Quest Resource Holding Corp - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2019

Commission file number: 001-36451

Quest Resource Holding Corporation

(Exact Name of Registrant as Specified in its Charter)

3481 Plano Parkway

The Colony, Texas 75056

(Address of Principal Executive Offices and Zip Code)

(972) 464-0004

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Securities registered pursuant to Section 12(b) of the Act:

As of November 1, 2019, there were outstanding 15,350,153 shares of the registrant’s common stock, $0.001 par value, outstanding.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. The Company and Description of Business

The accompanying condensed consolidated financial statements include the accounts of Quest Resource Holding Corporation (“QRHC”) and its subsidiaries, Quest Resource Management Group, LLC (“Quest”), Landfill Diversion Innovations, LLC (“LDI”), Youchange, Inc. (“Youchange”), Quest Vertigent Corporation (“QVC”), Quest Vertigent One, LLC (“QV One”), and Quest Sustainability Services, Inc. (“QSS”) (collectively, “we,” “us,” “our,” or “our company”).  

Operations – We are a national provider of reuse, recycling, and disposal services that enable our customers to achieve and satisfy their environmental and sustainability goals and responsibilities.  We provide businesses across multiple industry sectors with single source solutions for the reuse, recycling, and disposal of a wide variety of waste streams and recyclables generated by their operations.

2. Summary of Significant Accounting Policies

Principles of Presentation and Consolidation

The condensed consolidated financial statements included herein have been prepared by us without audit pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with our audited financial statements for the year ended December 31, 2018. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted as permitted by the SEC, although we believe the disclosures that are made are adequate to make the information presented herein not misleading.

The accompanying condensed consolidated financial statements reflect, in our opinion, all normal recurring adjustments necessary to present fairly our financial position at September 30, 2019 and the results of our operations and cash flows for the periods presented. We derived the December 31, 2018 condensed consolidated balance sheet data from audited financial statements; however, we did not include all disclosures required by GAAP. As QRHC, Quest, LDI, Youchange, QVC, QV One, and QSS each operate as environmental-based service companies, we did not deem segment reporting necessary.

All intercompany accounts and transactions have been eliminated in consolidation. Interim results are subject to seasonal variations, and the results of operations for the nine months ended September 30, 2019 are not necessarily indicative of the results to be expected for the full year.

Recent Accounting Pronouncements

Adopted

On January 1, 2019, we adopted Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), using a modified retrospective approach with an effective date as of January 1, 2019.  Accordingly, prior year financial statement data is presented in accordance with the previous ASC Topic 840, Leases, and no retrospective adjustments were made to the comparative periods presented.  We elected the package of practical expedients, which allowed us to carryforward our historical assessment of (1) whether contracts are or contain leases, (2) lease classification, and (3) initial direct costs.  As of January 1, 2019, we recognized an operating right-of-use asset of approximately $2.0 million and corresponding operating lease liabilities of approximately $2.2 million.  Finance lease assets were not impacted by the adoption of ASC 842, as finance lease liabilities and the corresponding assets were already recorded on the balance sheet under ASC 840.  The adoption did not materially impact our results of operations or cash flows and no cumulative adjustment to accumulated deficit was necessary as of January 1, 2019.  Refer to Note 7, Leases for additional information and enhanced disclosures related to this amended guidance.

On January 1, 2018, we adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), using the full retrospective approach for all ongoing customer contracts.  Refer to Note 8, Revenue for additional information and disclosures related to this amended guidance.

Pending Adoption

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which provides guidance on measuring credit losses on financial instruments.  The amended guidance replaces current incurred loss impairment methodology of recognizing credit losses when a loss is probable with a methodology that reflects expected credit losses and requires a broader range of reasonable and supportable information to assess credit loss estimates.  ASU 2016-13 is effective for us on January 1, 2023.  We are assessing the provisions of this amended guidance; however, the adoption of the standard is not expected to have a material effect on our consolidated financial statements.

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There have been no other recent accounting pronouncements or changes in accounting pronouncements that have been issued but not yet adopted that are of significance, or potential significance, to us.

3. Property and Equipment, net, and Other Assets

At September 30, 2019 and December 31, 2018, property and equipment, net, and other assets consisted of the following:

We compute depreciation using the straight-line method over the estimated useful lives of the property and equipment. Depreciation expense for the three months ended September 30, 2019 was $58,933, including $24,695 of depreciation expense reflected within “Cost of revenue” in our condensed consolidated statements of operations as it related to assets used in directly servicing customer contracts, and was $175,562 for the nine months ended September 30, 2019, including $73,704 of depreciation expense reflected within “Cost of revenue.”  Depreciation expense for the three months ended September 30, 2018 was $97,679, including $45,576 of depreciation expense reflected within “Cost of revenue,” and was $301,651 for the nine months ended September 30, 2018, including $136,574 reflected within “Cost of revenue.”  

We recorded a right-of-use operating lease asset of $2.0 million related to our corporate office lease upon the adoption of ASC 842 effective January 1, 2019.  Refer to Note 7, Leases for additional information.

On February 20, 2018 (the “Closing Date”), we entered into an Asset Purchase Agreement with Earth Media Partners, LLC to sell certain assets of our wholly owned subsidiary, Earth911, Inc., in exchange for a 19% interest in Earth Media Partners, LLC, which was recorded as an investment in the amount of $246,585 as of the Closing Date, and a potential future earn-out amount of approximately $350,000.  The net assets sold related to the Earth911.com website business and consisted primarily of the website and its content and customers, deferred revenue, and accounts receivable as of the Closing Date.  Earth911, Inc. was subsequently renamed Quest Sustainability Services, Inc.  In addition to our investment in Earth Media Partners, LLC, we accrued a receivable in the amount of $134,926 related to the earn-out as of September 30, 2019.  The carrying amount of our investment and the accrued earn-out receivable are included in other assets.

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4. Goodwill and Other Intangible Assets

The components of goodwill and other intangible assets were as follows:

We compute amortization using the straight-line method over the estimated useful lives of the finite lived intangible assets. Amortization expense related to finite lived intangible assets was $295,304 and $354,623 for the three months ended September 30, 2019 and 2018, respectively.  Amortization expense related to finite lived intangible assets was $880,564 and $2,207,840 for the nine months ended September 30, 2019 and 2018, respectively.

We have no indefinite-lived intangible assets other than goodwill. The goodwill is not deductible for tax purposes.  

We performed our annual impairment analysis for goodwill and other intangible assets in the third quarter of 2019 with no impairment recorded.

5. Accounts Payable and Accrued Liabilities

The components of Accounts payable and accrued liabilities were as follows:

Refer to Note 7, Leases for additional disclosure related to the operating lease liability recorded upon the adoption of ASC 842 Leases.

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6. Revolving Credit Facility

We entered into a Loan, Security and Guaranty Agreement (the “Citizens Loan Agreement”), dated as of February 24, 2017, with Citizens Bank, National Association as a lender, and as administrative agent, collateral agent, and issuing bank, which provides for an asset-based revolving credit facility (the “ABL Facility”) of up to $20 million and an equipment loan facility in the maximum principal amount of $2.0 million.

Each loan under the ABL Facility bears interest, at our option, at either the Base Rate, as defined in the Citizens Loan Agreement, plus a margin ranging from 1.0% to 1.5% (6.25% as of September 30, 2019), or the LIBOR lending rate for the interest period in effect, plus a margin ranging from 2.0% to 2.5% (4.37% as of September 30, 2019). The maturity date of the ABL Facility is February 24, 2022.  

LIBOR is expected to be discontinued after 2021. The ABL Facility provides procedures for determining a replacement or alternative rate in the event that LIBOR is unavailable. However, there can be no assurances as to whether such replacement or alternative rate will be more or less favorable than LIBOR. We intend to monitor the developments with respect to the potential phasing out of LIBOR after 2021 and will work with Citizens Bank, National Association to ensure any transition away from LIBOR will have minimal impact on our financial condition. We however can provide no assurances regarding the impact of the discontinuation of LIBOR on the interest rate that we would be required to pay or on our financial condition.

We had no borrowings under the equipment loan facility, which were required to be requested no later than February 24, 2019.  

The ABL Facility contains certain specific financial covenants regarding a minimum liquidity requirement and a minimum fixed charge coverage ratio.  In addition, the ABL Facility contains negative covenants limiting, among other things, additional indebtedness, transactions with affiliates, additional liens, sales of assets, dividends, investments and advances, mergers and acquisitions, and other matters customarily restricted in such agreements.

The amount of interest expense related to borrowings for the three months ended September 30, 2019 and 2018 was $86,765 and $81,644, respectively.  The amount of interest expense related to borrowings for the nine months ended September 30, 2019 and 2018  was $263,542 and $247,071, respectively.  Debt issuance cost of $469,507 is being amortized to interest expense over the term of the ABL Facility.  As of September 30, 2019, the unamortized portion of the debt issuance costs was $226,928.  The amount of interest expense related to the amortization of the discount on the ABL Facility for the nine months ended September 30, 2019 and 2018 was $70,426.  As of September 30, 2019, the ABL Facility borrowing base availability was $9,625,000, of which $4,455,183 was outstanding.  The outstanding liability as of September 30, 2019 was $4,228,255, net of unamortized debt issuance cost of $226,928.

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7. Leases

ASU 2016-02 Adoption

On January 1, 2019, we adopted ASU 2016-02, Leases (Topic 842), and the related amendments (collectively “ASC 842”).  We used the optional transition method of adoption, in which the cumulative effect of initially applying the new standard, as of January 1, 2109, to our existing leases was approximately $2.0 million and $2.2 million to record the operating lease right-of-use asset and the related liabilities, respectively, all of which relate to our corporate office lease.  Under this method of adoption, the comparative information in the condensed consolidated financial statements has not been revised and continues to be reported under the previous applicable lease accounting guidance (ASC 840).  Leases with terms of 12 months or less are not recorded on the balance sheet.

When we have the option to extend the lease term, terminate the lease before the contractual expiration date, or purchase the leased asset, and if it is reasonably certain that we will exercise the option, we consider these options in determining the classification and measurement of the lease.

As of December 31, 2018, leases classified as capital leases under ASC 840 were included in Property and equipment, net and represented almost fully depreciated office equipment with a negligible book value.

We lease certain equipment to a customer under a lease arrangement that expires in 2020.  The capital lease receivable amounts are approximately $8,000 at September 30, 2019, the majority of which is included in Prepaid expenses and other current assets.  

Balance Sheet Classification

The table below presents the lease related assets and liabilities recorded on the balance sheet. Right-of-use assets and related liabilities related to finance leases at September 30, 2019 are de minimis and mature in less than 12 months.

Lease Costs

For the three and nine months ended September 30, 2019, we recorded approximately $150,000 and $450,000 of fixed cost operating lease expense, respectively.  Our operating lease expense is offset by a minimum annual incentive received from a local Economic Development Council, which is accrued monthly and will continue over the term of the lease through August 2022.  This minimum annual incentive is $63,000, which will increase to $93,600 for the annual incentive period starting September 2020.  

Cash paid for operating leases approximated operating lease expense and non-cash right of use asset amortization for the three and nine months ended September 30, 2019.  We did not obtain any new operating lease right-of-use assets in the nine months ended September 30, 2019.

Other Information

Our office lease had a remaining term of 3 years as of September 30, 2019, and we used an effective interest rate of 2.456%, which was our incremental borrowing rate in effect at the inception of the lease as our lease does not provide a readily determinable implicit rate.

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The future minimum lease payments required under our office lease as of September 30, 2019 were as follows:    

8. Revenue

Operating Revenues

We provide businesses with services to reuse, recycle, and dispose of a wide variety of waste streams and recyclables generated by their operations.  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.  

Revenue Recognition

We recognize revenue as services are performed or products are delivered.  For example, we recognize revenue as waste and recyclable material are collected or when products are delivered.  We recognize revenue net of any contracted pricing discounts or rebate arrangements.    

We generally recognize revenue for the gross amount of consideration received as we are generally the primary obligor (or principal) in our contracts with customers as we hold complete responsibility to the customer for contract fulfillment.  We record amounts collected from customers for sales tax on a net basis.

Disaggregation of Revenue

The following table presents our revenue disaggregated by source.  Three customers accounted for 49.4% of revenue for the three months ended September 30, 2019, and three customers accounted for 48.6% of revenue for the three months ended September 30, 2018.  Three customers accounted for 54.6% of revenue for the nine months ended September 30, 2019, and three customers accounted for 50.1% of revenue for the nine months ended September 30, 2018. We operate primarily in the United States, with minor services in Canada.

Contract Balances

Our incremental direct costs of obtaining a customer contract are generally deferred and amortized to selling, general, and administrative expense or as a reduction to revenue (depending on the nature of the cost) over the estimated life of the customer contract.  We classify our contract acquisition costs as current or noncurrent based on the timing of when we expect to recognize the amortization and are included in other assets.

As of September 30, 2019 and December 31, 2018, we had $67,500 and $7,448, respectively, of deferred contract costs.  During the three months ended September 30, 2019, we amortized $53,750 of deferred contract costs to selling, general, and administrative expense.  During the three months ended September 30, 2018, we amortized $53,750 of deferred contract costs to selling, general, and administrative expense.  During the nine months ended September 30, 2019, we amortized $161,250 of deferred contract costs to selling, general, and administrative expense.  During the nine months ended September 30, 2018, we amortized $157,500 and $36,139 of deferred contract costs to selling, general, and administrative expense and as a reduction to income, respectively.

We bill certain customers in advance, and, accordingly, we defer recognition of related revenues as a contract liability until the services are provided and control is transferred to the customer.  As of September 30, 2019 and December 31, 2018, we had $15,516 and $69,473, respectively, of deferred revenue, the majority of which was classified in “Deferred revenue and other current liabilities.”

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9. Income Taxes

Our statutory income tax rate is anticipated to be 27%.  However, we had income tax expense of $164,311 for the nine months ended September 30, 2019, which is attributable to state tax obligations for states with no net operating loss carryforwards, and the continued reserve against the benefit of the net operating losses at the federal level.

We compute income taxes using the asset and liability method in accordance with FASB ASC Topic 740, Income Taxes. Under the asset and liability method, we determine deferred income tax assets and liabilities based on the differences between the financial reporting and tax bases of assets and liabilities and measure them using currently enacted tax rates and laws. We provide a valuation allowance to reduce the amount of deferred tax assets that, based on available evidence, is more likely than not to be realized. Realization of our net operating loss carryforward was not reasonably assured as of September 30, 2019 and December 31, 2018, and we had recorded a valuation allowance of $12,075,000 and $12,202,000, respectively, against deferred tax assets in excess of deferred tax liabilities in the accompanying condensed consolidated financial statements. As of September 30, 2019 and December 31, 2018, we had federal income tax net operating loss carryforwards of approximately $17,900,000 and $18,900,000, respectively, which expire at various dates ranging from 2031-2037.

10. Fair Value of Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, deferred revenue, and the ABL Facility. We do not believe that we are exposed to significant interest, currency, or credit risks arising from these financial instruments.  The fair values of these financial instruments approximate their carrying values using Level 3 inputs, based on their short maturities or, for the ABL Facility, based on borrowing rates currently available to us for loans with similar terms and maturities.

11. Stockholders’ Equity

Preferred Stock – Our authorized preferred stock consists of 10,000,000 shares of preferred stock with a par value of $0.001, of which no shares have been issued or are outstanding.

Common Stock – Our authorized common stock consists of 200,000,000 shares of common stock with a par value of $0.001, of which 15,350,153 and 15,328,870 shares were issued and outstanding as of September 30, 2019 and December 31, 2018, respectively.

Employee Stock Purchase Plan – On September 17, 2014, our stockholders approved our 2014 Employee Stock Purchase Plan (“ESPP”).  On May 14, 2019, we issued 21,283 shares to employees for $29,669 under our ESPP for options that vested and were exercised.  We recorded expense of $20,617 and $9,317 related to the ESPP for the nine months ended September 30, 2019 and 2018, respectively.

Warrants – At September 30, 2019, we had outstanding exercisable warrants to purchase 608,560 shares of common stock.  Warrants to purchase 1,125,005 shares of common stock expired on September 24, 2019.  

The following table summarizes the warrants issued and outstanding as of September 30, 2019:

Stock Options – We recorded stock option expense of $729,431 and $584,204 for the nine months ended September 30, 2019 and 2018, respectively.  The following table summarizes the stock option activity for the nine months ended September 30, 2019:

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Deferred Stock Units – Effective September 1, 2019, nonemployee directors can elect to receive all or a portion of their annual retainers in the form of deferred stock units (“DSUs”).   The DSUs are recognized at their fair value on the date of grant.  Each DSU represents the right to receive one share of our common stock following the completion of a director’s service.  During the nine months ended September 30, 2019, we granted 3,464 DSUs and recorded director compensation expense of $8,660 related to the grants.

12. Net Income (Loss) per Share

We compute basic net income (loss) per share using the weighted average number of shares of common stock outstanding plus the number of common stock equivalents for DSUs during the period. We compute diluted net income (loss) per share using the weighted average number of shares of common stock outstanding during the period, adjusted for the dilutive effect of common stock equivalents.  In periods where losses are reported, the weighted average number of shares of common stock outstanding excludes common stock equivalents because their inclusion would be anti-dilutive.  Dilutive potential common shares consist of the incremental common shares issuable upon the exercise of outstanding stock options.  Dilutive potential securities are excluded from the computation of earnings per share if their effect is antidilutive.  The dilutive effect of outstanding stock options and warrants is reflected in diluted earnings per share by application of the treasury stock method.  Deferred stock units (see Note 11) are included in both basic and diluted earnings per share computations.  

The computation of basic and diluted net income (loss) per share attributable to common stockholders is as follows:

13.  Related Party Transactions

During the quarter ended June 30, 2019, three stockholders sold approximately 4.3 million shares of our common stock in a registered public offering that closed on April 11, 2019.  In a separate private transaction, a certain selling stockholder sold 1,750,000 shares of our common stock.  The offering and private transaction, together the “Transactions”, closed on April 11, 2019.  We did not receive any proceeds from sales by the selling stockholders in the Transactions.  We incurred costs and expenses in connection with the Transactions, consisting of various registration, due diligence, printing, and professional service fees and expenses, and such costs, less amounts reimbursed by the selling stockholders at the closing of the Transactions, were approximately $248,000, and is included in selling, general, and administrative expense for the nine months ended September 30, 2019.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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. 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,” “may,” “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; exposure to significant interest, currency, or credit risks arising from our financial instruments; sufficiency of our cash and cash equivalents, borrowing capacity, and cash generated from operations to fund our operations for the next 12 months; and estimated amortization expense of intangible assets for future periods.  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 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, 2018.  

Overview

We were incorporated in Nevada in July 2002 under the name BlueStar Financial Group, Inc. On July 16, 2013, we acquired all of the issued and outstanding membership interests of Quest Resource Management Group, LLC, or Quest, held by Quest Resource Group LLC, or QRG, comprising 50% of the membership interests of Quest, or the Quest Interests. Our wholly owned subsidiary, Quest Sustainability Services, Inc., or QSS, (formerly known as Earth911, Inc.), held the remaining 50% of the membership interests of Quest for several years.  Concurrently with our acquisition of the Quest Interests, we assigned the Quest Interests to QSS so that QSS now holds 100% of the issued and outstanding membership interests of Quest. On October 28, 2013, we changed our name to Quest Resource Holding Corporation.

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 Quest.

Three and Nine Months Ended September 30, 2019 and 2018 Operating Results

The following table summarizes our operating results for the three and nine months ended September 30, 2019 and 2018:

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Three and Nine Months Ended September 30, 2019 compared to Three and Nine Months Ended September 30, 2018

Revenue

For the quarter ended September 30, 2019, revenue was $23.9 million, a decrease of $2.0 million, or 7.7%, compared with $25.9 million for the quarter ended September 30, 2018.  For the nine months ended September 30, 2019, revenue was $76.0 million, a decrease of $2.5 million or 3.2%, compared with $78.5 million for the nine months ended September 30, 2018.  The decrease was primarily due to our strategic focus to transition away from lower value-added services, which resulted in exiting low-margin service business with a customer in late 2018, partially offset by increased services of generally higher-value solutions from both our continuing and new customer base.  

Cost of Revenue/Gross Profit

Cost of revenue decreased $2.3 million to $19.2 million for the quarter ended September 30, 2019 from $21.4 million for the quarter ended September 30, 2018.  Cost of revenue decreased $4.1 million to $62.0 million for the nine months ended September 30, 2019 from $66.1 million for the nine months ended September 30, 2018.  The decreases were primarily due to the impact of exiting low-margin service with a customer in late 2018, partially offset by increased services of generally higher-value solutions from both our continuing and new customer base.

Gross profit for the quarter ended September 30, 2019 was $4.8 million, an increase of $301,000, or 6.7%, compared with $4.5 million for the quarter ended September 30, 2018.  The gross profit margin rose to 19.9% for the quarter ended September 30, 2019 compared with 17.2% for the quarter ended September 30, 2018.  Gross profit for the nine months ended September 30, 2019 was $14.1 million, an increase of $1.6 million, or 13.0%, compared with $12.5 million for the nine months ended September 30, 2018.  The gross profit margin rose to 18.5% for the nine months ended September 30, 2019 compared with 15.8% for the nine months ended September 30, 2018. The changes in gross profit and gross profit margin percentage for the three and nine months ended September 30, 2019 were primarily due to the net effect of increased generally value-added services from both our continuing and new customer base, and lower costs related to certain contracted services.

Revenue, gross profit, and gross profit margins are affected period to period by the volumes of waste and recycling materials generated by our customers, the frequency and type of services provided, the price and mix of the services provided, commodity index adjustments for recycled materials, and the cost and mix of subcontracted services provided in any one reporting period.

Operating Expenses

Operating expenses were $4.5 million and $5.0 million for the three months ended September 30, 2019 and 2018, respectively, a decrease of $494,000.  Operating expenses were $13.6 million and $14.6 million for the nine months ended September 30, 2019 and 2018, respectively, a decrease of $998,000.

In the quarter ended June 30, 2019, three stockholders sold approximately 4.3 million shares of our common stock in a registered public offering that closed on April 11, 2019.  In a separate private transaction, a certain selling stockholder sold 1,750,000 shares of our common stock.  The offering and private transaction, together the “Transactions”, closed on April 11, 2019.  We did not receive any proceeds from sales by the selling stockholders in the Transactions.  We incurred costs and expenses in connection with the Transactions, consisting of various registration, due diligence, printing, and professional service fees and expenses, and such costs, less amounts reimbursed by the selling stockholders at the closing of the Transactions, were approximately $248,000, and is included in selling, general, and administrative expense for the nine months ended September 30, 2019.  

Selling, general, and administrative expenses were $4.2 million and $4.6 million for the three months ended September 30, 2019 and 2018, respectively, a decrease of approximately $417,000. The decrease primarily relates to a decrease in bad debt expense of $846,000 and professional fees of $45,000, partially offset by increases in labor related expenses of approximately $191,000, stock related compensation of $99,000 and advertising and tradeshow expenses of $45,000.  Selling, general, and administrative expenses were $12.7 million and $12.3 million for the nine months ended September 30, 2019 and 2018, respectively, an increase of approximately $393,000.  The increase primarily relates to increases in labor related expenses of approximately $659,000, professional fees related to the Transactions of $248,000, advertising and tradeshow expenses of $126,000, stock related compensation of $165,000, and travel of $62,000, partially offset by a decrease in bad debt expense of $961,000.

Operating expenses also included depreciation and amortization of approximately $330,000 and $407,000 for the three months ended September 30, 2019 and 2018, respectively, a decrease of approximately $77,000.  Depreciation and amortization expenses were approximately $982,000 and $2.4 million for the nine months ended September 30, 2019 and 2018, respectively.  The decrease in depreciation and amortization was primarily due to lower amortization related to certain intangible assets that were fully amortized as of July 2018.  

Interest Expense

Interest expense was $119,000 and $106,000 for the three months ended September 30, 2019 and 2018, respectively, an increase of approximately $13,000.  Interest expense was $344,000 and $336,000 for the nine months ended September 30, 2019 and 2018,

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respectively, an increase of approximately $8,000.  See Note 6 to our condensed consolidated financial statements for a discussion of the ABL Facility.

Income Taxes

We recorded a provision for income taxes of $55,000 and $164,000 for the three and nine months ended September 30, 2019, respectively, primarily related to tax basis net income at the state level for several states with no net operating loss carryforwards.  For the three and nine months ended September 30, 2018, we were in a net loss position and recorded no provision.

Net Income (Loss)

Net income for the quarter ended September 30, 2019 was $47,000 compared with a net loss of $(681,000) for the quarter ended September 30, 2018.  Net loss for the nine months ended September 30, 2019 was $(90,000) compared to a net loss of $(2.5) million for the nine months ended September 30, 2018. The explanations above detail the majority of the changes related to net income (loss).

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

Income (Loss) per Share

Net income per basic and diluted share was $0.00 for the quarter ended September 30, 2019 compared with a net loss per basic and diluted share of $(0.04) for the quarter ended September 30, 2018. The basic and diluted weighted average number of shares of common stock outstanding were approximately 15.4 million and 15.3 million for the three months ended September 30, 2019 and 2018, respectively.

Net loss per basic and diluted share was $(0.01) for the nine months ended September 30, 2019 compared with a net loss per basic and diluted share of $(0.17) for the nine months ended September 30, 2018.  The basic and diluted weighted average number of shares of common stock outstanding were approximately 15.3 million for both the nine months ended September 30, 2019 and 2018.  

Adjusted EBITDA

We use the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, stock-related compensation charges, and other adjustments, or “Adjusted EBITDA,” as another metric to evaluate our performance.  Adjusted EBITDA is a non-GAAP measure that we believe can be helpful in assessing our overall performance as an indicator of operating and earnings quality. 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, 2019, other adjustments of nil and $247,589 included costs related to the Transactions as further discussed above.  For the three and nine months ended September 30, 2018, other adjustments of $610,272 and $661,956, respectively, included an adjustment to bad debt expense of $610,272 to reflect our assessment of collectability of accounts receivable related to a customer’s bankruptcy filing.  Other adjustments for the nine months ended September 30, 2018 also included legal fees related to our sale of certain Earth911 assets.

The following table reflects Adjusted EBITDA for the three and nine months ended September 30, 2019 and 2018:

RECONCILIATION OF NET INCOME (LOSS) TO ADJUSTED EBITDA

(UNAUDITED)

Liquidity and Capital Resources

As of September 30, 2019 and December 31, 2018, we had $2.1 million in cash and cash equivalents. Working capital was $4.0 million as of September 30, 2019 and December 31, 2018.

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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 $2.1 million, our borrowing availability under our $20.0 million ABL Facility (which was $9.6 million as of September 30, 2019), and cash expected to be generated from operations will be sufficient to fund our operations for the next 12 months.  In addition, we believe we can access the capital markets with placements of our securities, if necessary or desirable.  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, 2019 and 2018.

Cash Flows from Operating Activities

Net cash provided by operating activities was $1.2 million for the nine months ended September 30, 2019 compared with $2.1 million for the nine months ended September 30, 2018.

Net cash provided by operating activities for the nine months ended September 30, 2019 related primarily to the net effect of the following:

Net cash provided by operating activities for the nine months ended September 30, 2018 related primarily to the net effect of the following:

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, commodity contracts, and our business volume levels. 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, 2019 and 2018 was $210,000 and $203,000, respectively, primarily from costs related to software development and purchases of property and equipment.  

Cash Flows from Financing Activities

Net cash used in financing activities was $1.0 million for the nine months ended September 30, 2019, primarily from net repayments on the ABL Facility.  Net cash used in financing activities was $1.9 million for the nine months ended September 30, 2018, primarily from net repayments on the ABL Facility.  See Note 6 to our condensed consolidated financial statements for a discussion of the ABL Facility.

Inflation

We do not believe that inflation had a material impact on us during the nine months ended September 30, 2019 and 2018.

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

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amounts of accounts receivable, goodwill and other intangible assets, stock-based compensation expense, and deferred taxes. 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 I, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2018 Annual Report.  There have been no changes in our critical accounting policies during the first nine months of 2019.

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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

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, 2019.

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.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We may be subject to legal proceedings in the ordinary course of business. As of the date of this Quarterly Report on Form 10-Q, we are not aware of any legal proceedings to which we are a party that we believe could have a material adverse effect on us.

Item 1A. Risk Factors

Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

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Item 6. Exhibits

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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