Good morning. My name is Dennis, I will be your conference operator today. At this time, I would like to welcome everyone to the Waste Management National Services first quarter 2017 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 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the call over to Mr. Ed Egl, Director of Investor Relations. Please go ahead, sir.
Thank you, Dennis. Good morning, everyone, thank you for joining us for our first quarter 2017 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer, Jim Trevathan, Executive Vice President and Chief Operating Officer, and Devina Rankin, Senior Vice President, Chief Financial Officer, and Treasurer. You will hear prepared comments from each of them today. Jim Fish will cover high-level financials and provide a strategic overview. Jim Trevathan will cover price and volume details and provide an operating overview, Devina will cover the details of the financials. 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. Jim and Jim will discuss our results in the areas of yield and volume, which, unless stated otherwise, are more specifically references to internal revenue growth, or IRG, from yield or volume. During the call, Jim, and Devina will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share. They'll also address operating EBITDA and operating EBITDA margin as defined in the earnings press release. Any comparisons, unless otherwise stated, will be with the first quarter of 2016.
The first quarter of 2017 results have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations. These adjusted 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 reconciliations 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 10th. 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 94449507.
Time-sensitive information provided during today's call, which is occurring on April 26th, 2017, 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 CEO, Jim Fish.
Thanks, Ed, and thank you all for joining us this morning. 2017 is off to a terrific start. Our strong first quarter results continue to demonstrate the effectiveness of our strategy of improving core price, adding profitable volume in a disciplined manner, and controlling costs as we met or exceeded all our internal targets. In the first quarter, we saw revenue grow by more than 8%. Operating income grew by 10%, and operating EBITDA grew 8%. Our operations produced $0.66 of earnings per share in the first quarter, despite a $0.02 impact from executive severance, which was an increase of almost 14% when compared to the first quarter of 2016. We've built a strong foundation and have the momentum to continue to generate growth throughout the remainder of 2017. In the first quarter, our revenues grew by more than $260 million, or 8.3%.
Almost all of this increase was organically driven. Our first quarter revenue was the largest organic growth we've generated in over a decade. One of the drivers of our success was the disciplined execution of our pricing programs. In the first quarter, our collection and disposal core price was 5.1%, and our yield was 2%. Looking at volumes, our traditional solid waste volumes were positive 1.9% in the first quarter. We've been keenly focused on delivering excellent customer service and directing our sales efforts and growth capital on the portions of the U.S. economy that are seeing the strongest economic development. In the last five quarters, we've seen these efforts result in volume growth that is generating strong incremental earnings and cash flow. Jim will discuss our customer service focus in more detail, but we continue to see improvements in our churn, which finished the quarter at 8.3%.
That's the lowest number we've seen since 2002. In addition to the strong solid waste core price and volume, recycling commodity prices added over $110 million to our revenue growth in the quarter. This revenue growth was the primary driver of our year-over-year increase in the earnings of our recycling business, which contributed about $0.065 of earnings per share to the quarter. In the past We've discussed the volatility that market prices for commodities create in our recycling business, and it appears that 2017 will be an even more volatile year than we anticipated. In the first quarter, we saw recycling commodity prices up almost 70% at our recycling facilities. Yet, in the beginning of the second quarter, we've seen those prices drop significantly.
Due to this commodity price volatility, we're leaving our guidance for the recycling business unchanged, though the bias is to the upside, and that should become clearer after the second quarter. Although this is a line of business that's more difficult to forecast, recycling is a service that our customers want, and we remain committed to it. We will continue to optimize recycling to ensure we generate the returns our shareholders expect, whether commodity prices are high or low. Looking at cash flow in the quarter, once again, our strong operating EBITDA performance drove our free cash flow. We anticipated that our first quarter cash flow results would be lower than the prior year due to a couple of unusual items that Devina will discuss.
We exceeded our internal expectations and remain confident that we can achieve our full year guidance of between $1.5 billion and $1.6 billion. Our preference after paying our dividend is still to use free cash flow to acquire accretive businesses at a reasonable purchase price. We continue to diligently identify attractive acquisition targets. Our strategy continues to deliver value to our shareholders, and we will not deviate from improving price, obtaining profitable volumes, and reducing costs through continuous improvement to generate strong cash flow. In addition to these core fundamentals, we will stay focused on attracting and retaining the best team in the industry, safely providing superior customer service and differentiation through technology. When it comes to our employees, we're focused on identifying and developing our future leaders. Since November, we've promoted three high-performing team members into open area vice president roles.
You've also heard us talk about technology as a key strategic pillar for our long-term success. We expect to name a chief technology officer this year to lead our talented team as we further develop solutions that enhance the ease of our customer interaction and improve the efficiency of providing that service. This includes rolling out a new wm.com for our customers and using big data across multiple disciplines to improve the business. As part of our long-term strategy to grow profitable volumes, we want to be the premier waste service provider for all customers, large and small. Recently, two very large customers, New York City and the City of Los Angeles, have decided to partner with us to serve significant portions of their city's long-term needs.
We're excited to be positioned to dedicate both the human and financial capital required to serve these two cities, and we look forward to delivering excellent customer service to them for the next two decades. To sum it up, we've set the bar high with our solid first quarter results, and we're confident in our ability to deliver strong performance through the remainder of 2017 and beyond. We're reaffirming our full year EPS guidance of between $3.14 and $3.18, and our full-year free cash flow guidance of $1.5 billion to $1.6 billion. With that, I'll now turn the call over to Jim to discuss our first quarter operating results in more detail.
Thanks, Jim, and good morning. Our revenue growth in the first quarter of 2017 reflected the continuation of the strong execution of our price, customer service, and discipline growth strategies that we saw throughout 2016. Revenues in the quarter were $3.44 billion, an increase of $264 million or 8.3% when compared to the first quarter of 2016. First quarter revenue growth in our collection and disposal business from the combined impact of price and volume was $113 million. First quarter revenues also benefited from higher recycling commodity prices, which drove a $111 million increase in recycling revenues. Fuel surcharges and foreign currency fluctuations increased $25 million, and acquisitions also increased revenues for the quarter by $12 million. Looking at internal revenue growth in the first quarter, our collection and disposal core price was 5.1%, consistent with the fourth quarter of 2016, and yield was 2%.
Both total volumes and traditional solid waste volumes improved 1.9%. On a workday-adjusted basis, total volumes and traditional solid waste volumes were 1.4%. Our continued focus on customer service is having a positive impact on volumes as we achieve the lowest churn since the third quarter of 2002 at 8.3%, an improvement of 90 basis points from the first quarter of 2016. Our field collection, call centers, sales, and technology teams are aligned around improving service to our customers in a world-class manner, and our results demonstrate this alignment. We also saw service increases exceeding service decreases for the 13th consecutive quarter, supporting continued commercial volume growth. Price rollbacks improved 60 basis points compared to the first quarter of 2016. The combined positive price and positive volume led to total company income from operations growing $50 million.
Operating income margin expanding 20 basis points to 16.2%, and operating EBITDA growing $66 million. Our collection lines of business continued to perform exceptionally well. In the first quarter, commercial core price was 7.9%, with volumes up 2.5%, a 50 basis point improvement from the fourth quarter. Industrial core price was 9.7%, with volume up 2.7% in the first quarter, up 170 basis points from the growth that we saw in the fourth quarter of 2016. In the residential line of business, core price was 2.6%. Residential volumes were down 1.9% in the first quarter, but that is a 70 basis point sequential improvement from the fourth quarter of 2016. The combined price and volume increases in our collection line of business led to income from operations growing $29 million, and operating EBITDA growing $33 million. In the landfill line of business, total volumes increased 3.7%.
MSW volumes grew 6.8%, C&D volume grew 18.9%, and combined special waste and revenue generating cover volumes grew about 1%. We achieved core price of 2.1% in the landfill line of business. As Jim mentioned, our recycling business exceeded our expectations in the first quarter, primarily driven by a 70% increase in recycled commodity prices at our recycling facilities. Our recycling operations increased EPS by $0.0660 when compared to the first quarter of 2016. Most of the increase in EPS, or $0.0550, was driven by improved commodity prices. The remaining $0.011 was due to renegotiating contract terms and improvements in operating costs, which directly aligns with our recycling strategy to reduce risk and improve the recycling business model.
While these results are higher than we anticipated in the first quarter, in April, we have seen export prices decline between $50 and $75 per ton, depending on the specific commodity. Given this volatility, we will wait until later in the year to provide any full-year change to our recycling guidance. Moving now to operating expenses. In the first quarter, total operating cost increased $173 million when compared with the first quarter of 2016. The cost increases were largely related to higher recycled commodity rebates to our customers, increased labor costs due to growing volumes and rising fuel expenses. Fuel negatively impacted our EPS by about $0.02 from the combination of our fuel surcharge not yet catching up with the increased fuel cost and the absence of a CNG fuel tax credit.
Our operating expenses as a % of revenue increased 20 basis points from 62.8% in the first quarter of 2016 to 63% in the first quarter of 2017. The combined cost of recycling rebates and higher fuel expenses increased almost 200 basis points as a % of revenue. However, through efficiency gains and cost control efforts, we were able to offset 180 of almost 200 basis point increase in the commodity base cost in the quarter. Labor and transfer and disposal cost each improved 50 basis points as a % of revenue, while risk management and subcontractor cost each improved 30 basis points. Our employees have done a good job at managing our controllable costs as volumes have increased, which is demonstrated by eight consecutive quarters of productivity improvement in our collection lines of business. Overall, we are very pleased with our collection and disposal operations.
They continue to contribute to the growth in our operating EBITDA, adding more than $53 million in the first quarter when compared to the first quarter of 2016. I'll now turn the call over to Devina to discuss our financial results.
Thanks, Jim, Good morning, everyone. For the first quarter of 2017, as a % of revenue, SG&A costs were 11.3%. That's a 10 basis point improvement from the first quarter of 2016. On a dollar basis, SG&A costs were $390 million in the first quarter, or $28 million higher than in the prior year period. SG&A costs during the quarter included $13 million of executive severance costs, most of which was non-cash. These charges negatively impacted EPS by $0.02 per share and SG&A costs as a % of revenue by 30 basis points. The remaining increase in SG&A dollars during the quarter primarily relates to the timing of incentive compensation accruals, which we do not expect to meaningfully impact the comparability of our SG&A costs for the full year.
When we consider these one-time charges and the impact of timing differences, our SG&A costs were essentially flat in dollars, positioning us very well for SG&A costs as a percentage of revenue to approach 10% for the year. Turning to cash flow. In the first quarter, cash provided by operating activities was $721 million. Compared to $732 million in the first quarter of 2016. We saw the business generate operating EBITDA growth of $66 million in the first quarter, and that's an 8% increase compared to the first quarter of 2016. As Jim discussed, this operating EBITDA growth was driven by the performance of our core solid waste operations and complemented by strong recycling commodity prices.
Our cash flow from operations also benefited from reduced interest payments, as well as our focus on working capital optimization. We're very pleased to see that we continue to convert more of our revenue dollars into cash. These cash flow benefits were offset by a couple of items. As you likely remember, in the first quarter of 2016, we had a $67 million benefit from the termination of a cross-currency hedge. Additionally, in the first quarter of 2017, we saw increased incentive compensation payments related to the strong performance that we achieved in 2016. These two items more than offset the benefit from increased operating EBITDA and were the primary reason for the slight decline in cash provided by operating activities. During the first quarter, we spent $332 million on capital expenditures.
That's an increase of $15 million from 2016, in line with our disciplined focus on managing capital expenditures to between 9% and 10% of revenue. Divestiture proceeds weren't significant during the quarter. Combined, we generated $396 million of free cash flow in the first quarter of 2017, which exceeded our expectations. This strong performance puts us well on our way to achieving our free cash flow guidance of between $1.5 billion and $1.6 billion for 2017. In the first quarter, we paid $194 million in dividends to our shareholders. At the end of the first quarter, our debt to EBITDA ratio measured based on our bank covenants was 2.4. Our weighted average cost of debt for the quarter was about 4.2%, and the floating rate portion of our total debt portfolio was 12% at the end of the quarter.
Our effective tax rate for the first quarter of 2017 was approximately 31.7%, which is almost five percentage points lower than the rate that we used to build our outlook for the year. The difference is due to tax benefits we recognized during the quarter for the vesting and exercise of stock-based compensation awards. The inclusion of this tax benefit as a reduction to our reported provision for income taxes is new in 2017. It's the result of a new accounting standard. We're going to include additional details about the impact of the accounting standard in our Form 10-Q, which we plan to file later today. These tax benefits are difficult to predict and depend on factors like our stock price and employee exercise activity. With the senior executive severance impacts, predicting this activity is even more difficult.
We chose to exclude the $0.07 per share tax benefit from our as adjusted earnings. Adjusting out the impact of this accounting change, our effective tax rate for the quarter would have been 36.8%, which is slightly higher than we anticipated. We continue to expect our full year 2017 adjusted tax rate to be about 36.5%. In summary, the strong results of our first quarter reflect continued execution of our core operating objectives and focus on continuous improvement. The Waste Management team has once again demonstrated our disciplined focus on serving the customer while optimizing our business. 2017 is off to a strong start, and we look forward to that continuing throughout the year. With that, Dennis, let's open the lines for questions.
At this time, I would like to remind everyone, if you would like to ask a question, simply press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question will come from the line of Michael Hoffman with Stifel. Please go ahead.
Thanks for taking my questions, Jim, and Devina.
Good morning.
Morning. Of the $59 million in volume sale growth in the quarter, how do I think about the mix from MSW versus construction and the special waste? I know you gave me percentage changes of year-over-year, but I'm curious to understand the trend line, like in commercial, is there still an upside from new business formation and then service level upgrades that's playing out?
Yeah. If you look at the quarterly numbers by line of business, then you look at those waste streams, and I hope I'm answering your question as you're asking it here, commercial continues to be strong. It looks strong even as we head into the month of April. It's been on that kind of continuous improvement track, as Jim said, for about 5 quarters. When you look at industrial as well, I would tell you that industrial has been higher than the 2.7 that we finished in the first quarter, but sequentially, we were up from a 1% number to a 2.7% number from Q4 to Q1. That one also continues to look good into April. Part of that is our energy services business, Michael. It looks like it's starting to pick up a little bit.
Might have the first quarter of year-over-year improvement in 2 years in the energy services business by the time we get to the second quarter. When you look at those waste streams within the landfill business MSW was strong, it's been strong. MSW volume has been strong, I think our focus is not only on the volume side, but also on the price side of MSW. We can talk about that a little bit as well. The only weak waste stream for us, and weak is kind of a comparative term here because it was weak by comparison to other quarters, but still 2.6% on special waste. With that said, the pipeline looks good with special waste. C&D has been incredibly strong. I think that demonstrates the strength of the housing business around the U.S. and Canada.
That's a pretty good, I think, overview of what our volumes look like and the mix of those different waste streams.
Okay. If I just parse one thing specifically, commercial in particular is one of your best margin businesses. How would you think about the service interval upgrade cycle on a same-store basis today compared to what-
Sorry, go ahead. I'm sorry.
Well, compared to what that same service interval looked like before the Great Recession. Are we back to those levels?
Yeah. The right question, Michael. I'll start with container weights in the commercial line of business. Our container weights into Q1 were up at a higher percentage than previous year quarter by more than we've seen in over a decade. Residential line of business as well, container weights are up. I think it signals well for the economy and for our collection business itself. On the roll-off side, those weights were about at the same level as 2016. As I mentioned earlier, we saw service increases outpace the decreases for the 13th consecutive quarter. It's a really good sign for us. We don't measure it versus the Great Recession, but I would tell you we're in the, I would guess, the middle innings of that growth in the commercial line of business especially. We're seeing good opportunity for us. We're really focused on the higher margin side of it.
We've seen good growth in the national account business, the multi-location commercial customer. It started in the second half of last year, you'll see that in the second half of this year anniversary. We may not be at that 2.5% level, but we'll still be positive and making progress.
Okay. Switching gears, Jim Fish, you alluded to this. I was going to ask, are you seeing any signs of a recovery in the E&P drilling world, and I gather you are.
Well, we are. Look, the rebound is heaviest in the Permian Basin where we don't have a presence. We're encouraged to see that in the month of March, first month, when we look at it on a monthly basis, the first month that we've seen year-over-year improvement in the Marcellus and the Niobrara in two years. We think that that portends a pickup on a quarterly basis when we get to the second quarter. We're pretty encouraged with the pickup we're seeing. It still is more heavily weighted here in West Texas, but it's starting to show up in places where we have a presence.
Okay. Another gear switch. On the recycling side, one of the things that sometimes I think gets overlooked, you have a pretty big brokerage business, which has got a great cash generator and return on capital basis, but it's relatively in low margin. Can you frame of this positive trend in recycling, how much came from the brokerage side so we put in perspective the margin?
Yeah, Michael. Absolutely. The brokerage side of our recycling business, it's about 41%-42% of the total volume, and that's relatively flat. I think one year was 41% and this year 42%. Last year was 41%, so we're roughly in the same place as a percentage of the revenue. You're right, the margin is mid-single digit margins. As you stated, there's no capital expense involved, so the ROI is really high, and it really gives us leverage in the sale of commodities, in addition to just providing more value to our customers, more stickiness with customers that have both large commodity volumes and other waste service needs. We're very pleased with that business, but it's relatively flat with prior year on a volume basis.
Okay. That accounts for as strong as the whole recycling pie was, why we might not see is we got really great free cash flow leverage, but not as much marginal leverage. We shouldn't get as hung up about the margin. We should be paying attention to free cash.
Yeah, we won't get margin leverage there. We make a percentage on those transactions, and that'll continue. It won't go down or up much at all. Not enough to move the needle of the whole company, and yet still really good business for us when it connects with all the other lines of business.
Okay. Last question. You said in your comments that you exceeded your own internal expectations for free cash flow. I'm curious by how much.
I would say when we look at free cash flow, really where we're focusing is the EBITDA growth that we saw. EBITDA of 8% in the first quarter exceeded our expectations. As Jim and Jim have said, we're waiting to see the seasonal uptick with regard to core collection and disposal business, and then how recycling commodity prices impact the second quarter before we update our guidance for the full year. The EBITDA piece of it, as a reminder, we expected full year EBITDA growth to be $240 million-$290 million. It's typical for us to see more of that in the second and third quarters than in Q1. If you use Q1 and extrapolate it would imply that we're well on our way to be at the top end of that.
We're waiting to see how the second quarter unfolds before we give an update on full year guidance.
Perfect. Thanks for taking my question.
Your next question is from the line of Noah Kaye with Oppenheimer. Please go ahead.
Thanks for taking my question. Good morning, Jim, and Devina. Just to dig a little bit more into the recycling. First, we had been hearing about recent volatility in the international markets, especially following China's crackdown on waste exports. Can you just talk about what you're generally assuming for price trends over the balance of 2017, and how we should think about the sensitivity there? You mentioned you had some bias to the upside for the business.
First, I would tell you that it's pretty tough to predict commodity prices. We have a hard time predicting 30 days out, let alone eight or nine months out. We did build into our guidance $0.03 of improvement in the recycling business. We use the rule, and it still holds, that for every $10 move, it's worth about $0.04. That would tell you that we built about $7 or $8 of improvement in for the year. Obviously, it was better than that in the first quarter. When we look at the second quarter with the real volatility, OCC down 10%, ONP down 40% in one week's time. It reminds us that don't get too giddy about commodity prices because they can come back pretty quickly.
Switching gears, you mentioned that you're going to be hiring a Chief Technology Officer. You talked a little bit about the new wm.com and trying to position closer to customers. I wonder, where do you see sort of the low-hanging fruit at this point from a technology side? Certainly, as we've watched technology diffusion across the industry, you guys have been doing route optimization and other kind of innovative data management techniques for many years now. Where do you kind of see the incremental improvements at this point? Where do you see the possibilities there?
Right. That's a good question, Noah. Technology, as you know, is a big umbrella. There's a lot underneath the umbrella. There's data, there's equipment, there's customer-facing solutions, Internet of Things. I think to answer your question, you're right. We've put a lot of effort into the onboard computers and the resulting efficiency improvement that we see out of those. You'll start to see us using big data in a much more sophisticated way. We're already starting that with our pricing. You'll also see it with things like predictive maintenance, as we look at how do we predict, and we've just started down that path, but how do we predict when things like hydraulics on vehicles will give. As opposed to waiting and handling our maintenance in a reactive manner, we handle it more proactively, and that is much more cost effective for us.
Jim, that predictive modeling begins to pay off. We absolutely see signs of that and have real tests underway with real application. To your question, Noah, it'll affect not just the operating cost side of the house, but service to customers as we-
For sure
put more trucks out on the route-
That's right
Improve that consistency of delivery, and not have as many road calls, for example, on the cost side of the house. It'll affect those operating costs. It has affected operating costs and will the service to our customers as well.
Yeah. If you can imagine, Noah, a truck that goes down on the road unexpectedly with a hydraulic hose going out, we're probably paying overtime there to the driver. We've got to pay a towing charge. We may have some type of cleanup charge. To Jim's point, we have a customer service interruption. If we can do this predictively, all of that goes away, and it's better for our bottom line and better for our customers.
Great. If I could just sneak in one more. Are you still confident in getting to that 50-plus basis points of incremental of operating EBITDA margin expansion year-over-year? It seems that, just going back to your SG&A comments, that you don't need to squeeze that much juice on the operating expense side to get there, despite some of the fuel headwinds. Just wanted to make sure that that kind of modeling assumption for the year is still holding.
Definitely. I think we guided to 50 to 100 basis points of improvement in margins there, and we're still comfortable with that range. To your point on SG&A, as Devina mentioned, we said we'd like to approach 10%, and we still feel like we have a shot at that.
Okay, great. Thank you so much for taking my questions.
You bet.
Your next question is from the line of Andrew Bisceglia with Credit Suisse. Please go ahead.
Hey, guys.
Yeah.
Can you talk a little bit about your fuel expense? You guys said the surcharge didn't catch up in the quarter. Tax credit went away. How do we think about this going forward in terms of modeling fuel?
Our fuel costs were up a total of $32 million in the quarter on a year-over-year basis, and that's a combination of our direct costs, our fuel surcharges that we pay to our subcontractors, and then also the fuel tax credit going away. The increase in revenue that we saw on the fuel surcharge side was only $20 million, so that $12 million delta is what's driving that $0.02 impact. When we look at the full year, what we've seen with diesel cost prices leveling out, if our expectation is that those level out, then we think about $0.01 of the headwind in Q1 we should get back over the remainder of the year as the lag in the fuel surcharge part of the revenue equation catches up.
The piece that we can't provide any clarity on whether or not we'll get back is the extension of the fuel tax credit. With tax reform in its infancy from a conversation perspective, it's too early for us to say whether or not we'll get that back. So the $0.01 that we saw in headwind for that in the first quarter, you could extrapolate to the remainder of the year of having up to a $0.04 impact for the full year.
Yeah, Andrew, if you look at that tax credit itself, the expectation from our contacts in D.C., if comprehensive tax reform happens, we don't think we'll see that fuel tax credit. It'll be bundled in with other corporate tax reductions. If that falls apart, then I think you'll see that happen. They'll go ahead and pass those extenders, but who knows what's going to happen in D.C. today, Andrew?
Well, we'd be happy to give up the fuel tax credit in return for a rate reduction in corporate tax rates.
Okay. All right. That's helpful. Just switching gears on your volumes. You guys didn't really call out anything pertaining to weather in the quarter. I would've thought that would've helped you. Can you just talk about that? It sounds like it probably got offset with poor weather in other areas.
The weather was good for the first quarter. I would tell you that last year, part of the reason we didn't say anything is because, you can always talk about the weather, and we try not to talk about it too much, last year was really unusually mild. In an odd sort of way, even though we had a good winter this year, it wasn't as mild as last year. We had a few shutdowns this year in the Northeast, a couple in the Midwest. I don't recall any shutdowns in the winter of 2016. Whereas last year, we actually did talk about the fact that we were concerned we might have borrowed some volume from Q2 in Q1. I don't think we have that feel, and it looks to be the case when we look at our April numbers.
Okay.
The other thing I would say about weather is, in California in particular, we did have an impact from all of the rain that that region saw, we did see a bit of a negative impact on those businesses, that was isolated and minor to the quarter.
Okay, that's helpful. Thanks, guys.
Thank you.
Your next question is from the line of Hamzah Mazari with Macquarie Capital. Please go ahead.
Good morning. Thank you. The first question is just around customer churn. It's improved, obviously, over the last couple of years. Could you give us a sense whether 7% is realistic there or whether you have a target there that you think is achievable, and where does that come from?
Hamzah, good to hear from you. 8.3 is a really good number. That's pretty close to what we had targeted for the whole year. I'll tell you, there's still room for improvement, and we would never say otherwise. We've been in the upper sevens before, but it's been over a decade ago, as we began to roll out Service Machine, an internal initiative. We're back in that vicinity now. We'll continue to seek improvement. We'll look for improvement. Upper sevens, lower eights, pretty good number given our history and given the opportunity in the marketplace. We think that'll continue to see small improvements, but that are big with regard to the impact on the business from the commercial line of business, especially in keeping those high margin, high ROI customers.
Got it. Just on the share buyback. It seems like leverage is low. If you get tax reform, cash flow goes up. You already have cut SG&A over time. What does your M&A pipeline look like? Just remind us what verticals you guys consider core.
Yes. Good morning, Hamzah. When we think about M&A, we're certainly interested in core acquisitions. To your question, we would define core as being, of course, core solid waste, industrial hazardous, potentially energy services, even recycling. All of those we throw in that core bucket. Anything that would be a good strategic fit for us within those core buckets at a fair price, we would consider, and we continue to look for those.
Okay, got it. Last question, I'll turn it over. You guys mentioned the brokerage volume on recycling. You've also done some contract work around your recycling business. Could you just remind us, is the operating leverage in your recycling business lower than what it's been historically? OCC pricing was up a lot, it seems like the flow-through wasn't very high. Just trying to get a sense of, is there anything different around the rebate structure, contract structure, or anything else versus history?
Yeah, Hamzah. We believe that the recycling strategy that we laid out a couple of years ago was to reduce the risk in that line of business, and we've done that through the contract renegotiations and renewals. We now charge a processing fee that we believe provides our shareholders with a reasonable return, a creative return, and yet gives customers what they want. Yet we're not rebating at the same level with floors in place like we had before. You saw that in Q1, our recycling rebates to customers were up. Yet our margin was accretive to the company and was very positive for us. The whole goal was to reduce the risk and yet still play in that marketplace and provide customers what they expect from us, and we've done that.
I think, Hamzah, the restructuring of the contracts that you mentioned, you'll see that show up most when we are down at the low end of commodity prices. To Jim's point, we've de-risked the business down there. When you're kind of in the middle or in the upper end where we've been the last couple of quarters, you don't see the change from the contract restructuring so much when prices are where they are.
Part of the continuous improvement for the whole company, we are really focused on the operating side. If you compare us back today versus two or three years ago, the gross operating expense per ton is consistently lower quarter by quarter. We're in good shape there, Hamzah, on a long-term basis.
Okay, great. Thanks so much.
Your next question's from the line of Brian Maguire with Goldman Sachs. Please go ahead.
Hi, good morning, everyone, and congrats to Devina on removing the interim tag.
Thank you.
Making it official. Great. Yeah, you guys, really strong volumes again. You mentioned some of the regional impacts, but I was wondering if you could maybe just step back and look at the country more broadly and talk about what kind of regional trends you saw and where the strength was a little bit better than average or maybe was held back by some factors.
Sure, Brian. Particularly as you look at C&D, for example, C&D was very strong in the quarter. It has been strong for probably five or six consecutive quarters. Regionally, that's where you would expect to see it. It's in the South, it's in the West. Really, it's hard to find a place where C&D showed weakness, honestly. It wasn't as strong in maybe the Midwest and the upper Midwest as it was in Florida. I wouldn't characterize it as being weak. When you look at C&D, that, I think, demonstrates that the housing market and maybe the overall economy seem to be somewhat optimistic and on an upswing. We talked about our industrial business, or the industrial piece of our business that is related to energy services. That's been starting to show some real signs of recovery as well.
Of course, those are in those areas of the country where we have energy services operations, specifically Pennsylvania, Colorado, Texas. It's somewhat limited there. You don't see it in areas where we don't have energy services.
Okay, thanks for that. Recycled commodity prices, particularly recycled fiber, tends to be real volatile. I think one of the theories for why it spiked so much over the last couple of months was maybe just a shift in trends from retail brick and mortar to e-commerce and changes that might have on collection patterns. Since you guys are a little bit more on the forefront of that, just wondering if you've seen that in how your recycled fiber volumes have trended over the last couple of months. We know the pricing's been up a lot, but just kind of a look at how the volumes have been.
Yeah, the volumes have been, I think we're up 1% in volumes for the quarter. Definitely over the long term, the move or the shift that we're seeing in retail is going to affect volumes. It's hard to see it on a quarter-to-quarter basis, though. When we look at pricing of commodities, the volatility is greatest where the Chinese have the greatest impact. For us, for example, virtually all of our newsprint goes to China. When the Chinese decide they're not going to buy newsprint as they did a couple of weeks back, it really dramatically impacts the price of O&P, hence the drop of 40%. We end up selling about maybe 30% of our OCC to China. While they still have a big and material impact on price, that one was only off about 10% a couple of weeks ago.
Really the pricing is probably driven as much by what the Chinese do. The volume is much more of a longer-term trend. Some of it, to your point, will be a result of the shift in the retail business.
Okay, thanks. Just one more, if I could. You mentioned a little bit about the fuel tax credit as a bit of a headwind. Just wondering if there's, tied to that, if there's any change in some of the energy credits that you get off of the landfills, or any of the pricing on some of that may have changed in the last couple of months.
That would affect the tax line, you'll see with the 36.8% that we basically came in right at our guidance. We've not seen a negative impact on that at this point.
Okay, thanks very much.
Your next question's from the line of Al Kaschalk with Wedbush Securities. Please go ahead.
Good morning, Waste Management team.
Morning, Al.
Morning.
I want to come back to recycling and the energy piece, but I think Jim Trevathan talked a little earlier about the strategic process or changes you guys have made. It strikes me as, I don't know, it's just curious, I guess, that a $10 move now only has $0.04 benefit to you, which is similar to others in the industry. Why would you I understand you're trying to do, and properly do, is minimize the risk, but why would you give up so much of the upside in a business that your customers are demanding versus you maybe necessarily seeing the ROIC for the investments?
Al, we haven't given up any of the upside with all of our contract renegotiations. We've just minimized the downside risk. That's where, as Jim said earlier, where you will see that impact. We've always said, for the last handful of years, that that $10 price change is about a $0.04 impact to EPS. That's not been changed from previous conversation on these calls or in person. I think the business is much better set than the past for those years like we had, what, in 2011 and 2012, when commodity prices dramatically went down, and we weren't charging for processing to cover our cost. Now we do. We absolutely price all of our contracts to cover the processing cost, plus an accretive margin to the company with a really healthy ROI, extremely healthy ROI, in fact.
Yet we've reduced that downside risk and yet kept customers engaged by giving them roughly the same upside that they've always had.
Yeah. I just remember on 175-200 of OCC pricing, the numbers were something more like $0.10-$0.12. It was clear that the industry, not just Waste Management, but the industry was over-earning at that time. To me, we are back, not necessarily to those levels, but we're up. It doesn't seem like the flow-through, particularly in Q1, is where I guess maybe a lot of us were thinking it would be, at least in particular, this analyst. All right. Switching gears, the comment on waste diversion technology, you wrote off. Could you just talk about, well, obviously, it's probably not significant anymore, but what the nature behind that?
Sure. We were in a joint venture to build a gas to liquids plant on one of our landfills in Oklahoma. The focus of that joint venture was to take methane and natural gas and convert it into a higher value hydrocarbon. As with many commodity-driven, energy-based commodity-driven investments, the financial outlook for those investments has changed as energy prices has been relatively low over the long term. As we looked at this project and prospects for building this project further from the one plant in Oklahoma, those became less appealing, as a result, we went ahead and impaired that investment to our view of the fair value of the assets that are on our site.
Right. Okay. Thank you for that, Devina. Finally, on the energy side, historically, I think you've had more traditional landfills taking in waste. Given the market and conditions and the improvement that you've had in cash flow and the balance sheet and the long-term opportunity, should we not see maybe a little more strategic investment there, specifically in the disposal capabilities directly related to tailings and energy by-product?
Yeah. As to one of the earlier questions, we did mention that when we think about core investments, definitely energy services is one of those. It's not for lack of looking around. We've looked at energy services opportunities, but it's got to be the right strategic fit for us. It's got to be the right place, particularly when we think about energy services. It's got to be the right geography for us. It's got to be fairly priced. It is definitely an area that we are exploring from an M&A standpoint. It just has to be the right strategic fit for us.
Got it. Thanks a lot, Jim.
You bet.
Our next question is from the line of Michael Finnegan with Bank of America. Please go ahead.
Hey, guys. Thanks for taking my questions. First question, I just was hoping if we could just dive into a little bit on the incremental margin. For the last two quarters, it appears there's been some one-time costs in there that may have weighted down, limiting that margin expansion. I know growth of free cash flow exceeded your internal expectations. I'm just curious how you're thinking about those incrementals. What is keeping you from getting to the top end of the range of the 50 to 100 basis points of expansion in this type of backdrop?
I don't think anything's keeping us from getting there. We still have an expectation that we will get 50 to 100 basis points of margin improvement. I think when you look at the first quarter, and you say, on the surface, it looks like we were flat on our reported numbers, then you have to consider the $0.02 that we had in executive severance that really is a one-time impact to us, and consider the $0.016 for fuel that Devina went through. Really, it's about a quarter lag there for us on fuel between when we see the increase in the price of fuel and our fuel surcharge catch up to that. With those two, you're looking at as much as 100 basis point improvement in EBITDA margins, if you take those two out.
That doesn't consider the timing difference that she mentioned in her script of incentive comp that amounted to as much as $0.015. We think that 50 to 100 basis points, while it didn't show up in Q1, it really was because of a couple of those, either timing related issues or the one-timer with executive severance.
Jim, I might mention a couple of things that I did earlier in the prepared comments, but if you look at some of the controllable operating expenses, we improved labor 50 basis points, transportation and disposal, each 50 basis points, the risk part of our business, 30 basis points improvement, and our subcontractor cost 30 basis points. There's real leverage there that offset a couple of those uncontrollables.
Yeah. If you combine that with what we think about SG&A going forward, I think that probably demonstrates why we are so confident in the 50 basis points-100 basis points.
Perfect. Lastly, I'm just curious how you're viewing your current balance sheet, especially in this gradually improving environment. What's the leverage range that you're most comfortable with? Do you think, to some extent, your balance sheet might be, "too strong" in this backdrop?
With a 2.4 leverage, we're certainly comfortable that the balance sheet is in really good shape for us to think about opportunistic acquisitions as a priority. That's really how we look at our leverage, as optimal. We're certainly at the low end, but we could see that tick down from here as EBITDA grows. If we don't have strategic M&A that's a good fit for us and at the right price to go execute. I think what is most important in how we message that is that we really want to be positioned so that we can execute at the right time, at the right price, to contribute to the long-term growth of the organization. We're not going to chase the leverage up as EBITDA grows.
Okay. That's fair enough. I guess, when we think about the $100 million-$200 million guidance on the M&A, can you talk about how that's trending and how the pipeline's looking?
Sure. We actually meet later today. We meet once a month as a team to look at the pipeline. I would say the pipeline is strong and we see opportunities across the landscape that Jim was describing. It's interesting to see valuations at this point in the market. One of the things that we're committed to is being diligent users of our shareholders' capital to be sure that we prudently spend dollars at the right valuations. That's really what comes into play when we look at that M&A landscape today.
Just to make sure you're clear on the $100 million-$200 million, those are really tuck-ins. We've had several questions today about what types of businesses we'd be interested in, and we went through what we consider to be core. When we think about that $100 million-$200 million, those are really typically small tuck-ins, pretty much solely in the solid waste space.
Perfect. Thanks, guys.
Your next question is from the line of Corey Greendale with First Analysis. Please go ahead.
Thanks. This is Ken Wang on for Corey. Just for the first one, just wondering if you can talk a little bit about any, just for modeling purposes, year-on-year workday discrepancies for each of the remaining quarters in 2017.
Sure. We had an additional 0.7 workdays in Q1. We give that back in the third quarter of this year to be flat by the end of September. In the fourth quarter, we'll actually have a workday difference that goes the other way. All in for the full year, we'll have about one less workday.
Just FYI, when we think about workdays, the extra workday, the extra 0.7 workdays that Devina mentioned, typically work against us, because you have the labor cost in most of your lines of business. The only lines of business where it works for you are with landfill tons and roll-off. When you get that extra workday in the first quarter, which are lighter than the other three quarters in terms of roll-off and landfill tons, it does work against you. We think that it could have been as much as $5 million-$6 million of headwind. We haven't talked about that at all in Q1 for us this year. No reason to talk about it because we get it back and then some at the end of the year, with this year not being a leap year, obviously.
Thank you. That's very helpful. Just going back to the big data remarks that you had earlier, can you give us a sense of your IT infrastructure, specifically, given your roll-off strategy, do you have all the systems in place to pull all of this data together? If not, can you give us a sense of what type of investment it would require to do so?
Yeah. We have, we acquired a group about four years ago that's strictly an OR group. That group is the team that's pulling together, the example that we went through with predictive maintenance, that's the team that's doing a lot of that predictive maintenance analytics. We feel that we have absolutely the right group to do that. They're not just focused, by the way, on maintenance. That's the group that's been doing all of our automation of routes. They're also doing things like looking at our safety data and taking a predictive approach to that so that we can proactively train. There's a number of things they're focused on, but that all falls under our operations research group.
Thank you.
You bet.
Your next question is from the line of Joe Box with KeyBanc Capital Markets. Please go ahead.
Hey, good morning, everyone.
Joe.
Maybe just to dovetail into the prior balance sheet question. I think you guys have earmarked about $500 million or so for share buyback in 2017. Any thoughts of the timing on that $500 million, or even any plans to do another accelerated buyback?
We continue to have that in our plan for the back half of the year because we're wanting to see how that M&A pipeline shakes out. With regard to how we execute it, we certainly look at ASRs as an efficient way to execute our share buyback. That $500 million continues to be in our forecasts, and right now it's all forecast for the second half of the year.
Okay, could that theoretically go away based off the size of a deal that you do?
Theoretically, yes.
Okay.
Sure. I think, Joe, when you look at capital allocation, first and foremost, dividend. What we've said about the dividend is we want to see kind of a confirmation of that higher base of free cash flow that we've talked about over the last couple of quarters in 2017 before we make a decision to do anything with the dividend in early 2018. Then, of course, we've talked on this call a lot about the fact that the balance sheet, the leverage ratio continues to go down. That really, as Devina said, is in the hopes that we find a strategic fit for us. You're right. In theory, depending on the size of that sure, you could absolutely see share buybacks go away completely for a period of time, depending on the size of an acquisition.
Then switching gears, I know it's obviously not a big line of business for you, but curious if you've noticed any sort of uptick in your hazardous waste business, largely from the inflection that we've seen in both industrial production and crude production.
Yeah, Joe, that business is a really strategic line of business for us because it connects with most of the other lines, and we're very pleased with it. We have seen at specific sites some real growth there along the Gulf Coast. The West Coast, with all of the rain that Jim mentioned earlier, it slowed down a little bit of the project work that we typically do in that line of business that's on customers or our cleanup sites. That was a little slower in Q1, given the rain, and especially in California, Southern Cali. We've that one large site for us, Kettleman, has been a real producer for us, and it was a little slower in Q1. In general, it's a very well-performing business, and we see upside.
When you look at the commitments to investment from the petrochemical industry along the Gulf Coast, from Texas across to Florida, you see huge dollars planned for the next decade in the petrochemical side of the house. That bodes well because we're so well positioned with the Texas business, but with that site in Louisiana, with sites in special waste in Louisiana as well along the Gulf Coast, and then an Alabama hazardous site. We are extremely well positioned there and expect that business to continue to grow for us.
Yeah. I would just, Joe, add to what Jim said there and say that both our hazardous and our non-hazardous special waste were a little slower than we would like. I think the outlook is pretty strong. Obviously, if some type of infrastructure bill could get passed out of Congress, that would be positive for us. On both sides of that, both haz and non-haz. While both hazardous waste and special waste were not weak, but not super strong, I think the outlook is where we're encouraged.
Understood. Thank you.
Yep.
Your next question is from the line of Tyler Brown with Raymond James. Please go ahead.
Hey, good morning.
Hey, Tyler.
Morning.
Hey, I know the call's been long, I've just got one here. Jim, I know there's a lot of talk about tax reform out there. If we just kind of set that aside for a sec. I think back in 2010, you guys made some investments in low income housing and such. I surmised that was designed to lower the corporate tax rate. I am curious, one, assuming no reform, when would we expect those credits to sunset, driving a more normalized tax rate? Two, if we do get reform to a simplified code, would that potentially drive an impairment in those investments, as I assume you wouldn't be able to take those credits?
All very good questions, Tyler. I'll take that. We expect the sunset of both the low income housing tax credit investment and the alternate fuel tax credit investment that we've made to sunset, I think, beginning in 2018, 2019. We can get more details on that. The normalized tax rate without tax reform wouldn't happen until probably around 2019.
Okay.
When we think about whether or not there'd be an impairment associated with any of that We're still looking into that, but I can tell you that the way that those deals have been structured is in addition to the investment that we have, we also have future cash flow obligations that we kind of account for as debt on our balance sheet. We think impairment impacts would be limited because that asset goes away, but so does the liability.
It's not expected to be material. As Jim mentioned earlier, all in, we think that tax reform would be a net benefit to us, even with those investments going away.
Sure. Okay. All right. Thank you.
Thanks, Tyler. Your next question is from the line of Barbara Noverini with Morningstar. Please go ahead.
Hey, thanks. Just a quick one from me. Jim Fish, you've mentioned publicly in the past that there's a lot of interesting recycling technology out there, but of course, many lack scale. Given your strong cash flow recently, what's your appetite at this time for either acquiring or investing in any of these technologies, kind of as an industry leader maybe to support building that scale? I guess, is there anything out there that you may have your eye on that's interesting from a technology perspective?
Hi, Barbara. Yeah, good question. We recently had a senior leadership strategy meeting, one of the things we talked about at that meeting was what does the recycle facility of the future look like? When we think about investing in recycling, I think I would tell you that investing just in the same type of technology that we have today would be less interesting to us than investing in improved technology that helps improve recycling rates for us.
Got it. Thanks.
You bet.
At this time, there are no further questions. Please continue with any closing remarks.
All right. Thank you. In closing here, we're obviously pleased with the quarter from a financial results perspective, but we're also pleased with the cultural shifts we're seeing internally at Waste Management, because of our focus on our people, our customers, and our technology. That was best demonstrated, I think, on the people side with the succession planning and the promotion of three high-performing leaders into the AVP roles that I mentioned. Also on the customer service results that Jim Trevathan talked about, this obsession with the customer is something that I think you'll see Waste Management really focus on. A lot of conversation this morning around technology, around pricing and routing and logistics, and the sophistication of data that we're beginning to bring to our business. We think it's the beginning of this path that we're on for cultural change.
I think it makes us the right choice when it comes to an employer, a service provider, a partner, or an investment of choice. Thanks, everybody, for joining us this morning, and we will see you next quarter.
Ladies and gentlemen, thank you for joining today's call. This call will be available for replay beginning at 1:00 P.M. Eastern Time today through midnight on Wednesday, May 10th, 2017. The conference ID number for the replay is 94449507. Again, the conference ID number for the replay is 94449507. The number to dial for the replay is 8558592056 or 4045373406. This does conclude the Waste Management National Services First Quarter 2017 Earnings Release Conference Call. You may now disconnect.