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Waste Management, Inc. (NYSE:WM)

Q3 2013 Earnings Conference Call

October 29, 2013 10:00 ET

Executives

Ed Egl - Director, Investor Relations

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

Analysts

Hamzah Mazari - Credit Suisse

Corey Greendale - First Analysis

Michael Hoffman - Wunderlich Securities

Usha Gunthapally - Goldman Sachs

Al Kaschalk – Wedbush Securities

Joe Box - KeyBanc Capital Markets

Adam Thalhimer - BB&T

Barbara Noverini – Morningstar

Operator

Good morning. My name is Jenisha and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2013 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Ed Egl, Director, Investor Relations, you may begin your conference.

Ed Egl

Thank you, Jenisha. Good morning, everyone and thank you for joining us for our third quarter 2013 earnings conference call. With me this morning are David Steiner, President and Chief Executive Officer; Jim Fish, Executive Vice President and Chief Financial Officer; and Jim Trevathan, Executive Vice President and Chief Operating Officer.

Before we get started, please note that we have filed a Form 8-K this morning that includes the earnings press release 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. During the call you will hear a forward-looking statements which are based on current expectations, projections, estimates, opinions or beliefs about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are detailed in today’s press release and our filings with the Securities and Exchange Commission, including our most recent Form 10-K.

David and Jim will discuss our results in the areas of internal revenue growth from yield and internal revenue growth from volume. Unless stated otherwise please note that any reference to yield or volume results are more specifically referring to your internal revenue growth or RG from yield or volume. Additional any comparisons unless otherwise stated will be with the third quarter of 2012. During the calls David and Jim will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share on an as-adjusted basis. David will also discuss operating EBITDA as defined in our Form 8-K filed today. Our EPS, operating EBITDA, operating EBITDA margin, income from operations, income from operations margins, operating expenses and prior year SG&A expense have been adjusted to exclude items that management believe do not reflect a fundamental business performance were not indicative of our results of operations. These measures in addition to free cash flow are non-GAAP measures. Please refer to the earnings press release footnote and the schedules 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 measures and additional information about our use of non-GAAP measures.

This call is being recorded and will be available 24 hours a day beginning at approximately 1:00 p.m. Eastern Time today until 5:00 p.m. Eastern Time on November 12th. 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 66496035.

Time-sensitive information provided during today’s call which is occurring on October 29, 2013, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited.

Now I’ll turn the call over to Waste Management’s President and CEO, David Steiner.

David Steiner

Thanks Ed and good morning from Houston. We’re pleased with our results for the third quarter as our earnings per share increased 30% on an as reported basis and 6.6% as adjusted to $0.65 per share. At the beginning of the year we said that we would get back to basics by focusing on yield and cost controls. Our corporate and field managers have done just that and done it very well. On the cost side SG&A as a percent of revenue is 9.6%, the lowest since 2005. Our operating cost program continues to gain traction and should expurgate into 2014. On the yields side our results again show that focusing on yield works and we will continue to do so. Driven by the improved yield we expanded both income from operations and operating EBITDA margins in the quarter. Despite continued headwinds confronting our recycling and waste to energy businesses and modestly lower volumes.

In the third quarter our overall income from operations grew $33 million and the overall income from operations margin grew 20 basis points. We also grew overall operating EBITDA by $46 million and overall operating EBITDA margin at 10 basis points. The results were even more impressive when you drill down into our traditional solid waste business where income from operations grew $71 million and the income from operations margin grew a 120 basis points while operating EBITDA grew by $74 million and operating EBITDA margin grew 90 basis points. This demonstrates the continued strength of our core solid waste business.

In our recycling business we expected the third quarter impact to be a negative $0.01 to earnings per share. The recycling operations actually were of negative $0.02 effect on the quarter. In the quarter we saw a slight improvement in recycling commodity prices that was more than offset by increased cost from the operations of acquired businesses and the continued impact of the Chinese Green Fence.

For fourth quarter recycling operations we had most recently projected a positive $0.01 impact on earnings per share when compared to 2012. We now think that the impact from our recycling operations will be approximately a negative $0.03 per share in the fourth quarter, which is slightly worse than Q3. That is a result of tougher year-over-year comparisons and relatively flat commodity prices when looking at our full basket of recycled commodities.

So for the full year, we anticipate that the negative impact from recycling operations will be around $0.13 per share. The last two years at our recycling facilities have been characterized by low commodity prices and higher operating costs. We have incurred extra costs as we have had to reduce contamination from materials processed in our single stream plants to improve the quality of our bails to meet regulatory and customer requirements. In addition, recycling commodity prices can be volatile, which leads to volatile earnings in our recycling business. There is no quick easy solution for these challenges. So we are taking a variety of steps to increase earnings and decrease volatility. These solutions require us to change the way that we contract with our customers. Already, our areas are having more direct conversations with customers and are successfully decreasing rebate because of increased contamination levels in the customer’s recycling streams, but we must do more.

Going forward, our contracts will contain the following protections that we need in effort to earn an acceptable return on the capital that we have invested in our recycling business. First, many recycling contracts simply call for a split of the revenue from the sale of the commodities. This approach limits our ability to fully recover our processing costs when commodity prices are low. So our new contracts will call for us to be paid a processing fee before there is a split of revenue from commodity sales. However, when operating costs go up as they have under the Chinese Green Fence, we still risk losing money unless we can recover those increased costs. The single largest factor driving up processing cost is the level of contamination in the materials that we receive from our customers.

So the second change we will make is that going forward, our customer contracts will have contamination limits. We will also require a mechanism to audit the inbound materials to ensure compliance with those limits. If the materials contain too much contamination, either we will recover a higher processing fee or we will reduce the rebate for the customer to cover our increased costs. We will also continue to educate our customers of the proper materials to placing their recycling wins through our recycle often recycle write program to try to reduce contamination rates.

Third, our contracts need to have some flexibility to increase the processing charge or decrease rebates when outside business factors drive up our processing or other costs. So for example, if regulations like the Chinese Green Fence increase our costs, we should be able to pass-through incremental pricing to cover those costs.

Finally, we need to do a better job of working with our customers to ensure that we can earn an acceptable return on commodities that are or that may become low value commodities. For example, today, we lose money recycling glass. In most locations, we have to pay a third-party to take the glass. For those types of materials, our contracts need to contain language that either allow us to pass along those increased cost to our customers or allow the customer to make a decision to remove a low value commodity from the recycling stream until such time as the commodity could be economically recycled. So as you can see, there is no easy fix in the recycling business. Our recycling contracts are generally three-year to five-year contracts. So over time, as more and more of our contracts contain these protections, we should see recycling return to being a more stable income producer that consistently earns a fair return on capital.

Turning back to yield, our yield from our collection and disposal operations was 2.3%, the fifth consecutive quarter of sequential yield improvement and nearly triple the yield we saw in the third quarter of 2012. If you add in our fuel surcharge and adjust for our South Florida waste-to-energy plants, we achieved yield of 2.8%. We achieved core price of 3.9%, which is an increase of 160 basis points from the third quarter of 2012. This is our best core price performance just before 2010. We also saw the highest core price in over 10 years in the commercial and industrial lines of business and the second highest in the landfill line of business. Our yield increase in the quarter more than offset the loss in volumes resulting in overall growth in revenues and margins. The benefit of strong yield is most evident in our industrial line of business where we achieved the highest ever income from operations and income from operations margin despite negative volumes. This industrial income increase was driven by yield of 5.5% and core price of 8.4% which is the highest and nearly a decade. We have also intentionally shared low margin roll-out volumes and avoided adding low margin new business, repeatedly over the years. The yield versus volume trade-off always favored yields. In third quarter we proved this once again.

Of course we want to retain our current customer base but we want to do so using tools other than price. We will focus on improving retention by providing customers with better service and higher value solutions but we will not chase volumes with low prices or large roll-backs.

In our commercial and residential line of business we have the highest yield that we have seen since 2011. Commercial yield was 3.4% in the quarter and residential yield was 2%, finally MSW yield was the highest since 2010 at 1.9%.

Taking the loan, the yield story is the great one but the bigger story is the increased income from operations and margins in each of these lines of business that are driven by increased yield. The commercial business saw increased margins of 40 basis points; industrial margins increased a 130 basis points. Residential margins increased 60 basis points and our landfill margins increased 80 basis points. We saw this margin growth even though volumes were down 0.6% in the quarter and down 1.3% on a work day adjusted basis.

However the lower volumes were more than offset by higher yield. For the quarter recycling volumes declined 1.2% versus last year’s high single digit growth. Our waste to energy volumes were down 3.2% primarily due to lower third party volumes at our South Florida plants.

We also saw a modest sequential decline in volumes in our collection and landfill business. On the positive side we are encouraged to see that the service increases in our commercial business exceeded service decreases for the second consecutive quarter. In summary we maintained our disciplined approach to improving price, reducing cost and managing working capital and capital expenditures which is reflected in our third quarter results.

We remain confident that we will achieve our goals despite an expected $0.13 per share of full year headwinds from our recycling operations which is $0.11 per share more than we anticipated at the beginning of the year. Based upon our year-to-date results we are confident that we can achieve our guidance range of between $2.15 and $2.20 of adjusted EPS. And with our strong free cash flow we’re raising our free cash flow target by a $100 million to between $1.2 billion and $1.3 billion. So we have laid a solid foundation in 2013, a foundation built-up yield and cost control and driven by our corporate and fields management who continue to perform at an extraordinary level.

That foundation is serving us well in 2013 and we expect the foundation to continue to drive high single digit earnings growth in 2014. I will now turn the call over to Jim to discuss our third quarter results in more detail.

Jim Fish

Thank you David. I will start by discussing our SG&A cost and cash flow performance. Then I will expand on David’s comments about the results of operations and volume in our various lines of business. I will conclude with a discuss of our financial metrics.

Our SG&A as a percent of revenue was 9.6% of third quarter; this is the lowest expense since third quarter 2005. We improved SG&A as a percent of revenue by retaining the savings from our restructuring and focusing on control of cost. We did so despite of net increase of $50 million in accruals for our annual incentive plans. The $50 million change was driven by a reversal of the 2012 bonus accrual and a normal accrual in the current year for incentive compensation. SG&A cost were $3.49 million in the quarter an increase of $17 million compared to the third quarter of 2012.

In the third quarter we saw improvements in bad debt, litigation settlements and professional fees which were offset by the compensation accruals that I mentioned earlier. Without those accruals, SG&A cost would have improved $33 million. On a year-to-date basis, SG&A costs were lower by $19 million despite an increase of $93 million in compensation plan accruals over 2012.

Turning to cash flow, third quarter 2013 net cash provided by operating activities was $736 million. This is an increase of $162 million compared to the third quarter of 2012. The strong performance on a working capital yield and cost control were the primary contributors to the almost 30% increase in net cash provided by operating activities. Working capital improved during the quarter as we tightened up on our receivables and payables. This is particularly evident in our DSO, where DSO has improved for three consecutive quarters and improved more than two days when compared to the third quarter of 2012.

Our capital expenditures for the third quarter were $323 million, which is $79 million lower than the third quarter of 2012. Through the first nine months of 2013, capital expenditures were $824 million. We still anticipate capital spending of between $1.3 billion and $1.4 billion for the full year of 2013. We remain disciplined on ensuring that we spend capital on assets that fit within our long-term strategy and generate acceptable returns.

Putting all of this together, our free cash flow for the quarter was $452 million, an increase of $272 million compared to the third quarter 2012. Free cash flow in the quarter was $413 million if you exclude divestiture proceeds. Year-to-date free cash flow was $1.15 billion as compared to $614 million for the first nine months of 2012, an improvement of $533 million. Excluding divestiture proceeds, year-to-date free cash flow was $1.03 billion. As David said, based on strong year-to-date free cash flow driven by yield, SG&A savings, working capital improvements and capital spending discipline, we are raising our 2013 free cash flow targets from between $1.1 billion and $1.2 billion to between $1.2 billion and $1.3 billion.

We returned $171 million to our shareholders through our third quarter dividends and we invested $488 million in acquisitions primarily the acquisition of RCI in Montreal. Yield on our collection and disposal operations grew 2.3% in the third quarter. We believe that on average we need about 2% of yield to cover cost inflation. Over the last two years, our yield has not been enough to recover cost inflation. However, over the last three quarters, we have shown sequential growth in yield and in third quarter we fully offset the cost inflation in our business.

Moving to volumes, internal volume growth was negative 0.6% in the quarter and negative 1.3% if you adjust for the one additional day in the current quarter. We saw overall collection volume decline by 2%, a modest deterioration from the second quarter level of negative 1.4%. More specifically, commercial volumes declined 3.1%, industrial volumes declined 2.2% and residential declined 1.4%. In the industrial line of business, we continue to see tough competition for both temporary and permanent roll-off work. For example, we have seen temporary roll-off volumes declined 3.1% while our rate per hall has increased by more than 5% we emphasized price over volume gains. We will continue our focus on improving yields and on pursuing higher margin roll-off business. This trade-off was very profitable for us in the third quarter as our industrial line of business achieved the highest income from operations and income from operations margins that we have seen.

In the landfill line of business, volumes were positive 4.1%; MSW volumes grew by 4.3%; and C&D volume rose 9.3%. Combined special waste and revenue generating cover volume were positive 1.9%. That growth is a reflection of the growth we have seen in our energy services business. When you look at overall operating results, our income from operations margin increased 20 basis points to 16.8% when compared to the third quarter of 2012. As David mentioned, our traditional solid waste business collection, landfill and transfer stations had a very good quarter. Income from operations in those lines of business increased $71 million and income from operations margins increased 120 basis points. The collection lines of business drove most of the income from operations increase as all three lines of business increased when compared to the third quarter of 2012. These improvements were partially offset by a combined 70 basis point decline in our recycling and waste energy operations.

In our waste energy business, average electricity pricing improved almost 3% in the third quarter when compared to the third quarter of 2012. The price improvement was offset by a lower volumes and an increase in repair and maintenance cost due to timing of plant turnarounds. Overall the waste energy business earnings per share were almost $0.01 lower than the third quarter of 2012 and we expect a similar headwind in the fourth quarter which is consistent with our annual guidance of negative $0.02 per share given at the beginning of the year. In recycling business we have seen increased cost related to Chinese Green Fence and from acquired operations. In addition to the structural, contract changes as David mentioned, we’re also focused on operating cost improvement. We’re looking at ways to reduce the 10% increase in operating cost at our cycling facilities. This will take some time but we have to decisive action to generate an appropriate return on our investments in recycling assets.

Turning specifically to operating expenses, the acquired operations of RCI and Greenstar accounted for almost $60 million of our $97 million increase in operating expenses. The majority of the remaining increase related to other recycling cost, the timing of repair and maintenance at waste energy and the timing of repair and maintenance at waste energy facilities.

Finally looking at other financial metrics at the end of the third quarter our weighted average cost of that 5.06% and our debt to total capital ratio was 58.9% consistent with our targeted ratio of 60%.

The floating rate portion of our total debt portfolio was 13% at the end of the quarter. Our disciplined approach to yield management, cost control and capital spending is working. Despite significant projected headwinds for the full year from our recycling operations the results of the first nine months of 2013 have put us in a position to achieve our exceed our yield, SG&A, earnings per share and free cash flow goals and we’re not going to change our focus. We thank all of our employees who worked hard to achieve these excellent results.

With that Jenisha let’s open the line for questions.

Question-and-Answer Session

Operator

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

Hamzah Mazari - Credit Suisse

The first question is just on you know how should investors think about your ability to buy back stock you know given higher free cash flow guidance, but also given some other moving parts like you know higher CapEx spend, you know next year you will have, you will presumably going to payout bonuses which aren’t in cash flow this year but your cost control is better. So maybe help us think about the moving parts you know leverage on the balance sheet, how do we think about buy back here? You haven't been in the market for a while.

David Steiner

Couple of things here, first of all in 2014 we expect to allocate free cash flow to dividends as we always do about a 100 million to a 150 acquisitions and the remainder to go towards the combination of debt repayment and share repurchase and in fact we have proceeds from divestures and the proceeds from the exercise of stock options this year that we plan to use to buy back some shares in Q4. I will determine how much of that we will use once we see October free cash flow. When you think about what you talked about which was couple of the headwinds that we have on free cash flow, we have got you know the bonus payout, we have the expiration of bonus depreciation which will negatively impact us by that 230 million and on the other side we have the drivers of this year which we will expect to continue of course yield cost control capital discipline and working capital management. So and of course we intend to drive operating costs next year as well. I expect 2014 to be a solid year for us even with a little bit of headwind from those two items.

Hamzah Mazari - Credit Suisse

Okay and just on the recycling side could you give us the sense of you know the time frame and really negotiating these contracts. You know do you have to wait for these to expire, you said they were 3 to 5 years and does that Greenstar acquisition earlier this year, how does that mix differ from your legacy business and does that complicate the process further in terms of fixing the recycling business?

David Steiner

Yeah you know we do have to wait for those contracts to expire but even in our existing contracts you know we have got plenty of contracts right now that have contamination level clauses and so we need to go back and forth that’s why we say, today we’re having conversations with our customers about that and we’re seeing some movement. We just can’t see a movement across the 100% of the base. So it's going to take that three years as we see the contracts roll off. As far as the mix from Green Star, we inherited a couple of bad contracts in that deal, but as far as the mix no, it’s not a dramatic mix different than our current recycling business.

Hamzah Mazari - Credit Suisse

Okay, great. And then lastly, could you remind us how much of your business now resets on CBI in Q3 traditionally? Thank you.

David Steiner

Well, about 40% of the entire business reset and that’s generally about 50:50 between January 1 and July 30.

Hamzah Mazari - Credit Suisse

Okay, great. Thanks a lot Dave.

David Steiner

Sure.

Operator

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

Corey Greendale - First Analysis

Hey, good morning.

David Steiner

Good morning.

Corey Greendale - First Analysis

Couple of questions. So first of all, it sounds like underlying volume trend to a positive, but could you just speak to that a little bit more specifically given it sounds like you are pushing some volume all way because of the focus on yield. So just speak to broadly what you are seeing in the economy any reasonable variation what you are seeing in terms of that customer service levels any increases yet?

David Steiner

Yes, what we are seeing what I’d call, I think you would characterize it correctly, I recall the volume environment very stable. On the industrial side, we aren’t going to chase that low margin business, right. And so other folks are going to chase that low margin business, they are going to fill up their capacity and we are going to go on the other side, we are going to get yield on the industrial side rather than volume. So as we said that, that trade-off was pretty spectacular with margins on the industrial line moving up 130 basis points.

The residential line, I would say, pricing and volumes are fairly stable, but there is always some interesting bidding on the residential side. And look I will tell you in the last few years, we probably had some interesting bids on the residential side. We have gotten much more disciplined on making sure that we don’t go after residential business, which is generally low margin, low return on capital and high investment of capital. We are just not going to chase those kind of volumes unless we can get sufficient returns. And then I guess the one that’s really popped up the most recently is on the recycling side. We recognized that we have to make a systemic change in the way we approach the market on recycling, so that we can get long-term stable earnings. And I talked about the four things we are going to do to change the way we approach the market, but you still see some folks that are out bidding large recycling contracts with just with a low processing fee or a simple split of the revenue. And my guess is that the market will adjust to these environments of high operating cost and low commodity prices. My guess is the market will adjust, but we can’t control that. Also we can control is what we do and we are going to take a much more disciplined approach to the recycling market.

Corey Greendale - First Analysis

Okay. And actually following up on that point some of the changes that you are talking about, have you had any feedbacks from the market either from customers or from your people in the field on the receptivity to that kind of stuff? And then what’s involved in managing some of these things like the auditing, the recycling stream, what’s involved operationally in doing that and in terms of dealing with any customer complaints and people come back and say hey, I didn’t actually have that much laugh in there or anything like that?

David Steiner

Well, these are mostly large municipal contracts when you are doing these audits. And so the – it’s a real interesting situation that you got going on in the recycling markets. We have pushed and everybody has pushed single stream recycling throughout the United States. What we haven’t pushed is educating the consumers as to what can go in there that can be recycled and what goes in that causes processing cost to go up. So we have to do a better job of educating what – and we can do that in conjunction with our municipal customers.

As far as how are those conversations going? Look I – and I like in this to what happened in our company about 10 years ago when we put in a fuel surcharge, right. When we first put in the fuel surcharge on residential contracts, there was a lot of pushback from municipal customers. There were plenty of municipal customers that said we are not going to put a fuel surcharge in, because we have never done it before and we said fine, that’s fine we are not going to bid those residential contracts. And over time as fuel became more important to everybody, the market basically reset and now you don’t see contracts that are put out without a fuel surcharge. I would expect that same thing to happen in recycling. Look, the recycling business has not being economically viable for anyone over the last few years, we want to recycle as much as we can, we want to help our customers recycle but we obviously can’t do that unless what we have is a long term sustainable business model and so we’re going to reset our business practices to do that you know I would be surprised to see the market do the same.

Corey Greendale - First Analysis

Okay last quick one for me, I think David at the beginning of your comments you said something about your operating cost program accelerating in 2014, I was just hoping you might just elaborate on that what kind of cost savings you’re talking about and where you might find those cost savings?

Jim Trevathan

We’re doing very well with our collection business that we’re focused on, the operating side. We’re making real headway especially in some of our certified locations. We have touched about half of our areas to-date; we have got a couple of dozen sites that we have certified as meeting the goals. We’re not ready yet until guidance next year to begin to talk about those dollars but we’re excited about the opportunity Corey and see real improvement on the operating side both efficiency and cost per unit.

David Steiner

What Jim and his team have done on the operating cost side is you know nothing short of remarkable I mean, it really is a culture change in the way we treat both our efficiency and our service right? And it takes a long time to change that culture, so we have been doing this for a while we’re going to continue to do it, it's going to be the way we do business forever and so we have full expect to see that continue to accelerate in 2014.

Jim Trevathan

Corey it's really is adding the technology that we put on trucks those on-board computers and added a real defined management process along with an accounting process to get the value out of the on-board computers and we have seen other industries do it, we are leaving hours and we will get it done over the next couple of years.

Operator

Your next question comes from the line of Michael Hoffman of Wunderlich.

Michael Hoffman - Wunderlich Securities

So on capital spending, can we talk about that from a philosophical standpoint because you clearly have this objecting of driving better returns and one of the three value drivers you got your hands around, you’re driving better price the other is your cost side on margins but the third one is capital efficiency. So can you frame where your head is with regards to maintenance capital spending, how should we think about that as a percentage of the business. If your company is growing sort of organically 3% to 4%?

Jim Fish

First of all when you think about capital spending for the year, year-to-date we’re about $476 million under the low end of our guidance for the year so we have got to spend 476 million for the fourth quarter, we have averaged about 400 million the last two years and we have also accelerated just recently some truck and some AT [ph] purchases and heavy equipment purchases in Q4. So we think we will be at or near the bottom end of that guidance range that we originally gave. With that said I think you know we think that 9% to 10% of revenue will be appropriate level of capital spend for waste management and we think we will finish the year within that range, basically the bottom-line here is that Jim and I have put some discipline into the process this year by trimming out some of the nice to have requests. We probably Jim approved 90% rest of the request that had come across our desk.

David Steiner

In the second half, Jim as we instituted the discipline in the first quarter.

Jim Fish

Yeah so I think this is really cutting out those request that we kind of categorize is nice to have and are approving all of the must have requests and Mike we have also kind of redefined what we consider to be maintenance capital versus growth capital, we used to think of a contract renewal where we had the business and the renewal required new trucks. We used to think of that as being growth capital and we agree to find that, that really isn't growth capital because it doesn’t add any top line dollars. That’s maintenance capital and has to pull out of that area vice president’s leave [ph] plan.

Michael Hoffman - Wunderlich Securities

Okay so if I’m hearing this correctly we should see growth capital one come down proportionally but also there is maybe a new level where maintenance is even managed tighter and so while 9 to 10 in the aggregate maintenance is not 9 to 10 it's going to be less than that.

David Steiner

Yes so I’m saying overall total capital is in the 10% range and I would say that on the growth capital side, we need to look just got the appropriate returns. We haven’t turned it down. We have invested capital in our energy services business, which we considered to be a nice growth business. But I think you are right about maintenance capital where we are narrowing the definition of this and putting some discipline into the process.

Jim Fish

And by the way, Michael, when you grow revenue through yield, it takes absolutely zero capital.

Michael Hoffman - Wunderlich Securities

Right, exactly. Okay. So for you David, on fees and surcharges, how much money are you leaving on the table by having rolled back or waived fees and surcharges? And where are you in bringing new discipline around that?

David Steiner

Yes. I mean, it’s a significant dollar amount. When we look at all of our charges, if we were at a 100% compliant and obviously you never going to get to 100% compliant, but if we were at a 100% compliant that would be roughly $360 million. And so look, we aren’t going to back down from our yield programs. What we are trying to do is drive a lot of different parts of the yield program, not just raising prices, but driving other pieces that can drive yield and either the nail on their head. One of our key focuses in 2014 will be driving environmental fee and fuel surcharge compliance up.

Michael Hoffman - Wunderlich Securities

And that’s – I mean, that’s an existing, it’s already in the invoice, so this isn’t I am still going to see improving the reported to us, the reported yield should still continue to improve, because you have got a discipline there, but you also capture an incremental revenue dollar that was already in the invoice you have just rolled it back? Right, is that the right way to think about?

David Steiner

Yes. I mean, what’s going on right now is that depending on the fee of the surcharge, only 55% to 75% of the customers actually even have the surcharge. And so just to give you an easy example, on the fuel environmental surcharge in the past, if a salesperson went out and waived the – either waived the fuel surcharge or the environmental surcharge for both of them, if they waived it for a customer, there was really no oversight about that. What we have done now is we put the rules in place that if you waive them, you’ve got to get a higher level of approval and you can imagine just that focus on fuel and environmental raises the compliance rates. And so on new business, we are going to make sure that we get it more often. And on existing business, we are going to go back and in every case, where we can get it we are going to try to get it there. And then obviously, we have got other folks that aren’t at full fuel at environmental, and that’s what you are talking about. When they are not at full fuel at environmental we can raise up – we can raise them up to get them closer to or at the full fuel or environmental surcharge.

Michael Hoffman - Wunderlich Securities

Okay. So now, I am hearing is two bites at that apple, which is even more interesting. So David, you kindly offered in the second quarter that free cash flow will be flat year-over-year. Having raised the guidance, will we still be flat in ‘14 and it sounded like Jim, you alluded to without saying it specifically in your opening comments that, that would in fact be the case. But I just want to get a feel for what a free cash – how we should think about ‘14’s free cash?

David Steiner

Yes, I mean look Jim talked about it earlier that there is a lot of ins and outs in ‘14 with bonus depreciation with the cash going out from the compensation accruals that we are having this year, the movement of working capital, but what we have always said that this company is first and foremost a free cash flow generating machine. Our guidance this year was $1.1 billion to $1.2 billion. We have now raised that to $1.2 billion to $1.3 billion. And Michael, you and I have had this conversation many times. I have always said this company had a very minimum every year it should generate $1.2 billion in free cash flow (indiscernible) and but the – with the focus that Jim and Jim have put on capital, I am very confident that we can do that not jut in 2014 but going forward.

Michael Hoffman - Wunderlich Securities

Okay. And then question for you, as there is lots of success, landfill price seems to be more muted, what can be different in ‘14 put out the depth in which you can – breadth of which you can raise landfill price?

David Steiner

Right. I mean, there are two things one is the contractual nature, right, I mean, those are different types of contracts longer term contracts, but two is just the visibility. Just this year, we have started to get reports on sort of the top 10 customers at every landfill we will get every quarter, we will get what the price action has been with those top 10, top 20 type customers. So look pricing is all about discipline and accountability and you can’t have accountability without visibility. So you know it's the same approach we’ve taken whether it's pricing or cost, we have said you know what we are going to get the visibility so that we can hold people accountable and once you hold people accountable it's amazing what this organization does. I mean this is an execution organization and once we set the right direction they will execute and we’re holding our field managers accountable and they are holding both accountable down the line it's truly amazing what this organization can accomplish.

Operator

Your next question comes from the line of Alex Ovshey of Goldman Sachs.

Usha Gunthapally - Goldman Sachs

This is Usha Gunthapally on behalf of Alex, how are you?

David Steiner

Good morning. Doing well.

Usha Gunthapally - Goldman Sachs

Any updated thoughts on the divestment pipeline for 2013 and any potential for 2014?

David Steiner

Can you repeat the question for me?

Usha Gunthapally - Goldman Sachs

What is your divestment pipeline look like for 2013 and anything going at a 2014?

David Steiner

So this year we have divested somewhere in the neighborhood of a $100 million and that’s probably about where we typically are through the year so I wouldn’t expect it to differ dramatically in 2014.

Usha Gunthapally - Goldman Sachs

And was there any noticeable change in construction related volumes in third quarter and any early read on the fourth quarter trends?

David Steiner

Yeah you know I think like we said earlier I think that we can certainly say that the volume trend for us is very stable, you know when we look at the construction related volumes we have got very good volumes at our landfill which is very high margin. You know we don’t have as a good volume and industrial line; it's what we’re talking about earlier. We basically intentionally share some low margin industrial business and we’re not going out and chasing new industrial business at low margins. You know we have got the highest new business rate that we have had in the industrial line probably since I’ve been here. So we aren’t chasing collection [ph] volumes on the construction side. The good news is and we’re not chasing those at low margins. If we can get the right margins we will chase them but we’re not chasing them at low margins, the good news is we’re still seeing that volume come into our landfills at very high margins. So I would say that we have seen a nice uptick on the construction side for us, it manifest itself more at the landfill you know last year we had some industrial volumes from Sandy that obviously won't repeat in the fourth quarter but other than that we see the volumes on the construction side being pretty robust.

Usha Gunthapally - Goldman Sachs

That’s helpful and obviously you’re focused on pricing growth but in the medium term what’s the upside do you see from changing your recycling contract structure and surcharges?

David Steiner

Yeah you know that’s like I said there is no quick and easy fix on the recycling front. You know that’s going to take some time, you know we have got some plans in place to see improvement but frankly it's modest improvement in the near term. You know in the medium term you know I would like to sort to see how the program plays out a little bit before we make a call and what we’re going to see in the medium term but you know look this is again this is no different than what we did with the fuel surcharge 10 years ago. We sort of led the industry and it became an industry standard, look if customers want to have recycling for the long term which is look that’s what all of our goal is to have recycling for the long term. We all need to make it a more stable and profitable business and that’s what our program is designed to do.

Operator

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

Al Kaschalk – Wedbush Securities

Just wanted a follow-up on this recycling concern or issue and David you touched a little bit upon on it, but to me if you’re calling yourself the leader why wouldn’t we start to think about doing something more of the largest scale or more I say inflection point and how the business is being grown and that is have you looked at third party processing our outsourcing of this, is this something you can get an economic value on doing some of the things you’re talking about doing and can you do it sooner versus later because back in the 90s or maybe in earlier than that, recycling was a bus for lot of companies with commodity prices down, it doesn’t seem to be generating the cost of capital returns that you would like? And pricing is something that you are never going to control, so to me as I look at this business, are we going to continue to have headwinds on this relative to your ability to drive returns in other areas?

David Steiner

Right. Look, short-term, I think you are absolutely right. We are looking at everything we can look at short-term to improve the business. So for example, we shut down two recycling facilities and we moved up volume to third-party processors. So what you see in recycling is basically same thing you see in the solid waste which is innovating market by market analysis. So in California where you are supported by fees to support recycling, we have never really seen profitability win. And so I think you are absolutely right, Al, in the short-term we can do some things to change that. But in the long-term we need to make the entire business more profitable and more stable. And I think the four actions we talked about will do just that.

Al Kaschalk – Wedbush Securities

How many facilities do you have that are recycling oriented?

David Steiner

Yes, we have got about 120 total, about 40ish, 35, 40 single street.

Al Kaschalk – Wedbush Securities

Okay. I may have misplaced my second question here, but…

David Steiner

So Al, while you are looking for your second question, I think it’s important to say that the recycling business is difficult as it been for us over the last two years. Recycling, it’s imperative that we would be in this business for our customer needs. Customers require it, we need to provide it. We just have to improve the business at this point and that’s why we are taking – tackling these issues as David went through.

Al Kaschalk – Wedbush Securities

Yes, but I think I agree with 100% with that, but my concern is that at the end of the day, it appears not only for you, but for the industry that this is almost a lost leader in the short-term, because you are of the education process and change in habits that needs to take place to drive better than corporate average return on the business, but….

David Steiner

Yes, but again, Al, I go back to the – I go back to the fuel surcharge on the residential contract that occurred probably 10 years ago. At that point in time, our residential business was low single-digit margins and now what you see is sort of mid-teen type margin. So a lot of that is driven by the fact that what used to happen as you would enter into a long-term contract, fuel would go up, so your cost structure went up and before you knew it, you are losing money on a residential contract that when you are originally fitted, you made some money on and then if the municipality had a five-year renewal, they would renew it for five years and you continue to lose money on it. And so basically what we did is we said look we have got to find out what are the drivers of profitability in the residential line of business and how do we fix this from our point of view so that we don’t get stuck in this constant low single-digit margin business.

Recycling is in the exact same spot here. Jim is absolutely right. We have got to meet our customer demands and we fully expect to meet our customer demands, but our customers need to realize that if they want us to meet their demands long-term, we need to make it a more viable business and we need to do that by ensuring that when times are good everybody is happy right. When times are good, we are having a revenue split with our customer. They are making money. We are making money. The problem is when commodity prices go down and processing costs go up, our customers don’t lose money, we lose money on the recycling side. So we just need to make them understand that in order to make this business work long-term, we have to make some structural changes. And I would expect that over time, you will see exactly that happened and what you will find is that we are certainly the leader in recycling. I would like to be the leader in a business that has projectable solid returns.

Al Kaschalk – Wedbush Securities

I agree. I think sometimes it’s also a constructive and healthy to fire clients so our customers. My second question is that and I am trying to appreciate obviously the comments have been focused around pricing. You can only continue to get pricing when you see the volume trend being positive as well so – or we had a spot here where you are going to be offsetting top line maybe a net positive because of the pricing but at some point your customer they start to push back on little bit more aggressive pricing in the marketplace.

David Steiner

Well look you know we certainly haven't seen that point but obviously pricing gets better as volumes get better. You know we have got a good I would characterize the volume environment right now as very stable but it's not growing like it did in the ’05 to ’07 time frame. I think if we continue to see housing starts above a 1 million, you will also see new starts pick up because you have to build new businesses around those new subdivisions and you know we expect the volume trends to not get dramatically better but we certainly don’t expect them to get dramatically worse. What we found is that since I’ve been CEO now for 10 years what we found is that our churn rate doesn’t change dramatically regardless of the level of pricing program that we have put in place and so you know I think there is still a lot of runway to go from a pricing point of view but you’re absolutely right I will much prefer to see a robust volume environment that would certainly help both from a leveraging volume point of view and from a price point of view.

Jim Fish

One quick thing here when you think about volume one sure way for us to create shareholder value and really what is a mature industry here is to price increase. Now if we’re going to make collection price increasing or increases sustainable we got to get price increases on the disposal side and I think Michael asked me question earlier about that but that is going to be important for us in 2014 is to make sure that we’re mirroring the success we’re having on a collection side of pricing with success on the disposal side and if we do and we think that that’s a long term sustainable model for growing shareholder value.

Al Kaschalk – Wedbush Securities

And finally the volume decline it was more noticeable or meaningful on the industrial side and going over the next near term should we still expect, so we think about volumes comp in negative or are we back to flat line here?

David Steiner

On the adjusted and industrial line you mean?

Al Kaschalk – Wedbush Securities

Well I’m trying to appreciate. I think heard volumes were while you reported down 0.6 and down 1.3 day adjusted. I thought I heard industrial was where you were pushing some volumes away maybe that was a major component to the decline, going forward do you still have a few quarters where you’re sort of pruning the volume based and therefore we should expect the negative volume comp near term?

David Steiner

I wouldn’t be surprised by that, you know it's not just that we’re pruning unprofitable business, we also are chasing the low margin roll off business, you know like I said if you give me the option of getting negative on a work day adjusted basis the industrial volumes were negative 2.2%. If we can get 5.5% yield and 8.4% core price I will take that trade off every day and so what’s really going on here is that we’re shedding some volumes intentionally but we’re also not just taking our chance and throwing them out on the street you know when as other folks throw their chance out on the street and their capacity gets maximized we’re then able to go in and get selective hauls at higher prices which you know for us is a spectacular trade-off. Like we said this is the highest income from operations we’ve had in our industrial line since I’ve been here and that’s with the 2.2% volume decrease. So the price volume trade-off for us is working very well and we don’t anticipate change in that.

Operator

Your next question comes from the line of Joe Box of KeyBanc Capital.

Joe Box - KeyBanc Capital Markets

Question on your SG&A savings program, now that you guys are about a year in and it looks like waste fundamentals are starting to turn. Can you just maybe give us a sense of the type of leverage that you’re thinking we can get on SG&A as volumes do come back and ultimately do you think that the 100 basis points of expansion from 2012 levels are still generally doable?

Jim Fish

Yes so what I would say on SG&A is that that’s you know the comps get more difficult but what we have said to the field for 2014 is that’s not only where we are going to be flat from ‘12 to ’13 in absolute dollars, but we said we are going to be flat from ‘13 to ‘14. And we are in the process of going through budget reviews right now. It’s as you can imagine. That’s a difficult message for not only to feel, but for corporate to hear, but we think that it’s achievable. At some point, obviously as your business grows, you are not able to hold flat in absolute dollar terms, but we do think over this three-year period we can hold flat on SG&A and work our way through the increases, the headwinds that we face each year from conversation.

David Steiner

By the way, SG&A as Jim exactly like what I said about capital before if you add yields you don’t have to add SG&A. If you add volume you do.

Joe Box - KeyBanc Capital Markets

And that’s really helpful. And I guess, Jim, just to be clear, if you hold SG&A flat, does that include the acquisitions or is that excluding the acquisitions that you have done?

Jim Fish

Well, it’s a good question. We have basically held it flat, including the acquisitions this year, which has been quite a task, but we expect as we said at the beginning of the year, we said we would hold flat. We are on track at this point to hold flat. We will run a little negative in the fourth quarter. We have got about $26 million worth of comp related headwinds in Q4. As I mentioned, we had about $50 million in Q3, but we still think even with $26 million in comp related headwinds, we will finish at or below last year’s levels.

Joe Box - KeyBanc Capital Markets

Perfect, that’s helpful. And then just a question on the industrial roll-off side, clearly you guys are taking more disciplined approach there, can you just give us a sense of one, where utilization is at for these assets? And two, I mean, if you – what is your view on the pricing market going forward, does it ever improve to the point where it actually makes sense to put these assets back to work?

David Steiner

Yes. So I can’t give you an exact utilization number, but I will tell you we just went through our business reviews with our market areas two weeks ago. And you told here anyone that says that they are missing volumes, because they don’t have equipment right. And so I would characterize the market as fairly tight from an equipment point of view and look that bodes well. I think that bodes very well for us both from a volume and from a pricing point of views, but like I said before, we expect to see some stability there. I would not be surprised if we see housing starts continue at over million starts that we see both price and volume on the industrial side, but we will wait to see it before we declare victory.

Joe Box - KeyBanc Capital Markets

Perfect thanks guys.

David Steiner

Thank you.

Operator

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

Adam Thalhimer - BB&T

Hey good morning guys. I would also say congratulations on a nice quarter.

David Steiner

Thank you, Adam.

Adam Thalhimer - BB&T

David, as it relates to pricing, I don’t hear you saying a lot, hey, we are going out there and we are pushing price, I hear you are talking about a mix issue, you are not going out and chasing low margin work, I hear you are talking about surcharges, but I mean, the works I know you are actively out there pushing price?

David Steiner

Yes. Well, look our core price was the highest again that we have seen in a long time, but I think it’s a great point. Look, well, we have been our first cut of our pricing programs in sort of the 2004 to 2008 timeframe. The primary weapon that we had were price increases. We are a much more sophisticated pricing company at this point in time and we look at a number of different areas. One of the areas where we end up giving away dollars is on new business pricing versus lost business pricing and then lost business versus new business right, you lose business at a high margin and if you gain business at a low margin, you are going to lose EBIT dollars. And so we sort of changed the way that we look at pricing from quite frankly, we don’t look at yield. I mean, obviously yield is an indicator, but what we look at is total dollars dropped to the bottom line from all the actions we take on pricing whether it’s core price or which includes the fees and surcharges rollbacks, new business pricing, lost business pricing. We take a look at all of it to understand the bottom line effect of our pricing program. So getting the 2.3% yield and dropping to zero dollars to the bottom line is not what we are looking to do. We are looking to see yield go up only as an indicator of dropping more dollars to the bottom line. And so the short answer to your question is I think you are being very perceptive which is you know this is much more than just core price increases it's about pulling a lot of different levers in pricing and dropping dollars to the bottom line not just a reported number.

Adam Thalhimer - BB&T

Okay and then I guess the question there really is can you get more aggressive as the volume recovery plays out?

David Steiner

I don’t think there is any doubt but again we can get more aggressive both on you know if you will net price increases but that means we can also get more aggressive on roll-backs that means we can also get more aggressive on new business pricing so there is a lot of ways you can drop dollars to the bottom line over and above just raising prices on current customers.

Jim Fish

It's really important that we address it on the disposal side too. So in order for us to continue down this path of success on collection pricing we have to be equally successful on the disposal side.

Adam Thalhimer - BB&T

And Jim is that harder or how would you characterize that versus the collections side?

Jim Fish

Yeah I think it is harder because typically you have fewer customers they are bigger customers, so there is you know little more perceived risk in the managers mind there but you know so increasing a small you know restaurant has relatively low risk to an area of Vice President versus a big disposal customer. So yeah it is probably more difficult but I think it's equally critical.

Adam Thalhimer - BB&T

Okay and then just in terms of industry volumes what’s your sense of the having been in this industry for decade, what is your sense of the environment out there? What you’re seeing how sustainable it is et cetera.

Jim Fish

Yeah I would say that it's again I would say it's look we’re not seeing dramatic volume growth but what we’re seeing is good steady volume growth and you know we’re seeing, you know where we’re seeing the best volume growth frankly is at our landfill which obviously is our highest margin business so that’s a good thing but you know again when you look at it from our point of view the industry volumes I would say right now are doing more to support our pricing programs than providing volume leverage obviously at negative 1.3% volume we’re not providing a lot of volume leverage but what it's doing is it's filling up capacity for the rest of the industry at lower margins and we’re able to that’s able to support our pricing program.

So you know we’re not going to go after I think the industry is actually growing volumes faster than we’re and by the way we’re perfectly comfortable with that because you know if the industry wants to chase there is always going to be someone that’s going to chase those low margin volumes and as long as they fill up their capacity chasing those low margin volumes we can take the higher margin volumes and when they collect it they are still going to show up with at our landfills.

Operator

Your final question comes from the line of Barbara Noverini of Morningstar.

Barbara Noverini – Morningstar

So should we expect increase investment in your existing recycling plants in order to more efficiently handle contamination for example can increased automation make it (indiscernible) and processing cost at this stage and if not what more can you do to reduce operational cost as you work on educating your customers and improving those contract term?

David Steiner

Yeah you know they really isn't a lot that we can do from a technology point of view to make the processing easier and so you can’t really do it inside the plant you really have to do it outside the plant with the materials right and so you know we have got plenty of contracts that have maximum contamination levels call it at 10% and when recycling prices are high and everybody is making money you don’t go in and audit it and go back to your customer but once you start to realize that you’re getting 20% to 30% contamination and your processing cost goes up and the commodity prices go down and you start losing money that’s when you need to say look we need to go back in where we have these clauses in the contracts, we need to go back in with the customers and say we need to do a better job of helping you get these contamination rates down but in the meantime we need to either charge a higher processing fee or reduce the rebate to cover our increased processing cost.

Barbara Noverini - Morningstar

What’s involved in that auditing cost? As I assume that happens at the recycling plant as the waste arrives, how do you go about providing that?

David Steiner

Yes you do it as the waste arrives and you go through sample loads.

Jim Fish

Barbara, I was also going to mention that there are specific things we can do in addition to the structural changes that Dave mentioned. We are – this business has grown fairly dramatically in the number of recycling facilities over the last handful of years and it probably has exceeded the experienced base of managers that have manufacturing like experience we are moving people around they have had a great experience and they have managed cost to locations that have the largest need and we are having real success there. You will see that little by little as we drive down that 10% increase we have seen in the operating cost per ton we will start cutting into that in Q4 and especially into next year.

David Steiner

Barbara, I guess, when I look at the recycling business what happened someone referred to it earlier on one of the prior questions what you have had in the past, there are some dramatic price dips on the commodity. So back in the 90s, you had it and then back in the great recession you had it, but those were always V-shaped drops in price right. They dropped dramatically and fast, but then they came back dramatically in past. So you said okay, well we can live with a little volatility now and then. But what you have seen lately is a more sustained period of low commodity prices, but so we looked at it with low commodity prices in 2009-2010, we said okay with low commodity prices, let’s do something to fix that and we put in floors and different things like that, not thinking that our processing cost could go up because of regulations imposed by China, so the cost go up from the regulations in China and we address that. And what I am saying is we can fix some of that short-term, just like we fixed the pricing or the low commodity price short-term, we can take some actions to fix it short-term, but what we need to do is fix it long-term, because if we don’t fix it long-term, what you are going to see is that there is not going to be recycling facilities anymore, because look we want to help our customers, but we also want to do it by earning a decent return on the capital that we have got invested in this business. So we need to make some systemic changes so that we can both continue to recycle, but then also recycle even more for our customers.

Barbara Noverini - Morningstar

Yes, it’s great to see you digging into those issues. And just on the Chinese restrictions, have you seen any of that becoming less stringent, I noticed there is supposed to be a temporary measure, but do have any indication that it’s going to lift anytime soon?

David Steiner

Yes, they recently extended it into 2014. I would say that in certain locations, you have seen a little bit of easing, but certainly not enough to make a dramatic difference.

Barbara Noverini - Morningstar

Got it. Thanks for the additional details.

David Steiner

No problem. Thank you.

Operator

And there are no further questions.

David Steiner

Thank you all for joining our call. We get the honor of reporting the results to you, but I can guarantee you that we don’t drive the results we have got 45,000 people at this company that are working hard every day to drive the results. And in the third quarter, they did another spectacular job, so I wanted to say personally to them thank you very much. And we will see everybody on the phone out on the road and we will see some of our 45,000 employees on to the road to give them a personal thanks. So we will see you next quarter. Thank you.

Operator

Thank you for participating in today’s third quarter 2013 earnings release conference call. This call will be available for replay beginning at 1:00 PM Eastern Standard Time today through 5:00 PM Eastern Standard Time, Tuesday, November, 12, 2013. The conference ID number for the replay is 66496035. Again, the conference ID number for the replay is 66496035. The number to dial for the replay is 1-800-585-8367 or 1-404-537-3406.

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