Earnings Call Transcript - QRHC Q1 2021

Operator, Operator

Good day, everyone, and welcome to the Quest Resource Holding Corporation First Quarter 2021 Earnings Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Dave Mossberg, Investor Relations representative. Please go ahead, sir.

Dave Mossberg, Investor Relations

Thank you, Christie, 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 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. Thanks to everyone for your interest in Quest. We are off to a great start in 2021, after what’s been an incredibly challenging year. During the first quarter, we had top line growth nearly 40%, with organic growth representing more than half of that. This performance reflects gains across our growth initiatives of supporting existing customers, driving organic growth and adding customers through acquisitions, plus a surge in demand due to COVID recovery in certain end markets. We also reached new records in terms of gross profit dollars and adjusted EBITDA.

Laurie Latham, CFO

Thank you, Ray, and good afternoon to everyone on the call. First quarter revenue was $35.1 million, an increase of 38.6% compared to the first quarter last year. Growth came from both new and existing customers, and we were able to more than offset weakness in some markets with strength in others. About a third of the increase was related to the Green Remedies acquisition, which we completed during the fourth quarter last year. I would also point out that we benefited from a significant ramp-up in activity with our industrial end market. As we discussed in the press release, activity levels and waste volumes grew significantly at these locations as they looked to make up for COVID-related constraints last year. These activity levels were ahead of our expectations and we believe are likely to subside as the production backlogs are reduced. During the first quarter, gross profit was $6.4 million, an increase of 41.8% when compared with the first quarter last year. Gross margin for the first quarter was 18.3% of revenue, which was 40 basis points ahead of last year and is in line with our targeted levels. SG&A expenses were $4.3 million during the first quarter, a decrease of $147,000 compared to the same period last year. The decrease was primarily related to lower travel, advertising, stock-based compensation and trade show 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 throughout the year due to business recovery. In addition, we plan on adding national account salespeople and other personnel to support growth, as well as vendor relationship managers. We also plan to increase investment in technology this year that will further improve operations and add scalability to our platform.

Ray Hatch, CEO

Thank you, Laurie. We had an exceptionally strong start to the year with solid growth and record EBITDA. This performance represents the tangible results from the key strategies we implemented to reposition the Company over the last several years, as well as the actions we took during the downturn so that we could rebound quickly as the economy begins to recover. Our key strategies resulted in the expansion of gross margin by more than 10 percentage points over the last five years. The improvement in gross margin has also been stable and sustainable. The first quarter of 2021 marked the 12th consecutive quarter of gross margin within or above our targeted range. Our key strategies also broadened the scope of our services and diversified our end markets. Having a more diversified end market mix was very beneficial during the pandemic as strength in some markets, such as retail/grocery, was able to offset weakness in others, such as full-service restaurants. Another key strategy was the introduction of a disciplined corporate development effort with a dedicated internal team. We successfully completed our first acquisition last year and have built a pipeline of potential targets. The goal is to find strong businesses with value-added services that can be layered over our existing national service platform, which is capable of operating at a much larger scale without having to make substantial incremental investment. This means we have significant operating leverage in our business, which is evident by the relative growth in profitability during the first quarter.

Operator, Operator

We’ll go first to Amit Dayal from H.C. Wainwright. Your line is open.

Amit Dayal, Analyst

Thank you. Hi Ray, hi Laurie. Congrats on the strong start to the year.

Ray Hatch, CEO

Thanks, Amit. Thanks.

Amit Dayal, Analyst

Regarding the revenue mix for the quarter, did the industrial segment show significant strength while other segments may catch up in future quarters? Could you provide the percentage breakdown of the mix between industrial and other segments for the quarter?

Ray Hatch, CEO

I’ll start, Amit, and Laurie can follow up, if I miss something. But, no, usually we don’t speak about percentages on how it breaks out. But your assumption is correct that the industrial segment had exceptional performance for us. And we believe a big part of it has to do with pent-up demand during the pandemic. So, there was a lot of growth there, but there was growth in other segments as well, as we laid out. And I believe they’re going to continue to recover and improve and grow in the other segments as well through the balance of the year. But, there was growth in most all of the segments minus food service.

Laurie Latham, CFO

Yes, we noted in the prepared statement that the organic growth, excluding Green Remedies, accounted for a little over half of the total growth, including the industrial segment. When we factor in Green Remedies, which contributed significantly, we saw a notable surge in industrial recovery that was somewhat unexpected but welcomed, indicating a rebound and additional growth. We also mentioned the addition of three new substantial customers, although they are just beginning to impact our overall organic growth.

Amit Dayal, Analyst

Understood.

Laurie Latham, CFO

Let me add one other thing. We do have some other end markets. And I think automotive is one we’ve talked about in the past that’s still recovering. So, as we progress through this year, we anticipate seeing some additional recovery from that end market.

Amit Dayal, Analyst

Okay. And with respect to Green Remedies, Laurie, do you still believe you could see additional contribution or growth from Green Remedies, or do those revenues sort of stabilize at least for the near-term before maybe picking up again in the future?

Laurie Latham, CFO

From the perspective of M&A, our growth is driven by our acquisition, which is contributing to quarter-over-quarter growth. Additionally, we expect the operating group to experience growth throughout the year.

Ray Hatch, CEO

Yes, absolutely. One of the reasons we acquired Green Remedies is their consistent growth profile that they’ve had over the years, and it is continuing, and we expect that trend to persist. This is a growth factor, not solely due to the acquisition. Additionally, the Quest platform is designed to enable growth at a faster rate than before.

Amit Dayal, Analyst

And when we think about gross margins going forward, I know you were emphasizing the gross profit dollars. But, in terms of gross margins or even for the gross profit dollars, how should we think about drivers for margins or profits at the gross level with this new sort of revenue mix that you have?

Ray Hatch, CEO

So, are you asking if that gross profit margin profile would change based on this revenue mix?

Amit Dayal, Analyst

Yes…

Ray Hatch, CEO

Let me answer your question and please let me know if I’m addressing it correctly. Our gross margins, and you’re correct that we focus on gross profit dollars, whereas the gross profit percentage is just a mathematical calculation. We need to continue growing gross profit dollars. However, we see a consistent performance with our business profile and our current gross profit margins. I don't expect significant changes in that regard. Additionally, as we expand, industrial has become a substantial part of our business and presents many profit opportunities. To clarify, I don’t foresee major shifts in our gross profit margins.

Amit Dayal, Analyst

I get it and I’ll follow-up with you on that one. Yes.

Ray Hatch, CEO

Okay.

Laurie Latham, CFO

Okay. Yes. And it’s always going to vary when we have a big change in revenue mix, which we have had this quarter that we are going to see some movement. But it doesn’t mean that directionally, we aren’t seeing still gross profit dollars grow. So, I think that’s what we want to clarify.

Amit Dayal, Analyst

So, just one last one from me. Do you think with how the year has started for you, 1Q could be probably the strongest quarter, or do you think you have an opportunity over the remainder of the year to maybe have a stronger quarter than what you saw in the first quarter?

Ray Hatch, CEO

Yes. Obviously, we believe there’s a chance to have that. I mean, this first quarter had a surge, we didn’t expect, like Laurie mentioned, in our piece. That doesn’t mean that we can’t have it come from other channels as well, as we move down there. We’re adding new quality customers. We’re rolling out more locations with existing customers. And these types of unexpected surges like that can happen again. We just want to be clear that this is obviously the strongest quarter we’ve ever had as a company. We expect, at some point, to pass that too. I just don’t know that it’d necessarily be in Q2.

Operator, Operator

Next, we’ll go to Greg Kitt from Pinnacle Fund. Your line is open.

Greg Kitt, Analyst

Hi, Ray and Laurie. Thank you for just an incredible quarter.

Ray Hatch, CEO

Yes. Thanks, Greg.

Laurie Latham, CFO

We’re very happy about it too.

Ray Hatch, CEO

Yes, we are.

Greg Kitt, Analyst

So, I think on the Q3 earnings call, you talked about a national auto service customer pilot. Is that the potentially $10 million revenue contributor? Is it fully scaled?

Ray Hatch, CEO

No, it’s actually a new industrial client that is quite large in terms of the number of locations and their volume. This will scale over the next several quarters. We are hopeful that the annualized number we mentioned will materialize. However, it’s not in the automotive sector.

Greg Kitt, Analyst

Okay, great. Is there an update on whether that pilot has concluded? Did that customer make a decision yet?

Ray Hatch, CEO

Pilot’s not concluded. We’ve got some penetration in it. The revenue showed up. Some of the beginnings of the revenue showed up in Q1. It’s like many of these things, Greg. It takes a while to roll through all there. But no, it’s not concluded. There’s a lot of upside left from that opportunity.

Greg Kitt, Analyst

Okay, great. I mean, it’s just so exciting having watched your company for so many years to start to see several seven-figure plus customers, new customers, all being added on to your platform. At the same time, I’m just so excited that you’re starting to see that organic revenue growth, not just because of reflation, but because you fine-tuned the message to be able to win new customers. Is there anything that you can point to where you can say, you know what, now is different because we’re able to win new customers better than we had in the past?

Ray Hatch, CEO

Yes, Greg, identifying one specific aspect will be challenging, but there are multiple factors. I can say that we've improved in delivering our message since our offering isn't just a straightforward sale; it's something that hasn't been presented to these companies before. We're getting better at consolidating our message. I mentioned earlier that we've adjusted and enhanced our marketing strategy, including the tools we're using and how we communicate our brand to these companies. First, we can explain Quest more effectively than we could in previous years. Second, our execution is continually improving. We have many satisfied customers as a result of this execution, which is beneficial for attracting new ones as well.

Greg Kitt, Analyst

Thank you. The second thing that caught my attention was the incremental margins. If I understood you correctly, we should anticipate that operating expenses will increase at half the rate of the growth in gross profit. Is that correct? So, if gross profit increases by $1 million, should we expect operating expenses to rise by $500,000?

Laurie Latham, CFO

Yes. That’s directionally correct. That’s right.

Greg Kitt, Analyst

Okay, great. I appreciate that you’re making smart investments to position the Company for growth while still generating positive incremental margins or positive operating leverage. For my last question, you had an impressive free cash flow quarter and benefited from working capital this quarter as well. Should we expect that around 50 percent of EBITDA will convert to free cash flow over the course of the year?

Laurie Latham, CFO

Well, we have some other investments and things we’re going to be doing throughout the year. So, I think we’re going to continue to generate good cash flow. I’m not sure it’s exactly that ratio. Let me think about that, Greg. But, we did have an exceptional cash flow quarter. And it really benefited almost half that cash flow was a benefit of working capital changes versus operational contributions from just the P&L. But the two together were very powerful, and we wound up with $4 million in cash generated.

Greg Kitt, Analyst

Thank you. And so, just as I’m thinking through this opportunity, last point, you’re adding new customers, your existing customers are growing because of economic reflation, but you’re also growing service lines with them because they’ve grown in confidence with you. And so, growing with new and existing customers and you have positive incremental margins from gross profit dollars and generating positive cash. I think it’s just a really exciting opportunity and I wish that I owned more. So, thank you very much for your hard work. And yes, I can’t wait to see the rest of the year.

Ray Hatch, CEO

Thank you, Greg. We appreciate that, really do.

Laurie Latham, CFO

Thank you.

Operator, Operator

And next, we’ll go to George Melas with MKH Management. Your line is open.

George Melas, Analyst

Thank you. I want to express my gratitude to everyone for their hard work. It’s an amazing result.

Ray Hatch, CEO

Thank you, George. We’ll pass that on to everybody. Thanks for that.

George Melas, Analyst

Yes. Greg and George, congratulations there. On the sales, I mean, this is a quarter where sales have been tremendous and amazing conversion from gross profit to EBITDA. And I think you said that you are actually making additional investments in sales and marketing, adding some national account salespeople and also, I think, some account managers. Can you talk a little bit about the transformation of the sales force, and what you see happening in 2021?

Ray Hatch, CEO

Yes, I'm glad to share, George. Internally, we refer to our initiatives as growth investments. Growth encompasses more than just hiring salespeople, although that's a significant aspect. We're investing in additional sales personnel to drive new account revenue, enhancing client services to strengthen our relationships and position with current clients, and focusing on corporate development to ensure we excel there. We're also prioritizing vendor relations, which involves sourcing and procurement. This approach allows us to negotiate better pricing while expanding our service offerings, necessitating a broader network to achieve that. A capable team in vendor relations helps us enhance our capabilities. On the sales front, we are concentrating on specific market segments, like industrial and automotive, where representatives can communicate effectively. We're also improving our messaging and giving credit to the marketing team for that, alongside providing our salesforce with better tools to target their outreach. We leverage advanced technology to help our salespeople enhance their targeting efforts and achieve higher close rates. We'll continue to pursue this path and aim to perform better than we have previously.

Operator, Operator

And at this time, I’ll turn it back to Ray Hatch for closing remarks.

Ray Hatch, CEO

Thank you very much. As Laurie mentioned, this is a great quarter, and I want to take this opportunity to thank my team. It's a challenging role when you're predominantly working from home and trying to communicate and care for your customers, but they have done a fantastic job, as shown by this quarter's results. The entire team has executed very well, and I appreciate that. Additionally, I want to comment on the growth and evolution of this company. I've watched it for five years now, and it continues to impress as it changes, adapts, expands, and grows. We’re looking forward to a great year here at Quest, and I appreciate everyone's support out there.

Operator, Operator

And that does conclude our call for today. Thank you for your participation. You may now disconnect.