Good morning. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management First Quarter 2010 Earnings Release Conference Call. I will now turn the conference over to Mr. Jim Alderson, Director of Investor Relations.
Sir, you may begin.
Thank you, Tina. Good morning, everyone, and thank you for joining us for our Q1 20 10 earnings conference call. With me this morning are David Steinas, Chief Executive Officer Larry O'Donnell, President and Chief Operating Officer and Bob Simpson, Senior Vice President and Chief Financial Officer. David will start things off with a summary of a summary of the financial results for the quarter and a review of the details of our revenue growth, including price and volume trends. Larry will discuss operating costs and Bob will cover the financial statements.
We will conclude with questions and answers. During their statements, any comparisons made by David, Bob or Larry unless otherwise stated will be with the Q1 of 2019. Before we get started, me remind you that in addition to our press release that was issued this morning, we have filed a Form 8 ks that includes the press release as an attachment and is available on our website atwm.com. The Form 8 ks, the press release and the schedules for the release include important information that you should refer to. That is because David, Larry and Bob will discuss our results on an as adjusted basis.
Unless otherwise noted, all of the financial measures referenced information on all of our non GAAP measures that will be discussed on this morning's call and have reconciled them to the most comparable GAAP measures. And you can find that information in the schedules to the earnings press release and the Form 8 ks filed today, which can be found on the company's website at wm.com. Additionally, during the call, you will hear certain forward looking statements concerning our plans and expectations for Q2 and full year 2010. Actual results could differ materially from our plans and expectations. Certain factors related to future expectations are detailed in our press release this morning and our filings with the Securities and Exchange Commission, including Form 10 ks filed for 2,009.
This call is being recorded and will be available 24 hours a day beginning approximately 1 p. M. Eastern Time today until 5 p. M. Eastern Time on May 13.
To hear a replay of
the call over the Internet, access the Waste Management website at wm.com. To hear a telephonic replay of the call, dial 800 642-1687 and enter reservation code 6,471,13,577. 577. Time sensitive information given during the course of today's call, which is occurring on April 29, 2010 will no longer be accurate at the time of the replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Waste Management is prohibited.
Now I will turn the call over to Waste Management's CEO, David Steiner.
Thanks, Jim, and good morning from Houston. We earned $0.41 per share in the Q1, consistent with our full year expectations. We also saw some very positive signs in volumes as the quarter progressed. We performed solidly in the Q1 despite some headwinds. Winter weather was unusually severe in the 1st 2 months of this year, which adversely affected operations during the quarter.
The year over year impact of fuel surcharge revenues, was negative $0.02 per diluted share this quarter. And in the quarter, we had $0.01 of expense relating to the switch to stock options as part of our long term compensation plan. So we had a few headwinds in the quarter, but as the quarter progressed, saw some very positive trends that point to further volume improvements as the year progresses. And we still expect our volumes to turn positive in the second half of the year. Despite the impact of weather in the first quarter, revenue increased by $125,000,000 or 4.4 percent from the prior year period.
This is the first positive year over year revenue comparison since the Q3 of 2,008. Major drivers of our revenue improvement are
are the steady upward trend in recycling commodity
prices and year over year yield increases. Internal revenue growth from yield on our collection and disposal operations was 1.8% in the quarter. The decline in the consumer price index experienced in the second half of two thousand and nine impacted our yield in the first quarter. Annual price adjustments for most of our municipal Excluding the price impact associated with municipal and franchise contracts, which are primarily driven by CPI adjustments, internal revenue growth from yield would have been 2.5% for the quarter. CPI has increased to over 2% for the 1st 3 months of 2010 and many of our contracts adjust on July 1.
So CPI should not be as significant of a drag in the second half of the year. In addition, we raised our environmental fee from 6% to 7.5%. We're also focused on our normal price increase process. Each field management team has a specific pricing plan tailored to their customer base and designed to meet their area's 20 10 pricing goals. We remain committed to our pricing discipline.
And as I've stated previously, we've designed our our by 50 basis points in 2010. If we do not achieve the pricing targets, then no bonuses will be paid under the 20 10 annual incentive program. For the Q1, we did not meet our pricing gate. So unless we increase our pricing activity, there will be no bonuses paid in 20 10. As you can imagine, that has our managers focused on utilizing all of their pricing levers.
The combined internal revenue growth from yield in the industrial, commercial and residential lines of our collection business was 2.1% in the first quarter. Commercial and industrial yields were 2% and 2.6% respectively. The yield component of internal revenue growth in our residential line of business was 1.9%. New business pricing for the Q1 was strongest in our commercial line of business, increasing by over 9%. Our customer churn has been improving steadily since the Q1 of 2,009 and improved to 9.3% in the Q1 of 2010, the best performance we've seen since the Q4 of 2,006.
We monitor service increases, net of service decreases, because year and in the Q1 of 2010 it turned positive, which is the first time it's been positive since the Q3 of 2,008. On the volume side of the business, internal revenue growth from volume declined 4.9% in the quarter, a 150 basis point improvement from the Q4 of 2,009. Despite the weather impact in the Q1 of 2010, we're on track to meet our during the Q3 of 2009, Q1 2010 volumes have improved 400 basis points and the rate of volume decline has improved each quarter since Q3 of 2009. In our collection business, the recession resistant lines, namely commercial and residential collections, saw volume declines of 4.8% and 3% respectively. In our more economically sensitive industrial line of business, volumes were off 12.4%, a 300 basis point improvement compared with the Q4 of 2,009.
Despite lower volumes, we maintained our focus on industrial pricing, which resulted in revenue growth from yield of 2.6% for the quarter in the industrial line of business. Overall, we continued to expand our income from operations margin in the collection line of business, which increased by 40 basis points compared with the prior year period. In the landfill side of the business, 1st quarter 2,009 decline of 14.3%. Internal revenue growth from volume for special waste was positive 0.3 percent, which has dramatically improved compared with the 12.1% decrease experienced in the Q4 of 2,009. This is the first positive year over year volume comparison in special waste since the Q3 of 2,008.
For MSW, internal revenue growth from volume was negative 1 0.2%, improving from a decline of 5.1% in the Q4 of 2,009. Volumes were softest in our more economically sensitive C and D line, which was negative by 25.6%. On the pricing front, pricing was strongest in our MSW line with per unit pricing up by 3.6%. This pricing level is an improvement of 60 basis points compared with the Q4 of 2,009. As we built our forecast for volumes for the remainder of the year, we looked at volume trends during the Q1 and into the 1st few weeks of April.
What we've seen is steady sequential improvement in most of our business lines. On the industrial side of the business, Workday adjusted internal revenue growth from volume was negative 12.7% in January, but improved to negative 9.7% by March. On the MSW side, Workday adjusted volume was negative 2.4% in January and actually
turned
continue to see volume improvement. On the industrial side of the business, recent weekly volumes have surpassed prior year levels in the South and the East and almost reached prior year levels in the Midwest. On the land sale fill side of the business, we've seen some weeks where company wide average tonnage per day has exceeded prior year levels. These signs of improvement certainly bode well for the rest of the year. Increased commodity prices contributed about $0.06 of positive year over year earnings per diluted share in the Q1 of 2010, which is consistent with our expectations.
We continue to expect a year over year positive impact to earnings per diluted share from commodity prices of 0 point $4 to $0.08 per share. Virtually all of the benefit will occur during the 1st 2 quarters of the year. Our forecast equates to 30% higher average commodity pricing for the full year of 2010 compared with 2,009. So we saw a number of encouraging signs during the Q1 and we're confident that we can meet our full year earnings forecast of $2.09 to $2.13 per diluted share. I would note that our full year earnings per share guidance excludes the benefit of our recent settlement with SAP.
So in summary, we're quite pleased with our Q1 and we realize that our full year results will be driven by improving volumes, a renewed focus on pricing, improved commodity prices and our continued focus on operational excellence. And with that, I'll turn the call over to Larry.
Thank you, David, and good morning. I'll now review our operating quarter of 2010. Adjusting for the items noted in our press release, operating expenses in the Q1 of 2010 were $1,853,000,000 or 63.1 percent of revenue, compared with 1,000,000,007 $25,000,000,000 or 61.4 percent of revenue in the prior year period. While the negative volume trends we've seen over the last 18 months continued into the Q1, the rate of the volume decline is slowing significantly. Volumes in our more recession resistant lines of business, especially residential have held up the best.
Volumes in our more economically sensitive lines of business, primarily provides a very solid foundation because it's very stable, but it carries the lowest margins of all our collection lines of business. The landfill business carries some of our highest margins, but it's very difficult to flex down costs, especially labor as this line of business is less labor intensive than our collection line of business. We continue to see larger percentage volume declines at our landfills than in our residential line of business, which causes a change in our business mix. This change in mix has negatively impacted our margins as we lost more higher margin business than lower margin business. Mentioned, over the last few weeks, we've seen positive year over year landfill and roll off volumes in some of our groups.
As our landfill and roll off volumes rebound, we expect to see a positive impact
to
our overall operating margin. We will continue to work hard at aggressively flexing and eliminating costs and for the full year 2010, we expect margins to improve. As many of you are aware, one of the key financial components to our annual incentive plan is expansion of our income from operations margins as a percent of revenue. If we don't expand that margin in 2010 as compared to 2,009, we will not receive an incentive payout for that portion of the bonus plan. So you can be assured that everyone is working hard to find ways to control our costs
a
basis points as a percent of revenue in the quarter after adjusting for a $28,000,000 charge for the partial withdrawal of an funded Teamster Pension Plan. This improvement results primarily from reducing routes and reaction to the volume decline. This helped offset the wage increase for hourly employees that we implemented at the end of June 2000 about 394,000 hours in the Q1 by taking trucks off the road as volumes decline and using our routing tools to build more efficient routes. Cost of goods sold increased by $77,000,000 in the Q1 as a result of higher recycling commodity prices that increased our rebates to our customers. This negatively impacted our operating costs as a percent of revenue by 2 50 basis points.
Our direct fuel costs increased approximately $28,000,000 or about 80 basis points as a percent of revenue as a result of higher diesel fuel prices. The average price of diesel fuel increased by approximately $0.65 a gallon in the Q1 of this year compared to the same period last year. In direct fuel costs charged to us by our subcontract transfer station haulers also increased by approximately 4,000,000 Compared to the Q1 of 2019, fuel costs increased more than fuel surcharge revenues causing a 60 basis points decrease in our income from operations margin and a negative year over year impact to earnings of 0 point increase is due to higher remedial liability costs and higher weather related operating costs in the Q1 of this year. In addition, the Q1 of last year had a $10,000,000 favorable adjustment due to the higher due to the effect of higher rates on the estimated present value of our environmental remediation obligations. Overall, this increase in cost caused a 70 basis point decrease in our income from operations margin.
The discipline we've used to manage our costs as volumes have declined has put us in a position to leverage our cost structure as volumes turn positive. Coupled with the disciplined approach our team has shown in executing our pricing strategies, we remain confident that we will again make progress on expanding margins as well as our primary goals of generating strong free cash flow and growing earnings. And with that, I'll turn the call over to Bob.
Thank you, Larry. I will start by discussing our SG and A costs. These costs increased by $14,000,000 year over year to 351,000,000 dollars during the Q1 of 2010. This increase resulted primarily from additional costs related to our growth initiatives information technology expenses to upgrade outdated equipment and applications, both of which we discussed at our Investor Day in March. Our Our $1,000,000 Managing our receivables very closely remains
a high
priority. Depreciation and amortization expense for the Q1 of 2010 increased $3,000,000 when compared with the Q1 of 2019. This is primarily due to an increase in intangible amortization expense from acquisitions closed during the prior year. As a percent of revenue, depreciation and amortization expense was 9.9% compared with 10 0.3% in the prior year quarter. As anticipated, our interest expense net of interest income for the Q1 increased by 11,000,000 dollars compared with the prior year period, primarily due to interest on a $600,000,000 of senior notes we issued in November of 2,009.
Our debt to total capital ratio for the quarter is 57.4 percent below our target ratio of about 60%. The floating rate portion of our total debt portfolio was 21% at the end of the quarter. From the $600,000,000 of proceeds from the notes we issued in November, we paid $142,000,000 to purchase a 40 percent equity interest in the Shanghai Environment Group, a company focused on developing waste to energy plants in China. This transaction closed on March 23 this year. We expect to close today on the purchase of a waste to energy plant in Virginia, which will cost $150,000,000 In addition to the waste to energy investments, we have targeted $250,000,000 to 3 $50,000,000 for other business acquisitions and investments, of which we spent $80,000,000 in the Q1 of 2010.
I'd like to discuss our new electricity hedging program. Since 2,008, our 2,000 on a merchant basis. Today, we sell approximately 46% of our waste to energy power on a merchant basis and we expect this to increase to approximately 53% by the end of 2010. For our merchant energy stream, we have implemented a more actively managed hedging program to decrease the volatility of our electricity sales prices. We expect to have hedges in place on about 20% of our total annual energy stream for durations ranging from 60 days up to 9 months.
So our plan is to continue putting in place additional short term rolling hedges and when we see an opportunity to lock in portions of our portfolio longer term. Turning to cash flow. Q1 2010 net cash provided by operating activities was 496 $1,000,000 Our capital expenditures for the quarter were about $255,000,000 a decrease of $70,000,000
compared with the prior year period.
Our free cash flow for the quarter was $253,000,000 This is consistent with our previously discussed full year 20 10 guidance of approximately $1,200,000,000 for capital expenditures and a range of $1,200,000,000 to $1,300,000,000 for free cash flow. In the Q1, we paid $153,000,000 in dividends and we repurchased 100 $120,000,000 of our common stock. Our dividend yield is currently 3.5%. The good The good results that Waste Management has demonstrated in the Q1 can be accomplished only through the hard work of our employees and we thank them for their effort and
Our first question will come from the line of Hamzah Mazaria with Credit Suisse.
Thank you. Good morning. Just a couple of questions. On the volume side, you guys are looking for positive volumes in the second half. Could you comment on how much is just comps getting easier versus actual demand pickup?
Is it too early to say that you're seeing strong seasonality right now? Because usually you see that sort of at the end of May? And what are you seeing in customer churn in some of your markets as well?
Yes. We've certainly seen a bigger pickup this year than we did last year, which gives us some optimism that remember last year we pretty much didn't see much seasonality at all. So we're encouraged by the signs. You're absolutely right. It's hard to make a full call on it until you've seen April May volumes, but we're encouraged by what we see so far in April.
As far as customer churn goes, we've again, we saw the lowest customer churn that we've seen in a couple of years and it's not particularly surprising to us, but as we've gone and put out our annual price increases as we've raised the environmental fee from 6% to 7.5%. We haven't seen it significantly affect churn.
Got you. And then the market longer term? Because you're spending more money there, to the market longer term because you're spending more money there as that business becomes bigger as part of your what your thoughts are there.
Do you want more exposure
to the what your thoughts are there. Do you want more exposure to the market longer term? Is sort of the 40 6% market exposure sort of what you're looking for? Or do you want it lower? Just curious to see how you think about that.
Yes. The Sipsa plant that we're closing on today is basically 50% merchant and 50% fixed. But the investment we made in China is 100% fixed because you'll sign 25 year electricity contracts. The bids that we're making in Europe are mostly fixed price contracts for 20 year terms, 10 to 20 year terms. So what that will is it will drive our portfolio to more fixed price than floating price.
Okay. And then just last question on your operating expenses. It seems like you've got some growth expenditure baked in there. Could you quantify that at all? And then your commodity rebates, is there some opportunity there to make those more favorable longer term?
Should we take your current operating expense run rate and SG and A? Is that going to be sequentially higher or flat going forward? Just some color there would be appreciated. Thank you.
Yes. On some of those investments we're making, it was probably about a $0.02 impact. We think those are going to be the investments that are going to pay off for us in the future to be able to deliver the type of things that our customers are going to be requiring in terms of services. And we just announced, as you saw at Investor Day, our Baxter products. So some of those we hope to start seeing some payback very soon.
And Hans, on SG and A expenses, we talked about it at Investor Day. What we said at Investor Day is what we think will happen for this year, which is basically as a percent of revenue flat to last year. But over the longer term, our goal is to get the SG and A cost down to 9% of revenue and just by growing revenue, but to actually get cost down. We need some help on the technology side to do that and we expect to get it. And so that's where we're shooting for.
Okay. Fair enough. Thank you.
All right.
Thanks, Tom. Thanks, Tom.
Our next question will come from
the line of Jonathan Ellis with Bank of America.
Thanks. Good morning, guys. Hi, John. Just first off on landfill pricing, you gave the MSW figure. Can you tell us what overall landfill pricing was?
And was there any implications for mix this quarter in terms of that pricing figure?
Yes. There's always implication in mix and we talked about special waste being positive in volume for the first time in a long time. That was also the special waste was also negative in pricing by 1.7%. So overall, landfill pricing was basically flat for the quarter.
Okay, And then just in terms of the environmental fee, was there any impact in the quarter or should we assume that the impact is really going to be in the second through 4th quarters? And also a related question is what portion of the revenue base is the environmental fee applied to now?
Yes, there was no impact from the increase in the environmental fee in the Q1 that went out with April billings. And so we'll see the impact of that as we go through the year.
Okay, great. And then just if we talk a little bit about the CPI adjustments, can you help us understand what and you mentioned where CPI is now, but for the adjustments on contracts in the Q1 and presumably that will impact the second quarter as well, what is the average CPI that's being applied to those contracts?
Yes, the average CPI, as we talked about it, some of them are negative, some of them are positive. We haven't gone back to check on the average. My guess is the average is well below 1%.
Okay. Should we assume though that on a full year basis that you're still committed to the previous guidance of 1% to 2 percent price growth in index based contracts?
Absolutely.
Okay, great. Just couple of quick questions, if I may. Just on the waste energy business this quarter, I noticed that the downside in terms of electricity pricing was offset by increase in disposal pricing. And it seemed to be a pretty material increase, I think about 7.5% price growth for waste energy disposal. Anything that you're doing on the disposal side in the waste energy business to help to cushion some of the electricity volatility?
Well, if a couple of contracts came up, we were able to renegotiate the disposal side of the equation to mostly offset the impact of that contract. That's why we didn't really mention it as a headwind this year. It's pretty much an offset in this quarter. Now we our guidance is 0 point 0 $1 to $0.03 negative in electricity in the first half of this year offset by 0 point 0 $1 to 0 point 0 $3 positive in the second half, net net flat for the year and this is perfectly consistent with that. Okay, great.
Energy plant that you're closing on.
Is that included in your
really nothing this year
because we really nothing this year because we've got some expenses that we come out of the gate with to improve the plant. So for this year, there's basically no benefit from the
plant. Great. Thanks guys.
Thanks, John.
Thank you.
Our next question will come from
the line of Scott Levine with JPMorgan.
Following up on the question on Cipsa, so is your expectation there that that will be accretive in 2011 or is there anything that you can talk about to give us a sense of how that might impact results going forward?
Yes, we do expect it to be accretive in 2011. We haven't given guidance yet on what that exactly will be, but it'll be more than a penny. But beyond that, we'll wait till later to just talk about it.
Okay, great.
And following up on the pricing question, are you guys effectively affirming the 10, which I think was 2.5% to 3% positive?
Yes. What we've always said is that we want to get 50 basis points to 100 basis points above CPI and that regardless of what CPI is, we're going to get 2% yield. Obviously, the 1.8% that we got in the Q1 didn't meet that hurdle. That's why we've made sure that we went back and reinvigorated the pricing programs with our field. And again, as I mentioned in the script, if we don't meet the yield gate for the year, nobody gets a bonus in this company.
So you can bet that folks are focused on getting there. Now obviously, the CPI is going to create a headwind to our overall guidance of 2.5% to 3%. But if we see CPI pick up like we expect it, we certainly hope to get to that number.
Understood. Thanks. One last one on the weather. Did you guys indicate or can you quantify how much of an EPS impact weather was? And did that show up more in the volumes or in the cost?
It was in both. And we haven't given a number on that. 2,003 we gave a number and it's a real difficult item to quantify with any precision. It was at least what we did in 2,003. And the thing is when revenue comes back in March, is it because revenue goes up in March, is it because of the weather?
Or is it because of just economic improvement? It's just hard to know. So we chose to not give a specific number on that.
Okay, understood. Thanks guys.
Our next question will come from the line of Vance Edelson with Morgan Stanley.
Good morning. Hi.
Thanks a lot for taking the questions. On that last point, with the pricing gates not being met of late, were there any factors beyond CPI that you could point to? And did it have anything to do with the bar just being set a bit high in order to drive the team to perform?
Yes. No, I think you're exactly right. It has to do with setting the bar high. Look, every year when we come into our pricing year, we recognize that we've got things that we've got to improve on to lap. In other words, the environmental fee went up from 4.8% to 6% last and we knew that that's a headwind to yield.
So that means we've got to go out and be more vigorous on our commercial price increases. And that's where the bulk of the dollars comes from. So this year, we when we saw the remember we talked about it at Investor Day that we saw sort of the end of 2,008 start to go down in pricing. We made sure that when we looked at our went back and looked at our commercial price increase program that we put in higher price increases earlier in the year. So you need to do that in order to lap the headwinds that you have.
You need to do things like higher commercial price increases. You need to do things like raising your landfill pricing. You need to do things like having higher new business pricing. So as we've talked about many times and I think you all saw on Investor Day, there's a lot pricing levers that you can pull and you just got to go pull every one of them if you're going to make up for the headwinds of what you did last year, right?
Okay. That makes sense. And there was a comment on the Iron Mountain call this morning about their relationship with to sell their recycled paper. Would you characterize that as one of many arrangements that you have to drive your recycling volumes higher? And are there more wholesale opportunities like that with hopefully nationwide partners?
We're working with all the big players out there and looking to grow that business and so we can utilize the capacity that we have. So that's something we continue to be focused on.
And maybe just one more question. Could you comment on the nature of the tuck in acquisitions? Is this mainly contiguous geographies? And would you expect the rate of tuck in acquisitions to kind of continue at a similar rate the rest of the year?
Well, our expectation is to spend as much as $350,000,000 And typically, a typical tuck in is continuous geographies or within a geography where we already have some routes. Some of the acquisitions we did were also though in the recycling line of business, where we used to we're able to get into new markets more quickly like for example the Houston, San Antonio and Dallas markets from an acquisition we did earlier this year that allow us to get single stream capability throughout Texas, the first to be able to do that. So that's the kind of those will be the kind of acquisitions we're talking about. Yes.
But certainly the bulk
of the acquisitions are going to be exactly as you described, tuck in, staple on acquisition.
Okay. It. And on Shanghai, I may have missed it, but any update as to when that might begin to bear fruit or is that
to see is already in our guidance. We'll look then as they can if that business continues to grow, we'll see more and more benefit from it as time goes on. So it's definitely something we'll see some profits from when it comes through. Now remember, this will go through income. So you won't see it in the income from operations line, it will go through other income.
Okay, got it. All right.
Thanks a lot guys.
Thanks, Dan. Thank you.
Our next question will come from the line of Alker Chalk with Wedbush Securities.
Good morning, Alker. Good morning, guys.
Good morning.
Just to hammer the price question again. It was my understanding that on the contracts that there was not you were protected somewhat on the floor from a negative pricing impact. Obviously, that's a misunderstanding on my part, but could you comment on that? Is that something to consider
do contracts and they range all over the board. So some of them do have protection, many of them don't. That's one of the things that it's interesting in this economic downturn, I think this whole industry has learned quite a bit. So for example, when we saw the recycling commodity prices fall off the face of the earth, we restructured the contracts to say, okay, if that ever happens again, we need to make sure that we're protected on the downside. I think when you're doing municipal contracts in a 3% to 5% CPI environment, you're probably not thinking about negative CPI.
But again, that's another lesson learned that now as we do municipal contracts, we need to make sure that we provide in there that we do set a floor so that we don't go backwards if there's negative CPI. So I think that's the lessons we've got to take out of this downturn. Obviously, they hurt us a little bit today, but in the future, we need to make sure it doesn't happen again.
Would it be difficult to contribute what your exposure still may be or have you looked at that? Is it something you're willing to share in terms of expectations? Again, I appreciate that there's a think you're at in terms of the exposure and what's left that could potentially if we hang out here at a flat CPI number?
Yes. Well, obviously, we won't see the most of the contracts that we have are going to renew pricing on July 1, and
we certainly won't see flat CPI for that
with CPI running at 2% right now. Negative between now and July 1. Okay. If I may switch to the back to negative between now July 1.
Okay. If I may switch to the collection business, I know there was a fair amount of commentary that everybody provided, but the collection business seemed to be pretty strong, at least relative to my expectations. And so, is that a function of the assessment of your customer base getting additional volumes now on customers where you can see incremental revenue from or is it just a function of the easy comp?
Yes. When we look at the indicators, for example, pounds per yard, when we look at service increases and service decreases, that gives us the indicators that show whether it's economic or not. And we certainly think that it is driven by more business. Now look, there's it's also comps. I mean, it's more business than what had last year, which is still less business than what they had 2 years ago.
So it's certainly driven by both. But the indicators that we see that we look at for economic activity have been virtually all positive for the last couple of months.
And finally, if I may, and I know Larry provided a lot of the one time charges or explanations on some of these expenses, but it seems like the the margins were a little bit soft, certainly from our expectations. And I was wondering if you could comment relative to your own internal expectations, if that was the case?
Well, we did see our income from operations margin improve in our collection business overall. We did see a negative impact at the landfills just as we've been talking about. It's really hard to flex down the cost at a landfill. You just don't have as many levers available to you. You don't have many people out there.
And in terms of trying to reduce hours or you're not going to have the landfill just open for half a day, because the volumes come in throughout the day. So it really is a challenge at the landfill and we certainly expect as we see volumes rebound that we're going to see the reverse. That will enable us to see some increasing margins and those are our highest margin businesses as I described. The mix should help us as volumes turn around and go the other way.
And sorry, Larry, what was change in mix of the drop off in the higher margin business would have been which components?
Well, the landfill is going to be the biggest component. That's the biggest driver of the decrease in margin. And then we also had the impact from our energy prices.
When you look at the IRG impact, just to give you the numbers, if you look at the total collection line of business, it was only down 4.9%. When you look at the total landfill business, it's down 7.5%. So you've got 2 60 basis points of difference right there.
Our next question will come from the line of Bill Fisher with Raymond James.
Good morning,
Bill. Thank
you. Just on the diesel prices with those moving up in the Q1, do you see that being a catalyst at all for raising MSW landfill prices, particularly on your sites that are closer into the markets?
Well, we continue to look at the landfill as a place that we ought to be impacting our pricing. And that's something not just driven by increased diesel fuel prices. It's something that we need to do. And that's something I can assure you the whole team is focused
I guess, I was just talking about the haulers would have more cost going
through there.
Right, your transportation costs. Yes.
Okay.
Yes. I mean, when we look at pricing, it's a function you've got the nail right on the head. It's a function of the tip fee plus the transportation costs. And so as the transportation costs go up, the closer in network is benefited and we think we have the best close in network in the business.
Okay. Thanks. And then on the special waste, obviously, you said it was up slightly this quarter. Is the bid activity picking up there as you look into Q2, Q3 versus where you've of seen it recently?
Yes, we're pretty much hearing that they don't think it's just a one time blip in special waste that there's a pretty healthy pipeline out there as projects pick up, as the economic stimulus starts to take effect, what we're hearing. We've always said that our business sort of lags the general economy by 6 months and I think that's an indicator that that's the case. And so as the economic activity China joint venture is that you mentioned SEPSA
wouldn't be accretive this year, but would
China be slightly
accretive coming out of the box? Well, both of them, this year, but would China be slightly accretive coming out of the box?
Well, both of them actually are slightly accretive. Cipso will be accretive this year. It's just a pretty small number. And China will be accretive at probably twice of what Cipso will be.
Okay, great. Thank you.
Thanks. Thank you. Thanks, Phil.
Our next question will come from the line of Alex Afshay with Goldman Sachs.
Thanks. Good morning. Good morning.
Good morning.
Good morning. Just
a question on the guidance. In the second half of twenty ten when volumes are expected to begin to show year over year improvement, can you share with us what you're assuming for incremental margins on the volumes growth?
We went through that in the at the Investor Day Alex and I think that model still works will work well for you. It certainly works for us.
Okay. We've got
a little model in there that I think will help you with that.
Okay. That's helpful. And then just as we think about the incremental margins, once volumes begin to once the volumes recovery begins to take hold, how do you see that them changing if at all relative to margins when volumes just begin to recover?
I didn't follow Alex, forgive me that again.
So as the volumes recovery takes hold, do you anticipate incremental margins changing at all?
We expect margins well, at some point they do and this is a question we got at Investor Day as well. And at some point they do the incremental margin benefit you get will be impacted by the need to add more costs, for example. And then it's a stair stepping arrangement really. And we didn't give a number on that. I don't think that that's something
that But we're looking forward to the opportunity to see it happen. Yes, absolutely.
Fair enough. Fair enough. And I just want to just ask one question on the pricing side as volumes come back as you said, you look forward to seeing. Do you think there'll be a greater opportunity to raise prices on the non
capacity in the industry starts getting taken out because volumes are going up, that's going to give you that opportunity, absolutely. And that's we talked about it that when we first started our pricing programs many years ago, we talked about the fact that, for example, in the roll off line of business, can. And that prices before you run out of can. And that's how I feel about the economic upturn right now. We're not going to wait for the economic upturn to start raising prices as capacity gets taken out.
We've got to get ahead of that game and make sure that we're taking advantage of it even before the volumes pick up. So again, you can be assured that everybody in this business, in this company is laser focused on pricing right now.
Great. Thank you very much for taking my questions.
Thanks, Alex. Thank you.
Our next question will come from the line of Michael Hoffman with WSI.
Good morning, Michael.
Good morning, all. Can you I hate to come back to price and beat this horse to death, but can we walk through the components that front end loader is up, if you tell a percentage that would be great, but front end loader is up, residential is flat to slightly down, industrial is
Are you talking pricing, Michael?
Yes. To add I'm trying to think of the pieces that you put together and I get to 1.7, what's up, what's down across the mix?
Yes, basically every line in the collection business is up, commercial at 2%, industrial 2.6%, residential 1.9%. And so what you see is the overall collection business was 2.1%. That gets dragged down a little bit. As I said, landfill pricing was basically flat, but it was negative 0.2%. And so you start to see the where you saw the drag a little bit was at the landfill.
Okay. So that takes me to the next piece. The landfill volumes that you report, 20 2,000,000 in December go to $20,000,000 in January or in March, that's a bigger than normal dip seasonally. So how much of the weather impacted that?
Yes, it's really not a dramatically different dip than what we've seen over the last few years, but certainly weather played a part in that this year.
But it's definitely bigger than normal. I mean, I get that there's a seasonal dip there,
but that's it's so I'm
trying to understand how much of
that's just the weather versus something
else dip was about 13%. And obviously, that was more economy. Last year, the sequential dip was about 13% and obviously that was more economy last year. The year before that it was about 8.5%. And so it's not dramatically different, but certainly weather did play an effect there.
Okay. So when you look at March and then April year over year kind of what's happening on a volume basis because you get that data every single day. How does that start to trend relative to the pattern?
Yes. I mean, frankly, what we're seeing this year is different than what we saw last year. Last year, we just didn't see the seasonal uptick. We think if you just look at our volume reports, we're seeing the beginnings
of a seasonal uptick.
As I said earlier, you can't really make the call on that until you're into sort of the May, early June timeframe. But we're optimistic that what we're seeing is more of a normal seasonal uptick than what we saw last year.
When you think about your landfill business, when do you think the landfills go to 0 volume on a comparative basis as you look at the trend in
the business at this point?
Yes. Michael, it really you really have to take it apart and look at it component by component, right? So as we said, special weights is already flat. MSW in March was already positive. And so the big drags that we have are in C and D and revenue generating cover.
I mean those are the big drags. So once we get that C and D volume, not negative 25%, but we can absorb a negative 5% to 10% as we the landfill, that's the biggest economic indicator C and D volumes. And so, the landfill, that's the biggest economic indicator, C and D volumes. And so we'll see MSW in special waste go positive and I think stay positive for the remainder of the year. The question is, when are we going to see some improvement in that C and D volume?
Okay. Bob, on the working capital, there's generally a pattern of slight negative in the Q1, at least as I look back over multiple years. And this year, it's neutral to positive. So is that DSO improvement a permanent improvement or is that something that was how do I think about that?
Well, it's incremental, right? And we don't expect to give it back. So I would expect it to be what we get today, we'll keep today and try to get more tomorrow. We still our DSOs are still at the 42 day level. So we still have a room for improvement there.
Okay. So as you factor that plus the SAP settlement into the free cash flow analysis, I mean just taking the SAP award, that puts me at the upper end of your free cash flow plus this improvement in DSO.
Yes. Michael, the DSO improvements in the math, right? We expected to get that and we continue to expect to push that. With respect to the litigation settlement item that we talked about today or actually that we've highlighted in the footnotes and I think what you can say there is that, we'll relatively recent. We'll work through the math on that and update our guidance on
second quarter call.
Okay. And then capital spending in the quarter, how much of that was impacted by the weather just delaying activity because it's just a little bit lower than I thought it was going to be?
Michael, it really wasn't. There was, but we made up for it, I guess. I mean, there's what was going to happen in February probably didn't happen until March. The spending we had was actually pretty much what we typically spend in the Q1 typically. What's different this year is the carryover from last year.
You may recall that at the end of the Q4, with its Q4, we ended up not accruing as much at the end in the Q4 as we did the year before. And so we had less carryover to pay for in the first quarter. So that really is the difference.
Okay. That helps. And then on the churn, when you look at the 9.3%, which is a terrific number, how is that splitting up now between that which you can control and that which you can't? I mean, the thing you can't control is somebody closes a business and moves the
about what it's run over the past few years, which is sort of the fifty-fifty split between controllable what we call controllable and uncontrollable churn.
Okay. But the good part of that is that the closing of your business whether it's a bankruptcy or moving to a bigger place, that's coming down too?
Yes, absolutely right. So that's a huge indicator as well? Absolutely right, sure.
Okay. And then on the recycling, help me understand the rebate trend as I look forward. So I get the pressure in this quarter, but what you're doing going to improve that so I get a little less pressure on margins or am I looking at that pressure as a permanent part of the model if the prices stay where they are?
Well, our rebate structure, if you compare year over year, it was certainly the rebates we paid out last year were low because of the commodity prices were so low. So you have seen our rebate, the amount that we paid go up, you saw in cost of goods sold because the commodity prices have come up. And you'll continue to see that as long as commodity prices are higher than they were last year, you're going to see that impact in our cost of goods sold.
Well, I apologize. I didn't ask that question very clearly. If I understood what I thought was the mix of when you get to a certain level, how much you got to give back, it just seemed like the rebate seemed a little higher than I would have expected as the rates were rising. I mean, I get that rebates in absolute dollars are going to be up. I'm just trying to figure out on 7,000,000 tonnes, what your exposure on rebates are.
Did that something change year over year on the exposure rebates as a percentage of the rising price?
Well, a couple of things have changed. One is, on the downside, we're going to make sure that we are going to be covered on our we're going to we've sort of ensured we get our processing costs covered. And then we typically have a sharing of the commodity prices after that, anywhere from eightytwenty, seventy 30 something like that in that range. Now that's on that's at the MRF. When you look at the brokerage side, those averages tend to be we keep about maybe 3% to 4% there.
So as have more brokerage, it's going to make it it's going to make that overall mix move to where it looks like we're paying out higher rebates. Does that make sense?
I think so, but maybe I'll follow-up.
Yes. In other words, Michael, you can't look at the increase in recycling revenue and figure that it all comes from processing processing rebates. A good portion of that also comes from brokerage rebates, which are much lower than the processing
rebate. So it's
a mix issue.
Okay.
So it's hard to predict basically
is what I'm hearing, because the mix between brokerage and processing conditions.
It depends on where the volume comes in.
Right, okay. Lastly, the fuel surcharge, just for clarity on my part, the $28,000,000 that you've identified is exposure to not having had enough surcharge offset and that if you continue to press your surcharges through the course of the year, basically make that up in some later quarter.
Yes, the $28,000,000 is the direct fuel cost increase.
Now we did get $13,000,000 of that back through fuel surcharge, but you're correct. The way it works is that, as you know, it lags as the fuel prices go up and down relatively quickly, but it is designed to get it all back. So you would expect us to get that back in the coming quarters. Right. And so you couldn't have predicted the rate at which the price is going to go up when you're giving your guidance.
So I think I've is going to go
up when you're giving your guidance. So I think I've got a couple of pennies of play here then as a result of the success of your surcharge for the remainder of the year?
Well, Michael, there's always ins and outs every quarter, but yes, that's
Okay. I just want to make sure I understood it correctly. All right. Well, terrific free cash flow folks.
Hope you keep it up.
All right. Thank you, Michael. Thank you, Michael.
And I would now like to turn the call back to Mr. David Steiner for closing remarks.
Thank you. Well, as you all can tell from what we've been saying, we're very pleased with the Q1, but we're also very pleased the volume trends and the other business events that occurred in April. And so we look forward to talking to everyone on our 2nd quarter conference call. Thank you.
Thank you for participating in today's Waste Management First Quarter 20 10 Earnings Release Conference Call. This will be available for replay beginning at noon Central Time today, April 29, 2010 through 11 59 pm Eastern Time on Thursday, May 13, 2010. The conference ID number for the replay is 6,471,137. Again, the conference ID number for the replay is 6,407,137. The 577.
The number to dial for the replay is 1-eight hundred-six forty two-six 87 or 1-seven zero six-six forty five-nine thousand two hundred and ninety one. Thank you. Have a good day.