Quest Resource Holding Corporation (NASDAQ:QRHC) Q4 2023 Earnings Call Transcript

Quest Resource Holding Corporation (NASDAQ:QRHC) Q4 2023 Earnings Call Transcript March 12, 2024

Quest Resource Holding Corporation misses on earnings expectations. Reported EPS is $-0.11 EPS, expectations were $-0.05. QRHC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. This is the conference operator. Welcome to the Quest Resource Holding Corp’s Fourth quarter and Full Year 2023 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Dave Mossberg, Investor Relations representative. Please go ahead.

Dave Mossberg: Thank you, Carl, and 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 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 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 by law to do so. 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 this information.

Certain non-GAAP financial measures will be discussed during this 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 that the presentation of these non-GAAP financial measures is useful to investors understanding and 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 thank you for those joining us on today’s call. We made considerable progress at Quest in 2023, and have begun to see the results of the significant investments we’ve made in the business, both in sales and operations. The actions we’ve taken to date, adding to our sales team, broadening our efforts in a number of verticals, investing in our technology and processes, improving our ability to serve clients, improving our ability to scale the business, and increase operating profits. All of these have positioned us incredibly well, given our robust pipeline, customer focus, efficiency program implementation, and strong competitive position, we expect this momentum to continue into 2024. Simply, our growth focus strategies are working.

We are extremely encouraged by what we’re seeing in the business, both on the top and the bottom line. During the year, we made strides across nearly all facets of our business. We experienced notable customer renewals, growing quality and volume of opportunities in our pipeline, and new business wins, as well as meaningful operational efficiency improvement. We’ve completed the integration of acquired businesses, including RWS, fully incorporating them into the Quest platform. As we mentioned previously, we expect that efficiency initiatives related to RWS will deliver $1.7 million in annual cost savings, and expect to generate additional operating efficiencies and expand our margins in 2024. I also want to point out that Glenn Culpepper, our current Quest’s Director and former Chief Financial Officer of Republic Services, will join the Audit Committee as Chairman.

Glenn will provide new leadership and perspective within the critical function, and we’re grateful he’s assuming this new role. Last quarter, I said I’m more excited than ever about the foundation and underlying strength of our business. This statement was more bullish than any other I’ve made in recent years. Just a few months later, evidence of enthusiasm has borne out. We’ve renewed 2 of our largest accounts. We’ve signed 6 new customers in 2024 alone. And as such, I’m even more confident in our outlook, I look forward to share more details after the financial review. I’ll turn the call over to our CFO, Brett Johnston.

Brett Johnston: Thanks, Ray, and good afternoon, everyone. We had strong fundamental performance during the fourth quarter with year-over-year improvement in revenue, gross profit dollars, and profitability. Revenue increased 11.4% during the fourth quarter to $69.3 million. The revenue increase was primarily related to strong demand for recyclables and non-recyclable material services from both new and existing customers. The revenue increase was partially offset by lower commodity prices realized from certain recyclable materials. While prices for recyclable materials did somewhat offset growth in revenue during the fourth quarter, it did not affect gross profit dollars. Our customer agreements produced consistent gross profit dollars from recyclable materials based on volumes that are not tied to commodity price fluctuations.

For those of you who may be new to our story, this is the reason we use gross profit dollars as a key metric to measure financial performance. Moving on to gross profit dollar comparisons, during the fourth quarter, we reported $11.5 million of gross profit dollars, a 6.9% increase year-over-year. Fourth quarter gross profit includes the effect of $1.2 million non-cash adjustment to the cost of revenue related to the RWS business during prior year periods. In the process of reconciling RWS accounts payable for periods prior to 2023, we found some items at RWS that were not properly expensed in 2021 and 2022. While the integration of RWS had been slower than we would have liked, given the systems that we inherited and the volume of them voices that needed to be worked through, it is important to keep in mind that substantially all of the adjustments made were related to 2022 and earlier.

Any acquisitions will be integrated quickly to avoid this in the future. I also want to point out that with the integration of RWS and all other acquisitions complete, all our clients acquired organically or through acquisitions are running on the same platform with the same processes and controls. Additionally, through our work to become an accelerated filer at the end of 2023, we had an outside firm test and evaluate our controls and processes. We are confident that our systems that handle tens of thousands of transactions across hundreds of vendors can process all our current and growing business. We have not had these types of adjustments in the past with our core operations. Excluding adjustments, we had strong growth in gross profit dollars’ year-over-year.

It was a really strong performance in the fourth quarter and a good end of the year. Looking to the first quarter in 2024, we are encouraged by the record number of new customer wins, Ray mentioned earlier, and expect strong year-over-year growth and sequential growth in gross profit dollars and expect that to continue through the year. Moving on to SG&A expenses, which were $9.4 million during the fourth quarter, down from $9.8 million during the same period last year and in line with our expectations. Looking forward, we expect lower integration costs and to gain efficiencies from the investments we made in our platform. We plan to continue to grow the bottom line, continue to pay down debt, and reinvest savings into growth and efficiency initiatives, continuing to increase our ability to bring value to our clients.

As a result, we expect SG&A expenses will be about $10 million in the first quarter. As efficiency gains are offset by expenses to support new growth and other initiatives, we expect margins to continue to expand from efficiencies and to deliver improving operating leverage in the quarters to come. During the fourth quarter, depreciation and amortization was $2.5 million, which was relatively flat compared with the prior year. Moving on to a review of the cash flow and balance sheet. Our liquidity is in good shape. In this high interest rate environment, we have been actively looking to reduce interest expense by optimizing cash management, carrying less cash, and minimizing borrowings on the line of credit. As part of our working capital management, and in light of increasing interest rates, we paid $7 million in voluntary prepayments toward our term debt in 2023, utilizing excess cash.

Our cash balance was $324,000 at the end of the fourth quarter, and we had $13.2 million drawn on our $25 million operating borrowing line. This compares to $12.2 million at the beginning of the year. Our adjusted EBITDA to senior debt leverage ratio has dropped from 4.3 times in Q4 2022 to 3.6 times in Q4 2023, excluding adjustments. To that end, to further strengthen Quest’s long-term financial position, Quest’s Board of Directors has formed a committee that along with management, will evaluate alternative long-term debt structures to ensure the company can lower its cost of capital and preserve its ability to maximize growth. The committee is in the process of retaining an independent financial advisor to assist in the process. We look forward to discussing this with you over the course of the year.

For the year, we used $1.3 million to fund operations, which was primarily to fund working capital demands at the end of this year. During the fourth quarter, we had slow payments from several of our largest customers, resulting in $7.8 million increase in accounts receivable. This is a temporary increase in AR, and it is not uncommon for our largest customers to slow pay towards the end of the year, which was the case at the end of 2023. AR DSOs were 75 days at the end of the quarter, but we expect they will return to their average in the low-60s that we have experienced during the last several years. At the end of the year, we had $67.8 million in notes payable versus $74.9 million at the beginning of the year. The reduction reflects normal principal payments and voluntary term loan prepayments, partially offset by an increase in borrowing on our asset baseline with PNC.

Through our cash management efforts and the reduction in borrowings, we continue to 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. I have a lot of positive highlights to share with you today, the most exciting of which is the momentum of our organic growth initiatives. So I’ll start off there. The pace of signing new business coming out at the end of the year has picked up significantly, and we have continued to gain momentum in the beginning of 2024. We have more new client wins to talk about on this call than ever in recent history. We’re seeing the results of the hard work by many of the team over the last 2 years to develop our go-to-market sales efforts. We’re producing record customer wins and meaningfully expanding existing client relationships at an accelerated pace. We’ve recorded 6 new client wins, 3 of them are 7-digit, and another 1 is an 8-digit win.

In addition, we’ve expanded a smaller customer to 7 digits and renewed and expanded services with 2 of our largest customers. The rate of this new customer growth is unprecedented for Quest, and we’re excited for the future. The 8-figure win is with a Fortune 200 company that’s one of the largest food distributors in the U.S. This is a new end-market vertical for us in the food sector, one that I know well from my food distribution days. We believe we’ll be able to say more about this over the next few weeks, and we’ll begin servicing this client during the second quarter and anticipate they’ll ramp quickly over a 3-month period. Previously, this client was handling their solid ways through a vertically integrated national provider.

This was a competitive process, and we want it based on our reputation, cost effectiveness, a line commitment to diverting greater portion of ways from the landfills, and the ability for us to provide added visibility from our data portal and platform. The three 7-figure wins were with 1 industrial company and 2 large retailers. All 3 of these clients are large companies with national footprints. We’ll begin servicing all of them at the beginning of the second quarter and the opportunity exists to significantly expand the lines of service with all three of these customers. With one of the retailers and the industrial client, we have the opportunity to grow these to 8 figures in annual revenue over time. In addition, we had 2 smaller wins, including 1 with a new automotive service client.

With our initial engagement, we’ll begin servicing a dozen of their several hundred locations and are actively working to secure their entire footprint. In addition to closing several deals in recent months, we’ve continued to see a noticeable uptick in not only the number, but the size of opportunities in our pipeline. With success we’re having with new client wins, we plan to accelerate our investment in organic growth initiatives, including investments in marketing and sales during 2024. Our last call, we spoke about the new sales leadership and investments in sales operations that will allow our sales folks to spend more time on closing and less time on the more administrative functions such as proposals and lead generation. In addition, we’re shortening the sales cycle by simplifying our contracts and using our new sourcing tool to turn around proposals more quickly.

Our sourcing tool allows our staff to look across our entire footprint of vendors for qualification and pricing data. The tool reduces the time it takes for our staff to find optimal solutions from days to minutes. These investments in sales are helping us grow our pipeline, shorten the sales cycle, and create a better yield in converting proposals into agreements going forward. Regarding client renewals, we have recently signed multi-year renewals and expanded our engagement with 2 of our largest clients. It says a lot about our value add when clients award you additional business. It comes as a direct result of our focus on long-term strategic relationships and not having relationships that are transactional in nature. Importantly, our success is also driven by our people.

We have an outstanding team of operations folks that go above and beyond to help our clients and cost effectively meet or exceed their sustainability goals, and I really want to recognize them for their hard work. Because of our strategic client relationship focus and our great people, the average engagement of our top 20 clients is 9 years. Our land and expand strategy has consistently delivered solid growth from our existing client base in the last 5 years, and we feel there are ample opportunities for continued growth from our existing clients for multiple years to come. I will now review the investments we’re making in technology. Over the years, we built a technology platform that will be able to scale to the size of a much larger enterprise.

The technology platform has been a key deciding factor for several competitive wins, and it’s helped us maintain enduring client relationships due to the incremental value that we provide. In recent years, we’ve stepped up investments in our technology platform so that we can stay ahead and continuously improve client value, efficiency, and scalability. We’re actively introducing additional technology improvements in 2024. These improvements will enable us to further automate, lower the cost to process invoices, provide major enhancements to our ability to scale, and to expand our margins. A good example is a new vendor source until that I discussed earlier, which is helping us accelerate our quoting and onboarding process. In addition, we’re rolling out a technology enhancement that will allow us to further automate the processing of vendor invoices and achieve significant cost savings and margin improvements.

Our technology investments are aimed at improving customer experience, increased in efficiency, and lowering our cost to serve. A great example is vendor management. We’ve added more than 400 new vendors to our platform, providing 7 new service lines, all of which have great revenue potential across our customer base. Our technology is enabling us to do this faster, more efficiently, and at a lower cost. Over the past year, we’ve lost our vendor portal, which allows an automated self-service type of completion documentation and onboarding for a vendor. This is saving hours of work, increasing accuracy, and lowering our costs. Before I move on to our outlook, let me make a brief comment about the macro environment and our views on inflation and broader economic uncertainty.

During the fourth quarter and in recent months, we continue to see stable activity levels across our end markets. We managed cost pressures and fluctuation in the price of the recycle materials as well. The waste business is generally resistant to recession, 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 private relationships that endure during periods of economic weakness. Regarding our outlook, I want to emphasize the conviction on our trajectory and on 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 for 2024 and beyond.

I feel very good about the organic growth we have in front of us, pressure to improve sustainability, increasing regulation, increasing cost of landfills, continue to lower bar for adoption of our recycling services. We have multiple sources of organic growth from expanding with our existing clients, ramping up recent wins, and growing the pipeline of new business. I also want to reiterate that we have a large opportunity to grow gross profit dollar growth on the cost side by optimizing the business we have in hand. As we bring revenue onto our platform, we’ve proven our ability to optimize cost of services through vendor relations and procurement management that drives our continued growth in gross profit dollars. Similarly, we have multiple ways of improving efficiency by utilizing the technology investments we’ve made over the last several years.

With the integration of RWS complete, it has transitioned from being a distraction to a value-added part of our overall business. While the cleanup adjustments for RWS have been very frustrating, we’re now running all of our business on a common platform. Through our integration efforts and other actions, we expect to recognize approximately $1.7 million in annualized savings from RWS, a portion of which began during the fourth quarter of 2023. We also expect additional savings from other niches as well. Finally, we have reduced our leverage, will continue to pay down debt, and plan to lower our cost of capital, while preserving our ability to grow. With fiscal 2024 now underway, we look ahead with great confidence. The work we’ve done is centered on building a consistent and sustainable business focused on providing valued services to our clients.

The foundation is set for continued success and to build value for our shareholders. We expect our momentum to carry through this year and beyond, I couldn’t be more excited about what’s to come. I look forward to keeping you updated on our progress. We’d now like the operator to provide instructions on how listeners can queue up questions. Operator?

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Aaron Spychalla of Craig-Hallum. Please go ahead.

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Q&A Session

Aaron Spychalla: Yeah, good afternoon, Ray and Brett. Thanks for taking the questions.

Ray Hatch: Hi, Aaron.

Brett Johnston: Hi, Aaron.

Aaron Spychalla: Hi. Maybe, first, thanks for the color on the wins and definitely good to see. Can you just talk about are you starting to see improvements in pipeline conversion or is it still kind of status quo just given the macro? And then, maybe not customer by customer, but it sounds like there’s still some good potential for land and expand there. And then just also on the onboarding times, you kind of mentioned a handful of months. Can you just kind of talk about where that stands today and then some of the efforts there to kind of shorten those onboarding times?

Ray Hatch: Yeah, I’ll go to the question about the pipeline. We’re really focused on growing that with quality clients or prospects, I guess, at that point. And really it’s accelerated and it’s continued to accelerate. I really want to congratulate the sales team for being very aggressive in getting a message out and getting them in. So as far as conversion rate goes, it’s obviously picked up, Aaron, because the number of signed deals that we have in just in the last several months have exceeded anything we’ve done for several years, frankly, as far as new clients go. So we’re excited about that. So, I guess, you can say the pipeline’s moving more quickly and it’s bringing us really the type of clients we’re looking for.

And your second comment, I believe, is about land and expand. All of these clients, some of them with huge amounts of upside, these are relatively large clients that are generating a lot of waste and have a lot of need for what Quest is bringing them. So I’m really excited about the ability to continue to ramp those things up and mine continuous new revenue and profit, profitable exercises to those new clients we’re bringing on board and the wins that we already have on. And you had another part there, Aaron, oh, it was about ramp up time, I believe. And it depends on the type of client, Aaron. I mean, some of them are 30 to 60 days, some of them are a couple of quarters. Industrial wins take a little longer. But, I think, we mentioned specifically on the largest win we just mentioned, we’re looking at a 90 days or less window of ramp.

So as we move through Q2, that should get us through the ramp on that client. Others will just come as they come.

Aaron Spychalla: Understood. Thanks. And then just maybe on free cash flow, you touched on it a little bit, but it sounds like that was mostly kind of working capital related to end the year. Just it sounds like are you thinking that that improves as we kind of move throughout 2024?

Brett Johnston: Yeah, absolutely, Aaron. We’ve talked about that at the timing. We expect to finish the quarter strong, especially on AR, and collect a lot of that push forward. So, you back that out, and we certainly would have finished the year as a generator of operating cash. So we feel really confident about going forward.

Aaron Spychalla: All right. And then if I could just sneak one more in, just on the RWS kind of revenue adjustment in the quarter, can you just kind of talk about are we kind of complete with those integration initiatives and, hopefully, shouldn’t hear too much more there moving forward?

Brett Johnston: Absolutely. And just to be clear, it was a cost of revenue, not a revenue adjustment. So it was on the cost side. And, absolutely, we knew we needed to get them on our platform, our processes, first and foremost. And then it was just about going back and doing some cleanup work. So we feel very confident going forward.

Aaron Spychalla: All right. Thanks for taking the questions, and congrats on all the progress. I’ll turn it over.

Brett Johnston: Thank you.

Ray Hatch: Thanks, Aaron.

Operator: The next question comes from Gerry Sweeney of Roth Capital. Please go ahead. Mr. Sweeney, your line is open. Please go ahead, sir.

Ray Hatch: Hey, Gerry.

Gerard Sweeney: Hey, sorry about that. I was on mute. Thanks, Ray and Brett. Thanks for taking my call. Question on the food side or the food distributor win. I was curious if this has to deal with the Proganics program, and if it does – is this maybe an opportunity – this Fortune 200 company, is this sort of a foothold win with Proganics, and potentially into the rest of the industry?

Ray Hatch: So that’s one of the great things about all the multiple services that Quest has to offer. Initially, it doesn’t have it, but that’s because it’s expanding to that over time. So that’s all upside for us as we move through the next few months with them. And then, also, there’s things like fleets and other stuff, too. So there’s an infinite number of penetration opportunities there, and we’re excited about Proganics being part of that. And, yes, this is our first food distributor. And I’m obviously, from my background, pretty excited about that. And we think that this is going to hopefully yield us a lot of penetration of that vertical going forward.

Gerard Sweeney: So suffice to say, $10 million – well, 8-digits, I’m saying $10 million, hopefully, it may be a little more, but that’s even without Proganics. So I mean, that’s a big win with a lot of runway in front of it.

Ray Hatch: Yeah, the revenue piece there is without all the penetration pieces that we expect to be bringing in the relative near future.

Gerard Sweeney: Got it. Couple questions, SG&A, $10 million. I think on Q1, you talked about spending a little bit on tech, but also ramping up, I think, sales and marketing. If memory serves correct, I’m getting a little older, I was under the impression technology spending may be coming down a little bit. But I’m just curious as to where – spending on sales and marketing is great, especially if you can get a return on it. I understand that. Just curious as to where SG&A will come out in the future. And certainly, if it’s higher, how much technology versus increase in sales and marketing?