Good afternoon, everyone, welcome to the Republic Services first quarter 2018 investor conference call. Republic Services is traded on the New York Stock Exchange under the symbol RSG. All participants in today's call will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone, to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Nicole Giandinoto, Vice President of Treasury and Investor Relations. Please go ahead.
Good afternoon, and thank you for joining us. I would like to welcome everyone to Republic Services' first quarter 2018 conference call. Don Slager, our CEO, and Chuck Serianni, our CFO, are joining me as we discuss our performance. I would like to take a moment to remind everyone that some of the information we discuss on today's call contains forward-looking statements, which involve risks and uncertainties and may be materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations. The material that we discuss today is time-sensitive. If, in the future, you listen to a rebroadcast or re-recording of this conference call, you should be sensitive to the date of the original call, which is May 2nd, 2018. Please note that this call is the property of Republic Services, Inc.
Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Republic Services is strictly prohibited. I want to point out that our SEC filings, our earnings press release, which includes GAAP reconciliation tables and a discussion of business activities, along with a recording of this call, are all available on Republic's website at republicservices.com. Also included in our press release are unaudited supplemental schedules that include a pro forma review of 2017 revenue and costs had we adopted the new Revenue Recognition standard as of January 1st, 2017. During today's call, all references to changes versus the prior year are based on the 2017 pro forma figures, which are comparable to our 2018 results. I want to remind you that Republic's management team routinely participates in investor conferences. When events are scheduled, the dates, times, and presentations are posted on our website.
With that, I would like to turn the call over to Don.
Thanks, Nicole. Good afternoon, everyone, and thank you for joining us. We are extremely pleased with our strong start to the year. Through the team's relentless execution of our plan in the first quarter, we grew revenue, expanded EBITDA margins, produced over 30% growth in earnings and free cash flow per share, and returned essentially all of our free cash flow to shareholders. The solid waste business performed exceptionally well in the quarter and contributed 140 basis points of EBITDA margin expansion over the prior year. Within the solid waste business, we saw strong operating leverage in the disposal, small container, and large container businesses. Additionally, as expected, SG&A as a % of revenue decreased 20 basis points and landfill operating costs as a % of revenue also decreased. Overall, our first quarter results position us well to achieve our full-year EPS and free cash flow guidance.
Additional highlights of the quarter include: adjusted of $0.74, an increase of 35%. Adjusted free cash flow of $356 million, an increase of 48%. EBITDA increased $45 million or 7% over the prior year. EBITDA margin expanded 30 basis points to 28.8%, despite a 160 basis point headwind from recycling. Core price was 3.8% and average yield was 2.2%, both in line with our expectations. Average yield was strongest in our small container and large container businesses. The majority of these customers are in open markets where we can leverage increases in demand for service, our enhanced product offerings, and our digital platform. We now have approximately $570 million in annual revenue that uses a waste-related index or a fixed rate increase of 3% or greater for the annual price adjustment. These waste indices are more closely aligned with our cost structure and have historically run higher than CPI.
Volumes increased 2% and exceeded our expectations. We invested $26 million in tuck-in acquisitions in the first quarter and another $53 million in April for a total investment of $79 million to date. Finally, we returned $350 million to our shareholders through dividends and share repurchases. Before turning the call over to Chuck, I'd like to make a few comments on our recycling business. First, it's important to keep in mind that our recycling processing and sale of commodities business is only 4% of total revenue. Second, despite a $0.06 headwind in the first quarter from lower commodity prices and higher labor costs on our sorting lines, we still outperformed relative to our expectations given the strength of our solid waste business.
Third, we continue to believe recycled commodity prices will increase from April levels and have already begun to see clear evidence of this in the last couple of weeks. Finally, we continue to make progress moving to a fee-based pricing model with a more equitable risk-sharing arrangement. We believe the current situation in China will serve as a catalyst in transitioning our municipal customers to this more durable model. Our customers have told us recycling is important to them, and we remain committed to de-risking this core service offering and ensuring its sustainability for generations to come. I'll now turn the call over to Chuck to discuss our financial results. Chuck?
Thanks, Don. First quarter revenue was approximately $2.4 billion, an increase of $129 million, or 5.6% over the prior year. The increase in revenue includes internal growth of 3.8% and acquisitions of 1.8%. The components of internal growth are as follows. First, average yield increased 2.2% and was in line with our expectations. Average yield in the collection business was 2.4%, which includes 2.6% in the small container business, 2.6% in the large container business, and 2.1% in the residential business. Average yield in the post-collection business was 1.7%, which includes landfill MSW of 2.2%. A majority of our third-party landfill MSW business is with municipal customers that have contracts containing pricing restrictions. Total core price, which measures price increases less rollbacks, was 3.8%. Core price consisted of 4.6% in the open market and 2.5% in the restricted portion of our business.
The second component of internal growth is total volume, which increased 2% over the prior year. Volumes increased 1.9% in our large container business and, as expected, were essentially flat in our small container business. Small container volumes included the 90 basis point impact from intentionally shedding certain work performed on behalf of brokers, which we view as non-regrettable. Excluding these losses, small container volumes would have increased 80 basis points. Volumes decreased 2.7% in the residential business. The decrease was expected and resulted from not renewing certain contracts that fell below our return criteria. The post-collection business made up of third-party landfill and transfer station volumes increased 11.1%. Landfill volume increased 12.7%, which included C&D of 5.7% and special waste of 35.9%. The strong growth in special waste exceeded our expectations and was due to a large project completed during the quarter.
MSW volumes decreased 1.1% versus the prior year. The third component of internal growth is fuel recovery fees, which increased 50 basis points. The increase relates to a rise in the cost of fuel. The average price per gallon of diesel increased to $3.02 in the first quarter from $2.57 in the prior year, an increase of 18%. The current average diesel price is $3.16 per gallon. The increase in the cost of diesel was partially offset by CNG tax credits. The credits contributed $0.04 to EPS and included a $0.03 benefit in cost of operations and a $0.01 benefit in the tax provision. The next component, energy services revenue, increased 40 basis points. The growth in energy services revenue is primarily due to increase in drilling activity in the Permian Basin, where we continue to be well-positioned.
The final component of internal growth is commodity revenue, which decreased 1.3%. The decrease in commodity sales revenue primarily relates to a decrease in recycled commodity prices. Excluding glass and organics, average commodity prices decreased 31% to $112 per ton in the first quarter from $162 per ton in the prior year. Now I will discuss changes in margin. In the first quarter, adjusted EBITDA margin increased 30 basis points to 28.8% versus 28.5% in the prior year. This included 140 basis points of expansion from the solid waste business and 50 basis points of expansion from the CNG tax credit, partially offset by 160 basis point headwind from recycling. As a reminder, the 30 basis points of margin expansion does not include a benefit from adopting the new revenue accounting standard in 2018. First quarter 2018 interest expense was $95 million, which included $11 million of non-cash amortization.
Our adjusted effective tax rate was 23.5% and was lower than expected due to the CNG tax credit and unanticipated federal and state tax refunds. The refunds provided an approximate $0.02 benefit to EPS. Adjusted EPS was $0.74, an increase of $0.19 or 35% over the prior year. EPS included a $0.12 benefit from tax reform. Excluding the benefit from tax reform, EPS increased 13% versus the prior year. First quarter adjusted free cash flow was $356 million, an increase of 48% versus the prior year. The growth in free cash flow was due to strong growth in EBITDA and a favorable benefit from the timing of working capital in CapEx. We returned $350 million of cash to our shareholders through dividends and share repurchases. This included 3.5 million shares repurchased for approximately $236 million.
Finally, as Don mentioned earlier, we remain comfortable with our full year 2018 EPS and free cash flow guidance given our first quarter results, the underlying strength of our solid waste business, and our ability to continue to effectively manage our costs. I will turn the call back to Don.
Thank you, Chuck. To conclude, we are very pleased with our first quarter performance. Strong, solid waste fundamentals, together with relentless operational execution, resulted in double-digit growth in both earnings and free cash flow. This performance keeps us well-positioned to achieve our full-year goals. Before opening the call to questions, I would like to congratulate the Republic team for being named to the first annual Barron's 100 Most Sustainable Companies list and recognized by Ethisphere as one of the world's most ethical companies for the second year in a row. These awards serve as external validation of strong ethical culture that we are building at Republic, which includes conducting our business with the highest levels of integrity and developing sustainable business practices to enhance long-term value creation. Operator, we're going to open the call to questions.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. In the interest of time, we do ask that you limit yourself to one question and one follow-up question today. If your question has been addressed and you would like to withdraw your question, please press star then two. If you are using a speakerphone, please pick up your handset before pressing the keys. Our first questioner today will be Hamzah Mazari with Macquarie. Please go ahead.
Good afternoon. Thank you. The first question is just on the pricing side. Don, maybe if you want to just touch on where do you think going forward you see the most opportunity on pricing? Is it on commercial collection, or is it on landfill, or is it simply higher inflation is going to lift all boats going forward?
Good question, Hamzah. There's a couple of things. One, CPI is on the rise, right? CPI has been really kind of dogging us here for the last few years. As you know, we've been kind of punished by this compounding headwind of low CPI on that big $2.5 billion book of business. Two things are happening there. One, as I said in my notes, we've got about $570 million of that $2.5 billion now converted to an alternative index or a fixed rate increase of 3% or greater. That's happening. You're seeing that layer into the business now, so you'll continue to see the year-over-year benefit of that, and we're going to continue to go for more, because as you've seen every quarter, we've improved that number. Second, as good CPI is on the rise, people are now expecting 2.5% CPI for the year.
As we get into the second half of the year, we'll see some of those contracts that are still tied to CPI start to roll over at a higher price. That's great. The open market has been a very good place for pricing for us now for a number of quarters. We exited the year real strong. That's continuing now in the beginning part of the year. We think that's holding up fine, and frankly, historically, as CPI rises, open market pricing stays strong and frankly improves. That's a pretty good sign. Lastly, landfill pricing is still a little weak, frankly.
I would have expected the landfill pricing would have rose a little faster than maybe it had because, again, just the high cost of landfills today, the higher cost of leachate, some of the costs that we're seeing in the business, we need to be revisiting our landfill prices and seeing what we can do there and starting to have those conversations with our municipal customers. Again, most of our third-party volume in the landfills comes through municipal customers. Again, they're tied to these long-term contracts that have been, again, subject to that lower CPI environment. As we're having renewal discussions with those customers, we're introducing some of these higher costs that we're facing. We'd like to expect over the longer term, better pricing there. Overall, we're seeing pricing across the board. Again, we've got good tools. We use our Capture tool.
All of our salespeople are equipped with their tablets. They're all using the system properly. Frankly, pricing churn has continued to be a great story for us. It's actually come down a little bit this quarter. We're seeing lower defection, that's helping to drive price and kind of all systems go. There's still some room to run here.
Okay, great. Just a follow-up question on just acquisitions. You mentioned $79 million year-to-date investment. You still have a target of $100 million to $150 million, at the same time, the industry seems very bullish on M&A. Some of your competitors have closed significantly above their targets in terms of deal flow. Is there anything you would sort of comment on in terms of RSG's focus is more return of cash, or maybe there's antitrust issues in doing larger deals? Any kind of color you want to share on acquisitions and how you think about those?
Well, sure. I would start off by saying the pipeline's still robust. We're seeing a lot of deal flow. We're getting a look at a lot of good high-quality companies. The majority of the companies we're buying tend to be smaller, the multiples we're paying are still in that 4.5 to kind of 5.5 range, very comfortable multiples. When we buy something a little bit bigger, the multiples get a little higher. You start buying more real property, infrastructure, permits, things that you just have to spend a little bit more money for. The activity we've seen out there, I think maybe some of the other companies have made some bigger purchases than we have this year. I would tell you that we were in the hunt on a couple of those, we're well aware of them.
Maybe it was a better fit for somebody else in their market, they were willing to pay a little bit more than we were, just because it fit their system better. Maybe they needed something more than we did. As I always say, there tends to be a natural buyer in these deals, when we're the natural buyer and we've got relationships and it fits our business, we think we can get good deals at the right multiples. We're very focused on returns.
Okay, great. Thank you.
Our next questioner today will be Corey Greendale with First Analysis. Please go ahead.
Hey, good afternoon. Just a couple quick ones. I realize your practice is to update guidance midway through the year, but just obviously did a nice job offsetting the impact of recycling in the quarter. Just, can you give us some view? Can you continue doing that? In other words, are you still at least comfortable with the guidance you have put out there?
Yeah. I'm going to give you some color, and then I'll let Chuck give you a little more on the number side. We've been saying, I think a lot of people in writing that April really was expected to be sort of the floor, the bottom this year. That's proving out to be true, as I said in my comments over these last couple of weeks, we've seen prices start to bounce. The reality is the inventories in China are very low. We actually mentioned this last week when we spoke at WasteExpo. Our team went over to China a few weeks back and met with our mills there. Normally they have about 30 or 60 days of material inventory. They were sitting on about 10 days of inventory. Normally, they have a fair amount of inventory in transit, in ocean-going vessels from port to port.
There's very little, if any, in transit. This is very sort of what I would call simple, Econ 101, supply and demand economics. At some point, they need to make paper, and they're buying a lot of raw pulp. They're paying eight times what they used to pay. We think that's the reason that prices are starting to come up. Chuck can give you kind of a color of where we were at the beginning of the year, where we were in April, and where we think the year ends up for us.
Yeah, sure. For the quarter, average price was $100 a ton. What we saw in April was closer to $105. As we go forward, we think that the average will be closer to $115. Corey, to your point, we were able to more than offset the headwind associated with commodities in Q1. Right now we're estimating that we're going to be able to do the same thing for the rest of the year with commodities at $115 a ton, that being a little bit of a headwind for us based upon our original guide, but being able to offset that through continued outperformance in the solid waste business.
Okay, thank you. The second question I had is on the volume side, where you are intentionally shedding some broker volumes. I think I'm hearing that the underlying kind of small container business is strong. Can you give us a sense, like when you anniversary shedding those volumes, or is that kind of a continual thing? As you anniversary that, do you think you can get to even higher volume growth levels than you're at now?
Yeah. If we take out what we call non-regrettable losses, our volume would've been-
110
110 basis points. Kind of in line with our expectations. As it relates specifically to broker, by the end of the year, we'll have maybe only $100 million or so left of broker business to shed. That's a little lumpy as it happens, but we're cutting through it. Again, by the end of the year, I won't say near the end, but that'll probably happen. That last little bit will probably happen over two or three years.
All right. I will turn it over. Thank you.
Right.
The next questioner today will be Michael Hoffman with Stifel. Please go ahead.
Hi. Thank you for taking my questions. If I could follow up just a little bit to clarify. From this point forward, if we had 135 as our assumption for recycling, go take that down to 115 for 2Q through the remainder of the year, which is about $0.08 of incremental headwind. You feel that given the power of the first quarter, and it was a great quarter in garbage, that you can make that up.
Yeah, that's right, Michael. Yeah, on average, $115 for the remainder of the year. Your math is right, it's about $0.08. We feel like we can make that up through the outperformance in the solid waste business.
To that end, you exceeded your own budget, I mean, your own guidance on volume. We should walk volume up as we think about modeling? You had a 2.25 was your reported price for the year. Your volume assumption is going to be 0 to a quarter of a point. How do I think about volume in the guidance at this point?
Yes.
Is that-
Yeah. Michael, first quarter volume was very strong because of special waste. Obviously, we'll take that into consideration when we do a broader update of guidance as we always do in Q2. Where you're going with that, right? Volume's good. I would say it's strong. We're seeing strong volume in C&D landfill. We're seeing strong volume in large container. We're seeing strong volume in temp, good housing market. I mentioned we were seeing lower customer defection, right? Our customer defection actually fell below 7% for the first time in our history. Okay? All of those things factor into volume, Michael, as you know.
Yep.
As Chuck said, as we get through May and June and understand our sort of normal seasonality and how things are coming back, and we're going to come back to you in the second quarter call and have a clear picture for you.
Fair enough. I'm interpreting it correctly, that I get that you're not changing guidance until?
Directionally, you are correct.
Okay. The price seems to have a little bit better momentum as well. That's the other part of it. If the volume trends that good, that gives you that much more room to push on the leverage on price.
Well, look, I've always said, when organic volume growth is good, pricing goes along with that. When organic volume growth dips and goes negative, that's when pricing gets a little squirrely, right? If volume growing, organic's growing, housing's growing, all those things that we're seeing in the broader macro are good. We think volume holds up and is a pretty good story for this year, and pricing comes right alongside of it.
On the recycling issue and your following comment, which I hope the industry is able to take advantage of this and fix this. From a fundamental standpoint, I look at this, what's going on is we clear the deck in 2018 and 2019, whatever the lower number is, it's the lower number, and we just plow on with good garbage in the E&P business. This is the debt-clearing year. How long do you think, though, it will take to get the customer to agree this has to change?
Well, let me help you.
It's slow historically.
Okay. I'm going to burn a little time on this answer, okay? This is really important for everybody to try to understand. Everyone listening on the call, we make two assumptions, and we would posit them as facts. The first fact is customers want to recycle, okay? Part B of that first fact is customers are showing us that they're willing to pay for recycling. I'll come back to that. The second important fact that we posit is that paper packaging demand is not decreasing. In fact, most people would argue it's on the increase. Recycling, there's a business here, right? People want to do it, and there's a demand for paper packaging. Most of what we recycle is fiber. I mean, the lion's share of it is fiber. We receive recycling through three channels or three lanes.
The first inbound lane comes from in our open market collection business. These are front load, rear load commercial customers where we put out 3-yarders, 4-yarders, 8-yarders, right? In that business, we've reported, quarter after quarter, that we've been increasing the price we charge for commercial recycling in our small container business. Started out $0.28, $0.30, or 30% of trash rates. Now it's 90% plus of trash rates. Okay? Customers are saying, "I'm willing to pay for that because I want to do it." We've corrected that space. Customers are voting with their wallets, and we haven't lost any volume. We're making money in that business. We're making an appropriate return so we can continue to offer that important service to our customers. Second lane that we bring material into our company is through our recycling facilities, right?
This is where third parties who don't own their own manufacturing or processing capacity, but they have their collection trucks. These are primarily cities. Cities collecting waste from the curb and some other competitors or smaller haulers bring us material to our facilities. In those cases, in that lane, the lion's share, 85% of those contracts, of that volume now is coming in at what we would call kind of a fee-based structure or a fair share arrangement. We're no longer holding all the risk. Now, we're giving away some of the upside, but we're getting a certainty of a return on that revenue. Those are the first two lanes. The third lane is the biggest, and it's most difficult. That is municipalities where we go out and collect with our trucks and either bring them to our own facilities or to third-party facilities.
This is the same group of people who we're trying to move away from a CPI index to an alternative index. You see the results we're having there. We've moved now well over 20% of that business to a fair share arrangement or an alternative index. Now we're having that same conversation with those customers. It's going to take some time, but my comments in my prepared remarks, this chaos, if you will, this crisis, if you will, in China, is the catalyst to fix this business. If I look at the first two lanes, those first two customer groups, they've already demonstrated customers understand the economics, and they're willing to pay for it because they want sustainability. They want recycling. We just have to do the work. Frankly, we're built for that.
We get up every day, we pick up the garbage. We get up every day, pardon the football analogy, but we run the ground game. Customers are going to have to understand, if you want to recycle, it's not free. This stuff is not worth gold, okay? We got residual issues, too much trash in the garbage. We've got glass, which is a contaminant at some point. We've got materials that don't have value that we have to deal with, okay? These are the discussions we're having with customers, and it's going to take some time, but we're very determined.
As I've said a few times now, it's kind of a perverse statement, but frankly, in one way, I kind of welcome this China chaos, because it gives us the platform that we need to go have the conversation that we frankly probably should have been having 10 years ago. Okay? It's going to be a good business. It is a good business in some markets, and some markets are lagging. Again, as we talk about return on invested capital, it can be a better business on net basis than the landfill business, than the solid waste business. It is a growing segment. It's a growing waste stream. We want to get in front of the growth, but we're not going to do it for practice. You'll see the returns improving in this business. You'll see the story change over time.
That's all I've got to say today. That's the reality we're living in, and our team's poised to go out there and make it happen. We've got a strong team here. They're getting good results in other ways. I would say lastly, we've seen these issues before in solid waste. When fuel became volatile in 2004, we implemented a fuel recovery fee, which is a very fair way to deal with fuel costs with customers. It goes up and down based on fuel markets, so customers are treated fairly. We see CPI, which has become an unfair index. We're going to a fair index, and customers are coming along with us. Now we have to deal with this last sort of issue, this sort of last frontier of volatility in our business, and we're going to be through that.
It may take a few years to do, but we're going to see progress. How'd I do, Michael? Are you still there?
Yep. No, I'm here.
Okay.
Well, somehow I'm supposed to work in some corny analogy about, but football games are won but passing. On the passing side, I don't know how I'm drawing this all together this way, so we'll scratch that and just go. Your $570 million out of $2.5 billion you did in about 30 months. Is that about the way we should think of about the pace of being able to fix the 80% of the recycling?
Yeah, I don't know. Let us get going on it, and we'll see in a couple of quarters. We're determined. Again, we're pretty good at picking up trash and recycling. We don't need practice doing it for free. Right?
Right.
My final word on it, I'm sort of the master of the obvious here, right? My team's heard it a thousand times. Sustainability, my customers, is not possible without profitability. Organizations like ours cannot invest in sustainable practices in recycling unless there is a return that we can count on. That's the nature of the beast. That's what we believe, and that's what you'll see happen in our business. Anybody who doesn't believe that, it's kind of a fool's errand, so.
Right.
Okay.
The only thing we care about is we don't want to see the price recover too fast, so the customer won't come to the table. At $115, that still leaves you room to argue, "Hey, you got to fix this.
Even if it goes to $200, we've got to fix it because here's what we know, it will go down again.
Right. Okay.
Okay. Again, we've been doing a lot of other great work in the company over the last seven or eight years. We've been doing a lot of good things like One Fleet and all the other good stuff and Capture and PBS. We've been doing a lot of great things to make the company better. This is the great thing we're going to be doing over the next couple of years.
Okay, great. Thank you.
The next questioner today will be Michael Feniger with Bank of America. Please go ahead.
Hey, guys. Thanks for taking my questions. First off, I mean, EBITDA margins up 30 basis points year-over-year, despite the headwind on recycling. I know you guys aren't updating your guidance right now and the components, is there anything we should be aware of, the cadence of margins throughout the year? Is there anything that should stick out? With that, I mean, the landfill operating costs, I think fell 5% year-over-year. This was clearly an issue last year. Can you just provide us an update there? Is that something that's sustainable and should be kind of the run rate going forward for the year? Thanks.
Think about some of the major components, right? We told you last year that some of the SG&A investments we made were going to anniversary. We're seeing that, right? We're very much in control of our SG&A spend, right? We've got a pretty good handle on that. Made those investments last year, the year before. Now they're coming down, just as we said. We told you last year we were doing some additional work at some of the landfills related to some various permit issues and some leachate issues. We're coming through that. That's going to start working its way down. We've already seen that in the first quarter, we've got a good handle on that. I mentioned One Fleet earlier. Our fleet costs are solid. Our labor costs are in line. The core solid waste business is running well.
The operating team is doing a fantastic job. Again, growth, right? We're seeing pretty consistent growth, positive sort of economic factors across the portfolio. Yeah, we think it's sustainable. Over the long term, we still aren't backing away from 30% EBITDA margins because we're going to see CPI improve. We're going to see our conversion to a better index continue. We're going to see improvement in this recycling business. We've got the courage and stamina to do what we need to do there. Again, we've got customer willingness to pay on our side. We're improving the products. We're improving the quality. We're improving service. We're improving fleet reliability. As I said, our defection has come down. All those kind of things. A lot of really good stuff going on here. Someday we won't have to talk about recycling so much. Well, let's not.
What else you got, Michael?
I guess I just wanted to follow up on that. You mentioned, obviously, organic growth helps drive the pricing dynamic, but we're also seeing it driving investment back into the fleet. Your CapEx is up. Some of your suppliers to the industry, they have pretty big backlogs. I guess the big picture question here, you guys are clearly adding some routes. Are you seeing anything in the open market of the small mom and pops adding trucks, or maybe too many trucks as the supply-demand balance of that with the open market?
I would answer it this way. I think we're getting our fair share of the organic growth. Again, we target our sales force toward customers that we think use some kind of a value equation in their thinking. People that like the idea of great service and solutions and recycling those services and a broader suite of services. We don't expect to chase every account or have every new yard of growth, but we're getting our fair share. As long as we're getting our fair share and maybe a little more because our products are strong, then we're okay with that. Meanwhile, we're getting pricing to offset inflation, and that's an important factor of the overall story. Nothing bad to report there.
That's great. Just my last question. We saw an industrial company last week kind of make a comment about peak or near peak. Clearly, it's a different type of industrial company and business. It sounds like from what you're seeing on the volume side and with your different aspects of what you guys touch in the economy, there's nothing that suggests to you any areas of the business that feel frothy to you or peak-ish in any way? Does it still feel like you have a runway ahead on a multi-year basis?
Simple answer is we think there's still room to run, and we back that up with some statistics. Why don't I let Chuck back it up with statistics since I've been doing all the talking. How's that?
What we talk about is there being a 90% correlation to our volume growth overall, entire company, and single-family housing starts when you lag single-family housing starts by 1 year since we're late cycle, obviously. As we look at single-family housing starts, the print for March was 1.3 million units on an annual basis. It's been increasing slowly over time. Based on the experts that we talk to, we think there's nothing that will prevent us from getting back to a longer-term average of close to 1.4 million, 1.5 million units. There's also been a number of articles written recently that say that there is actually a lack of supply of new single-family housing throughout the U.S. They estimated that to be an additional 7.3 million units.
All of that in combination, we would say that back to Don's point, that there's still plenty of room to run here in this economy.
That's great. Just lastly, the special waste was really strong this quarter. You mentioned a big project. I was just wondering, do you guys quantify that big project that you completed this quarter? How does the pipeline look in special waste, since I think that's one of the reasons why your volume outlook for the year was flat to up 25 basis points?
We've had a tremendous growth in special waste over the course of the last several quarters, close to a year now. To grow on top of 30% type of growth year-over-year is really hard for us to do. Like you had mentioned, we had a really strong special waste job that occurred during the quarter that's ended now. Looking forward, we still see some growth there, to grow 30% on top of 30% is difficult to do. What it does speak to, though, this event work, it's a precursor to single-family housing starts and to development in general. That's another indication that we think that the economy still has room to run.
Great. Thanks, guys.
Thanks, Mike.
The next questioner today will be Noah Kaye with Oppenheimer & Company. Please go ahead.
Thanks for taking the questions, a great quarter. I think free cash flow conversion this quarter really stood out. Historically, I think it attracted around 8%-9% of revenue. Prior guidance probably implied something like 11% this year. For 1Q, it was almost 15% of revenue, I'm not sure if that's a high water mark, but it looks very impressive. Can you comment on a couple of things here? First, you mentioned the working capital benefit, how to think about that maybe reversing over the course of the year. Second, just again, to one particular line item, it looks like the capping closure and post-closure expenditures were down pretty markedly to about $7 million, which is a much lower run rate than it had been in past quarters. Is that sort of $7 million the right run rate for the balance of 2018?
Thanks.
A couple of questions there. The first one being the working capital. We think that that is timing, that'll end up reversing kind of evenly throughout the rest of the year. Not really a permanent benefit, but more of a timing benefit. To your point on the capping and closure post-closure, that tends to be lumpy. Obviously, we don't cap until we need to. That'll depend upon when we need to do the capping and also the weather to a certain extent. It does tend to be a little lumpy, but we don't expect there to be a significant change in that cash expenditure year-over-year.
Thank you. That's very helpful. You mentioned weather. Obviously a strong quarter on a number of metrics, but I think most folks have been expecting a little bit of a weather-related headwind this year. Can you comment on to what extent any of that might have held back? How that might have impacted any part of the business?
Yeah. The weather ended up being a little bit of an offset. We had a lot of rain on the West Coast last year. This year we had a little bit of weather, as you're aware, on the East Coast, it tended to offset. We didn't see a real significant impact in the business overall this quarter because of weather.
Okay. That's helpful. Then maybe one more. Really appreciate the adjustments on pro forma so we can compare like for like. A point I'm getting a bit confused on, if we look at the recycled commodity revenue line, it barely moved year-over-year, looks like it's down 3%-4%, when the commodity basket is obviously down a lot more. I'm sure part of this is to do with Revenue Recognition and the changes, could you just help us explain why the line didn't drop that much?
Yeah. Hi, Noah, this is Nicole. When you look at the supplemental schedules, you kind of cut out a little bit, hopefully I'm asking your question. When you look at the revenue dollars, there wasn't a significant decrease, that's because, if you recall, this time last year, we didn't have ReCommunity. That's kind of offsetting some of the decline in RSG legacy recycling commodity revenue. When you go to the components of internal growth, there you refer to the 1.3% decline, again, that is more of a same store legacy Republic Services. The impact of ReCommunity is down in the acquisition line.
That's very helpful. Thanks so much.
Sure.
The next questioner today will be Jeffrey Silber with BMO Capital Markets. Please go ahead.
Hey, good afternoon. It's Henry Chen calling for Jeff. Just wanted to follow up on some of the volume trends on the residential side and the small collection side. You mentioned some of the rationalizations or I guess the shedding of the broker business and some of the changes in contracts on the residential side. I'm just curious, does that change the margin structure of those two businesses? How should we think about that going forward?
Yeah. The business that we're shedding, both on the small container side and on the residential side.
Yeah
That's business that it's regrettable. I mean, it's not regrettable that we're shedding that business. That's because it's at lower margins. Part of the reason why we're doing that is because we didn't feel like we were getting an appropriate return on our investment. What we've always said is that we're very much focused in on ROIC. Obviously shutting that work and then deploying those assets in other pieces of business that provide us with a better return, obviously will help us enhance our margins.
Keep in mind that those are small moves, right? They're directionally going to improve the margins over time. Keep in mind that when we're the incumbent in a residential contract, we know all the costs right down to the Nth degree, right? We're very aware when a contract is sort of not meeting our threshold returns and when a customer doesn't really value what we're doing. If we can't get the extensions at the right price or the right kind of built-in indexes or as we relate to recycling, we got to move away from them. We're having a good success rate in converting and increasing and extending contracts as well. Every now and then we're going to cross one where we just can't get it done.
The good news is the team has the courage to walk away from that business and go find another customer who wants to value great service.
Got it. Okay, great, that's good to hear. Just on the cost side, some companies seem to have some difficulties in transportation costs and labor costs. Just wondering how you're thinking about that. Is that potentially an issue going forward or something that you're keeping an aware of? Thanks.
Well, certainly something we think about. We spend a lot of time and effort, energy, thinking about working on employee engagement at Republic. Our employee engagement rates are at all-time highs. Our turnover has been flattish year-over-year. We think our employee turnover is best in class. Even in light of a good or even an improving economy where you might lose more people, we're actually holding our own quite nicely. We're spending more and more effort in just making Republic Services a great place to work. We think as it relates to our frontline people, truck drivers appreciate our One Fleet initiative, having reliable, safe trucks. Our techs enjoy working in a shop where we take fleet seriously. Our professional salespeople like the tools that we've created for them. Again, we're working on the work environment at the facilities.
As I said last quarter, we're going to spend about $100 million over the next few years improving frontline facilities, locker rooms, training rooms, break rooms, those kind of things. We put a lot of effort into just creating the best work environment. We've got a number of external agencies and experts that have given us some acknowledgement and some accolades around that, but it's something we take really seriously. It doesn't mean that we won't be affected by things to come, but I think we're ahead of the curve.
Got it. Okay. That's great. Thanks so much.
Our next questioner today will be Hamzah Mazari with Macquarie. Please go ahead.
Hey, I just had a quick follow-up for Chuck. Chuck, do you know what your updated tax rate is in your guidance, given Q1 was lower? Is it still 27% or has that changed? Thanks.
Yeah, it is, Hamza. It's still 27%.
Okay. Thank you.
Just to clarify, 27% for the remainder of the year, the full year average would be closer to 26. Just to clarify.
Okay. Thank you.
Yeah. Hamza said everybody else got four questions. I need to ask another.
Yeah, he said this is four.
Thanks, Hamza.
Thank you.
Our next questioner today will be Tyler Brown with Raymond James. Please go ahead.
Hey, thanks, guys, for squeezing me in here. Hey, Chuck, just real quick, it's a little unclear, was the $0.04 CNG tax credit contemplated in the guidance from last quarter?
No, it wasn't.
Okay.
If you remember, that was part of the budget reconciliation package that came out a couple of days after our conference call, our earnings call.
Do we tack on $0.04 to the guide, or is it used to absorb some of the recycling?
That's what absorbed the recycling during the period. Keep in mind, we had about a $0.06 headwind from recycling during the period. We had about $0.04 of a benefit from CNG, and then another $0.02 benefit from the tax refunds that I talked about. That's what offset the recycling.
That's helpful. I apologize, but can you go back over the margin math? Are you saying that if you exclude the tax credit, ReCommunity dilution, and recycling prices, basically solid waste margins were up 140 basis points. Is that right?
Yeah, right. Solid waste up 140 basis points. The CNG tax credit, as I had mentioned, was about 50 basis points. Recycling operations, that was a negative, a headwind of 160 basis points. The net of all of that is the 30 basis points that we called out.
Okay. Perfect. I do want to go back to the transportation question, one line item we've been watching pretty close is the subcontractor hauling costs, I think you guys saw a pretty pronounced squeeze this quarter. I think some of your peers have as well. I know it's a pretty granular question, can you guys talk about what the expectation there is? Transportation costs don't look like they're abating anytime soon, in my humble opinion, should we expect that that is a margin headwind for the rest of the year?
No, not necessarily. What we saw in the first quarter was a little bit of a spike in our transportation subcontract costs because of business mix. There was a little bit higher national accounts subcontract work that was performed, that was in the mix, and just a mix of the business in general. We're not necessarily saying that that's a trend that's going to continue.
Also, Tyler, on a large group of those waste moves, if you will, we've got long-term contracts with stable providers we're in pretty good shape there.
Right. Okay. Maybe my last one, I don't know if you can parse this out, but how much did the shedding of the broker business help margins, solid waste specifically?
Yeah, Tyler, I don't have that at my fingertips.
Okay.
As Don mentioned before, it's small-
Right
relative to the rest of the business. Incrementally, as we continue to do this over time, it is going to improve our margins.
Right. Okay. All right. Thank you.
Thanks, Tyler.
The next questioner today will be Brian Maguire with Goldman Sachs. Please go ahead.
Hey, good afternoon.
Hey, Brian.
Just following on Tyler's question there, just to make sure I have it clear, the energy credit was about, I would say, about a $14 million benefit to EBITDA, we shouldn't think about that recurring in the future, right?
Yeah, it was about $15 million. That's right.
Okay.
That was a one-time benefit that actually pertained to 2017.
Got it. Okay. It just wasn't included because the tax law clarification didn't come out until after you gave the original guidance, is that right?
That was part of the budget reconciliation package that came out a couple of days after we had already had our earnings call. Correct.
Yep. Okay. Thanks for the clarification there. Not to belabor the recycling point too much, but just the contaminant levels that China's trying to get to, I know that's a big obstacle to try and get down to like 50 basis points of contamination. Just wondering, as you've changed your operations and you're incurring these additional costs, how close are you getting to that level? Are you seeing maybe some different markets develop in recycled fiber where some higher quality stuff like OCC number 12 or DLK is trading at a little bit of a higher price than some of the more commodity grades? Is that sort of what you're seeing, too? Is that what you're sort of referencing when you say you're starting to see some signs of uplift on recycled fibers?
Yeah, that's fair. With OCC, we're doing a pretty good job. With the mixed paper and some of the other grades, it's a little bit tougher, as you can imagine. We've opened up other outlets. We're moving our export material to a number of other places now that we didn't previously. Ultimately, China's going to have to figure out that they've got to make paper, and they have to decide whether they're going to deal with some of this contaminant or they're going to keep buying pulp and chopping up trees. We're just going to keep working it out. It's supply and demand, and we're already starting to see the bounce.
Chuck talked about the rates we experienced in Q1, where the April dip was, and now we're seeing a bounce already the last part of April and here in early May. We're pretty confident it's going to come back, as we said, in line with that 115 number. Our team's doing a great job getting the material moved. Again, we threw a little extra labor at it in Q1 to do a little better job of cleaning up. I think it's going to come back for us.
Okay. Just one last housekeeping one. Appreciate the restated 2017 numbers. Just was wondering why the Looks like the adjusted EBITDA was a little bit lower than what we had in our model as the reported numbers from last year. Any reason why the accounting change would modestly lower the EBITDA in 2017?
Yeah. It was 110 basis point impact from the Revenue Recognition change. I'm not really sure why that would be different than what you had in your models.
Okay. I'll follow up with that later. Appreciate it.
At this time, there appear to be no further questions. Mr. Slager, I'll turn the call back over to you for your closing remarks.
Thank you, William. In closing, we will continue to manage the business to create long-term value and remain focused on executing our strategy of profitable growth through differentiation. I would like to thank all Republic employees for their hard work, their commitment, and dedication to operational excellence and creating the Republic Way. Thanks, everybody. Thank you for spending time with us today. Have a good evening and be safe out there.
This conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.