Heritage-Crystal Clean, Inc (NASDAQ:HCCI) Q4 2022 Earnings Call Transcript

Heritage-Crystal Clean, Inc (NASDAQ:HCCI) Q4 2022 Earnings Call Transcript March 2, 2023

Operator: Good morning, ladies and gentleman, and welcome to the Heritage-Crystal Clean, Incorporated Fourth Quarter 2022 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 your questions. Instructions will be provided at that time for you to queue up your question. 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 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 Executive Vice President and 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 Recatto: Thank you, Colby. Good morning, everyone, and thank you for joining us today. On behalf of the entire Crystal Clean team, I want to let our investors know that we are very pleased with our record setting fourth quarter and full-year performance. We produced record revenue, net income and EBITDA during the fourth quarter. Mark will provide additional detail, but total fourth quarter revenue exceeded expectations at $241.1 million, which helped produce record EBITDA of $52.9 million. Now, I’d like to discuss the results in both of our reporting segments. Let me start with our Oil Business segment. During the fourth quarter of fiscal 2022, Oil Business revenues increased 14.3% to $75.3 million compared to the fourth quarter of fiscal 2021.

The increase in revenue was mainly due to an increase in our base oil netback of $0.67 per gallon compared to the fourth quarter of 2021. Oil Business segment operating margin performed better than expected for the fourth quarter of 2022, but decreased 7.3 percentage points to 26.4% compared to 33.7% during the same period of 2021. The better than expected operating margin was mainly attributable to a higher spread between the netback on our base oil sales and the price paid/charged to our customers for the removal of their used oil. In comparison with the fourth quarter of 2021, the decrease in operating margin was mainly due to increased cost related to transportation and hydrogen expense, as well as lower leveraging of fixed cost due to lower production partially offset by an increase in the spread.

Our re-refinery team produced 13 million gallons of base oil during the quarter, which was approximately 8.1% less than the fourth quarter of 2021. A lower production was caused by an increase in unplanned downtime when compared to the fourth quarter of 2021. Let’s now move on to the Environmental Services segment. In the Environmental Services segment revenue for the fourth quarter of 2022 was $165.8 million compared to $103.7 million for the same quarter of 2021, an increase of $62.2 million or 60%. The increase in revenue was mainly due to the continued reopening of the U.S. economy post the COVID-19 pandemic, as well as revenue from our acquisition of Patriot Environmental during the third quarter of fiscal 2022. We experienced volume increases across all of our service lines in this segment during the fourth quarter of fiscal 2022 when compared to the fourth quarter of 2021.

Our revenue growth was achieved despite the negative impact of winter storms in parts of the Midwest and Eastern U.S. near the end of the fourth quarter. Environmental Services segment profit before corporate selling, general and administrative expenses was $35.1 million or 21.2% of revenue compared to $22.8 million or 22% of revenue in the year-ago quarter. The decline in margin on a percentage basis was due in part to increased equipment rental expense and solvent cost. While we are disappointing with our operating margin in this segment during the fourth quarter, we have a plan to improve our performance in upcoming quarters. One of the areas which impacted our legacy branch business during the fourth quarter and throughout 2022 was supply chain issues related to third-party waste disposal.

For example, our main outlet for incineration waste disposal was down and could not process waste for a majority of 2022. We also encountered multiple situations throughout last year when other third-party disposal outlets had operational challenges and could not accept waste. These outages caused us to redirect hazardous waste to secondary outlets at a higher overall transportation and disposal cost. Looking forward, our main incineration outlet has been back online and processing waste for a few months. We are also hopeful that between our efforts to vertically integrate from a waste processing standpoint and receiving more reliable service from other hazardous waste processing partners at 2023 will bring improved efficiencies related to waste disposal.

We successfully processed approximately 88,000 waste containers at our non-hazardous waste processing facilities and expect to increase our throughput by 30,000 containers during 2020. We are also beginning to see tailwinds in other commodities, supporting our drum transportation and disposal business items such as containers, fuel, treatment chemicals, and parts washer solvent have all stabilized or decreased in price over the past few months. From a revenue perspective, in our Environmental Services segment, we’re expecting to continue to have topline revenue growth as we are not seeing any measurable decrease in demand during the early part of the first quarter. We expect to have strong double-digit revenue growth in early 2023 with moderating growth as we progress through the remainder of the year due to an expected slowdown in macroeconomic conditions.

The expected strong revenue growth is particularly exciting given the strong comps we’ll be facing throughout 2023. From an operating margin percentage standpoint. Despite our fourth quarter results, we still believe we can increase profitability to the mid-20% range, even though it is taking longer than expected. Did a continued inflationary and hazardous waste supply chain issues. We initiated another price increase at the end of the fourth quarter, and we expect to realize most of the benefits of this increase in the first quarter of 2023. Machine translated an improvement in operating margin as we move forward. On a run rate basis, we expect to exit 2023 in the mid-20% range from an operating margin perspective. In the Oil Business segment towards the end of the fourth quarter of 2022, we saw base oil demand softening.

Inline with seasonal expectations, we have continued to experience soft demand in the beginning of 2023. During the first half of this year, we expect spreads to continue to be strong. We are forecasting spreads to moderate the second half of the year to what we think will be the new long-term norm, which we believe will be above pre-pandemic levels. From an operating margin standpoint, we expect full-year 2023 to be in the mid-20% range with higher margins in the first half of the year than moving slightly lower in the second half of the year. Finally, I want to take a minute to discuss one of our more exciting opportunities. In early 2023, we introduced our 4never branded solution for management of PFAS contaminated waste. 4never is a first to market program, which utilizes both PFAS concentration and destruction technology, which provide landfills and industrial businesses, a single solution to the complex and potentially costly problem of management of PFAS waste streams.

We are very excited about this opportunity and we have received a lot of interest in this new service from the marketplace. Our current focus is on ramping up our ability to provide this service to meet the demands of the market. While we are in the infancy of the program, we believe this business has the potential to deliver approximately $25 million in revenue on a run rate basis by the end of 2023. With that, Mark will take us through our fourth quarter financial results.

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Mark DeVita: Thanks, Brian. It’s a pleasure to speak with everyone today. In 2022, we generated $709.3 million of revenue compared to prior year revenue of $515.3 million, an increase of $194 million or 37.6%. The company’s 2022 fiscal year was comprised of 254 working days compared to 253 working days in fiscal 2021. On a sales per working day basis, revenue increased approximately 37.1% in fiscal 2022 compared to the prior year. This increase in revenue was due to improvement in base oil pricing in our Oil Business segment, along with increased demand and higher selling prices. For the products and services in our Environmental Services segment, as well as by revenue from our acquisition of Patriot Environmental near the end of the third quarter of 2022.

Net income was $27.6 million or $1.16 per diluted share for the fourth quarter of 2022. This compares to net income of $18.1 million or $0.77 per diluted share in the year earlier quarter. Adjusted net earnings for the quarter were $18.8 million with the largest adjustment compared to GAAP net income being a $12.2 million unrealized gain recorded in the fourth quarter of 2022 as a result of a remeasurement of our investment in Retriev Holdco, LLC, which was initially made earlier in 2022. Our fourth quarter 2022 adjusted diluted earnings per share were $0.81 compared to $0.79 in the fourth quarter of 2021. Let’s get into the details and discuss our Oil Business segment results. As Brian mentioned, our Oil Business segment revenue increased 14.3% to $75.3 million compared to the fourth quarter of fiscal 2021.

An increase in base oil prices was the main driver of the increase in revenue on a year-over-year basis. Brian mentioned that the base oil market softened during the fourth quarter compared to the third quarter of fiscal 2022. This softening resulted in our base oil netback decreasing by $0.80 per gallon during the fourth quarter compared to the third quarter of 2022. From a volume perspective, we sold 13.7 million gallons of base oil during the fourth quarter, which represents a 2.2% decline compared to the fourth quarter of fiscal 2021. From a profitability standpoint, Oil Business segment operating margin was $19.9 million or 26.4% of segment revenue during the fourth quarter compared to $22.2 million or 33.7% in the year-ago quarter. In addition to the factors Brian already mentioned, segment profitability was also negatively impacted by higher natural gas costs.

On the used oil collection side of the business, our weighted average pay for oil increased by $0.22 per gallon in the fourth quarter of 2022 compared to the fourth quarter of 2021. Compared to the third quarter, our pay for oil decreased by $0.03 per gallon during the fourth quarter. The fourth quarter was the first quarter since Q2 2020 that our pay for oil declined on a sequential basis. From a volume perspective, we collected 13.7% more used oil during the fourth quarter of 2022 compared to the fourth quarter of 2021. From the re-refinery perspective, we produced 47.2 million gallons of base oil during fiscal 2022, which represents 94.4% of nameplate base oil capacity. This represents a slight decline from record production in 2021. The decrease in base oil production was primarily due to the increase in unplanned downtime at the re-refinery during the fourth quarter, which Brian mentioned earlier.

Now let’s discuss Environmental Services. The Environmental Services segment reported revenue of $165.8 million, an increase of $62.2 million or 60% during the quarter €“ compared to the fourth quarter of fiscal 2021. The increase in revenue was mainly due to the continued reopening of the U.S. economy post the COVID-19 pandemic, as well as revenue from our acquisition of Patriot Environmental made during the third quarter of fiscal 2022. The organic revenue increased during the fourth quarter compared to the prior year quarter was driven by both volume and pricing in our parts cleaning, wastewater vacuum and antifreeze businesses, and primarily volume in the containerized waste and field services businesses. Revenue from the Patriot Environmental acquisition during the fourth quarter was $36.6 million, which represented 35.3% of revenue growth for the segment compared to the fourth quarter of fiscal 2021.

On a sales per working day basis, overall Environmental Services segment revenue increased approximately 57.9% compared to the prior year quarter. Our profit before corporate SG&A expense as a percentage of revenue decreased to 21.2% compared to 22% in a year-ago quarter. The decline in margin percentage was primarily driven by higher fuel costs, solvent expenses and equipment rental expense. Our overall corporate SG&A expense of $28.7 million increased by $8.2 million compared to the year-ago quarter. The increase was mainly driven by higher salaries and benefits as well as higher amortization of intangibles related to acquisitions. Corporate SG&A expense as a percentage of revenue decreased slightly to 11.9% from 12.1% in the year-ago quarter, mainly due to higher revenue and lower share-based compensation expense.

EBITDA for the fourth quarter was $52.9 million and up 60% or $19.7 million compared to the year-ago quarter. This represents the third consecutive quarter of record EBITDA, adjusted EBITDA of $42.1 million with 17.5% of revenue and represents a 17.9% increase compared to the prior year quarter. The company’s effective income tax rate for fiscal 2022 was 26.5% compared to 25.8% in fiscal 2021. The difference in the effective tax rate is principally attributable to the diminished impact of certain required adjustments to financial reporting income in determining taxable income in fiscal 2022 as compared to the impact of those adjustments in fiscal 2021. Looking at the balance sheet, we had $22.1 million of cash on hand at the end of the quarter.

This balance is reflective of a $10 million payment on our revolving loan made during the fourth quarter. Our primary sources of liquidity for the quarter were cash flows from operations and funds available to borrow under our revolving bank credit facility. We generated $34.2 million in cash flow from operations during the quarter, which represents a 22.6% increase compared to the fourth quarter of 2021. We generated free cash flow of $10.7 million during the fourth quarter of 2022 compared to $15.9 million during the fourth quarter of 2021. From an M&A perspective, we have a robust pipeline of opportunities and we continue to look for target companies, which we believe will fit well with our strategy. Regarding our recent acquisition of Patriot Environmental as at the end of fiscal 2022 on an annualized basis, we effectively achieved our cost synergy goal and we continue to look for more synergy opportunities as a result of this transaction.

I want to let everyone know that we intend to begin reporting our results in three segments, beginning in the first quarter of 2023. Our Oil Business segment will continue to reflect the same activities reflected in the Oil Business segment in the past. However, we will begin to report the results from the former Patriot Environmental business, the HCC Legacy Field Services business, and the operations of our non-hazardous waste processing facilities in our new industrial and field services segment. For clarity, our non-hazardous waste processing facilities include our wastewater treatment and containerized waste processing operations. We believe the new industrial and field services segment will represent approximately one-third of the revenue previously included in the Environmental Services segment.

The remainder of the activity historically reported in the Environmental Services segment will continue to be reported in the new Environmental Services segment. As it relates to Brian’s forward looking comments about the Environmental Services segment, we expect the new Environmental Services and the new Industrial and Field Services segments to have similar revenue growth rates. Regarding operating margin, the guidance Brian just provided was based on if we were to continue to report Environmental Services on a combined basis. As we begin to strip out industrial and field services and report it separately, we would expect the new Environmental Services segment to have an operating margin, which is a couple percentage points higher than what Brian alluded to earlier on a combined basis.

And we would expect the new industrial and field services segment to have an operating margin percentage, which is a few percentage points lower than what the operating margin percentage would have been on a combined basis. In addition to the reporting segment changes I just mentioned, I want to remind everyone that effective January 1, 2023, we are reporting our results on a calendar quarter and calendar year basis. To summarize, we are excited with the strong topline growth we’ve experienced in our Environmental Services segment, and we are focused on finding ways to improve our operating margin in this segment. We continue to be pleased with our ability to capitalize on the new fundamentals and our Oil Business segment and to produce improved profitability compared to pre-2020 results.

This concludes our prepared remarks. I will now turn the call over to Colby to take your questions.

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Q&A Session

Operator: Your first question comes from the line of Quinn Fredrickson from Baird. Your line is open.

Quinn Fredrickson: Hey. Good morning, guys. First just on the new segment reporting structure. Will we be getting historical pro formas? Will that just be provided on the first quarter or will we get that ahead of time? Just wondering on what we’ll be getting for that?

Mark DeVita: That will be with the quarter. Yes. We’d like to send it out ahead of time, but we want to make sure it’s right. Obviously there’s a lot of minutiae to the reforecast or recasting I should say, of the business. So that’s when you should expect to see it.

Quinn Fredrickson: Okay. Thank you. And then secondly, I was wondering if you could break down some of the factors that underlie your 2023 organic growth outlook for ES in terms of what you might be assuming for market growth, any rollover pricing, new pricing and share gains?

Mark DeVita: Well, I’ll start off, Brian can contribute. But just from a pricing breakdown, we’ve seen in most of the lines of business, and I mentioned €“ I called a few of them out the last quarter and probably for the last couple of quarters, we’ve seen roughly a 50-50% or 50-50 breakdown, maybe a little more skewed towards volume in one quarter in 2022 and price the other, but pretty close to 50-50 as far as price and volume that’s driving the increase. Containerized waste has been more skewed to volume, but the rest of them have been in that range, and we would expect to see roughly that same amount. I mean, volume should be coming €“ we’re not €“ Brian alluded to, we’re not going to be growing at the same rate that we’ve been growing at in a lot of businesses and the inorganic growth.

But from a pricing standpoint, also, if there is a softening of the economy, which we believe is inevitable here, and that starts to add headwinds to volume, we’re probably not going to be able to take as much price as we’ve been able to do in the last 18 months. I mean, we’ve had roughly four price increases in that timeframe, and it’s going to probably get harder and harder, even though our realization has still been pretty good. We don’t expect to see that. So we see both of them coming down together, but there should be a mix of both. I don’t know, Brian, if you have any clear view

Brian Recatto: I do think Quinn, from a hazardous waste standpoint, we’ll do some additional price increases throughout the year in a more rifle shot approach, just because the demand is still very, very strong in our ES business and the hazardous waste treatment facilities are still a bit backed up with waste that’s sitting at the customer location. So we will see another opportunity to raise prices on the hazardous waste end. And obviously, you know, that we’re building our own treatment capabilities in the non-haz market, which has given us some nice tailwinds in terms of growth where we’re able to go out and chase some larger industrial business. As we talked about in our prepared remarks, we’re pretty excited about the PFAS growth opportunities.

We already have equipment working at our Michigan location, so we are treating PFAS contaminated water and it’s going to be a nice tailwind towards the back of the year to help us with ES growth. So we still feel very good about overall prospects in ES.

Quinn Fredrickson: Okay. That’s helpful. And then if I could just sneak one more in, you mentioned the mid-20s operating margin for oil business. Is that still kind of the right way to think about that business as a normalized margin rate going forward even beyond 2023?