Waste Management, Inc. (WM) Q1 2018 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Waste Management First Quarter 2018 Earnings Release Conference Call. At this time, all participants are in a listen only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder today's program is being recorded. I would now like to turn this conference call to Mr. Ed Egl, Director of Investor Relations. You may begin, sir.

Thank you, Kevin. Good morning, everyone, and thank you for joining us for our first quarter 2018 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; Jim Trevathan, Executive Vice President and Chief Operating Officer; and Devina Rankin, Senior Vice President and Chief Financial Officer. You'll hear prepared comments from each of them today. Jim Fish will cover our high-level financials and provide a strategic update, Jim Trevathan will cover price and volume details and provide an operating overview, and Devina will cover the details of the financials. Before we get started, please note that we have filed the Form 8-K this morning that includes the earnings press release and is available on our website at www.wm.com. The Form 8-K, the press release, and the schedule for the press release include important information. During the call, you will hear forward-looking statements, which are based on current expectations, projections or opinions about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K. Jim and Jim will discuss our results in the areas of yield and volume, which, unless otherwise stated, are more specifically references to internal revenue growth or IRG from yield or volume. All volume results discussed are on a workday adjusted basis. During the call, Jim, Jim, and Devina will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share, and they are also address operating EBITDA which is income from operations before depreciation and amortization and operating EBITDA margin. Any comparisons, unless otherwise stated, will be with the first quarter of 2017. Net income, and EPS for the first quarter of 2017 have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations. These adjusted measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release note and schedules, which can be found on the company's website at www.wm.com for reconciliations to the most comparable GAAP measures and additional information about our use of non-GAAP measures. This call is being recorded and will be available 24 hours a day beginning approximately 1:00 PM Eastern Time today until 5:00 PM Eastern Time on May 4th. 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 855-859-2056 and enter reservation code 3888516. Time-sensitive information provided during today's call, which is occurring on April 20, 2018, may no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited. Now, I’ll turn the call over to Waste Management's President and CEO, Jim Fish.

Thanks, Ed. And thank you, all for joining us this morning. The first quarter of 2018 was an excellent quarter that continued the strong growth we saw throughout 2017. Over the past year our traditional solid waste business has proven to be a strong as we have ever seen at Waste Management and the first quarter was continuation of that trend. Much of the strength can be attributed to our focus on discipline growth, our commitment to delivering exceptional customer service and our improving cost structure, aided by solid economic growth in the United States and Canada. In the first quarter, we saw collection and disposal revenue grow by more than 6%, total company operating income grow by 9% and operating EBITDA grow by almost 8%. Once again our strong operating EBITDA performance translated into excellent free cash flow, which continues to demonstrate the cash generation strength of our strategy. The strong performance in our free cash flow allowed us to repurchase shares and spend $248 million on acquisitions, in addition to our previously announced 9.4% increase in our dividend. The acquisition pipeline remains robust and we continue to look for opportunities that surpass our return criteria and create value for our shareholders. Our operations produced $0.91 of EPS in the quarter, and we have built a strong foundation for the remainder of 2018. Excluding the $0.12 EPS benefit from tax reform, our EPS grew close to 20% when compared to the first quarter of 2017. In the first quarter, revenues from our collection and disposal business grew by more than $183 million with most of this increase being organically driven. A key driver of our revenue growth was the disciplined execution of our pricing programs. In the first quarter our collection and disposal core price was 4.9% and our yield was 2.3%, in line with our full year goals. Looking at volumes, our traditional solid waste volumes were positive 3.4% in the first quarter, an increase of 200 basis points compared to the first quarter of 2017. The volume growth continues to be driven by our highest return and best margin businesses, commercial, landfill and industrial. Our plan to focus on delivering excellent customer service and directing our sales efforts and growth capital to the portions of the U.S. and Canadian economies that are seeing the strongest economic development is generating the results that we expected. Our traditional solid waste performance is as good as we have seen it. On the other hand the recycling business is in a state of transformation. In the quarter, recycling commodities -- recycling commodity prices declined 36% and volumes declined 1% at our recycling facilities. And while recycling is only one-tenth of the size of our traditional solid waste business, it still impacted the first quarter EPS by $0.08 on a year-over-year basis. We’ve said for years, that recycling is a business that Waste Management is committed to and we still are. But we simply can’t continue with the model in its current state. The original concept of recycling was to reuse materials either in their existing form or in some other form to minimize the consumption of natural resources. Unfortunately in North America today the word recycling seems to have been replaced with a new word, diversion. When diversion away from your trash pan is your primary goal then putting more material in the recycle bin does not necessarily mean that we're saving more natural resources. What it does mean is that the recycle bin almost inevitably has a higher percentage of trash or as the industry calls it contamination. Last year, the Chinese government decided that they were tired of importing increasingly contaminated recyclables. So they changed their policy to only accept recyclables with the 0.5% contamination content. Some of our plans see material come in the front door that is 40% trash. So we have to try and pull out almost 99% of that trash from the recycle stream in order to sell it to China as recycled commodities. Even our best-in-class inbound streams, which have only 10% contaminations still have to pull out 95% of the trash before they can sell it. As diversion goals have increased so too have our contamination percentages, which have increased from 10% to 15% five years ago to 20% to 25% today. In addition to that, China temporarily suspended import licenses, which caused global commodity prices to plummet last fall and they have yet to recover. Clearly, this is not a sustainable recycling business model. We must address higher operating cost in our recycling facilities and shrinking revenues from the sale of recycled products. As a result, we are continuing to educate our customers on how to lower contamination by recycling right and partnering with industry stakeholders on expanding these efforts. At the same time, we are auditing loads received at our centers [ph] and we are rejecting and charging back for contamination where we can. These efforts should enable us to recoup part of our increased processing costs and residue disposal costs. In our new contracts, we are looking to shift even more of the commodity price risk to our customers and more easily recapture our actual processing costs going forward. We started this shift several years ago by restructuring contracts and this is the next evolution in that shift. Lastly, we are communicating with our customers on the extent of these global recycling market changes. Our customers appreciate the transparency Waste Management provides and they seem willing to work with us to ensure the longevity of the recycling business. While these are difficult times in recycling, our goal in this transformation is to build a recycling program for both Waste Management and our customers that ensures environmental and economic sustainability for the long-term. Ultimately, we hope to see a shift in thinking away from the value being placed on how much gets put into the cart to how much truly gets recycled into new products. So while our recycling results in the first quarter were about what we expected, our recycling outlook for the remainder of 2018 has changed from our original guidance. We're already hard at work to combat contamination and control our costs, but the financial benefits of our actions will likely take time to materialize. And since our previous guidance, OCC prices have declined to nine year lows and mixed paper has dropped 80% to prices at zero or negative in some markets. So we now believe that the year-over-year decline in our recycling line of business will be between $0.12 and $0.15 per share versus our original guidance of a negative $0.08 to $0.10. To come full circle, in spite of these significant challenges in the recycling line of business, the large majority of our business is hitting on all cylinders. And therefore we remained confident in our ability to deliver strong performance throughout the remainder of 2018. As a result, just to be clear, we are reaffirming all of our full year guidance including operating EBITDA, EPS and free cash flow. I will now turn the call over to Jim to discuss the first quarter operating results in more detail.

Thanks, Jim and good morning. Our results in the first quarter continue the strong trend as we saw throughout all of 2017. We saw both price and volume in our traditional solid waste business exceed 2% for the fourth consecutive quarter. As a result, total company income from operations grew $50 million, an increase of 9% and income from operations margin expanded 110 basis points to 17.3% when compared to the first quarter of last year. Our operating EBITDA grew $69 million, an increase of nearly 8% when compared to the first quarter of 2017. And our operating EBITDA margin expanded 140 basis points to 27.2% when compared to last year. Revenues in the quarter were $3.51 billion. First quarter revenue growth in our collection and disposal business from the combined impact of price and volume was a $160 million. First quarter revenues were negatively impacted by lower recycling commodity prices and lower volumes, which drove a $77 million decline in recycling revenues. Looking at internal revenue growth in the first quarter, our collection and disposal core price was 4.9% and yield was 2.3%. Traditional solid waste volumes improved 3.4%, while total company volumes increased 3%. Volumes in the first quarter included about 40 basis points natural disaster cleanups in Florida and California. Volumes in our transfer station line of business were 6.4%, primarily due to the new New York City disposal contract. Looking at our other revenue metrics, service increases exceeded service decreases for the 17th consecutive quarter. And new business continued to exceed lost business for the 12th consecutive quarter. Our churn rate was 9.6% in the first quarter or 8.9% excluding the expected churn from the implementation of the City of Los Angeles franchise contract. And our rollbacks were 18.8%. Our collection lines of business continue to perform exceptionally well. In the first quarter, commercial core price was 5.9%, with volumes up 2.7%. Industrial core price was 9.9%, with volumes up 3.9% in that first quarter. In the residential line of business core price was 3.3%. Residential volumes were down 1% in the first quarter, but that is 110 basis points sequential improvement from the fourth quarter of 2017. The combined price and volume increases in our collection line of business led to income from operations growing $64 million, income from operations margin, growing 130 basis points, operating EBITDA growing $68 million, and operating EBITDA margin growing 100 basis points. In the landfill line of business, total volume increased 9.5%, MSW volume grew 2.2%, C&D volume grew 28.1%, and combined special waste in revenue generating cover volume grew 4.5%. We achieved core price of 3.3% in the landfill line of business. For the first quarter our landfill line of business grew income from operations by $30 million and income from operations margin by 90 basis points, while operating EBITDA grew $42 million, and operating EBITDA margin rose by 100 basis points. Moving now to operating expenses, in the first quarter, total operating costs as a percent of revenue improved 80 basis points to 62.2%. On a dollar basis, cost increased $18 million when compared with the first quarter of 2017. Our cost of goods sold decreased year-over-year, primarily due to the 36% reduction in recycled commodity prices. We also had lower fuel expenses in the quarter due to the 2017 fuel tax credits, which reduced our current quarter costs by about $28 million. The costs of goods sold and the fuel benefit were partially offset by an increase in labor costs due to the $2,000 employee bonus and volume increases in our commercial and industrial businesses. When we isolate the impacts of these items to focus on the operating costs and margins of our traditional solid waste business, we are pleased that our costs control efforts are working in a growing volume environment. If we net the positive impact from the fuel tax credits with the negative impacts to margin from our recycling line of business and the employee bonus operating expense margin from our traditional solid waste business improve over 50 basis points. Overall we are very pleased with our operating performance in the first quarter and I know our employees are hard at work to make 2018 another successful year. I’ll now turn the call over to Devina, to discuss our financial results.

Thanks, Jim, good morning, everyone. In the first quarter we continue to see our strong operating EBITDA translate into free cash flow growth. We generated $809 million of cash from operations and that’s an increase of 12% from the prior year period. Our cash flow from operations as a percentage of revenue grew more than 200 basis points from the prior year to 23%. We continue to demonstrate the ability to convert more of our operating EBITDA into cash from operations, positioning us very well to continue our commitment of investing in growth and returning cash to our shareholders. During the first quarter we spent $400 million on capital expenditures, that’s an increase of $68 million from 2017. It is in line with our expectations as we intentionally spent more of our fleet capital early in the year to support our growth. As we have said before, we have seen significantly organic growth in our business and we’re investing in our fleet and our landfills to respond to the needs of our customers. We continue to expect that our capital expenditures will be between $1.6 billion and $1.7 billion for 2018. We generated $423 million of free cash flow in the first quarter, that’s an increase of $26 million or more than 6% from the first quarter of 2017. In the quarter we converted more than 44% of our operating EBITDA into free cash flow. This strong performance puts us well on our way to achieving our free cash flow guidance of between $1.95 billion and $2.05 billion for 2018. In the first quarter we returned more than 100% of the free cash flow we generated to shareholders, as we paid $206 million in dividends and paid $250 million to repurchase shares. In addition we spent $248 million on traditional solid waste acquisition, demonstrating our commitment to identifying accretive transactions in growth market. That will allow us to more effectively leverage our people and our assets to service our customers. Turning to SG&A, for the first quarter as a percent of revenue SG&A costs were 10.6%, a 70 basis point improvement from the first quarter of 2017. On a dollar basis SG&A costs were $373 million in the first quarter or $17 million lower than the prior year period. The reduction in SG&A costs is due to our continued focus on managing our discretionary funding, as well as a decrease in our labor expenses that can largely be attributed to prior year executive severance costs. Our effective tax rate for the first quarter of 2018 was approximately 23% and we now expect our full year 2018 tax rate to be between 24% and 25%. Each of these rates is a little more than 1 percentage point less than we previously expected, this revised outlook is due to additional clarity we now have on the impacts of tax reform. The EPS benefit of this revised tax outlook was $0.01 per share for the first quarter of 2018 and is projected to be about $0.06 per share for the full year. Our key financial metrics remain strong, as we continue to see the benefits of earnings growth and disciplined allocation of our free cash flow. At the end of the first quarter our debt to EBITDA ratio measured based on our bank covenants was 2.4 times and our weighted average cost of debt for the quarter was about 4%. The floating rate portion of our debt was 17% at the end of the first quarter. In summary, 2018 is off to a strong start, with the first quarter reflecting the continued execution of our core operating objectives and focus on continuous improvement. Our strong traditional solid waste business performance overcame headwinds from recycling to produce a healthy increase in both cash and earnings. We expect that trend to continue throughout 2018. The Waste Management team has once again demonstrated that our disciplined focus on serving the customer, while optimizing our business generates strong operating results and we look forward to that continuing throughout the year. With that Kevin, let’s open the lines for questions.

[Operator instructions] Our first question comes from Brian Maguire with Goldman Sachs.

Hi, good morning everyone.

Good morning, Brian.

Hey, Jim appreciate your comments on the recycling markets these days and sounds like you guys are taking a leadership position there as you should and trying to clean up the industry and change some of the habits, practices being employed just into the new environment all seems very logical. Just some questions around the impact in 1Q from because I noticed you said there was a $0.08 hit to EPS on I think it was about $77 million of sales. I think last year’s total benefit was around $0.085 on roughly 3 times the sales amounts so just wondering if you could maybe dig into that a little bit more why the sensitivity in the margin is a little bit different on the way down than it was last year on the way up.

Yes, so the EBITDA impact was about $46 million for us for the quarter and that’s driven by those things I mentioned in my prepared remarks. The big decline in OCC mix, paper down 85%, but what’s maybe a little different from prior years is that we’re seeing a big uptick in operating costs that’s as a result of that 0.5% contamination limit that China has put on. And then in addition to that think of it this way, we were shipping about 30% of our cardboard a year ago to China and it’s now about 2%. Fortunately we have markets that we can ship to not everybody is that fortunate. But there’s a higher transportation costs that comes with that, those markets are markets like India and Vietnam, and so the haul is longer to get to those countries versus China. So we’ve seen an increase in our transportation cost as well. But I think maybe more directly to your question as we think about what this looks like going forward. There is a bare case to be made here about recycle, as well as a whole case to be made about recycling and that is that not only are we going through those steps to improve the business in the short-term, but look China needs cardboard and there’s probably 5% growth of cardboards in China expected for 2018 and they really have three sources of it, one is OCC, imported OCC which I mentioned we’re -- really we’re not sending ours and most are not either. So they’re not getting OCC from the import market. The domestic Chinese OCC market is drastically insufficient to satisfy their demand so they’ve resorted to pulp, which is just spite as a result of the artificial shortfall in supply without OCC. So I think there’s a case to be made that theirs is ball case to be made here. And I think the other side of that is that we’re looking for the medium and long-term at changing some of our technology and our plans, so that we can better handle contamination coming in the front door. I don’t know whether that answers your question, but that’s kind of the bull on bear case for us.

Jim maybe for Brian benefit mentioned too that alliance with your bull case right now that $0.12 to $0.15 revised guidance is based on about $80 a ton for our commodities. We’re now at about $70, $72, $73 in that vicinity. So it’s not a huge upside that’s built into that guidance on the commodity side we have some upside expected, but we truly see that because of Jim’s bull case we not fully expect that to happen. In addition if you just look at the commodity trends right now domestic OCC and we see it trending up from that April level that we saw that’s exceptionally low as Jim pointed out. The export OCC we also see that trend up for the Jim’s bull case example, export OMP, we see moving up from the April level significantly and that’s in our guidance number. And really down one is that mix paper that we’ll see moving forward as we move forward. But the point is that in that new revised guidance we got about $10 of commodity price that we build in on the upside into that guidance.

But I think the wrench in the mask there really is the operating cost that’s what’s -- that’s kind of the short answer, we gave a long answer to your short question, but that is if you're just looking at kind of commodity prices, you should be able to kind of do the math that you were doing. The wrench is operating cost and then that’s something we haven't necessarily seen and seen a big spike is what's caused the difference.

That's a great answer. Just do you think then we need to maybe update the sensitivity that we've been using the $0.04 per $10 move. And then just sort of to Jim's point on what's baked into the guidance, it looks like an incremental $0.04 to $0.07 hit for the rest of the year after the $0.08 this quarter. It seems awfully low considering I think the 2Q comp will be even tougher. I would think that 2Q number would be even bigger than the $0.07 high into that range. So are you sort of assuming that it's a year-over-year good guide for the second half of the year is that what I'm hearing?

So Brian, I would start by saying with regard to the guidance that we've always provided with respect to that $0.04 impact for the $10 shift in prices. What's important there is to reiterate Jim's point is that is the commodity price piece only. And so that speaks to revenue sensitivity. The operating expense sensitivity is the other piece of the equation. So we wouldn't break with that guidance, because they're not necessarily connected. So what we did see in the first quarter is that in addition to the EPS impact, which were about 75% to 80% of the $0.08 of negative impact that we saw in the quarter from commodity price changes, we also saw that OpEx be about 20% to 25% of an impact. With respect to the last part of your question, I think what's important to remember is first quarter was really the strongest quarter for recycling in the prior year. And the comps and the decline in commodity prices we really started to see in the fall of 2017. And so the more positive outlook for the remainder of the year relative to what we saw in the first quarter really has to do with the impacts of those year-over-year comps, and then to some extent starting to see some benefits of the specific action that the company is taking.

Yes Brian, we also on the operating costs side we expect that it's built into that guidance. We expect to see operating costs improvement versus the first quarter. We've got some strong actions underway. We look by Murf [ph] at where their commodities are being shipped. And then address the contamination cleanup level to the end marketplace. And perhaps in the first quarter we weren't as good at that as we implemented that Chinese the new standard. And you'll see operating costs on the recycle side get better that will help us meet that new guidance number versus the trend for Q1.

I know we're spending a lot of time on this question here, but this is really the -- it's the major detractor everything else was really, really strong in this quarter. And yet when you look at recycling, we knew there were going to be some questions on it. And we can go into the strength of solid waste, we talked a bit about it in our scripts. But Brian, last thing I would say is about second quarter and then guidance for the remainder of the year is when you see China do these -- kind of take these types of steps, they always do it in the first quarter. Because that is -- that's the quarter where they can afford to see OCC drop from 30% to 2% from Waste Management or from anybody else for that matter. But they do have a need as I said for cardboard and it's 5% there really is -- their options are pretty limited. I gave three and really that second option is not much of an option domestic OCC. So it's going to have to be imported OCC or pulp and pulp has doubled. So at some point they have to come back to import OCC, which is why we think the price as Jim said has some upside, much more upside potential than down side.

Okay, appreciate the detailed answer. Sorry to lead off with this quirky wheel you will, but appreciate the color.

Okay.

Our next question comes from Hamzah Mazari with Macquarie Capital.

Hey, good morning. The first question is just around more work you plan to do with your cash, leverage is at an all-time low, free cash flow is at all-time high, does it probably antitrust issues in growing in the core business. So the question really is do you return 100% of your free cash flow back like one of your competitors. Or are there better options for that cash?

So Hamzah I would say the first quarter is a really good indicator of our confident in the free cash flow generation and the balance sheet strength that you mentioned. And as I mentioned we allocated more than 100% of free cash flow through a combination of share buyback and the dividend and then on top of that acquired $248 million of solid waste businesses. And so I think that’s a really good indication of how we think about capital allocation going forward. We’re continuing to commit to growing the dividend over the long-term as we did this year with a 9.4% increase on a year-over-year basis. And then we’re looking at $750 million baseline of share buyback for the year, so committed to that strong allocation, as we have always been.

Hamzah those $248 million of acquisitions that Devina mentioned it’s seven or eight transaction in Q1 of excellent tuck-ins that are in really good markets for us, where we’re asset strong and can internalize and get some synergies out of that material. So we’re excited about that revenue that was added. Early pipeline for 2018 is strong as well, and we’ll still look for really good acquisitions at a fair price, they are accretive to our business and expect to do more of them in 2018.

Great. And then just second question, I know you gave a lot of detail on recycling, but my question is a little more specific around recycling is, overtime you have restructured some contracts, you have tried to derisk that business. But I guess the question is, is the real issue that you need to restructure contracts to get processing costs back or is it protection of downside of pricing and is the issue is more municipalities that you are dealing with. Question is more from a contract structure perspective, can you do anything?

Yes, Hamzah, we are doing something about that, this week in fact a few of us from the SLT met with our public sector team they work from each of our 17 areas. We had already rolled out a three phase plan to do just that and look at contracts in their existing form, where we can make operating changes around contamination and then look for opportunities to renegotiate current agreement. Some will have to wait till the end of the term and take a hard look, but our customers fully understand the situation that we’re in with contamination and we’re taking strong action in that regard. The last action what three or four years ago is primarily around floor pricing and getting the price right. What we’re having to do now because of the reset button of recycling business is take a look at that contamination and make sure that we’re getting that fair payment for processing. And as Jim mentioned in his earlier statements, make sure that the customer's taking the risk on commodity price not just us.

Really Hamzah -- this is Jim and I just going to reiterate this point that Jim has made. Contamination is the route of this, it is -- and it goes back to that statement I made earlier, which is we’ve kind gone away from recycling to diversion. So there is this lack of congruency here between recycling more meaning putting it to an alternative use or turning it back into the same thing, turning a plastic bottle back into another plastic bottle. And we have gone to diversion, which means I divert more away from my trash bin into my recycle bin. And inevitably that ends up meaning that you’re going to have more trash in your recycle bin and that is what we’ve seen. The numbers that I gave are actual numbers, five years ago we’re in the 10% to 15% contamination range at our single streams, and now we are 20% to 25% and that I think is what caused China to ultimately say we’re tired of importing your trash, so get your act together. So it may not be a message that’s necessarily pleasing to hear for our customers, but it’s not our trash that we’re creating. This is coming out in the inbound side and when you have some plans that are 40% contamination in the inbound stream, that simply can’t continue.

And Hamzah I would add that the contract renegotiations that we did over the last three to five years really did provide some real value to the company in 2018 we expected to provide value over the course of the year, it could have been that much worse. If you think about where we resulted -- where our Q1 results reflect the recycling line of business to be, which as Jim said was a $46 million year-over-year decline in EBITDA. We actually estimate that the impact from recycling for 2018 could have been as much as $0.08 to $0.10 worse than we’re projecting is not for the work already done by our teams.

Got it, very helpful. Thank you very much.

Our next question comes from Michael Hoffman with Stifel.

Thank you very much for taking the question and if I can ask your different thread on the recycling, because I thought your explanation of the demand was good, but can you help us think about if they use 1Q to do whatever they want to do, what's the pattern look like typically April, May, June, July, August. What do you see and one of your biggest customers is Nine Dragons and they are adding 2 million tons of capacity in middle of the year, how does that layer into some of the thinking? Can you get a little more color around that?

Yes, I mean I think Michael, first of all the pattern tends to be as they prepare cardboard for shipping for the Christmas season, it tends to be kind of Q2 and Q3, it's not Q4. So we've typically seen pricing, commodity pricing drop off in Q4. Couple of years ago it did not and that was somewhat unusual, but historically you've seen kind of the low course be Q1 and Q4 and the stronger quarters be Q2 and Q3.

Okay. And so your anticipation is given the fundamentals and all the little brown boxes that show up in all of our houses that demand driver is going to be good in 2 and 3?

Well, look it’s not as if China is not going to ship cardboard boxes. So, if you believe that their growth year-over-year is going to be 5%. They’ve got to find the cardboard somewhere, but we don't take issue with their point on contamination, I mean, if what's coming into their -- to Nine Dragons is heavily contaminated, it increases their costs. So I think they have taken a stance and it's hard to argue that stance, but once we start cleaning out the stream and that's why we spent a fair amount doing that. And I think you'll see them start to import where we're seeing a bit of that already and then I think the price will come along with that. We're not projecting prices up where they were in 2017, but certainly as Jim said, we think prices will bounce off of where they were in March.

Michael, we think we'll come out of this reset even stronger than before. We -- our brokerage business is the great example of that, what we shipped to China in Q1 for example two-thirds of it came from our brokerage volumes very clean materials. And that we could combine with materials from our Murf that we appoint appropriately. So, we think that we'll come through this fine and that demand has to be there. We expected to grow and as I mentioned earlier with the Brian's question that export OCC, we think has some real upside over the April numbers and we bake that in and we see signs of it.

And are you still approximately 50-50 brokerage versus your own Murf rev when the rev dollar?

Might be a little bit higher or our own but more like 60-40 maybe, but yes, I mean, in that neighborhood.

Okay. And then switching gears to solid waste business, a year ago you had a 19% year-over-year growth in C&D and you come back in 2018 and done 28% and we had a regular winter. Can you talk about what's going on across your 17 regions and what you are seeing because that's really good?

Yes, I think Michael, you've talk about a lot in some of your reporting, I mean, if you look at housing starts, housing starts have been on a really nice consistent upward trend with March I think being the highest number that we've seen over the last few years and I think 1.3 or something like that. It's not up to where it was in 2006 at 2.1 or a big number like that. But it's been a nice consistent upward trend. And so hence we're seeing that sharpen our C&D business and I might kind of answer a question for you in advance here, but because we've spend so much time on recycling, let me just give you Michael and everyone a number here that that is really eye opening about the strength of the solid waste business and that is our EBITDA growth. When you think about EBITDA, and we showed a number of $69 million in growth in EBITDA for the quarter, but what's included in that is the bonus, which the $2 bonus, which was $18 million we already talked about the $46 million headwind in recycling. And then the fuel tax credit, which was $28 million positive for us. If you said let’s adjust for those and just see what the solid waste business is doing, the traditional solid waste adjusting those three things out, you get $105 million in growth, which is 11.9%, almost 12% almost all organic growth in an EBITDA line and a 2.5% economy. So -- and if you do that math on a free cash line it’s absolutely ridiculous the number is so good. So I think Mike I’ve kind of answered a question that you didn’t asked, but maybe you were going to get to it or somebody else was. But I know we’re going to spent a lot of time talking about recycling, but I want to everybody understand first of all recycling is one-tenth the size of the solid waste business and the solid waste business is absolutely rocking and rolling right now.

And Michael the 28% that you mentioned on C&D you’re right that’s a really strong number. I don’t see that moving forward at that level in future quarters that’s a lot of that volume for the national disaster clean ups in Florida and in Northern California. Yet it will be positive it was last year even before given the construction activity in North America. So it’ll be positive, but it isn’t going to be a 28% in my estimation, I’d love for that to happen. The other point to mention is that C&D is about 10% of our total landfill volume. So although very positive the rest of the lines of business in landfill were really strong as well.

And that was where I was going to go with this is, ultimately this is a very consumer sensitive business because what happens in commercial collection and when you look at weight on a same-store basis in commercial collection, how do you frame that trend?

Yes, Michael I don’t see it up dramatically it’s in fact slightly down by container, which is unusual because the total volume looked really healthy. You saw it for all of the lines of business both price and volume were extremely healthy. So I'm not sure that’s -- I know that’s not what’s driving it is the weight by container, it’s the total volume of our business.

Okay. And if weight is not rising there, but you’re getting the level of pricing, so what’s supporting that, because you are heavily urban model. So the level of pricing you’re getting given as urban as you are and as much competition as you have to deal with, is impressive.

Yes, you look Michael at the two lines of business that are driving that, the commercial and the industry line of business. I think Jim nailed it in his opening comments and that’s we have excellent asset in those urban markets. We have moved some really strong process and people and to those growth markets and are getting at least our fair share of the growth in those MSAs in commercial and in the industrial lines of business. It’s helping the collection side, but it’s also supporting the landfill line of business because we internalize that volume.

Okay. Devina at a 21% tax rate have you started a dialog with the rating agencies that say listen you used all of us to a standard of 3% to hold on to a Triple B leverage, but that’s a 35% tax rather 21% will they adjust your leverage up and allow you to be Triple B still?

Yes, we’re actively engaged in conversations with all of the rating agencies Michael and I would tell you we have some positive outlook associated with where our ratings are today. And hopeful that we’ll see those come through in the short period of time.

So in a consolidating climate what I'm hearing is that you could get levered and hold on to your rating and because of the difference in the tax structure and that they are opened to that dialog?

We haven’t specifically talked about a new kind of turn of leverage that would acceptable in order to maintain investment grade. But we certainly are seeing that they see the fundamentals of the business have always been the cornerstone of what allows solid waste to be more heavily levered than other typical industrials that are more cyclical. And we expect that they’ll continue to see that not just for us, but across the companies that they rate with the lower tax environment it’s just difficult for us to say how high we would expect leverage to go. We’ve always talked about 3.25 kind of being the max level of leverage for investment grade rating and what would be comfortable for us. We don't know how much that will change with tax reform.

All right. And then last question, just a detail, you have foreign exchange and other line as negative at 1.6 yet the Canadian dollar actually is up. So what's causing it to be negative because that should have been positive?

Yes, it's a combination of two things. One is the change in accounting standard that you guys are aware of. And then the other is a change in some of our pass through revenues.

So if that's where the rev rec is being adjusted?

It is.

Okay. And am I supposed to assume there is $40 million of added or $40 million to $50 million for the next three quarters?

That's about right.

Okay, thanks.

Thank you.

Our next question comes from Jeff Silber with BMO Capital Markets.

Thanks so much. I'm not going ask about recycling. My first question you mentioned the employee bonus, I know it's still very early. But I'm just wondering if you could talk about the impact either in terms of retention in moral recruiting what you’ve seen so far?

So retention we haven't seen -- the first two months at least January and February didn't see a big change in retention. March, we saw a bit of a change. I would guess that as we get later in the year that we'll see additional change in retention. We have not made any decisions on what we're going to do with respect to retention programs going forward. And as far as moral goes, I said a lot of time out in the field as does the entire SLT and hopefully the view that we get is an accurate view. But it seems to be reasonably good right now, now I don't know how much of that is attributable to $2,000 bonus and how much is attributable to just a strong performing business right now. But I'd like to think that the moral is pretty decent right now.

And how about from a recruiting perspective, is this something that you're using to recruit folks?

Well for sure the $2,000 bonus in 2018 because one of the things we said was that it's not just for people how are employed as of January 6th or whatever the day was we announced. If you start in 2018, and you're in one of those groups it's largely hourly employees then you qualify for this bonus. You have to wait a year to get it and that was the retention aspect. But if I start on December 15, 2018, I qualify for the $2,000 bonus. I don't get it on December 31st, like everybody else, but I have to wait a year. But there is a value in it that if I start sometime in 2018 I qualify for the $2,000.

Yes, I guess, I understood that, but I'm just wondering has it been easier to recruit folks using this. I know it's still difficult out there?

I don't know that we've enough data to say one way or the other, but it’s a good question I just don't know that we have enough data to say one way or the other whether it's made our job easier or not.

Okay, fair enough. And then just shifting gears to the acquisitions, the market spend this past quarter I think was more than you spend last year. Was it just an issue with timing or are you becoming a little bit more aggressive on the acquisition side.

Yes, I think it was timing Jeff, but plus one of them probably a little higher average size than in our typical tuck-in that drove that dollar value up, but primarily collection business that tucks-in really well. I think that the opportunities are out there and we're aggressively seeking them as the other industry participants are. And the climate is just good for those tuck-in acquisitions at this point, whether the number gets close to that I can't say it takes two of us to agree on a fair price.

And Jeff I would just add that, it probably goes without saying, but I think it's worth saying anyway. With tax reform more deals are going across our hurdle rates. And so we certainly are committed to continuing to invest in consolidation of the business where it make sense and where we think the there is real value. And so I think the first quarter number is an indication of that.

Great. And what do you think the impact on revenue growth from those acquisitions will be this year?

I don't have that number right on my fingertips, but we'll get back with you.

Okay, great. Thanks so much.

Our next question comes from Tyler Brown with Raymond James.

Hey, good morning, guys.

Good morning, Tyler.

Hey. Devina real quick, was the CNG tax credit about $0.04 was it in OpEx or the tax? And then to be clear, was it contemplated in the guidance from last quarter?

Yes so it was about $0.05. And it was in operating expense, a little bit in tax so not much. And it was contemplated in our guidance for the year.

Okay perfect. Obviously on -- yes, sorry go ahead.

One thing I would add though is that is not in our free cash flow for the quarter, we’ll see it later in the year.

Okay, that’s helpful. And then obviously $250 million in M&A in the quarter obviously very strong, maybe to the prior question, do you have an expected EBITDA contribution or maybe would it be safe to assume you allocated it call it mid-single digit type multiples?

You’re right there, that’s a reasonable assumption. What I would say and we always talk about is where you do see our tuck-in acquisitions show up is on the EBITDA line, it’s harder to see them on the EPS line because of some of the purchase price impacts to intangible amortization. So we do expect these transactions to be EBITDA positive and contributing right away. In our guidance for the year we did expect about $200 million of tuck-in acquisitions, it’s just more heavily weighted towards the first quarter than we anticipated.

Right. So should we assume that there is any more M&A included in the guide?

Not at this point.

Okay. Then quickly on recycling, did I hear you right, is the commodity basket today at about $72 a ton right now, is that right Jim Trevathan? And then for a quick clarification, is that just OCC or is that a broader basket?

That’s a broader basket and it is about $70. And in the current guidance, the revised guidance it’s about $80 for the whole basket of materials.

Okay, perfect. Yes, I just want to be clear on that. And then Jim Fish, I hear you on the difference between diversion and recycling I completely agree. Maybe you guys won’t agree with me maybe I am being a bit too colorful, but am I crazy to think that this maybe the best thing that ever happened to recycling? Meaning, I assume this is got to materially change the conversations as you go back to those municipalities?

Yes, I don’t know whether I’d characterize it as the best thing that ever happened to recycling after seeing the $46 million decline. But I do think you are right, it is something that needs to change, when we all think about recycling, recycling is a good thing, but unfortunately it has shifted away from this recycling for the saving of the world’s natural resources to diversion, which just means how much less can I put in my trash bin and how much more can I put in my recycle bin. And I think that has kind of a bad unintended consequence.

Tyler, I think somebody pointed aspirational recycling versus the real recycling that I think we all is right and our customers get it. They fully -- they understand it, some of them don’t like it, but they truly understand it. And I think you’ll see overtime, we will make this business better in the long run.

Maybe one last example here Tyler is, kind of a funny example, but maybe the -- maybe where the misunderstanding is, is that look a lawn mower has a lot of recycle material on it, it doesn’t mean that you can put it in your recycle bin and send it to our single stream, because we don’t have the equipment to breakdown the lawn mower, I mean yes the blades made out of steel, but we -- our single stream equipment cannot process a lawn mower or a baby stroller or name any other item like that. And so there is -- I think there is a misunderstanding about what our recycle facilities will actually process, they obviously do the good job of processing tin cans, and aluminum cans and plastic bottles and cardboard and papers, but they can’t take the rubber out of a hose and they can’t take the metal out of a lawn mower.

Right.

And we can’t keep the economics working to where that whatever even be feasible.

Okay. So this all comes back to the same kind of talking about the same thing here, it’s contamination really is the route of the problem, then why not abandon single stream and just go back to the simple basic, maybe call it dual stream or just simple commercial recycling?

Yes, look I mean, first of all our customers want single streamer recycling and we’re committed to the single streamer recycling. So what we do want do is make sure that we improve the process. Now some of these as I said can be done through technology improvement and we’re looking at different technologies to improve the stream, but I think we’re too far down the path to do anything other than what we’re doing today in terms of single stream. And I think lot of people reference Europe and what they do with their sell sort, but we’ve become a single stream society and I think our best course of action is to improve the model both on the financial side, but also on the material side.

Okay. And then Jim Trevathan, I apologize for being uninformed here, but what is the roll back has been I think you said 18% what does that mean is that a spread between new and lost business or is that the percent of volume that’s all roll back or I just frankly don’t know what that is?

Yes Tyler, the easiest way I can tell you is as we roll out price increases some customers question and challenge that number and we to retain very profitable accretive business will roll back a portion of that to retain that customer and that’s…

So simple.

Yes, no I understand what a roll back is, I mean, what does the 18% mean now is that how much you rolled back like in percentage wise I'm just…

Yes, 18% of the total price increase we rolled out in the marketplace.

Okay, thanks for the clarification. Thank you, guys.

Our next question comes from Corey Greendale with First Analysis.

Hi, thanks this is Ken Wang, on for Corey. Pretty much all my questions have been asked at this point. So maybe I’ll just ask any notable changes in competitor behavior seen during the quarter?

No, I think, everybody seems to like the current environment that’s for sure, with the economy doing as well as it is and solid waste is a good business right now.

Perfect, thank you.

Our next question comes from Noah Kaye with Oppenheimer.

Yes, thanks for squeezing me in. So in this quarter resi volumes still down though improving and really getting the growth, more growth both on price and volumes is in the C&I the higher margin part of the business. So obviously a very good trend for overall company financials. I want to ask as you look out to the book for the rest of the year, how do those sort of the underlying trends look to you do you expect resi volumes to maybe turn positive or get back a little closer to the C&I side of the business in terms of volume growth? Or do you think C&I will kind of continue to really outpace on both metrics?

Yes, Noah I think that the commercial and industrial volumes will always outpace the residential volume. We look at it differently in that return on capital is really the focus on that residential line of business. It requires generally when you add customers, new capital, new trucks to service, a new marketplace. And so we look at that differently than those volumes that can fit if you will on our current route structure. So we’re not hungry and aggressively seeking that residential growth. We like the fact that it is improving, but I'm not going to forecast that it gets positive or moves into that 2% or 3% range like the commercial and the industrial business are. Yet we’re very pleased with what we’re doing in that line of business. We’ve got real focus to move that margin up and to improve that return on invested capital, but the trend is good, but don’t expect it to get to commercial and industrial level. The other thing I’ll mention on the commercial side, it’s very positive the last few quarters. Remember that we added that business. And so we got a little headwind we’ll anniversary that in the second half of this year, it will stay positive and we’ll beat our guidance number there, but it won’t probably be at the same high levels unless the marketplace continues to improve.

Okay, great. Thanks so much I’ll take the rest of questions offline.

Our next question comes from William Griffin with UBS.

Hey, good morning guys. So you may have already touched on this, but I just wanted to confirm quickly, was there a change in 2018 related to re-classing, recycling rebates from expense to counter revenue?

There was.

Okay. And could you tell me the approximate dollar amount for 1Q and the EBITDA margin impact from that change?

So as I mentioned earlier it’s in that foreign currency line item in the internal revenue growth table. And so in total you saw 1.6% change in revenue associated with that, but it’s included with other things. With regard to margin impact, the margin impact was in total around 50 basis points on OpEx as a percentage of revenue.

Got you. And I guess can we expect sort of that relative amount to be consistent going forward over the course of this year?

Yes, but I would say generally though is that the impact of Q1 is a little higher than the full year run rate because Q1 is a lighter revenue quarter than the other quarters.

All right, perfect. Thank you very much.

Our next question comes from Michael Feniger with Bank of America.

Hey, guys thanks for squeezing me in. Just on the recycling just curious, I mean, on the 40% of this brokerage can you just walk us through how the economics for that portion of your business is perhaps different? And with the contamination issues you mentioned how some centers were clearly just starting to turn away I'm just curious is that just all going to end up -- will some of that end up at landfill like is that what could play out probably you could just address that?

I’ll take the second question, I’ll let Jim address the broker question, but yes, I mean, ultimately what happens and that’s the irony of all this is that when this material comes in the front door if you have a plan where the inbound stream is 40% contaminated materials, today we sent a piece of it out as commodities, but that 40% as much of that as we can pull out ultimately ends up in a landfill and that is the irony of diversion. Is that while it may get diverted at the first step, which is at the curb, it doesn’t get diverted overall that’s why we believe that recycling should be the goal not diversion because diversion ultimately just means that it ends up getting processed through our plant, but still ends up going to a landfill. So there’s really no economic gain in pushing that through a plant. But Jim the broker question.

Yes, and maybe just to comment too for Michael on that last point and that’s why we are working with our customers, our largest residential customers in cities and communities around education that is -- that can be a true mitigator of that factor is to not contaminate if you will some of the recyclables, but we’re not going to wait for that to happen. We’re going to execute as the contracts allow and as third parties bring us material contamination charges that are allowable and reject materials that can’t be recycled because it can’t be sold. On the brokerage business it really are they are large volume customers that we end up just marketing their product for them. So we have a very low margin, low mid-single-digit kind of margin, but no capital involved, there are no trucks involved, we’re not collecting the material. We’re just helping them broker their material and combining it with our excellent team that has the outlets all over the world. So it’s again low margin, but really valuable for us and aligns us better with our customers as well.

That’s helpful. And then on to I mean obviously the CapEx was high this quarter like you said you’re making some investments in your fleet and your landfills does that mean you’re actually adding -- are you adding routes, are you also seeing some smaller players investing in their fleets and trying to add routes as well maybe because they’re seeing the higher growth in the market?

Yes, Michael I can’t speak to the competitors, but we have added routes, but at a lower percentage in the commercial, in residential and industrial all three lines of business than our volume growth of course resi is not growing. But -- so we’re getting some efficiency there in routes versus the volume growth. But yes we are adding routes in those two lines of businesses.

That’s great. And then just on the margin performance I guess big picture if you’re in an environment where volumes are 2% your yield is 2% core prices like 4%, 5%, I mean, what tenure now to fully expand your margins in the solid waste business in that backdrop?

So aspirationally we look to expand margins 50 to 100 basis points for the year. We certainly outperformed that in the first quarter some of the outperformance came from the fuel tax credits, but even if you peel back the impact of the fuel tax credits to traditional solid waste business did see that 50 basis point plus margin expansion for the year, I mean, you really are hitting on it. If you look at price we’ve always known that price is one of the levers that helps us to expand margin. But to Jim’s point when you’re adding volume at a pace that outpaces meaningfully the rate of routes increases and labor costs you’re going to get leverage from that as well. And so we’re certainly seeing that show up.

Michael I think if you look at margins, I mean, margin is maybe an underappreciated, really good story. If you look back over the last four years, Q1 of 2014 our EBITDA margins were 23.1%. And then -- and you continue down the road I mean 24.5% and 25.8%, I mean, it’s been on a continuing upward trend. So does it continue on a straight line, I don’t know but boy it’s sure it has been a good story that I think is a little bit under appreciated.

Yes, I would agree with that, I mean, I am just -- I guess I am curious, could you guys just remind us like what has changed to be able to get this type of margin performance, is it just better cost control, is it removing costs during a low CPI environment. Just curious if you could touch on some buckets of how you guys have been doing that and why we could expect the 50 to 100 basis points, which we might not have been able to expect in the prior cycles, why we can expect that going forward?

Look some of it is -- you have said on the kind of the key items, I mean, we’ve -- as you know I mean we’ve kept control of SG&A, since I was CFO. So SG&A has -- and that SG&A percentage as Devina said in her prepared remarks has come down. So SG&A, operating costs controls with SDO which we’ve talked about for years. And then when your top-line growth is coming in C&I and landfill that’s going to be good for your margins. So we think we’re doing some things with the customer in terms of customer -- improving customer experience, we’re very, very focused on a best-in-class customer experience. And we think that is showing up in our growth numbers in the commercial and industrial lines of business.

Michael Jim called it in his early statements of disciplined growth and our term for that what that includes is that point of where we grow and at what price we grow our business. We are very careful to make sure we’re not just adding volume, we are adding it in the right places that add that margin expansion and with where we can internalize that volume. So it’s not just the economic growth, it’s the discipline of grow at the price with the right customer base that adds to that margin expansion.

That’s perfect, guys. And I know -- and lastly I know we touched a little bit on April with recycling price, I am just curious anything on the solid core waste, is it the trends you kind of saw in February and March continue in April and any impact from weather at all?

Are you asking about pricing for solid waste?

Yes, price and volume basically…

Yes, so I would say, well look through it’s early in April, but our volumes still look good in April. Price continues -- price is something that we have been focused on for a decade and we’re certainly not -- what helps us with price is taking this very strong stance on customer experience. I mean, the better our customer experience the more differentiated we are and easier it is to command a higher price. And then what was the last part of your question?

Weather.

Weather, yes, so we didn’t really use the W word in because it happens every year, what I would say is that this is a little bit tougher winter than last year, last two years actually were pretty mild, we actually pulled the field and we had 30 more lost days to weather this year and that’s area days. So the areas themselves had 30 more lost days this year than last year. So the weather did affect us, but look we work through that, it’s winter.

Yes, thank you.

Thank you.

And I am not showing any further question at this time, I’d like to turn the call back over to our host.

Okay, well thank you very much. In closing today look I’d just like to say I know we talked a lot about recycling, I think it was the right thing to talk about, it’s an important part of our business. But as I said it is a smaller part of our business compared to the solid waste and with respect to solid waste I would just say that maybe more than any other quarter my carrier of Waste Management this quarter highlights the strength of core, the core of this business. So we look forward to the rest of the year and we look forward to seeing many of you next week in Los Vegas at Waste Expo. Thank you.

Ladies and gentlemen that concludes today’s presentation. You may now disconnect and have a wonderful day.