Heritage-Crystal Clean Inc (HCCI) 2011 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Heritage-Crystal Clean, Inc. third-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. (Operator Instructions)

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

These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward-looking statements speak as of today and you should not rely to 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 result. 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 and the Chief Financial Officer and Vice President of Business Management Mr. Greg Ray. At this time I would like to turn the call over to Joe Chalhoub. Please go ahead, sir.

Thank you. Good morning. Thank you and welcome to our conference call.

Last night we issued our third-quarter 2011 press release and posted it on the Investor Relations page of our website for your review. This morning we will discuss the financial statements and our operations in the third quarter and first three quarters of the year, and we will respond to questions you may have relating to our business.

We are pleased to report that our third-quarter sales were $37.2 million compared to $26.7 million in the third quarter of 2010, reflecting a growth rate of 39%. Year-to-date sales increased 29% to $98 million compared to $76.1 million for the first three quarters of 2010.

Our average sales per working day increased to approximately $640,000 compared to $540,000 in the second quarter of 2011 and compared to $460,000 in the third quarter of 2010. In the latest quarter, we completed construction of the front end of our used oil re-refinery and started operational testing of this section, including the production and selling of intermediate products such as vacuum gas oil.

Construction remains on schedule for the second phase of the plant, which includes the hydrotreater section, and we expect to begin producing lube oil near the end of the year. Through the end of the third quarter we have spent approximately $37.6 million and have issued an additional $9.6 million to purchase -- for purchase commitment. We are pleased that the project continues on schedule.

As a result of our progress with the re-refinery, our oil business delivered meaningful revenue growth and also contributed to our profit before corporate SG&A. Our Environmental Services segment also reported good revenue growth of 16% compared to the year-ago quarter, but margins in this segment declined as the energy surcharges we billed to our customers were insufficient to mitigate the higher costs we incurred for solvent and fuel. We are currently investigating ways to improve the margins in this segment and will put our annual price increase into effect later this year as part of our plans for improvement.

I am quite happy that we are able to report good progress with our used oil collection, including rapid new truck deployments and continued geographic expansion. In the third quarter we continued the expansion of our used oil collections program adding eight additional new oil collection trucks. By the end of the period we had 72 oil collection trucks and we expect to continue to add new trucks at an accelerated pace in 2011.

This illustrates the tremendous value of our established branch network. Without the investment we put in place over the last decade to develop these locations and the team of dedicated professionals that manages them, we wouldn't be able to deliver this growth in used oil collection that is so critical to our entry in the re-refining business. This is a key to our future success.

These are exciting times in our organization and both the Environmental Services and Oil Business teams are engaged and look forward to the opportunities ahead of us. Our Chief Financial Officer and Vice President Business Management, Mr. Greg Ray, will now further discuss the financials, and then we will open the call for your questions.

Thank you, Joe. It's good to be with our investors today for HCCI's third-quarter 2011 conference call. I am excited about our third-quarter revenue growth as outlined in last evening's press release.

Revenues continued to grow at double-digit rates in both of our segments. In the Environmental Services segment sales grew $3.7 million, or 16%, in the third quarter and $10.6 million, or 15%, for the first three quarters of the year. As mentioned in our second-quarter conference call, we are now reporting same-branch sales for only the Environmental Services segment as opposed to consolidated same-branch sales, as this is a more meaningful benchmark for our investors.

Of the 62 branches that were in operation throughout both the third quarters of 2011 and 2010 the Environmental Services growth in these branches was 13.7%. For the first three quarters of this year same-branch sales increased 13.9% based on the 62 branches that were in operation throughout both first three quarters of 2011 and 2010.

Operating costs in Environmental Services segment increased approximately $4.9 million compared to the third quarter of 2010. Of this the net impact of higher energy prices was approximately $800,000 as higher prices for fuel, transportation, and solvent led to roughly $1.2 million of higher costs that were partially offset by a $400,000 benefit due to higher sales prices on reused solvent.

In the Oil Business segment, sales for the third quarter grew $6.8 million or 239% and for the first three quarters sales grew $11.3 million or 213% as a result of initial sales of intermediate products from our used oil re-refinery. Our Oil Business delivered income before corporate SG&A of $1.5 million, which improved by approximately $1.8 million compared to the year-ago quarter.

For the first three quarters of the year our Oil Business income before corporate SG&A increased by approximately $1.4 million to $300,000. The Oil Business profitability before corporate SG&A improved as sales improved and due to increased margins on intermediate products sold from our refinery.

We continue to roll out new used oil route trucks to increase the collection volume of used oil to feed to the re-refinery. As we have noted previously, this rollout puts some pressure on our margins, but this is not a as significant as it has been in the past as we now have the ability to upgrade the value of the collected used oil by processing it in our re-refinery.

In our Oil Business segment, additional energy-related costs for fuel, transportation, and used oil were mitigated by the increased value of used oil inventory and higher margins on intermediate product sold from our re-refinery.

Corporate SG&A was 13.1% of sales, down from 15% in the year-ago quarter. For the first three quarters of the year corporate SG&A was 14.5% of sales, down from 16.4% during the first three quarters of 2010. During the third quarter we made a second draw of $10 million on our Term A loan to fund investment in the re-refinery, and at the end of the quarter we had $20 million of bank debt and $12.7 million of cash.

We incurred $9,000 of interest expense for the third quarter of 2011 compared to zero interest in the year-ago quarter. And we incurred $23,000 of interest in the first three quarters of this year compared to zero in the first three quarters of 2010.

For the third quarter, our net income available to common stockholders was $600,000 compared to $700,000 in the third quarter of 2010. For the first three quarters, our net income available to common stockholders was $1.7 million compared to $2.3 million on the first three quarters of 2010.

Our basic and fully diluted earnings per share for the quarter were both $0.04 compared to $0.05 in the year-ago quarter. For the first three quarters of the year our basic earnings per share was $0.12 and our diluted earnings per share was $0.11 compared to basic and diluted earnings per share of $0.19 for the first three quarters of last year when we had fewer shares outstanding.

The third quarter was very positive as we were able to begin operating the front end of our re-refinery and produced and sold intermediate products. Equally important, the construction project remains on track and we expect to begin producing lube oil soon. Market conditions for lube oil sales remain at this time.

Our sales and service organization remains highly motivated with good double-digit growth in our traditional Environmental Services business as well as the used oil volumes that are the feedstock for our re-refinery.

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. Thank you.

(Operator Instructions) Ryan Merkel, William Blair.

Good morning, everyone. So my first question has to do with sales of intermediate products. It sounded like that accelerated this quarter. Do you expect it to pick up more in the fourth quarter or does that start to level off a bit as the lube oil starts to be produced?

We won't be producing much lube oil until the end, towards the end of the year. As we said earlier, we are expecting to start up near the end of the year. So, if anything, we are making now and until mid- to late-December it's going to be sold in the vacuum gas oil market.

Okay. And then maybe for Greg -- I am sorry. Maybe for Greg, I wanted to ask about the footnote that there was an error that helped boost the third quarter. Could you just talk a little bit about what that was and did that impact Environmental Services or the Oil Business?

That was an accounting error that occurred during the second quarter that was not caught until the third quarter. The net income effect was right around $100,000; it was the Environmental Services segment.

Essentially in the second quarter we under-reported or under-measured our inventory and so we artificially reduced or diminished the earnings of Environmental Services in the second quarter, and by correcting that in the third quarter it had a positive impact of that $100,000 after-tax.

Okay. And then last question for me. I wanted to talk about the margins in the Environmental Services business. We were down year over year; how much of that was due to increased solvent costs and the fuel, and then -- versus adding more trucks? And can that start to pick back up in the fourth quarter?

Well, we shared with you already that a couple of the components of the analysis, the impact due to energy price alone, which was solvent fuel for our own trucks and third-party transportation, was $1.2 million just due to price. No volume effects in that.

Then we also reported that mitigating that somewhat was the $400,000 benefit that we got for higher than year-ago selling price on our reuse of solvent. So that explains a chunk, but not the majority, of the additional cost.

There were also, as you alluded to, higher fuel costs related to expanding the business, more new and efficient trucks. Also, to some degree, higher transportation costs because some of our newer branch growth is in more distant areas from our current hub infrastructure, and so we have got more drive distance for the newer locations we are opening out West.

I think that the biggest factor in looking ahead and trying to think about how that is going to evolve over time, the biggest factor is probably the pricing impact and what is going to happen with the cost of hydrocarbons. Another big factor is going to be how much of that we are effectively able to recover with changed pricing. You know that we do an annual price increase that is coming up for us and for our customers, and the margin erosion is obviously going to cause us to be aggressive about increasing prices where we feel we can to recoup that.

Thanks for taking the questions. I will jump back in the queue.

Sean Hannan, Needham & Co.

Yes, good morning, Greg and Joe. So the sales for the Environmental was actually pretty flat quarter to quarter and kind of a similar trends to last year. I realize you think of this business more in terms of annualized terms. But can you remind us of what we should expect normally in this side of your business as you move through the year?

First, how to you think of perhaps when you typically expect sequential improvements. Maybe, second, how the revenues materialize here in the corner or how they did materialize versus your expectations. And then, third, how do you see that business actually performing today, shaping up for the fourth quarter. Is there anything that may drive that business that stands out to you?

Well, if we are talking specifically about the Environmental Services business, we don't typically give a lot of credit to there being substantial seasonality in that. We think that it has been, and we expect it to continue to be, a 15% top-line growth business.

We have seen that over the last couple of quarters. That obviously was not the story during the recession, but since we have emerged from that recession we think we are back in that range and we look for that to continue.

The one seasonal effect that I am sure, Sean, you are already aware of -- it's not really seasonality, it's a calendaring issue -- is that our fourth quarter is longer than the first three quarters. Because of our fiscal calendar the fourth quarter is 16 or sometimes 17 weeks and the first three quarters are 12 weeks. That is not a hard thing to adjust for.

That is one of the reasons we have been reporting average daily sales. Of course, we have seen average daily sales continue to improve for our business. I am not sure -- you asked a couple of questions here. Maybe I could ask you to come back and refocus me on what else you would like to hear?

Actually, Greg, that answer is I think all of the or the majority of the sub-components to the question. But I guess as a follow-up on the Environmental Services topic, can you give us an indication of how each of the lines of business in that group performs during the quarter? Were they all up double digits, I think, similar to what we have been seeing the last couple of quarters or is there anything that moved?

Yes, I think all the businesses were strong and had double-digit growth. If we focus on the sales side, on the P&L we do not break out our accounting for the individual segments. But given what we have been talking about with energy and your understanding of our business, that all of these businesses use vehicles and have the same transportation issues, there is not a lot of differentiation there in terms of different performance.

I think the other one of your questions I now recall you kind of asked at the beginning -- maybe I misunderstood it but it sounded to me like you were asking about what we are seeing in the market, and I do get asked that question often.

At this point, we have not seen any indications from our customer base that would cause us to feel like the statistics are pointing to another recession or double-dip or whatever we would want to characterize it as. We sometimes are a little bit nervous with what we read in the newspaper, but we are not seeing any symptoms of that in our customer base at this time.

But we also recognize that in some respects our customers' activity that we do with them may be more of a trailing than a leading indicator, because we are often picking up the waste materials that were generated in their production activities two or three months earlier. And so we might not immediately see in our volumes an impact of reduced business activity.

But the feedback we are getting from our tens of thousands of customers and our hundreds of reps in the field is that business conditions remain firm. And we are continuing to find that we can grow our business and add new customers.

That is very helpful, Joe. Then one last question before I jump back in the queue. On the Oil Business side -- so these delta versus June is about $5 million, so I guess kind of part A) would the majority of that delta have been the VGO product or was it all of it?

And then separately, when actually during the quarter were you shifting and recognizing the revenues on that? So, effectively, whatever it is that we did recognize in the quarter, how much of that was actually active during the course of the quarter?

The majority of the increase in revenue was from VGO sales. The production process that is operating right now and making these intermediate products is making -- VGO is the primary revenue generator.

It's also making some of the same by-products that we will continue to produce as we are operating the full re-refinery in the future in making lube oil. One of those is asphalt flux that is sold to the paving industry and so we sold some of that and that is a small part of the revenue. But VGO was the biggest part.

In terms of the production operation and the timing of that, the plant during the third quarter was doing exactly what we had expected which is that we were starting up and working out kinks in the system. And so there was some production activity kind of spread out throughout the quarter.

Obviously we were getting a little better at maintaining the normal operations toward the end of the quarter than towards the beginning, but it's still in a mode where we deem that the plan is kind of going through its testing processes. We haven't completed every aspect of the evaluation and kind of turned it on for normal, routine day-to-day business.

Okay, that is helpful. I will jump back in the queue. Thanks so much.

David Manthey, Robert W. Baird.

Good morning. First off, in terms of the adjustment that you made this quarter, could you tell us what the pretax impact was, Greg?

$180,000.

$180,000, okay.

Pretax. That is the inventory adjustment we talked about.

Right, okay. But that is the P&L impact?

That is the pretax P&L impact of the under-reported inventory in the second quarter corrected in the third quarter.

Got it, okay. Then, second, could you talk about the margins that you are getting or maybe the contribution margins on the intermediate product versus what you will ultimately get on re-refined oil? I think you said north of 20% EBITDA on lube oil, but could you talk about the intermediate product, where that falls today?

Well, when we talk about margins part of the complexity, Dave, is that you are right to cite our original plant announcement of the year-plus ago where we said we would be getting a 20% margin at the re-refinery when it was producing lube oil and when it was operating at capacity. If we want to go back and compare that to what we are doing right now, we are not making lube oil and we are not running it at capacity, although pricing in the marketplace is significantly different.

It's not something where we are sort of looking at and reporting a margin percentage on the dollar selling price of VGO. Right now it's somewhat sensitive to the volume that goes through the plant and that is changing on a regular basis.

What I would want you and others to understand is that the difference between making the VGO product and selling it at today's spot prices and making lube oil and selling it is quite substantial. And so there is still a tremendous room for further margin improvement in the business. Not only as we get the plant up to capacity, but more importantly, as we begin making the higher value lube oil.

So we can't wait to get there. We are doing everything we can to go quickly and get the plant in lube production and operation. As I mentioned before, the market seems strong in terms of pricing being attractive. It also seems strong in terms of customer interest in the product that we will make.

We have many inquiries and interested parties who are talking to us regularly trying to make sure that they can secure a stake in the product we are going to make and have an opportunity to buy it. So we are very encouraged about all those indications. We would expect to see as we start to make lube oil that the margins for the Oil Business will increase dramatically from what you are seeing in the third quarter or what you may see in the fourth quarter.

Okay. Could you tell us what the capacity today is of your network in collecting used oil? And as you move forward here should we assume that you will buy from third parties to get up to your capacity?

Then, finally, when do you think you can reach this 50 million gallons of input overall? And then, finally, how do you think it will take you to get to 50 million internally? I know that is a lot of questions, but it's sort of a timeline question.

Sure. I will try and do my best. Catch me if I drop anything.

Your first question I remember you asked about was the capacity of our collection business today. And I want to be sure I differentiate between the physical capacity and what we are actually collecting, because as you know we have many new trucks that are not fully loaded and are not fully productive.

The capacity of the trucks we have out there right now is in the neighborhood of 30 million to 35 million gallons a year if they were all fully loaded. But they are not. In fact, our stated goal for our business in terms of our own collection volume remains as we have articulated before, which is that we are attempting to be in a position where we are collecting approximately half of our re-refinery capacity.

Our re-refinery capacity is 50 million gallons a year, so we want to be collecting about 25 million gallons a year on Heritage-Crystal Clean trucks by the time the plant starts making lube oil just a few months away. So we are working towards that goal.

You asked about purchases from third parties. The answer is yes. We have already begun to purchase some used oil from third parties. We expect that that is likely to continue, and we may look for that to increase to some degree as we get our re-refinery up and running and making lube oil, and feel that we have an opportunity to run more oil through that plant to get it closer to capacity.

In terms of the schedule for building up our volumes and operations at the plant, we have not changed our thinking that we would expect to start the plant around the end of this year in making lube oil. Our goal is to have it running at full capacity a year later. So if we start around the end of 2011 we would expect to be running at about 50 million gallons a year around the end of 2012.

We have not shared with anyone a very detailed model of how that ramp up will occur. We are not quite sure what bottlenecks we may run into. Possible sources of bottlenecks during that first year or areas where we may need to do work could include logistics and shipping issues of getting material into our plant or material out of the plant.

They could include plant operational issues themselves; need to tinker with the design or more likely replace some aspect of equipment that has early failure or something. It may include the market development and we may find that we can't rapidly and immediately sell all of our product until we have more time to build relationships with important customers. And we may be feedstock constrained during that first year.

And so with all those possibilities of things that could slow us down, we have said we are allowing ourselves a year to work through all of that and get the plant up to capacity.

I think your last question had to do with how quickly we would be able to feed the plant ourselves from our own collection. Historically, we have said that that would probably come another year later. That is a somewhat fluid target, because we continue to think about how much more rapidly we can grow our collection business.

If we find that we are able to continue to effectively roll out our own trucks and go very quickly, we would love to accelerate that because our perspective is that increasing the rate of supply from our own business, as opposed to purchases from third parties, has several benefits. One of them is a potentially lower-cost feedstock supply, another is potentially better quality control on the feedstock when we do it ourselves and when we buy it in bulk from others, and a third is obviously the increased number of customers that we have relationships with that we can then leveraged through cross-selling.

Okay, thank you for that. Just one more question here. In terms of the profitability of the ES business, we have seen plenty of periods in the past where we have had rising oil prices and we have never seen quite the degradation that we saw in the margin this quarter. When you talk about the impact of just rising prices, it doesn't sound like it's the majority of the move here.

I am just wondering, as you go out and try to recover some of that are the issues you are seeing in ES in this quarter, are they structural? Or can we, by going back to customers and trying to get some relief there and changing some other things, can you get the margins back up over 20% before everything?

Yes, I think we are certainly expecting to get the margins back up. I don't think that there is things that are structural in the market that have changed anything about the business.

In terms of why we haven't seen this kind of margin erosion as clearly in other situations I would actually point to this year as part of the explanation. The first two quarters of this year we were seeing higher energy-related costs, substantially higher compared to a year ago, but they were almost entirely mitigated by sequentially rising energy prices having a positive effect on our inventory values and on our sales of reused solvent and other materials.

So they are somewhat masked in the short term. We have talked about that I think a few times before that in a market where prices move the first move results in higher costs that get mitigated by improved inventory values. And only after those inventory values have stabilized do we start to see the net bottom-line impact of the higher costs.

Here we saw that happen for a couple of quarters. We were getting higher costs, but also getting improved inventory values. And then in the third quarter we kind of saw energy prices stabilize compared to the first and second quarter, and we didn't get any more inventory benefit and had to live with the higher cost.

The other aspect of this in a long-range or medium-range scenario and the timing challenge is, as we have talked about before, we do try and mitigate these higher costs with energy surcharges and we ultimately feel we can mitigate them with price increases. So our business has sort of a different look.

If energy prices go up in June and we then are looking at October, November, December price increase you may not see it at all, because if we get one quarter of higher costs that is mitigated by inventory or even two quarters that is mitigated by that short-term inventory benefit, and then we have time to raise prices, it sort of flows through and you don't see much affecting the bottom line.

When energy prices go up early in the calendar year and right after we have done a price increase, particularly if the price increase was not very aggressive or was modest compared to our historical average as happened this time, then there is a longer period of time for that increase to flow through the P&L and for you to see the result. It really just -- I guess you could think of this as having to do with the fact that we do our price increase at the same time every year rather than adjusting our timing to more nearly match when our costs go up. And that is what leads to this sort of timing phenomenon.

I don't know if I made myself clear with that, but if you have any follow-up questions I would be pleased to try and address it.

Yes, that helps a lot. So we should pretty much expect maybe more of the same in fourth quarter, but getting relief in the first quarter of next year?

I think that is reasonable, yes.

Got it. All right, Greg. Thank you.

Sean Hannan, Needham & Co.

It sounds like you had a comment around the interest coming from customers; you have a lot of interested parties. Can you update us around what -- is there anything that has actually changed versus a few months or quarters ago?

Has that interest really always been there and we are continuing to pursue that and have discussions and getting prepared to provide product? Or has there actually been an acceleration in terms of the number of interested parties and the degree of that interest?

Most of the customers we anticipate selling the lube oil to are independent lubricant manufacturers, and there is a multitude of these customers representing a good-sized industry. Since we have announced the construction of the plant, we have approached some and some have approached us. We have had a pretty high level of interest as our very limited suppliers of lube base oil in the United States and these independents have been looking at diverse sourcing of their needs.

I would say that over that -- since we have announced the project and as we stand now, we have had an increased interest. The market remains pretty tight and we are pretty confident about our ability to market the product. And so we are looking forward to the start of the hydrotreater in order to get this uptick in value compared to our current vacuum gas oil prices.

So it sounds like net-net the interest level has always been strong, either proactively or then brought to you as well, but that is also an interest level that has been -- that continues to accelerate. Is that fair?

Yes.

Terrific. Thank you so much.

(Operator Instructions) And thank you for your time and interest. We are grateful for your support. We invite you to join us for our next conference call.