Welcome to the Waste Connections first quarter 2015 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 Tuesday, April 28, 2015. I would now like to turn the conference over to Ronald Mittelstaedt, Chairman of the Board and Chief Executive Officer. Please go ahead, sir.
Okay. Thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our first quarter 2015 results and provide a detailed outlook for the second quarter. I'm joined this morning by Worthing Jackman, our CFO, as well as several other members of our senior management team. In the first quarter, strong performance from our solid waste collection and disposal operations enabled us to exceed our margin expectations for the quarter and keep us on track to attain our free cash flow target for the year. We are particularly pleased with these results in the period in light of difficult weather conditions in certain markets, lower than expected recycled commodity values, and an estimated $5.4 million of expenses incurred in connection with both startup costs at two new E&P waste facilities and storm-related cleanup and repair costs at our Permian Basin facilities.
Solid waste organic price plus volume growth was 4.4% in the first quarter, and adjusted EBITDA margins in our solid waste collection and disposal business expanded 165 basis points over the prior year period. Free cash flow in Q1 was $123 million, or 24% of revenue, and on track to meet our full-year target of between $350 million and $360 million, despite a more precipitous decline in expected E&P waste activity than anticipated a few months ago. Regarding the macro E&P environment, as noted in our earnings release, over the past few months, estimates for projected 2015 U.S. E&P CapEx spending decreased another 15%, to down 45%-50% year-over-year. While the deceleration in drilling resulting from lower customer spending has been faster and harsher than analysts had expected, many industry analysts now anticipate a spending rebound in 2016.
This more precipitous decline in drilling activity was evident in our E&P waste operations beginning in late March and will continue to impact our higher margin E&P waste-related volumes for the remainder of the year. However, better-than-expected performance in our solid waste operations, improving recycled commodity values, and potential acquisitions should help absorb a portion of this impact. Based on what we hear and see today, if crude prices hold at current levels, Q2 could prove to be the bottoming of our E&P waste business. 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. Good morning. We must inform everyone listening that certain matters discussed in this conference call are forward-looking statements intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995, including statements related to expected operating trends, fuel costs, crude oil prices, recycled commodity values and E&P waste activity, expectations regarding period-to-period comparisons, potential acquisition activity, contribution from closed acquisitions, the timing and contribution of newly opened facilities, our return of capital to stockholders, our second quarter and full year outlook for financial results. Such forward-looking statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those currently anticipated. These results and uncertainties are set forth in the Company's periodic filings with the Securities and Exchange Commission, including our most recent annual report on Form 10-K.
Stockholders, potential investors, other participants are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this conference call. The Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. On the call, we will discuss non-GAAP measures such as adjusted EBITDA, adjusted net income, adjusted net income per diluted share, 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. I'll now turn the call back over to Ron.
Thank you, Worthing. Revenue in the first quarter was $506.1 million, up 5.1% over the prior year period, with acquisitions completed since the prior year period contributing about 2.9% to year-over-year growth. Solid waste price and volume growth in the quarter were a combined 4.4%, broken down as follows: positive 2.8% from core price and positive 1.6% volume. Core pricing in the quarter was consistent with our expectations. We continue to expect it to average about 2.6% for the full year and range between 2.4% and 2.8% in any quarter. A decrease in surcharges, primarily resulting from current lower fuel prices, could reduce all-in pricing by up to 20 basis points in the second half of the year.
Solid waste volume growth in the first quarter was near the lower end of our expectations, as improving collection and disposal trends were somewhat impacted in late February and early March by severe winter weather in certain markets. We estimate that weather impacted total revenue, primarily landfill-related, by about $3 million, or 70 basis points in reported volume growth. Solid waste collection revenue, net of acquisitions, increased 5.2% in the period, primarily due to higher roll-off and commercial collection activity. Roll-off revenue on a same-store basis grew 11.5% in Q1. Roll-off pulls per day in the quarter were up about 8%. Revenue per roll-off pull increased more than 3%. Pulls per day increased in each of our three solid waste regions, with our Western region up 5%, our Central region up 8%, our Eastern region up 10%.
Commercial collection increased 5% in the period, as pricing and net new business trends continue to reflect an improving economy. Solid waste landfill revenue in the first quarter declined about 1%, with flat volumes on a tonnage basis. Again, this is where we experienced most of the weather-related impact in the quarter. MSW tons increased 3% in the period, with our three solid waste regions up between 2% and 5% year-over-year. Special waste tonnage decreased 3% year-over-year in Q1 due to both a tough prior year comp in our Central region, where we had benefited from a large project in Minnesota last year, and inclement weather in our first quarter, especially in our Eastern region. These influences can be seen in our results as our Western region experienced an 8% increase in special waste tonnage, while our Central and Eastern regions were down 12% and 2% respectively.
C&D tonnage declined 4% in Q1, primarily due to weather, but also on a tough comp in Colorado, where we had benefited from flood-related cleanup activity in the prior year period. C&D tonnage in our Western region increased 5%, while our Eastern region saw an 8% increase due to the opening of our new C&D landfill in New York's Hudson Valley. C&D tonnage in our Central region decreased 13% on a tough comp. Recycling revenue was $10.8 million in the first quarter, down about $3.4 million or 24% year-over-year, with about half of the dollar decline due to lower recycled commodity values and the remainder due to our decision to close and outsource our San Jose recycling operation, the impact of which fully anniversaried at the end of March.
Recycling revenue in the period was about $1 million below our expectations in early February due to subsequent further weakening of commodity prices and labor-related slowdowns at West Coast ports. Prices for OCC, or old corrugated containers, averaged about $92 per ton during the first quarter, down about 31% from the year ago period, and down 15% sequentially from Q4. While current OCC prices remain down significantly on a year-over-year basis, we believe the lowest prices for the year are now behind us and expect continuing improvement over the next few quarters, narrowing the year-to-year comparison as the year progresses. Turning now to E&P waste activity. We reported $68.6 million of E&P waste revenue in the first quarter, essentially flat compared to the prior year period. Revenue on a same-store basis decreased about 13% in Q1, which was offset primarily by acquisitions completed since the year ago period.
E&P waste revenue was about $3 million below our expectations for the quarter due to the more precipitous decline in E&P activity late in the quarter than industry analysts had projected only a few months ago. Recognizing that E&P industry estimates may be continually changing, the goal we set forth for 2015 was to outperform the macro. While our E&P waste operations are most highly correlated to changes in linear feet drilled, more frequently published rig data, adjusted for drilling productivity and efficiency improvements, is a good proxy for relative changes in same-store E&P waste volumes at our facilities. We outperformed the rig count macro in Q1. As mentioned earlier, same-store revenue in Q1 was down 13% year-over-year, comparing favorably to an estimated 21% decline in average rig count in the basins where our E&P operations are located.
On a combined basis, same-store volume and average price per unit were each up single digits in the period. Average rig count declines in Q1 within our key basins were as follows: Permian down 21%, Bakken down 28%, Louisiana and Gulf Coast combined down 11%, and Eagle Ford down 26%. Rig count declines in our basins accelerated during the quarter, from down 2% in January to 21.5% in February, and down 38% in March. Rig count for April is expected to take another step down to down almost 50% compared to April 2014. Some industry analysts are predicting slight additional dips in May and June, with a bottoming around mid-year. As discussed earlier on this call, the more rapid deceleration in drilling activity has added another 15% since early February to estimated 2015 year-over-year E&P CapEx reductions and will impact us for the remainder of the year.
Because the bottom appears to be occurring sooner than many experts had previously expected, we estimate this will reduce our original 2015 outlook for E&P waste revenue by approximately $40 million, at about a 75% decremental EBITDA margin. About 40% of this reduction will impact our second quarter's results, with the remainder spread out over the second half of the year. With the E&P sector washout happening quicker and more severely than previously expected, many estimates now predict a rebound in 2016, with a sustained $60-$65 per barrel crude price necessary for E&P companies to consider mobilizing additional rigs in certain basins.
Just as the decline in drilling activity lagged crude oil's price decline by about four months, we believe any rebound in such activity will also lag the requisite increase in the price of crude, especially since there is an existing backlog of drilled but uncompleted wells. As mentioned earlier, free cash flow in the quarter was $123 million, or over 24% of revenue, and we remain on track to meet our full-year target of between $350 million and $360 million, despite the more precipitous decline in expected E&P waste activity. In Q1, we deployed about $90 million on acquisitions and $35 million on return of capital to stockholders. On our February call, we discussed the Shale Gas Services acquisition and solid waste tuck-in acquisitions in North Carolina and Washington completed earlier in the year.
In March, we also acquired a permitted but undeveloped E&P waste landfill in the New Mexico Permian for potential future growth. With this start to the year, we believe we're on pace for what we consider to be a more typical M&A year. That is, completing transactions totaling about $75 million of acquired annualized revenue. Regarding return of capital to stockholders, as noted on our February call, we expect to repurchase between 2% and 3% of outstanding shares in 2015, or another two million to three million shares in addition to what we've already repurchased year-to-date. If M&A plays out as expected and we repurchase 3% of our outstanding shares, our leverage ratio would end the year around our targeted 2.75 times debt-to-EBITDA, leaving us tremendous flexibility to fund larger M&A opportunities or opportunistically increase the return of capital to stockholders.
I'd like to pass the call to Worthing to review more in depth the financial highlights of the first quarter and to provide a detailed outlook for Q2. I will then wrap up before heading into Q&A.
Thank you, Ron. Since Ron already reviewed the components of revenue growth, I'll begin with a discussion of adjusted EBITDA. In Q1, adjusted EBITDA, as reconciled in our earnings release, increased 2.5% to $168.3 million. As a percentage of revenue, this was 33.3%, or about 30 basis points above the high end of our outlook range, despite incurring more expenses than anticipated at the time of our February call in connection with E&P facility startup and storm-related repair costs in the period. Had we adjusted for these impacts, adjusted EBITDA margins in the quarter would have increased 20 basis points year-over-year. In the first quarter, adjusted EBITDA margins within our solid waste collection and disposal operations increased about 165 basis points, primarily due to lower fuel costs. Recycling was near breakeven on an EBITDA basis in the quarter.
The year-over-year change in margins within our E&P waste business in the first quarter can be broken down into three buckets. First, the estimated $5.4 million of facility startup and storm-related repair costs impacted segment margins by about 800 basis points. Second, declines in same-store margins of approximately 800 basis points on a 13% decrease in revenue impacted segment margins by approximately 625 basis points, given the revenue weighting within the segment. Third, acquisitions diluted segment margins by about 275 basis points in the period, due primarily to the lower-margin Shale Gas Services facilities, where the value of its recovered commodity is linked to and hampered by lower diesel prices. Shale Gas Services reported less than a 20% EBITDA margin in the period.
On a consolidated basis, the following are certain line items that moved a notable amount in the first quarter from the year-ago period as a percentage of revenue. Brokerage and rail drayage costs increased 90 basis points on higher intermodal activity. E&P-related subcontractor cleanup, equipment rental, and repair costs increased 80 basis points. Labor and supervisory expense increased 40 basis points, partly due to new E&P facility startup costs. Third-party disposal and transfer costs increased 35 basis points. Fuel expense decreased 140 basis points, and risk management insurance expense decreased 50 basis points. Fuel expense in Q1 was about 4.35% of revenue, and we averaged approximately $2.95 per gallon for diesel, which was down about $0.67 per gallon from the year-ago period and down $0.33 sequentially from Q4.
Depreciation and amortization expense for the first quarter were 12.7% of revenue, down 30 basis points year-over-year, due primarily to lower landfill depletion expense as a percentage of revenue. Interest expense in the quarter decreased $1.2 million over the prior year period to $15.7 million, due to reduced borrowing costs on our bank facilities and lower average outstanding balances. Our effective tax rate for the first quarter was 39.4%, consistent with our expectations for the full year. GAAP and adjusted net income per diluted share in the first quarter were $0.42 and $0.46 respectively. Adjusted net income includes, among other items, the amortization of acquisition-related intangibles. Debt outstanding at quarter end was just under $2 billion, and our leverage ratio, as defined in our credit facility, was approximately 2.67 times debt to adjusted EBITDA. I will now review our outlook for the second quarter.
Before I do, we'd like to remind everyone once again that actual results may vary significantly based on risks and uncertainties outlined in our safe harbor statement and our various SEC filings. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic and operating environment. It excludes the impact of any acquisitions that may close during the period and expensing of any acquisition-related transaction costs. Revenue in the second quarter is estimated to be approximately $530 million. Solid waste price and volume growth on a combined basis is expected to be about 5% in the quarter, up sequentially from 4.4% in Q1. Recycling, intermodal, and other growth is expected to be between 0.5% and 1%, as increases in intermodal activity should more than offset the impact of year-over-year declines in recycled commodity values.
Revenue from E&P waste activity is expected to be between $50 million and $55 million, or down almost 35% year-over-year. An estimated 40% decrease in same-store revenue is expected to be somewhat offset by contributions from acquisitions and our recently opened landfill in the West Texas Permian, not reflected in the prior year's results. Adjusted EBITDA for Q2 is estimated to be between 33% and 33.5% of revenue. Margin expansion within our solid waste operations is expected, again, to be more than fully offset by high decrementals associated with lower E&P waste activity, and, to a lesser extent, the impact of a lower margin Shale Gas Services acquisition and remaining start-up costs at our new Eagle Ford deep well disposal facility. Depreciation and amortization expense in the second quarter is estimated to be about 12.4% of revenue.
Amortization of intangibles in the quarter is at about $7.3 million or almost $0.04 per diluted share. Operating income for the second quarter is estimated to be between 20.5% and 21% of revenue. Interest expense in Q2 is estimated to be about $15.5 million. Our effective tax rate in Q2 is estimated to be about 39.4%. Non-controlling interest is expected to reduce net income by about $300,000 in the second quarter. Finally, it's important to note that on an earnings-per-share basis, we estimate the year-over-year change in the performance of our E&P business to be about a $0.10 drag to reported results in the second quarter when compared to the prior year period, fully masking earnings growth within our solid waste business. Now let me turn the call back over to Ron for some final remarks before Q&A.
Okay. Thank you, Worthing. Again, we are pleased with our performance in the quarter, especially in light of the E&P, recycling, and weather-related headwinds. Solid waste drove our results in the period and should remain above original expectations throughout the year. In addition, we believe the worst of recycling and weather-related issues are behind us. These improving trends, together with potential acquisitions, should help us offset a portion of the impact from the more precipitous drop in E&P CapEx spending than the market estimates just a few months ago predicted. On our February earnings call, we identified the financial objectives we hold ourselves accountable for in 2015. First, to expand margins within solid waste, in addition to any benefit from lower fuel costs. Second, to outperform the macro trends within the E&P sector. Third, to increase free cash flow more than 10%.
Fourth, to maintain discipline in capital deployment, both in acquisitions and the return of capital to stockholders. We remain on track to deliver on each of these objectives. We appreciate your time today. I will now turn the call over to the operator and 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. One moment, please, for the first question. Our first question coming from the line of Joe Box with KeyBanc Capital Markets. Please proceed with your question.
Hey, good morning, guys.
Hey, Joe. Good morning.
Morning, Joe.
Ron, your volume walk was helpful on the E&P side. Can you maybe just give us a little bit more color on E&P landfill pricing? Curious if you've seen a stabilization on that front or if it's still trying to find a bottom.
Yeah. I think it depends on the basin, Joe. For the most part, certainly in Louisiana and the Eagle Ford, I think it's been stable there throughout the quarter. I would say over the last two to four weeks, it has stabilized in the Bakken and the Permian, at least within a range. Obviously, most of landfill pricing is quoted on a transportation and disposal basis. It's a little misleading when you look at somebody who says that price dropped from $65-$55 a ton. The reality is that was probably $9.50 of transportation due to the decreased fuel price, and $0.50 on the disposal end, illustratively. We're not really seeing large declines in disposal pricing in the Bakken or the Permian. We're seeing larger declines in the revenue piece, which includes the transportation.
Joe, if you look at Q1, again, as we said on the call, on a same-store basis, revenue was down 13%. Average price across the business was down 6%-7%, as was the volume, on the same-store basis. In Q2, what we've assumed is that average price declines range between down 10%-15% in the quarter. We've already baked in the recent prices we've seen and the stabilization in those ranges. Therefore volume is assumed to be down 25%-30% to get to that same store number of down about 40%.
I would tell you that almost all of that down 6% or so of price in Q1 came in March, which is why we have baked in a higher amount coming in Q2. It's just a rollover effect of March.
Understood. I missed just a second of your guidance commentary. I caught the two Q comments. Did you address full year EBITDA guidance?
What we said is just with regards to the E&P business. Relative to what we said in February, where we guided at about $260 million-$275 million of revenue within E&P, we've taken that down $40 million. That would get you, if you're doing the math at home, it would get you to about $220 million-$235 million on the top line. What we've said is that $40 million would come off at a decremental margin of 75%. That would take $30 million of EBITDA out of that number associated again with E&P.
We said that we believe greater strength in the solid waste business, improvement in commodities over the balance of the year, and potential acquisitions would impact some of that 75%.
Offset some of that.
Offset some of that 75% in EBITDA.
There's not an official number, but we're migrating closer to something around $700.
Right. We always wait till July to give an update on the full year, because by July, we've got six months actual, we've got it for the upcoming three months. We'll look to July to update the totality of the business at that point in time.
Understood completely. I'll hop back in queue. Thank you.
Thank you.
Thank you. Our next question coming from the line of Al Kaschalk with Wedbush Securities. Please proceed with your question.
Good morning, guys.
Hey, good morning, Al.
Hey, good morning, Al.
Just to follow up on E&P. Ron and Worthing, have you heard, in terms of your outlook, how would you characterize your visibility for the 2Q troughing in terms of the June timeframe from recent conversations with your customer base?
Well, look, you had a pretty precipitous decline in Q1, Al Kaschalk, we were under our guidance for Q1 and E&P by $2 million or $3 million. That was less than 4%. If I was to tell you that I think we're within a 5% range, I feel pretty good about that. Our guidance assumes that there are no incremental new rigs that either come into our geographic area or that we secure if they do. Any of that would be an improvement potentially to our performance. It assumes that the existing rigs that we have today in our areas stay other than the ones we've been notified that upon completion, they will be removed. Again, revenue, we're pretty tight in how we can forecast revenue.
Obviously, that business is moving around more than our solid waste business ever would, we feel pretty good about it.
Yeah. It seems like the worst of the rig declines is almost upon us. As we said, we're just seeing dribs and drabs here and there at this point in time. More importantly, we're going into what's typically an uptick in activity in that business seasonally. Plus, we're getting in the part of the year where remediation jobs and some other revenue line items can come into play that you don't normally see in Q1.
Yeah. Just anecdotally, Al Kaschalk, there is a couple E&P companies in the Permian that had pulled rigs in the $40 range, in the mid-$50s have made commitments to redeploy rigs, we picked up three or four of those over the course of the last week. We do feel from things like that, anecdotally, that Q2 should be the bottom again, with the assumption that crude stays in this band that it's in today.
Right. As you take a step back here, given what is very strong cash flow, both in the core, or what I call the core in your solid waste business, do you get more aggressive from an M&A perspective given the carnage in the market? Do you stay true to this $75 million revenue contribution from acquisitions in the year?
Well, Al, I think that the reality is that we try to always stay about as aggressive as we can and as disciplined as we can. I don't think right now is any different from that. We're looking at a number of opportunities on the solid waste side. Over the course of the last week, I've reviewed with our M&A group no less than about half dozen new opportunities. There still is what I'd consider a bit of a disconnect between market valuation that we're willing to pay and sellers' expectations. Having said that, there are ones, if you stay at it long enough and you cross enough, there's ones you're going to get, and that's happening with us.
I don't think we step on the accelerator and stretch multiples as a way to, quote, "offset the impact of E&P." You get an opportunity to spend capital once, we pride ourselves on trying to do it right, if that opportunistically happens in this window, great. If it doesn't, well, we'll wait till it does.
Very good. Finally, if I may, could you add some additional color to the extent you can? The intermodal seems to be very strong. Given where it's located, I guess it's more the franchise market. I would think that would be a very healthy contribution on the margin side. Anyway, if there's any color you could add to that, I'd appreciate it. Thank you.
Sure, Al. The strength in intermodal has kind of taken a lockstep up in performance. It's associated with the change in port of call by a couple of shipping lines that have moved out of the Portland area and now call on the Seattle-Tacoma area. Our business running a daily direct train between Seattle, Tacoma, and Portland is benefiting from the repositioning of those containers back down into the Portland marketplace for subsequent distribution out on rail and trucks from that location. That business in Q1 was up about 45%, meaning it went from about $8 million in change up to about $12 million in change of revenue in the quarter. Q2, we're seeing another step increase, putting that business on maybe a $14 million-$15 million per quarter run rate.
If you look back over the 10+ years or so of ownership of that business, it's generally ranged between $35 million and low $40 million, $40 million, $42 million of revenue. This year it's hitting new heights, and the incrementals associated with that are not dilutive to the business because obviously the yard cost, the overhead, et cetera, is already covered. It's required some incremental CapEx as we've grown the business to handle the increased container count. This is a very good year for that business, or it's setting itself up to be a good year for that business.
Just to clarify, Al, not dilutive to the intermodal business' margin. Obviously, the intermodal business, even with incremental revenues like this, is still nominally below company average.
Great. Got it. Thanks.
Thank you. Our next question coming from the line of Alex Ojea with Goldman Sachs. Please proceed with your question.
Great. Thank you. Good morning, everyone.
Good morning, Alex.
A couple of questions for you, Ron Worthing. First, on the free cash flow number and the ability to be able to maintain that number in the context of a weaker E&P outlook. Can you just talk about some of the levers you're pulling that are going to let you get to your original guidance for free cash flow?
Sure. A couple of buckets there. One is lower CapEx year-over-year. Last year, we did about $240 million of CapEx. This year's guided CapEx is $30 million-$40 million below last year's number. That alone represents a 10%+ increase in year-over-year free cash flow. Other levers we had, we came into the year with between a $7 million and $10 million tax overpayment position, just given the timing of when wealth appreciation was approved by Obama last year. We had a working capital approaching $20 million or $25 million of cushion on that side as we went into this year. Going into the year, if you just add all those up, that gets you close to $60 million or so.
Obviously, with the decline of the E&P business on a year-over-year basis, just from a receivables collection standpoint, as you get to a lower level of activity, it puts another $5 million-$10 million of collections into the system. As we said going into the year, there are plenty enough levers that we knew we had to withstand any surprises in the E&P business. As we sit here today, it's how the year's playing out.
Got it. Very helpful, Worthing. On the pricing side for the E&P business. Coming into the year, were you guys expecting to see much pricing erosion in that business, or is that something that's surprised you as we move through the year here?
No, it has not surprised us, Alex. Again, as we said, it was about 6% or so in Q1. Probably 10%-15% in Q2. Again, while that sounds like a lot, remember that includes transportation as well as disposal. As fuel drops because crude drops, your transportation component just naturally drops. It's not as weak as that sounds, is I guess what I would say. It is different than we price MSW C&D landfills, where we price just disposal, and if you were talking about a 6%-15% decline there in price, that would be very substantial. Here, we price it including the transportation to most of our customers. You just have a natural increase or decrease in price as fuel changes.
Yeah. That's a very helpful nuance there. Just last question from me on the recycling side. If I heard you correctly, you said you were breakeven EBITDA. Can you comment on what sort of normalized EBITDA in that business should be, if there's such a thing, and maybe just give us some perspective of what that EBITDA margin has been in the recycling business for you over time?
Well, obviously, it depends on commodity prices. I think what you're seeing is that Q1 with OCC at around $92 on average, and obviously the other commodities that we handle generally bring the average price for all commodities handled at the facility down into that mid to high 70s range at that kind of OCC price. Given processing costs and given logistics to get to port, that's about a breakeven price point. The question would be, the answer to your margin is really, where do you see commodity prices going? If commodity prices rise 20% from here, that probably puts that business back into around a 15% margin business. You can just extrapolate the math from there.
Great. All right. Thank you. Very helpful. Thank you.
Thank you, Alex.
Thank you. Our next question coming from the line of Tyler Brown with Raymond James. Please proceed with your question.
Hey, good morning, everyone.
Good morning, Tyler.
Hey, Ron. I was just curious to get your thoughts on maybe the solid waste by geographic region. We've been talking with our housing team quite a bit, and it sounds like that West Coast, and maybe even specifically coastal California, is just pretty darn hot, and I was just curious if that's translating into your business. It seems like your Western region's doing pretty well, and if that's any opportunity to maybe come in better this year.
Certainly, I think you heard it in our commentary, Tyler, our West Coast, whether you look at it on roll-off pulls or MSW volumes or special waste or C&D, was our leading region in the quarter. Of course, it's our largest region in the company, and it is our region that is 95% franchised or exclusive. We have always said when that turns, it's very beneficial to us because we get 100% of the volume at a guaranteed price. The incremental margins are fairly strong and stronger than our corporate average EBITDA margin. Yeah, that's part of what we're hoping for to plug some of the E&P shortfall over the balance of this year.
We are also seeing and hearing up and down the West Coast, really, of residential construction for the first time in some areas since 2007, 8 years or so, in areas like Vancouver, Washington, in areas outside of Tacoma. In areas really all throughout Southern California and the Bay Area. We don't have a collection presence in Southern California, but we have a disposal. We do have a collection presence in the Bay Area. The pocket of weakness that remains on the West Coast is the Central Valley of California, from Bakersfield really to the Oregon border on the I-5 corridor, and we have a decent presence there, that is a little weak. Coastal Oregon remains a little weak. Most of the rest of the West Coast, we've seen a strong improvement in over the last 4 to 5 months.
Yeah. That's great color. Perfect. Worthing, I'm just curious if we can work through fuel again for you guys. I think in the past, you guys have said you burn, let's call it, 30 million gallons of fuel, and maybe a third of that is hedged. I get it. I think you guys have mentioned you don't have a lot of surcharge revenue. How should we think about that 20 million gallons? If it's off a buck, is that largely flowing through for, call it, maybe three quarters of the year? What is the year-to-year impact there?
That's about 10 months to 10.5 month impact until you start anniversarying the declines we saw late last year. What we've assumed here in our numbers is about anywhere from a $12 million-$14 million retention of those savings, because you will see surcharges in some markets begin to roll back nominally, as we mentioned, in the second half of this year.
Okay, perfect. Just maybe last, I don't really want to beat the E&P horse here, real quickly. How should we think about those earn-outs or contingent payments? To my understanding, a lot of those deals were structured with an earn-out. I surmise, given the conditions in the space, that you will probably see maybe a reversal on the balance sheet from those. Do you think that that provides a buffer this year, or am I reading too much into that?
Well, number one, Tyler, only a few of our deals. They were really the ones done in the second half of last year as crude started to contract. It represents two or three deals where there was some sort of earn-out. Those earn-outs generally have a measurement period of approximately a year and a half to two years. There really shouldn't be, per se, a benefit in 2015, potentially, unless it's so clear that it can't be made. It would probably be more of a benefit in 2016 or even into 2017.
Tyler, any benefit from that, we would call out and adjust out of our results, because obviously that's a non-cash, one-time item.
Yeah. Perfect. Okay. On the corporate expense, though, there was nothing unusual this quarter. It just looked awfully low on the corporate expense side. There wasn't a reversal there?
No, it's really just we increased the allocation of overhead to the field in a couple of our regions. Basically, you saw embedded within the region, some of them went up 50 basis points in their absorption of allocated cost. That's why you see almost all the corporate or just the allocable cost being absorbed in the region versus having a stub amount at corporate.
Okay, perfect. Thank you.
Thank you. Our next question coming from the line of Scott Levine with Imperial Capital. Please proceed with your question.
Hey, good morning, guys.
Good morning, Scott.
Really just curious for your take, and you did this new acquisition here in E&P Waste, obviously, been interested in growing this business, investing in it last few quarters. Curious for your updated thoughts on that, including the potential, are you looking at the Northeast as an opportunity to expand that at all, or maybe a little bit more color, your thoughts there, and plans for growth investment in that business in 2015, the current environment?
Let's tackle the easier of the two first, Scott. Right now, we are not looking at anything in the E&P business in the Northeast, in the Marcellus or the Utica. The reality is those are fairly urban, for the most part, plays or in proximity to urban plays, and they have long-lived, low-cost MSW landfills up and down the I-95 corridor for the most part, and then down, obviously, through Pennsylvania, that can take these wastes fairly inexpensively. If you look at such as Waste Management or Republic, the vast majority of what they do in E&P is in the Marcellus and the Utica, really not anywhere else to speak of, prior to the Tervita acquisition, obviously, by Republic. As far as our interest in the space.
Look, we feel we've got tremendous assets right now in the remaining shale basins that are out there off of the East Coast. We're going to look to continue to densify that asset position and shore it up in any area that we might feel there could be a little bit of an improvement in. I wouldn't expect that to be a tremendous amount, but we have done one in the first quarter. We're looking at some others. Particularly, if we can get those based on $40 crude at reasonable multiples. If we get something at a four to five EBITDA margin on current run rate, as crude turns and hopefully gets back to $70-$80 at some point, that'll turn into a two multiple. We will be looking at it like that.
Yeah. I'd say, the closer-term opportunity for us from an investment standpoint, periodically, we've been talking about our attempt to get a liquid disposal well in our New Mexico Permian operation because of the amount of money we're spending on third-party water disposal at that facility. We've been working a couple of years now trying to get that permitted. We're getting close to when we hoped we can do that. Obviously, if we can do that may be about an $8 or $10 million investment on us, but in under a three-year payback, given the cost we can take out of the business there. We'll continue to update you on that one. Because that's a certainty of return given the reduction of internal cost.
Got it. Thank you. As my follow-up, I guess, you mentioned in the press release and on this call, you expect to offset a portion of the E&P downside with upside in these other areas. I know you update formal guidance mid-year, but maybe trying for a little bit more detail or color in terms of either the proportion or whether it's kind of equal parts, solid waste, commodities, M&A. You're talking about a pretty nice outlook for M&A at $75 million in annual revenue this year.
Yes.
Maybe a little bit more detail where the upside's coming from.
Yeah. We would never guide M&A that's not completed. If you just focused on solid waste and recycling and try to quantify that, for instance. Look, solid waste, we're already guiding to 5% price plus volume growth in Q2. That's a fairly strong number compared to anyone's data that's being released. If you look at the balance of the year, remember, just to move the needle 50 basis points in volume is a big number, and now we're just staring at half of a year left beyond Q2. 50 basis points over half a year is only about $5 or $6 million of incremental volume. You put a margin on that, you're talking about $2 to $3 million maybe of incremental EBITDA per 50 basis points over half a year. You start looking at recycled commodities.
If those come up 10% or 15%, you're looking at another $4 to $5 million of incremental revenue at a high flow through. Long way of saying, if the headwind is $40 million of revenue, well, what we just talked about from a revenue standpoint is maybe we could offset 20% or 25% of that. If the EBITDA headwind is $30 million, well, what we just added up to is maybe 20% of that being offset. You got to put the buckets in perspective, and keep acquisitions out of the analysis.
Yeah. Scott, again, remember, we're sitting here almost in May, if we did $50 million of acquired revenue over the balance of the year, that tells you $25 million would hit the P&L approximately. That's assuming it was done by July 1. If it's done after that, maybe an average of, let's say, September, just pick a point, it's going to be a number closer to $15 to $20 million hits the P&L.
$10 to $12.
In 2015.
$10-$12.
That's correct. I'm sorry. I apologize. Hit the P&L. Then you assume that those deals come on at somewhere around 25%, which is our typical history. You're looking at $3 million-$5 million, depending on the timing of EBITDA that could impact this year. Again, we're not going to be able to offset dollar for dollar most likely, unless there were some very large job or very large deal that we got done that was highly accretive. We don't see that, but we will offset a portion of it.
Yeah. Other drivers in the business that we don't control. Obviously, special waste could pick up above expectations second half of the year. The much-discussed coal ash that we don't put in our outlook. If coal ash were to start coming to fruition in the second half of the year, you could see some contribution from that as well. Again, let's just wait till July and have a better insight looking at the business.
Got it. Thank you.
Thank you. Our next question coming from the line of Michael Hoffman with Stifel. Please proceed with your question.
Thank you very much for taking my call. Ron and Worthing, on the free cash flow, just to kind of close the loop on that. Start of the year with a 26% of revs was cash flow from ops. I assume that walks up maybe a half a point. Most of that would be working capital to help stay in this target range of $350-$360?
Yeah. You get about a 30-50 basis point walk up on that.
Okay. Then on solid waste, can we talk a little bit about some of the trends that we haven't discussed yet? Front-end loader, the weight per yard trends had been improving through the second half of 2014. How does that look in coming into 2015, and how do you think about that service interval cycle? I'm assuming that's not in the guidance either, so that's another sort of opportunity for margin.
Yeah. I would say certainly some of that is in the guidance, Michael. The reality is that to have 2%-2.5% positive volume in a GDP environment that is running approximately that, you're getting some benefit of that. Again, each of the last three quarters now, service increases over service decreases in our commercial system has expanded both in number of customers and $ amount. We're continuing to get that, and we expect that to continue. It's not growing at an explosive pace, but it's growing at a very steady and predictable pace. I think to get to, I'm just using this, 3%-4%-type volume growth that many would like to see, we really need to get back to a 1.5 million plus housing start number. That's sort of the piece that we haven't, not we, the whole industry, hasn't yet seen.
The commercial business is performing very strong right now with regard to service increases.
Okay. Following that line of questioning. On the C&D pull trend, can you tell whether there's a res versus non-res component to that? Non-res hasn't recovered yet. There's a little bit of activity in 2014, but that's also another opportunity, is for non-res construction to come back?
Yeah, we concur with that. If you look at it, our business is split not quite on the temporary roll-off pulls, which is I think where you're referring, are dead on about 50/50 historically between res and non-res. Certainly right now, the non-res is a little larger. It's more like 60%-65%. There certainly is an opportunity for that to provide some acceleration if housing continues to pick up. We are seeing it pick up on our West Coast specifically.
Okay. I just want to make sure I got the mix right. The res part is 60/65, so if non-res picks up-
No, inverse of that.
Okay.
Yeah, the non-res right now.
Okay. That's the other question I had on the res part. We did just under 1.1 million starts last year. That was in your guidance, basically your assumption was we'd be flattened starts year-over-year. Is the premise going into the year, and if it's better than that, great.
Yeah, we thought there'd be about 1 million. That's correct.
Right. Okay. I mean, the smarter people than me on housing think that it's going to be 1.2 to 1.3. Are you starting to see that kind of level of activity beyond just the West Coast?
I would say we've felt that the Midwest and the Southeast has been pretty strong throughout 2014 and 2015. I don't think we've seen a palpable change there. Where we're seeing the change is the West Coast for us.
Okay. On the recycling, has the congestion in the ports cleared so that overhang's gone?
Virtually. It hasn't completely cleared, it is not a reason for a price dislocation at this point in commodities. The turnaround times are such that's not causing any discounting.
All right. Last on solid waste price retention, given better volume trends, are we seeing just better overall price retention? You're not having to give as much back?
We are. Our price retention right now is hovering right around 89%-90%, which is very good. By the way, that's in our competitive footprint. Our price retention in our exclusive is 100%. Company together, it's 95%. That is indicative of a stronger economic environment where in the competitive areas, you're able to raise price without as much retribution from private haulers because they're getting organic growth in their business, too. That overarching improvement in the economy helps the pricing environment without question.
Okay, one last question on E&P. In your conversations-
Let's get the horse out of the glue factory. Go on.
What's that? Oh.
Let's get the horse out of the glue factory.
Yeah, no. Well, this one's slightly different. In your conversations with your customers, where do they think they are in successfully reducing costs of drilling, cost of completion, such that the new normal now is $50-$60, and they can make money, and they'll start doing business again. Where do they think they are in that process? Do you have a sense of that?
Yeah, we've had those conversations. I will tell you, we were with a couple of the larger drillers who would tell you that one year ago today, their AFE for a drill was $8 million-$8.5 million. They're saying that exact same AFE today is between $4.8 million and $5.4 million. They're saying they need to knock another $200,000-$500,000 out of that to give them, at current oil pricing, the same IRR they had at the $8 million-$8.5 million. They think they're very close. Obviously, anything above this price, they're there.
Okay. By all reckoning then, they're a conservative bunch. They fight for that through the mid-year, maybe that's the turn in the rig count?
Well, again.
That's the way to think about that.
I think that is a possibility, assuming crude stays where it is today or above.
Right. Okay. Thank you very much.
Thank you.
Thank you. Our next question coming from the line of Charles Redding with BB&T Capital Markets. Please proceed with your question.
Hi. Good morning, gentlemen. Thanks for taking my call.
Good morning.
Just a little bit of a follow-up here. If you could just drill down a little more on the stronger roll-off activity. What were some of the components of the business that were really strong in the quarter, then where do you see that heading over the next quarter or two?
Yeah. Well, overall roll-off poles were up 8%. They were up in all three of our regions. Price was up almost 3.5% per pole. We would expect the price component to stay relatively consistent. I would expect the incremental increase in poles to stay relatively consistent. I haven't looked at last year's Q2 to know what type of comp we're looking at yet. The reality is the business was strong across the board. Different reasons in different places. In the Southeast, we're seeing some recovery in some of the manufacturing, particularly the marine industry. Of course, the auto industry that we didn't have as much of in 2013 and 2014 in the Midwest.
Despite the fact that the Midwest, from the Dakotas down through Oklahoma, is in and around the strong shale plays, we're still seeing 2%-3% unemployment in those areas and just overarching strong construction commercially, strip malls, restaurants, apartments, et cetera. On the West Coast, we're starting to see it in residential housing, particularly in the Pacific Northwest and in parts of Northern and Southern California. A little bit different by geography, but all the geographies contributed to roll-off pulls increase both temporary and our permanent industrial customers.
Okay, great. I guess on special waste, I know that's off a little on the tougher comp. Just stepping back, how do you think about that business and is it possible to have any visibility in that business, or is it simply limited as a function of how you're collecting?
Well, you do have some visibility in that business. We monitor all permits pulled in the geographic areas of every one of our landfills that can handle special waste. We have estimates of the size of the projects and when those projects will begin and when they will end. You know what you're awarded. Based on those, you can triangulate where special waste approximately will be. The only thing that causes a difference to that is that sometimes jobs get delayed in starting, or they drag out longer than anticipated. Any given 90-day period might be greater or less than you projected.
Again, the only reason that Q1 was down in special waste was just due to our central region and the fact it was a very large storm cleanup where rivers flooded throughout parts of Colorado last year, and we were awarded several cleanup jobs in several markets because of our landfill network in Colorado. We just didn't have that this year. That caused 13% decline in that region, and that's what led to the overall company being down. We don't have that as much in Q2. I would expect special waste in Q2 to be flat to up, not down.
That's great. Thanks, Ron.
Thank you. Ladies and gentlemen, as a reminder to register for a question, please press the one followed by the four. Our next question coming from the line of Barbara Noverini with Morningstar. Please proceed with your question.
Hi. Good morning, everybody.
Good morning.
Morning.
You talked about this briefly in the last question. I just want to revisit it. Are you starting to see any ripple effects in your central solid waste region as a result of E&P special weakness? I'd expect that since that is a significant driver of the economic environment in that region specifically, you might start to see a little bit something maybe into Q2 or a little bit later in the year.
Yes. Very good question. We are seeing some ripple effects of that, Barbara. The reality is that with the laydown of rigs in places like North Dakota, in places like Colorado, in Oklahoma, you're seeing fairly substantial, in some cases, job loss off of those rigs. You're seeing a little bit less commercial activity at restaurants. You're seeing a little bit less commercial activity at apartments and temporary lodging. It's not really affecting our residential business at all. It's just a fairly nominal effect right now on our commercial business in the central portion of the country.
Got it. That's helpful. Thank you.
Thank you.
Thank you. Our next question coming from the line of Corey Greendale with First Analysis. Please proceed with your question.
Hey, good morning.
Good morning, Corey.
Good morning.
Brendan, you have me worried that I'm going to have the animal rights people after me if I ask a question about the E&P waste business with your glue factory metaphor.
Do it at your own risk then.
You're going to have them.
Well, I'll take my chances on a couple slightly different angles. The first is actually, Ron, maybe this is a reach, but I know that historically you talk about one of You're very focused on building and developing good talent at the company. Is there any silver lining to the downturn in that maybe there's more good talent out there or more opportunities in the Woodlands area to accumulate either space or people based on weakness in E&P?
We don't need any more space right now, that's a good thing. In the Woodlands, despite the fact that there's a lot of E&P business here, the commercial vacancies remain under 2%. The market's still very strong. You're correct. We're constantly focused on making certain that we've got the best possible people we can. To be honest, in the E&P niche specifically, yes, this is an opportunity to do that. This is an opportunity for us to upgrade really at some levels as talent comes on the market, we are looking at that. We have taken advantage of some of that recently, such as on the sales side. It's not a needle-moving opportunity, but it all matters ultimately.
Secondly, on the regulatory environment with volumes being this weak, first of all, do you see any kind of slide back, people using open pits instead of lined landfills? Do you think the weakness slows down any of the legislative or regulatory wheels that could be moving toward more forcing people to use lined landfills?
One thing you see to the extent that pricing comes down in those states that still allow pits, you see landfilling being a lot more competitive to the cost of using pits. We do see some additional rigs moving into landfills and away from reserve pits. On the regulatory front, for instance, you saw in North Dakota the first of what could be two initiatives to encourage more landfilling or just moving away from reserve pits. The first one that they did was a bill that recently passed to the extent that the waste stream goes into a recycle and reuse format, which we've got a couple of technologies that could apply there. It's more advantageous to the generator of waste in that the liability chain gets cut. That's one way the state's tried to induce additional moves away from reserve pits.
One that is still out there is I know North Dakota has considered doing basically a tax incentive in order to encourage the use of landfills. In other words, to the extent that they could get folks out of reserve pits, basically the tax credit alone is almost equal to the cost of disposal. Again, we do see initiatives in states that are still allowing reserve pits to try to encourage folks to move away from them.
Great. Thank you. Let it be known the horse is walking into the barn under his own power.
Thank you. Our next question coming from the line of Adam Baumgarten with Macquarie. Please proceed with your question.
Hey, thanks for taking my question. Could you guys just touch on the pricing you're seeing across different lines, commercial, industrial, and residential, what the trends you're seeing there?
Yeah. Our industrial is sort of encompassed in the roll-off pricing that we gave out today. That 3%-4% range in our competitive markets is a fair number. I would tell you that our commercial and our residential, we are seeing in our competitive markets a 3%-4%. In our exclusive markets, both residential and commercial, we get approximately the CPI on both those lines, as well as roll-off in that piece of the business. That is running for us probably between 1.8% and 2.2% in most parts of the West Coast. We've seen some as low as 1.4%-1.6%. We've seen others a little higher than 2.2%, but really in line with our expectations so far this year.
Great. Thank you.
Thank you. Our next question coming from the line of Tony Bancroft with Gabelli. Please proceed with your question.
Morning, gents. Thanks for taking my call.
Hey, Tony.
Hey. Just, I'll beat the horse one more time. Just with on the MLP front, if now that the PLR has been paused and lifted, maybe a rebound in 2016, what's the interest potential there in doing that?
Well, again, the lifting of the PLR issuance by the IRS had no impact on us because we already have our PLR. With regards to any MLP-ing of that business, we've really stated from day one that as that business crossed the $400 million or so dollar in revenue scale, that's a scale and amount of EBITDA and tax shielding that we'd want to pursue that may make sense at that point in time to consider an MLP. Clearly, at kind of the low 200 run rate, we have a ways to go. We'll see the pace of the recovery in 2016, see what that adds to growth, and for that matter, into 2017 and continuously evaluate that.
Thanks for taking my call.
Thank you. Our next question is a follow-up question coming from the line of Tyler Brown with Raymond James. Please proceed with your question.
Hey guys, just real quick modeling question here, what is the plan on the hedged fuel? I think that the expiration on that hedge is in December. Do you guys expect to rehedge or do you just want to roll it off to the market?
Tyler, we constantly look at both hedging in the derivative market for fuel. There's been some dislocation over the past four or five months as some of the indices that have traditionally been used, meaning the DOE retail index, has been dislocated from the downward movement of diesel. We're now starting to see that market loosen up a bit and getting bids now for 2016 and 2017 on diesel. We are evaluating that. We're also now at a point in the year in 2015 that some of our distributors in local markets are now willing to price us for calendar 2016 for fuel locks. We have already started looking at doing some of those in the markets that we're able to do that.
Okay. You would think of it like 10 million gallons coming down to somewhat close to spot. I think, are the hedges and locks around 360 or so?
That's right. Again, if you're looking into 2016 and the forward curve is not at spot, the forward curve against that 360 is probably somewhere in the DOE retail , somewhere down $0.40-$0.45 on that hedge right now where you lock it today. For those districts where we have fuel locks in place from a local distributor this year, those hedges are also looking somewhere in the down $0.80 or so to the $0.60 range relative to how they were locked this year. There is some rollover savings in that as well.
Yeah.
Okay, cool.
I think it's safe to assume a 30%-40% of our fuel will be hedged most likely for 2016.
Okay, perfect. Just real quickly, I know you've got $175 million of notes. I think they're like the six and five-eighths maybe coming up this year. Do you expect to just roll that off into the term loan, or do you expect to refinance it?
When we did our bank refinancing in January, we put the capacity of that facility up in anticipation of taking those notes into the revolver. I'm not saying we wouldn't look to do a fixed rate note financing at some point if it made sense to lock low rates longer term. Right now, the plan of finance is to put them in the revolver.
All right. Thanks.
Thank you. Our next question is a follow-up question from the line of Michael Hoffman with Stifel. Please proceed with your question.
I'm trying to avoid horse questions since I own them. Let's talk about solid waste. The drought in California, how big of a deal is that to the business?
Well, I guess the reality is we don't exactly know yet, Michael. They've been in a drought for three years. We don't think it will impact any commercial, industrial, or retail businesses whatsoever. The only impact really, and I think it's an offsetting impact, the only impact is you're going to have less green waste residentially. That's actually good for us because we're paid a flat rate fee, and our costs will go down per home, in disposal, in composting, in labor, et cetera. It's very nominal. Again, so will drive-in customers at each of our California transfer stations where they will have less yard waste to dispose of that they pay a fair number for. I think they're probably offsetting. There's nothing that any of our California locations have told us based on the drought that is going to, per se, negatively impact their business.
The only negative potential impact out there is that we do have to have dust and erosion control measures in place at our landfills. We have some large landfills in California. It depends on what kind of restrictions they put on water usage there and what we can take out of our own wells versus what we might have to buy in the market or buy credits for. We don't think that is a big number. It's a de minimis number, but we're very aware of the ins and outs of this in our P&L.
Okay. Then I have to slip an E&P question in. The market share of outsourcing versus on-site is surprisingly low in North Dakota. Coming out of 2014, has that started to shift, ex the 1390 being passed and therefore there's another play here, maybe you start to capture share because of the incremental outsourcing and that helps this story?
Yeah, I'd say outsourcing's actually up a little bit from year-end, not for the reason you think. The reason why it's up a little bit is some of those rigs that were using reserve pits have gone away. The share of those rigs that are going to landfills has necessarily gone up. We're somewhere approaching that 55%-60% outsourcing in the Bakken, up from about 50% at year-end. The Bakken right now probably has close to 75 or so, plus or minus rigs, in the basin. You're looking at potentially another 30-35 rigs that are still using reserve pits at this amount of activity.
Okay, great. Thanks.
Thank you. Mr. Mittelstaedt, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.
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. Worthing 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. We look forward to speaking with you at upcoming investor calls, conferences, or on our next earnings call. Thank you very much.
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. Have a great day.