CLH

Clean Harbors, Inc. - 10-Q Summary (Period Ended September 30, 2003)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2003, and the nine months ended on that date. Clean Harbors, Inc. provides environmental services, including hazardous waste treatment, disposal, and site remediation. The reporting period is significantly influenced by the integration of the Chemical Services Division (CSD) acquired from Safety-Kleen Corp. in September 2002. The company operates two primary segments: Technical Services (waste treatment/disposal) and Site Services (remediation and industrial maintenance).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 81% year-over-year for the quarter ($67.7 million increase) and 137% for the nine-month period ($268.6 million increase), driven primarily by the inclusion of the CSD acquisition.
• Profitability: The company reported a net income of $7.4 million for the quarter, a significant improvement from a net loss of $33.4 million in the same period in 2002. The prior year loss included $24.7 million in debt extinguishment costs and $4.7 million in acquisition costs.
• Non-Operating Income: A non-operating gain of $8.7 million was recorded in the quarter due to the mark-to-market adjustment of an embedded derivative in the Series C Preferred Stock, driven by a decline in the company's common stock price.
• Cost Structure: Cost of revenues as a percentage of revenue decreased to 71.9% for the quarter (from 74.4% in 2002) due to the internalization of waste disposal previously outsourced to third parties.

Guidance, Outlook, Risks, and Unusual Items

• Loan Covenants: The company violated EBITDA covenants in the first and second quarters of 2003 but successfully negotiated amendments (Second and Third Amendments) to reset covenants. The company met the revised EBITDA requirement of $15.7 million for the quarter ended September 30, 2003. Future covenants require increasing EBITDA levels through 2005.
• Environmental Liabilities: The company assumed approximately $184.5 million in environmental liabilities from the CSD acquisition. In Q3 2003, the company recorded an additional $17.6 million in liabilities ($13.4 million for Marine Shale Processors and $4.2 million for Ville Mercier Legal Proceedings) as purchase price adjustments. Management estimates total remedial liabilities at $156.6 million, with a "reasonably possible" additional liability of up to $22.6 million.
• Accounting Changes: The company adopted SFAS No. 143 (Asset Retirement Obligations) in Q1 2003, resulting in a $46.7 million reduction in recorded environmental liabilities and a corresponding reduction in asset values. This adoption also resulted in a cumulative effect adjustment of $8,000 (net of tax) in the nine-month period.
• Capital Markets Restriction: Due to Safety-Kleen's historical financial system deficiencies, the company cannot file audited pro forma statements for the CSD. Consequently, the company is restricted from filing registration statements for public securities offerings for up to three years following the acquisition, limiting access to public capital markets.
• Internal Controls: The company identified material weaknesses in internal controls related to environmental liabilities, deferred revenue, and expense recording, largely stemming from the CSD integration. Management is implementing remediation plans.

Investor Verification Checklist

• Covenant Compliance: Verify the company's ability to meet the escalating EBITDA and fixed charge coverage ratios required by the amended loan agreements through 2005.
• Environmental Liability Estimates: Monitor updates on the $156.6 million remedial liability estimate, particularly regarding the "reasonably possible" additional $22.6 million and the status of the Ville Mercier and Marine Shale proceedings.
• Derivative Valuation: Assess the volatility of the embedded derivative in the Series C Preferred Stock, which caused an $8.7 million non-operating gain in Q3 and could result in significant future losses if stock prices rise.
• Integration Progress: Evaluate the timeline for resolving internal control weaknesses and the ability to generate meaningful volume/price/mix revenue analysis post-acquisition.
• Liquidity Position: Review the utilization of the $100 million Revolving Credit Facility (currently $35.7 million drawn) and the $85.9 million in outstanding letters of credit.