Waste Management - Earnings Call - Q1 2011
April 28, 2011
Transcript
Speaker 3
Good morning. My name is Nicole, and I will be your conference aide. At this time, I would like to welcome everyone to the Waste Management First Quarter 2011 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now like to turn the call over to Ed Egl, Director of Investor Relations. Sir, you may begin your conference.
Speaker 5
Thank you, Nicole. Good morning, everyone, and thank you for joining us for the First Quarter 2011 Earnings Conference Call. With me this morning are David Steiner, Chief Executive Officer, and Robert Simpson, Senior Vice President and Chief Financial Officer. David will start things off with a summary of the financial results for the quarter and a review of the details of our revenue growth, including price and volume trends. Robert will cover operating costs and the financial statements. We will conclude with questions and answers. During your statements, any comparisons made by David and Robert, unless otherwise stated, will be with the first quarter of 2010. Before we get started, let me remind you that in addition to our press release that was issued this morning, we have filed a Form 8-K that includes the press release as an attachment and is available on our website at www.wm.com.
The Form 8-K, the press release, and the schedule for the release include important information that you should refer to. During the call, David and Robert will discuss earnings per fully diluted share, which they may refer to as EPS, and the impacts certain adjustments would have on EPS. The adjustments discussed are items management believes do not reflect our solid waste business performance and are not indicative of our results of operations. EPS excluding certain items, projected adjusted EPS, and free cash flow are non-GAAP measures. Please refer to the reconciliations to the most comparable GAAP measures in the Form 8-K filed today and the earnings press release footnote and schedules there too, 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.
Those 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. 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 May 12th. 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 512-72844. Time-sensitive information provided during today's call, which is occurring on April 28th, 2011, may no longer be accurate at the time of a replay.
Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now I'll return the call over to Waste Management CEO, David Steiner.
Speaker 0
Thanks, Ed, and good morning from Houston. During the first quarter, our solid waste operations performed well, with strong yield performance offsetting weaker than expected volumes. Our overall business earned $0.39 per diluted share, with about $0.09 of impacts from short-term headwinds. Year over year, we had a negative impact of $0.02 per diluted share from our waste-to-energy operations and $0.01 per diluted share from stock option grants under our long-term compensation program. We also had negative impacts of $0.03 per diluted share from our cost reduction initiatives and a negative $0.03 per diluted share from our growth initiatives. Without these, our earnings would have been $0.48 per diluted share, which demonstrates the strength of our solid waste business. Spending on our cost reduction initiatives will slow in the second quarter, and we should begin to see year-over-year benefits in the third quarter.
Our portfolio of growth initiatives like Bagster and medical waste management will negatively affect the second and possibly the third quarters, but should become profitable by the end of the year. Our waste-to-energy business will have a small negative effect in the second quarter, but will begin to add year-over-year earnings growth in the third or fourth quarter. These headwinds should be very short-term, and we expect them to drive operational and earnings improvement for years to come. During the first quarter, revenue increased by $168 million, or 5.7% from the prior year quarter. This is the fifth consecutive quarter of positive year-over-year revenue comparison. Major drivers of our revenue improvement are improved recycling volumes and higher commodity prices, the continued emphasis on year-over-year yield increases, and acquisitions. Internal revenue growth from yield on our collection and disposal operations was 2.8% in the quarter.
This represents the highest yield since the third quarter of 2009 and the third quarter of sequential growth. In the coming quarters, many of our fees and surcharges will anniversary, causing downward pressure on yield growth. CPI is an important component of pricing in our municipal sector. CPI increased about 1% for the first three months of 2011, consistent with our expectations, but below the level we saw in the first quarter of 2010. We had approximately a 40 basis point reduction in yield from CPI in the first quarter. Many of our contracts adjust on July 1, so the low CPI will continue to negatively affect yield in the second half of the year. Despite these pricing pressures, we'll continue to maintain our pricing discipline and fully expect to achieve or exceed our full-year yield target.
The combined internal revenue growth from yield in the industrial, commercial, and residential lines of our collection business was 3.3% in the first quarter. Commercial and industrial yields were 4.1% and 3.4% respectively. The yield component of internal revenue growth in our residential line of business was 2.3%. Both commercial and industrial new business pricing increased compared to the first quarter of last year. The commercial increase represents the seventh consecutive quarter of year-over-year improvement. Our customer churn has been improving steadily over the last three quarters and improved to 9.5% in the first quarter of 2011. On the volume side of the business, internal revenue growth from volume declined 1.7% in the quarter, a 10 basis point sequential improvement from the fourth quarter of 2010. We had expected that volumes would be stronger in the first quarter. However, the winter weather certainly had a negative effect on volumes.
Both our commercial and residential collection lines of business saw year-over-year volume declines of 5.6%. The residential line of business improved 30 basis points from the fourth quarter, which is the first sequential improvement in residential volumes since the fourth quarter of 2009. Industrial volumes declined by 2.8% on a year-over-year basis, which was the seventh straight quarter of sequential improvement. By focusing on pricing, we were able to overcome the declining volumes and grow income from operations and margins year-over-year in the collection line of business. In the landfill side of the business, first quarter 2011 internal revenue growth from volume improved by 1.6% compared to the first quarter of 2010. C&D volumes improved 6.4% year-over-year, up from the flat volumes that we experienced in the fourth quarter. Internal revenue growth from volume for special waste was positive 2.9% year-over-year.
As you know, special waste is generally more affected by weather than other volumes, so the severe winter weather had a bigger effect on this segment. We still see strength in the pipeline for special waste volumes and expect them to improve during the coming quarters. For MSW, internal revenue growth from volume was negative 6.7% year-over-year. On the yield front, all of the waste streams had positive revenue growth from yield for the first quarter. The landfill business overcame the weather drag on volumes with strong revenue growth from yield, and income from operations in the landfill line of business also improved from the first quarter of 2010. When looking at the combination of the collection and the landfill lines of business, income from operations grew 4% compared to the first quarter of 2010, and income from operations margins grew over 30 basis points.
In our waste-to-energy operations, income from operations declined in the first quarter compared to the first quarter of 2010. The expiration of a long-term electric power capacity agreement had a $6.3 million negative effect in the quarter. Also affecting the decline were upgrades to our acquired facility in Virginia, lower electricity revenues, and weather, all of which are expected to improve as we progress throughout the remainder of 2011. For the rest of 2011, we expect to have an additional $0.02 earnings per share year-over-year drag in the second quarter, with the third and fourth quarters being flat to slightly positive year-over-year. 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 first quarter of 2011, which was consistent with our expectations for the first quarter. Commodity prices have increased approximately 18% when compared with last year.
We had expected prices to come down during the year, but so far they've remained strong. If prices continue to remain strong, we should see about a $0.02 earnings per share benefit in each of the second and third quarters and no net effect in the fourth quarter. With respect to solid waste volumes, through the last weeks of March and the first few weeks of April, we've seen some encouraging signs. We expect to see our normal seasonal improvement during the quarter, leading to steady improvement through the second and third quarters, such that 2011 volumes should be closer to flat when compared with the full year 2010. Of course, it's difficult to extrapolate first quarter volumes to the rest of the year, particularly due to severe weather effects in the first quarter. We will have more clarity about our volume projections after we see second quarter volumes.
We made good progress in the first quarter, and we fully expect our cost reduction programs and growth initiatives to turn from headwinds to tailwinds in the second half of the year. With improving volumes, our customer-focused growth initiatives, and our continued focus on operational excellence, we're confident that we're on track to meet our full-year adjusted earnings forecast of $2.24 to $2.30 per diluted share. With that, I'll turn the call over to Bob.
Speaker 4
Thank you, David. I will begin by discussing operating costs. These costs increased by $114 million in the first quarter to 64.3% of revenue. Cost of goods sold increased $67 million in the quarter, mainly because of rebates due to higher recycling commodity prices. These higher prices net of rebates have resulted in an increase in earnings per diluted share from our recycling operations of approximately $0.03 in the quarter. Direct fuel costs increased approximately $27 million, primarily because of a 27% increase in diesel fuel. Subcontractor costs increased $15 million in the quarter, primarily relating to the increased special waste hauling and increased fuel costs at our transfer station operations. In 2010, we redesigned our fuel surcharge to better match changes in diesel fuel costs.
In the first quarter, the redesign worked as planned, as the fuel surcharge offset the increased cost of direct fuel and of our fuel increases that are included in our subcontractor costs. Maintenance costs increased $11 million due to planned maintenance projects at our waste-to-energy and our landfill gas-to-energy facilities. Operating costs at businesses we acquired accounted for $24 million of the increase. Foreign currency translation for our Canadian operations accounted for an increase of an operating cost of approximately $6 million. Our SG&A costs increased $31 million year over year, and as a percentage of revenue, increased 30 basis points to 12.3%. The increased costs in SG&A relate primarily to our strategic growth plans and cost reduction initiatives and expenses related to our stock option grants under our long-term compensation program.
Our growth initiatives, which include medical waste management and Bagster, had a negative $0.03 per diluted share impact on the quarter. We expect our growth initiatives to have a negative earnings per share impact in the second and third quarters and to be flat to slightly positive in the fourth quarter. One of our three long-term strategic goals is to continuously improve our operational efficiency. During our fourth quarter conference call, we told you that we had brought in external consulting to assist us with initiatives to reduce costs and improve efficiencies in areas like procurement, routing, and logistics optimization, and the centralization of certain functions, such as dispatch. The upfront costs for these initiatives were approximately $20 million in the first quarter.
The outside consultant costs are expected to be a negative $0.02 per share in the second quarter and a negative $0.01 per share in each of the third and fourth quarters as we internalize the work of the consultants. The benefits from our cost reduction initiatives are expected to more than offset these costs in the third and fourth quarter and accelerate into 2012. In summary, in the first quarter, we faced $0.09 of EPS headwinds. We expect these headwinds to be approximately a negative $0.06 per share in the second quarter, consisting of a negative $0.02 per share from each of our waste-to-energy operations, our growth initiatives, and our cost reduction initiatives. We expect these investments will benefit the second half of the year, accelerate in 2012, and will lead to sustained margin expansion. Interest expense for the first quarter increased $9 million compared with the prior year period.
This is primarily due to higher upfront costs and usage fees on the revolving credit facility that we executed in June 2010. On March 31, 2011, our weighted average cost of debt was 5.6%, and our debt-to-total capital ratio for the quarter was 58%, 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. Our income tax rate, as reported for the first quarter of 2011, was 35.9%. Included in the first quarter effective tax rate are adjustments to our net deferred taxes, including a $2.2 million expense related to an income tax rate increase in Illinois. For 2011, we expect the recurring effective tax rate to be approximately 35%. Turning to cash flow, first quarter 2011 net cash provided by operating activities was $600 million.
This represents a 21% increase over the first quarter of 2010 and is the highest first quarter net cash provided by operating activities since the first quarter of 2006. The increase was driven primarily by changes in our working capital. Our capital expenditures for the first quarter were $316 million. We still anticipate spending between $1.35 billion and $1.45 billion on capital expenditures during 2011. Our free cash flow for the first quarter was $289 million, which is $36 million better than the prior year quarter, despite an increase in capital expenditures of $61 million. This performance puts us well on the way of achieving our expected free cash flow for 2011 of between $1.25 billion and $1.35 billion. In the first quarter of 2011, we paid $162 million in dividends, and we repurchased $63 million of our common stock, continuing our long-standing emphasis to return cash to our shareholders.
We also completed approximately $100 million in business acquisitions. As we go forward with our cost reduction and growth initiatives, it is encouraging to see our traditional solid waste business perform so well. Through the dedication of our hardworking employees, we were able to achieve solid performance in this quarter, and for that, we thank them. Nicole, let's open the line for questions.
Speaker 3
At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Vance Edelson with Morgan Stanley.
Speaker 1
Thanks for taking the questions. On the C&D, it sounded like a good bounce back despite any weather impact. What's your outlook for the rest of the year and into 2012? Any feel for what the pattern might be?
Speaker 0
Yeah, you know, when you look at the C&D volumes, obviously, you also have to look at the industrial volumes. What we've seen over the last few quarters is fairly consistent growth in that. Now, obviously, industrial hauls are still down in the quarter, but you're starting to see that they've improved quarter to quarter now for quite a while. We would fully expect to see those C&D volumes at sort of positive 5% to 10% continue for the rest of the year.
Speaker 1
Okay, great. Any update on what you see for landfill pricing as a sort of a target for this year? Do you still think mid-single digits for pricing or even higher is possible for the full year?
Speaker 0
Yeah, you know, the first quarter, our pricing was fairly consistent at the landfill where it's been for the last year or two. I would think that two things are going to help us improve that during the year. First, you've got seasonality. As volumes improve, you ought to have more opportunity for pricing. We've always said that sometimes high fuel costs are our friend, right? We get to pass through the higher fuel costs through our fuel surcharge. That worked very well this quarter, having no net effect on the quarter. With our landfills being positioned in a lot of places and advantaged geographic locations, it now becomes a lot more expensive to drive past our landfill and to bring it to a competing landfill. Both of those factors should help us in pricing during the course of the year.
Speaker 1
Okay, great. Just one more question for me. What do you feel is driving the improved recycling volumes? Do you think that's mainly cyclical as the economy gets better, or do you discern any longer-term trends there?
Speaker 0
I think, generally, the long-term trend has been that demand from Asia, primarily China, has been driving recycled commodity prices. The encouraging thing is that because of some consolidation in the mills in the United States, you've actually seen the United States' domestic mills requiring more recycled papers. For the first time that I can recall, you're seeing a healthy domestic market and a healthy export market, and I think that bodes well for the rest of the year.
Speaker 1
Okay, that's helpful. Thanks a lot.
Speaker 0
Thanks, Vance.
Speaker 3
Your next question comes from the line of Hamza Mazzari with Credit Suisse.
Speaker 1
Hello, Hamza. Hi, good morning. Just a couple of questions. The first question is on volume. Could you give us any sense of what the underlying volume decline is if we adjust for the severe weather impact? Also, you're guiding volume flat for the year. I'm wondering what you're assuming on seasonality within that guidance and what you believe the ramp-up looks like in volumes for the balance of the year.
Speaker 0
Right. First off, on the weather, we think that the weather in the first quarter was probably about a 0.30% drag on volumes. For the rest of the year, from a seasonality point of view, when we look at last week's March and the first weeks of April, in the lines in our industrial and in our landfill line, we're seeing more weeks that have been year-over-year positive than negative. We've still seen some negative weeks, but more weeks have been positive than negative. Frankly, we're still not seeing a lot of movement in the commercial volumes. We've been talking about that now for three or four quarters. The year-over-year uptick will be driven primarily through the landfill volumes and improved industrial hauls.
Speaker 1
Okay. Just a question on pricing. That came in higher than expected. Could you give us a sense of where the upside is coming from? It's obviously not coming from CPI. It seems like landfill pricing is still what it was a quarter or two ago. How aggressive are you being on pricing new business?
Speaker 0
Yeah, that's a great question because I think it's very perceptive. We're not seeing yet a large pop from landfill pricing in overall IRG. Certainly, CPI has been a drag. What we've seen is that our new business pricing has been driving it fairly dramatically, and then our fees and surcharges have been driving it. The container service fee that we instituted a couple of quarters ago, the environmental fee still is driving it, but that'll anniversary in the second quarter. Our administrative fee provides some benefit in the quarter. That also anniversaries in the second quarter. What's going to have to drive it going forward? We expect to see some headwinds, as I said, from CPI and from the anniversary of fees. What's going to have to drive it going forward is a continued, as you point out, continued new business pricing continue to increase.
Price increases on our commercial line of business, which we've been pretty good about doing in the last five years, and then better landfill pricing in the back half of the year.
Speaker 1
Okay. Just last question on capital allocation. If you could just touch on, you know, how you're thinking about that. It seems like you're, you know, you've backed away sort of a little bit in terms of going after any large deals over the next 14 months. If you could just update us there, thank you.
Speaker 0
Hamza, we don't comment specifically on anything, but we think there's a pretty good pipeline of acquisitions, and we will continue to pursue them. I don't see us doing anything gigantic, but I do see us continuing to look at the pipeline and playing where we think we can get some value.
Speaker 1
Thank you.
Speaker 0
Thank you.
Speaker 3
Your next question comes from the line of Scott Levine with JP Morgan.
Speaker 0
Hey, Scott.
Speaker 1
Hey, good morning, guys.
Speaker 0
Good morning.
Speaker 1
Your pricing number is stronger than we expected, and it looks like it's accelerating despite some of the headwinds that you mentioned. Could you talk about how that came in relative to internal expectations? Given the fact that inflation is starting to move back up, could you talk maybe about how that should impact pricing within your business as you move through this year into next? Should we think about, like you said, the fees anniversary, what have you, the expectation for the year? I think you mentioned in the last call at 2%. How should we think about all that playing out and pricing trends through this year and into next?
Speaker 0
Yeah, obviously, with the strong start we've got in the first quarter, you know, our 2% goal, we certainly believe we should exceed that for the year. The way, Scott, that I sort of look at pricing for the year is that the back half of the year, we're going to have the headwinds of CPI, and we're going to have the headwinds of the anniversary and fees. In 2012, you know, the CPI should become a tailwind, which hopefully offsets the headwinds from the anniversary and of the fees. You know, then you're back to sort of a normal state, if you will, where pricing is driven more by the traditional methods of pricing, which is, you know, annual price increases on your customers at both the collection and landfill line of business.
The back half of the year, I would expect, you know, we're going to maintain our pricing discipline. I'm not surprised by the 2.8% in the first quarter. You know, I wouldn't be surprised to see that come down a little bit in the remaining quarters of 2011, but then I would expect to see it go back up in 2012 as we start getting the tailwinds from the CPI benefit.
Speaker 1
Additionally, with regard to the quarter, you know, you had some maybe unforeseen headwinds with weather and fuel, which you didn't quantify in the release. Was the first quarter result relative to your initial expectations pretty much consistent with internal expectations? Just trying to get a sense of whether we should be favoring the higher or the lower end of the guidance range at this point in time.
Speaker 0
Yeah, I would say it was fairly consistent with internal expectations. We had the penny from stock options, which was not built into our budget when we put our budget together. We probably had a little bit, probably a penny worth of weather that we didn't build into our budget. The rest of it was pretty much built in. I would say it was consistent with our internal expectations. You all can see it just like we see it, which is we've got to get those cost savings in the back half of the year if we're going to make our number. Right now, we've got some fairly good visibility into that, and we're pretty confident we can get it done.
Speaker 1
Understood. One last one, if I may. I saw you made an acquisition here of some water treatment assets in the Marcellus. Could you talk maybe about some of the acquisitions? I think you said were $100 million in the quarter. Maybe some color around some of the areas. Was most of that solid waste, or are there some niche areas where you're looking to increase your capabilities?
Speaker 0
Yeah, most of that was in recycling assets along the Atlantic Coast and solid waste acquisitions. What you're talking about, the water treatment acquisition in the Marcellus Shale was a fairly small acquisition. It's interesting that, as we've turned the company to focus more on growth initiatives, you've had people that have taken it upon themselves to find ways to grow. That Marcellus Shale is a great example of an area where we were already providing services of disposal of drill cuttings into our landfill. By doing that, we started to recognize there was a need for water and for water services, for fracking fluid. We were able to get into that at a fairly low cost and to supplement our offering with our landfill offerings in Pennsylvania. It's been a really nice success story for us. It's a real competitive offering.
Speaker 1
Got it. Thanks, guys.
Speaker 3
Your next question comes from the line of Jonathan Ellis with Bank of America Merrill Lynch.
Speaker 0
Morning, Jonathan. Good morning, guys.
Speaker 1
Morning, guys. Wanted to first talk about, and I realized all of your commentary was tied to year-over-year comparisons, but I guess what I struggle with a little bit is that when I look at the fourth quarter of 2010 results and the first quarter of 2011, you know, your price and volume trends were fairly consistent. Yet, you know, you saw a pretty material sequential decline, about a 300 basis point sequential decline in gross margins. I'm just trying to get a sense. Presumably, you know, the cost spending on growth initiatives and cost savings wasn't significantly different. I'm just trying to understand if there's anything on a sequential basis that we should be sensitive to that drove the gross margin down. Other than, and I realize weather was clearly a factor, other than the weather.
Speaker 0
Weather was certainly a part of it, but I think you also have to look at the growth initiatives, which we really spent substantial amounts on the cost side. I'm sorry, the cost initiatives, we really started investing in January. Those are 100 basis points off the gross margin right there. Our waste-to-energy business, you know, we knew we had some issues we were going to address at one of our plants. We forecasted it in our own work, and that was another 60 basis points of impact that we had. I really think that's the driving piece of it. It's those particular items that make up the headwinds that we've already talked about.
Speaker 1
Okay. That's helpful. Maybe you could talk a little bit about the, I know you said the commercial volumes haven't picked up that much, but can you talk a little bit about weight per container? Is that showing any improvement, or is that really flat as well?
Speaker 0
Yeah, it was close to flat. Frankly, what we've been seeing over the last three years is that container weights have been generally down, a couple of quarters where it's been up. It was improved. It was less negative, but it was still just slightly negative.
Speaker 1
Okay. Okay. On landfill pricing, to make sure I'm clear, I think last quarter you talked about a target of 5% to 7% for this year for the open markets, and I believe contracts that are coming up for repricing, if I'm not mistaken. Can you talk about, based on what you saw in the first quarter, do you still think 5% to 7% is achievable for the year, or is there going to be too much sort of a catch-up required to get to that target?
Speaker 0
Yeah, you know, John, I think, as you're well aware, the first quarter with the volumes being down, it's sort of hard to be too aggressive on pricing. When we looked at it, even in the first quarter, about two-thirds of our landfills had price increases at them, and nearly 50% of those price increases were over 3%. We made some good progress in the first quarter, but we've got to make better progress if we want to hit that 5% to 7% goal. I think you're absolutely right. We've got to make some pretty strong progress here in the second and third quarters. Whether we hit that for the full year or whether we hit that as a run rate, I think is still an open question.
Speaker 1
Okay. That's helpful. Just on the volume outlook, to make sure I'm clear, I think, and maybe we're splitting hairs here a little bit, but I think last quarter you said that volumes for the year could be flat to slightly positive. Just so I'm clear, is the commentary now on could be close to flat just a function of what happened in the first quarter, or is that also reflective of a changed view on the second, third, or fourth quarter?
Speaker 0
No, I think you've hit the nail right on the head. You know, when we look at the first quarter, we were stronger on pricing than we thought we would be. We said we think we'll meet or exceed the budget on pricing, and we were weaker than we thought we'd be on volume. We decided to say it's going to be closer to flat for the year, obviously. Like we said, the first quarter, it's hard to tell what's going on in the first quarter because of weather. We also had some pretty bad weather right at the end of the year in the fourth quarter. After we see those second quarter volumes, we'll get a better feel for what we think the full year will be.
We thought, given the negative 1.7% in the first quarter, we wanted to be a little bit more conservative on volumes for the year. Again, we'll know more after we see second quarter seasonality trends.
Speaker 1
Okay, that's helpful. Just my final question, on the core price for the year, I appreciate the commentary around the effects of CPI and the anniversary of the fees. Can you help us to sort of understand, holding your current prices constant in terms of whatever you've achieved year to date, what is going to be the stairstep impact of the anniversary of the fees and the CPI resets on July 1? If you can help us understand how that flows through.
Speaker 0
Yeah, so when you look at our fees, you know, there are three primary fees that we have. We've got our environmental fee, which went up last year, and it'll anniversary starting in June. We got about an $11 million benefit from that in the first quarter. We don't expect that to be a benefit in the back half of the year. It could be even slightly negative, but basically flat in the back half of the year. We've got our administrative fee, which gave us an $8 million benefit in the first quarter, and again, that anniversary is in the second quarter, so we'd expect to get no benefit from that. We've got our new container service fee, which was an $11 million benefit in Q2. We'd expect to see roughly that amount in the remaining quarters because that was not one that we instituted last year.
Net-net, you're looking at sort of a $10 to $15 million drag to pricing from the anniversary of the fees.
Speaker 1
On the CPI, recent.
Speaker 0
On CPI, you know, what we've seen obviously is CPI going up a little bit, but most of those July 1st contracts actually price off of March to March timing, right? You're not going to get the full benefit of the March to April quarter increase from CPI because they don't, on July 1st, trigger off of July 1st CPI, right? What you'll see is that in the back half of this year, we won't see a benefit from CPI. In fact, we'll still see a little bit of a drag if you use March to March, April to April type CPI. We'll start to see that benefit on the contracts that reprice on January 1st, 2012. That's why CPI will be a drag in 2011 and turn in hopefully to a tailwind in 2012.
Speaker 1
Got it. Thanks, guys.
Speaker 0
Thanks, Scott.
Speaker 3
Your next question comes from the line of Michael Hoffman with Wonderlic Securities.
Speaker 0
Morning, Michael.
Speaker 1
Good morning, Bob, David. To dig a little deeper into the waste-to-energy data, because I'm struggling a little bit based on the charts you've provided. Revenues are actually up year over year. You show, you know, in your yield calculation, flat from a disposal standpoint, flat from an energy standpoint, yet it's a drag. This has to be a cost issue. I'm trying to understand what's happening in the costs.
Speaker 0
are three components, Michael. The first is the loss of the capacity plane payment, and that was more of a revenue issue than a cost issue. We had additional repairs and maintenance that we accelerated into the first quarter of 2011 for the plant we bought in Portsmouth, Virginia, last year. It was work that needed to be done. We talked about this in the fourth quarter, that the maintenance hadn't been done in that plant for quite a while, and just catching that up turned out to be more expensive than we thought. It's not cost we won't spend someday. It's just cost we had to move up till now. We had some timing of other repair and maintenance operations that moved into this quarter, and that's why we expect in half of the year, it won't be quite as much of an issue.
Speaker 1
Okay, that's what I thought was going to be the answer. You pulled forward a lot of maintenance.
Speaker 0
Yeah, that's right.
Speaker 1
Okay. The stock options, that was a negative $0.01 in Q1. How do I think about the options layering it out for the rest of the year?
Speaker 0
That should be it. Michael, that hit relates to the fact that under our option plan, and by the way, we have a bit more mix. We changed our mix of options versus performance shares to put more into options. The return isn't silly, but the retirement provision in our option plan allows both people who are retirement eligible to vest immediately, and you have to take the hit immediately.
Speaker 1
To continue vesting.
Speaker 0
To continue, yeah. Even though that allows them to continue vesting even after they retire, I'm a person, I'm a beneficiary of that, so I both feel bad and good about it. Anyway, that's really the cause of it. Once that's booked, you don't have any other continuing impact from it.
Speaker 1
Okay. You've taken your one-time hit for this year, and do we think about that as a first quarter event going forward?
Speaker 0
It will be only if the mix changes.
Speaker 1
Okay.
Speaker 0
Right. It should be the same thing next year unless we decide to change the retirement provision.
Speaker 1
Okay.
Speaker 0
Which one of us is in favor of?
Speaker 1
Yeah, there's a difference in ages. The CPI helped me a little bit here. Everybody's talking about CPI, but you all are actually talking about this more negatively than everybody else is. There's a more positive bent on CPI from your overall in the market, but then strictly specifically related to your peers. I'm having a, I mean, there's no question we're seeing some inflation, and I'm having a little trouble why you're counting it as a negative at this point.
Speaker 0
Yeah, there's absolutely no doubt, Michael, that we will see a benefit from CPI. It's just a matter of when you see the benefit. You know, what you're seeing is CPI going up in the last couple of months. Our contracts don't use current CPI. They basically, most of our contracts are July 1st, January 1st. The July 1st contracts will use CPI generally on a March to March, April to April basis. There you're seeing more in line with the 1%, 1% to 2% type CPI. Year over year, it will continue to drag in the second half of the year. The better CPI that we're seeing today will end up going into our repricing in January of next year. We'll get the benefit. It's just a matter of when. We won't get it in the back half of the year.
We'll start to get it in the first quarter of 2012.
Speaker 1
Okay. Help me get comfortable with why you have such confidence that the $0.03 drag becomes $0.02 and goes to maybe $0.01 and then $0.00, and then is additive going into 2012.
Speaker 0
Michael, let me see.
Speaker 1
For a long time, we've heard Waste Management talk about investing to save, and it's hard to see the save. We've seen the investing, but help us get comfortable why you really believe that.
Speaker 0
Yeah, Michael, that's a very good question. I was going to clarify a little bit. The pennies that we talked about will be going through SG&A. The benefits will be going through operating expense primarily in this year. Some of it will go through SG&A, but mostly it'll go through operating expense. We do expect the benefits to be seen starting toward the end of the second quarter and well into the end to be relatively significant in the third and fourth quarter. Here's why we believe it. The two areas we're focusing on primarily, there's a lot of areas we're focusing on, but two are procurement and the routing logistics side of the business. With procurement, it's pretty easy to see where the opportunities are. Once you start the process of renegotiating contracts and getting through that whole effort, you can see that the benefits are going to come.
We have good visibility to that. That one, we're quite comfortable with. We think there's a significant opportunity there. In the other area, the routing and logistics, we expect there'll be some benefits this year. We'll spend a little bit more in the second half on that than we will with procurement. The nice thing about procurement is once you've gotten it going, you internalize it pretty quickly, and you take it from there, and you don't really need to have the consulting costs to help. On the routing and logistics, that's going to take a little bit more time. We've already started the process of taking our redesigned or the effort of taking our redesigned processes supported by a technology through one area, one market area. We're about to begin to roll it out in a second market area.
Because of the complication of it, we're taking time to do it. We've found that just putting a new technology on a truck isn't enough unless you really take the time to retrain people to use the information and change the processes. That's just going to take a little longer. That gives us comfort that that'll take us into next year. The procurement benefits will continue. The routing and logistics benefits will continue. The third area we talked about was consolidating certain functions. In order to do that, you've got to go through a process redesign, pick a location, find the right people, and then staff that function. That's something that'll take a couple of years, a good 12 to 18 months to organize and do. It will take a little longer for those things to get in to see the benefits.
The pieces from the procurement and some of the other things we'll see pretty quickly. You know, Michael, the way I look at it is, as we've looked at the downturn with the decrease in volumes, frankly, I've been extremely impressed on the cost side on how our folks have been able to flex down costs. When, as Bob talked about, when you look at the procurement and the logistics departments, they've done a great job at flexing down costs and generally maintaining margins, increasing margins year over year, every year since I've been here, even though we've had declining volumes. Having said all that, you get to a point where you're not getting as much traction. As Bob talked about the onboard computers, we were getting benefits from that.
Sometimes you have to bring in sort of outside eyes to take a look at it and show you some new ways to do things. That's exactly what we've done here. It's been very good. We're seeing some really good progress. Ultimately, it becomes the way you do business and you get rid of those outside eyes. That's the process we're going through right now. Obviously, it takes some investment to do that, but we're counting on that being a fairly quick payback in 2011 and then accelerating into 2012. You'll see two things in the second half of the year. You'll see the consulting cost coming down. You'll see the benefits picking up.
Speaker 1
Okay. I know this isn't a stated after-the-market goal. This is an internal one, but you have this vision of being at 9% SG&A margins by the end of 2012. There's a lot of room between the lip and the cup on that at this point.
Speaker 0
Yeah, there is, Michael, you're right. A lot of work to do.
Speaker 1
I mean, you can't be just growing your way to that.
Speaker 0
No, I can't, Michael. You got to, you know, we did some analysis on that, and what we've got to do, we've got to assume that our sales group, through their customer-focused growth effort, will be able to grow revenue to keep their share of the cost down at a certain level that fits a 9% SG&A run rate going forward. We've got to assume our growth initiatives will do the same thing. They've got plans that tell us that they're working on plans to get to that. On the G&A side, we've got to take a fair amount of costs out, and you don't do that without the efforts we're going through right now.
Speaker 1
On the growth side, you're losing money right now. I get it. You're investing, but you're losing money. You're losing money at a tune of, you know, depending on what your tax issues, something in the $75 million to $100 million a year. Are there revenues at this juncture offsetting that, or is this all investing? I mean, serial revenues, not serious revenues, not a little bit of revenues.
Speaker 0
Yeah, no, I mean, there's revenue, but not enough to offset it, right? I mean, when you look at the two primary growth initiatives that we focus on, Bagster and medical waste, what you've got in Bagster is huge growth rates. I mean, we grew the number of bags sold in March. We're about 24,000. That was over a 100% increase from last year. The problem is that you've got to spend a lot of advertising dollars to get customer awareness, and that's basically what drags down Bagster, is the fact that you've got to get that customer awareness built up. You build volume, obviously, that helps. As you get more market awareness, ultimately, you won't need to spend as much on marketing. On the medical waste side, the investments we've made have been mostly in building out infrastructure.
Once you build out the infrastructure, you've got to add salespeople in order to go out and get revenue. It's a fairly long cycle sale in the medical waste side. Both of those don't have enough revenue to offset those sort of startup costs.
Speaker 1
Okay. Two last questions. The last time gas prices got really high, it clearly had a compression on the consumer activity. What's your sort of feel about that? Admittedly, that was in the middle of or at the start of a recession, but what do you feel about it today? We're on the backside of this recession, but gas prices are high.
Speaker 0
Yeah, you know, it's interesting. You all see the headlines just like we see the headlines. I've been surprised that with gasoline prices as high as they are, there hasn't been as much talk about it. I mean, in other words, I think the last time it happened, there was the initial shock because it really hadn't happened before. Now I think people are pretty used to gasoline with a $3 per gallon, has a three with it, right? Obviously, I think all American businesses have to be concerned about higher fuel prices dampening the economy. Frankly, for us, I think there's sort of a sweet spot in there between, you know, at roughly $3.50 a gallon of gasoline, where frankly, it's not so high that we can't recover it through our fuel surcharge and our customers don't complain about that.
Yet, it's, you know, as we've talked about before, our smaller local competitors that don't have a fuel surcharge are going to have one choice or two choices: make less money or increase prices. That's a good thing. As the price of diesel goes up, if they're going to drive by our landfill, we basically price our landfills by figuring out what's the cost of the next best alternative. All of a sudden, the next best alternative becomes a lot more expensive at higher diesel prices. I think you've hit the nail right on the head. My concern is not that it's going to impact our business because frankly, I think the impacts to our business are pretty good. My bigger concern would be that it would have an impact on the larger economy. So far, I think people have been a little bit immune to the higher prices.
Speaker 1
Okay.
Speaker 0
It continues.
Speaker 1
All right.
Speaker 0
Our investment in the natural gas fleets of CNG is helpful to us.
Speaker 1
Right. Last question. Rates are about as low as we're probably ever going to see in our lifetime again. Is there something you can or should be doing, read the balance sheet, that could just take advantage of driving your overall cost to your balance sheet down?
Speaker 0
I think it's a wonderful idea. We've put in some swaps this quarter to take advantage of it, about $600 million of notional value. We'll continue to take a look at that. We aren't going to add that just because it's cheap. We need to have a reason to do it. We certainly will look at it all the time.
Speaker 1
Thanks, Michael.
Speaker 0
Thanks, Michael.
Speaker 3
Your next question comes from the line of Bill Fisher with Raymond James.
Speaker 1
Morning.
Speaker 0
Morning.
Speaker 1
Morning, Bill.
Speaker 0
Hey, just following up on the last question on the fuel and related thing and landfill pricing. I noticed your transfer station revenue has been weaker in some of the other lines. Is that partially just the longer haul waste, you know, maybe staying closer to home? Does that give you an opportunity, as you think you've touched on, to price up more of your in-town, if you will, landfills? It's interesting that you say that because I think you're absolutely right. We've seen the costs go up there. For the first time in a long time, we've actually started to see some positive pricing at the transfer station level. Generally, the transfer stations have almost been viewed as a pass-through. A couple of years ago, we got folks to focus on them as more of a cost center and a profit center.
I think you're seeing the results of that.
Speaker 1
Seeing pricing there. On the surcharge, you touched on that as well. I guess based on where fuel is now and be up another, that your fuel surcharge, if you will, on collection, be up another couple hundred basis points in Q2. I know you've done a great job getting a surcharge through, but is there any pushback, say, in commercial on the acceptance of that? I mean, any churn related to that at all?
Speaker 0
I mean, we have seen virtually no noise on pushback from the fuel surcharge. Now, you know, interestingly, one of the things we have seen is that some of our both national and local competitors have been out offering new business pricing with no fuel surcharge. I got to tell you, that's going to be a tactic they are going to regret in the next year.
Speaker 1
Okay. All right. Thank you.
Speaker 0
Thanks, Bill.
Speaker 3
Your next question comes from the line of Al Kaschuk with Wedbush Securities.
Speaker 1
Hello, Al.
Speaker 2
Morning, Houston.
Speaker 0
Morning!
Speaker 2
I want to go back on the growth initiative, and I think, David, what you said is you're counting on a volume recovery to get the Bagster and medical waste to a positive contribution, at least at the EPS line. It appears that when you aggregate some of the macro comments, that's more of a challenge than maybe it appears. Could you maybe just comment on what needs to happen for your forecast to be achieved?
Speaker 0
Yeah, on the Bagster side, I think you're right. You have to see activity. One of the things that we saw when we first looked at this Bagster opportunity was with the new housing starts down, you're going to have more people doing remodeling, right? That's a perfect opportunity for Bagster. I'm not certain that Bagster is as much tied into the overall economy as, for example, our typical rollout balls. As you see fewer people buying homes or constructing homes, your rollout balls go down. What that means is that you've got to remodel your current home, and that should drive Bagster sales up. On the medical waste side, it's not as tied to the economy, frankly, as it is tied to getting the salesforce in place and getting them through the long cycle of sales, right?
In other words, you build the infrastructure, and that costs you money, and that has costs. Then you add salespeople, and that adds costs. If your sales cycle is three to six months on the medical waste side, you're going to suffer those costs before you start seeing revenue. We've been adding salespeople. We continue to add salespeople in medical waste. We need to see them starting to generate enough revenue to pay for themselves, if you will. Because of the long sales cycle in medical waste, that takes a little bit longer.
Speaker 2
Are you seeing, I mean, there's six months basically left to really hit the number, I guess, are you seeing the sales drive some incremental volume here on the medical waste side to support what is probably at least a penny or two of that growth initiative attributable to medical waste?
Speaker 0
Yeah, you know, we just picked up a bunch of hospitals from a large hospital chain. That comes on board in the first and through the second quarter. That's going to add revenue. We've had quite a few successes on the medical waste side out in the West Coast and the East Coast. Those are customers that we're adding basically in the first and second quarter. You should have some additional revenue generation. Frankly, it's been a little bit slower than we expected because we've got a competitor out there that's pretty fierce in doing whatever they need to do to retain customers. That too will pass. We think that medical waste will be a great business for us. On Bagster, clearly what we've seen year over year is over 100% growth on sales and over 200% growth on pickups. We're pretty confident that we'll see improvements there.
I will tell you that in my mind, the back half of the year is a heck of a lot more focused on the cost reduction initiatives than it is the growth initiatives. Remember what we said about the growth initiatives is that they're going to continue to be negative in the second and third quarter and sort of flat to maybe slightly positive in the fourth quarter. We're not banking the back half of the year on our growth initiatives. We're banking the back half of our year on the cost reduction initiatives.
Speaker 2
Okay. To that point, profit center versus cost center, when you look back a couple of quarters, including this quarter, Q4 may have been the exception of 2010, your cost of goods, cost of sales rate of increase is greater than the revenue. While I know there's a lot of moving parts here, I'm wondering if you're moving fast enough on the cost side, given what you've seen in the economy and helping that gross margin story.
Speaker 0
Are we moving fast enough? We think so. That's certainly what we're trying to do here. I think that's the purpose of the effort. You have to go back a couple of quarters, and you can see the significant cost reductions that we've had on the operating side. As David said, as time goes on, those get harder and harder to do, and you need to find something new. We were going through these cost reduction initiatives. Al, we do think that it's time to do it. When you look at the fourth quarter and the first quarter, you've also got to recognize that we had sort of a mix issue, right? When you look at this quarter, for example, on special waste, only being positive, roughly 3%.
That's one of our highest margin businesses right there, and the same with the other landfill volumes in the commercial line of business. You've got a little bit of mix that I think was driven more by weather. Between that and what Bob talked about, I think you should see that normalize as we go through the seasonal uptick.
Speaker 1
Thank you very much.
Speaker 0
Thanks, Al.
Speaker 3
Your next question comes from the line of Jerry Revich with First Analysis.
Speaker 2
Morning, guys.
Speaker 0
Morning.
Speaker 1
Hoping to get a little more detail on the redesigned fuel surcharge you mentioned in your opening remarks. Can you tell us a little bit about what that involves? Is that something that is currently fully implemented, or is it being phased in over time? As you look ahead to future quarters, would you expect it to be as effective in offsetting any spikes in diesel costs as it was in Q1?
Speaker 0
We redesigned it mid-year last year, and so it's fully rolled out. All we did in the redesign was make sure we got better coverage as fuel prices went up, so our fuel surcharge followed more quickly. It's working just the way we expected it to, the way we redesigned it. I expect as fuel prices adjust throughout the rest of the year, it'll adjust as quickly.
Speaker 1
Okay, thank you very much.
Speaker 0
Sure, thank you.
Speaker 3
There are no further questions at this time. Are there any closing remarks?
Speaker 0
Thank you all for joining us. We think we had a very solid start to the year. We expect that to continue the second quarter, obviously with acceleration in the back half of the year. I'm very confident that we've got the right people in place and the right ideas in place to see that happen. We look forward to the rest of 2011.
Speaker 3
Thank you for participating in today's Waste Management First Quarter 2011 Earnings Release Conference. This call will be available for replay beginning approximately 1:00 P.M. Eastern Standard Time today through 11:59 P.M. Eastern Standard Time on Thursday, May 12, 2011. The conference ID number for the replay is 512-72844. Again, the conference ID number for the replay is 512-72844. The number to dial for the replay is 1-800-642-1687 or 706-645.