Waste Connections, Inc.
Q1 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q1 2013 Waste Connections' Earnings Conference Call. My name is Alison, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Mr. Ron Mittelstaedt, Chairman of the Board and CEO. Please proceed, sir.

[Ronald J. Mittelstaedt:]

Okay, thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our first quarter 2013 results and provide a detailed outlook for the second quarter. I'm joined this morning by Steve Bouck, our President; Darrell Chambliss, our COO; Worthing Jackman, our CFO; and several other members of our Senior Management team. As noted in our earnings release, 2013 is off to a great start. Consistently strong pricing growth, improving landfill volumes and increasing E&P activity drove better-than-expected financial results in the first quarter. Solid waste volume growth slightly exceeded our outlook for the period as well, despite harsh winter weather conditions in many markets. In addition, revenue per day from E&P waste increased about 12.5% from early January to late March. Adjusted EBITDA was 32.5% of revenue in the first quarter or about 50 basis points above our outlook. More importantly, adjusted free cash flow, a hallmark of our strategy, increased 29% to more than $100 million in the period or 22.3% of revenue. We remain cautiously optimistic about the balance of the year as solid waste pricing growth is already dialed in, year-over-year volume growth comparisons should continue to improve and E&P activity should continue to ramp, especially in the Bakken due to a combination of factors, including seasonal increases and newly permitted on-site solidification capabilities. Before we get into much more detail, let me turn the call over to Worthing for our forward-looking disclaimer, as well as other housekeeping items.

[Worthing F. Jackman:]

Thank you, Ron, good morning. We must inform everyone listening that certain matters discussed in this conference call are forward-looking statements, intended to qualify for the Safe Harbor's from liability established by the Private Securities Litigation Reform Act of 1995, including statements related to expected volume and pricing trends, E&P activity in margins, recycled commodity prices, expectations regarding period-to-period comparisons, potential acquisition activity, contributions from closed acquisitions, the timing of permitting activities and inquiries related to MLP treatment, the impact of the relocation of the company's corporate headquarters from California to Texas and our second quarter outlook for financial results. Such forward-looking statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those currently anticipated. These risks and uncertainties are set forth in the company's periodic filings with the Securities and Exchange Commission. Stockholders, potential investors and other participants are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this conference call and the company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. On the call, we will discuss non-GAAP measures, such as adjusted EBITDA, adjusted net income and adjusted net income per diluted share and adjusted free cash flow. Please refer to our earnings release for a reconciliation of such non-GAAP measures to the most comparable GAAP measure. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations, other companies may calculate these non-GAAP items differently. I will now turn the call back over to Ron.

[Ronald J. Mittelstaedt:]

Okay, thank you, Worthing. Revenue in Q1 was $449.9 million, up 19.5% over the prior-year period. As noted earlier, revenue met the upper end of our expectations, despite harsh winter weather conditions in multiple markets. Internal growth in the quarter was almost 1% broken down as follows

[Worthing F. Jackman:]

Thank you, Ron. In the first quarter, revenue of $449.9 million increased 19.5% over the prior-year period. Mostly due to acquisitions completed during the prior year. Adjusted EBITDA, as reconciled in our earnings release, increased 25.6% to $146.1 million. As a percentage of revenue, this was 32.5% or about 160 basis points above the year-ago period. We estimate that margins on the same-store basis within our solid waste business expanded about 10 basis points year-over-year, as strong pricing helped us more than offset an estimated negative 80-basis-point year-over-year margin impact from lower recycled commodity values, our target weight [ph] of the lower price customer of our Chiquita Canyon landfill and higher diesel prices. Acquisitions added an estimated 150 basis points to year-over-year margin expansion. The following are certain line items that moved a notable amount from the year-ago period as a percentage of revenue, primarily due to a change in revenue mix resulting from the higher margin R360 acquisition. Labor and supervisory expense decreased 100 basis points. Third party disposal and transfer cost decreased 80 basis points; rebates, revenue sharing and pass-through fees and expenses decreased 70 basis points; fuel expense decreased 40 basis points; third party equipment rental and subcontracted expenses increased 65 basis points; and real estate cost and related utilities expense increased 55 basis points. SG&A, as a percentage of revenue, adjusting for the items reconciled in our earnings release, was about 11.7% of revenue in both Q1 and the prior-year period. We expect SG&A, as a percentage of revenue, to decline as we now move into higher revenue quarters. Fuel expense in Q1 was about 6.1% of revenue. And we averaged approximately $3.73 per gallon for diesel or about $0.11 a gallon above the year-ago period, and up $0.16 sequentially from Q4. Depreciation and amortization expenses for the first quarter increased $15.3 million year-over-year, and were 12.9% of revenue, up more than 150 basis points year-over-year due to higher acquisition-related depletion cost. As we've noted before, about 2/3 of the R360 purchase price will be expensed through the P&L, primarily thorough noncash depletion expense, given the landfill-oriented nature of its assets. This significant increase in D&A as a percentage of revenue due to acquisition-related accounting further widens the difference between D&A and CapEx, which runs about 9.5% of revenue. This 300-basis-point difference is noncash and does not impact free cash flow, but it does dampen reported operating income, net income and GAAP EPS. Interest expense in the quarter increased $6.7 million over the prior-year period to $19 million, due to higher outstanding balances resulted from the R360 acquisition. Our effective tax rate for the first quarter was 39.3%, our fully diluted outstanding share count for Q1 was 123.9 million shares, an increase of about 8 million shares or 7% from the year-ago period, due to the impact of our equity offering during that prior-year period. GAAP and adjusted EPS in the first quarter were $0.34 and $0.37, respectively. Adjusted net income in the comparative periods, includes, among other items, an add-back for amortization of acquisition-related intangibles to help certain investors bridge a portion of the significant difference between GAAP net income and free cash flow, especially following the R360 transaction. As Ron mentioned earlier, adjusted free cash flow in the first quarter was $100.2 million or 22.3% of revenue. The first quarter is traditionally the highest free cash flow period, given the timing of tax and interest payments, although some of this calming benefit is offset by annual performance bonuses we typically pay in February as we did again this year. Our adjusted free cash flow margin in Q1 would have been about 25% of revenue had we not accrued and paid bonuses for the prior year. Debt outstanding at quarter end was about $2.1 billion. And we had over $400 million of available capacity under our credit facility. Our strong free cash flow enabled us to pay down more than $100 million of debt during Q1. And our leverage ratio at quarter end, as defined in our credit facility improved to 3.2x adjusted EBITDA. We expect this ratio to improve further to below 3x by the end of 2013, excluding the impact of any acquisitions that might close during the year. I will now review our outlook for the second quarter of 2013. Before I do, we'd like to remind everyone once, again, that actual results may vary significantly based on risks and uncertainties outlined in our Safe Harbor Statement, and our various SEC filings. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic environment, and excludes the impact of any additional acquisitions that may close during the period, expensing of acquisition-related transaction cost and any remaining cost incurred in connection with the relocation of our company's corporate headquarters in California to Texas, including an anticipated charge for the write-down of our prior corporate office lease. Starting with revenue. Revenue in the second quarter is estimated to be between $480 million and $482 million, up about 17% over Q2 of 2012. Organic growth is expected to be between positive 0.5% and 1%, with net pricing of almost 3%, and volume growth between negative 1% and negative 1.5%. Recycling, intermodal and other is expected to be down about 1%. We've assumed recycled commodity prices decline somewhat from current levels. Adjusted EBITDA for Q2 is estimated to be between $164 million and $165 million, reflecting a margin of about 34.2% or about 220 basis points above the prior-year period. Depreciation and amortization for the second quarter is estimated to be about 12.6% of revenue, up 140 basis points over the prior-year period due to the impact of acquisition-related accounting. Amortization of intangibles in the quarter is estimated to be about $6.2 million or $0.03 per diluted share. Operating income for the second quarter is estimated to be about 21.6% of revenue. Interest expense in Q2 is, again, estimated to be about $19 million. Our effective tax rate in Q2 is estimated to be about 39.2%. Noncontrolling interest is expected to reduce net income by about $200,000. And our diluted share count in Q2 is assumed to be about 124 million shares. Finally, as a reminder to what we've discussed on prior calls and noted in various SEC filings, we expect to take a onetime charge to write down our prior corporate office lease in California. This charge is expected to occur in either the second or third quarter of 2013 and is estimated to be between $8 million and $10 million. We expect to move out of our temporary space in the Woodlands and complete the move into our new permanent corporate office here around midyear. Now, let me turn the call back over to Ron for some final remarks, before Q&A.

[Ronald J. Mittelstaedt:]

Okay, thank you, Worthing. We're off to a great start in 2013 and remain well-positioned for double-digit, year-over-year growth in revenue, adjusted EPS and free cash flow. Our solid waste business is fairly well-dialed in for the year and continues to meet or exceed our own expectations. Meanwhile margins and activity within our E&P waste business continue to improve, with its' overall performance for 2013 still dependent on how broad-based and steep the ramp is during the year. The strength of our free cash flow generation remains a hallmark of our differentiated strategy. We have combined the demonstrated resilience and predictability of our solid waste business, with the potential higher growth of an evolving E&P waste business. As an integrated company, we maintain industry-leading EBITDA, operating and free cash flow margins, while positioning the company for future growth. Growth from continued solid waste price increases and an improving economy, growth from changes to or enforcement of E&P waste regulations, growth from potential newly permitted E&P waste facilities, growth from potential acquisitions and growth in the return of capital to our stockholders. Clearly, we're only the company in the space which can make all of these statements. Most others struggle to achieve 1 or 2 of them. We appreciate your time today. I will now turn this call over to the operator to open up the lines for your questions. Operator?

[Operator:]

[Operator Instructions] And your first question comes from Hamzah Mazari of Crédit Suisse.

[Hamzah Mazari:]

The first question is just on -- you talked about the MLP structure and seeking a private letter ruling. Could you maybe address the timing of that? Is that more of a Q4 event? How should we think about next steps?

[Worthing F. Jackman:]

Yes, it's likely a Q1 event. Once we're able to get it filed, it could take the IRS between 6 and 9 months, it's hard to predict what their turnaround timing would be. So it's likely Q1 of next year.

[Hamzah Mazari:]

Okay, great. And then on the volume side, could you maybe talk about what you're seeing in your Commercial business? And any changes in trends in April versus what you saw during the first quarter?

[Ronald J. Mittelstaedt:]

Yes Hamzah, this is Ron. Not really much of any -- I mean April starts our seasonal uptick that happens in our roll-off business, as well as in some of the C&D business that we have. And so just other than seasonal upticks, I would say that just sort of steady from Q1. I would note that in some parts of the country, I mean, here we are almost to May and we're still getting snow. So the spring is coming a little later in some parts of the country than others maybe. But, overall, the volume is steady to slightly improving. And we would expect a seasonal ramp, that is normal in Q2.

[Hamzah Mazari:]

Okay, and just this last question for me. On the R360 business, you talked about a ramp up in the second half. Could you maybe talk about what key metrics you're looking at to track that business, given drilling efficiencies. Is rig count still a good metric for you guys?

[Ronald J. Mittelstaedt:]

Yes, I mean, Hamzah, it is a good proxy over a period of time. And that period of time might be half a year to 1 year. But within any given quarter that in and of itself cannot be the determining factor because of what you just mentioned, the efficiencies of rigs -- of drilling rigs are getting so much better. And so really we're sort of looking at projected linear feet drilled by basin and that's sort of what we track.

[Operator:]

And your next question comes from the line of Alex Ovshey of Goldman Sachs.

[Alex Ovshey Ovshey:]

If you were to isolate the parts of the business that you feel are most directly exposed to the housing market, can you just talk about the latest trends that you're seeing in those parts of the business?

[Ronald J. Mittelstaedt:]

Yes. Well, obviously, the -- for us, which is a little different than the other guys, the parts of our business that are most associated with housing are obviously our roll-off business. The on-demand service where we're servicing new construction activity, as well as once homeowners are moved in, clean-up activity from the move-in of that. And obviously, we see that throughout our system. But we see it most pronounced on the West Coast because of the fact that there we get 100% of that volume in our markets at a the guaranteed price. There's no -- there's nothing, no price discovery. And so we are seeing the West region, which is our exclusive region, have the largest rebound and roll-off in the first quarter and here, again, at the start of the second quarter. So we are definitely getting some benefit from what improvement in housing there is. Most of the improvement in the housing in the West Coast right now is not new starts. It's actually soaking up of existing inventory for the most part. And then the second place we see it in our system is obviously in the C&D line at our landfills. And I think we noted that C&D was up in the quarter, again, about double-digits. And so obviously, particularly, given the fact that the first quarter, is the winter quarter a decent amount of that would be new housing-related activity in certain of the markets.

[Alex Ovshey Ovshey:]

And on the MLP topic, I think you said that you believe that some of your traditional legacy landfills may be able to qualify. Would you able to give us a sense for the order of magnitude of the revenue size of the legacy assets that you think may potentially qualify?

[Worthing F. Jackman:]

Well Alex when we talk about traditional landfills, we're focused on our traditional MSW and C&D landfills. I'm not aware of a private letter ruling that currently exists for that line of business. And so if you look at any of the companies in this space, what you're looking at as a proxy for potential revenue is obviously what each of the companies does and MSW disposal revenue and all the companies report that. And then within that, you look at a subset because strategically, some landfills may be more applicable to such structure than others.

[Operator:]

And your next question comes from Michael Hoffman of Wunderlich.

[Michael E. Hoffman:]

With regards to the sort of the strength of the cash at this juncture to, at what point could you see the buyback starting back at this -- given how good the cash is in?

[Worthing F. Jackman:]

As we said earlier, in the year, our focus in the near-term is get leverage back below 3x and preserve capacity for acquisitions and construction of newly-permit E&P sites. We would think those are better uses of cash at this point. As we get into the latter part of this year or early next, as we've clicked below 3x, and we're taking a kind of check in the pulse of potential acquisition activity for '14, and newly permitted E&P sites, then at that point, we'd reconsider whether or not we turn the buyback back on.

[Michael E. Hoffman:]

Okay. And then on the MLP subject, I mean, I'm presuming that when you say selective, it also -- you wouldn't knowingly want to put assets into a business where you could no longer operate them as an integrated company. So that's why this gets to be fairly limited, because if you lose that competitive advantage of being fully integrated, I mean you now have 2 different Boards of Directors with very different adjectives, one driving cash generation would want you to lower price at the landfill versus the other wanting you to maximize collective integration operating leverage. So that limits this opportunity as well doesn't it?

[Worthing F. Jackman:]

Well, at this point, we don't see that limitation based on our strategy and the profile of our assets. What I would also say is that, as a company, we could also be a general partner or the managing partner of that MLP to make sure we don't run into the issues that you're discussing.

[Michael E. Hoffman:]

Wouldn't you have 2 conflicting boards at that juncture -- I mean, because the MLP has to go public to be defined as an MLP? And again those are things that we'll be looking at considering when we evaluate such a structure.

[Ronald J. Mittelstaedt:]

And Michael, the reality is, is I think, there are certain of the landfills based on intercompany transactions that, or lack of intercompany transactions and much higher E&P volumes and other things that are important in the MLP structure, that make them obvious candidates. And then I think there are other landfills that are obvious candidates not to be because of some of the potential inherent conflicts. But I would say this to Worthing, the basket of opportunity within our assets set is far greater than it is in the other companies because of what you cited.

[Michael E. Hoffman:]

Right, okay. That's what I thought. Just -- and then what are you looking at from a cost standpoint to do a PLR?

[Worthing F. Jackman:]

It's a...

[Ronald J. Mittelstaedt:]

Pretty di minimus.

[Worthing F. Jackman:]

Yes, it's not a major cost item.

[Michael E. Hoffman:]

Okay, and does the IRS have some expectation if you ask, it's a little bit of be careful what you ask for because if they say yes, they expect you to do it?

[Worthing F. Jackman:]

No, that's not right.

[Ronald J. Mittelstaedt:]

No.

[Worthing F. Jackman:]

I think the important observation I think is it's hard to consider something that you don't have the approval to do. And so just like we have the ruling for the E&P assets that basically is in the top drawer, I think you need a similar ruling on the other side of disposal business, such that then it makes sense to burn the brain cells and calories to see if there's merit to doing it. Right now, you're just speculating.

[Michael E. Hoffman:]

And then back to the housing start question. So C&D is an obvious beneficiary. But have you started to see any of that, call it the second and third derivative, where you got -- you build a house but somebody's actually got to buy it and then it becomes a residential contract. And if you build enough of them somebody decides maybe I'll put a Quick Mart or a strip mall or maybe even a school in. Has that started happening?

[Ronald J. Mittelstaedt:]

Michael, not really to be honest. And I think that's the good news is that the results that we have are without that. I mean, we're still at the early stages of housing recovery. I mean, let's remember, I mean, large areas of housing recovery right now are California and Florida. Obviously, we have a big presence in California. We have no presence in Florida. The pickup there in housing is largely inventory reduction. So as far as the new home starts, the numbers that are being thrown around out there at around 1 million new home starts or so. I mean, again, I would say it's probably 6 to 12 months after those are really going that we really start to see the benefit in the core systems, the residential collection and commercial collection.

[Operator:]

And your next question comes from Al Kaschalk of Wedbush Securities.

[Albert Leo Kaschalk:]

Sort of a granular question, but on the segment reporting, I think looking at an EBITDA margin, the Eastern region really did a great job this quarter relative to Q2 -- Q1 of last year. And obviously, there's certain macro concerns there, but what drove that almost 700 basis point improvement on the margin there?

[Ronald J. Mittelstaedt:]

They probably realigned it....

[Worthing F. Jackman:]

No, there are number of items there, but the east region before had a very large MERV and that had, obviously, they had a big drop in pricing last year. We worked hard to improve the performance of that recycling facility, and you're seeing that come through. You're also seeing pickup in disposal volumes year-over-year and also the pricing power and the spreads you get to the cost inflation.

[Albert Leo Kaschalk:]

Is that market selectively geared towards either commercial, industrial or resi?

[Ronald J. Mittelstaedt:]

No, it's very well balanced between them, consistent with the rest of our operations.

[Albert Leo Kaschalk:]

Okay. I noticed there was no update on 2013 guidance but you did give Q2 commentary. Is there something we should read into that?

[Worthing F. Jackman:]

No. look, our MO traditionally is to wait until July call because by then we've got 6 months actual, we've got third quarter forecast. And by that point in time, we can also extrapolate the sequential trend into Q4. So we'll be updating our full year outlook, if necessary, at that point in time.

[Albert Leo Kaschalk:]

Okay. And then finally on the E&P side, in particular, I think, Ron, you cited April was up from March trend. I assume that's in the wet solids area and therefore consistent with the commentary of expectations of margin improvement as we go deeper into '13?

[Worthing F. Jackman:]

Yes. That is...

[Ronald J. Mittelstaedt:]

That is correct.

[Worthing F. Jackman:]

Yes, as we said we expect about a 500 basis point improvement Q1 to Q2. Some of that is based on successes we've had on the -- on kind of eliminating some things we've been outsourcing. But more importantly, the ramp in revenue that you get and the high flow-through from that.

[Albert Leo Kaschalk:]

So is there a function of a volume there that's beyond the normal seasonal pickup? Is there increased activity? Or is it getting to the spot of a tougher comp here?

[Worthing F. Jackman:]

Well, I think what you're also getting is just the discussions around changing customer behavior as well because remember, in some of these basins, one of your primary competitors is just reserve pits. And I think we've got more customers that are looking to move away from that for the obvious reasons.

[Operator:]

And your next question comes from Bill Fisher of Raymond James.

[William H. Fisher:]

Actually just to follow up on that, Worthing, the improvement you saw in April in the Bakken, was -- do you think that any of that was the reserve pit moving away from that, or is this more just weather and seasonal?

[Worthing F. Jackman:]

It's more seasonal at this point.

[Ronald J. Mittelstaedt:]

Yes.

[William H. Fisher:]

Okay. And then, Ron, just -- when you mentioned some of the opportunities at R360 to Eagle Ford permits or Texas permits and Oklahoma, over the next year, would you rank one of those as -- the permits that those getting those landfills, would that be a bigger impact? Or if there was more drilling in Oklahoma, would that help more?

[Ronald J. Mittelstaedt:]

Well, I would tell you that getting the permits in the Eagle Ford and the Permian would have the largest impact and opportunity, number one. Number two, the drilling activity in Oklahoma is very strong, but the issue in Oklahoma is that regulatorily, they are allowed to land apply. And so you're competing against a market that is effectively a zero cost market. There is a lot of pressure coming from a variety of groups to end the process of land application for obvious reasons of potential aquifer damage, and there are a number of larger E&P companies that are looking to move away from the practice as well. So Oklahoma is more of a regulatory issue. And so I would rank that a little bit behind the Eagle Ford and the Permian opportunity.

[William H. Fisher:]

Okay, great. And just on the Saratoga, is that Saratoga privatization supposed to be awarded in May or any update on that?

[Worthing F. Jackman:]

It's hard to assess timing on that. I mean, that's been on the calendar now for some time now. I would suspect sometime during Q3, we'll have a better update for that.

[Operator:]

And your next question comes from Corey Greendale of First Analysis.

[Corey Greendale:]

Just a couple of questions. I know there is very little chance that you're going to say anything other than we're off to a good start to the year. But the free cash flow in Q1 was quite strong and extrapolating usual seasonality would suggest you'd be quite nicely above the $300 million for the year. Is there anything you can say beyond good start and still think $300 million or better?

[Worthing F. Jackman:]

I think it's a great start to the year, Corey.

[Ronald J. Mittelstaedt:]

Yes, I mean, Corey, we didn't have a cash tax payment in Q1 as we did note in our commentary. We typically get a ramp in Q2 and into Q3 in CapEx. So there are things that will, I don't want people to read into the fact that we think we're going to do 22.3% for a full year. I think that would be misleading, but I think it clearly gives us an opportunity to have a shot at beating our $300 million target.

[Worthing F. Jackman:]

Yes, and what you also have to realize, Corey, is that as E&P ramps, that also eats up some working capital because it's a slower pay side of the business. And so again, I think that how fast E&P ramps in the back half of the year could soak up some of the excesses above $300 million. So let's -- again, let's wait until we get into July and have a better look at it.

[Corey Greendale:]

Okay, great. Sorry, I appreciate the commentary on R360's -- the ramp there or the E&P ramp sequentially. Can you just give us a little bit more, I'm sorry if I missed it, on the year-over-year trends in R360?

[Worthing F. Jackman:]

Yes, I mean, year-over-year, it's, again, it's a basin-by-basin discussion. As we said last year, so many of the drillers, especially up in Williston and the -- up in the Bakken, got such a fast start to the year and you didn't -- seasonality wasn't a question -- an issue up there in Q1 of last year because people were spending almost whatever it took to keep drilling and get the process going up there. And so year-over-year, we've had -- this year, we've had seasonality in Q1 within the Bakken. And so within that area, the Bakken is down year-over-year. But again, I think as we said before, last year, you had the Bakken start strong, finish slow. This year you've got the inverse where it started slow, and now you're seeing it ramp. And so hopefully, as we move through this year it ramps. The exit point this year is a lot higher than the exit point last year, which gives us a higher entry point [indiscernible].

[Ronald J. Mittelstaedt:]

Yes. And if you look at it, Corey, I mean, across the major basins, the Permian is up year-over-year, the Eagle Ford is up year-over-year, Oklahoma is up year-over-year and Louisiana is down year-over-year, and the Bakken is down year-over-year. So and -- then there's some smaller areas in Oklahoma -- excuse me, in Colorado and Wyoming that are smaller basins that really are not significant to the numbers, but those are the 5 major basins right now that we operate in. And so 3 are up, 2 are down, 1 that's down. Louisiana is more a function of storm damage that happened last year, and the slowing of that entire area that occurred and is really getting back and then the Bakken is what Worthing outlined.

[Corey Greendale:]

Okay, great. And especially strong Q1, what's the pipeline look like for the rest of the year?

[Ronald J. Mittelstaedt:]

The pipeline there is a lot of jobs that we have bid on, a lot of jobs that we have been awarded. We expect it to continue to stay strong based on what we're seeing right now. I mean, your visibility on that is never more than about 60 to 90 days out because you know what you've been awarded. But even once you've been awarded it, there can be delays in the actual start-up jobs. I mean, there are jobs that we were awarded last year that haven't started yet. So it's a little bit -- that business is much more speculative. But if we look at our traditional hit rates on the business, the amount that we bid on and the amount we actually turn into revenue in the quarter and assuming that stays consistent, the next couple of quarters look solid.

[Operator:]

And your next question comes from Adam Thalhimer of BB&T Capital Markets.

[Adam R. Thalhimer:]

Most of my questions have been answered here. I did want to ask about the expanded permit in the Bakken, you said, to handle more wet solids. What's the potential revenue associated with that?

[Ronald J. Mittelstaedt:]

That's our guesstimate right now, Adam. We were able to handle waste that was -- had a liquid content up to a certain amount and then had to be dried or solidified before being landfilled, and we've gotten an ability to handle wetter liquid, if you will and then solidify it. So it opens up streams that were not coming to our site from existing drillers. So it's hard to say. It could be an incremental 20% in volumes over the period of -- over the next year or so. That would be a size of a breadbasket, but 0% to 20%.

[Adam R. Thalhimer:]

Got it. And then, could you explain a little bit on the movement from the open pits to the permitted facilities in the Bakken. You said it was kind of up to the drillers themselves, but what kind of regulatory pressure are they under to facilitate that move?

[Ronald J. Mittelstaedt:]

Well, let's see, North Dakota has regulation around reserve pits and they make a distinction between a drilling pit and a reserve pit. And a drilling pit is something that is a newer concept to the state, where it's sort of a smaller on-site pit and it's designed for more temporary usage than long-term usage. We believe that ultimately, they will move away from both the reserve and drilling pits in North Dakota, and all that waste will move offsite. If you look at the legislation that the current administration in D.C. is saying, which they are saying they will promulgate in fairly very short order, we don't know what that means. But I take it to mean in this quarter coming up, they are talking about undergirding legislation that would affect how water is handled and how the -- what the disclosure is of water. And one of their major concerns about that is what is leaching into the aquifer. Well, if you take that to its logical conclusion, the #1 thing leaking into the aquifer is coming from drilling and reserve pits. So we believe that, ultimately, the federal legislation will eliminate the use of reserve and drilling pits. And so I think it will happen on a state level. I think, ultimately will happen on a federal level but the timing of that is hard to predict.

[Adam R. Thalhimer:]

And do you have any sense for what percent currently goes into the permitted facility versus the reserve...

[Ronald J. Mittelstaedt:]

Sure. Yes, in the Bakken 30% -- 30% to 35% goes into a permitted, 65% to 70% goes into a reserve to drilling pit. So it would virtually triple the addressable market.

[Adam R. Thalhimer:]

Do you have enough landfill airspace there to handle all that?

[Ronald J. Mittelstaedt:]

For a few years.

[Worthing F. Jackman:]

No, we do.

[Ronald J. Mittelstaedt:]

We do.

[Operator:]

And your next question comes from Joe Box of KeyBanc Capital Markets.

[Joe Box:]

A question on the solid waste business. One of your peers is out talking up pricing, and it actually looks like it's starting to materialize in their yields. Have you seen anything where you might have some overlap in competitive markets or even on the landfill side where there's more discipline out there now, and it's making the pricing dynamic a little bit easier?

[Ronald J. Mittelstaedt:]

Well, Joe, as you know, talking and doing are 2 different things. But the first part is pretty easy. We really do not have a lot of overlap with waste management. Where we do have overlap, we are seeing them -- I mean, we've always seen them to be a pretty disciplined pricing competitor in the markets we were in. And I use Waste Management is one of the large national company, we have more overlap with them than we do with Republic as an example. Between the 2, we have less than 15% of our revenue that has overlap with either company. So we're not a great proxy for what they're doing. But where we are and they are, we're comfortably the pricing leader, you're seeing that in the numbers. And I think they have greater opportunity. Again, our model is a very different pricing model than theirs, and we're thankful for that. I mean, again, they're in tough, competitive urban markets, where customer churn is 3x ours and therefore, you're going to struggle to get 1% to 2% price, which is what they do. That is a good job in that environment. We just don't have those type of markets.

[Joe Box:]

Understood. Question on the E&P side then, kind of switching years. We are hearing about some incremental E&P disposal that's coming online particularly in the Bakken. Can you maybe just talk to the supply-demand dynamics in that market right now in particular, and then maybe note what you're seeing across all of R360's footprint relative to new potential supply?

[Ronald J. Mittelstaedt:]

New potential supply of disposal capacity?

[Joe Box:]

Correct.

[Ronald J. Mittelstaedt:]

Yes, I'm really -- we're really not seeing any new potential supply of disposal capacity come online in really any of the basins to speak off. I mean, we are aware of some folks attempting some things. We are aware of some other companies that by the way, talk about disposal. And I think the Street misunderstands that with landfill disposal. They are referring to saltwater disposal in many of these other companies. But as far as what we do, there are not, to my knowledge, any new sites opening that we are aware of, except one potentially in the South Bakken, which really doesn't compete with us because the lake divides the Bakken play, because there's only 2 access points across the Bakken play. And we are north of the lake. So the volumes we get today are north of it. And so that site really wouldn't have an impact to us. It might have an impact to Clean Harbors, but it wouldn't to us. And so, because we're not in the south. But other than that, we're not aware of any others.

[Joe Box:]

Okay, great. That was the one we were picking up on. And then, Worthing, just a clarification on the E&P guidance. In the release, it has E&P revenues at about $60 million. But if you look through the 10-Q, there's a $57 million number, and then it looks like standalone R360 did $51 million. When you guided the $250 million to $275 million, was that for all-in E&P that's in the earnings release? Or is that something else?

[Worthing F. Jackman:]

It's actually a combination of both when you look at the revenue. But you also have to look at it on eliminated basis because the $60 million that we -- almost $60 million that we had uneliminated had about $2.5 million of eliminations against that, and now you've got -- that's where the $57 million comes from. It's hard to break out if -- it's easy for us to break out by facility where it's coming from, but we're already starting to move some volumes around and away from R360 sites into our sites, and so you don't see that in that segment, you see it over on the other side. So again, we're looking at total E&P revenue throughout the system.

[Joe Box:]

So just to be clear, it is the number then that's in the earnings release?

[Worthing F. Jackman:]

Less eliminations, that's right. So in other words, you have to -- you'll see in the revenue breakdown there's eliminations in the company activity. There's about $2.5 million of eliminations in Q1.

[Operator:]

Your next question comes from Tony Bancroft of Gabelli & Company.

[Tony Bancroft:]

And so back to the PLR, why wouldn't you just form R360 is an MLP with the PLR you've gotten and then drop down your landfill assets that are -- have a high percentage in E&P waste into it versus -- like a typical MLP does versus taking the risk of trying to get a PLR for traditional landfill?

[Worthing F. Jackman:]

Well, it's 2 things. First off as we said last call, we got a step-up basis in the R360 acquisition. And so we already have a tax shield be in place for a good portion of the cash taxes being paid on that side. What I'd also say is in any MLP, there's a limitation on nonqualified revenue within the structure. And if traditional landfill activity has not been qualified, you're letting a pretty strong risk there of getting over your skis on -- and getting into trouble on that side.

[Tony Bancroft:]

Right. So okay, and then just to clarify, all of the -- what you consider qualifying incomes, say for this PLR that you're looking to pursue later in the year, this is all mainly is going to be from E&P waste, is that correct? Or is there something else?

[Worthing F. Jackman:]

Yes, we already have E&P ruling in hand. It's what we term traditional landfill business.

[Tony Bancroft:]

Right. That's what I mean. If you look at that R7704 or the -- yes, the IRC 7704, just for qualifying income I'm trying to see where else -- what are you looking at as being other qualifying income at a traditional landfill?

[Worthing F. Jackman:]

Well, traditional landfill is MSW-related, so it's not E&P related. And so we're looking to see if that revenue activity is qualifying income.

[Tony Bancroft:]

Okay. So you're just going to test it out, but I mean, just what we look at -- just from the IRC 7704, there's nothing specific in there that you're targeting. It's just you're going to go check it out with the IRS?

[Worthing F. Jackman:]

Correct.

[Operator:]

Your next question comes from Barbara Noverini of Morningstar.

[Barbara Noverini:]

When you think about the longer term in the shale basins, there's going to be a crossover point when there's less drilling and more production. So as I understand it, more solid waste is generated through the drilling process and more liquid waste, drilling fluids, wastewater, that kind of thing through the production process. So once we reach this crossover point, I realize it may take a while. But once we get there, what services does R360 provide to handle this type of waste? Will you have to invest in more capacity to handle it? Can you compare the margin profile of liquid waste handling versus the solid waste or wet solid waste handling?

[Ronald J. Mittelstaedt:]

Sure. Okay, a number of questions you asked there. First off, R360 does handle that today and handles production water and production fluids from wells that have been intact and have been in place for many, many years. That represents about 1/4 of their business today. We believe that over time, as basins mature such as the Permian basin is a mature basin, but as the Bakken and as the Eagle Ford and others mature, like the Permian has, you will move to probably 40% to 45% to maybe up to 50% of R360's revenue would be -- come from the recurring production side on the waterside and the balance would go to drilling. So the production side would almost double. We are very comfortable with that because, a, the margins are very similar in that business; and b, while they may be somewhat lower, the revenue was much greater -- has much greater predictability. So what it does is it really smoothes the volatility in the R360 model out over time. And we would give up a nominal amount of margin for that smoothing to occur. It's a higher return on capital business or as higher return on capital business because it is not a capital-intensive as the landfill business on the drilling side. We would not really have to invest much more in incremental assets. Those incremental assets tend to be saltwater wells, deep well injection sites, in radiuses around our landfills, as well as potentially in other handling water and solid handling equipment. So it's something we're doing. It's something that we'll continue to grow, and it's something that we have the assets in place to do going forward.

[Barbara Noverini:]

Great. And is it fair to say that there are more competitors in this part of the waste process than there would be in solids waste handling?

[Ronald J. Mittelstaedt:]

Without question.

[Operator:]

And your next question comes from Jeff Osborne of Stifel.

[Jeffrey D. Osborne:]

Just 2 quick ones for me here. Ron, I was wondering if you could just touch on the acquisitions that you elected to pass on in the quarter. Were those more on the traditional MSW side or more on the E&P side?

[Ronald J. Mittelstaedt:]

They were both, Jeff. We passed on a couple of reasonable size solid waste, integrated solid waste transactions that were private regional companies, multi-state regional companies that are being -- going to market through a traditional bank process, and we got the books. And we knew the companies extremely well. In fact, we had done a transaction almost a decade ago with one of them, so we know their assets very well. And we passed on that opportunity, and for a host of reasons. And then we have some outstanding offers going in the E&P waste side right now, and we passed on some E&P waste opportunities in the quarter as well. So it was a combination of both.

[Jeffrey D. Osborne:]

Got you. And the last question, appreciate the detail on that. The last question is, are there any other permits kind of up in the air or that you're seeking beyond the 4 that you discussed earlier in the call?

[Worthing F. Jackman:]

There are a few more, but not material enough to discuss at this point.

[Operator:]

Your next call is from Al Kaschalk of Wedbush Securities.

[Albert Leo Kaschalk:]

Ron, just a follow-up from prior calls and discussions in the market in Southern California. Is there any change to the closure of landfill and market actions responses now? Or do we still need to wait until late October early November?

[Ronald J. Mittelstaedt:]

Yes, well, there's no change. It is closing and it has been announced its -- Puente Hills is scheduled to close October 31 at the end of the operating day. So that is not going to change. As far as how -- what the impact will be in the market in terms of both price and volume opportunity, we're in the discovery piece of that right now. The city of Los Angeles has put out some bids. They've put out some bids that had responses due in April. They have some more that are due in June. And those results have not been posted. So I don't know what the results of those are, meaning I don't know who bid and I do not know the pricing that they bid. So it's hard for me to say right now. As we alluded to on an earlier -- or not we alluded to, we answered to an earlier call, some surrounding municipal governments outside of the L.A. County basin, who traditionally have only handled waste within their own county, have put in bids to the Los Angeles market to open their landfills for out-of-area waste because of the extreme budget shortfalls that are going on throughout local governments in California. And that is a bit of a wildcard that is occurring. We believe that they could only, I say only -- could probably only take somewhere between 35% and 50% of the total that will be displaced by Puente Hills because of their permit restrictions, but -- and so we don't know what the impact of that will be. I mean they have traditionally handled the volumes in their counties at rates between $55 and $75 a ton, and they are quoting rates to come in to their county as low as $15 a ton. So obviously, they're in the pursuit of volume because of the cash-strapped nature of some local governments in California.

[Operator:]

And your next question comes from Stewart Scharf of S&P Capital IQ.

[Stewart Scharf:]

Talk little a bit about your fleet and any conversion to CNG, and also your hedging program and expanded pricing, how much is locked in? Are you up to maybe 90% at this time of year?

[Ronald J. Mittelstaedt:]

Hedging on diesel fuel was your question? The second part of your question?

[Stewart Scharf:]

Yes.

[Worthing F. Jackman:]

Yes, I'll take the second part first. For the diesel side, we do have some fixed price purchase contracts in place. But at this point in time, that's probably less than 30% of our uses this year. We have hedges that start in 2014 that cover about 5 million gallons a year, both in '14 and '15. And as a reminder, right now, we're utilizing somewhere between 23 million and 25 million gallons a year. And so we've got a head start already to our hedging efforts next year. On the first question Ron?

[Ronald J. Mittelstaedt:]

Yes, on the first question, today, about 5% to 6% of our fleet is CNG or LNG or nondiesel, if you will. We will be moving that upwards over the ensuing years. It is not something that we're in a footrace to do. We look at it market by market, and some states have tax and other financial incentives to build fueling infrastructures, which is the critical piece that's sort of missing out there right now, and we have put fueling infrastructures in a number of our facilities in 2011 and '12 and more in '13. But ultimately, we believe the fueling infrastructure will get there over the next 5 to 10 years. And I think as it does, you'll see that we move our fleet higher every year. About 20% of our vehicles this year that we are ordering are CNG, and that number is likely to move up to somewhere between 30% and 35% in '14 and beyond. Again, and I know there's been a lot of ruckus about the difference between CNG and diesel made recently. I want to underscore that the difference between pricing and fueling CNG and diesel is $1 as of today, not $2 or $3. So suddenly the equation looks very different at $1 than at $2 or $3. And that's one of the reasons we have been proceeding -- one of the reasons we're proceeding more cautiously and we're making sure there are economic incentives to get a return on the capital other than just the differential that people think might ultimately be there. As gas prices move up, that differential is going to close and it is closed dramatically in the last 6 weeks.

[Stewart Scharf:]

Okay. And regarding the headcount, I assume that you're not planning to add to it based on the volume until you get to the low-single digit volume growth probably enough to go to '14 at least?

[Ronald J. Mittelstaedt:]

Yes, our headcount is down this year almost 1% for the year so far, and it is down 14% since '08.

[Operator:]

[Operator Instructions] Your next question comes from the line of Michael Hoffman of Wunderlich.

[Michael E. Hoffman:]

If I could just have a couple follow-ups. Just to be clear on the Bakken weakness, that weakness is the weather just delayed activity because the permit numbers are still running at a relatively constant about 180 to 200 wells a month?

[Worthing F. Jackman:]

Right, and that weakness was called early January, and that's why we gave you the comparative stats as you move January through March, and now just March into April [indiscernible].

[Michael E. Hoffman:]

Okay, and then there was another question earlier about worrying about this crossover issue, but while plays maybe mature, mature means they're just at a -- they got to the level of drilling that's going to occur in them. I mean, there are folks think that the Eagle Ford and the Bakken, you're going to be drilling for 15 more years?

[Worthing F. Jackman:]

Longer than that.

[Michael E. Hoffman:]

At the rates that we're at. So crossovers are way out there.

[Worthing F. Jackman:]

You're looking at 20-plus years.

[Michael E. Hoffman:]

Yes, that's right.

[Worthing F. Jackman:]

This is in near term.

[Unknown Executive:]

Yes, okay. I just want to be clear. And then on the CNG side, just to be clear, I mean, I wouldn't think that fuel would be the reason to move anyway. A long -- the real play long term besides politics and tax incentives is that they've proven to be lower cost to maintain and therefore -- and then just the drivers -- it improves the quality life of the drivers. So the combination of those 2 things, you wouldn't do it just for the fuel difference because you can't rely on that fuel difference to stay in place.

[Ronald J. Mittelstaedt:]

Yes, well, Michael, I would tell you that if you were to look at the commentary of the larger companies recently that are making large discussions about it, they are doing -- they are making that commentary solely based on the fuel price disparity and what that is doing to their -- or will do toward their P&L. That's why I made that comment. I would agree with you that you do not do it just for the fuel. I think that's one reason. Certainly on the West Coast where we have a large presence, the political issue is a very real and very big one, and it gives us an opportunity to extend and increase -- extend contracts and increase prices in exchange for automating and going to an alternative fuel out there. So it makes tremendous sense to us out there. As far as the maintenance, Michael, there is some difference because you get out of emission scrubbers and stuff that have to be maintained on the diesel, but there are offsets. And obviously, the capital outlay is about 10% to 12% more per truck. So you need to be getting about somewhere between a 3% and a 5% better savings per vehicle aside from the fuel per year for the maintenance costs to justify the capital.

[Operator:]

I'd now like to turn the call back over to Ron Mittelstaedt for closing remarks.

[Ronald J. Mittelstaedt:]

Okay, well, if there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in our call today. Worthing, Mary Anne, Steve and I will be here today to answer any direct questions that we did not cover that we are allowed to answer under Regulation FD and Regulation G. We thank you, again, and we look forward to speaking with you at either Waste Expo or at upcoming investor conferences or on our next earnings call. Thank you very much.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and good day.