Waste Management Inc (WM) — Q2 2022 Earnings Call Transcript

Thank you, Valerie. Good morning, everyone, and thank you for joining us for our Second Quarter 2022 Earnings Conference Call. With me this morning are Jim Fish, President and Chief Executive Officer; John Morris, Executive Vice President and Chief Operating Officer; and Devina Rankin, Executive Vice President and Chief Financial Officer. You will hear prepared comments from each of them today. Jim will cover high-level financials and provide a strategic update. John will cover 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. The Form 8-K, the press release, and the schedules of 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. All forward-looking 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. Then we'll discuss our results in the areas of yield and volume, which unless stated otherwise, are more specifically references to internal revenue growth, or IRG, from yield or volume. During the call, Jim, John, and Devina will discuss operating EBITDA, which is income from operations before depreciation and amortization. Any comparisons, unless otherwise stated, will be with the second quarter of 2021. Net income, EPS, operating EBITDA and margin, and operating and SG&A expense results have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations. These adjusted measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release and tables, which can be found on the company's website for reconciliations to the most comparable GAAP measures and additional information about our use of non-GAAP measures and non-GAAP projections. This call is being recorded and will be available 24 hours a day beginning approximately 1:00 p.m. Eastern Time today. To hear a replay of the call, access the WM website. Time-sensitive information provided during today's call may no longer be accurate at the time of a replay. Any redistribution, retransmission, or rebroadcast of this call in any form without the expressed written consent of WM is prohibited. Now I'll turn the call over to WM's President and CEO, Jim Fish.

Thank you, Ed, and thank you all for joining us. The strength and resilience of our business were clearly evident in the second quarter as we built on our momentum from the first quarter to achieve results that surpassed our expectations. Our teams remain committed to addressing inflationary cost pressures, achieving our best ever core price yield results. The combination of our pricing performance, volume growth, and sustainability efforts drove quarterly revenue above $5 billion for the first time. This substantial revenue growth resulted in adjusted operating EBITDA growth of 7.8%, exceeding the upper limit of our long-term growth target of 5% to 7%. Cash from operations stayed robust in the second quarter, enabling us to return more than $0.5 billion to our shareholders, bringing the total for the year to over $1 billion. You will hear more details from Devina, but our strong start to the year has given us the confidence to raise our 2022 forecasts for revenue, adjusted operating EBITDA, and free cash flow. In the second quarter, we continued to observe strong volumes, which is a promising indicator of economic activity in the regions we serve. Currently, our key business metrics suggest ongoing positive economic activity. Nonetheless, WM is well-equipped to thrive in any economic climate. Our resilient business model is supported by our diverse customer base and the essential nature of our services, with approximately 75% of our revenue exhibiting annuity-like characteristics. We are advancing our long-term strategic goals of providing an excellent workplace for our employees, investing in differentiating technology and automation that permanently lowers our service costs, and leveraging our sustainability platform for growth. By making WM a great place to build a career and reducing our reliance on labor through attrition and automation, we are well prepared to navigate this tight labor market. During our sustainability journey, we reached two significant milestones in the second quarter. We opened our fifth WM-owned RNG plant in Oklahoma, the first of the 17 new facilities we announced that are expected to contribute 21 million MMBtu of RNG to our renewable energy portfolio by 2026. We anticipate completing construction of the next RNG facility by the end of the year. Additionally, we launched our Houston MRF, which is the sixth redesigned advanced technology recycling facility aimed at lowering labor costs and enhancing product quality. Our advanced technology MRFs are delivering tangible benefits, achieving about a 30% reduction in labor costs per ton compared to the rest of the single-stream network. In the latter half of the year, we plan to open two more advanced technology recycling facilities and enter a new recycling market, keeping us aligned with our recycling investment goals. I would like to discuss our capital allocation priorities, especially regarding M&A. Our strong operating EBITDA growth has enabled us to absorb the $4.6 billion acquisition of Advanced Disposal while quickly restoring our balance sheet to pre-ADS leverage levels. We typically consider an M&A year to involve between $100 million and $200 million in acquisitions. This year, we have the most robust pipeline we've seen in a long time and expect to close between $300 million and $400 million in acquisitions. We will remain disciplined in our approach to solid waste tuck-ins and recycling acquisitions to sustain our strong financial position and deliver leading industry returns. Our cash generation, paired with our solid balance sheet, enables us to allocate capital effectively, investing in organic growth and sustainability initiatives, consistently increasing our dividends, completing accretive acquisitions, and returning cash through share repurchases. In closing, I want to extend my gratitude to the entire WM team for their hard work and dedication. I'm looking forward to the rest of 2022 as we continue to fulfill our commitments to our team members, customers, communities, and shareholders. I will now turn the call over to John to review our operational results for the quarter.

Thanks, Jim, and good morning, everyone. Once again, we achieved exceptional organic revenue growth in the second quarter, led by collection and disposal yield of 6.2%. Our pricing accelerated sequentially as we continue to address persistent inflationary cost pressures throughout the business. Second quarter core price increased 20 basis points from the first quarter to a record 7.5%. Core price was strong across every line of business, and we had standout performance of 10.6% in our industrial business and 9.4% in our commercial business. Customer receptivity to our pricing remains strong as second quarter churn, adjusted for the intentional loss of an unprofitable national account contract, was 9%. We remain confident that our pricing strategies are appropriately responsive to rising costs while prioritizing customer lifetime value. Our teams continue to be focused on disciplined pricing in the second half of the year, and we now expect 2022 core price of more than 7% and collection and disposal yield approaching 6%. Key indicators in our business continue to signal healthy economic activity in the quarter. Second quarter collection and disposal volume grew 2.3%, with commercial volumes growing 1.6% and special waste volumes up more than 19%. Additionally, new business exceeded lost business as service increases continue to outpace service decreases by a wide margin. Second half volumes are expected to remain strong and for the full year, we expect collection and disposal volume growth of about 2.5%. Our teams remain focused on controlling operating cost. Adjusted operating expenses were 62.4% of revenue in the second quarter, a 130 basis point increase from the second quarter of 2021. The year-over-year increase in operating expenses as a percentage of revenue was largely driven by fuel and commodity price impacts, 70 basis points from higher fuel costs, 30 basis points related to the alternative fuel tax credits received in 2021 that have not yet been renewed for 2022, and 30 basis points from the impact of higher commodity prices on our recycling brokerage business. In the second quarter, we again saw high single-digit inflation in our costs, and we are managing through this with both pricing and cost controls. Our core price is recovering our cost of inflation in each line of business, except residential, where the impacts of higher labor costs are most pronounced. In that line of business, our conversion of approximately 2,000 railroad routes to automated side loaders will both reduce labor and significantly improve efficiency. This is one of the ways where we are investing in technology to reduce our dependency on certain high-turnover positions. Additionally, early results from our pilot programs to fully optimize our roll-off routes are showing efficiency gains in the range of high single to low double-digit percentage increases. As we move into the second half of the year, we expect inflationary cost pressures to ease on a year-over-year basis given the proactive steps we took to raise frontline wages in the second half of 2021. As Jim mentioned, we're excited about growth opportunities in our recycling and renewable energy businesses, and both businesses continue to deliver strong results. Together, recycling and renewable energy contributed $19 million of operating EBITDA growth in the second quarter. The recycling business is on track to deliver results on par or modestly higher than the record earnings we achieved in 2021. Our blended average recycling stream commodity price was $131 per ton in the second quarter, and we continue to expect a full year average of $125 per ton. In the renewable energy business, better pricing for renewable natural gas, electricity, and environmental credits is driving our full year outlook for this business higher than our original guidance by $35 million to $45 million. Overall, our second quarter results exceeded our expectations as we demonstrated our ability to execute on our disciplined pricing programs and manage costs. I'm extremely proud of having the entire WM team work together to provide safe and reliable service to our customers. I'll now turn the call over to Devina to discuss our financial results in further detail.

Thanks, John, and good morning. The strong operating and financial results of the second quarter confirmed a number of important indicators we saw emerge in Q1, positioning us to increase our full year financial outlook. I'll cover our updated guidance in a moment, but I want to give a little more color around our second quarter and year-to-date financials first. As John discussed, our results have been driven by robust organic growth, led by our disciplined pricing focus as well as diligent cost management. Proactive management of our SG&A has been an important element of those cost management efforts. In the second quarter, adjusted SG&A was 9.4% of revenue, a 20 basis point improvement over the same period in 2021. We accomplished this result in spite of an increase in incentive compensation due to our focus on controlling discretionary SG&A spending and leveraging technology investments to reduce the customer sales and back-office functions. We are on track to deliver SG&A as a percentage of revenue of about 9.6% for the full year. Operating EBITDA increased more than $100 million in the second quarter, driven by an increase in the operating EBITDA of our collection and disposal business of $107 million. Operating EBITDA margin in the quarter was 28.1%, a 50 basis point improvement from the first quarter of 2022. We are confident in our ability to achieve our full year margin outlook, which is a particularly strong result given the dilutive impacts from rising fuel costs, which we now estimate could be about 60 basis points for the year. Year-to-date cash flow from operations was up $142 million or about 6.5% from the prior year, which has been driven by operating EBITDA growth of over 9%. Cash flow from operations growth was slightly muted relative to operating EBITDA growth due to higher cash taxes, which will continue throughout the year, and working capital pressure that we expect to moderate over the remainder of the year. During the first half of the year, we've invested $856 million in capital to support the business, and we invested an additional $112 million to support the strategic growth of our recycling and renewable energy businesses. Our year-to-date free cash flow, which includes the impact of capital outlays to support our sustainability growth investments, is $1.35 billion, putting us on pace to exceed the upper end of our initial 2022 guidance of $2.05 billion to $2.15 billion. While the pace of capital spending has been slower than expected in the first half of 2022, we currently expect truck deliveries, landfill construction, and sustainability capital projects to ramp in the second half of the year. We're encouraged to see supply chain constraints in certain asset categories begin to show promising signs of improvement, though we are proactively managing the business in anticipation of the longer delivery schedules we've experienced over the last year. We will revisit capital and free cash flow guidance in more detail next quarter. As Jim discussed, we are well positioned to allocate free cash flow among all our capital allocation priorities. In addition to increased acquisition expectations for the year, we now expect to allocate our full $1.5 billion authorization to share repurchases. Turning now to our updated 2022 guidance. We expect revenue growth of approximately 10% and adjusted operating EBITDA in the range of $5.5 billion to $5.6 billion. The $175 million increase in operating EBITDA guidance is driven by more than $325 million from increased price and volume performance and $40 million from better performance in the renewable energy business. Those things are partially offset by approximately $190 million of higher costs, which were driven by a combination of inflation pressure and incentive compensation. Note that this outlook assumes fuel prices remain at June levels for the second half of the year, equating to a 60 basis point drag to full year operating EBITDA margin. Even still, we expect to deliver margin of 28.1% at the midpoint of our guidance. We remain optimistic that the alternative fuel tax credits will be approved in 2022 and continue to include the approximately $55 million benefit we would expect to receive in our outlook. In closing, our excellent first half performance sets us up to deliver another year of strong financial growth in 2022. I can't thank the WM team enough for all their contributions to our success. With that, Valerie, let's open the line for questions.

You guys threw out quite a bit in the prepared remarks, but I just want to make sure I have it. So on the down 120 basis points on the margin walk, it was 70 basis points from fuel, 30 from the CNG credit, and 30 from commodities. Is that right?

That's correct. When we look at the operating expense line concerning our EBITDA margin, it's important to consider it in two parts. Firstly, we are very pleased with how we performed against the expectations set at the beginning of the year. Our outperformance came from two areas: our traditional solid waste business exceeded expectations by about 40 basis points, while our renewable energy business surpassed expectations by 20 basis points. We did encounter a few challenges compared to our initial expectations, notably related to fuel costs, alternative fuel tax credits, and incentive compensation. However, when we factor everything in and review our outlook for the full year alongside our first-half performance in relation to our original guidance, we find we're 60 basis points ahead of expectations on base performance, which is a strong outlook. Specifically for Q2, comparing the 29.3% margin from Q2 of '21, our best quarterly margin to date, to the 28.1% achieved today, fuel is the primary factor behind this change. In that 120 basis point decrease, 80 basis points are attributed to fuel—50 basis points stem from higher fuel costs, and 30 basis points are due to the alternative fuel tax credits. The recycling segment negatively impacted margins by 40 basis points, which aligned with our expectations, and 30 basis points of that came from the brokerage business where higher commodity prices led to a dollar-for-dollar rise in costs. Additionally, incentive compensation costs increased by 30 basis points. Overall, we are very pleased with the solid waste business's strong performance, which stands out when examining the margins for the quarter.

That's why she's the CFO, Tyler.

Yes, I was going to say that was extremely helpful, very detailed. So real quickly, not to focus too much on the margins, but it does feel like you're looking for a margin uplift in the back half, I think, somewhere circa, call it 50 basis points. But I just want to kind of think about it conceptually. So is it that the pricing contribution will kind of hang around the same place, but your unit cost inflation kind of eases? Because I think John talked about it, you pulled some frontline wages, I believe, forward in the back half of '21. Is that kind of how that will work?

Yes, I think that's right, Tyler. I mean, listen, we got out from the labor issue kind of Q2, Q3 last year. So we feel like while we're still seeing labor inflation, it's not going to be at the same rate. And there's other obviously inflationary pressures, but I think you got it right.

Okay, great. And just my last one, John, just real quick. Can you remind us what percent of your revenue is, call it, temporary roll-off in C&D landfill volumes? Just I've been getting some questions about housing, just kind of your exposure there.

Yes, we're not really exposed too much there, Tyler. The temp C&D business is low single digits.

Nice quarter. I'm wondering if we could trouble you just for an update on how pricing is tracking now that your landfill gas facilities are coming online. Jim, how are you feeling about the pricing point relative to the mid-20s that you underwrote the investments in? And is the offtake market developing?

I thought you would focus on solid waste pricing. Regarding RNG, we have factored in $2.80 for the latter half of the year, which we believe is a comfortable estimate. As we've discussed, the business was initially valued at much lower figures. Even with those lower estimates of $2 for RIN and $2.50 for natural gas, this remains an excellent business in terms of returns. Specifically, for the second half of 2022, we expect RIN pricing to be at $2.80, and we are confident in that projection.

And Jim, in terms of the offtake market, is that developing? What's your level of inbounds for folks that are looking to lock in long-term agreements? And can you comment on how those conversations are going?

Yes, Jerry. I would say that the RIN market is what it is, and that's part of our portfolio. However, we have started to engage in some direct offtakes for renewable natural gas, and we are experiencing good momentum in some of those contracted rates.

Okay, super. And Jim, since you want to talk about it, the solid waste pricing. Can we talk about that? So big CPI tailwind into next year, obviously positive revision to pricing over the course of this year. As you look at the book of business today, what's your best sense for how pricing might look in '23? It feels like just with CPI pricing rolling and the timing of C&I increases, you probably have 5 points of core price already in your back pocket entering '23. But I'm wondering if you could comment on that.

You're absolutely right about the benefits to those businesses from an index-type increase. The 12-month lag we've discussed starts to have a significant impact in the first quarter of next year. If we assume that CPI is near its peak at 9.1%, we would expect pricing in those open market businesses to decrease if inflation starts to decline, but not exactly in line. We've previously compared it to banks, where their spreads improve at lower rates. If inflation decreases, we anticipate that a larger portion of our pricing will contribute to margin improvement rather than just covering costs. Currently, we are focused on managing costs with the CPI at 9.1%. Regarding your initial question, yes, in the first half of 2023, remember that around 70% of those index-driven price increases occur in the first half of the year while 30% happens in the latter half. Thus, while we will see some benefits from CPI in the second half of 2022, it will be less significant since only 30% of the revenue is affected.

Jim, I'd like to follow-up on the price conversation because I think this is one of the most critical issues the industry has going for it. So tackling what you just said and summarizing it, you're about 60-40 open market versus index, and I get the weighting first half, second half. But if CPI goes to 3%, you're still going to get a good spread to it, call it 100, 150 basis points in your open market. And then you're going to have your index at an 8-something, maybe closer to 9%. In just the algebra formula, there is a greater price in '23 than I am in '22 before I factor in churn. That's the math, right?

I think you're spot on, Michael. I mean, look, we're not crazy about 9.1% inflation. And as I said, we're doing everything we can with price and doing a good job with it, but to cover our cost. If inflation comes back down to a more reasonable number, let's call it 3% over the next kind of 2 to 3 quarters, then I think we have a greater percentage of our price that actually goes to margin improvement and not just focused on cost recovery, which is kind of where we are today with the open market pricing.

Right. I was thinking, go ahead, John, sorry.

I was just going to say, Michael, I think the one caveat to that is what we're specifically doing in residential. And you can see that we continue to make progress on the core price side and the yield side, and we're still being pretty deliberate about what volume we're going to keep and what volume we're not going to keep. That would be the one caveat to what Jim commented on.

Yes, and I get that, and I keep trying to convince the market you're supposed to pay attention to price, not volume, because at the end of the day, you'll have a better quality business. So the other part of the price question that keeps coming up and we try to help the market understand is how sticky unit prices are. So the rate of change in open market might go from a 7 core to a 5 core, but the underlying unit prices are very, very sticky, price per yard, price per ton, price per pull. Can we help everybody appreciate the significance of that as well?

We believe our business is quite price-insensitive because it constitutes a minimal portion of the total costs for our customers. We've found that it varies somewhat between residential and business customers, but typically it's around 0.5% of a small business's overall expenditures. Additionally, our efforts to genuinely set ourselves apart contribute to keeping our prices stable. Therefore, we tend to retain more of our pricing power compared to many other businesses.

Right. And my point being is if all of this unwinds from an inflationary standpoint or there's a recession, you don't walk back unit prices. You hold on to the unit price, plus I've got the favorable trend of higher price versus underlying internal cost of inflation in '23. The power of that is pretty compelling.

The RIN recycling upside of $35 million to $45 million, I'm assuming that's mostly all weighted in the first half because the RIN's coming down, and recycling's come down sequentially. And so the benefit of that has already been captured.

So I'll take that in two pieces, Michael. On the recycling side of the business, we were better in the first half about $28 million. We expect actually to give some of that up in the second half of the year. So we expect about $20 million to $25 million of earnings pressure in the second half just because of where commodity prices were in the second half of '21 relative to what we expect them to be in the second half of '22. On the renewable energy side, we have captured $27 million in the first half of '22, and we expect another $10 million to $20 million of incremental earnings in the back half. So when you net those two, we expect to be down in the, call it, $10 million to $15 million range.

Okay, that's very helpful. And then, Devina, on the guide at the beginning of the year, you framed it as negative 100 basis points of headwind. First half, plus 100 to 140; second half, sort of 0 to 40 up. You were actually pretty close to the negative 100, a little less actually. But you're now telling us it's less than positive 100, 140 in the second half. That's if we're revising part of the messaging, that's the other part of it?

That's right. But what I would say is the plus 100 to plus 140 now looks more like, call it, plus 80 to plus 120. And when you consider the impact of fuel at 60 basis points, that really does speak to the strength of the underlying fundamentals of solid waste and the incremental benefit of the renewable energy business relative to our initial expectations.

Fair enough. Just to clarify, that 60 basis points is simply a mathematical pass-through. It does not represent an actual cost increase. The surcharge offsets the cost, making it just a mathematical adjustment.

Yes, that's correct. From an earnings standpoint, it should be a zero-sum game for us. In terms of revenue growth related to fuel surcharges, we recorded $129 million in Q2. We anticipate similar figures, with possibly a slight decrease in the second half of the year on a quarterly basis. However, that essentially serves as a dollar-for-dollar offset against increased operating costs, including both direct fuel expenses and indirect costs from subcontractors and other business transfer elements.

My first question is about how you expect this business to perform during a new recession. I understand that the business is quite resilient, and while most companies haven't yet experienced a downturn, I'm curious about the differences between now and 2009 when volumes dropped by 10% and recovery took much longer. Investors likely have the challenging year of COVID in mind when your internal revenue growth was negative 3%, which was quite a shock. Can you explain how your business is different this time? We are noticing pricing and that the sector seems more disciplined. Please outline your approach for handling a downturn and discuss the resilience of your business, noting that it typically lags entering a downturn.

Thanks, Hamzah. You addressed the volume aspect, but there are several components to your question. I'm optimistic about a few factors. We recognize that most of the discussion on this call will focus on future projections. Firstly, regarding pricing, we have a customer base that is very sensitive to price changes, which is a positive sign in terms of maintaining pricing stability. Price is one of the three critical areas we monitor: price, volume, and cost control, and we are confident about our pricing. When we consider volume, I want to share some insights. We recently had quarterly reviews with our 16 area vice presidents, and they all expressed optimism about their specific regions. Our volume figures for July have been promising, essentially mirroring June's performance, despite having one fewer workday due to the Fourth of July falling on a Monday this year instead of a Sunday last year. Additionally, on the commercial side, we intentionally let go of a significant national account, which impacted our volume by nearly one percentage point. Even after accounting for such factors, our volume remains strong. Special waste, specifically, increased by 19% in Q2, and our pipeline looks good for the rest of the year. Our volume in the first three weeks of July also appears strong in that area. Regarding your question about what distinguishes us from other industries, I don't necessarily think we're that different. However, our company believes we are starting to gain market share. It’s challenging for many companies due to the current operational environment, and John mentioned the ongoing labor shortage, which doesn't seem to be a short-term issue. This is why we emphasize cost control, leveraging attrition within our business. Some roles experience 50% turnover, so rather than continually hiring, we’re using technology to allow certain positions to naturally diminish, benefiting our operations. Many other companies in our field lack the technology or resources to manage this effectively. Ultimately, this puts us in a favorable position, even in tough market conditions, as we feel we’re gaining market share despite the challenging environment.

Got it. Very helpful. And just you had flagged an above-normal M&A year. I know it's still sort of $300 million, $400 million figure. But just maybe frame for us, what's driving that? How long do you think an above-normal M&A environment could last? And any change in valuations you're seeing in the private market?

Yes. So I just talked about the fact that it is a bit of a tough operating environment out there for a lot of companies. And so what we don't want to do and we've said this on several of our previous calls, we don't want to bail somebody out of a problem. I mean, we're still going to be conservative when it comes to valuations. But we think there's some really good companies out there that are not asking for ridiculous prices, purchase prices, and those are attractive to us. And we see enough of those to say that in the solid waste space and in the recycling space, we feel more like a $300 million to $400 million a year versus more of our traditional $100 million to $200 million is appropriate.

Got it. Just a clarification question and I'll turn it over, just for Devina. I think you had flagged $129 million sort of out of the $153 million that's fuel surcharge recovery in Q2. Just comparing that number, did you mention sort of how much fuel increased for you, when we're looking at that $129 million number? What did your cost increase for fuel just comparing the $129 million? Was it over $100 million or less than $100 million? Just any sense there.

It was effectively equal. So it was a combination of direct fuel and indirect. So you can think of it effectively like a dollar-for-dollar offset.

I just wanted to come back to inflation. Last quarter, you guys quoted, I think, around 9%. Wondering what that was in the second quarter. And just this dynamic around comping the heavy wage increases. Last year, it was interesting how we think about how that part of the inflation algorithm trends into the second half. But what else should we be aware of in terms of what's happening under the hood in terms of inflation? I mean, outside of wages, are things still ramping, cooling off? Any color on that element would be helpful.

Yes, Sean, I think the commentary on labor, we got out front of it last year. And we see, while it's not going all the way down, it's going to moderate in the back half of the year because of the intentional steps we took last year. Devina touched on it, but we're still seeing inflationary pressure on third party on maintenance and repair. Subcontractors is one that sticks out. And clearly, whether it's by rail or by truck, we're seeing the fuel impact there as well. That's a big chunk of the indirect pressure we're seeing. And I think the commodity piece runs through that a little bit as well. When you think about third-party maintenance and repairs, there's a commodity element to that. So I would tell you that I feel like it's peaked, generally speaking. And I think the benefit we'll see is in terms of what we did with our labor, which is a big chunk of our operating expense line.

I do think, Sean, that Devina touched on it in her remarks. But the supply chain itself, I mean, she mentioned that we're seeing a little bit of easing there, and that is true. But that's pretty important to us, particularly as you think about the delivery of trucks to us. I mean, last year, we didn't get the trucks that we ordered. And so far this year, we have not gotten to the number that we expected. We're hopeful that in the back half of the year, we start to see a pretty significant ramp-up there in the vehicles that we've ordered. That's a pretty important part of the inflation picture because, as John mentioned, maintenance cost is not insignificant as a cost line item. And that obviously is impacted as you're having to keep older trucks in the fleet.

Okay, that's interesting and kind of a segue into my next question. I think in the prepared remarks, you guys had mentioned that capital spending is running a little below expectations in the first half. Maybe you'd revisit that guidance next quarter. I mean, is it really just trucks we're talking about here? I wondered if some of these capital spending delays also are being seen around the sustainability investment program. And whether there's any risk to that incremental EBITDA we're expecting to see roll out of those investments into next year.

Yes, great question, Sean. First and foremost, I would say it's important to hear the message that we are very confident with the rollout of our sustainability initiatives, and those investments are on track. We talked about both the renewable energy facility and the recycling facility coming online and expectations for the remainder of the year there. It continues to be strong relative to our initial expectations. So when we look at capital being below our guided levels, it really is more in the traditional solid waste space and specifically for trucks. As Jim just mentioned, our truck deliveries in 2022 have really been slow relative to our initial expectations. And even after we saw Q1 unfold, we revised those expectations, and they're still below what we had expected at that point in time. So as we look at how we spend our capital, we're adapting for that slowdown on the truck front. And we're looking at places across the rest of our business to proactively pull forward capital, whether it be in the landfill line of business where we've seen strong volumes, particularly in special waste, or as we look at other parts of the business that are performing well and have continued investment opportunities because those returns have been strong. So overall, what I would tell you is we still need Q3 to unfold before we can give you the additional detail on the traditional capital part. I would tell you, at this point, we completely expect to stand firm on the sustainability capital at about $550 million for the year.

That last question connects well with what I wanted to ask regarding the medium to long-term planning for some of the investments that Jim and John mentioned, particularly about increasing ASL's share in the fleet and the recycling automation. Generally, could you outline these investments aimed at reducing labor intensity? You mentioned your goals for four years ahead. How should we consider the next couple of years? Assuming we can overcome some of the supply chain constraints, could you share your expectations for the next 12 to 24 months and where you think you can reach?

I believe your question is really about whether we are meeting our expectations regarding capital or what the operating impact will be from not filling some of these roles. I want to make sure we're on the same page.

It's both, right, because we understand that one will follow the other. So...

Let's discuss the capital aspect first. I've mentioned the elimination of 5,000 to 7,000 positions that we will not refill. The main focus is transitioning from rear-load trucks to ASL trucks. A rear-load truck costs around $280,000 to $300,000, while an ASL truck runs about $100,000 more. The good news is that the investment in an ASL truck typically pays itself off within a year since it allows us to eliminate a helper from the back, significantly boosting productivity. We have successfully made this shift multiple times, seeing about a 15% increase in efficiency. The cost for hiring those helpers, often temporary laborers, ranges from $75,000 to $100,000 annually. Therefore, even with the extra capital expenditure for the trucks, the operating costs decrease quickly. Another area to consider is recycling. We've noted that we're looking at reducing around 1,000 to 1,200 positions there, and I mentioned earlier that we've observed a 30% reduction in labor costs at the first five locations we've revamped, with potential reductions between 30% and 50%. One example is our rebuilt plant in Salt Lake City, which saw a nearly 50% decrease in labor costs. The capital expenditure for these upgrades has already been projected at approximately $800 million over four years. Additionally, improvements in recycling lead to better quality materials at the plant's output, which benefits our top-line revenue. For instance, before the upgrades, our Salt Lake plant had to sell mixed paper as low-grade. Now, they're capable of separating it, resulting in a significant portion of high-grade paper that commands a higher price.

I want to add to what Jim has said by highlighting that we are taking a comprehensive view of total operating costs. The residential sector is a good example of this, considering both capital and operational expenditures. Additionally, it's important to note that as we embarked on this journey a few years ago, particularly with recycling and residential projects, the calculations we made back then are becoming more favorable in the current environment marked by labor inflation. As Jim indicated, we do not expect the labor shortage or wage pressures to ease in the near future. Therefore, as we continue to invest, the projections for our operations are improving over time.

Yes. To complete the answer and thank you for the insight, John. What do we anticipate this impact to be? Essentially, you can assign any number you like to the 5,000 to 7,000 positions that won't be refilled. The good news is that this isn't a traditional approach where we're cutting 10% of the workforce. This is a strategic method to lessen our reliance on labor by capitalizing on the high turnover rates in certain jobs. The exit costs are quite low, the capital costs are mostly accounted for, and the operating improvements, whether in SG&A or operating costs, if we consider 5,000 jobs, we can estimate an impact of $50,000 to $100,000 each. That's a significant effect on operating expenses and SG&A. If we reach the upper limit of 7,000 jobs, the benefits would increase even more.

Yes. That's great color. Just wanted to get a little bit of color as well on the M&A pipeline, and good to see you coming back in greater force to the market. But is this primarily traditional solid waste? Is it recycling? Can you give us a sense of the mix in terms of where you're seeing the opportunities?

It's a combination of both. We view recycling as part of traditional solid waste, but there is more to it. Recently, we discussed our ongoing investments, particularly in low-value plastics that weren't generating much revenue, along with some low-value mixed papers. We are repurposing these materials into roofing products. Our focus is on identifying materials that currently enter landfills without adding much value, particularly lightweight items like plastics, which while light, are highly recyclable. We are already maximizing efforts with plastics such as PET and HDPE through traditional single-stream methods. We're also exploring ways to divert additional plastics from landfills where they can take centuries to decompose, ultimately taking actions that are beneficial for both the environment and our economic model. Furthermore, we are looking into traditional solid waste acquisitions to fill gaps in our network or to acquire assets that would enhance our operations at a reasonable cost.

I would like to discuss mergers and acquisitions. This year, you are engaging in two to three times the activity compared to a typical year. When assessing the market available for acquisitions and considering what is not controlled by the major players, do you view the entire market as a target, or would you focus on a smaller segment of it over the next five to ten years?

We consider ourselves a North American company, so we haven't explored acquisitions outside of North America for solid waste. This doesn't qualify as a tuck-in since we lack overseas operations. Therefore, when we examine acquisitions within North America, we focus on strategic relevance and how we can enhance our operations. We're enthusiastic about reducing labor dependency, as it allows us an edge if our competitors cannot leverage technology in the same way. This opens up opportunities to create more synergies when acquiring a company. We're open to exploring everything within North America. Any necessary filings will be reviewed by Justice. We prioritize being conservative with valuations, and it's crucial for any acquisition to align with our strategic goals and be valued appropriately.

I guess, not only does it bring in more synergies, Jim, it also makes it harder for those mom-and-pops to compete with you and perhaps drive more to you, given that they can't match your technological investment. Is that fair to say?

Yes, reducing our cost structure is very important to us. If others struggle to do that, that's their issue, not ours. However, it creates an opportunity, which is why we have a strong pipeline. Many companies are realizing they don't want to manage HR constantly or invest in technology like WM does, so they prefer to sell to us at a reasonable valuation. That's perfectly acceptable.

We lost Dave. He fell off the screen.

Can you hear me?

Third time's the charm here, I guess. Congratulations on a good quarter. I have a couple of quick questions. It seems like you’re moving past peak inflation, but it’s uncertain how long it will take to return to normal inflation levels. You've been pricing to offset inflation costs, but I'm curious if there's been an effort to capture more of that inflation through core pricing instead of a surcharge program. I assume that if more inflation can be captured through core pricing, it would result in a stickier situation as inflation decreases and CPI starts to decline.

I believe I understood your question correctly. It's somewhat a mix of the two aspects you mentioned. There are some surcharges involved, but we don't include fuel in our core pricing or yield figures. It is meant to simply pass through to our customers. We do incorporate an environmental fee, which does get included in our pricing metrics. If that's what you were asking, it indeed reflects a mix of core price increases. Additionally, there's another aspect related to maintaining those price increases, which is why there's always some fluctuation in pricing. This has been our model since the company's inception. Retaining a higher percentage of those price increases is a crucial element.

No, that's helpful. No, that's exactly what I was looking for. Just one last question from me. You mentioned the repricing of index contracts and the 12-month lag. In some other industries I cover, there has been a push to reduce that timeline due to acute inflation, allowing for quicker repricing when pressures arise. Has there been any effort on your part to shorten that lag? Is there any interest from your customers to reduce that lag, similar to what we've observed in other sectors?

Yes, I believe residential is a good example of this. Examining our core pricing and yield results over the past six to ten quarters shows that they have outpaced CPI in recent quarters. However, this has not been the case in the last few quarters, which illustrates, Kevin, our approach to pricing and maintaining the right balance between our contracted rate increases and what we are willing to accept moving forward. The most encouraging aspect is that within our residential business line, we have exceeded CPI performance, with the most recent quarters being the exception. Additionally, we aim to maintain volume without sacrificing profitability. The trade-offs in volume we've made, combined with our pricing strategy, continue to reflect this approach in the current quarter as well.

And just one last point. That 12-month lag that you talked about is really contractual with these big municipalities. So there's not really an option for us to change that unless they choose to change their bid specs.

Apologies about that. My main question, I know we're up on the hour, Jim, is your margin is going to finish this year at 28.1%. 5 years ago, it was at 28.3%. So it's basically been kind of range-bound. Yet now, you have a very profitable sustainability business with renewables. Your pricing is very strong in Q2. Does it feel like 2023 is when this margin range really breaks out 50 basis points or higher? Just based on where this business is today compared to even where it was 5 years ago?

There have been several developments as we've aimed for our ambitious margin target of 30%. The acquisition of ADS impacted our margin because that business operated at about a 24% margin when we were at 28%. However, it has been a valuable addition for us. After completing the integration of ADS, we then faced significant pressure from fuel costs. Devina mentioned that while this situation is destructive to margins, it won't hurt our earnings; it should remain neutral from an EBITDA perspective, but it does negatively affect our margins. We are working to raise the ADS business to our margin levels, which will be beneficial. As fuel prices decrease, while we aren't taking specific actions to improve margins, it will positively impact us. Additionally, we are currently seeing pricing that covers costs, and as inflation decreases, more of that pricing will contribute to margin growth. Furthermore, as we permanently reduce costs and become less reliant on labor, this will also positively influence margins. All these factors lead me to believe that as we look to 2023 and beyond, we will witness an improvement in overall margins.

Jim, I think that color was fantastic. The one thing I would emphasize, Michael, in terms of looking at the total company margin over that 5-year period, in addition to what Jim outlined specifically for commodity-based impacts and the ADS acquisition, is that when you think about the investment we're making in technology, it's showing up in our SG&A in a different way than it would have had we effectively decided to have SG&A dollars be to run the business model. And so what you see from us is that we have a different level of SG&A than we otherwise would have if we weren't making these strategic investments that will provide significant returns over the long term. And so I really do think that you have to consider that aspect of how we have strategically changed over the last 5 years in terms of thinking about how our margins have adapted in that period.

That was helpful to give us context of how to think about it over that 5-year stretch. And just lastly, Jim, I mean, what do you think is the right level of CPI for the business? What is the sweet spot? Because obviously, CPI of 1% for like that decade clearly doesn't feel like that's a great place for the industry and for your operations. Now CPI at 9%, that's another story. Is there a sweet spot that you feel like is the right number where it helps you get good pricing resets on those contracts, yet you guys can also handle the cost inflation on the business in terms of also getting productivity savings every year? What would be that CPI sweet spot for the business, you think?

That's a great question. I'm not exactly sure what the right number is, but I know that 9.1% is definitely too high. We've discussed how inflation is decreasing, and banks are likely analyzing the situation too. I'm uncertain about the ideal rate for me when it comes to CPI. If I had to choose, I might estimate it to be around 2% or 3%. However, I can't say that with certainty, and we haven't conducted any calculations yet. There wasn't really a need to do the math until about a year and a half ago since it has generally remained below 2% for most of my career. Now there's a reason to explore this question, and we'll be doing some analysis on it.

A macro question. So you're not seeing a slowdown at this point despite some increased caution in the general macro environment. But are there any particular industries within commercial, for example, that are being a bit more cautious? Have the conversations changed at all?

You're right, Toni. There's a lot of speculation about when the recession will hit, how severe it will be, and its duration. The good news for us is that approximately 75% of our business is resilient to downturns, so we perform well in any situation. We've discussed special waste extensively over the past few quarters. Most of our revenue is more of a lagging indicator, but special waste serves as one leading indicator. We also have a couple of others, like construction and demolition, although that's a smaller part of our business. Special waste is strong because it primarily involves industrial-type jobs, and those companies are still deciding when to allocate their budgets. We're not seeing any slowdown in that area. Our special waste performance was very strong in the first and second quarters, and we're optimistic about its continued strength. Even looking at July's numbers, we see very positive trends in special waste. While I do believe a recession is on the horizon, I don't disagree with the general sentiment because many are predicting one. However, I feel confident we're in a great position to endure any challenges ahead, especially with our technology advancements and efforts to reduce our labor dependence, which should enable us to emerge from this situation stronger than our competitors.

Sounds good. As a follow-up, you mentioned strong results and an improved outlook. I'm curious about the commercial and industrial pricing this quarter, which was impressive. How are you approaching pricing for commercial and industrial landfills as the year progresses?

Landfill pricing has been a key focus for us over the past three to four years, and we saw positive results in both Q1 and Q2. We're pleased with our ability to implement landfill pricing successfully. In terms of commercial and industrial pricing, it has also been very strong. Overall, I can't identify any weaknesses in our pricing performance, whether it's in residential, commercial, or industrial landfill services. Customers seem receptive to price increases, likely because they are aware of the broader inflation trends and recognize that our services represent a small portion of their total expenses. Thank you for joining us today. In conclusion, during a time filled with uncertainty about the macro outlook, we take pride in being a symbol of stability and strength for our investors. We emphasized today that WM's short-term outlook is positive, but more importantly, we are very excited and confident about the long-term outlook. Our long-term strategy is unfolding as we anticipated and communicated back in 2019 at our Investor Day. We expect this to continue not just through the end of 2022, but also into 2023, 2024, and beyond. Thank you again for joining us this morning, and we look forward to speaking with you next quarter.