Clean Harbors - Q3 2014

Transcript

Operator (participant)

Greetings and welcome to the Clean Harbors, Inc. third quarter 2014 conference call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael McDonald, General Counsel for Clean Harbors, Inc. Thank you, Mr. McDonald. You may now begin.

Michael McDonald (General Counsel)

Well, thank you, Rob, and good morning, everyone. Thank you for joining us today. On the call with me are Chairman and Chief Executive Officer Alan S. McKim, Vice Chairman, President, and Chief Financial Officer Jim Rutledge, and our SVP of Investor Relations and Corporate Communications, Jim Buckley. We have posted our slides for today's call to the IR section of our website. We invite you to open the file and follow the presentation along with us. 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 this date, November 5th, 2014. Information on the potential factors and risks that could affect the company's actual results of operations is included in our filings with the SEC.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's press release or this morning's call, other than through SEC filings that will be made concerning this reporting period. In addition, I'd like to remind you that 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, which can be found on our website, cleanharbors.com, as well as in the appendix of today's presentation. And now, I'd like to turn the call over to our CEO, Alan McKim. Alan.

Thanks, Michael. Good morning, everyone. Thank you for joining us today. Starting here on slide three with a summary of our Q3 results, revenue for the quarter was below our expectations and down 6% from a year ago. We saw a further reduction in activity in the oil sands and a slowdown in overall projects, due in part to the declining crude oil prices throughout the quarter. We've been focusing our resources on our highest margin opportunities and our cost reduction efforts. Despite the revenue shortfall, we nearly achieved our adjusted EBITDA target for the quarter and at 18% delivered our strongest EBITDA margin in two years. Improved profitability, primarily in tech services in both Safety-Kleen segments, drove a 190 basis point EBITDA increase from Q3 of last year. Looking at our segment performance in more detail, beginning with slide four, tech services revenue increased 2% in Q3.

This number would have been higher, but we completed scheduled maintenance shutdowns 1 quarter earlier than planned on two of our largest incinerators. As a result, our Q3 incineration utilization was 90%. But we exited the quarter with a strong backlog of drums and other waste streams. Adjusted EBITDA increased 10% from a year ago with nearly a 200 basis point improvement. Our Canadian incineration facility operated near capacity for the third straight quarter, so hats off to that team at that facility. Landfill volumes were up 5% from a year ago due to less project work. Overall, tech services performed well in the quarter and continues to benefit from Safety-Kleen volumes. Turning to industrial and field services on slide five, you can see the effect of the oil sands slowdown on this business, along with the lower Canadian dollar.

Revenue was down 7% in the period, with profitability down even more based on our mix of business. In Q3, we again didn't see any major emergency response events, in fact, only a limited number of smaller events. Even so, the field services component of this segment enjoyed a relatively good quarter. Cross-selling to the Safety-Kleen customer base remained strong. Overall utilization for our billable personnel in this whole segment decreased several points to 81% from the second quarter. Turning to slide six, revenue in oil re-refining and recycling edged up in the quarter. Margin enhancement strategies, including lowering our PFO cost, improved efficiencies, and taking advantage of opportunistic pricing opportunities have been paying off. Adjusted EBITDA was up 15% from a year ago, and margins exceeded 24%. Clean Harbors captured good margin base of business, particularly early in the quarter when prices were higher.

At the same time, we walked away from some low margin, high volume blended business as we raised some of our blended prices. The result was that blended products only accounted for 33.5% of volumes, down from Q2 and below our target going forward. Increasing our blended mix remains a priority. And while the sales cycle is long and we're in the early stages with our EcoPower program, we continue to believe that customers are looking for eco-friendly products. Moving to slide seven, Safety-Kleen environmental services remained a steady and reliable performer. The segment grew incrementally from a year ago, primarily due to the gains in containerized waste services. Service numbers increased 10% on our parts washers from Q2. We collected 55 million gallons of waste oil, consistent with Q2 and reflecting the seasonally strong period.

Even at this elevated level of collection in the quarter, we continue to lower our average price for oil. We now succeed, excuse me, we've now succeeded in lowering the average PFO price by $0.06 year to date. We believe that we have a long way to go to get PFO down further, but the recent decline in crude prices will accelerate our efforts. Moving to slide 8, environmental services, three factors led to lower revenues in Q3: currency translation, weakness in our drill camp business, and a limited contribution from our manufacturing facility. As they have for the previous 2 quarters, our fixed lodges performed well in the market, where a number of our larger competitors have really struggled. Even as activity has slowed in the oil sands, our fixed locations have maintained our room utilization in the 70% range.

The quality of our locations, facilities, and service and our ability to be flexible with customers has allowed us to keep room rates fairly strong. Due to the performance of our fixed lodges, our EBITDA margins rose above 40%, 400 basis points higher than a year ago. Turning to slide 9, oil and gas field service revenue reflected ongoing softness due to the market pressures and compounded by the currency translation effect. We've talked about our seismic support business on the past several conference calls as that continues to be a weak spot for us. The exploration marketplace remains in a down period, particularly with the recent step down in the price of crude. Our average number of rigs serviced in our surface rental business in the quarter was 138, which is slightly ahead of our seasonally weaker second quarter.

Average utilization of our key equipment, which is predominantly our centrifuges for processing waste, increased to 54% from 40% in Q2. We continue to make good progress in the U.S., particularly in some of the smaller shale plays. I'd like to point out that the team recently surpassed 50 solids control packages in the U.S., which is an important milestone that we've been after for some time. So congrats to that group for getting us over that hump. Moving to slide 10 in our corporate initiatives. First, we remain on track to achieve $75 million in annualized cost reductions by year-end. We continue to expect that in 2014, we'll likely see savings of approximately $40 million. We completed our strategic review during Q3. As you know, we brought in two strategic advisory firms during the spring and summer months.

Working with all the top leaders in the company, we assessed all the elements of our business model. The process was thorough and well-documented, and we looked at all of our lines of business. The collective data and findings gathered by the consultants were recently presented to our board, and the review by our board is continuing. We are not in a point today where we can provide much of the way of specific details on our plans. For the protection of our business, our employees, and our customers, it would be premature of us to comment at this time. I can say that the actions that we will take will be driven by a goal of improving return on invested capital and improving our EBITDA margins and building shareholder value. Moving to our outlook on slide 11 and 12, I'll briefly touch on some of these.

Within tech services, we expect to extend our momentum in capturing waste streams from our top verticals such as manufacturing and chemicals. Our plan is to expand in markets where we are getting good penetration, including retail and mining. In addition, we're making progress on our new El Dorado incinerator, where we officially broke ground in September. Startup is still expected to be in late 2016, with commercial operation in early 2017. Within industrial and field, cross-selling our services to Safety-Kleen customers will continue to be a primary focus. Within the oil sands, we believe that some new pipelines planned to come online in 2017 should improve oil sands customer spending in the second half of 2015. Within our oil recycling and re-refining segment, we're going to be laser-focused on lowering our transportation and PFO costs, particularly in light of the tremendous pricing pressure in the base oil market.

Turning to slide 12, on the Safety-Kleen branch side, we're in the process of opening a number of new branches along with colocating with existing field service locations. We also have a number of branch optimization programs underway to further improve margins in that business. However, our top priority here remains lowering our PFO costs. For lodging, we're pursuing opportunities to capitalize on the upcoming busiest winter season to really maximize our occupancy at our fixed locations. We're also exploring opportunities created by the new oil and gas pipelines to either deploy some of our underutilized mobile camp assets or to build facilities for our energy customers. With oil and gas, we're continuing to pursue our strategy of U.S. expansion on the solids control and production services side. Our primary focus is getting our existing equipment out in the field working.

While crude price may limit companies' oil exploration budgets in the near term, we remain heavily involved in the gas side of the market, which appears to be a bit more promising. We continue to see a number of emerging opportunities around potential gas exploration and drilling in Northern BC. Jim will be providing you with our revised 2014 guidance. Clearly, we are countering some near-term headwinds in some of our businesses, which is why we are reducing our 2014 guidance. Looking at slide 13, base oil pricing continues to drop to levels not seen in many years in the face of two significant changes: a dislocation from crude oil pricing and certainly now with the lower crude oil pricing hitting us. I've been in this business for over 40 years, and I've never seen such a dramatic change in such a short time frame.

Our team has worked tirelessly to counter these unprecedented events. I'm proud of their efforts that they have put forth. The current environment gives us an opportunity to really reset our PFO pricing structure with our customers as they recognize the current market conditions. That said, we head into 2015 knowing that we'll need to continue to drive down costs across our business. I'm challenging our organization to reduce our costs by more than $75 million this year. We have many initiatives underway, and I would expect to see our margins continue to improve next year, even with the headwinds we face. Our technical services business is as strong as ever, and the containerized waste volumes we're gathering through Safety-Kleen are driving our margin improvements. In fact, we believe we'll be timing the market just right when our new incinerator comes online.

I'm confident that the Safety-Kleen branch business has a lot of margin upside and organic growth opportunities going forward. Cross-selling with field services is working, and we're on the front edge of that success. Our industrial service business is seeing a strong pipeline of activity in the U.S., particularly in the Gulf region, and next year should really see heavy turnaround business. Due to the low cost of natural gas, the chemical and petrochemical industries in that region are expected to steadily expand next year and beyond. So with that, let me turn it over to Jim for his financial review. Jim.

Jim Rutledge (Vice Chairman, President, and CFO)

Thank you, Alan, and good morning, everyone. To start here on slide 15, here's a quick snapshot of how our verticals performed in Q3. Due to a reclassification of a number of accounts, now that Safety-Kleen has been operating on our platform for several quarters, automotive now represents the company's largest vertical, accounting for 18% of our revenue in Q3. This vertical was up slightly from a year ago as we continued to cross-sell disposal and other services to Safety-Kleen's legacy customers. Refineries and oil sands customers accounted for 12% of Q3 revenue. This vertical was down about 3% from a year ago as increased activity in the U.S. and expansion at refinery customers was offset by lower oil sands activity. General manufacturing was 11% of total revenue, with stable base business and higher customer spending helping to drive 8% growth compared with a year ago.

Customers are focused on on-site cleaning activities. The chemical vertical represented 11% of Q3 revenue and was up 4% from a year ago. This reflects healthy base demand driven by strong chemical exports resulting from the low cost of natural gas, which serves as both fuel and raw material for petrochemicals. The third quarter was also helped by a number of remediation projects. Oil and gas production accounted for 7% of revenue and was down 21% from a year ago as we experienced sizable declines in our drill camps, drill support, and production services. Looking at our smaller verticals, one where we continue to experience great success is utilities, where we generated double-digit sales growth for the third straight quarter. With winter approaching, we saw higher project spending by utilities in the quarter.

On slide 16, here's how our Q3 direct revenue breaks out among our six segments, ranging from lodging at 4%-37%. This revenue split was not surprising as it is the seasonally strongest quarter for our environmental business, and some of our other businesses were hurt by the macroeconomic trends Alan described. Turning to slide 17 and the income statement, we reported Q3 revenue of $851.5 million, which is down more than $50 million from a year ago. Growth that we achieved in certain business lines was not enough to offset the foreign currency translation impact, oil sands, and the oil and gas slowdown, and weaker base oil pricing. Gross profit for the third quarter was $253.1 million, or a gross margin of 29.7%, which represents a 100 basis point improvement over the 28.7% we reported in the same quarter last year.

The margin improvement reflects our success in significantly reducing our cost structure compared with a year ago. SG&A for the quarter was 11.7% of revenue and was below $100 million for the first time since we acquired Safety-Kleen. The 90 basis point improvement from a year ago is due to Safety-Kleen cost synergies, our expense reduction plan, and lower incentive compensation. Excluding severance and integration costs of nearly $1.5 million recorded in SG&A in Q3 2014, our SG&A percentage was 11.5%. For the full year, which obviously includes the previous quarters, we are still projecting our SG&A percentage to be around 13%. Depreciation and amortization was essentially flat with a year ago at $70 million. We remain on track for full-year D&A of approximately $275 million.

This morning, we announced that we are taking a pre-tax non-cash goodwill impairment charge of $123.4 million related to our oil re-refining and recycling segment. We are taking the non-cash charge based on the significant recent price declines for both our base and blended oil products. While the team has made tremendous headway in lowering our operational costs and our input costs through better PFO pricing, we are at a point where the goodwill on our balance sheet for the oil re-refining and recycling reporting unit needed to be written down based on accounting rules. Excluding the impairment, adjusted income from operations increased to $80.7 million, or 9.5% of revenues, compared with 8.1% of revenues in Q3 a year ago. That 140 basis point improvement reflects the success of our cost and efficiency initiatives in both operating cost of revenues and SG&A.

Our adjusted EBITDA was $153.4 million, or a margin of 18%, as Alan highlighted. If you add back the $1.8 million of severance and integration costs, we would have met our adjusted EBITDA guidance for the quarter despite the revenue shortfall. The effective tax rate for Q3 was 55.6% compared with 34.7% in Q3 a year ago. With respect to our tax provision in Q3, we recorded a $9.2 million charge to adjust a deferred tax asset acquired as part of the Safety-Kleen purchase price allocation related to pre-acquisition goodwill. The effective tax rate for Q3, excluding this adjustment and the effect of the $123.4 million impairment charge, was 40.7% compared with the 34.7% in Q3 a year ago. This effective tax rate remains above our historical levels due to the reduced profits in Canada, which is subject to lower tax rates than the U.S.

We expect our effective tax rate in Q4 to be approximately 40% given this mix of relative profitability. On an EPS basis, excluding the impairment, we would have reported an EPS of $0.45 per share. Turning to slide 8, our balance sheet remains strong. Cash and marketable securities as of September 30th total $258 million, down from $278.6 million at the end of Q2. We generated positive cash flow in the quarter and invested $37.6 million in share repurchases during the quarter. Year to date, we have purchased nearly 923,000 shares at a total cost of $53.8 million. Total accounts receivable were up slightly since the end of Q2. DSO increased by two days during Q3 to 70 days.

The changes we have made to enhance the Safety-Kleen billing process have added some days to our Safety-Kleen invoicing, but will ultimately result in more accurate billing going forward while capturing revenue opportunities. As I said last quarter, we expect DSO will remain in the mid to high 60-day range for the near term. Environmental liabilities at September 30th were $213 million, down approximately $6.6 million from the beginning of the year. The decrease is primarily due to environmental expenditures in excess of accretion by over $4 million. The rest of the decrease is due to environmental credits achieved since the beginning of the year and foreign exchange translation. CapEx was $60.7 million, down from $66.2 million in Q3 of last year and $63.2 million in Q2 of this year. For 2014, we remain on track for our CapEx spending target of approximately $250 million.

Our cash flow from operations this quarter was lighter than we expected at $81.1 million, which is down from a year ago. I should point out that our cash flow performance this quarter reflects an increase in our receivables and inventory working capital. For the full year 2014, we now expect our cash flow from operations to be in the $300 million range. Moving to guidance on slide 19, we are updating our full year 2014 guidance. As a result of our year-to-date performance, recent headwinds, and current market outlook, we now expect revenues in the range of $3.40 billion-$3.42 billion. We expect adjusted EBITDA for the full year to be in the range of $510 million-$520 million, which is down from our previous guidance. With that, Operator, could you please open the call up for questions?

Operator (participant)

Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Al Kaschalk with Wedbush. Please go ahead with your question.

Al Kaschalk (SVP)

Good morning, guys.

Jim Rutledge (Vice Chairman, President, and CFO)

Good morning.

Alan S. McKim (Chairman and CEO)

Good morning.

Al Kaschalk (SVP)

Excellent job on the margin side. However, I want to focus on visibility here, in particular Q4 and in 2015. Perhaps I think if you look at the math right, you're cutting revenue about $150 million and EBITDA around $30 million. So what changed from the maybe I don't know if it's mid-September timeframe to where you're at today, in particular on projects? I guess this is highly related to the oil sands area. Or if not, could you share some color on that?

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. If you want, Alan, I can just start.

Alan S. McKim (Chairman and CEO)

Sure.

Jim Rutledge (Vice Chairman, President, and CFO)

First of all, the $50 million shortfall in revenues in Q3 impacts the full-year guidance clearly. And also, we had indicated at the last call that we expected to be at the low end of our $3.5 billion-$3.6 billion in revenue. So it really is the performance year-to-date and the expectation for Q4 that's driving it down. But I think it is the factors that we talked about. I mean, we've seen some horrific price declines in base oil, as you know. During the quarter, we saw $0.25, and then we saw a recent announcement that we believe is $0.25, and we're getting updated on how that'll flow through. But these are big declines in base oil pricing that affect our re-refined oil and recycling business.

Clearly, the oil sands we're looking at, and we see the reduced activity, and that's having an impact, and that's affecting both our industrial services business and our lodging business up there. And then in the oil and gas segment, particularly in the seismic part of the business on the land exploration that's going on, the reduction in projects has been huge because spending is being cut back. Our outlook for the longer term in the oil sands is clearly, as it is with many of the players up there, positive. But the logistics up there, certainly the price affects it a little bit, although after the differential, the prices haven't changed dramatically up in the oil sands.

But it still is all about logistics and getting a lot of that out of there, which is being a lot of the oil transported out of there, which is being worked on. So our long-term outlook is good, but certainly there's some short-term impacts. So I don't know, Alan, if you wanted to add anything.

Alan S. McKim (Chairman and CEO)

No, I think that was great.

Al Kaschalk (SVP)

Okay. All right. So, were there any specifics, not that you want to provide specific customer reductions, but did you see projects get canceled now that oil prices hit these levels that would come out of the oil sands business?

Alan S. McKim (Chairman and CEO)

Yeah. We did see projects get canceled. We literally were on site on a couple of projects, one in Alaska, and those projects were canceled. We saw funding scale back several million dollars on another project. So this is somewhat of a moving target for us, Al, in some parts of our business here because of really the decline in oil and what we're all reading about, even in the journal this morning, a very important article there. So I think we're being conservative, and we're kind of up to date, at least in regard to what we're hearing and seeing out there.

Al Kaschalk (SVP)

My follow-up, although I would have thought CapEx would come down from that, but my follow-up is on the strategic review. I realize you're not going to share anything, but if the actions are completed, when should we look for something to come from the company or from the board on this decision time, whether it's?

Alan S. McKim (Chairman and CEO)

We didn't want to set, we really didn't want to set an expectation or a timeframe on that, Al. I mean, I think we made it clear in the beginning of this year of what we were going to do, and we've completed that. We've accomplished that, and we're spending quite a bit of time, thoughtful time in regard to the short-term headwinds that the company is facing, but also the long-term strategy for the business. And we will communicate that in a way that will be clear, I think, to everybody involved as best we can. But as you can imagine, we are dealing with important customers that we cross-sell to. We have a lot of employees that we share across the organization.

And so this is going to be as we continue to analyze and make decisions, it's a fully integrated company, and it's not an easy decision for us as we move down the path here. I would say, Al, just a comment on your CapEx comment there. Last year was about $280 million. This year at $250 million. That includes the incinerator project too. So we have significantly reduced capital spending in light of the fact that we've got a big project going on here. And we continued on our growth cap. We continue to look very closely at that, meeting regularly, reviewing that and managing that closely.

Al Kaschalk (SVP)

Very good. Thanks a lot, Alan.

Alan S. McKim (Chairman and CEO)

Yep.

Jim Rutledge (Vice Chairman, President, and CFO)

Thank you.

Alan S. McKim (Chairman and CEO)

Thank you. Our next question is from the line of Jim Giannakouros with Oppenheimer. Please go ahead with your question.

Jim Giannakouros (Managing Director and Senior Analyst)

Good morning, Alan. Jim.

Alan S. McKim (Chairman and CEO)

Good morning.

Jim Giannakouros (Managing Director and Senior Analyst)

Good morning. Incineration utilization was down versus 2Q, and landfill volumes, I believe, are also down. How are you able to maintain such high margins in tech services? Are there mixed benefits you could speak to? Are there changes to the cost accounting between segments that are affecting that comparison to last year?

Jim Rutledge (Vice Chairman, President, and CFO)

No, there's no changes with respect to that. Clearly, what is driving a lot of the high margin in both areas is we're getting a lot more volumes now that are being processed through the Safety-Kleen organization. A lot of drum volumes are up. And you see the benefit of both of that showing up in the margins of Tech Services and of Safety-Kleen Environmental. So you're getting a better operating leverage that you're getting. Now, one of the things that I would also point out is that our deferred revenue went up during the quarter because there was the backlog from the two plants doing an advanced scheduled shutdown. So we are able to recognize some revenues for the waste streams getting into the TSDF, but not all the way through to the incinerator.

But we do have a nice backlog as evidenced by the deferred revenue going up. So that should help us going forward for the rest of the year. There is a little bit of a mix, to your point about mix, in the landfill. We had a little bit of better mix. Some of the projects that were off were lower margin. So some of the routine projects that were flowing through, and in fact, the more base business flowing through landfills was higher, as it typically is in the quarter. But projects brought it down, and some of those projects had a lower margin. So there was a mixed impact, but that's more in the landfill than anything. So it's a combination of a few things. Sorry for the long answer on that, but that's basically what's driving that.

Jim Giannakouros (Managing Director and Senior Analyst)

Got it. Okay. And just one follow-up, if I may. We're used to getting a preliminary next-year guide from you guys. I don't know if you held off on that just because of where you are in the strategic review. But any comments on a consolidated or on a per-segment basis as far as what you see trends indicating for either top line or EBITDA would be extremely helpful. Thanks.

Alan S. McKim (Chairman and CEO)

Sure. We're in the budgeting phase both at the sales and operating level. So we're going through that effort, and we'll be presenting that budget to our board in the middle of December. Jim, do you want to talk a little bit about some of the thoughts on segment or?

Jim Rutledge (Vice Chairman, President, and CFO)

Absolutely. Yeah. I think if you look across our businesses, clearly on the environmental side, what we've talked about in terms of our normal growth, which follows industrial production and GDP, we expect things to be fine there. That would go across both technical services, obviously, field service within industrial and field services, and also, I would say, Safety-Kleen Environmental as well. So we have some nice growth going on in those areas. But clearly, a lot of the uncertainty in where we're analyzing as part of our bottom-up budget process, it's very much a bottom-up process looking across customers and rolling all that up. We hope to have better visibility on where oil and gas will be across seismic, surface rentals, solids control, and production services. And then also on the oil sands. We're taking a very good look by customer what the expectation is for the year.

And with our sales force and operating management, we should have some pretty good estimates. And then also in lodging, clearly, that's all in Western Canada for us. So that supports the oil sands as well as drill camps and the drilling activity and even some pipeline activity. So we're looking at all that to see how it would be in. So really, we were thinking at this point, even absent the strategic review, there are some things that we really want to go through the bottom-up and finish that up rather than giving a preliminary, as we've done in the past, which was top-down. And with all these macroeconomic factors going on, and I didn't even mention Base oil pricing, we think we know that right now. We can estimate some things around that. But still, will there be any more price decreases?

We want to make sure it doesn't occur before we start putting out numbers for next year. So I don't know. Does that help at all, Alan?

Alan S. McKim (Chairman and CEO)

I just think one other thing is just we anticipate the industrial business to be stronger next year.

Jim Rutledge (Vice Chairman, President, and CFO)

Oh, right.

Alan S. McKim (Chairman and CEO)

As you look at the last three or four years on turnaround.

Jim Rutledge (Vice Chairman, President, and CFO)

Turnarounds, yeah.

Alan S. McKim (Chairman and CEO)

This year was a relatively soft market for turnaround services, and we're booked very heavy for next year. So I would expect our industrial business and field services to be much better than this year here.

Jim Rutledge (Vice Chairman, President, and CFO)

I agree with that.

Alan S. McKim (Chairman and CEO)

Yep.

Jim Rutledge (Vice Chairman, President, and CFO)

And then you always have emergency response that could be on top of that, as you know.

Alan S. McKim (Chairman and CEO)

Yeah. The currency is the other issue that we haven't talked about. I mean, the Canadian dollar two years ago at par, and now we're at $0.86-$0.87. That has had probably the greatest revenue impact. We do close to $1 billion in Canada. So it's had a big impact on our revenues across our entire business up there, so.

Jim Rutledge (Vice Chairman, President, and CFO)

Absolutely.

Jim Giannakouros (Managing Director and Senior Analyst)

That's all very helpful. Thank you.

Alan S. McKim (Chairman and CEO)

All right. Thanks, Jim.

Operator (participant)

Thank you. As a reminder, in the interest of time and to allow as many as possible to ask questions, we ask that you please limit yourself to one question and one follow-up. Our next question is from the line of David Manthey with Robert W. Baird. Please go ahead with your question.

David Manthey (Senior Research Analyst)

Good morning. Thank you.

Jim Rutledge (Vice Chairman, President, and CFO)

Good morning.

David Manthey (Senior Research Analyst)

First off, given the TS maintenance shutdowns that you pulled into the third quarter, it would appear the results could have actually been better this quarter without that. I'm just thinking about the normal seasonal cadence as you look third quarter to fourth quarter. Because you pulled that forward, and it won't be in the fourth quarter now, plus you noted you have somewhat of a stockpile of waste that you'll be able to run through, should we expect that the normal seasonal third quarter to fourth quarter pattern, you may be able to offset that almost completely based on how things are setting up here?

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. Dave, I would agree with what you're saying there because you even look at the deferred revenue. I mean, at the beginning of the year, it was like $55 million. We're at $64 million now, almost. Certainly, that represents revenue that'll come through as we process waste, that difference there. So yeah, I think we'll see several million dollars of revenue and profit coming through that could offset that normal seasonal slowdown that you see as we go into the winter.

David Manthey (Senior Research Analyst)

Yeah. Okay. And then I guess the logical conclusion would also be with utilization being higher than in the fourth quarter, your adjusted EBITDA margins, they could actually be greater sequentially just because of the assumed higher utilization in the fourth quarter versus the third where you had the shutdowns.

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. We went through that. I mean, obviously, there are some parts of the business that are like in landfill and other parts that are not affected like the incinerator is. And typically, you do see a little drop-off in landfill and other areas of the environmental business, including SK Environmental, when you see the driving season. Seasonally, you see less oil changes and things like that that'll affect the waste coming out of a lot of those shops in fourth quarter. So I would be cautious with that one, and that's why we're cautious with the guidance that we put out.

David Manthey (Senior Research Analyst)

Okay. And then just on the $75 million cost cutting, if you could tell us what you think the run rate of that was in the third quarter and then what you expect for the fourth quarter? I assume you expect to achieve the full run rate at some point in the first half of next year.

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. We had indicated that we were going to be at about $40 million, and that's turning out to be true of what we captured in the year. It was part of a total $75 million program. We're at that run rate now on an annual basis. We expect next year to achieve the full $75 million, but obviously, only the incremental part over the $40+ million that is in this year will show up as a variance. Does that make sense?

David Manthey (Senior Research Analyst)

Yeah. I guess to follow that through, if you expect to get 40 this year, could you tell us what you've already achieved through the third quarter total?

Jim Rutledge (Vice Chairman, President, and CFO)

Oh, yeah. Well, the headcount was about a third of the total program. And that we had achieved most of that by the end of April. We had some headcount reductions in our business. Then a lot of the operational efficiencies, whether they be reducing subcontractors, office consolidation, equipment rentals, and maintenance internalization, all those we've been going through the year with. I would say that by the end of the third quarter, we were about, I would say, more than three quarters of the way through what needed to be done. So there's just a little bit left in Q4 to do to get to that total run rate of $75 million. We're pretty close. I would say we might be just $20 million, maybe shy of that total run rate.

David Manthey (Senior Research Analyst)

Okay. That's great.

Jim Rutledge (Vice Chairman, President, and CFO)

That's an estimate. That's a high-level estimate. Yeah.

David Manthey (Senior Research Analyst)

Yeah. Okay. Great. Thank you very much.

Jim Rutledge (Vice Chairman, President, and CFO)

Thank you, Dave.

Operator (participant)

Thank you. Our next question is from the line of Michael Hoffman with Stifel. Please proceed with your question.

Michael Hoffman (Managing Director)

Hi. Thank you very much.

Alan S. McKim (Chairman and CEO)

Hi, Michael.

Michael Hoffman (Managing Director)

How you doing, Jim? Jim, Alan. Alan, why can't you take pay for oil down faster than you are?

Alan S. McKim (Chairman and CEO)

I think there is a historical index and pricing strategy that Safety-Kleen employed that is no longer valid in this market. It is really in our control and our responsibility to affect that change. That is my number one priority.

Michael Hoffman (Managing Director)

The answer is you will take it down faster than because you're going to break up that historical structure.

Alan S. McKim (Chairman and CEO)

Yep. We will. I think, given the team, some of the tools that they need to look at not only the PFO cost, but also the total delivered cost to the facilities that we have. And those are tools that they never had before. And I think we will change our incentive programs. We will change our customer indexes. And we will do everything we need to do to reduce that cost. And that is a big part of the $75 million of additional cost savings that you'll see come through next year.

Michael Hoffman (Managing Director)

Okay. So you've just answered my other question. So we have $75 million in 2014. We're going to get another $75 million in 2015.

Alan S. McKim (Chairman and CEO)

Yeah. As you know, we always have a number of operational excellence programs to deal with not only the standard increasing costs that we get from wages and healthcare costs and other costs, but we know for us to continue to improve our margin even in light of the market's headwinds that we've been talking about here this morning. We need to continue to drive the cost out of our business. We can do better. We're only just completing our second year. Safety-Kleen has got a powerful franchise, a wonderful network, a great opportunity for us to leverage those assets and to work across their organization. And I think being a very strong sales and marketing organization now with a company like ours, which is a very strong operationally based company, I feel very, very excited about the Safety-Kleen business moving forward here.

There's some real opportunities for some cost savings there.

Michael Hoffman (Managing Director)

Okay. And then are you prepared to shrink this company to grow it?

Alan S. McKim (Chairman and CEO)

Yes. Yes. And that certainly is part of the thought process that I think between the management and the board. We've had a strategy of five-year strategic plan to grow our business to $5 billion and beyond and really to try to leverage our infrastructure and leverage our systems and our processes to get to that 20% EBITDA margin and better. I don't think we're going to change that. But certainly, how do we get there? Are we in the right lines of business? And should we change that long-term goal is all really in our thinking. And we want to communicate that to people as openly and as transparent as we can, but certainly do it with the board's support.

Michael Hoffman (Managing Director)

Okay. Last one for me. When does capital spending all in growth maintenance get to 180-200 as a range?

Alan S. McKim (Chairman and CEO)

It's a great question. We continue to see great opportunities to grow our business. And with that, as you know, some of our lines of business are very capital intensive. And we've really constrained the growth in some of our business, to be honest. And that's one of the issues that we're dealing with right now is how do we continue to provide the capital necessary in some of these capital-intensive parts of our company and at the same time recognize that we need to improve returns and get a better return on our new capital being deployed. So that's a moving target, Michael. And I'm not going to commit to one, but I can just tell you that it is a real focus of ours.

Michael Hoffman (Managing Director)

Okay. Thanks, Alan.

Alan S. McKim (Chairman and CEO)

Yep.

Operator (participant)

Our next question is from the line of Joe Box with KeyBanc Capital Markets. Please proceed with your question.

Joe Box (Director and Senior Equity Research Analyst)

Hey. Good morning, guys.

Jim Rutledge (Vice Chairman, President, and CFO)

Good morning, John.

Joe Box (Director and Senior Equity Research Analyst)

Question for you on the cost front. It seems to me that most of the headcount reduction really came in Q2. So I'm a little bit surprised by the big move in SG&A this quarter, I guess specifically within corporate expense. So I just want to ask how much of this was fixed cost takeout as opposed to maybe some variable expenses like bonus accrual that could eventually come back in time?

Jim Rutledge (Vice Chairman, President, and CFO)

There was, Joe, there was a whole myriad of projects, some 30 projects as part of our cost reduction plan. Some of it, for example, I'll just give you one example during the quarter. Our IT costs, which we have been working on and certainly aren't part of headcount, but they involve other contractors, some hardware, software. That was like $3 million that we experienced the reduction just in that quarter alone. We had some good experience with our healthcare costs coming down a bit. We're on a new program that's more efficient overall. So we saw some reduction there. Some of the other there was some incentive compensation that we had taken down. The headcount, as you point out, has been somewhat level because we took most of that reduction already. But it's a lot of one-off items like that. We also had reduced travel.

We're trying to be more efficient. We use our telepresence more and having our people travel around less just to be more cost-efficient and things like that that we're able to operate at.

Joe Box (Director and Senior Equity Research Analyst)

So I appreciate that, Jim. Can you maybe just give us directionally 50% of it is sticky, whereas 50% of it could come back in time? Just to maybe nail that down a bit.

Jim Rutledge (Vice Chairman, President, and CFO)

Oh, I think I would say that we're probably at about 12%. I would say I feel pretty comfortable between 12% and 12.5% of revenue kind of run rate. I mean, we'll finish up 13% for the full year because we had higher costs in the beginning of the year. But I think we're around that 12%-12.5% of revenue. So that incorporates it. I think that's our rate. I mean, obviously, that would change if there's any decrease in the size of our business or, say, an increase from an acquisition, for example. Either way, that would cause some decreases. But we're good at holding the line on SG&A costs. And the organization is very good with that.

But I think that 12%-12.5%, just looking out in the short term, I think is reasonable. And we'll confirm that all when we do guidance for next year.

Joe Box (Director and Senior Equity Research Analyst)

I appreciate that. Thank you. I certainly appreciate that you guys don't want to share your findings on the strategic review. I'm not going to ask that. I do want to ask some background questions. I guess, first, does the new energy outlook change your view on any of your businesses? Or is it incorporated in that if energy prices are at $80, it suggests this with the business? Then second, with Relational Investors winding down, I'm curious if they had involvement right up to the end of the process or if they stepped away prior to the conclusion.

Alan S. McKim (Chairman and CEO)

I guess in regard to Relational, we don't have any comment whatsoever on what they're doing. It wouldn't be appropriate for us to comment about Relational. I think regarding energy, quite frankly, the real problem that we went through this year was more of the disconnect between how we sell and market our base and blended oil products in conjunction where crude oil was. All of our pricing, for the most part, was based on crude oil on the feed side, on the source of our product side. It's also what's driving all of our costs for our diesel, our gasoline, our fuel surcharges. All the things are driven by that. Over the last three months, there's been a significant change in Gulf Coast No. 2 in crude oil and essentially in our indexes.

So we see real benefits in some parts of our business with lower prices of fuel. Gasoline, we burn 25 million gallons of diesel fuel a year, for example. So we're going to see some real benefits there. Natural gas has been holding relatively firm. And so as we go through the winter months, that's a higher cost for us because of all the facilities, the 100 plants that we run. So we see higher costs there over the winter. But we are looking at all of those different kind of components of energy and how they impact our cost structure as well as impact our top-line revenue growth for parts of our business. And quite frankly, all of that change that's been taking place over the last three or four months is why we're hesitant about giving out some guidance today.

Joe Box (Director and Senior Equity Research Analyst)

Understood. Thank you.

Alan S. McKim (Chairman and CEO)

Okay. Thanks, John.

Operator (participant)

Our next question is from the line of Sean Hannan of Needham & Company. Please bear with your question.

Sean Hannan (Managing Director of Equity Research)

Yes. Good morning. Can you hear me?

Alan S. McKim (Chairman and CEO)

Yes.

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. Good morning, Sean.

Sean Hannan (Managing Director of Equity Research)

Good morning. So I'm sorry if I'm going to beat a little bit of a dead horse here. But if I think about the guidance, it seems like the revenues for the fourth quarter will be pretty flat. Gross margins may be down. SG&A, maybe that's down a bit, but not much if I work toward what I'm understanding of the implied EBITDA expectation. Well, your EBITDA would be down a fair bit quarter-over-quarter. And trying to understand what drives this more in the order of magnitude, you've mentioned a few things. I expect, and there was an earlier question that got to this, that there'd be at least a little bit of an offset in refined oil with some PFO costs coming down. You're probably going to still have your revenues in lodging and oil and gas up a little bit in the quarter, even though disappointing.

I'm just trying to understand exactly what's weighing here and why in that degree of magnitude. Thanks.

Jim Rutledge (Vice Chairman, President, and CFO)

I can start, Sean, by just saying that the areas that I talked about, clearly, as you alluded to, the base oil pricing had tremendous decrease just in recent months. Tremendous amount of decrease. More than the whole year or so. I mean, the base oil pricing is at a four-year low right now where it went to. So that does have an impact on the revenue line as well as dollar for dollar on the EBITDA line. So then you have the cancellation of some of the projects within oil and gas. You have the reduced activity in oil sands. So you have all those things contributing to it. Clearly, our cost savings program continues to help. But what we have seen historically in our environmental business and our overall business is that as you approach the winter months, you see some decline. You see it in the margin.

I mean, Q3 is our strongest quarter of the year. Q4 is our second weakest of the year. So you do go into a quarter where it's best for us to have our outlook be at the lower side of margins given that because winter can be severe. It can start early and all those things that just affect our overall business there. So that's the best that I can really give you. But we've certainly gotten into this pretty detail. Typically, we do see a drop off in margins. Hopefully, we can do better. We're certainly doing a lot to try to. We do that all the time.

Sean Hannan (Managing Director of Equity Research)

Okay. So it's just really typical step down quarter to quarter in terms of mixed impact on margins and that you've got a couple of things in the background that are really just not performing.

Alan S. McKim (Chairman and CEO)

Well, yeah. Just holidays and the way that the holidays hit us in November, December as well has an impact on some parts of our business more than others.

Sean Hannan (Managing Director of Equity Research)

Okay. Then a quick follow-up here. If you can talk a little bit more about your presence and expectations in gas. I might be wrong. But Alan, I think I sensed a greater emphasis on this versus how you've referenced the market in the past. So can you talk about differentiation of activity related to gas, where and how there might be some sustainable momentum and any progress there if that's the case? Thanks.

Alan S. McKim (Chairman and CEO)

Well, certainly, Canada is doing much stronger for us right now because of gas and because of the expectations of moving gas west. And so we have been picking up new contracts and expanding, particularly in the BC province. But in general, the oil issue is sort of evident by everybody. But the gas side has stayed relatively strong. And if we have another strong winter, cold winter, we continue to think that gas will continue to require the kind of services that we offer.

Sean Hannan (Managing Director of Equity Research)

Gotcha. Okay. Thanks so much.

Alan S. McKim (Chairman and CEO)

Yeah. Thanks, Sean.

Operator (participant)

Our next question is from the line of Charles Redding with BB&T. Please go ahead with your question.

Charles Redding (VP and Equity Product Manager)

Good morning, gentlemen. Thanks for taking my call.

Jim Rutledge (Vice Chairman, President, and CFO)

Good morning to you, guys.

Charles Redding (VP and Equity Product Manager)

Just thinking about occupancy right now with lodging right now at 76%. What portion of the current occupancy do you consider long-term? Really, can you shift that focus more towards short-term oriented occupancy given the pullback in projects?

Jim Rutledge (Vice Chairman, President, and CFO)

Yeah. I'll start this. It's Jim. The bulk of that occupancy that we're reporting is longer term. We have contracts that go out 2-3 years. Clearly, with Ruth Lake, they're shorter term now, to your point, in trying to fill that facility within the current environment, we're doing shorter term. But I would say probably anywhere from maybe two-thirds of the occupancy that we're talking about as a rough estimate of how much is longer term.

Charles Redding (VP and Equity Product Manager)

Okay. Thanks. I guess in thinking about the current outlook for refinery turnarounds, I know you're pretty bullish there for next year. Is that really more due to contracts that are already locked in? Or is that really more a function of higher expected maintenance just given the declining crude that we've seen?

Alan S. McKim (Chairman and CEO)

It's both. And I don't think it's the declining crude necessarily. It's just the way that the schedules are rolling out. And most of those refineries all post their schedules and try to make sure that they have an adequate amount of contractors able to help do their turnaround work. So we've got a number of contracts already signed. And we're planning. And we also see a lot more sort of an ad hoc demand for them as well.

Charles Redding (VP and Equity Product Manager)

Okay. Thank you very much.

Alan S. McKim (Chairman and CEO)

Yep. Thank you, Charles.

Operator (participant)

Thank you. Our next question is from the line of Larry Solow with CJS Securities. Please proceed with your question.

Larry Solow (Managing Director)

Hi. Good morning. Most of my questions have been answered. Just quickly, just on the activity in oil sands, it's been obviously weak for a few quarters. I know the long-term growth projections are obviously very bullish. What do you think it will take? Is it going to take a recovery in the energy markets? Or is it really going to take sort of an improvement in the glut in the supply chain and the transportation chain that's going to improve that? And a follow-on to that, will the more Republican-led House and Senate maybe help to move the Keystone Pipeline forward and be a potential catalyst for that?

Alan S. McKim (Chairman and CEO)

Yeah. I think, Larry, a couple of things to comment. I mean, we are bidding on some nice work up there. There's still a continuation of spending, make no mistake about it. Instead of at that $20 billion range, we're probably at the $15 billion or so range in spending throughout the province up there. So huge amounts of spending going on still. And we're bidding on a lot of work. And we're doing a ton of business up there. We're the largest player, as you know.

Larry Solow (Managing Director)

Absolutely.

Alan S. McKim (Chairman and CEO)

That being said, there is a real frustration in being able to move product. And so the government is working with industry to do everything, including reversing pipelines and putting in new pipelines and really making it a priority because it's important for the country. And we think that as they sort that out, and we think they're going to sort that out, there's a lot behind it. We will continue to have a strong business there. And we are very well positioned in that market, not only for growth but for the ongoing maintenance that's taking place within the oil sands regions.

Larry Solow (Managing Director)

Okay. And then just one other quickly, just on oil services. Over the last couple of years, one of your strategies has been to shift some equipment, obviously, out of Canada into the U.S. With more competition that you've noted in the last couple of quarters in the U.S., falling prices of energy, has that somewhat been hampered? And where do you sort of stand with that? And maybe Canada is not as maybe you don't want to shift as much or can't as you previously thought you would?

Alan S. McKim (Chairman and CEO)

I think one of the strengths of our business model really is the ability to not only cascade assets cross-border but really across businesses. We are repositioning assets, underutilized assets out of Canada into our industrial and field services business. So moving them out of our oil and gas business, moving it out of our oil sands business, and putting them in the other markets. And that's a real strength that we have to be able to cascade our hydrovacs and our vacuum trucks. And we're very strong in that asset management area. And that's a real benefit, I think, that we have in our business.

Larry Solow (Managing Director)

Okay. Great. Thanks, Alan.

Alan S. McKim (Chairman and CEO)

Yep.

Operator (participant)

Thank you. If you'd like to ask a question, you may press star one. We ask that you limit yourself to one question and one follow-up. The next question comes from the line of Barbara Noverini with Morningstar. Please proceed with your question.

Barbara Noverini (Senior Equity Analyst)

Hello. Good morning, everybody.

Jim Rutledge (Vice Chairman, President, and CFO)

Good morning, Barbara.

Barbara Noverini (Senior Equity Analyst)

Just kind of as a follow-up to the last question. So are your efforts on expanding oil services in the U.S. primarily focused on the natural gas areas versus the oil areas? I know that even a couple of years ago, you guys were in the Marcellus and kind of pulled your assets out of there. So where do we stand with that? Is that primarily where your focus lies today, is the natural gas areas?

Alan S. McKim (Chairman and CEO)

Not necessarily. But the drilling rigs, whether they're drilling for gas or oil, the types of services they need and the types of assets that we have to support their needs really can work in both areas, whether it's liquid-rich or gas or oil. So we're really trying to partner with a larger number of producers and a larger number of contractors to be subcontract too. And we've been really pretty successful here now having over 50 packages. And we'd like to get to 60 as our next hurdle. So I would say that it really doesn't matter to us.

Barbara Noverini (Senior Equity Analyst)

Okay. Thanks a lot.

Alan S. McKim (Chairman and CEO)

Yeah. Thank you.

Operator (participant)

Thank you. At this time, I will turn the floor back to management for additional closing comments.

Alan S. McKim (Chairman and CEO)

Well, thank you all for calling and having a call with us today and joining us today. We really appreciate your questions, your comments. We hope to see many of you at some of our upcoming conferences that we're participating in and look forward to updating you on our year-end early next year. Thank you.

Operator (participant)

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.