美國廢棄物管理公司 (WM) 2007 Q2 法說會逐字稿

Good morning. My name is Nicole, and I will be your conference operator today. At this, I would like to welcome everyone to the Waste Management second quarter 2007 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) Thank you.

I would now like to turn the conference over to Mr. Greg Nikkel, Director, Investor Relations. Mr. Nikkel, you may begin your conference.

Thank you, Nicole. 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 the financial results for the quarter, our review of the details of our revenue growth, including price and volume trends, and our updated 2007 earnings 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 hours a day beginning approximately Noon Central time today until 5:00 p.m. on August 14. To hear a replay of the call over the Internet access the Waste Management web site at wm.com. To hear a telephonic replay of the call dial 1-800-642-1687 and enter reservation code 4344708.

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 Act of 1934.

These forward-looking statements are subject to a number of risks and uncertainties which are described in detail on Waste Management's Annual Report on Form 10-K for the year ending December 31, 2006, 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.

During the course of the presentation, we will discuss free cash flow, which is a non-GAAP financial measure. We will also discuss earnings per share, earnings per share growth, earnings per share projections, effective tax rates, income from operations, or EBIT, and income from operations as a percent of revenue, all adjusted for certain one-time items which are also non-GAAP financial measures.

David's and Bob's comments on these 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 web site at wm.com .

As I stated earlier, this call will be available for replay during a two-week period. Time sensitive information given during the course of today's call, which is occurring on July 31, 2007, may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited.

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

Thanks, Greg. Good morning from Houston. I will begin by summarizing our quarterly results and will then review our pricing and volume performance in the second quarter. I will close by updating you on our expectations for the remainder of the year.

I am pleased to say that we again accomplished our primary financial goals of earnings growth, margin expansion, and strong free cash flow generation that we can return to our shareholders. This strong performance shows that our strategy at executing our disciplined pricing program, along with operational improvements, continues to be the right approach.

We earned $0.56 per diluted share in the second quarter. This is an increase of $0.11 per share, or over 24% when compared to second quarter 2006 earnings. Income from operations as a percent of revenue increased by 210 basis points to 17.9%. And we produced $475 million in free cash flow in the quarter bringing our free cash flow for the first half of the year to over $800 million.

Revenue growth from yield was again a key driver behind our strong results this quarter. We generated base business revenue growth from yield of 3.4%. If we include the 2.2% benefit from higher recycling commodity prices, yield increased a total of 5.6%. Internal revenue growth from yield increased across all four of our geographic operating groups and in our Wheelabrator and Recycle America units.

The largest contribution to our internal revenue growth from yield was again from our collection business. Combined, the revenue growth from yield in the Industrial, Commercial and Residential lines of our collection business was 4.6% this quarter. Pricing in the Commercial collection line of business led the way with internal revenue growth from yield reaching 5.7% in the second quarter of this year, which is the highest level we have achieved dating back to at least 2002.

Pricing was also stronger for the Residential and Roll-off lines of our collection business. In our Roll-off line, yield was up 4.3% despite volumes being down over 8%. This shows our disciplined approach to pricing despite the downturn in Roll-off volumes and, more importantly, even with volumes down over 8%, EBIT dollars were up in the Roll-off line of business. The price volume trade off continues to be positive.

Finally, an increase in our environmental fee from 2% to 3% also contributed to the higher yield in our collection line of business.

The internal revenue growth from yield at our landfills and transfer stations also improved in the second quarter of 2007, and we expect that to continue as we begin to see more benefits from our disposal pricing excellence program.

The pricing on MSW volumes coming into our landfills continues to grow. On a per ton basis pricing on the MSW tons progressively increased over the last several years. The percentage increases in price are comparable to the percentage price increases we are achieving in our collection line of business.

Revenue was down $52 million in the second quarter of this year as we continued to execute our strategy to the divest underperforming operations and to price increase or divest underperforming accounts in our three collection lines of business. Second quarter revenues would have actually increased $52 million, or about 1.5% compared to the prior year if you adjust for the $104 million in divested revenues.

Turning to the volume component of our internal revenue growth, we saw an overall decline in IRG from volumes of 4.4% in the second quarter of this year. Internal revenue growth from volume in our collection line of business declined 4.8% in the second quarter of 2007. The volume loss in the collection side of the business is a combination of our pricing strategy and a continued softness in roll-off [poles] related to economic conditions.

We can't control the economy, but we can control our pricing strategy and it is working. Our strategy remains to price our services to fully recover our costs, to expand our operating margins and to generate adequate returns on our investments. In doing so, we have targeted unprofitable and low-margin business. Where we have lost volumes, we have focused on flexing down our operating costs. The net result is higher income from operations and significant margin expansion in our collection line of business.

Income from operations dollars from our collection business grew by 20% in the second quarter of this year compared with the same period of 2006. Our income from operations margin in our collections business expanded by nearly 400 basis points.

We are achieving growth in income from operations and margins across all three lines of our collection business, again, despite lower volumes. This, again, confirmed what we have stated for some time, that not all collection volume is good volume, particularly if the revenue from that volume doesn't even cover the cost of disposal. When you can shed those volumes and flex costs down, EBIT dollars, EBIT margins and return on capital all grow.

That is exactly what we did with our collection business, again, in the second quarter, growing EBIT dollars by 20% and we we'll maintain that focus going forward.

At our landfills, our internal revenue growth from volume was a negative 4.4% during the second quarter of 2007. External volumes coming into our landfills showed steady seasonal improvement during the quarter, but on a year-over-year basis volumes were still lower than the volumes we saw in the second quarter of 2006.

The decline in internal revenue growth due to lower MSW volumes was negative 2%, and was primarily due to the closure of our Settler's Hill landfill in the Chicago area at the end of 2006 and our Bradley landfill in Los Angeles in April of this year. Without those events, volumes would have been flat in the MSW line.

In light of the lower landfill volumes we have seen this quarter, our financial performance was quite impressive and, again, demonstrates the quality of our pricing and operating cost programs in our collection line of business. Our strong first half results, along with our expectations for the last two quarters of the year led us to update our earnings outlook for the full year of 2007. We now expect our full-year 2007 earnings to be within a range of $2.07 to $2.11 per diluted share, excluding certain items as noted in our press release today.

As we look ahead to the remainder of 2007, we assume the economy in the second half of the year will be similar to the first half of the year. We certainly expect our earnings growth will continue to be driven by our pricing efforts and our shedding of unprofitable and low-margin collection volumes, and we expect to continue to improve our operating cost structure.

Our results in the last few years clearly shows that our strategy is working. Quarter after quarter, we continue to show significant earnings and margin expansion driven by the sustainability of our pricing excellence programs. We certainly expect that trend to continue in the near future and stronger than expected landfill volumes and roll-off [poles] would only accelerate that growth.

The success behind our strategy is due to the quality of our Waste Management employees who are responsible for developing and executing the strategy. I believe this is the best group of people in the industry and they will maintain the level of achievement necessary to accomplish our goals for the remainder of the year. With that, I will turn the call over to Larry.

Thank you, David, and good morning. I will begin by reviewing our operating cost results for the quarter. I am very pleased with the continued success of our operational excellence initiative.

During the second quarter of 2007, we again reduced our operating expenses when compared with the prior year quarter. Operating expenses in the second quarter of 2007 were $2.092 billion, or $107 million lower than in the second quarter of 2006. This is a 4.9% improvement and marks the fourth consecutive quarter in which we have reduced year-over-year operating costs on an absolute dollar basis.

As we have seen for some time, a number of factors contributed to the reduction in costs this quarter. These included our success in flexing down our operations as we shed volumes due to our pricing efforts, and the ongoing divestiture of non-strategic operations. Also, we continue to see a positive impact from our operational excellence initiatives, particularly in the area of safety.

As a percent of revenue, operating expenses improved to 62.3% in the second quarter of 2007 compared with 64.5% in the second quarter of 2006. This 220-basis-point improvement marks the eighth consecutive quarter in which our year-over-year results have improved on a percent of revenue basis due to the combination of our pricing and operational excellence initiatives.

I will now review our performance in a number of cost categories using basis-point changes as a percent of revenue in my explanation. As a percent of revenue, we reduced labor and related benefits costs by about 50 basis points. On an absolute dollar basis, we lowered our labor and related benefits costs by $26 million compared with the second quarter of 2006.

We achieved the most significant savings in the areas of overtime expense, hourly wages, and contract labor, which indicates that we are successfully managing our workforce and flexing down costs as we have reduced volumes. Improved efficiencies in all three of our collection lines of business also contributed to the reduction in costs.

We lowered our maintenance costs by about 40 basis points in the quarter. I am pleased with this result considering we estimate the annual inflation rate on our maintenance costs to be about 4% to 5%. We continue to utilize our COMPASS maintenance information system along with our standardization of best practices and tools to lower our fleet maintenance costs as we reduce driver hours. Our field managers continue to use the better information available to them to maximize vehicle utilization leading to the retirement of excess vehicles and the identification of the highest cost vehicles that we can target for replacement.

Risk management cost as a percent of revenue improved by over 70 basis points. Once again this was driven by lower worker's compensation costs, and a reduction in auto and general liability claim expenses. Our safety performance, as measured by our total recordable injury rate, an OSHA safety measure, continues to improve. We lowered our TRI-R year-over-year for the 26th consecutive quarter. In the second quarter of 2007, we improved our TRI-R performance to 4.5, which is over a 9% reduction compared with the second quarter of 2006.

There is nothing I am more proud of than the progress we have made in safety. Safety is a core value for us here at Waste Management and our people's dedication to safety continues to give us what we believe to be industry leading results. The progress we're making in safety is translating to bottom line savings. We reduced our total risk management costs by $25 million in the second quarter of 2007 compared to the same period in 2006, over half of which is due to the reduction of actuarial projections of claim losses.

Subcontractor costs improved by over 60 basis points in the quarter, as we utilized fewer third-party contractors due to lower volumes and divestitures. Lower direct diesel fuel costs translated into about a 25-basis-point improvement in operating expense as a percent of revenue. This was caused primarily by the decline in our overall fuel consumption due to the reduction in our collection volumes.

The impact of the change in diesel fuel prices was minimal as they were relatively flat between periods. Transfer and disposal expenses improved by 80 basis points during the second quarter of 2007. Our focus on exiting low-margin collection businesses where we don't internalize the volume contributed to the improvement.

One significant headwind on operating cost in the quarter was the cost of goods sold which increased by over 130 basis points during the second quarter of 2007 due to higher recycling commodity prices and the higher rebates we paid to our customers.

In the other cost category, we lowered operating our expenses as a percent of revenue by over 30 basis points in the second quarter of this year. You may recall that in the second quarter of 2006, cost relating primarily to a strike in New York City increased operating expenses by about $11 million, $8 million of that amount fell into this cost category in 2006, the absence of which largely explains the year-over-year improvement in this year's quarter.

Many of you have read recent news accounts about our union contract negotiations in our early July lockout of approximately 500 workers in the Oakland, California area. I am pleased to report that we reached agreement with the union last Thursday, July 26, and our union employees have returned to work. This labor disruption had no material impact on second quarter 2007 results. We do expect it to have a financial impact on third quarter 2007 results, and we will inform you about that in our third quarter conference call.

In all of our labor union negotiations, we have a primary objective to ensure that we treat all of our employees, both union and non-union, in a fair and equitable manner. This includes offering competitive wages and benefits and safe working conditions to each and every employee within Waste Management.

Before the lockout, we had certain goals for the Oakland collective bargaining agreement. We achieved all of our goals through the lockout, and our union employees clearly found the new agreement to be fair as they overwhelmingly approved the new agreement on Saturday.

I am proud of the efforts of our Green Team and other Waste Management replacement workers who are some of the best drivers, mechanics and route managers we have in the Company, along with the outstanding efforts of our local team on the West Coast, the call center employees around the country who handle calls for Oakland, and others within Waste Management who helped us during the duration of the labor disruption.

As I stated at the beginning of my remarks, the second quarter marks the eighth straight quarter in which the combination of our pricing and operational excellence initiatives have enabled us to reduce year-over-year operating expenses as a percent of revenue. An overall cost decrease of 4.9% on an absolute dollar basis is our best performance in a number of years. I am pleased that we have continued to make improvements through our various initiatives in spite of inflationary pressures. This demonstrates to me that our team is focused on the right things, and we remain committed to showing sustained improvement. With that, I will turn the call over to Bob.

Thank you, Larry. I will start with a review of SG&A costs for the second quarter of 2007. SG&A expenses were 10.2% of revenue during the second quarter of 2007, which was better than our expectations. Our year-over-year costs increased $15 million to $343 million in the second quarter of 2007. The primary drivers of the year-over-year increases were annual salary/merit increases and the implementation costs of our strategic initiatives, including the SAP revenue management system.

Depreciation and amortization expense for the second quarter of 2007 was down $23 million when compared with the second quarter of 2006. This year-over-year decline is due to the impacts of lower landfill volumes, divestitures and reduced depreciation expense, as we have fully depreciated an information technology system. As a percent of revenue, depreciation and amortization expense was 9.6%, compared with 10.1% in the prior year quarter.

Moving down the income statement, income from the gains on divestitures totaled $33 million during the second quarter of 2007. During the second quarter of 2007, we divested operations with annualized revenues of $172 million. Interest expense was $132 million in the second quarter of this year, a $6 million decrease from the same period of 2006. This decrease is due primarily to the $351 million decrease in total reported debt compared with the second quarter of 2006.

Our debt to total capital ratio decreased to 57.6%, in-line with our objective to be at or below 60%, and largely unchanged from last year's second quarter. The floating rate portion of our total debt portfolio stood at 37% at the end of the quarter. Interest income decreased from $20 million to $11 million for the second quarter of 2007 due to the expected reduction in cash balances and short-term investments, and the lower interest income related to a second quarter 2007 income audit settlement.

I now want to take a few moments to discuss several income tax related matters. After adjusting for the tax related benefits that we noted in today's press release, our effective tax rate in the second quarter was 34%, which reflects a 29% phase-out of our Section 45K tax credits. This phase-out percentage is based on our estimate at June 30 of the average crude oil price for the full year.

Related to that phase-out percentage are the expenses associated with our two synthetic fuel investments. These are included on the line item entitled "Equity in Net Losses of Unconsolidated Entities" which totaled $22 million for the second quarter of 2007.

For the third quarter of 2007, we currently project a benefit of $0.02 per diluted share related to our Section 45K tax credits and the operation of the two synthetic fuel plants. At the projected phase-out level of 29%, we expect a full year 2007 effective tax rate of 34% and a benefit from Section 45K tax credits of $0.09 per diluted share for the full year 2007, down from $0.11 had there been no phase-out of the credits.

Regarding 2008 expectations, Section 45K tax credits, and the related EPS benefit, go away at the end of 2007. Consequently, we expect our 2008 effective tax rate to increase to approximately 40%. Also in 2008, the income statement line titled "Equity in Net Losses of Unconsolidated Entities" will not include any ongoing costs relating to the investments in the two synthetic fuel plants, which account for virtually all of the dollars in this line item. In 2008, there will not be any earnings per share benefit from Section 45K tax credits.

We generated $537 million in net cash from operations during the second quarter 2007, a decline of $20 million when compared with the second quarter of 2006. The drop in net cash from operations resulted primarily from higher income tax payments in the second quarter 2007, and unfavorable changes in working capital due to the timing of payments. These items were offset in part by a $45 million increase in earnings before interest, taxes, depreciation and amortization.

Capital expenditures were reported at $209 million. Adding in the $147 million in proceeds from divestitures and other asset sales, our free cash flow was $475 million in the second quarter of 2007. That brings our free cash flow for the first half of 2007 to $810 million. As noted in the press release, we now expect to meet or exceed our previously projected free cash flow range of $1.3 billion to $1.4 billion for the full year 2007.

During the second quarter, we utilized our free cash flow and available cash to repurchase approximately 5.5 million shares for $196 million. We also paid $125 million in cash dividends during the second quarter of 2007. We are very pleased with the first half of the year.

As David and Larry indicated, we will continue to pursue our pricing and operational strategies which we expect will lead to the improved financial performance we outlined for the full year 2007. With that, operator, let's open the line for questions.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster. First question is from the line of Jagdeep Ghuman with Credit Suisse.

Good morning.

How are you?

Not too bad. Good quarter. I have a couple questions here. One, could you give us an update on the progress in terms of your account-by-account review on commercial accounts? Where you stand there and at what point you will start pushing price even more so on that end?

Yes. There are really two phases to it. First, we go out and we audit those customers as we talked about before with a route auditor checking waits and times to service, and then we pass those costs on to our sales department who then go out and talks with the customers that are underperforming customers. So there are two pieces to it.

The second piece, which is passing it on to the sales folks, also has two pieces to it. There are customers who we go out and immediately talk to and then there are customers like national accounts or regional accounts where we have got to get through all of the locations before we go and talk to them. Having said all that, we have been through 350,000 customers so far. We have found very consistently that about 15% to 20% of those customers are under water. Of the customers we have passed over to our sales department, the average price increase has been between 25% and 30%. It continues to work very well. We expect it to continue to provide benefits to our yield throughout 2007/2008.

Got it. Okay. Fair enough. Also, can you provide a progress update on your divestitures you have outlined, as far as assets up for sale? How much is left? What kind of progress are you seeing there?

We mentioned a couple quarters ago that we are no longer going to look upon that as a program. We're going to continue as the normal course of our business to sell our underperforming businesses if we think that is the right course of action. I will tell you the original program, we have sold well over half of the amount we originally identified and we still have others that we will sell as the opportunity presents itself.

Okay. Fair enough. One final question, with regards to your free cash flow guidance, what kind of uses for this cash are you seeing in regards to share repurchase or dividend increases? How do you rank order these things in terms of priority?

We have authority from our board of directors to spend $600 million in excess of what we guided at the beginning of the year. We still have much of that authority available.

We haven't used it yet. We clearly expect to get into that as the year goes on. With respect to other opportunities, if there's a wonderful acquisition of a landfill, close in landfill in an inner city area, we would love to buy it. There are not too many of those. If the opportunity presents itself, we will certainly would move for that.

Thank you very much, great quarter.

Thank you.

Your next question comes from the line of Jonathan Ellis with Merrill Lynch.

Great. Thanks, good morning, guys.

Good morning.

Hoping you can talk a little bit about landfill volumes? You did walk through the change year-over-year on the MSW side. I'm wondering if you can speak to landfill volumes within C&D, and also special waste?

Sure. We talked about special waste quite often. Special waste jobs can be lumpy. What we saw this quarter is that if you exclude the hurricane volumes from last year, special waste was basically flat. Flat special waste volumes are down a little bit from what we saw in previous quarters but still flat.

On the C&D line, what we saw was C&D continues to be negative, negative in the 20% to 25% range like it has been since the slowdown in the housing starts. Basically, what we saw during the quarter was a normal seasonal upturn. The volumes didn't get back to the rates they were at in 2006. Remember, in 2006 we had some great volumes in the first half of the year. What we saw were volumes that we think have stabilized.

We think, obviously, the second half of the year has easier comps. With respect to the dramatic drop off in C&D volumes that really only accounts for about 2% of our revenue, so it doesn't have a dramatic effect on earnings on the bottom line. I guess the long and the short of it is we saw volumes through this normal seasonal upturn, we saw them stabilize through the quarter and we would expect to see the same performance the second half of the year.

Great. And then just turning your attention to the pricing side, I am wondering if you can talk a little bit about pricing trends both in terms of gate rates versus contract pricing, and also in the context of contract pricing, I'm curious if you're looking at shortening any of your contact durations or strategically how you are approaching your landfill contracts now?

Yes, when you look -- we've talked about it a lot. About 70% to 75% of the volumes at the landfill are contracted volumes. There are two pieces to that, too. There are pieces where you don't really have much of a say in the duration of the contract. When a big bid comes up from a municipality, they're going to dictate what the length of the contract is, so you're not going to play with that.

Frankly, on the non-municipal contracts, basically third-party haulers, we're going to do what is right for our business, whether it is a one-year contract, a two-year contract, or a three-year contract, we are going to make a decision that is based on return on invested capital. If we can get a high enough price and lock it in for a period where we get good price increases through the term of the contract, I don't see why we would want to lock into a one-year contract.

When you are the price leader you want to stay the price leader. If you can get a contract that keeps you as the price leader I don't know why we wouldn't do that. At the gate, what we have seen as the prices at the landfill have basically come up to the same type of levels, in some cases exceeded the levels of our collection pricing program. We're very happy to say that disposal price in excellence is working. We expect to see continued benefits out of that through 2007/2008.

Great. And then just a final question from me, in terms of capital spending, it looks like you lowered the high end of your guidance from $1.38 billion to $1.35 billion, according to the press release. Wondering if you can talk about what precipitated that?

I don't think we did that at all. I think what we said was that we expect to meet or exceed our free cash flow guidance for the year.

Yes. I think our guidance initially was $1.3 billion to $1.4 billion.

Correct.

We think we will meet or exceed that.

Okay, I am sorry. I was comparing the 1Q press release to the 2Q press release. Thank you.

Certainly. Thank you.

Your next question comes from the line of Corey Greendale with First Analysis.

Hi. Good morning.

Good morning.

On the landfill pricing, can you talk about what you're seeing from competitors as you raise price, whether they are going along with you or not?

You have to break it down into the various segments. It is interesting, at the special waste line, again, special waste jobs can be, there is a huge mix component in special waste, unlike some of the other line items. We have seen great price increases on our side of the table in special waste. Quite frankly, that is why we lost volume in the quarter.

What we saw were some big jobs that came up where folks were bidding high, low, single or single-digit or low double-digit pricing. We are not going to go there from a special waste point of view. So on special waste, I think the competitive arena is still very active and you haven't seen a lot of price movement on special waste.

You've seen more on C&D and MSW. We have talked about it now for 18 months. It is spotty. You see some places where folks are reacting such that you know they're taking into account return on invested capital, and they are understanding that you will never be able to sell landfill ton again. If you can hold on to it it will be worth more in the future. We're starting to see people understand that, but then you will see some places where it is a little bit spotty. We talked about it before. That is mostly places like the Midwest.

Okay. For Bob, can you share any thoughts, or are you willing to share any thoughts on where SG&A and D&A come in for the full year as a percent of revenue?

I don't think we're going to change our view on the SG&A for the year. We'd said it would be a little bit above 10.5%, I don't think that will change. I think there's some timing issue here on some of the SG&A spending, if that does change we can certainly talk about it in the future. We expect D&A to be down comparable to what it was this time for the full year as a percent of revenue basis, maybe a little bit higher.

Okay, and is there any reason, I was just looking at the historical seasonality on the gross margin line. Any reason to think that historical trends are not pretty indicative of what you will see this year?

I can't imagine why you'd see any change in the pattern.

Okay. And my other question is just any revised thoughts on CapEx with volumes down? Are you still thinking it will be about what you suggested at the beginning of the year?

We haven't updated that guidance. At the beginning of the year, I think we said $1.25 billion to $1.35 billion. I think we will see -- in fact, we have curtailed some of our container purchasing with the volume declines, but we haven't updated that range. I would expect to be still somewhere probably in that range, maybe a little below it.

Thank you.

Your next question comes from the line of Scott Levine with JPMorgan.

Good morning.

Good morning, Scott.

Regarding volumes, a little bit of improvement here, Q1 to Q2. Wondering if you could discuss your thoughts on the macro landscape and how that is coming in relative to your expectations and what your thoughts, in particular, are on the roll-off segment of the business as we move into the back half of the year?

Yes. I think it is safe to say that at the macro level, remember, at the beginning of the year, we talked about, as far as seeing a back half weighted year, I think it is safe to say that, frankly, the volumes have not been as robust as we expected them to be when we looked at the year -- at the beginning of the year. Frankly, our operational improvements and our pricing programs have made up for that decrease in volume.

When you are growing EBIT dollars on the collection line by 15% to 20%, that can make up for a little bit of softness in the landfill volumes. And that's exactly what we've seen. That's why we say, if we see landfill volumes or roll-off [poles] bounce back in the second half of the year, there is going to be an upside to our guidance.

On the roll-off line, I think it is safe to say, remember, in the first quarter, roll-off [poles] were down over 9%, second quarter they were down 8%. The comps get easier in the back half of the year. We would expect the [poles] to stabilize. What we think we have seen is that we've seen some stabilization. It is going to be a U-shaped recovery in the housing sector. it won't be a V-shaped recovery. What we have seen, we believe, is the bottom of that curve. So that we're going to see stabilizing volumes, which, obviously, will look better in the second half of the year because the comps will be easier.

Okay. Turning to price, could you talk a little bit about how the retention rates are looking on your collection business and how they are coming in relative to your expectations at the beginning of the year, as well?

Yes. Our churn rate stays at the 9.3% level. Again, that is well below where we have been historically in the past. That is about where we expected at the beginning of the year. When we expected that, the 9% to 9.5% range at the beginning of the year, that wasn't taking into account that we would be shedding a lot of customers intentionally through our business improvement process.

Frankly, I think it is a great performance on the retention side given that we are voluntarily asking -- when I talked about that business improvement process, the one thing I failed to mention was that for those customers where we are asking for price increases, on average 25% to 30%, when we are asking for those price increases, about 85% of those customers are sticking with us. But 15% are leaving. So given that, I think the 9.3% churn rate is quite an accomplishment.

Okay. One last one on costs. Are there any other areas you would point to because your dollar savings on a year-over-year basis are increasing the last couple quarters? Are there any areas you'd point us to as you see as the greatest sources of further improvement over the next few quarters?

We are going to keep focusing on the initiatives that we have had going here for awhile. Everything from safety, safety continues to give us some great results. It has the added benefit of making it a safer place to work and a safer place for our communities. We are continuing to see the improvements there.

When you look at productivity, which we now call efficiency, I think there is still opportunity there. That is part of what we get out of our business improvement process. It is not only about pricing. It is also about finding ways to run our routes more efficiently. I think we will continue to see opportunities there, and maintenance is another area we have been focused on for awhile.

We now, have information that our maintenance technicians have available to them. That is certainly helping drive our improvement. Those are the areas we will continue to focus on. I think there is still opportunity in each one of those areas to help us further improve our costs.

Okay, and one quick add-on. I know you didn't quantify the strike related costs in Q3, but you had a strike in the second quarter in New York and D.C. Can we use that as a rough approximation in terms of the duration and number of people to estimate what the expected costs might be here for the Bay area?

The lockout just ended did this weekend, and we are just beginning to get the bills in from some of the costs. In fact, some of the replacement workers just started going home on Sunday. It is really too early for us to be able to give you a good number on what that number is expected to be. That is certainly something we will cover in our third quarter call.

We had a lot of people out there. This was a big event, big labor disruption for us, a lot bigger than anyone that we'd had before. I am going to expect -- I suspect the expense is going to be higher than what we saw in the other locations, but I won't know that, none of us will know that until we start pulling together the costs as they start coming in.

Okay, great. Thank you.

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

Good morning.

Good morning, Bill.

Yes, a couple things. First, if you look at the mix of your higher margin commercial collection versus lower margin industrial roll-off side, with all the divestitures and volume changes, do you see a mix move toward the commercial side, a higher mix of that? Where I am going with that is, do you also see the more volatile temporary roll-off side shrinking as a percentage of total from where you were last year?

Clearly, when you have got 8% this quarter, 9% last quarter, when you have that kind of volume loss on the industrial side, again, mostly temporary roll-off, certainly you see a slight mix shift, just like when we started culling out the unprofitable residential contracts, you saw a slight mix shift there.

Bill, again, when I look at the collection line of business I like to look at bottom line EBIT dollars because whether we make an EBIT dollar at a great margin on the residential line, the commercial line, or the roll-off line it is all about dropping more EBIT dollars to the bottom line. And we're very pleased this quarter to see those EBIT dollars grow by 20%.

Okay, great. And just following up on the pricing you mentioned earlier on, I think it was 350,000 customers you had targeted on the one initiative. Can you remind us how many total customers you have, or how far you are through on that part of the pricing?

We are 50% through on the audit side. Again, you have to remember that when you're 50% through on the audit side, that doesn't mean you have touched 50% of the customers because a number of those customers, in fact, a good number of those customers have to be deferred until you cover all of their locations. If you have a regional or local or a national customer, you have got to get through all of their locations before you can go talk to the customer. So the fact we have been through 50% of the audits does not mean we have been through 50% of the customers to seek a price increase.

Okay, great, thank you.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Leone Young with Citigroup.

Yes. Good morning.

Good morning.

Two things. To the extent you can talk about it, Larry, you mentioned that you did achieve several goals with the lockout. Could you be a little more specific and possibly whether they have positive or negative ramifications of your settlement on upcoming labor negotiations?

Sure. I would be happy to. We really had an unusual agreement in Oakland. I would say the agreement we had previously in Oakland was unlike any other union contract, certainly, that I am aware of, and I've been told probably anywhere in any industry. One of our goals was about safety. As you have heard us talk for a long time, we are serious about improving the safety for our employees as well as the communities we serve. It has been, for a long time, our goal to become world class in safety.

When you look at our Oakland operations, as it turns out, they actually have the worst safety record of anywhere in our Company. I will just give you a couple examples. Number one, the driver incident rate is about 200 times, 200% higher than our Company average. When you look at the number of drivers that have been involved in multiple accidents, they are 310% above the Company average.

In the prior collective bargaining agreement we had with the Teamsters, really prevented us from being able to implement effectively the Waste Management safety program that we have put in everywhere else. And, of course, you have heard me report on the dramatic improvement we have had everywhere else with the a successful program, but unfortunately we weren't able to implement it effectively given the agreement that we had previously there, the collective bargaining agreement that we had in Oakland.

That was a focus for us. We wanted to make sure that we were able to provide a safe environment for our employees, as well as for our community. That is what our safety program is all about and so it was very important, it was a top priority for us to be able to get the appropriate safety rules in the collective bargaining agreement so we could begin to see the improvement in Oakland that we had seen everywhere else. So that was goal number one and we were successful in getting that type of language in the agreement.

Number two -- and this was what was very unusual -- I am not aware of this language being in any other collective bargaining agreement anywhere. They essentially had the right to go on strike any time they wanted for whatever reason they wanted any time. They could actually use that to -- as a threat, and they had used it as a threat. We were having negotiations with other unions in other cities. It would come up that Oakland was going to go out on strike in support if we didn't agree to various terms. So we constantly had that threat hanging over our heads.

What you find, it is very standard language in typical collective bargaining agreements is a provision that says during the term of the agreement, the Company won't lockout the employees and the employees won't strike. If you have any disagreements there is a process, usually some form of binding arbitration or something like that.

We did not have that language previously in that agreement. Very, very unusual. That was important to us to get that standard type language in our agreement so that we could ensure we would have labor peace throughout the term of the agreement, and not constantly suffer the threat of disrupted service to our Oakland customers there. So that was important to us and we were able to get that language that we wanted in the agreement.

We were very pleased with that. Those were our two primary objectives which we were able to achieve. The reason we ended up having to lock out the employees, it was clear to us what they were going to try to do -- they had refused to negotiate at all with us. It appeared to us they were trying to delay negotiations to then get it lined up in time with the negotiations that we were then going to have in Los Angeles.

We had that contract -- union contract will expire at the end of September. We felt it important to deal with Oakland on its own, separately, while we could cover the routes and make sure we able to continue to provide service to the Oakland customers, and deal with that and not have it line up with the expiration of the Los Angeles contract.

Terrific. My second question, could we get an update on your SAP implementation?

Yes, Leone, the pilot in New Mexico continues. We have learned a lot from it. We are now in the process of not only continuing that pilot, but also taking the learnings from that pilot and working with SAP to enhance the program to cover needs we have identified that we didn't understand until we went through the pilot. So I think it is moving along, perhaps not as fast as we would like, but it is moving along quite well. We expect, we to believe we have an excellent product by the time we finish implementing the solution review. I think we are moving along just fine.

Thank you.

Your final question comes from the line of Brian Butler with FBR.

Good morning.

Good morning, Brian.

Just two quick ones. On new business pricing, can you comment a little bit on the trend there and how that is comparing to your current pricing? Is it moderating or is the spread between the two widening?

Yes. Remember, Brian, when we first started the pricing program 18 months to two years ago, we were seeing new business pricing, that is exactly where we focused was on new business pricing. And we were seeing new business pricing in the range of 10% to 20% when we originally started the pricing program. Obviously, you are not going to see that kind of increase year-over-year. You saw it early on. It has moderated. It has moderated into the high single-digits on new business pricing.

But one of the things we always look at, and we've talked about before, it happened first in the second quarter of 2006, which is that the average price at which we are selling new business. If you are selling new business at $5 a yard, the average price at which we are selling new business is higher than the average price at which we are losing new business. So if you are selling new business at $5 a yard, you're losing it at $4.60 a yard, obviously, you get some great earnings benefit from that.

We've seen that, we saw that flip in the second quarter of 2006, we still continue to see that in both the commercial and the industrial lines of business. I think you have hit the nail on the head. New business pricing is absolutely a focus of ours. We continue to see robust increases in new business pricing.

Okay. Great. Last question, when you think about this pricing strategy, it has been working great as you said for the last 18 months, you have seen very good margin improvement. Over the next, let's say, 18 to 24 months, how much more margin improvement is reasonable, I guess? Is there any expectation there?

We haven't talked about a particular margin improvement. But, certainly, if we can't get price increases that are in the range of 100 basis points above CPI, and if we ultimately see the volumes moderate such that we are not losing volumes, we're getting our fair share of the volumes from GDP growth, certainly, you should expect to continue to see triple-digit margin expansion from us.

Great. Thank you very much.

Thank you. In summary, we once again had another great quarter here at Waste Management. We're very pleased by the price volume trade off. And, Brian, I think, hit the nail on the head in the last question, which is 18 months to two years ago, everybody wondered when we started the pricing program, is it going to be sustainable?

I think what we have shown over the last two years is that the pricing program is sustainable. We absolutely expect it to continue on in the future, and we absolutely continue to expect to meet our three primary goals of growing earnings, growing margins, and growing free cash flow that we can return to shareholders. With that, operator, we will say thank you, and we will see you all again next quarter.

Thank you for participating in today's Waste Management second quarter 2007 earnings release conference call.

This call will be available for replay beginning at 1:00 p.m. Eastern Standard Time today through 11:59 p.m. Eastern Standard Time on Tuesday, August 14, 2007. The conference ID number for the replay is 4344708. Again, the conference ID number for the replay is 4344708. The number to dial for the replay is 1-800-642-1687, or 706-645-9291. You may now, disconnect.