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Waste Management, Inc. (NYSE:WM)

Q4 2012 Earnings Call

February 14, 2013 10:00 am ET

Executives

Ed Egl – Director of Investor Relations

David P. Steiner – President and Chief Executive Officer

James E. Trevathan – Executive Vice President and Chief Operating Officer

James C. Fish, Jr. – Executive Vice President and Chief Financial Officer

Analysts

Hamzah Mazari – Credit Suisse

William H. Fisher – Raymond James & Associates, Inc.

Adam R. Thalhimer – BB&T Capital Markets

Albert Leo Kaschalk – Wedbush Securities Inc.

Michael E. Hoffman – Wunderlich Securities Inc.

David Warner – First Analysis Corporation

Joe Box – KeyBanc Capital Markets Inc.

Operator

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 Fourth 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. (Operator Instructions)

I would now like to turn the call over to Ed Egl, Director of Investor Relations. Please go ahead sir.

Ed Egl

Thank you, Carmen. Good morning, everyone, and thank you for joining us for our fourth quarter 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; 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 and overview of our plan for 2013. Jim will cover our revenue growth, including price and volume trends, operating costs and the financial statements. We will include with questions and answers. During their statements, any comparisons unless otherwise stated will be with the fourth quarter 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-K that includes the earnings press release as Exhibit 99.1 and is available on our website at www.wm.com. The Form 8-K, the press release and the schedules to the 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 our filings with the Securities and Exchange Commission, including our most recent Form 10-K.

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&A expenses, and expenses as a percent of revenue have been adjusted to exclude items detailed in our earnings press release that management believe 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 schedule attached thereto, together with item 2.02 of the Form 8-K filed today. Both of which can be found on the company’s website at www.wm.com, for 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 pm Eastern Time today until 5 pm Eastern Time on March 1. To hear a replay of the call over the Internet, access the Waste Management website at www.wm.com.

To hear a telephonic replay of the call, dial 855-859-2056 and enter reservation code 88156298. Time-sensitive information provided during today’s call, which is occurring on February 14, 2013, may no longer be accurate at the time of the 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.

David P. 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 three 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 at 1% and volume slightly positive. We expect each of those metrics to further improve in 2013 and we expect to take significant cost out of the business as a result of our restructuring, our productivity initiatives, and our back-office consolidation.

So I’m very optimistic about our traditional business. We expect to see about 7% to 10% growth and earnings in our additional business driven by pricing, cost controls and volume improvements. The expected growth and earnings would have been much higher about 15%, but for the expected increase and 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 $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 Greenstar, which will add about 1.5 million tons of sorted and 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 customer 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 end of 2013 and assuming five-year average commodity prices, we would expect to receive from Greenstar about $30 million in annualized income from operations excluding depreciation and amortization.

With Greestar added to business a $10 movement in commodity prices would have about $30 million to $40 million effect on earnings. So we are very well positioned to commodity price increase. As we have with our existing recycling business, we will also work to negotiate recycling contracts on new volumes that provide protection if commodity prices decline.

For 2013, we 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 2013 compared to 2012. In January, the Blended rated our recycling facilities as approximately $93 per ton.

Some of you may remember the space 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 increasing complexity in contamination levels of materials we see, its 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 remained 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 two years.

Accordingly, overall we expect our waste-to-energy business to have a negative $0.2 impact on 2013 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 fourth quarter of 2012. And we continue to see improved MSW volumes, which should help landfill pricing.

Before we expect both price and volume metric to improve in 2013, and our January results reflected that. Of course, one 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 million of free cash flow. We saw a significant drag on free cash flow from our recycling operations, cash taxes, and working capital. In 2013, we expect to grow free cash flow by 33% to 45%, to $1.1 billion to $1.2 billion, without the benefit of any divestitures.

However, we accomplish our $1.1 billion to $1.2 billion goal for free cash flow in 2013; but first, we forecast cash from operations to increase about a $100 million. We should also get about a $120 million benefit from working capital, primarily as a result of reduced bonuses for 2012 but 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 $1.3 billion to $1.4 billion 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 $1.1 billion to $1.2 billion free cash flow goal.

Though we will not spend our full 2013 capital budget until we know we can reach our goal, we generally spend about $1 billion in capital expenditures to meet our landfill fleet container need. With the increase in our purchase of natural gas vehicles, we will 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 project in 2013, but we will better monitor the pace of spending to remain on track to meet out 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, where commodity prices slide in 2013 like it did in 2012, we will manage our capital expenditures accordingly to meet our free cash flow goals.

We expect to achieve our cash flow goal without any benefit from divestitures. Any divestiture would obviously create additional free cash flow. And we do expect to have some divestitures in 2013 and 2014, but we did not build our targets assuming that will 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 assets, divestitures that might add to free cash flow, in the past few years, we spent cash on growth projects another areas outside of our traditional solid waste business. We believe these investments have positioned us well to meet the changing needs of our customers.

In the next two 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 a number of hydrocarbon assets that we estimate have a value in excess of $200 million.

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 the best 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% and 6%, but very strong free cash flow growth of between 33% and 45%. I previously discussed how we’ll grow cash flow in such a significant pace.

Projected earnings growth has been impacted by about $120 million of compensation headwinds from accruals that we expect in 2013, assuming target payout of our annual long-term incentive plans, compared to a significantly low 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 the strong and steady free cash flow at about $1.2 billion per year and growing over time. We’re confident that we 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 technology. 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 2005 to 2007 pricing and cost controls 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. Overtime we expect the commodity prices and recovering economy should return us to growing free cash flow and the 8% to 12% annual earnings growth.

I’ll now turn the call over to Jim to discuss our fourth quarter results and our 2013 outlook in more detail.

James C. Fish, Jr.

Thank you, David. I’m going to review the results of the fourth quarter and expectations for 2013. I’ll start with a review of the fourth quarter yield and volume; I will then go into the key drivers of expense and cash flow.

Revenue for the fourth quarter increased by $28 million or 0.8% from the prior year period; our revenue equivalent was driven by year-over-year increases in both yield and acquisitions, and we also continue to see improving volume trends in many areas of the business. The growth was muted by a decline in recycle commodity prices.

Yield on our collection and disposal operations was up 0.9% in the fourth quarter and 0.8% in the full year. Adjusted for the change in pricing at our waste-to-energy plant in South Florida, our yield growth for the fourth quarter of 2012 was 1.1% and was 1% for the full year. This is the second 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 and our collection business was 1.3% in the fourth quarter, with 0.9% growth in commercial, 2.2% growth in industrial, and 1.5% growth in residential. Our industrial and residential had the highest yield of the year in the fourth quarter.

In the landfill line of business, we achieved yield of 1%, up from the 0.6% that we saw in the third quarter. In the fourth quarter both MSW and C&D 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 1% to 1.5%. On the volume side of the business, internal revenue growth from volume improved by 0.4% in the quarter. This is the first year since 2005 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 Maersk, landfill tons, and the industrial line of business.

Specifically, in the landfill business, C&D volumes grew by 20.7%, 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 drivers increased volume from Oakleaf and 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%, and 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 million in the fourth quarter to 64.3% of revenue compared to 62.9% in the fourth quarter of 2011.

The primary drivers of the increase were cost associated with operating recently acquired businesses, maintenance and labor. When compared to the fourth quarter of 2011, maintenance cost increased 6.6% and labor cost increased 2.3%.

SG&A costs were $355 million in the fourth quarter, an improvement of $26 million. As a percentage of revenue, SG&A cost improved 90 basis points to 10.3%, the main drivers, the improvement in SG&A costs, or a reduction in incentive compensation accruals and savings from our reorganization. We fully expect 2013 adjusted SG&A costs to remain flat to improve 10 basis points as a percentage of revenue.

We expect significant costs reductions from our reorganization in 2013. We also have plans in place to reduce SG&A costs further. 2013, we are looking at non-labor SG&A costs and in 2014, back office consolidation to continue the down drive SG&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 fourth quarter of 2012 was 32.4% and 34% for the full year, for 2013, we expect our tax rate to be approximately 35%.

Turning to cash flow, fourth quarter 2012 income from operations, excluding depreciation and amortization was $873 million, and net cash provided by operating activities was $577 million. Our capital expenditures for the fourth quarter were $378 million and our free cash flow for the quarter was $215 million.

For the full year 2012, free cash flow was $829 million, after capital expenditures of approximately $1.5 billion. Our free cash flow would have been up had we not had approximately $200 million in headwinds from commodity and cash taxes and $200 million in increased capital spending primarily related to C&D vehicles.

We returned $165 million to our shareholders through our fourth quarter dividend and we invested $72 million in acquisitions. For the full year 2012, we returned $658 million to our shareholders in dividends and we invested $250 million on acquisitions. Our Board has indicated it will increase dividends in 2013 by 2.8% to $1.46 per share on an annual basis, which would result in dividend yield of approximately 4%. This is the tenth consecutive year of increasing the dividend. For 2013, the anticipated annual dividends equate to $680 million to be returned to our shareholders. We also have an authorization to repurchase up to $500 million of our shares.

During 2013, we expect capital expenditures of approximately $1.3 billion to $1.4 billion and free cash flow in 2013 is expected to grow between 33% and 45% to between $1.1 billion and $1.2 billion. In 2013, we are focused on improving yield, reducing costs and efficiently allocating capital. For yield, the fourth quarter results are accelerating in January. They are stepping in the right direction and we have a long way to go to achieve our goals.

On the cost reduction fronts, we are on track to achieve our full annual savings from the restructuring, but we are not stopping there. We have plans in place to continue to reduce our cost structure in both operating and SG&A costs and continued rollout of our routing and logistic solution will help us achieve the cost reduction targets.

To reinforce this, our annual incentive compensation plans and corporate cost saving scopes for employees and 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&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 to extract value from the materials that we manage.

If a project, a landfill or a collection asset is not meeting 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 and payouts over a longer period of time.

In the next few years, we’ll focus more on building out our existing suite of conversion technologies, such as our Philadelphia spec fuel plant and investing in areas that offer quicker returns like traditional solid waste dumping 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 between 33% and 45%, and we estimate our 2013 fully diluted earnings per share to be between $2.15 and $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.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Hamzah Mazari with Credit Suisse.

Hamzah Mazari – Credit Suisse

Good morning. Thank you.

David P. Steiner

Good morning.

Hamzah Mazari – Credit Suisse

Hey, David, my first question is, if you could talk about your interest for the work that you’ve done may be to explore a more tax efficient structure, whether it be on the MLP or REIT side, I realize that there are precedence on the landfill MLP side, but the REIT side may be tougher given the various businesses you are in, but the landscape that 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.

David P. Steiner

Yeah, Hamzah, I think obviously we are 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 is 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 President by getting a private letter rule or anything 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 is always a lot of both operational and as you know technical issues that you have to resolve and we are constantly looking at those through our tax department, through our outside advisors.

Hamzah Mazari – Credit Suisse

That’s a very helpful. And then maybe if you could talk about how investors should think about the restructuring the 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? Are we going to see Waste Management’s margins 300, 400 bps higher by the end of 2015? Or shall we continue to expect offsets on the costs side longer-term? Any color you can give there.

James C. Fish, Jr.

Yeah, 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 million 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, to get that 300 basis points of margin improvement, we have to do a few things.

First, in 2013, we are looking at additional non-labor SG&A savings, and we will 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 are going to get the cost improvement or get the 300 basis points of margin expansion is about 100 basis points of operating costs, which are riding logistics efforts.

And then we’ve got to get our yield backup – pushing backup towards 2%, while continuing to grow volumes, right. 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 two to three years. This year, we just happen to have that bonus accrual that will offset it from earnings point of view, but won’t offset it from a cash point of view.

David P. Steiner

So I will just add to that Hamzah, that we are taking a very strong stance on not only non-labor SG&A, but further labor-related SG&A costs going into 2013.

Hamzah Mazari – Credit Suisse

Okay. And then just last question from me, have you guys thought about bringing the pricing back that you had, a number of years ago and you took that out. Is that something that you want to bring in an up market or down market? Maybe help us understand that dynamic.

David P. Steiner

Absolutely, and as you know, Hamzah, my commitment that pricing is doesn’t matter, but it’s 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 and we took the yield gate 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 of 1.5% for each of the next two years. And so that’s a significant amount of compensation and risk for them. And I fully expect that we’ll see the appropriate behavior for them to realize those benefits.

Hamzah Mazari – Credit Suisse

Okay, great. Thanks a lot.

David P. Steiner

Certainly.

Operator

Your next question is from the line of Bill Fisher with Raymond James.

William H. Fisher – Raymond James & Associates, Inc.

Thank you. Good morning.

David P. Steiner

Good morning, Bill.

William H. Fisher – Raymond James & Associates, Inc.

Hey, just some questions maybe on volume side, one on just the special waste outlook, can you just give us some color on what you are looking at for drilling or other waste streams in 2013 if you can grow that?

David P. Steiner

So for drilling, Bill, I would say that 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 progress on that front and then I would say that special waste right now looks pretty decent for us going forward.

William H. Fisher – Raymond James & Associates, Inc.

Okay. And then on the collection side, you are getting some growth on the industrial and even on the landfill side, which is great. On the commercial collection, you seem to stuck in the negative buying range there. What would really takes that to turn, is it just more the simply the economy or pricing strategies or what’s on that end?

David P. Steiner

Yeah, 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. But we’ve also seen our rollbacks come down to the lowest level they are in the year and we thought a modest increase in the churn rate of 20 basis point increase in the churn rate. So, that’s what leads us to believe that it’s not our pricing program that’s driving it, it’s more economic related.

William H. Fisher – Raymond James & Associates, Inc.

Okay, great. Thank you.

Operator

Your next question comes from the line of Adam Thalhimer with BB&T.

Adam R. Thalhimer – BB&T Capital Markets

Good morning. I wanted to ask David, what’s the long-term strategic vision for the waste-to-energy business?

David P. Steiner

Yeah, the waste-to-energy business for us obviously has introduced some volatility into the earnings because of natural gas prices and the reset. What happened here was a lot of these plants were built 20 years ago and when they were built with financing; the 20-year bond 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 in electricity point of view. They couldn’t have come off, obviously they couldn’t have rolled off in a worst time from a disposal point of view and that’s what we are 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 the 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 UK, which is a high growth market; we are the leading company in design and developing new projects there. So we think that once we get through these reset like I said in the next two years, only 10% from a disposal point of view and 5% from an electricity point of view, we will roll off in the next two years. So we should start to see some stability in the core business and we should start seeing that profitability uptick.

Adam R. Thalhimer – BB&T Capital Markets

Okay, great. And then can you just comment may be a little bit on the construction and demolition business and what your outlook is there for 2013?

David P. Steiner

Yeah, 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 2005 and 2007 range. So we are expecting modest growth in 2013 and if something better happens, we will be pretty surprise.

Adam R. Thalhimer – BB&T Capital Markets

Okay. Thank you very much.

David P. Steiner

Thank you.

Operator

Your next question comes from the line of Al Kaschalk with Wedbush Securities.

Albert Leo Kaschalk – Wedbush Securities Inc.

Good morning.

David P. Steiner

Good morning.

Albert Leo Kaschalk – Wedbush Securities Inc.

I want to try and drill down upon intended on this yield for 2013 1% and 1.5% and specifically the lack of pull through maybe that’s coming through with the margin line and specifically EBITDA margins. So we heard earlier last week about pricing wasn’t necessarily improving dramatically, but I hear from your color and cadence and by the 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?

David P. Steiner

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 cost 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 million 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, it’s the time for us to get a little bit more aggressive on the landfill 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 now that there is a – there is one geographic area that we are focused on, or one particular line of business that we are 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.

Albert Leo Kaschalk – Wedbush Securities Inc.

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 a point 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, may be just hoping to see if you could shed some light on that?

David P. Steiner

You know, 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 in yield gates and our compensation plan in 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 diluted margins both from Oakleaf and from recycling commodity prices when you can understate the $120 million, $130 million that came down in commodity prices in 2012. We don’t expect those same types of headwinds in 2013, so that’s when you can see the margins turn back and we’ve got the compensation plan that required us for that to happen for us to get paid.

James C. Fish, Jr.

So, I have one quick comment Al, but this is not so much that pricing is not fallen to the bottom line, but we’ve got some things that we are focused on, I mentioned operating expense was up $71 million for the quarter that we mentioned back in the third quarter, we’ve got to reign in maintenance costs, so maintenance costs was – in the fourth quarter was again up year-over-year pretty significantly.

So we feel like it’s not that the 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 cost that there is somewhat out of line and our estimation, we’ve bought lot of trucks in 2012, that just start to have an impact, but it’s also a process issue there, so we got to manage that seem to get it and some others that have not learned their secrets yet. So we will look to pass that on to the rest of the company.

Albert Leo Kaschalk – Wedbush Securities Inc.

Okay, I guess you are still long way either from 2% yield which I think is a little bit longer maybe it’s a near-term target, maybe it’s 14%/15%. But I just don’t hear from you and others that the end market is necessarily accepting a facilitating price at the upper end of that 1.5, I hope I’m wrong, but…

David P. Steiner

No, I think actually the markets – I think at this point in time, the market is going to favor [of it]. We did come out of the deepest recession that we’ve been in, a lot 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.

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. That’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. 2013, we’ve got to drive that and look how we 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 margin up about 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. 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 anniversary of these 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 at above 1.5%.

Albert Leo Kaschalk – Wedbush Securities Inc.

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 shared 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?

David P. Steiner

Yeah, when I’m talking about non-core, I’m talking about anything that is not solid waste or recycling related.

Albert Leo Kaschalk – Wedbush Securities Inc.

Okay, but that...

David P. Steiner

So there is two categories, there is the hydrocarbon properties which we talk about. And then there is 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 design 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’ve made those investments two and three years ago, a couple of those in the next two 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 we’ll see a couple of those investments go public, which give us the opportunity to monetize it if we decide to. We have a couple with that aren’t as strategic to us which we thought maybe three years ago and we may look to settle some of those investments. And then we are not going to make a level of investments that we’ve made over the last few years.

Look, we’ve got our – what I call our green portfolio in pretty good shape. We’ve been investing over the last few years at a fairly high rate, we’re not going to invest at that high rates going forward. And so, what we are 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 investment that we made over the last three years and we’re going to start to monetize some of those.

So over the next two to three years, you should see that portfolio turn from being a net cash drag to be net cash positive, and its the exact same thing with the hydrocarbon properties. We’ve been investing over the last three years. You should see us monetizing over the next three.

Albert Leo Kaschalk – Wedbush Securities Inc.

Thank you, David, for your time.

David P. Steiner

Sure, no problem.

Operator

Your next question is from the line of Michael Hoffman with Wunderlich Securities.

Michael E. Hoffman – Wunderlich Securities Inc.

Good morning and thank you for taking my questions.

David P. Steiner

Hi, Michael.

Michael E. Hoffman – Wunderlich Securities Inc.

Hey, David, how are you doing?

David P. Steiner

Great.

Michael E. Hoffman – Wunderlich Securities Inc.

Jim, David, could you walk through on the free cash side I think I followed this correctly. If I start with $829 million, it seems like it’s add into the bottom of $1.1 billion. $110 million from restructuring, somewhere between $115 million to $200 million from less capital spending, other cost savings of $130 million to $230 million that achieved in non-labor, G&A and the cost it 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 got a….?

James C. Fish, Jr.

That’s just an accrual Michael; it’s not cash. It’s just an accrual. So that’s the difference.

Michael E. Hoffman – Wunderlich Securities Inc.

So you don’t expect to pay any cash out in 2013?

James C. Fish, Jr.

We pay it in 2014. So if we are at bonus in 2013 we don’t pay at 2014.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay. So the reflection here in this other cost savings, the G&A and the cost of goods savings, because I’ve got a $30 million headwind from heating and electricity if that match correctly in $0.04?

David P. Steiner

Right, right.

Michael E. Hoffman – Wunderlich Securities Inc.

So that sort of a progress of that, I’ve got that sort of match approximately…

James C. Fish, Jr.

Yeah, you got – you sort of start with $825 million. We had $100 million from operations. If you add a $120 million from working capital and that gets you up to sort of $1 billion plus and then the filler if you will is the CapEx. Like as you said somewhere between $50 million to $100 million gets you to the bottom end of that range.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay, all right. And then how do you think about the incentive comp plan as it relates to the returns on capital as well. And you had nearly 5 years of a negative slope to your return line, I assuming that’s an another area that most interesting thing you will change that trend. So how do I think about – you just talk to us about in your returns on capital in 2013?

James C. Fish, Jr.

So I would – let me take a shot it down Michael. One of the things that I talked about 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 will be looking at. I think it’s kind of simple microeconomics that we’ve got in terms of disposal probably too much capacity chasing to few tons, as we mentioned, we’ve seen a big drop off over the last few years. So I think, and maybe that I was planning I think that ultimately helps the prices climate down the road.

Michael E. Hoffman – Wunderlich Securities Inc.

All right. Well, you’ve given me a perfect segway to one of my question. How do you think about the prospects of being able to [mass dwell] your space? And all the complexities around closure and post-closure and looking at accounts what can you do, is that in the task will you do that and therefore get capacity on the market?

David P. Steiner

I think probably one thing more complicated than REIT, and that is landfill permits. We’re in the early stages there, we will give you some more information going forward, but certainly it’s not easy.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay. But it’s – that’s something that’s being explored, that’s what I’m hearing?

David P. Steiner

True.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay. And then thanks for giving the opening on the REIT too. 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 would change in the future.

David P. Steiner

Yeah, I think that’s fair. I probably characterize it Michael. I think there is more of a chance if it’s happening today than there was two years ago, but there is 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 of uncertainty around it. Why do I say that? You got a lot of operating issues, you’ve got a lot of technical issues, and in order to get pass both of those you’ve got to spend that heck of a lot of money. And so I would like to see, I would 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 radical.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay.

James C. Fish, Jr.

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 first.

Michael E. Hoffman – Wunderlich Securities Inc.

Okay. Thanks.

David P. Steiner

Thank you.

Operator

Your next question comes from the line of Corey Greendale with First Analysis.

David Warner – First Analysis Corporation

Good morning. This is David Warner for Corey. 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 are volume trends, or you were getting some better pricing, what actually occurred in January that makes us optimistic for 2013?

David P. Steiner

Like I said one month doesn’t make a trend, but we exited 2012 with some momentum in pricing and that’s what I talked about before, because we started in September with our folks putting together detailed plan and we went out in the fourth quarter and said let’s not be shy about implementing this plan, let’s not wait till January 1, implement this plan, 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 and December of last year and we saw that momentum carryover 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 a came out of the back half of the year, feeling pretty good about volumes. 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 four or five months into the year before you can really start to understand what’s going on because of the seasonality, because of the weather, because of the business, Michael. 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 fourth quarter continued into January.

David Warner – First Analysis Corporation

Okay, thanks a lot. That’s helpful. Just one follow-up on the landfill C&D volumes were up, I was wondering if you could maybe sort of just disaggregate Sandy out of that and then talk about whether you are seeing some evidence of nation housing recovery showing up in the C&D volumes?

James C. Fish, Jr.

So actually the large majority of that increase in C&D volumes was due to Sandy. C&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 ADPs seeing the housing market start to show some signs of strength. And I mention that on the special waste side, we’ve got a fairly strong pipeline going forward, so I think I’d say we’re cautious about optimism.

David P. Steiner

Yeah, I don’t about you all, but for about two years from 2010, 2012, when I go overseas particularly the 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 see 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 will actually continue to see some modest growth.

David Warner – First Analysis Corporation

Okay. Thank you.

Operator

Your next question is from the line of Joe Box with KeyBanc Capital Markets.

Joe Box – KeyBanc Capital Markets Inc.

Hey, good morning, guys.

David P. Steiner

Good morning.

James C. Fish, Jr.

Good morning, Joe.

Joe Box – KeyBanc Capital Markets Inc.

The question in 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 two, I guess what gives you the comfort that putting that high of a target on costs, it doesn’t disincentive employees from pursuing growth or working capital or any other critical metrics?

David P. Steiner

Yeah, look, incentive plan design is part of science, part hot. And I’ve been doing this 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 metric, 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 that sometimes counterbalance each other. So when we do our plans, we generally look at margin, because margin in my mind is what means if you’re going to get profitable growth. Look we don’t want growth for growth 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 two things in 2013. One is our routing and 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 at SG&A from the reorganization which we’ve gotten, we then going to get 100 basis points out of operating costs, which is our routing and logistics program, and then we are going to turn back to SG&A and get another 100 basis points after back-office consolidation.

So 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 program. We also need to maintain that 130 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 in two places, price and cost in 2013 and there is not going to be anything else, lot of other things matter, but that’s going to be the two things that are going to drive profitability and frankly when you look back at our best years of profitability from 2005 to 2008, that’s what drove it then.

So we decided to put a large waiting that 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&A, so that we don’t give away that $130 million 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.

James C. Fish, Jr.

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 to top line while they dilute their margins.

Joe Box – KeyBanc Capital Markets Inc.

Understood; thanks. Could you may be just give us a little bit of historical context on this bid pricing that you’ve referred to and may be just talk for the timing and willingness to recycling customers to may be accept those price increases?

David P. Steiner

Sure. So when we did what we call a business improvement process, what we did was 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 you know I think it’s a fundamental premise of pricing that when you got a customer that’s underwater, you can be a little bit more aggressive trying to raise their price right, because if they leave you, you are not overly disappointed when you are losing 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 million to $150 million last year in recycling, because commodity prices were down, our margins went down, our return on capital went down, and we need to make sure that our customer share some of that, plan and simple.

So we need to go out and find those unprofitable customers that we’ve got in our system and we need to make them profitable or let them lead the system. I think that we will 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 b 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 are in the process right now of doing that analysis, understanding who are profitable and unprofitable customers are and then understanding when we can take the pricing actions to bring them back to profitability.

Joe Box – KeyBanc Capital Markets Inc.

Sure. And then I guess we had to ballpark it, I mean do you have a sense of what percentage of your customers would possibly qualify for this?

David P. Steiner

It would be hard to ballpark it, but I would tell you, you just think about 8 million tons we processed and $130 million 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 loose 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, 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 where we are going to go through and make sure it occurs in 2013.

Joe Box – KeyBanc Capital Markets Inc.

Understood. Thanks for your time.

David P. Steiner

Thank you.

Operator

Ladies and gentlemen, we have reached the allotted time for question-and-answers today. I would now like to turn the conference back to David Steiner for closing remarks.

David P. Steiner

Thank you all for joining us today. As I think you can see we’re pretty optimistic about 2013. We completely recognize that first and foremost Waste Management is a cash generating company. And in 2013, we’re going to get back to generate that $1.1 billion to $1.2 billion of free cash. And in 2014, we’re going to get back to generating $1.2 billion 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 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.

Operator

Thank you for participating in today’s Waste Management conference call. This call will be available for replay beginning at 1 pm Eastern Standard Time today through 11:59 pm Eastern Standard Time on Thursday, February 28, 2013. The conference ID number for the replay is 88156298. Again, the conference ID number for the replay is 88156298. The number to dial for the replay is 1-855-859-2056. Thank you. You may now disconnect.

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