Quest Resource Holding Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. The unaudited statements reflect Quest Resource Management Group (Quest) only from its July 16 acquisition; consequently, reported comparisons with 2012 are not like-for-like. Quest provides commercial recycling and waste-management services, while Earth911 provides consumer recycling information and related services.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $28.90 million | $0.34 million | $29.61 million | $0.79 million |
| Gross profit / margin | $2.67 million / 9.2% | $0.34 million | $3.23 million / 10.9% | $0.79 million |
| Operating loss | $(6.62) million | $(0.84) million | $(10.74) million | $(3.65) million |
| Net loss | $(9.25) million | $(0.52) million | $(14.86) million | $(3.91) million |
| Loss per share | $(0.10) | $(0.01) | $(0.21) | $(0.08) |
Reported revenue growth primarily reflects consolidation of Quest, which contributed about $28.6 million of revenue after acquisition. On a pro forma basis, assuming Quest was consolidated for the full comparable periods, sales were $34.85 million in Q3 2013 versus $33.18 million in Q3 2012, while gross profit declined to $3.15 million from $3.59 million. Pro forma nine-month sales were $98.47 million versus $99.76 million; pro forma net loss was $14.19 million versus $2.36 million.
- Cash flow: Nine-month operating cash use was $3.13 million, compared with $2.61 million in 2012. Investing activities provided $5.33 million, including $4.24 million of cash acquired with Quest; financing activities provided $0.94 million. Cash ended at $3.63 million.
- Liquidity: Current assets were $21.71 million and current liabilities $25.64 million, a $3.94 million working-capital deficit. Accounts receivable was $17.71 million; accounts payable was $20.09 million.
- Debt: The balance sheet reported $16.88 million of long-term related-party convertible notes, net of discount, plus a $2.25 million revolving credit balance and smaller current debt and lease obligations. The Quest sellers’ notes have $22 million aggregate principal, bear 7% interest, mature July 2016, and are convertible at $2 per share. The Regions Bank credit facility is $10 million, with approximately $7.75 million available at quarter-end; outstanding amounts were due December 15, 2013.
- Margins and costs: Reported gross margin was approximately 9.2% for Q3 and 10.9% for the first nine months. Costs included acquisition-related amortization and restructuring, as well as higher interest expense.
Material changes and unusual items
- On July 16, 2013, the company acquired the remaining 50% of Quest, which it had previously accounted for as an equity-method investment. Consideration included 22 million common shares and $22 million in sellers’ notes. Quest was valued at $77.2 million for acquisition accounting, including substantial goodwill and intangible assets.
- The company recorded a $3.40 million goodwill impairment and approximately $0.77 million of acquisition-related intangible amortization during the period. Reported nine-month interest expense was $3.32 million; total other expense was $4.79 million, including $1.47 million of related-party note financing costs.
- Common shares outstanding increased from 58.0 million at year-end 2012 to 95.8 million at September 30, 2013, mainly from the Quest acquisition, warrant exercises, and note conversions.
- Earth911 and Youchange were restructured and relocated. Management estimated the changes would reduce related expenses by approximately $4 million annually; restructuring costs were approximately $1.66 million.
Outlook, risks, and other disclosures
Management said the Quest acquisition and restructuring should provide sufficient liquidity for current operations and expects to pursue growth through sales, cost control, and other initiatives. The filing provides no quantified revenue or earnings guidance. Management also stated that additional capital may be needed for expansion and that financing may not be available on acceptable terms; equity financing could dilute shareholders. The 2012 audit had raised substantial doubt about the company’s ability to continue as a going concern. Management believed the current actions addressed liquidity needs, but that assessment is not assurance of future funding or cash generation.
Other risks include integrating and expanding operations, sustaining profitability, collecting receivables, and realizing goodwill and deferred tax assets. The company maintained a full valuation allowance against deferred tax assets. Management reported effective disclosure controls at quarter-end and said the previously identified material weakness had been remediated after hiring a new CFO. The filing reported no known legal proceedings believed likely to have a material adverse effect and no material changes to previously disclosed risk factors. Effective October 28, 2013, the company changed its name to Quest Resource Holding Corporation, increased authorized common shares to 200 million, and adopted the QRHC trading symbol.
Important facts for investors to verify
- Whether Quest generates sufficient operating cash to cover debt service and address the working-capital deficit.
- The December 15, 2013 credit-facility maturity and subsequent repayment, renewal, or refinancing.
- The terms, security, conversion potential, and repayment status of the $22 million sellers’ notes.
- Whether the projected $4 million annual restructuring savings are achieved and whether further impairment or integration costs arise.
- Customer receivable collectability, particularly given the $17.71 million receivable balance and $296,184 allowance for doubtful accounts.
- Actual dilution from the acquisition consideration, convertible notes, options, and future financing needs.