Good morning. My name is Janisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2016 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 would now like to turn the call over to Mr. Ed Eckel, Director of Investor Relations. Thank you, Mr. Eckel. You may begin your conference.
Thank you, Genisha. Good morning, everyone, and thank you for joining us for our Q2 2016 earnings conference call. With me this morning are David Steiner, President and Chief Executive Officer Jim Fish, Executive Vice President and Chief Financial Officer and Jim Trevason, Executive Vice President and Chief Operating Officer. 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 our filings with the SEC, including our most recent Form 10 ks. David and Jim will discuss our results in the areas of yield and volume, which unless otherwise stated, are more specifically references to internal revenue growth or IRG from yield or volume. During the call, David and Jim will also discuss our earnings per diluted share, which they may refer to as EPS or earnings per share.
And David and Jim will address operating EBITDA and operating EBITDA margin as defined in the footnotes to the earnings press release. Any comparisons unless otherwise stated will be with the Q2 of 2015. The Q2 of 2016 and 2015 results have been adjusted to enhance comparability by excluding certain items that management 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 August 11.
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 4,398, 6,112. Time sensitive information provided during today's call, which is occurring on July 27, 2016, 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 President and CEO, David Steiner.
Thanks, Ed, and good morning from Houston.
Our second quarter results again exceeded our internal expectations and mirror the trends we've seen for a number of quarters, improving volumes, strong execution of our pricing programs and greater traction in our cost programs. In the Q2, we earned $0.74 per share, an increase of more than 10% from our Q2 2015 results. The combined revenue growth and cost improvement led to strong growth in operating EBITDA to $955,000,000 an increase of almost 9% and an improvement in our operating EBITDA margin of 140 basis points to 27.9%. This is the highest operating EBITDA margin that we've achieved in 7 years. Our pricing programs continued to drive earnings growth and margin expansion.
For the Q2, our collection and disposal core price was 4.9% and yield was 2.6%. Core price improved 80 basis points from the Q2 of 2015 and yield was up 90 basis points. Core price in the industrial line was 9.5 percent. In the commercial line, it was 7.6%. In our landfill line, it was 2.7%.
And in our residential line, it was 2.5%. Importantly, in the Q2, our churn was 9.1%, 120 basis points better than last year and 10 basis points better than the Q1 of 2016, which demonstrates our ability to retain pricing and retain customers through improvements in our service efforts. At this point, we would certainly expect to exceed our full year core price target of 4% and our 2% yield target, although both metrics could moderate somewhat in the back half of the year due to year over year comparisons. With respect to volumes, we saw positive volume growth in the Q2 just as we did in the Q1. But most encouraging is that we saw volume growth in the right volumes, our high margin commercial, industrial and landfill lines.
In fact, our commercial volumes turned positive for the first time in over a decade. We shed volumes in the lower margin residential and recycling lines of business as we continue to eliminate low or negative margin contracts. Our traditional solid waste volumes were positive 0.8% in the Q2 of 2016, a 140 basis point improvement from the Q2 of 2015. Our commercial volumes were 0.3% in the 2nd quarter, an improvement of 50 basis points from the 1st quarter and a 250 basis point improvement from Q2 of 2015. As this is our highest margin collection segment, this is a significant accomplishment and is reflected in the income from operations of the commercial line of business, where we achieved the highest results ever.
We expect to see continued growth in our commercial line as the year progresses, which is a tribute to the efforts of our sales and marketing teams. So our strategy of maintaining price discipline while adding the right volumes continued to bear fruit. We did see slightly stronger volume growth in the Q1 with weather in the Q1 of 2016 much milder than in the Q1 of 2015, So we weren't surprised to see a little less volume growth in the Q2 versus the first, but we expect total company volumes to continue to improve throughout the remainder of the year. And we now expect our traditional solid waste volumes to exceed 1% positive by year end. Residential and recycling volumes were down in the quarter and we'd expect them to be down for the remainder of the year, but the loss of those volumes is mostly intentional given that they are low margin or oftentimes even negative margin volumes.
Our landfill line of business continues to show strong results, which Jim will discuss in more detail. However, as we mentioned on the Q1 conference call, we've seen a significant increase in the cost of managing the liquids that naturally occur in our landfills. In the Q2 of 2016, the increase in leachate cost was about $22,000,000
or $0.03
per share. As of July 1, we've implemented a wastewater management charge at all of our landfills for customers that are not under contract. We're still in the early stages, but so far there has not been significant pushback. The next step will be to apply the charge to our disposal contracts as they renew. By passing these cost increases on to our customers, we'll ensure that we maintain an adequate return on the huge capital investments that we make in our landfills.
Turning to recycling, we saw a 2.3% increase in average commodity prices for the quarter and a 2.9% decrease in volumes. We continue to focus on managing operating costs as we've seen our recycling operating costs improve more than 9% when compared to the Q2 of 2015. These operational improvements and the increase in commodity prices drove the recycling line of business to its highest income from operations since 2012 when the blended commodity prices were $109 per ton versus $85 in the Q2 of 2016. Year over year, the recycling line of business contributed $0.01 per share to earnings. We continue to work with our customers to develop a mutually beneficial solution that allows for a sustainable recycling business model.
To summarize, the positive momentum that we saw in the Q1 continued throughout the Q2. All of our employees worked hard to deliver strong first half results by focusing on improving price, driving disciplined volume growth and managing costs. In light of the strong first half performance, we're increasing our adjusted earnings per diluted share guidance to between $2.83 $2.86 for the full year, a $0.09 to $0.12 increase from the low end of our previous guidance. More importantly, we're also raising our free cash flow guidance for 2016 to between $1,600,000,000 $1,700,000,000 a $100,000,000 to $200,000,000 increase from the low end of our previous guidance, despite our expected capital expenditures being slightly higher than our previous guidance. So the momentum in our business continues and our focus has never been sharper.
We look forward to our corporate and field teams building upon this strong performance to drive even better results for the remainder of 2016 and beyond. I'll now turn the call over to Jim to discuss our 2nd quarter results in more detail.
Thanks, David.
In the
2nd quarter, revenues were $3,430,000,000 an increase of $110,000,000 or 3.3 percent when compared to the Q2 of 2015. We saw $150,000,000 increase in our traditional solid waste business due to a $98,000,000 increase from the combined impacts of price and volume and $52,000,000 increase in revenues from acquisitions net of divestitures. These increases were partially offset by declines of $24,000,000 in lower fuel surcharge revenues, dollars 10,000,000 in foreign currency fluctuations and a $5,000,000 decline from lower recycling revenues. Looking at internal revenue growth for the company in the 2nd quarter, our collection and disposal core price was 4.9% and yield was 2.6% with total volumes improving 0.4%. Volumes were positive for the 2nd consecutive quarter.
The combined positive price and positive volume led to total company income from operations growing $58,000,000 operating income margin expanding 120 basis points to 18 percent Operating EBITDA growing $76,000,000 and operating EBITDA margin growing 140 basis points to 27.9%. Our collection lines of business continue to see the benefits of our disciplined pricing programs and improved volumes. Overall, collection core price was 6.3% and yield was 3.3%. Industrial demand continued the strong performance that we saw in the Q1. Volume was up 1.5% in the 2nd quarter, 150 basis point improvement from the Q2 of 2015.
And as David mentioned, commercial volumes were positive for the first time since 2000 and 5 at 0.3% for the 2nd quarter, a 250 basis point improvement from the Q2 of 2015. Our residential business continues to be a drag on overall collection volumes, down 3.5% in the 2nd quarter, similar to the declines that we've experienced throughout 2014 2015. However, strong core price and positive volume in the high margin commercial and industrial lines of business led to our collection income from operations growing $44,000,000 and the operating margin growing 120 basis points. EBITDA grew $54,000,000 and EBITDA margin increased 150 basis points. In the landfill line of business, we again saw the benefits of both positive volume to positive yield in the Q2 just as we did last year.
Total landfill volumes increased 6.5%. Our landfill volume growth is very consistent with the volume growth over the past 2 years. MSW volumes grew by 5.2%, C and D volume grew 12.5% and combined special waste and revenue generating cover volumes grew 4.4%. We achieved core price of 2.7 percent, an increase of 40 basis points from the Q2 of 2015 and saw same store average MSW rates increase year over year by 1.9% from Q2 of 2015. Moving now to operating expenses.
As a percent of revenue, those expenses improved 140 basis points to 62.2%. For the Q2, operating expenses increased $22,000,000 when compared to the Q2 of 2015. Landfill operating costs represented the largest increase up $28,000,000 $22,000,000 of the $28,000,000 increase were the increased leachate costs with remaining $6,000,000 increase related to the decline in the U. S. Treasury rate used for discounting our long term care obligations.
Reminder of the operating cost dollar increase primarily relates to our increased volumes and costs related to acquired operations, which were partially offset by savings from lower fuel and risk management costs. For the 2nd quarter as a percent of revenue, SG and A costs were 9.9%, up 20 basis points when compared to the Q2 of 2015. On a dollar basis, SG and A costs were $340,000,000 an increase of $18,000,000 compared to 20.15. Labor costs drove the majority of the increase, primarily related to acquisitions and higher accruals for stock based incentive compensation. As you may recall, our stock based incentive compensation is based upon performance in the areas of free cash flow and total shareholder return And we've achieved strong performance in both metrics the last 2 years.
In the second quarter, those costs increased $11,000,000 compared to the Q2 of 2015. We expect that these costs will exceed last year by about the same amount in the back half of the year. We still expect to improve SG and A cost as a percent of revenue for the full year when compared to 2015. Turning to cash flow in the Q2. Cash provided by operating activities was $748,000,000 compared to $816,000,000 in the Q2 of 2015.
Our operations continue to perform very well as we achieved operating EBITDA increase of $76,000,000 However, this increase was more than offset by the impact of timing differences in cash tax payments of $75,000,000 and working capital changes. We expect the working capital changes to even out over the remainder of the year. During the Q2, we spent $312,000,000 on capital expenditures, an increase of $16,000,000 when compared to the Q2 of 2015. Through the 1st 6 months of 2016, CapEx has increased $100,000,000 compared to 2015. A large portion of the increase relates to one time capital spending for leachate treatment facility and the timing of truck purchases.
As a result, we now expect that capital expenditures will be between $1,400,000,000 $1,450,000,000 for 2016. We do not believe that this year's increase in capital spending over our original guidance is a permanent increase due to the one time nature of the extra spend. In the Q2, we had $11,000,000 in proceeds from divested assets, a decrease of $48,000,000 from last year. Combined, we generated $447,000,000 of free cash flow and almost $849,000,000 year to date. Given this strong first half performance, we're raising our free cash flow guidance to between 1 point $6,000,000,000 $1,700,000,000 In the second quarter, we returned $431,000,000 to shareholders.
We paid $181,000,000 in dividends and repurchased $251,000,000 of shares. Finally, looking at our other financial metrics at the end of the second quarter, our debt to EBITDA ratio measured based on our bank covenants was 2.67 and our weighted average cost of debt was 4.22%. The floating rate portion of our total debt portfolio was 10% at the end of the quarter. The effective tax rate was 37.6% in the 2nd quarter. Adjusting for the impairments, the tax rate was 34.7%.
We still expect our full year adjusted tax rate to be approximately 35%. In summary, through the 1st 6 months of 2016, our employees have driven strong operational and financial performance that's exceeded our expectations. And for that, I want to thank them. The second half of twenty sixteen will have tougher year over year comparisons. However, we're confident that we can execute our strategy to have a successful 2016.
And with that, Janisha, let's open the line for questions.
Your first question comes from the line of Joe Box of KeyBanc Capital.
Hey, good morning guys.
Good morning. Good morning, Joe.
I just want to flush out the better than expected performance within really just your gross margins here in the quarter. How much of that would you attribute to the volumes kind of really turning the corner here and maybe getting a little more route density within some of your higher margin businesses like commercial versus say the reduction in churn that you saw in the quarter and maybe not losing some of those more profitable existing customers?
Yes. I think they're 2 sides of the same coin, right? I mean, I think our performance on the volume side was driven by both. You can't have continued volume increases when you're leaking customers out the back end. So we've really done a nice job this year of not only adding more new business, but losing less of our business.
And so what I'd say, Joe, is that we did a great job on that front, but as we get the tools in place to really understand profitability by customer, we can be a lot more focused on maintaining the right customers rather than just retaining the right number of customers.
Joe, I would say on the operating with respect to operating expenses, that was a good story as well. We were up $22,000,000 if you exclude that pension charge last year, but you're up $22,000,000 on 3.3 percent top line growth. So if you adjust for revenue growth, our salary and wages line improved by about 20 basis points. And we really overcame the merit increase, the annual merit increase of about 2.5% and that increase in landfill operating costs.
Got it. And I guess ultimately what I'm trying to get at is you've had the price lever that you've been pulling. Now you're starting to see volume. Obviously, you've been working the cost side. Should we think about the incremental EBITDA margins maybe being north of that typical kind of 30 ish plus percent that I typically think about going forward?
Is that a reasonable bogey?
Yes, certainly on the commercial line that's a reasonable bogey. I mean you hit on it earlier which is the route density. The ability for us to add the right customers in the right location at the right price is really the core to our sales and marketing efforts.
And David, just to be clear, I was talking total company, not just commercial on that incremental EBITDA?
Yes. Well, the commercial line is yes, you are absolutely right. Certainly, the landfill line is higher than that. The industrial line, it will be higher than that. But the commercial line is really where you get that benefit of added density.
And then maybe just one last quick one and I'll turn it over. I think it's interesting that your commercial volumes are starting to turn the corner. Really at the same time, it looks like consumer maybe could be getting a bit punkish. Are you thinking that this is going to be the beginning of a sustainable recovery in commercial volumes? Or would you caution us that it's going to be somewhat lumpy?
No. When you look at what's happened to our commercial volume over the last, call it, 10 quarters, it's been a really steady progression of about 0.5% to 0.8% every single quarter. And so the beauty of the commercial line of business is once you sign up those customers, unless they go out of business, they're with you for a long time. And with the churn rate going down, I would say we are at the beginning of the cycle, nowhere near the end. Joe, I'd also add that most of our new customers, our greenfield sites, they're new customers, new startups.
It's about at the 60% mark of new customers. So that tells you there's some economy positives occurring.
Great. I appreciate the color. Thank you, guys. Thank you.
Your next question comes from the line of Andrew Mushkaiglia of Credit Suisse.
Hey, guys. Thanks for my question. Sure. So just looking at your volumes too, I mean, so now we got our 2nd quarter in a row of positive volumes. How did it track towards what you guys were expecting in the quarter?
I know we had a lot of noise last quarter, but were these better than you expected? And then how did things trend through July so far?
Yes. I'd say they're a little bit ahead of where we expected. Like I said, the commercial line of business has been a very easy pattern to follow. The March has been very steady at about 0.5 point to a point of improvement every quarter. Obviously, the industrial line is a little bit more seasonal and we probably had some of those volumes move into the Q1 with a stronger construction season in the Q1.
The landfill line, again, has been a pretty steady March. Again, a little bit of volume probably in the Q1. So I'd say we're a little bit ahead of where we are, but we don't expect the trend to change. That's why we think that we're on a very good march toward that positive 1% plus volumes by the end of the year.
Andrew, the big question that we had really at the end of the Q1 was how much volume did we borrow because of the model that David mentioned, how much did we borrow in Q1 from Q2. And that borrowing would have occurred really in two lines of business, would have occurred in the roll off line of business, primarily within the temporary roll off component and then it would have occurred in the landfill line of business. And then looking at it, it looks like if you adjust out kind of the added workday we had in Q1, we think we probably borrowed somewhere in the neighborhood of 60 basis points to 80 basis points of volume in those two lines of business. But still, when you look at 150 basis point improvements in industrial versus last year and commercial being up 2.50 basis points, which didn't see any borrowing from Q1 to Q2, we felt pretty good about volume in Q2. And as David said, probably a little bit ahead of where we expect it to be, particularly on the commercial line.
And with respect to the last part of the question, obviously, it's still early, but July volumes continue to show the steady progression. Okay. So let's
go into July. I mean, you said you could probably do better than that 1%, but I guess what's the hesitation there? I mean, are there some pretty large contracts rolling off in Q3 and Q4? Or is it just tough comps or what I guess what do we expect into the second half?
Yes. Obviously, the comps get a little bit tougher. And so there's no there are no big contracts. In fact, we have a couple of contracts on our national account side that will be coming on in the back half of the year. And so, there really aren't any large volume losses like we've had in the past few years particularly in the residential line of business.
But there are a little bit tougher year over year comps.
Okay, got it. Thanks guys. Thank you.
Your next question comes from the line of Michael Hoffman of Stifel.
Hi, David, Jim, Jim, how are you today?
Hey, Michael. Good morning.
So I have a question on the price side. You noted that you had a delta of about 80 basis points year over year on the core, but you had a 90 basis points on yield in the inside solid waste. So you clearly that's the right direction. You're retaining more price within the core. What are you doing proactively to offset the leakage from, $450 ish million of price you're going to the market with versus what you're reporting?
Yes, Michael, as you've heard us talk, that's our Periscope project and Jim Trebathen is leading that. So maybe he can talk a little bit about what we're doing with Periscope. Yes, Michael, you've noticed well because that is absolutely true. Part of it can be mix that we don't have control over, but what we do have control over, we're seeing the benefit of that. We're retaining more of that price.
Periscope, and it's a self-service analytical platform. It really marries kind of revenue cost unit data. It gives us profitability and trending profitability. We can do it, Michael, by customer, by sales rep. We can do it by customer segment or a sales channel, by route, by geography.
It really will help us as we move forward. We're about halfway through rolling it out to our 17 areas. Not all of them are executing with it. We're in the final steps of putting together a playbook that really will be because the analytics are so intuitive and so obvious, it will be really heavy on action. What do we do with the tool to get benefit?
Most of that will come as we finish the rollout in Q4 and especially into 2017. But for those areas that have been have had it up and running, we see the benefit. We also see some real strong effort just in We've got really good processes that are being We've got really good processes that are being executed across the areas to retain customers and our operating teams providing a lot better service that we measure really consistently with real accountability processes. So I think that trend will continue.
Okay. And based on the early rollouts where it's been in for a while, what's the pace of that gap narrowing? I mean, is it 10 basis points a quarter or is it 20 basis points or 30 basis points quarter?
Michael, we've got I don't have the number in front of me, but we piloted in the Southeast and that's one of our highest yield and our most improved from a retention standpoint area. So we see the benefit of that from that area using it and implementing the tool.
Okay. And then on volume, if I follow the path of the sequential progression and you exit the year at over 1%, but it feels like you start the year at almost 2% based on that. I mean the reported number will be over 1%, but you're starting 17 at 2% on volume. Am I being overly optimistic about your volume outlook for 2017?
Yes. Obviously, we put our budgets together in the October, November timeframe. So we'll look at it then and where we are at that point in time. But what I've said, Michael, is that I do think we're progressing toward that, what I call the 2% price, 2% volume, the 2% and 2%. I've said that it's probably 18 months away.
But as we put together our budget for 2017, hopefully we will see it on the horizon a little sooner.
Okay. And then there is lots of hand wringing in the stock market about the economy and recession here, there, Brexit, all that. Can we break into 2 sort of pieces of your business, so the part that Harry Lamberton runs that approximately $1,000,000,000 it's industrial. If I pull out the energy waste business, which I get is down for secular reasons, what's the rest of the trend? And are you seeing any recessionary signs?
No. It's interesting because you hear everybody talking about this industrial recession that's going on in the U. S. And I would tell you we're not seeing it. Our C and V volume, which is part of the industrial line of business and then our special waste volumes are probably the best gauges of the economy, that part of the economy and they're pretty strong.
Both were solid in Q2. June was the strongest month of the quarter and July shows continued strength. So we're just not seeing the industrial recession. Now maybe it's because we're at the back end of the cycle, but I would tell you we're even when we look at our special waste pipeline, it looks pretty strong. So I would tell you we're not seeing what the rest of the country seems to be talking about.
And Michael, I'm not sure when the country talks about an industrial recession, I think they're thinking about things like automobiles and refrigerators. I think Houston is sort of indicative of the country, which is the west side of Houston is not doing so great because of low oil prices. But the east side of Houston, when you go to Beaumont, Lake Charles, the spots where we have our industrial landfill base, because of the low energy price inputs, those places are booming. You can't buy a house in Beaumont, not that anyone would want to, but that side, that's a wonderful city. But the chemical corridor is doing spectacularly well, certainly is not in any kind of industrial recession.
So when we look at our overall industrial business, it's actually performing very well. Okay.
And then if I follow that through on the consumer side, so every restaurant company in the country that's casual or fast casual is reporting lousy comps. So yes, you have shown positive commercial volume. And I think the restaurant comp issue is they thought their comps were going to be 34 and they're coming in at 12 and that's deemed lousy. How do you see like the commercial market in the context of like end markets like restaurants or the entertainment or services sector?
Yes. The overall commercial business as Jim Trevathan mentioned with about 60% to 70% of our new business coming from Greenfields, which are brand new operating businesses, it seems to us that the whole commercial end market is very strong. We don't look at it necessarily by the various segments, but the end market actually seems to be very strong.
And then last one for me on your free cash flow raise 1.6% to 1.7%, how many dollars of one time that are unique to 16% are in that $1.6 to $1.7?
Yes. There's probably three numbers that really matter in that, Michael. You've got the one time CapEx piece and that's about $100,000,000 and that's offset by kind of a one time cash flow monetization, cash taxes monetization. So those 2 offset one another at about $100,000,000 piece. And then you've got just the business itself growing at about $100,000,000 coming in through the EBITDA line.
Okay. That's great to know. Thank you.
Your next question comes from the line of Corey Greendale of First Analysis.
Thank you. This is Ken Wang on for Corey. Just focusing on the decline in recycling volume this quarter, which I believe may be a part of the volume you're shedding. Can you speak a bit about the dynamics here just given that commodity prices have been on an upward trajectory recently?
Yes. The bulk of those volume declines were large contracts where we were losing money and we rebid them to make money and someone else took the contract. And so those were losing those volumes is the best thing we can do for recycling because they were literally negative margin volume.
Okay. Thanks. That's helpful. And then kind of on the same topic, I know you've put into place recycling contracts that limit price exposure. And again, with prices up for commodities, how will this affect the bottom line?
Is there kind of a formula that you can give us or some kind of rule of thumb?
Yes. And look prices are up, not dramatically just in that 2% to 3% range for the quarter. So not a dramatic increase in price. And as we look forward, remember every year you seem to have that seasonal uptick and then starting in July it starts to tick down. So we're not certain that we're going to see that benefit in the back half of the year.
But generally what we say is that every $10 in commodity prices equates to about $30,000,000 of EBIT for us. And so what we've tried to do in this business is to make sure that if commodity prices go down, our earnings don't take a negative hit. But if commodity prices go up, they take a positive hit. So we try to de risk the business so that there's no downside, only upside. If the commodity prices go down in the back half of the year, we think we can offset that with operational improvements.
So we don't expect any negative benefit in the back half of the year. If we see anything in the back half of the year, it will be a positive benefit from recycling.
Ken, if you look at the whole first half of the year on recycling, while we were up in commodity prices for Q2 by about 2.3%, We're actually down still year to date over 4% in commodity prices. And to David's point, we think that will probably even out. We're cautiously optimistic because of the dynamic that he mentioned with kind of high prices in Q2 and then a tail off in Q3 and Q4. But we're cautiously optimistic that we might be able to get to flat pricing. All the benefit that you're seeing from recycling, a big chunk of the benefit you're seeing from recycling for us has been on the OpEx side where we've taken quite a bit of OpEx out for the 1st 6 months and we'll continue to do so in the back
half. Thank you.
Thank you.
Your next question comes from the line of Al Cashtalk of Wedbush Securities.
Good morning, everyone.
Good morning, Al.
From L. A, I should say, right, as opposed to Houston. On the recycling piece, maybe we can talk a little further on that please for clarification. A couple of years ago, you called out, and I think it was actually dollar valued sort of the improvement that you were looking for operationally. A lot of it was through negotiating and renegotiating contracts, some of the commodity price headwinds, etcetera.
But where are we at in terms of that tailwind on the improvement. You earned $0.01 I think this quarter or you commented that I think you got $0.01 which is the first time you turned profitable in a while. And so maybe I'll just leave it at that and let you take it from there to see if you can share an update on where you're at.
Yes, sure. We're about 75% to 80% of the way through, what I'd call those negative margin contracts. We still have a couple more that will roll off over the next 6 to 9 months. And so and that's why I say in the back half of the year, being 75% to 80% through those contracts, obviously, we still have 20% to 25% that have some exposure to downward commodity prices. But if that 20% to 25% sees downward commodity prices, we do think we can offset that with operational improvement.
So that's why I say in the back half of the year, there really is only upside from recycling. There really isn't much downside. Now as we look back into the back half of the year, we're not counting on a dramatic commodity price increase, but any commodity price increase that we have obviously falls straight to the bottom line.
All right. Are you hearing from customers in terms of new service adds in this area? Are people municipalities, I guess, in particular, are they still do they get it yet in terms of understanding the cost? I know your messaging has been very direct there, but what's the feedback that you're getting as folks are looking at the service?
Yes. Look, I think they get it. It's been a very prolonged downturn. This has been a different downturn than we've ever seen in the recycling markets. And so I think they get it.
Now early on in the cycle, you had some people that came in and bid some of these contracts under the old methodology, right? And they're not fuel with the fuel surcharge back in the early 2000s where initially people go, well, we will count on the markets bouncing back. So we will continue to bid under the old model. They are now stuck with 3 to 5 year contracts where they are going to lose money for 3 to 5 years. The next time those contracts come up, they will be bid more rationally.
So not only do the municipalities get it, but I think that the recycling business community gets it too. And so I think what you'll see is a much more rational bidding behavior over the next 5 years.
Switching gears on the industrial side, you guys were on record and talking about this being a very strong growth area for you. It would suggest to me it was more M and A implied, but also organically. Could you talk about the environment there? There's certainly been a few companies that have struggled in this area. We've had a fair amount of tailwind from sort of the energy concept, which largely now I think is anticipated out of numbers, so called easy comps.
But and then I think Jim made some comments earlier about C and D and special waste. But let's talk about you put up 9.5% price, which I think was pretty you got that number right, correct. Where do we go from here?
Yes. Al, there's a couple of components of that industrial line of business. It's a big category. Of course, energy services, I mean, we've had some questions when we've been out talking to investors about, are you seeing your energy services business coming back because you're seeing price of oil bouncing back up. And what we've said is look energy services is really not so much driven by the price of oil as it is driven by drilling activity.
And we've not seen drilling activity rebound in the form of rig counts. So the Energy Service piece is still pretty soft. Year over year, it's a pretty big negative for us that we've fought back against. Coal ash is another component. Coal ash, as you know, we have a big Duke contract that is proceeding well for us.
And we're seeing some certainly seeing landfill impact from that contract. The utilities the public utilities are out there developing their coal combustion residual plans and each for each plant. And we expect that those plans will result in a combination of kind of on-site work and some off-site disposal for us in the next few years. So, coal ash will be good. I would tell you that for the most part these companies prefer to handle it on-site, prefer beneficial reuse.
We can handle all 3, But we'll certainly see some benefit in addition to the Duke contract. C and D, we talked about C and D has been strong. And I would tell you that in talking to one of our area vice presidents who has a strong C and D market right now. He believes that that's part of what's affecting his commercial volume is that David has said it many times, it's when you start seeing these big tracts of land being taken out and we get that C and D business, maybe the more beneficial side of that is getting the commercial volume, the permanent business on the back end of that. And this VP seems to think that's exactly what's going on.
And then there are a couple of other components within the industrial line of business as well. But overall, I think industrial looks to be reasonably strong for us and appears to be continuing down that path.
Great. Jim, on your coal ash opportunity, there are a couple of companies, one in particular that has a fair amount of relationships with the utilities on the sort of selling that ash out for beneficial reuse. Is M and A an opportunity for you guys here understanding that disposal or the off-site work you certainly are set up for, but wondering about the on-site work and the marketing of Ash?
Yes. So M and A is an opportunity for us there, although we bought a company called Flash Direct a couple of years ago and they have really grown tremendously since the acquisition of since we acquired them a couple of years ago. So while we're always looking for proprietary technologies and that's what Flash Direct brought to us, Right now, we feel good with that acquisition, but not to say we wouldn't look at another acquisition there or in any other space. In energy services, for example, it's got to be properly priced and we don't want to kind of buy at the bottom. But and we can talk more about M and A later.
But yes, we'd certainly be interested in acquisitions. We just need to make sure it's the right technology and provides the right returns.
Great. Finally, David, if I can come back to your comment on your prepared remarks, I think you said that core price 4% yield 2% and then you followed that with it could moderate in the second half of twenty sixteen. Help me appreciate what you were I won't say Yes.
No, what I meant, Al, is that our original targets were 4% core price, 2% yield. We are going to exceed those. There is no doubt about it. This quarter, it was 4.9%, so well above our target and 2.6%, percent, well above our 2% target. And so in the back half of the year, we have got some CPI headwinds, we have got some year over year comp issues, we've got the timing of price increases.
So it might moderate a little bit, but nothing dramatic, nothing that will dramatically affects profitability. We still expect to have a great back half of the year. And for the full year, we'll clearly exceed that 4% core price target and that 2% yield target.
Okay. So you were saying moderate from the 4.9% and 2.6
Exactly.
All right. We'll look forward to seeing the results. Thanks a lot.
Thank you, pal.
Your next question comes from the line of Noah Kaye of Oppenheimer.
Yes. Thank you. Good morning. Just wondering if we can touch on the residential portion of the business. You did shed some of the unprofitable volumes.
Can you give us an update on how you're tracking with migrating to the Waste CPI sub index, something that I know certainly a competitor has talked about quite a bit. Can you give us a way to sort of measure where you are on the progress of that initiative?
Yes. Noah, Jim Trevathan here. We absolutely are focused on that not just with the residential line of business, but with our national account business with CPI obviously below 1 and not looking for any real strength in that number, we have migrated in that regard. We're on new contracts. That is the goal on every new contract to have a metric that's closer to our cost increases rather than CPI.
And we're on the resi side probably a third of the way through on the national account side. We're getting a different metric on every renewal of a contract. It may not be the full wastewater treatment metric that's generally 200, 300 basis points higher than CPI, but we see that as the way forward to minimize the margin deterioration as our costs go up, but yet CPI stays below 1%. So that is absolutely a focus and we're a little less than halfway through. But again, those are long term contracts.
So as they change, that's the goal.
No. Even with the positive progress that Jim just talked about on shifting within these contracts. It's no secret that resi is a tough line of business for us. And I think it to me it highlights the need for good solid disposal pricing. And we believe that's we've made some progress on disposal pricing not as much as we would like part of you'll see an improvement as our charge kind of that we put in last quarter actually started on July 1 starts to kind of come to fruition.
But look, that line of business has in all honesty has been a disappointment for us. We're doing a lot to try and fix it and part of that is addressing it on the disposal side of our business.
And Noah, an example of that focus on the residential line, we were over 2% in yield for the quarter where we haven't been over 2% for a couple of years on the resi line of business. So we're making real progress. It's measurable.
Okay. That is incredibly helpful. Thank you. That additional $100,000,000 to 200,000,000 dollars of free cash flow, a nice upward revision there. Wondering kind of how you're thinking about allocation generally these days, how you're looking at the M and A landscape.
Certainly, rising tide tends to lift all boats and potentially evaluations, but we are seeing more industry discipline on a number of fronts. So wondering how you're thinking about the M and A opportunities and also what kind of opportunities you're seeing for any kind of asset swaps and market consolidation?
Yes. When we look at the acquisition market, basically the last 3 years we've done a moderate sized deal each year that added sort of that $50,000,000 to $75,000,000 of EBITDA. So we did Dieffenbaugh RCI in Montreal, Dieffenbaugh in Kansas City and then FWS in South Florida. And we really don't see another one of those on the horizon. We've looked at a number of deals in the Southeast and some other places where what you said is exactly right.
Sellers have gotten a little bit undisciplined on what they want. We're generally willing to pay sort of 6 to 8 times EBITDA given the synergies we can pull out for a bigger deal. We might pay 7 to 9 times EBITDA, again because we can get good synergies and post synergies we can get it at
of 6 to 7.5 times EBITDA.
The problem part of the problem is we've got a lot of the solid waste sellers that want 12 times EBITDA and that's just not a number that really works for us. And so we really don't see one of those decent sized solid waste acquisitions on the near horizon. We aren't looking dramatically outside of our core solid waste. As Jim said, if we saw some opportunistic buying on the industrial side or energy services, we'd look at that. But we are not currently actively looking at anything in that arena.
And so we're sort of back to what I'd say are our smaller tuck in acquisitions, sort of the $10,000,000 to $20,000,000 type acquisitions and we've asked our business developers to pick up the pace on those to make up for the fact that we don't have any of those larger transactions on the horizon. And so you know the deal. These things go in cycles. There are not a lot of buyers out there. You really haven't seen a dramatic amount of activity in the M and A side.
And so and I think that's probably because a lot of these sellers have heightened expectations as the industry dynamics have improved. I would say that the industry is showing just as much discipline on the M and A side as they are on the operational and pricing side. No one is out there paying crazy numbers. So those businesses are going to be sold. It's just a matter of when they get to a reasonable multiple.
Yes. Yes. Well, thank you very
much and congrats on the quarter.
Thank you.
Your next question comes from the line of Scott Levine of Imperial Capital.
Hey, good morning guys. Good morning, Scott. Just want to push a little bit more on the guidance revision and what's behind it. It looks like the recycling business did a little better than you were budgeting for in the first half of the year, 1Q exceptionally strong, volume seasonally, maybe a little bit more detail on explicitly what's behind the guidance raise? And also, I know you don't give guidance first half versus second half per se, but is this mostly just outperformance in the first half?
Or is it factors that should continue to lend themselves to upside in the back half of the year and beyond?
Yes. When I look at the first half of the year and the outperformance in recycling, the outperformance in recycling is sort of offset by the underperformance on our leachate costs, which as we've said were up 20 $2,000,000 this quarter. And so those actually that's a slight negative overall. And so from a business point of view, when I look at the year, it's the plain and simple stuff. It's the blocking and tackling price, volume and cost control, right?
And we've seen steady progress on all three of those. We don't expect that to slow down. And so the back half of the year obviously ramps up a little bit more than the first half of the year, but we're pretty optimistic that we're going to continue to see the strong performance continue. Again, it's blocking and tackling price, volume, cost.
Got it. Fair enough. Thanks. And as my follow-up, not to beat the dead horse on residential, volume. I don't recall offhand if that's better than it's been or maybe just a little bit more elaboration on what's driving the weakness and it sounds like you're doing some things on the pricing side that are working well.
But how fixable is this? Or is this kind of an industry phenomenon? And how confident are you that this business just in general that the metrics improve going forward?
Yes. Look, it's about the same. I mean, last quarter was negative 3.4. We've had some 2.6s and last year we had a couple of negative 3.6s on volume. So it's not been a great volume business for us.
By the way, a lot of that is by design. But I think the changes that Jim talked about in those contracts are to kind of back to David's point about de risking the business are helping to de risk the line of business. And then I think it's very important that we've had some very stiff competition within the resi line of business. And so it's important for us to continue to push disposal price increases in addition to collection price increases. We're pushing collection price increases through this residential line of business on our customers.
But I think it's important that we push disposal price increases on our 3rd party customers as well. I mean they should have to pay their fair share.
And is it a certain class of competitor where you're seeing the issues as large residential contracts where it's just intense competition for them and landfill prices delever to drive improvement or is there more to it than that?
Yes, Scott. Jim to read that. I think part of the issue on some of that volume loss, not all of it, but enough that it's measurable are from our local competitors. When you look at interest rates where they are, they can lease trucks really at a really low cost and come in and take some of the neighborhoods, for example, that are around the Houston area. Now they probably don't have the capital, the capability from a capital standpoint to handle one of the larger locations or franchises, but they put pricing pressure on some of those local neighborhoods where they can get a couple of trucks really, really inexpensively.
And I that's part of the effect. What we do is look at it from an integrated standpoint. As Jim Fish said, we're integrated and we're taking the handling the disposal we'll we'll help turn that volume loose where it's a low collection margin and put that capital to work at a place that we get a better return. And the beauty of that is, when you see that local competitor take on sort of a moderate sized residential contract, generally what happens is they lose their focus on the commercial and industrial side. So they're adding trucks on the residential side.
We don't have any problem with that as long as they're not adding trucks on the commercial industrial side. So for us, it's really a matter of balance, where do you want to invest your capital. And for us, we'd much rather invest our capital on the commercial industrial side than on the residential side.
Understood. Appreciate the color. Thanks.
Your next question comes from the line of Michael Feniger of Bank of America AML.
Thanks guys. With maybe not a large transaction on the horizon and with free cash flow coming stronger than expected, could we maybe see more put to share buybacks or dividend growth perhaps?
How are you guys thinking about that?
Yes. It's really a great question. And look, as we've said many times, our first priority would be to reinvest it in the business through acquisitions. The fact that we don't have one on the horizon doesn't mean these things happen fairly quickly. And so we want to make sure that we keep enough powder dry that if something comes along, we're able to act and act fast without leveraging up the balance sheet too dramatically.
And so we're always going
to save a little bit
of dry powder to make sure that we can do any of those acquisitions that come along. And then when we look at it, obviously, our dividend yield has gone down with the stock price going up. And so at the end of the year, when we look at our dividend, I would expect that we'll see another good increase in the dividend coming into the back half of the year. And then on the share repurchase side, the bulk of the remainder of our cash goes to our share repurchase. We don't really time share repurchases.
And so we're going to ultimately do sort of $500,000,000 to $800,000,000 of share repurchases every year and I'd expect to see that continue.
Great. And on the churn rate, I guess, how low can that go? What's the ceiling or I guess the better term is the floor? How should we think about that progression?
Michael, we ask ourselves that same question regularly. In the vicinity of 5% is structural churn. It's businesses, small businesses that open and then come and go. So we probably at this point have about 400 basis points to play with. We I fully expect it to stay in single digits and whether our next goal is to get it below that 9 number and into the 8.
I think that is an achievable goal over the next few quarters, next year or 2. And that's what we're after. We won't that's affected both by service, by how we handle customer issues as they come up. I think the Periscope tool will help us in that regard and help us focus price increases on customer segments that tend to accept them better and therefore reduce that churn number. Some of the process issues I mentioned earlier will help us in that regard, but a lot of it boils down to much better just frontline service provision that our field guys are 100% focused on.
Great. Thanks guys.
Thank you.
Your final question comes from the line of Tyler Brown of Raymond James.
Hey, good morning guys. Good morning. Hey, congrats on swinging the pendulum over to the positive side on commercial volume. But Jim Trevathan, can you talk a little bit about the front load fleet? How much excess capacity do you think you have in that fleet?
And how much volume growth do you think you could absorb before you would have to see a bump in CapEx?
Yes. Tyler, we have plenty of capacity. There are a handful of markets where we've added some front load capacity on the route side, but our system has plenty of capacity when you look across the whole network to handle more volume. There are places, as I said earlier, that we've added routes. But with the tools that we now have through service delivery optimization and SDO with the onboard computers, when we add that, we're adding it at that low cost basis rather than just a truck handling a handful of customers.
We reroute regularly with that tool and make sure that the efficiency numbers stay up and they have as we've added volume in high growth markets. So I don't think you're going to see a huge impact whether it's through efficiency. You'll see most of those dollars on the commercial customer additions going to the bottom line.
By the way, Tom, we are buying more trucks this year. We're probably going to buy 10% more trucks this year than last year. So we are buying some additional trucks. And you can imagine, we're not buying a lot of resi trucks. So most of them are showing up on the industrial line of business, but also the commercial line.
Right. We'll buy about 1300, 1315 trucks this year versus 11 20 last year. So we see that upside and yet our efficiency Tyler is still positive about 1% year
to date. That's a good
number for us compared to historic numbers.
Yes. That was actually my second question. So is that 1300, is that a heightened replacement or is that more of a normal replacement cycle? I assume it's heightened.
Yes, it's heightened somewhat, especially as Jim said on the industrial side because we're seeing more growth there and have consistently over the last couple of years. But it's you're going to see it stay in that vicinity. We expect that volume, as Dave said earlier, to go past 1 and we'll continue in that 1300 or so trucks on just a replacement basis.
Okay. And then Jim Fish, maybe I'm reading into it a little bit, but did your comments kind of indicate that CapEx would decline in 2017 given the leachate investments? Or do those stick around into 2017? Just any way to think about that.
Well, specific to the leachate investment, yes, I think you're going to see a decline because as we talked about that kind of 100,000,000 dollars not all of it is the leachate plant, but the wastewater treatment plant. But yes, specific to that, they will decline. Now there are some other things that could affect it. If we were to win a big contract, for example, next year, that might offset some of that. But not knowing that at this point, I would say that we would see at least a partial decline off of this kind of $14,000,000 or $145,000,000 number.
Okay, very helpful. And then this is a housekeeping question. I apologize, I got on the call late, I may have missed it. But what was the $40,000,000 expense
in the
other line that was below EBIT? And can you give us any help on what how to think about that line going forward?
Yes. That's the impairment of some conversion technology investments that we had. Okay.
All right. Perfect. Thank
you. Thank you.
I will now turn the call over to Mr. David Steiner for an announcement and closing remarks.
Thank you. In a year where there doesn't seem to be a lot of good presidential news, we actually have some very good presidential news here at Waste Management. Today, we'll be issuing a press release and we're going to file an 8 ks announcing that we're promoting Jim Fish to the role of President. I wish I could promote him to role of President of the United States, but unfortunately all I can do is promote him to President of Waste Management. As part of our ongoing succession planning process, the Board and I felt that the next logical step in that process was for us to name Jim President.
We are conducting a search for a new Chief Financial Officer who will report to Jim and while that search is underway, Jim will retain CFO responsibilities. Obviously, you all on the phone know Jim very well. Many of you have worked with him for a while now, so you know why the Board and I have such confidence in him. He's really been pivotal to the success of our company and he's also a talented leader with tremendous knowledge of all aspects of our business. The promotion is a well deserved recognition of his past accomplishments and another step in his development as a leader.
I'm sure you'll all join me, our Board, our senior leadership team and the rest of our Waste Management family in congratulating Jim on this great achievement. And with that operator, we'll see you next quarter. Thank you.
Thank you for participating in today's Waste Management conference call. This call will be available for replay beginning today at 1:30 p. M. Eastern Standard Time through 11:59 p. M.
Eastern Standard Time on August 11, 2016. The conference ID number for the replay is 4,398, 6,112. Again, the conference ID number for the replay is 4,398,6,112. The number to dial for the replay is 855-859-2056. This concludes today's Waste Management conference call.