CLEAN HARBORS INC quarterly report, Q2 FY2013

Clean Harbors, Inc. — Q2 2013 Form 10-Q Summary

Business context and reporting period

Clean Harbors provides environmental, energy and industrial services across North America. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods. Results include Safety-Kleen, acquired on December 28, 2012, for the first full comparable reporting period. Operations were reorganized into five reportable segments: Technical Services, Oil Re-refining and Recycling, SK Environmental Services, Industrial and Field Services, and Oil and Gas Field Services.

Key financial metrics

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Total revenue	$860.5 million	$523.1 million	$1.723 billion	$1.095 billion
Income from operations	$53.2 million	$47.5 million	$88.1 million	$109.2 million
Net income	$22.9 million	$23.4 million	$33.4 million	$55.4 million
Diluted EPS	$0.38	$0.44	$0.55	$1.04
Adjusted EBITDA	$123.6 million	$88.7 million	$234.8 million	$189.6 million
Cash flow from operations	Not separately provided	Not separately provided	$137.6 million	$175.8 million

Q2 revenue increased 64.5%, while six-month revenue increased 57.3%, primarily because of the Safety-Kleen acquisition. Q2 gross margin was 28.6%, versus 29.7% in the prior-year quarter; the filing attributes the decline primarily to Safety-Kleen’s lower-margin business and weaker Oil and Gas Field Services margins. Operating margin was approximately 6.2% in Q2 2013 versus 9.1% in Q2 2012, and net margin was approximately 2.7% versus 4.5%.

Liquidity, debt and capital investment

Cash and cash equivalents were $263.5 million at June 30, 2013, compared with $229.8 million at December 31, 2012. Foreign subsidiaries held $48.0 million and U.S. operations held approximately $215.4 million.
Total long-term debt was $1.4 billion, consisting of $800 million of 5.25% senior unsecured notes due 2020 and $600 million of 5.125% senior unsecured notes due 2021.
The $400 million revolving credit facility had no borrowings, $262.5 million available capacity and $137.5 million of outstanding letters of credit.
Operating cash flow declined 21.7% year over year to $137.6 million, primarily because of increased working-capital investment.
Capital expenditures were $141.5 million, compared with $83.0 million in the prior-year period, resulting in negative operating cash flow less capital expenditures of approximately $3.9 million before other investing items.
Management stated that existing cash, operating cash flow and available revolver capacity should satisfy operating, investing and financing requirements. The company was in compliance with its debt covenants at June 30, 2013.

Material changes versus the prior comparable period

Safety-Kleen added the Oil Re-refining and Recycling and SK Environmental Services businesses, contributing substantial new revenue and EBITDA but also increasing depreciation, amortization, corporate costs and interest expense.
Q2 Adjusted EBITDA increased 39.3% to $123.6 million; six-month Adjusted EBITDA increased 23.8% to $234.8 million. Adjusted EBITDA is a non-GAAP measure and should be considered with GAAP results.
Interest expense increased to $19.6 million in Q2 from $11.0 million and to $39.5 million for six months from $22.2 million, primarily because of debt issued in 2012.
Depreciation and amortization increased 74.5% in Q2 and 68.9% year to date because of acquisitions and higher capital investment.
Oil and Gas Field Services revenue declined 10.0% in Q2 and 15.8% year to date, while its Q2 Adjusted EBITDA declined 50.2%, reflecting lower Western Canadian rig activity, early spring break-up and historic flooding.
Industrial and Field Services remained a growth contributor, with Q2 direct revenue up 21.6% and Adjusted EBITDA up 33.6%.
Q2 Technical Services incinerator utilization was 92.3%, versus 90.3% in the prior-year quarter, despite a three-week unplanned shutdown at the Deer Park facility. Landfill volumes increased approximately 17% year over year.
Six-month results included approximately $10.2 million of one-time, non-cash acquisition-accounting reductions to Safety-Kleen deferred revenue and approximately $3.4 million of related cost adjustments.
Accumulated other comprehensive income declined by $59.4 million, primarily from foreign-currency translation losses, resulting in accumulated other comprehensive loss of $9.7 million at June 30, 2013.

Outlook, risks, contingencies and unusual items

Management expects operating cash flow to fund operating requirements, capital expenditures and environmental liabilities over the short and long term, but notes that future environmental-law changes or unexpected remediation events could accelerate or increase required payments.
Accrued environmental liabilities totaled approximately $218.3 million. Legal and administrative proceeding reserves were $42.2 million, with the company estimating that reasonably possible additional exposure could be as much as $3.5 million.
The company was involved in proceedings involving 121 Superfund sites. Potential liabilities are difficult to estimate because of uncertainty regarding responsibility, remediation costs, timing, other potentially responsible parties and indemnification arrangements.
Safety-Kleen was named in approximately 64 product-liability proceedings and several customer fee class-action matters. The company could not estimate ultimate aggregate exposure for these matters, and no reserve was recorded for the fee class actions.
The Oil and Gas Field Services reporting unit had lower-than-anticipated Q2 results due primarily to Western Canadian flooding. Management concluded that fair value more likely than not exceeded carrying value at June 30, 2013, but stated that future events could result in goodwill impairment.
The company held $4.4 million of illiquid auction-rate securities. These securities retained AAA underlying ratings and were assessed as temporarily impaired, but may not be readily saleable without a potential loss of principal.
Commodity collars acquired or entered into by Safety-Kleen are intended to reduce exposure to declines in oil prices but limit upside above contractual caps. The filing states that the exposure is not expected to be material.
No material changes were reported to the risk factors in the 2012 Form 10-K. Disclosure controls were effective as of June 30, 2013.

Most important facts for investors to verify

Whether Safety-Kleen integration produces sustainable revenue and cost synergies without continued pressure on consolidated gross and operating margins.
Progress in converting Adjusted EBITDA growth into operating cash flow, particularly given higher working-capital needs and capital expenditures.
Debt-service capacity and covenant headroom under $1.4 billion of senior unsecured notes and the $400 million revolving facility.
Recovery in Western Canadian oil and gas activity and the potential effects of weather, rig counts and commodity prices on that segment.
Potential goodwill impairment in Oil and Gas Field Services and the finalization of provisional Safety-Kleen purchase accounting.
Changes in environmental, Superfund, product-liability and customer-fee litigation exposure beyond recorded reserves.
Liquidity and valuation developments for the auction-rate securities and the effectiveness of the company’s oil-price derivative arrangements.