Heritage-Crystal Clean Inc (HCCI) 2011 Q4 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Heritage-Crystal Clean Inc. fourth-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 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 aim, anticipate, believe, could, can reach, estimate, expect, intend, may, plan, project, should, will, 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. For these forward-looking statements speak as of today and you should not rely on them as representing our views in the future. We undertake the obligation to update these statements after this call.

Please refer to our SEC filings including -- or our annual results on Form 10-K as our -- earnings release post 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 reconciliation 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 Founder, President and Chief Financial Officer (sic) Joseph Chalhoub; the Chief Operating Officer, Mr. Greg Ray; and the Chief Financial Officer, Mr. Mark DeVita. At this time I would like to turn the call over to Joe Chalhoub. Please go ahead sir.

Thank you and welcome to our conference call. Last night we issued our fourth-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 fourth quarter and for all of 2011. We will also respond to questions you may have relating to our business.

We are pleased to report that our fourth-quarter sales were $54.9 million compared to $36 million in the fourth quarter of 2010, reflecting a growth rate of 53%. Full-year sales increased 36% to $152.9 million compared to $112.1 million for fiscal year 2010. Our average sales per working day increased to approximately $710,000 in the fourth quarter of 2011 compared to $640,000 in the third quarter of 2011, and compared to $475,000 in the fourth quarter of 2010.

During the fourth quarter we completed construction of the hydrotreater section of our used oil re-refinery, finishing the entire project ahead of our original schedule. The completion of this section has enabled us to begin producing lube oil during the first quarter of 2012. The total cost of the project is approximately $54 million. We are currently working through the shakedown phase of the plant startup.

The fourth quarter showed strong growth in all business with revenue of $16.8 million, up 542% from the fourth quarter of 2010. This revenue growth resulted from operating our re-refinery and producing and selling intermediate products. To enable us to increase our operating rates over time, we intend to increase our used oil collection volumes.

We began 2011 with 38 route trucks and ended the year with 94. And our rate of new truck additions was increased towards the end of the year.

Our past investment in building our branch network provides us with a platform that we believe enables us to grow at this rapid pace. To further accelerate this effort, near the end of the fourth quarter we completed the acquisition of assets relating to the used oil collection of Crystal Flash Limited partnership of Michigan.

The rollout of route oil collection trucks at an accelerated pace resulted in higher collection costs during the fourth quarter and for the year. While we are confident that the ramp-up in used oil collection will help us improve our return on investment in the re-refinery, these costs negatively impacted our fourth-quarter earnings.

The environmental services segment produced revenue growth of $4.7 million or 14.1% for the fourth quarter, and growth of $15.3 million for the fiscal year. Our strategies of geographic expansion and of increasing penetration in existing markets continued to serve us well. However, we remain challenged by higher energy related costs and higher operating costs for branches we recently opened in the western US, which negatively impacted our margins in the quarter and throughout the second half of 2011.

For the fourth quarter we experienced a loss of $0.01 per share compared to a profit of $0.07 per share in the year-ago quarter. For the fiscal year, our EPS was $0.10 compared to $0.26 for 2010. While our earnings were disappointing, some of the increased costs we incurred are related to initiatives that we believe will enable us to grow faster and improve our results in 2012.

Overall, we are pleased with what we have accomplished through the quarter and for all of 2011. The efforts of our entire sales and service team allowed us to add customers at a record pace during the year. At the end of 2011 we're proud to serve 58,000 active customer locations compared to 44,000 one year ago.

This is a transformational time for Heritage-Crystal Clean. The entire organization is focused on capitalizing on the recent investments we've made by producing positive results during 2012.

Our Chief Operating Officer, Mr. Greg Ray, will now further discuss the financial results and then we will open the call for your questions.

Thank you, Joe. It is good to be with our investors today for Heritage-Crystal Clean's fourth-quarter 2011 conference call. I'm excited about our fourth-quarter revenue growth as outlined in last evening's press release. Revenue continues to grow at double-digit rates in both of our segments.

In our Environmental Services segment, sales grew $4.7 million or 14% in the fourth quarter and $15.3 million or 15% for fiscal year 2011. As we mentioned in our second-quarter conference call, we are now reporting the same branch sales for only the Environmental Services segment as opposed to all revenue, as we believe this is a more meaningful benchmark for our investors.

Of the 62 branches that were in operations throughout both the fourth quarter of 2011 and 2010, the growth in these branches was 9.7%. For the full fiscal year same branch sales increased 12.6% based on the 62 branches that were in operation for all of 2011 and 2010.

Operating costs in the Environmental Services segment increased approximately $5.4 million compared to the fourth quarter of 2010. The largest portion of this increase was due to the impact of higher energy prices, which led to higher prices for diesel fuel, transportation and the solvent used in our parts cleaning service.

As Joe mentioned earlier, we also experienced higher cost to open and operate branches in the western US. These branches are located further away from our operating hubs compared to similar branches in the US, leading to higher transportation and logistics costs.

As discussed in our last quarterly call, we intend to restore our Environmental Services profit margins in part by implementing a price increase. And this was put in place near the end of the fourth quarter.

In our Oil Business segment, sales for the fourth quarter grew by $14.2 million or 542%. And for fiscal year 2011, Oil Business sales grew $25.4 million or 322% as a result of increasing sales of intermediate products from our used oil re-refinery and increased used oil collection volume.

For the latest quarter our Oil Business had a loss before corporate SG&A of $1 million, which was down by approximately $100,000 compared to the year-ago quarter. For the full year our Oil Business had a loss before corporate SG&A of approximately $700,000 compared to a loss of $1.9 million in 2010.

The Oil Business profitability was negatively impacted by the additional costs of ramping up our used oil collection efforts. In general, our used oil collection costs are significantly higher on new trucks than those that have been active for a year or more due to the benefit of increasing rev density over time. As new trucks become more productive, our collection costs per gallon is expected to decline.

Since we began our re-refinery project in 2010, our engineering and construction team has worked diligently to deliver this project quickly and efficiently. We wanted to begin operating our plant as soon as possible, and we also recognize that completing construction during 2011 would make us eligible for favorable federal tax treatment.

We were able to accomplish this goal in part by offering performance incentives to our subcontractors. And as a result, we were able to take advantage of bonus tax depreciation in 2011 on the majority of our plant investment. As a result during the fourth quarter we recorded a significant deferred tax liability and deferred tax asset related to our net operating loss carry forward of $15.2 million.

I would like to clarify that this will not change our reported effective tax rate. It will simply mean that we don't have to pay any significant federal income tax for a while until we have recorded taxable income equal to this NOL.

During 2011, our business was negatively impacted by our obligation to share in the cleanup costs at one of our former third-party disposal vendors, ESI. We had delivered oily waste water to ESI for them to recycle. And when they closed their facility, they failed to empty and clean their storage tanks.

We, along with numerous other companies, are working with the US EPA to clean up the problem. During 2011, we recorded $600,000 in expenses related to our share of the cleanup costs, of which $400,000 was recorded in the fourth quarter.

Our insurance carrier initially provided us with some coverage, but then they backed away and we have challenged their denial of coverage. We also intend to pursue coverage under ESI's environmental insurance policy where we are identified as an additional insured.

While incidents like this one are unfortunate, they are a part of our business. And we feel that over the past 12 years we have done a good job of mitigating our exposure to this type of problem. We also must recall that the risk of this type of incident is one of the reasons that our customers choose to use Heritage-Crystal Clean, because we have a good track record of avoiding these problems, and in the rare instance that we get involved with a contaminated site, we stand between our customers and the problem.

For the fourth quarter, corporate SG&A was 11.8% of sales, down from 15.4% in the year-ago quarter. For the entire year, corporate SG&A was 13.6% of sales, down from 16.1% during 2010. This reduction reflects the leverage of some of our fixed SG&A costs with revenue growth and in particular, the rapid revenue growth coming from our Oil Business.

We incurred $14,000 of interest expense in the fourth quarter of 2011 compared to zero interest in the year-ago quarter. We incurred $37,000 of interest expense in total for 2011 compared to zero in 2010. Note that much of the interest we incurred during 2011 was capitalized in connection with the re-refinery construction.

For the fourth quarter we recorded a net loss of $200,000 compared to net income of $1 million during the same quarter one year ago. For the year our net income was $1.5 million compared to $3.3 million for fiscal year 2010.

Though our fourth-quarter earnings were subpar, we believe that we have laid the foundations for positive earnings growth in 2012. We are now getting through the shakedown phase of the re-refinery startup and beginning to produce and sell high-quality, Group II base lubricating oil. Market conditions for lube oil sales remain good at this time.

Our sales and service organization remains highly motivated with good double-digit revenue growth in our traditional Environmental Services business, and even more rapid growth with respect to 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. She will advise you of the procedure to submit your questions.

(Operator instructions) Ryan Merkel, William Blair.

Hi guys. Can you hear me? This is Paul calling in for Ryan. I've just got a few questions. So, with regards to same-store sales on the Environmental Services side, it dipped slightly below 10%. Is this a result of a weaker economy or is something else going on?

I believe that while we have continued to work hard at balancing our focus on both of our businesses, that to some degree we have been pushing so hard in the fourth quarter on growing the Oil Business that that could account for some slight reduction in focus there. But, Joe, do you have other comments about that?

No, nothing -- we're seeing pretty good activity here as we started the year, and so there is no -- there is nothing that is systemic for the Environmental Service business growth.

Okay. So you're not seeing any changes in the competitive landscape, especially with -- and maybe any activity relating to safety claims?

I would say that that is correct, that we think the competitive landscape or environment remains similar or consistent to what we've been dealing with for many years now. And our field organization's morale remains strong, and we feel that they are confident of their ability to continue to gain share and grow in the business.

Great to hear. Can you guys quantify maybe the amount of used oil you are collecting right now with the ramp-up?

Yes, as we stand now and in the first quarter and the most recent volume, we're collecting internally at the run rate of 28 million gallons of used oil.

Okay, that's great. Are you guys -- so does that give you confidence that you guys might be able to reach your target of 100% faster, then, by the end of the year?

I think we would still leave that as our goal. But I think that there certainly is a possibility we could get there faster, but I don't think we really want to change our stated expectation that our goal is to be fully self-sufficient with that 50,000,000 gallons to feed the plant around the end of this year. And again, we think we are on pace to do that, but we will keep talking about that every quarter.

One of the things that historically we have only reported collection gallons on an annual basis in our 10-K. We're going to make that a metric we begin to report on, on a quarterly basis now, as it is increasingly important to the success of our Oil Business. At the end of the first quarter that will be part of our disclosed statistics, is the annualized collection rate of used oil volume through our own branch network.

All right, that is fantastic. I'm sure everybody will appreciate the extra clarity. And then my last question is can you guys give maybe a little bit more clarity on the shakedown timeline? Thank you.

Yes, we have started the hydrotreater at the beginning of the year. And as a typical plant of this complexity, our initial startup issues with the new plant, and we have been working on these, these last few weeks. And we expect to have most of the shakedown behind us by the end of the quarter. Did we answer your questions?

Yes, thank you very much.

Luke Junk, Robert W. Baird.

First question is, relative to the re-refinery setup, could you maybe quantify some of these temporary costs that we're seeing right now related to the shakedown? Are we looking at something that is in the hundreds of thousands of dollars, or millions? Would you be comfortable quantifying that at all?

When we refer to the shakedown, and what we are saying here is that during the initial startup of the plant, we don't -- typically we don't run at full capacity. And so we had -- as we were explaining how we view the buildup of our roll-in, I think we shared with investors that we have planned to get that when the plant starts. And we're looking at running about half of the plant capacity, ramping this up to approved capacity by late in the year, early 2013.

And so when we talk about shakedown, we're not talking about significant costs relating to operations of the business. There's obviously some overtime and additional cost. But these are not significant, in our mind.

The significant part of it is how many gallons are we going to be able to run? What percentage of the plant capacity? And this is where we will end eventually leverage that investment by collecting and processing and setting the 16 million gallons.

Okay, that's very helpful. Related to that I guess, a question I would have is as we think about the progression from the fourth quarter to the first quarter and as you begin testing at the hydrotreater portion of the plant, would it be fair to assume that given the fourth quarter that you are producing the VGO and now we're back to more of a testing phase with the full plant. Would it be unreasonable to think that the actual volume of gallons that you are putting through the plant in the first quarter could be conceivably down sequentially? Or would that be incorrect?

Down -- we have the first quarter is a -- for a period and the first one is three periods, and so it is 12 versus 16. So we need to take that into consideration.

But I'm expecting the run rate in (inaudible) put through the plant in the first quarter per four-week period will be at a higher level than the fourth quarter. And it will be a combination of -- the product would be a combination of lube oil and vacuum gas oil.

And to add to that in terms of a modeling thought, Luke, to the extent that we are producing -- we were producing the VGO during Q4, that was a product that was really very much a commodity and we were able to pretty much market or sell it as a commodity as it was made.

The lube oil we've built, and we'll probably continue to build from inventory because we didn't have any inventory of that, and our customers are going through the testing and evaluation processes and things, so I would expect that you would have a difference between your plant production rates and how that flows through the revenue line.

That's very helpful. And then, Greg, you just mentioned in your prepared remarks that higher energy costs -- still an issue in the legacy Environmental Services business. It looks like the cost in the inventory dynamic somewhat normalized this quarter. Would that be fair to say? Could you maybe provide some more detail there?

Yes, I'll try and help and you can tell me if I'm on target here. You know, I think what we said last quarter and at different points in 2011 was that early in the calendar or fiscal year we started to see higher costs for fuel and solvent. And if those were flowing through to our P&L directly, we would've seen early in the year some margin erosion related to that.

But the fact was that that got buffered or we were insulated from that effect in the short term, because we were having inventory benefits as we had held inventory of solvent for resale. And we were able to sell it for the first and second quarter at those higher prices. That mitigated the higher costs hitting our P&L.

We really exhausted those inventory benefits by the end of the second quarter. And so in Q3 and Q4, both quarters, we started to have the higher cost structure hitting our Environmental Services segment and impacting our margins in the direct or visible way that you've seen.

And our thought back when we saw this materializing was that we'd hoped we'd be able to hang in there, and go forward with a price increase to restore our margin. So that is kind of how I view it. I don't know if that is directly responsive to your question, but if it's not, please follow up.

Yes. No, that is what I was looking for; appreciate the detail.

Do you have any more questions for a slip?

That's it for me.

Sean Hannan, Needham & Company.

Good morning. So, first, I was looking to see if I could get a little bit of detail of the performance in each of the lines of business within Environmental Services.

Performance in terms of just the qualitative things, I think we continue to be pleased with the growth in all of the segments. There is nothing that is that's a dog for us.

The parts cleaning business, which is our largest line of business in Environmental Services, continued to show unit growth and revenue growth. And the drum waste business has continued to be robust, and the vacuum service has shown good topline growth as well as contribution growth there. So across the board we've been pleased with the year over year progress or sequential progress with those businesses.

Okay, that's helpful. And then on the Oil Business side, excuse me if I've missed this. Did you quantify how much VGO sales were in the quarter?

We did not publish a volume statistic on how many gallons of the VGO we sold.

Or what they contributed to the topline would be helpful.

While we're on the call will see if we can come up with a quick estimate for that, and if we don't get it in the next few minutes, then we will follow up with you on that.

Okay, that's helpful. And then in terms of margins, I think you've already hit on this in a couple of different ways. So, one thing I'm looking to see if I can get some color on is -- do we have visibility to get, at least on the Environmental Services, some visibility to get them back sustainably into kind of the 20% range? It sounds like there should be some alleviation based on getting past the ESI pressures.

And then on the oil side, as we bring better volume through that business, did I understand it correctly? That is really the factor for improving the margins there versus any type of material major costs that would end up going anyway.

On the -- starting with the second question on the Oil Business, the profitability, change would be based on our startup of the hydrotreater where we can produce and sell a product that sells significantly higher price than the vacuum gas oil. And obviously the more we put through the plant, the more we sell in that area, that would keep improving our profitability for the oil business.

On the Environmental Services business, we have put a price increase towards the end of the year and we will review the results. The price increase has -- on the parts cleaning side of the business has been well received. Not that any price increase is well-received by the customers, but we haven't had a pushback from the customers, and though we are in the process of putting a price increase on the drum business.

We will review the impact of these and our margins, and act accordingly in the future. But our plan is to see our margins improve. We're not happy with what developed in the second half of last year with the Environmental Services business. We are confident with our position in the marketplace that we should, over time, improve these margins.

This is Greg speaking. I just wanted to get back to you on your earlier question and give you a rough figure. During the fourth quarter, our sales of vacuum gas oil, which is the main intermediate product we made out of the re-refinery, represented a volume of approximately 5,000,000 gallons. And that is just VGO.

There was additional volume of the byproducts that you know we produce from the process, including fuel and asphalt extender. But the main incremental revenue would come from the 5 million gallons of VGO. And that 5 million gallons was roughly twice the volume that we were able to produce and sell during the third quarter. Is that helpful?

That is helpful. Thank you.

Going back to Joe's comments, on the price increases that you are talking about for the drum business, did I understand that correctly that you're in the middle of putting those in? So that is not something that we would have seen as even a factor in 4Q and we're not going to see the full effects, perhaps, in 1Q. Or any color around that would be helpful.

I will talk about price increases and the normal pattern. We often talk with you guys about how we typically implement our price increase in the November, December timeframe. And the reason we choose that timing is because we have a segment of our customer base that is on calendar year budgeting, and really wants to get an indication of what our pricing will be like for the coming year.

So we typically announced the new year's pricing a couple of months before the year starts, but we don't really push all of our pricing and all of our customers onto that new pricing in November and December. Rather, we announce it and in selective areas where we can, we implement it and pick it up. But from our perspective, it really becomes effective in January.

And what we usually see is that in the first couple months of the new price increase, we are in a negotiation mode where most of our customers accept it and it is implemented. But there will be a handful of customers who didn't get notice or don't accept it, or have a PO system in place that we haven't followed their protocol exactly. We generally see it takes a couple of months for the price increase to be fully implemented, and for us to be in the final position where we can gauge the net result and say this is how much of the slated increase we actually achieved.

Over many years of doing this, I would say it is typical for us in parts cleaning to realize a number between 80% and 90% of our stated price increase. So if we go out initially and raise everybody's price by 10%, we would expect to realize an 8% or 9% increase a quarter after that is implemented.

We do not historically do as well in achieving the target price increases with some of our other lines of business, like the drum waste business or the vacuum service business, because they lack that anchor of the machine that ties the customer to us via an extended contract. So it is relatively easier for a customer to push back or renegotiate a price on those lines of business.

In the latest year we did in November of 2011, we did the price increase on parts cleaning and that has worked well. And we did not implement the drum price increase. At the same time, that's being done really as we speak. So we will probably see the results of that lag by a couple of months.

So last quick question on margins and I will jump back in the queue. It sounds like for the expense related to ESI, we don't -- to what degree do we have something recurring in 1Q?

That's a very good question. As a quick answer I would say that I view it as a nonrecurring expense. If you've ever been involved with any other firms that have been engaged in site cleanup with the EPA under CERCLA, the process is one where a budget is established and the costs are funded.

And there are possibilities for cost overruns or increases. We've actually increase some of this already on this project, and so I don't want to tell you that we have the final reckoning or accounting. This is our best reasonable estimate for the total cost of the cleanup, but it is actually possible that the net impact of this will go up or down.

Obviously it will go up because the ongoing cleanup costs would get revised based on what is found at the site. The costs could go down as a result of cost recovery efforts, which could include our successful pursuit of other responsible parties who sent waste to the site, as well as our cost recovery opportunity with respect to our own insurance and the insurance of ESI. So we think what we've got is a fair recognition, but it's possible that there could be some additional cost at some point over the next year or two.

Thanks so much for all the detail.

Pleasure.

(Operator instructions) Sean Hannan.

That was quick. So, I guess the last one here really is trying to see if I can get an understanding of your branch goals for the year, and then the trucks you've talked about, or had already mentioned in your remarks as well as the release, you were going to be on a stronger pace in '12. So if you could put some context around the numbers and how you expect to add and how that transpires, that would be great.

Our branch goals remain consistent with what we have said in the past. We would like to open four or five new branches in each year, so that will be our goal for this year as well.

In terms of trucks and specifically oil trucks, we have our own internal plants but I don't think we're going to quantify those for the Street at this time. But I think we are continuing to accelerate the pace of new truck additions and we think that has worked very well for us. We're really pleased with the rate of organic growth of our oil collection business.

Obviously it is acting as something of a headwind in terms of earnings. If you compared the growth that we are accomplishing with our rollout of oil collection trucks and the investment we are making to what a comparable investment would be like a by acquiring other collectors, we think that what we're doing organically is much less expensive as well as giving us the benefit of being able to integrate the new accounts and drivers and routes into our system immediately, and on our pattern or framework as we do it.

So we really like how effective we've become at doing this, and we haven't been trying to grow our Oil Business aggressively for a long time. It's really only been something that we've been working at diligently for the last year or so, and we see signs that we're getting better all the time.

But I'm going to stop short of giving you a specific truck count number to shoot for. We have a couple of different scenarios in our plans right now, and we're not quite sure which one we will pick in terms of the number of trucks that we're going to try and end the year at. We do think it remains a reasonable objective for us to keep adding trucks and improving density at a pace, though, that will let us reach our 50 million gallon target towards the end of 2012.

Okay, well, perhaps is there a way -- I don't think that I saw it in the release there, that you could share with us your track count today, and what you had aggregated in 2011?

Yes, during 2011 we went from -- at the start of the year from around 34 trucks to just under 100 at the end of 2011. So we added approximately 60 trucks during the year and we think that we can go even faster than that potentially over the next several quarters.

Just to give you a little bit more color and as far as our thinking, it took us 12 years of investment to get our 70 Branches in place. And then we've invested very heavily in our plant in Indianapolis. We feel that we have a pretty strong asset base in our branch network and the people we have.

And so we want to leverage that because it also will secure supply for the plant, and also gives us a relationship with the customers where we can leverage these customers and offer all of our environmental services.

That's terrific. Thank you so much again.

Thank you, Sean.

Thank you. Ladies and gentlemen, thank you for your time and interest. We're grateful for your support. We invite you to join us for our next conference call.