Heritage-Crystal Clean, Inc. - Quarter Report: 2008 September (Form 10-Q)

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Heritage-Crystal Clean, Inc.

Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

 

		First Three Quarters Ended
		September 6, 2008				September 8, 2007
Cash Flows from Operating Activities:
Net income		$	263			$	5,889
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			2,441				1,917
Bad debt provision			584				454
Share-based compensation			3,333				204
Non-cash inventory charge related to contract termination			-				2,182
Deferred tax expense			1,048				-
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivables			(2,654	)			(2,339	)
Decrease (increase) in inventory			(4,082	)			(2,564	)
Decrease (increase) in prepaid and other current assets			(730	)			(186	)
Increase (decrease) in accounts payable			210				1,093
Increase (decrease) in accrued expenses			1,824				689
Cash provided by operating activities			2,237				7,339
Cash flows from Investing Activities:
Capital expenditures			(3,436	)			(5,612	)
Software and intangible asset costs			(489	)			(126	)
Cash used in investing activities			(3,925	)			(5,738	)
Cash flows from Financing Activities:
Deferred offering costs			-				(559	)
Deferred financing costs			-				(33	)
Proceeds from issuance of common stock, net of offering costs			34,220				-
Proceeds from note payable - bank			30,760				19,974
Repayments of note payable - bank			(51,640	)			(18,679	)
Common member contributions			-				2
Distributions to preferred members			(11,768	)			(2,375	)
Cash provided by (used in) financing activities			1,572				(1,670	)
Net increase (decrease) in cash and cash equivalents			(116	)			(69	)
Cash and cash equivalents, beginning of period			479				271
Cash and cash equivalents, end of period		$	363			$	202
Supplemental disclosure of cash flow information:
Cash paid for interest		$	526			$	1,104
Payables for construction in process			-				751
Payables for offering costs			103				-
Income taxes paid			1,024				-

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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HERITAGE-CRYSTAL CLEAN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 6, 2008

(Unaudited)

(1)  ORGANIZATION AND NATURE OF OPERATIONS

Heritage-Crystal Clean, Inc. and its subsidiaries (the “Company”), a Delaware corporation, provides parts cleaning, hazardous and non-hazardous waste services to small and mid-sized customers in both the manufacturing and automotive service sectors.  Our service programs include parts cleaning, containerized waste management, used oil collection, and vacuum truck services.

On March 12, 2008, Heritage-Crystal Clean, Inc. raised net proceeds of $33.2 million in an initial public offering and a direct placement (the “offerings”). Concurrently, the Company paid preferred members an accrued return through March 11, 2008 of $10.9 million as part of a reorganization, in which, prior to the consummation of the offerings, the members of Heritage-Crystal Clean, LLC and the former stockholders of BRS-HCC Investment Co., Inc. became stockholders of Heritage-Crystal Clean, Inc. (the “reorganization”). Further details regarding these transactions can be found below under the heading “Shareholders’ Equity.”

Prior to the completion of the reorganization, the Company filed an amendment to its certificate of incorporation with the Delaware Secretary of State, increasing its authorized capital to 15,000,000 shares of common stock at a par value of $0.01 per share and 500,000 shares of undesignated preferred stock.

(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of consolidation and basis of presentation

The Company conducts its primary business operations through Heritage-Crystal Clean, LLC., its wholly owned subsidiary, and all intercompany balances have been eliminated in consolidation.

The unaudited interim financial statements included herein have been prepared by the Company in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Operating results for interim periods are not necessarily indicative of results that may be expected for the year as a whole. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These financial statements and notes thereto should  be read in conjunction with the Company’s audited financial statements for the fiscal year ended December 29, 2007 filed with the Unites States Securities and Exchange Commission on a Registration Statement on Form S-1, as amended (SEC Reg. No. 333-143864)

The 2007 year-end consolidated balance sheet data included in this Form 10-Q was derived from the audited financial statements referenced above, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

GAAP requires the use of certain estimates by management in determining the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Significant items subject to such estimates and assumptions are the allowance for doubtful accounts receivable and valuation of inventory at lower of cost or market. Actual results could differ from those estimates.

The Company’s fiscal year ends on the Saturday closest to December 31. The most recent fiscal year ended on December 29, 2007. Our convention with respect to reporting periodic financial data is such that each of our first three fiscal quarters consist of twelve weeks while our last fiscal quarter consists of sixteen or seventeen weeks. Interim results are presented for the twelve week periods and thirty-six week periods ended September 6, 2008 and September 8, 2007 each referred to as “third quarter ended” or “third fiscal quarter” and “first three quarters ended” respectively.

 (b) Income Taxes

In connection with the Company's reorganization and initial public offering, the Company became a ‘C’ corporation subject to federal and state income taxes. The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes ("SFAS No. 109"), under which deferred assets and liabilities are recognized based upon anticipated future tax consequences attributable to differences between financial statement carrying values of assets and liabilities and their respective tax bases. A valuation allowance is established to reduce the carrying value of deferred tax assets if it is considered more likely than not that

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such assets will not be realized. Any change in the valuation allowance would be charged to income in the period such determination was made.

Prior to converting to a ‘C’ corporation on March 11, 2008, the Company operated as a limited liability company and was taxed as a partnership. As such, the Company's income or losses were passed through to its owners who are liable for any related income taxes.

(c) Stock-Based Compensation

Effective January 1, 2006, the Company adopted FASB Statement No. 123(R), Share-Based Payment (Statement 123(R)). This statement replaces FASB Statement No. 123, Accounting for Stock-Based Compensation (Statement 123) and supersedes APB No. 25. Statement 123(R) requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. This statement was adopted using the prospective method of application, which requires the Company to recognize compensation cost on a prospective basis. For share-based awards granted after January 1, 2006, the Company recognized compensation expense based on estimated grant date fair value.

The Company values restricted stock as of the closing stock price on the grant date, then amortizes the expense on a straight-line basis in accordance with FASB Statement No. 123(R) over the remaining vesting period of the awards.

The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The following assumptions are used in the Black-Scholes-Merton option pricing model:

Expected Term —The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding;

Expected Volatility —Due to the Company’s limited trading history, the average volatility estimate used was determined by using a composite group of peer companies;

Expected Dividend —The Black-Scholes-Merton valuation model calls for a single expected dividend yield as an input. The Company currently pays no dividends and does not expect to pay dividends in the foreseeable future;

Risk-Free Interest Rate —The Company bases the risk-free interest rate on the implied yield currently available on United States Treasury zero-coupon issues with an equivalent remaining term.

(d) Recent Accounting Pronouncements  

In December 2007, the FASB issued FASB Statement No. 141R, Business Combinations (Statement 141R) and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment to ARB No. 51 (Statement 160). Statements 141R and 160 require most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both Statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. Statement 141R will be applied to business combinations occurring after the effective date. Statement 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. The impact of SFAS 141R on the Company will be dependant upon the extent to which we have transactions or events occur that are within its scope.

(e) New Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies to previous accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Delayed application is permitted for nonfinancial assets and nonfinancial liabilities except for items that are recognized or disclosed at fair value in the Financial Statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008. The Company has adopted SFAS 157 and the impact has been immaterial to the consolidated financial statements.

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including on amendment of FASB Statement No. 115 (SFAS 159). This standard amends SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, with respect to accounting for a transfer to the trading category for all entities with available-for-sale and trading securities electing the fair value option. This standard allows companies to elect fair value accounting for many financial instruments and other items that currently are not required to be accounted as such, allows different applications for electing the option for a single item or groups of items, and requires disclosures to facilitate comparisons of similar assets and liabilities that are

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accounted for differently in relation to the fair valueoption. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company has adopted SFAS 159 and the impact has been immaterial to the consolidated financial statements.

(3)  INVENTORY

The carrying value of inventory consisted of the following (in thousands):

 

		September 6, 2008				December 29, 2007
Machines		$	2,494			$	2,228
Solvents			9,901				6,379
Drums			1,110				1,004
Accessories			1,025				836
Total inventory		$	14,530			$	10,447

 

(4)   NOTE PAYABLE

The Company has a bank credit facility that provides for borrowings of up to $25 million. On March 3, 2008, the Company amended the credit facility to extend the maturity date of the credit facility to December 31, 2010. As of September 6, 2008 and December 29, 2007, $1.2 million and $22.0 million respectively, were outstanding under the credit facility. Under the terms of the credit facility, interest is payable monthly at the prime rate, unless the total leverage ratio is greater than or equal to 2.75 to 1. The weighted average effective interest rate for amounts outstanding was 6.68% and 8.34% at September 6, 2008 and December 29, 2007, respectively. Amounts borrowed under the credit facility are secured by a security interest in substantially all of the Company’s tangible and intangible assets. As of September 6, 2008, the Company was in compliance with all covenants under its credit facility. As of September 6, 2008 and December 29, 2007 $23.8 million and $3.0 million respectively, were available under the credit facility.

(5)   COMMITMENTS AND CONTINGENCIES

The Company is subject to contingencies as a result of environmental laws and regulations. The related future cost is not determinable due to such factors as the unknown timing and extent of corrective actions, if any, that may be required and also due to the application of joint and several liability. The Company believes, however, that any such costs will not have a material adverse effect on its financial position, future operations, or cash flows.

The Company leases office space, equipment, and vehicles under noncancelable operating lease agreements which expire through 2016. Rental expense under operating leases was approximately $1.7 million and $1.6 million for the third quarter of 2008 and 2007, respectively, and $5.2 million and $4.5 million for the first three quarters of 2008 and 2007, respectively.

Future minimum lease payments under noncancelable operating leases as of September 6, 2008 are as follows (in thousands):

 

Fiscal period:

Remainder of 2008		$	2,669
2009			7,066
2010			5,649
2011			4,314
2012			3,562
Thereafter			4,449
Total		$	27,709

 

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(6)  INCOME TAXES

On March 11, 2008, in connection with the reorganization and the Company converting from a limited liability company to a 'C' corporation, the Company established beginning balances in its deferred tax assets and liabilities in accordance with SFAS No. 109. Accordingly, the Company recorded a cumulative net deferred tax asset of $0.1 million.   Of this amount, a tax benefit of $2.3 million was recorded directly to equity in accordance with EITF 94-10, related to the increase in the tax basis of the Company's assets due to the reorganization. This was partially offset by a $2.2 million tax liability related to the change in tax status which was recorded as a component of the income tax provision.

Components of the Company's income tax benefit and provision for the period following the Company's conversion to a ‘C’ corporation from December 30, 2007 through September 6, 2008, including the $2.2 million deferred tax charge discussed above, are as follows:

 

		December 30, 2007
		through
		September 6, 2008
Current:
Federal		$	1,759
State			399
Total current		$	2,158
Deferred:
Change in tax status		$	2,210
Federal			(1,017	)
State			(145	)
Total deferred		$	1,048
Income tax provision		$	3,206
Pro forma tax for period prior to conversion			497
Total pro forma tax provision		$	3,703

 

A reconciliation of the expected income taxes at the statutory federal rate to the Company's actual income taxes for December 30, 2007 through September 6, 2008, is as follows:

 

		December 30, 2007
		through
		September 6, 2008
Tax at statutory federal rate		$	1,180
State and local tax, net of federal benefit			164
Other			149
Change in tax status			2,210
Earnings for period prior to conversion			(497	)
Total income tax provision		$	3,206
Pro forma tax for period prior to conversion			497
Total pro forma tax provision		$	3,703

 

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Components of deferred tax assets (liabilities) are as follows:

 

		September 6, 2008
Deferred tax assets:
Tax intangible assets		$	2,272
Allowances			765
Accrued other			728
Stock compensation			1,182
Total deferred tax asset		$	4,947
Deferred tax liabilities:
Prepaids			(360	)
Depreciation and amortization			(3,292	)
Total deferred tax liability		$	(3,652	)
Net deferred tax asset		$	1,295
Current deferred tax asset		$	1,163
Noncurrent deferred tax asset			132
Net deferred tax asset		$	1,295

 

The Company has not provided any valuation allowance as it believes the realization of its deferred tax assets is more likely than not based on the expectation of future taxable income.

(7)  SHAREHOLDERS’ EQUITY

 

On March 11, 2008 the Company completed a reorganization, initial public offering and direct placement.  In connection with the reorganization, initial public offering and direct placement the Company:

 

•   Became a ‘C’ corporation through the reorganization of Heritage-Crystal Clean, LLC and a merger of BRS-HCC Investment Co., Inc. with and into Heritage-Crystal Clean, Inc.;

 

•   Issued an aggregate of 1,217,390 shares of common stock as part of the exchange of preferred units of Heritage-Crystal Clean, LLC into common stock of Heritage-Crystal Clean, Inc. in the reorganization;

 

•   Issued an aggregate of 6,056,900 shares of common stock as part of the exchange of common units of Heritage-Crystal Clean, LLC into common stock of Heritage-Crystal Clean, Inc.

 

•   Sold 2,201,100 shares of common stock in the initial public offering, at $11.50 per share, raising approximately $20.4 million after underwriting discounts and transaction costs;

 

•   Sold 1,200,000 new shares at $11.50 per share in a direct placement, raising approximately $12.8 million after underwriting discounts and transaction costs;

 

•    Repaid approximately $21.3 million of indebtedness with the proceeds raised in the initial public offering and direct placement;

 

•    Paid distributions of $10.9 million to preferred unit holders of Heritage-Crystal Clean, LLC as part of the reorganization relating to an accrued return through March 11, 2008; and

 

•    Recorded a cumulative net deferred tax liability of $2.2 million and a corresponding charge to our provision for income taxes upon becoming taxable as a ‘C’ corporation.

 

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(8) SHARE-BASED COMPENSATION

 

On March 3, 2008, the Company adopted the 2008 Omnibus Incentive Plan (the “Plan”) to promote the interests of the Company and its stockholders by providing employees of the Company and its subsidiaries and members of the Board who are not employees of the Company (“Non-Employee Directors) with additional incentives to increase their efforts on the Company’s behalf and to remain in the employ or service of the Company and with the opportunity, through stock ownership, to increase their proprietary interest in the Company and their personal interest in its continued success and progress.  The aggregate number of shares of common stock which may be issued under the Plan is 1,902,077 plus any common stock that becomes available for issuance pursuant to the reusage provision of the Plan.

These options may vest over various periods up to four years and expire no more than ten years from the date of grant. A summary of activity under this Plan is as follows (in thousands):

 

		Options								Weighted Average Fair				Weighted Average Exercise
		Available				Number of				Value Per				Price Per
		For Grant				Options				Option				Option
Balance at December 29, 2007			-				-				-				-
Shares reserved			1,902				-				-				-
Options granted			(732	)			732			$	3.90			$	11.50
Balance at September 6, 2008			1,170				732			$	3.90			$	11.50

 

 At September 6, 2008, 732,045 options were outstanding and had a weighted-average remaining contractual life of 9.54 years and an exercise price of $11.50. All of these options are fully vested and exercisable and the Company incurred $2.9 million of non-cash share-based compensation expense with respect to these options. The Company also incurred $0.3 million of non-cash share-based compensation expense that related to Key Employee Membership Interest Trust “KEMIT” units that converted to shares of common stock upon the completion of our initial public offering.

The fair values of employee stock options granted were estimated to be $3.90 per share on the date of grant using the Black-Scholes-Merton option-pricing model with the following assumptions:

•

Volatility of 33.23%;

•

Risk-free interest rate of 2.76%;

•

Expected term of 5 years;

•

No dividend yield; and

•

Market value per share of stock on measurement date of $11.50.

In addition to the stock options listed above, in February 2007, the Company granted to certain key employees in our oil and vacuum business 120 common units that subsequently converted to 60,000 restricted shares in connection with our initial public offering in March 2008. These shares are subject to forfeiture if certain performance goals are not achieved by fiscal year end 2011. As of September 6, 2008, the Company believes that the performance criteria will be met and has recorded compensation expense of $33,000 and $99,000 during the third quarter and first three quarters of 2008, respectively, with respect to these shares. At September 6, 2008, there was approximately $0.5 million of unrecognized compensation expense related to these awards which will be recorded through 2011.

The Company has granted in May 2008, 9,072 restricted shares to its Board of Directors in which the shares become fully vested after one year of service from their grant date. At September 6, 2008, there was less than $0.1 million of unrecognized compensation expense related to these awards which will be recorded through the second quarter of 2009.

 

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(9) PRO FORMA NET INCOME PER COMMON SHARE

Basic net income per common share is computed by dividing net income available for common shareholders by the weighted average number of common shares outstanding for the period in accordance with FASB Statement No. 128, Earnings per Share. Diluted net income per common share is computed by dividing the sum of net income available for common shareholders by the sum of the weighted average number of common shares outstanding and any dilutive potential common equivalents for the period.

The following table reconciles the components of net income, net income available to common shareholders, and pro forma net income available to common members both for basic and diluted income per common share (in thousands, except per share data):

 

		Third Quarter Ended								First Three Quarters Ended
		September 6, 2008				September 8, 2007				September 6, 2008				September 8, 2007
Net income (loss) available to common shareholders		$	1,622			$	1,420			$	(76	)		$	4,718
Net income (loss) per share available to common shareholders: basic		$	0.15			$	0.20			$	(0.01	)		$	0.66
Net income (loss) per share available to common shareholders: diluted		$	0.15			$	0.20			$	(0.01	)		$	0.65
Pro Forma
Net Income		$	1,622			$	1,810			$	263			$	5,889
Pro forma provision for income taxes			-				742				497				2,415
Return on perferred and mandatorily redeemable capital units			-				401				372				1,206
Pro forma net income (loss) available to common members		$	1,622			$	667			$	(606	)		$	2,268
Pro forma net income (loss) per share: basic		$	0.15			$	0.09			$	(0.06	)		$	0.32
Pro forma net income (loss) per share: diluted		$	0.15			$	0.09			$	(0.06	)		$	0.31
Number of weighted average common shares outstanding: basic			10,675				7,182				9,657				7,176
Diluted shares for share-based compensation plans			173				60				-				47
Number of weighted average common shares outstanding: diluted			10,848				7,242				9,657				7,223