Good morning. My name is Janisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter and year-end 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. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. I would now like to turn the call over to Mr. Ed Egl, Director of Investor Relations. Thank you, Mr. Egl. You may begin your conference.
Thank you, Janisha. Good morning, everyone, and thank you for joining us for our fourth 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 and is available on our website at www.wm.com. The Form 8-K, the press release, and the schedules for the press release include important information. During the call, you'll 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 stated otherwise, are more specifically references to internal revenue growth, or IRG, from yield and volume. Additionally, any comparisons, unless otherwise stated, will be with the fourth 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 address operating EBITDA margin as defined in Footnote B to today's press release.
Our EPS, as well as income from operations margin and operating EBITDA margin for our traditional solid waste business, have been adjusted to exclude items that management believes do not reflect our fundamental business performance or are not indicative of our results of operation. These measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release footnote and schedules, which can be found on the company's website at www.wm.com for reconciliations 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 1:00 P.M. Eastern Time today until 5:00 P.M. Eastern Time on March 4th. 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 31500809. Time-sensitive information provided during today's call, which is occurring on February 18th, 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 express written consent of Waste Management is prohibited. I'll turn the call over to Waste Management's President and CEO, David Steiner.
Thanks, Ed, and good morning from Houston. Looking at 2013, we built strong momentum in the first three quarters of the year, and that momentum continued into the fourth quarter, with our traditional solid waste business growing margins by 150 basis points. However, quarterly EPS results, particularly fourth quarter EPS results, can be impacted by accruals, sometimes positive and sometimes negative. In the fourth quarter of 2013, we had $0.11 more expense from accruals than in 2012. $0.02 of that $0.11 was offset by tax benefits. We had a net of $0.09 more from these type of accruals per share than we had in 2012. This $0.09 consists of about $0.06 from incentive compensation and $0.03 from risk management. Without these accruals, our earnings would have continued to show strong year-over-year growth in the fourth quarter.
Our traditional solid waste business is strong and our earnings momentum continues. Indeed, we've seen that momentum extended to January as preliminary results show income from operations improving 12% and income from operations margins expanding about 110 basis points when compared to January of 2013. Looking at the full year, we had a very successful 2013 as we met all the goals that we set out to accomplish. Our plan to increase yield, better manage costs, and have disciplined capital spending paid off in 2013 and should lead us to continued success in 2014. In 2013, we achieved full-year earnings per share of $2.15 and free cash flow of $1.32 billion, all despite $0.10 of unanticipated headwinds from our recycling business. In 2013, we expected yield to be between 1% and 1.5%, and we exceeded that target.
For the full year, our collection and disposal yield was 2.1%, with each quarter sequentially higher than the previous one, culminating with the fourth quarter at the highest level for the year at 2.4%. Each of our lines of business had positive yield for the full year, with the exception of landfill C&D, which was impacted by Superstorm Sandy last year. Core price increased to 3.8% in 2013, an improvement of 90 basis points, and average landfill rates per unit for MSW ended the year with the highest rates that we've seen, increasing about 3.5% compared to 2012. This is a tremendous accomplishment by our team, and they have plans in place to continue that success in 2014. We expect that internal revenue growth from yield should be approximately 2% for 2014.
As we've said before, we need to get about 2% yield to offset cost inflation and grow margins. We did that in 2013, and we expect to do so again in 2014. In the fourth quarter, about a third of our volume decrease resulted from the year-over-year effect of volumes from Superstorm Sandy. We also lost national account business that we were not willing to keep at low rates. Looking at 2014 total volumes, we expect internal revenue growth from volume for 2014 to be very similar to 2013, about 1% negative. We'll see lower national account volumes in 2014 as we drive pricing at our low-margin customers. We need to be more aggressive on those specific national accounts where we're providing platinum service at bronze pricing.
The winter weather is definitely having a negative impact on volumes in the first quarter, we expect our normal seasonal upturn to occur as winter recedes. When we look at volumes, we're more focused on getting the right volumes, not the most volumes. We're looking for the best mix of yield and volumes to drive income from operating margins and dollars. In our industry, that mix always favors yield. Jim will give you the numbers, despite negative volumes, we increased income from operations dollars and margins in every collection line, which demonstrates the importance of yield. Turning to landfill volumes, all categories of our landfill volumes were positive for the full year, and we expect that to continue into 2014. This strong demand should allow us to continue to see better pricing at our landfills.
Once again, our traditional solid waste business performed very well in 2013, with strong margin improvement in all three of our collection and landfill lines of business. Our income from operations margins grew 90 basis points, and operating EBITDA margins grew by 80 basis points in the traditional solid waste business. In 2014, we expect to grow earnings and margins in our traditional business through pricing, cost controls, and increased deployment of our productivity initiatives. On the recycling front, we had a $0.12 decline year-over-year in earnings per share compared to the $0.02 decline that we anticipated at the beginning of 2013. As we outlined on our third quarter conference call, we're taking steps to improve the profitability of our recycling business.
When contracts come up for renewal, we plan to increase processing fees, include tighter contamination limits with provisions that allow us to audit the inbound material, add language that allows us to recover increased costs due to unforeseen events, and increase consumer education through our Recycle Often. Recycle Right. program. These initiatives are starting to work. We've audited virtually all of our municipal contracts and have found numerous opportunities to charge customers for exceeding contractual contamination limits. We've seen residue as a percentage of tons sold decrease for three consecutive months. Even with these improvements, we want to be cautious in predicting recycling results in 2014, and we're assuming that operational savings will be offset by slight commodity price declines, such that we expect to have no year-over-year EPS impact from our recycling line of business.
Turning to our waste-to-energy business, in 2013, our operations were essentially flat when compared to 2012. With long-term natural gas and electricity prices projected to remain low, the outlook for growth in our waste-to-energy business is limited. This, as well as lower disposal tip fees and volumes resulting from contract transitions, are the primary reasons why we had to record a non-cash write-off of a significant portion of the goodwill of our waste-to-energy business. The charges are the result of projected long-term cash flows, not short-term issues. For 2014, we expect income from operations to be flat when compared to 2013 from our waste-to-energy operations. Turning to free cash flow, our disciplined approach to managing expenses and capital spending in 2013 allowed us to generate $1.32 billion of free cash flow, an increase of almost 60% compared to 2012.
Excluding divestitures, free cash flow grew 51% when compared to 2012 to $1.18 billion. In the fourth quarter, we prepaid $51 million of accrued expenses to help offset some cash flow headwinds in 2014. Excluding that payment, our 2013 free cash flow without divestitures would have been $1.24 billion, well within our range of $1.2 billion-$1.3 billion. In 2014, we expect that free cash flow will be very similar to 2013 at over $1.3 billion. We should achieve this despite anticipated headwinds of approximately $125 million from the expiration of bonus depreciation and the payment of incentive compensation. We should be able to overcome these headwinds through a combination of increased earnings, improvements in working capital, and capital spending discipline. The strong free cash flow that we generated in 2013 allowed us to return over $900 million to our shareholders in the form of dividends and share repurchases.
This is the highest amount of cash returned since 2011. For 2014, we anticipate continuing to grow the amount that we return to shareholders. In summary, when we look back at 2013, we built a strong foundation with our pricing and cost control programs. The momentum from these programs gives us the confidence that we can achieve our full year goals of adjusted EPS of between $2.30-$2.35 per fully diluted share and free cash flow of greater than $1.3 billion. I'll now turn the call over to Jim to discuss our fourth quarter results and our 2014 outlook in more detail.
Thank you, David. I'm going to review the results of the fourth quarter and expectations for 2014. I will start by discussing our SG&A costs and cash flow performance. I'll expand on David's comments about the results of operations yield and volume in our various lines of business. I will conclude with a discussion of our financial metrics. The results for SG&A were better than we projected at the beginning of the year. We anticipated costs being flat when compared to 2012, and for SG&A cost as a percent of revenue to improve 10 basis points. I'm pleased with the overall results as SG&A costs for the year improved $4 million to $1.47 billion, and improved as a percent of revenue by 30 basis points to 10.5%. For the fourth quarter, SG&A costs were $376 million, an increase of $20 million.
As a percent of revenue, SG&A costs rose to 10.7%. Both increases are a result of the accruals that David mentioned. This will not be our 2014 run rate, as we expect that SG&A dollars will remain flat in 2014, and that SG&A as a percent of revenue will improve from 2013. We saw that in January as SG&A improved $8 million as compared to January of 2013. Turning to cash flow. For the full year, we generated $1.32 billion of free cash flow, an increase of almost $500 million when compared to 2012. We accomplished this in part by growing our net cash provided by operating activities, $160 million to $2.46 billion, and by maintaining discipline on capital spending. Our capital expenditures for the year were $1.27 billion. If you exclude divestitures, free cash flow for the year grew nearly $400 million to $1.18 billion.
Without the prepayment that David mentioned, free cash flow would've been $1.24 billion. In the fourth quarter, we returned $410 million to our shareholders through a combination of $171 million for our dividends and $239 million in share purchases. We also invested $26 million in tuck-in acquisitions in the fourth quarter. For the full year 2013, we returned $922 million to our shareholders, consisting of $683 million in dividends and share purchases of $239 million. Our board has indicated its intention to increase the dividend in 2014 by 2.7% to $1.50 per share on an annual basis, which would result in a dividend yield of approximately 3.4%. This is the 11th consecutive year of increasing the dividend. For 2014, the anticipated annual dividends equate to $700 million to be returned to our shareholders. We also have authorization from our board of directors to repurchase $600 million of our shares.
During 2014, we expect capital expenditures of approximately $1.2 billion-$1.3 billion, which is between 8.3%-9% of revenue, and free cash flow in 2014 is expected to be in excess of $1.3 billion, assuming $100 million of divestitures, and despite the $125 million in headwinds that David mentioned. For 2014, we expect to spend between $100 million and $250 million on solid waste tuck-in acquisitions. I will now review internal revenue growth components and operating results. In the waste industry, if we lower price, there's no new volume created. Putting garbage on sale does not incentivize customers to create more garbage. If we were in an industry that could create incremental volume by lowering price, like the consumer products industry, we might look at yield and volume mix differently. In our industry, we can't do that.
When we look at the trade-off between yield and volume, we look at them together to determine the best mix in order to maximize income from operations dollars and margins. This strategy worked in the fourth quarter and for the full year in every line of business, where we increased income from operations dollars and margins despite negative volumes. For example, in the fourth quarter, commercial yield was 4.9%, which is the highest yield since the second quarter of 2008, and volumes declined 5%. With this yield and volume trade-off, income from operations grew $21 million, and margin grew 200 basis points. For the full year, commercial yield grew 3.3%, and volumes declined 3.4%. Despite the volume loss, income from operations grew $42 million, and margin expanded 70 basis points.
For industrial, fourth quarter yield grew 4.3%, volumes declined 3.7%, income from operations grew $15 million, and margin expanded 230 basis points. For the full year, industrial yield grew 4.5%, and volumes declined 1.9%. Despite the volume loss, income from operations grew $48 million, and margin expanded 140 basis points. Similarly, the residential line of business also grew despite contractual restrictions on raising prices. In the fourth quarter, yield for the residential line of business grew 1.7%, and volumes declined 2.9%, which resulted in income from operations growing $4 million and margin expanding 60 basis points. For the full year, residential yield grew 1.8% and volumes declined 1.7%, which resulted in income from operations increasing $14 million and margins expanding 40 basis points. As you can see, the price and volume trade-off worked in all lines of our collection business.
The income from operations trend improved in the fourth quarter, and we expect this trend to continue into 2014. I will now review the landfill line of business for the fourth quarter, where we saw the benefits of positive volume and positive yield. Volumes were a positive 5.6% after adjusting for Sandy volumes. MSW yield was 1.7%, with revenue per unit increasing 3.5%. Sandy-adjusted MSW volumes grew by 1.6%, and C&D volume rose 6.6%. Combined special waste and revenue-generating cover volumes were a positive 3.9%. Income from operations grew $25 million, and margin grew 250 basis points. Our overall internal volume growth was negative 2.2% in the quarter, and negative 1.5% if you adjust for the Sandy storm volumes. I will now discuss operating costs. Operating costs increased by $43 million in the fourth quarter, 64.8% of revenue, which was flat with the fourth quarter 2012.
For the full year, operating costs increased $233 million to 65.2% of revenues, compared to 65.1% in 2012. In both the fourth quarter and the full year, the majority of the increases were for costs associated with recently acquired businesses and labor increases. Finally, looking at our other financial metrics, at the end of the fourth quarter, our weighted average cost of debt was 4.97%, and our debt-to-total capital ratio was 63%. The increase in this ratio from 58.9% in the third quarter is primarily the result of the impairment charges. The floating rate portion of our total debt portfolio was 15% at the end of the quarter. Our recurring income tax rate was 34.6% for both the fourth quarter and the full year. For 2014, we expect our tax rate to be approximately 35%. One last item that I'd like to address is our asset impairments and unusual items.
These non-cash charges are primarily related to goodwill associated with our waste-to- energy business and other post-collection assets and related goodwill. David mentioned the impairment of historical goodwill in our waste-to- energy business. The second category relates to asset impairments from our asset rationalization program. As we've discussed, we've been reviewing our post-collection assets to determine where we have cash flow negative or poor-performing assets that do not fit into our strategic plan. The impairment of assets in the fourth quarter resulted from our analysis and led to our decision to mothball certain post-collection facilities. This includes deferring active pursuit of expansion permits at four landfills. In our review, we determined that we're able to move volumes to other Waste Management facilities without materially impacting customers or operations.
Of course, if volumes available to the mothballed facilities increase in the future, we could reactivate expansion permitting efforts or operations at those facilities. I would be remiss if I did not close by thanking all of our employees. They made 2013 as successful as it was, and we appreciate their hard work. With that, Janisha, let's open the line for questions.
At this time, I would like to remind everyone, in order to ask a question, please press star and the number 1. Your first question comes from the line of Hamzah Mazari of Credit Suisse.
Good morning. Thank you. Just a question on volume. If we adjust for the low-margin national account business that you're walking away from and maybe some weather impact, could you maybe comment on what the underlying volume growth is for 2014 that you're guiding to? Also maybe comment on how you balance volume loss with negative operating density.
Yeah. When we look at 2014, Hamzah, probably about 60%-65% of the volume loss in 2014 is going to be from national accounts. As you know, that's generally very low-margin business. We just recently lost our largest national account, which was low single-digit margin, because we didn't want to reduce or stay flat on the price. We wanted to get a price increase because our margin was low single digits. So we knew that was coming, and it was the right business decision to make. So that's going to account for roughly 50% to two-thirds of the volume loss in 2014. The remainder, the first quarter is going to have a tough Sandy comp still from Superstorm Sandy, obviously we've got bad weather, so you've got a little bit of an effect there.
We still expect that our pricing programs are going to drive out a bit of our commercial volume. Most of what you see in 2014 is culling out that low-margin business and then the year-over-year comps in the first quarter. As far as the density goes, look, that's a fundamental premise of this business, that if you can create route density, obviously you can service the customer at a much lower cost. We can't let that benefit that we get upset our pricing program, right? We've got to be the pricing leader, and if we aren't, then no one else is going to do it. We're going to be the pricing leader. We recognize that you get benefits from density. We certainly are looking to grow our commercial volume, but we will not grow our commercial volume at the expense of price.
Very helpful. A question on SG&A. If we assume that bonuses continue into the future, how should we think about SG&A going forward? Is it fair to say that it should run up to 10.5%-11% on a normalized basis if we assume that Management continues to get bonuses?
Hamzah, on the SG&A, look, I was pretty pleased with how we turned out in 2013. We said we'd be flat. We were actually down a little bit, about $4 million. We've guided to flat in dollars in 2014. When you think about it on a percentage basis, look, as the top line increases, we expect that that percentage will start to get down to the 10% and potentially below 10% range. To really be in the low nines, I think you're going to need to see a pretty robust rebound in the overall economy. For us, that has to be the big driver of top line growth. The pricing strategy is clearly the right strategy, as you heard from my numbers. In order to get revenue to really take off, it's got to be from robust economic growth.
We can't afford that price-volume trade-off in the wrong direction. When we think about SG&A as a percent of revenue, I would expect that the flat SG&A will produce, obviously, it's going to produce a lower percentage because of some increase in top line. Are we going to get down to 9%? Not going to get down to 9% until we really see the overall economy take off. I'll tell you, there's still room for dollars on SG&A, both on the labor front and the non-labor front. We're not giving any guidance for 2015, but I would expect they'll hear the same message when we talk next year about being flat year-over-year.
Great. Just last question, I'll turn it over. Any update on the divestitures? It seems like you had some this quarter. How should we think about where you are in that process? Thank you.
Yeah. When we look at the divestitures, as we said, we're assuming $100 million of divestitures during the year. We've got a few in the pipeline, particularly in the non-core business. We've looked at our Chinese joint venture, we may look to monetize that this year. So that $100 million, I would tell you, I think there is some upside to that. The bulk of that divestiture would be non-core solid waste. We should have $50 million-$100 million of dispositions in the core solid waste business, the upside would be all those non-core asset sales.
Okay, great. Thanks a lot.
Your next question comes from the line of Derek Abracano of Macquarie.
Great. Hey, guys. Thanks for taking my question.
Morning.
Good morning. If you could talk a little bit about, very encouraging to see the internal revenue growth stay strong in the fourth quarter, 2%, and you're guiding flat for 2014. Can you just talk about some of the things you're seeing and doing which gives you confidence that you'll be able to offset some of the CPI headwinds with some of the business that's not linked to CPI?
Yeah. It's a great question because when we look at yield, frankly, we don't look at the number, the 2%, the 2.4% in the quarter, the 2% for 2014. We don't particularly look at that yield number. When we build our plan, we build our plan to determine the amount of dollars that will drop to the bottom line from all of our pricing actions, because pricing actions are not just core price increases, but it's also rollbacks. It's also the effect of lost business. There's a lot of different effects that go into what drops to the bottom line from pricing. When we look at that, when we look at dollars to the bottom line, we think dollars to the bottom line will be very similar in 2014 to where they were in 2013. Now, you've hit the nail right on the head.
In order to get that, we're going to have to do more robust price increases to offset the CPI. That CPI is what's going to drive the yield down toward the 2%. As we look at 2014, we don't think there will be a material difference in the amount of dollars going to the bottom line, but CPI will mute the numbers a little bit as far as yield goes.
Okay, that's helpful. Just one more. It's good to see the CapEx guidance essentially in line with 2013 levels. Is there anything we should be thinking about with regards to that number? I actually would have assumed it would have gone a little bit higher, just kind of thinking that you would have seen some cost inflation with regards to capital purchases and some of the initiatives you guys are putting in place with the onboard computers and stuff like that.
Yeah. When you look at CapEx, what we're doing in 2014 is making sure that we put the right amount of capital into our core solid waste business, right? We've talked about it in the past. We've got to make sure that we aren't under-investing in the core business, and we aren't. Primarily what you'll see in 2014 is that we're going to cut back on those types of investments that haven't been getting us the kind of returns that we want over the last few years, primarily recycling. We're not going to starve the core business. The CapEx will be a little bit down because of what we call sort of growth capital and capital for those other types of businesses that generally have not been earning their return on capital for the last two years.
That's very helpful. Thanks very much.
Certainly.
Your next question comes from the line of Bill Fisher of Raymond James.
Thank you. Good morning.
Morning.
Just on the EPS growth, I think at the midpoint is around 8%, and obviously you mentioned your organic growth is around one. Can you touch on some of the drivers there? Obviously, you have a possibly lower share count acquisitions. I think David, you mentioned the pricing actions, it seems like you've got to have some good cost controls because gross margins would seem to have to rise.
Yeah. Well, look, when we look at 2014, just to try to sort of put it in context, I think that there is some potential upside on yield. I think there's some potential upside on free cash flow. As you well know, Bill, the last two years, we've predicted our recycling operations to be last year $0.02 negative, they ended up $0.12 negative. The year before we had a similar type of result. We wanted to be very cautious on predicting. We've said it before, we can drive sort of 8%-12% earnings growth through the price volume combination. In order to get up into that low mid-teens, we've got to get help from waste to energy and from recycling.
We haven't done that in the last few years, when we put together the plan, we said let's assume that we're going to be very cautious on getting any benefit from it. Frankly, when you look at the beginning of the year with slower growth in China, with the weather that's been impacting recycling volumes, I think that's a good assumption. We wanted to be conservative because of those two big headwinds that we've had in the last couple of years.
Hey, Bill, one of the reasons we talked about January, which we've really never done before, but one of the reasons we talked about January is because we didn't want folks to mistake the accruals there at the end of the year for a change in trend. January clearly showed to us that the trend that we'd seen really for the first probably 10 months of the year is continuing into next year. When we think about 2014, for whatever it's worth, right? January is one month out of 12, but we felt good about what we saw. I mentioned SG&A costs being better by $8 million. We felt good about what we saw really overall.
Even in light of a really tough weather month, our core business was actually better than prior years. I think we've got a pretty good start going here, we'll see what February brings. February has been a tough weather month as well.
Okay, thanks. Wanted to follow up with David, you're keeping the yield north of 2%. I think last year you had some good success on that regulatory fee. Are there any new incentives or strategies this year? I noticed the commercial price is really strong for you in Q4.
Yeah. No, frankly, 2014 is going to be sort of the same. It's a repeat of 2013. It's going to be the same things that drive it. Again, we talked a little bit about the CPI headwind that we have to overcome, it's going to be the same types of things. Bill, we'll never rule out doing something during the course of the year. We didn't build in any plans to increase that, we'll see how the year plays out. Look, the reality is that as we've gone through the various cycles, we've never seen a dramatic amount of pushback to the fees. I think customers get the point that our cost structure is going up every year, we have to recover that. Could it happen in 2014? Absolutely. Is hitting our target dependent upon it? No.
Okay, great. Thank you.
Certainly.
Your next question comes from the line of Corey Greendale of First Analysis.
Hey, good morning.
Good morning, Corey.
I think, David, that you said something like half to two-thirds of the volume decline that you're projecting for 2014 is because of national accounts. I'm just trying to get a sense, what do you think is underlying volume growth in the market in 2014? Then on top of that, how much are you projecting that you're losing because of your being aggressive and being the price leader?
Yeah. Again, I think 2014, from an overall volume perspective, is going to be fairly similar to 2013. Look, we've said it now for the last two years that what we need to see in order to really get robust volumes is we need to see an economy that's driven by housing starts, by new business starts, and by industrial production, right? We can't see an economy where growth is driven by non-infrastructure government spend and by the service sector, right? So, I think that's the big question for 2014. Are we going to continue to see the rebound in housing, and are we going to start to see new business generation? Again, when we plan for 2014, we're planning like we aren't. Like we aren't going to see a dramatic uptick.
So, from an overall volume point of view, I think what you'll see in 2014 will be similar to what you see in 2013, at least for us, with collection volumes remaining negative and landfill volumes remaining positive.
Okay. I'm fine just to help set the expectations. Given all the things you're saying, Q1, do you expect that Q1 will be the worst year-over-year comp environment and improves as you get to the end of the year?
Yeah, I would be surprised if Q1 is not the worst year-over-year. The large national account that I talked about, we lost about $90 million of national account business last year. Our largest national account will lose in sort of mid-year this year. You'll get a little bit of that effect in the back half, but because of the weather effects and because of the Sandy effects and because of the national accounts, yeah, I would expect the first quarter to be the toughest comp quarter and for it to improve going forward.
Okay. By the way, is that competition on national accounts, is that coming from your large national competitor? Are you seeing new businesses like Oakleaf forming?
I think it's a combination of both. Look, it doesn't matter where it's coming from, because even if it's a broker, it's coming from our large national competitors. We don't do business with brokers, right? From our point of view, we don't see why we would strengthen a competitor by acting as a subcontractor for these new brokers in various markets. We don't understand why you would help a competitor. We don't do business with the national brokers. Even if the bid isn't won by our large national competitors, they're doing business with those brokers, so they're getting some of that business. I think the answer would be yes, predominantly, we're losing it to the large national players, either directly or indirectly, because they're working for the brokers.
Okay. One quick one for Jim. In the press release, you talk about the $0.09 impact. Some of that's the bonus accruals, but some of it is also risk management. Can you just elaborate a little on that? Is that a one-time adjustment of what your expectation is for risk management expense going forward?
The risk management was a benefit, actually, prior year. We typically expect with our safety improvements, we've been seeing $0.01-$0.02 per year. This year, we actually went the other way. We had a couple of incidents, we ended up with a $0.01 charge. Last year, it was a $0.02 benefit on risk management adjustments. Is it a one-timer? Certainly, the trend would say that we wouldn't see a repeat of that, but it's hard to say it's a one-timer.
Yeah, when you look at our safety numbers, our safety numbers are actually improving, which would lead you to believe that we would have gotten a positive accrual. The problem is we had a couple or a few large incidents that we accrued for in the fourth quarter. Again, like Jim said, you'd expect it to be positive, but you just never know when these large incidents are going to happen.
Got it. Thank you.
Thank you.
Your next question comes from the line of Adam Thalhimer of BB&T Capital Markets.
Hi, good morning, guys.
Good morning.
Thanks for the detail you provided in terms of the yield and volume in your various businesses. I'm curious, from your perspective, is the yield volume trade-off working better on the industrial line than the commercial line? On the commercial line, it looks like you're getting 5% price, but then giving up 5% volumes, whereas on the industrial side, you're getting a lot of price but not giving up as much volumes.
Yeah, when you look at it from a pure dollars point of view, maybe you'd say the commercial's doing better, I think you're right. Look, it goes back to the earlier question about route density. You don't have the same issues with route density on the roll-off side that you do with the commercial side. Look, in this business, there's a few large chunks of business that you can go after very quickly. You can get large residential contracts, you can get large national accounts, and you can get temporary roll-off business. You can sort of flip a switch and get any of those three. The problem is you're going to get those three at very low margins.
We know that if we look, if the large player goes out and grabs a bunch of volume at low margin, what's the rest of the industry going to do? From our perspective, we've got the right trade-off. What we're expecting to see is our volumes recover with the economy, not for our volumes to recover because we keep our price flat. We're going to continue to push our price, and make sure that we get above that 2% so that we can expand margin.
Adam, it's also worth mentioning that some piece of our volume loss is not a function of price. We don't know exactly how much that is, some piece of it is related to customer service, and we are really focused at this point on customer service and improving the experience to the customer. Getting that volume back has no negative impact on the price side as we would if we were simply lowering price to get more volume. We're keenly focused on that.
Got it. Okay. That's very helpful. Just as a follow-up, in terms of you guys are obviously being aggressive on pricing, which is probably a good thing for the whole industry. What exactly are you seeing in terms of how your competitors are responding to that?
Yeah. Look, I would say that we'd love to see all of our competitors, large and small, lead rather than follow. We recognize that generally they aren't going to lead. Mostly what we've seen is what I would call rational behavior. Like there always is, there are pockets where you see some unusual actions. Generally, those are in markets where you've seen a lot of stress put on volume. We just recently saw a competitor lower their own price by $4 million in the Northeast on a disposal contract, sort of bidding against themselves. We saw a competitor drop price at the landfill by 20%-25% in South Florida, because both of those markets are fairly challenged.
That's the kind of behavior that for us is going to cost us a lot of volumes, and again, we can't go out and do that type of behavior. Look, I've always said we can lead the industry in one of two ways. We can't control what they do. We have absolutely no control over what anyone else in the industry does other than us. As the largest in the industry, we can take one of two stances. We can say, we're going to go after volume and give away price. We can say we're going to go after price and give away volume. Both of those can lead to what we call sort of a spiral effect, either downward or upward. Look, Jim said it. You can't lower price and create demand.
Sheree Rice, who used to be with our company, used to say, "With shoes, if you lower the price of shoes, people buy more shoes." When you lower the price of garbage, people don't create more garbage. When you're working with a fixed pie, you're always going to be benefited by driving yield up because you can't steal enough volume to make up for that yield. If we go and start stealing volume, then it creates that domino effect of everybody stealing everybody's volume, and that's not a path that we're willing to go down.
Got it. Okay, thanks for the color.
Thank you.
Your next question comes from the line of Al Kaschalk of Wedbush Securities.
Good morning, David.
Al.
Could you just clarify on the Sandy headwind, what that is for 2014 in terms of a comp headwind on a volume basis?
Yeah, again, that's primarily in Q1. If you look at it in Q4, you saw that it was 0.6%. I would expect it to be a little bit more muted in the first quarter, but probably somewhere between that sort of 0.3%-0.6%.
Okay. Should we assume the balance is national accounts?
Yeah, look, you got national accounts and you've got the commercial business going down, but all that is offset by landfill volumes going up. Again, look, that goes back to the trade-off, right? If you tell me that my low-margin national account business is going to go down and my landfill business is going to go up, I'll take that trade-off six ways to Sunday.
Al, if you haven't heard it from the other guys, which you probably have, the weather is throwing volumes out of whack. We were pleased with the results, as we said, in January, but boy, we've had several operations, especially in February, where we've been shut down in a big part of the South. You expect to be shut down in the North and the Midwest, but when Atlanta shuts down for two days, that generally is not expected going into the winter. I think there's going to be an impact from the weather that is yet to be determined.
Al, we say it every year that you can't make a call on full year volumes based on the first quarter because of the seasonality, right? We've said that every year since I've been here. To Jim's point, more so this year than ever before because it has been a ridiculously brutal winter, not just in those places where we always have a brutal winter, but in places where you don't have brutal winters. We had two days of school shutdowns in Houston, Texas from the winter weather. You saw what happened in Atlanta. What I would say, Al, is we have no idea what Q1 volumes are going to be. We'd expect them to not be robust. I don't think that's an indicator of what you're going to see for the full year.
We'll really know what full year volumes are going to do once we see the seasonal upturn in March. March, April, May.
Well, here's the broader question, David, and I appreciate the color from both you and Jim. You're guiding us for 1% volume decline and better than 2% pricing. If I look at the others in the industry, all the other metrics, those metrics are flipped. I certainly appreciate you going out and focusing on price. Can you explain why that is such a diverse message coming from you or why I prefer you talk about your business, but why you're seeing metrics that are different than the rest of the crew?
Yeah, look, again, I think we're seeing a lot of metrics that are different than competitors. Again, you got to take out the fourth quarter accruals, but let's take a look at the full year. Again, when we talk about metrics, what we're talking about is income dollars and margins. Take a look at those metrics. In every line of business, we increased dollars, we increased margins. I can only speak for us, but we did it in every line of business. There's only one thing I can tell you. We've seen what happened when we had 1% yield and 1.5% volume. We saw it. We saw it in 2012. I guarantee you what's going to happen. Margins go down and income from operations dollars go down, particularly when the volume that you're picking up is low-margin business.
You can't get enough volume in order to make up for lower yield. I think everybody in this industry would acknowledge that you need to get sort of 1.8% to 2% yield in order to expand margins. That's the question. Do you want to expand income from operations and margins, or do you want to see them go backwards? You have to get the yield in order to do that. Again, we've seen many times what happens in our business when we give away price to get volume, and it's not a healthy trade-off when it comes to income from operations dollars and margins.
It's fair to say that, not that you want to quantify a guidance for 2014, although it would be helpful, how much in basis points do you expect EBITDA margin, excuse me, there's only one margin, to improve in 2014 relative to 2013 on an apples-to-apples basis?
Yeah. Again, remember, as we looked at 2013, we had to sort of look at the core solid waste business because of the negative effects from recycling and waste-to- energy, that was 150 basis points. Next year, we shouldn't get detriments from those two businesses, we think that if that plays out like that, we should get 50 to 100 basis points of margin expansion.
Finally, on this waste to energy business, you take the impairment charge. Why be in that business? Why aren't we thinking about, or maybe you are, what strategic nature does that provide to your portfolio?
Yeah. The waste to energy business is really two different businesses, right? The waste to energy business is electricity, which is what they sell out of the back end of the plant, and it's basically a landfill at the front end of the plant, right? They take in waste, and they charge a tip fee. When we look at it, we say that the electricity certainly is not core to us, and it's not something that we have deep expertise in. Obviously, our folks at Wheelabrator have expertise, but we're not a power company, so we don't have as deep an expertise as folks whose primary business is power. You're absolutely right. On the power side, it's not strategic. On the tip fee side, it's absolutely strategic.
We always call the Wheelabrator plants the bottomless landfills because they can take it and keep taking in waste, and they never fill up. When we look at it from that point of view, it's absolutely strategic.
Okay, thank you.
Thank you.
You have a question from the line of Michael Hoffman of Wunderlich.
I can promise you, we don't have a question from the line of Michael Hoffman. We will have many questions from the line of Michael Hoffman.
How are you doing, David?
Hey, Michael. Doing great.
I guess I'm going to have to live up to that now. I only really had one written down, but I guess I'll make a bunch more up.
Don't feel like you have to live up.
If I can follow on the last question. The way that was answered would say a creative thought about maintaining that strategic exposure to the tip fee side, but finding somebody else who could actually leverage the electricity side is not off the table.
When we look at the electricity side, we're always looking at what we can do to improve it. In the past, we've hedged it. We're always looking for ways where we can take the volatility out of the earning stream.
Okay. On the volume side, you give us some great tables. One of them is called operating revenues by lines of business. When we think about where things are gone because of like a lost national account or Sandy, can you point out, is the lost national account coming out of the industrial line, or is that coming out of commercial? There's a pretty steep decline in both.
Yeah, a little bit of both. It depends on what type of national account customer you have, it's going to come out of both. I'd say roughly sort of 50/50, maybe a little bit more leaning toward the permanent roll-off side.
Okay. One of the things that hasn't been discussed, I have to believe you're seeing this, is that if you own a same-store basis in your commercial business, which is that small container business. If you're going to get what you pointed to earlier, housing starts leads to new household formation, which leads to new business formation, this volume shows up there. How would you characterize the volume in the container that's still there year in and year out?
Yeah. Well, let's talk a little bit about the commercial business, because I will tell you, Michael, when we look at the lines of business, what I would tell you is, look, if we're going to lose low margin temporary roll-off business, I'm not going to lose a heck of a lot of sleep over that, right? If we're going to lose low single digit national account business, I'm not going to lose a lot of sleep over that. Now, don't get me wrong. I would love to have that volume. The problem is, what does that do to the pricing dynamic? When I'm losing those low margin lines of business, I'm not particularly upset by it.
I would tell you that the commercial line of business is the one. If you could tell me which one line of business do we want to get focused on to stem the losses, I would tell you it's the commercial line. It's because, again, going back to that earlier question, the benefit that you get from route density is incredible. That's why, as Jim said, that's why we're sort of putting some more effort into customer retention without using price, right? When you look at that small container business, what you've seen over the last couple of years is sort of the amount of waste going in the container varies sort of mildly from negative 2% to positive 2%. We just haven't seen that real kick start that's going to dramatically change those commercial volumes.
Again, I think in the natural economic cycle, you'll see it, right? As new houses get built, no one builds a new gas station in the middle of nowhere. No one builds a new grocery store in the middle of nowhere. As new subdivisions start getting built, then they've got to build a gas station. They've got to build a dry cleaner. I think new business starts naturally trend behind housing starts. If we continue to see housing starts positive into 2014, I would hope that we'd start to see more new small business creation. If we can get that 2%-3% GDP, hopefully that, at a very minimum, will at least stabilize those volumes.
If I take what I'm hearing, what you're saying is that there is a slightly positive trend line that's starting to replicate or match this improving housing start number, but not enough yet to change the economic model. The direction's moving, it's moving in the right direction.
I think that's absolutely right.
Okay. Changing gears. Capital spending, would you break the 1.2 to 1.3 or take the midpoint 1.25? How does that break out in your definition of growth versus maintenance?
Yeah, Michael, we said last year that we had kind of redefined that. There was some growth, what had otherwise been considered growth capital previously, that we retitled to maintenance capital. If we had a contract that came up for rebid, previously, that would've been considered growth capital as we went through the process of evaluating it. That now is considered maintenance capital, even if the contract requires new vehicles. At this point, the growth capital number has shrunk pretty considerably, and what we're left with is a maintenance capital number that's probably in the $900 to billion range. Growth capital is the $200 to $300. Jim and I have taken a very discriminating view, as David said. When we make capital expense decisions, we discriminate, and we discriminate against those that provide lower returns.
Michael, when you look at what I'd traditionally call growth capital, I'll divide it into three categories, right? You've got landfill gas to energy. You've got alternative technologies, and you've got recycling. Those are sort of the three big buckets that we've spent, what we'll call, quote-unquote, growth capital on in the last five years. In 2014, you're not going to see a lot of spending in recycling or in alternative technologies. You'll see some spending in landfill gas to energy, you're not going to see it in those two areas. The obvious question is, why? Because we aren't seeing the returns in those areas. Again, as Jim said, we certainly aren't starting the business. We think we're at a good level of CapEx, and we don't expect to see that dramatically go up over the next few years.
Okay. Speaking of recycling, when you think about your efforts on going back to the customer like you did post the great recession and establishing pricing floors, what's the reception been on, we really need to talk about the quality you're sending us, and if you don't send better quality, we've got to charge you more?
Yeah, I think the reception has been, I would say, fine. Those are not hard conversations to have. I think the more important thing, Michael, is what's going to happen going forward, right? I liken this to what we did in the early 2000s with the fuel surcharge. When we first started the fuel surcharge, municipalities said, "Well, we don't have a fuel surcharge in our contract, so we're not going to allow you to bid if you take an exception for the fuel surcharge." We said, "Fine, we're not going to bid." After a while, that became an industry standard. Other industry players said, "Well, gosh, we're getting killed by fuel too, so we're not going to bid if there's not a fuel surcharge." Now virtually all contracts are bid with a fuel surcharge.
Going forward, the question is, we're not going to bid these contracts if they don't have the types of provisions that we need in order to make money. The question is the industry going to do like they did with the fuel surcharge and say, "Gosh, we aren't making any money either, so we're not going to bid these contracts"? That's going to be the big question going forward. Is someone going to be optimistic enough that they're going to bid contracts without the protections that they need in order to make sure they make a return on the investment? Are they going to do like we do and say, "Look, we want to be the largest recycler in North America. We don't have any intention of not being.
We also are not in this to lose money, and we've got to systemically change the way our contracts work going forward so that we can make sure we make an adequate return." The contamination level only gets to a certain amount of dollars. The rebate is a big part of it, too. Again, educating the consumer. You have to go at it from all of these angles. I would tell you the reception has been fine, but just getting a good reception from municipalities and changing those contracts doesn't get us anywhere near where we want to be from a return point of view. The only way we get there is if we fix these contracts going forward.
Okay. Jim Fish, on cash flow from operations, is it just margin that gets you from 17.6% of revenues to a 20% target, or is there working capital as well?
There's probably four things, we saw them in January, I think we'll see them for the rest of the year, that drive cash flow from operations and ultimately free cash flow. Those four things, I guess I'm speaking about free cash flow here because I'm including capital in there, but cash flow from operations, yield, of course, and cost control, both SG&A cost control and operating cost control. When you take that to free cash flow, CapEx. Of course, as you mentioned, working capital, and it's an item we haven't talked about on this call, but it's been an area of focus for us, particularly in the last two quarters of the year. To give you a couple of numbers, we improved our DSO by two days. Not happy with that.
It's in the right direction, not happy with the number. We've got to improve DSO more than that, I think you'll see that in 2014. Our days to pay, we really didn't start working on that in earnest until August. From August through December, we improved our days to pay by we increased that metric by three days. Really, there's quite a bit more to come there in 2014 as those pay cycles cycle through. We didn't change payment terms until November, December timeframe. I think you'll start to see a benefit in working capital from continued improvement in DSO and then a full year of improvement in days to pay.
Okay. That's great. Just a couple housekeeping items. In your guidance, what share count are you using to do the 230-235?
What we'd expect, Michael, is that we offset dilution, that we buy back at least enough shares to offset dilution. Yeah. I think we were at 470 million at the end of the year or so. We would buy back shares, as David said, in 2014 to offset dilution and then make-
Your dilution runs about 2%-3% of share count?
Correct. That's about right.
Yeah. Okay. The tax rate in 2013 is relatively lumpy in the quarters. How do we think about that in 2014? Since you've given an EPS number, it tends to have pretty dramatic impact on EPS by quarters.
Yeah. We can get you the quarterly number. The annual number is basically flat at about 35%.
Right. Okay, great. I hope I didn't disappoint you. I could come up with some more if you want, but I'm good.
That was excellent.
Thanks, guys.
Thanks, Michael.
Your next question comes from the line of Alex Ovchar of Goldman Sachs.
Thank you. Good morning. David, can you hear me?
Hey, Alex. Yeah.
Hey. Excellent. Just one question and a follow-on to it. Can you talk about how you expect your yield to perform at the landfills relative to the collection business in 2014? Just from a volume perspective, should we expect that volumes at the landfill at some point are going to begin to narrow with what you're seeing on the collection side, or is there a reason to think you can continue to outperform on the landfill side volume-wise relative to collection?
Yeah, we certainly expect volumes at the landfill to be positive in 2014. Like we said, particularly in the landfill line of business where you're seeing positive volumes, that should lead to better yield.
Okay. Thank you.
Thank you.
Your next question comes from the line of Barbara Noverini of Morningstar.
Good morning, everybody.
Good morning.
Jim, you referred to asset rationalization in your post-collection facilities and specifically mentioned a few cash flow negative landfills. You've talked about this in the past, but how much of this that was just reported was related to recycling assets? Further, is it fair to say that asset rationalization is continuing in your recycling portfolio as you work through these contracts? Would you say you've got a pretty good handle on projected future cash flows of your portfolio at present?
A bigger portion of that asset impairment, the biggest portion of it was, of course, the landfills. A piece of it was recycling facilities. We're not aware of any additional impairments at this point, but we always review our assets and where appropriate, we would close facilities. We felt like this year, we'd gone through a pretty extensive analysis, and by the time we got to the fourth quarter, we were prepared to make a call on those.
Okay, great. Just quickly, on the lost national accounts businesses that you were talking about earlier, how much of that is related to disappointment on your end from what they're demanding on the solid waste front versus the recycling front? Have you seen that demands from those customers in recycling is above what you're prepared to give at this point?
No. When you look at the national accounts, most of the national accounts do want recycling, frankly, that's one of the positives that we have, right? That we have the largest network of recycling facilities. The more recycling they want, the better chance we have at winning the bid. Look, basically what it's come down to is that our primary competition, as we talked about, is other large national players and then the brokers. I think the brokers are they're both very competitive, the brokers model, which by the way, we have a brokerage model too. The brokers model is to go out and try to get very low margin work done by subcontractors, as long as there's folks willing to do that, they're going to be able to continue to reduce price.
From our point of view, we always say, we don't need to practice our business. We've got plenty of ways to practice. We don't need to go out and do it for low margins. If other folks want to fill up their capacity with that low margin business, that's quite all right. When the economy comes back and we start seeing better volumes, we'll have that excess capacity that we can stretch in to get new volumes at higher margins, obviously, those competitors won't.
Okay. That's it for me. Thanks very much.
Thank you.
Your final question comes from the line of Jeff [Albert] of Stifel.
Great. Good morning. Just a couple quick questions from my end. I was wondering, David, on the national account side, you mentioned there was a $90 million headwind in 2013, and the largest customer, I think you articulated, would come offline mid this year. Would you expect that number to be higher than $90 million in terms of lost revenue in 2014?
You mean as far as new lost revenue or the rollover effect of the $90? You mean new?
It was the new lost revenue is what I was looking for.
Yeah, no.
I assume that.
That national account is roughly $50 million-$60 million. I'm sorry, $60 million-$70 million of annual revenue. Again, it's at low single-digit margins.
Got you.
When we look at other national accounts, the way we define national accounts is not just those $60 million and $70 million customers. The way we define national accounts is that, basically, if they cross over geographic market areas, they become a national account. A lot of those national accounts are regional. The bulk of our national account business is great business because we can create that route density. I wouldn't expect that we're going to lose another $90 million of national accounts in 2014. We'll continue to add sort of the smaller regional national accounts. Overall, the net effect will be that we will lose some revenue in national accounts, but we expect that our national accounts, EBIT dollars, will actually be flat to up.
Understand. In that same vein, can you just touch on the commercial side of the business in terms of service frequency increases, excluding the national account lost sales in 2013? What kind of the trajectory is or rhythm was through the year, and maybe touch on January. Are you seeing greater frequency increases excluding the lost customers?
Yeah, we haven't seen the January numbers. Again, what we saw in 2013 was sort of a fairly narrow band of positive, negative. Sort of down 2%, up 2%. We had a couple numbers that were up 2% or 3%, or down 2% or 3%. Basically, what I would say is that the overall trend in 2013 was slightly positive. We would expect that trend to continue, in fact, probably get a little bit better in 2014.
Excellent. My last question is just can you touch on the $200 million in growth CapEx that you mentioned before? I think it was to Michael's question. In particular, I was looking for where you are in terms of your natural gas fleet. Did you accelerate that last year with the accelerated depreciation? Would you look to decelerate the amount of new nat gas vehicles in 2014 added? Or just an update as to where that is exiting the year and what the plans are for this year would be helpful.
Yeah, Jeff. Jim Trevathan in here. We still plan to buy about 90% of our new trucks will be natural gas trucks. We're installing about 15 new locations across the country where we put the infrastructure in. We'll continue that. The payback was excellent in 2013, and we expect the very same in 2014. I don't see any change in that strategy at all around implementing natural gas fleet. Our customers like it. It obviously cleaner air. Both residential and commercial customers appreciate it. We'll continue that focus.
Just to put it in perspective, Jim, in terms of the percentage of the fleet today, are you in the mid-teens or whereabout are we?
13%. 16 now.
13.
I'm sorry.
16. Okay. Thank you very much.
16% of the total fleet. We put about 900 trucks on the road that were natural gas in 2013, and it moved that percentage up a couple of points.
Thank you.
Thank you.
Yeah. Thank you.
I would now like to turn the call back over to Mr. David Steiner for closing remarks.
Thank you. As we said, from a business point of view, 2014 is off to a great start. From a personal point of view, 2014 is not such a great start. We recently lost two of our corporate family to cancer. I wanted to say that our sympathies go out to the families of Jim Perry and Scott Stelman. I can promise you that they may be gone, but they are not forgotten. Thank you, operator.
Thank you for participating in today's fourth quarter and year-end 2013 earnings release conference call. Replay dial-in number, 800-859-2056. International local dial-in number, 404-537-3406. Conference code, 31500809. You may now disconnect.