Clean Harbors Inc (CLH) 2017 Q2 法說會逐字稿

Greetings, and welcome to Clean Harbors, Inc. Second Quarter 2017 Conference Call. (Operator Instructions)

It is now my pleasure to turn the conference over to your host today, Mr. Michael McDonald. Thank you. You may begin.

Thank you, Robin. Good morning, everyone. On today's call with me are Chairman, President and Chief Executive Officer, Alan S. McKim; EVP and Chief Financial Officer, Mike Battles; and our SVP of Investor Relations, Jim Buckley. Slides for today's call are posted on our website, and we invite you to follow along. Matters we are discussing today that are not historical facts are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Participants are cautioned not to place undue reliance on these statements, which reflect management's opinions only as of today, August 2, 2017.

Information on potential factors and risks that could affect our actual results of operations is included in our SEC filings. The company undertakes no obligation to revise or publicly release the results of any revision to the statements made in this morning's call other than through filings that will be made concerning this reporting period. In addition, today's discussion will include references to non-GAAP measures. Clean Harbors believes that such information provides an additional measurement and consistent historical comparison of its performance. A reconciliation of the non-GAAP measures to the most directly comparable GAAP measures is available in today's news release, on our website and in the appendix of today's presentation.

And I would like to turn the call over to our CEO, Alan McKim. Alan?

Thanks, Michael, and good morning, everyone. Turning to Slide 3. We delivered strong growth in Q2 as we saw good success on many strategic fronts. Revenues increased 8% to $752.8 million. And adjusted EBITDA grew by 9% to $120.7 million. While our growth was led by tech services and Safety-Kleen, I'm pleased to report that all 4 segments grew both their revenues and adjusted EBITDA from a year ago. Technical Services revenues were up sharply with the addition of the El Dorado incinerator and a rebound in landfill volumes as the overall macroeconomic environment improved. Industrial and Field Services delivered improved margins on strong growth. Safety-Kleen grew both revenue and adjusted EBITDA by 9%. Oil, Gas and Lodging Services posted a higher top and bottom line for the first time in several years as North American energy markets showed some signs of stabilizing.

Turning to the segments in more detail starting with tech services on Slide 4. The full launch of our El Dorado incinerator in Q2 coupled with several project wins, our retail initiative and an increase in base business helped produce a strong quarter. Incineration utilization of 87% in the quarter would have been 99% without the additional capacity of the new kiln. We also grew our landfill tonnage by 23% from a year ago through a solid increase in base business supported by an uptick in project volumes. Technical service revenues rose 11%. This translated into a 6% increase in adjusted EBITDA, largely because of a lower margin mix, including some high-volume incineration projects. In addition, we're still absorbing some cost in the shakedown process of the new El Do incinerator as well as investing to further grow the business.

Turning to Slide 5. Our Industrial and Field Services segment also had an excellent quarter. Our Field Services business grew revenue by double digits for the second consecutive quarter with some nice wins across our branch network, particularly in the Northeast and on the West Coast. We sold our Catalyst Service business in Q3 of 2016. Excluding Catalyst, our industrial service business including daylight and production services increased by more than 15% with growth in the U.S. and some turnaround work and project wins in Western Canada. With the acquisition of Lonestar, which we completed last month, we see an opportunity to accelerate our position in the daylighting and hydro excavation services market. Based on our cost reduction programs and mix of business in Q2, we grew adjusted EBITDA by 8% and increased our segment margin. When you exclude catalyst, our adjusted EBITDA was up more than 25%. Personnel utilization in the quarter was 84%, which is up slightly from a year ago.

Moving to Slide 6. Safety-Kleen's 9% revenue increase reflected a mix of organic growth and the benefits of the 27 -- 2016 acquisitions. We saw good performance in the core offerings of our Safety-Kleen branches, including [parts] washer services, which increased to 251,000 from 248,000 a year ago. Collections remain strong as we gathered 6 million gallons more of waste oil than a year ago aided by the acquisition. Safety-Kleen's margins were unchanged from Q2 a year ago as we made some additional investments in the segment and unfortunately had 2 small but costly upsets at Tuohy refineries, which cost us both production of base oil and approximately $2 million in expenses and repairs. We are making investments in centralizing some functions in Safety-Kleen, including a national customer care center. In addition, we are continuing to invest in the closed loop program, including additional sales personnel, infrastructure and distribution. To date, we've had good success with direct sales to many of our smaller Safety-Kleen customers. Since launching the program early this year, we have now sold our lubricants to more than 10,000 unique customers with contributions from every SK branch and salesperson. Direct sales in Q2 represented 4% of total volume sold compared with 3% in the first quarter this year. Overall, our sales trends are positive in Safety-Kleen. And we remain confident that the closed loop program is going to generate considerable value for our shareholders.

Turning to Slide 7. Revenue in our Oil, Gas and Lodging Services grew 6% as we capitalized on the improving drilling environment and turnaround activity in the oil sands. Average rig service, while still low at 71, given the seasonal weakness of Q2, were up 65% from a year ago. Average utilization of key equipment also more than doubled, but was still only 28%. At our fixed lodges, outside room utilization rose to 48% from 44% a year ago when utilization was up due to the fire that devastated the Fort McMurray area. Overall, our aggressive cost reduction efforts combined with an improved environment enabled us to deliver positive adjusted EBITDA in Q2.

Turning to Slide 8 for a quick update on some corporate initiatives. We recently refinanced some of our debt. Based on current rates, we will reduce our annual interest expense by $8 million. And as I mentioned on our Q1 call, top line growth remains one of our highest priorities. And we are off to a good start. Our El Dorado facility is running well and was a strong contributor in Q1. The equipment shakedown process continues, and we've identified some areas where we could improve the performance of the overall plant. We look forward to ramping up the volumes at the facilities in the quarters ahead.

In terms of our OilPlus program, we continue to expand our bulk products offering into more metropolitan markets. In Q2, we continued the rollout of our OilPlus in several markets across the country with more planned for the back half of the year. In Q2, we sold our transformer services business to a strategic buyer. With fewer transformers containing PCBs, the business had become more about electrical distribution than hazardous waste, and thus did not align with our objectives. With the sale of Catalyst Services, transformer services and certain assets in the past 12 months, the company generated more than $100 million in proceeds.

Turning to our capital allocation strategy on Slide 9. With the refinancing of a portion of our debt, we now have the flexibility to repay some of our debt without penalty. While we're comfortable with our current debt profile, repaying our debt is now something we can weigh against internal investments in our business, acquisitions and share repurchases going forward.

Moving to our outlook on Slide 10. Our focus in 2017 remains on profitable growth. Within tech services, we look to extend the momentum of driving more waste streams and volumes into our network of disposal assets. Project bids have been increasing recently. And we'd like to see more of those convert into revenue.

In Industrial and Field Services, we want to repeat the successes that we achieved in Q2 and continue growing those businesses. For Field Services, we continue to collaborate with the Safety-Kleen network to expand our overall presence. Within industrial, we're moving forward with integrating Lonestar and expanding our presence in the daylighting marketplace. For Safety-Kleen, we'll continue to proactively manage the spread in our re-refinery business and will continue with the rollout of our OilPlus closed loop program into more regions as we seek to accelerate the growth of our blended products.

Within Oil, Gas and Lodging Services, we're seeking to capitalize on the steady recovery we've seen in the energy markets, particularly as it relates to drill rig activity. We are, of course, maintaining our focus on cost but are seeing some signs of life in certain regions. Within our fixed lodges, we're pushing hard to drive occupancy. The overall sentiment for this segment is more positive than it has been for more than a year's time.

So in conclusion, we're encouraged by our Q2 performance and cautiously optimistic about each segment as we begin the second half of 2017. Crude prices have stabilized, which helps drive customer spending and investment. With U.S. industrial production rising for 5 straight months through June and a noticeable uptick in customer activity, sales opportunities are increasing. And our pipeline is growing across our segments. We believe that our profitability -- profitable growth initiatives, combined with our ongoing cost reduction programs set the stage for a strong second half of the year.

So with that, let me turn it over to our Chief Financial Officer, Mike Battles. Mike?

Thank you, Alan, and good morning, everyone. Turning to our income statement on Slide 12. As Alan highlighted, revenue increased by 8% in Q2, largely due to sizable growth in tech services and Safety-Kleen. Gross profit for the quarter was $233 million or 30.9% of revenue. Gross margin was down slightly from a year ago, mostly due in the mix of business in the quarter as we focus on driving greater volumes through our disposal network. We did not reduce our pricing in the quarter. But given the level of project work, we saw higher volumes with lower price streams.

SG&A expenses were up slightly to $112.3 million year-over-year, reflecting higher overall revenue and the impact of the 2016 acquisitions. On a percentage basis, however, SG&A costs improved by 40 basis points to 14.9%. For full year 2017, we continue to expect SG&A expenses to increase on an absolute dollar basis as higher incentive compensation is largely offset by lower integration severance expense and cost actions.

Depreciation and amortization was $71.5 million in Q2. For 2017, we continue to expect depreciation and amortization to be flat with 2016 in the range of $280 million to $290 million despite the addition of $5 million related to the new El Dorado incinerator as well as the full year effects of the 2016 acquisitions.

Income from operations increased 35% from Q2 2016 to $46.7 million, primarily reflecting higher year-over-year revenue.

Q2 adjusted EBITDA was up 9% from a year ago driven by higher revenue and supported by our cost-reduction programs. On a GAAP basis, our EPS was $0.45 per share. Adjusting for the sale of our transformer services business as well as other items, we recorded adjusted net income of $13.7 million or $0.24 per share.

Turning to the balance sheet on Slide 13. We ended Q2 with $446.4 million in cash compared with $297.4 million in March. The large increase in our cash balance was a result of 3 primary factors: first, the timing of activities related to the refinancing of our debt; the second was $44.4 million in net proceeds we received from our transformer sale; and third, we had solid free cash flow in the quarter.

DSO in the quarter came in at 67 days for the second consecutive quarter, which is encouraging after having been in the 70-plus range since 2014. Good revenue generation and improving economy helps DSO quite a bit. In addition, the team continues to do well with collection efforts and improving cycle times. We will work to keep DSO in the high 60s in the quarters ahead.

Q2 CapEx net of disposals was $45.2 million, which is similar to the $46.4 million we recorded in Q2 of last year. For the full year, we are continuing to target CapEx net of asset disposals of $160 million to $170 million. For the first half, adjusted free cash flow was $30.3 million versus a negative $0.8 million from a year ago. For 2017, we continue to expect adjusted free cash flow in the range of $140 million to $180 million, excluding the sale of transformer services as well as any cash taxes related to the gain on that sale.

During Q2, we repurchased $5.5 million of stock and have approximately $88 million remaining on our $300 million authorized buyback plan.

Moving to guidance on Slide 14. We are reiterating our full year 2017 adjusted EBITDA guidance of $435 million to $475 million, which at the midpoint represents a 14% growth. With a 19% increase in Q1 and a 9% increase in Q2, we are where we expected to be and remain on track to hit our annual guidance.

Here's how the guidance translates into a segment perspective. We expect Technical Services adjusted EBITDA to be up low to mid-single digits in 2017 due to good traction from the addition of the El Dorado incinerator as well as GDP growth in the U.S. and the recent upturn in U.S. industrial production. We now expect Industrial and Field Services growth to be in the low single digits compared with 2016. We expect a majority of the profitability improvements for the full year to come from the U.S. although we did see some nice project flow and launched some significant turnaround work in Western Canada in Q2. Margins in these segments have still a ways to go to return to more historical levels, and we don't see that changing much of this year. But we are encouraged by signs of life we saw this past quarter and the growth in Field Services overall. We now expect Safety-Kleen to generate growth in the mid-teens. Our profitability growth will continue to be driven by better pricing, our 2016 acquisitions, our closed loop offering and contributions from our SK branch network.

For Oil and Gas and Lodging Services, we now anticipate adjusted EBITDA to be slightly positive for the year. Rig counts are continuing to rise in the U.S. and to a lesser degree, in Canada. Our Lodging business had a strong spring turnaround season. And we're hopeful that we see similar pickup in the fall turnarounds.

Our corporate segment adjusted EBITDA loss is expected to be slightly higher in 2017 with costs from acquisitions and higher incentive compensation balancing out our expected cost savings and lower integration severance costs. Overall, our 2000 expectations remain -- 2017 expectations remain on track, especially given our Q2 performance. Market trends appear to be favorable, particularly as they relate to our tech services segment and the related waste streams we are capturing. We have seen momentum across multiple businesses on the sales front. We are executing well on other strategic growth initiatives and continuing our focus on cost reductions.

With that, Rob, please open up the call for questions.

(Operator Instructions) Our first question comes from Noah Kaye with Oppenheimer & Co.

Alan and Mike, maybe we can start with tech services. Very nice top line growth there. So just looking at the margins, is there a way to disaggregate some of the puts and takes you identified around mix and the El Dorado ramp? To what extent were those headwinds to margins? And then how should we think about kind of the mix of the waste streams that you're looking at going forward? You mentioned an uptick in project activity and nice trends.

Sure. So I think because of the projects that we have been successful at winning, particularly as it relates to incineration volumes, that larger volume has impacted some of our margins a little bit. I would also say that as we ramp up El Do, which quite frankly is really doing very well after only several months being in production, we've seen for the total site a number of 1 million pound plus days at that facility. And clearly, at 1 million pounds is what's going to get us at 150,000-ton a year kind of rate across those 3 units of that are now running at that site. So we're really excited about the production we're getting out of the new plant and the overall plant. Our deferred revenue also went up. So we have quite a bit of growth that we have now deferred. And some of that is also showing up in those margins. Our deferred this now up to about $72 million, Mike, I think, which is growth of about $6 million to $7 million. So I think that gives us good visibility into the volume and probably had a little impact on the margins as well.

Okay. Great. Touch on M&A for a second. You made the acquisition of the Hydro Vac daylighting business. As you kind of look across the portfolio, what comes to mind in terms of obvious areas within the segments or adjacencies where you feel still may make sense to do some additions?

I think we've -- each year, we move forward with our strategic plan for the -- looking out over the next 3 to 5 years. We've discussed that with our board and done a lot of analysis of that over the last several years. And as a result of that as we talked about earlier, we divested a couple of businesses that we weren't the natural owner for any longer and raised some great proceeds from those sales. There are continuous review of some of the businesses we're in, relatively small pieces of our business that may not fit in the long term for us. So we'll continue to be looking at that. On the other hand, the daylighting business that we expanded into, we have about 130 or so daylighting units. We've now added close to another 100 now with the Lonestar acquisition, really start giving us some scale allowing them to leverage off of our network and getting some real synergies there on the cost side. So I think you're going to continue to see our daylighting business expand, particularly with our industrial and refining customers.

Our next question comes from Michael Hoffman with Stifel.

This is Brian Butler in for Michael. Just starting on the Safety-Kleen segment, when you talked about the upsets in the re-refineries, so that was like a $2 million expense in the quarter. When you combine that with the loss kind of a base oil production, can you give a little color on what that does -- what that did to the segment EBITDA combined in margins?

Maybe I'll start and then Mike can chime in here, but I think it's important. We bought several re-refineries last year through acquisitions. And one particular one is a plant that we really had a couple of struggles with as we turned that plant on. It was a dormant facility when we acquired it, so we had to basically go through a full startup. And as we've done that, we've determined some engineering issues as it related to the construction of that plant that we are solving, particularly around catalyst and our reactors. And the quality of our oil has been superb. But as we have suffered through some degradation in our catalyst, that has impacted our quality and also impacted our runs there. And so that would probably be the main facility. When we did a turnaround in the Chicago plant, which is 120 million-gallon plant, we had some additional maintenance work that we found during that turnaround. And that extended out our downtime by another 5 or 6 days at those sites. So several million gallons have impacted on the production side. And as people probably know in the base oil market, it's been a very strong market, very tight supply. And so we did everything to meet our contractual obligations with our customers. But clearly, we were off on volume as it relates to the 2 plants there and their production upsets.

Yes, Brian. This is Mike. The only thing I would add to Alan is I think that those disruptions, we can talk about the exact amount, but we think they're in the rearview mirror. I think those are onetimey in nature. I mean, obviously, bad things happen and we plan for that, but these were kind of above and beyond kind of what we expected so that along with the centralization program that Alan mentioned in his prepared remarks I think are part of the reason why there's a bit of a drag on the Safety-Kleen margins for the quarter.

So looking at the third quarter and the rest of the year, you're expecting those margins to be ticking up just in the sense that I mean maybe it's some number greater than $2 million just on the expense side. But going forward, that's not going to be there assuming current prices for everything else remains stable.

Yes. Brian, so for the downtime in the plant, we feel like they're in the rearview mirror, the centralization program, there's a long-term savings plan associated with that. But that's going to be a bit of a drag in the rest of the year as well.

Okay. And just kind of, I guess, looking at the Hydro Vac business that you guys had picked up, can you give a little bit of color on just kind of where the margins there, ballpark are, versus kind of the rest of the business?

Yes, sure. So it is about a $5 million to $6 million of EBITDA, maybe going in to -- as we look at the future in the back half, I think given the startup costs and so forth probably closer to $2 million. We don't give out kind of revenue numbers there. But that kind of gives you a sense, and it's a public company, you can go looking for yourself as to what the historical kind of revenue is. And so again, we think that, that business the back half of the year is going to be rocky. We have some severance cost we have to work our way through. But I don't think it's a huge number, but there's a number there. But I think going to '18, we think that's a $6 million incremental EBITDA number.

So annually, it's kind of $6 million on a normalized basis is the right way to think about where we're starting.

Fair enough. Yes.

Working capital this quarter was kind of a big negative. When you get think about getting to your guidance for the free cash flow, how should we think about working capital swinging in the second half? Is that going to swing back another positive $20 million? Or is it possibly greater than that?

Yes, Brian. Revenue was growing, right? And we haven't really experienced this much recently. But when revenue is going, it gets stuck in receivables. So there is a bit of a lag there as we grow 8%, 9% in the quarter whereas -- although DSO is down, that cash is not collected. We're going to collect that in Q3. We're doing really well on our cash taxes. Obviously, we lowered our interest expense. And so I think we're still well in the range. But as business is growing, that free cash flow does get a little trapped. So it is a bit of a lag associated with that. But there's nothing to think that -- so we ended the first half with $30-plus million of free cash flow. There's nothing to think we won't get into the range for the year.

And then last one on taxes, you mentioned it, what should we think, be thinking about the tax rate, book tax rate in the second half? Is it still kind of in that 45% range?

Probably a little lower than that, probably in the low 40s. We did a lot of things to be fair around managing our effective rate, doing different types of programs in Canada to minimize the valuation allowances. Those things starting to turn around, too. It's also helpful. So we think it's going to be in the low 40s kind of going forward, definitely.

Our next question comes from Brian Lee with Goldman Sachs.

Maybe first off on the incinerator business, the 99% base utilization, helpful for that color but when you back into it, it seems like only a few percentage points of the increase in tonnage this quarter was driven by El Dorado. So first off, is that a fair assumption? And then how should we be thinking about the contribution trend from that new facility in the back half? I guess in the context of overall utilization at 87%, where does that go to exiting this year?

So I would say -- and Alan, feel free to chime in. It's hard to think of it as a stand-alone plant. It's a network. We say that often, but it's true. We have a whole routing team that spends all the time thinking about how to get the wastes in the right locations based on where it's generated, based on the type of waste, type of food groups and what burns well where. And it's difficult to put a pinpoint on that. I would say that given the fact that we just opened up this facility and we're at 87% kind of all in, is a great story. And I think it's consistent with what -- it's going faster than what we said back 90 days ago. So I couldn't be more pleased with the El Dorado incinerator and the overall network and rolling kind of doing really well. And so as for the back half we made prepared remarks on kind of where we think kind of tech services is going to be in total. And that includes the new incinerator and all the incinerators kind of working as planned.

You guys were definitely ahead of our anticipated utilization rates. So you do seem to be ramping ahead of plan. Maybe a second question on Technical Services while we're on the topic. You mentioned the large projects in the quarter. Can you give us some sense of the cadence of that? Do those roll off in 3Q or how do we think about the sustainability of those new ones?

Yes, I think we've seen a pipeline of opportunities across both our waste projects and remediation business. And I think that's going to continue in the third quarter and beyond. So I think we've got some pretty good visibility. Providing nothing gets pushed, we feel pretty good about volumes, both incineration and landfill.

Yes, Brian. I will just add to that saying that we talked in year-end and in Q1 kind of signs of life and we see good pipelines and this and that. I think this in Q2, we're starting to see the manifestation of that in the financial statements.

Last one for me and I'll pass it on. But first a bit of a follow-up to an earlier question around Safety-Kleen and the view on margins heading through the back half of the year. You know you guys talked to some of the incremental investments that are ongoing. Can you give us a sense for maybe how much is left in that investment cycle?

Well, we're -- we have added about 120 or so folks to our customer care center based outside of Dallas. And that team is handling about 50% to 60% of the Safety-Kleen branch of business today. So there's some continuous investment going on there. But I would say that adding additional sales personnel is still in the works as it relates to our direct sales for lube oil hiring a number of folks across the network to help develop that -- those new markets for us. So some continuation on that. And I think on the margin standpoint, Mike, I guess ...

I think margins will stay kind of really healthy. It's just versus an expectation of what. And we were really pleased about the fact we've grown $30 million, $40 million from 15 to 16. And now 16 to 17 we said mid-teens, which we did do the math, that's another $40 million on top of that. And so again, we can talk about margins and talk about our investments, and I'm happy to do so because again we're playing the long game and we're making investments in the future. But I couldn't be more pleased with the success that we're having at Safety-Kleen and the managing of the spread, the parts washer services are up. And I think the closed loop is 10,000 customers. Again we can talk about margins and there are some margin challenges, certainly we talked about them. But I think they're a small piece of the overall kind of very positive story around Safety-Kleen.

Yes. And I think just recently in the last month or so here both put forth more pricing increases on the Charge-for-Oil program on the collection side and even this morning came out with a small $0.10 a gallon price increase for our group 2 plus base oil. So we continue to manage the spread, I think, well. And the team is operating around the market dynamics that exist today in the crude oil market.

Our next question comes from Joe Box with KeyBanc.

So Mike, speaking in the long game and some investments for the future, can you maybe just dig into what the right incremental EBITDA margin is for your business? And maybe if you could just help us understand how the incremental margins could shake out in the near term as you guys pursue some of those growth initiatives versus maybe what you expect longer term once some of those initiatives have really taken root.

When you think about margins and we don't give out revenue guidance so it's tricky to speak to that. We have tried to go 75 to 100 basis points of margin improvement every year. That's been our goal. That's been our target. We're working toward that end. I think there's nothing -- even with the investors are talking about here, nothing that would prevent us from reaching those goals in 2017. I think that, again, the long game, we talked about over a long term trying to get to 20%. And again, I think the investments we're making will allow us to get to that answer.

So I mean you guys put up, what, 18.5% incremental EBITDA margins in the quarter. Was that in line with your expectations? Was that below your expectations? Better? I'm just curious how ultimately this is shaking out.

A little below what we wanted to do. We were thinking a little higher. At the end of the day, we're pleased with the progress we're making and with the project work. And we're starting to see some of that so I feel good about the back half of the year, given that volume of the flow. We talked a lot about it and I was concerned that wouldn't materialize. Things get pushed, different things happen that prevent us from experiencing that. But that's not the case. It's actually coming through. And we see the project work in our waste projects, and in our remediation and base work as well.

I guess speaking on the back half, you called out some severance expense for the back half stemming from your acquisition. Historically, you guys have included this in your number. So I'm curious, how should we be thinking about that incremental severance relative to your maintained EBITDA guide? Is that a needle mover or no?

It's not, Joe. It's just more -- when speaking for Lonestar, I wanted people to understand where some costs are going to be, as we kind of work our way through integrating that business. So it's not a needle mover at all, and that was included, a relatively small number.

Compared to last year, certainly a smaller number than last year.

Nothing has changed in our guidance, Joe, around that discussion.

Changing gears with the flexibility of term loan B, how should be thinking about the percentage of free cash that could be earmarked toward debt paydown?

Joe, that certainly gives us that optionality, which is a good thing to have. And obviously, we lowered our interest expense by 200 basis points. It's also nice to have. But again, we measure these investments based on return on invested capital and whether that means stock buybacks or acquisitions or paying down the debt. That's something we're just going to have to evaluate. I don't really have anything earmarked. I know other companies do stuff like that. And maybe we get some good cash flow numbers on the board, we can have that conversation. But right now, I think we kind of measure our back half of the year, see how we do and then continue to do an assessment of different types of investments, whether it be acquisitions, whether it be CapEx, whether it be buyback programs or now we have debt repayment. And just as a reminder, Joe, we do have a minimum 1% we have to pay down per year so that's a $4 million payment, we'll make $1 million a quarter here starting in Q3.

Our next question comes from Hamzah Mazari with Macquarie.

This is Kayvan Rahbar filling in for Hamzah Mazari. I have a question about the possibilities of doing business in the health care pharma waste sector. What's your current strategy in there? And what's the outlook? We know it's early in terms of -- it's an early stage for you guys but maybe you give some color.

Yes, we have been rolling out a program focused in both red bag medical waste mail back return and other waste streams, particularly focused on some of the retail, the pharmacy retail. And I think we're in the early innings of that rollout. We have opened up in a number of markets across U.S., not in Canada just yet. And I think we're seeing some real good opportunities there. We've looked at our pipeline. On a revenue basis, relatively small. It's a little bit longer cycle relating to how contracts mature and how we penetrate some of those customers today. But I think we are seeing good opportunities in that market and will continue to drive that program.

Okay. Maybe switching gears to the energy business. What's -- what kind of breakeven oil price do you need for that business to get back to around 50%, 60% of the prior peak?

Certainly in Canada, I think they've been working real hard to lower cost to try to get that number down significantly, down to the $40. But historically, it'd been north of $60 for many of the producers up there. But we've had to adjust our cost structure. We've had to consolidate and change our whole business model to meet customers' expectations on costs. Now our hope is that we will now start seeing improvement in utilization. As we mentioned on our call, utilization was up. But still when you look at the sheer size of our organization and our fleet of assets, only at 28%. So we've got a lot of opportunity to put more equipment to work up there. And we're hoping that with the cost structures that are now in place we can grow that business again.

It's very difficult to kind of give that because at one juncture, as Alan said, it was $60, $70 a barrel. And now it's probably lower than that just given the fact that us and everyone else taking a lot of cost out the network. And so we're hopeful as you see drill rates kind of slightly creeping up here in Western Canada, we see there could be an opportunity here. But as we gave guidance in the back half of the year, as I said in prepared remarks, we're not anticipating a recovery in Western Canada in the back half of '17.

Our next question comes from Luke Junk with Robert W. Baird and Company.

First question, I'm just trying to put a finer point on the incremental profitability drivers for Technical Services in the second half of this year relative to the factors that you mentioned in prepared remarks, Alan, how should we be thinking about the various impacts on incremental profitability in the near term?

I'll jump in and certainly, Luke, and Alan can speak to this. At the end of the day, good project pipeline is going to generate kind of very good EBITDA growth. And as we said in our prepared remarks, some of these waste streams are bulk waste and bulk solid that have lower price points. It does not mean that our prices have not changed. It's actually gone up a bit this year. It's just that we haven't seen the mix of the business, which is a good thing. In my opinion, it's a good thing because we're using our new incinerator. Our landfills are getting good utilization. And we're kind of pleased with the back half program. And so the margins yeah, there's been some slippage in margin, but I'm not necessarily concerned about that. I think as we get the incinerator kind of up and fully all shook out and rolling well, we'll be able to take higher waste streams. So we'll be able to kind of push and pull and drive higher margin, like we've done in the past -- done in the past. I'm new to the company, but this is not new to them. So this is something we'll do again.

I think we've added over 100 personnel to run the new incinerator. And certainly, when we look at the tonnage that we're operating on right now, that is impacting our overall margins, so as we continue to ramp up production at that facility, you're going to start seeing that incremental margin really start to flow through. And we historically have seen about 30% margin on that incremental dollar on our core Technical Service business. I think you're just seeing right now just a little bit of remnants of the startup of that massive plant that we built. And like we said, the team is doing extremely well getting that facility online and quite frankly ahead of plan based on what we're seeing in production down there.

Yes, I want to repeat, we're pleased about the utilization numbers. Those were a bit of a surprise to us. We thought it's going to take a little longer. We're pleased about -- that shows you the level of project work that's happening in the marketplace. We can quickly go from 79% to 87% really in the quarter.

And then second question just in terms of the Industrial Field Services business, obviously some nice upside this quarter. I'm just curious about the sustainability of that upside, maybe thinking the 2 big parts of that business what you see in the U.S. and perchance the likelihood of some additional upside in Canada as well.

It's clearly a lumpy business, more seasonal with turnaround works. So we expect a much stronger fourth quarter for example than we would in the third quarter simply because the turnarounds that take place. I would say that we've had very little event business. Our Field Service business every year typically enjoys some large event-related work. And although we've had some small activity there but nothing significant like we've seen in the past. So we're expanding our footprint with our field business. And I think from a pipeline standpoint on the industrial, it looks really good for us. But it is a little bit more lumpy. And so the second quarter is pretty strong for us.

And Luke, there were no ER events in Q1 -- that would be no national ER events in Q1 or in Q2.

Our next question comes from Sean Hannan with Needham & Company.

A few questions here. I wanted to see if I could start on Safety-Kleen. Did you say that the parts washing business is up on a same-branch basis or that we have more activity or really more branches that are out there serving this? Just trying to get a better understanding there and where you are in perhaps either expanding your market share or expanding the market, et cetera, and particularly again kind of coming back to what you have for the branches from an overall number standpoint.

Sure. Our -- as you look at the Safety-Kleen branches, there's not a number of new locations per se across the Safety-Kleen network at this time. We have been expanding in Western Canada with Safety-Kleen. The services that we mentioned, how our services are up, I think are more reflective of our service intervals than it is actually placement of and growth of machines. We still have over 200,000 machines that we service out there, and we track that weekly. We've got a good handle on how that business is going. We are seeing growth in our DIY business and our oil filter recycling business. We touched on the 6 million gallons of additional used motor oil collected. So I think all of the key performance indicators for Safety-Kleen, I think, are all up. And we're really excited about the growth potential that continues to exist across the Safety-Kleen branch network.

Okay. Yes, sorry the initial question was a little convoluted there. Ultimately, do you feel that you're expanding TAM or do you feel that you're gaining share?

What was the first part of the question?

Expanding the TAM or gaining share.

I don't think the market is growing per se. When we look at the machines that -- I guess what I would say is that when we're moving into a different style machine, we've expanded some of the technology that we're using so there's a little bit of shifting going on, moving from solvent to aqueous, for example. But overall, I would say that we're growing that business as a result of just the market growing. I think the automotive industry, I think, has been growing. And the services are growing. And I think that is reflected in growth that you're seeing in the Safety-Kleen business.

I'd say that -- just to add on to what Alan said, I'll say that miles driven is up a bit, so that's a good sign. But I'd say that we constantly are kind of competing with our strong competitors and sometimes we're up a bit and sometimes down a bit. I don't think that's -- overall I think it's a little bit of market growth. I'm not sure it's a market share thing.

So the TAM has expanded a little bit, but it's a natural flux is what it sounds like.

Yes.

On the re-refining segment, can you share any feedback on the progress you're making for the announcement on the collection charges? I realize this is relatively recent. But any more detail you can provide on how that's working so far?

As you implement price increases across any part of our business, it always takes some time and lags a little bit. But I think overall, we are communicating with our customers. We're setting the expectations of the realities of what's going on in the market, where crude was operating in. The 6 oil market was impacting a little bit on the CFO in the first half of the year. It was relatively strong, which is what we tend to compete with for used motor oil to run our re-refineries. So we saw even folks that are selling into that market having their margins compressed as well. And so I think our competitors along with ourselves realized that we need to manage our spread and do a better job of that. And I think we've been doing a good job of convincing our customers why that's important for both of us.

Okay. And then on the re-refined facilities where you had the hiccups, do you feel that you now have a strong handle on what needs to be addressed there? In essence, you've gone through perhaps a stepped-up diligence review of the facility so we don't run into others surprises? Or are there aspects of some deeper reviews, a little further on down the road for you? Just trying to understand really where you have those facilities from a comfort level standpoint.

Yes. First, I would say that we have an exceptional team that runs the re-refinery network that we have, the levels of production that we're getting out of our plants and the quality of the product. We're creating close to a group 3 oil as we speak. And that's really the result of the work that the team has done, not only in running the plants but the research and the development side that we're focused on. And so some of the work that we're doing around catalyst has somewhat to do with the improvement in what we're trying to get out of our products to try to get to that higher price point. And when you're doing that in a production environment, you tend to burn out your catalyst, maybe -- or cause some upset conditions but all for the right reason, which is to drive a higher-quality, higher-priced, higher-margin product. And so to that extent, we're going to continue to investigate that and push that envelope. On the other hand, as it related to the acquisition that we made last year, particularly the Nevada plant that we bought, there were some bottlenecks in that plant that need to be addressed, and we have addressed them. There is still some additional engineering and equipment. And that has been ordered and will be installed the latter half of this year that will make that plant even better. But we are running very safe and well-run plants right now.

Okay. So from a review, assess and put some new plans into action standpoint, we feel comfortable that this is now done. We can proceed and move forward and execute.

Yes. And I would say we just had one of our oil summit meetings and Scott Miller, who's the gentleman that runs these plants, 20-plus years with the Safety-Kleen organization, he is leading the team around those points that I was making. You never -- I can't say never that you would have an upset condition again in any of our plants because that's just the nature of handling hazardous waste and waste in general. You tend to have upset conditions, whether it be around fouling or quality or water, whatever it might be. But overall, directionally, this team is creating some great products and really doing a great job of converting those base oils now to blended oil. And that I think is going to continue to perform really well.

Our next question comes from Tyler Brown with Raymond James.

Just a few questions on the Safety-Kleen segment from a modeling perspective. So I know at this point you've got 6 re-refineries in the fleet, but it's still a little unclear to me how much nameplate UMO processing capacity you have, I guess, annually. I still don't know what Nevada, Washington and Kansas are contributing.

I don't have that number, Tyler. I don't know if we've given that out publicly before but let us research that and get back to you.

I think general, just directionally, about a little over 200 million gallons is what these plants take in as a feed. And they yield us typically around that 70%, 71% level. So directionally in that number, but don't hold us to it, okay?

Okay. And then you collected 60 million UMO in the quarter. Is that the good run rate? Or would you expect some of the pricing actions will bring that down back into the mid-50s?

I think second quarter and third quarter are seasonally strong. So you're going to continue to see that. The demand for our business -- the demand for services are growing. And even with pricing that we put out there, we are winning contracts. So I would say that we're going to continue to see strong volumes. We realize...

It is lumpy. It is a little lumpy.

It is lumpy. But we're going to lose some -- we'll lose some customers to a competitor who might try to increase -- take advantage of our price increase. But generally speaking, our volumes are going to continue to be pretty strong.

Right. And then on CFO, I think the slides noted a $0.10 drop year-over-year. But that would still imply a pretty big sequential step-down. I guess I'm just still a little unclear why that happened. And that seemed to be a relatively big move.

I would say, Tyler, that at the end of the day as we've been able to get -- oil prices have increased, that's going to be a natural answer that CFO pricing is going to decrease. And so our sequential drop, we didn't publish, is consistent with our peer group. And I think that that's part of the reason why. Again trying to get ahead of it, we announced in July CFO price increase. So again with the idea being widen that spread from base oil pricing at the street and the market as well as our feedstock cost.

Okay. So when you announced your CFO kind of pricing, does that include the stop fees or is that a completely separate revenue line?

Tyler, it's Jim. That number we provided since we had Safety-Kleen has always been an all-in number. Some are charged stop fees, some are charged per gallon, some are charged per mix and what we give to The Street has always been a compilation of everything.

Okay. Good. And on SG&A side, Mike, is this level basically assuming 100% accrual on the incentive comp? Or is it over 100% this year? I'm just basically trying to figure out if this year's SG&A is a baseline.

It's a good baseline. It will be a little higher than last year and includes not at 100% but a very high level.

Okay. And my last one, on incineration, Alan, you noted that mix played a role in pricing, but if you stripped it down, do you feel that pricing is positive on an apples-to-apples basis? Or is it a little more flat?

I think it's positive. We initiated price increases in our tech services business this year. As expected, those lagged as they get implemented, and we will continue to see those price increases come across in the third and fourth quarter.

Our next question comes from Jeff Silber with BMO Capital Markets.

It looks like you raised your adjusted net income guidance for the year. Is that just because of the refinancing? Is there any impact from Lonestar in there as well? I'm just curious.

Interest expense, Jeff.

Our next question comes from Noah Kaye with Oppenheimer & Co.

Just on a prior question around SG&A levels. You mentioned you're at 50% to 60% use of the consolidated call centers. So presumably, you've got a lot of duplicative costs at this point, which is partly creating that headwind there. Can you just remind us at what point this starts to be net good guy this effort and kind of what the magnitude of that should be?

So Alan is going to talk a little bit about the centralization program. There's a lot of goodness coming out of it. I think that's going to be a bit of headwind here in '18 -- in '17. I don't think it's a really super good guy in '18 as well so I just want people to be aware that this is kind of a long-term investment. We recognize the fact we're kind of lowering churn, getting better routing, helping with collection, there's a lot of things the team is doing and just going to take time. And so I don't anticipate this being like a huge winner in 2018 as we start taking on a lot of costs. It was more of kind of increasing revenue, driving revenue to a centralization, better customer service, higher quality service, lower churn ...

Lower churn for sure. It's about $5 million of cost roughly is what that added cost is annually.

Our next question comes from Sean Hannan with Needham & Company.

I just want to see if we could get some specific detail on the -- what you're seeing for turnarounds work for how that's trending right now specifically versus what you were seeing a few months ago.

I'll start now. Alan can chime in. Again, we have gotten good -- now that we've had Salesforce.com now in the system now for a year plus, we're really seeing kind of better trend in, and again we talked about this for a long time, the level of -- we're going to our legal department, we can triangulate it many different ways. We look at it what's happening in the market, what our peers are doing and how we feel about it. And again, I can't stress enough that I feel good about the level of project work that's out there and the opportunity for us to win, not just small guys but medium and large size projects. So although things get pushed, things can happen, I get that. I've sat in this chair before for years and kind of explained that, so bad things can happen. But I say the volume speaks to the fact that there's good trends.

The volume has been out there for a period of time, right? And there's just been so many quarters where we've heard, there are more pushes than we would like or than what we had expected. So I'm just trying to get a sense of when we talk about trends today, is it really materialization that those turnarounds truly are starting to come back in that activity work?

Well, I think -- I mean, when you look at what the oil industry has gone through since crude oil crashed from $100 down to where it went and where it's been going here, there is no question that every customer of ours is holding back spending and pushing and delaying and doing everything they can to deal with this market that they were in. And so what we have seen is turnarounds getting pushed. What we also have seen is some turnarounds becoming more driven by events. And then they become even longer because now you're really spending a lot more money because you're really dragging out some of these plants and running them too long. So there's quite a bit of noise in there, Sean, and I think a lot of it has to do with individual companies doing everything they can to address cost as it relates to the impact of the crude oil market.

Our last question comes from Barbara Noverini with MorningStar.

So going back to some signs of life in Western Canada, I'm wondering if you could provide us maybe with a road map to recovery, if you will. You talked a little bit about turnaround work ticking up in the area as well as outside room utilization improving in Lodging. But maybe you could share with us some additional indicators you might be monitoring that would help you feel more confident that recovery in the region would be gaining traction.

We have not seen any recovery really whatsoever in our seismic business, our survey, our -- which is really a leading indicator of future spending, to be honest with you. And that is something that is a good indicator of what's going to happen in the market. So budgets should come out September-October time frame. We should start getting some color for you in the third quarter as well as obviously for us. But I would say that is something that we're still watching and have not seen any signs of life yet.

At this point, I'd like to turn the call back to Alan McKim for closing comments.

Okay. Thank you, Rob, and thanks, everybody, for joining us today. We are speaking at the Canaccord Conference in Boston next week. And we'll be at other events in the fall, and so we look forward to seeing many of you there and enjoy the rest of the summer.

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.