Morning. My name is Rachey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management Second Quarter 2013 Earnings Release Conference Call. All lines have been placed on mute within any background noise. After the speakers' remarks, there will be a question and I would now like to turn the call over to Ed Eggle, Director, Investor Relations.
Thank you. Mr. Eggle, you may begin your conference.
Thank you, O'Shea. Good morning, everyone, and thank you for joining us for our Q2 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. David will start things off
with a summary of the financial results for
the quarter, including internal revenue growth from yield and volume. Jim will cover our revenue growth, price and volume trends, operating costs and the financial statements. We will conclude with questions and answers. During their statements, any comparisons unless otherwise stated will be with the Q2 of 2012. Before we get started, let me remind you that in addition to our earnings press release that was issued this morning, we have filed a Form 8 ks that includes the earnings press release at Exhibit 99.1 and is available on our website at www.wm.com.
The Form 8 ks, the press release and the schedules to press release include important information that you should refer to. During the call, you will hear certain forward looking statements, which are based on current expectations, projections, estimates, opinions or beliefs about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are detailed in today's press release and in our filings with the Securities and Exchange Commission, including our most recent Form 10 ks. Additionally, during the call, David and Jim will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share on an as adjusted basis.
David will also discuss operating EBITDA as defined in our Form 8 ks filed today. Our EPS and operating EBITDA have been adjusted to exclude items disclosed in our earnings press release that management believes do not reflect our fundamental business performance or are not indicative of our results of operations. These measures in addition to free cash flow are non GAAP measures. Please refer to the earnings press release footnote and the schedule attached thereto together with item 2.02 of the Form 8 ks filed today, both of 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. David and Jim will also discuss our results in areas of internal revenue growth from yield and internal revenue growth from volume.
Unless otherwise stated, please note that any references to yield or volume results are more specifically referring to internal revenue growth or IRG from yield or volume. This call is being recorded and will be available 24 hours a day beginning approximately 1 p. M. Eastern Time today until 5 p. M.
Eastern Time on August 13. To hear a replay of the call over the Internet, access the Waste Management 6 and enter reservation code 9,780,3740. Provided during today's call, which is occurring on July 30, 2013, 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. Now, I'll turn the call over to Waste Management's President and CEO, David Steiner.
Thanks, Ed, and good morning from Houston. During the Q2, our earnings per share grew to $0.54 overcoming $0.03 of unexpected headwinds. We had a negative $0.02 additional headwind from our recycling operations and a negative $0.01 from litigation settlements. Without these headwinds, we would have earned $0.57 per share close to 10% earnings growth. Our disciplined approach to improving price, reducing costs and managing capital expenditures is reflected in this earnings growth and in our free cash flow.
So we're pleased with our results for the Q2 year to date, which are right on plan despite the negative impacts from our recycling business. The story of our quarter is that we had very strong results in our traditional solid waste operations. But overall results were muted by unexpected headwinds in our recycling business. Even with these headwinds, our operating EBITDA margins grew by 20 basis points. In our traditional solid waste business, we grew income from operations margins by 80 basis points, driven by our yield and cost programs.
We expect this margin expansion to continue throughout 2013 and to accelerate into 2014. Volumes improved sequentially in all of our collection lines of business except recycling and roll off. We offset roll off volume losses with very strong yield, which drove 90 basis points of margin expansion in our roll off business. In our recycling business, we expected the 2nd quarter impact to be a negative $0.03 to earnings per share.
The actual result was a
negative $0.05 Looking out to the 3rd 4th quarters, we originally expected a positive $0.04 impact on earnings per share when compared to 20.12 We now think that the impact from our recycling operations will be flat year over year in the second half of twenty thirteen. Thus, we now expect a full year negative impact of $0.08 per share versus the negative $0.02 per share we had originally anticipated. Many of you have heard about the Chinese green vents, which is affecting our recycling operations. The Chinese government has recently begun to enforce limits on moisture and non conforming materials in imported fiber and plastics. The higher quality expectations have translated into additional labor and maintenance costs to remove residual waste from the recyclable materials that we process for our customers.
It has also resulted in fewer volumes to sell because of the higher residual material. That in turn has reduced revenue and increased residual disposal costs. So you can see why the green fence has had a negative effect on the results of our recycling operations. As we've discussed, we've been implementing a business improvement plan in our recycling line of business. First, we'll be working with our customers to improve the quality of the inbound streams of material.
Our contracts with many large customers limit the amount of residue in the recyclables they deliver to us. We will be working with them to ensure compliance with these limits or we will charge them to cover our increased costs. 2nd, we are modifying our operating procedures to reduce costs and residual waste. Finally, we will also look at each of our recycling facilities and rationalize those that continue to lose money. Our municipal, commercial and industrial customers want to recycle their waste materials.
We have the best assets in the industry to support that desire, but we will do so with a pricing and operating strategy that supports both our customers and our shareholders. Our solid waste pricing programs had a very positive impact in the Q2 of 2013. Yield from our collection and disposal operations was 2.1%. This is the highest yield since the Q1 of 2011 and we've seen yield improve sequentially for 4 consecutive quarters. If you add in our fuel surcharge and adjust for our South Florida waste to energy plants, we achieved yield of 2.6%.
We achieved core price of 3.6%, an increase of 110 basis points from the Q2 of 2012. It's worth noting that the uptick in yield more than offset the reduction in volumes. So our pricing program is working very well. During the Q1, we mentioned the steps that we're taking to improve yield and in the Q2 we saw positive results. Average rates for both commercial and industrial new business pricing exceeded lost business pricing for the 2nd consecutive quarter.
Service increases in our commercial business exceeded decreases for the first time since the Q3 of 2010 and price rollbacks are down almost 2 thirds from the peak in the Q4 of 2011. Our pricing momentum continued to build in the Q2. In our commercial line of business, we had the highest yield that we've seen since 2011 at 3.1%. Importantly, our pricing actions didn't reduce volumes in the commercial line. In fact, volumes improved slightly over the Q1 of 2013.
On the industrial side, we did not see volume growth in our industrial line, with volumes down 1.2% for the quarter. What we did see in our industrial line of business was a yield of 4.8%, which is the highest yield since Q1 of 2007. We also saw the highest new business pricing that we have ever seen in our roll off line of business. There are all sorts of roll off customers, some value service and quality and some value price. We are clearly more focused on attaining higher margin customers that value service and quality And we simply won't chase low margin roll off business.
And the trade off is very positive. In both our commercial and industrial lines of business, we saw margins expand by 100 basis points. So we focused on core price increases and we've moved core price close to 4%. In future quarters, we will continue that focus, but we will also turn our attention to fees and surcharges. When you look at our average customers over time, the combination of fees and surcharges between 20% 30% of the total bill.
So every time we waive the fees and surcharges, it's the equivalent of giving a 20 percent to 30% price decrease versus the opportunity. Increasingly, we've seen our competition offer to waive fees and surcharges, particularly in the roll off line of business. When we match that action, it equates to a 20% to 30% rollback of prices, which dwarfs a 4% core price increase. So in the second half of twenty thirteen, we will focus on obtaining the fees and surcharges. With fuel and environmental compliance costs growing drastically over the years, this is the only way that we can ensure we cover our increasing costs so that our other programs can drive margin expansion.
Overall, volumes were negative 0.6% in the second quarter. But it's important to note that one of the main drivers of the decline in volume was in the recycling business. Recycling volumes were down almost 1%, a notable swing from recent increases in the range of 6% to 8%. Volumes have been impacted by China's Green Fence initiative and we've also seen several large new plants pass their 1st year anniversary. In both our commercial and residential lines of business, we saw a sequential improvement in the rate of decline in volumes for the 3rd consecutive quarter.
For the second half of the year, we don't expect volumes to change much from the second quarter. That assumes slightly negative Q2. That assumes slightly negative collection volumes, but our increase in yield should more than make up for the lower volumes. In our waste to energy business, average electricity pricing improved almost 5% in the Q2 when compared to the Q2 of 2012. We also saw improved SG and A expenses.
These improvements basically offset an increase in repair and maintenance costs due to the timing of outages. Overall, the waste to energy business was basically flat for the quarter and the first half of twenty thirteen when compared to the second quarter and first half of twenty twelve. We still expect the full year impact on earnings per share from our waste to energy operations to be approximately a negative $0.02 per share compared to 2012. In summary, we had greater than expected recycling headwinds in the Q2, but we overcame them. Consequently, we're on plan through the 1st 2 quarters of 2013.
We overcame the headwinds through good cost controls and an IRG that is more weighted to price than volume. We expect that our continued execution on yield and costs will help us manage against the $0.08 per share of recycling headwinds that we anticipate for the full year. Accordingly, we still expect to achieve full year guidance of between $2.15 $2.20 of adjusted fully diluted earnings per share and free cash flow of between $1,100,000,000 $1,200,000,000 This quarter clearly shows how well our field operations can perform when they're focused on the right items. In the past few years, we diluted some of the messages to our field operations. But this year, we asked them to focus on 2 things yield and costs.
And in the Q2, they delivered on both. Our overall IRG was right where we expected it to be, but weighted more toward price than volumes, which is a very positive fact. Jim will talk about our cost programs, but when it comes to yield, we've put the plans in place and our corporate and field leaders are doing a superb job in executing the plan. We are focused on adding volumes in the higher margin lines of business like our landfill and commercial lines. In our lower margin lines of business, we're either going to improve their profitability or we're going to disinvest in them.
Given cost inflation, we must have better pricing to drive sustainable margin expansion in these lower margin lines. We simply will not chase volumes at inadequate prices. For example, we've not bid on a number of residential contracts. And in those that we do bid, we're generally bidding higher prices. This may cost us some volumes, but losing volumes in a low margin line of business can be a very smart move to drive returns on capital.
This is particularly true in the residential line of business that on a non integrated basis contributes about 15% of our collection earnings, but takes up over 40% of our fleet capital spend. In the temporary roll off business, many competitors are willing to put their cans to work at a low price. We will not do that. As I mentioned, our new business pricing in our roll off line has hit its highest level in the history of our company. The 100 basis point improvement in margins in our collection business reflects the success of this trade off of price versus volume.
Obviously, if we're going to charge higher prices, we need to provide greater value by being the service leader and we have a number of programs designed to give great value to those higher priced customers. We are constantly trying to improve the value delivered for the prices we charge. And we will continue to add programs for those customers to make their experience the best in the industry.
I'll now turn the call over to Jim to discuss our 2nd quarter results in more detail. Thank you, David. I will start by discussing our strong SG and A and cash flow performance. Then I will expand on David's comments about the results of operations from my traditional solid waste business and yield and volume in our various lines of business. I will conclude with a discussion of our financial metrics.
In our SG and A cost category, we continue to see the results of our restructuring and focus on controlling costs. SG and A costs were $353,000,000 in the 2nd quarter and 10% of revenue, an improvement of $21,000,000 and an 80 basis point improvement compared to the Q2 of 2012 as a percent of revenue. The 2 biggest areas of savings came from labor due to our restructuring last year and our focus on lower controllable costs. These savings were partially muted by a $30,000,000 incremental compensation plan accrual that did not occur in 2012. Bad debt expense improved SG and A costs by $8,000,000 due to the partial collection of a receivable at our Puerto Rico operation.
Additionally, DSO improved sequentially. In fact, we've improved DSO sequentially for 3 consecutive quarters. We are pleased with the 2nd quarter SG and A results, but we still have a lot of work in front of us achieve our full year goals. In the Q3, we expect approximately $45,000,000 of headwind in SG and A from incentive compensation accruals. We only had $30,000,000 in the Q2 of 2013.
However, for the full year, we still anticipate achieving our goal of flat SG and A costs when compared to the full year of 2012. Turning to cash flow. Q2 2013 net cash provided by operating activities was $545,000,000 This is a decrease of $124,000,000 compared to the Q2 of 2012. In 2013, we had $117,000,000 increase in taxes paid based on higher income and the timing of estimated tax payments. In 2012, we benefited from $72,000,000 of proceeds from swap terminations.
Cash from operations was very strong. Net of those two items, cash from operations would have been up $65,000,000 Our capital expenditures for the Q2 were $235,000,000 an improvement of $116,000,000 compared to the Q2 of 2012. We remain disciplined on ensuring that we spend capital on assets that fit within our long term strategy. As we've mentioned in the past, we are also looking at rationalizing our asset base. For instance, during the quarter, we recorded an impairment charge on a disposal facility that was cash flow negative.
When we close the facility, we will move the volume to another waste management facility so that we maintain the associated revenue. Putting all of this together, our free cash flow for the quarter was $347,000,000 an increase of $15,000,000 compared to the Q2 20 12. Year to date, free cash flow increased $261,000,000 to 695 from sale of assets, free cash flow is $621,000,000 year to date and puts us well on the way to achieving our goal of generating between $1,100,000,000 $1,200,000,000 of free cash flow for the year. We returned $171,000,000 to our shareholders through our 2nd quarter dividends. We invested $30,000,000 on acquisitions and we repaid $290,000,000 in debt.
Our pricing programs are improving each of our collection lines of business as well as our overall results. Yield on our collection and disposal operations grew 2.1% in the Q2. Our yield growth for the Q2 of 2013 would have been 2.6% if you include the fuel surcharge and adjust for the change in pricing at our waste energy plants in South Florida. In Q3, we will see a portion of our contracts reset price again on tip fees in our South Florida Waste Energy business, where a competitor took some volumes at about a 40% per ton reduction from our rates. Combined internal revenue growth from yield in our collection business was 2.9% in the 2nd quarter, with 4.8% growth in industrial, 3.1% growth in commercial and 1.5% growth in residential.
The industrial yield is the highest that we've seen since Q1 of 2007 and for the commercial line of business, it's the highest since 2011. The increase in yield has not had impact on collection volumes as the commercial and residential lines of business saw sequential improvement in the rate of decline of volume loss. In landfill line of business, we achieved MSW yield of 1.8%. Moving to volumes. Internal volume growth was negative 0.6% in the quarter.
The decline was primarily driven by a decrease in recycled volumes as David mentioned. We saw collection volume decline by 1.4%, although the rate of decline on collection volumes slowed. More specifically, commercial volumes declined 2.7%, industrial volumes declined 1 0.2% and residential declined 1.1%. In the landfill line of business, volumes were positive 6.6%. MSW volumes grew by 6.3%, primarily from increased Oakleaf vendor hauler volumes and special waste volumes grew 5% as our pipeline for jobs remains strong.
We also saw strong volumes from revenue generating cover and C and D tons. When look at our overall operating results, our income from operations margin was flat at 14.8% when compared to the Q2 of 2012. As David mentioned, our traditional solid waste business collection, landfill and transfer stations had a very good quarter. Income from operations in those lines of business increased $47,000,000 and income from operations margins increased 80 basis points. The collection lines of business drove most of the income from operations increase.
Both our commercial and industrial lines of business improved when compared to the Q2 of 2012. The residential business continues to be a challenge, primarily in the South, where contract changes in Florida related to the waste energy business drove a slight decline in income from operations. So the 80 basis point improvement in the traditional solid waste business was offset by a decline in the recycling business. We've been very clear with our field operations that we must pass through the recycling increases to our customers in the coming quarters. Turning specifically to operating The improvement that we saw in our traditional solid waste business was muted by an increase in operating expenses, primarily from increased costs energy facilities.
These items were $35,000,000 of our $51,000,000 increase. We remain focused on controlling costs and expect to see improvement as we progress through the remainder of 2013. In fact, when you look at our traditional solid waste business, our maintenance costs were essentially flat when compared to the Q2 of 2012. Finally, looking at our other financial metrics, at the end the second quarter, our weighted average cost of debt was 5.1%. Our debt to total capital ratio was 58.9%, consistent with our target ratio of about 60%.
The floating rate portion of our total debt portfolio was 10% at the end of the quarter. Overall, results are proceeding as expected as our pricing and cost control programs have allowed us to overcome the recycling headwinds in the 1st 2 quarters and remain on plan. Results of the 1st 6 months of 2013 have put us in position to achieve our yield, SG and A, earnings per share and free cash flow goals. We continue to take a strong stance on controlling SG and A costs. We've saved $38,000,000 year to date when compared to 20 12.
Our stated goal for SG and A is to remain flat with 2012. Even though the 3rd quarter comparison will be tough with $45,000,000 of compensation accrual headwinds, we still expect to meet our full year target. Similarly, we're applying a very disciplined approach to capital management. Combining this with our focus on yield, SG and A and improvement in working capital and earnings, we've already generated $621,000,000 of free cash flow, exclusive of the sale of assets. This puts us more than halfway to our goal.
We will continue this disciplined approach in order to achieve our free cash flow goal of between $1,100,000,000 $1,200,000,000 for 20
Your first question comes from the line of Hamzah Mazari with Credit Suisse.
Good morning. Thank you.
Good morning, Hamzah. Happy birthday, by the way.
Hey, thanks a lot. I appreciate it. The first question, David, is just on volume. It seems like the recycling business is 12% of revenue. It's not that big.
You guys said that it's 1% down on volume. Is all of the volume loss or below volume relative to expectations given what you're seeing with the rest of the sector, in that as well?
Yes. No, I think that's basically it, Hamz. I mean, as we mentioned, we've got the highest new business pricing that we've ever seen in the roll off line of business. When you think about it, if you look at the roll off line of business as a 20% call it a 20% margin business, every time you get a new can 20% of it drops to the bottom line. Every time you get 1% price, 100% drops to the bottom line.
So you have to get 5% volume in order to make up for 1% price. What we saw in this quarter was basically you saw our the quarter to quarter change in yield was 1.3%. In order for that to equate to a fair trade off, we have to get 7% volume. You can't do that in this business. And so we went around and talked to our folks out in the field and they said, look, we can go get roll off volumes if you want us to, but what we're going to do is we're going to mess up the market at a lower price and we're going to get low margins on it.
We would much rather go out at higher price, offer good quality for what we're doing and get that higher priced roll off volume. And as you can see the trade offs worked very well with 100 basis points of margin expansion.
Okay. And maybe if you could give us a sense of the lag that it may take the field organization in making the adjustments on the recycling business to get the surcharges and fees? How much of a lag do you think it's going to take the field to get the recycling business from sort of not being a margin headwind? Is this more of a 2 quarter lag or any sense of expectation there?
Yes. I mean there's sort of 2 pieces to the recycling business. There's the commercial recycling that is as close as we can get sort of to spot recycling, if you will. And on those types of transactions, we can change the price today. And we've got folks and teams out in the field doing just that.
In other cases, we have long term contracts with municipalities and other folks. And we need to get through those contracts. We need to understand what our rights are under those contracts and we need to go and talk to the customers. So it's there are pieces of it that we can do quickly. There are pieces of it that take time.
I would say, frankly Hamzah overall, it's going to take a little bit of time. But what we've told our field operations is we don't have the luxury of time right now. I mean, we are losing money in our recycling operations. In most of our recycling operations, we've got to turn that around and we've got to turn it around now.
And just last question for me. I'll turn it over. The landfill pricing, it seems like that that decelerated at 1.8% relative to sort of the mid-two percent it was running. Could you maybe comment on that? You.
Actually it was up in the quarter from prior quarters. The last time we saw a yield that high was Q1 of 12 on the MSW line. But look, we've talked about it very vocally that we need to get that sort of 5% to 7% price increase at the landfill. That is like the recycling business in that you've got a lot of long term contracts, so you have to work through those issues. And we're absolutely working through those issues.
We will not back down on our 5% to 7% price increases.
Great. Thanks a lot.
Sure.
Your next question comes from the line of Bill Fisher with Raymond James.
Good morning.
Good morning, Bill.
Hey, first on Jim. You mentioned, I think, I just want to make sure I had the numbers right, of the operating costs increase like $30,000,000 of it was wheelerbrader maintenance and recycling. Is that roughly right?
About $35,000,000 was a combination of the one time wheeler breeder events, maintenance events and recycling.
So the rest of it, if you do the math, roughly was the cost was only up say 1% or so. So you had good cost control on the rest of it?
Yes. And one thing Bill that we've talked a bit about in previous quarters was maintenance costs. Okay, great. And then just quickly on acquisitions and divestitures. Did
Okay, great. And then just quickly on acquisitions and divestitures, did you I thought I saw on the Quebec papers, did you guys were you able to close that RCI transaction?
Are you able to read the Quebec papers?
Yes. I had to translate it, but
that's what it looked like. Yes, we did. We closed it in early July.
Okay. And any rough handle on what the annualized revenues of that could be?
Yes. The annualized revenue is roughly 170,000,000 dollars Okay. And Bill, when we had actually intended to close that, we had an agreement to close that for quite a while. When we gave our full year guidance, we actually expected to close that at the beginning of the year not in the middle of the year. So it is baked into our Lucian Remyard ran a spectacular business up there and we're looking forward to leveraging the great company that he built.
Okay. And you have a lot you have some decent overlap on the hauling side too or do you not in that market?
Well, frankly, this is sort of the minnow swallowing the whale. We have a fairly small presence from a collection point of view in the Montreal market area. RCI had a much bigger presence. So we're going to keep the RCI brand in Montreal.
Okay, great. Thank you.
And your next question is from the line of Corey Greendale with First Analysis.
Hi, good morning. Good morning.
First, just wanted to ask about the price. So given, obviously, it's moving in the right direction, would you say that you have most of the pricing action kind of fully baked in Q2, so we should expect a similar level of price growth in Q3? Or could there still be some acceleration as you keep implementing that stuff?
Yes. We the regulatory cost recovery fee did not we didn't get a full quarter benefit out of it in this quarter because implemented it sort of mid quarter. But we will also have some headwinds coming in the back half of the year from CPI from the resets of the contract in Florida. All in all, I'd sort of call it a wash. We said at the beginning of the year that we would be at sort of 1% to 1.5% yield.
For the first half of the year, we're at 1.7%. I now expect that for the full year, we'd probably be at that 1.5% to 2% type of range. There are a couple factors that come into the second half of the year that lead me to not try to say we're going to see dramatic acceleration. But I can promise you from a total dollars to the bottom line, we aren't taking our foot off the pedal.
Can you give us a sense how much of that 2.1% yield was from the regulatory recovery fee?
Just about $8,000,000 in the quarter. Okay.
And then in your commentary, David, you talked about the non compliance in some cases with the fees and surcharges. Can you put some kind of parameters around that? Like how much of an opportunity what percentage of the customer base is compliant with that? What's the opportunity to get where you get closer to 100% compliance?
Yes. I mean, look, the opportunity is tremendous. What I talked about, it's basically a 20% to 30% price decrease when you waive fees and surcharges. On our commercial line of business, we're at about 85% compliance. On the roll off line of business, we're only at about 55%, because basically what you've got the roll off line of business, it's a little baffling to me that in a low margin line of business, you'd see folks out there waiving fees and surcharges on the roll off line of business.
And so it's very competitive in the roll off line of business. Our compliance is about at 55%. So just take 20% to 30% price rollback and add it back into that and you can see the dramatic effect that that has on earnings. And
on that front, are
you starting to see new entrants into that business? Or is
it primarily the Well, I think it's I think it's I think it's I think it's I think it's I think it's I think
Well, I think that one's sort of across the board. There's obviously a lot of competition in the roll off line. It's very low barrier to entry. But I would say that it's sort of across the board. Generally, what you've seen is that the smaller players sometimes don't even have the fees and surcharges.
The larger players generally are the ones that will roll it back.
Okay. And then just a quick housekeeping one for Jim. What would you suggest is the tax rate for the back half of the year?
We're at we always say we're going to approach the statutory rates of 35% and I would stick with that.
Okay. Great. Thank you.
Your next question is from the line of Alex O'Shea with Goldman Sachs.
Good morning. This is Ashishya Guntupalli on behalf of Alk Omshet. How are you?
Good morning. Doing well.
Great. And just on the CapEx expectations for full year 2013, the run rate so far seems to be below your initial guidance. How do we think about a lower bound?
Well, I would say that we're still on track to hit our guidance of 1.3 to 1.4. Typically, we see an acceleration of capital spending in the second half of the year. So while it may look like if you straight line it that we're going to be at 1.3 to 1.4 range, we'll more than likely see an acceleration in the second half as we always do and end up right within the range.
Got it. And one more. So on rollback in Q2, they were lower by 45% year on year without increasing the churn rate. Does this imply improved pricing discipline in the industry generally?
Oh, I don't think there's any doubt. I mean, look, we can't particularly speak for the industry. We can only speak for what we do. And I can promise you that there's absolutely no doubt there's been increased discipline with our folks as far as rolling back prices. And look it's a tribute to our sales folks and to our training folks who this doesn't happen just by putting an edict out that we're going to not roll back prices.
There's a lot of training that goes into it. There's a lot of preparation that goes into it. There's a lot of work by our customer service reps that go into it. And they've done a phenomenal job turning it frankly that
fast. Got it. And any expectations for second half on roll off rates?
Yes. Generally, roll off or rollbacks?
Rollback, sorry.
Yes. Generally, rollbacks do pick up a little bit in the back half of the year, but we've done a nice job of holding the line and I wouldn't expect to see it materially change. It could tick up a little bit, but I wouldn't expect to see it materially change.
Got it. Thank you.
Thank you.
And your next question comes from the line of Joe Boggs with KeyBanc Capital.
Really nice job on the SG and A front. I understand you guys reiterated your flat year over year guidance. And I guess that makes sense with comps getting tougher in 3Q and accrual sequentially ramping. I'm just curious if you can maybe give us a little more color on how much flexibility you have that flat guidance? Is that a stretch?
Or are you thinking you could actually put up better SG and A margin given the improvement you've seen so far?
Joe, I would
say it's not a huge stretch, but it's also I don't think we have a whole lot of room there either. I think we're probably pretty comfortable with flat year over year, which is saying something considering the comp headwinds that we faced. So I think we're probably on track to hit the flat guidance with 2012 that we've given.
Okay. And switching gear to the recycling side, I'm sure we could probably back into this. I just want to check. Can you just flush out what the swing in recycling volumes ended up contributing to the 60 basis points of volume degradation that you had?
Yes. We'll run that calculation for you and check it and get the number to you. Okay. Yes, that'd be helpful. And then I don't know how to do that complicated math.
Was there any difference then between your internal MRFs, what you saw from a volume basis there or your brokered volumes? Or was
it basically 1 and the same?
It was basically 1 and the same.
Great. That's all for me. Thanks.
Thank you. Thanks, Joe.
Your next question comes from the line of Michael Hoffman with Wedbush Securities.
Good morning and thank you for taking my call.
Hey, Michael. Good morning, Michael.
How are
you doing David, Tim?
Can we just push on the volume subject a little bit? I get the bottle. You're going to push price and you're willing to push some less marginal volume away. But if I looked at the business that you've gotten price and kept the customer, what's happening on the volume in those customers?
You mean as far as weights or Yes.
Like I mean it's like for like in your front end loader business, are you seeing container rates starting to rise?
Because I
wouldn't think you would push this pricing forever if you didn't think the macro volume environment was gradually improving as well.
Yes. I don't think there's any doubt that we're seeing improvement in the commercial line of business. Again, it's not dramatic, but it's consistent. And so we saw weights up frankly across all of our collection lines in the quarter. Obviously, it was a very wet quarter, so that added some to the weight.
But the other thing that is very encouraging for me is what we mentioned about the service increases and service decreases. For the Q2 in a row, we've seen service increases outpace service decreases, which tells you that, yes, there was some wet weather in the Q2, but we are seeing the customers start to move up to the larger containers. So again, like we've said in the past, we're not going to declare victory. It's certainly a long slug for us to get there. But in the commercial line of business, we actually are seeing some very good signs.
And then if I were parsing a rise, which would be consistent with the sort of improving construction environment?
Yes. We saw C and D volumes up in the quarter as I recall around 4.5%, 4.5%, let me that's right, yes 4.5%. Okay. So across the landfill, we're seeing actually very good volumes. We saw volumes up nicely on the MSW side.
Special waste, C and D were both up. And so look, it comes back to what I said in the script. If you're going to add volumes, let's add them in the right line of business. And if you're going to be aggressive on pricing, let's be aggressive on pricing in those low margin lines of business where the only way you're going to drive look, it takes a long time to drive costs out of the system. And so you're never going to get margin expansion if all you're going to try to do is drive costs.
And so in those low margin lines, you absolutely have to raise price. And of business, call it a 10% to 15% margin, if it was a 10% of business call it a 10% to 15% margin, if it was a 10% margin customer, you can gain 1% volume and 1% price and lose 10% of your volume and still be equal. And by the way, price comes without any capital investment. So, look, this is Michael, this is not any different than what we did from 2,004 through 2,008. That's what I said in my script.
I think we got the message to the field a little bit mixed up the last couple of years and we got them unfocused on price and costs. We got it back. You saw some progress in it this quarter. We still got a long way to go. But I think you're going to see it accelerate throughout 2013 2014.
So where I would connect the dots between your comments and my questions are there's a point of operating leverage that should start to accelerate as macro volumes continue to improve. You continue to be successful on this price as well as the discipline around the G and A. What's your thoughts about the visibility on that? Where are we? A year away from that?
Are we 6 months away from that? Where is that?
Well, look, I'm encouraged that we saw the EBITDA margins turn positive this quarter. Look, I will tell you Jim talked about the flat SG and A guidance for the rest of the year. Jim Fish and Jim Trebathen have done a phenomenal job on holding the line on SG and A costs. So I don't expect to see SG and A costs go up materially this year or next year frankly. And so we've got to drive operating costs out of the system.
We're starting to get a little bit of traction on that. And I think what we saw was look the biggest leverage is always going to come from yield in this business. And I think you saw us start to get some traction back in that in the quarter. So all we need is for the economy to continue to improve so that we don't see the dramatic volume drop offs that we saw in 2,009. And I think you've begun to see the leverage in the operating model.
I think you should see that accelerate in the next 18 months. And Michael just
one quick point Michael on operating expenses that David talked about. I mentioned that a big slug of that operating expense increase was related to recycling. I think when you think about the leverage going forward, if we can't squeeze that operating cost out that's related to this quality control measure from China, then we plan to pass it through to our customers. And that in and of itself helps us reduce operating expenses as a percent of revenue.
That's a great point. Every penny that we improve in recycling drops straight to the bottom line and there's a lot of room for improvement there right
now.
Okay. So my last stock connection on this. It sounds like if I take the bonus accruals for this year plus the headwind from bonus depreciation, but netted against the successes you're having on G and A pricing and operating leverage, you should be able to produce a flat year over year free cash flow maybe even a teeny bit of growth given those 2 cash headwinds?
Michael, yes, we'll wait until 2014 to give the guidance. But look, I said all along, this is a business that should generate $1,100,000,000 to $1,200,000,000 of free cash flow come hell or high water. Look, we didn't do that last year. That's not going to happen again. The other thing that I can say that Jim and Jim have been phenomenal at is the capital discipline.
And we're going to manage the capital such that we make this at least a $1,100,000,000 to $1,200,000,000 free cash flow company every year come hell or high water. I wouldn't expect that to change next year. Michael, did you say
flat for 2014 versus 2013? Are you saying flat for
2020? Yes.
Okay. All right.
Yes. Flat so if you're so in 2014 you should do 1.1% to 1.2% again even with those two headwinds given the leverage from your price and your cost controls.
I just want to make sure because 2012 to 2013 is going to be a dramatic improvement in free cash flow.
All right, Michael. You snuck some 2014 guidance out of us, but I'll give it to you. We're going to do at least 1.1 to 1.2 in 2014.
There you go. Thanks a lot.
Your next question comes from the line of Adam Thalhimer with BB and T Capital Markets.
Thanks. Good morning, guys.
Good morning.
Are the green fence costs or do you think those are permanent? And how long should it take to get to pass those costs on to your customers?
Yes. We've looked a lot at this. And as you can imagine, it's been a big topic of conversation. And there's so much international trade involved that it's hard to get really good visibility. But we've sort of decided that we need to take the approach that it is going to be if not permanent at least long term.
We can't sit and say, well, we're just going to let the business continue, the way it's been in the past and wait for the green fence to clear and everything's going to be all right. We're not going to take that approach. So if we're not going to take that approach, We're not going to take that approach. So if we're not going to take that approach, we absolutely have to start driving costs out of the system and going back to So look, it's I will tell you, I don't even want to try to put a guess on the time frame to when recycling gets back to where we want it to be. All I can tell you is that we need to see incremental improvement every quarter and we've got the plans in place to do that.
And how are the recycling contracts structured? I mean, how they only come up once every 5 years. So it's hard to push price or how hard is it to push price I guess is the question.
Yes. I mean it depends on the type of customer, right? And so we've got plenty of commercial recycling customers that are just like our regular commercial customers where we can change the price immediately, right? And then we've got other customers that are municipal customers where the contracts are going to be more the 3 to 5 year type traditional municipal contracts. And so what we've done is we've asked every one of our operations to get their top contracts, right?
Let's start out with let's go where the dollars are first. And let's go to our biggest contracts in every one of our market areas and start going to those customers. And most of those contracts are going to allow us in some manner to either pass on increased price, lower rebates or higher processing costs. And so let's go after the big ones first and let's make sure that we go out and talk with those customers to cover our increased costs. And then on the other side, the non contracted customers like our commercial customers, we've run a couple of pilots to look at what we can do from a pricing point of view there and we're going to spread those across the country.
Look, from a commercial customer commercial recycling customer point of view, there's going to be a lot of places where they're going to have a decision to make. They're either going to have to pay us more to recycle or they're going to have to move back away from recycling and just use their one disposal can. And so we've got to do that. It's certainly not something that we relish doing, but we need to have the customers make the decision on how what they
want us to do from a recycling their materials point of view. Adam, one quick point here on these contracts. While it may sound difficult to change the price, many of these contracts have residual percentages in them. Many of these contracts have composition components to them. So we're going to go and look and see whether and we'll hold these customers to their contracts.
If their residual percentage is 10% and we're getting 20% out of their contract, then we're going to go back to them and have a discussion. And similarly, if we expected to get a certain percentage of glass by weight out of a municipality and we're getting a much bigger percentage of glass then we'll also go back and have a discussion with them.
Well, I hope you're successful, right? Because that doesn't seem like the trend is going to slow down. I mean, I imagine your commercial customers are going to continue to recycle. It's just a matter of you being able to push price, right?
Absolutely. They're going to continue to recycle and we look forward to helping them recycle.
All right. And one more question. I hate to ask it because I know you're not focused on this. But for us analysts trying to plug numbers into a model, I mean, what would be your thoughts on volume growth in the back half?
Yes. Obviously, no one knows what the future holds. But at the beginning of the year, we said we were going to have positive volumes. Obviously, in the Q2 what you saw in the Q2 was recycling driving the bulk of the I don't know if we've got that number yet, but we saw recycling driving the bulk of the decrease in volumes. And the only other line of business where we saw negative volumes was on the roll off side where volumes were negative 1.2%.
Now volumes fall off the face of the earth or anything of the sort like that, but we didn't expect a volume decline in recycling. And we don't expect to see our roll off line bounce back to where we're getting hugely costed volumes because we're just not going to chase low margin business. So for the back half of the year, I think we're looking at volumes similar to what we saw in the Q2. But look, basically what you saw in the 2nd quarter is our volumes went down 0.5% and our price went up 0.5%. And if I can get our price up 0.5% and our volume down 0.5%, I'll take that trade off 6 ways to Sunday.
Okay. Great color. Thank you. Thank you.
And your next question comes from the line of Jeff Osborne with Stifel.
Good morning. I just had two quick questions for you, David. On the Greenfence side, the rule has been in place for quite some time, it's my understanding, but is the enforcement from China stepped up over the past couple of months? Is that part of the issue at play here?
Yes. With the change in Premier's in China, you saw early this year, you saw basically a declaration by them across all sorts of type of environmental initiatives. And so even though the regulation has been on the books, they finally just passed I mean not just passed, but they just mandated that they're going to enforce those regulations basically in February this year.
Understand. And then on the M and A side, just what are you seeing out there in terms of either tuck ins or potentially getting into oil and gas, which I think you had talked about at the Waste Expo Yes.
We just closed, as we mentioned, our RCI deal in Montreal. That was obviously a fairly large deal for us. Other than that, we're just looking at sort of our typical smaller tuck in acquisitions. On the oil and gas side, we closed a small acquisition there. We're constantly looking for further acquisitions, but that's been a fairly pricey market.
So I don't anticipate that we'll spend a lot of money there. At this point in time, I'd say we're sort of through the largest acquisitions that we had in the pipeline. RCI was basically the final one of those. And now we'll be back to sort of our typical $100,000,000 to $200,000,000 of tuck in acquisition.
Very good. Thanks much.
Thank you.
Your final question is from the line of Al Kasakh with Wedbush.
Good morning, David. Good morning, team.
Hi, Al.
David, in terms of I apologize, I joined the call late, but have you commented on how the integration of RCI is going? I know it's 1 month, but could you just comment?
Yes. We didn't specifically comment on it. But what we've got in Montreal is that we have fairly small collection operations. And so we're basically tucking operations into RCI. So far that's gone very well.
RCI had some very high quality management there. And so they've done a great job of tucking our operations into theirs.
And the interest of the acquisition was largely predicated on what in terms of the opportunities that you see going forward besides not previously having a lot of collection operations there?
Yes. I mean, Montreal was a fairly unique market for us in that we had a lot of disposal capacity, but very little in the way of collection operations. We've tried to build up those collection operations over time, but frankly they've got some they have one spectacular company there in RCI that made it difficult for us to get into the collection business. And so we had a landfill that pre recession was actually fine because there was an excess of tonnage in the market and our landfill was fine. After the recession, tonnage in the market to fill all the landfills.
And so we had a choice to make. We could either get deeper into the collection business to help feed our landfill network or we were going to see volumes deteriorate at our landfill and we were going to be at the mercy of other collection companies. And so it was a perfect tuck in acquisition for us. It's a great market. We've been looking at it for a long time.
Lucian Remyard, as I said earlier, ran a great business and we look forward to continuing his successes.
This is an MSW landfill David or is there other waste streams it can take?
Yes. No, it's MSW.
Okay. And then finally if I may and sorry if this has been a topic that I missed, but the on the SG and A front, you have talked about cost savings on the gross side of $120,000,000 You did 10% I believe as a percentage of revenue in the quarter. How much of that benefit for lack of a better word is due to the lower recycling volumes? And how much are you really on track to hit that gross target number?
Due to the lower recycling volumes, I wouldn't say any of it's due to the lower recycling volumes. Restructuring has had a big impact. And we've kind of gone over and above the restructuring by taking out a chunk of non labor SG and A as well throughout the year. So those are the 2 big components of our SG and A. And we've talked about not only holding flat from 2012 to 2013, but looking to hold flat from 2013 to 2014 in absolute dollars.
So a $3.53 run rate is what you're suggesting we should think about in terms of Q3 and forward?
Well, so Q3 has and we talked about this a little bit earlier, but Q3 and Q4 have a bit of headwinds with respect to compensation accruals year over year. So while we're up for the 1st two quarters of the year, we expect that we'll have a little bit of headwinds and that's why I think we're comfortable saying that we'll be flat year over year.
Okay.
Jim, my point about recycling is that, if prices are down then I would think that that would hurt the operating margin on that business. And there may be some, I won't say idle cost, but let's say not fully utilized cost. And that's what I'm just getting at trying to triangulate. You're getting to an EBITDA margin of 25% I think is above that is the easy hurdle. And we just didn't see the progress in the quarter.
So I'm trying to decipher out whether that was an SG and A or an operating cost.
Yes. I mean it was operating cost at our recycling operations. Remember that had a 90 basis point effect on margin.
So
it was purely well look when it comes to recycling basically the breakdown you had is that the bulk of the problem with the $0.05 headwind was in pricing. Commodity pricing is down 12.5 percent for the quarter. Next was operating costs. Operating costs are up because we have to get lower residue. And then you have the volume and the integration of the acquisition pieces a little bit small pieces in there too.
So look the 2 biggest things are price and operating costs. And those are 2 things that we can affect in recycling. You can affect price by going and looking at rebates. You can affect operating costs by driving the inefficiencies out of the system. So that's where we're focused on recycling.
When we talked about margin expansion, we got a 20 basis points of EBITDA margin expansion. Obviously, that would have been back over 100 if we had gotten just flat in recycling. Once we get to the point where we're positive from the recycling operations, that's when you'll really see the leverage there.
Okay. And you've left what's the assumption on commodity price, David, for or Jim for the past half of twenty thirteen?
We expect
it to be pretty much flat for the rest of the year. You had the mid year up and we're expecting it to sort of be flat for the rest of the year.
Okay. Thanks for taking my questions.
Not a problem.
Thank you. Mr. Dave Steiner, do you have any closing remarks?
No. Thank you all for joining us in the quarter. And I know Jim and Jim will be out on the road in New York next week. So look forward to seeing you out on the road.
Thank you for participating in today's Waste Management Conference Call. This call will be available for replay beginning at 1 o'clock p. M. Eastern Time today through 11:59 p. M.
Eastern Time on August 13, 2013. The conference ID number for the replay is 9,780,000,740. Again, the conference ID number for the replay is 9,780,000,740. The number to dial for the replay is 1-eight hundred-five eighty five-eight thirty 67 or 1-four zero four five three seven three four zero six.