Waste Connections, Inc. (WCN) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Waste Connections First Quarter 2018 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, May 3, 2018. I would now like to turn the conference over to Mr. Ronald Mittelstaedt, Chairman of the Board and CEO. Please go ahead, sir.

Okay. Thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our first quarter 2018 results and provide our financial outlook for the second quarter. I'm joined this morning by Steve Bouck, our President; Worthing Jackman, our CFO; and several other members of our senior management team. As noted in our earnings release, better than expected solid waste price growth and E&P waste activity drove strong performance in the period and position us well for the remainder of 2018. Adjusted EBITDA margins in the first quarter increased 80 basis points year-over-year in spite of both the precipitous decline in recycled fiber values and weather-related impacts across the majority of our operational footprint. Given our strong start to the year and recent acquisitions, we believe adjusted free cash flow is tracking to exceed our original outlook of $850 million for 2018. Regarding acquisition activity, we've signed or completed acquisitions with total annualized revenue of approximately $165 million year-to-date, including three new market entries, and the pipeline for potential additional acquisitions exceeds what's been completed so far in 2018. Finally, as anticipated, we resumed our share repurchase program opportunistically buying back approximately $42 million of shares in the first quarter. Before we get into much more detail, let me turn the call over to Worthing for our forward-looking disclaimer and other housekeeping items.

Thank you, Ron, and good morning. The discussion during today's call includes forward-looking statements made pursuant to the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995, including forward-looking information within the meaning of applicable Canadian securities laws. Actual results could differ materially from those made in such forward-looking statements due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement on page 2 of our May 2 earnings release and in greater detail in Waste Connections' filings with the U.S. Securities and Exchange Commission and the securities commissions or similar regulatory authorities in Canada. You should not place undue reliance on forward-looking statements and information, as there may be additional risks, of which we are not presently aware or that we currently believe are immaterial which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements and information in order to reflect the events or circumstances that may change after today's date. On the call, we will discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share, and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non-GAAP measures to the most comparable GAAP measure. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations. Other companies may calculate these non-GAAP measures differently. I'll now turn the call back over to Ron.

Okay. Thank you, Worthing. In the first quarter, solid waste price plus volume growth was 3.2%, in line with our overall expectations. Total price of 4.3% exceeded our outlook for the quarter and increased 60 basis points sequentially from Q4. This sequential increase was due to both an approximate 150 basis point improvement in our mostly exclusive market, Western region, where price increases approached 3.5%. And we achieved high price retention rates across our secondary markets. Reported volume growth in Q1 was negative 1.1%. Purposeful shedding of less attractive revenue across the former Progressive Waste footprint, particularly in Canada and the Northeast, accounted for an estimated 80 basis points of reported negative volume growth in the period, most of which should abate by the end of Q3. An additional estimated 40 basis points impact of volume growth can be attributed to tougher weather conditions and special waste timing. And lastly, the permitted volume change at our Chiquita Canyon Landfill in Q3 of last year reduced reported volumes by almost 30 basis points. Net of these items, overall volumes were up about 0.5 percentage points in the period, while delivering price growth of 4.3%. On a same-store basis in Q1, commercial collection revenue increased about 5% and roll-off revenue increased 4% from the prior year period. In the U.S., roll-off pulls per day increased 2% and revenue per pull rose about 3.5%. In Canada, a 7% decrease in pulls per day, primarily related to the purposeful shedding of lower quality revenue and some severe weather conditions, was more than offset by an 8% increase in revenue per pull. Solid waste landfill tonnage in Q1 on a same-store basis was slightly up over the prior year period. MSW tons rose approximately 0.5%, special waste tons increased 3.5%, and C&D tons decreased 7.5%. The decrease in C&D tons was primarily due to difficult weather conditions relative to the year ago period across most of our footprint, tough year-over-year comparisons at several of our landfills, and limitations imposed by the new conditional use permit at our Chiquita Canyon Landfill in Southern California. New limitations at the Chiquita Canyon Landfill resulted in a 60% reduction in special waste tonnage and a 54% reduction in C&D tons at this site. Excluding these reductions, which anniversary in August, special waste tonnages were up 10% in the first quarter and C&D tons were effectively flat. Recycling revenue, excluding acquisitions, was about $22 million in the first quarter, down more than $18 million or 45% year-over-year due to the precipitous drop in recycled fiber values, especially prices for recovered mixed paper. Prices for OCC, or old corrugated containers, in Q1 averaged about $102 per ton, which was down 38% from year ago period and down 16% sequentially from Q4. Mixed paper values declined an estimated 80% year-over-year. We estimate these declines in fiber values, along with increased recycling processing cost, impacted EBITDA by approximately $14 million and earnings per share by $0.04 in Q1 compared to the year ago period. OCC prices have since recovered almost 10% off recent lows and currently average around $90 per ton or down about 12% compared sequentially to Q1's average and down 48% from the level we averaged in last year's second quarter. At current OCC and mixed paper values, we estimate this sequential decline from Q1, together with incremental processing cost, will add an additional 20 basis points margin headwind and around $0.01 earnings per share drag per quarter for the remainder of the year relative to our original outlook provided in February. This additional drag could be overcome though if the recent recovery trend in OCC prices continues. Looking at E&P waste activity, we reported $55.6 million of E&P waste revenue in the first quarter, up 51% year-over-year and up 4% sequentially from Q4. Activity ramped a little faster than we had expected in the period, providing a higher run rate into the remainder of the year. In addition, we've recently received three new permits to expand our asset positioning within the West Texas Permian. We'll likely commence construction on at least two of these permits later this year, providing additional growth opportunities beginning in the second half of 2019. Looking at acquisition activity since our last update in February. In March, we acquired Right Away Disposal, an integrated provider of solid waste collection, recycling, transfer and disposal services in Arizona's fast-growing Pima, Pinal and Maricopa Counties, consisting of three collection operations, one recycling facility, two transfer stations and a large municipal solid waste landfill. This is basically the market area in the valley between Phoenix and Tucson. In early April, we acquired the Heart of Florida landfill in Central Florida, a municipal solid waste landfill that complements our existing operations. And on May 1, we signed a definitive agreement for a new market entry to acquire a provider of collection, processing and transfer services with approximately $55 million of annualized revenue. This is expected to close in June. These acquisitions, together with the previously discussed Bay Disposal transactions and smaller tuck-ins completed in Idaho, Nebraska, North Carolina and Texas, aggregate to a total of approximately $165 million of annualized revenue we've signed or closed year-to-date, including three new market entries for future growth opportunities. At this level, we've already completed what we would consider an above average amount of acquisitions for the year. And, as mentioned earlier, the pipeline for potential additional acquisitions exceeds what's been completed year-to-date. We clearly have visibility on 4% to 5% or greater acquisition growth for 2018. As noted earlier, we resumed our share repurchase program, opportunistically buying back approximately $42 million of shares in the first quarter. This is a good start to our full year repurchase target of between $250 million and $400 million. We are fortunate that the strength of our financial profile and free cash flow generation provides us with the flexibility to increase the return of capital to shareholders, while funding an above average amount of acquisition activity. And now, I'd like to pass the call to Worthing to review more in-depth the financial highlights of the first quarter and to provide a detailed outlook for Q2. I will then wrap up before heading into Q&A.

Thank you, Ron. In the first quarter, revenue was $1.14 billion, up $48.9 million over the prior year period. Acquisitions completed since the year ago period contributed about $38.7 million of revenue in the quarter and about $10.8 million net of divestitures. Adjusted EBITDA for Q1, as reconciled in our earnings release, was $356.9 million or almost $4 million above our outlook for the period due to higher than expected revenue and margins. In spite of the high margin negative flow-through impact from the precipitous decline in recycled commodity values, adjusted EBITDA in the period increased more than $24 million year-over-year or about a 50% flow-through on the incremental change in revenue. Adjusted EBITDA as a percentage of revenue was 31.6% in Q1, up 80 basis points year-over-year and 20 basis points above our margin outlook. A majority of margin improvement in the period was attributed to a year-over-year increase in E&P waste activity. Within solid waste, margin expansion in Q1 was driven by strong pricing growth, which enabled us to overcome an estimated 155 basis point margin drag from recycling and 25 basis points from limitations imposed by the new conditional use permit at our Chiquita Canyon Landfill, plus additional weather-related impacts. Fuel expense in Q1 was about 3.7% of revenue and we averaged approximately $2.68 per gallon for diesel in the quarter, which was up about $0.20 and $0.07 per gallon, respectively, from the year ago period and sequentially from Q4. Depreciation and amortization expense for the first quarter was 14% of revenue, up 20 basis points year-over-year due to increased depreciation expense from capital expenditure outlays since the year ago period. Interest expense in the quarter increased $3.2 million over the prior-year period to $32.4 million due to higher interest rates as compared to the prior-year period. Net of interest income from invested cash balances, interest expense increased $2.5 million year-over-year. Debt outstanding at quarter-end was about $3.9 billion, about 27% of which was floating rate, and our leverage ratio, as defined in our credit agreement, was about 2.4 times debt-to-EBITDA. Our effective tax rate for the first quarter was 20.3% or 30 basis points higher than our outlook for the period. The effective tax rate for the period included $4.6 million benefit to the provision related to excess tax benefit associated with equity-based compensation, which is down about $2.4 million from the prior year period or $0.01 impact to EPS. Looking at the remainder of 2018, we now expect our effective tax rate to be approximately 23%, subject to some variability quarter to quarter. GAAP and adjusted net income per diluted share were $0.47 and $0.56, respectively, in the first quarter. Adjusted net income in Q1 primarily excludes the impact of intangible amortization and acquisition-related items. Adjusted free cash flow in Q1 was $220.2 million or 19.3% of revenue. Given our strong start to the year and recent acquisitions, adjusted free cash flow is tracking to exceed our original outlook of $850 million for 2018. I will now review our outlook for the second quarter. Before I do, we'd like to remind everyone once again that actual results may differ significantly based on risks and uncertainties outlined in our Safe Harbor statement and filings we've made with the SEC and the securities commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic and operating environment. It also excludes any remaining rebranding costs resulting from the Progressive Waste acquisition and any costs related to additional acquisitions that may close during the period. Revenue in Q2 is estimated to be approximately $1.225 billion. We expect pricing growth for solid waste to be about 4% in Q2 with volume losses similar to Q1 given lingering winter weather impacts in many markets throughout April that have delayed the typical seasonal ramp in those geographies. Adjusted EBITDA in Q2 is estimated to be approximately $395 million or about 32.2% of revenue. This reflects an expected 40 basis point year-over-year margin expansion in the upcoming quarter in spite of expected margin headwinds, similar to those we experienced in the first quarter, predominantly from recycled commodity declines year-over-year. Depreciation and amortization expense for the second quarter is estimated to be about $13.9% of revenue. Of that amount, amortization of intangibles in the quarter is estimated to be about $26.5 million or $0.07 per diluted share net of taxes. Interest expense net of interest income in Q2 is estimated to be approximately $32.5 million. Finally, our effective tax rate in Q2, as noted earlier, is estimated to be about 23% subject to some variability. And now, let me turn the call back over to Ron for some final remarks before Q&A.

Okay. Thank you, Worthing. Again, we are extremely pleased with our start to the year. Near-record solid waste pricing growth and increased E&P waste activity have enabled us to overcome significant recycling headwinds and position us well for the remainder of the year. Acquisition activity is another bright spot with an above average amount of transactions already signed or closed and an even bigger pipeline under active dialog. Finally, our return of capital is ratcheting up with the resumption of our share repurchase program. We are pleased to note that adjusted free cash flow is trending above our original $850 million outlook for the year. But with recycling prices beginning to rise again and acquisition activity set to close, we believe it's prudent to wait until our Q2 earnings release to formally update our outlook for the full year. We appreciate your time today. I will now turn this call over to the operator to open up the lines for your questions. Operator?

Thank you. [Operator Instructions] And our first question comes from the line of Tyler Brown with Raymond James. Please proceed with your question.

Hey. Good morning, guys.

Hey, Tyler.

Hi, Tyler.

Hey, nice quarter. Hey, Worthing, I just want to make sure I have it right. But of the $165 million of acquired revenue year-to-date, should we think about $70 million of that is effectively being in that $850 million guidance? The other pro rata share of, call it, the $100 million is basically incremental to the guide. Is that right?

With regards for the cash flow guide, that's correct. And if you look at the timing of that incremental $100 million or so, as you say, that would likely contribute around $65 million plus or minus to the revenue guide, assuming this next transaction that we signed yesterday closes in June. And then you'll get some obviously EBITDA flow through and incremental free cash flow through the $850 million on top of that.

Okay. And then any color on maybe a blended basis what EBITDA margins could be there, I'd think maybe high 20s?

On a blended basis, that's right, because the first $110 million or so came in at about the corporate average given the landfill mix with that because we've got three landfills in those transactions. The next one set to close does not own the landfill. It's in a disposal neutral market, so that comes in at in the low to mid-20s from a margin standpoint. So when you blend those together you're right. You get into the kind of 28% plus or minus blend.

Okay. Perfect. And then, Ron, I know north of 4% pricing here, I guess, as you look at the first half is obviously quite good. It's well ahead of the 3.5% guidance. But how should we think about pricing for the remainder of the year? I mean, it feels like CPI is improving, churn's low, small haulers are full. Any reason to think that the back half can't see the same as what we're seeing here in the first half.

No. I mean, no real reason to think that. Again, Tyler, remember, I'm going to estimate but between 70% and 75% of our price increase for the year is completed by April 1. So unless there's a material change in churn your denominator that you're working off of is effectively fixed. So there's not a reason to think it would change materially.

It moves down a little bit as the seasonal denominator increases.

That's right. If the seasonal revenue is come in, particularly in Q3, but you're not talking about material changes.

It doesn't matter.

Right. Right. Okay. Perfect. And then maybe just the last one. Was there anything in there from a CNG tax credit? I'm guessing it would be de minimis.

It's de minimis. It's a couple million. It's de minimis. You're right.

Okay. Okay. All right. Perfect. Thanks, guys.

Our next question comes from the line of Hamzah Mazari with Macquarie Bank. Please proceed with your question.

Hey. Good morning. Thank you. The first question is just on M&A as well. You're starting up the buyback. You've done a record number of deals this year. Is there anything to read into that maybe the deal activity going forward is not as strong because you're ratcheting up the buyback? Or maybe just frame for us – are there still chunkier deals in the pipeline or maybe this is just a timing thing?

Yeah. No, Hamzah. I mean, number one, nothing to read into it. As you know, we were always very active in our buyback, very consistent, leading up to the Progressive transaction that we'll have completed two years ago within the next couple of weeks here. And because with that deal we took leverage up significantly and have worked from the low 3s down into the low 2s now, we really resumed it because we're very comfortable with where our leverage is. As we're continuing to add deals, we're bringing EBITDA in. Leverage is continuing to drop. We have been only utilizing cash on the balance sheet. We haven't even used all the cash on the balance sheet. And so, again, we're seeing leverage come down by more than 0.1 turns of EBITDA per quarter just based on EBITDA and cash flow. And so we are very comfortable that with everything we see out there we're still going to be below our leverage target. So it's really a very good problem to have. I mean again we haven't even got to the $850 million of free cash that we're guiding already for the year. So nothing to read into that. Deals can be chunkier, you are correct, but, as we've said, the pipeline is as strong as I've seen it in 18 plus years, probably going back to the late 1990s in terms of opportunities. That doesn't mean they're going to translate, but as far as opportunities. So no correlation between the two there.

Yeah. And just a follow-up to that. As you're bidding on these deals, maybe if you could give some color as to, has the competition on these deals changed against you when you're bidding or is there really no competition? I know there is new PE money that's been raised that's chasing the space now. One of the largest competitors spent a lot on acquisitions this quarter. And so just curious if there's any change in who you're going up against as sort of valuations are relatively high in the sector?

Yeah. I mean no real material change, Hamzah. Obviously, as our footprint has increased due to the transaction we did almost two years ago with Progressive, certainly, that puts us in some areas where there is more competition for deals. Generally, Hamzah, and I say generally, 8 to 8.5 out of every 10 deals we're really not bidding. We don't really do auctions. If it's an auction, we're going to probably lose. Probably a PE is going to win because they're not going to know what they're doing and they're going to overpay. So we just really don't participate in those much. Most of the deals we do are, I would say, somewhat sole-source. We're sort of a logical buyer. And while sellers are obviously going to shop, we're going to pay what we're going to pay. So we haven't seen that competition is materially different for transaction in what we do than say three years ago.

Okay. Great. A follow-up question and I'll turn it over. It's pretty well understood, waste fundamentals are pretty strong for the group. But maybe if you could just frame how investors should think about risks to the waste cycle going forward. I realize the business lags by a year going into a recession as well as coming out. But just any sense of how you're thinking about risks on a slowdown. Is it higher inflation, higher interest rates, any view there? Thank you.

Yeah. Well, I mean, number one, we are not seeing any signs anywhere that would indicate to us that a contraction is around the corner. I mean GDP is rising. Certainly, relative to the last eight years, GDP is rising. Interest rates that are moving up very slowly. We just saw the Fed pause this week on what was expected to be another increase. The volume environment is solid. As you've seen, the pricing environment is solid. We've benefited, I think, disproportionately because of our large franchise presence in the Western U.S. And you've seen the CPI move up over 100 basis points or approaching that over the last year or so in the West Coast. It continues to be higher, so that bodes well for 2019, because we'll be getting our 2019 prices based off the July CPI of 2018. So we can look out and see into 2020 that pricing should remain strong, unless something collapses between now and July, which is 60 days away. So I mean quite a bit of visibility on price in the space. Acquisition environment is strong. As we've talked about a lot of reasons for that. I think sellers of all type view that there is a window, that tax change has benefited buyers. Tax change has benefited sellers. Rising interest rates help sellers to reinvest the after-tax proceeds in fixed income. The economy is strong. And they fear that there could be a political change perhaps in 2020 that could change things. So there's a window. And we heard that repeatedly at WasteExpo from sellers of all types last week. So I think other than commodities, which are obviously very negative relative to a year ago, the space is extremely strong. And we're not seeing any signs of weakness in it. Obviously, a tough, a strong economy leads to a tight labor market. You're seeing wage pressures, but they are manageable, I would say, at this point in time. And we're exceeding our wage with our price. So if recycling were there, I'd really say the industry would be firing on all eight cylinders in an eight cylinder engine. So right now it's probably at least six or seven of eight.

But even this year you're seeing all the companies overcome the impact of recycling. And you fast forward to 2019, it's anniversaried.

Yeah. And if you were on the Republic call yesterday, I listened briefly. I could not agree more with what their executive team said. I mean I actually think this recycling thing is a good thing. It's a chance, potentially, if the price stays low enough, long enough, it's a chance to fix a very broken economic model and address it that otherwise the industry probably won't address. So I actually view that as a positive thing, and I'm thankful it's happening now under what's very strong umbrella.

Great. Thank you.

Our next question comes from the line of Derek Spronck with RBC Capital Markets. Please proceed with your question.

Okay. Thanks so much. The pricing environment seems pretty strong. How much revenue do you have tied to CPI? And is the pricing increase broad-based? Or are you being a little bit more purposeful towards pricing versus volume? Or is it just generally a better pricing environment right now?

Well, let's attack each of those. Derek, first off, I would say that the pricing is broad-based. The first part of your question, was how much do we have tied to the CPI? I would say we have, I'm going to round, between 40% and 45% of revenue, particularly collection revenue, tied to a CPI or some sort of CPI-based index. So it's a pretty large number and we like that. And as we said that that number on the West Coast is pushing towards 3.5%, and appears already locked in to be somewhat similar to that for 2019, again because we'll be basing it mostly on the July CPI. Pricing is broad-based. We've got very strong pricing across our Canadian footprint. In fact, our Canadian footprint probably had the highest pricing that we achieved albeit with some volume trade-off. And all of our regions geographically exceeded 3.5%. So there wasn't one that was below it. So I would tell you broad-based due to a good economic environment, good GDP environment. I would also tell you that if you're not getting 3% price in this environment, you're probably having margin compression. I think you're seeing that in other company. Despite strong price, if you exclude accounting changes and CNG credits with this recycling, you're still getting margin compression. So you really need to be north of 3% or so in this cost environment we believe to get margin expansion and we pushed it hard. I mean, we will be the first say we pushed it hard.

Is there any concern that from an absolute level pricing or your contract rates are reaching a point where there will be customer pushback or would you say that your services that you're providing are still – you're still providing some pretty good value on an absolute price level?

Well, I would say that's a market-by-market issue, Derek. Pricing is a – again it is not a science. Pricing is an art. I mean we look at pricing on a local market basis through 517 P&Ls amongst 7 million customers. And there's not a broad brush. You see it amalgamated as a broad brush for the company and by region, but it's very different. There are a number of markets where we are not doing price increases. There are a number of customers where we are not doing price increases. So obviously that tells you there are markets that we're well north of 5% to get to where we are. And that's because it's a market-centric issue. It's based on your asset positioning, based on your cost structure. It's based on your competitive positioning. And so, look, the reality is whether you raise price 2% or you raise it 10%, the same customer is going to cry, right. That has never changed in this business. So you might as well do it 5% to 8% and make it worth your while. But – so yes, I think whether – we are providing what we believe is a quality service, but there's a percentage of those customers that, no matter what service level we're providing, price adjustments are difficult. And so that's something we have to battle through.

Okay. It's great color. And just quickly. Could you talk a little bit about the assets that you've bought, in particular the Heart of Florida Landfill? What sort of capacity and/or do you see the ability to implement some pricing increases in that landfill and how it relates to your JED Landfill and some of your collection assets in the area?

Yeah. Well, I mean the Heart of Florida Landfill basically serves the Ocala market area predominantly where the JED Landfill sort of serves a market south of that which is more the Orlando and south market area. So there is really not pricing opportunities, per se. We didn't buy it for a pricing opportunity in the market. We bought it for the opportunity to internalize some of our other volumes that came through the Progressive transaction that we couldn't internalize to our JED Landfill. The Heart of Florida is a very large, very new MSW landfill. I'll go out on a limb and say I believe one of the only, if not the only, remaining privately-owned MSW landfill in the state of Florida. There are several C&D landfills. There are several municipal MSW, but privately-owned MSW landfill, I believe, this was the last one. And so we view it as a very strategic asset, both in the short and the long-term. There is a number of opportunities around it. We believe over time to consolidate. So again that's what I would tell you. We think it's a very strategic asset for our footprint.

Okay. That's great. All right. Thanks, Ron.

Our next question comes from Brian Maguire with Goldman Sachs. Please proceed with your question.

Hey. Good morning, everyone.

Hey. Good morning.

Hi, Brian.

Hey. Ron, just following on your comments earlier about recycling and how this could potentially be a good thing for the industry longer-term. We've heard from both Republic, as you mentioned, and Waste Management talk about efforts to try and change how the payment structure is done and maybe de-risk the business going forward. Is that your sense as well that we're going to have to maybe have some tough conversations with customers about getting paid for the value that you guys provide there and trying to remove some of the maybe upside and downside risk from the business? And to the extent you've already started to have those types of conversations, any comments you can make on how those are going and any expectations about success that you might have with that.

Yeah. Well, number one, Brian, and yeah the answer to your question is yes to all the above. I mean I think that we – I can't speak for anyone else, but, look, we view – if you think about this on the solid waste side, we don't go to customers and price their collection of garbage based on what we might make at the landfill. We price their garbage based on the return that we need to account for the capital and the cost structure for collection, for the containers we put out there, the trucks we send to them, our hauling infrastructure on a local market basis and we expect a return. The landfill should be, if we own it, an upside opportunity because that also has a capital base associated with it. That's not how the industry has done recycling for a host of reasons. The industry has said, well, let's sort of just forget about our cost of collection and recycling. Let's just call that $2 a home. We send the same trucks that we send to collect garbage and get $20, we get $2 or 3$ for recycling, and let's use our landfill for processing that has a commodity, let's use that as our payment. Well, that all works when the payment's $150 to $200 a ton. And when it's like it is today it doesn't work. And, so I don't think that we – I don't think our investors want us allocating capital to something that there's a return one year and no return maybe for the next year or two, and then there's a return. So we've got to take the volatility out of this business. That means giving up some of the upside when commodities are very high and taking out some of the downside. So, much like you heard Republic say, I mean we are working on similar things. I would tell you we are behind them, in that, I do that as not a good thing, but an opportunity for us, our margins where they are despite being behind in that opportunity. Remember, for us, it's 2% of revenue, not 5.5%. So it's a much smaller problem on a percentage basis to deal with. But this is a long-term issue to correct. It will not be corrected in one or two years. We can make good headway as a company and an industry, but you're talking about many contracts that are three, five, seven, 10 years long. So it involve substantive renegotiation. But I think we can make quite a bit of progress over the next few years at the areas where we have the biggest exposure. And, effectively, look, we want to be paid a processing fee per ton for a customer that gives us a return on our cost structure for the capital outlay. And whatever that commodity is it's the customer's commodity. It's not ours. I mean we're willing to let him have the benefit and the determent of it and we're willing to do some risk sharing, because the customer is going to want to do that. But to take 100% of it, which is really what many customers would prefer that we and our industry do and the industry has made a practice of that's not something I see as continuing indefinitely.

Okay. Thanks for the thorough answer and the good color there. Just switching gears a bit, I think, I heard you cite weather more than you typically do. And I think you mentioned a couple of stats but it was pretty quick there in the prepared remarks. So I wonder if you can kind of summarize what you think the overall weather impact might have been in 1Q and sounds like in 2Q you're expecting some of that to carry over. Any kind of rough rule of thumb on how much we can expect weather to impact 2Q as well.

Sure. What we mentioned in Q1 was about a 40 basis point estimated impact on volumes in the period because remember last year, in many parts of the U.S. and Canada, the winter was not as harsh. In fact, it was a very mild winter. This year, you saw very tough winters throughout the first four months of the year in Canada. You saw a dip in through the Upper Midwest. You saw it go down the East Coast. You saw four nor'easters hit various parts of the country. So anyway you've got – the majority of that impact of 40 was in Q1 because now you just have the month of April and in certain parts of the geographies I can only estimate, but it's probably going to be 10 to 20 basis point volume impact in Q2. And that's baked into the numbers that we guided to for Q2. From a margin standpoint, obviously, we didn't quantify the margin impact, but there was additional margin impact in the period that we overcame in our margin piece.

Okay. Just one last one from me. On Chiquita Canyon, it's obviously a drag on volumes quite a bit, and I think over time I'd expect it could be offset by some increase in pricing and tipping fees. Just wondering how – what's sort of the pricing environment in that region given people have to be put in their stuff somewhere or maybe paying more for the limited capacity that's available, and any opportunities or timing on when some of those price increase potentially could reopen? Anything that contractually would keep you from doing it, but just on any kind of color on timing for potentially being able to recover some of the lost volumes through pricing.

Yeah. Well, first off, Brian, the vast majority of the lost volumes has been – let me back up. I'm going to [ph] wound. We went from taking approximately 3 million tons annually at Chiquita Canyon under our old permit to being allowed to take 2 million. So it's about a million ton a year differential that started abating in the late third quarter, early fourth quarter last year. That's why you're seeing it fully in Q1. So it was about – I'm mean around 200,000 tons in Q1 of this year less than Q1 of last year. Now, the vast majority of that million tons was special waste and C&D that was lower price, lower margin business that we pushed out purposely, so that we wanted the higher priced MSW. In addition, we have been steadily raising both the gate rates and where we did not have contracts, the rates for that MSW. So you are correct. On a revenue and an EBITDA basis we are not fully offsetting by any means, but we are making a material impact to where we were on a revenue basis.

Yeah. Brian, you might recall when we first talked about Chiquita last year, we estimated about a 40 basis point margin impact. And to Ron's point, the higher price points that we've been working hard to get was just a 25 basis point margin headwind in the current quarter.

Yeah. And so I mean that is happening on a real-time basis and has been happening really since Q4 of last year on the price basis, Brian. As far as where that volume has gone, well, I mean that volume has gone to a variety of location. There's only a couple landfill owners within the county, and most of them are at their cap. So they've seen some benefit, but most of it has gone outside the county. Most of it is traveling further distances into facilities in the Inland Empire, into the desert towards Arizona. And so it's traveling further distances is the short answer to your question.

Okay. Appreciate the answer there. Thanks a lot.

Our next question comes from the line of Noah Kaye with Oppenheimer. Please proceed with your question.

Thanks very much for taking the question. E&P kind of continually getting a little bit stronger seems like every quarter, but we're still, I think, about 30% on a run rate basis below where this kind of was at the peak, maybe even a little bit more. And it seems like there's still a number of plays left to really kind of come back here. Lots of positive commentary from a number of industrials so far this period around continued growth in E&P. Just wondering what are your expectations now? You talk about double-digit growth last time. Does that still feel right? Do you think there may be some upside potential to that? And what are you seeing on the ground?

Yeah. When we laid out our outlook for E&P back in February we were at about $190 million, $195 million of revenue run rate entering this year. We talked in terms of about a $30 million increase baked into our outlook, meaning getting to about $220 million or so, $225 million. Kind of the higher exit speed from Q1 into Q2 probably puts us at that $230 million to $235 million type run rate clip right now. We'll see how the balance of the year plays out. So we're probably running about $10 million plus or minus above our prior assumption. So obviously that's being utilized to offset some increased weakness in recycling. But you're right about from the prior peak. I mean the prior peak, we reported about $300 million of revenue in 2014. And so we're running about 25% or so – 20% to 25% below that. And your point is dead on. I mean back then, the Bakken was our largest play. And obviously the Bakken is still yet to wake up. So the Bakken is probably running 80% below its prior peak right now. Obviously, Gulf of Mexico, Eagle Ford, some other parts of Louisiana on the Gulf Coast are still yet to fully show up like we saw in 2014. So if you strip away on a basin basis, we're actually running ahead of where we were in 2014 for those basins that are active right now.

That's great color. And then just so we all have our cadence of volume, right, I mean a lot of focus on price, rightfully so. And pricing is stronger than what we'd perhaps thought. But with your comments on a little bit of incremental weather headwind, getting close to kind of a negative 1% headline in 2Q, should we think about kind of that 0% to 0.5% headline volume for the year? Maybe being at the lower end now? Or do you think sort of there's some timing here that could maybe push some volume growth a little bit stronger in the back half?

Well, I think that's one of the reasons why we said, wait till July, because when you've seen such a prolonged winter, the question really is, how high is the seasonal snapback? Because in those markets that were heavily impacted by winter yet saw spring come in late March, early April, we saw tremendous seasonal pop, above average seasonal increase. And so we got to – let's see how May plays out to see what the seasonal increase is April to May, now that that April winter has really exited most of those affected markets.

Yeah, thankfully so. Thanks for taking the questions.

Sure.

Our next question comes from the line of Corey Greendale with First Analysis. Please proceed with your question.

Thank you. Good morning. I just had a couple quick ones. First of all, Ron, you've touched a couple times on the 3.5% price in the Western region, which in terms of all the sequential pickup in the absolute number, that seems like a higher number that I would've expected, given the exclusive nature of those markets. And CPI said – and you said you're pushing hard on price. But how did you – could you comment more on how you achieved such a strong result in the exclusive market?

Yeah. Yeah. Corey, it's Worthing. I'll start with that one. I mean it's not just the CPIs but obviously in certain rate of return markets, the CapEx investment has driven some of the trajectory on pricing in those markets. And also our folks have been very proactive with municipalities around the impact of recycling. And in some cases, we're getting increased core price to help offset some of the impact of the declines in recycling.

Okay. Great. And then, Worthing, I'll ask you a question and if Ron wants to answer that's fine. On the free cash flow side, I understand you're ahead of pace. If you look at the cadence in 2017 and take the same percentage, it's not sort of – it doesn't necessarily look that way. So but, I mean I think obviously you're on top of it. But can you just give us a sense of the quarterly cadence of free cash flow to set expectations?

Sure. I mean what you had last year is we had a lot of CapEx that we pulled into last year, but the overhang of the bills, the cash outflow hit us earlier this year. And so, number one, you'll see that repeat itself again as we exit this year now that our CapEx clip is running $0.5 billion or more. So that's number one. Number two, you see it's a question of timing. If you note accrued liabilities and payables are down dramatically. And that's where you see the majority of that reflected. If you annualize Q1, we're running comfortably ahead of $850 million. And if you look at the timing of cash tax payments those mostly are in Q2, Q3 and Q4 you see a dramatic shift in that. You'll see the working capital come back from that reductions in payables and liabilities during the course of the year. And as we've said all along, I mean there is a good $75 million or $80 million of tax prepaid that's not in our $850 million guidance and we're not pulling on that to suggest that that's why we're going to be exceeding the $850 million. So you'll see a different quarter-to-quarter variability this year relative to what you saw last year. But again most of that you'll see that came out of Q1 will come back into Q4.

Got it. And then I just had one last quick one for Ron and if this is not – feels free to give a really quick answer if you prefer. But your comment about price being more of an art than a science, I know there are some others in the industry that are looking at data and trying to apply more science to it and that's true across numbers of industries. But just what's your view of sort of applying technology to that problem and over time should it become more of a science than an art?

Well, look, I think, Corey, I would agree with the greater utilization of data. I mean, I still think it's an art. The greater utilization of data just makes you a better painter. I mean – and to know what to do where. And we use a lot of data to determine how we should paint that picture as well. So we should be more pinpoint, therefore, more scientific in that way as we go forward, as our data improves. But at the end of the day, this still gets down to, in our opinion, your ability to push prices really determined by a market model and your positioning within each market. And that's where we spend a lot of our time and had since the inception of the company. And, again, I would point to our 4% price up against I think the next highest is about 2.5% to 2.7%. So with that, I would say that the market model is outperforming the data model.

Got it. I appreciate the thoughts. Thanks.

[Operator Instructions] And our next question comes from the line of Michael Hoffman with Stifel. Please proceed with your question.

Thank you for taking my questions and good morning.

Sure. Good morning.

Worthing, on the guidance for 2Q in the $1.225 billion, what's the deal number like you gave for how it played out for 1Q where you went $39 million to gross $11 million net? What's that assumption in the $1.225 billion?

Ask your next question and I'll get the answer to that.

Okay. And then on E&P, just to follow-on very quickly, you're trending at $55 million plus at this pace. So we shouldn't be surprised we'd hit $60 million or approach $60 million in any given quarter and then maybe a seasonal dip, but that's the trend, right, $55 million plus?

That's correct. I mean we – that's suggesting it's going to hit $60 million but it could be damn close to $60 million. We'll see how it plays out.

And then, Ron, safety is clearly a big focus. You've spent a lot of effort to fix the – culture had been about this. Can you update us on the trend?

Sure. I mean, yes, Michael, it is a huge focus for us, as you know. We believe that safety is – and the reduction of incidents is an excellent indicator of the health of the culture of the company because we believe it's heavily tied to turnover, who we are hiring and how they are treated as they are employed. So a better, more empowered employee tends to be safer no matter what. So we look at it because they're our employees and we look at it because it's an indicator of how the health of the company is in our opinion. Things continue to improve albeit at a lower clip, where, I don't want to say we're getting to a point of no return, but we're certainly getting to a point of diminishing return. To give you a perspective, Michael, when we closed the Progressive transaction not quite 24 months ago, their incident rate was approaching 60% at its peak. For those that aren't aware, that means six out of every 10 employees will have a recordable accident or injury every 12 months. Waste Connections, at the time that we closed, was at about a 0.14%. So 14 out of 100 would have an accident or injury every 12 month. We have decreased the Progressive side to approximately a 0.21% or so, right in that range, so we've reduced it about almost 70%, a little less than 70%, bringing our blended performance up to about 0.18% or thereabout because Waste Connections has basically stayed flat at where we were pre-merger. So it has been a reduction off the peak of over 4,000 incidents a year of the rolling average of over 2,000 incidents a year. So there has been substantive improvement.

And how's that levered into labor turnover, given labor has been this ongoing challenge of finding people?

Yeah. I mean our labor turnover has been running pretty flat now for about four quarters within a 1% variability. Again, on the former Progressive side, to provide a number, at close, turnover was running around 43% to 44% and 90-plus-percent of that was voluntary. We have got the turnover in that footprint down to about 26% to 27% and about 60% of that is voluntary. Our goal is to get to at least under 50% voluntary. And our target is to get that down into the low 20s to the high teens. We think that's a healthy way particularly if half of that is on a voluntary basis. Then we're getting down to high-single-digits of people that are leaving voluntarily versus involuntary and that's very manageable. So we have some room to go there but despite tougher and tougher labor – tightening of the labor market we continue to be flat to nominal improvement.

And I think all of that ultimately leads into defection-related issues around price. So can you talk about in the quarter what your retention rate look like on price? It feels like you retain more of what you went to the market with. Not only did you go with a bigger number, you had retained more of it too?

Yeah. And certainly, to your first comment, Michael, certainly service quality has probably as much or more to do with retention as anything. But the other thing that has a lot to do with retention is the health of the economy, right. I mean again in 40% to 43% of our business, there's no worry about retention. You get 100% retention of what's put out because of the franchise nature of the business. So that allows us to focus on the other 57% of the business where you don't have guaranteed retention. There service quality is extremely important. And I think we continue to work on improving that. But again so is the health of the economy because when the economy is healthy, the private haulers who tend to live at a lower margin, they're getting their growth through the growth in the market which provides a better pricing umbrella for all of the players in the market and allows for higher retention. So to answer your question, the retention was north of 90%.

Okay. And one takeaway we saw from expo was talking to the privates. They fundamentally said they were full in commercial collection. That, at this juncture, they'd have to either add a route or displace a lower margin customer to add a customer. Would you buy into that statement?

Yeah. I think that's why so many of them were in line at expo. I mean, they are at a capital inflection point, right. It's one of the things that drives, whether a small, medium or large, drives their consideration to sell of those catalysts. I mean taxes, interest rates, strength of the business and where are they at a capital inflection point in their business. So I can't make that statement for every company, but certainly a lot of them are now well ahead of where they were pre-Great Recession coming out of that in 2012 or 2013.

Okay. All right. Worthing, did we buy you enough time?

Oh, yeah. You could have asked me your follow-up about 10 minutes ago in your first question. We've assumed new acquisition contribution is about $54 million in the period and divestiture impact is about $28 million. And so the net of that is $26 million. Now that does not include any contribution potentially from a transaction we saw in yesterday that could contribute during the month of June depending on when we close it.

Great. Thanks for taking my questions.

Sure. Thank you, Michael.

And there are presently no further questions on the phone lines at this time.

Okay. Well, if there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in the call today. Both Mary Anne and Worthing are available today to answer any direct questions that we did not cover that we are allowed to answer under Regulation FD, Regulation G and applicable securities laws in Canada. We thank you again, and we look forward to speaking with you at upcoming investor conferences or on our next earnings call.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.