Quest Resource Holding Corp - Quarter Report: 2021 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2021

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)

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

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  ☒

As of November 1, 2021, there were 19,020,946 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 waste and recycling services to customers from across multiple industry sectors that are typically larger, multi-location businesses.  We create customer-specific programs and perform the related services for the collection, processing, recycling, disposal, and tracking of waste streams and recyclables.

In March 2020, the World Health Organization categorized Coronavirus Disease 2019 (“COVID-19”) as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency.  The waste management and recycling services we provide are currently designated an essential critical infrastructure business under the President’s COVID-19 guidance, the continued operation of which is vital for national public health, safety and national economic security.  The extent of the impact of the COVID-19 outbreak on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, its impact on our customers and subcontractors, and the range of governmental and community reactions to the pandemic, which are uncertain and cannot be fully predicted at this time.

On October 19, 2020, Quest acquired substantially all of the assets used in the business of Green Remedies Waste and Recycling, Inc. (“Green Remedies”), a leading provider of independent environmental services, particularly in multi-family housing, located in Burlington, NC. On June 30, 2021, Quest acquired substantially all of the assets used in the business of an Atlanta-based independent environmental services company.  On November 5, 2021, Quest acquired substantially all of the assets used in the business of a Kentucky-based independent environmental services company. See Note 3 for more information regarding the acquisitions.

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, 2020. 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, 2021 and the results of our operations and cash flows for the periods presented. We derived the December 31, 2020 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, 2021 are not necessarily indicative of the results to be expected for the full year.

Recent Accounting Pronouncements

Adopted

On January 1, 2021, we adopted Accounting Standards Update (“ASU”) 2019-12, Income Taxes – (Topic 740), which simplifies the accounting for income taxes by removing certain exceptions and amending guidance to improve consistent application of accounting over income taxes.  The adoption of the standard did not have a material effect on our consolidated financial statements.

In March 2020, the Financial Accounting Standards Board (the “FASB”) issued ASU 2020-04, Reference Rate Reform (Topic 848):  Facilitation of the Effects of Reference Rate Reform on Financial Reporting.  This standard provides operational guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting due to the cessation of the London Interbank Offered Rate (“LIBOR”).  The amendments are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued.  The expedients and exceptions provided by the amendments generally do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022.  As further discussed in Note 7, our ABL facility

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provides procedures for determining a replacement or alternative rate in the event that LIBOR is unavailable.   As such, we do not expect the transition away from LIBOR to have a material impact on our consolidated financial statements.

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.

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.  Acquisitions

On October 19, 2020, we acquired substantially all of the assets of Green Remedies (the “Green Remedies Assets”) pursuant to the Asset Purchase Agreement (the “Asset Purchase Agreement”), dated as of October 19, 2020, among the Company, Green Remedies and Alan Allred (the “Acquisition”). Green Remedies is a leading provider of independent environmental services, particularly in the multi-family housing market, and is located in Burlington, NC.  The Acquisition strengthens our presence across key markets, particularly in multi-family housing.  The total purchase price for the Green Remedies Assets was approximately $16.1 million at close, which includes an earn-out estimate tied to future performance over the next three years.  We funded the Acquisition primarily with funds pursuant to the Monroe Capital term note, as further discussed in Note 7, which is secured by a first priority lien on substantially all of QRHC’s tangible and intangible assets.

The following table sets forth the purchase price allocation amount of assets acquired and liabilities assumed as of the acquisition date:

The purchase price was allocated based on an estimate of the fair value of assets acquired and liabilities assumed as of the acquisition date.

Goodwill represents the amount by which the purchase price exceeds the estimated fair value of the net assets acquired and primarily reflects future synergies.  The goodwill related to the Green Remedies Assets is deductible for income tax purposes.

Deferred consideration payable to Green Remedies includes (i) $2,684,250 payable in either cash or shares of our common stock at our option, in two equal installments on the first and second anniversaries of the closing date of the Acquisition pursuant to a Consideration Agreement, as defined in the Asset Purchase Agreement; and (ii) an earn-out not to exceed $2,250,000 over an earn-out period, as defined in the Asset Purchase Agreement.  We settled the first payment under the Consideration Agreement with the issuance of 218,587 shares of common stock on October 19, 2021. We valued the earn-out liability at $440,000 using a Monte Carlo simulation (a Level 3 measurement under Accounting Standards Codification (“ASC”) 820, Fair Value Measurement).  The fair value estimate uses unobservable inputs that reflect our own assumptions as to the performance target benchmarks of the acquired business and discount rates used in the calculation.  As the earn-out liability is a contingent consideration arrangement, it is subject to periodic revaluation in accordance with ASC 820.  Changes in the estimated fair value of the contingent earn-out consideration would be reflected in our results of operations in the period in which they are identified.  We believe the estimated fair value of the earn-out, based on the evaluation of the performance of the acquired business is materially accurate as of September 30, 2021.

The following table presents unaudited pro forma information for the three and nine months ended September 30, 2020 as if the Acquisition had occurred at the beginning of our 2020 fiscal year.  The unaudited pro forma information includes adjustments for amortization expense on definite lived intangible assets acquired, interest expense on debt incurred related to the Acquisition, and the related income tax effects.  

The unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the Acquisition had been effected on the dates previously set forth, nor is it indicative of the future operating results or financial position in combination.

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On June 30, 2021, we acquired substantially all of the assets of an Atlanta-based independent environmental services company.  On November 5, 2021, we acquired substantially all of the assets of a Kentucky-based independent environmental services company. Neither acquisition had a material impact on our financial position or results of operations and are not reflected in the above pro forma presentation.  

4. Property and Equipment, net, and Other Assets

At September 30, 2021 and December 31, 2020, 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, 2021 was $119,865, including $74,495 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 $345,463 for the nine months ended September 30, 2021, including $215,287 of depreciation expense reflected within “Cost of revenue.”  Depreciation expense for the three months ended September 30, 2020 was $63,089, including $25,597 of depreciation expense reflected within “Cost of revenue,” and was $164,156 for the nine months ended September 30, 2020, including $53,871 reflected within “Cost of revenue.”

We recorded right-of-use operating lease assets related to our corporate office lease and the office lease space in Burlington, NC in accordance with ASC 842.  Refer to Note 8, 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.  The carrying amount of our investment in Earth Media Partners, LLC is included in “Security deposits and other assets” and we have an accrued receivable in the amount of $333,929 and $259,017 related to the earn-out included as of September 30, 2021 and December 31, 2020, respectively.

5. Goodwill and Other Intangible Assets

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

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We compute amortization using the straight-line method over the useful lives of the finite lived intangible assets.  Amortization expense related to finite lived intangible assets was $463,087 and $112,679 for the three months ended September 30, 2021 and 2020, respectively.  Amortization expense related to finite lived intangible assets was $1,194,215 and $707,775 for the nine months ended September 30, 2021 and 2020, respectively.

We have no indefinite-lived intangible assets other than goodwill. $58.2 million of the goodwill is not deductible for tax purposes, while $8.6 million of goodwill is deductible over its tax-basis life.  

We performed our annual impairment analysis for goodwill and other intangible assets in the third quarter of 2021 with no impairment recorded.

6.  Current Liabilities

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

Refer to Note 8, Leases for additional disclosure related to the operating lease liability.

The components of Other current liabilities were as follows:

Refer to Note 3, Acquisitions for additional disclosure related to the deferred seller consideration related to the Acquisition.

7. Notes Payable and Other Long-term Liabilities, net

Our debt obligations are as follows:

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We capitalize financing costs we incur related to implementing our debt arrangements.  We record these debt issuance costs associated with our revolving credit facility and our term loan as a reduction of long-term debt, net and amortize them over the contractual life of the related debt arrangements.  The table below summarizes changes in debt issuance costs.

Revolving Credit Facility

On August 5, 2020, QRHC and certain of its domestic subsidiaries entered into a Loan, Security and Guaranty Agreement (the “PNC Loan Agreement”), which was subsequently amended on October 19, 2020, with BBVA USA(which was subsequently succeeded in interest by PNC Bank, National Association (“PNC”)), as a lender, and as administrative agent, collateral agent, and issuing bank, which provides for a credit facility (the “ABL Facility”) comprising the following:

The PNC Loan Agreement contains certain financial covenants, including a minimum fixed charge coverage ratio. In addition, the PNC Loan Agreement contains negative covenants limiting, among other things, additional indebtedness, transactions with affiliates, additional liens, sales of assets, dividends, investments and advances, prepayments of debt, mergers and acquisitions, and other matter customarily restricted in such agreements. The PNC Loan Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, change of control, and failure of any guaranty or security document supporting the PNC Loan Agreement to be in full force and effect. Upon the occurrence of an event of default, the outstanding obligations under the PNC Loan Agreement may be accelerated and become immediately due and payable.

As of September 30, 2021, the ABL Facility borrowing base availability was $15,000,000, of which $5,249,535 principal was outstanding.

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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 PNC 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.

Monroe Term Loan

On October 19, 2020, QRHC and certain of its domestic subsidiaries entered into a Credit Agreement (the “Credit Agreement”), dated as of October 19, 2020, which was subsequently amended on September 3, 2021, with Monroe Capital Management Advisors, LLC (“Monroe Capital”), as administrative agent for the lenders thereto.  Among other things, the Credit Agreement provides for the following:

The Credit Agreement contains certain financial covenants, including a minimum fixed charge coverage ratio and a senior net leverage ratio.  In addition, the Credit Agreement contains negative covenants limiting, among other things, additional indebtedness, transactions with affiliates, additional liens, sales of assets, dividends, investments and advances, prepayments of debt, mergers and acquisitions, and other matters customarily restricted in such agreements.  The Credit Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, change of control, and failure of any guaranty or security document supporting the Credit Agreement to be in full force and effect. Upon the occurrence of an event of default, the outstanding obligations under the Credit Agreement may be accelerated and become immediately due and payable.

At the same time as the borrowing of the $11.5 million under the Credit Agreement, in a separate agreement, we issued Monroe Capital a warrant to purchase 500,000 shares of QRHC’s common stock exercisable immediately.  For the $12.5 million delayed draw term loan facility, we will issue a separate warrant to purchase 350,000 shares upon drawing on this facility or on November 30, 2021, whichever occurs first, or upon certain other events.  Both warrants have an exercise price of $1.50 per share and an expiration date of March 19, 2028.  We estimated the value of the 500,000-share warrant issued using the Black Scholes option pricing model and recorded a debt discount of approximately $766,000 which is being amortized over the term of the Credit Agreement.  We also executed a letter agreement that provides that the warrant holder will receive minimum net proceeds of $1 million less any net proceeds received from the sale of the warrant shares, which is conditional on the full exercise and sale of all the warrant shares at the same time and upon a date two years after the closing date of the agreement.

Green Remedies Promissory Note

On October 19, 2020, we issued an unsecured subordinated promissory note to Green Remedies in the aggregate principal amount of $2,684,250, payable commencing on January 1, 2021 in quarterly installments through October 1, 2025 and subject to an interest rate of 3.0% per annum.

Interest Expense

The amount of interest expense related to borrowings for the three months ended September 30, 2021 and 2020 was $334,946 and $56,845, respectively.  The amount of interest expense related to borrowings for the nine months ended September 30, 2021 and 2020 was $1,030,377 and $181,439, respectively.  Debt issuance costs of $1,757,856 are being amortized to interest expense over the lives of the related debt arrangements.  As of September 30, 2021, the unamortized portion of the debt issuance costs was $1,404,376.  The amount of interest expense related to the amortization of debt issuance costs for the nine months ended September 30, 2021 and 2020

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was $266,153 and $62,684, respectively.  Debt discount (“OID”) of $1,674,178 is being amortized to interest expense over the lives of the related debt and consideration arrangements.  As of September 30, 2021, the unamortized portion of OIDs was $1,246,726.  The amount of interest expense related to the amortization of OID costs for the nine months ended September 30, 2021 and 2020 is $349,418 and nil, respectively.

Other long-term liabilities, net

We recorded deferred consideration in connection with the Acquisition as further described in Note 3.  At September 30, 2021 and December 31, 2020 the unamortized portion of OID on the deferred consideration was $208,253 and $356,097, respectively.  The non-current portion of deferred consideration payable to Green Remedies is payable in either cash or shares of our common stock at our option.  The earn-out is not to exceed $2,250,000 over an earn-out period, as defined in the Asset Purchase Agreement.  We valued the earn-out liability at $440,000 using a Monte Carlo simulation.

8. Leases

We lease corporate office space in The Colony, Texas under an 84-month, non-cancelable operating lease.  Upon the adoption of ASC 842 on January 1, 2019, we recorded approximately $2.0 million and $2.2 million to record the operating lease right-of-use asset and the related liabilities, respectively.  Our office lease had a remaining term of 1.0 year as of September 30, 2021, 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.

In connection with our acquisition of the Green Remedies Assets, we entered into a lease for office space in Burlington, NC.  We recorded a right-of-use asset associated with this lease of approximately $80,000.  The lease expires in October 2023.  This office lease had a remaining term of 2.1 years as of September 30, 2021, and we used an effective interest rate of 9.50%, 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.  This lease may be terminated under certain conditions as defined in the lease agreement.  The lessor is a related party that is owned by the shareholder of Green Remedies and is employed by us.

The future minimum lease payments required under our office leases as of September 30, 2021 are as follows:    

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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, 2021 are de minimis.

Lease Costs

For the three and nine months ended September 30, 2021, we recorded approximately $158,000 and $475,000, respectively, of fixed cost operating lease expense.  For the three and nine months ended September 30, 2020, we recorded approximately $150,000 and $450,000, respectively, of fixed cost operating lease expense.  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 corporate office lease through August 2022.  This minimum annual incentive is $93,600 effective September 2020 through the remainder of the lease term.

Effective December 1, 2019, we subleased a portion of our corporate office space to a single tenant.  The sublease agreement is accounted for as an operating lease and we recognize sublease income as an offset to operating lease expense on a straight-line basis over the term of the sublease agreement through August 2022.  Sublease income, net of amortized leasing costs, for the nine months ended September 30, 2021 was approximately $39,000.    

Cash paid for operating leases approximated operating lease expense and non-cash right of use asset amortization for the nine months ended September 30, 2021 and 2020.  We did not obtain any new operating lease right-of-use assets in the nine months ended September 30, 2021.

9. 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.  Service revenues are primarily generated from fees charged for our collection, transfer, disposal and recycling services and from sales of commodities by our recycling 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.  Two customers accounted for 39.4% of revenue for the three months ended September 30, 2021, and three customers accounted for 49.4% of revenue for the three months ended September 30, 2020.   Two customers accounted for 43.8% of revenue for the nine months ended September 30, 2021, and three customers accounted for 52.0% of revenue for the nine months ended September 30, 2020.  We operate primarily in the United States, with minor services in Canada.

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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, 2021 and December 31, 2020, we had $60,000 and $100,000 of deferred contract costs, respectively.  During the three and nine months ended September 30, 2021, we amortized $50,000 and $150,000, respectively, of deferred contract costs to selling, general, and administrative expense.  During the three and nine months ended September 30, 2020, we amortized $52,500 and $161,250, respectively, of deferred contract costs to selling, general, and administrative expense.

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, 2021 and December 31, 2020, we had $336,245 and $50,454, respectively, of deferred revenue which was classified in “Other current liabilities.”

10. Income Taxes

Our statutory income tax rate is anticipated to be 27%.  We had income tax expense of $262,449 and $63,800 for the nine months ended September 30, 2021 and 2020, respectively, which was attributable to state tax obligations based on current estimated state tax apportionments for states with no net operating loss carryforwards, and the 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, 2021 and December 31, 2020, and we had recorded a valuation allowance of $11,087,000 and $12,533,000, respectively, against deferred tax assets in excess of deferred tax liabilities in the accompanying condensed consolidated financial statements. As of September 30, 2021 and December 31, 2020, we had federal income tax net operating loss carryforwards of approximately $10,200,000 and $14,500,000, respectively, which expire at various dates ranging from 2032-2037.

11. Fair Value of Financial Instruments

Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, deferred revenue, and notes payable. 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, based on their short maturities or, for notes payable, based on borrowing rates currently available to us for loans with similar terms and maturities.  Contingent liabilities are measured at fair value on a recurring basis.  The fair value measurements are generally determined using unobservable inputs and are classified within Level 3 of the fair value hierarchy.  See discussion of the contingent earn-out liability in Note 3, Acquisitions.

12. 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 18,802,359 and 18,413,419 shares were issued and outstanding as of September 30, 2021 and December 31, 2020, respectively.

Employee Stock Purchase Plan – On September 17, 2014, our stockholders approved our 2014 Employee Stock Purchase Plan (as amended, the “ESPP”).  On May 14, 2021, we issued 22,937 shares to employees for $38,988 under our ESPP for options that vested

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and were exercised.  We recorded expense of $24,586 and $25,280 related to the ESPP for the nine months ended September 30, 2021 and 2020, respectively.

Warrants –

Warrant activity for the nine months ended September 30, 2021 was as follows:

The following table summarizes the warrants issued and outstanding as of September 30, 2021:

Stock Options – We recorded stock option expense of $575,437 and $878,405 for the nine months ended September 30, 2021 and 2020, respectively.  The following table summarizes the stock option activity for the nine months ended September 30, 2021:

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, 2021, we granted 81,249 DSUs and recorded director compensation expense of $384,708 related to the grants.  In addition, during the nine months ended September 30, 2021 we granted 49,775 DSUs to executive employees and recorded compensation expense of $157,009, which includes an accrual of anticipated bonus expense to be paid in DSUs for certain executive employees.  During the nine months ended September 30, 2020, we granted 41,719 DSUs and recorded director compensation expense of $63,234 related to the grants.  In addition, during the nine months ended September 30, 2020, we granted 39,684 DSUs to executive employees and recorded compensation expense of $134,509.  We had 196,513 and 73,231 DSUs outstanding at September 30, 2021 and December 31, 2020, respectively.

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13. Net Income per Share

We compute basic net income 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 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, warrants and shares issued pursuant to a Consideration Agreement as discussed in Note 3.  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.  

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

14. Subsequent Events

On October 21, 2021, we issued 218,587 shares of common stock to Green Remedies pursuant to that certain Consideration Agreement, dated October 19, 2020, between QRHC and Green Remedies, entered into in connection with the Acquisition. This issuance reflects the first of two equal installments payable to Green Remedies in either cash or shares of QRHC’s common stock, at our option, on the first and second anniversaries of the closing date of the Acquisition.

On November 5, 2021, Quest acquired substantially all of the assets of a Kentucky-based independent environmental services company, which did not have a material impact on our financial position or results of operations. 

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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 (the “Exchange Act”). All statements other than statements of historical facts contained in or incorporated by reference into this Form 10-Q, including statements regarding our future operating results, future financial position, business strategy, objectives, goals, plans, prospects, and markets, and plans and objectives for future operations, are forward-looking statements.  In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “targets,” “contemplates,” “projects,” “predicts,” “may,” “might,” “plan,” “will,” “would,” “should,” “could,” “can,” “potential,” “continue,” “objective,” or the negative of those terms, or similar expressions intended to identify forward-looking statements.  However, not all forward-looking statements contain these identifying words.  Specific forward-looking statements in this Form 10-Q include statements regarding the impact, if any, of the adoption of the ASU on our consolidated financial statements; the impact of the COVID-19 pandemic on our results of operations and any changes to inflation rates; exposure to significant interest, currency, or credit risks arising from our financial instruments; and sufficiency of our cash and cash equivalents, borrowing capacity, and cash generated from operations to fund our operations for the next 12 months.  All forward-looking statements included herein are based on information available to us as of the date hereof and speak only as of such date.  Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.  The forward-looking statements contained in or incorporated by reference into this Form 10-Q reflect our views as of the date of this Form 10-Q about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results, performance, or achievements to differ significantly from those expressed or implied in any forward-looking statement.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, performance, or achievements.  A number of factors, including the impact of our asset acquisition of Green Remedies Waste and Recycling, Inc. (“Green Remedies”) on future results, 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, 2020 (the “2020 Annual Report”).  

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, or QRHC.  On October 19, 2020, Quest acquired substantially all of the assets used in the business of Green Remedies, a leading provider of independent environmental services, particularly in multi-family housing, located in Burlington, NC. On June 30, 2021, Quest acquired substantially all of the assets of an Atlanta-based independent environmental services company, which did not have a material impact on our financial position or results of operations. On November 5, 2021, Quest acquired substantially all of the assets of a Kentucky-based independent environmental services company, which did not have a material impact on our financial position or results of operations. See Note 3 to our condensed consolidated financial statements for more information regarding the acquisitions.  The results for the nine months ended September 30, 2021 reflect the impact of the Green Remedies acquisition, but the prior year period does not.

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 (collectively, “we,” “us,” “our,” or “our company”).

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Three and Nine Months Ended September 30, 2021 and 2020 Operating Results

The following table summarizes our operating results for the three and nine months ended September 30, 2021 and 2020: