Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Waster Management, Inc. (NYSE:WM)

Q4 2009 Earnings Call

February 16, 2010 10:00 am ET

Executives

Jim Alderson – Director Investor Relations

David Steiner – Chief Executive Officer

Lawrence O’Donnell – President, Chief Operating Officer

Robert Simpson – Senior Vice President, Chief Financial Officer

Analysts

[Al Katchoff – Wedbush Securities]

Jonathan Ellis – Bank of America

Hamzah Mazari – Credit Suisse

Michael Hoffman – Wunderlich Securities

Scott Levine – J.P. Morgan

Alex for Richard Skidmore – Goldman Sachs

Cory Greendale – First Analysis

Vance Edelson – Morgan Stanley

Operator

I would like to welcome everyone to the fourth quarter and full year 2009 earnings release conference call. (Operator Instructions) I would now like to introduce Mr. Jim Alderson, Director Investor Relations.

Jim Alderson

Good morning everyone and thank you for joining us for our fourth quarter 2009 earnings conference call. With me this morning are David Steiner, Chief Executive Officer, Larry O’Donnell, President and Chief Operating Officer and Bob Simpson, Senior Vice President and Chief Financial Officer.

David will start things off with a summary of the financial results for the quarter and a review of the details of our revenue growth including price and volume trends. Larry will discuss operating costs and Bob will cover the financial statement. We will conclude with questions and answers. During their statements any comparisons made by David, Bob or Larry unless otherwise stated will be with the fourth quarter of 2008.

Before we get started, let me remind you that in addition to our press release that was issued this morning, we have filed a Form 8-K that includes the press release as an attachment and is available on our website at www.wm.com. The Form 8-K, the press release and the schedules to the release include important information that you should refer to. That is because David, Larry and Bob will discuss our results on an as adjusted basis.

Unless otherwise noted, all of the financial measures referenced on the call including net income, earnings per share, income from operations, operating expenses and operating margins are adjusted for items we deem unusual or non operational in nature. We will also discuss free cash flow. All of these are non-GAAP financial measures.

We have given detailed information on all of the non-GAAP measures that will be discussed on this morning’s call and have reconciled them to the most comparable GAAP measures, and you can find that information in the schedules to the earnings press release and the Form 8-K filed today which can be found on the company’s web site at www.wm.com.

Additionally, during the call you will hear certain forward-looking statements concerning our plans and expectations for first quarter and full year 2010. Actual results could differ materially from our plans and expectations. Certain factors related to future expectations are detailed in our press release this morning and in our filings with the Securities and Exchange Commission including the Form 10-K filed for 2009.

This call is being recorded and will be available 24 hours a day beginning approximately 1:00 pm Eastern time today until 5:00 pm Eastern time on March 2. 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 800-642-1687 and enter reservation code 49511473.

Time sensitive information given during the course of today’s call which is occurring on February 16, 2010 may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited.

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

David Steiner

Thanks Jim and good morning from Houston. Our fourth quarter was a positive note in a challenging year and we believe the signs we saw in the fourth quarter point toward a better 2010. We earned $0.52 per share in 2009’s fourth quarter, an increase of over 6% compared to the $0.49 we earned in the prior year quarter.

Revenue declined by $102 million or 3.3% from the prior year quarter which is a significant improvement from the 14.2% decline experienced in the third quarter of 2009. Benefits from our reorganization announced in February exceeded our original target of $120 million in annualized savings.

We continue to see positive signs on the macro economic front with recycling commodity pricings continuing to trend upward. Commodity prices have now increased every month since January of 2009.

Natural gas markets, which affect the electricity sales prices at some of our Waste Energy and Landfill Gas Energy plants, continued to move upward during the fourth quarter, and by December 2009, matched prior year prices.

Pricing continued to be strong and consistent and internal growth from yield in the fourth quarter was 2.7%. Internal revenue growth from yield was strongest in the three collection lines of business. Combined, the revenue growth from yield in the industrial, commercial and residential lines of our collection business was 3.4% in the fourth quarter.

Commercial and industrial produced the strongest results where internal revenue growth from yield from both business lines was 3.5% in the quarter. The yield component of internal revenue growth in our residential line of business was 3%.

New business pricing for the fourth quarter in both the commercial and industrial line of business was the best we’ve seen in some time. Commercial new business pricing was the strongest we’ve seen since 2007, increasing by over 6% while industrial new business pricing increased almost 12% which was our strongest industrial new business pricing since 2006.

On the volume side of the business, internal revenue growth from volume declined 6.4% in the quarter, a 250 basis point improvement from the third quarter of 2009. Our collection and disposal internal revenue growth from volume was negative 7.3%, a significant improvement from the negative 10.2% that we saw in the third quarter of 2009.

The recession resistant lines of our business, namely commercial and residential collection, saw both volume declines of 5.1% and 2.6% respectively. The commercial volume decline was similar to what we’ve seen in recent quarters, but the residential volume decline was much improved.

In our more economically sensitive industrial line of business, volumes were off 15.4%, a 280 basis point improvement compared with the third quarter of 2009. Despite lower volumes, we maintained our focus on industrial pricing which resulted in revenue growth from yield of 3.5% for the quarter. We will continue to work to obtain price increases in our industrial line despite lower volumes.

Overall, we continue to expand our income from operations margin in the collection line of business which increased by 20 basis points compared with the prior year period.

In the landfill side of the business, fourth quarter 2009 internal revenue growth from volume decreased by 14.3%, a 540 basis point improvement from the third quarter of 2009. The softness occurred primarily on a more economically sensitive C&D line which was negative by 34.4%. The fourth quarter of 2008 included C&D volume from Hurricane Ike. Excluding the effect of this additional hurricane volume, C&D would have declined 19.6% in the quarter.

Internal revenue growth from volume for special waste was negative 12.1% which improved significantly compared with the 20.5% decrease experienced in the third quarter of 2009.

For NSW, internal revenue growth from volume was negative 5.1%, also an improvement from the third quarter of 2009.

On the pricing front, pricing was strongest in our MSW line with per unit pricing up by 3%. Again, we’ll maintain our focus on MSW pricing despite lower volumes.

Looking forward, in 2010 we’ll focus on maintaining our pricing discipline and improving our sales and marketing performance to generate profitable revenue growth. We expect our internal revenue growth from yield to be within a range of 2.5% to 3%, consistent with our performance in 2009.

You may remember that last year we had a pricing gate to ensure that we maintained our focus on pricing. If the company didn’t meet or exceed the gate, no annual bonuses would be paid. In 2009 we exceeded the gate. In 2010 we will design the pricing gate to increase the gate by 50 basis points. As we did in 2009, we would expect to meet or exceed the gate.

Average recycling commodity sales prices increased each month in the fourth quarter and surpassed the price levels of the prior year quarter by almost 20%. Since January of 2009, average commodity sales prices have almost doubled. Increased commodity prices contributed $0.04 of positive year over year earnings of diluted share in the fourth quarter of 2009, consistent with our expectations.

For our recycling line of business in 2010, we are anticipating a year over year positive impact to earnings per diluted share of between $0.04 and $0.08, most of which we expect to occur during the first half of the year.

This equate to 2010 pricing for both old corrugated cardboard and old newsprint of between $90 and $95 per ton on average.

Electricity sales prices at our Waste Energy and Landfill gas to energy operations declined year over year and caused a negative impact of approximately $0.03 per diluted share during the fourth quarter of 2009 in line with the expectations we announced in our third quarter 2009 earnings release.

Approximately 46% of our waste to energy power is currently being sold on merchant basis and we expect this to remain constant throughout 2010. For this merchant energy stream, we will be implementing a more actively managed energy program to decrease the volatility of our electricity sales prices beginning with rolling short term hedges. However, if we see an opportunity, we will lock in longer term.

For our Waste Energy operations in 2010 we’re anticipating no net impact from electricity sales prices compared with 2009. However, we expect a $0.01 to $0.03 per diluted share negative impact in the first half of year, offset by a positive $0.01 to $0.03 diluted share impact in the second half of the year.

Our guidance equates to an average price per million BPU of approximately $5.70 for 2010. Every $0.10 per million BPU change in natural gas prices translates to a change in income from operations of between $1.7 million and $2.4 million on an annualized basis.

On the volume side of the business in 2010 we anticipate that year over year comparisons should continue to be negative for the first half of the year, but with the negative volume comparisons improving each quarter.

We anticipate flat to slightly positive volumes for the second half of the year. Thus, we expect that the volume comparisons for the entire year will fall between negative 1% and negative 3%. Certainly, if the economy improves at a faster rate than we see right now, volumes could be better than these projected levels.

However, our guidance does not take into affect the severe winter weather the entire United States has experienced in the last few weeks. We would expect this to negatively affect volumes in the first quarter.

Our revenue in 2010 will also benefit from the roll over effect of approximately $200 million of annualized revenue from acquisitions closed during 2009. This should add over 1% of revenue in 2010. For 2010 we’re targeting acquisition opportunities in the range of $250 million to $350 million.

Looking at our costs, after holding wages flat for our exempt employees in 2009, we expect to resume annual merit increases which will add approximately $40 million to 2010 costs. Primarily in order to upgrade outdated IT equipment and applications, we’re planning to increase IT expenses by approximately $35 million.

And we expect interest expense to increase approximately $65 million because of the interest on the $600 million on senior notes that we issued in November of 2009 and also because we anticipate higher rates and fees for the renewal of our revolving line of credit that will renegotiate later this year.

Given our assumptions, and despite the additional costs I just highlighted, we still expect to generate between $1.2 billion and $1.3 billion in free cash flow and we believe that our full year 2010 earnings will fall within a range of $2.09 to $2.13 per diluted share.

Clearly, the severe winter weather we’ve experienced so far this quarter will have an affect on first quarter results, but through our cost and pricing programs, we’re confident we can achieve our $2.09 to $2.13 guidance.

2009 was a strong year under a difficult economic environment. We’re proud of our accomplishments in 2009 but we know that it was the people of Waste Management that made it happen, and we’re confident they’ll do so again in 2010.

With that, I’ll turn the call over to Larry.

Lawrence O’Donnell

Thank you David and good morning. I’ll now review our operating cost results for the fourth quarter and full year 2009.

Adjusting for the items noted in our press release, operating expenses in the fourth quarter of 2009 were $1.874 million or 62.3% of revenue, an improvement of $44 million from the fourth quarter of 2008. As a percent of revenue, operating expenses were 60 basis higher than the prior period.

For the full year 2009, operating expenses were $7.2 billion, an improvement of $1.2 billion compared with the prior year period. On a full year basis, our operating expenses were 61.3% of revenue compared with 62.6% for the prior year, an improvement of 130 basis points.

As we’ve been saying for the last 18 months, we’ve seen a consistent trend in our business. Volumes in our more recession resistant lines of business, especially residential, have held up the best. Volumes in our more economically sensitive lines of business, primarily landfill and roll off, have consistently seen the largest declines.

Our residential collection line of business provides a very solid foundation because it’s very stable, but it carries the lowest margins of all our collection lines of business. The landfill business carries some of our highest margins, but it is very difficult to flex down costs, especially labor, as this line of business is less labor intensive than our collection line of business.

We continue to see larger volume declines at our landfills than in our residential line of business which causes a change in our business mix. This change in mix impacts our operating margins as we lose more higher margin business than lower margin business.

Our restructuring and cost saving measures we implemented at the beginning of 2009 helped offset the impact of this mix change on our margins early in the year, but the cumulative impact of this mix change was more pronounced in the fourth quarter. Of course when our landfill and roll off volumes begin to rebound, we expect to see the reverse for a positive impact to our overall operating margins.

Also contributing to the margin decrease were $8 million of expenses related to environmental liabilities at some of our closed landfill sites and $10 million of expenses related to our growth initiatives.

We will continue to work hard at aggressively flexing and eliminating costs. So for the full year 2010 we expect margins to continue to improve, and as many of you are aware, one of our key financial components to our annual incentive plan is expansion of our income operations margin as a percent of revenue.

If we don’t expand that margin in 2010 as compared to 2009, we will not receive an incentive payout for that portion of the bonus plan, so you can be assured that everyone will be working hard to find ways to control our costs and improve our margins.

Labor and employee benefit costs improved by $7 million in the quarter. This improvement results primarily from reducing routes in reaction to the volume declines and labor cost savings that resulted from our restructuring that we implemented at the beginning of 2009. This helped offset the wage increase for hourly employees that we implemented in June of 2009.

We reduced our driver hours by about 600,000 hours in the fourth quarter by taking trucks off the road as volumes declined and using our routing tools to build more efficient routes.

Subcontractor costs improved by $35 million in the fourth quarter of 2009 as a result of using fewer third party contractors because of lower volumes, and negotiating down our third party transportation costs.

Cost of goods sold increased by $9 million in the fourth quarter as a result of increased recycling commodity revenues. We benefited from higher recycling commodity prices as well as the implementation of our new recycling pricing and rebate program. The program is designed to enable us to recover our processing costs and earn a fair return on our investment before we share commodity proceeds with customers.

We lowered our direct fuel costs by approximately $12 million compared to the fourth quarter of 2008 as a result of lower diesel fuel prices and using less fuel as volumes declined. The average diesel fuel price was $0.23 per gallon lower in the fourth quarter of 2009 compared to the same period last year.

Indirect fuel costs charged to us by our subcontract transfer station haulers, declined by approximately $5 million. Compared to the fourth quarter of 2008, fuel surcharge revenue declined more than fuel costs causing a negative year over year impact of $0.03 per diluted share.

Our new organizational structure that we put in place as part of our restructuring in 2009 has enabled us to become even more proactive in managing our costs and efficiently adjusting our operations to match our volumes. This certainly helped us throughout last year and will continue to serve us well as we begin 2010.

This organization structure also positions us well to leverage our cost structure when volumes begin to recover.

I want to thank all our employees for their hard work and focus in helping us build a great company. With that, I’ll turn the call over to Bob.

Robert Simpson

Thank you Larry. I’d like to start by discussing SG&A costs. These costs decreased by $17 million to $365 million during the fourth quarter of 2009 and for the full year 2009 they decreased by $113 million. This decrease is primarily due to labor cost savings that resulted from our restructuring announced in February 2009. Also contributing to the decrease are lower advertising, travel and bad debt expenses.

Partially offsetting these cost decreases is an increase in litigation settlements during the fourth quarter. Bad debt expense decreased by $7 million for the quarter and our day sales outstanding improved by four tenths of a day. This was a good result particularly given the economy and we will continue to manage our receivables very closely.

Depreciation and amortization expense for the fourth quarter of 2009 declined $23 million when compared with the fourth quarter of 2008. In the fourth quarter of each year we review the estimated costs to cap, close and maintain the fill portions at our landfills. In 2009 the review resulted in a net favorable year over year adjustment of $16 million for changes in estimates relating principally to our capping events.

The rest of the decrease in depreciation and amortization resulted principally from volume declines. As a percent of revenue, depreciation and amortization expense was 9.1% compared with 9.6% in the prior year quarter.

Our interest expense net of interest income for the fourth quarter declined by $2 million compared with the prior year period primarily due to lower interest rates offset by higher debt levels. Our debt to total capital ratio of 57.4% is better than our target ratio of about 60%. The floating rate portion of our total debt portfolio was 22% at the end of the quarter.

In November 2009, we issued $600 million in 30 year six and an eighth percent senior notes. This contributed to our large cash balance at the end of the year, but we expect that approximately $150 million of cash will be used during the first half of 2010 to close the purchase of a Waste Energy plant in Virginia.

We will also spend in the first quarter about $150 million to purchase a 40% equity interest in Shanghai Environment Group, a company focused on developing waste energy plants in China.

In addition to the $300 million for the waste to energy investments, we have targeted $250 million to $350 million for business acquisitions and investments.

Moving to income taxes, in the fourth quarter of 2009, our effective tax rate was approximately 4.9%. The decease in our tax rate is primarily the results of favorable impacts from the carry back of the capital loss, recognition of state net operating losses and tax credits and the revaluation of deferred taxes resulting from reductions in Canadian tax rates.

Our $0.52 earnings per diluted share as adjusted includes a benefit of $30 million for the recognition of state net operating losses and tax credits. For 2010 we expect the effective tax rate to be approximately 37.5%.

Turning to cash flow, fourth quarter 2009 net cash provided by operating activities was $720 million. Our capital expenditures for the quarter were about $356 million, a decrease of $78 million when compared with the prior year period.

Our free cash flow for the quarter was approximately $372 million resulting in a free cash flow margin of 12%, the best fourth quarter performance in recent years. For the full year 2009, free cash flow was about $1.2 billion after capital expenditures of approximately $1.18 billion.

Our accrual for incurred but not yet paid capital expenditures was reduced from the fourth quarter 20078 level by $100 million, explaining the increase in capital expenditures compared to our prior guidance.

We returned $795 million to shareholders in 2009 through dividends and common stock repurchases. As you all know, our capital allocation program over the past few years has been very clear; return cash to our shareholders through dividends and share repurchases while opportunistically making strategic investments and acquiring assets.

For 2010 our capital allocation plan is to return up to $1.3 billion to our shareholders through a combination of dividends and share repurchases. The plan includes increasing the dividend by 8.6% to $1.26 per share on an annual basis, which would result in a dividend yield of 4%.

We also intend to repurchase as much as $685 million of common stock. As I previously mentioned, we intend to spend $300 million closing deals that we entered into in 2009 related to new waste energy projects in the U.S. and China and we expect to spend between $250 million and $350 million in business acquisitions and investments.

We do not expect to spend more than $350 million in acquisitions and investments, nor do we see a compelling reason to buy back debt. But if those opportunities occur, we always have the ability to reduce the amount of our share repurchases.

I would also like to thank our employees because the company’s success is due to their hard work and dedication.

And with that, let’s open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Al Katchoff – Wedbush Securities]

[Al Katchoff – Wedbush Securities]

Congratulations on an excellent quarter. Can you comment absent any recovery in the economy in particular on the commercial and industrial side, have you seen the change in revenue mix or business mix that can help margin expand for 2010?

David Steiner

Obviously, when you look at, I think what we’re trying to say is that when you look at it, the commercial and residential is always pretty stable, right? And so the big changes that you see are in our economically sensitive lines of business like roll off and landfill.

I think we’ve bottomed out in seeing that happen. As you see those volumes come back, obviously they come back at a very high incremental margin. We got caught this quarter by the business mix. That should continue in the first half of 2010 because we don’t expect those volumes to turn positive until the second half of 2010.

We just need to do a better job of overcoming that mix issue with our cost and pricing programs.

[Al Katchoff – Wedbush Securities]

Is it fair to say that service decreases relative to service increases would have netted out to a positive going forward or is that a big of a challenge to make that call?

David Steiner

No, they’ve been flat to slightly positive for the last two quarters so I would expect that to continue.

[Al Katchoff – Wedbush Securities]

If I may just clarify on capital allocation, the $300 million of waste energy investments that are expected in the first half of 2010, that’s $250 million to $350 million in acquisitions, is potentially over and above that $300 million, is that right?

David Steiner

That’s correct.

Operator

Your next question comes from Jonathan Ellis – Bank of America.

Jonathan Ellis – Bank of America

A quick question about fourth quarter then I’ll turn the attention to 2010. Landfill price, I know that you gave the MSW number. Do you have the overall landfill pricing number for the quarter?

Robert Simpson

When you look at overall landfill pricing it was basically flat, slightly up at .1%.

Jonathan Ellis – Bank of America

Just a little bit about 2010, in terms of the yield, you talked about 2.5% to 3%. Within that are you assuming any benefit or incremental contribution from a higher environment fee this year? I know you had rolled that into administrative fee last year. Is that being stepped up? Can you say anything about the fees vis a vis core price increases for 2010?

David Steiner

As you know we moved that environment fee up to 6% last year. I don’t see us moving that incrementally higher in 2010. I think the same thing would apply for the other fees and charges.

This year, we’re going to have to get pricing from our core pricing programs from price increases and from new business pricing. So we won’t get a lot of benefit from visa surcharges.

Jonathan Ellis – Bank of America

Talking about the costs, you outlined a couple of specific costs that are going to be a source of pressure, margin drain in 2010. Just to be clear though, is that effectively ring fencing all of the cost inflation this year or would you still expect natural inflationary pressures in other cost items that we should be adding on top of the specific items that you identified?

Robert Simpson

I think we would expect natural cost pressures. We just wanted to point out the ones that go beyond natural inflation so we wanted to call those out to you.

Jonathan Ellis – Bank of America

The estimated, in the free cash flow guidance, the impact, I know it hasn’t been passed yet, but if bonus depreciation was not going to be extended, Bob do you have a figure this for what the tax cash drain would be?

Robert Simpson

If bonus depreciation is not extended, we expect the tax payments to go up about $115 million, but we also expect to receive in the second half of this year a refund on the capital loss that we took benefit for but excluded from our adjusted earnings of about $65 million. So the net of that is about $50 million and if bonus depreciation is extended, we would expect $50 million to $60 million benefit to come from that. That’s not in our guidance.

Jonathan Ellis – Bank of America

In terms of the new credit facility, can you give us some sense as you look at where things stand today and the discussions you’ve had, what your expectations are potentially for increased costs on that facility?

Robert Simpson

We expect the costs will be $20 million higher than they were this year, and what we’re hearing and seeing is that the fees that we’re going to be charged, that everybody is charged will have gone up very, very much, four or five times over what they’ve been in the past. So the number we’ve got on our math is about $20 million for higher revolver costs.

Jonathan Ellis – Bank of America

That’s $20 million on an ongoing basis, or $20 in upfront costs.

Robert Simpson

That would be the ongoing basis.

Operator

Your next question comes from Hamzah Mazari – Credit Suisse.

Hamzah Mazari – Credit Suisse

On pricing, your mentioned pricing on new business is up more than you’ve seen in the past. Could you put some color around that? Is that just coming off of a lower base and how should we think about your increasing price by 50 bips this year? Is that contingent on volume sort of running flat from where we are right now?

Robert Simpson

First, you’re absolutely right, it is running off of a lower base. It’s the highest we’ve seen in a couple of years, but it is running off that lower base.

On the 50 basis points, let me make that clear that the 50 basis point increase is our pricing gate, right? Remember last year we put in a pricing gate that said if we don’t reach a certain amount of yield, no one is going to get a bonus. So that’s not our target for the year obviously. That’s just a gate that we have to get over in order for anyone to receive a bonus.

So it’s not intended to be our target. It’s intended to make sure that folks stay focused on pricing so that we reach our target. Last year that was basically done to equate to a 2% yield. This year, remember how we did it.

We used average prices for all of our lines of business other than special waste. So this year we moved the gate up by 50 basis points. Now that doesn’t necessarily mean that pricing goes up by 50 basis points because of the correlation between the gate and yield, but it certainly should still result in a bottom line yield of 2% or greater.

Remember, that’s what we’ve always said our bottom line is. If we can’t do 2% yield, then we will be very upset so we’re basically putting this gate in to say we want to make sure that at a very minimum, we’re doing 2% yield. But our target is 2.5% to 3%.

Hamzah Mazari – Credit Suisse

On waste energy, could you remind us again how much exposure you have to market pricing this year and going into next year, what your contracts are struck at right now and longer term what kind of exposure do you want to sort of the market pricing?

Lawrence O’Donnell

At the end of the year, about 43% of our contracts were at merchant and almost all of those are in a spot rate of the market. You may recall that we decided to do that at the beginning of the year because of our expectation that prices would go up as the year went on and that turned out not to be the case and we’ve seen the results of that.

Going forward, we expect this year to get closer to 50%, about 46% of our electricity will be on a merchant basis, but we intend, as David said in his remarks, we intend to do short term hedges to lock in rates over a period of time, and then as we see opportunities to go longer term, that is what we will do.

And I think we’ll be sure to keep everybody informed about this as we go forward. You don’t want to lock in long term if you think the rates are going to go up further and you do want to get off the floor.

Robert Simpson

The reason why we’re doing the rolling short term is that you don’t want to lock in the entire portfolio. If you locked in the entire 46% that’s merchant on day one, then you can’t adjust until, if you lock it in for a year, you can’t adjust the entire portfolio for a full year.

So we’re going to start out by doing short term rolling hedges so that we can have various portions of the portfolio maturing at different points in time so that if we see an opportunity to lock in, we’re able to lock in as much of the portfolio as we can.

Hamzah Mazari – Credit Suisse

On your guidance, is it fair to say after adjusting for your acquisitions that you’re going to do the buybacks sort of look more like in the $300 million range?

Robert Simpson

No, the $685 million in share repurchases assumes $250 million to $350 million of tuck in of other acquisitions, so the capital allocation plan is $685 million of share buybacks, $615 million of dividends, and that is in addition to our budgeted amount of acquisitions of $250 million to $350 million.

Operator

Your next question comes from Michael Hoffman – Wunderlich Securities.

Michael Hoffman – Wunderlich Securities

On the recycle commodity guidance of $0.48, if you’re at $90 to $95 dollars in your pricing assumption, that’s a pretty wide range. How do you get the $0.08 on that basis of pricing?

David Steiner

The $0.08 is based on whether that pricing continues to go forward at a higher level than we’re currently anticipating.

Michael Hoffman – Wunderlich Securities

So where are you today in January on OMC and ONP?

Robert Simpson

In the $1.20 to $1.30 range.

Michael Hoffman – Wunderlich Securities

So is it fair to say that $1.20 drives it to the $8.00 and the $1.90 to $1.95 has it at $4.00?

Robert Simpson

The other thing you have to keep in mind is the weather impacts that we’ve seen in the Northeast particularly. While we’re getting pretty good pricing, you’re probably going to see some lower volumes given what we’re seeing with the weather.

Michael Hoffman – Wunderlich Securities

Just so I’m actually clear, you had an average rate last year you’re implying of 51 megawatt hours, I think that’s what you meant by $5.07.

Robert Simpson

That was the price of natural gas.

Michael Hoffman – Wunderlich Securities

Last year you were basically and inadvertently became a play on natural gas and your garbage company, there’s better ways to plays in natural gas. Is it safe to say that your hedging program has eliminated that, you no longer have to worry about ways to penetrate being a play on natural gas? We’ve taken that volatility out?

David Steiner

Not yet. That’s why we say we’re going to start this program. Look, we want to make sure that we’re locking in at the right rates and so we’re going to, and you’ve got to find the counterparty that’s willing to go long term.

So we’re going to start by doing again, short term rolling hedges so that we can start locking in portions of the portfolio. But then we’ll also have the option as we see prices firm and if you see the outer end of the forward curve increasing, we’d have the option to lock in longer term.

So at this point in time we have not locked in longer term. Obviously we’ll keep you all advised on the course of the year as we’re able to get more certainty or take the volatility out by locking in longer term hedges.

Michael Hoffman – Wunderlich Securities

I get you’re playing for a portfolio renewable standard and you’ve got energy credits and all that, but the August PGM forward rates are $65 from $10 and for August 2011 they’re at $73. So those seem like really good rates to be trying to capture.

David Steiner

And that’s exactly why we’re looking at doing a longer term hedge program in addition to our short term rolling hedge.

You must appreciate though that whatever our specific moves will be, we’re not going to talk about them until after because we don’t want to lose an advantage we have in the market by talking about it on a call like this.

Michael Hoffman – Wunderlich Securities

Capital spending is up year over year and yet you pulled forward capital spending in the fourth quarter to take advantage of bonus depreciation.

David Steiner

No, we didn’t do that. What happened in the fourth quarter, you may recall last year in the fourth quarter of 2008, we had a relatively large accrual for incurred but not yet paid capital. We expected that accrual to carry over at the end of 2009. In fact it was $100 million less.

So we spent everything in 2009 that we thought we would on the projects we thought we’d spend it on. We just had less of accrual at year end and the primary reason for that is the projects finished earlier in the quarter and we paid the bills associated with those projects. So it’s just we had less of an accrual at the end of the quarter.

Now going into 2010, we do expect to spend a little bit more in capital than we did in 2009. We’re going to be investing more in some single string recycling facilities and landfill gas to energy facilities than we did in 2009. While we’ll spend less in fleet, we do expect to spend a little bit more on the landfill side.

We have another very favorable expansion in Greenfields projects that have reached the point where we’re going to have to build or we want to build in 2010 and we’re going to go ahead and get started on that work. So that’s really the dynamic there.

Michael Hoffman – Wunderlich Securities

Just to make sure I understood clearly, the $1.2 billion to $1.3 billion guidance for free cash flow does not capture any benefit of extending bonus depreciation in 2010?

David Steiner

Right.

Michael Hoffman – Wunderlich Securities

And if it happens it would be incrementally $65 million. Is that what I heard correctly?

Robert Simpson

It would be incremental $55 million to $65 million.

Michael Hoffman – Wunderlich Securities

If your landfill volumes are down and pulling down margin aggregate for the company and you’re paying people to drive margin, if one were to follow that string on a sweater you’d get worried that people would go after volume to be able to drive margin, but they’d have to use price to do it. What are your protections to not let that happen locally?

Lawrence O’Donnell

One is the price gate that David talked about. That certainly worked well for us in 2009 which is why we’re extending it further into this year.

Robert Simpson

Let me make it very clear, that’s exactly the behavior we want to drive. We want folks to get volume and price.

Michael Hoffman – Wunderlich Securities

You don’t want to get volume at the expense of price.

Lawrence O’Donnell

Absolutely not.

Michael Hoffman – Wunderlich Securities

Tell me why you’re not getting better than 3% pricing in MSW given the structure of the landfill market today in 2010?

Robert Simpson

We are still getting that 3% on a per unit basis. The reality is that when you look at the landfill line of business with the volumes dropping mid to high teens, it’s a little bit difficult to get huge price increases. It’s a little bit easier to get it across your commercial and industrial base.

But long term, I think you’re absolutely right. We’ve got to do better on MSW pricing in order to support our pricing programs. There’s absolutely no doubt about it and you can bet that we’re focused on it.

Michael Hoffman – Wunderlich Securities

On the SG&A increase, is that $35 million a one time thing or a permanent change in the SG&A?

Robert Simpson

That’s to take care of a series of investments that we just need to make to update our applications and so I don’t see those particular investments reoccurring, at least not on a regular basis.

Michael Hoffman – Wunderlich Securities

Can we then think about G&A as having an uptick in 2010 but trending back down again in 2011? That’s the way to think about it?

Robert Simpson

That’s what we have to tell you. We have a relatively short term goal, three to five years out to get our SG&A below 9% of revenue and that’s something that we’ve put together a strategy to get there. We’ll talk more about that perhaps down the road, but we’re going to make some investments now that will allow us to do that. So I would think over the long term, we’re going to continue to see it come down.

Michael Hoffman – Wunderlich Securities

How much of that can happen on a constant revenue model that you have today in this economic environment versus having to have revenue grow to get that to happen?

Robert Simpson

The charge I’m working with is to work off of $13 million revenue base.

Michael Hoffman – Wunderlich Securities

You gave a volume decline in industrial, a pretty steep one, but I’m assuming that was more from the temporary side than the permanent side. I’m supposing the permanent side while it might not have been down 5% wasn’t certainly down double digits.

David Steiner

Generally you’re right. The permanent side is going to act more like the commercial line of business and be a little bit more stable.

Michael Hoffman – Wunderlich Securities

Having said that, your temporary side is a far smaller part of your business so in theory, I should start seeing some product on a line on that decline.

David Steiner

If I knew I’d have some product, I’d agree with you.

Michael Hoffman – Wunderlich Securities

On the dividend payout, how do you want us to think about that as a payout ratio? Is it some percent of free cash on an ongoing basis or you emphasized the yield number today. How do you want us to think about that in the context of modeling?

David Steiner

We certainly like the yield number to be lower without reducing the dividend and that goes without saying, but I said it anyway. The Board makes the decision on what the dividend rate is going to be and when the Board makes the decision, they consider a number of factors. Among those factors is we generally don’t want the dividend to be more than half of the total dividend paid, more than half of our free cash flow.

They like to dividend to be in the upper quartile of the S&P 500 dividend paying companies, but if our yield ends up dropping down and out of that upper quartile because our stock price moves, we’re not going to jump back up real fast. We’re going to do it regularly over time and that’s the way to think about that. There’s no other formula.

And I think the third piece of that is we like to see it growing incrementally year to year.

Michael Hoffman – Wunderlich Securities

What’s the share count guidance in your ‘09 to ‘13?

David Steiner

It’s 480 million. It’s down about 13 million shares.

Operator

Your next question comes from Scott Levine – J.P. Morgan.

Scott Levine – J.P. Morgan

On the volume side, when you say you can get this up slightly by second half, should we assume that that assumes no lift in the economy and are you seeing anywhere or do you expect anywhere in your business any kind of confidence level might you put around that?

David Steiner

We’re basically looking at the trend line over the last two quarters and then extending that into this year, so I think you’re right. We’re not expecting a huge amount of economic lift.

Scott Levine – J.P. Morgan

Are you seeing any difference anywhere with your footprint that’s notable either to the upside or to the downside?

David Steiner

It’s interesting that out of most economic downturns in the last 20 years, what you’ve generally seen is that the Northeast is sort of the first to go in and the last to come out, and the west coast and the sunbelt are the last to go in and the first to come out. And you’re not seeing that in this downturn.

You still see Florida and California very weak. You actually see some improvement throughout the Midwest and the Northeast. So I would generally say that it’s a little bit weaker in those places that as you can imagine were more affected by the housing downturn.

Scott Levine – J.P. Morgan

To turn to pricing really quickly, could you tell us what assumptions are embedded in terms of y our municipal or franchise contracts for pricing 2010 versus ’09 how big a piece of your total business that is?

David Steiner

The index of pricing in our collection line of business is about 35% of our revenue and the total number for the company is probably closer to 40% when you look at the landfill side. We’re assuming a pretty modest price increase in that area, 1% to 2%.

Scott Levine – J.P. Morgan

What was that in ’09 roughly speaking?

David Steiner

Actually I don’t have that handy. It was a little bit more than that. It was about 2.5%. We have started to see the impact and I know that others have talked about this too, the impact of CPI resetting and we’ve seen that. It’s just not as big a part of our business as might be otherwise.

Scott Levine – J.P. Morgan

On acquisitions, $250 million and $350 million in targeted spend I think you indicated. Is that right?

David Steiner

Correct.

Scott Levine – J.P. Morgan

Could you rough out, tuck in versus medical versus waste energy recycling, any other areas, is the profile all of the above or are you tilted one area or the other? What additional color can you provide there?

David Steiner

The $250 million to $350 million I would say is going to be predominantly solid waste tuck ins. Now there will be some, I certainly hope there will be some medical waste and recycling acquisitions but the bulk of it is going to be our typical bread and butter solid waste tuck in acquisitions.

We don’t see anything on the horizon as far as buying more waste energy plants. The $300 million that we basically committed last year but will pay this year should cover the waste energy acquisition. So that $250 million to $350 million again should be our core solid waste tuck ins predominantly.

Operator

Your next question comes from Alex for Richard Skidmore – Goldman Sachs.

Alex for Richard Skidmore – Goldman Sachs

On the operating leverage in the business, would you be comfortable in giving us a sense of how to think about or a rule of thumb to think about the incremental margin and the business may be once volumes begin to come back?

David Steiner

I think what we’d like to do, we’re going to actually cover that in some depth in our investor day which will take place in the afternoon of March 3 and the morning of March 4. So I’d like to hold that question until them.

Alex for Richard Skidmore – Goldman Sachs

Shifting to the recycling business, give us a sense of how to think of the sensitivity around the $8.00 to $10.00 change in OCC and old newspaper prices, how that would flow through to the bottom line for waste management or any sensitivity that you usually provide.

David Steiner

The price is about two-thirds of our revenue and we’re assuming $90 to $95 and $10.00 is a little bit over 10% of that.

Robert Simpson

But keep in mind our new rebate structure, what we did is we assured ourselves protection on the downside. So there is an affect with revenue share, so it doesn’t flow through 100% on the revenue side.

Alex for Richard Skidmore – Goldman Sachs

How would that work? Is there any more detail you can give there because OCC is close to $150 now so in terms of the way the contracts are set up, how much of that upside at current prices would you have to give up to the people you collect the OCC from?

Robert Simpson

We have those numbers in a sensitivity analysis. We had those numbers a couple of quarters ago. We talked about it when we were in the throws of a downturn. That’s probably another good one, and it is a little bit more complicated because of the different types of materials and with the volume numbers and the new pricing mechanism, that’s probably a very good one for you to get some more detailed information. The director will be covering that during his presentation.

Operator

Your next question comes from Cory Greendale – First Analysis.

Cory Greendale – First Analysis

I wanted to also ask you about the volumes. Notably both the performance in the quarter and guidance are a little better than your large competitor so I know you’re not going to comment on public guidance, but is there anything going on in the market that you would contribute that to? Do you think you’re getting more of your fair share of volumes than the overall market would be?

David Steiner

I don’t think we are. It’s just a guess on my part but my guess is that as they moved from more of a sunbelt focused company when the sunbelt was expanding to being more of a national company. I think they’re finding out that when you’re a national company, you’ve got to ride the national economy. You can’t just have good volumes when you’re in the sunbelt and I’m sure they’re probably very glad they also got the national economy because you don’t want to be too exposed to sunbelts.

But we’ve always talked about our national footprint. We’re not going to be tied in to any particular region of the economy and I think back when the sunbelt was growing a lot faster than other regions, everyone said gosh, why do you want to have a national footprint? Well, now you know why.

So my guess is that’s what they’re experiencing. They’re experiencing the effect of having that national footprint.

Cory Greendale – First Analysis

On the other side of that price trade off, I think during your script you said 12% price growth on new business for industrial and in perspective given the volumes it sounds like a pretty high number. Is that, I can’t imagine that independents are raising price that much. Maybe I’m wrong, but to the extent do you think you’re losing volumes in exchange for that kind of increase?

David Steiner

You’ve heard me say it 100 times that the trade off because of the huge leverage you get out of price, the trade off is always beneficial and the industrial line of business, you can get 1% price and lose 3% volume and still be ahead of the game as far as EBIT dollars go.

The reverse is not the case. You can’t drop price by 1% and pick up 3% volume. That’s not going to happen. When we first put the price gate into effect in December of 2008 looking forward to 2009, we did it because we knew volumes were going to go down, and so the only way we can weather through and hit the targets we want to hit is be getting prices.

So it’s really just a continuation of the strategy that we talked about for the last few years which is we know we’re going to lose some volume as we push price. But we think the trade off is hugely beneficial because when you raise prices by 1% again, you can lose 3% to 4% of your volume and still be ahead of the game. But frankly what it tells you is we should push prices even harder.

Cory Greendale – First Analysis

The question is just whether there is a change in that dynamic. It sounds like you’re saying it’s a continuation not that the trade off would accelerate so more price and more volumes lost than you’ve been seeing recently?

David Steiner

No. I think it’s just the opposite. I think as we’ve been pushing price we’ve actually seen the volume start to come back to us a little bit.

Cory Greendale – First Analysis

Larry in your presentation you said there was a $0.03 negative impact from fuel costs above what you were able to net back from surcharges. Is that just because of the one month lag in the surcharges?

Lawrence O’Donnell

The way our program is set up, it’s designed that over time it stays even and when you look at the whole year, I think we had a slight under recovery in Q1 and Q3 and slight over recovery in Q2. So over time it should balance out.

Robert Simpson

It’s really the year over year comparison. Remember last year in the fourth quarter you had fuel prices drop precipitously, so we actually got a $0.03 benefit in the fourth quarter of last year. We just didn’t get that this year. We broke even on the fuel surcharge. So it wasn’t really that we made less money on the fuel surcharge, it’s that we had a $0.03 negative impact because we made $0.03 on it in the fourth quarter last year when prices fell so fast.

Operator

Your next question comes from Vance Edelson – Morgan Stanley.

Vance Edelson – Morgan Stanley

Regarding the inclement weather in the Northeast, and I’m looking at a blizzard outside my window this morning, you’re not including the impact yet in guidance presumably because it’s a moving target. But could you give us a feel based on past episodes of severe weather, how you are going to mitigate and what the ultimate earnings impact might be.

David Steiner

When we look back, because we can see that the weather is going to have an affect on the quarter, and if you look back at what we’ve done in the past, the last time that we really had a dramatic affect from the weather was 2003. In 2003 we estimated that we had a $0.02 negative impact to the quarter as a result of weather.

We have not gone back to see if this is a more severe event than that, but as I recall, 2003 it was more sort of Midwest, Mideast focused and not, I don’t know if you saw but the other day there were 49 out of 50 states in the United States that had snow on the ground, the exception being Hawaii.

I think that’s unprecedented. So certainly the weather is going to affect us. We closed January’s books and when we looked at January volumes, the January volumes were slightly better than the volumes were in Q4, but we’ve certainly seen more severe weather in February. So it’s a little early to predict volumes for the quarter.

When we closed January we also saw that pricing softened a bit in January and so we decided to be more aggressive with our pricing program. So just recently we increased the amount of our annual price increase to ensure that we’re going to meet out full year pricing targets.

When you raise prices by a higher amount today, it takes a month and a half for that to run through the system because of the billing cycle, so we would expect to see the full effect of our turbo charged if you will price increase, we’d expect to see the full effect of that come through in the second quarter.

Vance Edelson – Morgan Stanley

Should the surge in recycled prices continue which is not at all certain, but let’s just say for argument’s sake that prices eventually break through previous highs after peaking at the end of ’08, how should we think about upside potential for you that might not materialize this time around given the new contract structure for recycling even though the new structure itself makes a lot of sense given the uncertainty ahead.

David Steiner

The new structure is not designed to hurt us on the upside. It does a little bit but not dramatically. So we shouldn’t see any deterioration in the upside of prices from a new contract structure. We should see the same type of benefit that we saw in ’07 and early ’08.

In summation, thank you all for joining us, and as Bob mentioned we will have our investor day in early March. We look forward to talking to you about this great business that we have and getting you a chance to meet some of the great leaders that we have and we look forward to seeing you all in south Florida then.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Waste Management, Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts