Waste Management Inc (WM) — Q3 2015 Earnings Call Transcript

Thank you, Junisha. Good morning, everyone, and thank you for joining us for our third quarter 2015 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 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 forward-looking statements, which are based on current expectations, projections or opinions 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 discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K. David and Jim will discuss our results in the areas of yield and volume, which unless otherwise stated, are more specifically references to internal revenue growth, or IRG, from yield or volume. During the call, David and Jim will also discuss our earnings per diluted share, which they may refer to as EPS, or earnings per share. And David and Jim will address operating EBITDA and operating EBITDA margin, as defined in the earnings press release. Any comparison, unless otherwise stated, will be with the third quarter of 2014. The third quarter of 2014 results have been adjusted to enhance comparability by excluding certain items that management believes do not reflect the fundamental business performance or results of operations, and by excluding amounts attributed to businesses and assets divested in 2014. These adjusted measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release footnote and schedules, which can be found on the company's website at www.wm.com for reconciliations to the most comparable GAAP measures and additional information of our use of non-GAAP measures. This call is being recorded and will be available 24 hours a day beginning approximately 1:00 p.m. Eastern Time today until 5:00 p.m. Eastern Time on November 10. 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 32546520. Time-sensitive information provided during today's call, which is occurring on October 27, 2015, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now I'll turn the call over to Waste Management's President and CEO, David Steiner.

Thanks, Ed, and good morning from Houston. Our strong third quarter results continued what we saw through the first six months of the year. Disciplined pricing and cost control programs are driving improvement in our business. In the third quarter, we earned $0.74 per share, an increase of more than 10% from the third quarter of 2014. Each of our net income, operating income and margin, operating EBITDA and margin, and earnings per diluted share improved when compared to the third quarter of 2014. Through the first nine months of the year, our operations have generated almost $2 billion in cash provided from operating activities, which is a 16.5% increase from the prior year when you exclude divested businesses. Our strong performance puts us on track to exceed our full year goals, and we're excited about the positive momentum built into the fourth quarter and heading into 2016. Again, in the third quarter, our pricing programs continue to be a big part of our earnings growth and margin expansion. For the third quarter, our collection and disposal core price was 4%, which is consistent with the third quarter of 2014 and yield was 1.8%. Core price in the industrial line was 8.4%. In the commercial line, it was 5.7%. In our residential line, it was 2.2%. And in our landfill line, it was 2.3%. Year-to-date, through September, core price was 4.2%, which exceeds our 2015 core price target of 3.8%. As we saw in the first half of the year, core price continues to drive margin expansion as our traditional solid waste business operating EBITDA and operating EBITDA margin increased when compared to the third quarter of 2014. Turning to volumes. When we look at our business, we track traditional solid waste volumes, which exclude recycling and non-solid waste revenues. Our traditional solid waste volumes were basically flat, declining only 0.1% in the third quarter of 2015 versus a decline of 1.9% in the third quarter of 2014, a 180-basis-point year-over-year improvement and a 50-basis-point sequential improvement from the 0.6 decline in the second quarter of 2015. Overall volume, which includes recycling and those non-solid waste volumes, declined 1.4% in the third quarter. In our industrial line of business, the positive momentum that we saw in the second quarter continued into the third quarter. Strong new business pricing outpaced the price of lost business. So we were able to get both a strong price and positive volumes in the quarter, as industrial volume was a positive 0.4% in the third quarter of 2015, improving 290 basis points from negative 2.5% in the third quarter of 2014. We also saw the rate of decline in our commercial line of business improve again, as the rate of loss in commercial volumes improved 360 basis points compared to the third quarter of 2014 and 90 basis points sequentially from a negative 4.9% in the third quarter of 2014 to a negative 1.3% in the third quarter of 2015. This is the best commercial volume that we've seen since 2006. Our service increases continued to exceed decreases, and new business in our commercial and industrial lines combined exceeded lost business for the second consecutive quarter. These are all positive signs that make us optimistic that volume should continue to strengthen into 2016. Turning to recycling. We continue to work together with our customers, vendors, and industry groups to improve the long-term outlook for recycling through educating the public on what and how to recycle to bring down contamination levels. We have also made progress on renegotiating contractual terms with our customers, including exiting some unprofitable contracts. Ultimately, we want to provide recycling solutions that both meet our customers' needs and generate an appropriate return for us. Recycling is the right option for the environment, and we're working to make it the right business decision for our shareholders as well. Moving to current results from our recycling operations in the third quarter, earnings per share from the recycling operations were flat compared to the third quarter of 2014, despite a 15% drop in average commodity prices and a 6.4% decline in volumes, which is largely associated with contractual losses as we shed unprofitable business. Our recycling employees performed incredibly in reducing operating costs and improving the business. In the third quarter, we saw a 7% improvement in operating cost per ton compared to 2014. So we're moving in the right direction and our results in 2015 will exceed the expectations we laid out earlier in the year, but there's still a long way to go to get the appropriate returns on our existing assets. With respect to potential acquisitions, as we mentioned on our second quarter conference call, we believe that we can execute agreements to add an additional $50 million to $75 million of operating EBITDA in 2016. Recently, we closed on two acquisitions that we expect to generate approximately $18 million in operating EBITDA in 2016. Our pipeline still looks strong, and we're in the advanced stages of some transactions. Consequently, we still believe that we can close transactions that will generate $50 million to $70 million of additional 2016 operating EBITDA. So we expect to see strong operating EBITDA growth from our core business and from acquisitions in 2016. But I'll remind you that the operating EBITDA from acquisitions won't translate to earnings per share in 2016 because we'll have corresponding intangible amortization. However, the transactions will generate cash flow, which is the most important metric in our business. And we expect that our cash flow in 2016 will be strong. In conclusion, we've seen three consecutive quarters of strong results, and we're confident that strength will continue as we conclude the year and look forward to 2016. This performance is a tribute to our employees executing our pricing, disciplined growth and cost control strategies. We're confident that our employees' focus on our core business will allow us to meet the analysts' fourth quarter consensus of $0.67 of adjusted earnings per diluted share, which will allow us to exceed the upper end of our 2015 adjusted earnings per diluted share guidance of $2.55. We also expect to exceed the upper end of our full year free cash guidance of $1.5 billion, in which case we may decide to prepay some items to help offset tax and other cash flow headwinds in 2016. I'll now turn the call over to Jim to discuss our third quarter results in more detail.

Thanks, David. In the third quarter of 2015, SG&A costs continued to be a bright spot in our results even as we face tougher comparisons to the prior year. Overall, SG&A costs improved $8 million compared to the third quarter of 2014. As a percent of revenue, SG&A costs were 9.8%, an improvement of 10 basis points compared to the third quarter of 2014. With the strong results in the first nine months of 2015, we expect to achieve our full year goal of reducing SG&A costs by $60 million. Turning to cash flow for the third quarter. Net cash provided by operating activities was $657 million compared to $627 million in the third quarter of 2014 after adjusting for $45 million from the divested operations. Other impacts on our cash provided by operating activities were $40 million paid to complete our withdrawal from the central states pension plan and a $60 million reduction in cash taxes paid. During the third quarter, we continued to improve our working capital position, as we reduced days sales outstanding by 1.4 days and increased days payables outstanding by 3.9 days. We're pleased with these results as our team has done a terrific job of making these improvements, and we expect to see continued improvement into 2016. Free cash flow was $358 million in the third quarter 2015, an increase of $20 million when excluding free cash flow from divested operations in 2014. Our capital expenditures for the quarter were $335 million, $28 million more than the third quarter of 2014. As David mentioned, we've generated almost $2 billion of cash provided by operating activities through the first nine months of 2015. In addition, we've generated over $1.2 billion of free cash flow. Given that, we expect that free cash flow in 2015 will exceed the upper end of our guidance range of $1.5 billion. David mentioned that we would prepay some expenses in the event that we exceed our free cash flow guidance. An example might be prepaying cash taxes. We currently anticipate that our 2016 cash taxes will increase by $300 million to $400 million. If we have excess free cash flow, we may elect to prepay some of the cash tax increase at year-end to lessen the impact of this increase. Third quarter revenues were $3.36 billion. We saw a $53 million increase in revenues from acquisitions and a $48 million increase in our traditional solid waste business. We also saw an overall revenue decline of $186 million from divestitures, a $49 million decline from lower recycling revenues, $47 million in lower fuel surcharge revenues and $41 million in foreign currency fluctuations. Looking at internal revenue growth in the third quarter. Our collection and disposal core price was 4%, with total volumes declining 1.4%. This led to total company income from operations growing $24 million, operating income margin expanding 110 basis points, operating EBITDA growing $29 million and operating EBITDA margin growing 140 basis points, in each case, compared to third quarter 2014 results. Our collection lines of business continues to see the benefit of core price and disciplined growth as operating EBITDA and operating EBITDA margins grew. In the landfill line of business, we saw the benefits of both positive volume and positive core price in the third quarter. We saw same-store average MSW rates increase year-over-year for the 10th consecutive quarter, up 3.6% from Q3 2014. MSW volumes grew 5.9%, C&D volume grew 4.9% and special waste volumes were a positive 2.4%. Total landfill volumes increased 4%. Our special waste pipeline looks strong and we expect to see landfill volumes remain strong through 2016. Moving to operating expenses. As a percent of revenue, operating costs improved 140 basis points to 62.4%. Lower diesel costs and lower recycling commodity rebates to our customers contributed $73 million to the improvements. We also had reduced expenses from foreign currency fluctuations. Subcontractor costs improved $17 million and labor and related benefits improved to $12 million when compared to the third quarter of 2014 as we continue to see improvement from our service delivery optimization program. These savings were partially offset by increased disposal costs related to our improved volumes and slightly higher maintenance costs. Overall, operating costs improved $91 million in the third quarter. Finally, looking at our other financial metrics. At the end of the third quarter, our debt-to-total capital ratio was 63.3% and our weighted average cost of debt was 4.4%. The floating rate portion of our total debt portfolio was 8% at the end of the quarter. In the third quarter, we repurchased 5.9 million of our outstanding shares for $300 million and paid $172 million in dividends. This $472 million reflects our confidence in the cash generation of our business and our commitment to return cash to our shareholders. Our income tax rate in the third quarter was 32.3%, which compares to the 30.6% for the third quarter of 2014. A tribute to the late and great Hall of Famer, Yogi Berra, our third quarter results were déjà vu all over again. We've seen three consecutive quarters of year-over-year improvement, and we expect that to continue into the fourth quarter. All of our employees have worked hard to deliver these solid results and for that, I want to thank them. We are very confident that we'll continue to deliver strong earnings and cash flow to complete a successful 2015 and set us up for continued improvement throughout 2016. And with that, Junisha, let's open the line up for questions.

So just looking for maybe a little bit of an update on the pricing environment, core pricing looked like it was pretty strong in the quarter, but it sounds like a lot of the gross margin expansion you're getting is from lower fuel and commodity costs. But are you still seeing a pretty good pricing environment out there? How are you progressing with regard to your price gauge? Are you still getting good margin expansion associated with your internal pricing activities?

Yes, I'd say sort of as a follow-on to last quarter, I would say that the overall pricing environment is as solid as I've seen it since I've been at Waste Management. We see real good progress across all lines of business, except for our residential line. And as you all know, the residential line is traditionally the most competitive line. I would say even in the residential line though, we're seeing very disciplined pricing based on return on invested capital type of metrics from the large national players. It's always sort of those small, local, and regional players that seem to sometimes forget that if you offer a lower price and you invest a lot of capital in those residential contracts, that over the term of those contracts, you don't make as much money as you think. But even in the residential line, what we're seeing is sort of those large national companies are bidding based on return on capital not on chasing low-priced volume. So I'd say overall, I'm extremely encouraged by the pricing environment, we expect it to hold into 2016.

Got it. And maybe shifting to tax a little bit here. So I don't know if Jim had given a tax rate assumption for the fourth quarter. Did you give one?

I did not. Tax rate in the fourth quarter is going to be similar to the third quarter.

Okay. So, let's say, about 32%. And then with 2016, you mentioned it being a $300 million to $400 million pickup in cash tax, but for some of this prepayment, maybe a little bit more elaboration there. And if we do get renewal bonus depreciation, might you see a significant benefit associated with that, and one that you might be able to take an early shot of quantifying?

Yes, if we receive bonus depreciation, it seems likely that it will come at the end of the year, and we anticipate it will be around $70 million. When considering the expected cash tax pickup of $300 million to $400 million, this includes the prepayment from last year and approximately $150 million from the early extinguishment of debt earlier this year. Combining these benefits with earnings growth in 2016, our cash tax headwind will fall within that range, which is why David and I mentioned the possibility of making a prepayment. It's likely that about half of the benefit from the early extinguishment of debt will be recognized in 2016, and depending on our free cash flow performance, we may prepay additional taxes at the end of the quarter.

Got it. So put another way, perhaps at least half of that increase in 2016 might be realized in the fourth quarter based on your current expectations.

I think that sounds about right.

Got it. One last one on the M&A side. So you're essentially, I guess, affirming the EBITDA target that you expected to acquire for next year. Should we assume those are kind of your traditional solid waste acquisitions? Or has your review changed at all with regard to, call it, the nontraditional waste business, whether it's industrial, energy, or otherwise?

Yes, we consider core solid waste along with hazardous waste and energy services as essential parts of our business. If there are opportunities in those areas, we would certainly evaluate them. Our assessment would be based on the current market conditions rather than past or future scenarios. Regarding the additional $50 million to $70 million on top of the $18 million we have already completed, we would regard those as traditional solid waste operations.

First, I wanted to follow-up on Scott's question about price, it sounds like the environment is favorable, overall. But I guess, first of all, can you just verify, I had from my notes that about 40% of your revenue base is tied directly to CPI? Do I have that right?

That's about right, yes.

So can you just address that portion specifically? Given where CPI is at, should we expect a lower price in those markets in '16 and what does that imply for overall price growth in '16 relative to '15?

Yes, when we examine our CPI business, we acknowledge that it is a government-reported statistic that we cannot control. Sometimes it will negatively impact us, and other times it may help us. Unfortunately, over the past few years, we have mostly faced drawbacks from it. For 2016, we do not anticipate benefiting from CPI; in fact, we expect a slight negative impact on pricing due to CPI. However, as we have always stated, this is beyond our control. What we can manage is the core pricing on the rest of our business. My expectation is that we will maintain a consistent core price target next year, similar to what we achieved in 2014 and 2015. If CPI does not provide support, we will compensate by improving core pricing in our other business segments.

Got it. And just to clarify. When you say you can't control CPI, obviously, that's true. But one of your large competitors has talked about trying to shift customers to more of a sewer water waste index instead of CPI. Is that something that you've thought about or doing at all?

Oh, absolutely. We've actually done that. We've tried to use that index. We've also used what we call sort of our solid waste index. And so every time that we talked to the customers, look, this goes back 10 to 12 years ago when we first instituted a fuel surcharge because we saw fuel prices fluctuating. What has to happen is that everyone in the industry needs to say, look, this just doesn't make sense for us unless we look at these contracts with this type of adjustment in it. And so going back 10 years ago, when we first put in the fuel surcharge on our residential contracts, everyone said that's never going to happen because the municipalities won't accept it. And as the industry said, we're just not going to bid unless we have a fuel surcharge, customers started to accept it. It's the same thing with CPI. Look, every single company has been hurt by CPI in the last five years. And I think it's incumbent upon the largest companies to say, look, we're just not going to bid these under the traditional CPIs, or even worse, 75% of CPI type of contracts. And if the industry is able to do that, then you'll see municipalities change. But they're not going to change when only one player is out there doing it. So we've been doing that particularly in California for the last number of years, and we'll continue to do that throughout the country.

Yes, I understand. David, could you share your thoughts on how you are approaching new business and your sales strategy in a strengthening economic environment? What is the status of your sales team, are you expanding the team, and are you altering their incentives in any way to attract new business?

Yes, I'm not sure I'd say that we're growing our sales force. I'd say what we're doing is we're sort of reallocating our sales force. From our perspective, what we've tried to do is put our sales force in those areas where it's growing. So when we look at a market area that's not growing, we might reduce the sales force. Whereas, when we look at a market area there that is growing, we might add the sales force. And so there won't be a drastic addition to our sales force; there will certainly be a reallocation of our efforts in those lines of business that are growing and in those geographies that are growing.

Okay. And then one more for me. Dave, it sounds like you're making good progress on reducing your recycling processing costs. Can you just give us a couple of sentences on what that constitutes, whether it's a labor question or you're putting in different equipment, just what you're doing there? And then, secondly, the reduction that you've seen so far, how far does that take you towards your goal, I think the goal is reducing average cost per ton by $10 or something like that?

Yes, I would estimate that we're around 70% towards our goals. There's still significant room for improvement. The cost reductions we've achieved have stemmed from various factors. Primarily, we've made operational improvements and discontinued some of our higher-cost operations. Additionally, we need to exit certain high-processing contracts. It's also crucial to lower contamination levels, as they have significantly impacted our operating costs. We plan to work closely with our customers to ensure they meet the contamination rate goals outlined in our contracts, which we have in almost all cases. We will conduct audits to help reduce these rates. Our recycling team has done an excellent job addressing operating costs from multiple angles. While there's still room for further improvement in 2016, they've made remarkable progress thus far.

They're still there with some of those contracts that will fall off during '16. It will provide some structural improvement as well to the recycling business.

Corey, I believe this is the first time we've discussed that 2016 is not projected to be a significant downturn compared to the previous year in recycling. This improvement isn't due to any assistance from commodity prices; rather, it's a result of our team's efforts to fundamentally change our business operations in terms of costs, which are beginning to yield positive results.

So I just wanted to dig into the moderating decline in solid waste volumes. How would you explain the 180 basis point of improvement year-over-year? Is that more a function of waste fundamentals improving? Is it better sales execution? Or is it maybe just a function of your pricing is up, but it's not up quite as much? Just any color on that would be helpful.

Yes, I would say that, primarily, it's related to improving fundamentals in the industry. We really aren't using price to go out and chase volumes. So you've got improving fundamentals across some lines like the industrial line where, frankly, in the industrial line, we probably could've grown it more in the last couple of quarters. But we're constrained by the number of containers and drivers and trucks that we have on the road. And so primarily, it's improving industry fundamentals. But we really have seen a nice improvement in productivity from our sales force. When I talked about it earlier, we're not adding a lot of folks to our sales force, but we are top-grading our sales force. And the folks we have right now are much more productive than they'd been in the past. And so it's really sales productivity and mostly improving business fundamentals.

Joe, we've discussed how crucial pricing is in our disposal business. With same-store average MSW rates nearing 4% and CPI hovering around 0 in nearly a zero-inflation economy, we’re quite satisfied. Additionally, we’re observing almost 6% growth in MSW volumes. For us, the focus really needs to be on enhancing the disposal side of our operations.

Joe, I was going to add, also, that you've mentioned you're open with price comment, and we've maintained that approximate 4% core price number while improving volumes. We also had rollbacks for the quarter at about 18%. So that's a real improvement versus prior year. So all of those factors have helped improve volume. Yes, we've been maintained the price focus.

And to Jim's point, on the industrial line, our new business pricing is actually higher than our average rates, and so we're seeing real strong pricing on the industrial side. Look, industrial volumes are as close to a spot market as we have, as we've talked about many times. And the spot market right now is very strong. And so you should be getting both positive price and positive volume. Obviously, that will moderate as we come into the seasonality and the weather of the fourth quarter and the first quarter. But I would expect to see that improve, both volume and price improve, as we come out of the winter and get into the seasonal uptick next year.

That's great color. And let me actually just follow up on that. You guys have made it clear that you do want to manage to a certain price increase, and I guess the specific metric that you're looking at is core price. Jim, you mentioned better rollbacks. And I think, David, you said something about the industrial business not necessarily coming in at a lower price. So I understand there are some nuances here. But how are you incentivizing the sales force to really minimize the impact of rollbacks and lower new business coming online with the exception of industrial?

Joe, our sales incentive plan for the account managers that manage our current business is directly linked to how much price they get for their current customers, and whether or not they're rolled back. So it is a direct impact on that sales rep when they increase rollbacks or they don't get their price, so it's a direct link. And that has...

Okay. So it's not just core price?

No.

It's also looking at rollbacks and where they're bringing on new business.

Absolutely. New business pricing, yes, the payout as well.

And Joe, look, when it comes to the sales incentive plan, I think everyone that's ever managed a sales force would love to have EBIT as their core metric rather than revenue growth, right? Because you can get revenue growth at low margins and that doesn't do anyone very much good. We've got a tool that we're rolling out in '15. It'll be fully rolled out in 2016 that will allow us to measure profitability at the customer level. At that point in time, I would expect us to really look at the compensation plans and say, okay, rather than focusing on revenue and price, let's start now focusing on the actual EBIT that we're generating and start incentivizing folks to generate higher EBIT. How do you do that? By selling the right volume. By selling the right volume at the right price. And so we've got compensation plans in place right now that I think drive the right behavior. That's only going to get better through '16 and into '17.

In the meantime, Joe, we have absolute control over the pricing, the area level and the corporate for larger accounts. So we know exactly where our reps are going in from a price standpoint on an overall basis. So we're not waiting for that tool to help us in that regard.

If I could, just want to back up a little bit around the solid waste and the commentary on volumes, just to slice it once a little bit differently. If you looked at the same store volume trends on front-end loaded business, residential and your permanent roll-off, because I get the temporary has been very strong on the permanent. What's the trend on a same-store basis for each of those lines in collection?

Yes, it does vary a bit from quarter to quarter. However, the overall trend indicates that both metrics were slightly negative this quarter, although they were up in the previous two quarters. I would say that the trend is upward. Additionally, increases in service have outpaced decreases. Every trend line we analyze is currently positive.

Okay, just to clarify my understanding, the overall trend in permanent roll-off front-end loader and residential is positive, which suggests an improving volume pattern structurally.

Yes, I would say that's true for commercial and industrial. Residential, we, frankly, we don't look at that. We look at that a little bit differently than we look at the other lines of business. So we're not as focused on waste in the residential side.

And fair enough, because it's really about the asset utilization of the equipment going down the route. How would you frame your churn trend at this juncture as well, with both the direction and then the rate of replacement?

Yes, so the rate of replacement actually has improved fairly dramatically over the last four quarters. And the churn rate, so this quarter, we saw about an 80 basis improvement in the churn rate. But it's stubbornly stuck at sort of that 10% to 10.5% churn. Our focus in 2016 is going to be to try to drive that churn rate down below 10%. Now look, again, this is a simple business if you want to use price as your lever. We can drive that churn rate well below 10% if we just exceeded every single customer asking for a price rollback. But as Jim pointed out, our price rollback trends are actually very positive, too. So again, when you look at the combination of trends, you can look at rollback and say, boy, rollbacks are going great. But if you're doing it by a price, not so great. And what we've done over the last two years is seen the churn rate come down marginally, not as much as we'd like to see it come down, but we've seen the rollback rates also perform very well while not giving away the price. And so the combination of the three is very positive.

Joe, one thing we’ve changed is how we measure missed pickups. We’re performing quite well in comparison to other industries based on customer reports. We’re now considering additional factors, as Dave mentioned regarding maintenance. We’re looking at service failures where a truck may have broken down late in the day, causing us to miss part of a route. From the customer’s perspective, that’s a missed pickup, and we’re incorporating that into our metrics. We want to rebuild trust when a truck malfunctions, and fleet management is part of that. However, a significant part of the issue also lies in our call centers and their ability to connect with the field. We need to respond to customer needs more promptly. This has always been a major focus for us, but we are adding more depth to our approach.

When you consider our productivity efforts and service optimization, do you believe this is what allows you to confidently predict that we will go below 10% in 2016 as you address the missed pickups, which are typically caused by issues like truck breakdowns?

Yes, you made another important point. It's not just about aiming for excellent service; it's also essential to be able to deliver that service, which depends on having operational trucks. We've taken a comprehensive approach to understand what leads to service failures. Often, it's because we don't have a functioning truck available. To strive for keeping our missed pickups below 10%, we need all our operations to work seamlessly with our sales team. I'm genuinely impressed with how well we manage our tasks daily across the solid waste industry. However, at Waste Management, we've decided that being good is not sufficient; we need to aim for greatness, and that's the goal James has set for the company.

Michael, we've made some changes regarding missed pickups. Our measurements show we perform well in comparison to other industries based on customer reports. We're now considering service failures, such as when a truck breaks down late in the day, causing us to miss half a route. This counts as a missed pickup from the customer's perspective, and we're incorporating this into our metrics to enhance customer confidence. The condition of our trucks is a factor, but the larger issue relates to our call centers and their connection to the field, enabling us to respond to customer needs more promptly. This has always been a significant focus for us, and we're adding more depth to our approach.

And then, Jim Fish, I think I understand what you're saying about free cash flow; I just want to say it out loud to make sure I get it. So I'm picking a number just to frame it. If $1.5 billion is this year's number, and all things being equal, that number would be a midpoint of the $300 million to $340 million is $350 million. So if $1.5 billion is down by $350 million because of more cash tax, and then it grows based on all the other things you would do, and your intention is to pay some of that $350 million this year so that the $15 million would be less, it's smoothing your cash, which is perfectly appropriate. I just want to make sure I understand it.

Yes, I think that's about right. One thing I would say, Michael, about free cash is that we're pleased with being in the range of $1.2 billion to $1.3 billion in free cash flow over the last six years. What you're seeing in 2015 and into 2016 is that we're starting to transition to more of a $1.4 billion free cash flow company. This change is primarily due to the factors we've discussed, with organic growth being a significant contributor.

Right. So if you didn't prepay anything, it's not an unreasonable observation that sequentially the cash could be down. That's not a bad sign, since the timing of big flows like that. If we didn't have BD and all that, we wouldn't be having this conversation.

I believe we should not overlook Jim's point, which is that we are setting a new baseline as a company generating $1.4 billion in free cash flow. Some years we may produce $1.5 billion or $1.6 billion, and in those cases where we can prepay cash taxes to ensure we reach the $1.4 million baseline without any headwinds, we should do that. Moving forward, I would say, Michael, that $1.4 billion will serve as our starting point. We will provide more specific guidance when we present it in February. At this moment, we have transitioned from stating we are a $1.2 billion to $1.3 billion baseline free cash flow company to now affirming that we are a $1.4 billion baseline free cash flow company.

Yes, we agree. So how do you think about the sustainable growth rate of that $1.4 billion, if you took a five-year view?

We believe that free cash flow growth will be around 3% to 5% per year. When considering free cash flow, I focus on two aspects. First, it relates to our capital allocation program, which enables us to grow free cash flow through acquisitions. As Jim Fish has noted, we have effectively replaced Wheelabrator's EBITDA not through acquisitions, but by enhancing our business operations. We plan to make additional acquisitions in 2016, aiming for an increase of $50 million to $70 million in EBITDA. Secondly, I also examine cash flow on a per share basis. With our share buybacks, cash flow per share is expected to rise. So, in terms of our capital allocation program, we are aiming for a balanced approach that will increase both operating cash flow and cash flow per share.

Okay. And then, Jim Trevathan, how would you frame your current on a same-store basis recycling plant capacity utilization? It's got 1,000 tons per day. Is it 60% or 80% run rate? And what can you do to improve that?

Michael, we're closer to that 80% than 60%. Part of it is volume-driven as well as specific plans, part of it is shutting down the plant in cities where we have to dual capacity. But that's the goal. And there's still room for improvement there. We won't stop at where we are with that, what, 7% to 8% improvement in cost. Year-to-date, that's still going to go further into '16.

I'm not sure if this is the right question for today's call, but I'll give it a try. If I take a step back and consider the aspect of cost improvement, in relation to your comment about nearly offsetting all of the EBITDA from Wheelabrator, are you indicating that your annual cost improvements in the business are nearing completion? Or is there still potential for further improvement?

I wouldn't say that, Al. On the cost side, let’s break it down into operational expenses and selling, general and administrative expenses. Regarding operational expenses, over the past few years, we have added more computers to all of our trucks. I can tell you that we are only at halftime when it comes to utilizing the onboard computer to its full potential. For instance, we can route our trucks dynamically, but that is only effective if the driver follows the route that the computer suggests. Currently, we are adhering to that route about 80% of the time, whereas best-in-class companies like FedEx or UPS manage around 95% to 97% compliance. While our performance seems decent, that last 15 to 20 percentage points can make a significant financial difference. There’s a lot of process improvement needed in this area. We have implemented the technology, but we still need to enhance our operational processes. Another aspect of operational expenses is maintenance costs, and I would say we are just beginning to address those costs. We do not leverage data as effectively as many larger companies do to proactively manage maintenance costs, which means we often react to issues after they arise instead of preventing breakdowns on the road. We believe there is significant potential for improvement in our operating costs moving forward. Jim Trevathan mentioned the potential benefits on the recycling side of our business in terms of costs. As for selling, general and administrative expenses, our goal over the past three years has been to keep this figure below 10%. Given that we have not yet fully compensated for the revenue loss from Wheelabrator and the businesses we divested, achieving 10% will be challenging. Maintaining flat SG&A while still providing our employees with merit increases is no easy feat. We have also planned to hold SG&A flat from 2015 to 2016, on top of the $60 million in savings we projected for this year.

Al, I might to Jim's mentioning of the onboard units, we were positive in all three lines of business on the collection side in Q3 and efficiency. And we're really starting a hard look at cost per unit and starting to move the needle on a CPU basis, which is where the money is, not just in a unit measurement, on a COGS per hour, for example. And that'll have a real impact. Volume has helped, but that's not the driver. We're still negative, for example, in residential volume, as Dave mentioned, and yet we were positive on the efficiency side. And moving that way on the CPU with real upside left as we fully implement SPO and some of the process work that will continue to work across all business.

Are you able to discuss any thresholds in terms of the dollars, the cost of operation that come out on an annual basis or margin improvement beyond basis points? I appreciate the macro commentary, and I know there was mention of truck efficiencies down about 15 to 20 basis points. But can you provide details on the operations side, specifically regarding some goals and where those stand on a quantified basis?

James Fish mentioned that they have made about 33% to 40% progress towards their cost target. Starting a cost program is always challenging for a company, but they are optimistic about reaching this goal. It's a multi-year objective, and they are confident they will achieve it within the next two years.

Great. We'll certainly be watching, right?

On the acquisition side, did I hear correctly that the targets include energy services and energy waste? However, your current focus is more on the solid waste sector. Yes. I would say we're primarily focused on our core solid waste business and not looking to pursue acquisitions outside of that. Currently, our main focus is on traditional solid waste operations. However, we do see industrial waste and energy services as part of our core solid waste business. We would consider assets in the industrial sector since they align well with our existing operations. Regarding energy services, any potential deal would need to be opportunistic. We are not looking to significantly expand our energy services footprint as we have in the past, but if appropriate opportunities arise at the right price, we believe that energy services could be a valuable business in the long term. However, we don't expect it to be a strong segment in the next year or two, so any investments in energy services would need to align with a long-term perspective and favorable pricing.

I don't want to get too caught up in the vernaculars here, but can you give us what average yield was in industrial and commercial? I just assumed that, including the impact of churn, it's a bit more meaningful in volumes are improving.

Yes, the average yield on the commercial side was 2.6%. And on the industrial side was 3%.

Perfect. And Jim Fish, just a quick clarification, but when you talk about exceeding the $1.5 billion of free cash, are you including or excluding divestitures?

Yes, we're including it. There's not a lot there. We excluded the big ones last year. So we've always included them, but they are not significant in number. Obviously, last year, we had to exclude them because they were all so substantial.

Okay, but you are including them in the $1.5 billion this year?

Correct.

I'm curious about what is driving the results that are exceeding the range. Are you performing better on cash from operations, is capital expenditures tracking towards the lower end, or is it a combination of both?

No, it's definitely not the case. CapEx is just at the high end of the range we provided, which was between $1.2 billion and $1.3 billion. We are at the high end, and we might even go slightly beyond that. So it's not due to any restrictions on CapEx. I think EBITDA is really the best indicator of how a business is performing, and ours seems to be doing quite well. Some of it is related to yield, and the main factors are yield and operating expenses. Additionally, our energy services business is projected to be down as much as 30% for the year, which is significant and hasn't been discussed much. However, this is offsetting the progress we’re achieving with the other parts of our EBITDA.

Tyler, the improving volumes have obviously helped as well on the free cash flow for sure.

Sure. If I consider everything, I appreciate that you're not providing guidance for 2016, but I'm looking at the different factors. Starting with cash from operations, let's estimate it around 27 to 28 million for this year. You will recover the $40 million from the Central States Payment that won’t be applicable next year. There's also some expected growth in core EBITDA from the base business. We’ve discussed potential mergers and acquisitions that might materialize. However, you will face a loss of $300 million to $400 million due to increased cash taxes, plus whatever you plan to do with that prepay. Are there any significant factors that I might be overlooking?

I believe we're making progress on working capital. There's a lot that contributes to that line. However, the Central States Pension had a significant impact this quarter. Despite that, we have made considerable improvements, although they were somewhat overshadowed by the Central States situation. With Days Payable Outstanding increasing by 3.9 days and Days Sales Outstanding decreasing by 1.4 days, this is quite an improvement, especially when just a couple of years ago we had a 20- to 25-day negative difference. Our DSO was at 45 to 47 days and DPO was at 22 days. Now, we're over 30, nearing 31 days on DPO and down to 42 days on DSO. This progress shouldn't be overlooked as it significantly affects our cash flow.

Sure. Okay. So working capital might help a little next year as well. Okay, and then on the M&A, I'm just curious, is at $50 million to $17 million EBITDA with justice at this point, for review?

Yes.

Or does it have to go to review?

Yes. That level of purchase price, it has to go through Justice. And we do have one transaction that's going through Justice and some others in the pipeline.

Okay. Perfect. And then maybe just my last question for Jim Trevathan. It sounds like you're core solid waste business is pretty solid. But I'm curious, have you guys seen anything, even small, a deterioration in the hazardous waste side of the house or maybe anything on your industrial services lines?

No, Tyler, we haven't. It's been very strong for us this year. The base business, more than the event business, is positioned well geographically, right where much of the construction in the petrochemical industry is happening. The low energy costs have contributed to low feedstock prices for that industry. Our sites in Alabama and Louisiana are in a great position for base businesses as that sector continues to grow. The business on the West Coast, particularly in the Pacific Northwest, has also been performing well. In the Southeast, the performance has been more variable, but overall, we are very satisfied with that business and expect it to continue improving.

Tyler, Jim and I recently met with some of our major customers in Louisiana. They are benefiting from lower energy prices. While producers and service providers are facing challenges, consumers are seeing advantages. We met with some of our significant consumer clients, and they expressed optimism about their industrial business with us in 2016. Additionally, our hazardous materials business, although still small compared to our solid waste business, is growing year-over-year.

Okay. Yes, I assume the Mill is very well positioned to capture that petrochemical story over the next few years.

Lake Charles, is sitting right in the middle of it.

Yes, perfect. Okay. And then just lastly, have you guys seen anything in the coal ash side? Is there anything to think about as we look to '16?

Yes, we are in the early stages of this opportunity. We believe it presents a good long-term chance for us, although it is quite capital-intensive. This could be beneficial as it helps set us apart from smaller competitors who lack the capital to invest. However, it is still very early. We are beginning to see some of these companies make decisions regarding coal ash, and we feel that we are well positioned.

Given the current situation in the energy waste business and the prolonged period of low crude prices, customers are likely feeling financially constrained. Are you encountering any difficulties with your contracts or negotiating concessions with them?

Yes, I mean, they've come back to us over the last probably 12 months and asked for price concessions. In some cases, we've made some price concessions; in some cases, we haven't. It's as much as anything a function of where our assets are relative to the drilling that's taking place. But certainly, there's been some real pressure in that business and that's why our revenue will be down probably 30% for the year.

Got it. I understand you've talked about the M&A related to your services. If there were to be a one-off deal, what would the current market rate be? Can you provide a rough estimate of what you would expect to pay?

Going rate in terms of a multiple, is that what you're asking?

Yes, yes.

Oh, I don't know.

I'm not sure the multiple changes. But your forecast changes, right? In other words, it's a multiple of EBITDA and we aren't paying trailing 12 on EBITDA. What we're going to do is say, okay, let's look at a forecast of what we think is going to happen over the next three, five, ten-year horizon and let's discount it forward and figure out a reasonable multiple to pay. But I would tell you, again, when I look at our pipeline of acquisition, I would say that the pipeline that is the least full would be energy services. I mean, we are not actively looking at any transactions in any services of any magnitude. And so like I say, we'll be opportunistic. But we're not going to be as actively searching for deals in energy waste as we are going to be actively searching for deals in solid waste.

Just a quick one on dividend. I mean, you talked about this sort of 3% to 5% free cash flow growth going forward. I mean, is that what we should expect for the dividend? Or could we see some upside there in the years ahead?

Yes, we've always said we want to have a balanced dividend, where we want to have a payout ratio somewhere around 50%. We want to be in the top quartile of S&P 500 dividend paying companies. We're in that sweet spot right now. We've had pretty consistent growth in our dividend over the last few years and I'd expect that to continue.

Thank you. I'll fill in for Ed. I wanted to thank the entire Waste Management team for some spectacular business results. But every once in a while, an event happens that makes you realize that the reason that we all are here is not for business, it's for family. And we actually had one of those events yesterday when Jim and René Trevathan welcomed Georgia Marie, their grandchild. And...

Number eight, Dave. Number eight. It makes me feel old.

Number eight. So Jim is going to start some routing programs for his grandchildren because he now has eight of them running around. It makes you realize what's important. And I certainly hope that Georgia Marie has as good a 2016 as we expect to have at Waste Management. Thank you.