Ladies and gentlemen, thank you for standing by. Welcome to the Waste Connections Third 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 Thursday, October 27th, 2016. I would now like to turn the conference over to Ronald Mittelstaedt, Chairman and CEO. Please go ahead.
Okay. Thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our third quarter 2016 results and provide our financial outlook for Q4. I'm joined this morning by Steve Bouck, our President, Worthing Jackman, our CFO, and several other members of our senior management team. As noted in our earnings release, our financial results continue to track at or above the increased expectations we communicated in August, and we are extremely pleased that safety, pricing, and operational improvements within recently acquired operations continue ahead of schedule. Adjusted free cash flow remains notably strong at $205.8 million in the third quarter, which reflects our first full quarter of combined operations since completing the Progressive Waste acquisition. Adjusted free cash flow on a year-to-date basis, which only includes four months of combined operations, was $440.3 million or 18.9% of revenue.
Our strong free cash flow profile following the Progressive merger positions us for an outsized 24% increase in our quarterly cash dividend while maintaining a payout ratio at less than 20% of expected annual free cash flows. This financial strength and flexibility, together with our expanded footprint following the merger, keep us well-positioned to execute our growth strategy at a time when acquisition dialogue is near record high levels, all while increasing our 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 US 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 two of our October 26 earnings release and in greater detail in filings that have been made by Waste Connections, formerly named Progressive Waste Solutions Ltd., and Waste Connections 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 and adjusted net income per diluted share, and adjusted free cash flow. Please refer to our earnings release for 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, and other companies may calculate these non-GAAP measures differently. Finally, reported results reflect the impact of our merger with Progressive Waste on June 1st.
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 will now turn the call back over to Ron.
Okay. Thank you, Worthing. In the third quarter, solid waste core price and organic volume growth was 3.7%. Core price increases in the period were 2.6% year-over-year, with total pricing growth net of surcharge reductions of 2.3%. Core price is on target to be about 2.7% for the full year. Volume growth in Q3 was 1.1%, driven primarily by the West Coast, where we have seen strength for the past several quarters. A year-over-year decline in special waste activity in Minnesota was about a 70-basis point drag to volume growth in the period and is expected to continue in Q4 as certain projects in that market have been pushed into 2017. For the full year, we expect our volume growth to be around 1.7%, with core price growth plus volume of about 4.4%.
We believe the volume growth environment remains in the range of about 1%-2% under current economic conditions. It could run a little above that range in some periods due to the timing of special waste activity or items within a prior year comparison. As we've consistently communicated, we try to be conservative in guiding volume growth, particularly given that 2016 is the fourth year of strong MSW volumes. The deeper we get into this recovery, the tougher we expect the comparisons to be, unless the economy shifts into a higher gear, which with housing starts still running around 1 million units we're not yet seeing or expecting. As a reminder, until we anniversary the Progressive Waste acquisition, a 50-basis point change in volume is currently about $2.5 million of revenue in a quarter.
Volume growth in the third quarter was primarily driven by double-digit increases in MSW disposal volumes, along with higher commercial collection and roll-off activity. MSW tons increased 11% in Q3, with about 75% of our landfills reporting higher MSW tons year-over-year in the period. Special waste and C&D tonnage were each down 6% due to the previously discussed decline in special waste activity in Minnesota and tough C&D comps at two landfills. Solid waste landfill tonnage overall on a same-store basis increased 3% year-over-year in the third quarter. On a same-store basis, commercial collection revenue increased almost 7% year-over-year in Q3, and roll-off pulls per day increased about 4%. All regions reported higher roll-off activity compared to the year-ago period, as pulls per day increased about 8% in our eastern region, 3% in our western region, and 2% in our central region.
Increases were widespread, with notable exceptions in both coal and E&P-influenced volumes. Recycling revenue, excluding acquisitions, was $13.9 million in the third quarter, up almost $1.9 million or about 15% year-over-year, due primarily to higher commodity values for fiber. Prices for OCC, or old corrugated containers, averaged about $123 per ton during Q3, up 11% from the year-ago period and up 18% sequentially from Q2. OCC prices currently are around $115 per ton, up about 8.5% from the level we averaged in last year's fourth quarter, but down off of Q3's highs. Regarding E&P waste activity, we reported $30.1 million of E&P waste revenue in the third quarter, consistent with our revenue guide for the period, with segment EBITDA margins of about 30%. Monthly revenue is up as much as 20% from its low earlier this year, with margins almost 500 basis points above the trough.
As a landfill-oriented business, any revenue growth resulting from increases in drilling activity should flow through at high incremental margins. Moving on to the Progressive Waste acquisition. As noted earlier and in our press release, results continue to track at or above the increased expectations we communicated in August, and we are extremely pleased that safety, pricing, and operational improvements continue ahead of schedule. October safety-related incident frequency for Progressive's legacy operations is currently trending about 40% lower than pre-acquisition levels. To put that in perspective, in September and October as a total company, we had fewer incidents than Progressive Waste had as a standalone company in many months throughout 2015. Pricing improvement initiatives within Progressive's footprint are also well underway, resulting in price increases within these markets expected to range between 2.5%-3% in Q4, up from less than 1% in Q1.
Our focus remains 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. As mentioned already, this involves a heavy focus on price improvements, but an equally heavy focus on shedding unprofitable volumes. The adjusted EBITDA margin of Progressive's operations before corporate overhead was about 30% in the third quarter, and we are extremely pleased to have reported over $200 million of adjusted free cash flow in Q3, which was the first full quarter of combined operations since completing the Progressive Waste acquisition. Regarding other potential M&A activity, acquisition dialogue is near record-high levels. These opportunities include new market entries and tuck-ins, competitive and exclusive markets, integrated and non-integrated opportunities. In some instances, concerns over potential post-election tax laws are driving the timing.
Additional transactions in the pipeline that may get completed either later this year or early next year should easily surpass the $120 million of acquired annualized revenue we thought we would complete in an average year based on our expanded footprint following the Progressive Waste merger. Similarly, interest in market divestitures or asset swaps remains very high, and we will look to complete that process by Q1 2017. We currently expect to rationalize about $225 million in annual revenue and, through swaps, obtain approximately $100 million-$125 million of annual revenue in return, but with greater EBITDA coming in than what's going out. Once completed, this should add about 100 basis points to consolidated company margins and reduce our CapEx as a percentage of revenue, driving even higher conversion of EBITDA to free cash flow. We currently have two to three options on each of the potential asset rationalizations.
Finally, as also announced yesterday, our board of directors authorized a 24.1% increase in our quarterly cash dividend, our sixth consecutive double-digit annual increase since commencing the dividend in 2010. Even with this increase, our dividend remains less than 20% of our expected annual free cash flow following the merger, providing tremendous flexibility to fund our growth strategy and further increase 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 third quarter and to provide you an outlook for Q4.
Thank you, Ron. In the third quarter, revenue was $1.085 billion, or about $10 million above the upper end of our outlook for the period. Acquisitions completed since the year-ago period contributed about $538 million of revenue in the quarter, with Progressive Waste accounting for $513 million of that amount. Adjusted EBITDA, as reconciled in our earnings release, was $342.3 million, or 31.6% of revenue, and in line with our margin outlook for Q3. Year-over-year adjusted EBITDA margin reported for the third quarter declined by almost 300 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 activity.
Fuel expense in Q3 was about 3.7% of revenue, and we averaged approximately $2.33 per gallon for diesel, which was down about $0.46 per gallon from the year-ago period and $0.16 per gallon sequentially from Q2. Depreciation and amortization expenses for the third quarter were 14.1% of revenue. The 155 basis point year-over-year increase as a percentage of revenue was primarily due to acquisitions completed since the year-ago period, as D&A expense was about 15.6% of incremental revenue contributed from the Progressive Waste acquisition, or over 300 basis points higher than legacy Waste Connections. Acquisition accounting typically increases our D&A as a percentage of revenue following a material transaction, due primarily to the expensing of that portion of the purchase price allocated to both intangibles and landfills.
As we've noted before, while a higher D&A percentage impacts GAAP results, it has no impact on free cash flow generation. Interest expense in the quarter increased CAD 11.3 million over the prior year period to CAD 27.6 million, due to the additional debt outstanding resulting from acquisitions completed since the year ago period and higher interest rates associated with fixed rate notes issued since the prior year period. Debt outstanding at quarter end was about CAD 3.66 billion, and our leverage ratio, as defined in our credit facility, decreased to less than 2.8 times debt to EBITDA. GAAP and adjusted net income per diluted share in the third quarter were CAD 0.50 and CAD 0.72 respectively.
Adjusted net income in Q3 excludes the impact of almost CAD 38 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. Our effective tax rate for the third quarter was 32.3%, which included a CAD 2 million impact to the provision associated with a change in deferred tax liabilities resulting from the Progressive merger. Excluding the acquisition-related deferred tax item, our effective tax rate was closer to 30.8% in the period. We still anticipate our effective tax rate to be between 30% and 31%, subject to some variability depending on the percentage of total profitability contributed by operations in the U.S. versus Canada. I'll now review our outlook for the fourth quarter.
Before I do, 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 Securities Commission for 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 period. Revenue in Q4 is estimated to be about CAD 1.02 billion. We expect core price plus volume growth for solid waste to be between 3% and 3.5%. Adjusted EBITDA in Q4 is estimated to be almost CAD 315 million, or about 30.8% of revenue.
Depreciation and amortization expense for the fourth quarter is estimated to be about 14.4% of revenue. Amortization of intangibles in the quarter is estimated to be about CAD 27.4 million, or a little more than CAD 0.10 per diluted share, net of taxes. Operating income for the fourth quarter is estimated to be almost 16.5% of revenue. Interest expense in Q4 is estimated to be about CAD 27.1 million. As mentioned earlier, our effective tax rate in Q4 is estimated to be up to 31%, subject to some variability. Non-controlling interest is expected to reduce net income by about CAD 200,000 in the fourth quarter. Finally, our fully diluted share count in Q4 is estimated to be about 176 million shares. Now, let me turn the call back over to Ron for some final remarks before Q&A.
Okay. Thank you, Worthing. We are quite pleased that our financial results continue to track at or above the increased expectations we communicated in August. We're extremely pleased that safety, pricing, and operational improvements within recently acquired operations continue ahead of schedule. Our adjusted free cash flow remains notably strong at over $200 million in Q3 alone, our first full quarter combined operations following the Progressive merger. Our strong free cash flow profile enable us to announce a record increase in our quarterly cash dividend while also maintaining tremendous flexibility to fund our growth strategy, particularly important given record M&A dialogue. Our revenue and EBITDA outlook for Q4 is consistent with the sequential Q3 to Q4 expectations we provided back in August, and we have no reason at this point to alter the early thoughts for 2017 that we also had provided.
We'll be better positioned in February when we provide our formal 2017 outlook to incorporate the impact of any acquisitions and divestitures either signed or completed by that date. We appreciate your time today, and will now turn the 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 for a question at this time, please press the one followed by the four on your telephones. You will hear a phone prompt to acknowledge your request. If your question has been answered and would like to withdraw your registration, please press the one followed by the three. If you're 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 Tyler Brown with Raymond James. Please go ahead.
Hey, good morning, guys.
Good morning.
Hey, good morning.
Hey, nice quarter. Hey Ron, I believe post the deal, you guys had talked about getting back to call it a 32% EBITDA margin by maybe 2018 or so. This quarter, you guys posted about a 31.6%. I get it, the Q3 is probably one of the better quarters, but it sounds like you have 100 basis points of margin uplift potential from divestitures. You got some additional opportunity from heres and theres with insurance and safety, and it really doesn't even contemplate E&P or even a full round of pricing at Progressive. I guess my question is, why shouldn't we start to think about 2017 margins coming in closer to that 32% and maybe even 33% into 2018?
Tyler, you just laid out what we believe is achievable. You laid the building blocks out properly. It's hard to argue, since we did just do 31.6%. We did just say there's another 100 basis points through the rationalization, so that takes you to 32.6%. We said there's about 50 basis points in safety. We're on track for that. That takes you to 33.1%. That's before we really improve pricing and other operating things. That also takes you to that in the best seasonal quarter of the year, too. In fairness, I think we now believe, cautiously, that we can get 2017 to a 32% type EBITDA margin, where we thought that would take us fully into 2018. I think it's reasonable to think that we can get well beyond that, probably approaching 33% in 2018. That's without E&P help.
If we get E&P help, that number is north of 34 pretty quickly. Which is where we were, as you know, before the deal and before some declines in E&P. It's a long way around the bend to say we thought ultimately post-deal because of the lower margin profile of Progressive overall, that if we got back to 32, we'd be happy. We now see a pathway to get to 33 to 34 on the margin side.
Yep. No, very helpful. Worthing, just maybe one follow-up here. Just hoping to deconstruct free cash flow next year. If we start with, call it that, 1,365 or so in EBITDA, and you take out, I don't know, maybe mid-400s for CapEx, you've got some cash interest, some cash taxes. Is it crazy to think about free cash approaching that $700 million mark sometime next year for the full year next year?
No, there's math that gets you at least $700 million for calendar year 2017.
Okay. All right, perfect. Thanks, guys.
Our next question comes from the line of Derek Spronck with RBC Capital Markets. Please go ahead.
Great. Thanks for taking my question.
Sure.
Yeah. On the acquisition front, is the environment and opportunity lending itself more towards tuck-ins, or are there more material acquisitions that could develop?
Well, Derek, again, as we said in the call, we've got all of the above. We've got standalone platform transactions. We've got tuck-ins. We've got integrated opportunities. We've got franchise opportunities. We're really seeing a variety of things become available, in part due to a potential fear of tax raises, depending on who wins the White House this year in November. It's a combination. Now, again, I would caution materials, and everybody defines material differently. What we said is that we thought an average year would be CAD 100 million-CAD 120 million in our new platform a year, and we're saying that the number ought to be well north of that. There obviously is some reasonable size in our model, standalone transactions to get to those kind of numbers.
Is that partly why you weren't really that active with your NCIB the past few months after announcing a 8.8 million share buyback?
No, that's right. As we've always said, we think properly priced, strategically consistent acquisitions are our highest and best use of excess capital. Given what we see in the pipeline, we stayed out of the market during Q3 while we see what deals actually do get across the finish line.
Yeah, that makes sense. Can you do more material acquisitions or larger scale acquisitions as you're currently in the midst of integrating the BIN assets?
Well, people forget that we already did $2 billion-plus of revenue this year.
Yeah. Derek, again, we're not sitting here saying we're doing, as you know, we're not sitting here saying we're doing something the size of a Progressive, because that doesn't exist. Can we do numbers north of CAD 120 million by 1.5 to 2.5 times. Yes, we can. That speaks to our divisional and our regional field infrastructure. They can absorb those types of things, especially as it's spread out. Whereas the Progressive merger has put obviously tremendous resources constrained on the corporate group because of the size of it. Our field infrastructure can do several hundred million CAD and continue to still deal with the integration of Progressive.
That's great. Just one more quickly. Are you able to leverage being now domiciled in Canada? Are you able to leverage that better for U.S. acquisitions?
Look, we do that evaluation on every deal we do. To the extent there is some planning we can do, we'll pursue it. It's really on a case-by-case basis.
Okay. That's great. Thanks a lot, guys.
Thanks, Eric.
Our next question comes from the line of Al Kaschalk with Wedbush Securities. Please go ahead.
Hey, good morning, guys.
Hey, good morning, Al.
Good morning.
Looks like you set the new benchmark for free cash flow, as well as the conversion of EBITDA to free cash flow for not only yourselves, but for the industry. Keep up the good work.
Thank you.
Ron, I had a question on your M&A comments and portfolio commentary. It sounds like you're, without putting words in your mouth, exiting the New York area based on the commentary. You also said that there's some competitive markets that you're looking at from an M&A perspective, which is slightly different than the legacy Waste Connections, but I'm sure still very focused on the right return. If you could add a little more commentary around those comments.
Well, Al, are you exiting the securities research industry? We haven't publicly mentioned any markets at all. I wouldn't put words in our mouth with regards to New York City.
Yeah, I was going to say, I don't think we said that we're leaving New York. People may draw that conclusion because obviously it's a heavily urban-centric market. I will tell you that the margins in New York are up over two and a half times since April. Just as a cautionary word there on people guessing what we are or aren't doing.
The safety performance has been nothing short of exceptional.
Yeah. Again, we don't talk about any markets that we may or may not be in until we're not there or we are there. I will tell you that our New York team has just done an incredible job since before the close. Having said that, Al, as you know, we have always tried to do a couple of different things in our market model, and that is enter markets where we can ultimately have the business perform less like a commodity than it might otherwise, where we can create a greater sustainable pricing platform and a more predictable volume platform, and therefore a margin profile, and therefore a free cash flow profile. That's ultimately what we do. We do that through contract markets, which is a hallmark of the Western U.S. Off of that, outside of the Western U.S., we go into competitive markets.
They may not all be urban-centered, and in fact, aren't, but competitive markets where we can get large collection positions and an integrated disposal position. Those are the things that we look for in competitive markets. The transactions we are looking at doing continue to fit that profile. We are not deviating. We've said all along, the larger footprint profile of Progressive, that 85%+ of it was consistent with our market platforms. The 15% that wasn't, we would take a hard look at, and we're doing that. We're not changing our market strategy or our return strategy because we have a bigger profile footprint now. I guess that's a long way around the barn to tell you nothing's changed in our M&A thought process. What's changed is we have a larger platform, and we have less competitors competing for that M&A opportunity. That's what's changed.
No, that's very helpful, and I didn't mean to imply maybe what you'd heard. On the follow-up question, Worthing, on the tax rate, I know it's obviously about jurisdiction and where revenue's coming in or income, but 31% seems a little bit above maybe what thoughts were. Is that still something you're working on? Is that where we'll be level setting going forward? What are the thoughts there?
The range of 30%-31% is still consistent with what we said in our last call. We also have reminded people since the day we announced the transaction, really, is that the more improvement we get into the U.S. operations in Progressive and raise the profitability in the U.S., that tax rate will click up a little bit. For us to have already gotten Progressive to a 30% EBITDA margin, you're starting to see us move that tax rate to the upper end of that. It's a good problem to have, not a bad problem. I agree. All right, we'll watch. Good luck, guys. Thank you.
Thanks, Al.
Our next question comes from the line of Bert Powell with BMO Capital Markets. Please go ahead.
Guess I must have said that wrong. It's actually BMO. Hi, good morning, guys.
Good morning, Bert.
Just on the CapEx number for the quarter, if I think about the seasonality of it, usually Q4 is a little heavier. This quarter looked a little lighter. Can you help us understand that a little bit better? Is there a bit of a CapEx holiday, or is this just really timing?
Yeah.
How should we think about CapEx in the fourth quarter?
Yeah, it's more of a timing issue. Last call, we had laid out an expected CapEx spending for the second half of the year of about $225 million or so. The fact that about $95 million of it got done in Q3 just tells you that Q4 will be a little heavier than that at about $120, $125 million. Purely timing.
Okay. That's helpful, Worthy. When you think about next year in terms of overall cash flow, you're still thinking about CapEx as a percentage of revenue in that 10%-10.5% range?
Correct.
Okay. The volumes, the specialty waste or C&D volumes that you mentioned that got pushed off or will be more of a 2017 impact, can you just give us a sense of magnitude? How material is that?
Well, again, in the quarter, it was about CAD three and a half million of revenue in Minnesota alone.
Okay.
That was 70 basis points. We've been highlighting this kind of election malaise, so to speak, within some state government spending, especially on infrastructure projects. The timing is curious, but there's a cover piece in the Wall Street Journal that just covers that specific topic of how states have cut back dramatically on infrastructure spending. We didn't place that article the same day as our call. It's just a coincidence, by the way.
Okay. Just last question, Worthing, I know we chatted about this a bit, but I wanted to just revisit leachate. It was mentioned on the Waste Management call. It seemed to be indicated a little bit more problematic for the whole industry. I'm just wondering how you would position your leachate relative to peers based on where your footprint is.
Well, Bert, look, we're now in 40 states. Relative to our peers, Waste Management, Republic obviously are complete national companies, as are we being in 40 states now. There's no really geographic differences in any of our companies. There's no real change in leachate. What there are changes to is the enforcement standards of the various POTWs or treatment facilities throughout the U.S. that are happening because of various localized or state reasons requiring lower particulate and other concentration matters in leachate to meet the discharge standards, and that comes at a greater cost. If you were to take an example, a state like Washington has a very high standard for the discharge into the POTWs of leachate compared to other states, perhaps not on the West Coast or not on the East Coast. The coasts tend to be concentrated in population.
They tend to be concentrated with a lot of development, and they have higher discharge standards. You tend to have more costs where you have landfills on the coasts. If you get into the central part of the country where there's more space available and it's not quite as concentrated, you tend to have lower costs. This is really an evolutionary issue. There's no real change in what's going on with leachate, other than you have larger landfills now in the U.S. that are more regionalized with greater waste footprints, and therefore, when rain falls on them, you have a greater amount of leachate coming off. It's just a geometry issue. There's no real change going on.
Okay, yeah. I think the positioning, or at least the indications were that it was a little bit of a step change, and you're not saying that's the case.
Yeah. Again, that's a geographic issue and a landfill-specific issue. I think overall, the step change is that you're seeing greater enforcement activity and therefore more stringent self-police treatment standards that we must put, and that does come at a nominally higher cost.
Okay.
This has been going on for several years.
Okay, perfect. Okay, thanks, Ron. Thanks, Worthy.
Thank you.
Our next question comes from the line of Noah Kaye with Oppenheimer. Please go ahead.
Good morning. As a New Yorker, thank you to your New York team for the improved safety performance. Much appreciated. Sticking with special waste, I'd like to ask about the coal ash opportunity. I think it's been a minute since we talked about this, but just wondering how you're seeing that kind of opportunity set heading into 2017. Can that be a tailwind for you at this point?
Well, look, any coal ash we get is a tailwind because we have very little to none of it right now. Look, we've consistently said, for us, we view this as something that is two to three years out. The utilities are first trying to address some critical ponds ASAP. Longer term, they're trying to figure out what's the best way to either minimize the cost of themselves or shift as much to the rate base as possible. When certain areas get addressed that are approximate to our landfills, I'm sure we'll get our share of that waste stream. Those actions are not going on right now at approximate locations. For us, I don't see it as a 2017 opportunity. If it happens, that's great. We've always viewed this as kind of a 2018, 2019, 2020 opportunity for us.
Look, North Carolina's ground zero for a lot of this, our assumption is that the mandated date of which these things need to be addressed will ultimately get pushed out, as most of these sorts of things do over time. I'm sure this will be no different.
Thank you. Just maybe a question about the volume growth mix. You had another nice 7% growth in roll-offs, but as you talked before about the 1%-2% type volume growth, how do you think about the mix of that on a sector basis? Is the type of volume growth that you're expecting, how would you think about the relative margin profile of where you're expecting the growth? Thanks.
Look, first and foremost, I know you talked about volume growth, obviously our focus has been on price, and price.
Many of the markets, given our market shares that we have, the numbers you see on volume growth are purely a reflection of the underlying economy and how well or not it's doing. Obviously, as we've talked about, the Progressive Waste operations are trying to shed some CAD 50 million to CAD 70 million of unprofitable or unsafe or broker-related business. As Progressive Waste comes into the volume mixture and calculation starting June 1st, you'll see that negative volume being incorporated into our reported volume growth. That'll give a cloudy picture on volume growth and potentially some incorrect takeaways as to what's really going on. First and foremost, focused on the price. I'll tell you, with regards to flow-through, again, our business is no different than others in our sector. Flow-through, if it's coming out the landfill, is coming in at 60%-70%+ type incremental margins.
If it's coming off the front load commercial system, it's coming in at as much as 40% incremental margins. If it's coming in on residential, it could be a 20%-25% incremental. If it's roll-off on the collection side, it's going to be about 10% or 15% incremental. It really depends on where you see the economy firing next year.
Yeah, sure. I think we'd love to get your views on that at this point. We did have a competitor talking about it yesterday. Just kind of curious, this is really a macro question, right?
You mean, Noah, a macro question about where the economy's going?
What you're seeing right now. We had folks talking yesterday about still lagging on housing starts versus a steady run rate, and the idea that that could drive growth, and the idea that commercial could follow. I'm just curious for your views at this point. That's right.
Yeah. Okay. Thank you. Sorry for the clarification. Look, we said today on the script that we see the economy in a 1%-2% volume range, that's not coincidental that that approximates what GDP is. Everything we've seen, it's been running about 1%-2%. Sometimes it's higher, it's re-corrected downward. I'm going to call it this, at 750,000 to 1 million housing starts, that's about a 1.5%-2% type volume environment on a historical basis for our industry. To get into that 2.5%+, we need to be, as an industry, as a nation, doing about 1.5 million-1.7 million annual housing starts. If you go back to when that happened last, which was back in 2006-2008, we ran that, the sector was actually getting 3%+ volume growth.
The reason is because at those levels of housing, that leads to new infrastructure requirement development, and it leads to new commercial retail development, and ultimately, we're getting that across our system. We're getting construction, which feeds our roll-off system in our landfill. We're getting commercial starts, and we're getting new residential starts. Every leg is getting fed there and outpacing competitive poaching. There is a step change that happens if we get another 500,000-750,000 homes a year being built. It does take us probably to that 2.5%-3% volume growth as a sector and us as a company, we're not seeing that at this point in time. We're seeing half of that.
Yep. Great. Thank you very much. Appreciate it.
Our next question comes from the line of Joe Box with KeyBanc Capital Markets. Please go ahead.
Yeah. Hey, guys. Can we just go back to the comment on volume at BIN? Can you maybe just give us a little bit of color on the $50 million-$70 million that you said needs to be replaced? I'm curious, is that just going away altogether, or is that a repricing opportunity? Ultimately, what I'm trying to understand here is just how much of their book should be repriced, so a nice pop
should think about maybe the volume declines over the next couple of years as you go through and update that book?
Yeah. Well, Joe, look, I think, as Worthing said, there's probably ultimately $50 million-$75 million of business. If you take that off a $2 billion footprint, that's 3%-3.5% of business that needs to go away. What I mean by that is, unless we materially can change the price, we're not going to do business for 0%-10% EBITDA margins that's not going to our landfill. That's a waste of time, it's a waste of capital, it's a waste of risk allocation, it's a waste of overhead. We're happy to give that to somebody else. There's brokerage business that we are actively shedding or giving notice to, that upon expiration, we're done doing it unless it's materially repriced. There are unsafe stops that we have directed the field that they are free to get rid of and allocate to another competitor.
There is non-integrated business that the margins are unacceptable. We've said either materially raise the price or do the same. That is an active process that's going on right now. It is not something that happens overnight. It's going to take time. It's going to take us a couple of years to get through that. I think we'll probably shed, I'm going to round, $30 million-$50 million of that business in between now and the end of 2017. To do that, there's double that business we will look at shedding, and we will improve it through price or another service mechanism and get it to an acceptable return. That means we probably attack $100 million to get to $30 million-$50 million that we ultimately shed.
This should be, when we say replace it, as we've said all along, we believe within Progressive that we're going to take what was a $480 million EBITDA business that closed on $1.95 billion of revenue. We're going to turn it into a $600 million EBITDA business on $1.8 billion of revenue or less by the end of 2017. We don't really look at it as replacing. We look at it as there's some very good business within there that was being clouded by some very poor business.
Got it. Maybe just to clarify on that, on the volume front then. Once you do work through that, and I get that it's going to take time, should we think about the BIN volume backdrop kind of migrating towards a market growth type backdrop, or will it still be maybe a little bit light just because you'll be pushing price higher?
Look, I think that you should think of it as a market type volume growth. It's going to be our sales force. It's going to be the approaches that have generated what Waste Connections has done over time. I do not think that that's going to change. Look, when we start shedding business, we will obviously report what real reported volume is, but we'll give you what underlying volume is and what the business we drove out purposely is so that you really know what's happening in the underlying volume environment. Said another way, if we come through and we report a negative half in a quarter on the total footprint, but we drove out 2.5%, we're going to tell you, here's what volume really was.
Got it. That'd be helpful. Thanks, Ron.
Our next question comes from the line of Michael Hoffman from Stifel. Please go ahead.
Hey, Ron, Steve, Worthing. Thanks for taking my questions.
Sure. Good morning.
Sure. Good morning, Michael.
Morning. In 2Q in August, you were asked about sort of the free cash flow trend for the second half of 2016, and you responded it's about CAD 300 million. My sense is we're now more in a CAD 330-CAD 350 range for the second half. Is that an accurate conclusion?
Yeah, it really depends on some timing of a few things at the end of December or late December. You're probably at the low end, CAD 315 or so for the second half of the year. At the upper end, you can get to the kind of number you just laid out. It's more of a timing, late December versus early January on a couple items.
Timing meaning capital spending and acquisition stuff?
Capital spending, timing of some working capital payments, timing of tax payments, and amount of tax payments in December, things like that.
Okay. You got asked earlier and did say, yes, 2017 should be $700 million or better, you've also talked about getting to a $450 - $475 a share type free cash flow number, which if you go back to some level of normal buyback, call it 2% a year, that puts you in a $780 million-$800 million kind of number by 2018. We're going to have this sort of step up from where we are to $700 million, then towards $800 million, and then settle into a long-term growth rate. You add in the buyback, we're a low double digit per share growth in free cash. Is that the right conclusion?
It sounds like a leading question, but that's right. No, you're right.
I wasn't trying to be that obvious.
We've always talked about kind of $450-$475 or so in free cash flow per share target internally here in 2018. If we can do at least $700 million next year, we've got a $4 a share number, assuming no buybacks next year in 2017. That kind of puts us well on track to that kind of number for 2018.
Okay. Then on all of the deal stuff, both selling and buying, how do you think about where valuations are today? Are people being rational? Is it a buyer's market for what you want to buy, but it's a seller market for what you want to sell? How do you see that?
Well, I think, Michael, let's break it into two buckets. As we said, on divestitures or rationalizations that we're looking at, much of that we're doing in swaps. That's really an EBITDA before EBITDA-type swap. Perhaps if there's some CapEx or other differences, that's trued up. There's really not a multiple, and that's happening between public companies and large regional companies. I would just say that that doesn't really affect the swaps. On the acquisition environment, look, I would tell you that you've typically seen that out of Waste Connections, that we've probably been a, I'm going to round, a five to seven and a half times EBITDA buyer between sort of tuck-ins and a highly integrated or franchised standalone at the end.
What you've seen is that upper end has probably moved up a turn or a little more than a turn over the course of the last several years. Why? Well, because market multiples have moved up, public company multiples have moved up, interest rates have come down, a variety of reasons, and the long-term cost of debt capital allows it to move up that much and still get the same type returns on capital. There are sellers out there that think they ought to get our multiple. We've told them go public, and that tends to end that conversation. For the most part, I think you would find that we're going to be right in line on sort of a historical basis with where we've been on a multiple, whilst some of those larger transactions might be a turn to turn and a half higher.
Okay, that's great. Last one for me, you accrued about CAD 5.5 million for bonus, if I double that says you're doing CAD 105-CAD 110 for the synergies in the July program you rolled out. Is that the right conclusion?
It says we're trending above CAD 100. Obviously, we need to wait to see how Q4 plays out, we're clearly trending above CAD 100.
Michael, I would remind you, I know you're aware of this, just for those listening, when you say synergies, that's synergies and cash tax benefits.
It's just the SG&A portion, because remember, pricing improvement's not in a number, operational improvements, safety improvements.
Yes.
This is, again, just focused on.
Just SG&A.
SG&A and cash tax savings.
That's right.
Right. Juxtaposed against the 85 that you told us in June.
That's right.
That's right.
When we closed the deal. Right. Okay.
That's correct.
Okay. Then one last on the volume, just to try and bring some clarity. You're looking at structural same-store volume trends and bin assets that are priced correctly versus Waste Connections, they're doing the same things. They're participating in market volume in the same manner.
Yeah. If you look at, for instance, at the underlying Progressive operations as an example in Q3 and Q4, you've heard that their pricing is now trending towards ours in that mid two or better range. We've seen their volume again in that low 1% range. They're trending in that 1% to 2%. Remember that low 1% range includes some impact, as Ron talked about turning away some existing revenue. The trends are very similar. Also, I'll tell you where, again, we've talked about weakness in the E&P influence economies or coal influence economies. Again, Alberta is no different in Canada. They see similar sorts of weakness up there until you see the crude economy recover.
Michael, just as a comparison, again, if we looked at where Progressive was running prior to the deal, they were running between 0.7% and 1% price and 2.5% plus volume. We've completely inverted that.
Which is more operating numbers.
We've driven the price to two and a half plus and the volume down to about one, and we want that trade-off.
Right.
We said from day one, we'll take that trade-off all day long.
Remember the Q1, they were 4% plus volume and sub 1% price.
Right.
That's on.
Right. Which all comes back to how you'll do $700 million or better in free cash and almost $800 million in 2018. That's one of the drivers.
That is a material driver. Look, Mike, getting greater profitability through price, servicing customers that we can be safe at and cost effective at, and driving down the CapEx as a percentage of revenue, all three of those flow to free cash.
Great. Thanks for taking my questions.
Our next question comes from the line of Hamzah Mazari with Macquarie Capital. Please go ahead.
Good morning. Thank you. Ron, you mentioned a lot of comments around sort of drivers for volume. I was wondering if you could sort of just frame for us where we sit in today's cycle. You talked about fourth year of positive MSW volume. In past cycles, is that generally a trend to look at? Is it six years of positive volume, or are we in the eighth inning or the fifth inning of the waste cycle? If one wants to call there being a cycle in waste. Any sort of color around that? I realize sort of what the drivers of volume growth are.
Yeah. Hamzah, good to talk to you. Well, look, Hamzah, I would generally tell you that historical past cycles, sort of the volume increases run 4-6 years, and then you tend to see some sort of economic change, and as you know, we're a laggard in that effect. We tend to still have positive volumes a year and a half into a contraction. I don't know that that's a good indicator, Hamzah. We also thought interest rates would rise 6-7 years ago, and they've gone the other way, and there's no indication that that's going to change. As long as the government's going to continue to print money and make things free, you're going to continue to see this slow growth train just continue along.
It's not about what inning we're in, it's just these innings are longer innings.
Yeah. In that way, I would tell you we're in the fifth or sixth inning, not the eighth.
Got it. Okay. Yeah, no, that's helpful. On the divestitures and rationalization, I think you mentioned there are a couple of options around asset rationalization. I was wondering if you could walk through those. Also, how should investors think about the risk to that 100 basis points of margin expansion? I realize one of the risks is a deal doesn't get done, but any sort of confidence level around that margin expansion? Thank you.
Yeah. Thanks, Hamzah. Well, look, as far as more color on divestitures, rationalizations, we're not going to provide specifics on that, A, because of the competitive nature of that, B, the sensitivity of that, both on our side as well as those that we're discussing this with. We really just are not at liberty to do that at this point in time. What I will tell you is that what I meant by there are two to three options, I meant that in each of our potential rationalizations, we are talking to several players or have talked to several players and had discussions of what those options look like that they may or may not be interested in.
We've identified sort of a lead option for each of our rationalizations and swaps, and we're going to work through that, and if that doesn't work, we're going to go to option 2. How confident am I in the 100 basis points? I'm very confident in the 100 basis points. We're going to get that done either through swaps or we're going to get it done through exiting that business in some manner or another. Either way, the 100 basis points is going to happen. I'm highly confident that it will happen in the manner that we've outlined.
Hamzah, remember, the 100 basis points, if you go through the math of what Ron laid out before, it is just math. If we're getting the same or slightly higher EBITDA dollars, being able to do that on $100 million-$125 million of less revenue, the math is you've got 100 basis point margin expansion. It's not like consolidated margins up 100 on the same revenue or higher. The key is obviously, if you can keep that same dollar of EBITDA and actually shrink that revenue by $100 million-$125 million, you're pulling off $10 million-$12 million of CapEx related to that EBITDA and dramatically improving the EBITDA minus CapEx conversion of that to free cash flow. The 100 basis points to consolidate margins is just the output of math. The key thing is more of the free cash flow profile.
Again, I want to emphasize, Hamzah, the whole key in these, what I'll call rationalizations or swaps, is these are not bad businesses or markets. These are markets where our position isn't good. The whole opportunity here is can we get something where one and one equals three, and whoever's getting what we have, one and one equals three for them. We're fixing market positions for, meaning improving the market position, for ourselves and for our competitor. That's the challenge. These are not bad markets. These are just positions that aren't optimal for whoever owns the asset, in this case, us, on these assets.
Great. That's very helpful. Good talking to you as well, guys. Thank you.
Thanks, Hamzah.
Our next question comes from the line of Corey Greendale with First Analysis. Please go ahead.
Hey, good morning. Most of my questions are answered, so I'll just ask a quick one. The Q4 guidance implies less seasonality in EBITDA margin than you've seen before. I'm assuming it's because you've ramped up some of the things you're working on with Progressive, and once all the moving pieces anniversary, you'd expect more traditional seasonality. Just looking for some thoughts on how to model seasonality once everything normalizes.
Yeah. The seasonality that we're expecting is really the same seasonality we laid out in the August With regards to the sequential change Q3 to Q4, any comparison to the, what I call old Waste Connections, obviously Progressive is less landfill revenue as a percentage of the total. Obviously the landfill side of the business is where you see more of a seasonal dip Q3 to Q4. The extent that the mix of our P&L looks different now post-combination, that might be what's influencing some of the outcome here.
Great. Since I called, I'll turn it over. Thanks, and nice work.
Thanks, Corey.
Our next question comes from the line of Chris Murray with AltaCorp Capital. Please go ahead.
Thanks, guys. Good morning.
Hey, morning, Chris.
Morning. On the E&P business, I guess a couple pieces of this. One, you've talked in the past about the fact that the margin coming back comes back pretty strong, high double digits, definitely. Can you give us some idea of what the guys are seeing in the field right now? I know it's sort of almost on a daily basis that we're seeing changes in rig counts and some activity levels coming back. Any thoughts around that? I guess if we think into 2017, if for whatever reason that we do see some stabilization or improvement, is this an area where you guys would look to more acquisitions or you think you've got enough for what you have right now?
First on the activity side, just as the rig count data might suggest, we're seeing the most improvement in the West Texas Permian. We're seeing a few things, a few rigs click into the New Mexico side, and obviously when you get to the New Mexico side, it's kind of a bigger impact on us because there the state regulation requires all the volume to go to a landfill. Louisiana is seeing some improvement as well. We're looking potential improvements, believe it or not, in Eagle Ford or in South Texas as kind of some gas drilling has come back into play. We've actually seen a return of a rig or two in Oklahoma, in the Fayetteville. I'd say the Bakken is probably the least active, for the obvious reasons right now. We are seeing it, but again, the Permian is where we're seeing the most activity.
Our asset positioning is still what we believe is the best in the industry. From an M&A standpoint, while we have looked at a couple of one-off assets that might expand our geographic footprint, a lot of our efforts have been historically on just greenfield permitting, and we're still pursuing four to five new greenfield permits to try to expand our footprint because where we want to be, there are no assets right now. You got to work heavily on the permitting side.
Great. Moving, one of the things that I know I've always been focusing on is sort of the safety performance. You've got the human impact of what that does in the environment, but there's also been the cost impact. I think if we go back to pre the announcement, I think the comment that you made is that BIN was running roughly three to four times your absolute safety cost. We've heard some good stats on incident rates and things like that, and I think that's a great leading indicator. You made the comment that you're a little ahead of plan in terms of safety performance. How should we start thinking about where you are along this journey to get what the BIN rate was in terms of a cost back down to where Waste Connections was historically?
Well, I'll give you some actual numbers, hopefully that puts it in perspective. At the closing, Waste Connections had what, in our industry, we look at as an incident rate, that effectively measures how many of your employees per year are going to have an accident or an injury statistically based on what is actually occurring. Ours was about one in eight. Okay? Or an incident rate of 12-13. BIN was one in two, so an incident rate of 50. Okay? We have the combined company back down into the mid-20s, we will have the combined company by the anniversary date under 20. To put that in perspective, that will yield a 60-plus% reduction in incidents in the first 12 months at BIN.
Okay. Then if you were to put a number on it, I think your safety cost was running something in the 1%-plus range of revenues, pre the acquisition. You're thinking that you just sort of use that. Was that a fair way to think, just dimensionalizing off the incident rate would be a good proxy?
It's a little different. Obviously in the U.S., where we have workers' comp and auto, BIN was running about 220 basis points higher than us as a percentage of revenue. That's why we've always targeted at least a $25 million savings as we thought about the overall reduction. Could it hit a number closer to 30 if we're truly successful across all markets? Sure. 25 is still the bogey we've targeted as a cost reduction.
Understand that part of this also, while we believe the safety reduction was we get the I rate down into the low teens, you can do math and get to a number that's closer to $40 million. Part of our program, we give back safety improvements to those driving it, meaning the frontline employees. They share a greater percentage as we improve. You can't just look at the pure savings and say we're going to take all that because we're going to give part of that back to the employees driving it.
Okay, great. You feel like you're well on track to hit that number?
We're well ahead. Yeah, we were hoping by year-end to get to a 20%-25% reduction, and we're at 40% in October. We're on track to approach a 50% reduction by year-end. That's almost double where we thought we'd be.
Again, as we've talked about in the past, how it comes through is more of a timing issue.
Yeah.
You get more of the cash flow savings immediate because we're not hitting things or people aren't hitting us. With high deductible programs, we're going out of pocket with less frequency, right? Because we're not having as many incidents. From an actuarial standpoint, because we still have legacy Progressive in the trailing analysis, you don't really see the flow through yet on the actuarial analysis coming through the P&L rules until you get beyond the anniversary of the closing, and we start anniversarying these improvements. We've always said the GAAP benefit is more of a second half 2017 timing, where the cash benefit is immediate.
Okay, great. Thanks, guys.
Yep.
Our next question comes from the line of Andrew Buscaglia with Credit Suisse. Please go ahead.
Hey, guys. Just a quick one for me. Can you talk a little bit about just BIN operationally in the quarter? Just on a standalone basis, how did they do? I know you talked about some pricing volume stuff for them, but can you just talk about what the margins would've been or how they would've done?
Yeah. We laid it out in the prepared remarks that the Progressive operations did about 30% EBITDA margin in the period.
Okay.
That's obviously before any incremental corporate over allocation from this office.
Okay. Can you talk a little bit about, it sounds like they actually were doing fairly well or are a little bit more on track to improve. As you've now seen them for a full quarter, how much of their operations have they started to turn around and that you're kind of benefiting from as well at this point?
Yeah.
All hands on deck.
Yeah. Look, Canada had an exceptional quarter. They didn't have turnaround per se to worry about because they've been performing well for a long time. They even on their standard, had a very good quarter. We've seen very nice improvement in the East Coast of Progressive's operations, really dating back to the beginning of the merger. Where the laggard had been, which is the southern region, which is the largest piece of the Progressive footprint in the United States. We've seen nice improvements in Florida. We've seen nice improvements in parts of Texas. We've seen nice improvements in parts of Louisiana. Arkansas has continued to be strong, and Missouri has continued to be strong. There's really not a part of the U.S. footprint that has declined performance-wise.
All of the operations in the macro or market areas in the macro in the U.S. are improved since the closing.
All right, that's helpful. Nothing else for me. Thanks, guys.
Ladies and gentlemen, as a reminder, if you would like to register for a question, please press the one followed by the four on your telephones. Our next question comes from the line of Barbara Noverini with Morningstar. Please go ahead.
Hey, good morning, everybody. Jumping off the comments that there is some improving activity in certain North American oil and gas areas, are you starting to see any signs of life on the MSW waste side in the communities that surround the oil and gas regions? Would you say that it's still too early to really see that? Is there any difference in the activity you see in the communities near the U.S.-based oil and gas areas versus the Canadian-based areas?
Yeah. Barbara, we have. We have started to see the U.S., particularly when you look at North Dakota, you look at parts of New Mexico, parts of South Texas, parts of the Gulf Coast in Louisiana, really large parts of Oklahoma. Those are the areas that took the crude decline hard in their local communities, large losses of jobs, and large impacts on the commercial and the retail front in those markets. We saw that really bottom in Q1 and start to show some signs of improvement, in Texas, New Mexico, and Louisiana in Q2, and step up again in Q3. We have not really yet seen those improvements flow through in, for example, North Dakota or in Oklahoma. Those markets still have been on the MSW side, pretty impacted.
In the others, we are starting to see the MSW as jobs come back and some small businesses are able to come back. We're starting to see some of that flow through.
Excellent. Thanks for that and nice quarter.
Thank you.
Thank you.
There appears to be no further questions on the phone lines at this time.
Okay. Well, if there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in the call today. Both Worthy and Mary Anne Whitney are available today to answer any direct questions that we did not cover that we are allowed to answer under Regulation FD and Regulation G. We thank you again, and we look forward to speaking with you at upcoming investor conferences or at 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.