Quest Resource Holding Corp: Form 10-Q for the period ended Sep 30, 2023

The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in or incorporated by reference into this Form 10-Q, including statements regarding our future operating results, future financial position, business strategy, objectives, goals, plans, prospects, and markets, and plans and objectives for future operations, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “targets,” “contemplates,” “projects,” “predicts,” “may,” “might,” “plan,” “will,” “would,” “should,” “could,” “can,” “potential,” “continue,” “objective,” or the negative of those terms, or similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. Specific forward-looking statements in this Form 10-Q include statements regarding the impact, if any, of the adoption of the ASU on our consolidated financial statements; the impact of the Coronavirus Disease 2019 (“COVID-19”) pandemic on our results of operations and any changes to inflation rates; exposure to significant interest, currency, or credit risks arising from our financial instruments; and sufficiency of our cash and cash equivalents, borrowing capacity, and cash generated from operations to fund our operations for the next 12 months. All forward-looking statements included herein are based on information available to us as of the date hereof and speak only as of such date. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The forward-looking statements contained in or incorporated by reference into this Form 10-Q reflect our views as of the date of this Form 10-Q about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results, performance, or achievements to differ significantly from those expressed or implied in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, performance, or achievements. A number of factors, including the impact of our business acquisitions in 2022 and 2021 on future results, the state of the U.S. economy in general, general economic conditions and the potential effect of inflationary pressures and increased interest rates on our cost of doing business, could cause actual results to differ materially from those indicated by the forward-looking statements and other risks detailed from time to time in our reports to the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual Report”).

Business Overview

We are a national provider of waste and recycling services to customers from across multiple industry sectors that are typically larger, multi-location businesses. We create customer-specific programs and perform the related services for the collection, processing, recycling, disposal, and tracking of waste streams and recyclables. We also provide information and data that tracks and reports the detailed transactional and environmental results of our services and provides actionable data to improve business operations. The data we generate also enables our customers to address their business, sustainability, environmental, social and governance goals and responsibilities.

Our revenue is primarily generated from fees charged for our collection, transfer, disposal and services for both solid waste and recyclable materials and from sales of recyclable materials. In addition, we have product sales and other revenue primarily from sales of products such as antifreeze and windshield washer fluid, as well as minor ancillary services.

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on and relates primarily to the operations of QRHC and QRMG (collectively, “we,” “us,” “our,” or “our company”).

Three and Nine Months Ended September 30, 2023 and 2022 Operating Results

The following table summarizes our operating results for the three and nine months ended September 30, 2023 and 2022:

(Unaudited)

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14

Three and Nine Months Ended September 30, 2023 compared to Three and Nine Months Ended September 30, 2022

Global Economic Trends

The global economy, including credit and financial markets, has experienced extreme volatility and disruptions, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, increases in inflation rates and uncertainty about economic stability. For example, the current conflict between Ukraine and Russia has created extreme volatility in the global capital markets and is expected to have further global economic consequences, including disruptions of the global supply chain and energy markets. Any such volatility and disruptions may have adverse consequences on us or the third parties on whom we rely. If the equity and credit markets continue to deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner or on favorable terms, more costly or more dilutive. Inflation can adversely affect us by increasing our costs, including salary costs. Any significant increases in inflation and related increases in interest rates could have a material adverse effect on our business, results of operations and financial condition.

Revenue

For the quarter ended September 30, 2023, revenue was $70.4 million, a decrease of $2.9 million, or 4.0%, compared to $73.4 million for the quarter ended September 30, 2022. For the nine months ended September 30, 2023, revenue was $219.0 million, a decrease of $2.7 million, or 1.2%, compared to $221.8 million for the nine months ended September 30, 2022.

The decrease for the quarter was primarily due to an approximately $6 million decrease in revenues at RWS, which was acquired in 2021. These declines were partially offset by an overall strong increase in demand for non-recyclable materials services from both new and continuing customers resulting in approximately $4 million in additional revenues, which includes an approximately $0.4 million negative billing adjustment for a large customer. Recyclable materials revenues decreased approximately $1 million in the quarter compared to the prior year.

For the nine months ended September 30, 2023, revenues declined slightly as an approximately $15.5 million increase in overall demand for non-recyclable materials services from both new and continuing customers were offset by an approximately $7 million decrease in recyclable materials revenues and an approximately $11 million decline in revenues from RWS.

Cost of Revenue/Gross Profit

Cost of revenue decreased $3.2 million to $58.0 million for the quarter ended September 30, 2023 from $61.2 million for the quarter ended September 30, 2022. Cost of revenue decreased $3.2 million to $180.5 million for the nine months ended September 30, 2023 compared to $183.7 million for the nine months ended September 30, 2022. The changes were primarily due to the same reasons impacting the decrease in revenue and also includes an unfavorable adjustment to cost of revenues of approximately $0.5 million related to RWS.

Gross profit for the quarter ended September 30, 2023 was $12.4 million, an increase of $0.2 million, compared to $12.2 million for the quarter ended September 30, 2022. The gross profit margin was 17.7% for the quarter ended September 30, 2023 compared to 16.6% for the same quarter of 2022. Gross profit for the nine months ended September 30, 2023 was $38.6 million, compared to $38.1 million for the nine months ended September 30, 2022. The gross profit margin was 17.6% for the nine months ended September 30, 2023, compared to 17.2% for the nine months ended September 30, 2022. The changes in gross profit and gross profit margin percentage for the quarter were primarily due to the net effect of the impact of increased services from certain new and continuing customers, change in the mix of services and relative gross profit margins from new and acquired customer base, reduced operations at certain other customers, and changes in values for recyclable materials.

Revenue, gross profit, and gross profit margins are affected period to period by the volumes of waste and recyclable materials generated by our customers, the frequency and type of services provided, the price and mix of the services provided, price changes for recyclable materials, the cost and mix of subcontracted services provided in any one reporting period, and the timing of acquisitions and integration. Volumes of waste and recycling materials generated by our customers is impacted period to period based on several factors including their production or sales levels, demand of their product or services in the market, supply chain reliability, and labor force stability, among other business factors.

Operating Expenses

Operating expenses were $12.0 million and $11.8 million for the quarters ended September 30, 2023 and 2022, respectively. Operating expenses were $35.5 million and $35.3 million for the nine months ended September 30, 2023 and 2022, respectively.

Selling, general, and administrative expenses were $9.6 million and $9.3 million for the quarters ended September 30, 2023 and 2022, respectively. Selling, general, and administrative expenses were $28.2 million and $28.0 million for the nine months ended September 30, 2023 and 2022, respectively. Selling, general, and administrative expenses for both the quarter and nine months were mostly flat compared to the prior year periods.

Operating expenses for the quarters ended September 30, 2023 and 2022 included depreciation and amortization of $2.3 million and $2.5 million, respectively. Operating expenses for the nine months ended September 30, 2023 and 2022 included depreciation and amortization of $7.2 million and $7.3 million, respectively.

Interest Expense

Interest expense was $2.4 million and $1.9 million for the quarters ended September 30, 2023 and 2022, respectively, an increase of approximately $0.5 million. Interest expense was $7.4 million and $5.1 million for the nine months ended September 30, 2023 and 2022, respectively, an increase of approximately $2.3 million. The increase is primarily due to increases in base interest rates which is partially offset by reduced borrowings from voluntary paydowns on the term loan in the first nine months of 2023. We are amortizing debt issuance costs of $3.3 million and OID of $2.2 million to interest expense over the life of the related debt arrangements as discussed in Note 8 to our condensed consolidated financial statements.

Income Taxes

We recorded a provision for income tax of $111,104 and $151,619 for the quarters ended September 30, 2023 and 2022, respectively. We recorded a provision for income tax of $650,387 and $479,011 for the nine months ended September 30, 2023 and 2022, respectively. The provision for income tax is primarily attributable to state tax obligations based on current estimated state tax apportionments for states with no net operating loss carryforwards.

We recorded a full valuation allowance against all our deferred tax assets (“DTAs”) as of both September 30, 2023 and December 31, 2022. We intend on maintaining a full valuation allowance on our DTAs until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 to 24 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain DTAs and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change based on the level of profitability that we are able to actually achieve.

Net Loss

Net loss for the quarter ended September 30, 2023 was $(2.1) million compared to net loss of $(1.7) million for the quarter ended September 30, 2022. Net loss for the nine months ended September 30, 2023 was $(5.0) million compared to net loss of $(2.7) million for the nine months ended September 30, 2022. The explanations above detail the majority of the changes related to the change in net results.

Our operating results, including revenue, operating expenses, and operating margins, will vary from period to period depending on commodity prices of recyclable materials, the volumes and mix of services provided, as well as customer mix during the reporting period, and the timing of acquisitions and integration.

Loss per Share

Net loss per basic and diluted share attributable to common stockholders was $(0.10) and $(0.09)for the quarters ended September 30, 2023 and 2022, respectively. Net loss per basic and diluted share attributable to common stockholders was $(0.25) and $(0.14) for the nine months ended September 30, 2023 and 2022, respectively.

The basic and diluted weighted average number of shares of common stock outstanding were approximately 20.1 million and 19.4 million for the three months ended September 30, 2023 and 2022, respectively. The basic and diluted weighted average number of shares of common stock outstanding were approximately 20.0 million and 19.3 million for the nine months ended September 30, 2023 and 2022, respectively.

Adjusted EBITDA

For the three months ended September 30, 2023, Adjusted EBITDA, a non-GAAP financial measure, decreased (3.6)% to $3.7 million from $3.8 million for the three months ended September 30, 2022. For the nine months ended September 30, 2023, Adjusted EBITDA decreased (10.0)% to $12.7 million from $14.1 million for the same period in 2022.

We use the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, stock-related compensation charges, and other adjustments, or “Adjusted EBITDA,” to evaluate our performance. Adjusted EBITDA is a non-GAAP measure that is also frequently used by analysts, investors and other interested parties to evaluate the market value of companies considered to be in similar businesses. We suggest that Adjusted EBITDA be viewed in conjunction with our reported financial results or other financial information prepared in accordance with GAAP. For the three and nine months ended September 30, 2023, other adjustments included severance and project costs as well as certain administrative fees related to borrowings. For the three and nine months ended September 30, 2022, other adjustments included severance costs, project costs and certain administrative costs related to borrowings.

The following table reflects the reconciliation of net loss to Adjusted EBITDA for the three and nine months ended September 30, 2023 and 2022:

(Unaudited)

(Unaudited)

Adjusted Net Income and Adjusted Net Income per Diluted Share

Adjusted net income, a non-GAAP financial measure, was $0.5 million for the three months ended September 30, 2023, compared with $0.9 million for the three months ended September 30, 2022. Adjusted net income was $2.7 million for the nine months ended September 30, 2023, compared with $6.2 million for the nine months ended September 30, 2022. We present adjusted net income and adjusted net income per diluted share, both non-GAAP financial measures, supplementally because they are widely used by investors as a valuation measure in the solid waste industry. Management uses adjusted net income and adjusted net income per diluted share as one of the principal measures to evaluate and monitor the ongoing financial performance of our operations. We provide adjusted net income to exclude the effects of items management believes impact the comparability of operating results between periods. Adjusted net income has limitations due to the fact that it excludes items that have an impact on our financial condition and results of operations. Adjusted net income and adjusted net income per diluted share are not a substitute for, and should be used in conjunction with, GAAP financial measures. Other companies may calculate these non-GAAP financial measures differently. Our adjusted net income and adjusted net income per diluted share for the three and nine months ended September 30, 2023 and 2022 are calculated as follows:

(Unaudited)

(Unaudited)

Liquidity and Capital Resources

As of September 30, 2023 and December 31, 2022, we had $0.9 million and $9.6 million in cash and cash equivalents, respectively. Working capital was $9.0 million and $19.7 million as of September 30, 2023 and December 31, 2022, respectively. As part of our working capital management and in light of increasing interest rates, we made $7.0 million in prepayments toward our variable rate debt in the first nine months of 2023, utilizing excess cash.

We derive our primary sources of funds for conducting our business activities from operating revenues; borrowings under our credit facilities; and the placement of our equity securities to investors. We require working capital primarily to carry accounts receivable, service debt, purchase capital assets, fund operating expenses, address unanticipated competitive threats or technical problems, withstand adverse economic conditions, fund potential acquisition transactions, and pursue goals and strategies.

We believe our existing cash and cash equivalents of $0.9 million, our borrowing availability under our $25.0 million ABL Facility (as defined and discussed in Note 8 to our condensed consolidated financial statements), and cash expected to be generated from operations will be sufficient to fund our operations for the next 12 months and thereafter for the foreseeable future. Our known current- and long-term uses of cash include, among other possible demands, capital expenditures, lease payments and repayments to service debt and other long-term obligations. We have no agreements, commitments, or understandings with respect to any such placements of our securities and any such placements could be dilutive to our stockholders.

Cash Flows

The following discussion relates to the major components of our cash flows for the nine months ended September 30, 2023 and 2022.

Cash Flows from Operating Activities

Net cash provided by operating activities was $6.7 million for the nine months ended September 30, 2023 compared with net cash used in operating activities of $(4.3) million for the nine months ended September 30, 2022.

Net cash provided by operating activities for the nine months ended September 30, 2023 related primarily to the net effect of the following:

• net loss of $(5.0) million;
• non-cash items of $10.5 million, which primarily related to depreciation, amortization of intangible assets and debt issuance costs, provision for doubtful accounts, and stock-based compensation; and
• net cash provided by the net change in operating assets and liabilities of $1.1 million, primarily associated with relative changes in accounts receivable, accounts payable, and accrued liabilities.

Net cash used in operating activities for the nine months ended September 30, 2022 related primarily to the net effect of the following:

• net loss of $(2.7) million;
• non-cash items of $10.7 million, which primarily related to depreciation, amortization of intangible assets and debt issuance costs, provision for doubtful accounts, and stock-based compensation; and
• net cash used in the net change in operating assets and liabilities of $(12.3) million, primarily associated with relative changes in accounts receivable, accounts payable, and accrued liabilities.

Our business, including revenue, operating expenses, and operating margins, may vary depending on the blend of services we provide to our customers, the terms of customer contracts, recyclable materials contracts, and our business volume levels. Fluctuations in net accounts receivable are generally attributable to a variety of factors including, but not limited to, the timing of cash receipts from customers, and the inception, increase, modification, or termination of customer relationships. Our operating activities may require additional cash in the future from our debt facilities and/or equity financings depending on the level of our operations.

Cash Flows from Investing Activities

Cash used in investing activities for the nine months ended September 30, 2023 was $(1.3) million. Cash used in investing activities for the nine months ended September 30, 2022 was $(4.4) million and primarily related to the $3.1 million net purchase of the assets of a northeast-based independent environmental services company on February 10, 2022. Other investing activities are primarily from purchases of property and equipment and intangible assets such as software development costs.

Cash Flows from Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2023 was $(14.1) million, primarily from net repayments of $(6.8) million on our ABL Facility and $(7.8) million repayment of long-term debt. Net cash provided by financing activities for the nine months ended September 30, 2022 was $7.4 million, primarily from net borrowings of $4.7 million on our ABL Facility and borrowings of $3.5 million from the Credit Agreement with Monroe Capital used to finance the February 2022 acquisition of an independent environmental services company. See Note 8 to our condensed consolidated financial statements for a discussion of the ABL Facility and other notes payable.

Inflation

Although the overall economy has experienced some inflationary pressures, we do not believe that inflation had a material impact on us during the nine months ended September 30, 2023 and 2022. We believe that current inflationary increases in costs, such as fuel, labor, and certain capital items, can be addressed by our flexible pricing structures and cost recovery fees allowing us to recover certain of the cost of inflation from our customer base. Consistent with industry practice, many of our contracts allow us to pass through certain costs to our customers or adjust pricing. Although we believe that we should be able to offset many cost increases that result from inflation in the ordinary course of business, we may be required to absorb at least part of these costs increases due to competitive pressures or delays in timing of rate increases. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation and increases in interest rates.

Critical Accounting Estimates and Policies

Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. These areas include carrying amounts of accounts receivable, goodwill and other intangible assets, stock-based compensation expense, deferred taxes and the fair value of assets and liabilities acquired in asset acquisitions. We base our estimates on historical experience, our observance of trends in particular areas, and information or valuations and various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying value of assets and liabilities that may not be readily apparent from other sources. Actual amounts could differ significantly from amounts previously estimated. For a discussion of our critical accounting policies, refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2022 Annual Report. Other than the adoption of ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) as discussed in Note 2 to our condensed consolidated financial statements, there have been no significant changes in our critical accounting policies during the nine months ended September 30, 2023.

Recent Accounting Pronouncements

See Note 2 to our condensed consolidated financial statements.

Off-Balance Sheet Arrangements

We have no off-balance sheet debt or similar obligations. We have no transactions or obligations with related parties that are not disclosed, consolidated into, or reflected in our reported results of operations or financial position. We do not guarantee any third-party debt.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2023.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, misstatements, errors, and instances of fraud, if any, within our Company have been or will be prevented or detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls also can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. We base the design of any system of controls in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, internal controls may become inadequate as a result of changes in conditions, or through the deterioration of the degree of compliance with policies or procedures.

The following risk factor supplements the risk factors described in Item 1A of our 2022 Annual Report and should be read in conjunction with the risk factors described in our 2022 Annual Report:

The instability of certain financial institutions may have adverse impacts on certain of our vendors and customers and/or on our ability to access our cash deposits and make borrowings, which could negatively impact our financial condition, results of operations and cash flows.

In 2023, there have been public reports of instability at certain financial institutions. Although we do not hold material deposits or investments at these financial institutions, and despite the steps taken to date by U.S. and foreign agencies and institutions to protect depositors, the follow-on effects of the events surrounding recent bank failures and pressure on other financial institutions are unknown, could include failures of other financial institutions to which we face direct or indirect exposure, and may lead to disruptions to the cash flows, operations and financial condition of our vendors, customers, and/or us. Additionally, tight credit conditions could generally result in economic slowdown and reduced demand for our services.