Heritage-Crystal Clean Inc (HCCI) 2018 Q1 法說會逐字稿

Good morning, ladies and gentleman, and welcome to Heritage-Crystal Clean, Inc. First Quarter 2018 Earnings Conference Call. Today's call is being recorded. (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 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, and adjusted EBITDA are non-GAAP measures. Please see our website for reconciliations of all 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 President and Chief Executive Officer, Mr. Brian Recatto; and the Chief Financial Officer, Mr. Mark DeVita.

At this time, I would like to turn the call over to Brian Recatto. Please go ahead, sir.

Thank you, and welcome to everyone joining us this morning. Last night, we reported our first quarter 2018 results. We recorded a basic loss per share during the quarter of $0.01 compared to basic earnings per share of $0.21 in the first quarter of 2017. It's important to remember that our first quarter 2017 results included a nonrecurring gain from an arbitration award worth $0.16 per share. Our revenues for the first quarter increased 3.3% compared to the first quarter of 2017 to $83.1 million, driven mainly by 8% growth in our Environmental Services segment. Mark will provide more financial details in a moment, after our review of various aspects of our business.

I would first like to discuss the results in our Environmental Services segment. From a revenue standpoint, I'm proud of the fact that we delivered high single-digit growth through our continued focus on industrial customers, cross-selling initiatives and additional sales and service resources. All of our lines of business in this segment experienced growth on a year-over-year basis, despite very difficult weather conditions.

Our revenue growth in 2018 has been aided by the 5 new branches we added during 2017 as well as our sales and service resources, such as branch sales managers, antifreeze sales and service reps, vacuum sales and service reps, ESP specialists and field services reps we added throughout 2017. The cost incurred during the first quarter of 2018 associated with the new branches and resources added during 2017, was approximately $2.1 million from which we generated approximately $2.3 million in revenue. Looking forward, we plan to continue to add new branches as well as sales and service resources in this segment. We estimate that we will incur $2 million of new cost for resources to be added during fiscal 2018. We anticipate these additional resources will generate almost $1.7 million of revenue during the year.

Our Environmental Services' operating margin in the first quarter of 2018 was 23.1%, down from 28.1% in the same quarter a year ago. The decrease in margin was mainly due to a spike in disposal and transportation cost. From a disposal perspective, we were forced to utilize a secondary disposal outlet for a material portion of our commercialized waste material during the first quarter due to an outage at one of our main third-party disposal sites, leading to the higher costs. In addition, we experienced higher than usual cost related to the disposal of aqueous parts cleaning waste during the first quarter, primarily because of the unusually cold weather in Indianapolis. The good news is our main third-party disposal outlet has now returned to normal operations, and we are no longer dealing with frozen waste drums. This should allow us to bring disposal cost back to previous levels.

Transportation cost in our vacuum business, which utilizes railcars to move waste to the proper disposal outlet, were negatively impacted by the challenges we faced in rail logistics, due to the unplanned downtime experienced at our re-refinery during the first quarter, which I will discuss further in a minute. However, we are confident the steps we've taken early in the second quarter will allow us to reduce these costs, relative to our revenue and give us the opportunity to restore our operating margins back to the level we experienced during the second half of fiscal 2017.

Moving on to our Oil Business now. As we alluded to you during our fourth quarter earnings conference call, we incurred significant unplanned downtime with the re-refinery during the first quarter. Low feedstock levels combined with record-low temperatures in Indianapolis during January placed undue stress on our operating equipment and forced us to shut down the re-refinery for the equivalent of approximately 20 days. This downtime led to a lack of production and higher maintenance costs during the first quarter as well as less leveraging of our fixed cost at our re-refinery. The unplanned downtime also caused a ripple effect across our logistics network, which led to overall higher transportation cost. As a result of these challenges, we operated the re-refinery at a rate of 75% of our nameplate capacity during the first quarter compared to 96% during the fourth quarter of fiscal 2017. Looking forward, we operated the re-refinery at capacity during the first 4 weeks of our second quarter, and we expect to run the re-refinery to mid-90s percent rate for the second quarter. During our fourth quarter earnings conference call, we talked about how our netback for base oil had trailed the market primarily due to a force majeure event. As expected, we saw an increase in our base oil netback during the quarter. Specifically, our base oil netback increased by $0.19 per gallon from the fourth quarter of 2017 to the first quarter of 2018. Even more promising during the last 4 weeks of the first quarter, our base oil netback was $0.12 per gallon higher than our average for the first quarter.

As you might expect with the rising price of crude oil and residual fuel, we continue to experience pricing pressure with regard to our cost to collect used oil. During the first quarter on average, we paid our customers for their used oil. The change in our weighted-average street price during the fourth quarter of 2017 compared with the weighted-average price we paid our customers during the first quarter of 2018 was $0.12 per gallon. The first quarter was the first time since the third quarter of 2015 that we paid our customers for their used oil on a weighted-average basis. While we still charge the fee for a majority of the used oil collection services we performed during the first quarter, the market continues to be very competitive, especially for large-volume customers. If crude oil and residual fuel prices stay in their current range, we would expect to continue to pay our customers for collection of the used oil on an overall weighted-average basis.

We're working hard to overcome the obstacles which led to our underperformance during the first quarter. Thankfully, most of those challenges are short term, and we expect to see improved operating margins in both of our reporting segments in the second quarter.

To help drive continued growth in our antifreeze business, we're happy to report that we closed on our first acquisition of 2018 earlier this week. The acquired company is primarily engaged in the collection and recycling of spent antifreeze as well as the selling of a full line of antifreeze products and its operations are within our current service territory. The annual revenue of the acquired business is expected to be approximately $7 million.

We will continue to pursue multiple additional tuck-in acquisition opportunities, and hope to close on several of them during the remainder of 2018.

Mark will now walk us through our first quarter financial results in detail.

Thanks, Brian. I will start by discussing the Environmental Services segment. In the first quarter of fiscal 2018, Environmental Services revenue increased by approximately $4.3 million or 8%, from $53.2 million in the first quarter of fiscal 2017 to $57.5 million in the first quarter of fiscal 2018. We experienced higher revenue in all lines of business in this segment. The revenue growth was a result of price gains in some of our businesses and volume increases in others. In the parts cleaning business, we experienced price gains, which more than offset a slight decline in volume. The volume decline was felt in the solvent parts cleaning portion of the business as our aqueous parts cleaning business continued to show strong growth. In our Containerized Waste business, we experienced strong volume growth with a slight decline in price and service mix. While in the vacuum services business, we experienced improvements in volume as well as price and service mix. Same branch revenues grew approximately 7.8% on a year-over-year basis during the first quarter.

Profit before corporate SG&A expense in the Environmental Services segment was $13.3 million. Our first quarter operating margin was 23.1% compared to operating margin of 28.1% in the first quarter of 2017. On a year-over-year basis, disposal costs were $1.4 million higher, and labor and transportation costs combined were $2.3 million higher compared to the first quarter of 2017. These cost overruns accounted for almost 75% of the 5 percentage points decline in our operating margin. While higher labor costs were expected due to our investments in new resources to grow their various businesses in this segment, the higher disposal and transportation costs were not. Brian mentioned some of the reasons behind the higher disposal and transportation costs. We expect these costs to decline as a percentage of revenue beginning in the second quarter. The result of which should be improved operating margin.

In the first quarter of fiscal 2018, Oil Business revenues were down $1.6 million or 5.8% compared to the first quarter of fiscal 2017. The revenue decrease was due to unplanned downtime at our re-refinery and significantly lower charges to customers for our used oil collection services. From a base oil perspective, we sold approximately 8.1 million gallons of base oil during the first quarter of 2018, compared to 9.6 million gallons in the first quarter of fiscal 2017. Lower sales volume was due to a decline in base oil production of 1.8 million gallons during the first quarter of 2018 compared to the first quarter of 2017 due to the untimed re-refinery downtime mentioned earlier. We also sold approximately 1.8 million gallons of RFO during the first quarter, which was down 28% to 0.7 million gallons compared to the first quarter of fiscal 2017.

Turning now to income before corporate SG&A expense. Oil Business income before corporate SG&A expense decreased $2.3 million in the first quarter from $0.9 million in the first quarter of fiscal 2017 to negative $1.4 million in the first quarter of fiscal 2018. Oil Business segment operating margin was negative 5.4% in the first quarter of 2018 compared to 3.4% in the first quarter of 2017. The negative operating margin for the quarter was due to poor leveraging of fixed cost as well as higher maintenance and transportation costs followed by unplanned downtime at the re-refinery. The impact of higher feedstock costs was almost completely offset by higher base oil price on a year-over-year comparative basis. Higher transportation and maintenance cost account for almost 2/3 of the market deterioration on a year-over-year basis. Site closure cost of $0.3 million also contributed to lower operating margin during the first quarter. Our overall corporate SG&A expense as a percentage of revenue was 14.2% compared to 16.4% from the year ago quarter, mainly due to lower legal fees and lower expense for incentive compensation.

The company's effective income tax rate for the first quarter of 2018 was 81% compared to 37% from the year ago quarter. The rate difference is principally attributable to the different treatment for financial reporting and income tax reporting of equity compensation. The unusually high first quarter effective income tax rate is also influenced by the new break-even pretax law result, which occurred during the quarter. We still expect our income tax rate to be in the mid-20% range for the full fiscal year 2018. First quarter EBITDA of $3.4 million was $8.4 million lower than the year ago quarter. EBITDA for the first quarter of fiscal 2017 included a onetime $5.1 million gain, resulting from an arbitration award. First quarter 2018 adjusted EBITDA was $4.2 million compared to $8.1 million in 2017.

Turning to the balance sheet. Cash on hand at the end of the quarter stood at $37.6 million compared to $41.9 million at the end of the fourth quarter of 2017. And total debt stood at $28.8 million compared to $28.7 million one year ago. We intend to use our excess cash balance to seek additional acquisition opportunities as well as pursue capital projects to help drive revenue growth and improve operational efficiency.

I want to thank everyone for their interest in Heritage-Crystal Clean.

Now I will turn control of the call over to our operator to advise you of the procedure to submit your questions. Operator?

(Operator Instructions) And our first question comes from the line of William Blair, Ryan Merkel.

So a couple of questions for me. So first on the Oil Business, you mentioned significantly lower charges to customers for used oil collection. Can you tell us how much lower year-over-year for the charges?

We've actually been giving, Ryan, that you're probably familiar with what sequentially we talk about it. So it was the delta between what we've obtained -- excuse me, charging in Q4. So Q4 2017 compared to -- then we swung into a pay this past quarter, first quarter of 2018, that delta was $0.12. So there's a $0.12, I guess, net deterioration on a weighted-average basis. Does that make sense?

Yes, got it, okay. I remember last time you mentioned...

Correspondingly, we picked up 19% in our base oil netback.

$0.19.

$0.19, yes.

Okay. All right. I'm going back to the last call, and I think you said that economics in the Oil Business were the best they'd been in 5 years. Is this still the case or has something changed?

I think, base oil, yes. It still is. I think we tried to extenuate -- or Brian did, about I'll call it the exit velocity in price. I mean, we had that $0.19 increase, but we talked about how the last 4 weeks of the first quarter were especially good. They were $0.12 higher than that average that we had had for the -- our average netback for the quarter. So we think those are really good. One thing that we did talk about -- go off on a small tangent, we talked about in last quarter on that front-end of that spread, how there were on improving conditions in the pricing of residual fuels versus crude oil. And unfortunately, that has started to turn. In fact, we'd often talk about when things were more stable, No. 6 oil, for instance, was at a price point between 80% to 85% of what WTI was. And when we were on the call here in March, it had started to get back. It had been way elevated throughout '17, but it started to come back close to that. While now if you look the last several days, it's back up to 91%, 92%. So things are still good and really good. We just had a couple of price increases announced on base oil within the last week. But the front end of the spread, there is still that pressure.

But Ryan, we are not expecting spread deterioration quarter-over-quarter because of the base oil price increases.

Yes, we would expect probably getting above it.

Yes, we would.

Okay, that's really what I'm getting at. Okay. That's good to hear. And then...

I mean, our problems in oil in Q1 were, obviously, production. I mean, we only produced -- only sold 8 million gallons of base oil due to the 20 days of downtime. We expect that number to be much better. In Q2 right now, we're forecasting a 3 million gallon increase quarter-over-quarter in production.

Okay. And then just lastly 2-part question on the ES business. Can you quantify how much did the outage at the third-party disposal site -- how much of that mean to higher costs? And then you mentioned you're taking steps to lower costs. Can you just -- I don't know if you said it, but can you talk about what those steps are?

Yes, I'll take the first part of that. On a per-unit basis, if you compare the pricing that we have with our primary vendor to the secondary vendor that we're using for -- it's a lot of our hazardous waste is what it was. And kind of I'm coming out at it really generically here, but on the liquid pumpable-type stuff, our secondary vendor is about third higher in price, and on more of the solid, they're 50% plus more. So that gives you an idea -- I mean, Brian went over and we went over in our prepared remarks the actual dollar impact in the quarter, but on a percentage basis, you can see how that can be punishing.

And Ryan, we're redirecting all of that waste back to our primary vendor now that they're back up and running. But that does take a little bit of time logistically, and we're in the process of making that happen now.

Our next question comes from the line of Luke Junk from Robert W. Baird.

First question back on the Oil Business. Obviously, we had the issue in the fourth quarter with the force majeure and whatnot in terms of your ability to raise price to your customers as the market was moving up. Just want to clarify, I mean, it sounds like it was onetime in nature, and obviously, your price is moving up now. Should price continue to move up, but is it something that could crop up again? Or was that in fact, just sort of a one-off kind of thing?

No, the force majeure was a one-off issue related to Hurricane Harvey. We don't expect to see that issue again.

Ryan, I think we talked about some changes we made so we're not centric on effectively -- it wasn't written that way, but effectively several of our contracts for the committed volume or contracted volume we have were tied almost to one facility, and we're working to change that. I think we talked about...

We have 2 of our...

Yes. We just have one left that is going to be a little later in the year that we need to modify or certainly into next year, it'll be gone.

Okay. That's helpful...

So, one, we don't have a big force majeure event. If we had another one, it would be muted. We may have a little bit impact between now and then, but that would be it.

Okay. That's nice. I just wanted to make sure. And then second on the ES business. Mark, you made some comments in terms of the price realization across the product lines. Just curious how that sorted versus your expectations, and I know you mentioned one area where price cost is a little negative. Were you expecting that?

We have been a little bit more aggressive in our Containerized Waste business. So that wasn't unexpected. So it was -- I mean, I guess I could just leave it there. But when we saw that number, did we want to also have price there with the double-digit volume gain we had, I'm sure. But we weren't -- we're not alarmed, it's pretty minor.

And I think we've been consistent with that in our prior calls, which is the strategy of ours, to aggressively pursue new industrial clients as it offers the best opportunity for us to cross-sell multiple services.

Yes. Okay. That makes sense. And then lastly, Brian, you said in terms of the investments in sales and service resources, $2 million of cost and about $1.7 million in revenues. Just to clarify, I assume you meant cumulatively over the rest of the year. Is that right? Or were you speaking more on a run rate basis?

No. I think the key is he was talking about the one netted last year.

Yes, that's right.

So we really have nothing hardly at all that -- of our 18 adds that drove -- I mean, there's a little bit. We had 1 branch that started at the end of the quarter, but that was about it.

The bulk of our 18 adds will be in the back half of the year, which is consistent with what we did last year as well.

Our next question comes from the line of Brian Butler from Stifel.

Just to be clear, just that 75% utilization. What's the nameplate capacity right now on the facility?

Yes, we're not changing it, what we talked about in last conference call, the $47 million, that's what -- that's your denominator if you want to get real mathematical.

Okay. I just want to make sure we're on the same page.

Yes. And we will be very formal and communicative if that ever changed.

Okay. On the base oil price, I mean, you had some color on the netback. But can you get a little bit more clarity just on what -- how much was base oil price up for you guys year-over-year versus first quarter? Because I mean, clearly, base oil sales were down significantly and the total revenues weren't that bad. So I'm guessing pricing was up. I'm just trying to get some visibility.

Yes, year-over-year the netback was up about $0.50.

Up about $0.50 cents. Okay...

A gallon.

All right. And then on the growth in the Environmental Services piece. So you had -- you said that last year was $2.1 million in costs and that was driving what an annualized $2.3 million in revenue. Did I guess that correct?

No that wasn't -- yes, that wasn't annualized.

That was just in the first quarter?

Yes.

And that's what's driving the 8% growth? So again, looking for that kind of spending, that's what's going to keep you guys in the high single digits? Is that still the expectation what -- where is the market is right now?

That is it.

Yes, that's still our expectation.

(Operator Instructions) And our next question comes from the line of Kevin Steinke from Barrington Research.

So on the Environmental Services, the margin you talked about that kind of normalizing now, now that you're getting past these higher transportation and disposal costs. Should we still expect going forward though that there will be some margin compression from the investment in sales resources, maybe in that, I don't know, 300 basis point range year-over-year? Or how you're thinking about that?

I think, Kevin, that we're still guiding to the 27% number. Obviously, we've got some transition work that we have to do during the second quarter to get us there as we redirect the waste streams back to our primary vendors and better manage logistics, minus the issues that we've had with our rail fleet because of the downtime of the re-refinery. So we're still consistent in our thoughts, and we expect to begin to see those numbers again in Q3 with an improvement in Q2.

Okay. All right. It's helpful. And I'm just trying to make the connection here. When you talked about transportation costs in the vacuum business being impacted by challenges in rail logistics related to the unplanned downtime at the re-refinery. I don't know if you could just clarify the connection between those 2?

Yes, I can do that. I mean, we move our wastewater to end-disposal sites utilizing railcars. We, obviously, have depots of wastewater-treatment plants. So out in the field, we're collecting retail use in our back trucks. We bring it into one of our depots of wastewater-treatment plants. Ultimately, you have to get it to an end-disposal site, if it's not at one of our facilities. And when your rail fleet's tied up with used motor oil because you can offload it in a full tank form, we have to conduct what we call pump downs out in the field and redirect it using an over-the-road vacuum truck, which unnecessarily adds to our cost. The alternative being that we would utilize our rail fleet to move that material around.

And I'll give you a similar scenario here. If we were to branch out that typically would offload into a railcar and go into one of our facilities, again, which has been saving us money, generating savings over the last 12-plus months, and that railcar isn't available, they now have to go to external -- or vendor, third-party direct at an elevated cost. So that's all kind of -- that's the ripple effect and negative impact on the ES margin that unfortunately bled from the re-refinery issue.

And I think we talked about this on prior calls. Our vacuum business is growing. We have a 100 vac trucks, so it's an important component of what we do and the rail logistics plays a meaningful role in disposal.

Okay. That's helpful. So the impact on the Oil Business margins in the quarter. You talked about 400 basis points, I believe, from the unplanned downtime at the re-refinery. And the maintenance and transportation costs add on top of that? Or did the unplanned downtime have more of an impact than you thought? I'm just trying to piece all of this.

Yes. Well, certainly from what we thought sitting here a couple of months ago, not only was production down a little more than we thought, so you get less leveraging, but the maintenance cost and transportation was the biggest one, which you just reiterated. I mean, if you look at transportation and maintenance costs alone, if you're comparing sequentially, our margins, it -- those were almost 2/3 of the reason why we underperformed margin-wise.

Yes. And we ensured 2.7 million gallons of production.

Yes. Okay. And then with the -- now you moving -- you've moved into a situation where you are now paying customers on average. Just give us a sense of -- but you're also benefiting from greater netbacks on the base oil. Just kind of give us the sense of how those factors will work together and factor into your Oil Business margins over the next couple of quarters here?

We expect that to be a positive impact on a net basis through our margin. There is a volume difference, that's why if you kind of look at some of the numbers that we've talked about here today, you might say, "Oh, well, it should have been positive already." We've seen some stability recently and again, it can change. But we've seen some stability in our PFO, I guess, we should call it now. And there's definitely tailwinds as we talked about on the price side. So even though it was that volume the yield loss. We're going to still expect to see improvement overall, not just in that spread, because you need more than improvement in spread because of the volume differential, but overall positive impact on the margin from the improvement in spread.

And our next question comes from the line of Gerry Sweeney from Roth Capital.

A lot of questions to answer, but could you give me maybe a little bit of view maybe on the macro picture looking out for base oil, looking after this summer? Obviously, we're going into the summer season. I think, there's more demand, prices have been ticking up. Does the market look supplied, undersupplied, et cetera? Any outages? Just for things like that just from a macro perspective.

Yes. From a macro perspective, we feel good about base oil pricing as we look into second quarter and the early part of Q3. I mean, it's hard to have visibility beyond that. There's a pretty robust export market. Yes, we're seeing a little bit of supply increase at some of the majors, but nothing that concerns us. High feedstock prices for the majors will continue to force them to look at price increase. As Mark mentioned earlier that we had a 20% price increase.

$0.20.

Yes, $0.20. Done that twice today. $0.20 price increase, levied by a couple of the majors that we will follow up on shortly, actually, next week. So overall, we feel good about base oil macro. High demand for our product (inaudible).

Yes. And then jumping over to, I guess, PFO, pay for oil, now. Obviously, in the downturn, there's always talk about pay, you're excited that benefited charging for oil and sort of hang on to those prices, now they're working it back -- their way back up. Are you disappointed in, I guess, the rate of change? Or is this what you expected? And in general, are competitors digging their heels in and trying to raise prices slowly? Or are there some bad actors out there, a little less price disciplined?

Yes. I think you're always going to see the regional players that are a little less price disciplined than we are. Overall, we still consider ourselves to be the price leader. We're still charging for oil at the local level for smaller retail generators. I think, Mark mentioned that in his prepared remarks. Our larger corporate accounts that have buying power and larger volumes were having to pay for that oil and that's why you're seeing an overall pay for oil in our program. But overall, I think, in general, I'm happy with the work that the field has done to maintain that local charge for oil. So I'm not disappointed.

And if you -- I think if you take a longer perspective, we talked about that base oil street charges. We're still, I think, far from a situation where that residual fuel might be driven by crude moves in a certain direction that we couldn't go right back into a weighted-average charge because we did charge a fair amount of our customers during the quarter. It's one of those things where it's more than fresh. It's not as if we've been in a PFO, or pay for oil, market as an industry for years and that was one of the challenges back in 2014, '15 was and it's been a while. So those dynamics don't go away. It's still available to us. But I think, Brian's got it right, your regional or local guys tend to be a little more loose. They are not public. They don't scrutinize it as much, so.

Okay. That's helpful. So I mean, at the end of the day, it sounds like the psychology of the last go around is not necessarily there. If dynamics change, there could be an easier move back to charge from oils. I guess what you're saying...

I think, it'll be seamless, to be honest. But it's really just commodity-driven at this point. There isn't that added barrier. At some time, if you got high enough or long enough then that could...

That would change. Yes.

(inaudible) or reform.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a nice day.