HCCI (2019 - Q3)

Good morning, ladies and gentlemen and welcome to the Heritage-Crystal Clean, Inc. Third Quarter 2019 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, tax, depreciation and amortization or EBITDA and adjusted 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. 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. Brian Re

Thank you, Catherine and welcome to everyone joining us this morning. I’ll begin with the brief review of our performance during the third quarter and Mark will provide more detail regarding our financial results. Following Mark’s presentation we will open up the lines and take your questions. I’m pleased to share with you that we reported third quarter revenue of $104.8 million which compares to $99.7 million in the third quarter of 2018 while net income was $6 million. From an earnings per share standpoint we recorded diluted income per share during the quarter of $0.25 compared to diluted income per share of $0.27 in the third quarter of 2018. Turning to our Environmental Service segment performance. I’m pleased that we delivered 8.9% revenue growth compared to the third quarter of 2018. This marks the seventh consecutive quarter of at least high single digit revenue growth in the segment. Overall Environmental Service’s revenue growth was 12.4% after adjusting our third quarter 2018 results for a large field services project. One of the contributors to our revenue growth has the addition of new sales resources and branches. For the first three quarters of 2019 we generated $6.2 million of revenue and incurred $5.2 million in operating cost related to investments in new field sales and service resources and new branches opened during 2018. If we continue on our current phase we would expect new sales and service resources and new branches added during 2019 to collectively add $8.7 million in revenue and $6 million in cost for the full year 2019. Our Environmental Service operating margin in the third quarter of 2019 was flat, a 25.7% compared to the same quarter a year ago. While we were able to achieve cost improvement in the few operating areas which Mark will explain in a minute, these improvements were primarily offset by unusually high healthcare cost incurred during the quarter. Now moving onto our overall business. In the third quarter of fiscal 2019, Oil Business revenues were down $0.5 million or 1.4% compared to the third quarter of fiscal 2018. The decreased revenue was driven by decrease in the selling price of our base oil partially offset by an increase in the volume of base oil gallons sold. Our base oil netback decreased by $0.22 per gallon during the third quarter compared to last year, but increased $0.08 per gallon compared to the second quarter of 2019. Our re-refinery continued to operate effectively at 108.3% of base oil capacity as we produced a 11.7 million gallons of base oil compared to a 11.2 gallons during the third quarter of fiscal 2018, an increase of almost 4.5%. On a weighted average basis we were still in a pay for oil position for the third quarter as a whole. Our average pay for oil increased $0.02 during the third quarter compared to the second quarter of 2019 and decreased $0.17 per gallon compared to the third quarter last year. Currently the base oil market is over supplied and all signs point to the situation continuing for the remainder of the year. Driven by the seasonal oversupply, we expect downward pressure on pricing by the end of 2019. The beginning of the fourth quarter is not provided any meaningful improvement used oil collection cost. Even though the price of HSFO has been as low as 73% of WTI crude recently there have also been times in the past month when HSFO pricing has been above the price of WTI. As of yet we have not seen any buildup of used oil inventories in the marketplace and the HSFO price volatility has not supported lower feed stock cost relative to crude pricing. However, we do expect used motor oil to lengthen as we get to the latter stages of the fourth quarter. From a re-refinery perspective, we continue to focus on improving our programs in the areas of mechanical integrity and the inventory of key spare parts and equipment. The recent improvements we've made at the re-refinery should once again allow us to increase our nameplate base oil capacity to approximately 49 million gallons annually beginning in 2020. In regard to IMO 2020, we continue to believe the submission will improve both the feedstock and finished product portions of our spread. While we anticipate seeing some of the effects from IMO 2020 prior to the end of 2019, we are not certain as to the exact timing or magnitude of these impacts. For now, we will continue working diligently to operate the re-refinery efficiently and manage our spreads as effectively as possible. However, if we do not see positive impacts from IMO 2020 before the end of 2019, we could see some spread compression during the fourth quarter in our oil business segment. This spread compression coupled with our schedule fall turnaround could increase pressure on operating margins in the quarter. From the Environmental Services segment perspective, we continue to see momentum that we believe will support high single-digit organic growth during the fourth quarter. From an operating margin perspective while we do not expect to incur multiple high dollar medical claims during the fourth quarter as we did in the third quarter, we still need to work to overcome our property and casualty premiums to restore our margins back to the 27% level. As we look toward 2020, we believe implementation of a price increase as well as capitalizing on cost improvement opportunities such as expanding our internal waste management capabilities and improving management of our internal fleet will help us produce annual operating margin in the 27% range for the year despite expected higher healthcare premiums and other inflationary pressure. With that Mark will now walk us through our third quarter financial results in more detail.

Thanks Brian, and good morning everyone. I'd like to begin with our Environmental Services segment. In the third quarter we posted segment revenues of $69 million compared to $63.3 million in the third quarter of 2018. The 9% increase in revenue was driven by growth in most of our product and service lines with vacuum, containerized waste plus cleaning and increase businesses all contributing to our growth. The growth in our organic business was due to improved pricing compared to the year earlier quarter. The growth in our vacuum business was volume presence and the growth in our containerized waste in antifreeze lines of business with the result of both volume increases and price improvement. Overall antifreeze business growth was primarily due to an acquisition we made during the first quarter of 2019. Revenues from this acquisition was approximately $1.2 million during the third quarter. Our overall same branch revenues grew approximately 8.9% on a year-over-year basis during the third quarter. Organic growth after adjusting for the field services project Brian mentioned earlier was 10.5% during the quarter. Moving on, profit before corporate SG&A expense in the Environmental Services segment was $17.8 million compared to $16.2 million in a year ago quarter. Operating margin came in flat compared to last year of 25.7%. Our segment operating margin fell short of expectations primarily due to higher than expected healthcare cost during the quarter eroding almost 1% of our operating margin. We also experienced an increase in non healthcare insurance related claims costs compared to the third quarter last year. This offset some improvements we realized in disposable comp and fleet related costs during the quarter. In the oil business segment we sold approximately 11.1 million gallons of base oil during the third quarter of 2019 compared to 10.5 million gallons in the third quarter of 2018, an increase of almost 6%. Profit before corporate SG&A expense in the oil business segments decreased $0.6 million in the third quarter as our operating margin percentage fell from 12% in the third quarter last year to 10.5% this year. The decline was due in part to our base oil netback falling further than our pay for oil during the third quarter which led to a compression of our spread. Additionally, we experienced higher transportation and catalyst costs during the third quarter compared to the third quarter of 2018. Moving on the corporate SG&A expense, overall corporate SG&A expenses the percentage of revenue came in at 11.5% compared to 11.4% from the year ago quarter mainly driven by higher bad debt expense, salaries and employee benefits partially offset by lower legal fees. The company’s effective income tax rate for the first three quarters of fiscal 2019 was 24% compared to 24.3% for the first three quarters of fiscal 2018. Third quarter EBITDA is $12.5 million compared to $12.7 million in the year ago quarter. Adjusted EBITDA for the third quarter was $14.6 million compared to $14.1 million in the third quarter of 2018. As Brian mentioned earlier, income per share on a diluted basis was $0.25 during the third quarter. On an adjusted basis excluding the impact of asset write-off another side closure cost primarily related to former SEC environmental locations, we acquired back in rank 2014 income per share on a diluted basis would have been $0.28. From a balance sheet perspective cash on hand at the end of the quarter was $59 million. We generated $11 million in cash flow from operations during the quarter compared to $10.2 in the third quarter of 2018. Old debt remained steady $29 million year-over-year. We continue to work on identifying opportunities to deploy our excess cash focusing on potential acquisition targets and organic growth initiatives. We feel will improve our business and help drive value for our shareholders. At the end of the third quarter, we hired a new director of M&A and are confident that filling this role will help us achieve our goal of producing more meaningful acquisitions in the future. In conclusion we're pleased with the solid third quarter results in our oil business segment and look to continue our strong revenue growth in the Environmental Services segment for the remainder of 2019. Thank you for joining us today. I will now turn the call back to Catherine to take your questions.

Thank you. [Operator Instructions] Our first question comes from Michael Hoffman with Stifel. Your line is open.

Hi Brian, Mark. Thanks for letting me have some questions.

Hi, Michael. How are you?

Good. Can't complain what's the point anyway. On the EES business, so can you help us understand what is, it was really confined to the third quarter because you had I am assuming claims based incidences and your self-insured like lots of people and so that's what's drove that up to isolate it. So we see where you're operating leverage was and then help us understand the point you're making Brian about, you still have got some work to do on prior paying casually rates. So we figure out how to balance this out. That's question one and then I will come back and ask another question.

Well, from as we alluded to in the little bit of detail that the big, I would say mix versus getting in that 27% range as far as operating margin performance was mainly due that we had multiple cases that -- all the way up into our stock loss, so that's not something we are used to seeing. So it was in the third quarter so we don't think –

Mark, can you get closer to the speaker. You are really hard to hear.

I am sorry.

That's all right.

Better good. So we had multiple claims in one quarter that got up to our stock loss coverage in feedstock which is not typical for us at all. And we don't expect that to recur based on our historical experience. We will see not so much until 2020, we will see higher premium as a result of that but there is somewhat of a bubble there as far as that portion of higher cost, the actual experience there. And then, we had other insurance claims nothing to do with healthcare just for different recurring stills and other things that when we look at what the headwinds were, be it much more smaller than the healthcare was prior to next biggest discernible piece of the headwind there. So are we going to continue to have occasional still in this business? Yes you are going to have that. So that's something that worse on a year-over-year basis in Q3, is the improvement to be made there probably but it wasn't the big driver here as to the healthcare cost.

Yes, as we look out in the 2020 Michael, you are well aware that healthcare costs are going up. So our comment around 2020 was just to that impact. We do expect premiums will increase in 2020. We could drive some of that to our employees, but it's a tough higher end market. We probably will not like to do a lot of that in 2020. So we will have higher healthcare costs and we will overcome that within the normal way that we do, we will pass those costs on our customers and we are going to see, you will see inflation pressure. We put our budgets together for 2020.

Yes, I mean in healthcare you are probably aware of that most people in the call are, but to look back as opposed to other types of claims other types of insurance is not that far. So when you have some of the recent experience we had it's going to hit you when you are renewing the work, calendar year renewal.

And just to be clear, have you quantified the stock loss impacts and the basis point, basis at a 100 basis points, 150 basis points that just related to the stock loss issue?

Yes, it was about 1% there, 100 basis points.

And then the used oil question?

So Michael, we would have been right on track with our margin performance. So from an operating standpoint I'm extremely pleased with the quarter.

Yes. That was the point I was trying to get at, as you hit your numbers from an operating leverage standpoint. This is unusual incidents and therefore. So used oil, the interesting challenges is that you had exceptional productivity, you actually produced, in a comparable basis to 2Q, 2019 a lot of things are similar as far as volume sold and volume produced and yet you gave up margin sequentially. Help us understand how we're to try and predict this because you've overcome your performance rated things that you're getting utilization but where do we get to some comfort on a baseline level of margin is to be out understanding what the operating leverage of the business might be?

I think Michael you're well aware that HSFO was extremely volatile in the quarter. We really didn't get the IMO 2020 bump that we expected in. HSFO, you saw it go from anywhere from 73% of WTI all the way to being priced over WTI and if I'm a collector out in the marketplace, I'm absolutely going to empty my tanks over the course of the quarter prepping for IMO 2020 knowing that used motor oils going to lengthen as we get to the back end of the year as we implement IMO 2020. You're going to have 60% less demand for HSFO as you look out into 2020. That's a significant amount of one molecule that's not going to be needed anymore. So, if I'm out there running trucks I'm going to make sure the tanks are empty and what we're seeing in the marketplace is that the tanks are beginning to fill up. We expect we'll begin to see the impact in the latter half of this quarter. You heard that in our prepared remarks and we still believe that. In order to drive the spread expansion we're going to have to do that with this motor oil. We expect base oil to continue to be soft, seasonally soft in the fourth quarter. We do expect VGO pricing, crude oil pricing to change in the early part of 2020 as the result of the need to produce a lot of additional distillate that's going to drive the price of the feedstock up. We're fairly comfortable that base oil pricing will go up in 2020, but certainly not going to happen at the end of this year. So we expect the drive expansion in our spread through control and used motor roll as a result of IMO 2020 then getting a little bit of a bump in base oil pricing as we look out into 2020.

Thank you.

You are welcome.

Thank you. And our next question comes from Gerry Sweeney with Roth Capital. Your line is open.

Good morning guys. Thanks for taking my call. How are you doing? I wanted to talk a little bit about the growth side on the Environmental Services. I think you were talking about five branches this year and we're moving into the fourth quarter. What do you see in terms of growth branch wise next year as well as I think you had some opportunity to layer on additional services at different branches? Maybe would you do parse that out a little bit. Thanks.

Yes, we are looking again to probably do four or five in 2020. We probably only did one through the first half of one new branch the first half of this year and quite honestly we've had this history or cadence of doing addition in the second half right at the end of the year. That timing time is going to change but realistically we're probably only going to probably add one more at the end of the year. So it will be a down year versus what we originally thought for 2019, but going to 2020 we're looking at four to five more and from a headcount standpoint, we certainly have already outstripped the headcount addition in 2018 we're not in anywhere near 2017. So we are in the middle there. What we would expect again from a headcount standpoint to get in the same rings that we're going to be in for 2019 and 2020. So another probably 15 to 20 adds.

Got it and the down…

We really expect to augment that growth as Mark talked about in his prepared remarks with acquisitions, we now have a full-time M&A person on board. We've got lots of active targets that fit with our desire to continue to expand in areas where we don't have current route density and concentration that would be in the western half of the U.S. and we're actively pursuing a few now. So I like the thought of balancing out the organic branches with the addition of acquisitions to help build our density and that's going to be our plan. We've got plenty of cash as you can see on the balance sheet. And we do think, it’s become more favorable as the market slows down for us to do acquisitions at the right multiple.

Got it, yes. I mean we have talked about acquisitions and I think the great opportunity, I would ask about it but I know you can't talk about it much then more than it's your targets we got them in the back in the backlog we're looking at. And then just the quick question on, you mention it down your to get target of five branches and it looks like there's going to be two. Is the driver behind that finding people to expand as branches or was it just other workload internally to prevent it?

Yes, it has been a difficult hiring market. We still have quite a few vacancies in our existing, more mature branches that we would like to fill those positions before we go out and do another green field. We see more opportunities for quicker more profitable growth if we can fill out our roster in the more matured branches. That's the main reason why we didn't speed up the organic growth. We do think the job market is loosening up. We are beginning to see some success at placing people and that will allow us as Mark said to get back on the trail of opening some organic branches with the addition of the acquisitions to speed up the density. We really want to speed it up versus the two and half years it takes to get branch up to some level of profitability.

And quite frankly something that again it's secondary tertiary, but the fact that we are able to just get new production out of our existing people whether they were adds in 2017 or 2018 or position maybe not exact person but a position that has been in place for ten years. We are able to still drive that high single digit growth on a branch, clean branch sales basis or just in for some of the episodic stuff we had last year technically double-digit growth. So if we worked in that range I would venture to say we would probably pushing a little harder but why make that suspect higher if you are still getting to growth that we think is accessible.

Got it and one more just maybe follow-up with that and then I will touch back in line but you have always talked to think 90 or so branches. How many of the branches are at say full capacity with available services?

Well, we have the full menu. Those probably maybe 25% of the branches have the full menu but I would say and again, to clarify your question in your last comment but none of them are at full capacity. Let me be crystal clear.

Got it. Full menu services but yes, perfect. Thanks. I will jump back in.

Thank you. Our next question comes from Quinn Fredrickson from Baird. Your line is open.

Good morning Brian.

Good morning.

So maybe just starting off on the ES business. You mentioned the plans, price increase for 2020, can you give us a sense for maybe the timing of implementing that. I know last year you said you guys implemented that a little bit earlier than normal. Would that be the case this year and then also just a sense of magnitude you might expect that to contribute just given some of the inflationary pressures you're seeing?

Yes. Our plans are to implement the price increases in period 12 this year consistent with our prior year history.

And yes, we're certainly going to see, I mean, we're coming off of a very robust market conditions. They're certainly going to be inflationary pressure. We haven't seen it in certainly our fuel costs because commodity prices in general have gone down but we've seen, when you have vacancies and everybody else has vacancies you've got a shortage of drivers. You certainly have seen some wage pressure. We will see other inflationary pressures but we certainly think we can get it back with our price increase. So we've done a very good job on the disposal end. As we talked about in our prepared remarks we're going to do more internalization of some of our waste streams, utilizing our wastewater treatment operations. We've been working on permits for a year and a half. We'll begin to see some of the efforts of our labor pay off in 2020 and then that will enhance our margins we think and help us overcome the inflationary pressure that we're going to see out there with a goal of maintaining this margin rate that we've been on in spite of the fact that we continue to have resources, I mean that's been and I just had a fresh off of a board meeting. I mean they're challenging us to grow faster because we have a ton of cash on the books and acquisitions have been difficult because of multiple. So it's the best use of our money at this point even if we give up a point or two on margins preparing for the future. It's good use of capital.

Thanks. That's helpful and then maybe near-term here just for the oil business expectations for utilization rates at the re-refinery and then just remind us, I know you said you did your normal fall shutdown. Any other shutdowns plan in the fourth quarter either normal or more extended?

Yes. Our comment was around our normal fall turnaround. It's typically our longer turn around but it’s in our plan nine, ten days of mechanical work that we will do our normal cleaning operation. We do expect production to be up year-over-year because if you remember we had a major construction project in Q4 of last year. So we had a larger turnaround. This will be a more like our normal turnaround. So the gallons will definitely be up. Absolutely issues and right now knock on wood the plants run great.

Got you. Thank you.

Welcome. Thank you.

Thank you. [Operator Instructions] And our next question comes from Kevin Steinke with Barrington Research. Your line is open.

Hi Kevin.

Hi. Good morning. So your commentary around oil business margins heading into the fourth quarter, I mean thing it sounds like it's safer to assume perhaps sequential contraction in oil business margin from the third quarter given some of the pressures on base oil pricing that you expect and the uncertainty of the timing of a benefit from IMO 2020. So I mean is that reasonable way to think about?

No, we are absolutely on track. I mean it's, every year we see seasonal declines in base oil prices. It's no different this year. The difference for us as we expected to see a more positive impact for IMO 2020 on feedstock cost, but everybody in the industry did the right thing by emptying their tanks and preparation for the lack of demand for used motor oil outside of actual plants and we came off of a pretty good construction season. So everybody had a place to assembly used motor oil. That's going to change. Now the actual plants are no longer operating and using used motor also the tanks are going to fill up, used motor oil is going to lengthen. We're going to fight hard to get some spread back on used motor oil and then we'll begin to see the change again in base oil over the first of the year. That's our expectation. So, yes as we mentioned in our prepared remarks we will see some compression in Q4.

Yes. That's helpful and so in regards to hiring the Director of M&A, it seems like obviously you're targeting more acquisition opportunities on the Environmental Services side. Would there be any areas of interest on the oil business side perhaps something to get you more into the branded lubricant space or is that not anything that you would really consider?

No. We are certainly going to focus our acquisition capital on ES opportunities. We're happy with where we are on the oil front, I mean obviously, it's a key component of our Environmental business because of the collection aspect of used motor oil but we certainly don't feel the need we've got some great wholesale partners that we sell base oil to. We're very comfortable with where we are in the marketplace. Our focus is going to be on growing throughout services business and expanding our environmental clients which all generate used motor oil.

Yes, I mean Brian, I'm telling you might see, if we run the opportunity where they have a part of their full menu is usual oil collection certainly not going to shy away from those. Some of those are some of the best opportunities for us but it's certainly not going to be a foot person oil approach far from it.

Yes. Good point, I mean almost every acquisition we look at they collect these motor oil.

And just maybe expand on increasing the capacity, the production capacity I mean, I guess your confidence in increasing that production capacity to 49 million is simply a matter of the effectiveness of how well the refinery has been running so therefore you feel like the baseline capacity is now higher than it was in the past?

Yes. I mean Kevin I am sorry, that's I talk with you and most of the investors certainly the analysts on this call around beginning of last year end of -- beginning of this year, end of last year about doing this and we said we needed to put together a few quarters of good performance. We obviously had some more rough patches in Q1 of this year and we're ready to do it because we need to demonstrate because of some of the improvements we made in Q4 last year that we really could do it and we have our again scheduled and nowhere near as long as last year but we do have as Brian mentioned somewhat longer quarter or somewhat longer shutdown in Q4 this year. So beginning Q1 we will start to rate it at that higher output of base oil of 49 million.

So Kevin, I mean obviously we made the changes in Q4 and we proved out a run rate in the middle of two quarters. So we're comfortable as we move into 2020 changing the nameplate.

Great. That's all I had. Thanks for taking my questions.

Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now all disconnect. Have a great day.