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Edited Transcript of HCCI earnings conference call or presentation 25-Jul-19 2:30pm GMT

Q2 2019 Heritage-Crystal Clean Inc Earnings Call

ELGIN Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Heritage-Crystal Clean Inc earnings conference call or presentation Thursday, July 25, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian J. Recatto

Heritage-Crystal Clean, Inc - CEO, President & Director

* Mark DeVita

Heritage-Crystal Clean, Inc - CFO

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Conference Call Participants

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* Brian Joseph Butler

Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst

* Kevin Mark Steinke

Barrington Research Associates, Inc., Research Division - MD

* Quinn Thomas Fredrickson

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Heritage-Crystal Clean, Inc. Second Quarter 2019 Earnings Conference Call. Today's call is being recorded. (Operator Instructions).

Some of the comments we will make today are forward-looking. Generally, the words aim, anticipate, believe, could, estimate, expect, intend, may, plan, project, should, will be, will continue, will likely result, would and similar expressions identify forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control.

These forward-looking statements speak as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Please refer to our SEC filings, including our annual report on Form 10-K as well as our earnings release posted on our website for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

Also, please note that certain financial measures we may use on this call, such as earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA are non-GAAP measures.

Please see our website for reconciliations of these non-GAAP financial measures to GAAP. For more information about our company, please visit our website at www.crystal-clean.com.

With us today from the company are the President and Chief Executive Officer, Mr. Brian Recatto; and the Chief Financial Officer, Mr. Mark DeVita.

At this time, I would like to turn the call over to Brian Recatto. Please go ahead, sir.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [2]

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Thank you, and welcome to everyone joining us this morning. I'm thrilled to share with you strong second quarter results that demonstrate the talent and dedication of our team. We reported second quarter record revenue of $105 million, which compares to $100.3 million in the second quarter of 2018. We improved our margins in both segments, and this performance allowed us to report net income of $7.1 million, which is a record for a 12-week quarter. From an earnings per share standpoint, we recorded diluted income per share during the quarter of $0.30 compared to diluted income per share of $0.26 in the second quarter of 2018.

I'll begin discussing our Environmental Service segment performance. From a revenue standpoint, I'm excited that we delivered 8.9% growth in this segment compared to the second quarter of 2018. This level of growth is even more impressive when you consider the unusually large field services project and was part of our second and third quarter results last year. Our second quarter revenue performance represents a second consecutive record for a 12-week quarter. I want to comment on the impact of the investments in organic revenue growth, which we made during 2018. The cost incurred during 2019 associated with the new branches and resources added during 2018 was approximately $2.9 million during the second quarter from which we generated approximately $3.1 million in revenue.

As previously mentioned, our plan for this year is to be more aggressive with the addition of new sales and service resources compared to last year. Our 2019 plan also includes the addition of approximately 5 new branches during 2019.

During the first half of 2019, we added 1 branch. For the full year 2019, we expect new sales and service resources and new branches to collectively add $4.1 million in cost and $4.8 million in revenue.

Through the second quarter of 2019, we incurred approximately $2.1 million in operating cost, while generating approximately $2.7 million in revenue for the resources added this year.

Our Environmental Services operating margin in the second quarter of 2019 was 27%, up from 25.6% in the same quarter a year ago. Better management of our disposal cost helped drive the improvement compared to last year, and we plan to build on this progress into the future. We expect some of the cost improvement to be driven by expanding our internal waste management capabilities, including consolidation at some of our sites of nonhazardous waste generated by our customers.

Moving on to our Oil Business. In the second quarter of fiscal 2019, Oil Business revenues were down $1.1 million or 2.9% compared to the record results we posted in the second quarter of fiscal 2018. The decrease in revenue was driven by a decrease in the selling price of our base oil, partially offset by an increase in the volume of base oil gallons sold.

Our base oil netback decreased by $0.30 per gallon during the second quarter compared to last year but increased $0.23 per gallon compared to the first quarter of 2019. While we improved our discipline and began charging our customers for used oil collection service during the first half of the quarter, during the second half of the quarter we moved back into a pay for oil position. On a weighted average basis, we were still on the slight pay for oil position for the second quarter as a whole. Our average pay for oil increased $0.02 during the second quarter compared to the first quarter of 2019 and decreased $0.12 per gallon compared to the second quarter last year.

I'm happy to report that our re-refinery operated at 109% of base oil capacity during the second quarter. During the quarter we increased base oil production by almost 3.6% compared to the same quarter a year ago, which resulted in record production and helped delivered double-digit operating margin.

Looking forward, base oil prices have been steady early in the third quarter in part due to higher crude oil prices. Used motor oil collection markets continue to be competitive with no noticeable impact from IMO 2020 as of yet. From a re-refinery perspective, we continue to work to improve the reliability of our operation. To support this goal we have enhanced our mechanical integrity programs, utilizing third-party expertise and have also hired a new reliability engineer.

As discussed last quarter, we will continue to improve metallurgy to limit unplanned downtime in the future. In regard to IMO 2020, we continue to believe this initiative will improve both the feedstock and finished product portions of our spread. While we anticipate seeing some of the effects from IMO 2020 prior to the end of 2019, we are not certain as to the exact timing or magnitude of these impacts.

For now, we will continue to work hard to operate the re-refinery efficiently and manage our spreads effectively.

From an Environmental Service segment perspective, we continue to see momentum that we believe will support high single-digit organic growth during 2019, despite tougher comparisons in 2018. We look to supplement our organic growth by closing on additional acquisition opportunities. Also, we expect our operating margin percentage for 2019 -- for the remainder of 2019 will be in the same range as our second quarter figure.

Mark will now walk us through our second quarter financial results in more detail.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [3]

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Thanks, Brian. Beginning with our Environmental Services segment. Second quarter revenues were a 12-week record of $70.2 million compared to $64.4 million in the year ago quarter. The 8.9% increase in the revenue was driven by continued growth in most of our product and service lines with the antifreeze, vacuum and containerized waste businesses being the largest contributors. The majority of growth in these 3 lines of business is due to volume increases. In the parts cleaning business, our growth was primarily price-driven during the quarter. The increase in antifreeze business was primarily due to gains from the acquisitions we made in 2018 and the first quarter of 2019.

Revenue from these acquisitions was approximately $1.5 million during the second quarter. It's important to note that our total Environmental Services revenue growth was 14.7%, if you exclude a $3.2 million from our second quarter 2018 results, which was generated from an unusually large field services project. Excluding the impact of this same project from our second quarter 2018 results, our organic growth during the quarter could have been 11.3%.

Our same branch revenues grew approximately 9% on a year-over-year basis during the second quarter or approximately 13%, excluding the impact of the previously mentioned field services project. Profit before corporate SG&A expense in the Environmental Services segment was $19 million compared to $16.5 million in the year ago quarter. Operating margin came in at 27% or 140 basis points better than last year. The $2.5 million increase in margins was mainly driven by higher revenue along with lower disposal costs partially offset by higher labor and employee benefit costs.

In the Oil Business segment, we produced a record 11.8 million gallons of base oil compared to 11.4 million gallons during the second quarter of fiscal 2018. From the sale standpoint, we sold approximately 10.9 million gallons of base oil during the second quarter of 2019 compared to 10.7 million gallons during the second quarter of 2018.

Profit before corporate SG&A expense in the Oil Business segment decreased $0.8 million in the second quarter as our operating margin percentage fell from a record high 13% in the second quarter last year to 11.2% this year. The decline was mainly driven by the speed drop in base oil pricing and the resulting decrease in the spreads between our feedstock costs and the selling price for base oil.

Our overall corporate SG&A expense, as a percentage of revenue, came in at 11.2% compared to 12.3% from the year ago quarter, mainly driven by higher revenue, lower severance costs and lower share-based compensation expense partially offset by higher bad debt expense. The company's effective income tax rate for the second quarter of fiscal 2019 was 23.1% compared to 26% in the second quarter of fiscal 2018.

The rate difference is principally attributable to windfall tax benefits associated with stock compensations having a greater effect on the tax rate in the second quarter of this year compared to the second quarter of 2018. Second quarter EBITDA was $13.6 million compared to $12.2 million in the year ago quarter. Adjusted EBITDA for the second quarter was a record of $15.9 million compared to $13.9 million in the second quarter of 2018.

As Brian mentioned, income per share on a diluted basis was $0.30 during the second quarter. If you exclude the impact of site closure costs, primarily related to a former FCC Environmental location we acquired back in late 2014, our adjusted income per share on a diluted basis would have been $0.35.

From a balance sheet perspective, cash on hand at the end of the quarter stood at a record $52.2 million. We generated $16.2 million in cash flow from operations during the quarter compared to $12.3 million in the second quarter of 2018. Total debt remained steady at $29 million year-over-year.

We continue to work on identifying opportunities to deploy our excess cash, focusing on potential acquisition targets and organic growth initiatives we feel will improve our business and help drive value for our shareholders.

In summary, we're very pleased with the hard work of the Crystal Clean team in delivering strong second quarter results, and we remain focused on executing our strategy of growth and profitability for the remainder of 2019.

Thank you for joining us today. I will now turn the call over to the operator to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question or comment comes from Quinn Fredrickson from Baird.

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Quinn Thomas Fredrickson, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [2]

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So I think you mentioned segment margins in ES for the rest of the year being pretty steady with 2Q. Curious how you guys are thinking about in the back half of the year for the Oil Business, the segment margins there?

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [3]

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For the Oil Business, we're probably thinking about the same direction that we gave you at this time last quarter, which is high single digits. We obviously have the potential to over perform and everything really depends on spreads and how we manage that in the near term here. But that's what we're targeting, assuming we get decent production from our re-refinery, I don't know that we can always expect the record performance we had in 2Q, but that's where we see it at this point.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [4]

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Yes, I would agree with that.

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Quinn Thomas Fredrickson, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [5]

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Got you. And then you guys talked about not yet seeing the benefits from IMO 2020. But just curious, has there been an uptick in awareness from other collectors that you're perceiving at this point? Or how would you kind of characterize awareness in the market, both from collectors and customers at this point?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [6]

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Well, there's no doubt that the people are aware of it because of the impact of pricing relative to No. 6. I mean we fully expect -- as you look at futures that No. 6 value will go down by the end of the year. There's certainly some angst among the collectors that are not affiliated with the re-refinery. We've yet to see it because it's not going to become an impact to the field until January, but there is certainly angst over it. We haven't seen the softening of the used motor oil market that we thought we'd see, but we fully expect it to develop over the back half of the year.

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Operator [7]

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Our next question or comment comes from the line of Kevin Steinke with Barrington Research.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [8]

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So I was curious about following-up on the ES operating margin. You cited better management of disposal cost as a driver there. Just wondering about if you could elaborate on that a little bit more. And what the opportunity is for that going forward to continue helping the ES margin?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [9]

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Yes, Kevin. From an operating standpoint, we've got to split the responsibility up amongst our product managers that really know each of these service lines, and they're responsible for helping us manage in-disposal costs. And obviously, we've worked hard to internalize as much as the waste as we can. You've heard on our conference calls that we're developing some of our in -- our own in-house waste water treatment capabilities, the ability to add some value to these waste streams. And that's really the initiative that we focused on, also better logistics cost.

We've upgraded our transportation team significantly over the past couple of years to enhance their ability to move this waste through our branches and hubs at a cheaper cost structure. So I think a little bit of internalization, better management of some of our hazardous waste vendors and logistics are the focus items for us that help us maintain our margins. But we want to continue to invest organically. We're going to continue to add resources as the best use of our money today. So that will obviously put a little bit pressure on margins. On a flip side, we've got to get it back by working hard on the operating side. We like the organic openings of branches and adding people.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [10]

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Okay. Got it. And I thought it was interesting that you expect ES margin to remain at that similar level the second quarter, even as it sounds like the new branch openings in the second half of '19 will be higher than the first half. I believe you said 1 branch was opened in the first half and you plan 5 for the year. So I guess, we should expect 4 in the second half, but you'll be able to offset cost pressure from those openings with the other initiatives.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [11]

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Yes. Just to understand as is in past years, most of our branch additions are typically in the latter half or the fourth quarter. It takes time to get the leases done, get it organized, get the people hired. But we've also added a lot of branch resources -- same branch resources, which increases our cost. Now that's important, an important initiative for us it gives us the opportunities at our stable branches to grow revenue organically as well. So most of the additions of the new branches will happen late in the year, which is why we're confident that we can maintain margins, absent any issues in the field.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [12]

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Okay. Great. And so obviously, really strong operating performance utilization at the re-refinery. Anything we should be thinking of -- thinking about for the second half that might cause lower utilization? I mean in terms of planned shutdowns or anything else that you anticipate in the second half?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [13]

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No. No out of the ordinary planned shutdown of the plant. We're not doing any large capital projects at the back half of the year. We have our normal turnarounds that are upcoming mainly for just routine maintenance. So we're more of the same in Q3 and we feel pretty good about it. I mean obviously, you have seasonal softness that begins to happen at the base oil market late fall but we're still seeing strong demand today, solid base oil pricing. So feel pretty good near term, plant's running great.

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Kevin Mark Steinke, Barrington Research Associates, Inc., Research Division - MD [14]

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Okay. And are you -- how far along are you with the various upgrades that you are making in terms of metallurgy or any other mechanical or other upgrades that you wanted to complete in the re-refinery?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [15]

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We have another round of upgrades that we'll be making at our large fall turnaround, which is a scheduled turnaround. That'll be the next phase of our improvement. What We're working on now is more system work to make sure that our mechanical integrity program is as good as exists in the industry, and we brought in some help as I commented in our prepared remarks to make sure that we build the systems, and we've added a reliability engineer to help on rotate equipment and of mechanical integrity. So just more of the same.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [16]

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Yes. But to reemphasize what Brian said in his earlier comment a minute ago. We have this planned outage that we have for Q4 where we were going to do some of this work. We're not planning anything anywhere near as long the planned outage of last year's Q4, I just want to make sure that, that's clear because that one was nearly 20 days of downtime. So this -- well we usually have one a year, usually around end of Q3 beginning of Q4 that is longer than 3- to 5-day ones that are typical in the other periods or the other times of the year. This isn't going to be one of those, at least not scheduled to be one of those 20-day type things.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [17]

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Correct.

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Operator [18]

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(Operator Instructions) Our next question or comment comes from the line of Brian Butler from Stifel.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [19]

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Just first on the Environmental Service piece. How much of the service or that field service project was in second quarter or -- I mean third quarter '18. So how much should we see -- how much of a headwind is that going next -- this quarter?

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [20]

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It should be about $2 million. And I think it was $1.9 million technically in Q3 of last year. So the lion share of it was -- I think we've said $3.5 million in our prepared remarks. The lion share of it was Q2 last year and then it was ramping down in Q3.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [21]

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Okay. And then when you think about back -- the back end weighting of the branch additions. When you think about going into 2020, is that going to be another headwind to margins for at least the first half, if not the full year, for 2020? Is that the right way to think about it? And what kind of headwind is that? Is that another 50 to 100 basis points?

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [22]

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I don't think it's that big a headwind. When you think about -- unless we decide that we're going to ramp-up the pace more than what we've stated, you're talking about these additions being on smaller and -- smaller additions overall versus larger and larger base number branches. So we don't anticipate at this point that there'd be anything more than our regular seasonality. We always know that Q1 is typically 200 to 300 basis points potentially lower. But that's -- could, I don't know, 50 basis points or less be -- from maybe -- from new additions, possibly. But it really won't be driving much margin erosion overall.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [23]

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And Brian, some of those new locations can come from acquisitions as well. We've got a pretty robust pipeline of smaller deals. And obviously, we look at them as opportunities to expand our footprint.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [24]

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Right. But I guess from a growth perspective when you look at least kind of the next 12 to 18 months that, that expansion, that geographic expansion in the branch additions is still somewhat of a limiter of margins really expand into what they can be, right? And until that starts to slow down, margins kind of where they are, is a reasonable place to be, I guess, is another way to look at it.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [25]

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Yes. We -- at this pace we probably should start to see maybe it's not 12 months, maybe it's 18, 24 months, to start to see actually still some incremental expansion, but to get to that 30% or even low 30s that we talk about, that we know, based on our mature branches that this segment is capable of [printing] that, that certainly is not going to be achieved here in the next 18 months.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [26]

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But a good use of our capital -- I mean absent any acquisitions. We will continue to invest in organic growth, and yes it'll have a marginal impact on percentages.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [27]

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Okay. And then on the site closure costs you had this quarter, is there any of those that roll into third quarter '19?

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [28]

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For that 1 site, it'd be very little on that. We do have other sites. I'll be honest, this is probably the largest site or one of the largest sites that we acquired in that acquisition you remember from -- almost 5 years ago now. And probably the most complicated, and we're running most of the other sites. And this is one that we never even operated because it has some issues. So we're just happy to put this chapter behind us. Will we have site closure cost occasionally from time to time? Yes, but they won't typically be this magnitude.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [29]

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And Brian, we expect to recover our cash when we sell the property.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [30]

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And we'll call that out assuming there's -- if we get what we want for it. There might be a material gain. So we'll -- like we have in -- I don't know if you remember, we sold the property in Southern Florida a couple of years ago. And I think we had I don't know $3-plus million gain on that one. So -- and we called that out.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [31]

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Okay. And then on Oil Business, just the spread trend definitely improved first quarter to -- or first quarter going in the second quarter. What's it look like I guess in the early part of third quarter here? Is it still -- I mean it sounds like pay for -- you're still in pay for oil environment, but has that on the pricing side improved?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [32]

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We're not expecting much of a spread change in Q3. And I think you could've picked that up from our prepared remarks. I mean 20% -- $0.20 spread improvement quarter-over-quarter. We expect it to be relatively flat in Q3.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [33]

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Okay. And then just a last one, on the scheduled downtime, what -- are those in third quarter or in the fourth quarter for your scheduled turnarounds?

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [34]

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Yes. This short shutdown in Q3. 5-day shutdown, which is typical for us.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [35]

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And then nothing in the fourth quarter?

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [36]

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No. And then the longer one that's like the more closer to 10 days one. But that -- those are -- again, that would be the plan as opposed to last Q4. Remember we had have something like a 20-day or around there.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [37]

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We did a major capital construction project last year, we're not doing it this year.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [38]

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Yes. We're lining our [BDUs] to some other things we talked about. So we don't have any of those big projects. The project within the projects are the ones Brian mentioned part of the beefing up our metallurgy and mechanical integrity initiatives that are ongoing. And these are ones that you can -- if you do it right you're planning well, you have the systems that Brian mentioned in his remarks that we've taken the strides to put in place. You should be able to do it in unison with some of this routine work.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [39]

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Okay. But in the second quarter, you didn't have any down -- any turnarounds or downtime, so that 109...

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [40]

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No. We had a -- some downtime in Q2.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [41]

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Yes and...

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [42]

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Normal routine maintenance. Similar to what we're going to have in Q3.

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Mark DeVita, Heritage-Crystal Clean, Inc - CFO [43]

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If you look going forward, and we talked about this in Q4 last year, unfortunately we had unplanned outage in Q1, which we talked about previously. But if we can show the consistency here, there's a good chance just like we said that 9 months-or-so ago that we'll probably re-rate the maximum for the plants as far as maximum output on a base oil basis.

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Brian J. Recatto, Heritage-Crystal Clean, Inc - CEO, President & Director [44]

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And in a normal year, absent any mechanical issues our goal is for 25 to 35 days of planned maintenance downtime. And that's -- still our consistent thoughts.

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Operator [45]

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I'm showing no additional questions in the queue at this time. Ladies and gentlemen, that concludes today's presentation. I would now like to thank you for your participation. You may now disconnect. Everyone, have a wonderful day.