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Executives

Robin Cohan - VP, Controller

Gary Enzor - CEO

Joe Troy - CFO

Analysts

Kevin Sterling - BB&T Capital Markets

Ken Hoexter - Merrill Lynch

Tom Wadewitz - JPMorgan

Ryan Cieslak - KeyBanc Capital Markets

Connor Hustava - Stephens

John Larkin - Stifel Nicolaus

Quality Distribution, Inc. (QLTY) Q2 2013 Earnings Call August 1, 2013 10:00 AM ET

Operator

Good day, everyone. Welcome to the Quality Distribution Second Quarter 2013 Results Conference Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Robin Cohan, VP Controller. Please go ahead.

Robin Cohan

Thank you, operator, and good morning, everyone. We're delighted to have you join us today for our second quarter 2013 earnings call. Our speakers today are Gary Enzor, our CEO; and Joe Troy, our CFO.

Before I turn the call over to Joe, I'd like to caution all participants that comments made by Quality's employees during this conference call may contain forward-looking statements. Actual results could differ materially from those projected or expected in these forward-looking statements.

Listeners are urged to carefully review and consider the various disclosures made by the company in this conference call and the Risk Factors disclosed in the company's Annual Report on Form 10-K for the year ended December 31, 2012, as well as other reports filed with the Securities and Exchange Commission.

Copies of the company's Annual Report on Form 10-K and other SEC reports are available on our website at www.qualitydistribution.com and on the SEC's website. The company disclaims any obligation to update any forward-looking statements after this conference call.

I also want to remind everyone that we refer to certain non-GAAP measures such as adjusted EPS and adjusted EBITDA that management needs to evaluate the business and to help provide additional measurements of earnings and cash flow that may be important to the investment community.

At this time, all participants have been placed in a listen-only mode. The forum will be open for question following the presentation.

With that, I would now like to turn the call over to our CFO, Joe Troy.

Joe Troy

Thank you, Robin, and good morning everyone. Yesterday we reported record quarterly revenues of nearly $240 million in the second quarter, as we continue to organically expand each of our business units. And we generated adjusted EPS of $0.20 per diluted share as our operations performed in line with our expectations.

Adjusted EPS this quarter excludes the $55.7 million goodwill impairment charge we reported in our Energy segment. This charge reflects lower than originally anticipated cash flows from our 2012 energy acquisitions, even though we realized recent improvement in operating results in that business.

Adjusted earnings also exclude $1.5 million of expenses in Energy, primarily related to our Marcellus Shale reorganization, plus some residual affiliate conversion cost related to our Chemical business.

Adjusted EPS in Q2 was down about $0.04 on a comparable year-over-year basis. This decline was primarily due to higher acquisition related interest expense and intangible amortization, reduced our net earnings from Energy, plus an expected reduction in Chemical operating results. These items were partially offset by strong profit improvement at Intermodal.

Excluding fuel surcharges, second quarter consolidated revenues were up 14.8% versus last year, as all of our businesses delivered top-line growth, with a bulk of the increase derived from our 2012 Energy Logistics acquisitions. And on a sequential basis, revenues were up 5% principally due to seasonal upticks by Chemicals and Energy.

Consolidated operating income on an adjusted basis was $15.7 million in Q2, a decrease of $2 million versus the prior year. Operating margin on an adjusted basis fell 170 basis points versus Q2 of last year, primarily due to incremental depreciation and amortization expenses from the 2012 acquisitions, plus reduced margins at Chemicals, primarily resulting from reduced profitability from terminals acquired during the affiliate conversion in Q3 of last year. However, consolidated adjusted operating income increased 14.5% versus Q1 driven by significant sequential improvements in our Energy business, offset by a slight decline in Chemicals.

Turning to our segments, Chemical Logistics revenue excluding fuel surcharges rose 4.2% in Q2 versus last year, primarily due to better pricing and higher volumes. Chemical Shipment demand continues to be strong in most areas of the country and our driver counts were up nearly 2% over last year resulting from an aggressive focus on recruiting and in retention.

Operating income at Chemicals, after adjusting for non-operating items, was down $2.8 million, as better pricing and volumes were offset by higher medical claims and affiliate conversion cost. And sequentially, operating income was down $500,000 versus Q1, as higher depreciation, medical expenses, and losses on asset sales, were partially offset by pricing and volume improvements.

The company-operated terminals, we took over from the affiliate conversion in Q3 of last year, continued to run at lower than standard margins during Q2. Although, we have now re-affiliated all of these terminals to existing independent affiliates, margin recovery will take some time as we provided certain incentives to accelerate the conversions.

At Energy, revenues were $45.1 million, up $19 million or 72.2% over the prior year quarter, as acquisitions and organic growth from affiliates more than offset a 27% decline in our Marcellus region. On a sequential basis revenues were up $4.2 million or 10.3% versus Q1, primarily due to continued strong growth in our Eagle Ford operations, incremental revenues acquired from our new Marcellus affiliate, and a 20% increase in our Woodford Shale region. Bakken Shale revenues were flat sequentially as we saw a decline in fresh and disposal water transportation revenues offset by increases in oil hauling work.

Our new affiliated Marcellus has gotten out of the blocks really well and sequentially we saw a growth in revenue and achieved profitability within this region during Q2. The new affiliate assumed operations of three terminals in Q2, and we are jointly evaluating an additional terminal conversion to them in the nearby Utica shale.

In July, we also ceased operating our brokerage command center in the Marcellus and expect to incur about $800,000 of cash and non-cash closure cost during Q3 to close down the unit.

After adjusting for items noted in our release, operating income at Energy was $2 million in Q2, up $2.5 million on a sequential basis from Q1, and adjusted EBITDA at Energy was $4.9 million in Q2, up $1 million versus the prior year period, and up $2.5 million or nearly 100% sequentially versus Q1. Both measures showed significant improvement due to a strong emphasis on cost controls and a focus on productivity, leading to higher operating profit in nearly all shale regions.

While our ongoing asset rationalization plan has resulted in cost repositioning expenses, and losses on dispositions, we are seeing equipment utilization rates rise in every region, which will provide benefits going forward as we refine the program. A key measure we used for utilization rates at Energy is revenue per unit, which improved on a sequential basis from Q1 by 11% for tractors and 8% for trailers. We still have work to do, but the metrics are moving in a right direction.

Intermodal segment revenues, excluding fuel surcharges, were up $2.9 million or 9.1%, primarily due to strong storage, rental, and service revenue. Demand for ISO container shipments continues to be favorable, which has lead to increases in trucking volumes and a stable to upward environment for pricing. Our New York, New Jersey facility, which was adversely impacted by the hurricane last year, has continued to rebound nicely, and showed sequential and year-over-year growth in Q2.

Operating income at Intermodal was up 37.1% versus last year, driving operating margins to expand by 340 basis points. This strong improvement stems primarily from increased storage and depot service revenues, which carry high margins.

As discussed in our release, we have raised $17.5 million in the new term loan facility to partially finance the redemption of $22.5 million of our high cost bonds in mid July. The balance of the redemption came from borrowings under our ABL facility, which did not materially impact our strong liquidity position. And we expect cash interest at cost to decline moderately in the second half of the year.

Capital expenditures for Q2 were $8.3 million, partially offset by $3.5 million of proceeds from asset sales. We are making tangible progress in addressing our 110 barrel fleet in our Energy business as we have cut the number of ideal units in half since Q1. We have more opportunities to convert these trailers into either day cabs or other useful equipment and also have several units up for sale.

On a year-to-date basis CapEx, net of proceeds from sales, were $3.1 million compared with $10.9 million for the comparable six month period last year. Net CapEx should decline over the next couple of quarters from Q2 levels as we remain on target to stay within our goal of $10 million to $15 million of net CapEx for 2013.

In the first half of this year, we generated $18.5 million of cash from operations, a significant jump from the $3.4 million we generated in the same period last year. On a high level basis we used roughly 65% of our first half cash flow for debt reduction, about 24% for share repurchases, and the balance for net CapEx. This waiving in favor of debt reduction is consistent with our stated focus of reducing leverage, which we will continue moving forward.

That concludes my prepared remarks. And at this point I will turn the call over to Gary.

Gary Enzor

Thanks, Joe. During Q2, Boasso continued to perform very well, Energy performed ahead of expectations, and Chemical was adversely impacted by the corporate cost and underperforming terminals.

The good news is that most of the Chemical decline should be eliminated since those terminals will be re-affiliated this week and will ramp up to a full affiliated fee over the next 12 months, and corporate medical costs are expected to return to normal levels. As we move into the first four weeks of Q3, the Chemical segment is running about 2% to 3% higher versus last year, excluding fuel surcharge. The Intermodal segment is up mid to high single digit like it has been running, and Energy contributed about $14 million in revenue, which is currently tracking about the same of last quarter.

As we stated last quarter, we took immediate and aggressive actions on many fronts in Energy and made substantial improvements during the quarter. We believe the business will continue to improve, but we currently expect Q3 of the Energy segment to run near Q2's revenue and profit levels, and are targeting further improvement for the fourth quarter. We plan to place our Oklahoma affiliate, who did a great job growing the business, with our Marcellus affiliate who runs a much larger well-capitalized business.

Our Bakken operation performed well in the second quarter, but will have less drilling related water revenue in the third quarter, so that will offset increases elsewhere and is a key driver in why Q3 is not expected to be higher. We just added a national account oil sales person in Denver to further bolster our oil sales efforts, and we plan to add two additional Energy sales resources during the quarter.

We're in the process of adding a new affiliate who formally worked in our Chemical segment to build out operations in the Tuscaloosa Shale. We continue to execute toward our strategy of building a large multi shale asset light energy business primarily focused on moving oil and produce water for our E&P customers. This business model will be much less volatile and typical energy Service Company and overtime should look much more like our Chemical segment. We believe we will be able to leverage our existing affiliates and create new affiliates to further this objective.

Looking forward in the Chemical segment, we anticipate the back half should look a lot like the front half on the top line and are pushing for some limited margin improvement on the bottom line. The re-affiliated terminals will continue to constraint margins, until they're ramped back to a full affiliate fee over the next 12 months, but the right steps are being taken.

Intermodal had performed very well the first half of this year and we expect them to perform in a similar well in the second half. Energy improved ahead of our expectations in Q2 and should carry that benefit forward. However, from our prior comments we expect Q3 to be similar to Q2 in the Energy segment, with potential upside in the fourth quarter.

Taken together, we expect the second half is somewhat better than the first half, driven by more Energy profit in the fourth quarter, a lot more Chemical profit, and some interest savings due to $22.5 million bond cost. We continue to target mid single-digit sales growth for Chemicals, high single-digit percentage sales growth for Boasso and double digit percentage sales growth for Energy. We plan to continue to spend most of our time improving Energy and reducing leverage to create shareholder value. We expect to manage availability so we're able to make another $22.5 million bond call next year and be in a position to catch a substantial interest cost savings once the bonds become callable next November.

Thank you, operator. We're ready for questions.

Question-And-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Kevin Sterling with BB&T Capital Markets. Your line is open.

Kevin Sterling - BB&T Capital Markets

Gary, let me start with some of the issues in Chemical Logistics such as medical claims and other corporate calls and it sounds like these will go away or work to the back half of the year, is the right way to think about it?

Gary Enzor

Well, our expectation on corporate medical is that we would be more normalized but the conversion cost from the affiliate will drag out over the next 12 months. As we said, we just plan on affiliating new terminal this week and since they were low profit terminals when they become affiliated, they don't start out with a standard 15% fee, they start with a much lower fee and over 12 months ramp to a full fee. So there will be compression in Chemical for the next three quarters as all the stuff gets straightened out. I do expect the medical not to recur but you can call that perfectly.

Kevin Sterling - BB&T Capital Markets

So, let me while I just wonder of Chemical, but if you kind of look at the underlying core drivers or at least the top-line revenue drivers it sounds like you can get the drivers. The drivers per se for the equipment, you can get to business. You now, have kind of heard that from other companies as well, that if they can find drivers, there's ample Chemical business out there. Is that how you think about it?

Gary Enzor

Yes, Randy Strutz is the President of our Chemical business has just said in his operating review this week that you got plenty of demand. It's more driver issue at this stage.

Kevin Sterling - BB&T Capital Markets

Joe, how much stocks you got buyback in the quarter and how much you have left on that program?

Joe Troy

Let me dig that number out but we did have -- we did about 135,000. We got $6.9 million less in the program.

Kevin Sterling - BB&T Capital Markets

Also, Joe, I think you mentioned in your prepared remarks closing down your command center in the Marcellus, and kind of big picture here. Is this part of your continued focus on more oily plays, more oil shale plays where I think most of the growth is coming from?

Joe Troy

Yeah, I think that's fair. We've said last quarter as we were transitioning away from company operations to affiliate operations in the Marcellus that we would continue to refine that mile. So we were purely asset light in the region. So command center not that it had a lot of assets but we did have some people there. We transitioned out of that. We had one unit left which is the Utica and we should be able to transition out of that. We'll fully asset light in that gas play and we'll have some company operations in some of the more oil rich plays.

Gary Enzor

Kevin, its Gary. When we started this business it was in the Marcellus it was all water based. A year ago we were about 75% water based; now we're a lot closer to 50% water base, 50% oil. And I don't have the produce to process fresh water/rig related split on the water, but that would be at least another 10%. So the business is now at least 60% of the stable revenue between oil and produced water, and our goal is to keep pushing to drive that north.

Kevin Sterling - BB&T Capital Markets

I guess as we look a couple of years, Gary, if you look at your Energy business, I mean it's predominantly going to be more oil base, is that kind of what you're telling us?

Gary Enzor

Oil base and produced water base because both of those revenue streams are stable and much less volatile than the fracking related revenue.

Kevin Sterling - BB&T Capital Markets

Right, totally agree with you there. Last question, you talked about repositioning cost and I think we're going to continue to see some of those. And is that mainly related to your Energy business and how much longer should we see some of these repositioning costs?

Joe Troy

Yes, that is mostly related to Energy. We continue to move assets around to optimize the usage of the equipment. So that will continue until where we will consider ourselves fully optimized. It will never really go away, Kevin because we're always going to be able to move assets into may be more active shale's, if one's decline we might pickup somewhere else, but very large repositioning costs that we have encountered over the last couple of quarters and may be for another quarter or two should begin to subside as we get all this equipment in the right place.

Operator

And the next question comes from Ken Hoexter with Merrill Lynch. Your line is open.

Ken Hoexter - Merrill Lynch

Joe or Gary just on the affiliating on the Chemical side, was there something you had to giveaway, was this I don't know forcing of the affiliates to expand with the bid process may be you can kind of walk us through the cost associated with that process?

Gary Enzor

Gary, Ken. Last year when we had one affiliate basically exit the business, he had about nine terminals and he had one in Energy and up roughly eight in Chemical. When he went away, we immediately affiliated about half the terminals but the other half of the terminals approximately four or five were bad performing terminals. So, we couldn't immediately affiliate those out, we had to take them in at company stores, stabilize them, but they're still not running at the type of margin level that would support us taking a 15% call the franchise fee off the top. So, what we will do when we give those back and we'll just pick the affiliates that make sense in the right market, a couple of these terminals were in the Midwest including Chicago. We may start it out at a 5% franchise fee and ramp it over 12 months to a full fee. I mean, that's generally how something like that would work.

Ken Hoexter - Merrill Lynch

And again, going back to the, was it a beta process from these affiliates or was it going to the ones that work in your buy and saying hey we need to do absorb this?

Gary Enzor

As such we're looking across all 26 and deciding who is the best fit and approaching a couple of them and picking the one we want.

Ken Hoexter - Merrill Lynch

And then in the, you noted that the drivers, I guess you noted the drivers is still a challenge, what did you do about that in terms of -- if the business is there, is this just a driver pay issue or how do you go about fixing that so to keep capturing that potential business?

Gary Enzor

Yeah, I mean I think that, that's the same issue everybody faces Ken, but we're more focused now on retention. So, if you can work that side, our turnover has been about the 50% range when we were putting in the EOBR it spiked into the 70s and it normally would tend around in the lower 40s. So, if we can improve retention by 10%, in essence we add another 10% of driver as long as you got the same floor on the other side. So, we're working some more retention based programs right now and then continue to work the applicant flow like everybody but it's a tough knot to crack, as you will know.

Joe Troy

We've also put into place Ken, some deals with outside vendors for lease purchase programs for equipment, some new tractors for potential owner operators as you know we lost a number of owner operators when we implemented EOBR last year. So that project is starting to get some traction and we're hoping that that will pick us up some net drivers.

Ken Hoexter - Merrill Lynch

And for me to wrap up let me just blend two questions I guess and one is on CapEx. But you talked about 50% reduction on your 110 barrel trucks, is that -- are you selling them, are you transit, are those some that got transitioned to other users, and then with CapEx, where do you focus this as is? Still on the Energy side that you need to spend money to help that transition and improvement on profits or where are you CapEx spending?

Joe Troy

Let me clarify the first one. It was my prepared comments. I think it was a 50% reduction in idle 110 barrel units. So, what we've done is a combination of either converting those 110 units into day cabs or other type of working units either or sold the units entirely. Some we sold to an affiliate, the new affiliate of Marcellus, well we put them use. So, we've been able to use them sporadically throughout the network.

So, from a CapEx perspective overall, our spending on a go forward basis would be more tailored towards growth type expenditures whether it's in the Chemical space with new acid tanks or just the growth in the fleet, we'll some replacement units as well that we continue to have to replenish the chemical fleet. And then as well as we will have Energy the opportunities -- growth opportunities with oil trailers and depending on the region. So, we have some plans to grow some units down the Texas region, which is being going very, very strongly for us. So, that's how I would characterize it.

Operator

And the next question comes from Tom Wadewitz with JPMorgan. Your line is open.

Tom Wadewitz - JPMorgan

I think you've given us some of this information in pieces, but I was wondering if you could just kind of put it together and review the different major shales where you participate and just tell us where you're at the present time, where you have a fit, where you affiliated and where you have ownership of the terminals? And then tell us where you would expect that to be different if you look out the year or so where, what might change?

Gary Enzor

Okay, Tom. We're affiliated in the Marcellus and plan to affiliate shortly in the Utica or in the Eagle Ford have a large affiliate operation and a large company operation that should all end up affiliate overtime. In Oklahoma, we talked about adding a large affiliate or swapping affiliates out there. So, we're partially affiliated in Oklahoma with company stores over the next 12 months, our desire would be to affiliate all of Oklahoma.

In the Bakken, it's a company store model but it's roughly 90% owner operated, so it still asset light, so that would be a longer put on deciding whether we affiliate that or not. In Wyoming, we're ramping in that particular shale and that will end up being affiliated. And as I said, we are adding a new affiliate near-term in one of the shales in Louisiana. So I would expect the majority of the locations 80% or more over the next 12 to 24 months to be affiliated and we have to decide what we want to do in North Dakota.

Tom Wadewitz - JPMorgan

So I guess you've got the I suppose two factors, one is the change in the structure with affiliating more terminals and at the same time addressing the -- doing -- taking further steps to address the equipment utilization. And so those two I think both will probably affect the margin performance. How far out should we look to think about what the kind of steady state margin would look like in Energy Logistics and where do you think that would be if you look at margin or OR in Energy Logistics when you address some of these changes that are likely to take place?

Gary Enzor

Yeah, I mean, if you have company's store obviously, you can have much higher margins because you play with a much higher gross margin. If everything is affiliated you're going to end up closer to 15 to 20 points of gross margin, depending on whether you're owing trailers or the affiliates own all the trailers. And quite honestly, we don't have a problem in dealing with all the trailers because then we are very asset light.

So the objective would be to get everything stabilized over roughly the next 12 to 24 months, probably closer to 24 months, and have everything running at margins that are generally affiliated, which should get you between 10 and 15 points of operating margin.

Tom Wadewitz - JPMorgan

And when you think about the revenue growth, take it to that greater mix, the stable kind of oil and production water, do you think revenue growth is down to get -- I mean, is that just the case where you lose the freshwater business and you have a lower revenue base but a more stable base or do you think that you kind of offset the loss in freshwater with just growth out of the production region, so that's rising off. So how would you look at the, I guess the net revenue, the revenue impact from those two opposing pieces?

Joe Troy

Yeah. Over a longer period I would say you don't expect it to go down because you still have assets that can move water. So you would expect to be able to add oil revenue and still do some level of water revenue but water is fracking and drilling related and that ebbs and flows as drilling ebbs and flows. So we just want to build a strong base of stable revenue and have 20% or less of the business that handles the more volatile fracking related revenue.

Tom Wadewitz - JPMorgan

So when you get beyond kind of lapping the acquisition impact and you are kind of I guess organic, or comparables, year-over-year you would actually expect to see growth in the Energy revenue?

Joe Troy

Yes.

Operator

And the next question comes from Ryan Cieslak with KeyBanc Capital Markets. Your line is open.

Ryan Cieslak - KeyBanc Capital Markets

I wonder if you can may be give a little bit more detail on the trends you highlighted within, specifically the Eagle Ford and even the Marcellus, it sounds like you've seen some nice improvement in both of those shales? I just wanted to get may be what's you're expecting out of those shales into the back half for the year and particularly as the new affiliate in the Marcellus continue to gain traction?

Gary Enzor

Yes, I think Ryan the Marcellus is doing well, but it's still, I think even that affiliate would characterize Marcellus as slow because of the where the gas prices are right now. So even though we've got some good traction there I wouldn't get too far out on potential growth in that region. But we'll see a lot of stabilization from this affiliate, he runs a very good operation and brought to us his existing operation, which was very well run and very strong.

In the Eagle Ford operation that we got, we got tremendous amount of growth opportunities, so we would expect to continue to see some solid growth out of the Eagle Ford in both of our affiliate and our company operations. So we tend to have very, very good asset utilization in that region. So as they can pickup drivers, which they do a very nice job doing, we can put assets to work very quickly there.

Ryan Cieslak - KeyBanc Capital Markets

And then, Joe, I know you guys don't give specifics of the exposure per sale but directionally, roughly how big is the Eagle Ford for you right now within Energy?

Joe Troy

Our North Dakota operation continues to be our largest shale, but Texas is catching up fairly rapidly. So Texas and the Eagle Ford would be a very close second.

Ryan Cieslak - KeyBanc Capital Markets

And then in the context of those comments and what, Gary what you said about the third quarter within Energy on the top-line relative to the second quarter being a relatively flatter similar, is it just the fact that you're seeing may be the Bakken a little bit below where you guys were expecting in the water holding volumes there may be just haven't been as strong as you would have thought?

Gary Enzor

Yeah, I think it varies within quarter and you can do several large fracking jobs, which we did in Q2. And if you don't have the same docket of fracking jobs in Q3 then you will be a blip down. So, and the short answer, yeah there is less water opportunity that we expect in Q3 in the Bakken and four weeks into the quarter it's still tracking at the same levels, which means you're getting offsets elsewhere.

Ryan Cieslak - KeyBanc Capital Markets

I mean, on the Chemical side, it sounds like there is a decent amount of underlying demand and the environment there looks good, may be just it's an issue with finding the drivers to support it. I just was curious to know is there anything you guys can do may be how you pricing that business going forward, if the demand environment is looking to be good, can you may be you can get something backwards, going back and getting some additional pricing from some of your customers?

Gary Enzor

Ryan, historically we've gotten a few points of pricing here. But with our business model it's kind of unusual where volume and price are essentially equal. So where I really incented, lose any revenue via price increases, which would make sense in most business models. And so we kind of take direction from our affiliates on pricing as long as they're making good margins, we would rather grow share and grow volume than raise rates, but whenever they need rates increased we will take that in.

So, we're running at lower rate increase probably this year than the past couple of years. However I do believe as all these massive capital investments by the chemical companies come on stream over the next few years, and I believe that the driver market will continue to get tighter that, price increases will be necessary, they make sure you can adequately compensate the drivers and provide the service levels required.

Ryan Cieslak - KeyBanc Capital Markets

And then last one I have is just on the Intermodal side, some really nice performance there, the last couple of quarters particularly on the margin side, it looks like some of that may be is related to some nice growth that you've seen in the higher margin service revenue. Gary and Joe, just how do we think about those margins, and that performance going forward is that, so like it's sustainable is that more, it can be vary quarter-by-quarter but you still like you consider you still see some nice improvement in the back half of the year?

Joe Troy

Yeah, I think, the way I would state it is the first half of the year we've benefited significantly from a lot of the ISO containers coming onshore, and requiring storage and handling and heating services where we make very, very good margins. That will slow a little bit in the second half, that we were at a pretty torrid pace in the first half, but I think we would expect their margins to be relatively stable. They might move around a little bit, but not a tremendous amount.

We still have a very strong outlook on the business and our management team there does an extremely good job of running the business. So, we would expect a certain level of stabilization, but improvement from here would be pretty difficult.

Operator

(Operator Instructions) We will go next to Jack Atkins with Stephens.

Connor Hustava - Stephens

Hi, guys. This is actually Connor Hustava on for Jack today.

Gary Enzor

Hey, Connor.

Joe Troy

Hey, Connor.

Connor Hustava - Stephens

Just a few questions from me. First off I was hoping if you guys could give us an update on the operational improvements, you've been targeting in the Energy sector. I think if I remember correctly, you all I think gave us an indication on the first quarter call that you've been targeting kind of $5 million to $8 million in cost savings there. Just curious to know kind of where you're at with respect to that?

Gary Enzor

Yeah, Connor, I'd say that was an annual cost savings number and the EBITDA between the quarters improved roughly $2 million, $2.5 million. So, I would say the majority of the cost savings were implemented and then the delta of incremental improvement above that was utilization.

Connor Hustava - Stephens

And then just a quick housekeeping item from me. On the adjusted tax rate, we noticed that came down this year to 36.5% from 39%. Is that what we should be thinking about going forward that 36.5%?

Joe Troy

It will probably between 36.5% and 39% Jack. So it's kind of hard to tell quarter-to-quarter, but that's we wouldn't see it going further below 36.5%.

Operator

And the next question comes from John Larkin with Stifel Nicolaus.

John Larkin - Stifel Nicolaus

Thanks for taking the questions. A lot of the questions were asked earlier were sort of dancing around the issue of what I would call sustainable growth rate. Gary, in your presentation you talked about your targeted revenue growth rate in each of the three businesses, there has been some discussion of margins may be being somewhat stable to slightly improving in Chemicals and Intermodal, but may be a big opportunity for margin expansion in the Energy sector. You mentioned to Tom Wadewitz that you could get 10 to 15 points of operating margin is that on gross revenue in the Energy business ultimately?

Gary Enzor

Yes, I'd say that is John ultimately.

John Larkin - Stifel Nicolaus

So that business has better profitability potentially than the other two is it fair to say that?

Gary Enzor

Well, if it's all affiliated John, it would be closer to Chemical, but with slightly better profitability potential.

Joe Troy

Yeah, just keep in mind John that, when you look at Chemical margins, the Chemical business is where all of our corporate overheads reside. So if you were to run the margins ex-corporate overheads you would get closer to what we're talking about without seeing Energy margins on longer-term basis. Is that makes sense?

John Larkin - Stifel Nicolaus

That's good clarification. So, at the end of the day, when you boil all this down and factor in some deleveraging may be something on the order of $20 million or $25 million a year, you did call out the $22.5 million in bonds you would like to call next year. Are we talking about kind of mid-teens sustainable earnings growth over the kind of three to five year planning horizon and it can be greater than that, is that through aggressive. Can you give us just a little bit of guidance around that that whole issue of how quickly you can grow earnings here over the planning horizon?

Joe Troy

Yeah, John, I mean we don't guide so. So we really would like to avoid getting to that level of guidance.

John Larkin - Stifel Nicolaus

I'll jump back in the wheelchair then with a question on the hours of service rule change that went into effect on July 1st. Is there an exclusion to that rule in the shales number one, and number two, what is the overall impact on the operation so far at least?

Gary Enzor

Yeah, I mean there are some different rules in the shale, but essentially our guys have calculated that they believe that the impact on the productivity overall is somewhere in the 5% range particularly in the Chemicals space. But we had enough latent capacity in the system that we can pickup that slack it becomes a problem going forward. And essentially what that means is, being covered the freight now, we have a shorter link to haul, our average link to haul tends to be 300 miles and we have a lot of short haul freight. So, near-term we can cover it. But as we need more capacity it's going to become an issue.

John Larkin - Stifel Nicolaus

And then in listening to a lot of the railroad calls, there are always multiple questions on the crude by rail phenomenon, and to an increasing extent you're sort of the first mile delivery to the rail terminal in the wet shales. And the question was, as the quarter developed the spread between rent and WTI kind of squeezed down quite dramatically, which in theory makes the interior oil little less attractive, let's say in the Mid Atlantic refineries that type of thing. Would you see any sort of decline in volume as result of that tightening of the spread as the quarter developed and what are you seeing in July?

Gary Enzor

Yeah, we didn't see a decline. Again, it's a huge market and we're still a small player in aggregate. So we'll probably able to work around it if it impacted other people. And in July, I can just tell you that revenues -- like we said, our issue this quarter was going to be less water related fracking revenue not oil move, so I can't call that any impact related to the spread change.

John Larkin - Stifel Nicolaus

And then, on the container business, I guess the bulk of that has always been off but I'll call the chemical coast down in Louisiana, Texas area. Is that still the case, I seem to recall that you all spend a little bit of money a couple of years back building a terminal up in New Jersey, is that fully from a come online, I know you're seeing nice growth there as well?

Joe Troy

Yeah, we are seeing some good growth out of New York that's the one I called out John that got hit by the hurricane last year. But it's coming back very nicely and strongly so they're in pretty good shape.

But you're right, they are really all up and down East Coast and in the Gulf Coast. We have not expanded beyond that at this juncture waiting for the Panama Canal to open up and see what happens from a marketplace perspective. We would expect to pickup business from that in a couple of years and then we will determine whether the West Coast might be a place for us to go next.

Operator

And our final question is a follow-up that comes from Ryan Cieslak with KeyBanc Capital Markets. Your line is open.

Ryan Cieslak - KeyBanc Capital Markets

Hey, guys. I just had a couple of follow-ups for you. I just wanted to get a sense. Joe, I know you're cannot give specific number on this, but into next year directionally how CapEx or net CapEx should look I mean relative to this year, is anything, any moving parts that we should be thinking about that would bring that up notably?

Joe Troy

I wouldn't want to put a bracket around that yet. We haven't gone through our budgeting process for 2014. But from a very high level it shouldn't be materially different. The 10 the 15 it might be may be closer to the high-end in that range, whereas this year we know we might be closer to midpoint or may be towards the lower end. But give me another quarter until we go through that process some more product, a better idea next quarter.

Ryan Cieslak - KeyBanc Capital Markets

And then, your pardon, if I missed this but you're based on obviously the redemption that you guys made here in July and how that plays out, it sounds like then you guys didn't make another opportunity this time next year for another $22 million. I mean, if I heard you correctly, you would still be pick the opportunity post a number first for '14, to be may be a little bit more aggressive with redemptions, has the premiums changed a little bit, is that correct?

Joe Troy

Well, to clarify, we have an ability to call in another 22.50 mid July of next year. So it's the first time we can do another one. After that, the bonds become callable in November of 2014 and they are callable at roughly 105. So whether we do it then or not we will determine what the market is like at that time, but that would be whether we did it then or in 2015. There is a potential significant pickup in interest savings by refinancing those bonds and so we can't tell you exactly when we're going to do it. We're going to take obviously a very hard look at it when it comes up for its first call.

Operator

And that does conclude the question-and-answer session. At this time for additional or closing remarks, I would like to turn the conference back over the Mr. Gary Enzor.

Gary Enzor

Thank you, operator, and thank you everyone for participating in our Q2 earnings call. We will speak with you next quarter.

Operator

Thank you. And that does conclude today's conference. Thank you for your participation.

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