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HCCI > SEC Filings for HCCI > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for HERITAGE-CRYSTAL CLEAN, INC.

Form 10-K for HERITAGE-CRYSTAL CLEAN, INC.


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Disclosure Regarding Forward-Looking Statements

You should read the following discussion in conjunction with our consolidated financial statements and related notes in our Annual Report on Form 10-K. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties, and assumptions that could cause actual results to differ materially from our expectations. Factors that could cause such differences include those described in the section titled "Risk Factors" and elsewhere in our Annual Report on Form 10-K. We undertake no obligation to update any of the forward-looking statements. Certain tabular information may not foot due to rounding. Our fiscal year ends on the Saturday closest to December 31. "Fiscal 2013" represents the 52-week period ended December 28, 2013, "fiscal 2012" represents the 52-week period ended December 29, 2012, and "fiscal 2011" represents the 52-week period ended December 31, 2011.

Overview

We provide parts cleaning, containerized waste management, used oil collection, vacuum truck services, and antifreeze recycling, and we own and operate a used oil re-refinery where we re-refine used lubricating oils into high quality lubricant base oil and by-products. We are the second largest provider of industrial and hazardous waste services to small and mid-sized customers in both the vehicle maintenance and manufacturing services, and we have the second largest used oil re-refining capacity in North America. Our services help our customers manage their used chemicals and liquid and solid wastes, while also helping to minimize their regulatory burdens. We operate from a network of 74 branch facilities providing services to customers in 42 states. We conduct business through two principal operating segments: Environmental Services and Oil Business.

Our Environmental Services segment revenues are generated primarily from providing parts cleaning, containerized waste management, vacuum truck, and antifreeze recycling services. Revenues from this segment accounted for approximately 55.5% of our total company revenues for fiscal 2013. In the Environmental Services segment, we define and measure same-branch sales for a given period as the subset of all our branches that have been open and operating throughout and between the periods being compared, and we refer to these as established branches. We calculate average sales per working day by dividing our sales by the number of non-holiday weekdays in the applicable fiscal year or fiscal quarter.

Our Oil Business segment consists of our used oil collection and used oil re-refining activities, which accounted for approximately 44.5% of our fiscal 2013 total company revenues.

No single customer accounted for more than 10% of consolidated revenues in fiscal 2013 or 2012. Revenues from one customer in the Oil Business segment represented approximately 15.4% of our consolidated revenues in fiscal 2011 when we sold higher amounts of intermediate product and by-products from the used oil re-refinery. There were no intersegment revenues during fiscal 2013.

We have established prices for our services, based on the relevant business variables for each service. With respect to our parts cleaning services, our pricing reflects the type of parts cleaning machine we provide (if any), the frequency of service visits, and the quantity and grade of solvent or other cleaning chemistry required. For our other services, our pricing typically reflects the nature and quality of the waste materials removed. Our customer agreements typically provide for annual renewal and price increases.

Our operating costs includes the costs of the materials we use in our services, such as solvent and other chemicals, transportation of solvents and waste, and our payments to third parties to recycle or dispose of the waste materials that we collect. The used solvent that we retrieve from customers in our product reuse program is accounted for as a reduction in our net cost of solvent under operating costs, whether placed in inventory or sold to a purchaser for reuse. Increased costs of crude oil, a component of solvent, can increase operating costs, although we attempt to offset such increases with increased prices for our services. Operating costs also include the costs of operating our re-refinery, recycling centers, hubs, and branch system including personnel costs (including commissions), facility rent, truck leases, fuel, and maintenance. Our operating costs as a percentage of sales generally increase in relation to the number of new branch openings. As new branches achieve route density and scale efficiencies, our operating costs as a percentage of sales generally decrease.

We use profit before corporate selling, general, and administrative expenses ("SG&A") as a key measure of segment profitability. We define profit before SG&A as sales less operating costs and depreciation and amortization from operations.

Our selling, general, and administrative expenses include the costs of performing centralized business functions, including sales management at or above the regional level, business management, billing, receivables management, accounting and finance, information technology, environmental health and safety, and legal.

We operate a used oil re-refinery located in Indianapolis, Indiana, through which we recycle used oil into high quality lubricant base oil and by-products. We supply the base oil to firms that produce and market finished lubricants. Our used oil re-refinery had an original input capacity of approximately 50 million gallons of used oil feedstock per year with an expected production of about 30 million gallons of base oil per year when operating at full capacity. We are in the process of expanding the annual input capacity of the Indianapolis re-refinery to 75 million gallons, which we believe will allow us to improve our utilization of resources and the operating results of our Oil Business segment. We expect the full amount of the additional capacity to be in place by mid-2014. During fiscal 2013, we achieved some of the additional capacity referenced above. This allowed us, at times, to produce base oil at a rate above the original capacity. As of the end of fiscal 2013, the re-refinery was operating at an annualized rate of used oil consumption of approximately 60 million gallons. We estimate the capital cost of the current expansion project will be approximately $20 to $25 million in total through fiscal 2014. We anticipate that we will use existing cash and cash equivalents to fund the expenditures for the re-refinery expansion project.

On December 31, 2012, we purchased substantially all of the operating assets of Mirachem Corporation, which provides us with the cleaning chemistry used in our aqueous parts cleaning service. We made an initial payment of approximately $2.5 million in cash at the time of closing and provided a note payable for an additional $0.8 million over two years. In a separate transaction, we acquired from a third party additional aqueous technologies in exchange for a 20% interest in Mirachem, LLC. We have an option to repurchase this 20% interest, and the current owner has a right to sell the interest, after January 1, 2016, at a price based on the trailing EBITDA of Mirachem, LLC, subject to potential modifications. We completed these transactions in order to secure the supply of our aqueous parts cleaning chemistry which, together with our patented aqueous parts cleaning equipment, should provide us with a strong platform from which to compete in the aqueous parts cleaning market. We consolidate Mirachem, LLC into our financial statements as part of the Environmental Services segment.

On June 26, 2013, we purchased substantially all of the operating assets of Recycling Fluid Technologies, Inc. ("RFTI"), which was based in Battle Creek, Michigan. RFTI's business consisted of collecting waste antifreeze, recycling the waste antifreeze, and through a recycling process producing a line of high quality antifreeze products which were sold for use in vehicle engine applications. We purchased RFTI for $4.9 million in cash and $1.2 million of our common stock, or 82,000 shares.

On July 19, 2013, we purchased substantially all of the operating assets of Recycle Technologies, Inc. ("RTI"), which was based in Wood Dale, Illinois. RTI's business and operations were very similar to the business and operations of the former RFTI, which is described above. We purchased RTI for $2.9 million in cash at the time of closing, $0.4 million in the form of a note payable, and $1.0 million of our common stock, or 69,322 shares.

The acquisitions of RFTI and RTI provide us with a presence in the antifreeze recycling market. The financial results of our antifreeze business are included in the Environmental Services segment.

On November 1, 2013, we acquired certain assets and liabilities of the northern territory of RS Used Oil Services, Inc., a subsidiary of Universal Lubricants, LLC ("ULNT/RS"), in exchange for $11.0 million in cash. The purchase of these service routes allows us to add used oil collection volume in Indiana, Ohio, Wisconsin, and parts of Illinois. The operating results of this acquisition are included in our consolidated results of operations, as part of the Oil Business segment, from the date of the acquisition.


For further discussion on these acquisitions, see Note 3 in our consolidated financial Statements included elsewhere in this document.

Critical Accounting Policies

Critical accounting policies are those that both are important to the accurate portrayal of a company's financial condition and results and require subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

In order to prepare financial statements that conform to accounting principles generally accepted in the United States, commonly referred to as GAAP, we make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Certain estimates are particularly sensitive due to their significance to the financial statements and the possibility that future events may be significantly different from our expectations.

We have identified the following accounting policies as those that require us to make the most subjective or complex judgments in order to fairly present our consolidated financial position and results of operations. Actual results in these areas could differ materially from management's estimates under different assumptions and conditions.

Acquisitions

We account for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, and contingent consideration be recorded as of the date of acquisition at their respective fair values. It further requires acquisition-related costs to be recognized separately from the acquisition and expensed as incurred and restructuring costs to be expensed in periods subsequent to the acquisition date.

Identifiable Intangible Assets

The fair value of intangible assets may be based on significant judgments made by management. We sometimes engage third party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies, and also include, but are not limited to, future expected cash flows to be earned from the continued operation of the acquired business and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates, or actual results. These intangible assets are amortized on a straight-line basis over their estimated economic lives.

Goodwill

Goodwill is measured as a residual amount as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. We test goodwill for impairment annually as well as in interim periods if changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. In fiscal 2013, we tested goodwill for impairment. Our tests indicated that the fair values were in excess of carrying values and thus did not fail step one of the goodwill impairment test. Our determination of fair value requires certain assumptions and estimates regarding future profitability and cash flows of acquired businesses and market conditions. However, due to the inherent uncertainties associated with using these assumptions, impairment charges could occur in future periods.

Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Consistent with industry practices, we require payment from most customers within 30 days of invoice date. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on analysis of customer creditworthiness, historical losses, and general economic trends and conditions. We perform periodic credit evaluations of our customers and typically do not require collateral. We have an estimation procedure, based on historical data and recent changes in the aging of these receivables that we use to record reserves throughout the year. In the last five years, our provisions for doubtful accounts have averaged 0.5% of sales. We do not have any off-balance sheet credit exposure related to our customers.


Inventory

Inventory consists primarily of used oil, processed oil, catalyst, new and used solvents, new and used antifreeze products, new and refurbished parts cleaning machines, drums, and other items. Inventories are valued at the lower of first-in, first-out ("FIFO") cost or market, net of any reserves for excess, obsolete, or unsalable inventory. We perform a physical inventory count on a periodic basis and use the results of these counts to determine inventory quantities. The quantities are used to help determine the value of our inventory. We continually monitor our inventory levels at each of our distribution locations and evaluate inventories for excess or slow-moving items. If circumstances indicate the cost of inventories exceed their recoverable value, inventories are reduced to net realizable value.

Share-Based Compensation

We recognize stock based compensation expense based on the estimated grant date fair value of the awards. We value restricted stock as of the closing stock price on the measurement date and amortize the expense on a straight-line basis over the requisite service period of the awards. See Note 15 "Share-Based Compensation" for more details.

Impairment of Long-Lived Assets

Long-lived assets, such as property and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. As no triggering events occurred during fiscal 2013 we have not tested for impairment.

RESULTS OF OPERATIONS

General

Fiscal Year Ended December 28, 2013 versus Fiscal Year Ended December 29, 2012

The following table sets forth certain operating data as a percentage of
revenues for the periods indicated (dollars in thousands):
                                                 For the Fiscal Years Ended,
                                       December 28, 2013             December 29, 2012
Revenues
  Product revenues                $     132,409        46.8 %   $     119,470        47.3 %
  Service revenues                      150,727        53.2 %         133,021        52.7 %
Total Revenues                    $     283,136       100.0 %   $     252,491       100.0 %
Operating expenses -
  Operating costs                 $     234,638        82.9 %   $     213,568        84.6 %
  Selling, general and
administrative expenses                  30,274        10.7 %          26,194        10.4 %
  Depreciation and amortization           9,524         3.4 %           8,141         3.2 %
  Other expense - net                       210         0.1 %               6           - %
Operating income                          8,490         3.0 %           4,582         1.8 %
  Interest expense - net                    417         0.1 %             585         0.2 %
Income before income taxes        $       8,073         2.9 %   $       3,997         1.6 %
Provision for income taxes                3,428         1.2 %           1,743         0.7 %
Net income                                4,645         1.6 %           2,254         0.9 %
Income attributable to
noncontrolling interest                     100           - %               -           - %
Net income attributable to
Heritage-Crystal Clean, Inc.
common stockholders               $       4,545         1.6 %   $       2,254         0.9 %


Revenues

In fiscal 2013, revenues increased $30.6 million, or 12.1%, to $283.1 million from $252.5 million in fiscal 2012. Revenues in the Environmental Services segment increased through increased volume and improved pricing from existing customers, as well as through acquisitions. In addition, Oil Business revenues increased as a result of the increase in volume of base oil and re-refinery by-products sold in fiscal 2013, compared to fiscal 2012, when we began initial sales of base oil and the re-refinery was in the start-up phase. During the second half of fiscal 2013, we began a project to expand the capacity of the re-refinery to an annual used oil input capacity of 75 million gallons per year. Although this project is expected to be completed sometime in mid-2014, we realized incremental capacity beyond the original nameplate capacity of 50 million gallons in the second half of fiscal 2013, which contributed to the increase in sales. Overall in fiscal 2013, the increase in base oil sales volume was offset by lower base oil prices compared to fiscal 2012. During fiscal 2013, the average spot market price for the Group II base oil product we produce declined approximately 18% compared to fiscal 2012.

Operating expenses

Operating costs

Operating costs increased $21.1 million, or 9.9%, from fiscal 2012 to fiscal 2013. In fiscal 2013 the increase in operating costs was primarily a result of increased production volumes in the Oil Business compared to fiscal 2012. In addition, operating costs increased in both segments as we continued to expand geographically, add customers, and add to our service offerings.

Selling, general, and administrative expenses

Selling, general, and administrative expenses increased $4.1 million, or 15.6%, from fiscal 2012 to fiscal 2013. Overall, selling, general and administrative expenses as a percentage of revenues increased to 10.7% in fiscal 2013 from 10.4% in fiscal 2012. The increase in selling, general, and administrative expenses as a percentage of revenues is primarily due to higher costs for incentive compensation.

Interest expense

Interest expense for fiscal 2013 was $0.4 million, compared $0.6 million in fiscal 2012. The decrease in interest expense in fiscal 2013 was a result of lower average debt outstanding in fiscal 2013 when our only bank debt outstanding was our Term A loan, compared to fiscal 2012 when we incurred interest from drawing on the revolving portion of our credit facility. In each of fiscal 2013 and 2012, we capitalized $0.1 million in interest.

Provision for income taxes

Our effective tax rate for fiscal 2013 was 42.5% compared to 43.6% in fiscal 2012. The decrease in the effective tax rate was, in part, due to certain true ups that were recorded in fiscal 2012 that increased the 2012 effective tax rate.

Segment Information

The following table presents sales by operating segment (dollars in thousands):
                                           For the Fiscal Year Ended,                      Increase

                                   December 28, 2013      December 29, 2012            $               %
Revenues:
   Environmental Services          $       157,282      $           139,154      $    18,128           13.0 %
   Oil Business                            125,854                  113,337           12,517           11.0 %
           Total                   $       283,136      $           252,491      $    30,645           12.1 %

In fiscal 2013, Environmental Services revenues increased $18.1 million, or 13.0%, compared to fiscal 2012. Revenues grew in all Environmental Services product lines which included parts cleaning, containerized waste, and vacuum truck services. We continued to add customers through the expansion of our branch network and increased penetration of markets at our existing branches. In addition we realized revenue growth from a combination of higher pricing and volume. We also experienced increased revenues from our acquisitions in this segment of $4.3 million in 2013.


At the end of fiscal 2013, the Environmental Services segment was operating in 74 branch locations compared with 71 at the end of fiscal 2012. There were 70 branches that were in operation throughout fiscal 2013 and fiscal 2012. In fiscal 2013 same branch sales increased $13.6 million, or 9.9%, for the 70 branches that were in operation during both years. Excluding the three branches in this group that gave up customers to new branch openings, the remaining 67 branches experienced an increase of $13.3 million, or 10.3%, for fiscal 2013.

In fiscal 2013, Oil Business revenues increased $12.5 million, or 11.0%, as production increased at the used oil re-refinery in fiscal 2013 compared to fiscal 2012. During fiscal 2013, we sold approximately 30.6 million gallons of base oil. During fiscal 2012, we sold approximately 21.9 million gallons of base oil.

Segment Profit (Loss) before Corporate Selling, General and Administrative Expenses ("SG&A")

The following table presents profit (loss) by operating segment before corporate SG&A (dollars in thousands):

For the Fiscal Year Ended, Increase (Decrease)

December 28, 2013 December 29, 2012 $ %
Profit (loss) before corporate SG&A*
       Environmental Services            $          41,886       $            29,545      $     12,341          41.8  %
       Oil Business                                 (1,689 )                   1,869            (3,558 )      (190.4 )%
              Total                      $          40,197       $            31,414      $      8,783          28.0  %

*Includes depreciation and amortization related to operating activity but not depreciation and amortization related to corporate selling, general, and administrative activity. For further discussion see Note 12 in our consolidated financial statements included elsewhere in this document.

In fiscal 2013, Environmental Services profit before SG&A increased 41.8% on increased revenues of 13.0%. Revenues grew as a result of increased pricing and volume. During fiscal 2013, we also improved our leveraging of fixed costs, which resulted in increased margin. During fiscal 2012, we added various sales and service resources which have grown in productivity and contributed to segment sales growth and profitability during fiscal 2013. In addition, in fiscal 2013, our new Mirachem subsidiary contributed $1.7 million to our profit before corporate SG&A in this segment.

The sale of used solvent generated by customers participating in our product reuse program for parts cleaning is not accounted for as revenues, but rather as a reduction in our net cost of solvent under operating costs. Reuse solvent sales provided a benefit during fiscal 2013 of $0.3 million compared to a benefit of less than $0.1 million in fiscal 2012.

In fiscal 2013, Oil Business profit before corporate SG&A decreased $3.6 million to a loss before corporate SG&A of $1.7 million. The decrease in profitability in the Oil Business compared to fiscal 2012 was primarily the result of lower base oil selling prices throughout fiscal 2013 compared to fiscal 2012. In addition, in the fourth quarter of fiscal 2013 we received some contaminated used oil feedstock from a customer. The contaminated used oil entered the re-refinery, which ultimately resulted in reduced production rates, a loss of inventory, transportation inefficiencies, and non-recurring costs for clean-up, disposal, and other items. We estimate that pre-tax income was negatively impacted by approximately $2.4 million due to the contamination event. While we had operational controls in place to prevent such contaminated oil from entering our collection system, the controls failed due to human errors. After the incident occurred, we implemented changes to our system which have strengthened our controls. These changes should minimize the risk of this type of significant contamination recurring in the future.


Fiscal Year Ended December 29, 2012 versus Fiscal Year Ended December 31, 2011

The following table sets forth certain operating data as a percentage of revenues for the periods indicated (dollars in thousands):

                                                      For the Fiscal Years Ended,
                                               December 29, 2012       December 31, 2011
Revenues
    Product revenues                         $    119,470   47.3 %   $   39,149    25.6  %
    Service revenues                              133,021   52.7 %      113,709    74.4  %
Total Revenues                               $    252,491  100.0 %   $  152,858   100.0  %
Operating expenses -
Operating costs                                   213,568   84.6 %      124,000    81.1  %
Selling, general and administrative expenses       26,194   10.4 %       20,715    13.6  %
Depreciation and amortization                       8,141    3.2 %        5,657     3.7  %
    Other expense (income) - net                        6      - %          (10 )     -  %
Operating income                                    4,582    1.8 %        2,496     1.6  %
Interest expense - net                                585    0.2 %           37       -  %
Income before income taxes                   $      3,997    1.6 %   $    2,459     1.6  %
Provision for income taxes                          1,743    0.7 %          985     0.6  %
Net income                                   $      2,254    0.9 %   $    1,474     1.0  %

Revenues

. . .

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