美國廢棄物管理公司 (WM) 2013 Q3 法說會逐字稿

Good morning. My name is Tanesha and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2013 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.

Mr. Ed Egl, Director, Investor Relations, you may begin your conference.

Good morning, everyone, and thank you for joining us for our third quarter 2013 earnings conference call. With me this morning are David Steiner, President and Chief Executive Officer; Jim Fish, Executive Vice President and Chief Financial Officer; and Jim Trevathan, Executive Vice President and Chief Operating Officer.

Before we get started, please note that we have filed a Form 8-K this morning that includes the earnings press release as Exhibit 99.1 and is available on our website at www.WM.com. The Form 8-K, the press release, and the schedule to the press release include important information.

During the call, you will hear forward-looking statements which are based on current expectations, projections, estimates, opinions, or beliefs about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are detailed in today's press release and in our filings with the Securities and Exchange Commission including our most recent Form 10-K.

David and Jim will discuss our results in the areas of internal revenue growth from yield and internal revenue growth from volume. Unless stated otherwise, please note that any reference to yield or volume results are more specifically referring to internal revenue growth or IRG from yield or volume. Additionally, any comparisons unless otherwise stated will be with the third quarter of 2012.

During the call, David and Jim will discuss our earnings per diluted share which they may refer to as EPS or earnings per share on an as adjusted basis. David will also discuss operating EBITDA as defined in our Form 8-K filed today. Our EPS, operating EBITDA, operating EBITDA margin, income from operations, income from operations margins, operating expenses and prior year SG&A expense have been adjusted to exclude items that management believes do not reflect our fundamental business performance or are not indicative of our results of operations.

These measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release footnote and the schedule attached thereto together with Item 2.02 of the Form 8-K filed today both of which can be found on the Company's website at www.WM.com for a reconciliation to the most comparable GAAP measures and additional information about our use of non-GAAP measures.

This call is being recorded and will be available 24 hours a day beginning approximately 1 PM Eastern time today until 5 PM Eastern time on November 12. 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 855-859-2056 and enter reservation code 66496035. Time sensitive information provided during today's call which is occurring on October 29, 2013 may no longer be accurate as of the time of a replay.

Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited.

Now I will turn the call over to Waste Management's President and CEO, David Steiner.

Thanks, Ed. Good morning from Houston. We are pleased with our results for the third quarter as our earnings per share increased 30% on an as reported basis and 6.6% as adjusted to $0.65 per share.

At the beginning of the year, we said that we would get back to basics by focusing on yield and cost controls. Our corporate and field managers have done just that and done it very well.

On the cost side, SG&A as a percent of revenue is 9.6%, the lowest it has been since 2005. Our operating cost programs continue to gain traction and should (technical difficulty) into 2014.

On the yield side, our results again show that focusing on yield works and we will continue to do so. Driven by the improved yield, we expanded both income from operations and operating EBITDA margins in the quarter despite continued headwinds confronting our recycling and waste to energy businesses and modestly lower volume.

In the third quarter, our overall income from operations grew $33 million and the overall income from operations margin grew 20 basis points. We also grew overall operating EBITDA by $46 million and overall operating EBITDA margin by 10 basis points.

The results were even more impressive when you drill down into our traditional solid waste business where income from operations grew $71 million and the income from operations margin grew 120 basis points while operating EBITDA grew by $74 million and operating EBITDA margin grew 90 basis points. This demonstrates the continued strength of our core solid waste business.

In our recycling business, we expected the third quarter impact to be a negative $0.01 to earnings per share but recycling operations actually had a negative $0.02 effect on the quarter. In the quarter, we saw a slight improvement in recycling commodity prices that was more than offset by increased costs from the operations of acquired businesses and the continued impact of the Chinese Green Fence.

For fourth-quarter recycling operations, we had most recently projected a positive $0.01 impact on earnings per share when compared to 2012. We now think that the impact from our recycling operations will be approximately a negative $0.03 per share in the fourth quarter which is slightly worse than Q3. That is a result of tougher year-over-year comparisons and relatively flat commodity prices when looking at our full basket of recycled commodities.

So for the full year, we anticipate that the negative impact from recycling operations will be around $0.13 per share.

The last two years at our recycling facilities have been characterized by low commodity prices and higher operating costs. We have incurred extra costs as we've had to reduce contamination from materials processed in our single stream plants to improve the quality of our bails to meet regulatory and customer requirements. In addition, recycling commodity prices can be volatile which leads to volatile earnings in our recycling business.

There is no quick easy solution to these challenges so we are taking a variety of steps to increase earnings and decrease volatility. These solutions require us to change the way that we contract with our customers. Already our areas are having more direct conversations with customers and are successfully decreasing rebates because of increased contamination levels in the customers' recycling streams. But we must do more.

Going forward, our contracts will contain the following protections that we need in order to earn an acceptable return on the capital we've invested in our recycling business.

First, many recycling contracts simply call for a split of the revenue from the sale of the commodities. This approach limits our ability to fully recover our processing costs when commodity prices are low. So, our new contracts will call for us to be paid a processing fee before there is a split of revenue from commodity sales. However, when operating costs go up as they have under the Chinese Green Fence, we still risk losing money unless we can recover those increased costs.

The single largest factor driving up processing costs is the level of contamination in the materials that we receive from our customers.

So the second change we will make is that going forward, our customer contracts will have contamination limits. We will also require a mechanism to audit the inbound materials to ensure compliance with those limits. If the materials contain too much contamination, either we will recover a higher processing fee or we will reduce the rebate to the customer to cover our increased cost.

We will also continue to educate our customers of the proper materials to place in their recycling bins through our Recycle Often, Recycle Right program to try to reduce contamination rates.

Third, our contracts need to have some flexibility to increase the processing charge or decrease rebates when outside business factors drive up our processing or other costs. So for example, if regulations like the Chinese Green Fence increase our costs we should be able to pass through incremental pricing to cover those costs.

Finally, we need to do a better job of working with our customers to ensure that we can earn an acceptable return on commodities that are or that may become low value commodities.

For example, today we lose money recycling glass. In most locations, we have to pay a third party to take the glass. For those types of materials, our contracts need to contain language that either allow us to pass along those increased costs to our customers or allow the customer to make a decision to remove a low value commodity from the recycling stream until such time as the commodity can be economically recycled.

So as you can see, there is no easy fix in the recycling business. Our recycling contracts are generally three- to five-year contracts so over time as more and more of our contracts contain these protections, we should see recycling return to being a more stable income producer that consistently earns a fair return on capital.

Turning back to yield, our yield from our collection and disposal operations was 2.3%, the fifth consecutive quarter of sequential yield improvement and nearly triple the yield we saw in the third quarter of 2012. If you add in our fuel surcharge and adjust for our South Florida waste to energy plant, we achieved yield of 2.8%.

We achieved core price of 3.9% which is an increase of 160 basis points from the third quarter of 2012. This is our best core price performance since before 2010. We also saw the highest core price in over 10 years in the commercial and industrial lines of business and the second highest in the landfill line of business.

Our yield increase in the quarter more than offset the loss in volumes resulting in overall growth in revenues and margins. The benefit of strong yield is most evident in our industrial line of business where we achieved the highest ever income from operations and income from operations margin despite negative volumes. This industrial income increase was driven by yield of 5.5% and core price of 8.4% which is the highest in nearly a decade.

We've also intentionally shed low margin rolloff volumes and avoided adding low margin new business. As we've said repeatedly over the years, the yield versus volume trade-off always favored yield and in third quarter, we proved this once again.

Of course, we want to retain our current customer base but we want to do so using tools other than price. We will focus on improving retention by providing customers with better service and higher value solutions but we will not chase volumes with low prices for large rollbacks.

In our commercial and residential line of business, we had the highest yield that we've seen since 2011. Commercial yield was 3.4% in the quarter and residential yield was 2%. Finally, MSW yield was the highest since 2010 at 1.9%.

Taken alone, the yield story is a great one but the bigger story is the increased income from operations and margins in each of these lines of business that are driven by increased yield. The commercial business saw increased margins of 40 basis points. Industrial margins increased 130 basis points. Residential margins increased 60 basis points and our landfill margins increased 80 basis points.

We saw this margin growth even though volumes were down 0.6% in the quarter and down 1.3% on a work day adjusted basis. However, the lower volumes were more than offset by higher yield.

For the quarter, recycling volumes declined 1.2% versus last year's high single digit growth. Our waste-to-energy volumes were down 3.2% primarily due to lower third-party volumes at our South Florida plants. We also saw a modest sequential decline in volumes in our collection and landfill business.

On the positive side, we are encouraged to see that the service increases in our commercial business exceeded service decreases for the second consecutive quarter.

In summary, we maintained our disciplined approach to improving price, reducing costs and managing working capital and capital expenditures which is reflected in our third-quarter results. We remain confident that we will achieve our goals despite an expected $0.13 per share of full-year headwinds from our recycling operations which is $0.11 per share more than we anticipated at the beginning of the year.

Based upon our year-to-date results, we are confident we can achieve our guidance range of between $2.15 and $2.20 of adjusted EPS and with our strong free cash flow, we are raising our free cash flow target by $100 million to between $1.2 billion and $1.3 billion.

So we've laid a solid foundation in 2013, a foundation built upon yield and cost control and driven by our corporate and field management who continue to perform at an extraordinary level. That foundation is serving us well in 2013 and we expect this foundation to continue to drive high single digit earnings growth in 2014.

I'll now turn the call over to Jim to discuss our third-quarter results in more detail.

Thank you, David. I will start by discussing our SG&A costs and cash flow performance and I will expand on David's comments about the results of operations and volume in our various lines of business. I will conclude with a discussion of our financial metrics.

Our SG&A has a percent of revenue was 9.6% for the third quarter. This is the lowest it has been since the third quarter of 2005. We improved SG&A as a percent of revenue by retaining the savings from our restructuring and focusing on controllable costs. We did so despite a net increase of $50 million in accruals for our annual incentive plans. The $50 million change was driven by a reversal of the 2012 bonus accrual and a normal accrual in the current year for incentive compensation.

SG&A costs were $349 million in the quarter, an increase of $17 million compared to the third quarter of 2012. In the third quarter, we saw improvements in bad debt, litigation settlements, and professional fees which were offset by the compensation accruals that I mentioned earlier. Without those accruals, SG&A costs would have improved $33 million. On a year-to-date basis, SG&A costs were lower by $19 million despite an increase of $93 million in compensation plan accruals over 2012.

Turning to cash flow, third-quarter 2013 net cash provided by operating activities was $736 million. This is an increase of $162 million compared to the third quarter of 2012. The strong performance on working capital, yield and cost control were the primary contributors to the almost 30% increase in net cash provided by operating activities.

Working capital improved during the quarter as we tightened up on our receivables and payables. This is particularly evidenced in our DSO where DSOs improved for three consecutive quarters and improved more than two days when compared to the third quarter of 2012.

Our capital expenditures for the third quarter were $323 million which is $79 million lower than the third quarter of 2012. Through the first nine months of 2013, capital expenditures were $824 million. We still anticipate capital spending of between $1.3 billion and $1.4 billion for the full year of 2013. We remain disciplined on ensuring that we spend capital on assets that fit within our long-term strategy and generate acceptable returns.

Putting all this together, our free cash flow for the quarter was $452 million, an increase of $272 million compared to the third quarter 2012. Free cash flow in the quarter was $413 million if you exclude divestiture proceeds. Year to date, free cash flow was $1.15 billion as compared to $614 million for the first nine months of 2012, an improvement of $533 million. Excluding divestiture proceeds, year-to-date free cash flow was $1.03 billion.

As David said, based on strong year-to-date free cash flow driven by yield, SG&A savings, working capital improvements and capital spending discipline, we are raising our 2013 free cash flow target from between $1.1 billion and $1.2 billion to between $1.2 billion and $1.3 billion.

We returned $171 million to our shareholders through our third-quarter dividend and we invested $488 million in acquisitions primarily the acquisition of RCI in Montreal.

Yield on our collection and disposal operations grew 2.3% in the third quarter. We believe that on average we need about 2% of yield to cover cost inflation. Over the last few years, our yield has not been enough to recover cost inflation. However, over the last three quarters, we have shown sequential growth in yield and in the third quarter we fully offset the cost inflation in our business.

Moving to volumes, internal volume growth was negative 0.6 in the quarter and negative 1.3% if you adjust for the one additional day in the current quarter. We saw overall collection volume decline by 2%, a modest deterioration from the second-quarter level of negative 1.4%. More specifically, commercial volumes declined 3.1%, industrial volumes declined 2.2%, and residential declined 1.4%.

In the industrial line of business, we continue to see tough competition for about temporary and permanent rolloff work. For example, we have seen temporary rolloff hauls declined 3.1% while our rate per haul has increased by more than 5% as we emphasized price over volume gains. We will continue our focus on improving yield and are pursuing higher-margin rolloff business. This trade-off was very profitable for us in the third quarter as our industrial line of business achieved the highest income from operations and income from operations margin that we have seen.

In the landfill line of business, volumes were a positive 4.1%; MSW volumes grew by 4.3%; and C&D volume rose 9.3%. Combined special waste and revenue generating cover volume were a positive 1.9%. That growth is a reflection of the growth we've seen in our energy services business.

When you look at overall operating results, our income from operations margin increased 20 basis points to 16.8% when compared to the third quarter of 2012. As David mentioned, our traditional solid waste business collection landfill and transfer stations had a very good quarter. Income from operations in those lines of business increased $71 million and income from operations margins increased 120 basis points.

The collection lines of business drove most of the income from operations increase as all three lines of business increased when compared to the third quarter of 2012. These improvements were partially offset by a combined 70 basis point decline in our recycling and waste energy operations.

In our waste energy business, average electricity pricing improved almost 3% in the third quarter when compared to the third quarter of 2012. The price improvement was offset by lower volumes and an increase in repair and maintenance costs due to the timing of plant turnarounds. Overall, the waste energy business earnings per share were almost $0.01 lower than the third quarter of 2012 and we expect a similar headwind in the fourth quarter which is consistent with our annual guidance of negative $0.02 per share given at the beginning of the year.

In the recycling business, we have seen increased costs related to the Chinese Green Fence and from acquired operations. In addition to the structural contract changes that David mentioned, we are also focused on operating cost improvements. We are looking at ways to reduce the 10% increase in operating costs at our recycling facilities. This will take some time but we have to take decisive actions to generate an appropriate return on our investments in recycling assets.

Turning specifically to operating expenses, the acquired operations of RCI and Greenstar accounted for almost $60 million of our $97 million increase in operating expenses. The majority of the remaining increase related to other recycling costs, and the timing of repair and maintenance at waste-to-energy facilities.

Finally, looking at other financial metrics, at the end of the third quarter our weighted average cost of debt was 5.06% and our debt to total capital ratio was 58.9%, consistent with our targeted ratio of 60%. The floating-rate portion of our total debt portfolio was 13% at the end of the quarter.

Our disciplined approach to yield management, cost control, capital spending is working despite significant projected headwinds for the full-year from our recycling operations, the results of the first nine months of 2013 have put us in a position to achieve or exceed our yield SG&A earnings per share and free cash flow goals and we are not going to change our focus.

We thank all of our employees who have worked hard to achieve these excellent results. With that, let's open the line for questions.

(Operator Instructions). Hamzah Mazari, Credit Suisse.

Good morning, thank you. The first question is -- just on -- how should investors think about your ability to buy back stock given higher free cash flow guidance but also given some other moving parts like higher CapEx spend? Next year, you are presumably going to pay out bonuses which aren't in cash flow this year but your cost control is better.

So maybe help us think about the moving parts, leverage on the balance sheet. How do we think about buybacks here? You haven't been in the market for a while.

Sure. A couple things here. First of all, in 2014, we expect to allocate free cash flow to dividends as we always do about $100 million to $150 million in acquisitions and the remainder to go towards a combination of debt repayment and share repurchase. And in fact, we have proceeds from divestitures and the proceeds from the exercise of stock options this year that we plan to use to buy back some shares in Q4. We will determine how much of that we will use once we see October free cash flow.

When you think about what you talked about which was a couple of the headwinds that we have on free cash flow, we have got the bonus payout, we have the expiration of bonus depreciation which will negatively impact us by about $230 million.

On the other side, we have the drivers of this year which we would expect to continue. Of course, yield, cost control, capital discipline and working capital management. So we -- and of course we intend to drive operating costs next year as well. I expect 2014 to be a solid year for us even with a little bit of headwind from those two items.

Okay. And just on the recycling side, could you give us a sense of the timeframe in renegotiating these contracts? Do you have to wait for these to expire? You said they were three to five years. And does that Greenstar acquisition earlier this year -- how does that mix differ from your legacy business and does that complicate the process further in terms of fixing the recycling business?

We do have to wait for those contracts to expire but even in our existing contracts, we have got plenty of contracts right now that have contamination level clauses and so we need to go back and enforce those. That's why we say today we are having conversations with our customers about that and we are seeing some movement. We just can't see a movement across 100% of the base. So it's going to take that three years as we see the contracts roll off.

As far as the mix from Greenstar, we inherited a couple bad contracts in that deal but as far as the mix, no, it's not a dramatic mix difference than our current recycling business.

Okay, great. And then lastly, could you remind us how much of your business now resets on CPI in Q3 traditionally? Thank you.

About 40% of the entire business resets and that's generally about 50-50 between January 1 and July 30.

Okay, great. Thanks a lot, Dave.

Corey Greendale, First Analysis.

Good morning. A couple questions. So first of all, it sounds like underlying volume trends are positive but could you speak to that a little bit more specifically given it sounds like you are pushing some volume away because of the focus on yield. So just speak to broadly what you are seeing in the economy, any regional variation what you are seeing in terms of customer service levels any increases yet?

Yes, what we are seeing -- what I would call the -- I think you'd characterized it correctly. I would call the volume environment very stable. On the industrial side, we aren't going to chase that low margin business. So other folks are going to chase that low margin business, they are going to fill up their capacity and we are going to go on the other side and we are going to get yield on the industrial side rather than volume.

So as we said, that trade-off was pretty spectacular with margins on the industrial line moving up 130 basis points.

The residential line I would say pricing and volumes are fairly stable but there's always some interesting bidding on the residential side and look, I will tell you in the last few years we probably had some interesting bids on the residential side. We've gotten much more disciplined on making sure that we don't go after residential business which is generally low margin, low return on capital and high investment of capital. We are just not going to chase those kind of volumes unless we can get sufficient returns.

Then I guess the one that's really popped up the most recently is on the recycling side. We recognize that we have to make a systemic change in the way we approach the market on recycling so that we can get long-term stable earnings. And I talked about the four things we are going to do to change the way we approach the market but you still see some folks that are out bidding large recycling contracts with just -- with a low processing fee or a simple split of the revenue and my guess is that the market will adjust to these environments of high operating costs and low commodity prices. My guess is the market will adjust but we can't control that. All we can control is what we do and we are going to take a much more disciplined approach to the recycling market.

Okay, and actually following up on that point, some of the changes that you are talking about, have you had any feedback from the market either from customers or from your people in the field on their receptivity to that kind of stuff?

And then what is involved in managing some of these things like the auditing, the recycling stream? What's involved operationally in doing that and in terms of dealing with any customer complaints and people come back and say, hey, I didn't actually have that much (inaudible) in there or anything like that?

Well, these are the mostly large municipal contracts where you are doing these audits and so it's a real interesting situation that you've got going on in the recycling market. We have pushed and everybody has pushed single-stream recycling throughout the United States. What we haven't pushed is educating the consumers as to what can go in there that can be recycled and what goes in that causes processing costs to go up. So we have to do a better job of educating and we can do that in conjunction with our municipal customers.

As far as how those conversations are going, look, I liken this to what happened in our Company about 10 years ago when we put in a fuel surcharge. When we first put in the fuel surcharge on residential contracts, there was a lot of pushback from municipal customers. There were plenty of municipal customers that said we are not going to put a fuel surcharge in because we've never done it before. We said fine, that's fine. We are not going to bid those residential contracts and over time, as fuel became more important to everybody, the market basically reset and now you don't see contracts that are put out without a fuel surcharge.

I would expect that same thing to happen in recycling. Look, the recycling business has not been economically viable for anyone over the last few years. We want to recycle as much as we can. We want to help our customers recycle but we obviously can't do that unless what we have is a long-term sustainable business model and so we are going to reset our business practices to do that. I wouldn't be surprised to see the market do the same.

Okay. And last quick one from me. I think, David, at the beginning of your comments you said something about your operating cost program accelerating in 2014. I was hoping you might just elaborate on that, what kind of cost savings you are talking about where you might find those cost savings.

Corey, Jim Trevathan here. We are doing very well with our -- it's a collection business that we are focused on on the operating side. We are making real headway especially in some of our certified locations. We've touch about half of our areas to date. We've got a couple dozen sites that we have certified as meeting the goals. We are not ready yet until guidance next year to begin to talk about those dollars but we are excited about the opportunity, Corey, and see real improvement on the operating side both efficiency and cost per unit.

Thanks and (multiple speakers) on the quarter.

What Jim and his team have done on the operating cost side is nothing short of remarkable. It really is a culture change in the way we treat our both our efficiency and our service. Right? And it takes a long time to change that culture. So we have been doing this for a while. We are going to continue to do it. It's going to be the way we do business forever and so we fully expect to see that continue to accelerate in 2014.

It really is adding the technology that we put on trucks, those onboard computers and added a real defined management process along with an accounting process to get the value out of the onboard computers and we've seen other industries do it. We are leading ours and we will get it done over the next couple of years.

Michael Hoffman, Wunderlich.

Good morning and congrats on a nice quarter, gentlemen.

Thanks, Michael.

So on capital spending, can we talk about that from a philosophical standpoint because you clearly have this objective of driving better returns and one of the three value drivers you've got your hands around you are driving better price, the other was your cost side on margins but the third one is capital efficiency. So can you frame where your head is with regards to maintenance capital spending, how we should think about that as a percentage of the business if your Company is growing organically 3% to 4%?

Sure, I will take that one, Michael. First of all, when you think about capital spending for the year, year to date, we are about $476 million under the low-end of our guidance for the year. So we've got to spend $476 million for the fourth quarter. We've averaged about $400 million the last two years and we've also accelerated just recently some truck and some HE purchases, some heavy equipment purchases end of Q4. So we think we will be at or near the bottom end of that guidance range that we originally gave.

With that said, I think -- we think that 9% to 10% of revenue is the appropriate level of capital spend for Waste Management and we think we will finish the year within that range. Basically the bottom line here is that Jim and I have put some discipline into the process this year by trimming out some of the nice to have requests. We probably, Jim, approved 90% of the rest of the requests that have come across our desk.

Especially in the second half of the year, Jim, as we instituted the discipline in the first quarter.

Yes, so I think this is really cutting out those requests that we kind of categorize as nice to have and are approving all the must have requests. Mike, we've also redefined what we'd consider to be maintenance capital versus growth capital. We used to think of a contract renewal where we had the business and the renewal required new trucks. We used to think of that as being growth capital and we have redefined that. That really isn't growth capital because it doesn't add any topline dollars. That is maintenance capital and that has to pull out of that area Vice President's fleet plan.

So if I'm hearing this correctly, we should see growth capital one come down proportionately but also there is maybe a new level where maintenance is even managed tighter and so while 9%, 10% in the aggregate maintenance is not 9% to 10%, it's going to be less than that?

Yes, so I'm saying overall total capital in the 9% to 10% range and I would say that on the growth capital side, look, if it's got the appropriate returns, we haven't turned it down. We have invested capital in our energy services business which we consider to be a nice growth business but I think you are right about maintenance capital. We are narrowing the definition a bit and putting some discipline into the process.

And by the way, Michael, when you grow revenue through yield, it takes absolutely zero capital.

Right, exactly. Okay, for you, David, on fees and surcharges, how much money are you leaving on the table by having rolled back or waived fees and surcharges and where are you in bringing new discipline around that?

Yes, it's a significant dollar amount. When we look at all of our charges, if we were at 100% compliance and obviously you are never going to get to 100% compliance but if we were at 100% compliance, that would be roughly $360 million. And so look, we aren't going to back down from our yield programs. What we are trying to do is drive a lot of different parts of the yield program not just raising prices but driving other pieces that can drive yield and you've hit the nail on the head. One of our key focuses in 2014 will be driving environmental fee and fuel surcharge compliance up.

And that's an existing -- it's already in the invoice so I'm still going to see improving the reported to us -- the reported yield should still continue to improve because you've got a discipline there but also capture an incremental revenue dollar that was already in the invoice; you've just rolled it back. Right? Is that the right way to think about it?

No, what's going on right now is that depending on the fee or the surcharge only 55% to 75% of the customers actually even have the surcharge.

And so just to give you an easy example. On the fuel environmental surcharge, in the past, if a salesperson went out and waived -- either waived the fuel surcharge or the environmental surcharge or both of them -- if they waived it for a customer, there was really no oversight about that. What we've done now is we've put rules in place that if you waive them you've got to get a higher level of approval and you can imagine just that focus on fuel and environmental raises the compliance rate.

So on new business we are going to make sure that we get it more often and on existing business, we're going to go back and in every case where we can get it, we are going to try to get it there.

And then obviously, we've got other folks that aren't at all fuel environmental and that's what you are talking about. When they are not at full fuel environmental, we can raise up -- we can raise them up to get them closer to or at the full fuel or environmental surcharge.

Okay. So now what I'm hearing is two bites at that apple which is even more interesting. So David, you kindly offered in the second quarter that free cash flow would be flat year-over-year. Having raised the guidance, will we still be flat in 2014? And it sounded like, Jim, you alluded to without saying it specifically in your opening comments, that that would in fact be the case. But I just want to get a feel for what -- how we should think about 2014's free cash.

Yes, look, Jim talked about it earlier that there's a lot of ins and outs in 2014 with bonus depreciation, with the cash going out from the compensation accruals that we are having this year, the movement of working capital. But, look, we've always said that this Company is first and foremost a free cash flow generating machine. Our guidance this year was $1.1 billion to $1.2 billion. We've now raised that to $1.2 billion to $1.3 billion.

And Michael, you and I have had this conversation many times. I've always said this Company at a very minimum every year should generate $1.2 billion in free cash flow come hell or high water but with the focus that Jim and Jim have put on capital, I am very confident that we can do that not just in 2014 but going forward.

Okay. And then collection price has lots of success. Landfill price seems to be more muted. What can be different in 2014 about the depth of which you can -- or breadth of which you can raise landfill price?

Right. There are two things. One is the contractual nature. Those are different types of contracts, longer-term contracts. But two is just the visibility. Just this year we started to get reports on sort of the top 10 customers at every landfill, we will get -- every quarter we will get what the price actions have been with those top 10 top 20 type customers.

Look, pricing is all about discipline and accountability and you can't have accountability without visibility. So it's the same approach we've taken whether it's pricing or cost. We said, you know what, we are going to get the visibility so we can hold people accountable and once you hold people accountable, it's amazing what this organization has done.

Look, this is an execution organization and once we set the right direction, they will execute and if we are holding our field managers accountable and they are holding folks accountable down the line, it's truly amazing what this organization can accomplish.

Okay, thanks very much for taking my questions.

Alex Ovshey, Goldman Sachs.

Good morning. This is (inaudible) on behalf of Alex. How are you? Any updated thoughts on the divestment pipeline for 2013 and any potential for 2014?

Can you repeat the question for me?

What does your divestment pipeline look like for 2013 and anything going into 2014?

This year we have divested somewhere in the neighborhood of $100 million and that's probably about where we typically are through the year. So I wouldn't expect it to differ dramatically in 2014.

Okay, that's helpful. And was there any noticeable change in construction related volume in third quarter and any early read on the fourth-quarter trend?

Yes, I think like we said earlier, I think that we can certainly say that the volume trend for us is very stable. When we look at the construction related volumes, we've got very good volumes at our landfill which is very high margin. We don't have as good of volume in industrial line and it's what we were talking about earlier. We basically intentionally shed some low margin industrial business and we are not going out chasing new industrial business at lower margins. We've got highest new business rate that we've had in the industrial line, goodness, probably since I've been here.

So we aren't chasing collection volumes on the construction side. The good news is -- and we're not chasing those at low margins. If we can get the right margins we will chase them but we are not chasing them at lower margin. The good news is we are still seeing that volume come into our landfills at very high margins.

So I would say that we've seen a nice uptick on the construction side. For us, it manifests itself more at the landfill. Last year, we had some industrial volumes from Sandy that obviously won't repeat in the fourth quarter but other than that, we see the volumes on the construction side being pretty robust.

That's helpful. And obviously you are focused on price and growth but in the medium-term what's the upside you see from changing your recycling contract structure and surcharges?

Look, like I said, there is no quick and easy fix on the recycling front. That's going to take some time. We have got some plans in place to see improvement but frankly it's modest improvement in the near term. In the medium term, I'd like to see how the program plays out a little bit before we make a call on what we are going to see in the medium term.

But look, again, this is no different than what we did with the fuel surcharge 10 years ago. We sort of led the industry and it became an industry standard. Look, if customers want to have recycling for the long-term which is, look, that's what all of our goal is is to have recycling for the long-term, we all need to make it a more stable and profitable business and that's what our program is designed to do.

Thank you.

Al Kaschalk, Wedbush Securities.

Good morning. Just wanted to follow up on this recycling concern or issue. David touched a little bit upon it but to me, if you are calling yourself the leader, why would we start to think about doing something more of a larger scale or more inflection point in how the business is being [grown] -- and that is have you looked at third-party processing or outsourcing of this?

Is this something you can get an economic value on doing some of the things you are talking about doing and can you do it sooner versus later because back in the 1990s or maybe even earlier than that, recycling was a bust for a lot of companies. With commodity prices down, it doesn't seem to be generating the cost of capital returns that you'd like and pricing is something that you're never going to control.

So to me, as I look at this business, are we going to continue to have headwinds on this relative to your ability to drive returns in other areas?

Right, look, short-term, I think you're absolutely right. We are looking at everything we can look short-term to improve the business. So for example, we shut down two recycling facilities and we moved that volume to third-party processors. So what you see in recycling is basically the same thing you see in the solid waste side which is it is a market-by-market analysis. So in California where you are supported by fees to support recycling, we've never really seen profitability wane.

So I think you are absolutely right. In the short term, we can do some things to change that but in the long-term, we need to make the entire business more profitable and more stable and I think the four actions we talked about will do just that.

How many facilities, David, do you have that are recycling oriented by (multiple speakers)?

Yes, we've got about 120 total and about 40-ish -- 35, 40 single stream.

Okay. I think I may have misplaced my second question. Bear with me.

Al, while you are looking for your second question, I think it's important to say that the recycling business as difficult as it has been for us over the last two years, the recycling -- it's imperative that we be in this business for our customer needs. Customers require it, we need to provide it. We just have to improve the business at this point. That's why we are taking a -- tackling these issues as David went through.

Yes, but -- I agree 100% with that but my concern is at the end of the day it appears not only for you but for the industry that this is almost a loss leader in the short term because of the education process and change in habits that need to take place to drive better than corporate average return on the business but --.

But again, Al, I go back to the fuel surcharge on the residential contract that occurred probably 10 years ago. At that point in time, our residential business was low single-digit margin and now what you see is sort of mid-teen type margins. A lot of that is driven by the fact that what used to happen is you'd enter into a long-term contract, fuel would go up so your cost structure went up and before you knew it, you were losing money on a residential contract that when you originally bid it you made some money on. And then if the municipality had a five-year renewal, they'd renew it for five years and you'd continue to lose money on it.

And so basically what we did is we said look, we've got to find out what are the drivers of profitability in the residential line of business and how do we fix this from our point of view so that we don't get stuck in this constant low single-digit margin business.

Recycling is in the exact same spot here. Jim is absolutely right. We've got to meet our customer demands and we fully expect to meet our customer demands but our customers need to realize that if they want us to meet their demands long-term, we need to make in a more viable business and we need to do that by ensuring that when times are good everybody's happy. When times are good, we are having a revenue split with our customer. They are making money, we are making money.

The problem is when commodity prices go down and processing costs go up, our customers don't lose money. We lose money on the recycling side. So we just need to make them understand that in order to make this business work long-term, we have to make some structural changes. And I would expect that over time you'll see exactly that happen and what you will find is that we are certainly the leader in recycling. I would like to be the leader in a business that has predictable solid returns.

I agree. I think sometimes it's also constructive and healthy to fire clients -- or customers.

My second question is this and I'm trying to appreciate -- obviously your comments have been focused around pricing. To me, you can only continue to get pricing when you see the volume trending positive as well. So -- or are we at a spot here where you are going to be offsetting top line on maybe a net positive because of the pricing but at some point your customer they start to push back on a little bit more aggressive pricing in the marketplace?

Well, look, we certainly haven't seen that point but look, obviously pricing gets better as volumes get better. We have got a good -- I would characterize the volume environment right now as very stable but it's not growing like it did in the 2005 to 2007 time frame. I think if we continue to see housing starts above 1 million, you will also see new business starts pick up because you have to build new businesses around those new subdivisions. And we expect the volume trends to not get dramatically better but we certainly don't expect them to get dramatically worse.

What we found is that since I have been CEO now for 10 years, what we found is that our churn rate doesn't change dramatically regardless of the level of pricing program that we put in place. So I think there's still a lot of runway to go from a pricing point of view.

But you are absolutely right, I would much prefer to see a robust volume environment. That would certainly help both from a leveraging volume point of view and from a price point of view.

One quick thing here. When you think about volume, one sure way for us to create shareholder value in really what is a mature industry here is through price increase. Now if we are going to make collection price increases sustainable we've got to get price increases on the disposal side. And I think Michael asked the question earlier about that but that is going to be important for us in 2014 is to make sure that we are mirroring the success we are having on the collection side of pricing with success on the disposal side.

If we do, then we think that that's a long-term sustainable model for growing shareholder value.

Finally, the volume decline, it was more noticeable or meaningful on the industrial side. And going over the next near-term, should we still expect -- should we think about volumes comping negative or are we back to flat line here?

Just on the industrial line, you mean?

Well I'm trying to appreciate -- I think I heard volumes were -- or you reported down 0.6 and down 1.3 day adjusted. I thought I heard industrial was where you were pushing some volumes away. Maybe that was the major component to the decline. Going forward, do you still have a few quarters where you are pruning the volume base and therefore we should expect a negative volume comp near-term?

I wouldn't be surprised by that. It's not just that we are pruning unprofitable business, we also are not chasing the low margin rolloff business. Like I said, if you give me the option of getting negative on a work day adjusted basis the industrial volumes are negative 2.2%, if we can get 5.5% yield and 8.4% core price, I'll take that trade-off every day. So what's really going on here is that we are shedding some volumes intentionally but we are also not just taking our cans and throwing them out on the street.

As other folks throw their cans out on the street and their capacity gets maximized, we are then able to go in and get selective hauls at higher prices which for us is a spectacular trade-off.

Like we said, this is the highest income from operations we've had in our industrial lines since I have been here and that's with a 2.2% volume decrease. So the price volume trade-off for us is working very well and we don't anticipate changing that.

Thanks a lot.

Joe Box, KeyBanc Capital.

Good morning guys. A question on your SG&A savings program. Now that you guys are about a year in and it looks like waste fundamentals are starting to turn, can you just maybe give us a sense of the type of leverage that you are thinking we can get on SG&A as volumes do come back? And ultimately do you think that the 100 basis points of expansion from 2012 levels are still generally doable?

What I would say on SG&A is that the comps get more difficult but what we've said to the field for 2014 is that not only were we going to be flat for 2012 to 2013 in absolute dollars but we said we are going to be flat for 2013 to 2014 and we are in the process of going through budget reviews right now. As you can imagine, that's a difficult message for not only the field but for corporate to hear but we think that it is achievable.

At some point, obviously, as your business grows you are not able to hold it flat in absolute dollars terms but we do think that over this three-year period we can hold flat on SG&A and work our way through the increases, the headwinds that we face each year from compensation.

By the way, SG&A is just exactly like what I said about capital before. If you add yield, you don't have to add SG&A. If you add volume, you do.

And that's really helpful. And I guess, Jim, just to be clear, if you hold SG&A flat, does that include the acquisitions or is that excluding the acquisitions that you've done?

It's a good question. We have basically held it flat including the acquisitions this year which has been quite a task but we expect as we said at the beginning of the year, we said we would hold flat. We are on track at this point to hold flat. We will run a little negative in the fourth quarter. We have got about $26 million worth of comp related headwinds in Q4.

As I mentioned, we had about $50 million in Q3 but we still think even with $26 million in comp related headwinds, we will finish at or below last year's levels.

Perfect, that's helpful. And then just a question on the industrial rolloff side, clearly you guys are taking a more disciplined approach there. Can you just give us a sense of, one, where your utilization is at for these assets? And two, what is your view on the pricing market going forward? Does it ever improve to the point where it actually makes sense to put these assets back to work?

I can't give you an exact utilization number but I will tell you we just went through our business reviews with our market areas two weeks ago and you don't hear anyone that says that they are missing volumes because they don't have equipment. Right? So I would characterize the market as fairly tight from an equipment point of view and look, that bodes well. That bodes very well for us both from a volume and from a pricing point of view.

Like I said before, we expect to see some stability there. I would not be surprised if we see housing starts continue at over 1 million starts that we see both price and volume on the industrial side. But we will wait to see it before we declare victory.

Perfect, thanks, guys.

Adam Thalhimer, BB&T.

Hey, good morning, guys. I would also say congratulations on a nice quarter.

David, as it relates to pricing, I don't hear you saying a lot -- hey, we are going out there and we're pushing price. I hear you talking about a mix issue. You're not going out and chasing low-margin work. I hear you talking about surcharges. But to what extent are you actively out there pushing price?

Well, look, our core price was the highest again that we've seen in a long time but I think it's a great point. Look, when we did our first cut of our pricing programs in the 2004 to 2008 timeframe, the primary weapon that we had were price increases. We are a much more sophisticated pricing company at this point time and we look at a number of different areas.

One of the areas where we end up giving away dollars is on new business pricing versus lost business pricing and then lost business versus new business. You lose business at a high margin and if you gain business at a low margin, you are going to lose EBIT dollars. So we've sort of changed the way we look at pricing from quite frankly, we don't look at yield. Obviously yield is an indicator but what we look at is total dollars drop to the bottom line from all the actions we take on pricing whether it's core price which includes fees and surcharges, rollbacks, new business pricing, lost business pricing, we take a look at all of it to understand the bottom line effect of our pricing program.

So getting a 2.3% yield and dropping zero dollars to the bottom line is not what we are looking to do. We are looking to see yield go up only as an indicator of dropping more dollars to the bottom line.

So the short answer to your question is I think you are being very perceptive which is this is much more than just core price increases. It is about pulling a lot of different levers in pricing and dropping dollars to the bottom line not just a reported number.

Okay. And then I guess the question there really is can you get more aggressive as the volume recovery plays out?

I don't think there is any doubt. But again, we can get more aggressive both on if you will net price increases but that means we can also get more aggressive on rollbacks. That means we can also get more aggressive on new business pricing. So there's a lot of ways you can drop dollars to the bottom line over and above just raising prices on current customers.

As I said earlier, Adam, it's really important that we address it on the disposal side too. So in order for us to continue down this path of success on collection pricing, we have to be equally successful on the disposal side.

Okay. Jim, is that harder or how would you characterize that versus the collection side?

Yes I think it is harder because typically you have fewer customers that are bigger customers. So there's a little more perceived risk in the manager's mind there but so increasing a small restaurant has relatively low risk to an area vice president versus a big disposal customer. So yes, it is probably more difficult but it's equally critical.

Okay. And then in terms of industry volumes, what's your sense of -- having been in this industry for decades -- what's your sense of the environment out there, what you are seeing, how sustainable it is, etc.?

Yes, I would say that it is -- again, I would say it's -- look, we are not seeing dramatic volume growth but what we are seeing is good steady volume growth and we are seeing -- where we are seeing the best volume growth frankly is at our landfill which obviously is our highest margin business so that's a good thing.

But again, when you look at it from our point of view the industry volumes I would say right now are doing more to support our pricing programs than providing volume leverage. Obviously at negative 1.3% volume, we are not providing a lot of volume leverage but what it's doing is it's filling up capacity for the rest of the industry at lower margins and we are able to -- that's able to support our pricing program.

So we are not going to go after -- I think the industry is actually growing volumes faster than we are and by the way, we are perfectly comfortable with that because if the industry wants to chase -- there's always going to be someone that's going to chase those low-margin volumes and as long as they fill up their capacity chasing those low-margin volumes, we can take the higher-margin volumes and when they collect it, they are still going to show up with it at our landfills.

It seems like almost everyone else is so kudos to you guys for being so disciplined. Thanks for the time.

Barbara Noverini, Morningstar.

Good morning. Nice job on the core business improvements.

Thank you.

So should we expect increased investment into your existing recycling plants in order to more efficiently handle contamination? For example, can increased automation make a dent in processing costs at this stage? And if not, what more can you do to reduce operational costs as you work on educating your customers and improving those contract terms?

Yes, there really isn't a lot that we can do from a technology point of view to make the processing easier. So you can't really do it inside the plant. You really have to do it outside the plant with the materials. We have got plenty of contracts that have maximum contamination levels call it at 10% and when recycling prices are high and everybody's making money, you don't go in and audit it and go back to your customer.

But once you start to realize that you are getting 20% to 30% contamination and your processing costs go up and the commodity prices go down and you start losing money, that's when you need to say look, we need to go back in where we have these clauses in the contracts, we need to go back in with the customers and say we need to do a better job of helping you get these contamination rates down. But in the meantime, we need to either charge a higher processing fee or reduce the rebate to cover our increased processing costs.

Got it. And what's involved in that auditing process? I assume that happens at the recycling plant as the waste arrives. How do you go about providing that?

(multiple speakers) You do it as the waste arrives and you go through sample loads.

I was also going to mention that there are specific things we can do in addition to the structural changes that Dave mentioned. We are -- this business has grown fairly dramatically in the number of recycling facilities over the last handful of years and it probably has exceeded the experience base of managers that have manufacturing like experience. We are moving people around that have great experience and have managed costs to locations that have the largest need and we are having real success there. You will see that little by little as we drive down that 10% increase we've seen in the operating cost per ton.

We will start cutting into that in Q4 and especially into next year.

Barbara, I guess when I look at the recycling business, what happened -- someone referred to it earlier on one of the prior questions -- what you've had in the past are some dramatic price dips on the commodities. So back in the 1990s you had it and then back in the Great Recession you had it. But those were always V shaped drops in price. They dropped dramatically and fast but then they came back dramatically and fast. So you said, okay, we can live with a little volatility now and then.

But what you've seen lately is a more sustained period of low commodity prices. So we looked at it with low commodity prices in 2009, 2010. We said, okay, we have low commodity prices, let's do something to fix that and we put in floors and different things like that not thinking that our processing costs could go up because of regulations imposed by China.

So the cost go up from the regulation to China and we addressed that and what I'm saying is we can fix some of that short-term just like we fixed the pricing or the low commodity prices short-term, we can take some actions to fix it short term but what we need to do is fix it long-term because if we don't fix it long-term, what you are going to see is that there's not going to be recycling facilities anymore.

Because, look, we want to help our customers but we also want to do it by earning a decent return on the capital that we've got invested in this business. So we need to make some systemic changes so that we can both continue to recycle but then also recycle even more for our customers.

Yes, it's great to see you digging into those issues and you know on the Chinese restrictions, have you seen any of that becoming less stringent? I know this is supposed to be a temporary measure but do you have any indication that it's going to lift anytime soon?

Yes, they recently extended it into 2014. I would say that in certain locations, you've seen a little bit of easing but certainly not enough to make a dramatic difference.

Got it, thanks for the additional details.

No problem, thank you.

And there are no further questions.

Thank you all for joining our call. We get the honor of reporting the results to you but I can guarantee you that we don't drive the results. We've got 45,000 people at this Company that are working hard every day to drive the results and in the third quarter, they did another spectacular job so I wanted to say personally to them thank you very much. And we will see everybody on the phone out on the road and we will see some of our 45,000 employees out on the road to give them a personal thanks.

So we will see you next quarter. Thank you.

Thank you for participating in today's third-quarter 2013 earnings release conference call. This call will be available for replay beginning at 1 PM Eastern Standard time today through 5 PM Eastern Standard time Tuesday, November 12, 2013. The conference ID number for the replay is 66496035. Again the conference ID number for the replay is 66496035. The number to dial for the replay is 1-800-585-8367 or 1-404-537-3406.