Earnings Call Transcript - QRHC Q3 2020

Operator, Operator

Good day and welcome to the Quest Resource Holding Corporation’s Third Quarter 2020 Earnings Call. Today's conference is being recorded. At this time I'd like to turn the conference over to David Mossberg, Investor Relations. Please go ahead, sir.

Dave Mossberg, Investor Relations

Thank you, Kareena. And thank you everyone for joining us on the call today. 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. Use of the words like anticipate, project, estimate, expect, intend, believe, and other similar expressions are intended to identify those forward-looking statements.

Ray Hatch, CEO

Thank you, Dave. And thanks everyone for your interest in Quest. We hope that you and your families are healthy and safe, and we appreciate that you've taken the time to join us to discuss our third quarter results. To start off, I'm happy to report that our business is on extremely solid footing. That said, we recognize the uncertainty in the current environment and remain ready to act in the event of any short-term softness in our business. During the third quarter, gross profit dollars improved sequentially from the second quarter, year-over-year gross profit dollars decreased by less than 5% as weakness in some of our end markets was almost entirely offset by strengthening in others. We benefited from a flexible cost structure and did a good job controlling costs, which led to a 15% year-over-year growth in EBITDA.

Laurie Latham, CFO

Thank you, Ray. Good afternoon to everyone on the call. Third quarter revenue was $23.7 million, relatively flat compared with $23.9 million in the third quarter last year. The decrease was primarily due to lower levels of services resulting from COVID-19 related shutdowns or reduced operations in some of our customers. These impacts are mostly offset by increased services above our continuing and new customer base. Gross profit was $4.6 million, a decrease of 4.5% when compared with the third quarter last year, and an increase of 4.2% sequentially from the second quarter of 2020. Gross margin for the third quarter was 19.2%, which was a 70 basis point decline compared with last year, but still well above our targeted level. The year-over-year decrease was primarily related to the mix of services that we performed. SG&A expenses were $4.3 million during the third quarter compared to $4.2 million during the same period last year. Included in SG&A for the third quarter were $355,000 in professional fees related to M&A activity. Excluding these fees, SG&A expenses would have decreased about 7% year-over-year. Most of that decline was related to reduced labor and travel expenses. In the near term, while certain SG&A expenses such as travel will continue to remain low, we expect SG&A costs will increase from Q3 levels due to business recovery. I’ll also note that we expect corporate development expenses in the fourth quarter will remain at elevated levels related to the closing of the Green Remedies transaction. During the third quarter, depreciation and amortization decreased year-over-year by approximately $180,000. This was primarily due to the full amortization of one of our intangible assets at the end of the second quarter.

Ray Hatch, CEO

Thank you, Laurie. Today I'd like to cover several key points in my prepared remarks. First, I'll give some details of what we're seeing in our major end-markets. Second, I'll discuss how new business opportunities are going to move our pipeline again. Finally, I will cover M&A activities and describe the opportunity we have for growth in the multifamily housing markets with the acquisition of Green Remedies. So first, in terms of what we're seeing in our end-markets, we're in frequent contact with our customers and monitoring end-markets across geographies in order to be prepared to adjust based on any changes in our customers' business. Keep in mind that what I'm about to describe reflects market activity levels, which correlate but do not always match our financial performance. Unfortunately, service businesses that are considered essential have remained operational through this period. We also have a diversified end-market mix, so strength in some markets offset weakness in others. The grocery market has stayed stable throughout this period and has even experienced modest growth year-over-year. We continue to work with our grocery customers to divert more waste from landfills and grow the programs we have in place. In the automotive market, demand for automotive repair and maintenance services has improved since April, although it is still down year-over-year. The number of passenger miles driven can be used as a proxy for overall economic activity in this segment. According to the U.S. Department of Transportation, passenger miles driven were down about 14% on average during the third quarter. They were down 18% at the beginning of the quarter but have remained down approximately 10% to 12% in the last couple of months. For reference, this is a significant recovery relative to the 50% decrease we saw during the lows of the pandemic in April. Activity levels in the industrial market have also recovered sequentially from the second quarter but are still down year-over-year. The pandemic had less effect on investment and did shift order deliveries due to temporary closures related to the virus and supply chain issues. Our customers are now working through backlogs, and activity levels have picked back up. Of all our end-markets, as you might expect, the restaurant sector is seeing the largest impact from the pandemic. This was one of our fastest-growing areas prior to COVID-19. However, I want to emphasize that our restaurant business still constitutes the smallest market in our overall mix. While our full-service restaurant customers have been significantly impacted, quick-service customers have performed well in terms of volumes. Overall, this end-market has recovered sequentially from the second quarter but remains significantly lower year-over-year. I want to address new customers and the velocity of our sales pipeline. During the early stages of the pandemic, there was little or no movement in our pipeline, as many prospects slowed or even stopped their evaluation projects, diverting their attention to focus on protecting the health and safety of their employees and adapting their operations to the market changes caused by the pandemic.

Operator, Operator

Thank you. We'll take our first question from Gerry Sweeney with Roth Capital. Please go ahead.

Gerry Sweeney, Analyst

Good afternoon, Laurie and Ray. Thanks for taking my call.

Ray Hatch, CEO

Hi, Gerry, how are you?

Laurie Latham, CFO

Hi.

Gerry Sweeney, Analyst

I wanted to start maybe a little bit on the COVID side and recognize that you may or may not want to answer the question in its entirety. But we've got to put it out there and how much visibility or communication do you have with your clients on what their view of the next several months in regards to COVID? And the second part of the question is, as you look at managing internally at Quest, are you prepared to handle moves up and down as your customers envision?

Ray Hatch, CEO

Okay, Gerry, I appreciate that. I'll answer your second question first. I think what I'll do is refer directly to the way Quest was able to handle the significant challenges in March and April, early in the pandemic. We assessed, evaluated, and executed, and the company managed quite well. I would expect us to manage future situations in the same effective way. Regarding the visibility to our customers and the COVID situation, it is quite challenging. We do have constant communication with those customers; our services team is in contact regularly, and the management group conducts business reviews that involve broader picture conversations. There is a lot of optimism, but the fact is we’re still waiting to see what happens. They don’t know what the future holds either. But with what happened last time, I was very pleased with our communication with customers during the pandemic and our ability to react to their changing situations. We executed well, which involved a lot of service adjustments in response to their needs. So, the visibility is seasonal; communication is great, but wider visibility remains difficult based on the situation.

Gerry Sweeney, Analyst

Got it, I appreciate it. I know it's not necessarily an easy question to answer. Switching gears to the automotive client that you're working with on a pilot project, is there any way you can provide either a potential size for the contract or how large that customer is? Additionally, what does the progression from pilot program to a more permanent arrangement look like?

Ray Hatch, CEO

Well, I can tell you the size of the opportunity is significant. The average deal size has been seven figures, and this opportunity is definitely above that number. From an opportunity perspective, we're anticipating that it will be successful and will roll out in Q1 or Q2, hopefully with impacts seen by then. It is a substantial opportunity, and we’re pleased with the challenges that it presents to various aspects of our business.

Gerry Sweeney, Analyst

Got it. And the pilot will start in Q1?

Ray Hatch, CEO

Yes, it will start in Q1.

Gerry Sweeney, Analyst

Got it, could you elaborate on timing regarding the pilot and rollout? It seems that might be dependent on the customer.

Ray Hatch, CEO

Yes, of course. This customer is looking for solutions to today’s problems, specifically focused on cost savings and environmental efficiencies. There are certainly a number of metrics that we are tracking, and we have a high degree of confidence in our ability to deliver for them.

Gerry Sweeney, Analyst

Got it. I'll jump back on the line and I don't want to dominate the question. Thanks.

Ray Hatch, CEO

Okay, thank you, Gerry.

Operator, Operator

Next, we'll take a question from Amit Dayal with H.C. Wainwright. Please go ahead.

Amit Dayal, Analyst

Hi, guys, how are you? Thanks for taking my questions. Regarding the Green Remedies acquisition, does the projected $2.5 million net income contribution factor in growth from your side, or does it just represent the business as it stands today?

Ray Hatch, CEO

Laurie?

Laurie Latham, CFO

That was the last trailing 12 months as it stands today through June.

Amit Dayal, Analyst

And it doesn’t include future growth?

Ray Hatch, CEO

Okay, Amit.

Laurie Latham, CFO

No, it only includes part of it.

Amit Dayal, Analyst

Understood, thank you. Can you provide some insight into the initiatives you may be implementing to drive growth in this business?

Ray Hatch, CEO

Driving growth with the Green Remedies acquisition? That’s a great question. First, Green Remedies is a regional player, 100% exclusive to the multifamily segment. They’ve done a great job in that space, but they face size constraints in handling the oncoming growth from an infrastructure standpoint. There are several areas where we see immediate growth potential. First, our existing technology platform can be integrated to exponentially create capacity for onboarding new customers. Secondly, we are a national player with a network in every market, which allows us to sell nationally where they faced regional limitations. Lastly, we offer a variety of alternatives for waste management and can upsell new recycling programs to customers who want more than what Green Remedies is currently offering. We are very encouraged by this growth potential.

Amit Dayal, Analyst

Understood, thank you. You mentioned potential hurdles or challenges coming from lockdowns. How are we positioned to manage working capital during this uncertain period?

Laurie Latham, CFO

Amit, as you're aware, we're in a very good position concerning our ABL, and we have flexibility, not only in our SG&A line but also in our cost of sales. We have many levers we can pull to maintain low travel expenses, and we've already implemented controls on expenses stemming from COVID-19. We are confident we can navigate through any bumps during this period.

Ray Hatch, CEO

Yes, even without the PPP. While we're thankful for it, we believe we would manage well regardless. Our business is highly variable, as Laurie mentioned, and both our cost of goods and our ability to serve have that flexibility. In terms of our position, I believe we are as well, if not better than others in navigating these challenges. Additionally, a significant aspect of Quest is the diversity of the end markets we serve. No matter what happens, our range of work—from heavy manufacturing to grocery, food manufacturing, and automotive—provides us with a buffer against non-controllable impacts. So with our variable cost structure and the diverse client base we serve, I think we're exceptionally well positioned regardless of the circumstances.

Laurie Latham, CFO

I'm sorry, Amit. Please go ahead.

Ray Hatch, CEO

Operator. Amit, okay.

Operator, Operator

He’s not responding. We'll take our next question from George Melas with MKH Management. Please go ahead.

George Melas, Analyst

Thank you. Thanks for taking my call. Could you talk a little bit? You mentioned a few wins in the prepared remarks, particularly with dealer QSR. Could you characterize those wins and help us understand the pipeline? How has the composition of the pipeline evolved, and at what stage are the current prospects?

Ray Hatch, CEO

Yes, to the first part of your question, I don't think I picked up what you asked about QSR restaurants. Can you clarify?

George Melas, Analyst

You mentioned that you had a few wins, and could you characterize that and tell us more about it?

Ray Hatch, CEO

Yes, we’ve secured a win in the quick-service restaurant franchisee group, which we're really excited about. There's great potential for growth there. Additionally, we mentioned a specialty retailer, which we are currently onboarding at various locations. We also referenced the pilot with the automotive service company, which has numerous locations across the U.S., presenting immense potential for us.

George Melas, Analyst

Okay, great. And maybe can you elaborate on how the composition of the pipeline has evolved in the last six months?

Ray Hatch, CEO

On the pipeline, I want to reiterate that there appears to be much more receptiveness now. People have likely gotten used to this situation, which has made it easier to schedule virtual meetings and have in-depth conversations. With some positive news and light at the end of the tunnel, I believe businesses want to emerge strong once we return to normalcy. This means audiences are more open to engaging in discussions about our offerings. Overall, the conversations are starting to ramp up again after several months of stagnation. Our pipeline is broad, covering various sectors, including restaurants and automotive, and many potential clients are eager to explore food waste diversion programs that were not considered prior to our current engagements.

George Melas, Analyst

Great. One last quick thing—has Quest implemented any changes to sales processes or internal procedures in light of these circumstances?

Ray Hatch, CEO

Yes, indeed. We've made considerable adjustments, including restructuring our cost systems, revising our marketing programs, and enhancing our joint marketing and sales activity to drive lead generation. We're learning to be more effective virtually, utilizing tools we've had access to but not fully leveraged before, such as social media for lead generation. In many ways, we have stepped into a more modern approach, and I believe it's resulting in increased activity and new opportunities.

George Melas, Analyst

Okay, great. Thank you very much.

Ray Hatch, CEO

Thank you, George.

Laurie Latham, CFO

Thank you.

Operator, Operator

That concludes today's question-and-answer session and today's conference call. We do appreciate your participation. You may now disconnect your phone lines.