Waste Management Inc (WM) — Q2 2017 Earnings Call Transcript

Hey, Marcus. Good morning, everyone, and thank you for joining us for our second quarter 2017 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; Jim Trevathan, Executive Vice President and Chief Operating Officer; and Devina Rankin, Senior Vice President, Chief Financial Officer and Treasurer. You'll hear prepared comments from each of them today. Jim Fish will cover high-level financials and provide a strategic overview. Jim Trevathan will cover price and volume details and provide an operating overview. And Devina will cover the details of the financials. 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 schedule from 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.

Thanks, Ed, and thank you, all, for joining us this morning. Our second quarter results have again demonstrated the cash-generating strength of our company. Our tactical focus on improving core price, adding profitable volume in a disciplined manner, and controlling costs is clearly the right direction for our business. The end result of that focus is once again a strong operating EBITDA performance, which translated into robust cash flow in the quarter. Our operating EBITDA grew about 8% in the quarter to $1.029 billion when compared to the second quarter of 2016. This was the highest operating EBITDA we've ever achieved in any quarter in Waste Management's long history. As a result, our free cash flow grew almost 13% for the same comparative period despite a significant increase in cash taxes paid. The conversion rate of operating EBITDA to free cash flow has increased sequentially for the past three quarters to over 50% in the second quarter of 2017. Devina will discuss our cash flow in detail, but we exceeded our internal expectations. And we remain confident that we can meet the upper end of our full year guidance of between $1.5 billion and $1.6 billion. Turning to earnings per share, we generated $0.81 of EPS in the second quarter, an increase of 10.4% when compared to the second quarter of 2016. Included in that 10.4% growth were a $0.04 drag to EPS, $0.02 from an increased tax rate, $0.01 from the expiration of fuel tax credits and $0.01 from two small impairments. But even with that $0.04 of headwind, we grew EPS by $0.07 versus the second quarter of 2016. Driving strong growth in EPS, EBITDA, and free cash flow with solid growth in revenue and operating income, our revenues grew by $252 million or 7.4%. And just as we saw in the first quarter, this increase was organically driven. Our income from operations grew 9.4% and margins also expanded with the income from operation margin of 30 basis points.

Thanks, Jim, and good morning. The fundamentals of our pricing programs, disciplined growth, and cost initiatives continue to drive income from operations and operating EBITDA growth. The combined positive price and positive volume led the total company income from operations growing $58 million, an increase of more than 9%, and operating EBITDA growing $78 million, an increase of about 8% compared to the second quarter of 2016. Looking at revenue in more detail in the second quarter, we continued to see strong organic revenue growth, as we focused on the execution of our price plans, customer service improvement, and disciplined growth. Revenues in the quarter were $3.68 billion, an increase of $252 million or 7.4% when compared to the second quarter of 2016. Second quarter revenue growth in our collection and disposal business from the combined impact of price and volume was $158 million. Second quarter revenues also benefited from higher recycling commodity prices and increased recycling volumes, which drove a $90 million increase in recycling revenues. Fuel surcharges increased $20 million, while foreign currency fluctuations decreased revenues by $8 million, and divestitures, net of acquisitions, also decreased revenue for the quarter by $8 million.

Thanks, Jim, and good morning, everyone. As Jim mentioned, the strength of our operating results in the second quarter can be seen most directly by looking at our cash flow from operations and free cash flow. In the second quarter, cash provided by operating activities was $813 million compared to $762 million in the second quarter of 2016. That's an increase of $51 million or almost 7% in spite of an additional $83 million in cash taxes. The significant increase in cash from operations for the quarter is the result of two things: operating EBITDA growth of $78 million or about 8%, and our disciplined focus on improving our working capital metrics. We're particularly pleased with the operating leverage that we can see in our cash flow from operations conversion metrics.

Hey, good morning, everyone. Just a question on margins. Obviously, really strong volumes in the quarter. I was a little surprised that it didn't translate into a little bit more operating leverage. And I know you mentioned the tax credit issues on the fuel that it was a bit of a headwind and some of the recycling rebate. But I just wondered if you could dig into it a little bit more. I mean what kind of – in a normal quarter, what kind of operating margin leverage would you normally expect on that kind of volume growth and maybe kind of an outlook for margins for the full year. I think you had guided to up 50 to 100 bps. Maybe just provide an update on where you see that coming for the full year.

Sure, Brian. I would actually say we felt good about our margins for the quarter, and here's why. The EBITDA margins were up 10 basis points, or better by 10 basis points, but they were impacted by two factors. You mentioned the one, which was fuel tax credits. That was worth about 20 basis points to us in margin. But the other one that Jim's going to give a little bit of color on is our recycling brokerage business. And that recycling brokerage business was up over 5% in revenue, which impacted margins by 50 basis points. And so, if you exclude those two, you're talking about 70 basis points of margin accretion there. So, that's why I would say we felt good about our margins even being better by only 10 basis points on the EBITDA line.

Good morning. Thank you. The first question is just if you could just outline whether 100 bps further opportunity on customer churn is realistic and where do you think that improvement comes from? Thank you.

Yeah, Hamzah, good to hear from you. I do think there's upside in our defection rate, 9% year-to-date basis improved about 10 basis points. We've made real strides in two parts of that. First, the core service delivery. We are really focused on our quality of service metric across all of our lines of business, and our areas are starting to clearly show that improvement that we expect in just the core delivery of what our customers pay for, and that'll continue, but that's a long-range impact to it, because we still deliver exceptional service and yet we want to get better. The other side to it, Hamzah, or at least one other side, is some of the electronic e-commerce opportunities that we have.

You're exactly right, Hamzah. With the free cash flow conversion that we saw in the second quarter, what we're really focused on is the positive trend that we're seeing of conversion, of revenue dollars, EBITDA dollars to free cash flow. We tend to focus more on the cash flow from operation piece because of the lumpiness of capital expenditures and just timing differences that can affect that. Our capital expenditures, as a percentage of revenue, we still target that at about 9% to 10% of revenue.

I mean, look, we're working with both heavy equipment and heavy truck manufacturing partners, but it's really on an R&D basis. And in the short-term, we're going to test an autonomous vehicle in one of our landfills in one of our MRFs probably within the next 12 months. But as I mentioned, and you said as well, that putting an autonomous vehicle on a collection route and I would like to be a residential route, is a much longer-term aspiration for us because of that public perception and government regulation.

Michael, I would – just a couple of comments there. I mean, we had to go through all of that effort to put onboard computers on every truck and create the management team at the local level that can handle that information and can try to begin to then manage through process their way through that to get to middle of the route improvements. So, that's done. Our districts, right now, 98% do certify that they have the mindset and the skill set in place and are getting efficiency.

Good morning. Thanks so much for taking the questions. Maybe we could start with the recycling line of business. So, obviously, the China policy, the notification to the WTO, that's all relatively recent. I wonder how do you think about the potential impact on the recycling business as a whole, maybe, in particular, the brokerage part of the business, because it does seem like what's going to be restricted, in particular, a certain categories of plastics. So not sure how that flows through to kind of the brokerage line of business. What do you think may change in terms of kind of the overall throughput going through that part of the business?

Yeah. Noah, great question. Good timing for it. But remember that our brokerage business is almost entirely fiber and not plastics-related. So, we see no impact from a plastics standpoint on the brokerage business with China's action. It's really going to be a fiber and then some plastics, but, again, not brokerage-related. It's because of the way we sort the mixed paper and we do it today. We sort every bit of the mixed paper we receive. We don't see a material impact to what we export on that side.

Thanks. I guess I'm going to have to say big Jim and little Jim and Devina. Is that what I heard, Jim Trevathan? I've been called worse.

Producing these levels of organic growth in almost every financial metric that are 2, 3, even 4 times the overall growth of North American economies can only be done through the collective efforts of our team of 42,000 people. And every day that passes for me in this CEO job, I'm more and more amazed by this team's dedication, innovation, work ethic, and their willingness to change. So, thank you to all of Waste Management's 42,000 team members for this performance. And thank you to all of you for joining us this morning. We'll talk to you again next quarter.