Ed Egl - Director, IR David Steiner - President and CEO Jim Fish - EVP and CFO Jim Trevathan - EVP and COO.
Scott Levine - Imperial Capital Derek Sbrogna - Macquarie Capital Amit Mehrotra - Deutsche Bank Hamzah Mazari - Credit Suisse Alex Ovshey - Goldman Sachs Joe Box - KeyBanc Capital Markets Corey Greendale - First Analysis Michael Hoffman - Stifel, Nicolaus Charles Redding - BB&T Capital Markets Barbara Noverini - Morningstar Tony Bancroft - Gabelli & Company.
Good morning, my name is Jenisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2014 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.
(Operator instructions) I will now turn the call over to Ed Egl, Director of Investor Relations. You may begin your call..
Thank you, Jenisha. Good morning everyone, and thank you for joining us for our second quarter 2014 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 and is available on our Web site at www.wm.com. The Form 8-K, the press release and the schedule for the press release include important information.
During the call you would hear forward-looking statements which are based on current expectations, projections or opinions 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 discussed in today’s press release and in our filings with the SEC, including our most recent Form 10-K. David and Jim will discuss our results in the areas of yield and volume which unless otherwise stated more specifically references the Internal Revenue Growth or IRG from yield or volume.
Additionally, any comparisons unless otherwise stated will be with the second quarter of 2013. During the call, David and Jim will discuss our earnings per diluted share, which they may refer to as EPS or Earnings Per Share. David and Jim will also address operating EBITDA and operating EBITDA margin as defined in the Form 8-K filed today.
EPS, income from operations margin, operating EBITDA, and operating EBITDA margin results discussed during the call have been adjusted to exclude items that management believes do not reflect the 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 schedules in the Form 8-K filed today which can be found on the Company’s Web site at www.wm.com for reconciliations to the most comparable GAAP measures and additional information about our use of non-GAAP measures.
Please note that our Form 8-K filed earlier this morning also include a copy of our press release announcing that we have entered into an agreement for the sale of Wheelabrator.
You should be aware that projected EPS, free cash flow and all other forward-looking statements except those specifically pertaining to the Wheelabrator transaction do not incorporate any benefits or costs associated with the Wheelabrator transaction.
For additional information on the proposed transaction or related risk and uncertainties, please see the press release filed at Exhibit 99.2 to our Form 8-K. This call is being recorded and will be available 24 hours a day beginning at approximately 1:00 PM Eastern Time today until 5:00 PM Eastern Time on August 12.
To hear a replay of the call over the Internet, access the Waste Management Web site at www.wm.com. To hear a telephonic replay of the call, dial 855-859-2056 and enter reservation code 63619185. Time-sensitive information provided during today’s call which is occurring on July 29, 2014, may no longer be accurate at the time of a replay.
Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited. Now, I will turn the call over to Waste Management’s President and CEO, David Steiner..
Thanks, Ed, and good morning from Houston. We had a very good quarter, and we’ll talk in detail about our results, but first I wanted to discuss the news in today’s press release announcing that we have signed a definitive agreement to sell our Wheelabrator waste-to-energy business to Energy Capital Partners for $1.94 billion.
As we have said before, our waste-to-energy business has two distinct components. The tip fees that we receive on the front-end, and the payments for energy on the back. We did not view the energy payments as strategic and we do not have the depth of energy expertise that Energy Capital Partners has.
Consequently we have entered into a waste supply agreement from the front-end, where we will use our expertise to fill up the plants for seven years just like we do today. But we will no longer have the volatility of the financial results related to Wheelabrator electricity sale.
We use the proceeds from the sale in a way that is most accretive to earnings and creates the most shareholder value. We’ll do so by buying back shares, or doing acquisitions in our core business if they’re more accretive and to create long-term shareholder value. We’ll do all of this while maintaining our strong balance sheet.
Wheelabrator is a high performing organization that reflects the quality of the people, our friends and colleagues that operate it. I want to thank Mark Weidman and the entire Wheelabrator team for their hard work and dedication.
They made our waste-to-energy business successful and we anticipate that the business will continue to be successful under Mark’s leadership and ECP’s ownership. Returning to second quarter results, the solid performance that we saw on the first quarter continued throughout the second quarter.
Once again our yield and cost control programs drove growth in both our income from operations and operating EBITDA and led to expanded margins in our traditional solid waste business and our overall business. In the second quarter, we earned $0.60 per share, an increase of over 10% when compared to the second quarter of 2013.
In addition we saw nice improvement in net cash provided by operations and free cash flow. Through the first six months of 2014 our employees have executed on our business plans and we’re encouraged by the strong results. We expect that this performance will continue throughout the remainder of the year.
Our yield program continues to be a significant driver of our margin expansion.
For the second quarter, our collection and disposal yield was 2.3% which is the fifth consecutive quarter of yield above 2%, it is down slightly from our Q1 yield primarily due to increased revenue and the anniversary of the implementation of our regulatory cost recovery fee in 2013.
Our core pricing remains very strong at 3.9%, a year-over-year improvement of 10 basis points. Each of our lines of business had positive yield with the exception of landfill C&D.
In the landfill MSW line same-store average rates increased 5.1% and through the second quarter nearly 90% of our contracted third-party landfill customers have received a price increase. The remaining landfill customers either perform event work or have restrictions that limit price increase opportunities.
When compared to the second quarter of 2013 same-store average rates in both the commercials and industrial lines increased 4.4%, and we saw a 3.1% increase in our residential line.
This has had some effect on volumes particularly with regard to national accounts and residential contracts but we continue to see the trademark as positive as the operating margin in our traditional solid waste business was up 50 basis points.
Turning to volumes, in the second quarter volumes were a negative 1.4% which is an improvement of 40 basis points from the first quarter. More than 50% of our volume decline came from several low margin, but large national account losses.
In the second quarter we saw a positive landfill and transportation volumes more than offset by declines in the collection lines of business. Despite negative volumes overall income from operations grew more than 9% and our income from operations margin grew 120 basis points.
In addition operating EBITDA increased more than 5% and operating EBITDA margins increased 120 basis points to 25.6%. When we issued volume patterns at the beginning of the year, we expected volumes to be around a negative 1% for 2014.
Through the first six months volumes have declined 1.6% and we now expect that to be about the run rate for the remainder of the year, with the change being primarily attributable to the continuing impact of lost national account business.
Our recycling operations also performed better in the quarter, adding almost $0.01 in earnings per share compared to the second quarter of 2013, despite a 2.1% decline in average commodity prices.
The efforts that we have put in place to improve our enforcement on contaminated loads and modify the methods for calculating rebates to customers are paying off. Operating cost in the recycling line of business improved almost 8%, primarily due to lower rebates and reduced labor costs.
Turning to our waste-to-energy business, in the second quarter operating results were essentially flat when compared to 2013. We did not change our full year EPS or free cash flow guidance as a result of the proposed sale of Wheelabrator. But if the deal closes before the end of the year, it could have a minor impact on earnings and cash.
On average our waste-to-energy operations would produce about $0.015 of earnings and $10 million in free cash flow per month. We expect that this transaction will close sometime in the last two months of the year, in which case the effect on this year’s earnings and free cash flow would be minimal.
Our solid first half performance on yield and cost controls makes us confident that we can meet or exceed our full year earnings growth goals.
But first and foremost our Company operates to generate cash flow and when we combine our yield and cost focus with our focus on capital discipline and working capital we expect to see strong cash flow in the second half of 2014. Consequently we expect to meet or exceed the 1.5 billion high-end of our free cash flow guidance.
I’m now going to turn the call over to Jim to discuss our second quarter results and the sale of Wheelabrator in more detail..
Thank you, David. Before discussing the details of our second quarter results I want to provide some additional information on the sale of our Wheelabrator business. After normal transaction adjustments to the sales price, we anticipate receiving about $1.85 billion in cash once the transaction is finalized late this year.
With our basis in Wheelabrator we will pay no taxes on the transaction and it should generate a capital loss of approximately $300 million that we can utilize over the next five years. Our base Wheelabrator divestiture model assumed a partial use of proceeds to maintain leverage neutrality with the majority of the proceeds going to share repurchases.
The diluted EPS accretion in that model is about $0.02 per share for 2015. Of course, we will look for reasonably priced core businesses to replace the $220 million of Wheelabrator EBITDA, if they are accretive to the base model.
In either case, we would selectively retire debt to the extent necessary to maintain our strong balance sheet and our target leverage ratio of about three times EBITDA. On the share repurchase front, we’d anticipate it that we would in the market repurchasing our shares in the first half of 2014.
However, we suspended share repurchases while the Wheelabrator transaction was pending. Now that we’ve announced the transaction we have entered into an accelerated share repurchase program to spend the full amount of our previously announced $600 million authorization on share repurchases.
We will fund the $600 million on August 1st, and we’ll see an initial delivery of approximately 9.6 million shares representing 70% of the shares expected to be retired.
The actual number of shares repurchased will depend upon the volume weighted average price of our stock, less a discount during the repurchase period which we expect to be three to six months. Turning to our second quarter results. Our revenue grew 1% to $3.56 billion.
Strong yield and acquisition revenue were the main drivers with volume declines and a negative foreign currency translation muting revenue growth. The foreign exchange impact on revenue was approximately $14 million. We continue to see improvement in all our cost lines.
Operating cost as a percent of revenue improved 90 basis points to 64.6% and improved $10 million in the second quarter. Reduced cost at our recycling facilities and the sale of an asset improved the cost of operations, $41 million, and we were partially offset by increased cost related to recently acquired businesses.
SG&A costs were flat when compared to the second quarter of 2013, at $353 million and improved as a percent of revenue by 10 basis points to 9.9%. We are still on target to achieve our full year SG&A goals. Turning to cash flow, for the second quarter we generated $447 million of free cash flow, an increase of $100 million when compared to 2013.
We accomplished this by growing our net cash provided by operating activities, $10 million to $555 million, by improving working capital and by maintaining discipline on capital spending.
The growth and net cash provided by operating activities was muted by an increase of over $70 million in cash taxes primarily related to the repatriation of accumulated cash from Puerto Rico operations and the expiration of the bonus depreciation allowance.
Our capital expenditures for the quarter were $208 million, a decrease of $27 million from the second quarter of 2013. We also divested our Puerto Rico operations and other assets in the quarter, for about $100 million. Year-to-date 2014, we’ve generated $931 million in total free cash flow and $665 million excluding divestiture proceeds.
This is the highest free cash flow we have ever generated through the first six months of the year, puts us on-track to meet or exceed the upper-end of our full year free cash flow goal of between $1.4 billion and $1.5 billion, despite a planned to pickup in capital expense, in the second half of 2014.
Looking at internal revenue growth for the total company, in the second quarter our collection and disposal yield was 2.3% with volumes declining 1.4%. This led to income from operations growing $48 million, operating income margin growing 120 basis points, operating EBITDA growing $48 million, and operating EBITDA margin growing 120 basis points.
Our collection line of business continues to see the benefit of the yield volume trade-off. Both our commercial and industrial yields were 4.2%m while residential was 1.6%. Overall collection yield was 3.2% with volumes declining 4.1%. This led to income from operations growing $7 million and margin expanding 10 basis points.
The industrial line of business drove the growth in income from operations, but that growth was muted by continued declines in the residential line where we lost two profitable franchised contracts.
In the landfill line of business for the second quarter, we saw the benefits of both positive volume and positive yield, just as we did in the first quarter. Total landfill volume increased 3.9%. Combined special waste and revenue generating cover volumes were positive 2.1%, MSW volumes grew by 4.4% and C&D volume grew 11.5%. MSW yield rose 2%.
This led to income from operations growing $9 million which is the fifth consecutive quarter of growth and margins grew 20 basis points. Finally looking at our other financial metrics, at the end of the second quarter our weighted average cost to debt was 4.79% and the floating rate portion of our total debt was 12% at the end of the quarter.
Our income tax rate in the quarter was 44.7% primarily because foreign cash accumulated in Puerto Rico was repatriated to United States upon divestiture of the operations. For the next two quarters we expect our tax rate to be approximately 35%.
We’re encouraged by the results for the first six months of the year which put us on-track to meet our full year targets. The strong momentum in our pricing and cost controls sets us up nicely for the second half of 2014 and positions us for continued success into 2015 as we look to redeploy the proceeds from the sale of Wheelabrator.
I would be remised if I do not thank our employees for their hard work, because of them 2014 has been successful so far and we’re looking forward to continued improvement with their help. I would particularly like to thank the employees of Wheelabrator. They have been valuable teammates. We take pride in running a great and safe business.
I know they will continue that success under the ownership of ECP. And Jenisha with that we’ll open the line up for questions..
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(Operator Instructions) Your first question comes from the line of Scott Levine of Imperial Capital..
Congratulations on the quarter and the sale of Wheelabrator there and I guess my first question here is in the press release announcing the sale you mentioned the fact that there are some targets out there that you’re interested in.
And that there is a good sized pipeline, we haven’t seen a lot of larger acquisitions with the exception of RCI, out of you guys recently but a little bit more color on what you see out there and additional thoughts with regards to the timing at which point you might look at deploying capital for buybacks versus M&A a bit more color on your investment plans and do you see them for the proceeds after the deal closes?.
Congratulations on the quarter and the sale of Wheelabrator there and I guess my first question here is in the press release announcing the sale you mentioned the fact that there are some targets out there that you’re interested in.
And that there is a good sized pipeline, we haven’t seen a lot of larger acquisitions with the exception of RCI, out of you guys recently but a little bit more color on what you see out there and additional thoughts with regards to the timing at which point you might look at deploying capital for buybacks versus M&A a bit more color on your investment plans and do you see them for the proceeds after the deal closes?.
Scott generally what we’re looking at is as you can well imagine are sort of those smaller tuck-in acquisitions. And obviously you’ve got to in order to spend the kind of money that we’re selling this Wheelabrator business for, we’re going to have to put together quite a lot of those. So it will take time if we’re going to replace that EBITDA.
As we’ve said to the extent we can’t do that we would buy back shares. The whole theory of the transaction was that we didn’t want to do a deal that wasn’t going to be accretive to earnings and so we used this base case of 100% of proceeds going to debt pay down and share repurchase as our base case.
The good news is that that’s accretive and to the extent that we can buy businesses to tuck them in that would replace the EBITDA that’s a net positive for us.
So we’ll be looking at that over the next few months as we move toward a closing and then I will expect Scott that once we do close it at the end of the third quarter mid fourth quarter we’d have a much better defined plan as to how much of those proceeds we can actually deploy into new businesses..
And then as my follow-up, I think Jim had mentioned that you’d lost a couple of profitable franchised contracts during the quarter. Maybe a little bit more color regarding the competitive landscape and your commitment to pricing, I am assuming that continues.
But is the environment becoming more or less competitive a bit more color on the operating environment and pricing there?.
And then as my follow-up, I think Jim had mentioned that you’d lost a couple of profitable franchised contracts during the quarter. Maybe a little bit more color regarding the competitive landscape and your commitment to pricing, I am assuming that continues.
But is the environment becoming more or less competitive a bit more color on the operating environment and pricing there?.
Look the residential line of business is always very competitive because they are large contracts, sort of just like the national accounts. I would characterize the pricing environment as fairly stable.
Look there is really only two things that we can look at to determine the pricing environments and that is the discussions with our local managers and publicly reported statistics. And I don’t think there is any doubt that in the last 12 months to 18 months we’ve seen some of our larger competitors favor volume over price.
That’s not something that we traditionally have done and obviously that has cost us volume. But overall I’d say that when you look at all the competition out there that it’s fairly stable..
Your next question comes from the line of Derek Sbrogna of Macquarie Capital..
So maybe one first on the core, the landfill pricing, I missed on your landfill pricing you mentioned of positive 5.1%. Does that include any of those contracts which are linked to CPI and maybe give us a sense I know you guys have talked about on the overall business about 40% of the contracts being linked to CPI.
But maybe give us a sense of what that is on the landfill side, just to get an understanding of how much of that business is versus competitive markets versus what’s linked to CPI?.
So maybe one first on the core, the landfill pricing, I missed on your landfill pricing you mentioned of positive 5.1%. Does that include any of those contracts which are linked to CPI and maybe give us a sense I know you guys have talked about on the overall business about 40% of the contracts being linked to CPI.
But maybe give us a sense of what that is on the landfill side, just to get an understanding of how much of that business is versus competitive markets versus what’s linked to CPI?.
Yes, when we look at landfill contracts, there is really two things. It’s not just CPI. There is also, a lot of those contracts will have just a standard price increase in it. So just to use an example, it might be a $30 contract, and it goes up to $32 the following year, 34.
So it won’t have a specific CPI related, but it will have a specific price increase.
So a large portion of our contracts would have those types of price escalators in them and what we have said is that we are going to look at those contracts as they renew, and we are going to get higher price increases and then to the extent that we have volume that we can raise price on. Immediately we’re going to look for 5% to 7% price increases.
We’re really just started to turn all of our focus to the landfill pricing over the last six months. I would tell you that we are sort of in the second or third inning on that project, there’s still a long way to go..
Got it, that was helpful. And then maybe one on Wheelabrator, this as we have talked about it over the last couple of years about potential sale.
Can you maybe talk about the timing, I mean why now and have you been in negotiations for a while for sale of this asset and maybe just a little more color around that please?.
Got it, that was helpful. And then maybe one on Wheelabrator, this as we have talked about it over the last couple of years about potential sale.
Can you maybe talk about the timing, I mean why now and have you been in negotiations for a while for sale of this asset and maybe just a little more color around that please?.
Look as you know, there has been rumors out there for probably two years that we have been looking at the sale of Wheelabrator. But it needed to be the right partner for us. We feel like we found the right partner. It needed to be the right waste supply agreements for us and we feel like we’ve crafted a good supply agreement with ECP.
So it was not so much around, when the timing was, but when we could get the various features of the agreement together, that satisfies both us and our -- and the partner that we are selling to..
And I would tell you that Jim led the negotiations for the transaction. And from Jim’s point of view, I can promise you that he thought the negotiations lasted a very long time because he spent a good portion of his time literally over the last six months getting this deal done..
My wife’s point of view as well..
Your next question comes from the line of Amit Mehrotra of Deutsche Bank..
Thanks, pretty close. It’s Amit Mehrotra here from Deutsche Bank. Congrats guys, you had a nice quarter and congrats on the announcement as well. First question is on pricing.
Could you just comment on maybe in terms of what inning you guys are in with respect to pricing growth, and if we look out this time next year we will be talking about the ninth straight quarter of 2% plus yield and just as a follow-up to that.
What level is the company willing to see, volume comps get more negative to get to the same level of price and mix growth?.
Thanks, pretty close. It’s Amit Mehrotra here from Deutsche Bank. Congrats guys, you had a nice quarter and congrats on the announcement as well. First question is on pricing.
Could you just comment on maybe in terms of what inning you guys are in with respect to pricing growth, and if we look out this time next year we will be talking about the ninth straight quarter of 2% plus yield and just as a follow-up to that.
What level is the company willing to see, volume comps get more negative to get to the same level of price and mix growth?.
Yes. When we look at the price volume trade-off, I will tell you that that I would expect that next year you’ll hear us say it’s the ninth straight quarter of over 2%. Now as we talked about, you saw it go from 2.6 to 2.3. That’s really more mathematical things than anything else. It’s the anniversary and has some various fees.
So it’s not an indication that we’re going backwards in pricing. It’s really more just an indication of mathematics, but you should see that above 2% for the -- certainly the near future and I would expect well through 2015. When you think about the volume trade-off, you got to look at it in various lines of business right.
When we look at it, we say what are those lines of business where we can get volumes without affecting the pricing dynamics in a market? And we are going to focus more on those volumes than we would on other volumes. And so we want to be a little bit more circumspect and how we manage our volumes.
We think that going into 2015 we should see some easier comps and we should see the volume start to stabilize. And look, that’s what we’ve always said. That this model really starts churning once you can get both, yield over 2% and positive volumes. I would hope that in 2015 we can see that reality for the first time in many years..
Okay, that’s helpful. And then just a follow-up on the sale announcement, can you just update us on the cost plan that you guys have in place in terms of the 100 basis points reduction on a run rate basis by the end of ’16.
I’m assuming that would need to be recalibrated given the divestiture and that impact on the sales level?.
Okay, that’s helpful. And then just a follow-up on the sale announcement, can you just update us on the cost plan that you guys have in place in terms of the 100 basis points reduction on a run rate basis by the end of ’16.
I’m assuming that would need to be recalibrated given the divestiture and that impact on the sales level?.
Yes I think, if you think about the cost piece, what we are mostly talking about with Jim Trevathan and his team is on the core side of our business and that is ongoing, and we feel like we are making progress there as you saw in our results. It won’t be affected in terms of absolute dollars.
It could be affected in terms of basis points, just simply because of the smaller business here. But I think the main point is that when we look at cost control, whether it is on operating cost or SG&A, we feel like we’re making very-very good progress, with still additional progress to go..
Your next question comes from the line of Hamzah Mazari of Credit Suisse..
Just a question on the supply agreement, could you give us a sense of how that supply agreement is structured with Energy Capital Partners? How long does it last for? And specifically what we’re looking for is, does this impact your ability be strategic on disposal pricing given that waste-to-energy plants are like landfills in your disposal network? Any color there would be good.
Thanks..
Just a question on the supply agreement, could you give us a sense of how that supply agreement is structured with Energy Capital Partners? How long does it last for? And specifically what we’re looking for is, does this impact your ability be strategic on disposal pricing given that waste-to-energy plants are like landfills in your disposal network? Any color there would be good.
Thanks..
So Hamzah look the intent of the negotiation of the waste supply agreement was to replicate what Waste Management and we have in place today. And I think we’ve done that, ECP’s primary interest in the waste supply agreement was volume certainty and both sides worked hard to crack an agreement to provide that volume certainty.
But it also allows us to optimize our operation. For example our landfills as you know are a critical piece of our business and we’ll continue to bring tonnes in those landfills while at the same time fulfilling the volume commitment.
And I don’t know whether that answers your question specifically but I think we feel good about the fact that we have crafted a waste supply agreement that satisfies both parties, needs..
Okay. I can follow-up offline on that that is fine. And then on the volume loss, could you give us a sense of how much more low margin business do you have in your portfolio? It seems like over the last couple of years we’ve been pruning that, now we have a pricing gate.
Are we near the end of pruning of low margin business and we should expect the pricing gate to come off once that process is done? Any color on that, thanks..
Okay. I can follow-up offline on that that is fine. And then on the volume loss, could you give us a sense of how much more low margin business do you have in your portfolio? It seems like over the last couple of years we’ve been pruning that, now we have a pricing gate.
Are we near the end of pruning of low margin business and we should expect the pricing gate to come off once that process is done? Any color on that, thanks..
Yes again Hamzah you’ve got to look at it by line of business. I would say that on the commercial line our primary focus is going to be on maintaining the customers that we have, right.
We’ve said it many times that some customers will leave for price and those customers are going to leave, but everybody else you got to make sure that you have a high level of service to maintain them. So our core strategy on the commercial side would be to provide the best service and reduce the churn rate.
On the roll-off side obviously as you see temporary roll-off improved throughout the country with residential and commercial construction going up, we would expect to get our fair share of volumes there. And so I would expect that we’ll see the volumes on the roll-off side turn positive in 2015.
And on the residential line we probably still have some residential contracts that are low margin contracts, you should see those start to be called out or re-priced throughout 2015.
So it depends upon what line of business you’re looking at and how we’ll approach it that sort of talked about what we’re going to do on each of the three collection lines..
And just last question I’ll turn it over. Are there any other adjacencies that you would like to get into? It seems like there maybe a little bit of medical waste still in the portfolio but the rest of the adjacencies are gone, is energy services a bigger vertical that you want to get bigger in? Thanks..
And just last question I’ll turn it over. Are there any other adjacencies that you would like to get into? It seems like there maybe a little bit of medical waste still in the portfolio but the rest of the adjacencies are gone, is energy services a bigger vertical that you want to get bigger in? Thanks..
Yes clearly we would look to get bigger in energy services it has been a good growth business for us. We’d expect that growth to continue and we’d like to get bigger there. On medical waste, I think it’s been well documented that they’re a very strong competitor that does a great job of keeping everybody out of that business.
And so we’d expect that business frankly to not be as much of a growth area as we thought it would be in the past. And so when we look at the growth areas we’re really looking at our manufacturing and industrial business and our energy services business..
Hamzah that energy services business continues to grow at a 25%, 30% cliff for us, it still is relatively small compared to the size of the overall business but certainly a nice growth engine..
Your next question comes from the line of Alex Ovshey of Goldman Sachs..
First on the pricing, thinking about the second half of ’14 will there be any notable impact from the flow through of the CPI, as it sort of flows through pricing in the back half versus the first half of the year?.
First on the pricing, thinking about the second half of ’14 will there be any notable impact from the flow through of the CPI, as it sort of flows through pricing in the back half versus the first half of the year?.
Yes the CPI will likely be a little bit lower in the back half of the year than it was in the front half of the year given the performance of CPI and the fact that a lot of our contracts reprise on July 1st. But again what we’ve always said is if CPI is lower we just have to go out and get those pricing dollars from other places.
And so we’d expect that to continue in the back half of ’14..
Got it David and I am not sure if I missed any incremental comments you had on bonus depreciation, but our another competitor talked about the potential for it to be retroactively extended before the year-end.
And I am curious if you have any thoughts around whether that potentially could happen? And if it does, what would be the impact on Waste Management’s cash flows?.
Got it David and I am not sure if I missed any incremental comments you had on bonus depreciation, but our another competitor talked about the potential for it to be retroactively extended before the year-end.
And I am curious if you have any thoughts around whether that potentially could happen? And if it does, what would be the impact on Waste Management’s cash flows?.
It’s hard to predict what the government is going to do I guess. But certainly could happen and we’d be happy if it were extended.
But the impact for us is substantial, it’s probably close to $80 million a year, so it’s substantial on part of when you look at cash flow from operations part of the headwind was the expiration of bonus depreciation for the quarter it was worth about $20 million..
Your next question comes from the line of Joe Box of KeyBanc Capital Markets..
Nice job on the recycling front, offsetting some commodity weakness, I think clearly a step in the right direction.
Can you just give us a feel for if this is the beginning, and we should continue to expect lower rebates and lower labor expense, or if this is maybe more of a one-time true up and we should continue to see things kind of at this level?.
Nice job on the recycling front, offsetting some commodity weakness, I think clearly a step in the right direction.
Can you just give us a feel for if this is the beginning, and we should continue to expect lower rebates and lower labor expense, or if this is maybe more of a one-time true up and we should continue to see things kind of at this level?.
Yes, I know. This is definitely the beginning and so you know it’s a combination of things. It’s continuing to manage our contracts and the rebate structure, it’s continuing to look at our cost structure and driving costs out, and then it’s also rationalizing the plants where we don’t have volume. They have done a nice job in the first half of 2014.
We would expect that to continue through the back half of 2014 and then as we have always said all along, this thing really starts to cook if we see the commodity prices turnaround. We’re not forecasting that for the back half of the year, but we would expect to see continued benefit year-over-year from our recycling operations for Q3 and Q4..
Understood.
And then on the residential side, I think, David you mentioned potentially calling some contracts, or re-pricing those contracts, I’m just curious of what’s your sense on the competitive environment for the residential business and maybe the appetite for some of your smaller peers to be bigger in this business has that changed at all over the last couple of quarters?.
Understood.
And then on the residential side, I think, David you mentioned potentially calling some contracts, or re-pricing those contracts, I’m just curious of what’s your sense on the competitive environment for the residential business and maybe the appetite for some of your smaller peers to be bigger in this business has that changed at all over the last couple of quarters?.
I’m not sure that has changed dramatically. Look, we’re always going to be the higher priced provider in the residential line of business. I can give you a perfect example of sort of a service price dynamic. We had a contract that we lost in Pennsylvania. We lost it clearly on price. And the contract went away.
And what the municipality found out is that that they had dramatic service issues with the new provider. They came back to us and then they said we need you to taking this contract back. We said, we will take it back but it’s going to be at our price.
And they said, that’s perfect, and then we said, that’s great, don’t worry, we will handle it from here. So it just goes to show that when you look at residential business, service matters. And when we look at the residential line of business, we’re not looking to win every bid.
What we’re looking to do is to renew our current contracts at that current or higher rate because of the service that we provide and the partnership that we have with our communities for many-many years..
Your next question comes from the line of Corey Greendale of First Analysis. .
Just a couple of clarifying questions from the responses earlier, someone asked earlier about the 5.1% growth in MSW pricing.
Is that including all of your MSW volumes, so that includes your long-term contractual stuff which suggests that you are pricing on the gate rate of significantly higher than 5.1%?.
Just a couple of clarifying questions from the responses earlier, someone asked earlier about the 5.1% growth in MSW pricing.
Is that including all of your MSW volumes, so that includes your long-term contractual stuff which suggests that you are pricing on the gate rate of significantly higher than 5.1%?.
That’s right. That’s exactly right..
So can you just help us to -- a little bit so like what percent of the overall volume are you able to raise price at any given year and what is the increase at the gate rate?.
So can you just help us to -- a little bit so like what percent of the overall volume are you able to raise price at any given year and what is the increase at the gate rate?.
Yes. Given that those contracts are generally 3 to 5 years you are seeing sort of anywhere from 20% to 30% of the volume that we can affect. And now remember that 5.1%. I don’t want you all to think that that’s across the board 5.1%.
There is some mix in there, right, because all that is doing, is taking a look at same-store sales, but there is absolutely no doubt. The folks sitting around this table are looking at landfill pricing every month and every quarter, and making sure that we are touching the customers that we can touch.
As we mentioned we get 90% of our landfill customers in the first half of the year. The other 10%, it’s not that we let them slide on pricing. It’s that they are either event work or they have contracts that prevent us from doing it.
And so we’re going to take the same approach on landfill pricing that we took on the residential pricing which is we are going to move that price up and it may end up costing us some volume.
But when you look at the overall competitive effect on our overall business both collection and landfill, driving that landfill price up is positive for the entire business..
Yes.
And you talked about the various impacts on volume you haven’t kind of called that one out, does that suggest that you’re not seeing a substantial volume impact from the higher landfill pricing?.
Yes.
And you talked about the various impacts on volume you haven’t kind of called that one out, does that suggest that you’re not seeing a substantial volume impact from the higher landfill pricing?.
Yes so far it has been, actually I would say the landfill pricing environment has been probably as good or better than the environment on the collection side, right, because as we have seen our pricing increases we have not seen a dramatic loss of volume, we are hoping that will continue.
Obviously, look, we can’t do anything other than what we can do. But the price environment has been fairly stable there..
This is Jim. As part of our answer honestly to our volume decline on the collection side is to raise prices on landfill side. We have talked about it a lot but that is a critical component and we’re not -- I wouldn’t say we are happy with the volume decline on the collection side. But we’re pleased with what we are seeing on the landfill side.
But pricing is critically important at those landfills to help us with our volume decline collection wise as is customer service.
But when you look at collection pricing, and I know your question was about landfill pricing but they are in a related we are just simply not going to turn the coin over that price volume coin that’s on the price side right now, we’ll be smart about it and -- but we’re not going to turn that coin over because it’s detrimental to our results..
Got it and then I had a follow-up question on the Wheelabrator proceeds. So by my calculation you are still around 3 times levered even without paying down anymore debt after you lose the $220 million in EBITDA.
So how should we think about how much you are going to deploy into paying down debt immediately versus how much cash you will sit on for potential acquisition?.
Got it and then I had a follow-up question on the Wheelabrator proceeds. So by my calculation you are still around 3 times levered even without paying down anymore debt after you lose the $220 million in EBITDA.
So how should we think about how much you are going to deploy into paying down debt immediately versus how much cash you will sit on for potential acquisition?.
Well I think you’re probably looking at where we were at the end of the quarter and we were a bit low there kind of artificially low with respect to leverage at the end of the quarter the reason for that is that because we hadn’t had any share repurchase year-to-date we ended up using that to pay down our revolver.
So a more normalized leverage ratio for us is 3% than as a consequence when you do divest that $220 million worth of EBITDA. Our calculation is we probably need about 400 million in debt pay down in order to maintain that leverage neutrality..
Thanks for that clarification..
Thanks for that clarification..
Your next question comes from the line of Michael Hoffman of Stifel..
If we could get a little clarity, sense of when you think the timing is for Wheelabrator?.
If we could get a little clarity, sense of when you think the timing is for Wheelabrator?.
It’s a bit hard to predict because it’s a function of FERC approval and that really is the biggest time controllable hurdle at this point. But in talking through this with ECP, we believe it’s somewhere within kind of three to five months probably closer to three to four..
So would you share with us then the year-to-date EBITDA, so inclined to pull it out of a model and model the business without it? What am I am I look at year-to-date at EBITDA?.
So would you share with us then the year-to-date EBITDA, so inclined to pull it out of a model and model the business without it? What am I am I look at year-to-date at EBITDA?.
Well on an annual basis the EBITDA as we said is about 220 million and really there is not a heck of lot of seasonality, there was a little bit more this year because of the real cold winter. But typically the volume is pretty static the price fluctuates a bit with your stronger electricity pricing quarters being Q1 and Q4.
But I’d straight line it for your analysis..
So can you help me with the 220, because if you I take the 10-K data add back the charge, it gets to 171 million? So what’s the difference between 171 and 220?.
So can you help me with the 220, because if you I take the 10-K data add back the charge, it gets to 171 million? So what’s the difference between 171 and 220?.
I’d have to look at that Mike..
And then was this shopped or was this is a privately-negotiated transaction?.
And then was this shopped or was this is a privately-negotiated transaction?.
What was the question again?.
Was it shopped was the deal -- was this is a fully marketed?.
Was it shopped was the deal -- was this is a fully marketed?.
While we didn’t do a per se a process on it but we had interest from at least one other company where they actually send a non-binding letter of intent to us. And we went through quite a bit of work with them and came up with a number that was a fair amount lower than the 1.94.
And then of course last year we -- probably no secrets to anyone but we had conversations with Covanta at that point as well. So I would say that that’s why I wasn’t formally a process pretty close..
And then if could talk about the pricing environment, when you think about the 5% number you have used around the landfill side or the 3 plus in the collection. How would you frame the per cent rollback trend at this point? Is it worsening, stable or getting better.
And I ask you in the context of volumes have been on a reasonably good positive trend, the market volumes.
And how is that flow seeing sort of rollbacks?.
And then if could talk about the pricing environment, when you think about the 5% number you have used around the landfill side or the 3 plus in the collection. How would you frame the per cent rollback trend at this point? Is it worsening, stable or getting better.
And I ask you in the context of volumes have been on a reasonably good positive trend, the market volumes.
And how is that flow seeing sort of rollbacks?.
Yes. We had a big jump up in rollbacks in 2012, since that time we basically held our rollbacks below 20%, and you saw the same thing this quarter. So I would say from a rollback perspective what you’re seeing is very much stability.
When you’re turning something around you see a very low number, we turned it around literally on a dime and when you see someone turn something around that fast, you wonder is it sustainable? And what we found on the rollback side that is sustainable and so I’d expect that to continue at below 20% into the future..
And your churn rates are running at about 11.5%?.
And your churn rates are running at about 11.5%?.
Yes the churn rate obviously it’s affected by the national account loss. But if you take out the national account loss, you’re looking at sort of 10% to 11% type churn..
And then are you at this juncture and it would appear you’re not replacing a 100% of your churn, you are replacing much of it but not all of it.
Is that an accurate observation?.
And then are you at this juncture and it would appear you’re not replacing a 100% of your churn, you are replacing much of it but not all of it.
Is that an accurate observation?.
That’s correct..
If you were to replace 100% of the churn and probably would drive rollbacks, that’s wide math effectively..
If you were to replace 100% of the churn and probably would drive rollbacks, that’s wide math effectively..
No I think that’s right..
And then on the landfill I just want to make sure I understood correctly on the landfill, the pricing issue, this is revisiting a strategy on collection be aggressive of our price now, let's bring a strategy to landfill, let's be aggressive on price and that's a newer initiative beginning about now? Did I understand that correctly?.
And then on the landfill I just want to make sure I understood correctly on the landfill, the pricing issue, this is revisiting a strategy on collection be aggressive of our price now, let's bring a strategy to landfill, let's be aggressive on price and that's a newer initiative beginning about now? Did I understand that correctly?.
Yes I mean we’ve always known that the landfill pricing is one of the keys to a long-term pricing program on the collection line of business.
As I’ve said before when you are going through the worst economic recession that you had, at least in our lifetimes, and you are losing volumes fairly faster, but the landfill is a little hard to go in and drive a pricing program. As we have seen the economy recovers, we’ve seen the volumes come back.
It’s a little easier to be more aggressive with the landfill. And we have done just that, and we would expect that to continue..
So this is a great way to force discipline into the market to the independents.
Have you seen any evidence that that is also helping your churn and your rollbacks that you are forcing them to absorb the single biggest costs they have?.
So this is a great way to force discipline into the market to the independents.
Have you seen any evidence that that is also helping your churn and your rollbacks that you are forcing them to absorb the single biggest costs they have?.
I would say, we certainly haven’t seen any ripple of that from pricing throughout the market. Those small competitors, in the regional, even the national competitors that might not be integrated in the market, there is always going to be a healthy amount of competition in every markets we serve.
So I’m not sure that that if they can have that dramatic an effect, but to the extent that it will have an effect over time, it will be over time. We are certainly not seeing any effect currently..
Your next question comes from the line of Charles Redding of BB&T Capital..
Just a quick follow-up on the front-end load side, is it overly optimistic to expect some margin lift here from increased contribution? Are we simply just at a point in the recovery where we can't do that?.
Just a quick follow-up on the front-end load side, is it overly optimistic to expect some margin lift here from increased contribution? Are we simply just at a point in the recovery where we can't do that?.
Are you talking about related to the transaction?.
No, on the commercial side in terms of collection volumes?.
No, on the commercial side in terms of collection volumes?.
Yes. We have to get better with our system. It’s what I talked about earlier that the big leverage that we’ve got in our business is really on the commercial side, because the density, the route density makes such a difference in there that you do have to look at from a contribution margin point of view.
So as we look at our business what we are going to try to do is look at those lines of business where we can pick up volume without affecting the market place and then we’re also going to look to start adding some density into our commercial wraps.
Now again we are not going to do it in such a manner to upset the competitive dynamics in any particular market. So, it’s going to take a period of time. Certainly as we see the economy improve and as we see the commercial business get better across the country that will give us more of an opportunity to go and take our fair share of the growth.
We’re not looking to grab market share here. What we’re looking to do is to get our fair share of the growth. So as you start to see those volumes grow, you should see our volumes in the commercial line get better. .
That's helpful.
And then in terms of the overall recovery, is it possible to see better commercial volume without housing? Are the two simply tied together such that you couldn't get better volume there?.
That's helpful.
And then in terms of the overall recovery, is it possible to see better commercial volume without housing? Are the two simply tied together such that you couldn't get better volume there?.
Yes, look, long-term. I have always said that what you’ve got going on in the economic recovery is, you got housing starts for the first 18 months, we’re sort of what I call it tuck-in housing. There was not a lot of new developments going up. It was tear downs and rebuilding houses.
What you see in last 18 months, you started to see some big take downs of large property [swaps] and you’ve seen new development, particularly in places like Texas, Florida, California, you are starting to see new housing development.
What comes along with housing development is commercial business, the new gas station, the new restaurant, the new gas, the new grocery store, and so. You absolutely need to see a sustained housing recovery to see a robust commercial volume recovery. I think we’re on -- you all see just like I do.
The housing starts number are sort of going in fits and starts over the last year. But I would say that as we go around and talk to our market, the trajectory is clearly up. You’re starting to see more and more housing developments, you’re starting to see more and more businesses that might have gone out of business during the downturn, reopened.
And so I would expect that throughout 2014 and particularly in the 2015 you should see those commercial volumes grow. Again, it’s not going to be everywhere. This is a geographic game for us. You’re not going to see commercial volumes grow as robust in some places as others.
But in those places where it is growing we want to make sure that we get our fair share growth. .
Your next question comes from the line of Barbara Noverini of Morningstar..
Hi, good morning, everybody. You mentioned that national account losses are partially responsible for the acceleration of volume declines past your original guidance.
So are you working through your national account contracts in a similar manner as the rest of your business from a pricing perspective? And secondly, are these contract losses also affecting your recycling volumes?.
Hi, good morning, everybody. You mentioned that national account losses are partially responsible for the acceleration of volume declines past your original guidance.
So are you working through your national account contracts in a similar manner as the rest of your business from a pricing perspective? And secondly, are these contract losses also affecting your recycling volumes?.
Yes. They are not so much affecting our recycling volumes, but they are more so affecting just our traditional collection volumes. But it’s exactly right. As we look through the national accounts, the largest one that we lost was a low single-digit margin contract.
And so we’re treating our national accounts business sort of just like we treated our residential business, 6 to 10 years ago which is we’re not going to -- we always say, we’re not doing this for practice and we don’t need a lot of practice doing this.
So we’re going to make sure that we get a fair price on those national account businesses and we’re not going to keep a national account just to maintain volume. The largest account -- the largest one that we lost again was a low single-digit margin business.
For the full year we expect that we’ll lose about $100 million of annualized revenue, of that annualized revenue about two-thirds of it will be very low single-digit margin. And about two-thirds of it has hit to June 30.
So the pace of that volume loss will accelerate a little bit in the back half of the year but again you won’t see a dramatic earnings hit because it was very low margin business..
I know we've been asking you this about every line of business today, but what [inning] are we in the reviews of your national account businesses?.
I know we've been asking you this about every line of business today, but what [inning] are we in the reviews of your national account businesses?.
Look we know exactly what we want to do in our national account business. So I would tell you that from a planning point of view we’re in the eighth inning, from an execution point of view I would tell you we’re in the third inning.
So there is still a lot of room to manage those contracts, we plan to do that over the next few years but we know exactly where we’re going with it..
Your next question comes from the line of Tony Bancroft of Gabelli..
You mentioned growth in the energy services as sort of the next step.
How much would you say looking five years out will be organic versus acquisitive growth and if there is acquisitive and if there are -- are there any large service Energy Service acquisitions that you have been looking at, or are out there?.
You mentioned growth in the energy services as sort of the next step.
How much would you say looking five years out will be organic versus acquisitive growth and if there is acquisitive and if there are -- are there any large service Energy Service acquisitions that you have been looking at, or are out there?.
We haven’t been looking any at this point but most of our growth has really come organically, we’ve done a few very small acquisitions in our energy services business. But we do consider part of our core and there was an acquisition out there that looked like it was priced properly..
I would now turn the call over to David Steiner President and CEO of Waste Management for closing remarks..
Thank you. Clearly we had great performance from our Waste Management employees in the quarter. As Jim said I think we’d be remised without recognizing our colleagues at Wheelabrator who have done a phenomenal job over the years and we don’t view this as an end of a relationship but as the beginning of another long-term relationship.
We are still going to be the primary provider of volume to the Wheelabrator plant. So this will be a change in the relationship but it’s been a great relationship and we expect that great relationship to continue. As we look at the rest of the year as Jim mentioned we’ve got FERC approval which could take anywhere from three to five months.
The good news with that is that it gives us three to five months to really develop a plan on what we’re going to do with the proceeds from the divestiture.
So I would expect that at the end of the third quarter we’ll have a fairly well defined plan that we can talk to you all about how we’re going to split those proceeds between purchasing tuck-in type of businesses and doing share repurchases. All of which we think is going to be a very positive driver for us at the end of 2014 and driving into 2015.
So once again we look forward to the future and we’ll talk to you all end of the third quarter..
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