter. Cash interest payments were $106 million in the third quarter, and are expected to be about $178 million during the fourth quarter.

We utilized our free cash flow to repurchase $307 million in shares during the third quarter, for the first nine months of the year our share repurchases have totaled $934 million, or over 27 million shares. We expect to repurchase just over $1 billion in shares for the full year. This includes the additional $350 million in shares previously authorized by the Board of Directors for 2006. For the fifth straight quarter, we have produced year-over-year increases in adjusted earnings and operating margins, as well as strong free cash flow. We have exceeded our internal expectations through the first three quarters of the year, which is reflected in the updated 2006 full year guidance that we gave today.

And with that, Kate, let's open the line for questions.

At this time, [OPERATOR INSTRUCTIONS] We will pause for just a moment to compile the Q&A roster. Your first question is from Jonathan Ellis from Merrill Lynch.

Hi, good morning, guys.

Good morning, Jon.

Good morning. Just, if we could talk a little bit about landfall prices. You mentioned that it was up. Can you give us some sense of, within the contest of gate rates versus long-term disposal contracts, how pricing fared during the quarter?

We don't split it out by long-term contract versus gate rate, but as you know, Jonathan, the approach that we have taken is that we have got to raise both, about 70 to 75% of our volume is under long-year contracts, one to three years, about 25% of it is at the gate.

I think the best way for the financial community to get a feel for where we're going with long-term contracts is to watch for those big bids that come out in places like Boston and Cleveland and Philadelphia, Atlanta, you know, if you keep an eye on the published reports of those bids, I think you will see the direction that our landfill price is going, and I think that you will see that in every instance, it has been up, and up fairly dramatically.

Okay. Then on the last quarter, you mentioned that renegotiating higher price points on some of these longer term disposal contracts have been problematic, so would you say it has gotten incrementally easier in the last quarter to realize higher price points on those contract negotiations?

It's always difficult that when you're trading high margin volume for price, but, you know, we have taken the position that what's important is not volume, but return on invested capital, and what's important is increasing our cash flow and our margins.

So is it difficult? It's always difficult, but just like we did in the collection line of business, we are going to step out in front and make those kind of changes. And, you know, what you have seen is that in the last five quarters, that trade off has been tremendously positive for us.

Great. And on the volume side of the landfills, you mentioned those up across the board for MSW, C&D, and Special Waste. Could you give us some sense, is there any deviation within those groups? Was one up or down more than the other?

You know, not anything materially different than what we saw in the first two quarters. You know, obviously C&D and Special Waste that led the way from a volume point of view, and that didn't change in the third quarter.

Okay. Great. And just on the national accounts business, can you remind us how big that business is in total for you right now?

Well, going into the beginning of the year, it was about nearly a billion dollars, really about $900 million in revenue, you know, as we have talked about it, it will drop below the $900 million this year, but we are going to make more money by doing less work. You know, that's basically the approach that we have taken with national accounts.

We are not going to bid national accounts that look real good when you look at the pro forma, and then when you go back and look at the historical operating margins, you find out you are losing money. We're just not going to play that game, and so we are going to do less volume with higher profits.

Okay. And in terms of the national accounts business that remains, can you give us a sense what portion of that is subcontracted?

As I recall, our subcontracted portion was around 20%.

Okay. Great. And then just last question on the divestiture program. Can you give us a sense where we are relative to the 900 million that had originally been targeted?

We still expect to sell most of that this year, and actually feel pretty good about the progress of it. I would tell you that we would love to see it go faster, but working through the transactions, working through the assignments, and the governmental approvals that are required, sometimes takes a lot longer than you would like.

I will say, though, we are seeing the benefit of the program already. You are seeing our operating expense margins, for example, improving significantly. A portion of that is because we have pushed out the costs associated with these underperforming operations. But I still expect that we could, we would be able to sell most of these this year, and then the rest we would try to do next year.

Great. Thanks, guys.

Sure.

Thank you.

Your next question is from Jamie Cook from Credit Suisse.

Good morning.

Good morning.

My first question, David, you know, when you look at the third quarter, I guess where was it relative to your expectations, and just because, you know, if you look at the third quarter, you beat the consensus by about $0.07, and we are raising the guidance for the full year by about that much. So is there anything, you know, when we look at the fourth quarter, is that conservatism? Are you concerned about anything, given what we are hearing about the U.S. economy. Should we be reading into that, I guess is the question.

That's a very good question. When we look at the third quarter, quite honestly, we saw the same thing we have been seeing for the last four quarters, expect that we saw, we certainly saw it improve in the third quarter. I said it in my script, I'll say it again. It is the best quarter we've seen since I have been at Waste Management. Usually you'll have a quarter you'll find one or two things in the quarter that you say well, maybe that's not so good. We couldn't find anything in this quarter that we didn't think showed dramatic improvements at Waste Management, so we once again exceeded our own expectations for the third quarter.

Now, the fourth quarter, you know, we talked a little bit about some of the factors that we had in the fourth quarter of 2005, that we don't think will repeat in 2006, but as you all know, the biggest factor in the fourth quarter is always weather. We saw some early bad weather in some parts of the Northeast and the MidWest, so we just think that it's prudent for everyone to be conservative when they look at the fourth quarter. But you know, we also want to point out that for the full year, we would be up 18 to 20% in earnings, given the range that we've given in the fourth quarter. So it is us being prudent, I think it is us being conservative.

In answer to the question of what are we seeing in the economy, we're basically seeing the same thing we've seen during the course of the year, which is there are parts of the economy that are slower. Mostly the industrial Northeast and the Midwest. You would expect the year-over-year comps to be a little bit tougher in the Gulf Coast, where we had the benefit of the hurricanes last year. But we truly believe that the progress we have made on pricing and operations this year is going to provide us a platform from which we are going to continue to succeed in 2007.

I know we are not going to talk about 2007 yet, but just as we hear about concerns about the economy, when you think about your approach to pricing in 2007, should we expect any adjustments, and you know, how aggressive you have been on pricing because of the potential slowdown in the U.S. economy?

Yes. We've talked about it a lot, that pricing is not just about raising prices on your current customers, in fact pricing is not just about raising new business pricing, which, you know, we've focused on, and we believe is really what is driving a big piece of our pricing improvement. But pricing also means losing unprofitable volumes and replacing them with profitable volumes. And do you that where whether the economy is good or bad.

So when we look at 2007, again we aren't really seeing a big slowdown in the economy, but when we look at 2007, whether the economy is good or bad, we're going to continue our program of making sure, one that we get paid for the services we provide, and that happens in a good economy or a bad economy, and two, making sure that, weed out our underperforming customers, customers that are actually losing us money, and replace them with customers that are profitable customers. So, again, whether the economy is good or bad in 2007, we see our, what we call our yield program, or pricing excellence program continuing to provide substantial benefits.

Great. Congratulations. I'll get back in queue.

Thank you.

Your next question is from Brian Butler from Friedman, Billings, Ramsey.

Good morning. How did the volume growth look if you exclude kind of the businesses that you consciously let go of, because they weren't taking the price increase, and following up on that, then when do you think you finish up pricing out this low profitability business? How many quarters does that take, or is that even longer?

Yes, sure. We'll go to the second question first, because, you know, that is a continuous process. If you have got a custom every that is a negative 15% margin, and you replace that person with someone who is making money, you are going to replace the negative 10% margin. Then you are going to replace the negative 5% margin. At some point in time, you're replacing the positive 5s, with positive 25 or positive 30, so that process of weeding out your underperformers, and replacing them with higher performers, whether it's replacing negative EBIT customers with positive EBIT customers, or replacing low EBIT customer with high EBIT customers, that is process that we will continue as long as we are at Waste Management.

So to say how long will it take? We think just to weed out the customers that are actually losing us money will take all of 2007, but it will be a continuous process of continually replacing low profit customers with high profit customers through new business pricing, you know, through increased new business pricing. So that's going to be a continuous process.

Now, in the quarter, what of the 0.9% volume that we lost, what portion of that are losing customers? I will tell you we do not track our customers, customer by customer in that manner. We have talked a lot about our C1 project, which is the SAP implementation that we are doing in 2007.

That will actually give us the ability to provide you that kind of data. Right now what we can say is, that we think that the volume loss that we had in the third quarter was the right type of volume loss. You know, to put it, you know be to put it quite simply, we believe that our shareholders are quite happy with us having lower volumes but higher return on invested capital, and that our shareholders are happy with us having lower volumes but having higher earnings.

It's very clear to us that some people in this industry believe that having higher volumes and lower margins is the right thing for their business, and maybe it is the right thing for their business, but we are not going to follow that strategy. We think lower volumes and higher earnings and higher return on invested capital is the strategy that we are going to follow.

Just to follow up though, from an industry point of view, do you see volume growth, volume growth still appears to be continuing from all outside data. I just want to make sure that in the markets where you do have good, let's say, customer pricing, you know, you are still saying positive pricing growth,or not pricing, I mean positive volume growth.

Yes. There's no doubt about it. Again, what we so from the economy is the economy churning along pretty much as we expected, but I would say when we look at the fourth quarter. When you look at the economy, I think you have to look at the economy from a longer term point of view, what's it going to do in the next 18 months.

When you take the short term view if what is going to happen in the fourth quarter, my personal opinion is that weather will be a bigger factor than the economy, so that's why we think we want to be conservative and prudent with the fourth quarter, given that we have already seen some bad weather in parts of the country.

Okay. And then on the asset sales again, year-to-date, how much in annualized revenues has been sold?

In annualized revenues? About 200 million.

About 200 million?

Yes.

So you still have a good portion of that what you were initially set out to sell in the fourth quarter?

Yes. I think if you look at the impact in this quarter, about 50 million, or $48 million of revenue $48 million of revenue was what we would have had had we not sold the business we sold.

Okay. And then lastly, can you help me understand the Section 45 tax credits kind of into '07? What is the right way to think about those?

You know, it really depends on where oil prices are going into '07. If oil prices inner '07 where they are today, we will get the full benefit of the tax credits. We will get all $0.11, $0.11 to $0.12 that we expect to get.

If oil prices get up into the 62 to 76 range, that range will move up a little bit in '07 with inflation, if oil prices go back up into that range, we will lose some portion of the credit in '07. We're not taking a view of that just yet ourselves, Brian.

Okay. So at current levels, you get the full $0.11, so that's about what, $2.60 kind of price?

$2.60 --

Per gallon, not per barrel.

Oh, I would look at it as just a, the cost of a barrel of crude oil. We don't look at it as a diesel cost, I haven't done calculations yet.

So crude somewhere in the under $50, or under $60 range?

I would use $62 as your starting point. As long as it's under $62 a barrel, I think we are going to feel comfortable that we're going to get the $0.11.

Thank you very much.

Thank you Brian.

Your next question is from Bill Fisher from Raymond James.

Just following up on the last question for Bob. You sold about 200 million year-to-date, in Q4 do you think you could ultimately divest like over half a billion of revenue?

Yes, I think we can. We were certainly expecting to, but the kind of issues you run into are the government approvals and the assignments you would have to go through to get these done.

If, for example, the transaction is large enough it requires Hart-Scott-Rodino process. And we acknowledge that as you get into the holiday season, some of the government agencies may not move as quickly as they would in the earlier part of the year, but we are still optimistic that we'll be able to get that done.

Okay. And just to follow up, actually for David, just on that. Assuming you get that more or less done as you move maybe into early '07, looking at the divestitures in '07, do you think you move more to a market swap type program? And I ask that in context of, if that can just be another ingredient on the pricing improvement, in terms of getting out of weaker markets and strengthening your other markets?

Yes, we would always prefer to do a swap whether it's in 2006 or 2007, so it's safe to say we would always prefer to do a swap rather than do a sale for cash. Quite honestly, that's been the most disappointing part of our divestiture program is that we haven't found a lot of opportunities where we can do swaps.

Okay. So it's just a continuum, probably the most focus will be on the divestiture side?

Yes, as far as we can see in the near term, that would be true.

Okay. Great. Thank you.

The next question is from Corey Greendale from First Analysis.

Good morning.

Hi Corey.

Dave, when you say that this is the best quarter you've seen, does that suggest that this to your mind is kind of the ideal trade-off? So that in other words we're not going to go further looking, you wouldn't look for further volume, like greater volume losses in return for greater margin improvement than you have this quarter?

I think we are saying that as long as that trade-off remains positive for our shareholders, we are going to continue to do it. When we go in and look at our typical business, we are still finding plenty of customers where we are, the cost that we're charging them is, doesn't cover our disposal costs.

And so, you know, we are going to spend all of 2007 making sure that we lose those customers and replace them with profitable customers. When I say lose those customers, the beauty of it is that what we have found is that as we go back to those customers and start raising prices, about 60% of them accept the price increase.

So it isn't really a matter of losing the customers. It's a matter of getting the right price from those customers, so as long as we see that trade off working for us, and it's absolutely worked for us over the last five quarters, we're going to continue the process.

Okay. So inherently you wouldn't have any problem with a 3 or 4% year-over-year volume decline, as long as you were getting margin benefit from us?

Well, it's not just margin benefit, we have got to see the return on invested capital. From a margin benefit, you also have to improve your return on invested capital, improve your cash flow. As long as what's important to our shareholders, what we found while going through our pricing program is that not all volumes are good volumes.

You know, I think this is an industry that has always believed all volume is good volume. But when you are losing money, when the volume is not covering your cost of disposal, that's not good volume, and we are going to make sure that we either replace that volume with profitable volume, or better yet, that we are able to raise the prices on those customers such that, can get them above water.

Okay. Understood. On the guidance, just it sounds like you're saying that there's some conservatism there. If you look back the past couple of years, even adjusting form the sort of nonrecurring things, the seasonality, there wasn't that big a drop-off from Q3 to Q4, going years before that, there was more of a drop-off from Q3 to Q4. Can you help me under stand kind of what you think is the go-forward seasonality in the numbers?

Yes, I think seasonality is the best word that we could use to describe it, because it is totally dependant on what happens in the season. Totally might be a little bit of an overstatement, but I think largely responsible for performance in the fourth quarter and the first quarter is weather. And, again remember last year, in the fourth quarter, and moving on to the first quarter, we did have extraordinarily warm weather.

That was right after the hurricane season, when everyone started talking about global warming, and that certainly benefited us last year. You know, we just want to make sure that, you know, if it goes the other way this year, that we let everybody know about that.

In Chicago, it's certainly easy to forget the extraordinarily warm weather, so-- [laughter] and on the landfill volumes, I know you said that the volume was up year-over-year in all three streams. If you look at the data in the release, the landfill tons were flat to down just slightly year-over-year.

Can you reconcile those two things?

Yes, that's total tons so what you're seeing in the price release is total, which includes internal and external tons. What we actually saw was that external tons were up, internal tons were down, which is exactly what you would expect as we reduced our collection volume. So basically what happened in the third quarter is we lost unprofitable collection volumes, but some of that waste that we didn't pick up, ended up coming back into our landfills which is a huge win/win for us.

And I'm going to sneak in one more if I could. On the fuel surcharge program, fuel costs are were up about 12 million on an absolute dollar basis year-over-year, and the surcharge program gave 33 million in revenue. Is it fair to assume that the extra revenue was because you are still rolling it out to a greater portion of the customer base?

No, when when you look at our, this is Larry. When you look at our fuel surcharge, I think the number was about 31 million. Our direct fuel cost increases were about 20. And our indirect fuel cost increase we estimate at about 12. So it just about covered the 31 million fuel surcharge just about covered the 32 million.

When you look at the price increase that occurred during the year, that is how we estimate those amounts.

And remember when you are looking at the year-over-year dollar increase, you are not taking into account the volume loss. It's not just 11 million. That's why we say it's 20 million on the direct, because it's not just the 11 million that went up. It's also the 9 million that we saved by reducing volume.

Okay. So in other words just to put it in simple terms, if fuel go this other way, you shouldn't lose more revenue than you are getting back in costs, right?

The way we have it set up now is it's designed to cover what the increase or decrease is. It adjusts. It fluctuates up and down.

Okay. Good. Thanks. I'll get back in the queue.

Next question?

Your next question from Scott Levine from J.P. Morgan.

Good morning.

Hey, Scott.

A question regarding the pricing levers. You to talked in the last call about extending the price, program pricing excellence to your franchise markets. Wondering how that process is proceeding, and hope you can remind us of how big a piece of your total business base the franchise piece is?

Yes, the total franchise piece is about a billion dollars of revenue, and quite honestly, it's about the same as we've seen in all the other lines where we've used pricing excellence, which is it's actually going better than we expected. So, you know, now what we're doing is stretching it onto the landfill to the collection side, I mean to the disposal side, transfer stations, so, you know, the pricing program continues the pace. We expect it to continue through 2007.

So maybe a little bit more of an incremental focus going forward on disposal versus collection all-in?

I think that's absolutely correct.

Okay. And you mentioned churn earlier. But I was hoping you might be able to comment with regard to how those churn rates are coming in relative to say your expectations, roughly speaking?

Yes. And you know the churn rate for the quarter was actual about 10.1%. But, you know, it's interesting as we've gone through the pricing excellence program I've take an different view of churn, which is you can have 10% churn, but if you are churning profitable customers, that's bad churn.

If you're churning unprofitable customers, that's good churn. When I look at churn, we had 10.1% for the quarter, but of that 10.1%, almost 1 whole percentage point was from national accounts. So without national account losses, which again was not profitable work, or below 5% margin work on average, without that, the churn was 9.2%, which is continuing the trend of going down throughout the year.

Okay. Moving to, I guess, volumes, or more accurately the macro environment, just hoping you can comment specifically on construction, I know construction is a relatively small piece of the total pie, but if you could talk a little bit about how the construction volumes are trending in commercial versus resident in the quarter?

Yes. And the first part of your statement is absolutely true. You know, the C&D volumes that come into our landfill is under 2% of our total revenue. So it is a small waste stream, but clearly what we have seen from a C&D point of view, is what you would expect to see given the economy and given the year-over-year costs.

We have seen some reductions along the Gulf Coast where last year we had huge C&D volumes coming in right after the hurricane. We have seen some reductions in the industrial portions of the Northeast, and some on the industrial portions of the Midwest. So, you know, it's been about as you would expect it to be, given what you have seen happen in the housing market and happening in the overall economy.

But, you know, when you look at the total construction starts, you see that commercial construction continues to be robust, so, you know again, I think that in the fourth quarter, C&D volumes will be at least as much affected by weather, as they will be affected by the overall economy.

Okay. One last one, then if I may. With regard to the asset sales, when you, you say you expect to achieve most of, I guess it's the 900 million in annualized revenue?

Right.

So what happens when you reach that end point? Is the program formally concluded, or will you continue to look at this as part of the the business ongoing more aggressively, or what are your thoughts beyond the 900 mill?

We do not think the 900 million is the end of the line. You may recall that this started with an analysis looks at over $3 billion of our revenue, because it was either, had EBIT margins of 10% or lower, or we projected that it would based on the market dynamics, and we put all of those businesses that make up that $3 billion of revenue through an analysis. Some of it is still going through the analysis, or we are waiting for the market dynamics to ripen before we get to the point where we might sell something.

So I don't think this will be the end of it at all when we get to the end of the 900 million. I think we will continue to add to the program as we go forward. We found in a number of instances is that we've been pushing pricing, and the results of that program, that it has really helped a lot of business units that had been underperforming in the past. So there will certainly be some impact from that.

Okay. Thank you.

Your next question is from Kevin [Fogarty] from Dupont Capital.

Hi, guys. Can you just clarify either free cash flow targets of, you know within 1.2 to 1.3? It looks like year-to-date you have already done over 1.2. Are you including the gains on asset sales, or how should we think about that? In the fourth quarter ramp, it was implied that it might be a very significant CapEx ramp to prebuy your truck fleet for emissions.

That's right. And we think given the guidance we gave last quarter of about $1.5 billion of capital spending this year, we're going to have to spend a little over $600 million in the fourth quarter to hit that 1.5 billion, and we've looked at it close and hard, and we'll certainly spend every dime we expect to spend on fleet.

It's possible some of the landfill projects and the land projects might shine slip into the first quarter, but right now we don't think so, so there will be a very big pickup in capital spending, and yes, we do include the divestiture proceed in our analysis of that business. But even with that higher capital spending, with the earnings we expect to generate, we still expect to meet or exceed the range.

So you may be free cash flow 100 or 200 million in the fourth quarter?

Yes, that's right.

Okay.

It could be, that certainly would get us to think about 100 million, or probably more is the way I would think about it.

Okay. Great. Thank you.

Your final question is from Leone Young from Citigroup.

Yes, good morning. First of all, back to the landfills, understanding what you are saying, David, you look at these big high-profile contracts, but maybe if we go one layer below, and you just look at, you know, independents coming into your site, ore other of these smaller, say, three to five-year landfill contracts you may have, what kind of success are you seeing there as those come up, raising prices, and what's been the competitive response?

Yes, and Leone, I think that the answer is that the competitive response has been pretty much what we have seen over the last year, which is that it's spotty, you know, in areas where you have large municipal players, obviously we've talked about that before, it's a different pricing structure when you have large municipalities involved. When you're looking at market areas with just the majors involved, again, it's pretty clear us to that if folks are raising landfill prices, that that message isn't getting out throughout the country.

You know, what we've said, we can't control what other people are going to do, we can only control what we are going to do, and what we've said is that we're going to be consistent, and we are going to be consistent in raising prices where we need to raise prices, in order to get an acceptable return on invested capital. I think the competitive response to that could best be characterized as spotty.

That said though, the 2.9%, as you said, that pricing is up, how would that compare roughly to last year?

Again that's the highest rate that we have seen in a number of years. The overall comparison to last year, Greg may have that number. Do you have the full year?

Not the full year. We just have the --

We have the five quarters sequential, you know, where it goes essentially from 2.5 to 2% in Q3 and Q4 of '05, to the 2.9% that you see in Q3 of '06. So, you know, a pretty substantial increase year to year.

Okay. And also for Bob, how are you finding with the divestitures, you noted last quarter that given their low margins, it really wasn't a concern on a dilution basis?

Yes, last quarter we didn't have as many closed as we do now, but I would tell you that I think, this is an estimate, but I would think $3 million to $5 million of EBIT is what we walked away from this quarter from the divestitures. So remember these are very low margin businesses.

Terrific. Thank you.

Thank you. With that, we'll wrap up the call.

Thank you will all again for joining us, and we look forward to talking to you after our fourth quarter results, at which time we'll give you our outlook for 2007. Thanks again.

Thank you for participating in today's conference call. This call will be available for replay beginning today, October 25th at 12:00 p.m. Eastern standard time. Through 11:59 p.m. Eastern standard time on November 8th, 2006.

The conference ID number for the replay is 7044631. Again, that conference I.D. is 7044631. The number to dial for the replay is 1-800-642-1687, or 706-645-9291. Thank you.