Good morning. My name is Dennis, and 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 speakers' remarks, there will be a question and answer session.
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, and thank you for joining us for our Q1 2017 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer Jim Dravathan, Executive Vice President and Chief Operating Officer and Devina Reinking, Senior Vice President, Chief Financial Officer and Treasurer. You will hear prepared comments from each of them today. Jim Tisch will cover high level financials and provide a strategic overview.
Jim Turethian will cover price and volume details and provide an operating overview and Devina will cover the details of the financials. Before we get started, please note that we have filed a Form 8 ks this morning that includes the earnings press release and is available on our website at www.wm.com. The Form 8 ks, the press release and the schedules of 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 ks. 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, Jim and Devina will discuss our earnings per diluted share, which they may refer to as EPS or earnings per share, and I'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 Q1 of 2016. The Q1 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 p. M. Eastern Time today until 5 p.
M. Eastern Time on May 10. 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 94 449,507. Time sensitive information provided during today's call, which is occurring on April 26, 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 expressed written consent of Waste Management is prohibited. Now I'll turn the call over to Waste Management's 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 Q1, 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 1st quarter. Despite a $0.02 impact from executive severance, which was an increase of almost 14% when compared to the Q1 of 2016. We've built a strong foundation and have the momentum to continue to generate growth throughout the remainder of 2017. In the Q1, our revenues grew by more than $260,000,000 or 8.3%. Almost all of this increase was organically driven.
And our 1st 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 Q1, 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. And 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 $110,000,000 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 $0.65 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 Q1, 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 clear after the Q2. 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. As a result, we will continue to optimize recycling to ensure we generate the returns our shareholders expect whether commodity prices are high or low. Now looking at cash flow in the quarter. Once again, our strong operating EBITDA performance drove our free cash flow.
We anticipated that our Q1 cash flow results would be lower than the prior year due to a couple of unusual items that Devina will discuss, but we exceeded our internal expectations and remain confident that we can achieve our full year guidance of between $1,500,000,000 $1,600,000,000 Our preference after paying our dividend is still to use free cash flow to acquire accretive businesses at a reasonable purchase price, so we continue to diligently identify attractive acquisition targets. So 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. And since November, we've promoted 3 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, 2 very large customers in 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 2 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. And so we're reaffirming our full year EPS guidance of between $3.14 $3.18 and our full year free cash flow guidance of $1,500,000,000 to $1,600,000,000 And with that, I'll now turn the call over to Jim to discuss our Q1 operating results in more detail. Thanks, Jim, and good morning. Our revenue growth in the Q1 of 2017 reflected the continuation of the strong execution of our price, customer service and disciplined growth strategies that we saw throughout 2016.
Revenues in the quarter were $3,440,000,000 an increase of $264,000,000 or 8.3 percent when compared to the Q1 of 2016. 1st quarter revenue growth in our collection and disposal business from the combined impact of price and volume was $113,000,000 1st quarter revenues also benefited from higher recycling commodity prices, which drove a $111,000,000 increase recycling revenues. Fuel surcharges and foreign currency fluctuations increased $25,000,000 and acquisitions also increased revenues for the quarter by $12,000,000 Looking at internal revenue growth in the Q1, our collection and disposal core price was 5.1% consistent with the Q4 of 2016 and yield was 2%. Both total volumes and traditional solid waste volumes improved 1.9%. On a workday adjusted basis, total volumes in traditional solid waste volumes were 1.4%.
Our continued focus on customer service is having a positive impact on volumes as we achieved the lowest churn since the Q3 of 2002 at 8.3%, an improvement of 90 basis points from the Q1 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 Q1 of 2016 and the combined positive price and positive volume led to total company income from operations growing $50,000,000 Operating income margin expanding 20 basis points to 16.2 percent and operating EBITDA growing $66,000,000 Our collection lines of business continued to perform exceptionally well. In the Q1, commercial core price was 7.9% with volumes up 2.5%, a 50 basis point improvement from the 4th quarter.
Industrial core price was 9.7 percent with volume up 2.7% in the 1st quarter, up 170 basis points from the growth that we saw in the Q4 of 2016. In the residential line of business, core price was 2 point 6%. Residential volumes were down 1.9% in the Q1, but that is a 70 basis point sequential improvement from the Q4 of 2016. The combined price and volume increases in our collection line of business led to income from operations growing $29,000,000 and operating EBITDA growing $33,000,000 In the landfill Lata business, total volumes increased 3.7%. MSW volumes grew 6.8%, C and 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 Q1, primarily driven by a 70% increase in recycled commodity prices at our recycling facilities. Our recycling operations increased EPS by $0.06 when compared to the Q1 of 2016. Most of the increase in EPS or $0.055 was driven by improved commodity prices. The remaining $0.01 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 Q1, in April, we have seen export prices decline between $50 $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 Q1, total operating cost increased $173,000,000 when compared with the Q1 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 percentage of revenue increased 20 basis points from 62.8% in the Q1 of 2016 to 63% in the Q1 of 2017. The combined cost of recycling rebates and higher fuel expenses increased almost 200 basis points as a percent 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 based cost in the quarter. Labor and transfer and disposal cost each improved 50 basis points as a percent of revenue, while risk management and subcontractor costs 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 8 consecutive quarters of productivity improvements 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 $53,000,000 in the Q1 when compared to the Q1 of 2016. And I'll now turn the call over to Devina to discuss our financial results.
Thanks, Jim, and good morning, everyone. For the Q1 of 2017, as a percent of revenue, SG and A costs were 11.3%. That's a 10 basis point improvement from the Q1 of 2016. On a dollar basis, SG and A costs were $390,000,000 in the first quarter or $28,000,000 higher than in the prior year period. SG and A costs during the quarter included $13,000,000 of executive severance costs, most of which was non cash.
These charges negatively impacted EPS by $0.02 per share and SG and A costs as a percent of revenue by 30 basis points. The remaining increase in SG and 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 and A costs for the full year. So when we consider these one time charges and the impact of timing differences, our SG and A costs were essentially flat in dollars. Positioning us very well for SG and A costs as a percentage of revenue to approach 10% for the year. Turning to cash flow.
In the Q1, cash provided by operating activities was $721,000,000 compared to $732,000,000 in the Q1 of 2016. We saw the business generate operating EBITDA growth of $66,000,000 in the Q1 and that's an 8% increase compared to the Q1 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, and 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 Q1 of 2016, we had a $67,000,000 benefit from the termination of a cross currency hedge. Additionally, in the Q1 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 Q1, we spent $332,000,000 on capital expenditures. That's an increase of $15,000,000 from 2016, but in line with our disciplined focus on managing capital expenditures to between 9% 10% of revenue.
Divestiture proceeds weren't significant during the quarter and combined we generated $396,000,000 of free cash flow in the Q1 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 $1,000,000,000 for 2017. In the Q1, we paid $194,000,000 in dividends to our shareholders. And at the end of the Q1, 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 Q1 of 2017 was approximately 31.7%, which is almost 5 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 2017 and it's the result of the 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.
And with the senior executive severance impacts, predicting this activity is even more difficult. So 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%. So in summary, the strong results of our Q1 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.
And your first question will come from the line of Michael Hoffman with Stifel. Please go ahead.
Thanks for taking my questions, Jim, Jim and Devina.
Good morning.
Good morning. Of the $59,000,000 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 a subside from new business formation and then service has an overall upgrade that's playing out?
Yes. So if you look at the quarterly numbers by line of business and then you look at those waste streams, Commercial has and I hope I'm answering your question as you're asking it here, but commercial continues to be strong. It looks strong even as we head into the month of April. And it's been on that kind of continuous improvement track, as Jim said, for about 5 quarters. Then when you look at, well, industrial as well, and I would tell you that industrial was has been higher than the 2.7% that we finished in the Q1.
But sequentially, we were up from a 1% number to a 2.7% number from Q4 to Q1. And 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 Q2. And then when you look at those waste streams within the landfill business, MSW was strong and that's been it's been strong.
MSW volume has been strong. And 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. But 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 and D has been incredibly strong. I think that demonstrates the strength of the housing business around the U. S. And Canada. But that's a pretty good, I think, overview of what our volumes look like and the mix of those different waste streams.
Okay. So if I just parse one thing specifically, commercial in particular is one of your best margin businesses and 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 looked like, what those same that same service interval looked like before the Great Recession. So are we back to those levels where
Yes. The right question, Michael. I'll start with container weights in the commercial line of business. I mean, our container weights in 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, that was weights were about at the same level as 16%. We 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. So you'll see that in the second half of this year anniversary.
So we may not be at that 2.5% level, but we'll still be positive and making progress.
Okay. Switching gears and Jim Fish, you alluded to this. I was going to ask, are you seeing any signs of a recovery in the
E and P drilling world and I gather you are? Well, we are. I mean, look, it's heaviest and the rebound is heaviest in the Permian Basin where we don't have a presence. But we're encouraged to see that in the month of March, 1st month when we look at it on a monthly basis, the 1st month that we've seen year over year improvement in the Marcellus and the Niobrara in 2 years. So we think that, that portends a pickup on a quarterly basis when we get to the Q2.
So 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 it's overlooked, you have a pretty big brokerage business, which has got a great cash generator and return on capital basis, but it's relatively low margin. So can you frame of this positive trend in recycling, how much came from the brokerage side so we put in perspective the margin?
Yes, 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 1 year was 41% and this year 42%, last year it was 41%. So we're roughly in the same place as a percentage of the revenue.
And you're right, the margin is it's mid single digit margins. But as you stated, it's very 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. So we're very pleased with that business. But it's relatively flat with prior year on a volume basis.
Okay. But that accounts for as strong as all recycling pie was, why we might not see is we got really great free cash flow leverage, but not as much margin leverage. We shouldn't get as hung up about the margin. We should be paying attention to free cash.
Yes. We won't get margin leverage there. We pass through a percentage. We make a percentage on those transactions, and that will continue. It won't go down or up much at all.
But it's very complicated but 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?
Well, I would say when we look at free cash flow, really where we're focusing is the EBITDA growth that we saw. And so EBITDA of 8% in the Q1 exceeded our expectations. But as Jim and Jim had 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 Q2 before we update our guidance for the full year. So the EBITDA piece of it, as a reminder, we expected full year EBITDA growth to be $240,000,000 to $290,000,000 And it's typical for us to see more of that in the second and third quarters than in Q1. And if you use Q1 and extrapolate it, it would imply that we're well on our way to be at the top end of that, but we're waiting to see how the full year or the Q2 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.
So 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 kind of the sensitivity there?
You mentioned you had some bias to the upside for the business.
Yes. 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 8 or 9 months out. But we did build into our guidance $0.03 of improvement in the recycling business. We kind of used the rule and it still holds that for every $10 move, it's worth about $0.04 So 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 Q1, but then when we look at the Q2 with the real volatility, OCC down 10%, O and P down 40% in 1 week's time. It kind of reminds us that don't get too giddy about commodity prices because they can come back pretty quickly.
Yes. Yes. And then 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, I mean, you guys have been doing route optimization and other innovative data management techniques for many years now. So 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. And technology, as you know, is a big umbrella. I mean, there 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 then the resulting efficiency improvement that we see out of those. But you'll start to see us using big data in a much more sophisticated way. We're already starting that with our pricing, but 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?
And then 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, you'll also that predictive modeling begins to pay off and we absolutely see signs of that and have real test underway with real application, it will affect to your question, Noah, it will affect not just the operating cost side of the house, but service to customers as we can support trucks out of the route and improve that consistency of delivery and not have as many road calls, for example, on the cost side of the house. So it will affect those operating costs. It has affected operating costs and will the service to our customers as well. Yes.
If you can imagine, Noah, a truck that goes down on the road unexpectedly with a hydraulic hose going out, we've got 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. And to Jim's point, we have a customer service interruption. So if we can do this predictably, then all of that goes away and it's better for our bottom line and better for our customers.
Great. And if I could just sneak in one more. Are you still confident in getting to that 50 plus bps of operating EBITDA margin expansion year over year. It seems that just going back to your SG and 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. But just want 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. And to your point on SG and 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.
Your next question is from the line of Andrew Buscaglia with Credit Suisse. Please go ahead.
Hey, guys. 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?
So our fuel costs were up a total of $32,000,000 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. And the increase in revenue that we saw on the fuel surcharge side was only $20,000,000 So that $12,000,000 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 a penny 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.
And with tax reform in its kind of infancy from a conversation perspective, it's too early for us to say whether or not we'll get that back. And so the penny that we saw in headwind for that in the Q1, you could extrapolate to the remainder of the year of having up to a $0.04 impact for the full year.
Yes. 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 that's who knows what's going to happen in D. C. Today, Greg. Yes.
We'd be happy to give up the fuel tax rate as a return for a rate reduction in corporate tax rates.
Okay. All right. That's helpful. And just switching gears on your volumes. You guys didn't really call out anything pertaining to weather in the quarter.
I would have thought that would have helped you, but I guess, I mean, 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 Q1. I would tell you that that's last year. Part of the reason we didn't say anything is because you can always talk about the weather and we don't we try not to talk about it too much. But last year was really unusually mild. So in an odd sort of way, even though we had a good winter this year, it wasn't as mild as last year.
So 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. So whereas last year, we actually did talk about the fact that we were concerned we might have borrowed some volume in Q 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.
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. And so we did see a bit of a negative impact on those businesses, but 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?
Umza, 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. But I'll tell you there's still room for improvement and we would never say otherwise. We've been in the upper 7s before, but it's been over a decade ago as we began to roll out service machine, an internal initiative.
And we're back in that vicinity now. So we'll continue to seek improvement. We'll look for improvement. But upper 7s, lower 8s, pretty good number given our history and given the opportunity in the marketplace. We think that will continue to see small improvements, but that are big with regard to the impact on the business from the commercial line of business, especially at keeping those high margin, high ROI customers.
Got it. And then 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 and A over time. What does your M and A pipeline look like?
And then just remind us what verticals you guys consider core?
Yes. So good morning, Hamzah. When we think about M and A, we're certainly interested in core acquisitions. And 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.
So 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, but it seems like the flow through wasn't very high. So just trying to get a sense of, is there anything different around the rebate structure, contract structure or anything else versus history?
Yes, Hamzah. We believe 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, an accretive return and yet gives customers what they want. But yet we were not rebating at the same level with floors in place like we had before. We you saw that in Q1, our recycling rebates to customers were up, but the whole goal was to reduce the risk and yet still play in that 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. And to Jim's point, we've derisked the business down there. When you're kind of in the middle or in the upper end where we've been in the last couple of quarters, you don't see the change from the contract restructuring so much when prices are where they are. And part of the continuous improvement for the whole company, we are really focused on the operating side. And if you compare us back today versus 2 or 3 years ago, the gross operating expense per ton is really consistently lower quarter by quarter.
So we're in good shape there Hamzah on a long term basis.
Okay, great. Thanks so much.
Your next question is 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. Yes, really strong volumes again, and you'd 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 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. When you look at particularly as you look at C and D, for example, C and D was very strong in the quarter. It has been strong for probably 5 or 6 consecutive quarters. Regionally, that's where you would expect to see it. It's in the South, it's in the West, But really, it's hard to find a place where C and D showed weakness.
Honestly, it wasn't as strong in maybe the Midwest and the upper Midwest as it was in Florida. But I wouldn't characterize it as being weak. So when you look at C and D, that I think demonstrates that the housing market and maybe the overall economy seem to be somewhat optimistic and on an upswing. And then when you look at our 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.
And of course, those are in those areas of the country where we have energy services operations, specifically Pennsylvania, Colorado, Texas. And so that it's somewhat limited there. You don't see it in areas we don't have energy services.
Okay. Thanks for that. And recycled commodity prices, particularly recycled fiber can it tends to be real volatile. And I think one of the theories for why it spikes 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 in the forefront of that. Just wondering if you've seen that and kind of how your recycled fiber volumes have trended over the last couple of months?
We know the pricing has been up a lot, but just kind of a look at how the volumes have been?
Yes. I mean the volumes have been I think we were up 1% in volumes for the quarter. Definitely over the long term, it's going to 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. And when we look at pricing of commodities, it's the volatility is greatest where the Chinese have the greatest impact.
So for us, for example, virtually all of our newsprint goes to China. And so 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 and P, the drop of 40%. We end up selling about maybe 30% of our OCC to China. So while they still have a big and material impact on price, that one was only off about 10% a couple weeks ago. So really the pricing is probably driven as much by what the Chinese do.
And then 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. And 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 that may have changed in the last couple of months?
That would affect the tax line and you'll see with the 36.8% that we basically came in right at our guidance. So we've not seen a negative impact on that at this point.
Okay. Thanks very much.
Your next question is from the line of Al Kishak with Wedbush Securities. Please go ahead.
Good morning, waste management team.
Good morning, Al.
I want to come back to recycling and the energy piece, but I think Jim Trevason 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 mean, I understand you're trying to do is 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. And that's where, as Jim said earlier, where you will see that impact. But 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.
So 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 didn't we were charging for processing to cover our cost and 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, but yet we've reduced that downside risk and yet kept customers engaged by giving them roughly the same upside that they've always had.
I just remember $175,000,000 to $200,000,000 of OCC pricing, the numbers were something more like $0.10 to $0.12 And it was clear that the industry, not just waste management, but the industry was over earning at that time. And so to me, we are back not necessarily to those levels, but we're up. But 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. So, 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. That we were in a joint venture to build gas to liquids plant on one of our landfills in Oklahoma. And the focus of that joint venture was to take methane and natural gas and convert it into a higher value hydrocarbon. And 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. And as we looked at this project and prospects for building this project further from the one plant in Oklahoma, those came less appealing.
And so 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, Davina. Finally, on the energy side, historically, I think you've had more traditional landfills taking in waste, given the market 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 byproduct?
Yes. As to one of the earlier questions, we did mention that when we think about core investments, definitely energy services is one of those. And we've 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, and it's got to be fairly priced. So it is definitely an area that we are exploring from an M and A standpoint. Just has to be the right strategic fit for us.
Got it. Thanks a lot, Jim.
You bet.
Your next question is from the line of Michael Feniger 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. So 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 incremental. So like what is keeping you from getting to the top end of the range of the 50 to 100 bps of expansion in this type of backdrop?
Well, I don't think anything is keeping us 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 Q1 and you say, well, 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 onetime impact to us. And consider the $0.016 for fuel that DaVina 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. And so with those 2, you're looking at as much as 100 basis point improvement in EBITDA margins if you take those 2 out.
And that doesn't consider the timing difference that she mentioned in her script of incentive comp that amounted to as much as a $0.01 a half. So we think that 50 basis points 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. So there's real leverage there that offset a couple of those uncontrollables.
Yes. And if you combine that with what we think about SG and A going forward, I think that probably demonstrates why we are still confident in the 50 to 100 basis points.
Perfect. And 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? And do you think, some extent your balance sheet might be like 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. And that's really how we look at our leverage as optimal. And we're certainly at the low end, but we could see that tick down from here as EBITDA grows. And if we don't have strategic M and A, it's a good fit for us and at the right price to go execute. And I think what is most important and how we message that is that we really want to be positioned so that we can we're not going to chase the leverage up, as we're not going to chase the leverage up, as EBITDA grows.
Okay. That's fair enough. I guess, we think about the $100,000,000 to $200,000,000 guidance on the M and A. Can you talk about how that's trending and how the pipeline is looking?
Sure. We actually meet later today. We meet once a month as a team to look at the pipeline. And 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.
And 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. And so that's really what comes into play when we look at the M and A landscape today.
And just to make sure you're clear on the $100,000,000 to $200,000,000 those are really tuck ins. Those are we've had several questions today about what type of what types of businesses we'd be interested in and we went through what we consider to be core. When we think about that $100,000,000 to $200,000,000 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. So 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. So we have an additional workday of 0.7 workdays in Q1. We give that back in the Q3 of this year to be flat by the end of September. And then in the 4th quarter, we'll actually have a workday difference that goes the other way. So all in for the full year, we'll have about one less workday.
And 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. And 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 was it could have been as much as $5,000,000 to $6,000,000 of headwind. We haven't talked about that at all in Q1 for us this year, But 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. And then 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 rollout strategy? Do you have all the systems in place to pull all of this data together? And if not, can you give us a sense of what type of investment it would require to do so?
Yes. So we have and we acquired a group about 4 years ago that's strictly an OR group, and that group is the team that's pulling together. The example that we went through was with Predictive Maintenance. That's the team that's doing a lot of that Predictive Maintenance analytics. So we feel that we have absolutely the right group to do that.
And they're not just focused, by the way, on maintenance. They're focused 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.
Your next question is from the line of Joe Box with KeyBanc Capital Markets. Please go ahead.
Hey, good morning, everyone.
Hey, Joe.
So maybe just to dovetail into the prior balance sheet question, I think you guys have earmarked about $500,000,000 or so for share buyback in 2017. Any thoughts on the timing on that $500,000,000 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 and A pipeline shakes out. And with regard to how we execute it, we certainly look at ASRs as an efficient way to execute our share buyback. But that $500,000,000 continues to be in our forecasts and right now it's all forecast for the second half of the year.
Okay. And could that theoretically go away based off the size of a deal that you do?
Theoretically, yes.
Okay.
Sure, sure. I think, Joe, when you look at capital allocation, I mean, 1st and foremost, dividend and 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. And 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. And that really, as Devina said, is in hopes that we find a strategic fit for us. But 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.
And 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?
Yes, Joe. That business is a really, 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. And that was a little slower in Q1 given the rain and especially in California, Southern Cali.
And we've got one large site for us, Kettleman has been a real producer for us and it was a little slower in Q1. But 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 in Alabama hazardous sites. So we are extremely well positioned there and expect that business to continue to grow for us.
Yes. I would just, Joe, add to what Jim said there and say that both our hazardous and our nonhazardous special waste were a little slower than we would like, but 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. So on both sides of that, both haz and non haz. So 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.
Your next question is from the line of Tyler Brown with Raymond James. Please go ahead.
Hey, good morning.
Hey, Tyler.
Hey, I know the call has been long, so I've just got one here. So 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 was surprised that was designed to lower the corporate tax rate. But I am curious, 1, assuming no reform, when would we expect those credits to sunset driving a more normalized tax rate?
And 2, if we do get reform to a simplified code, what would 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. So 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 18, 2019, and we can get more details on that. But the normalized tax rate without tax reform wouldn't happen until probably around 2019. And then 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. And so we think impairment impacts would be limited because that asset goes away, but that is the liability. But it's not expected to be material. And on the 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.
Your next question is from the line of Barbara Novarini with Morningstar. Please go ahead.
Hey, thanks. Just a quick one for me. But Jim says you've mentioned publicly in the past that there's a lot of interesting recycling technology out there, but of course many lacks scale. And 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 in order 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. Yes, good question. And what we we recently had a senior leadership strategy meeting and one of the things we talked about at that meeting was what does the recycle facility of the future look like. So 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.
And at this time, there are no further questions. Please continue with any closing remarks.
All right. Thank you. So in closing here, we're obviously pleased with the quarter from a financial results perspective, but we're also pleased we're pleased with the cultural shifts we're seeing internally in Waste Management because of our focus on our people, our customers and our technology. And that was best demonstrated, I think, on the people side with the succession planning and the promotion of 3 high performing leaders into the AVP roles that I mentioned. Also on the customer service results that Jim Trebathan talked about, this obsession with the customers is something that I think you'll see Waste Management really focus on.
And then 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. And 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 p. M. Eastern Time today through midnight on Wednesday, May 10, 2017. The conference ID number for the replay is 9,000,000,000 449,507.
Again, the conference ID number for the replay is 9,4, 449,507. The number to dial for the replay is 855 859-2056 or 404-537 3406. This does conclude the Waste Management National Services Q1 2017 earnings release conference call. You may now disconnect.