Ladies and gentlemen, thank you for standing by. Welcome to the Waste Connections fourth quarter 2016 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press star zero. As a reminder, this conference is being recorded Wednesday, February 22nd, 2017. I would now like to turn the conference over to Mr. Ron Mittelstaedt, Chairman of the Board and CEO. Please go ahead, sir.
Okay. Thank you, operator, and good morning. I am joined this morning by Worthing Jackman, our CFO, as well as several other members of our senior management team. As noted in our earnings release, our acquisition of Progressive Waste made 2016 a transformational year for Waste Connections. More importantly, our culture and operating playbook enabled us to drive significant improvements in safety, quality of revenue, and operating performance within the acquired operations, all pacing 12 to 18 months ahead of our original expectations. This was evident in Q4 as revenue, adjusted EBITDA, and margins once again exceeded expectations. This underlying strength, together with continuing improvements in recycled commodity values and E&P waste activity, should position us well for 2017.
In addition, having already announced the acquisition of Groot Industries, we are on track for another above-average year in M&A. We believe free cash flow generation is synonymous with our name. Waste Connections' industry-leading 50-plus percent conversion of EBITDA to free cash flow should drive a more than 15% year-over-year increase in free cash flow per share in 2017. Our strong financial profile provides us the flexibility to fund a continuing above-average amount of expected acquisition activity while increasing the return of capital to shareholders. Before we get into much more detail, let me turn the call over to Worthing for our forward-looking disclaimer and other housekeeping items.
Thank you, Ron, and good morning. The discussion during today's call includes forward-looking statements made pursuant to the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995 and applicable securities laws in Canada. Actual results could differ materially from those made in such forward-looking statements due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement on page three of our February 21st earnings release and in greater detail in filings that have been made by Waste Connections, formerly named Progressive Waste Solutions Limited, and Progressive Waste US Inc., with the Securities and Exchange Commission and the securities commissions or similar regulatory authorities in Canada.
You should not place undue reliance on forward-looking statements as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances that may change after today's date. On the call, we will discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share, and adjusted free cash flow. Please refer to our earnings release for a reconciliation of such non-GAAP measures to the most comparable GAAP measure. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations. Other companies may calculate these non-GAAP measures differently.
Reported results reflect the impact of our merger with Progressive Waste on June 1, 2016. Contribution from this combination will be treated as acquired revenue and will not be incorporated into organic growth statistics until 12 months from the closing date. I'll now turn the call back over to Ron.
Okay. Thank you, Worthing. In the fourth quarter, solid waste core price plus volume growth was 3.7%. Core price increases in the period were 2.7% year-over-year, with total pricing net of surcharge reductions of 2.6%, up 30 basis points sequentially from Q3. Volume growth of 1% in the fourth quarter was primarily driven by high single-digit increases in disposal volumes, commercial collection revenue, and roll-off activity, and most notable in our Western and Eastern regions. Solid waste landfill tonnages overall, on a same-store basis, increased 8% year-over-year in Q4, with all lines up year-over-year in the period. MSW tons rose 13%, special waste increased 2%, and C&D was up slightly. On a same-store basis, commercial collection and roll-off revenue in Q4 increased about 7% and 8% respectively from the prior year period.
Roll-off pulls per day increased a little more than 3%, with all regions reporting high roll-off activity compared to the year-ago period, primarily due to milder weather in many markets during the first two months of the quarter. Looking at the full year, core price was 2.8% and volume growth was 1.9%, or 10 and 20 basis points respectively above the expectations we had communicated on our last call. As Worthing noted earlier, price and volume growth from acquired operations are not reflected in our reported organic growth calculations until the anniversary date of the related transaction, which, for the Progressive Waste acquisition, will not be until June 1st.
However, we're extremely pleased to report that these recently acquired operations delivered over 3% pricing growth in Q4, and volumes in the period were slightly negative as expected, since we're well underway in our efforts to shed low quality and unsafe to service revenue. Recycling revenue, excluding acquisitions, was $13.2 million in the fourth quarter, up almost $1.8 million or about 16% year-over-year, due primarily to higher commodity values for fiber. Prices for OCC, or old corrugated containers, averaged about $125 per ton during Q4, up 18% from the year-ago period, and up 2% sequentially from Q3. OCC prices currently exceed $150 per ton, up over 50% from the level we averaged in last year's first quarter.
Regarding E&P waste activity, we reported $32.2 million of E&P waste revenue in the fourth quarter, up 7% sequentially from Q3, and slightly above our outlook for the period, with segment EBITDA margins well off their lows and now exceeding our corporate average. The rig count is now twice the level of last year's trough, and drilling activity is picking up in additional basins beyond just the Permian. As a result, we continue to see month-to-month revenue growth at high incremental flow-through in our E&P waste operations. With year-over-year declines in 2015 and 2016 now behind us and macro industry trends in our favor, we believe 2017 and 2018 are setting up for strong double-digit increases in E&P waste activity. Now moving on to the Progressive Waste acquisition.
As noted earlier and in our press release, we believe the integration of our culture and execution on our operating playbook have enabled us to drive significant improvements in safety, quality of revenue, and operating performance, all of which are pacing 12-18 months ahead of our initial expectations within the acquired operations. This success is a direct result of our employees embracing our safety-focused servant leadership-driven culture, honoring commitments, and accepting accountability at the local level. Progressive legacy operations exited 2016 with almost a 50% reduction in safety-related incident frequency as compared to pre-acquisition levels of the earlier months in 2016. This is a run rate reduction of almost 3,000 fewer accidents and injuries in their platform alone in the year.
Employee turnover at these operations is down from 42% in Q2 of 2016 to 26% in Q4 of 2016, a nearly 39% reduction in employee turnover thus far. Quality of revenue also continues to improve, with pricing growth, as noted earlier, now above 3%. In addition, the shedding of about $50 million of low-margin revenue across numerous markets is well underway, and we are seeing continuing momentum within our divestiture program. Just last week, we exited the Washington, D.C. market, which had an annual revenue run rate of about $50 million at a negative operating margin in 2016. As a reminder, our playbook focuses on improving the quality of revenue within Progressive's operations to drive higher EBITDA from less revenue, reduce the CapEx intensity necessary to generate the EBITDA, and therefore convert a higher percentage of EBITDA to free cash flow.
This playbook will reduce 2017 revenue generated by operations acquired in the Progressive acquisition by about 10% when compared to 2015, increase EBITDA by 25% and free cash flow by 100% over the same period. We've already been able to more than double Progressive's free cash flow margin from less than 8% in 2015 to our 16% plus corporate average and drive a company-wide 50% plus conversion of EBITDA to free cash flow. Looking at other acquisition activity, we're extremely pleased to have already announced our acquisition of Groot Industries earlier this year. Founded over a century ago, Groot was the largest privately owned solid waste services company in Illinois, with total annual revenue of approximately $200 million. Groot serves approximately 300,000 customers, primarily in Northern and Western Illinois, from a network of six collection operations, six transfer stations, and two recycling facilities.
With the majority of its operations contiguous to the Rock River assets we acquired in November 2015 and already bringing a substantial portion of its tonnage to our landfills, Groot solidifies our leading position in these markets, increases potential internalization benefits of additional disposal volumes into our landfills, and further expands our platform for additional growth opportunities. We are very honored that Groot shareholders chose Waste Connections purposely when deciding who would be the best steward of their fourth generation, 100-plus-year-old company. Groot is arguably one of the top five solid waste companies in the U.S. when viewed in terms of asset quality, market positioning, management depth, and community involvement. We congratulate Larry Groot and Lee Brandsma on all of their accomplishments over the past nearly 40 years. We welcome Jon Groot and Ryan Brandsma, along with all of the leaders and employees of Groot, to Waste Connections.
As a reminder, Groot was an outsized deal. In fact, it was the third largest in the company's history. Acquisition dialogue remains quite active, with our more traditional smaller-sized opportunities. For example, we've also signed an agreement requiring approximately $15 million revenue franchise operation on the West Coast, that due to a lengthy regulatory review process, should close in late Q2 or early Q3. Some potential sellers who may have been sidelined over the past several years due to high tax rates and low reinvestment rates are now testing the waters given current expectations for lower taxes and higher interest rates. With our strong free cash flow generation and recently committed $400 million note offering, we are well-positioned to fund the continuing above-average amount of acquisition activity while also increasing the return of capital to shareholders.
Now I'd like to pass the call to Worthing to review more in depth the financial highlights of the fourth quarter and to provide a detailed outlook for Q1 and the full year 2017. I will then wrap up before heading into Q&A.
Thank you, Ron. In the fourth quarter, revenue was $1.049 billion or almost $30 million above our outlook for the period. Acquisitions completed since the year-ago period contributed about $507 million of revenue in the quarter, with Progressive Waste accounting for $498 million of that amount. Adjusted EBITDA, as reconciled in our earnings release, was $325.4 million, or 31% of revenue and slightly above our margin outlook for Q4. Year-over-year, our adjusted EBITDA margin reported for the fourth quarter declined by 200 basis points, primarily due to the comparative lower margin profile of the Progressive Waste operations acquired since the year-ago period, and to a lesser extent, the impact of lower E&P waste activity.
Fuel expense in Q4 was about 3.85% of revenue, and we averaged approximately $2.42 per gallon for diesel, which was down about $0.14 per gallon from the year-ago period, and up about $0.09 per gallon sequentially from Q3. Depreciation and amortization expenses for the fourth quarter were 13.8% of revenue, up 70 basis points year-over-year, primarily due to acquisitions completed since the year-ago period. For the quarter, this was 60 basis points below our outlook due to $5.5 million lower than expected amortization of intangibles expense as we finalized the fair value of intangible assets during Q4 for the Progressive Waste acquisition. This lower than expected expense has no impact to adjusted EPS as we exclude this item in the calculation.
Interest expense in the quarter increased $10.6 million over the prior year period to $27.4 million, due to the additional debt outstanding resulting from acquisitions completed since the year-ago period and higher interest rates compared to the prior year period. Debt outstanding at quarter end was about $3.6 billion, and our leverage ratio, as defined in our credit facility, decreased to less than 2.7 times debt to EBITDA. Our effective tax rate for the fourth quarter was 24.2%, which included an approximate $4.1 million benefit to the tax provision related to our review of the deductibility of certain items from earlier in the year related to the Progressive Waste acquisition. Excluding these items, our effective tax rate was closer to 28% in the period. For full year 2016, our effective rate was 31.6%, which included a 2.3 percentage point impact from certain nondeductible items related to the Progressive Waste acquisition.
As that 2.3% impact was unique to 2016, as we look ahead, we expect our effective tax rate to be about 29%, subject to some variability depending on the percentage of total profitability contributed by operations in the U.S. versus Canada and discrete items in certain periods. GAAP and adjusted net income per diluted share in the fourth quarter were $0.49 and $0.68 respectively. Adjusted net income in Q4 excludes the impact of three items. $24.5 million after tax of acquisition-related items such as amortization of intangibles and certain items related to the Progressive Waste acquisition, including severance-related costs, accrued synergy bonus, and professional fees. $14.3 million after tax for impairments and other operating losses, primarily associated with a write-down of certain assets held for sale in connection with our previously discussed divestiture program. Finally, the previously mentioned $4.1 million benefit to our tax provision.
Adjusted free cash flow in 2016 was $550.9 million or 16.3% of revenue. As a percentage of adjusted EBITDA, this represents a conversion rate of over 51% in the year. I'll now review our outlook for the first quarter and full year 2017. Before I do that, we'd like to remind everyone once again that actual results may vary significantly based on risks and uncertainties outlined in our safe harbor statement and filings we've made, and Waste Connections US Inc. has made with the SEC and the securities commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic and operating environment. It also excludes any remaining severance, integration costs, or other items resulting from the Progressive Waste acquisition and any additional acquisitions or potential divestitures that may close during the respective periods.
Looking first at the full year 2017. Revenue in 2017 is estimated to be approximately $4.45 billion. We expect price plus underlying volume growth for solid waste to be between 4% and 4.5% in the U.S., less about 1% for the previously discussed low quality and unsafe to service revenue we are shedding in the U.S. In Canada, we expect price plus underlying volume growth for solid waste of about 4% on a constant currency basis, less about 2% for the previously discussed low quality and unsafe to service revenue we are shedding in Canada. Recycling and E&P waste-related revenue should each increase double digits on higher commodity values and drilling activity, respectively. As a reminder, Progressive's operations will be included in our organic growth statistics beginning June 1st.
Adjusted EBITDA in 2017, as reconciled in our earnings release, is estimated to be approximately $1.41 billion or about 31.7% of revenue. Margins for the year were trending above 32% before the impact of the comparably lower margin group transaction. I'd like to note that the timing of divestitures and the shedding of low-quality revenue could impact revenue and reported margins, but is not expected to impact EBITDA on a dollar basis. Adjusted free cash flow in 2017, as reconciled in our earnings release, is expected to be approximately $725 million or about 16.3% of revenue and more than 50% of EBITDA. We're off to a good start towards our target, having already generated more than $100 million of free cash flow in the month of January alone. Turning now to our outlook for Q1 2017. Revenue in Q1 is estimated to be approximately $1.075 billion.
We expect core price plus volume growth for solid waste to be between 3% and 3.5%. As a reminder, we have a tough comp against the prior year period in which we reported volume growth of 3.2%, due partially to the benefits of an extra leap year day, ramping of a recently opened landfill, and comparably milder weather. Adjusted EBITDA in Q1 is estimated to be approximately $322.5 million or about 30% of revenue. Depreciation and amortization expense for the first quarter is estimated to be about 14.1% of revenue. Amortization of intangibles in the quarter is estimated to be about $26.5 million or about $0.10 per diluted share net of taxes. Operating income for the first quarter is estimated to be about 15.8% of revenue. Interest expense in Q1 is estimated to be approximately $29 million.
Our effective tax rate in Q1 is estimated to be about 25%, subject to some variability. The effective rate for the period includes about a $6 million benefit to the provision due to a new accounting pronouncement that reclassifies excess tax benefits associated with equity-based compensation arrangements from the cash flow statement to the income tax provision. Finally, non-controlling interest is expected to reduce net income by about $225,000 in the first quarter. Now let me turn the call back over to Ron for some final remarks before Q&A.
Okay, thank you, Worthing. Again, 2016 was a transformational year for Waste Connections and our 13th consecutive year of positive returns for shareholders. We are quite pleased that our financial results continue to track above expectations. Moreover, 2017 is already setting up to be another exceptional year, given the strong momentum with which we exited 2016, the recently announced Groot acquisition, and increasing recycled commodity values and E&P waste activity, all driving a more than 15% expected growth in adjusted free cash flow per share. Sustainability of current commodity values or any additional acquisitions could provide further upside. Culture is a major contributor to our success, and safety is a key component of our culture. At Waste Connections, we believe that safety is the responsibility of each and every employee. It is ingrained in everything we do, and it is the best indicator of organizational health.
We're especially proud to report that the incident rate at former Progressive Operations has already fallen by about 50% since our combination. I'd like to recognize the tremendous efforts of all our employees in their tireless pursuit of zero incidents. We appreciate your time today. I will now turn this call over to the operator to open up the lines for your questions. Operator?
Thank you. Ladies and gentlemen, if you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. If you are using a speakerphone, please lift your handset before entering your request. One moment, please, for the first question. Our first question comes from the line of Michael Hoffman with Stifel. Please proceed with your question.
Thank you so much. Ron, Worthing, can we dig a little bit into the full-year guidance and just frame a little more narrowly what your underlying assumptions are for recycling and R360? How much of the upside of versus the average in 2016, for instance, in recycling, has baked into the outlook? Therefore, what do we have left if the prices stay where they are?
Yeah, Michael, we've only baked the current prices into the current quarter's outlook. We have not baked it in beyond Q1. So to the extent that those prices remain, that's likely about between another $5 million and $7 million of revenue per quarter in Q2, Q3, and Q4, with about a 70% flow through to pre-tax. With regards to E&P activity, we've seen continuing ramping month-to-month as we've kind of moved away from March and April of last year. As we noted already, Q4 was the second quarter in a row where sequential activity quarter-over-quarter increased about 7%. We're trending about that same percentage higher Q1 versus Q4 this year. So to the extent that trend continues throughout the year, that could be another $10 million or $15 million of top-line growth within E&P above current expectations.
Again, we're not going to put out guides for a full year including items we don't control and have to come back and take things down. We'd rather those kind of things all be upside to-
Fair enough.
Michael, just for the record for Q2 last year, commodity values were $104. Q3 they were $123, Q4 they were $125.
Okay.
Those are the numbers you have to compare against whatever your assumptions are.
Great. That's very helpful. Then in June, when you closed Progressive, you talked about an opportunity for maybe about $50 million of op savings. There was $25 million of risk and the other $25 million is for productivity and price. How would you frame where you are in that cycle now, is it bigger and faster, and how much of that's in 2017?
Well, yeah, I think generally you framed it accurately, Michael. I mean, look, we expected originally about $50 million of what I'll call SG&A savings, we achieved a little bit more than that, about $54 million, to be exact, by year-end. We expected $20 million-$25 million of initial safety improvements or risk improvements. I would tell you, we're ahead of that track without question. We have already reduced incidents more than we thought we would reduce by the end of 2017. We're north of that $25 million in savings. Then on price and operating, look, if you take an approximate $1.9 billion in revenue, you assume almost a 2%-2.5% improvement in price, let's just take 2%, that's $38 million. Of course, we've also added costs and other things against that, you're clearly ahead of the $25 million.
That's how I would frame each of those buckets right now. Obviously, if you go back to when we announced the transaction, we started by saying $1.25 million to $1.3 million of EBITDA, and now we just endorsed $1.41 million, take out Groot, and you get to $50 million to $100 million above the initial guidance. Obviously a lot of those improvements and then some are in there.
Got it. Okay. That helps. Then I noticed in your volumes, the MSW, there's a continuing acceleration of MSW, which is clearly higher margin. How do you frame where you think you are in the cycle of that MSW mix shift?
Well, every time we think you got to be closer to the end, another quarter or a year comes around. Man, I'm sitting here looking at really since 2011, we're entering our seventh year of double-digit increases now in MSW, and I would have thought that that would have lasted five years, maybe six years. Obviously, there's no mystery that we had a slower recovery for a variety of reasons. I think that recovery has been strong, and it's going to last longer because it took longer to come out of, and that's what we're seeing pretty much across all geographies now.
Okay. Then Worthing, this cash flow from ops for 2017 framed at 26% is a pretty healthy upside to the previous year 23%, 24%. Is that a permanent shift, or is that working capital moving between 2016 and 2017?
No, it's not a shift at all. Actually, if you adjust the 2016 numbers for all the deal costs, you get about 26.3%, 26.4% for 2016 on an adjusted basis. It's really no change relative to 2016 adjusted for transaction items.
Okay. This, we can model 26% going forward then?
We can model it in 2017. That's right, Michael. I promise.
Just trying to reach a little bit. All right. Thanks for taking my questions. I appreciate it.
Thanks, Michael. Take care.
You too.
Our next question comes from the line of Hamza Nazari with Macquarie Capital. Please proceed with your questions.
Good morning. Thank you.
Hey, Hamza.
Hey. Just had a question on how much of your business right now is truly franchise markets. How should we think about the adjustment of higher inflation, specifically within those franchise markets? Just trying to get a sense of how the company is different versus prior cycles when we saw inflation, and what the impact could be.
Sure. Well, Hamza, as you know, prior to the merger with Progressive, we ran about 51%-52% what we call exclusive markets, which are obviously more indexed to a CPI or other metric that's similar. Post-combination, we're about 43%-44%, what we call exclusive markets. Still very high, comfortably the highest in the sector by over 2x. As you know, it depends on the state, it depends on the indices. These are local indices that we operate off of. They trail six to 12 months. If we get into a higher CPI environment over the course of 2017 into 2018, that just would bode for higher pricing in 2018, 2019, and beyond for that segment of the business. It's pretty much correlated exactly. If you use the CPI and assume a little buffer north of the CPI, that's a good estimate.
Whatever your assumption is on that, you could apply it to that 43%-44% of revenue.
Okay, great. Just a follow-up question, maybe for Worthing. Do you guys have a sense of what pro forma cash taxes are for the business after Progressive? I know you did the inversion. Some of your peers have been pretty vocal on quantifying a cash tax savings number off of potential tax reform in the U.S. Anything you could maybe provide for us, a frame, relative to, obviously, there's some noise with the pro forma and then the inversion. Thank you.
Yeah. With regards to the reverse merger, we look at our cash tax to our GAAP provision for 2017 to be about 70% or so. If you think about potential tax law changes that bring the corporate tax rate down, likely doesn't change our. Well, depends on the final outcome. We'll get some cash tax savings to the extent that they obviously look to do 100% bonus depreciation. That will flow through some benefit. Our debt sits outside of the U.S., it sits in Canada. To the extent they remove interest rate deductibility, we retain the deductibility up in Canada. Obviously, any shift with regards to potential phasing out of interest deductibility in the U.S. is more than offset by the reduction in the effective tax rate.
While the 70% you see us paying cash tax against the GAAP accrual in 2017, once tax law changes come through, if they do, you'll see a reduction in the dollar of cash taxes. Because the provision will come down dramatically, you'll see an increase in the cash tax as a percentage of the provision. On a total dollar basis, we should be set up to save some money.
Yeah, Hamza, the way I think about it, look, in the U.S., we are approximately a 39.4% GAAP taxpayer still. Okay? That hasn't changed due to the structure. We pay the maximum 35% corporate rate in the U.S. There's been discussions that could go to 20 or 25 or whatever it goes to. Everybody makes their own assumptions. For every 1,000 basis point change in that rate, there's approximately an incremental $50 million of tax savings. Make your own assumption from what you assume the tax rate would move to in the U.S.
Again, depending upon the final makeup with regard to interest deductibility, et cetera. Any way you cut it, again, our cash tax on a dollar basis should decline if it comes out the way we think it comes out. Our percentage of the cash taxes as a GAAP accrual will go up because the GAAP accrual will come down a good size.
Got you. Thank you. Appreciate it.
Our next question comes from the line of Tyler Brown with Raymond James. Please proceed with your question.
Hey, good morning, guys.
Good morning, Tyler.
Hey, very nice quarter. Worthing, just a quick one here. Should we see a working capital outflow of cash here in Q1 from the payment of the incentive plan? Is that in the guidance?
Well, the $10 million-$11 million of synergy bonus will be adjusted back into free cash flow for the year, just like it was adjusted back into EBITDA for the year last year. Again, that's a small number relative to the $725 million.
Okay.
In January alone, we already did as much cash flows as we did in all of Q4 of last year.
Okay. Good. I'm just interested in the 8-K regarding the master note agreement. I think, Ron, you even mentioned it. You're looking to maybe sell $400 million of pretty nicely priced fixed rate notes, I think, in April. Should we think about that as incremental debt to pay for Groot? Is that just to fix some of the floating debt? Worthing, can you give us thoughts on full-year interest expense?
Sure. That's baked into our numbers already, Tyler, because we find that commitment already. We're just delaying the funding of that and taking down that money in April. That's purely just a fixed versus floating look at the world. We priced 10-year money at Treasuries plus 100. We priced seven-year money at Treasuries plus 95. We thought it was a good environment to lock in some long-term money and take some floating rate debt to fix. Again, the outflows associated with those notes are baked into all of our outlooks for interest expense.
Okay. Just maybe lastly, Ron, I'm curious, you guys are running 12 to 18 months ahead of schedule with Progressive, and you've only owned it for, let's just call it six months or so. I'm just curious, why do you think you're getting such quick buy-in, if you will, from everybody? What is it about this acquisition that's really, again, allowing you to get that buy-in?
I think the reality is that we had assumed Progressive was a better-run company than they ended up being. There was a lot more opportunity in basic blocking and tackling that we had just assumed was there, and it just wasn't. While there was a lot more work to do initially, and still, the opportunity was much greater. When you have a 42%-44% employee turnover, something unhealthy is going on. We had to stop that. You see, and we've seen it in our own company, because at one time we had that kind of turnover nine, 10 years ago. There's an exponential benefit in risk and other things by the reduction of turnover. Said another way, if you reduce turnover 15%, you'll see a multiple of that in risk, productivity, variable, and other things come through over time. That's what we're seeing.
We have over a 50% reduction in risk and a 35%-40% improvement in turnover already. We knew that Progressive had very good assets, with good asset positioning in markets that predominantly, 85%, were similar to ours. What we didn't really know fully is how they ran the business relative to how we do. It's a very, very different approach.
Okay. No, that's great color, and good job, guys. Thanks.
Our next question comes from the line of Derek Spronck with RBC Capital Markets. Please proceed with your question.
Good morning. Thanks for taking my questions.
Sure.
There's been discussions in the waste industry around changing towards a franchise-type model in Los Angeles, New York City, and some areas in Illinois. Ron, I'd be interested to get your thoughts on these potential developments, and does it change the way you're looking at the Progressive assets in the U.S. Northeast?
Well, Derek, very good question. Yes, in a way it does. Look, some municipalities, as you've mentioned, two large ones or three large ones there, Los Angeles and New York City, certainly, Los Angeles being the first one, for varying recycling and diversion requirements and legislation in those municipalities have moved to or are moving to a franchise model. We were a participant in the Los Angeles process. We did not have collection or transfer assets in Southern California, but we had a landfill asset. What that process showed us is those with assets, very difficult to replicate assets, transfer stations, recycleries, hauling companies, at the end of the day, they won the franchises. We did not have those assets, so we didn't win a franchise in Los Angeles. Those were won by Waste Management and Republic, and five very strong independents, all of who had great assets.
We are going to get some substantial disposal volumes through the franchises into our Southern California Chiquita Canyon landfill. As we look at New York, who is looking at a similar process, they haven't decided that, the former Progressive and now us comfortably has the best assets in two of the five boroughs in New York City, between transfer stations and collection operations. We have made a decision on New York for a couple of reasons. One is that we've seen a change in performance from low single-digit EBITDA margins when we closed the transaction to high double-digit EBITDA margins. To be honest, almost a 300% improvement in operating performance in seven months. That was one reason, and that we found that the market wasn't broken the way we assumed it was. The second thing is what you pointed out.
The potential of the franchising of the business, what we learned in the L.A. process may or may not play out in New York. If it does, we think we're positioned in some of the boroughs certainly better than anyone else at this point. I'm not exactly sure where you're speaking about in Illinois. It depends where that would be. Obviously, if it's anywhere north or west of the city, we now have the number one position there as well. Many of the western and northern markets in Illinois are already exclusive in some nature or another. That would be the answer on those, Derek.
Yeah, no, that's a great color. Thanks, Ron. Appreciate that. Just quickly too, with guidance now for 2017 coming in at $725 million for free cash flow. Last quarter, you were indicating that it was trending towards $700 million in 2017 and towards, I believe, $800 million in 2018. Is that incremental? I guess that's from Groot. Part of it is from Groot and some other tailwinds that you're seeing with the Progressive integration. Should we assume that 2018 now is trending towards $825 million in free cash?
Yeah, let's be very clear about this. When we talked in terms of $700 million for calendar 2017, that was before the Groot transaction. We mentioned Groot was about 3% accretive to that, so $21 million or so. We round that to $725 million for calendar 2017. With regards to 2018, we've been consistent all along pre-Groot to say that our targets for 2017 were between $4.50 a share and $4.75 a share. To the extent that Groot had 3% or so to that number, that's a kind of a revised target for the Groot transaction. We've shied away from putting a dollar number out on 2018 because it's too far out in the distance. Again, on a per-share basis, our guidance has been consistent at $4.50-$4.75 a share for 2018 prior to the Groot uptick.
Okay, great. Thanks very much for taking my question.
Thank you.
Our next question comes from the line of Noah Kaye with Oppenheimer. Please proceed with your question.
Good morning. Thanks very much for taking the question. First, just wanted to clarify some of the cost reduction benefits from the significant lowering in incident rates at Progressive. Understanding that, I believe you're likely seeing the cash benefits of that now. How do we think about that from a modeling perspective becoming more evident in the P&L? What's sort of the cadence of that, and how do you think about kind of a margin expansion benefit from that in 2017 as you can kind of recognize the effects of these improvements?
That's again, that margin benefit's baked in our outlook for 2017. You'll start seeing that come in the second half of the year from the anniversary of Progressive, because that way the actuary has more data points to see a trend being established versus kind of the success has been an anomaly. Again, you've seen the cash benefits already trickling through the cash flow. You'll see the P&L benefits trickling in the second half of this year. Again, that's baked into our outlook.
Yeah. Noah Kaye, I would also tell you that the P&L benefits trail the cash benefit because the reality is that we're working off a historical severity level, and it takes the actuaries time for those severity levels to run out. I remind you that in the prior four years, Progressive had 31 fatalities, and in 2016, in the first five months, they had six.
We've had zero since the close, thankfully. We're running out on 31 fatalities in the severity by the actuaries that is baked into our P&L for some time. You're really going to see a tail on this for some period of time if we continue the improvement as severity declines and the tail is able to run out on historical performance.
Good. That's very helpful clarification. Thanks. Maybe just one more from me. First wanted to clarify whether that potential $15 million franchise collection revenue acquisition is in the guidance already. I guess just generally for you, Ron, as you pointed out as it regards M&A, we don't really know what tax reform is going to look like. Pick your own assumptions, you did mention that it is certainly part of the driving factor in the conversation. I guess I'd just like to get a better sense of how it's impacted the conversations, how we think about the puts and takes of while we still have some uncertainty on the tax reform picture, clearly there seems to be a prospect for lower tax rates and for sellers to keep more of their profits.
With regards to the first question on the $15 million signed transaction, that is not in our outlook because, again, we don't bake anything into our outlook until a transaction closes. Once that closes, we'll update the numbers to reflect that. I'll start, and I'll let Ron finish on your second part. We always think about an average year being about $125 million plus or minus of acquired revenue. To the extent we've already done $200, it's my guess that we'll beat the $125. It's up.
Yeah. We better or we got an issue. To the second part of your question, Noah Kaye, look, we have said over time that low interest rates for reinvestment and high tax rates have been an inhibition to deals. They certainly slow things. Well, the prospects for each of those looking different in the future, potentially lower tax rates and higher interest rates, those help deals, pure and simple. We have seen an increase in activity since the November 9th, certainly inquiries of potential activity. We're busier now than we've been in quite some time, in years. Obviously, some people want to see what the clarity is on that tax law change, I don't think there's anyone that assumes it would be any worse. The assumption is universal that it will be better.
We've had some tightening, although pretty nominal, there is, if the economy continues to improve, we will see further tightening. Those are good for transactions overall. Sellers keep more of their after-tax proceeds, and they can earn more in the fixed income market on reinvestment. That helps sellers who have a single asset for their family think about whether it's the right time or not to do something. We have said we believe there is going to be a period here, and I believe this very strongly, that for certainly 2018 and 2019, and probably once tax law is clarified in 2017, there will be a flurry of acquisition and M&A activity. I don't just believe in our industry, I believe in most, because there will be a fear that come the next election, those tax laws could be reversed.
People will view this as a window after sitting on the sidelines for up to eight years because of what's been going on the other direction for eight years.
That is great color. Thank you very much, and congrats on the quarter and the outlook.
Thank you.
Our next question comes from the line of Corey Greendale with First Analysis. Please proceed with your question.
Hey, good morning.
Good morning, Corey.
Congratulations on the good year. Just a housekeeping question. You're saying that $200 million is a bigger number than $125 million?
Let me pull up my calculator. Yeah, in U.S. dollars it is. That's right.
Good to know. I just had a couple of actually real housekeeping questions. Could use your help on how to model internal growth after Progressive anniversaries. Did you start this cycle of kind of raising price and pushing away undesirable volumes immediately? In other words, once that's in the organic growth comp, do you still have this kind of 3% plus price and drag on volume, or what is the timing around that?
Yeah. First off, Corey, to answer your question, we did start it immediate, but I would say certainly by the end of last year's third quarter and in the fourth quarter, we were heavily into it.
Because the volumes turned negative.
Yeah
slightly in Q4.
That's right. I would tell you that that will continue through 2017, Corey. Do I believe we'll get most of it done in the first two quarters? Yes. A lot of this takes time. You have contracts you need to honor until expiration or whatever the case. We're not going to walk away from commitments to customers. The way to think about the growth, we just told you, we said earlier what our price was running. We told you that Progressive's is running north of 3%. As that comes into the growth calculation, you would expect price to elevate somewhat, just adding those two numbers together and dividing. You would expect volumes on a reported basis to come down somewhat because, again, we've given you guidance for Waste Connections. We've told you that Progressive is running slightly negative.
I think most of the negative will come out by about the beginning of the third quarter. You would probably see that volume to, it could be flat to slightly positive, it could be nominally negative. We will break out for people a reported growth number, and then what was in that underlying growth, meaning how much did we consciously shed to drive negative volume in the Progressive footprint, therefore, what was the underlying volume. We plan to do that for 2017. I would expect the culling to be done by the end of 2017.
Okay. Once the culling is done, Ron, at that point, do you think those operations are kind of a 3% price going forward, or does that come down once you're past the shed?
Well, look, what we've said is that it depends on what the macroeconomic environment is, the GDP environment is, Corey. What we've said is that we don't see a reason that price in the competitive piece of the Progressive footprint should look materially different than the Waste Connections over time.
Because you have a higher percentage in that competitive piece versus exclusive-
Yep
On a combined basis, its pricing relative to legacy Waste Connections should be slightly higher.
Yep.
No, it isn't. The 3% is not a one-time correction in price. No, it's a new shift in the overall strategy in pursuit of quality revenue.
Yep. Right. That helps. Then on D.C., the language was that you exited that market. Was that a divestiture or a swap?
That was a divestiture. It had some components of that. We took back a long-term disposal agreement for the market through transfer stations and landfills we have in the area. Effectively, we divested the collection and transfer operation, and we took back a long-term disposal agreement as part of the consideration to keep us, what I would call, EBITDA neutral without the $50 million of revenue associated to do so.
Okay. Is the target still about $225 million in acquired revenue that you think you're going to shed?
I think it's come down a little, Corey.
We've been saying $200 million.
Yeah, we've been saying, I think we said $200 million on the last call, and I think that number is $175 million-$200 million. So when you say, "Well, why has it come down?" We have been able to make improvements or identify other assets in some markets that we thought we would divest, that make those markets attractive. That has been somewhat of a surprise to us. I'm going to round, but we started with sort of six market areas that we weren't sure fit us strategically and asset positioning, and we've already taken two of those off the table and said, "No, we can make them fit through asset positioning improvements and performance improvements," and those are happening. I would tell you that number is $175 million-$200 million, and we've just done $50 million of it.
You should expect that you'll see more done in the first quarter announced as we complete that. I would expect that the balance of what we do will be signed and/or closed by the end of the second quarter.
Great. Thanks. I will turn it over.
Our next question comes from the line of Chris Murray with AltaCorp Capital. Please proceed with your question.
Yeah, thanks, guys. Good morning. Just very quickly, just on the E&P waste. Kind of running the 7% sequential number, so I guess that kind of gives us at least a runway into the double digit. One of the things, just curious about any changes at the federal level in terms of environmental regulation, how do you think that would play into maybe slowing down that growth rate?
Well, number 1, let's back up, Chris. First off, on E&P waste. E&P waste is the one waste stream in the U.S. that there is not federal regulations on. Each state has its own regulations with regard to E&P, and those vary from very stringent, like in New Mexico or Louisiana, to less stringent, like a Texas as an example, or an Oklahoma. There isn't federal regulation. In the current administration, where the belief by some is that there'll be less stringent regulation, there already isn't federal regulation in E&P. I don't think there would be any slowing of that growth rate due to regulation change as it regards E&P. Now, conversely, if you want to call it reduced regulation, accelerates the development of things like pipelines and others, which are positive drivers in the E&P space.
As well as other types of permits for new development of facilities. I believe with regard to certainly E&P, that the environment is an improving one, at least regulatorily.
Yeah, we've even seen a tightening of some regulations in Louisiana with regards to folks that bring waste in from offshore.
Yes.
That's, again, a further driver of activity in that area. Again, this is all at the state level within the U.S. versus the federal level.
Yeah, in Canada, there is federal regulation in Canada, but we do not do a lot of E&P waste in Canada.
That's fine. Great, guys. Thanks. I'll leave it there.
Thank you.
Ladies and gentlemen, as a reminder to register for a question, please press 14 on your telephone keypad. Our next question comes from the line of Brian Maguire with Goldman Sachs. Please proceed with your question.
Hey, good morning. It's Derrick Laton on for Brian. How are y'all?
Hey, Derek. Good.
Good morning, Derek.
Hey, just a quick one for me, kind of higher level. You'd mentioned, obviously, getting over $200 million in CapEx, or sorry, M&A so far in first quarter. Could you maybe just give us your thoughts higher level on how the M&A market's looking? Then how that's kind of trending versus your expectations, as you expected to see a pipeline increase from M&A opportunities from the larger Progressive footprint.
Sure. For those that have followed us on a historical basis, prior to the Progressive transaction, we always sort of said that, $60 million to $80 million of acquired revenue was sort of a normalized year. If you look at that was 3%-4% organic or external growth.
The footprint we had then, that was targeting about a $2 billion to $2.5 billion of identified opportunities.
That's right. Now what we're saying is that, we've increased that to sort of $125 million plus annualized. Again, that gets you to 3% plus external growth. We've now identified about $3.5 billion of potentially available acquisition candidates that fit our profile in both the U.S. and Canada. As Worthing said, we've done $200 million in the Groot transaction. We've already signed. We just told you about another $15 million franchise. We've signed other transactions beyond that. Obviously, we would hope and expect that this is going to end up being a strong year. I would hope to do another $125 million plus on top of the Groot transaction this year. Obviously, time will tell on that.
Great. I think that's really helpful. I'll go ahead and turn it over.
Please press one four for questions. Mr. Mittelstaedt, there are no further questions at this time. I will now turn the call back to you.
Okay, well, if there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in our call today. Both Worthing and Mary Anne Whitney are available to answer any direct questions that we did not cover that we're allowed to answer under Regulation FD and Regulation G. Thank you again. We look forward to speaking with you at upcoming investor conferences or on our next earnings call.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.