Quest Resource Holding Corporation (NASDAQ:QRHC) Q3 2023 Earnings Call Transcript

Quest Resource Holding Corporation (NASDAQ:QRHC) Q3 2023 Earnings Call Transcript November 14, 2023

Quest Resource Holding Corporation misses on earnings expectations. Reported EPS is $-0.10223 EPS, expectations were $-0.02.

Operator: Thank you for standing by. This is the conference operator. Welcome to the Quest Resource Holding Corp’s Third Quarter 2023 Earnings Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Dave Mossberg, Investor Relations representative. Please go ahead.

Dave Mossberg: Thank you. This is Dave Mossberg. Your line is cutting out a little bit. So I am going to go ahead and get started. Let me know if you can hear us. Well, thank you, everyone, for joining us on the call. Before we begin, I’d like to remind everyone that this conference call may contain predictions, estimates and other forward-looking statements regarding future events or future performance of Quest. Use of the words like anticipate, project, estimate, expect, intend, believe and other similar expressions are intended to identify those forward-looking statements. Such forward-looking statements are based on Quest’s current expectations, estimates, projections, beliefs and assumptions and involve significant risks and uncertainties.

Actual events or Quest results could differ materially from those discussed in the forward-looking statements as a result of various factors, which are discussed in greater detail in Quest’s filings with the Securities and Exchange Commission. You are cautioned not to place undue reliance on such statements and to consult our SEC filings for additional risks and uncertainties. Quest forward-looking statements are presented as of the date made, and we disclaim any duty to update such statements unless required to do so by law. In addition, in this call, we may include industry and market data and other statistical information, as well as Quest’s observations and views about industry conditions and developments. The data and information are based on Quest’s estimates, independent publications, government publications and reports by market research firms and other sources.

Although Quest believes these sources are reliable and the data and other information are accurate, we caution that Quest has not independently verified the reliability of the sources or the accuracy of the information. Certain non-GAAP financial measures will be discussed during the call. These non-GAAP measures are used by management to make strategic decisions, forecast future results and evaluate the company’s current performance. Management believes the presentation of these non-GAAP financial measures is useful to investors understanding of the assessment of the company’s ongoing core operations and prospects for the future. Unless it is otherwise stated, it should be assumed that any financials discussed in this call will be on a non-GAAP basis.

Full reconciliation of non-GAAP to GAAP financial measures are included in today’s earnings release. With all that said, I’ll now turn the call over to Ray Hatch, President and Chief Executive Officer.

Ray Hatch: Thank you, Dave, and thanks, everyone, for your interest in Quest. I want to start off by emphasizing how excited I am about what lies ahead for Quest in the next several years. We have made significant strides in laying the foundation for growth and earnings. This year, we have made a lot of positive progress, building our growth engine and investing in technology to drive efficiencies to support that growth. In recent months, we have seen a noticeable uptick of the number and the size of opportunities in our pipeline, and we have seen faster than anticipated ramp-up at one of our largest new customers. We also have a robust outlook for growth. In addition, at the end of third quarter we completed the systems integration of RWS.

We uncovered isolated issues related to RWS legacy systems, which resulted in cost of sales adjustments, mostly related to the activity prior to 2023. This is the primary cause of gross profit dollars from RWS being approximately $800,000 below our expectations during the third quarter. While RWS systems integration has been frustrating, it is complete and we have taken action to realize approximately $1.7 million in annualized SG&A cost savings, beginning in the fourth quarter of this year. In addition, we are bringing online several technology enhancements to our platform. We expect these enhancements to improve efficiency, scalability and continuously improve our client value proposition. In summary, I am more excited than ever with the underlying strength and the foundation of our business.

I am looking forward to realizing the resulting bottom-line improvements from our investments in the platform. I’ll now turn the call over to our CFO, Brett Johnson, for a financial overview. I will be back soon to discuss progress on our strategies.

Brett Johnston: Thanks, Ray, and good afternoon, everyone. A quick note about the sequential decrease in revenue. It was primarily related to commodity price fluctuations and normal quarterly volume fluctuations. As discussed on previous calls, commodity price fluctuations have not historically had material effects on gross profit dollars. Our customer agreements produced consistent gross profit dollars, based on volumes that are not tied to commodity price fluctuations. For those of you new to the story, this is the reason we use gross profit dollars as a key metric to measure financial performance. During the third quarter, gross profit dollars were $12.4 million, an increase of 2% versus the third quarter last year and a $1.1 million sequential decrease from second quarter.

The sequential decrease primarily reflected $800,000 from the underperformance of RWS. To a lesser extent, sequential comparisons were affected by decreased contribution from an RWS client that has been acquired by another company. That company that acquired this RWS client manages waste disposal internally, and decided to manage the RWS client similarly. As part of the process of fully integrating RWS onto our platform, we have gained efficiencies and have been able to reduce headcount and cut operating costs at RWS. We anticipate approximately $1.7 million in annualized cost savings beginning in the fourth quarter of this year. Sequential comparisons during the third quarter were also affected by a billing adjustment of approximately $400,000 from a quickly ramping new customer.

While it did affect third quarter results, it represents a very small percentage of this client’s total billings, and we maintain a strong relationship with this client. In fact, excluding this adjustment, the contribution from this client grew during the third quarter and continues to ramp in the fourth. Looking to the fourth quarter, we expect gross profit dollars to increase sequentially from third quarter, and expect our performance to be more in line with our performance in the second quarter. We expect our growth in the quarter will ramp and will mostly offset typical fourth quarter seasonality. In addition, we will benefit from the cost cutting at RWS and overall efficiency gains beginning in the fourth quarter. Moving on to SG&A expenses, which were $9.6 million during the third quarter compared to $9.3 million during the same period last year, and in line with our expectations.

Looking forward, we expect lower integration costs and we expect to gain efficiencies from the investments we have made in our platform. We plan to continue to reinvest these savings into growth initiatives that further improve efficiencies and increase our ability to bring value to our clients. As a result, we expect SG&A expenses will be about $9.5 million in the fourth quarter. Going forward, we expect to begin to see the steady benefits of both cost reductions at RWS and investments in technology and process improvements, which will lower our costs and improve ongoing operating efficiencies. As gross profit dollars increase, we expect operating expenses to grow at a slower pace, as we deliver improving operating leverage in the quarters to come.

During the third quarter, depreciation and amortization was $2.3 million, which was relatively flat with the prior year. Moving on to a review of the cash flow and balance sheet. We are in good shape liquidity-wise and continue to enhance our liquidity. In this high interest rate environment, we have been actively looking to reduce interest expense by optimizing cash management, carrying less cash and minimizing our borrowings on the line of credit. Our cash balance was $870,000 at the end of this quarter and we have $5.4 million drawn on our $25 million operating borrowing line. This compares to $12.2 million at the beginning of the year. We will continue to evaluate our overall leverage and ways to reduce our overall interest expense. Year-to-date, we produced $6.6 million in operating cash flow and third quarter marked our fourth straight quarter of positive operating cash flow.

At the end of the quarter, we had $56.8 million in notes payable versus $70.6 million at the beginning of the year. To summarize, this represents a $14 million reduction in long-term debt year-to-date, which included $7 million of voluntary term loan prepayments. The balance of the reduction reflects normal principal payments and a lower borrowing on our asset-based line with P&C. Through our cash management efforts and the reduction in borrowings, we expect to reduce interest expense by more than 1 million on an annualized basis. At this time, I’ll turn the call back to Ray.

Ray Hatch: Thank you, Brett. While the cleanup adjustments for RWF have been frustrating and have made our quarterly comparisons challenging. I want to emphasize the conviction on our trajectory and the overall outlook for the company. We’ve made tremendous progress during the last several years and are as confident as ever about our outlook for continued double digit growth over the next several years. We are now running all of our business on a common platform, so our integration efforts and other and other actions, we’ve been able to lower head count and can now begin to realize greater efficiencies from these acquired operations. As I said earlier, we’ll recognize approximately $1.7 million in annualized savings from RWS in the fourth quarter.

In addition, we expect to continue to lower overall operating costs and drive efficiencies across the operating platform. Let me make a brief comment about the macro environment and concerns over inflation and economic uncertainty. During the third quarter, we continued to see stable activity across our end markets. We managed cost pressures and fluctuation in the price of recycled materials as well. The waste business is generally resistant to recessions, and our clients continue to generate waste during the top and the bottom of the cycle. We also have compelling and differentiated value propositions, which create strong client relationships that endure during periods of economic weakness. Through our value add, we strive to have long-term strategic relationships with our customers and not have relationships that are transactional in nature.

To illustrate that point, we recently reviewed the longevity of our top 20 clients and noticed the average engagement for Quest was over nine years. We also recently signed a new five year extension and expansion agreement with one of our largest and longest standing clients. While our core business is strong, the one area where economic uncertainty has been affecting us has been the pace of adding new business, which is slower than we would’ve liked over this past year, but a portion of our new clients’ the onboarding ramp has been slower than expected. With certain clients, waste disposal is managed at a local level and in several of those cases has taken longer than we expected to roll out our programs approved by and being driven by the corporate level.

We also have several large opportunities that are taken longer expected to get signed. Anecdotally, these clients and prospects are telling us they believe strongly in our programs, but in some cases other priorities is simply push back implementations. We don’t have prospects falling out. They’re just not moving as quickly as we anticipated. I would also note that this is not the case across the board and we’re winning new business and we’re still seeing growth from existing clients. Moving on to a discussion of our growth. I feel very good about the organic growth we have in front of us. We have multiple sources of growth that give us confidence in our ability to post double digit gains in gross profit over the next several years. We expect growth to come from onboarding activities of recent wins.

In some cases, it can take 12 to 18 months to fully ramp clients, and there are several new clients that are still in the process of ramping, which will provide embedded growth for at least the next year. While the pace of onboarding has been slower than we would like with some clients, we have others that are accelerating the deployment of our programs. As we discussed last quarter, we began onboarding a new client during September at a small portion of their 380 locations. In a short period of time, this client has validated our value proposition and is now asking to roll out services to all their locations, faster than we had originally inspected. In addition, we are being asked to handle a broader line of services than we had previously planned.

With the acceleration of the rollout, we expect this could turn into an eight figure record revenue contributor closer to the end or to the shorter end of our 12 to 18 month timeframe. I should reiterate that this is a new end market vertical for us. There are a few large potential clients in this end market, and we are pursuing peers in this space. The services we provide for this client will have some overlap with our capabilities and existing waste streams, but also give us the scale that required to add capabilities for new waste streams, and we will, in turn, introduce to other new clients. Regarding new business, during the quarter, we had a win in a new automotive service client with a rapidly growing base of 50 locations. We expect this client to generate seven figures revenue at maturity.

In addition, during the third quarter, we had significant wins with existing clients in the retail, automotive and restaurant end markets. Our land and expand strategy has consistently delivered solid growth from our existing client base for the last five years, and we feel there is ample opportunities for continued growth from our existing clients for multiple years to come. We are making new investments in our sales force, which should also provide a driver for growth. On the last call, we spoke about adding a proven new sales leader. In addition, we are adding investments in sales operations that will allow our sales folks to spend more time on closing and less time on more administrative functions, such as proposals and lead generation.

In addition, we’re looking to shorten the sales cycle by simplifying our contracts and using our new sourcing tool to turnaround proposals much more quickly. Our new sourcing tool allows our staff to look across the entire footprint of vendors for qualification and pricing data. This tool reduces the time our staff needs to find optimal solution from days to minutes. These investments in sales should help us to grow our pipeline, shorten the sales cycle and create a better yield in converting proposals into agreements going forward. Another source of growth will come from our growing pipeline of opportunities. As we said in the release, in recent months, we have seen a noticeable uptick in the number and the size of the opportunities in our pipeline.

There are several factors that are likely driving the improvement. The single biggest reason is related to having referenceable clients that can attest to our strong value proposition. As we have demonstrated our value, we have been successful in adding new clients, and it has been much easier to open the discussion with potential clients. I hesitate to estimate when or if these deals may close, but I can say several very large opportunities have progressed to the final stages of approval, and I am confident we will be able to add several new clients in the coming quarters. I also want to reiterate that we have a large opportunity to drive gross profit dollar growth and on the cost side, by optimizing the business we have in hand. Over the last three years, we have more than doubled the size of our business, with about two-thirds of that growth coming from acquisitions and new clients.

As we bring revenue onto our platform, we have proven our ability to optimize the cost of services through vendor relations and procurement management that drives our continued growth and growth profit dollars. Before I move to our outlook, I want to talk a little bit about the investment we are making in technology. Over the years, we have built a technology platform that we will be able to scale to the size of a much larger enterprise. The technology platform we have built has been the key deciding factor for several competitive wins and helped us to maintain enduring client relationships, due to the incremental value we provide. In recent years, we have stepped-up investments in our technology platform, so we can stay ahead and continuously improve client value, efficiency and scalability.

We intend to introduce our new technology improvements during the first half of next year. These improvements will enable us to further automate and lower cost of process invoices and provide a major enhancement to our ability to scale. For example, this will allow us to further automate the processing of vendor invoices and achieve significant cost savings and margin improvements. Regarding our outlook. Based on the progress we have made, I am extremely encouraged with the underlying strength of our business and the ability to generate profitable growth. We expect to end the year strong with sequential improvement in both gross profit dollars and EBITDA. We expect to be a strong cash flow generator in the year of 2023. We have multiple sources of organic growth.

We will continue to drive operating efficiencies and to invest in capabilities. Pressure to improve sustainability, increasing regulation and increasing cost of landfills continue to lower the bar for adoption of our recycling services. We have a tremendous white space of opportunity and we are very optimistic that we will continue with positive momentum over the next several years. I look forward to keeping you updated on our progress. We would like now for the operator to provide instructions on how listeners can queue up for questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions]. Our first question is from Aaron Spychalla with Craig-Hallum. Please go ahead.

Aaron Spychalla: Good afternoon, Ray and Brett. Thanks for taking the questions. Maybe first for me. You kind of touched on it a little bit, but just with the uptake in kind of number and size of deals in the pipeline. It sounds like, it is pretty broad-based. But can you just talk about some of the drivers behind that and any areas or end markets in particular?

Ray Hatch: Actually, there are several end markets, Aaron. Thanks for your questions. Industrial continues to be a real opportunity for us and there is some opportunities in retail as well. I think I mentioned in the remarks, referenceable clients has helped us quite a bit. But also we have had a lot of work going on and prospecting is starting to come to fruition. So the focus that our leadership team on the sales side has putting a lot of great new prospects on the top, is starting to prove out and we are excited about that.

Aaron Spychalla: All right. Good. Thanks for that. And then maybe just on the food waste and Proganics. Seeing numerous states start to implement kind of reduction goals on the food side and penalties starting kind of early in 2024. Can you just give us an update there on where conversations stand with customers and how you see this business contributing to growth going forward?

Ray Hatch: Yes, sure. And you are absolutely right, Aaron. Food waste continues to be an area of focus and it continues to be probably the biggest opportunity or target for diversion from landfills. We have some great customers in that space today and we have some tremendous prospects that we are talking to as well. And to be honest with you, in many cases, grocers are really starting to look at opportunities to do more diversion than they did in the past, based on those pressures that you are just referencing, Aaron. So I encourage more and more regulation and pressures. It speeds up the sales process and we are encouraged by that.

Operator: The next question is from Gerry Sweeney with ROTH Capital.

Gerry Sweeney : Going back to the RWS and then I think the 400,000 charge for the ramp up, two different issues, but maybe looking at root cause. Is there any concern about processes, systems, et cetera that you have to take a look at to make sure this doesn’t happen again? Or how do we look at kind of the mitigation strategies around this?

Brett Johnston : Hey, this is Brett. I’ll take that question. Starting with RWS, I wouldn’t call these the broad base. They were really isolated to two specific issues that were difficult to identify. We’ve done a lot to work on our visibility within RWS before we brought them into our current environment. But we still had a few gaps there. These popped up as we went live in the new systems. And so we feel confident with the processes we have in place, being in our environment, managed through our accounting teams and our operational teams, that we’ve got much better visibility and consistency as we look at more of the recent numbers as we’ve gone live. And then to your other question on the quickly ramping customer, again, it’s a fairly large customer.

It’s really a very small percentage overall. Not systems related, not really a process. It was just an error that was made. And it was over a longer period of time that it was missed and we had a true up. And these things happen sometimes, and I don’t want to diminish it. We’re working on — we don’t want any, but we certainly don’t see any broader base concerns on these types of things.

Gerry Sweeney : Was the RWS — was the issue in the third quarter or was that a lingering issue from over time over the last couple of quarters as you had integrated it? And as you brought…

Brett Johnston : It was a lingering issue. As we stated, most of it was related to activities prior to 2023. So kind of sitting in there and even most of that was non-cash.

Gerry Sweeney : And then on the sales cycle, it seems like it some areas taking longer. I’m just curious if there’s any industries that are moving, maybe the ramp up is going faster than you anticipated and some are slower. And in particular, maybe if you have a lot of rest referenceable accounts in one industry, is that sales cycle sort of faster than an industry where you have less referenceable accounts?

Ray Hatch: Yes, referenceable customers definitely helps speed up the process, Gerry. There’s no question. It’s almost like a due diligence that doesn’t have to be performed by the prospect. So I don’t think there’s industry specific delay or improvement at or in-market specific. I mean, I think it depends on where the prospect is in their decision cycle, how they do it. Some of them are more complex than others. Some of them have a ridiculously long, frankly sign off process that goes through numerous departments. Some of them are much more quicker than that. But I guess what I’m saying is I don’t see that as in-market specific. It’s more company culture specific and how quickly they make decisions.

Gerry Sweeney : And some very large companies — sometimes these opportunities for signing when they come up every like over the course of one year or cycle, is that also part of it? It’s just the way these companies manage the outsourcing services, is that also a way of looking at it?