Good morning. My name is Carmen, and I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management 4th Quarter and Full Year 2012 Earnings 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.
Over to Ed Eigel, Director of Investor Relations. Please go ahead, sir.
Thank you, Carmen. Good morning, everyone, and thank you for joining us for our Q4 2012 earnings conference call. With me this morning are David Steiner, President and Chief Executive Officer Jim Fish, Executive Vice President and Chief Financial Officer Jim Trevathan, Executive Vice President and Chief Operating Officer. David will start things off with a summary of the financial results for the quarter and an overview of our plans for 2013. Tim will cover our revenue growth, including price and volume trends, operating costs and financial statements.
We will conclude with questions and answers. During our statements, any comparisons, unless otherwise stated, will be with the Q4 of 2011. 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 as 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, including our outlook for 2013, 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 those 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. Our EPS and net income as well as income from operations excluding depreciation and amortization, operating expenses, SG and A expenses and expenses as a percent of revenue have been adjusted to exclude items detailed in our earnings press release 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 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 measure and additional information about our use of non GAAP measures. David and Jim will also discuss our results in the areas of internal revenue growth from yield and internal revenue growth from volume.
Unless otherwise stated, please note that any reference to yield or volume results are more specifically referring to internal revenue growth 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 March 1. To hear a replay of this call over the Internet, access Waste Management's website at www.wm.com. To hear a telephonic replay of the call, dial 855-859-20566 and enter reservation code 8,8,156,298. Time sensitive information provided during today's call, which is occurring on February 14, 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 expressed 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. Before we talk about the specifics of the quarter, we wanted to look back at the full year 2012 and give a short overview of 2013. When we look at our business performance, we can divide it into 3 areas: traditional solid waste operations, our recycling operations and our waste to energy business. Our traditional solid waste business performed about as we expected in 2012 with margins improving, adjusted yield of 1% and volumes slightly positive. We expect each of those metrics to further improve in 2013 and we expect to take significant costs out of the business as a result of our restructuring, our productivity initiatives and our back office consolidations.
So I'm very optimistic about our traditional business. We expect to see about 7% to 10% growth in earnings in our traditional business driven by pricing, cost controls and volume improvements. The expected growth in earnings would have been much higher, about 15%, but for the expected increase in accruals for bonuses and long term incentives in 2013, which was much lower in 2012. So our traditional solid waste business is very well positioned to perform in 2013. On the recycling front, commodity prices had a dramatic impact on 2012 earnings.
2012 saw significant declines in commodity prices driving a $0.17 decline in earnings. Despite these results, we continue to believe that our future depends on diversion technologies because our customers are increasingly demanding that we provide those services. Consequently, we will continue to invest in diversion assets as evidenced by our recent acquisition of Green Star, which will add about 1,500,000 tons of sorted brokered recycling commodities to our business. This acquisition is integral to our strategy of extracting more value from the waste stream. It aligns with our customers' sustainability goals and it differentiates Waste Management from other competitors.
For 2013, we expect that GreenStar will have a negligible effect on earnings because we agreed to pay certain post closing expenses in return for a dollar for dollar reduction of the purchase price. After we complete the integration, which should occur by the end of 2013 and assuming 5 year average commodity prices, we would expect to receive from GreenStar about $30,000,000 in annualized income from operations excluding depreciation and amortization. With GreenStar Edge, our business a $10 movement in commodity prices would have about a $30,000,000 to $40,000,000 effect on earnings. So we're very well positioned to commodity prices increase. As we have with our existing recycling business, we'll also work to negotiate recycling contracts on new volumes that provide protection if commodity prices decline.
For 2013, we've built our plans using commodity prices that average about $100 per ton based upon the mix of commodities in our single stream facilities. In that case, our overall recycling business will be down approximately $0.02 in 20.13 compared to 20 12. In January, the blended rate at our recycling facilities is approximately $93 per ton. Some of you may remember the phase of our collection pricing programs that we called our Business Improvement Plan or BIP. BIP basically identified our underwater collection customers and implemented large price increases to bring those customers up to an acceptable level of profitability.
Most of the customers, about 80% accepted the price increases, which were in the 15% to 25% range. And the good news was that those customers that left were unprofitable, so it didn't affect our profitability. Given where commodity prices have been over the last year and the increasing complexity and contamination levels of materials we receive, it's time for us to do something similar with our recycling customers. As contracts come due, we will likely need to implement double digit price increases on some customers to return them to profitability. As for our waste to energy business, in 2012, our operations had a negative impact of $0.08 to our earnings per share.
Natural gas and electricity prices remain low. In addition, some of our long term waste disposal and electricity contracts are expiring and we'd expect them to be rebid at lower prices. The biggest impact to our waste to energy business will come from our South Florida plants, where long term disposal contracts are being rebid at rates as much as $15 per ton or 26% lower than current rates. After the South Florida reset, we'll only have about 10% of our long term disposal and 5% of our long term power contracts expiring in the next 2 years. Accordingly, overall, we expect our waste to energy business to have a negative $0.02 impact on 20.13 earnings.
There should not be significant variability in the earnings related to commodity prices as we have about 68% of the electricity pricing for the portfolio locked in for 2013. Returning to our solid waste operations, we continue to see positive signs through January. Yield for collection and disposal was the highest all year in the Q4 of 2012. And we continue to see improved MSW volumes, which should help landfill pricing. We fully expect both price and volume metrics to improve in 2013 and our January results reflect that.
Of course, 1 month does not make a trend, but we've set the plans and incentives in place to drive yield above 1% and moving toward 1.5% in 2013. We expect the full year 2013 volumes to be 0.5% to 1% positive compared with 2012. Turning to free cash flow. In 2012, we generated about $829,000,000 of free cash flow. We saw a significant drag on free cash flow from our recycling operations, taxes and working capital.
In 2013, we expect to grow free cash flow by 33% to 45% to $1,100,000,000 to $1,200,000,000 without the benefit of any divestitures. How will we accomplish our $1,100,000,000 to $1,200,000,000 goal for free cash flow in 2013? Well, first, we forecast cash from operations to increase about $100,000,000 We should also get about $120,000,000 benefit from working capital, primarily as a result of reduced bonuses for 2012 that would normally be paid in 2013. And finally, we will manage our capital expenditures in line with our free cash flow goal. We expect to spend about $1,300,000,000 to $1,400,000,000 in capital expenditures in 2013, which should allow us to continue to move to a natural gas fleet and invest in our business, while achieving our $1,100,000,000 to $1,200,000,000 free cash flow goal.
But we will not spend our full 2013 capital budget until we know we can reach our goal. We generally spend about $1,000,000,000 in capital expenditures to meet our landfill fleet and container needs. With the increase in our purchases of natural gas vehicles, we'll certainly spend that level of capital in 2013. Additional capital is spent on growth projects such as landfill gas to energy projects, recycling plants, transfer stations and new contracts. We fully expect to spend capital on these types of projects in 2015, but we will better monitor the pace of spending to remain on track to meet our free cash flow expectations.
In other words, we will aggressively manage our capital spending to achieve both our ROIC and our cash flow goals. If the economy is not as strong as we expect, for example, commodity prices slide in 2013 like they did in 2012, we will manage our capital expenditures accordingly to meet our free cash flow goal. We expect to achieve our cash flow goal without any benefit from divestitures. Any divestitures would obviously create additional free cash flow. And we do expect to have some divestitures in 2013 2014, but we did not build our targets assuming they'll happen.
If they do happen, that would be great and would give us more of an opportunity to pay down debt, return more cash to our shareholders or invest in our business. As an example of the types of asset divestitures that might add to free cash flow, in the past few years, we've spent cash on growth projects and other areas outside of our traditional solid waste business. We believe these investments have positioned us well to 2 years, we expect to reduce the number of investments and harvest or monetize some of our investments through sale or public offerings. I expect the cash proceeds we realize from those investments should exceed any amounts that we invest. In addition, we've also invested in a number of hydrocarbon assets that we estimate have a value in excess of $200,000,000 As you know, we look to monetize those investments in 2012, but the markets were not receptive.
We continue to look for opportunities to monetize these assets, but we will not sell at depressed prices. So again, I would expect these assets to be net cash positive over the next few years. Turning now to our earnings guidance, you can see that we're forecasting modest EPS growth in 2013 between 3% 6%, but very strong free cash flow growth of between 33% 45%. I previously discussed how we'll grow cash flow at such a significant pace. Projected earnings growth is being impacted by about $120,000,000 of compensation headwinds from accruals that we expect in 2013, assuming target payout of our annual and long term incentive plans compared to a significantly lower incentive compensation expense in 2012.
We do not expect to have those headwinds in 2014. So we expect our 2014 earnings growth to get back to the 8% to 12% growth that is our goal in a more normalized economic and commodity environment. And of course, if commodity prices rebound, we're in a great position to benefit from such a rebound. So in summary, when we look at 2013 and beyond, we expect to get back to strong and steady free cash flow at about $1,200,000,000 per year and growing over time. We're confident that can move towards that goal in 2013, while still growing our company and without any help and in fact assuming some headwinds from our recycling and our waste to energy businesses.
When commodity prices rebound and when the price resets are done at our waste to energy operations, those areas should contribute to cash flow growth, along with our continued focus on pricing and cost controls. Additionally, we believe that we can manage capital expenditures over the next few years to achieve our free cash flow targets while continuing to invest in our core business, including our natural gas fleet and diversion technologies. And finally, as we monetize some of our past investments, we'll have further opportunities to produce free cash that we can use to pay down debt, return to our shareholders or invest in our business. So that lays out our 2013 plan. We're going to return to those things that drove profitability from 2,005 to 2,007, pricing and cost control, while continuing to invest in our future.
We're confident that we can achieve our goals in a low growth economy with current commodity prices. Over time, we expect that commodity prices and a recovering economy should return us growing free cash flow and to 8% to 12% annual earnings growth. I'll now turn the call over to Jim to discuss our Q4 results and our 2013 outlook in more detail.
Thank you, David. I'm going to review the results of the 4th quarter and expectations for 2013. I will start with a review of the 4th quarter yield and volume. I will then go into the key drivers of expense and cash flow. Revenue for the 4th quarter increased by $28,000,000 or 0.8 percent from the prior year period.
Our revenue improvement was driven by year over year increases in both yield and acquisitions. We also continued to see improving volume trends in many areas of the business. The growth was muted by a decline in recycled commodity prices. Yield on our collection and disposal operations was 0.9% in the 4th quarter and 0.8% in the full year. Adjusted for the change in pricing at our waste energy plant in South Florida, our yield growth for the Q4 of 2020 was 1.1% and was 1% for the full year.
This is the 2nd consecutive quarter of sequential yield growth and demonstrates our commitment to yield management. Pricing efforts that we implemented during 2012 accelerated in the second half of the year and we've continued to see positive results in January. The combined internal revenue growth from yield in our collection business was 1.3% in the 4th quarter with 0.9% growth in commercial, 2.2 percent growth in industrial and 1.5% growth in residential. Our industrial and residential had the highest yield of the year in the 4th quarter. In the landfill line of business, we achieved yield of 1%, up from the 0.6% that we saw in the 3rd quarter.
In the 4th quarter, both MSW and CMD had the highest rate per unit we've seen all year. We are extremely committed to yield improvement in 2013. As David mentioned, we expect yield in the range of $0.01 to 1.5 percent On the volume side of the business, internal revenue growth from volume improved by 0.4% in the quarter. This is the 1st year since 2,005 that all four quarters had positive volume on a workday adjusted basis. The growth was primarily driven by an increase in recycling volumes at our MRFs, landfill tons and the industrial line of business.
Specifically in the landfill business, C and D volumes grew by 20.7 percent almost all from Hurricane Sandy. MSW grew by 3.2% and special waste volumes improved 0.4%. In the second half of the year, we've seen a nice improvement in MSW volumes. The largest driver is increased volume from Oak Leaf vendor haulers. Recycling and landfill volume growth was partially offset by collection volume declines of 1.6%.
More specifically, commercial volumes declined 2.7% and residential declined 2.2%. In the industrial business, volumes grew by 1.3%. In 2013, we anticipate that volumes should improve slightly from 2012 and range from 0.5% to 1% for the full year. I will now discuss operating costs. Operating costs increased by $71,000,000 in the 4th quarter to 64.3 percent of revenue compared to 60 2.9% in the Q4 of 2011.
The primary drivers of the increase were costs associated with operating recently acquired businesses, maintenance and labor. When compared to the Q4 of 2011, maintenance costs increased 6.6% and labor costs increased 2.3%. SG and A costs were $355,000,000 in the 4th quarter, an improvement of $26,000,000 As a percentage of revenue, SG and A cost improved 90 basis points to 10.3%. The main drivers of the improvement in SG and A costs were a reduction in incentive compensation accruals and savings from our reorganization. We fully expect 2013 adjusted SG and A costs to remain flat to improve 10 basis points as a percentage of revenue.
We expect significant cost reductions from our reorganization in 2013. We also have plans in place to reduce SG and A costs further. 2013, we're looking at non labor SG and A costs and in 2014 back office consolidation to consider to continue the downdrive SG and A costs to a goal of 10%. At year end, our weighted average cost of debt was 5.2% Our debt to total capital ratio for the quarter was 59.8%, consistent with our target ratio of about 60%. Floating rate portion of our debt portfolio was 10% at the end of the quarter.
Our income tax rate as reported in the Q4 of 2012 was 32.4% 34% for the full year. For 2013, we expect our tax rate to be approximately 35%. Turning to cash flow. Q4 2012 income from operations excluding depreciation and amortization was $873,000,000 and net cash provided by operating activities was $577,000,000 Our capital expenditures for the 4th quarter were $378,000,000 and our free cash flow for the quarter was $215,000,000 For the full year of 2012, free cash flow was $829,000,000 after capital expenditures of approximately $1,500,000,000 Our free cash flow would have been up had we not had approximately $200,000,000 in headwinds from commodity and cash taxes and $200,000,000 in increased capital spending primarily related to CNG vehicles. We returned $165,000,000 to our shareholders through our 4th quarter dividend and we invested $72,000,000 in acquisitions.
For the full year 2012, we returned $658,000,000 to our shareholders in dividends and we invested $250,000,000 on acquisitions. Our Board has indicated it will increase dividends in 2013 by 2.8 percent to $1.46 per share on an annual basis, which would result in a dividend yield of approximately 4%. This is the 10th consecutive year of increasing the dividend. For 2013, the anticipated annual dividends equate to $680,000,000 to be returned to our shareholders. We also have an authorization to repurchase up to $500,000,000 of our shares.
During 2013, we expect capital expenditures of approximately $1,300,000,000 to $1,400,000,000 and free cash flow in 2013 is expected to grow between 33% 45% to between $1,100,000,000 $1,200,000,000 In 2013, we are focused on improving yield, reducing costs and efficiently allocating capital. For yield, the 4th quarter results are accelerating into January. They are a step in the right direction, but we have a long way to go to achieve our goals. On the cost reduction front, we are on track to achieve our full annual savings from the restructuring,
but we're not stopping there. We have
plans in place to continue to reduce our cost structure in both operating and SG and A costs and continued rollout of our routing and logistics solution will help us achieve the cost reduction targets. To reinforce this, our annual incentive compensation plans incorporate cost savings goals. For employees in field operations, 50% of their plan is based on improving operating costs as a percent of revenue. For corporate employees, 50% of their annual bonus is based on achieving SG and A targets. As we look at capital and the declines in landfill tons we've seen over the last several years, we need to spend capital on assets that are performing the best and fit within our long term strategy extract value from the materials that we manage.
If a project, a landfill or a collection asset is not needing minimum returns, we will make the tough decision to rationalize the use of that asset and reduce capital or shift it to a more economical use. Also with respect to allocation of our cash, in the past few years, we've made investments in new technologies with payouts over a longer period of time. In the next few years, we will focus more on building out our existing suite of conversion technologies such as our Philadelphia spec fuel plants and investing in areas that offer quicker returns like traditional solid waste tuck in acquisitions. So when you put it all together, we expect that 2013 will be a year of modest earnings growth, but with free cash flow growing 33% 45%, and we estimate our 2013 fully diluted earnings per share to be between $2.15 $2.20 per share. I want to close by thanking our employees who worked tirelessly throughout a tough 2012 to position our company for an improved 2013 and beyond.
With that, Carmen, let's open the line for questions.
And your first question comes from the line of Hamzah Mazari with Credit Suisse.
Good morning. Thank you. Good morning. Hey. David, my first question is, if you could talk about your interest or the work that you've done maybe to explore a more tax efficient structure, whether it be on the MLP or REIT side.
I realize that there are precedents on the landfill MLP side, but the REIT side may be tougher given the various businesses you're in. But the landscape there has changed in the last 12 months. So maybe if you could talk about any work you've done there, which external advisors you've hired, when you did the work? And just maybe talk about your long term interest in moving to a more tax efficient structure, particularly as you become a more focused company in terms of divesting non core assets?
Yes. Hamzah, I think we've obviously, we're always interested in methods to create shareholder value. Since the first day I came here, I've been interested in the REIT structure. But as you know, the rules and regulations weren't particularly conducive to it. Certainly in the last couple of years, we've seen the developments that are more positive with respect to looking at a REIT structure.
But there's still a lot of uncertainty out there. And so we'll continue to monitor those developments and we'll see how it plays out. I would not expect that we would go out and try to set a precedent by getting a private letter ruling or anything of the sort like that. We'd like to see a little bit more positive development before we incur that kind of expense. But in the meantime, there's always a lot of both operational and as you know technical issues that you have to resolve.
And we're constantly looking at those through our tax department and through our outside advisors.
That's very helpful. And then maybe if you could talk about how investors should think about the restructuring plan that you guys have in place. It seems like nothing flows to the bottom line this year because you have higher bonus accruals. If you look long term, should investors expect this restructuring plan to be real? Should are we going to see Waste Management's margins 300, 400 bps higher in by the end of 2015?
Or should we continue to expect offsets on the cost side longer term? Any color you can give there?
Yes. Look, so in 2013 the good news in 2013 is that the offset of the restructuring is purely an accounting accrual. It's not cash, right? So we will drop that $110,000,000 from the reorganization. We will drop the cash to the bottom line in 2013.
There is absolutely no doubt about that. But when you look ahead to 2014, look, to that 300 basis points of margin improvement, we have to do a few things. First, in 2013, we're looking at additional non labor SG and A savings and we'll get those during the course of the year. And then in 2014, we start our back office consolidations and that should get us another 100 basis points of cost improvement. The other areas where we're going to get the cost improve or get the 300 basis points of margin expansion is about 100 basis points of operating costs, which are routing logistics efforts.
And then we've got to get our yield back up, pushing back up toward 2% while continuing to grow volumes, right? And so the other place you get that margin expansion is through raising yield and growing revenue. So I'm confident we can get that over the next 2 to 3 years. This year, we just happen to have that bonus accrual that will offset it from an earnings point of view, but won't offset it from a cash point of view.
So I would just add to that Hamzah that we're taking a very strong stance on not only non labor SG and A, but further labor related SG and A costs going into 2013.
Okay. And just last question for me. Have you guys thought about bringing the pricing gear back that you had a number of years ago and you took that What was is that something that you want to bring in an upmarket or downmarket? Maybe help us understand that dynamic.
Absolutely. And as you know, Hamzah, with my commitment to pricing, it doesn't matter if it's an up or down market. We're going to put the plans in place to drive yield. But you're absolutely right. I do think that we may have lost a little bit of our focus on yield when we took the yield gates off that certainly when you put incentive plans in place, it drives behavior.
So what we're doing in 2013 is we aren't putting a price gate in place. What we're putting in place is an incentive plan, right? And so what we've got is a plan that allows our field leaders to earn about 50% of their annual compensation dependent upon them achieving yield above 1.5% for each of the next 2 years. And so that's a significant amount of compensation at risk for them. And I fully expect that we'll see the appropriate behavior to for them to realize those benefits.
Okay, great. Thanks a lot.
Certainly.
Your next question is from the line of Bill Fisher with Raymond James.
Thank you. Good morning.
Good morning,
Bill. Hey, just some questions maybe on the volume side. 1 on just the special waste outlook. Can you just give some color on what you're looking at for drilling or other waste streams in 2013 if you can grow that?
So for drilling, Bill, I would say that that's we are pleased with the progress we're making in that sector. It tends to move around. You see some of the shale plays move rigs between Marcellus to Utica over to Bakken. But we've made nice progress on that front. And then I would say that special waste right now looks pretty decent for us going forward.
Okay. And then on the collection side, getting some growth on the industrial and even on the landfill side, which is great. On the commercial collection, you kind of seem to be stuck in the negative volume range there. What really takes that to turn? Is it just more than simply the economy or pricing strategies or kind of what's on that end?
Yes. As you know Bill that's been stubbornly low over the last few years. We think that it's more economic related than it is pricing related. But certainly in 2013, we are going to be more aggressive than we've ever been from the pricing point of view. We've also seen our rollbacks come down to the lowest level they are in the year and we saw a modest increase in the churn rate, a 20 basis point increase in the churn rate.
So that's what leads us to believe that it's not our pricing programs that's driving it. It's more economic related.
Okay, great. Thank you.
Your next question comes from the line of Adam Thalhimer with BB and T.
Good morning. I wanted to ask David, what's the long term strategic vision for the waste to energy business?
Yes. The Waste to Energy business for us obviously has introduced some volatility into the earnings because of natural gas prices and the resets. What happened here was a lot of these plants were built 20 years ago. And when they were built with public financing, the 20 year bonds had contracts that went with them both on the disposal side and on the electricity side. And so as those contracts roll off, they become merchant both from a disposal capacity and an electricity point of view.
They couldn't have come off obviously, they couldn't have rolled off in a worse time from a disposal point of view and that's we're seeing in South Florida. If they had rolled off in 2007, we would have been in a heck of a lot better shape, but we can't control that timing. But when you look at it long term, it's been a great business for us. They are very valuable disposal assets. And you've got some significant growth opportunities over in Europe.
Right now, I would say we are absolutely the leading company in the U. K, which is a high growth market. We're the leading company in design and developing new projects there. So we think that once we get through these resets, like I said, in the next 2 years only 10% from a disposal point of view and 5% from an electricity point of view will roll off in the next 2 years. So we should start to see some stability in the core business and we should start seeing that profitability uptick.
Okay. Great. And then can you just
comment maybe a little bit on the construction and demolition business and what your outlook is there for 2013?
Yes. I think the good news is we've seen some good stability and actually some decent growth in our roll off business. Now a lot of that obviously comes from the oil shale plays. But from a construction point of view, we've seen good volume growth. We expect that to continue into 2013, but we don't expect it to bounce dramatically back to where it was sort of in the 2,005 to 2,007 range.
So we're expecting modest growth in 2013. And if something better happens, we'll be pleasantly surprised.
Okay. Thank you very much.
Thank you.
Your next question comes from the line of Al Kaszak with Wedbush Securities.
Good morning.
Good morning.
I want to try and drill down, no pun intended on this on yield for 2013, 1% to 1.5% and specifically the lack of pull through maybe that's coming through at the margin line and specifically EBITDA margin. So we had heard earlier or last week about pricing wasn't necessarily improving dramatically, but I hear from your color and cadence and body tone that you expect pricing to increase. So specifically if I could, where what markets, not necessarily geography, but what functional service area do you think price improvement is expected to be the greatest?
Look, we started in September of last year putting together very specific market area by market area plan. I will tell you that there is no particular area of focus, right? In other words, we're looking at pricing across the board. Now when you look at it just from a pure dollar point of view, the biggest dollars obviously come out of our commercial line of business. And look, with our costs going up, we need to get the kind of price increases that will cover our costs and help us to expand those margins.
So just from a pure dollar point of view, you expect to see it mostly in the commercial line of business. But it's why we talked a little bit about recycling commodity prices. My personal opinion is that over the last couple of years, we have certainly focused on commercial and roll off pricing. We haven't been as focused on landfill and recycling prices. In a market like we had in 2012 where we lost $120,000,000 year over year from commodity prices, we need to be more aggressive in our pricing structure in order to return to profitability.
On the landfill side, now that we've seen some pretty good MSW growth over the last 12 months, now is the time for us to get a little bit more aggressive on the landfills, small side. And as we all know, the landfill side is going to help support the collection side. So if I look at 2013, I wouldn't say, Al, that there's one geographic area that we're focused on or particular line of business that we're focused on. But I would tell you that we are going to put more focus than we have in the past on our landfills and recycling.
David, what I'm specifically struggling with and I'm not sure I'm alone in this, but even with some of this price increase and the cost focus that you've been sharing with us, we don't see it pulling through down to the EBITDA line. And I don't know if that's really more just headwinds in the end markets for price or if it's competitors choking volume away or what's the real root of the cause? And I was maybe just hoping to see if you could shed some light on that.
Look, when we did the for example, when we did the Oakleaf deal, obviously, that was pretty margin dilutive because it's a brokerage business model and it's meant to be margin dilutive because you're earning low margins but with no capital involved, right? And so I don't think it would be unusual to see those EBITDA margins go down. Now we've anniversaried the Oakleaf acquisition. Now is when you actually should start seeing those EBITDA margins turn the other way in 2012. And quite honestly, we talk about our price and yield gates 2012, margin is 25% of the annual bonus for all of our leaders in the company.
And in order to earn that bonus, margins have to go up next year. So we sort of expected to take have dilutive margins both from Oak Leaf and from recycling commodity prices. I mean you can't understate the $120,000,000 that $130,000,000 that came down in commodity prices in 2012. We don't expect those same types of headwinds in 2013. So that's when you should see the margins turn back.
And we've got the compensation plans that require us to for that to happen for us to get
paid. And one quick comment, Al. It's look, it's not so much that pricing is not flowing to the bottom line, but we've got some things that we're focused on. I mentioned operating expense was up $71,000,000 for the quarter. We mentioned back in the Q3 that we've got a rein in maintenance costs.
The maintenance costs was in the 4th quarter was again up year over year pretty significantly. So we feel like it's not that yield isn't falling to the bottom line, but we've got some cost pressures that we are very much focused on. And that's why I wanted to mention the fact that we've got maintenance costs that is somewhat out of line by our estimation. We bought a lot of trucks in 2012. That should start to have an impact, but it's also a process issue there too.
We've got some areas that seem to get it and some other areas that have not learned their secrets yet. So we will look to pass that on to the rest of the company.
I guess you're still a long way though from 2% yield, which I think is a little bit longer. Maybe it's a nearer term target. Maybe it's 14fifteen. But I just don't hear from you and others that the end market is necessarily accepting or facilitating price at the upper end of that $1,500,000,000 I hope I'm wrong. But
No. I think actually the markets I think at this point in time the market is going to be fairly receptive to it. Look we did come out of the deepest recession that we've been in. A lot of industries, I think, bounced back from that recession pretty quickly. As you all know, volumes in our industry have not bounced back as quickly as they have in some other industries.
And so I think people were a little bit I can't speak for anyone else. I'll speak just for the waste management folks. The waste management folks were a little bit tepid in trying to put their toe into that pricing water. It's what I talked about earlier. When you had people that were a little bit tepid on putting their toe in the water and we didn't have the incentive in place to drive that behavior.
I do think that we lost a little bit of our focus on pricing. It won't happen again. In 2013, we've got to drive that. And look, Al, you got to take sort of one step at a time. So we're going to get that thing up above 1.5% and then we'll start talking about margins up above 2%.
But I think you're absolutely right. We'd expect that to happen over the next couple of years. What we've got going on pretty dramatically in the last couple of years are the anniversaries of our fees, particularly our environmental fee. And that's reached 10% at this point in time. The question is, how do we get those core price increases to make up for the anniversarying of those fees and surcharges.
We've got the plans in place to get that done. And as we start to see those anniversaries roll off, now you're starting to see all core price dropping to the bottom line and that's part of what will help us drive it up above 1 point 5%.
If I may just a clarification on the non core asset sales, what are we calling non core now? If hydrocarbon business, it sounds like that's going to be kept in the shed, if you will, and you're going to make some investments there. But what's non core? What should we be viewing as non core?
Yes. When I'm talking about non core, I'm talking about anything that is not solid waste or recycling related.
Okay. But that's
So there's 2 categories. There's the hydrocarbon properties, which we talked about. And then there's the investments that we've made in a number of companies that use alternate processing technologies. And some of those companies, as we've said all along, we've designed what I would call one of the better green portfolios in the United States. Some of those companies are going to win, some of them are going to lose.
I mean that's what the nature of the beast is. But we made those investments 2 3 years ago. A couple of those in the next 2 years I would expect to come to fruition. You don't invest in companies that go public the next day. You invest in companies and they go public over a longer period of time.
And so I would expect over the next few years that we'll see a couple of those investments go public, which would give us the opportunity to monetize it if we decide to. We'll have a couple that will put that aren't as strategic to us as we thought they'd be 3 years ago and we may look to sell some of those investments. And then we're not going to make the level of investments that we've made over the last few years. Look, we've got our what I call our green portfolio in So what So what we're trying to say is, those should be net cash positive. We'll still make some small investments, but we're not going to make the size of investments that we've made over the last 3 years and we're going to start to monetize some of those.
So over the next 2 to 3 years, you should see that portfolio turn from being a net cash drag to being net cash positive. And it's the exact same thing with the hydrocarbon properties. We've been investing over the last 3 years. You should see us monetizing over the next 3.
Thank you, David for your time.
Sure. No problem.
Your next question is from the line of Michael Hoffman with Wunderlich Securities.
Good morning and thank you for taking my questions. Hi, Michael. Hey, David. How are you doing? Doing great.
Tim, David, can we do a walk through on the free cash just so I think I followed this correctly. If I start with $829,000,000 the things I get to add into it to get to say the bottom $1,100,000,000 $110,000,000 from restructuring, somewhere between $150,000,000 $200,000,000 from less capital spending. Other cost saves of call it $130,000,000 to $230,000,000 that's the non labor G and A and the cost of goods sold. And then I've got headwinds of bonus accruals, which I didn't do in 2012 and I'm going to do in 2013. So I've got
a That's just an accrual, Michael. It's not cash. It's just an accrual. So that's the difference.
So you don't expect to pay any cash out in 2013?
We pay it in 2014. So if we earn bonus in 2013, we get we don't pay it until 2014.
Okay. So here then is in this other cost saves, the G and A and the cost of goods savings, because I've got about a $30,000,000 headwind from paper and electricity, if I gave that math correctly on the $0.04
Right. Okay.
So that's sort of the progress of that as I've got that sort of
maps practically right. Yes. You got you sort of start with the $825,000,000 you add $100,000,000 from operations. You add 100 and $20,000,000 from working capital and that gets you up to sort of $1,000,000,000 plus. And then the filler if you will is the CapEx.
As you said somewhere between $50,000,000 to $100,000,000 gets you to the bottom end of that range.
Okay. All right. And then how do you think about the incentive comp plan as it relates to returns on capital as well? I mean, you've had probably 5 years of a negative slope to your return line. I'm assuming that's another area of support's interest in seeing you change that trend.
So how do I think about what you've just talked to us about in your returns on capital in 2013? So I would let me take a shot at that one, Michael. I one of the things that I talked about in my script was the fact that we're going to go through a process of rationalizing assets. And
when you look at some
of these assets that are underperforming that have caused that degradation in return on capital, those are the ones that specifically we'll be looking at. I think it's kind of simple microeconomics that we've got in terms of disposal probably too much capacity chasing too few tons. As we mentioned, we've seen a big drop off in tons over the last few years. So I think and maybe back to Al's point, I think that ultimately helps the price climate down the road. All right.
Well, you gave me a perfect segue to one of my questions. How do you think about the prospects of being able to mothball airspace and all the complexities around closure and post closure and what the accountants want you to do? Is it possible to do that and therefore get capacity out of the market?
I think there's probably one thing more complicated than REITs and that is landfill permits.
We're in the early stages there. There's we'll give you some more information going forward, but certainly it's not easy. Okay. But it's that's something that's being explored is what I'm hearing? Totally.
Okay. And then thanks for giving me opening on the REIT. So as I write my note tomorrow, if I understood your statement, Waste Management is not pursuing a private letter ruling because it does not see as a viable opportunity at this time, but it remains open to alternative corporate structures if the rules should change in the future.
Yes. I think that's fair. I mean, I'd probably characterize it Michael as look I think there's more of a chance of it happening today than there was 2 years ago. But there's still a lot of uncertainty out there. And at this point in time, I would say, I don't see us sort of taking the lead to try to do something that has that much uncertainty around it.
Why do I say that? Well, you've got a lot of operating issues. You've got a lot technical issues. And in order to get past both of those, you've got to spend a heck of a lot of money. And so I'd like to see a little bit more clarity in that arena before we pull the trigger and spend a bunch of money chasing down that rabbit hole.
Okay. I guess Michael with that said, I mean we've done enough work on it on the concept to know that REITs are evolving to include some less conventional businesses. And as they continue to evolve, we'll keep our finger on that pulse. Okay. All right.
Thanks. Thank you.
Your next question comes from the line of Corey Greendale with First Analysis.
Good morning. This is David Warner for Cory. I had a quick question. You mentioned some positive trends in January.
I was wondering if you
could give a little more color on that whether those were volume trends or you were getting some better pricing? What actually occurred in January that makes you so optimistic for 2013?
Yes. And like I said, 1 month doesn't make a trend. But we exited 2012 with some momentum in pricing and it's what I talked about before. It's because we started in September with our folks putting together detailed plans. And we went out in the Q4 and said, let's not be shy about implementing these plans.
Let's not wait till January 1 to implement these plans. Let's start implementing them right now so that we can make sure we get the full benefit in 2013. And so from a pricing point of view, I think we developed a little bit of momentum in November December of last year and we saw that momentum carry over into January 2013. Again, we just got our books closed, so we haven't got great detail around it. But we certainly saw the momentum from our pricing continue into 2013.
I would say the same thing with respect to volumes. We sort of came out of the back half of the year feeling pretty good about volumes. As far as it's interesting that we can talk about 0.4% growth is feeling pretty good about volumes. That shows you what I talked about earlier that this industry's volumes haven't recovered like some. But on the volume side, we saw some good numbers in January too.
So again, I'm not going to we always say that you got to get that 4 or 5 months into the year before you can really start to understand what's going on because of seasonality, because of the weather, because of the business cycle. And so I'm not ready to declare victory. But given that we did see those January results, we just thought it would be useful to give you all some color to let you know that the momentum that we saw coming out of the Q4 continued into January.
Okay. That's helpful. Just one follow-up. The landfill C and D volumes were up. I was wondering if you could maybe sort of disaggregate Sandy out of that and then talk about whether you're seeing some evidence of a nascent housing recovery showing up in the C and D volumes?
So actually the large majority of that increase in C and D volumes was due to Sandy. C and D doesn't make up a huge percentage of our overall, but certainly the percentage increase was impressive and that was primarily due to Sandy. We are seeing anecdotally and talking to some of the AVPs seeing the housing market start to show some signs of strength. I mentioned that on the special waste side, we've got a fairly strong pipeline going forward. So I guess I'd say we're cautiously optimistic.
Yes. I don't know about you all, but for about 2 years from 2010 to 2012 when I'd go overseas particularly to China, it was the only place you'd go where you see cranes on the skyline. Over the last year traveling throughout the United States, I'm starting to seek out cranes on the skyline again, which I think is a positive sign. Again, we're not going to call that good times are here again. But I think it's safe to say that we believe what we're seeing is some stability and that we'll actually continue to see some modest growth.
Thank you.
Your next question is from the line of Joe Baux with KeyBanc Capital Markets.
Hey, good morning guys. Good morning.
Just a question on the change of incentive comp. I think one, you'd mentioned that about 50% is now based on either a cost or margin target. I'm just curious what that was before? And 2, I guess what gives you the comfort that putting that high of a target on cost doesn't disincentivize employees from pursuing growth or working capital or any other critical metrics?
Yes. Look, incentive plan design is part science, part And I've been doing it for a long time and take a lot of time and effort to do it. And what you've got to do is you've got to properly balance the metrics, right? You hit the nail right on the head. You can't put one metric in that drives behavior because every metric you put in will drive some good behavior and some bad behavior, right?
And so you've got to put in metrics that sometimes counterbalance each other. And so when we do our plans, we look at we generally look at margin because margin in my mind is what means that you're going to get profitable growth. Look, we don't want growth for growth's sake. We want growth at accretive margins. And so that's why we put the margin piece in.
Looking back at what you're talking with the focus on cost, we had costs in the program a year ago, but it was less weighted. We moved the cost side to 50% this year, because we are trying to drive 2 things in 2013. One is our routing logistics program and operating costs. So I'll take a step back. We've always said to get that 300 basis points, we're going to get 100 basis points out of SG and A from the reorganization, which we've gotten.
We're then going to get 100 basis points out of operating costs, which is our routing and logistics programs. And then we're going to turn back to SG and A and get another 100 basis points out through back office consolidation. So we are we've gotten the reorganization. We're now in Phase 2 where we need to get 100 basis points out of our routing and logistics programs. We also need to maintain that $130,000,000 that we got out of the reorganization.
So we wanted to put a little bit more weighting on cost this year because that's where the focus is going to be. The focus is going to be 2 places, price and cost in 2013. And there is not going to be anything else. A lot of other things matter, but that's going to be the 2 things that are going to drive profitability. And frankly, when you look back at our best years of profitability from 2,005 to 2,008 that's what drove it then.
So, we decided to put a large weighting as I talked about earlier on that incentive for the pricing side. And then we decided to take 50% of the annual bonus and put it on the cost side to make sure that everybody is focused. And then what we did was we made the field portion is based on operating costs. So they'll be focused on implementing our routing and logistics programs. The corporate side is on SG and A, so that we don't give away that $130,000,000 of benefit that we got last year.
So we think that creates a good balance between cost and growth, but we certainly want to make sure that folks are focused on both cost and price in 2013. And Joe, just
to touch on the last part of your question there about providing a disincentive there. That's why we do it on a percent of revenue, OpEx as a percent of revenue. We certainly don't want to discourage our area leaders from growing their business with things like oilfield services, but we just don't want them to grow the top line while they dilute their margins.
Understood. Thanks. Could you maybe just give us a little bit of historical context on this bit pricing that you referred to? And maybe just talk to the timing and willingness of recycling customers to maybe accept those price increases?
Sure. So when we did what we call our business improvement process, what we did is we went out and found the true cost to service our customers. And what we found was about 20% of our customers were actually underwater. And I think it's a fundamental premise of pricing that when you've got a customer that's underwater, you can be a little bit more aggressive trying to raise their right? Because if they leave you, you're not overly disappointed when you're losing an unprofitable customer.
And so we went through that process. Like I say, about 80% of our customers accepted the price increase and those price increases were in the 15% to 25% range. So some fairly dramatic price increases. Look, we gave away $130,000,000 to $150,000,000 last year in recycling because commodity prices were down. Our margins went down.
Our return on capital went down. We need to make sure that our customers share some of that plain and simple. So we need to go out and find those unprofitable customers that we've got in our system and we need to either make them profitable or let them leave the system. I think that we'll be able to retain them while driving up the profitability, but we need to go through that process. Now it is a completely different process to go through it from a recycling point of view than it was from a commercial point of view, because obviously you've got a lot of commercial customers and you have an opportunity to do price increases under the contract at any particular point in time.
On the recycling side, it won't be quite so easy. We do have fewer contracts, but many of those contracts don't allow the type of price movement that we would like to get. So we got to wait for them to roll off. And so we're in the process right now of doing that analysis, understanding who our profitable and unprofitable customers are and then understanding when we can take the pricing actions to bring them back to profitability.
Sure. And if I guess if you had to ballpark it, I mean do you have a sense of what percentage of your customers would possibly qualify for this? It
would be hard to ballpark it. But I would tell you, if you just think about the 8,000,000 tons we processed and the $130,000,000 that we lost and you can start to see what kind of price increases you need to get, right? I mean, look, we are not in the recycling business to lose money. We believe that absolutely we want to be in the recycling business long term, because our customers increasingly are demanding it and we can extract more value out of that material and we can make great money when commodity prices are up. We just need to make sure that we also make more money when commodity prices are down and that's what we're going to go through and make sure occurs in 2013.
Understood. Thanks for your time.
Thank you.
Ladies and gentlemen, we have reached the allotted time for questions and answers today. I would now like to turn the conference back to David Steiner for closing remarks.
Thank you all for joining us today. As I think you can see, we're pretty optimistic about 2013. We completely recognize that 1st and foremost, Waste Management is a cash generating company. And in 2013, we're going to get back to generating that $1,100,000,000 to $1,200,000,000 of free cash. And in 2014, we're going to get back to generating $1,200,000,000 plus and growing it over time.
So we've got a team that is fully committed to the process. We've got a team that understands the plan and we've got incentive plans that are going to drive exactly that behavior. So we look forward to a good 2013 and a great 2014 and we'll see you all on the road during the year. Thank you.
Thank you for participating in today's Waste Management Conference Call. This call will be available for replay beginning at 1 p. M. Eastern Standard Time today through 11:59 p. M.
Eastern Standard Time on Thursday, February 28, 2013. The conference ID number for the replay is 88 1,56,298. Again, the conference ID number for the replay is 8,8,156,298. The number to dial for the replay is 1-eight fifty five-eight fifty nine-two thousand and fifty six. Thank you.
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