Heritage-Crystal Clean, Inc
Q2 2017 Earnings Call Transcript

Published: 19 Oct 2017

[Operator:]

Good morning, ladies and gentlemen and welcome to the Heritage-Crystal Clean, Inc. Third Quarter 2017 Earnings Conference Call. Today's call is being recorded. At this time, all caller's microphones are muted and you'll have the opportunity at the end of the presentation to ask questions. Instructions will be provided at that time for you to queue up for questions. We ask that all callers limit themselves to one or two questions Some of the comments we will make today are forward-looking. Generally, the words aim, anticipate, believe, could, estimate, expect, intend, may, plan, project, should, will be, will continue, will likely result, would and similar expressions identify forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward-looking statements speak as of today and you should not rely on them as representing our views in the future. We undertake no obligations to update these statements after this call. Please refer to our SEC filings, including our annual report on Form 10-K as well as our earnings release posted on our website for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website. Also, please note that certain financial measures we may use on this call, such as earnings before interest, taxes, depreciation, amortization or EBITDA and adjusted EBITDA, are non-GAAP measures. Please see our website for reconciliations of these non-GAAP financial measures to GAAP. For more information about our company, please visit our website at www.crystal-clean.com. With us today from the company are the President and Chief Executive Officer, Mr. Brian Recatto; and Chief Financial Officer, Mr. Mark DeVita. At this time, I would like to turn the call over to Mr. Brian Recatto. Please go ahead, sir.

[Brian Recatto:]

Thank you and welcome to everyone, joining us this morning. Last night we reported our third quarter 2017 results. Our diluted earnings per share during the quarter was $0.20 compared to $0.10 in the third quarter of 2016. The third quarter results included a gain from the sale of property, which Mark will discuss in his prepared remarks. Our revenues for the third quarter increased 1.8% compared with the third quarter of 2016 to $83.3 million driven by strong growth in our Environmental Services segment. Mark will provide more financial details later, but I would like to talk about various aspects of our business. While first I'd like to discuss the results in our Environment Services segment. From a revenue standpoint, we continue to progress along a trajectory of growth we outlined during our last several earnings conference calls. Specifically, during the third quarter, we drew Environmental Services revenue 7.3% compared to the third quarter of 2016. We saw a growth in almost all lines of business in this segment on a year-over-year basis with the majority of revenue growth coming from our aqueous parts cleaning, containerized waste and vacuum services businesses. This growth has been aided by continued focus on industrial customers. We expect to achieve high single-digit revenue growth on a year-over-year basis during the fourth quarter of this year. During fiscal 2016, we have added sales resources such as brand sales managers, antifreeze sales and service reps, vacuum sales and service reps, ESP specialists and field services reps and we expect to add more of these types of resources during the fourth quarter. We also continue to expand our service area. During the third quarter, we added two service areas and plan on opening a few additional service areas during the remainder of fiscal 2017. Our Environmental Services operating margin in the third quarter of 2017 was down 2.2% compared to the same quarter a year ago. The largest single factor in the reduced operating margins was higher labor cost related to the new sales resources we've added during the year. As these new resources develop they will help fuel continued revenue growth. On the positive side, we continue to benefit from a lower disposal costs during the quarter. During the third quarter we were faced with the challenge of dealing with multiple natural disasters. Specifically, hurricane Harvey was most directly impacted our facilities in the Houston Texas area and at the on the quarter hurricane Irma was primarily affected our facilities in Florida. I'm proud to say that while both of our branches in the Houston area were closed for multiple days, the can-do spirit of our employees was on display during the aftermath of the storm. While faced personal hardship, our team managed to return to work with a determination to make up for lost time and a result we did not see any material negative impact on our revenue during the third quarter due to the storm. We will incur expenses to repair our facility in Baytown Texas, but we expect this should cost us less than $200,000. Hurricane Irma struck floor as our third quarter was ending, which meant that other than closing our Fort Lauderdale site, the last two work days of the quarter there was little impact on our third quarter results from the storm. During the beginning of our fourth quarter, we had multiple branches, which were closed for a few days as well as employees who were out even after our branches reopened as they struggle to provide their families with basic necessities. Once our branches reopen they were dealing with challenges such as wide areas in Florida without power and many of our customers still closed. While we experienced a loss of revenue in the short-term, we believe the Florida market will recover throughout the remainder of the quarter and we expect will be back to normal for the beginning of fiscal 2018. Now I'd like to talk about our oil business. I'm proud the way we performed during the quarter as worked through some short-term issues, which I'll discuss in a moment, but first I'll speak to the impact of some continuing factors, which affected our results in this segment. In the oil business, we have trends moving in both the positive and negative direction. From a positive standpoint, our base oil netback was up $0.03 per gallon versus the second quarter of 2017. The increase in base oil pricing has been driven by the continuing supply tightness for the type of group two light grade base oil we produce. The continued tightness was primarily due to unplanned shutdowns at virgin base oil refineries created by hurricane Harvey during the third quarter. During our second quarter conference call it seemed likely we would see increase in base oil supply and thus lower pricing during the fourth quarter of 2017. However, the situation has changed and with current conditions supporting slightly higher base oil prices, we may not have -- we may not experience the declines in pricing, which we typically see at the end of the year. While the third quarter provided higher base oil selling prices, our street price for used oil collection retreated for the fourth quarter in a row. During the third quarter our street price declined approximately $0.03 per gallon compared to the second quarter of fiscal 2017. We continue to battle our competition for used oil collection at various geographic markets. During the third quarter, used oil collectors who sold into the RFO market benefiting from tightness in the fuel market, which had number six trading above the price of WTI crude for short time. In the past number six oil was typically trading in the range of 80% to 85% of WTI. The resulting higher price of RFO relative to crude oil allows these collectors to be more aggressive than they might otherwise have been in the declining crude oil price environment. While our used oil collection route efficiency increased approximate 4% during the quarter compared to the third quarter of 2016, we continue to try to optimize the performance of these routes in the face of this competitive pressure. We operate the re-refinery at the rate of 91% of our nameplate capacity during the third quarter compared to 94% during the second quarter. As we discussed during our second quarter earnings call, we had planned extended shutdown during the third quarter to make some capital improvements to the re-refinery. Even with this extended shutdown, we only produced 300,000 less gallons of base oil than we did during the second quarter. We expect implementation of these improvements will allow us to increase base oil production at the re-refinery going forward. During the fourth quarter we estimate production increase by more than 1.5 million gallons compared to the fourth quarter of fiscal 2016 and optimal base oil production should now be in the range of 46 million to 47 million gallons annually. Between the improved leveraging of fixed cost and efficiencies, we expect to reduce our operating cost by approximate $0.06 to $0.07 per gallon versus before the improvements were installed. Like many businesses who transport material across the central and eastern portions of the U.S., we were negatively impacted by changes in service model implemented by one of our primary rail transportation providers during the third quarter. Service disruptions caused by these changes impact several aspects of our business, including our ability to transport used oil throughout our network as well as the ability to ship finished products from our re-refinery to our customers. These initial impact had a cascading effect on our ability to collect used oil, which impacted our ability to service our customers and generate service revenue. Additional impacts include the higher cost of alternative transportation and higher labor cost for loading at the re-refinery. The inability to ship base oil produce at the re-refinery reduced oil business segment revenue by approximately $1 million during the third quarter and the overall negative impact of these issues on our operating margin for the company was $0.5 million during the third quarter. While the above issues continued in the fourth quarter, we have seen some improvement in the service level. We expect to recoup loss base oil revenue and we also expect the overall negative impact during the fourth quarter related to logistics issues to be less than what we incurred during the third quarter. We're also pleased to report that we recently obtained a Title V air permit for the re-refinery. Our teams has worked very hard to obtain this permit and we expect to realize a cost reduction of approximately $0.01 to $0.02 per gallon of base oil produced, as a result of process changes this permit will allow us to implement. As I've discussed, our third quarter brought us many challenges, which impacted our results. However, I'm very proud of how our team responded. Whether natural disasters or industry issues our team has once again proved what a competitive advantage they provide us. Through their hard work, I believe we are positioned to have a strong fourth quarter of continued growth in our Environmental Services segment as well as improved profitability in our oil business. Mark will now walk us through our third quarter financial results in detail thanks.

[Mark DeVita:]

Thanks Brian. For the third quarter, we recorded net income attributable to common shareholders of $4.7 million, compared income attributable to common shareholders of $2.3 million in the third quarter of 2016. As Brian mentioned earlier, for the third quarter 2017 we recorded diluted earnings per share of $0.20 compared to diluted earnings of $0.10 per share in the third quarter of 2016. Our third quarter earnings included a gain related to the sale of a facility during the quarter. On a non-GAAP basis excluding the impact of the gain recorded to partially offset by severance costs incurred during the quarter, our adjusted diluted earnings per share was $0.15. Please refer to our reconciliation of GAAP to non-GAAP supporting schedules in our press release. In the third quarter of fiscal 2017 oil business revenues were down $2.3 million or 7.5% compared to the third quarter of fiscal 2016. The revenue decrease was due to lower used oil collection charges and lower RFO sales volumes, partially offset by higher selling prices for our base oil products. Results were also negatively affected by rail service issues, which Brian discussed earlier. During the third quarter of fiscal 2017, we sold approximately 8.9 million gallons of base oil, compared to 9 million gallons in the third quarter of fiscal 2016. Base oil production of 9.5 million gallons during the third quarter came in flat compared to the third quarter of 2016. We sold approximately 3.9 million gallons of RFO during the third quarter, which was down 38% of 2.4 million gallons compared to the third quarter of fiscal 2016. In the third quarter of fiscal 2017, environmental services revenues increased by approximately $3.8 million or 7.3% from $51.3 million in the third quarter of fiscal 2016 to $55 million in the third quarter of fiscal 2017. The increase in revenue was due to increased activity in all of the segment businesses except field services. The majority of the increase was due to increases in sales volume in these businesses. Turning now to income before corporate SG&A expense, oil business income before corporate SG&A expense decreased $0.4 million in the third quarter from income of $1.7 million in the third quarter of fiscal 2016 to income of $1.4 million in the third quarter of fiscal 2017. The decrease in income before corporate SG&A was mainly due to lower used oil collection charges, higher cost for third-party used oil feedstock, lower revenues and higher costs associated with the aforementioned rail logistics challenges as well as higher cost of approximately $0.4 million from the planned extended shutdown at our re-refinery. Despite these challenges, this marks the sixth straight quarter of operating income as this segment continues to demonstrate consistent positive results. Profit before corporate SG&A expense in the Environmental Services segment was $14.9 million. Our third quarter operating margin percentage was 27.2% compared to operating margin of 29.4% in the third quarter of 2016. The largest single factor in the decline in operating margin was higher labor costs from the addition of sales and service resources along with higher solvent and Workers Compensation expense, partially offset by lower disposal costs. Our overall corporate SG&A expense as a percentage of revenue was 14.2%, which was flat from a year ago. Our corporate SG&A expense includes $1.2 million in severance costs related to the departure of our former Chief Operating Officer. We have opportunities to improve our corporate SG&A expense and we expect to continue to drive this expense lower as a percentage of revenue over the coming year. During the third quarter, we recognized other income net of other expense items of $3.1 million, which consisted of a $3.1 million gain recognized from the sale of a facility located in Pompano Beach, Florida. This facility was acquired as part of our acquisition of FCC Environmental and was being underutilized. Third quarter EBITDA of $11.8 million was $3.8 million or 47.3% higher from the year ago quarter. Turning to the balance sheet, cash on hand at the end of the quarter stood at $33.5 million compared to $25.2 million quarter-over-quarter and total debt stood at $28.7 million. We intend to use our excess cash balance to seek acquisition opportunities as well as pursue capital projects to help drive growth and improve operational efficiency. In an effort to be more systematic in our approach towards acquisitions, we've recently created a position focused on this effort. This is in contrast to the team approach we utilized in the past. I want to thank everyone for their interest in Heritage-Crystal Clean. Now I'll turn control of the call over to our operator to advise you of the procedure to submit your questions.

[Operator:]

Thank you. [Operator instructions] And our first question comes from Paul Dircks from William Blair. Your line is open.

[Paul Dircks:]

Hi. Good morning, guys.

[Brian Recatto:]

Good morning. Paul, how are you?

[Paul Dircks:]

Doing well. Thank you. So just a couple quick ones for me. In Environmental Services, can you talk briefly about which geographic regions and markets relatively outperformed and underperformed during the quarter? Obviously 7% growth is quite strong and the trajectory is looking positive going into the end of year. Can you talk about which regions and markets were strong and maybe not so strong during the quarter?

[Mark DeVita:]

Paul, as you may remember last couple of quarters we have given a little color and this actually goes back for more quarters. We've given color that spoke to those branches that were in certain geographies that were more energy sector centric and those typically were along the Gulf Coast during Texas, Louisiana type market. Since those markets have more than stabilized, we didn't cited in our prepared remarks, but again we saw positive activity there and it is more in line or getting more and more in line with the rest of the company. We really didn't see any region that stood above or below the overall performance of the company. So, it was really a team effort across all the markets. There was a little bit of noise in some of the areas that Brian mentioned that were specifically impacted by the natural disasters, but as he stated, it was pretty muted even in those areas.

[Paul Dircks:]

Okay. That's helpful. Perhaps then could you also maybe touch a little bit upon how progress has been thus far through the expansion of your branches out in the Western part of U.S. and maybe tie into that how you think about -- how we should think about the Environmental Services margin trajectory here going forward as you balance that expansion into new markets and changing some branch sales manager strategies and incentive to go out and win new business with obviously trying to balance the Environmental Services margin profile as you? This quarter we saw obviously a pretty large step up year-over-year in operating expenses in Environmental Services. Is this level of year-to-year increase what we should be expecting here next quarter and into early '18?

[Mark DeVita:]

Yeah, I think that's impacted in line what we saw here was in line with a couple 100 basis points message we delivered for at least the last three quarters, that we were expecting the impact to be in that range eventually as we started to get to a rate and again it's been -- we haven't added all the resources nor do we probably ever plan on doing it all in all in one slog or in any one quarter. So, as we've ramped up into this plan, I think this is the level that we would expect it to be at. As long as we're continuing to add resources, we don't know that we would see any further deterioration at least related to the expansion of our sales resources and of our territories, but this should be the level we're at for a while. Obviously if whenever we would stop this, there's usually probably 12-month to 18-month ramp up for these services. So, whatever you -- if you would get into motor we stop it and we certainly -- our plan to continue this ramp up through 2018 at roughly the same rate. So, I don't think you're going to see a big step back up anytime soon, but this level is where we would expect and as far as the Western U.S. we are looking for some of our additional service locations to be in the Western U.S. here in the fourth quarter and more into 2018. Up till now in 2017 we haven't done a lot of new Western expansion. We've done branch in the Northwest Seattle area back in 2016, but we really haven't planted any new flag so to speak yet in that area as part of this new expansion. I don't know Brien if you have anything more to add.

[Brian Recatto:]

Yeah Paul, we have added 18 sales personnel -- professional salespeople to our roster over the course of this year. We expect to add six more and to Mark's point, we expect it'll take 12 to 18 months for these people to begin producing contribution margin. So, we're really right on track and we have a line of sight on your $7 million in annualized cost reductions that we're looking and we think we'll be able to achieve by the back end of 2018. We mentioned it before it's related to our logistics cost or we're in process now in terms of getting some of those costs out of the system. We take the full effect of what we realized by the end of 2018, we expect next year as we look to growth we're going to open five additional branches in 2018 that's our current business plan for now and we'll end up with probably a similar number of additional sales professionals to fulfill out those new service locations and branches. So, I think we're right on track with what we've been telling the market for the past couple of quarters. The growth is where and we've got a very healthy balance sheet as Mark talked about, $33 million in cash in the bank and we believe in ourselves and would rather invest in organic growth given the current conditions and the acquisition market obviously we're pursuing that as well. But like our chances organically we've got a proven track record of grow the business.

[Paul Dircks:]

That's very helpful color. Thank you, guys.

[Brian Recatto:]

Thank you.

[Operator:]

And our next question comes from Quinn Fredrickson from Baird. Your line is open.

[Quinn Fredrickson:]

Hi. Good morning. Thanks for taking my question. Just curious if you guys could lay out what you see as the current organic growth allorhythmia from a same-store sales perspective and the various components of that i.e. underlying volume growth, cross-selling share gains and price plus new locations?

[Mark DeVita:]

I think a lion's share of it -- well, first of all, the overall profile should be in that high single-digit range. We think with the continued investment that both Brian and I alluded to in talking to Paul a second ago, that will help support that. So that level of investment will help give us high single-digit growth rate. I think cross-selling is a big part of it. We think it's going to come across most of our lines of business in roughly the same rates that they exist now with maybe containerized waste being a little more weighted than let's say parts cleaning, which is a more mature market. And then our antifreeze business and some of our other more early-stage businesses will be yet even higher, but a small overall percentage because they're still in that 5% of total segment revenue range at this point. Cross-selling continues to be and has always been a part of our program. If you look at where we're at from a cross-selling standpoint and you projected out on an annual basis, it's probably getting close to or through the first three quarters it was around $9 million. So, it is been very possible for us. Will continue to be part of our growth into the future.

[Quinn Fredrickson:]

Okay. Thank you very much.

[Mark DeVita:]

No worries.

[Operator:]

And our next question comes from Sean Hannan from Needham & Company. Your line is open.

[Mark DeVita:]

Hi Sean.

[Sean Hannan:]

Good morning, folks. Thanks for taking the question here. Just wanted to see if I could follow-up around the Environmental Services sales growth. It's nice to see you folks at least returning back into the upper single-digit range. Just want to see if we can tease out a little bit more as we think about the 7% achieved in this third quarter and then looking at the expectations from a quassy quantitative, qualitative standpoint looking at those 4Q and forward, can you perhaps characterize a little bit better for us if we think that we're just truly at a stable point or do you feel that you're being conservative. Is there a conservative aspect to this that there should be some acceleration but we're only communicating what we know today? Any more color around that will be great.

[Brian Recatto:]

I didn't hear the first part acceleration and ES topline.

[Sean Hannan:]

ES topline.

[Mark DeVita:]

I think we are seeing acceleration in the path that we outlined basically a year ago Sean and that you whether it ends up being a 9%, 8% whatever the number is that with the types of investments we're committed to make almost finished for the year not quite obviously and then continue to make the same type of investments, that's what we expect to see going forward here at least into 2018 and for the year and a lot of it's going to be volume. We're going to continue to get some price in certain lines of business are more -- we'll support that more, but I think the growth rate we've been on and where we're at is exactly what we plan and we think we can repeat that, which is a high single-digit and keep that constant and keep that growth rate going.

[Brian Recatto:]

Yes Sean, I agree with Mark and absent any acquisitions I think we're going to be in that high single-digit growth rate area.

[Sean Hannan:]

Okay. And then when you look into the margins, you folks acknowledged some of these new resources really create a little bit of an investment downdraft right and we saw a little bit of compression that's going to ultimately reverse at some point. Can you give us little bit of some understanding around the timing of how you would expect perhaps at least to get back to what we've seen as margins in the second quarter? And as you think about that, I don't know if there is any incremental commentary to provide around how we should logically think about potential full price wages that may accelerate that path or perhaps provide a little more benefit in some of the future quarters.

[Mark DeVita:]

I think it comes down to -- it's a balancing act. We talked about that in the past and we feel comfortable at this margin level as long as we're generating the topline growth that we just alluded to that at least for the next five six quarters, that will be in this general position because we're going to continue as long -- as we're getting that growth we're going to continue to add resources and we don't want to get too detail about 2019 or anything like that. But as long as we're seeing the results that we have been seeing in growth throughout these first three quarters and expect to see in Q4 then not only we're going to do the same thing in '18 but it's even logical we usually don't plan that granularly more than a year out, but we're going to plan probably to add that same -- at that same rate the same amount of resources. And then you'll probably see as those resource have become a smaller and smaller part of the base, you will see that march back up, but it could be before we get back to that high 20%, 29% I mean 30% range, that could be a year and a half.

[Sean Hannan:]

Okay. That's actually very helpful. So -- sorry, go ahead.

[Brian Recatto:]

Sean to kind of summarize what Mark is saying, we expect our margins to remain flat. I think in a comment that I made a few minutes ago, we have line of sight on cost reductions going into 2018. We're in the process of implementing those changes, in terms of how we move material around between our branches and our hubs, it's $7 million to $8 million in cost reductions that will be worked out of the system through 2018, which will offset the additional people that we will add in 2018 to achieve the single-digit growth. So, I certainly think we can hold the margins flat as part of the fact that we'll be adding the headcount to achieve the growth.

[Sean Hannan:]

Understood. Make sense. Okay. Just to put some gears to the oil business side just want to understand a little bit more the impacts from your rail partner, how limited are you today at this point in time in terms of your ability to ship to customers and get some recognition on those revenues, opportunities and where you stand in current point in time on the cost of accomplishing that? A little bit more detail for where you are as of October 19 would be helpful.

[Brian Recatto:]

Sean obviously we in our prepared remarks, we talked about a $0.5 million impact to Q3. We're expecting less in Q4. We're close to back to normal out on the field especially on used motor oil collection. We're no longer having to ship use motor oil to our oil plants via truck and/or to our re-refinery by a truck. We're still not 100% back to normal at the re-refinery. We've seen some delays in shipping, but much better than it was in Q3. I expect the impact to be if anything a couple $100,000 for the quarter, but we're in much better shape in terms to deliver product to our customer. We're not trucking product any longer. Were back to rail with all of our base oil customers are back to rail with all of our used motor oil supply that was traditionally been railed into the plant. So, I think, by the end of this quarter, we'll be back to normal.

[Sean Hannan:]

Okay. So, we're making good progress and that sounds like that's really something we should maybe interpret as transitory.

[Mark DeVita:]

I think Brian spoke to it. The effort of our team, we're having the same tanker trucks to pump down railcars because they couldn't get moved. It was a massive effort and a subsided one, but I think it's important to understand how the team pulled through because it could've been a lot worse than $0.5 million.

[Brian Recatto:]

Yeah. That's right. We cut used motor oil collection trucks that couldn’t offload. It was a very difficult quarter logistically for us, but the worst off it is behind us and we we're getting close to normal now.

[Sean Hannan:]

Okay. Yeah and that's the kiosk trying to drive that. That's great. Last question here, I'll jump back in the queue. So, when you look at street pricing right now and obviously you've called out a few viewpoints for why we've had some good support of pricing dynamics that's brought the current point. Can you talk about the street pricing you're observing right now versus and that's tracking versus what was observed say as an average that impacted your top line in the third quarter? How does this compare at this current point in time?

[Brian Recatto:]

Yeah. I think in our prepared remarks, we highlighted that we were down $0.03 per gallon on street pricing. We are continuing to see some pressure RFO the recycled fuel margin…

[Sean Hannan:]

I am sorry Brian, I am sorry to interrupt you here. I am getting up to street pricing for the finished product, the re-refined product.

[Brian Recatto:]

Yeah. We actually feel pretty good about the re-refined base oil pricing. Obviously with hurricane Harvey we've seen a disruption in supply in the Gulf Coast market. We're down quite a bit in terms of base oil inventory across the U.S. marketplace. We're probably not at our lowest point year-to-date for base oil supply. I was at a conference this weekend and the mood in general is very positive about near-term base oil pricing. Obviously, we'll see the seasonal slowdowns as we look into Q3, we expect some degradation in pricing in Q1 of 2018. We'll begin to see our seasonal ramp up as we move into Q2 and Q3. Overall, I am very positive on base oil for Q4 and we're also going to produce a lot more of it given the changes that we made at the re-refinery, which we highlighted in our prepared remarks. Year-over-year we're going to produce 1.5 million gallons more than we did in 2016. So, lot of positives relative to re-refinery and base oil pricing as we move into Q4.

[Sean Hannan:]

Okay. But at the point of transaction right now are you in the industry getting better pricing than what you were observing on the average in the third quarter?

[Brian Recatto:]

Yes.

[Sean Hannan:]

Okay. Great. Thank you very much.

[Brian Recatto:]

You're welcome.

[Operator:]

And our next question comes from Michael Hoffman from Stifel. Your line is open.

[Michael Hoffman:]

Thank you very much. Hey Brian, how are you?

[Brian Recatto:]

Good.

[Michael Hoffman:]

Hey Mark, thanks for taking the question. So, let me circle back to ES, you've touched on this. I just want to make sure I'm summarizing this right. So historically when Heritage was growing through the branch network activity by adding branches in you were in margins in the 25% 27% range and gradually they drifted towards that 27% as you were improving that cross-selling and leverage. And then there was a period where we weren't doing that for a host of reasons and it helped margins improve because you weren’t investing and you were still maintain decent growth in the oil business hits you and the growth comes down but you drove better margins. Now we're back to an investing cycle and I understand this correctly that the new margin reset is 27%ish while we go through this expansion mode. So that's better than your history 200, 300 basis points better than history and then as we get to the targeted 100 branches, which I think that's still the numbers go from the low 80s to the 100, then you could see margins reassert itself as you stop that investment process. Have I thought through that correctly?

[Brian Recatto:]

You're absolutely correct. And it's not inconsistent with what we've been saying the past couple quarterly conference call.

[Michael Hoffman:]

So, an observation that would be -- I've been curious about, you have been talking about this, so obviously the stock trades down today on oh my goodness margin compression, where are you in the ability to look forward 90 days. So, and coming out of 2Q have been able to say hey we've been telling you about this investment, it is going to happen in 3Q, based on the rate of ads as opposed to just high-level because none of us has adapted for it. So, shame on us, you have been talking about it, none of us adjusted our models, but where are you on the ability to look forward and predict your business little better that way?

[Brian Recatto:]

Well a lot of it comes down to we have a plan of how many we're going to add as far as whether that's a certain sales and service position. The professional sales staff, our branch, all of those components of resource investment and growth process, but to be quite honest with you, especially when you're talking about personnel the variability in timing really means everything as to how it reflects in the results and it's still hard for us because we want to make sure we get the right resources especially when you're getting -- you're going to be the first our vacuum wrapper or whatever brand X. So, when we get right up to it then we know, but it is somewhat hard for us to say when these investments are actually going to come in within a year. So I wouldn't say we have or it's nowhere near 100% clarity and unless we can have that, it's hard for us to say when pound home, hey look for in August if you had that granularity that that's when it's going to hit because we could be delayed for all types of -- you got to have your Mercedes, you got to have the truck or you got to have the leads if it's a new branch and there's a lot of components not complaining, but it just -- it's not easily predictable within a month or two timeframe sometimes.

[Mark DeVita:]

But Michael we do have and I've said it three times on this call, we do have visibility to cost reductions that we're going to be working as we continue to grow the professional sales organization and we were fairly confident that we can offset those cost with the cost reductions as we move into our growth mode in 2018.

[Michael Hoffman:]

Which means that 27 is the right number for '18 with some upside if the cost cuts come through early versus later in the year.

[Mark DeVita:]

That's correct.

[Michael Hoffman:]

Okay. That's how we should think about it. Okay. So just to be clear the bulk of these new ads occurred in the third period since I had favorable margin trends in the first half…

[Mark DeVita:]

We've started adding them pretty heavily in the back end of Q2. So, in Q2 I think I even mentioned that even some of the adds we made there it was near the end. So, you only saw a glimpse of what the real cost picture was in the actual results.

[Michael Hoffman:]

Fair enough and 100 branches are still somewhat bogey is that's we're going from the low 80s towards a 100 that's the way to think about it.

[Brian Recatto:]

We think that's a realistic number given the fact that we want to be concentrated in larger cities. 100 has been our number.

[Michael Hoffman:]

Okay. Switching gears at oil, are you back to a pace that's $2.5 million to $2.75 million revenue per week per reporting period? You ran slower than that obviously in 3Q. You're in the two three range.

[Mark DeVita:]

Yeah obviously we were down for 9.5 days and we talked about the shutdown in Q2. We did a capital project in Q3 and we're seeing dividends from the capital project now. We're going to be resetting volume expectations for the re-refinery. We're seeing some pretty good numbers right now. We're going to go from 44 million annual gallons a year of base oil to 47 at this point and we got the Title V permit. We've made the changes to how we manage our catalyst program. So, we are seeing increased efficiencies as well. So not only do we have the additional production, but we've also got the cost reductions that come along with it. High visibility to $0.07 to $0.08 in cost savings on the 47 million gallons of production. So, we feel pretty good about the re-refinery.

[Michael Hoffman:]

Okay. And then obviously you answered this for Sean early, base oil prices are up sequentially. So, we'll get another cents per gallon help there, but I'm assuming all of the selling prices whether it's RFO or asphalt extender or all of them are doing a little bit better price because the crude oil price is also up sequentially.

[Mark DeVita:]

Yeah that's correct.

[Michael Hoffman:]

So that's more than offsetting at this point with higher utilization of the plant, which is -- that's a fixed cost lever issue, the pricing average selling price of all of the things you're selling and better throughput, we should see pretty decent operating leverage in 4Q is that a reasonable assumption?

[Mark DeVita:]

That's absolutely our expectation.

[Brian Recatto:]

That should be yours.

[Michael Hoffman:]

Okay. Good. So last question, inventories went up in the third quarter, is that due to the rail disruption and you ended up…

[Brian Recatto:]

Yeah it is, we did not get the product moved out, but we're going to catch up in Q4.

[Michael Hoffman:]

So that inventory number should come back down again.

[Brian Recatto:]

Yeah.

[Michael Hoffman:]

Okay. And does the rail disruption because equipment got displaced all over the country due to the storms and that impacted you or why was there a disruption?

[Brian Recatto:]

No, it was just the change in business model by our primary rail carrier. They want to their Canadian model. The CEO had their exposure or Canadian railroad and he had just in time system. They shut down some hubs. They brought down some power within the system, which impacted our ability to move cars. Very disruptive for a 90-day period as we alluded to earlier. They've been into this model now for roughly six months. We are beginning to see some progress and it's been well documented in various publications. They've had some congressional hearings discussing the shortcomings of the Eastern Railroad systems. So, it's been tough on a lot of manufactures. As Mark talked about, we got a hell of a job servicing our customers. When you lose any business, it cost us a $0.5 million because we had to do things differently to support our network but it was worth for us in terms of longevity with our customers.

[Mark DeVita:]

I would tell you Michael and again I know because of our quirky fiscal calendar, we were reporting earlier in the cycle in Q3 than a lot prior of the other companies, but anyone who had exposure in Eastern and Central U.S. is a very large provider I am going to unless they had slack to the point of inefficiency they're going to be impacted by this.

[Brian Recatto:]

And there was stopping in U.S. marketplace happen to be in Indianapolis which was not carried for our re-refinery.

[Michael Hoffman:]

Okay. Will you introduce it in 2018, should we expect a change in corporate structure?

[Brian Recatto:]

Had to ask, sorry. What do you mean?

[Michael Hoffman:]

Four normal quarters instead of 12.

[Brian Recatto:]

I don't know.

[Mark DeVita:]

We're working out debate that everyone.

[Brian Recatto:]

We're evaluating that, a period about 13 period of gas.

[Michael Hoffman:]

Okay. I just had to get it in there. Thanks for taking the questions. I appreciate it.

[Brian Recatto:]

Thank you, Michael.

[Operator:]

[Operator instructions] And our next question comes from Kevin Steinke from Barrington Research. Your line is open.

[Brian Recatto:]

Hi Kevin.

[Kevin Steinke:]

I think in your prepared comments you mentioned that you launched some new environmental services, some new service offerings. I just wanted to confirm that, just maybe if you can discuss a little bit more about what you're moving into and what else is on the plate?

[Brian Recatto:]

Michael, those were service areas, not service offerings. We expanded into a couple of new geographic areas during the quarter and we expect to open three more service areas in Q4 of 2017.

[Mark DeVita:]

Yes. So that's just a geographic expansion.

[Kevin Steinke:]

Okay. Got it. Got it, but you have been targeting industrial customers more aggressively. So, could you just update us on how that effort is going and are the new resources you're adding also targeted to industrial in some respects?

[Brian Recatto:]

Yeah Michael, the bulk of the people that were supporting industrial growth, there our brand sales managers. We got a targeted dedicated resource that's supporting the branch sales managers to pursue industrial accounts. Mark talked about cross-selling and that's we focus so heavily on industrial business versus the automotive because it allows us the ability to sell multiple service lines in an industrial account and we are seeing the growth from that effort.

[Mark DeVita:]

Yeah and that if you really get granular within our ES segment on a percentage basis the largest growth is in our containerized waste that's the real high end of single digit in this past quarter and that is where you see -- that's probably the biggest opportunity if you're more industrial as we define it focused is in that containerized waste business. So that the direct result of having these again the key position we call branch sales manager that is focused on these things and they're at the top of our list as far as number of new positions added have been in that area.

[Kevin Steinke:]

Okay. That sounds good and Mark I think you mentioned continuing -- that you continue to expect to drive SG&A expenses lower as a percentage of revenue over the next year, are we still thinking about that more as a 2018 event though as you execute on the initiatives you're doing?

[Mark DeVita:]

Yeah, I agree and a lot of it is -- we had initiatives even now but it's the noise you get let's say from severance if you made structural changes. So, the principle results are probably an '18 story to 2017 since we only have one quarter left that's going to be too early. I am not saying we're planning on having a lot more in '17, but our expectation is much higher for getting into like Q2, Q3 of 2018 that we'll have more tangible results.

[Kevin Steinke:]

Okay. Good. And you had started to mention in response to an earlier question that you were still seeing some pressure on used oil collection pricing. Any more -- can you expand on that a little bit more where it stands today? If you feel you can stabilize that anymore or what are the thoughts there?

[Mark DeVita:]

We gave up $0.03 quarter-over-quarter. We're going to continue to see some pressure. I don't think we'll see much more erosion in street pricing. We got a very tight market from a residual fuel standpoint. We had a refinery that was down in Mexico that produced fuel strong demand for Gulf Coast, recycled fuel to feed power plants in Mexico for example. We expect that'll continue. You've seen the spread between number six and WTI be extremely tight. It has loosened up a little bit recently. We are seeing crude go up through which is going to impact what people want to be paid for used motor oil on the streets. So, in our Q4 forecast, we are expecting another couple of pennies in decline, but nothing material and we think we'll make that up with pricing on base oil and certainly our increase production.

[Brian Recatto:]

But that bunker crude spread if it would even get close to back to what we used to consider normal even at a higher crude, soon we'll get the pass-through benefit on the higher price on our products should be an overall margin benefit. It's just been brutal last two quarters at least.

[Mark DeVita:]

Heavy demand for used motor oil on the street right now. Not that you're hearing that from other people.

[Kevin Steinke:]

Yeah. Okay. And lastly, you've talked about being folks down organic growth and all the opportunities there, although you also mentioned creating a new position focused on evaluating acquisitions. So just wondering what the impetus was behind that and what sort of opportunities are out there that you're evaluating?

[Brian Recatto:]

Well obviously, we've talked on prior conference calls, we really want to continue to grow our Western presence. It negatively impacts our ability to pursue larger corporate and national accounts because we don't have a strong footprint in the Western half of the U.S. I love our vacuum truck service line. I've plenty of experience in that area. It's a significant piece of our ES business. So, we're going to actively pursuing growth in those areas because it ties into an industrial account. If back truck customer is an industrial account that gives the ability to cross sell. So, we're going to look for acquisitions in those areas. Anything that they’ll containerize waste and certainly we're going to look to your geographically to the Western half of the U.S. because we want to expand our footprint.

[Mark DeVita:]

But we've done enough deals Kevin. You've covered us long enough. So, you know that we've I think demonstrated pretty well that we can acquire on a decent multiple and integrate well and having not only just the cash position, but having lived through the oil downturn and coming out the back end of it here now in pretty dam good shape in my opinion, I think we have the mental bandwidth not to match the cash that we have to go after these things. So, it's not in lieu of organic growth as we've tried to stress in this call. This will be in addition to. So, any acquisitions we can get done should drive higher growth rates than what we've talked about. So, you can get into double-digit growth rate that is really -- we don't want to say for sure we're going to do acquisitions. Obviously if you want to be disciplined, you can't guarantee you're going to do any deal, but that should be the thought that acquisitions are additive to that growth story.

[Brian Recatto:]

And we added a dedicated resource because obviously we don't wanted to be a part time function. We think it's important that our growth story. We have 84 branches, tremendous amount of people out in the field right now that interact with potential acquisitions with any one person dedicated to following up on those opportunities and we intend to close some in 2018.

[Kevin Steinke:]

Okay. That's very helpful. Thanks for taking the questions.

[Brian Recatto:]

Thank you.

[Mark DeVita:]

Thanks Kevin.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.

[Brian Recatto:]

Thank you.