Good morning. My name is Janisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management first quarter 2014 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the call over to Ed Egl, Director of Investor Relations. Thank you, Mr. Ed Egl. You may begin your conference.
Thank you, Janisha. Good morning, everyone, and thank you for joining us for our first quarter 2014 earnings conference call. With me this morning are David Steiner, President and Chief Executive Officer, Jim Fish, Executive Vice President and Chief Financial Officer, and Jim Trevathan, Executive Vice President and Chief Operating Officer. Before we get started, please note that we have filed a Form 8-K this morning that includes the earnings press release and is available on our website at www.wm.com. The Form 8-K, the press release, and the schedules for the press release include important information. During the call, you will hear forward-looking statements, which are based on current expectations, projections, or opinions about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially.
Some of these risks and uncertainties are discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K. David and Jim will discuss our results in the areas of yield and volume, which unless otherwise stated, are more specifically references to internal revenue growth, or IRG, from yield or volume. Additionally, any comparisons, unless otherwise stated, will be with the first quarter of 2013. During the call, David and Jim will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share. David and Jim will also address operating EBITDA and operating EBITDA margin as defined in the schedule to today's press release.
For purposes of comparison to the prior period, our first quarter 2013 EPS income from operations margin, operating EBITDA, and operating EBITDA margin have been adjusted to exclude items that management believes do not reflect our fundamental business performance or are not indicative of our results of operations. These measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release footnote and schedules, which can be found on the company's website at www.wm.com for reconciliation to the most comparable GAAP measures and additional information about our use of non-GAAP measures. This call is being recorded and will be available 24 hours a day, beginning approximately 1:00 P.M. Eastern Time today until 5:00 P.M. Eastern Time on May 8th. To hear a replay of the call over the Internet, access the Waste Management website at www.wm.com.
To hear a telephonic replay of the call, dial 855-859-2056 and enter reservation code 10543459. Time-sensitive information provided during today's call, which is occurring on April 24th, 2014, may no longer be accurate at the time of a replay. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now I'll turn the call over to Waste Management's President and CEO, David Steiner.
Thanks, Ed, and good morning from Houston. Our fourth quarter conference call, we said that January results indicated the strength of our business. That strength continued in February and March and led to a strong start to the year. The momentum in our yield and cost control programs continued throughout Q1. Our field operations teams also did a great job of managing the effects of the severe weather that pervaded the quarter. As a result, we earned $0.49 per share, an increase of more than 22% when compared to the first quarter of 2013. We saw good improvement in all areas, income from operations, operating EBITDA, margin, and free cash flow. We're encouraged by the strong start, and we expect the momentum to continue as we enter our seasonal upturn. Our yield programs continue to drive our margin expansion.
For the first quarter, our collection and disposal yield was 2.6%, which is the seventh consecutive quarter of sequential yield improvement. The effect of low inflation rates on our CPI-based contracts is certainly a headwind, but we overcame that headwind to drive yield to its highest level in three years. Core price increased to 4.2%, a year-over-year improvement of 100 basis points and the highest level we've ever seen. Each of our lines of business had positive yield except C&D, which was impacted by higher priced Superstorm Sandy tons we received in 2013. Average rates per unit for MSW, commercial, and industrial are also the highest rates that we've ever seen. When compared to the first quarter of 2013, average rates increased 5.6% in the industrial line, 4.9% in the commercial line, and 4% in our MSW line. This is a tremendous accomplishment by our team.
As we've repeatedly stated, we need yield at about 2% to see margin expansion. We will execute our yield programs to continue to drive that expansion. Clearly, this has some effect on volumes. The trade-off remains very positive. Turning to volumes. In the first quarter, volumes were -1.8%, which is an improvement of 40 basis points from the fourth quarter. The losses in our commercial volumes improved 30 basis points from the fourth quarter, but I wouldn't yet call that improvement a trend. Roll-off volumes were down about 200 basis points from the fourth quarter. We would expect those losses to moderate as we enter our seasonal upturn. Our landfill volumes, particularly special waste, were strong in the first quarter. They were offset by declines in the collection lines of business. As we've said in the past, we're not focused on getting the most volumes.
We're focused on getting the best volumes. We're looking for the best mix of yield and volumes to drive income from operations, dollars, and margins. Jim will give more details, despite negative volumes, overall income from operations grew more than 13%, and our income from operations margin grew 140 basis points. Operating EBITDA increased about 7%, operating EBITDA margins increased 100 basis points. Our traditional solid waste businesses performed very well in the first quarter. We saw strong income from operations and margin improvement in our commercial, industrial, landfill, and transfer station lines of business. Our overall traditional solid waste income from operations margin grew 50 basis points. Our recycling operations drove a little less than a $0.01 decline in earnings per share compared to the first quarter of 2013.
This decline is due to the 1.8% drop in average commodity prices for the quarter and weather-related operating challenges. We've seen our operating costs improve as we tighten our enforcement on contaminated loads and modify the methods for calculating rebates to customers. We're also engaged in broad-based efforts with our recycling customers, consumer brand owners, and others to educate them about the evolving recycling and commodities markets and how to reduce contamination. Overall, we still expect to achieve our recycling guidance of flat earnings per share when compared to 2013. Turning to our waste-to-energy business. In the first quarter, operating results were essentially flat when compared to 2013, overall results benefited from a spike in electricity prices in the quarter, driven by the colder than normal winter. In April, we're seeing electricity prices moderate as warmer weather has arrived on the East Coast.
We expect earnings from our waste-to-energy operations to be similar to 2013 in the remaining three quarters. Looking at free cash flow, the first quarter of 2014 is the highest free cash flow quarter since 2008, at $484 million, driven by our strong results and working capital management, supplemented by $166 million of divestitures, primarily our waste-to-energy joint venture in China. 2014 is off to a strong start, and we have the momentum to achieve our full-year goals of adjusted earnings per share of between $2.30 and $2.35 per fully diluted share. With the strong first quarter free cash flow, we now expect full-year free cash flow between $1.4 billion and $1.5 billion. As we move through the second quarter and see the seasonal upturn, we will likely refine the various elements of our guidance in connection with our second quarter results.
For now, we've demonstrated that our field and corporate managers can execute our pricing and cost control program, and through their efforts, we're confident we can achieve our goals. I'll now turn the call over to Jim to discuss our first quarter results in more detail.
Thank you, David. As David mentions, we had a strong performance in all aspects of our income statement. Our revenue grew 1.8% in the first quarter to $3.4 billion. Strong yield and acquisition revenue were the main drivers, with volume declines and a negative foreign currency translation muting revenue growth. The FX impact on revenue was approximately $17 million. We continue to see improvement in all our cost lines. With respect to operating costs, operating costs as a percent of revenue improved 50 basis points to 65.7% and increased $23 million in the first quarter. Costs associated with recently acquired businesses increased almost $30 million and were partially offset by improvements in disposal and labor costs. SG&A costs improved $15 million to $375 million and improved as a percent of revenue by 70 basis points to 11%.
With the strong results in the first quarter, we expect us to achieve our full-year SG&A goals. Turning to cash flow. For the first quarter, we generated $484 million of free cash flow, an increase of $136 million when compared to 2013. We accomplished this in part by growing our net cash provided by operating activities $7 million to $584 million, improving working capital, and by maintaining discipline on capital spending. We grew free cash flow despite over $100 million of headwinds from the payment of our annual incentive compensation and the maturity of interest rate swaps related to a planned senior note issuance. Our capital expenditures for the quarter were $266 million, the same amount that we spent in the first quarter of 2013. We also had some divestitures in the quarter. Most notably, we monetized our investment in China for about $155 million.
Even if you exclude the divestiture proceeds, our free cash flow of $318 million was still the highest free cash flow since 2008. Looking at internal revenue growth, we continue to execute on the trade-off between yield and volume to determine the best mix in order to maximize income from operations dollars and margins. Our strategy worked in the first quarter, just as it did for the full year 2013. For the total company, in the first quarter, our collection and disposal yield was 2.6%, with volumes declining 1.8%. This led to income from operations growing $55 million, margin growing 140 basis points, operating EBITDA growing $49 million, and operating EBITDA margin growing 100 basis points. Looking at the commercial and industrial lines of business, the yield and volume trade-off worked well.
In both cases, strong yield results offset volume declines, resulting in commercial income from operations growing more than $6 million and margin growing 50 basis points. In industrial, income from operations grew almost $7 million, and margin expanded 110 basis points. This is the seventh consecutive quarter of year-over-year margin expansion in industrial. Yield above 2% in those lines of business drove margin expansion despite negative volumes. This did not hold true in our residential line, where yield was 1.1%, driven by low CPI. In addition, we lost a few contracts where we saw competition significantly lower price to levels that were below our required return on capital. We expect to see margins improve as our cost control programs drive down operating costs and as we add new residential contracts at acceptable returns.
In the landfill line of business for the first quarter, we saw the benefits of positive volume and positive yield. Total landfill volumes increased 3.8%, combined special waste and revenue-generating cover volumes were a positive 7.9%, and MSW volumes grew by 0.9%. C&D volume declined 2.2%, primarily due to a tough Sandy comparison. This led to income from operations growing $11 million, which is the fourth consecutive quarter of growth, and margins grew 130 basis points. Finally, looking at our other financial metrics, at the end of the first quarter, our weighted average cost of debt was 4.9%, and our debt to total capital ratio was 62.8%. The floating rate portion of our total debt portfolio was 18% at the end of the quarter. Our income tax rate in the first quarter was 29.6% due to a non-cash adjustment to our deferred taxes from state tax law changes.
This benefited us by a positive $0.04 per diluted share in the first quarter. The year-over-year benefit was a positive $0.02 per share. For the next three quarters, we expect our tax rate to be approximately 35%. Our first quarter results have started 2014 on the right path. We are encouraged by the results, which could not have been achieved without the hard work of our employees. I know they're focused on making 2014 a successful year, and I thank them for that. With that, Janisha, let's open the line for questions.
At this time, I would like to remind everyone, in order to ask a question, please press star and the number one. Again, that's star and the number one. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Hamzah Mazari of Credit Suisse.
Good morning. Thank you.
Morning.
Hey, good morning. Just a question on the volume side. Do you have a sense of how much of your volume loss is self-inflicted in terms of walking away from low margin business versus other competitors in the marketplace being more aggressive? Separately on the volume side, is the spring slowdown within housing going to push out some of the commercial new business formation in your business? What's your view on those two topics within volume?
Yeah, Hamzah, on the first one, I don't think the slowdown in housing will push it out. As you know, we've been waiting for that commercial volume to see significant improvement. I don't think that one quarter slowing down on the housing starts or resales will have an effect on that. On the other one, you have to look at the various lines of business, right? I don't think there's any doubt that in the residential line of business and in the industrial line of business, we walk away from low margin business. There is absolutely no doubt about that.
On the commercial side, there's just not a lot of growth, and our strategy is that we aren't going to chase volumes, because if we chase volumes, and because there's not a lot of growth, we're going to have to take those volumes from someone else, and that's just not something we're willing to do. We're not willing to go out and grab volumes at a low price, because if we do that's what starts the downward spiral in price. When we see those volumes pick up, we fully expect to get our fair share of that. I would tell you that we walk away from residential and industrial business that's low margin. When it's low margin, it's generally low return on capital. We're making a good business decision to walk away from it.
On the commercial side, I wouldn't say that we are intentionally walking away from business. I would say that we're more focused on retaining the business that we have than going out and trying to get new volumes with low price. Once we see the rising tide, when we see those commercial volumes pick up, we fully expect to get our fair share.
Just on pricing, could you give us your thought process in putting up the pricing bonus structure? You put a pricing gate in place a couple of years ago, then it went away. How permanent is this pricing gate that you've set up? Should we expect, is this a signal to the market that you're more disciplined and you were not disciplined previously? How should we think about these pricing gates coming in sporadically and then maybe going out at certain times?
Yeah. Look, Hamzah, I think everybody knows that the strategy at Waste Management is that you're always better off getting yield over volumes, right? We're always going to be a yield-focused company. Now, you can get yield in a lot of ways. You can have the gate, which that you mentioned, which is sort of a hammer, if you will. Look, we meet with our folks every month to see how they're doing, and you've got that as sort of a governor on it. You can also put in place an incentive program. Look, when we saw the yield go down dramatically in 2012, we knew we had to do something dramatic.
We weren't going to just rely on meeting with folks every month and saying, obviously, your job is expected to be driving yield. We wanted to get a little bit more incentive. We decided to make it a positive incentive. As you can see, look, we've quadrupled yield since we put that in place. If that's what we have to do to get it done, it is a great trade-off for our shareholders, I can guarantee you. There will always be something that we will do with respect to yield. Either we'll put in place a gate, we'll put in place an incentive program, or we'll make sure that we have our focus on it so that our field manager's focus is on it. We will always do that. We're going to use a combination of those three things to continue to drive yield.
Okay. Just lastly, I'll turn it over, maybe for Jim. Could you help us understand why you're not raising earnings guidance, but free cash flow guidance is going up? Is that all asset divestitures? Or maybe give us a little more color on the delta between that.
Yeah. A couple of questions there, Hamzah. I think the reason we're not raising free cash flow guidance is because while we were pleased with the quarter, this is the first quarter. We've said that we'll refine our guidance in the second quarter. When you think about free cash flow, I think that was your question, was kind of the components of free cash flow, and I think that's kind of what you're getting at, is which pieces of it are sustainable and which are not. If you think about free cash flow and break it down to its component parts, CapEx was essentially flat. Exactly flat, actually. EBITDA was up $49 million, driven by a nice quarter for Wheelabrator, driven by some core business improvements and driven by SG&A cost controls.
The other piece, the other big mover there, outside of divestitures, which was almost exclusively the Chinese divestiture, the other big mover was cash flow from operations. We had about $100 million, 106 to be exact, of headwind there from the forward starting swap and then from the bonus payouts. Working in the right direction there was DSO and DPO, which were better by a day and five days respectively, so year-over-year. I think we have some room to improve there. I would argue that the quality here is pretty strong. Most of what I've talked about, I would argue, is sustainable, with the obvious exception of the one-time asset divestiture.
Yeah. Hamzah, I think the important thing is that we did $318 million without divestitures, which is the highest we've had since 2008, and that's with $100 million of headwinds. The beauty of it is those $100 million of headwinds were first quarter headwinds. They don't recur in the second and third and fourth quarter. We had a great first quarter despite the headwinds. We won't have those kind of headwinds in the future quarters. Obviously, we're very optimistic about free cash flow. As Jim said, we've always said, whether it's a good winter weather or a bad winter weather, it is hard to judge a full year by the first three months of the year. We like to see the seasonal upturn before we make a call on how the full year's going to play out.
We thought that's what would be prudent to do right here, which is to say, let's see what the seasonal upturn brings in the second quarter, and we'll refine the guidance as appropriate.
Okay, great. Thank you.
Thank you.
Your next question comes from the line of Joe Box of KeyBanc Capital Markets.
Good morning.
Good morning.
Question for you guys on landfill pricing and volume dynamics. Per your release, on an active landfill basis, it looks like volumes are up by about 3.4%. Can you guys give us a sense on yield for those landfills? You had a peer that reported landfill volumes up, I believe it was 9% earlier this week. Can you just help me bridge the gap there? I'm curious if that's a function of just geography or maybe if you're seeing a little bit less volume here because of your pricing strategy as well.
Look, the landfill volumes, those big numbers, when it happens for us, I won't speak to other companies, but when we get those type of big numbers, it's generally special waste jobs. You got two things going on there. You got year-over-year comps, right? If we had a great special waste quarter last year, it's a harder comp. You've got the fact that those special waste jobs are jobs, that they vary from season to season. What I would tell you is that we are very encouraged by the landfill volumes. We still see a very strong pipeline, we'd expect them to be positive for the full year. From a pricing perspective, as we said, look, price doesn't particularly matter as much in special waste and in C&D as it does in MSW.
When we look at the yield components, we look at MSW. When we look at the average unit price on the MSW line, we grew at 4%. We're well on our way to getting what we've said is sort of that 5%-7% price increase to landfill. At 4%, we're well on our way to getting there.
Perfect. That's helpful. Thank you.
Certainly.
David, I want to preface this question by just saying, I think that pricing discipline out of you guys is critical, but I'm just curious, when you started your pricing strategy about a year ago, were you expecting your peers to buy into raising rates? Then maybe what's your view on sustaining this strategy? If the waste recovery continues to be relatively slow, is this something that you could stick with to this magnitude for another year or two?
Look, I can't speak to what we expect or don't expect out of our competitors. All I can tell you is what we're going to do. It goes back to what I said earlier. Look, when you've got sort of a fixed pie, there's only one way you can get volumes, that is to go out and steal them from someone else. We've seen what happens when we do that. Look, we've done that in the past, where we steal volumes from someone else. What do they do? They steal them from us. Before you know it, you have a downward price spiral. You all have heard me say it a million times. It's a two-to-one or three-to-one trade-off. You can get 1% of price and lose 2%-3% of your volume, and you're still ahead of the game.
You just can't chase that downward spiral because you can never get enough volumes to make up for the drop in price. You're not going to see that strategy change for us. Now, look, would we rather have more volumes? Absolutely. But what I'm saying is, if when we get more volumes, it's not going to be because we're going out and stealing them at a lower price. It's going to be because everyone's getting more volumes, we fully expect to get our fair share of the increase in volumes. What we've seen is that we think the economy has moderated. We don't expect to see the volumes improve dramatically, but we don't expect to see them decrease dramatically either. Obviously, we're going to see improvement during the second quarter with the seasonal upturn.
I would say that we have a sort of a muted sense of optimism on volumes, but that you're not going to see us change our strategy because it's a strategy that drives shareholder value, and that is we're always going to favor yield over volume.
Right. Just one quick one. Jim, can you remind us what the flow-through is for that $27 million variance for electricity?
Most of that electricity was from rates, Joe. In fact, I would say it was exclusively from rates. Our kilowatt hours were actually down slightly due to some permanent plant shutdowns, reduced load, and some operating changes. I would say that the top-line benefit we saw was exclusively from rates, and so that ends up flowing through to the bottom line.
Great. Thanks for your time, guys.
Thank you.
Your next question comes from the line of Michael Hoffman of Wunderlich.
Good morning.
Good morning, Michael.
David, Jim, and Jim. I need a little clarity because there's numbers being thrown around, and I may have confused myself. In your release, you show, and it's a data point I think is a terrific one you show. You show having done 21.3 million tons at the landfill in 2014 versus 21.1 a year ago. 21.1 had Sandy in it. To get to the That's just about 1%, which I thought was great given the Sandy comparison, but everybody's talking about 3% or better. Help me understand how I'm understanding volume at the landfill, if I could.
Yeah. Look, Michael, as you know, when we look at internal revenue growth, we don't look at it on a tonnage basis. We look at it, there's a lot of different mix issues that go into it. When we're giving those numbers, you're looking at mix and price. When we look at least at C&D, I'm sorry, when we look at special waste, we put all of it into volume because you can't really pull out the price. You might get some little deviations there. When we look at it, we say the numbers are obviously indicative of the trend, and I think you hit the nail on the head. The trend is obviously positive, particularly given the Sandy comparisons, particularly given that so many of our operations were shut down during the quarter that the landfill trends are clearly positive.
Okay. The 3.8, when that was given earlier, that's actually the revenue growth. I actually think it's great that you show the 1% volume the way you've put it in the chart, given all of the headwinds this year you just described.
Right.
What I'm-
Yeah. No, the 3.8 is the total growth from volume. Again, with special waste, because special waste prices and transportation costs move around a lot, we don't split out price and volume in special waste. We put it all into volume. That skews the numbers a little bit. Again.
Versus the ton.
Exactly.
Okay. Versus the ton.
Directionally, you can see they're both positive directionally.
Perfect. The follow on to that would be, do you have a recall out of the 21.1 that's total tons in that you showed in disposal, how much of that was Superstorm Sandy? In reality, the landfill in 1Q 2014, weather aside, saw better than a 1% volume growth?
Yes.
Tons growth.
Yes, that's absolutely right.
Okay. The next question would be, if you were looking at who's driving across the scales, do you have a sense that this is more construction or it's actually maybe more commercial? Where I'm getting to is, are we starting to see that secular recovery of volume in the container, the commercial market, that somewhere out here in the next quarter or two starts converting into that operating leverage from service intervals?
No, I think that's right. I think if you asked our folks on the field, they'd tell you that special waste and C&D are where they see this real strength in the pipeline. Obviously, MSW has been a strength now for many quarters in a row. I think what they tell you they're very optimistic is about special waste and C&D. Look, the reality is that you had a lot of pent-up demand built, particularly in the Northeast and the Midwest. You had a lot of pent-up demand built up during the winter, and you see a little bit of that. We also think that we're seeing a secular pickup
Obviously in the construction industry.
Okay. On the free cash flow, I appreciate that you're being clear that you can add or subtract the asset sale number to do the calculation. If I looked at it on a cash from ops less capital spending approach, what does it take for this business to do $1.5 billion on those metrics? Because asset sales come and go. Where's the leverage without getting help from volume? This is you running the business better. Where do we see that? Where should we look for that as we progress, and how quickly could you get it?
Boy, how quickly can we get it? I don't know. I think we're making pretty good progress here. If you exclude, what you're doing is excluding that divestiture piece, which we look at that as well. Then you get to the progress we're making on working capital. David and I both have kind of touched on that today. We still have some room there, Michael. DSO improved by really only a day, and DPO by five days. Fairly pleased with the improvement of DPO, not necessarily pleased with the improvement of DSO. I think both of them still have room for improvement. I would argue that that's an area for continued improvement. $49 million in EBITDA and growth there is strong in light of what we faced in the winter season.
Our woody business did a nice job of offsetting the weather impact on our core business. Our core business still grew, which I think is an important thing to mention. Our core business grew. Look, we had some challenges. We didn't mention it in our scripts because we just don't want to blame anything on the weather. We felt pretty darn good about the growth in EBITDA, when at the same time, we were shut down in Houston for a couple of days. We were shut down in Atlanta, I think, for four days in the quarter. There clearly was some impact on the operation, but it does speak to a couple of things. That is that Jim Trevathan and his team did a nice job of pulling some cost out when we knew we were going to be shut down.
I think back to your original question, though, hard to say when exactly we will get to a number in the one five range excluding divestitures. I sure think we're on the right path with our cost control program, with our yield program, and then continued work on CapEx discipline and working capital.
Michael, look, just to add to that, from a sustained $1.5 billion point of view. You said talk about it without volume. The reality is you can't get there without volume, right? We've said it 1 million times, if we've said it once, which is you can't get margin expansion unless you get 2% yield, right? If you don't get the yield, you have no chance of getting there. You can't get there on cost alone, right? You got to get above 2% yield, or else you have no shot at getting there. We've done that. We've driven our yield up to 2.6%. If we got back the money that we lost from the lost volumes, which is mostly intentionally lost volumes, we're there, right?
I would tell you that from a sustained long-term point of view, $1.5 billion happens when we see our commercial volumes turn back to flat, when we stop seeing the leakage of cash from lost volumes. Look, you can't have your cake and eat it, too. Right now, like I keep saying, in this fixed pie environment, you can't have both. You can't have both 2.6% yield and 2.6% volume. We did that. Remember, we did that in 2012. We had positive volumes and 1% price. We all saw what that got us. That doesn't get you $1.5 billion in free cash. It doesn't get you margin expansion. What I would tell you, Michael, is you can't look at this without volumes. You've got to look at it as the right mix of price and volumes.
Until we see that commercial pie start to grow so that we can get back to flat volumes, you're going to see us generate somewhere between $1.3 billion and $1.5 billion. Once you see those volumes starting to turn, that's when you get $1.5 billion plus.
To that end, on the landfill side of your business, do you feel good about the nature of the pricing that you're instilling discipline in that commercial collection market by the private guy, as opposed to subsidizing their ability to poach you?
Look, again, you've heard me talk about that a million times. That's absolutely critical to the long-term strategy. Yeah, I actually feel very good about that.
Good about it in the sense that the market's starting to follow you as well, as opposed to you just caring more?
Look, we don't pay attention to what the market does, frankly, because what the market does is not going to influence what we do. We are going to do what we do because look, I've been here 10 years, and I've seen it both ways. I've seen us play the volume game, and I've seen us play the price game. There's only one way that we can grow the bottom line, and that is by playing the price game. I'm encouraged by it because we go through a monthly and a quarterly review with each of the folks that are managing those businesses.
We have started to ask them, "Tell us about your top 10 customers, and what are we doing with price?" We're seeing what we're doing out in the field, and so I'm encouraged because we're sitting down with those folks and actually seeing the results.
Okay. Thank you very much for taking my questions.
Thank you, Michael.
Your next question comes from the line of Derek Sbrogna of Macquarie.
Hey, good morning, guys. Thanks for taking my question.
Morning.
It was great to see the yield in the collection and transfer business continue moving higher. I'm wondering if you could talk, as you guys have a little bit in the past, about some of the things you're doing to retain the volumes without lowering price. If you could maybe kind of assess how successful you think some of these programs have been.
Yeah. It's a great question, and frankly, it's where the bulk of our focus is right now. The reality is that most customers, whether it's solid waste or cable or telephone or water service or electricity, most customers don't switch just because you put a 3% price increase on them. They understand that everybody has to get price increases because their cost base goes up, they get it. They don't leave you because you raised the price. If you raise the price and then have a service issue, that's when they leave you, right? If your cable repeatedly goes out, that's when you start going and looking for another provider. We need to be 100% focused on providing that best service to our customer and not give them a reason to leave. We've done the studies.
Everyone says, "Well, the customers leave you over price." We've done the studies. They don't leave you over price. That is not the number 1 reason they leave you. The number 1 reason they leave you is service issues. That's why we've dedicated a lot of human capital and a lot of technology to making sure that we can have the best service. We were glad to see that as we went through the pricing programs in 2013, our churn rate did pick up. We were glad to see that in the first quarter of 2014, the churn rate actually moderated and was down sequentially from the fourth quarter. Look, we still have a long way to go.
Yeah, that's very helpful. Just 1 more, if I can. With the stronger free cash flow, it doesn't look like you guys bought back any shares in Q1, but instituted the $600 million buyback last quarter. Can you talk about your appetite for buybacks here, given the stronger free cash flow?
You're right. We didn't buy back any shares in Q1, I would expect to see us back in the market buying shares sometime in Q2.
Okay, can you just remind us, there has been some talk about extending bonus depreciation. Can you just remind us of what that headwind is and what that could potentially add to free cash flow if that is reversed in 2014?
We estimated at about $70 million-$80 million was the headwind. Obviously if that law changes, if we get the extenders, then we would see that reversed. For now, we're expecting to see about $70 million-$80 million in headwind as a result of no bonus depreciation.
Yep, understood. Nice job. Congratulations.
Thank you.
Your next question comes from the line of Al Kaschalk of Wedbush.
Good morning.
Morning, Al.
Just to follow up, David, on a lot of this price to volume discussion, if you're prepared to continue the battle on the price and implement that, what expectation should you have for investors in terms of the volume comp? In terms of, are you getting to a point where you're going to annualize that and therefore volume declines will be getting closer to flat? Or should we start to still see some of these, the numbers that you're posting down 2%, 3%?
Yeah, look, that's a great question, Al. It goes back to one of the things I said in the script, which look is fundamental to our strategy, which is we aren't looking for the most volume. We are not the company that you're going to-- If you want the company that's getting the most volume, you need to look somewhere else. We're going to be the company that gets the best volume, right? The best volume mix that can get us the highest income from operations dollars and margins. So I would certainly expect to see, as the economy continues to improve, I would certainly expect to see those volumes get better. Now, having said that, remember, in the second quarter, as Jim mentioned, we lost a couple of resi contracts that folks bid at prices that we weren't willing to go to.
We have our largest national account that, quite frankly, was a low single-digit margin. Someone came in and undercut the price on that, even though ours was low single-digit, we weren't going to go there. We said, "Look, we'd rather not have the work than have the volume." We lose that volume starting April 1. You'll see a little bit tougher comp in the second quarter. The good news is we lost that volume. It came with virtually no earnings. We'll take that trade-off every day. We now can redeploy those trucks to going out and getting higher margin business, which from an earnings point of view, will be accretive to us. Look, that's our deal, is that when we lose volumes, I'm not telling you we're 100% perfect, because we're not perfect by any stretch.
The intention is that when we lose volumes, we want to lose those volumes that are lower margin then take those assets that we freed up and go allocate those to higher margin business. That's how you get the best volumes rather than just the most volume.
Right. Your competition is telling us you are 100% perfect, David. I'll have to correct them on that, okay?
I wish we were, we've got a long way to go.
Right. Okay.
What I would tell you, Al, is my folks out in the field are perfect. I'm nowhere near.
Okay. That's probably what they were saying, sir. Fair enough. I appreciate that color. What about, maybe you don't want to share this given the nature of the call, but where are you seeing, I won't say the perfect volume or the incremental dollar volume that you want to get, but where are you focusing or where are we looking for the incremental volume to come from, even if on a net basis, you're down as a company.
Right. Again, you've got to look at it by line of business. What I would tell you is that on the landfill side, we're very comfortable with where we are, right? On the collections side, again, on the residential side, we all know what's going on there. It's a lot of capital that you've got to invest, and so we have to look at that purely from a return on capital point of view. So, we're not getting big contracts that are low return on capital. We certainly want to retain the contracts that we have. On the industrial side, I would tell you that generally, we're going to get better margins on permanent roll-off than we're going to get on temporary roll-off, and we'll allocate dollars there.
On the commercial side, look, there's a lot of volume to be had if you want to go after these large school districts, for example. We've had very little school district business because we see competitors coming in at $1 to $1.50 a yard, and we're just not going to go there. What I would tell you is that we know where the higher margin customers are, and that's where we're going to fish. We're not going to go fish just to put our cans out. We're not going to go take a school district at $1 a yard.
One addition there is that when you think about volume that we like, our energy services volume is volume that we like. It's been a good growth story for us. March was the strongest month from a revenue standpoint and from a margin standpoint, but particularly from a revenue standpoint, that we've ever had. We were up 25% year-over-year for the quarter, even with a little bit of weather impact there. It was awfully cold in North Dakota, and still with that, we saw 25% top line growth in that business. It's good business for us. In addition, we expect that EPA at some point will promulgate coal ash disposal standards, and we're well positioned there to help that industry manage its coal combustion byproducts. That will be good business for us as well.
Great. Thanks for that color, Jim. Just to clarify, though, where are those businesses being reported, by line of business or
Are you talking about energy services? That all flows just through our core business.
Through the industrial line on the collection side and generally through the special waste line on the landfill side.
All right. You brought up a good point about coal ash. Could you just give us an update on what your expectations are there on regulation and when do you expect to hear?
Yeah. I believe the EPA has a court order to issue something by the end of the year. We would expect that because we're well positioned, we would expect that sometime in the 2015, 2016 period, we'll start to see this materially move the needle.
Is that the relationship with utility customers and to the landfill and the expectation that this will be Subtitle D, this disposal? Or Subtitle C?
I don't think anybody believes it'll be Subtitle C, but there's a number of things that they're looking for, including beneficial reuse, including management of their own landfills. A number of them have landfills. We can help them manage their landfills. Then, of course, if they care to take it off site, we can obviously handle that as well.
Right. Okay, thanks. Finally, one question here. Your asset sale and the JV in China, I think would maybe prompt a question on international and David, what's the plan here in terms of maybe growth or a refocused organization in terms of outside of North America?
Yeah, look, I think you hit the nail on the head. The word would be refocused, right? When we went to China, we had a spectacular partner there. Shanghai Chengtou, the parent company, and Shanghai Environment Group, the subsidiary that we directly worked with, was a great partner. In fact, even though we took out our equity investment in China, we actually will continue working with them, providing technical services. We'll still provide them people over there. We just thought that it was a better use of our capital. The other thing about the Chinese market is that it's a fast-growing market, but it's also a very competitive market. We just thought that we could better redeploy the capital into our core business in the United States.
We still have a waste-to-energy project being built in the United Kingdom, we'd expect to continue to see growth in projects over there. Look, I think you hit the nail on the head. Where we're completely refocused is on our core solid waste business in North America, and we were pretty pleased to see the improvement. We got some good benefit from Wheelabrator in the quarter. They had a spectacular quarter. We all know that was driven primarily by electricity prices that are going to moderate as the weather warms up. We'll take that additional capital, we'll refocus on the core business, and as Jim said, we'll use that free cash flow to go off and buy some shares this year.
Just to follow up on that one, the cash that you get, are you allowed to repatriate that back here or does it need to be deployed?
Yes. No, we repatriated the full $155 million back here.
Thank you, guys.
Thank you.
Your next question comes from the line of Corey Greendale of First Analysis.
Hi, good morning.
Good morning.
I'll try to keep it relatively brief. I think you've talked in the past about having a bunch of analytics behind your pricing. I realize there's difference by customer and market. Can you just talk about how close you are in the field to what you believe the optimum is based on your analytics?
Yeah. Gosh, Corey, I would tell you we're nowhere close to the optimum. We have so many customers that they're spread out fairly quickly. I would say that if you look at it from a customer-by-customer basis, we're nowhere near the optimum. If you look at sort of the overall strategic implementation of the pricing plan is out in the field, our folks out in the field completely get it. Do we make mistakes? Look, we've made plenty of bids where we thought we were going to earn X, and we ended up earning Y. We're nowhere near perfect, but they all get what the strategy is, and frankly, they're doing a great job of implementing it.
To follow up on Al's question about kind of that price volume trade-off, I assume the optimum is not on a company-wide basis to have 10% yield and negative whatever it would be volume. At a high level, that we could see, how close are we to what you think the optimum is where you would still be growing, maximizing operating income? What would the price volume look like?
Yeah. If you look at a business environment that isn't growing, I would tell you that I think we're right about there, right? If we're going to see above 2% yield, it would be very difficult for us to have positive volumes. It's just the nature of that beast. If you believe that there's not going to be any volume growth ever again, then I would tell you we're pretty close to optimized. What we need to see in order to get to the optimization of the overall business is we need to see volume growth. We're seeing that volume growth in the landfill. That's encouraging. We're starting to see that growth get a little bit better despite the first quarter, I would say, on the industrial side. Commercial stubbornly remains sort of stuck in that -3% to 5% range.
Corey, I would add that as a matter of course, Jim Trevathan has monthly calls with all of the areas, and we regularly look at income from operations by line of business. We are assessing whether we've pushed too hard. We'll look at specific areas and a specific line of business within those areas and determine whether his income from operations declining in the face of very heavy price increase and very heavy volume loss. That, to us, would indicate that maybe we've reached that kind of point of diminishing returns. I would also add that we've seen very few of those. I don't know exactly where we are, but we've seen very few of those. There's a couple of them, but for the most part, we still think we have room there to move ahead on price.
Jim, I would add, we have a couple that are in question, but they're MSAs. They're not entire areas. They're not one of our 17 areas. It may be one MSA that we're taking a harder look at.
Okay. I appreciate it. Thank you.
Certainly.
Your next question comes from the line of Tony Bancroft of Gabelli & Company.
Hey, good morning, gentlemen. Thanks for taking my call. Just a quick question on back to the JV monetization. I know you're saying that you're getting out of China, but if there's a potential opportunity over there that looks good, would you potentially go back in to trying to grow more in China? What's your sort of long-term outlook with that?
Yeah. I think everybody has seen sort of a little bit of a moderation in what's going on in China from a growth perspective, right? 3 years ago, China was sort of the dot-com of its time. It was growing so fast. Obviously, we've all seen that growth moderate over the last few years. It's a great point. It's one of the reasons why I'm glad of 2 things. One, that we still have a great relationship with our joint venture partner. Two, we're going to be continuing to provide them service over there because that will give us not as big a toehold as we had when we were helping them build plants, but it'll still give us a little bit of toehold over there so that if there is an opportunity, we'll be able to spot it.
Now, I would tell you, I don't see any of that on the near-term horizon. With China being such a large part of the world economy, I think it would be foolish to say we never want to go back to China, and I'm actually glad that we're maintaining a relationship with our partner over there.
Got it. Thank you. Just sort of jump back to some prior questions about long-term growth in lines of businesses. In 5 years, where is sort of the next focus? Not so much on your organic operations and trying to fine-tune those. You've mentioned about Energy Waste doing so well. You're a huge asset owner in most of the basins. Do you have any thoughts on that? I know we've talked about it before, but maybe there's been quite a bit of growth recently. Is there any more focus on that?
Yeah. I think that clearly energy services is an area where we have some longer-term visibility. I wouldn't say that about maybe the overall macroeconomic climate. I couldn't tell you what the economy is going to do in the U.S. and the rest of North America past 2015.
Energy services sure looks like that is a growth engine, not only for the economy, but for us specifically for the next five to 10 years. We think energy services and environmental services are two of those growth areas that you've asked about.
Then, to dovetail onto that, look, energy services is all about fracking and energy, and natural gas pricing. That low natural gas pricing, as you can see, is going to drive $ billions of infrastructure investment in the chemical corridors and in other areas. It's going to generate a tremendous amount of M&I, manufacturing and industrial activity. We certainly think that when you look at the energy services, not only do you see the growth there, but you see the adjacent growth as people try to take advantage of low energy pricing.
Got it. Thank you. I guess just, I've got to ask, if that business grew large enough, is that something you want to maybe expose in your quarterly reporting or maybe even do something more like spin-off? Is there any strategic thoughts about that?
Yeah, well, we generally don't look at that until it reaches 10% of our revenue, I would love to be able to report it. It's a good business, high margin. My guess is that you're going to see great growth, you won't see that kind of growth where we'd say, "Okay, let's go split it off separately.
Okay. I appreciate it. Thank you so much.
Certainly.
Your final question comes from the line of Barbara Noverini of Morningstar.
Good morning, everybody.
Morning.
Morning.
Regarding recycling, I know that you've mentioned this a little in the past, but have you been successful in charging customers penalties? I suppose that's not a very customer-friendly term, so maybe I'll rephrase that. Have you been successful at increasing fees for contaminated recyclables, or is this more a matter of educating customers still to give you less of them at the get-go?
Yeah, it's a combination of both. We've done just that. Not all of our contracts allow us to do that, but where we've been allowed contractually to do that, we've done just that. Long term, you've hit the nail on the head. Long term, it is an education. We're all better off if the consumer knows how to separate it so that we don't have the contamination to begin with. The consumer doesn't want to be penalized, or the customer doesn't want to be penalized for contaminated loads, and we certainly don't want to have those higher operating costs from contaminated loads. The short-term solution is to say, "We're going to charge you." The long-term solution is to educate the consumers and our customers.
Barbara, I might add that, as Dave mentioned, not all of our contracts allow for that charge for contamination. As we renew contracts, we are absolutely adding it to contracts so we're protected, and also the customer is protected and know what to expect from our charges.
Got you. Would you be willing to share a percentage? How many of these contracts up for renewal actually accept the terms that allow for a surcharge or fee on these contaminants?
Well, I can tell you 100% of the ones that we renew.
That's very helpful, thanks.
I think we'd all be guessing if we told you what % have not allowed it. I'd be shocked, and you can follow up with Ed, and he'll follow up with our recycling folks. I would be shocked if a large customer did not allow some level of contamination clause into the contract.
Got it. Jim, as you work with your field teams to help them educate customers, are customers getting it, or is this still a challenge that you guys are working through? I would imagine that in some cases, some larger or even some smaller customers are just not really that quick on the uptake. What do you do with your field team to help move that process along?
The customer in this instance ranges from a sort of a small customer with a small business to a large national account to large municipalities. All customers are different. The large customers that make up the bulk of the fiber markets absolutely get it. They understand. They see what's going on with demand out of China. They see what's going on with commodity prices, and more importantly, they see what's going on with investment in recycling infrastructure, right? We're not investing in recycling infrastructure, and as far as we know, nobody is making big investments in new recycling infrastructure. They understand that if you're a large city or if you're a large national account, you've got to make this a long-term sustainable business model in order to drive the investment so that you can drive more recycling.
I think they absolutely understand that. Like anything, though, markets don't turn on a dime, right? It's going to take some time for that to seep through the market and see sort of a long-term systemic change in the way folks do business in recycling.
All right, sounds good. Thanks very much.
Thank you.
Thank you.
I will now turn the call back over to Mr. David Steiner for closing remarks.
Thank you all for joining us. We certainly want to thank all of our field employees who did a phenomenal job working through a challenging first quarter. I'm sure they all, like we, welcome the seasonal turn and the warmer weather throughout the United States, and we look forward to talking to you all on our second quarter conference call.
Thank you for participating in today's Waste Management conference call. This call will be available for replay beginning at 2:00 P.M. Eastern Standard Time today through 11:59 P.M. Eastern Standard Time on Friday, May 9th. The conference ID number for the replay is 10543459. Again, the conference ID number for the replay is 10543459. The number to dial for the replay is 1-800-585-8367 or 855-859-2056 or 1-404-537-3406. This concludes today's Waste Management conference call. You may now disconnect.