Heritage-Crystal Clean Inc (HCCI) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Heritage-Crystal Clean Incorporated third-quarter 2010 earnings conference call. Today's call is being recorded. At this time, all callers' microphones are muted, and you will have an opportunity at the end of the presentation to ask questions. Instructions will be provided at the time for you to queue up for your questions. We ask that all callers limit themselves to one or two questions.

Some of the comments we will make today are forward-looking. Generally, the words aims, anticipate, believes, 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 quarterly report on Form 10-Q and 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. A copy 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, are non-GAAP measures. Please see our website for reconciliations of these non-GAAP financial measures to GAAP.

For more information on 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. Joseph Chalhoub; the Chief Financial Officer and VP of Business Management, Mr. Greg Ray; and the Chief Accounting Officer, Ms. Ellie Chaves. At this time, I would like to turn the call over to Mr. Joe Chalhoub. Please go ahead, sir.

Thank you, and welcome to our conference call. Last night, we issued our third-quarter 2010 press release and posted on the Investor Relations page of our website for your review. Today, we will discuss the financials and our operations in the third quarter, provide an update on our oil re-refining project and respond to questions you may have relating to our business.

I am very pleased to report that in Quarter 3, both our third-quarter and yearly growth rate are double-digit. Our sales for the third quarter were $26.7 million, an increase of 20% compared to $22.3 million for the same quarter of 2009.

Our seasonally strong sales of used oil fuel that we had inventoried in the prior quarter contributed to the sales growth, which Greg Ray will discuss in further detail later in the call. For our non-oil services, our sales growth was a more modest 16% compared to the year-ago quarter.

On a year-to-date basis, we achieved sales growth of 11%, as our sales increased to $76.1 million for the first three quarters of 2010 compared to $68.4 million during the same period of the prior year.

We continue to operate in 62 branches. Of these branches, there were 58 that were in operation throughout both the third quarter of 2010 and 2009. And these contributed same-branch sales growth of $4 million or 18% compared to the year-ago quarter.

I am pleased to share that we continue to make good progress on our used oil re-refining project. We have broken ground in Indianapolis and started to prepare the site for construction. We have continued the detailed engineering work and have placed orders for equipment and construction services.

Through the end of the third quarter, we have accumulated capitalized costs of $4.8 million for this project and have committed an additional $5.5 million in additional orders. We expect the pace of spending to [decrease] in coming quarters.

We also continued the expansion of our used oil collection program, as we added three new oil trucks during the third quarter, bringing the total new oil truck count to 10 for the year. We expect to continue to add new trucks at this pace for the remainder of 2010 and at a faster pace starting in 2011.

Our current-quarter revenue reflects strong sales growth compared to the year-ago quarter. However, considering seasonality and also the growing cost of our expansion in used oil collection, our EPS in the fourth quarter of 2010 may well be similar to the quarter just concluded.

Now, our Chief Financial Officer and Vice President of Business Management, Mr. Greg Ray, will further discuss financial results, and then we will open the call for your questions.

Thank you, Joe. I am pleased to be here today to discuss our results for the third quarter of 2010. Our third-quarter average daily sales was approximately $460,000 compared to $430,000 in the second quarter of 2010 and compared to $380,000 in the third quarter of 2009. I too am very encouraged to see our growth rates return to these levels.

However, as Joe mentioned, we sold higher levels of used oil fuel during this quarter. This was possible because we built up inventory in the prior quarter, which we were able to draw down and sell this quarter. We intend to continue to accelerate the growth of our used oil collection business, although we expect this activity will make no contribution to our earnings until we begin to operate our re-refinery.

For the third quarter of 2010, our net profit available to common shareholders was $727,000 compared to $569,000 in the third quarter of 2009. For the latest quarter, our fully-diluted earnings per share was $0.05 versus $0.05 in the year-ago quarter.

The weighted average shares outstanding in the third quarter of fiscal 2010 was $14.2 million compared to $12 million in the third fiscal quarter of 2009, with the increase in shares attributable to our June 2010 equity offering. For the first three quarters of this year, our basic and fully-diluted earnings per share was $0.19 compared to $0.12 in the first three quarters of 2009.

Our earnings reflect a higher level of sales in our non-oil services. This sales growth allows us to leverage our fixed costs, and despite having more branches and trucks and paying higher commissions and more for diesel fuel, we still achieved improvements to our operating results. In contrast, the higher level of sales in our used oil business did not deliver a proportionate contribution.

Our cost of sales in the third quarter as a percentage of revenue was 5.5% higher than in the same quarter of 2009. In large part, this was due to unusual benefits in our solvent cost line in the third quarter of 2009 that were not repeated in 2010. Additionally, during the latest quarter, our increased sales of used oil fuel, which has a higher cost of sales than our other businesses, contributed to the higher cost of sales percentage.

Our operating cost as a percentage of revenue was below the previous year's level, both for the quarter and year-to-date. As noted earlier, this reflects the leveraging of our fixed costs that we experience with sales growth. The 10 oil trucks that we have already placed in service this year cost us about $200,000 pretax during the third quarter compared to seven trucks and $150,000 in the second quarter of 2010. As previously communicated, we anticipate that these costs would start off slowly and escalate as additional trucks are deployed.

Our sales, general and administrative expense in the third quarter of 2010 was 15.5% of revenue compared to 17.2% of revenue in the third quarter of 2009. Year-to-date for 2010, our SG&A was 17% of revenue compared to the same 17% for the same period in 2009.

We incurred no interest expense in either the third quarter of 2010 or 2009, as we had no bank debt during these periods. At the end of the third quarter, we had more than $26 million of cash on hand, and we can borrow up to $29.8 million more under our revolving credit facility.

Our culture continues to focus on growth through excellent service, and we are pleased that many of our customers seem to be experiencing recoveries in their businesses. Our sales organization has been doing a fine job of adding many new customers and selling all of our services. And in many categories, we have now eclipsed our pre-recession high-water marks and are setting new sales records. We are satisfied with our recent progress on our re-refining project, and we intend to keep you updated as this project continues.

Thank you for your continuing interest in Heritage-Crystal Clean. At this time, I will turn control of the call over to our operator, and he will advise you of the procedure to submit your questions.

(Operator Instructions) David Manthey, Robert W. Baird.

First off, the inventory reduction, is there -- I'm looking at the balance sheet, and it looks like it came down by about $0.5 million. Is that the equivalent of the sales increase in the used oil business that was attributable to it, or is there any other adjustments there?

That's in the ballpark. I've got Ellie Chaves here. All the inventory reduction is oil. That is about the amount of the sales increase that you've got there.

Okay, great. And then in terms of the margins, I know this is -- it is a little unusual how it is calculated. But is there any way you can give us an idea of what the gross margin was this quarter? Again, understanding that there are different mechanics in how that goes relative to what you are buying for versus what you're selling for.

And then in terms of the operating profit contribution, are we to assume that it was -- it sounded like you are saying it is kind of flat. Could it have been actually negative?

When you asked about -- the first part of your question was about the gross margin, and there were you referring to just the used oil fuel sales, David, or are you talking about something broader?

Just the used oil, yes.

Probably the best way to get to that is answering the second part of your question. The overall used oil business, taking into consideration sort of the historic used oil collection business, as well as the growth that we've already described, has about a $200,000 cost to us during the quarter. And so in aggregate, it is basically a negative to the business during the quarter.

Okay, it had a negative $200,000 contribution to EBIT.

Sorry, what's that?

You said it had a negative $200,000 contribution to EBIT.

Right. That is the new route, and the other business is probably about flat. And so, we've got -- okay, so I'm just looking at the numbers while we are talking here. But yes, the other business for most of the recent history it has sort of materially been flat. And so most of the loss is from the overall oil business; so these new route to losses that we're disclosing, that is pretty much the way it's worked.

Got it. Okay, and that is related to the new trucks that you've added?

Right.

Okay. And I didn't quite catch those numbers. You said -- was it $200,000 incremental cost this quarter? And then I think you had a year-to-date number as well.

I don't think we gave year-to-date. We can add it up, but the cost in Q3 was $200,000. The cost in Q2 was $150,000. And Q1 was around $100,000.

Okay.

So we put that together, we are up to $450,000. And we had said that we thought the cost could be as much this year as $1 million. And we don't know where Q4 is going to come in, but it looks like we probably overestimated the total negative cost impact of the new route slightly for this year.

Okay, great. And then I think Joe said that you are planning on ramping the number of trucks even more aggressively next year. So I guess we should plan on a pretty steady increase in the used oil business and associated flat EBIT contribution, or even slightly negative, depending on the trucks and so forth going forward?

Yes, let me give you a little more specifics. We previously had, I believe, talked about the expectation that we'd likely double the rate of new truck rollout in 2011 compared to 2010. That is not a firm schedule yet, but it is likely to be that or even a little bit more aggressive. We are still talking about the specific schedule of truck orders for 2011.

In terms of the negative impact, what tends to happen with this oil businesses is that trucks start out and cost us money, as we've talked about. And when they get fairly efficient, if all we are doing is -- as we've been doing -- selling the used oil as fuel, about the best the truck does is get to kind of a breakeven level. It is not making much contribution.

And so you can really think about it as it's costing us on our P&L for all the new trucks, and the mature trucks aren't contributing anything until we get the re-refinery working. So if we double the rate of investment in new trucks next year, then if this year our total costs are going to be $800,000, then next year it could be $1.6 million of costs, compared to a year where we weren't rolling those trucks out, or an incremental $800,000 of costs compared to 2010. Does that make sense?

Yes, very much. That's great. Thanks a lot, guys.

(Operator Instructions) [David Mandel], William Blair.

Greg, can you discuss a little more regarding the gross margin compression, about how much was from last year's unusual benefit versus the used oil sales this year?

Yes, the unusual benefit last year was probably in the range of $600,000 to $700,000 that was due to sort of revaluing inventory. And I won't go through all the mechanics of it again. But that was sort of last year what the unusual benefit was in Q3.

In addition, stuff that we haven't exactly characterized as unusual, but just if you compared our total net solvent costs year-over-year for Q3, the comparison is up about $1 million with, as I said, $600,000 to $700,000 being the unusual benefit last year, and the difference being growth in volumes of our business this year, as well as higher unit solvent costs this year as we buy some of that product in. So that is a big chunk of the cost of sales difference on a year-over-year basis.

And then the oil business, we said the sales out of inventory were in the neighborhood of $600,000 or $700,000 in Q3, which you can think of as sort of nonrepeatable or nonrecurring, if you are forming a base for thinking about future quarters. That flows through our P&L with negligible contribution margin.

And then we are, of course, seeing growth in the oil business on a sort of steady-state basis, as our volume goes up and we collect more oil each quarter. That is not as big of a swing from one quarter to the next as the inventory issue was, the sale of inventory.

But that's another factor when you think about gross margins, is that as our used oil collection business continues to grow each quarter, and we sell that oil on a current basis rather than inventorying it, it comes through the P&L with very low contribution margin, lower gross margin than our normal business, and that continues to have a diminishing effect or a negative effect on our margin percentages.

All right. And now that you have sold out some of that inventory that you had left from last quarter, is there still inventory to sell or draw down once again in the upcoming quarters, or have you drawn that all down?

That's a fair question, and I think at the end of Q3 we had largely depleted the surplus inventory. There is always some working inventory, of course, but there wasn't nearly as much left at the end of Q3 as there was at the end of Q2, when we had built up volume.

And then one last question regarding pricing. I know last quarter you said year-over-year, you guys were getting some pricing. How was that in the third quarter?

I would say that our price increase from late 2009 has held up nicely. We've been, I would say, pleased with what we've accomplished there. And haven't seen negative pressure from customers that is causing us to feel like we are giving back much of that or that there is any net negative on that line.

We are, at the same time, making plans now -- this is the time of year that we typically start planning our next year's price increase, and we are in works to plan that now. And we expect to be implementing a price increase sometime during the fourth quarter that, as in prior years, will be, we expect, relatively heavier or we will realize more of a price increase for our parts cleaning service, which tends to be stickier and easier for us to implement price increases on. And we don't expect to get very much for the other lines of business.

Thank you for taking my questions.

Ted Kundtz, Needham.

Greg, could you go back over the -- I hate to keep beating this -- but I'm trying to get the gross margin understood. It was 69.6% this quarter, and it sounds like it is about -- would it be about 71.5% gross margin, excluding the sale of inventory? Assuming that was at a neutral zero margin. But I'm not sure I've got that math right.

So I'm trying to get to the -- the question really is what is the gross margins X the sale of that inventory? And what should we look to expect for gross margins kind of going forward, as this mix sort of changes gradually? You have two things going on here in the gross margins. I'm just trying to isolate them.

You are right, and there are two things going on. I don't have the percentage in front of me. Ellie is sitting here and is looking at it now while we talk. But we'll see if we can come up with a number for you of what the gross margin is X the inventory sale.

And as you remember from last quarter, I will remind you while Ellie is looking at the numbers, that these sort of seasonality cycles with used oil fuel will tend to wreak havoc with that gross margin calculation, both in the quarter we've just had, where we sell down inventory, and in a quarter where we built up inventory and we have the reverse effect. Because if we don't sell any of that oil, then we don't end up with the sales sort of being diluted with the low-margin business.

Right. But generally, they've been running around a 74%, 75% kind of range.

And that would still be for our non-oil business.

Ellie has just confirmed that she thinks that range is the right range for the non-used oil business.

Okay, so there was no change in the margins from the core non-oil business. So all of the -- the entire effect was due to this factor.

Now, again, the factor has two parts to it. So one of it is the unusual inventory sale because -- and that can swing, and it was a fairly big swing this quarter. But the second is this changing mix as you bring on the trucks.

Right.

And so I'm wondering what our margin outlook is going to be going forward. Is it probably going to be in the low 70%, 71%, 72% range? Is that a fair guess? As we look out into the next couple quarters -- excluding big swings in the inventory of used oil, that you may or may not bring in and sell out throughout the (multiple speakers).

Directionally, that's right. And again, we are talking about only the upcoming quarters, up until the re-re-finery begins operating.

Absolutely, right, because that will change the whole picture --

Right.

-- back up.

But directionally, we are going to -- as our oil volume grows, that will have this negative effect on margins, which is not like -- gross margin, which is not likely to be offset by the smaller improvement we would expect to see from price increases.

And it is sort of hard for us to give you the number in the sense that we are growing the oil business quickly, and we hope to grow it faster. We are talking now about how many more trucks we put on next year. If we can accelerate that pace and feel we can collect that oil, from our perspective, that is a good investment to do that and capture more volume, even if the effect on the gross margin is that it comes down at a faster rate, because it is all temporary.

Right, it is, and you are still reselling it, so you are still getting some (multiple speakers).

I don't mean to diminish your question. I realize you have to have something and want to forecast something in a model. So having it come down a couple hundred basis points from where it is now over the coming several quarters probably makes sense. But I don't have that in a model myself right now to give you what our internal forecast is.

Okay. Could you -- have you calculated what it did cost you this quarter? What the margins would have been without that in there?

What the gross margins would have been?

Would have been without the inventory swing in there.

Oil, without the inventory swing (multiple speakers).

The business, the total business without oil, we said was in the --

[I think we're at the 72%.]

Okay, so 72%.

Okay. That's what I thought, it was in that ball park. Okay. Terrific. Thank you.

Just anything different in the recovery in terms of the nature of your business, whether you are seeing it a little stronger on the manufacturing side or kind of the automotive oriented type of business? Or the kind of (multiple speakers).

I don't think we are seeing sort of a big difference. I think that what happened is that the manufacturing side fell so much further and it came back. So it had a better recovery because it had gone down further.

But both sides of the businesses seem to be humming at a reasonable rate of activity right now, and are both showing growth. We continue to gain customers and feel positive about that trend, which has been with us for a long time, even through the recession. But we are seeing, I guess, a strength in both the vehicle service and the industrial and manufacturing accounts.

Okay, terrific. You still plan on opening three or four branches next year?

Yes, that is right. That would be our expectation.

Okay. And just the last -- let's see, the refinery buildout is on track to really be up and running, operational by the second half of 2012. Is that still the timetable or have you changed that at all?

I think we are looking -- we've said mid-2012, and I would really comment now to say mid-2012 or earlier. We obviously have a contingency during the construction and contingency during the startup. So we are progressing well. And so there is going to be a shakedown once we finish the construction.

But we are really too early to give you a clearer picture. It depends on the severity of the winter in Indianapolis. But overall, the project is progressing really ahead of our expectation from the schedule. But we are still targeting mid-2012. But I can just add the word or earlier.

Okay, terrific. Thank you both.

Thank you for your time and interest. We are grateful for your support. Please plan on joining us for our fourth-quarter and fiscal-year 2010 earnings conference call in February 2011.

Ladies and gentlemen, thank you for participation in today's conference. This concludes the program. You may all now disconnect. Thank you, and have a nice day.