Waste Management, Inc. (WM) Q2 2011 Earnings Report, Transcript and Summary

Good morning. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management Second Quarter 2011 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Ed Egl, Director, Investor Relations. Please go ahead, sir.

Thank you, Nicole. Good morning, everyone and thank you for joining us for our second quarter 2011 earnings conference call. With me this morning are David Steiner, Chief Executive Officer; and Bob Simpson, Senior Vice President and Chief Financial Officer. David will start things off with a summary of the financial results of the quarter and a review of the details of our revenue growth, including price and volume trends. Bob will cover operating costs and the financial statements. We will conclude with questions and answers. During their statements, any comparisons made by David and Bob, unless otherwise stated, will be with the second quarter of 2010. Before we get started, let me remind you that in addition to our earnings press release that was issued this morning, we have filed a Form 8-K that includes the press release as Exhibit 99.1 and is available on our website at www.wm.com. The Form 8-K, the press release and the schedule for the release include important information that you should refer to. During the call, David and Bob will discuss earnings per fully diluted share, which they may refer to as EPS. Please note that projected adjusted EPS and free cash flow are non-GAAP measures. Please refer to the reconciliations to the most comparable GAAP measures in the earnings press release footnote in the schedules thereto, which can be found attached to the Form 8-K and on the company's website at www.wm.com. Additionally, during the call, you will hear certain forward-looking statements based on current expectations, opinions or beliefs about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are detailed in our earnings press release this morning and in our filings with the Securities and Exchange Commission, including our most recent Form 10-K. Please note that our Form 8-K filed earlier this morning also include a copy of our press release announcing our acquisition of Oakleaf. You should be aware that projected EPS, free cash flow and all other forward-looking statements, except those specifically pertaining to the Oakleaf transaction do not incorporate any benefits or costs associated with the Oakleaf transaction. For information on additional risks and uncertainties pertaining to the Oakleaf's transaction, please see the press release filed as Exhibit 99.2 to our Form 8-K. 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 August 11. To hear a replay of the call over the Internet, access the Waste Management website at www.wm.com. To hear a telephonic replay of the call, dial (800) 642-1687 and enter reservation code 73675301. Time sensitive information provided during today's call, which is occurring on July 28, 2011, may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited. Now I will turn the call over to Waste Management's CEO, David Steiner.

Thanks, Ed, and good morning from Houston. During the second quarter, we earned $0.50 per diluted share. A number of things in the quarter went just as we expected. As previously discussed, we had about $0.06 of combined earnings per share headwinds from our waste energy operations, our growth initiatives and our cost reduction programs. In the back half of the year, we expect these collective headwinds to abate and for our cost reduction efforts to begin to add to earnings. However, in the quarter, a few things did not go as we expected. We had a $0.04 reduction in earnings per share from increased maintenance from repair costs, legal items and risk management. The legal and risk management items are second quarter issues but the maintenance increase is primarily due to higher commodity prices. So we'll likely see higher maintenance costs in the back half of the year. Our revenue growth from yield was slightly below expectations for the quarter and our revenue growth from volume was lower than our expectations. With respect to yield, we're taking immediate and significant pricing actions to increase our yield. With respect to volumes, we continue to move forward with our customer focused growth initiatives, and the transaction that we announced today to purchase Oakleaf will certainly accelerate those efforts. We're pleased that during the second quarter, revenue increased by $189 million or 6% from the prior-year quarter. This is the sixth consecutive quarter of positive year-over-year revenue comparison. Higher commodity prices, improved recycling volumes, acquisitions and year-over-year yield increases contributed to the revenue growth. While internal revenue growth from yield continues to provide positive revenue growth, we're not satisfied with the results for the second quarter. Internal revenue growth from yield and our collection and disposal operations was 1.6% in the quarter and 2.2% year-to-date through June 30. The combined internal revenue growth from yield in the industrial, commercial and residential lines of our collection business was 2% in the second quarter. Commercial and industrial yields were 3.2% and 1.3%, respectively. Yield in our residential line of business was 0.9%. At the beginning of the year, we noted that the residential line of business was becoming more competitive. Local, regional and national companies have become more aggressive on price. Municipalities are also looking for price concessions, so although yield remains positive, we do not expect significant increases in the residential yield. Our price increases to customers were right on plan, but mix issues had about 60 to 80 basis points of negative effect on yield in the quarter, which is much higher than we've seen in the recent past. The mix issues were most common in our southern group, where, for example, in our franchise markets, we saw a dramatic shift in mix from higher-priced permanent roll-off to a lower-priced temporary roll-off. So looking at yield without mix, we would have been over 2% yield. Our pricing actions in the second half of the year should add about 80 to 100 basis points to yield, of course, offset by any continuing mix issues. Another factor affecting our yield has been rollbacks of our price increases. In our commercial line of business, we implemented significant price increases to our customers in the 6% to 7% range. This level of price increase has been the norm over the last 5 years of Waste Management. Local haulers often offer new business prices substantially below our prices. But lately, we've seen our regional and national competitors aggressively reduce prices to obtain volumes. We had to take action to retain profitable customers. And in the second quarter, we saw the highest level of price rollbacks since prior 2004. But the bottom line earnings benefit of increasing our yield continues to exceed earnings benefit you can get from purchasing volumes at low prices. So we will continue to maintain our pricing discipline even in the face of aggressive discounting by our competitors. Despite these pricing pressures, we maintained customer churn at about 10% in the second quarter, a 60 basis point improvement from the same quarter in the prior year. On the landfill yield front, all of the waste streams had positive revenue growth from yield during the second quarter, continuing the trend that we saw in the first quarter. On the volume side of the business, internal revenue growth from volume declined 1.7% in the quarter, which is flat compared to the first quarter of 2011. If you exclude the volumes associated with the Gulf Coast cleanup efforts in 2010, volume would have declined 1.1% in the quarter. Although we saw a good seasonal uptick in volumes in the first few weeks of April, volumes had a soft patch in May and June, mirroring the dip in the U.S. economy. Our commercial collection line of business saw a year-over-year volume decline of 4.9% and the residential line of business saw a 4.2% decline year-over-year. Both of these collection lines improved sequentially from the first quarter. Industrial volumes declined by 3.6% on a year-over-year basis. In the landfill side of the business, second quarter 2011 internal revenue growth from volume improved by 1.1% compared to the second quarter of 2010. Internal revenue growth from volume for special waste was positive 8.1% year-over-year. This is an increase sequentially from the positive 2.9% internal revenue growth from volumes that we saw in the first quarter. And we still see strength in the pipeline for special waste volumes. C&D volumes declined 7.8% year-over-year and MSW internal revenue growth from volumes was negative 7.5% year-over-year. Income from operations in the collection line of business improved slightly during the second quarter when compared to the same quarter last year. We increased our income from operations despite the declining volumes and increasing cost inflation in the price of tires, lubricants and steel parts. These maintenance-related costs have risen between 10% and 40% from the same quarter of 2010, reflecting the worldwide increase in commodity prices. As we expected, income from operations in our waste-to-energy line of business declined in the second quarter compared to the second quarter of 2010 by $0.02. The expiration of a long-term electric power capacity agreement in South Florida had a negative $6.6 million effect in the quarter. Also affecting the decline were upgrades to our acquired facility in Virginia and increased costs for fuel and chemical usage. For the rest of 2011, we expect the third and fourth quarter to be flat year-over-year for our waste-to-energy business and for earnings to begin to increase in the first quarter of 2012. Turning to our recycling business, increased commodity prices and volume contributed about $0.03 of positive year-over-year earnings per diluted share in the second quarter of 2011, which is similar to the first quarter. Commodity prices have increased approximately 25% when compared with the same quarter last year. If prices continue to remain strong, we expect to see about a $0.03 to $0.04 benefit for the second half of the year. With respect to solid waste volumes, we certainly expect to see stronger seasonal improvement during the second quarter. Landfill volumes have remained positive while the collection volumes have continued to show weakness. One positive in our collection business is that is service increases have exceeded decreases for the second consecutive quarter. Of course, in the third and fourth quarter, we'll have to overcome the increase in volume that we saw last year from the Gulf Coast cleanup, which added about 1.7% to volumes in the third quarter and about 0.8% in the fourth quarter. Volumes looked slightly better in July. But given our weak first half volumes, we now expect to see volumes in the negative 1.5% to negative 2.5% range for the full year. In response to the current business environment and our outlook for volumes, we've instituted yield improvement and cost containment plans. From a yield point of view, in order to strengthen our pricing in the second half of 2011, we've increased our environmental fee and accelerated our price increase programs. By doing this, we expect to be able to achieve our goal of 2% yield for the full year. We've also implemented a cost containment program to rein in on increasing costs. This program includes reducing travel and entertainment, eliminating discretionary spending and eliminating certain positions. We estimate that controlling these costs will add approximately $30 million to $40 million of income from operations when compared with the third and fourth quarters of 2010. Of course, we also realize that you have to spend some short-term money to get long-term benefits. And we will continue to invest in system upgrades, our innovation and optimization programs and customer-focused growth. We believe that incurring these costs today will ensure that we're a stronger company in the future. But we also have to be mindful of the present conditions and cut costs wherever we can. For the remainder of the year, we expect recycling commodity prices to remain strong and for our waste-to-energy operations to achieve earnings similar to 2010 second half earnings. Our cost programs and growth initiatives will continue to progress but we expect to see weaker volumes in the second half than we originally planned. Consequently, we now project full year adjusted earnings of between $2.14 and $2.18 per diluted share. Finally, today I'm excited to announce the acquisition of Oakleaf, the largest waste broker in the United States, with annualized revenues of about $580 million. This acquisition provides us an opportunity to add a significant amount of collection and disposal volumes through our systems. In our discussions with Oakleaf, we also recognize that they have some compelling value propositions that they can provide to customers, particularly in the commercial property and food and retail segments. It's similar to what we're doing in those segments through our customer-focused growth efforts. We expect that their excellent sales, management and service teams will greatly increase our penetration in those markets by providing value-added environmental solutions to customers. At the same time, we believe we'll be able to benefit both their current customers and their extensive vendor hauler network to create a win-win situation. The Oakleaf transaction provides great value and great opportunities for waste management. We look forward to our new partnership and we welcome the Oakleaf team to Waste Management. And with that, I'll turn the call over to Bob.

Thank you, David. I will begin by discussing operating costs. These costs increased by $144 million in the second quarter to 63.9% of revenue. The biggest contributor was cost of goods sold, which increased $95 million in the quarter, mainly because of rebates due to higher recycling commodity prices and volumes. Note that these higher commodity prices and volumes, net of rebates, resulted in an increase in our earnings per diluted share from our recycling operations of approximately $0.03 in the quarter. Direct fuel costs increased approximately $39 million, primarily because of a 33% increase in price per gallon of diesel fuel. Subcontractor costs increased $6 million in the quarter, primarily relating to the increased fuel costs at our transfer operations. In the second quarter, fuel surcharge revenue continued to offset the increased cost of direct fuel and fuel increases included in subcontractor costs. Maintenance costs increased $17 million, primarily related to the higher costs for parts and supply, tires and lubricants at our collection and landfill operations. As David said, we have seen prices for these items increased between 10% and 40% year-over-year, generally in line with prior commodity prices. Operating expenses increased $24 million due to acquisitions made within the last 12 months. And foreign currency translation for our Canadian operations accounted for an increase in operating costs of approximately $8 million. SG&A costs increased $37 million year-over-year and, as a percentage of revenue, increased 50 basis points to 11.4%. The increased costs in SG&A primarily relate to our strategic growth plans and our cost reduction initiatives and are in line with what we discussed on our previous conference calls this year. Our growth initiatives, which include medical waste and Bagster had a negative $0.03 per diluted share impact on the quarter. When we gave guidance for the year, we described the initiatives to reduce costs and improve efficiencies in areas like procurement, routing and logistics and the centralization of certain functions. We spent approximately $19 million on these initiatives in the second quarter, consistent with our expectation. We are now starting to see positive traction in procurement where we have $5 billion in spend that we can go after. Given the positive results that we have seen late in the second quarter, we feel confident that we will see the benefits in the third and fourth quarters that will more than offset the full year cost of these initiatives. We also expect that in the second half of 2011, the consulting costs for these initiatives will decline by $22 million. The remaining SG&A costs associated with these initiatives will support future revenue growth and will reduce operating expenses. Interest expense for the second quarter increased $3 million compared with the prior year. On June 30, 2011, our weighted average cost of debt was 5.4% and our debt-to-total-capital ratio for the quarter was 57.7%, consistent with our target ratio of about 60%. The floating rate portion of our total debt portfolio was 18% at the end of the quarter. During the second quarter, we amended our $2 billion revolving credit facility, significantly reducing the cost of the facility and extending its term to May 2016. The credit markets had improved significantly since we executed our agreement in June 2010 and we view this as an opportunity to meaningfully reduce our future interest cost. We estimate that we should save approximately $5 million in interest expense during the second half of 2011. Our income tax rate, as reported for the second quarter of 2011, was 34.5%. For 2011, we expect the recurring effective tax rate to be approximately 35%. Turning to cash flow. Second quarter 2011 net cash provided by operating activities was $478 million. This was flat compared to the second quarter of 2010. Our capital expenditures for the second quarter were $280 million, $60 million higher than the second quarter of 2010 and consistent with our plan to increase capital expenditures in 2011. We still anticipate spending between $1.35 billion and $1.45 billion on capital expenditures during 2011. Our free cash flow for the quarter was $206 million, which was $69 million less than the prior-year quarter, largely due to an increase in capital expenditures of $60 million. We still expect free cash flow for 2011 of about $1.25 billion. In the second quarter of 2011, we paid $161 million in dividends and we repurchased $105 million of our common stock, continuing our long-standing emphasis on returning cash to our shareholders. We also completed approximately $58 million in business acquisitions. Now, we believe that the actions we are taking to grow and to optimize our operations, including the acquisition of Oakleaf, are the right actions. And with the help of our employees, the best in the business, we will begin to see the results of those actions in the second half of this year and into 2012. And with that, Nicole, let's open the line for questions.

[Operator Instructions] Your first question comes from the line of Hamzah Mazari with Crédit Suisse. Hamzah Mazari - Crédit Suisse AG: The first question is just surrounding pricing. Maybe if you could give some color. Is the price discounting you're seeing from regionals broad-based? Or are you seeing that more in certain markets? And then what gives you confidence that the 80 bps to 100 bps of price actions that you're taking are going to materialize? Because it seems like the mix are towards temporary roll-off. It's not changing. It seems like the rollbacks likely are not changing and it seems like we're not expecting any incremental volume upticks here, which were -- maybe help pricing. If you could just add some color there.

Sure, and I think you're exactly right, Hamzah. The mix issues, you know, they were more dramatic at 60 to 80 basis points this quarter than they've been in the past. And frankly, we don't see those offsetting. And so what we need to do is we'll get that 80 to 100 basis points of benefit from the actions we're taking. And hopefully, that more than offsets the mix issues. Now obviously, if the mix issues get worse in the back half of the year and you can't predict the mix, it's a problem. If they were to get worse in the back half of the year, obviously, that would have more of an effect on that 100 basis point improvement. The first part of the question is interesting. I think everybody recognizes that we've generally been the price leader in the markets that we serve. And in the past, what we've seen is that the regional and national competitors that basically drafted off of our price actions and all the rises, all the tides lifted the rising boats. But what we've always seen sort of pockets of places where I would say there wasn't as much pricing discipline. Over the last couple of quarters, what we've seen is that those pockets have expanded to where it looks to us like it's virtually in every one of our markets that we're seeing folks that aren't drafting on our pricing actions anymore. They're taking actions that are designed more to get volume than to draft on our pricing actions, and that's become pretty widespread throughout our markets, obviously, as the economy hasn't improved. Now the reality is that you get -- you can never get as much benefit from volume as you can from pricing. All the pricing falls to the bottom line but the volume doesn't. And so we continue to recognize that the trade-off is positive. But the trade-off is positive. We've been raising prices on our current customer base where we've seen the deterioration. Again, as you pointed out, it's frankly in the pricing rollbacks in order to maintain our customers that are under attack and in the mix, which, obviously, we don't have any control over. So if we see sort of the 20 to 40 basis points of mix in the back half of the year offset by the 80 basis points to 100 basis points of pricing action, that's how you get back to our 2% yield. Hamzah Mazari - Crédit Suisse AG: Okay. And then just on the Oakleaf transaction. What kind of synergies are you targeting? Assuming that $80 million number is all synergies, and what buckets do you think those will come from? And does this transaction change any kind of your return of cash to shareowners? How should we think about that?

Yes, it shouldn't affect the return of our cash to the shareholders. And from a synergy point of view, certainly, there are synergies that will be obtained in the combination. But the primary driver of value here is the ability to manage the waste volumes that they're collecting from the customers. And so very little of the benefit comes from synergies. The primary driver of value here will be managing that network.

Your next question comes from the line of Scott Levine with JPMorgan. Scott Levine - JP Morgan Chase & Co: So looking for maybe a little bit more color on the pricing subject. It's a pretty big shift. It seems like within a relatively short period of time. So just maybe if you can provide a little bit more color on the types. I mean it seems regionally you're seeing more competition everywhere. But is it certain types of markets? Is it the urban markets? Or is it the more or less populated regions? Is it more within particular lines of business where you're starting to see competition pick-up? Any additional color there would be helpful.

Yes. And Scott, like I said before, the interesting thing that's happened over the last couple of quarters is that it has become more widespread throughout the business units. It started out at the beginning of the year. We recognized that there was going to be some pretty aggressive action in big residential contracts and we took account of that in our front year guidance. But it has spread to the roll-off in the commercial lines. We just got through in the last 2 weeks going through all 25 of our geographic areas to look at their market business strategy for the next 4 years. And for the first time since I've been meeting with these folks on a quarterly basis, it was virtually every market that said they're seeing very aggressive pricing action spreading, starting out, obviously, in the residential line of business but now spreading to the commercial and the industrial line. And that's why you see our price rollbacks growing. So in other words, I think the whole point of the pricing is a few things. First off, we're not going to back off on our price increases because the trade-off is still positive, but we are seeing more reductions from rollbacks, which is obviously competitively driven. And then we got this mix issue that, quite frankly, we didn't see coming in the beginning part of the year. You can't predict the mix. And it really hit us hard in the second quarter. We expect it to abate a little bit but we still expect to see some of that in the third and fourth quarters. Scott Levine - JP Morgan Chase & Co: Follow-up. I think you mentioned some changes recently to the senior leadership team. I was hoping you might be able to provide some color on that and maybe an update with regard to the CFO search.

When I look at the senior leadership team and the composition of the senior leadership team, what we were trying to do was to align the senior leadership team around our primary focuses. Right now, that is all about our customer focus, growth efforts and our innovation and optimization efforts. And I wanted to get the team aligned around that. Bringing Jim Trevathan in from the field, I think, was something that we needed in order to make sure that we could drive both of those into the field. I mean those are the 2 biggest things we're working on, and I needed someone with a depth of experience and with field credibility to be able to drive those big programs throughout the company. So I think Jim will be a tremendous benefit there. On the CFO search, as you all know, it will be very difficult to replace Bob, but we are well on the way in our search. And we fully expect that by the time he marches out the door on September 30, we'll have his replacement in the chair.

Your next question comes from the line of Bill Fisher with Raymond James. William Fisher - Raymond James & Associates, Inc.: A couple of things. One on the $80 million of operating income improvement you're targeting. Is that in the second half versus the first half? Or is that kind of a year-over-year thing?

That is the second half versus the first half. William Fisher - Raymond James & Associates, Inc.: Okay. And on that, you kind of roughly did -- I know it's coming from both operating improvements and SG&A, but is there -- should the SG&A, I think Bob highlighted some numbers, should that just drop sequentially in kind of a half-half split, if you will, between those 2 things?

I think what you'll see is the SG&A will still be up year-over-year. It won't be up as much as we had planned from the beginning. But the initiatives, the customer-focused growth initiatives and the innovation and business optimization initiatives, are going to continue. And they're incremental to what we were spending last year. So what we've done is we've been sourced a lot of the consulting work and won't be needing that anymore. And we produced ads in a number of places and in a number of functions. So I think that it will -- I expect SG&A for the year to be a little under 12% of revenue. William Fisher - Raymond James & Associates, Inc.: And on Oakleaf, is one of the benefits next year as well your -- to the extent another hauler in a local market serving a national account, and you have hauling obviously there, you can internalize that and then bring that collection in-house, if you will?

Yes, there's really 2 approaches that will take in every market. The obvious one is exactly that. But when you think about it, just to use an example, let's assume that a hauler has $100,000 of Oakleaf business in a particular market and that's 10% of their revenue. If $100,000 is 10% of their revenue, that means they have $1 million of total revenue, right? And that also means that about 30% to 40% of that $1 million is disposal costs for them. So they've got $300,000 to $400,000 of disposal costs on their $1 million of revenue, right? That's 3x to 4x the amount of revenue that Oakleaf has in that market, that $100,000. So when you think about it, you can get 3x to 4x the revenue if you're able to get all of their disposal volumes in a line of business that has about double the margins of the collection line of business. So if we're able to work with those haulers to get them to bring all of their volumes to our disposal and recycling facilities, we actually do a lot better than if we take over that business on the truck. We can do better on the order of magnitudes. So you're getting 3x to 4x the revenue in a line of business that probably has double the margin. So you're getting 6x to 8x more benefit if you can add that hauler, bring their volumes to your landfill network and your recycling network. And so we're going to work with those local haulers to actually keep them in place. But look, if we can provide better disposal solutions for them, that become a win for them and a win for us William Fisher - Raymond James & Associates, Inc.: And then just real quickly, that 80 to 100 basis point on price you're trying to get, would you say half of that's from that environmental fee increase? Or how do you think about that?

That's about right. It's about half -- a little bit more than half of the environmental fee, and then the rest from accelerating price increases into the year.

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

I want to press a little bit on this mix issue and in particular, what changed from sort of the April call to today or to adjusting guidance down what seems like a significant number in a very short period of time.

Yes. And frankly, we were a little bit surprised by it. When you look at the first quarter, we had a slight negative for mix. In the second quarter, that went to $19.5 million, and so it was a pretty dramatic shift pretty quickly. And most of that occurred in our southern group. So for example, in South Florida, we have franchise business. And in the franchise markets, our permanent roll-off is actually higher priced than our temporary roll-off, a little different than most of our other markets. But the permanent roll-off business has started in Florida, has started to feel the heat from the economy over the last few years. But actually, there was a pretty good tick-up in temporary businesses. So you had a mix in the roll-off line that went from higher-priced to lower-priced volumes. You've also had some residential contracts throughout the country where, in order to maintain or extend those contracts, we'll go in and offer a recycling service. So if you are doing a solid waste home at $12 a home and you go in and you do recycling at $2 a home, you've made a good business decision. But your yield looks like it's going down. And then we've got a lot of special waste, as you know, for the last few years and special waste is always interesting. The example I use is if you have a landfill where you are bringing in waste from a long distance, you might charge $18 at a whole but you charge $50 for transportation. But then if the volumes come in from closer, you might charge $20 at the whole with no transportation. So you're actually making a great business decision. You're making more money but it looks like your price has gone down because of the mix of volumes. And so I think with the increase in special waste, with the change in South Florida, with the change with some of the residential contracts and then with our normal churn, we saw that hit us a lot harder in the second quarter than we've seen in the past.

David, if I looked at the 1.5% to 2.5% decline and then back out the so-called large special waste item, that being in the gulf, what's the decline in the business now? Because you were basically suggesting flat heading into this sprint, but there's obviously these items you've talked about.

Yes. When we look at volumes, really, what you're seeing -- I think what we're seeing in volumes mirrors the U.S. economy, which is we just aren't seeing the West and the South come back, work through their housing problems as fast as we expected. And then -- so what we've seen in the last few quarters is that the Midwest and the East have actually been doing fairly well. The South and the West haven't been doing so well. And then this quarter, what you saw was that the West and the South continued to have negative volumes. But you also saw in May and June, you saw even some softness in the Midwest and the East, which, I think, is probably driven by the same effects, the same factors that you saw on the national economy. So what we're seeing is that volumes continue to remain stubbornly low. We've talked about it since the beginning of the downturn, which is what you'll see, I believe, is when you see the commercial volumes start to turn is when you'll see the volumes turn for us. And we just haven't seen that happen yet.

Okay. And then if I may try to bridge or do the waterfall from the prior EPS guidance to the current, which, I guess, excludes any consideration of the Oakleaf, it looks like at midpoint there's an $0.11 drop to the guidance. And so I was wondering, if someone could provide the buckets of which you would associate that $0.11 drop, so 50% volume, 3% of it's price, I mean what's the...

I would tell you that the drop is volume. That drop in volume, Al, is offset by the actions we're taking on the cost side. Remember, the actions we're taking on the yield side ought to just get us back to where our guidance was at the beginning of the year. And if the actions that we're taking on the cost side plus a little bit of improvement in our outlook for recycling commodity prices and recycling volumes.

And I would tell you that I think that's exactly right. The primary change is the volumes. The secondary change has been the price rollbacks. I mean we did not go into the year expecting to see the level of price rollbacks we have. Obviously, it's a more competitive market out there than we had anticipated. And I think that makes sense given where the volumes are. We expected there to be a little bit of return to the volume, which obviously takes a little bit of the pressure off of both local, regional and national players to lower price. I think as they've seen the volumes continue to remain weak, they've gotten more aggressive on price. And as I keep saying and saying and saying, and I'll continue to say, we're not going to take those actions but we're going to have to respond to those actions by maintaining customers through price rollbacks.

Structurally, don't expect any change in the price strategy, continue to be firm on that. But as a result of that, we should expect some net churn and higher churn in volume?

That is a result of that. I would say it's just what the volumes were with the economy this way.

And what it comes down to, I mean the churn rate in the quarter was actually slightly improved. But the problem is that we have to rollback prices to maintain those customers. So I don't think -- look, we have a choice. When every customer calls in and says they got a lower price from someone in the competition, we have two choices: let them go or maintain them by reducing their price as little as we can by offering them other services and things like that. But we need to maintain those customers. So at the same time, we've got a pricing strategy that says we're going to continue exactly as we've been in the past, getting those 6% to 7% price increases and maintaining our new business pricing discipline, but we're going to have to be more aggressive to maintain customers.

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

1Q '10, you had a price scenario that I'm going to try and possibly equate to what we're seeing in 2Q in the sense of it doesn't live up to your expectations. And you fairly quickly turned around to the system and said, fix it. And they did and we saw a rapid change in 2Q. Can you compare those 2 to us on the context of that you're dealing with and the probability of that ability to have that quick turn?

Yes, I think -- actually, that's a great question, Michael. And that's what we've been spending a lot of time. I would say we've been spending most of our time over the last probably 3 weeks working on. And I think you are exactly right. The parallel is very clear. The only difference is -- and so the organization will get it done. I don't have any doubt about that. We've already got the environmental fee rolling out. We've got the acceleration of our price increases in the pipeline. So the organization will respond. I don't have any doubt about that. The difference that we've got between this year and that year, because what you saw was we dropped below 1% and then we immediately snapped back well above 2%, the only difference you have between now and then is this mix issue, right? I mean we didn't have the 60 to 80 basis points of mix headwind. And again, mix doesn't necessarily reduce your bottom line earnings. In my examples, you're actually making more money but it looks like your yield is going down. And so you would see exactly the same snapback if it weren't for these mix issues. And the way we're looking at the mix issues right now, we're expecting them to continue in the back half of the year. So I think the corollary is identical. As soon as we see deterioration, we take action to do something about it and we intend to maintain that discipline.

Okay. And so another side of that question is, you're being more proactive about defending long-standing businesses as opposed...

Right.

Okay. But that in itself is not necessarily a bad thing either because the alternative is to replace it without being too long about this. I mean if you had a customer churn at 10%, then you're talking about having customers for 10 years. So if you've held on to somebody for 10 years and you put him in at $3 a yard 10 years ago but raised prices 6% year-over-year, you're somewhere in the $5 or $6 a yard now and the competitor's somewhere between $3 and $5 to try and pick it off.

You're exactly right. And when we look at it, we look at new business pricing, lost business pricing, the business that we look at from a lost business pricing point of view, the business that we have is spectacular business. It's way above what our competition is charging for new business. And so the smart thing to do is to maintain those customers because you don't have the -- obviously, you don't have the acquisition cost for those customers but you also have those customers already at great rates. And so you've hit the nail right on the head. The problem is that we have to spend our efforts defending the price, and we're going to do that. And I would hope that, as folks recognize, that we're not going to let go of customers as readily as we have in the past, that they'll realize that, for their own company, they're going to start a debt spiral that probably doesn't end where they want it to end.

All right. And then you've highlighted Florida very specifically. And unfortunately, there's 3 relatively sizable -- between Advanced Choice and Waste Pro, they're noted for being the price draggers in Florida. But the other thing is such -- I can see where maybe the -- that's why your problems -- but let me understand mix. So what I'm basically hearing is that bankruptcies are increasing or basically people going out of business that used to be permanent. But the temporary would suggest that there's some economic recovery recurring as well.

I think in South Florida, I'm not sure if I call it an economic recovery. It's a dead cat bounce, right? I mean the roll-off volumes went down so dramatically that it's pretty easy for them to grow, right? And so you've actually seen a little bit of growth in the temporary business but you've seen shrinkage in the permanent business.

All right. And then on the free cash flow side, to hit the goal for the rest of the year, you've done just under $500 million, if I brought math correctly, for the first half. That means you have to do 750-ish in the second half. And noting this $80 million that you're going to capture in savings between the yield and cost cuts, so that would suggest to me the run rate was 670 going in. That seems stronger than the normal. It's 55, 2nd half, 45, 1st half mix of your free cash.

It's like it will be more like last year where we have stronger free cash flow in the second half of the year than we had previously, and I think that's what we're expecting to see.

But the degree of that strength would suggest that it's not great news to be able to tell everybody that you're lowering guidance. I get all that. But reading through it, the degree of that strength would say that if I roll into '12, I'm going to be up in free cash.

In '12?

To '12, 2012.

But we haven't given guidance on that yet. But Michael, I don't know why that wouldn't be true.

Right. Just following the logic on this. The 2012, that's got to be higher than 1.25 based on what you're describing how this plays out in the second half.

Well, I think that's right. I mean we're taking a lot of steps. We're paying the price in SG&A now to grow our business, to reduce our costs. And we should see the benefits of those, some of it in the second half of this year but accelerating into 2012 and later years.

Okay. So not to press the fine point, where's the Board's tolerance or patience with regards to the show me this is really happening?

Yes, Michael, it's interesting because obviously, you have to spend money to make money. And we had a lot of opportunities to get long-term benefits. We identified it at the beginning of the year. We knew we had to spend money in order to get those benefits. I mean that's just the nature of the beast. But we also expected volumes to bounce back. I mean, look, the reality is that these dollars that we're spending to benefit our future wouldn't even be recognized if we were showing volume growth and continuing to get 2%-plus yield. It wouldn't be affecting our numbers whatsoever. We happen to be spending money for the future in the teeth of volumes and price that aren't as strong as we thought they would be. And so you have 2 choices, right? You either say, okay, we're going to cut the spending because we're not seeing the volumes with price come in, or you say, we're going to continue to do what we think is the best thing for the long term of this company. And you spend despite the fact that you’re seeing -- because you know you are going to get the future benefit and you keep spending despite the fact that it's been a tough year. I said it in my script, it's a tough balance to do for the long term and the short term. But we're going to spend to benefit the long term. But on the other hand, we're also going to go to our organization and say, look, we've got to find everywhere we can to cut out costs other than the investment in the future. And so when you talk about a Board, our Board is obviously a long-term thinking Board. We're a long-term thinking management team. And so I think they have -- as long as they're seeing the progress, I think they've got the right amount of patience.

I think they recognize that the journey is not a straight line.

Okay. And clearly, they targeted an $80 million number. You can't tell the market to not actually deliver on it. So you must have an awful lot of visibility on that number.

Well, as we said, a good part of that is from pricing actions, and we've already done that. Now if we had to roll that back dramatically, but we built into the plan what we think is a reasonable amount of rollback of that, and so that could affect it. And on the cost side, we've already taken a lot of the action to pull those costs down. So yes, we're pretty caught confident there.

All right. And then lastly, this isn't public records. So the Woodlands, Texas municipal bid, you guys lowered the price pretty significantly to keep it. I mean it was $12.50 a home and now you're at $9. So I mean that seems pretty -- is it taking that kind of change to be able to keep business?

Yes, it's a different -- we also had a different level of different service in there, right? And so I think that's a great point. That's a place where it looks like we are reducing price, but basically what we did was we went in with different service levels and we actually do just as well on that contract than we did at the higher price. And so it's one of those actions that is a good business decision but that also that makes it look like you're dropping price.

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

First question is, Bob, I think you commented that you think that increasing the yield level won't hit volumes. Could you just square that with the idea that right now you're going to rollback price more? And if it's not going to hit volumes, why not in for 2.5 points of price instead of 2 points?

Yes, I think what I was saying, Corey, is not yet in what I've -- first of all, I think we've shown over time that raising prices hasn't really impacted our churn rate. Our churns have been between 9 and 11, ever since I got here 12 years ago. It stayed in that range and it's still in that range now. So the impact of raising prices hasn't been a significant impact in how our volumes have performed. Now we have increased rollbacks in the second quarter and that maybe indicate a higher level of competition. But we're still going to get 2% yield even with a little bit higher level of rollbacks. We think the real driver of the volumes isn't the price increases. It's the economy and where businesses are right now.

Okay. And David, I think you said the roll-off, relative temporary roll-off strength was a dead cat bound to that. I think that's right. Assuming the cat doesn't keep bouncing indefinitely. Wouldn't that suggest that back half of the year, what you're going to see probably is more out and out weakness versus the mix issue?

Yes, from a volume perspective -- Corey, we just haven't seen -- and it's actually very interesting to watch our volume reports because what you'll see is a couple of weeks where you start to think that you're turning the corner and we've actually had a couple of weeks where our volumes were not only above 2010 volumes but we've done a roll-off in the disposal side. But they're not only above 2010 volumes, but they've been above 2009 volumes. And then all of a sudden, they've flattened out. And then on the commercial side, we just haven't seen -- unfortunately, I think that cat's been dead for a while and we just haven't seen any bounce on the commercial side. And that, to me, is indicative of the fact that there's not a lot of strength on the consumer side of the United States economy. There's strength on the manufacturing side. There's strength on the server-side. But right now, there's not a lot of strength on the consumer side.

Okay. And could you just give your thoughts on kind of the coordination between you all in Houston and the field in terms of some of the price rollbacks that you're seeing? Is that completely consistent with what you would have expected in Houston and with what you would have advocated for? Or would you say that the field has maybe been a little bit more aggressive in rolling back price to keep volumes in than you would have liked and you're looking to change that?

No, I think actually, they're doing a good job. I mean again, it comes down to the question of how fast could you add customers to replace the customers that you let leave you and at what rate are they leaving you. And when they're leaving us at the highest rate that we've seen from a rate per yard, rate per pull on the industrial site, when they're leaving us at the highest rates we've seen in a number of years, those are the types of customers -- not the highest rates in the volume point of view but the highest rates from a price per yard and price per pull point of view, those are customers that you don't want to lose. And then you've got to go out and acquire new customers to replace them if you want to maintain your volume. And that cost you some money. And in this environment, that's not an easy thing to do either without lowering your price. So it's the right strategy for us. Can we do better? Yes, we can do better. We can save them at higher prices, and we've got our folks focused on doing that. But it's the right business decision to make and it's one that we've got to continue to make.

Okay. And then a couple of questions on Oakleaf. I presume it's a relatively capital light model. But can you just give us some sense of what their CapEx is?

Yes, their CapEx is fairly low. Obviously, for us, we've got -- as I said before, we've got sort of the 2 business models. We've got the 1 business model where we will have to go in and become the hauler. But our preferred method would be to work with the vendor network to allow them to offer other services that we have, whether it's recycling, LampTracker, other types of services, and then able to offer disposal and recycling services to them across their business line. That's our preferred method. If we go in a market where we go about that method, obviously, there's no additional capital because the containers will stay in place. If we aren't to work out those types of arrangements with the vendor network, then we're going to have to go and replace them and spend some capital. But we don't see that. As I recall, Bob, that was sort of in the $10 million to $15 million on the high end that we have to spend in capital in the back half of the year. And again, if we can work with the vendor network in a win-win manner, we won't even have to spend that.

Okay. And could you just revisit -- I think in answer to the previous question, you were talking about being able to influence the people in the network to use your disposal. Can you just elaborate on that? And what is it about owning Oakleaf that makes that a more easier process than it would have been discussing that with those people when you didn't own Oakleaf?

Yes, well, it makes it easier because we now control a big portion of their collection business, right? I mean in the example I used, if 10% of their business is Oakleaf business, we would prefer to leave that in place and work out an arrangement with the vendor hauler where they bring us recycling volumes and disposal volumes at a level that's cost neutral or maybe even cost beneficial to them. So that's a huge win for them. It's a huge win for us. The reason why we're able to do that, that we aren't able to do now is we don't have -- 10% of their business in that market isn't controlled by Waste Management. As of today, it is. And so if you want to maintain that business, then we've got to look at the other parts of our business relationship to make it a win-win. It's not a win for Waste Management if one of our vendor haulers just simply maintains that $100,000 of business in the market and we do nothing. That is not a win for Waste Management. There's only 2 ways we can win: one, put it in on the back of our trucks and bring it in to our landfill. But then we only get that 10% of the business. If we can get 100% of their volumes into our disposal network, that's a huge win for us. And if we can do it at a cost-neutral, even a cost-beneficial number to the vendor hauler, it's a win for them. And so it's a bigger win for us and a good win for them, and we see that as positive for everyone.

Okay. I was just going to ask when that transaction is going to close?

Closed today.

That is all the time we have for questions today. Are there any closing remarks?

Yes, what I'd like to say is a couple of things. Obviously, we're not happy with what happened in our second quarter. And hopefully, what you've heard today is that we're going to take actions to get this thing right. But we're not going to do that by sacrificing the future. And then I think a couple of other things. On the Oakleaf transaction, I think we'd be remiss if we didn't mention the amazing work that our team did putting this together. We've been in discussions with them for quite a long time but we got into some very serious discussions over the last month or so. And I'd be remiss if I didn't mention John Stein [ph], our legal team and Joe Cassin and Buddy West and Shawn Hill in our finance group and Scott Stadelman in the sales department and tons of other people that have been working night and day to get this deal done. It was a phenomenal job by them. This is going to be a great opportunity for Waste Management. It's also going to be a great opportunity for the folks at Oakleaf. So we're really looking forward to getting to know our new partner. And I can promise you, we'll be meeting with them regularly to let them know what's going on, as we will with the vendor hauler network. And then finally, I wanted to say this is actually Bob's last quarterly conference call. And from my point of view, we've been together now for about 7 years. Bob's been a great business partner, but he's a better friend than a business partner. And we will certainly all miss his sage advice as he wanders off to retire to his beloved Kingwood. So Bob, congratulations on the retirement. And I'm sure I'll be visiting your house often.

Please come out.

Thank you, all.

Thank you.