Quest Resource Holding Corporation

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.

Thank you, Christy, 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. 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 forward-looking statements as a result of various factors which are discussed in greater detail with 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 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 observations and views about industry conditions and developments. that the data and information are based on Quest estimates, independent publications, government publications, and reports by market research firms and other sources. Although Quest believes these sources are reliable and data and other information are accurate, we caution that Quest has not independently verified the reliability of these sources or the accuracy of the 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 the presentation of these non-GAAP financial measures is useful for 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 reconciliations 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.

Thank you, Dave. Thanks, everyone, for your interest and 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 record 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. Gross profit was a record 6.4 million, representing 42% growth year over year. Adjusted EBITDA was also a record at 2.6 million, which is almost five times greater than the first quarter of last year. The success evidenced in the quarter is a result of the actions we took during the downturn, as well as the work we've done to position the company for both top-line and bottom-line growth over the last several years. I want to recognize and thank our team for their hard work and their perseverance over the many professional challenges and personal hardships of the past year. Before I go into a review of the trends in our major end markets and strategic initiatives, I'm going to turn the call over to Lori Latham, our Chief Financial Officer of Review Financials. Lori?

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. Overall, we expect operating expenses will grow at approximately half the rate of gross profit dollars during the balance of the year. During the first quarter, interest expense increased to $561,000 from $84,000 last year. The increase is primarily related to debt financing for the green remedies acquisition. Net income attributable to common stockholders per basic and diluted share was six cents for the first quarter, compared to a loss of two cents per share for the same period last year. As Ray mentioned, adjusted EBITDA increased 390% year-over-year for the first quarter to 2.6 million, which was a quarterly record. Moving on to the review of our cash flow and balance sheet. We had very strong cash flow generation during the quarter, with operating cash flow of 4 million. Strong cash flow was due to a combination of strong net income performance as well as positive working capital changes. We ended the quarter with $10.8 million in cash, which is up from $7.5 million at the beginning of the year. At the end of the quarter, we had $17.7 million of notes payable versus $18.5 million at the end of 2020. Total notes payable consists of the following. an $11.5 million term note. The principal of that note comes due in 2025. $2.6 million in the form of a five-year seller note, which is payable in quarterly installments. And the remaining $3.6 million is our revolving line of credit. From a liquidity perspective, we are very confident that with the cash on our balance sheet, availability on our capital lines, and strong cash flow generation, we have ample liquidity to support our M&A program, fund our operations, and service debt. So this time, I'll turn the call back to Ray.

Thank you, Lori. We had an exceptionally strong start to the year with a 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 sort of 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. In addition to the key strategies that we implemented over the last several years, during the downturn we took specific actions which enabled us to recover quickly as the economy recovered. The actions we took included prioritizing customer service and customer relationships, developing new innovative services, enhancing our marketing efforts, and developing new ways to gain efficiency without compromising service levels. We've been investing in a number of long-term growth initiatives, all of which we maintain through the downturn, some of which we're starting to see tangible results from. Over the last couple of years, we've been working with our customers to address the issue of organic waste. We've launched an innovative new program called Proganics. This program can cost-effectively divert as much as 100% of organic waste away from landfills. Proganics provides a singles collection process from multiple waste streams, including floral, cardboard, unpackaged food, as well as packaged food, along with the packaging. Organic materials are 100% diverted from landfill, recycled, and repurposed to create compost, biofuel, or animal feed. As grocery chains are increasingly implementing sustainability goals and facing increasing regulation regarding food waste, Proganic's ability to recycle packaged food in a cost-effective manner is significant, and key differentiator for us. We recently began introducing this service to our customers and prospects and have garnered our first win with the Midwest grocery chain. We think there is significant opportunity to expand this service and expect it to help us garner new customer wins along with expanding relationships with existing customers. During the downturn, we work with our customers, prioritizing their service needs, helping them to adjust to react to sudden changes in demand. It is straightforward. Treat your customers right, and they will remember and reward you. For example, during the downturn, many customers were generating lower volumes of waste or were forced to close locations. We found ways to flex their service levels so they were not paying for services they didn't need. In other cases where customers had increased volumes, we were able to help them manage their customer levels more efficiently and stay within budget constraints. We did the right thing during the downturn and, as a result, created stronger customer relationships. In turn, these customers are rewarding us with more business. Over the last few years, we've made reigniting organic growth a priority. We've continued to enhance our go-to-market capabilities. We've added a new marketing VP, added to the sales team, and have developed a new brand platform that is helping us to market the company more effectively. This effort also included enhancing our outreach programs through social media. Finally, during the downturn, we continued to focus on ways to gain operating efficiency without compromising service. Facing a great deal of uncertainty early on, we took a hard look at cost or cost structure and were successful in reducing unnecessary overhead costs. In addition, during the pandemic, We had to learn new ways to interact more efficiently in an environment where most of our folks were working from home. Even as the economy recovers and we begin to grow again, we'll continue to benefit from cost savings and efficiency gains we made during the downturn. These costs are now being reinvested in the company to add staff that can help drive growth and staff that can help us further improve cost of services. Now is probably a good time to give a quick update on what we're seeing in our end markets. The retail grocery market has stayed stable throughout this entire period and has experienced modest growth year over year. In the automotive market, demand for automotive repair and maintenance services has improved slightly since the fourth quarter, but is still down compared to the time period prior to COVID. The number of miles driven can be used as a proxy to the overall economic activity in this market. According to the U.S. Department of Transportation, during the first quarter of 2021, Miles driven were down in the highest single digits relative to 2019. In the few weeks that have been reported since the end of the quarter, the decrease in miles driven has improved for the first time since the pandemic began. Miles driven showed a positive increase relative to 2019 during the first week of April. Activity levels in the industrial market exceeded our expectations during the first quarter. Our customers' order backlogs were high coming into 2021, as pandemic-related closures last year shifted many orders from 2020. Industrial customers have significantly ramped production at their locations to catch up with order backlogs and strong demand conditions. We expect the comparisons in this market will continue to be positive, but are likely to be somewhat choppy from quarter to quarter, as supply chain issues could disrupt operations. Regarding our newest in-market multifamily housings, Volumes in the multifamily housing market have grown year over year due to increase in the volume of waste generated from people working and dining at home. As you might expect, volumes in restaurant end market continue to improve sequentially from the fourth quarter, but are still down year over year. I want to emphasize our restaurant business is still our smallest end market in our overall mix. Moving on to a discussion about our growth initiatives. During the first quarter, we had several wins with existing customers. A couple of notable wins are the Proganix customer I mentioned earlier. This chain is a subsidiary of a larger grocery chain that is an existing customer. They have about 100 locations, primarily located in the Midwest. We also had a win with an existing financial services customer to expand the footprint that we service. With this win, we're increasing our service footprint from 100 to 1,000 locations. Regarding wins with new customers, we recently secured two seven-figure wins. We've begun ramping up service with these customers and expect they'll be fully contributing by the third quarter of this year. We also had a large win with an industrial customer that will take a bit longer to ramp. We expect this customer to have been contributing during the fourth quarter and has the potential to ramp to annual sales of greater than 10 million over the course of several quarters thereafter. Next, I want to cover recent M&A activity. We expect M&A to be an important part of our growth and continue to evaluate and pursue a number of opportunities. Our industry is highly fragmented with 18,000 local or regional players, which provides plenty of opportunity for growth through consolidation. There's been a lot of talk about inflation recently. I want to address how that might affect us. Overall, we expect it to be net neutral for us. We have mechanisms in place with both our client and vendor contracts, that minimize our exposure to increasing costs. Where we and our clients can potentially benefit is when the increased landfill costs can make recycling even more economically feasible. Regarding our outlook, we are optimistic about delivering strong growth in the gross profit dollars for the year. Our end markets are strong and continue to recover. We expect the industrial end market to be a significant contributor to our growth but it's unlikely to be linear and may cause fluctuations from quarter to quarter. We expect the acquisition of green remedies to continue to be a strong contributor to growth. We continue to have success adding new customers and are expanding business with existing customers. In addition, we've seen increased movement in opportunities throughout pipeline, and the pace of organic growth is picking up. We have a solid value proposition that is resonating with customers. Customers tell us that they are choosing Quest because we offer a single-source solution that can provide service across a national footprint and for multiple waste streams. In addition, they like that we will provide consolidated and uniform data reporting that gives them operational insight and an audible data set for sustainability reporting. They appreciate our expertise for regulatory compliance and direct alignment with their sustainability goals to divert more waste away from the landfills. We continue to build out our acquisition pipeline and have ongoing discussions with business owners that see a potential fit for their customers and their employees as part of the Quest platform. We expect profitability will continue to outpace top-line growth as we benefit from greater scale and the operating leverage inherent in our business model. We have withstood many challenges presented by the pandemic and are coming out the other side as a stronger company able to drive further increases in profitability, returns, and in shareholder value. I look forward to keeping you updated on our progress. We'd now like the operator to provide instruction on how listeners can queue up for questions.

And at this time, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. If you're calling from a speakerphone, please make sure your mute function is off to ensure your signal can reach our equipment. Again, star one to ask a question. We'll go first to Amit Dayal from HC Wainwright. Your line is open.

Thank you. Hi, AI Laurie. Congrats on the strong start to the year. Thank you, Matt. Thanks. This is, you know, with respect to the revenue mix for the quarter, was it primarily from the industrial segment you saw a lot of strength with others potentially going to catch up, other segments catching up maybe in the coming quarters? You know, could you share in terms of, you know, percentage maybe what some of the mix was industrial versus other segments for the quarter?

I'll start on it, and Laurie can follow up if I missed something. But, no, usually they'll speak about percentages on how it breaks out, but your assumption is correct that the industrial segment had an exceptional performance for us. And, you know, 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, you know, I believe they're going to continue to recover and improve and grow the other segments as well through the balance of the year. But there was growth in most all the segments minus food service.

Yeah, I think we mentioned in the call here, in the prepared statement, that the organic growth, i.e. excluding green remedies, was a little over – was over half of the growth. And that would include the industrial. So you add green remedies in there, which was a big chunk, and the industrial recovery was a surge for us. A little unexpected, but it was a nice surge and showed recovery there plus some growth. And then we've talked about adding the three other new customers who are substantial, but they were just starting to contribute to our overall organic growth.

Understood.

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 we do, as we progress through this year, we anticipate seeing some additional recovery from that end market.

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?

Well, from the perspective of just the M&A growth, it's contributing growth because we acquired it. So that was, if you look quarter over quarter, it will be contributing to growth from that perspective. But as an operating group, we expect it to grow also during the year.

Yeah, 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. We expect it to continue. So it's a growth factor, not just obviously because of the acquisition. But in and of itself, the Quest platform actually enables it to grow faster than it did before, is the intent.

Yeah, that's really good. Thank you. And, you know, 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, you know, drivers for margins or profits at the gross level with this new sort of revenue mix that you have?

So are you asking if our gross profit margin profile would change based on this revenue mix? Yeah. I guess let me answer your question, I think, and then tell me if I'm answering it and help me. Our gross margins, and again, you're right, gross profit dollars is what we manage to do. The gross profit percent to me really is just a mathematical equation. We've got to keep growing gross profit dollars. But there's a consistent performance between our profile with the business that we're bringing on with the current margin or gross profit profile we have today. So I wouldn't anticipate, you know, huge changes there by any stretch. And I think as we add, industrial is a nice big part of our business, and it's got a lot of profit opportunities too. But am I answering your question on it in the sense that I don't see massive changes from a gross profit standpoint?

I get it, and I'll follow up with you on that one, yeah. Okay.

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

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

Yeah, obviously we believe there's a chance to have that. I mean, this first quarter had a surge we didn't expect, like Lori mentioned in her 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 type of unexpected little searches like that can happen again. We just wanted 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 will necessarily be in Q2.

Understood. That's fair. Thank you, guys. That's our last.

Thanks, Simon. Appreciate it.

And again, if you have a question, please press star, followed by the number one on your telephone keypad. Next, we'll go to Greg Kitt from Pinnacle Fund. Your line is open.

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

We're very happy about it, too.

Yeah, we are. 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 scales?

No, it's actually a new industrial client that is quite large as far as the number of locations and their volume. And that's going to be a scale project. That's going to be rolling out throughout the next several quarters to hopefully that annualized number we laid out. But it's not in the automotive sector.

Okay, great. And is there an update on is that pilot concluded and did that customer make a decision or not as of yet?

The 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. 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 onto 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?

Yeah, pointing to one specific thing would be difficult, Greg, but there are several things. I think we've I will tell you I know that we've gotten better in delivering our message, you know, because we're not a simple sell, you know, because it's not something that our business model, what we bring to the table isn't something these folks have had before. And I think we're getting much better at consolidating our message. I think I mentioned in the call that we've kind of changed or added a lot to our marketing direction as well, the tools we're using, how we're messaging our brand to these companies. So first, I think we're better able to explain Quest maybe than we were in years past. And second, our execution continues to improve. We have a lot of very happy customers through that execution, and that's very helpful in helping you gain new ones as well.

Thank you. And, you know, the second thing that popped out at me were the incremental margins and And I heard – I think if I heard you correctly, we should expect OPEX dollars to grow at half of the rate of gross profit dollars. Did I hear that correctly? So if you grew one gross profit dollars by a million dollars, should we expect OPEX to grow $500,000? Yes.

That's directionally correct. That's right.

Okay, great. So I – like that you're making smart investments to position the company to grow from a stronger platform while still showing positive incremental margins or positive operating leverage. And so last question was, you also had that great free cash flow quarter working capital benefit this quarter as well. Should we think about, is it fair to think that you could still have, you know, 50-ish percent of EBITDA converting to free cash flow? over the course of a year?

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 by 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.

Thank you. And so just as I'm thinking through this opportunity last point, you're adding new customers. Your existing customers are growing more. 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, yeah, I can't wait to see the rest of the year.

Thank you, Greg.

We appreciate that. Thank you.

Really do.

And next we'll go to George Mules with MKEdge Management. Your line is open.

Thank you. I just want to extend Greg's thanks. I just want to thank you guys and the whole team for the hard work. It's an amazing result.

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

Yes, me too. Yeah, yeah. It will be the Greg and George congratulations there. Yep. 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 were 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?

Yeah, I'm happy to, George. Thanks. internally what we're calling them is a broad sense is growth investments. And growth is more than just salespeople, although that's a big part of it. So we're investing in salespeople growth for new account revenue. We're investing in the client services side to help us continue to manage and penetrate and improve our position with existing clients. And we're investing in – we're also investing in CorpDev as well, you know, to help us continue to do a great job there So there's a lot of, oh, and vendor relations, I'm sorry, vendor relations as well, which is really, in our world, that's sourcing, procurement, George. And these guys, it's not only getting better pricing by negotiating with more folks, it's helping us expand our service lines. Because any time you expand your services, you've got to develop and broaden your network with which to accomplish that. And having a talented team on client service, or excuse me, vendor, relations or sourcing enables us to do that better. So that's truly a growth piece as well. On the Salesforce side, we'll continue. We are continuing to focus people on individual market segments, whether it be, you know, industrial, whether it be automotive, that type of thing, where they speak the language and focus on it. So we're expanding on the same thing. We've just, as I mentioned, I guess it was Greg's question, I think we're a lot better in messaging, and I'm giving the marketing group credit for that as well, and in tools for our sales force to more targeted, George, reach out. I mean, we're utilizing a lot of great tools that are available today with this technology to help our sales people be more targeted in their efforts so they have higher close ratios. But we're going to keep marching down that same path and just do it better than we've done in the past.

Okay, great. I have no questions. Things are so good. Thanks very much.

Thank you, George. We appreciate your support.

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

Thank you very much. As Lori said, this is a great quarter. I want to take this opportunity to thank my team, It's a challenging world when you're working from home mostly and trying to communicate and take care of your customers, and they've done a fantastic job, as evidenced by this quarter. The whole team has executed very well, and I'm appreciative of that. Secondly, I just want to comment on the growth and the changes and the evolution of this company. I've watched it for five years now, and it is continuing to impress as they change and adapt and expand and grow. So we're looking forward to a great year here at Quest, and thanks for everybody, all of your support out there.

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