Heritage-Crystal Clean Inc (HCCI) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Heritage-Crystal Clean, Inc. first-quarter 2011 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 that time for you to queue up for your question. 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 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 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. Joseph Chalhoub; the Chief Financial Officer and Vice President of Business Management, Mr. Greg Ray; and the VP Oil and 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 first-quarter 2011 press release and posted it on the Investor Relations page of our website for your review. Today, we will discuss the financials and our operations in the first quarter. Greg will discuss some of the changes to our financial reporting. And we will respond to questions you may have relating to our business.

We are pleased to report that our first quarter sales were $28.7 million, compared to $24 million in the first quarter of 2010, reflecting a growth rate of 20%.

Our average sales per working day increased to approximately $480,000, compared to $475,000 in the fourth quarter of 2010, and compared to $400,000 in the same quarter 1 year ago.

As we said in our last conference call, we opened 4 new branches in the first quarter, bringing the total number of branches in operation to 66. Of these branches, there were 62 that were in operation throughout both the first quarter of 2011 and 2010. And the growth in same-branch sales for these branches was 17% .

We continue to make good progress on our used oil re-refining project. Through the end of the first quarter, we have spent and capitalized approximately $21 million, and have issued an addition $9 million of [first used] commitment. We are pleased that the project continues ahead of schedule. And based on this progress, we now expect production of intermediate products in the third quarter of this year and startup of lube oil production near the end of the year.

We have recently begun hiring more staff in anticipation of the re-refining plant startup. We have added a lube industry sales veteran, Cary Palulis, as our VP of Base Lubricants Sales. We have also hired a great group of refinery operators, maintenance staff, and laboratory personnel. Most of these people are currently engaged in activities that allow us to capitalize their labor until startup.

We continue the expansion of our used oil collection program. During the quarter, we added 5 new oil collection trucks organically. We also acquired additional route trucks and volume through our acquisition of the Warrior Group as announced in our last quarter earnings release. The integration of the Warrior Group is going as planned, and we are happy to welcome the new employees to our company.

By the end of the period, we had 57 oil collection trucks, and we expect to continue to add new trucks at an accelerated pace in 2011. While this accelerated expansion puts downward pressure on our operating margins, our staff has been able to obtain new customers and get new trucks to breakeven in a reasonable period of time.

Over all, the attitude to win at the Heritage-Crystal Clean remains strong. Our sales team continues to grow both our Environmental Services business and our Oil Business. We are all very excited about the additional growth we anticipate once the re-refinery begins operating.

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

Thank you, Joe. It's good to be with our investors today for HCCI's first quarter 2011 conference call.

First, I would like to clarify some of the new terms Joe used earlier. As we enter the used oil re-refining business, we have decided to begin reporting our company's activity in 2 operating segments.

The first segment is Environmental Services, which includes parts cleaning, containerized waste, and vacuum services. The second segment is our Oil Business, which includes used oil collection and re-refining.

We feel that this new way of reporting will provide investors with a better understanding of our business, as we feel that these 2 segments will likely have different variables contributing to their results.

In the current quarter and until we begin operating our re-refinery, our Oil Business segment will reflect our used oil collection activity and also our sales of the used oil we collect.

Along with our new segment reporting, you will notice some changes to our income statement presentation, which are intended to make us more comparable with other public companies in our industry. Notably, our operating costs category now includes expenses that we formerly classified separately as cost of sales.

Like Joe, I'm pleased with our first-quarter revenue growth as outlined in last evening's press release. Revenues continue to grow at double-digit rates in both of our segments.

In the Environmental Services segment, sales grew $3.3 million, or 15%. And profits before corporate SG&A grew approximately $300,000, or 5%, compared to the first quarter of 2010.

Energy costs were higher than the year ago quarter. The cost increase due to higher energy prices was approximately $0.5 million dollars, compared to the year ago quarter. As higher prices for fuel, transportation, and solvent, were partially offset by a corresponding inventory valuation benefit.

We also opened 4 new branches in the quarter, but we're able to leverage much of this cost with increased sales. In response to the rising costs of petroleum-related prices, we had implemented a fuel surcharge on our services, effective the second quarter.

In the Oil Business segment, sales grew $1.4 million, or 112%, as a result of our growth in oil collection volumes and also higher prices. Our Oil Business profit before corporate SG&A declined by approximately $500,000, resulting in a current quarter loss of $777,000.

In our last conference call, we mentioned that until we begin to operate our re-refinery, the accelerated rollout of used oil route trucks will pressure our margins.

During the latest quarter, our losses in our newer, unproductive routes were approximately $0.5 million. In this segment, additional energy-related costs for fuel transportation and used oil were partially mitigated by the increased value of used oil inventory.

Corporate sales, general and administrative costs for the latest quarter was 15.8% of sales, down from 17.6% in the year ago quarter. We incurred $4,000 of imputed interest expense for the first quarter of 2011, compared to no interest in the year ago quarter.

For the first quarter, our net income was $338,000, compared to $662,000 in the first quarter of 2010. Our basic and fully diluted earnings per share was $0.02, compared to $0.06 in the year ago quarter, when we had fewer shares outstanding. The increased number of shares is due to our June 2010 equity offering.

In March, we increased our credit facility to $40 million. The new provisions allow for a $20 million Term A loan and a $20 million revolving line of credit. At the end of the first quarter, we had no debt outstanding on this facility, and we had approximately $11 million of cash on hand.

As we wrap up this quarter, we're pleased with our progress that results from the hard work of our outstanding team. Our field sales and service personnel have continued to gain accounts and help us grow our service business. And our engineers, operations group, and corporate staff have all stepped up their efforts to enable us to keep the re-refinery moving forward.

We look forward to sharing with you more exciting developments in coming quarters. Thank you for your continuing interest in Heritage-Crystal Clean.

At this time, I will turn control the call over to our operator, and she will advise you of the procedure to submit your questions.

(Operator Instructions). Ryan Merkel, William Blair.

Thank you. Good morning , everyone.

Good morning.

Good morning, Ryan.

So I want to start with the Oil Business. I think, Greg, you'd said that the bigger loss year over year, was that primarily due to adding new routes that are not yet profitable?

Yes.

Okay. And then secondarily, it sounds like you've added some people and that was the other piece of it?

Well, I would say that by far the largest piece of the increase in losses is the growth in adding new routes over the last year. It's not just in the latest quarter when we added 5 trucks, but on a year-over-year basis the organic growth is something more than 20 trucks.

And as you probably recall from other discussions, we figured out an average, it takes us a year to get a truck to breakeven in terms of volume or route density. So we're carrying at least 20 unproductive trucks at this point in time, and that's the biggest reason for the negative comparison on the bottom line in the Oil Business versus the year ago quarter.

Okay. And then --

The additional personnel you mentioned, Ryan, most of the people we're talking about adding other than the oil drivers, the other staff related to the re-refining project are substantially all being capitalized. They're not affecting our P&L at this time.

Got you. Okay. And then if I think about the next couple of quarters in the Oil Business, is it right to think that loss will probably minimize and then maybe flip to a profit as the re-refinery starts up?

I think that that's fair. I think that as Joe has just said, we're looking to start producing intermediate products in the third quarter. And we've been cautious or less than committal about what you should expect for the revenue or volumes associated with that. That's not really the main reason we're building the re-refinery as you know. It's really designed to produce lube oil, and that will be happening towards the end of the year.

But in intermediate phase when we're producing these marketable byproducts, we believe, we should -- we hope to see ourselves able to produce and sell that material. And I think you're right to guess that as we're able to do that, we're hoping that the Oil Business segment will flip from a loss to a profit when we're able to start doing it.

But it's a little bit uncertain, that part of our business, unlike everything else that we're doing, that's the one thing that in our business experience, we haven't really done this way before. And because it's just a short interval of time, we're not terribly worried about whether we have success with that activity during the third or fourth quarter or not.

Understood. And then just maybe, lastly, very quick on the Environmental Services business, nice topline growth, but the operating profit was only up about 5%. Is that primarily due to the higher fuel and solvent costs?

I'd say that's the biggest factor is the higher energy costs, which as we said were somewhat mitigated by some favorable inventory effect that happens when prices go up. But in response to that, as I mentioned, we're now in process of implementing energy surcharges, which we hope will balance that higher cost to a degree.

There are also some additional costs in this quarter maybe some margin pressure-related to the new branches we've opened in the past year. Those new branches have been more of the grass roots variety. You may recall, we've talked before about the 2 different models we used for opening branches. And in some cases, we've been successful opening branches adjacent to an existing location where we can do it relatively easily, cheaply, and quickly by building up a customer base or critical mass before we open a new branch.

As we've continued our westward expansion and have more new places out further west, those don't come adjacent to where we already have a branch -- they tend to be more remote. And so those branches are a little bit slower, and a little more expensive to start up than the ones we've been doing for most of our branches the last 3 or 4 years.

Joe, do you have something you wanted to add?

The fuel -- the surcharge would partially balance this increase.

Yes.

Okay. Thank you for the color. I'll jump back in the queue.

David Manthey, Robert W. Baird.

Thank you. Good morning.

Good morning.

I was wondering if you could tell us the number of trucks that you have today. And then when you talk about accelerating the growth, you're talking about going from 5 up to 7 or 8, not 15, right?

Well, the number of trucks we have as of the end of the first quarter is 57 trucks. And that's a pretty significant jump from the quarter through the prior quarter because we added about, I think, about 5 organically and we added around a dozen or 14 through the Warrior Group acquisition. So we had a big increase in truck count during the first quarter.

In terms of the pace at which we're adding trucks, Joe can probably flesh that out more clearly, but I think you're right to expect that we're just going to be ratcheting it up at a little bit faster than the 5 a quarter. I don't think we're talking about tripling the pace this year.

Joe, did you want to add anything else?

Yes. We're looking at adding 2 route trucks organically every period. And we're also going to be looking at small acquisitions, where it makes sense. And we're going to be relying more on organic growth. And once the plant starts producing intermediate products, we may accelerate that a little bit further.

Okay. Thank you. And when the re-refinery is up and running, is there any reason at all that you would sell used oil as fuel oil anymore? Or will 100% of that will be re-refined?

Most of it will be re-refined, only used oil that we would sell is the one that we would look at and feel it's more difficult to re-refine. There's certain industrial streams that we would probably want to direct into the fuel market by preference.

So there's a feedstock quality issue, but in our experience, only a tiny fraction of the used oil that we would pick up would be deemed inappropriate or not good feedstock for the re-refinery.

And the long-term answer to your question, the other thing to say, David, is that over an extended period of time if you're thinking about many years, we will hope that someday we could get ahead of our re-refining capacity. We're going to keep expanding used oil collection because, of course, the plant has an expandable design. And so, if we're able to collect more oil than the plant needs now, we would just view that as a good thing to have more feedstock available for future re-refining growth.

Okay. And then when you start making intermediaries or intermediates, I guess, the same deal there, the amount that you're selling as fuel oil would -- does it go almost to 0 in that case as well?

Yes.

Yes. If we're able to do what we're talking about. And again, I've hedged a lot that we're not sure and we're not promising exactly how that will work out, but if we're able to begin running our plant and making intermediates, what we'll be doing is feeding used oil to the plant and the primary product will be a vacuum gas oil-like material that's sold in the domestic VGO market.

And if we're able to do that, our current read of the economics would suggest that we would want to put all of our used oil into that VGO production and make that marketable product.

Now, as I've hedged on this, should we be unable to successfully produce and market that product, which we think is unlikely, but it's a possibility, then we would remain in the current business model that we're in today for another quarter or 2 perhaps. We might continue to have used oil that we sold as used oil until the full re-refinery came on-screen and we could begin producing lubricating oil.

Okay. Great. And last question, a little over a year ago, you had discussed the revenue run rate as about $90 million with a 20% EBITDA contribution. And I think, given that oil has moved up here, any chance we can get you to update what that might be at $100 oil? And then also, could you give us any color on the economics of the intermediates?

Yes. We're a little bit hesitant, quite frankly, to put an update, basically, the base model that was done on the price of crude was much lower. It gave us a 20%, we're happy with that return.

And crude has moved $10 a day the last couple of days. So until the plant starts and we see where we are in both the crude and the lubricant market, which has its own demand, we're sorry to say that at today's pricing, our margins are going to be substantially higher than what we had presented to you last year.

Regarding the VGO markets, the VGO markets in the last 30, 60 days have been very, very strong compared to its historic relationship with crude oil. We don't anticipate that to stay very long, if we look at where history has been. But in today's market, the conditioned VGO [isn't] a little bit higher than $3 a gallon.

I hope that answers your question, or partially?

Yes. And so at the end of the day, the spread between the 2, -- I mean, you're saying its $3, would be what you would be getting. Is the spread similar to lube oil?

Whether the lube oil is another $1 or a little bit over $1 above that. Today, quite a spread between used oil being sold in the fuel and VGO. And there's also quite a bit of spread between VGO and lube, lube oil being the ultimate highest value in the chain.

Got it. Okay. All right. Thank you very much.

Thank you.

Sean Hannan, Needham & Company.

Yes. Good morning.

Good morning, Sean.

Just want to see -- I might be splitting hairs on this I think that when you reported last quarter you talked about the production or the facility really being ready for production by the end of 4Q perhaps, early '12. I didn't hear '12 this year, is there increased confidence around being able to get that completed by the end of this year?

We like what we see so far on the construction site. As you know, we've taken the project here, and we've decided to take in 2 pieces to try to produce intermediate products. And we've had some delays because of the weather conditions, but overall, we've had more positive than negative.

So we're happy were we are. Definitely, we're closer to the startup with the vacuum gas oil. And as we said in the third quarter regarding the bareness of the plant, we see some improvements, but at this stage, we're saying near the end of the year, and because things can happen during startup or before startup can delay things by a few weeks.

But overall, we feel pretty happy. The time frame went shorter than longer. Typically this project, you plan it for X and end up being X plus plus and here we're able to do it the shorter period of time.

That's helpful. And then, actually, I think, as part of an earlier question you'd commented that there may be some truck additions through some smaller-scale acquisitions. And just trying to get a sense of -- do you have any -- or is there a decent probability that we might be acquiring more assets over the course of the next couple of quarters before we actually get that plant up and running? Or is that more of a 2012 scenario and building it out that route plan?

Well in the used oil industry versus the Environmental Services business, there's a lot of very small players. There's a few large players, but there's also a multitude of smaller players. And we've been approached and we are approaching people on a continuous basis, and we'll see how these discussions develop.

We believe we're going to be looking at some of these smaller acquisitions over the next year to 2. We're not making this as a focus of our growth. We like the way we're set up in a semi-unique basis, where we have 66 branches and we're planning to add branches to get up to, over the next few years as we've shared that in the past, to maybe around 80 branches.

And so, we like that approach where we can add route trucks. It takes a bit of time to grow them. But it's the most effective and long-term, also, economical way to build our supply.

Okay. That's helpful. And then in terms of the VGO, the [EMD] product there. I'm assuming to some degree, actually, I'm pretty sure, you guys at least have had some preliminary discussions in understanding whether you'd be able to go and move this.

And I'm just trying to figure -- get a little bit of clarity around what has been the explicit feedback that you've received that's going to help you determine whether you can ultimately sell this or not? Is the market certainly be very willing and ready to accept it and it's better you just have an acceptable product? If you could provide a little color there, that would be helpful.

Yes. Actually I can. I'll try to -- since there's a little bit of cloud in our mind, we're going to try to give you as much color as possible.

In the past, our experience has been to really take the used oil, and process it all the way to lube oil. So there's clarity about where the lube oil market is.

When it comes to VGO, there actually are a couple of players out there in the market that are producing VGO. The VGO that comes out of used oil has certain contaminants. And what we know through our discussions we had with potential buyers, that there is a market even with these contaminants. And there is an appetite recently. It has been quite an appetite for the VGO.

The price went up, quite a bit compared to crude oil, again, compared to historical values. It's a short-term for us. I mean, it's basically a quarter or 2. And we are hoping we can sell it at the prices we're seeing on the postings or close to the postings.

And if that happens, as we said earlier, we should take our losses in oil into a small profit. So there would be a nice swing for us, and gives us a little bit more confidence to more aggressively expand organically our used Oil Business. So that when the plant gets into full production near the end of the year, that we'll have more oil that we control directly.

Okay. That's helpful. And then last question, if I could. What is the biggest effort for you in terms of completing the back end of the re-refinery plant? Or is it really in terms of getting the right product and is over the goal line, how can you characterize the risk for us? Or what is the big nut that you need to crack at the very end of the process?

Yes. Are you asking -- I want to make sure I understood the question. Are you asking what's the one thing that is a hurdle to get the plant started?

Yes. For what you have for meaning in terms of milestones --

Yes.

What in your mind actually sticks out, as either the greatest or perhaps the greatest risk?

Actually, there's no risk in the pieces. We basically bought all of the equipment. We have all of the equipment for the re-refining plant has been purchased. Some of this has been purchased some time ago because it's been a long delivery.

And we're basically going to have in the next 90 days most of the equipment on site, and it would take some time to put it together; the piping, and electrical, and some of the civil work, etc.

And so, we don't see any one specific thing that can affect us as far as significant delay that can come in. Just it takes time to put these plans together, and our people and have done it at [regular] times.

Okay. Thanks very much for your time, and the answers to questions.

Okay.

Well, thank you, Sean.

(Operator Instructions). Ryan Merkel, William Blair.

Thanks. I wanted to ask about the Warrior acquisition. I know its early days, but how is it performing? And then what was the impact in the quarter? I can't recall when you actually closed that deal.

Yes. We didn't really have much in the quarter, just 1 period. And there were acquisition costs that were expensed, or legal, and accounting. And so, there has been some acquisitions --

Yes. A little less than $100,000 of transactional costs that are expensed related to the acquisition. Sorry to interrupt, Joe.

Well, that's all right. I guess this quarter we're in right now, we'd see the better picture of where this is.

But again, at the end of the day, we're tracking their customer base and their employee and the productivity. So that's going to be difficult to draw a clear line because most of these entities that we've acquired through this Warrior -- what we call the Warrior Group are areas where we collect oil.

And so at this stage, we're sharing the resources. But we'll be doing some internal tracking ourselves.

And we have started the initiative. And it's still too early to give you any quantitative results, but we have started the initiative of cross selling our services to the newly acquired Warrior accounts.

And there are some early indications of some good success and are getting parts cleaning and other business from customers that we obtained from the Warrior transaction.

Great. Thanks. And then last question, it sounds like you've made a strategic hire with the VP of Sales, I think, it was Cary. Can you talk a little bit about that investment? And how you see that helping you in your Oil Business?

Yes. I love Cary. He's a great guy. I've known Cary for 20-plus years. He's a veteran in the industry, not only in the re-refining segment, but he spent his entire career in the oil industry focusing on lube sales. And he worked for the big guys, and he worked for us when we were starting up the Chicago facility back at Safety-Kleen.

And Cary is very familiar with the lube-based oil sales. The market has changed tremendously for re-refined oil, compared to when he was first introduced in the re-refining business back in 1990, 1991. The market has a much higher appetite today. And so far, he's gone out and visited with key accounts, and he's pretty confident that we'll be getting some great results when we start up.

I'd add that in his background, I don't know how much you've seen about his bio from other things we'd published, but Cary has worked in lube-based stock sales for Exxon, to Mobil, and for Valero. He helped develop and establish a significant part of the base oil sales at Safety-Kleen when we started our large plant there. So he's got a lot of re-refining experience.

And I think very importantly, in his more recent positions, the last jobs that Cary has had have been crossing over the fence. And he had been on the side of the blenders and compounders and people who purchase base oil. And in that role, he was really working in the same capacity as our typical customers and independent blender compounder and lube company.

And in that role, Cary had had a preference for re-refined base oils. He was buying it because he felt it was good value and good quality, and he could make good products from it. So we really think that he's got the best possible experience now to be a spokesperson and salesperson for our product having been buying it for years as a customer, as well as having all of this major base oil sales experience.

Yes. That sounds like a tremendous hire. I appreciate you answering the questions. Thanks.

Sure.

Wilmot Kidd, Central Securities.

Hi. I wanted to ask, we've now got 57 trucks. What's our goal in trucks for collecting oil?

Good question, good question. This is Joe here. Our goal is to get the supply for that plant and our future plant to expand it totally, internally through our relationships with the generators of the used oil.

And so with this plant at 50 million gallons and if you look at each route truck at maturity doing 0.5 million that would be 100 trucks. And so our goal is to get to 100, 120 route trucks sometime over the next year to year and a half.

Great. And one other question. Thanks very much. And one other question is at year end, what do you expect your cash and debt to be right when we start this used oil production?

My expectation, Will -- this is Greg speaking -- and my expectation is that we're likely to draw the $20 million Term A loan we recently established as available to us. And that will probably be fully drawn at about the end of the year or before the end of the year.

And then the balance of any cash or debt will be linked to our working capital requirements. And we've said that we may need, in the ballpark of $5 million to $10 million of working capital, I could imagine we could end the year with that $20 million term loan out and with $5 million or $10 million on the revolver, I could imagine we'll have nothing significant on the revolver, just depending on how we're doing in terms of building inventory, and tying up cash, and product, and how quickly we're selling things, and how quickly we ramp the plant up to capacity.

I think you may recall that it's been our thinking that while we will want to build the volume on the plant up quite quickly based on the economics, we don't know that that's the way that things would progress. We allowed ourselves in our thoughts in the neighborhood of a year to build the volume up going through the plant and selling the finished products.

So, we may, towards the end of the year, just completed the capital construction and just be at the earlier stages of producing material and building inventory. And that would probably lead to a lower debt level than if we've got a lot tied up in working capital, if that make sense.

I understand. Thanks very much.

Sure.

Thank you. I'm showing no further questions in the queue. Thank you for your time and interest. We are grateful for support. We invite you join us for our next conference call.