Business context and reporting period
Quest Resource Holding Corporation (QRHC) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. The company provides recycling, waste-management and environmental information services. Results now include Quest Resource Management Group (Quest) as a wholly owned subsidiary following QRHC’s July 2013 acquisition of the remaining 50% interest. Accordingly, reported 2013 results are not directly comparable because Quest was then accounted for as an equity-method investment.
Financial performance and position
- Revenue: Q2 revenue was $42.5 million and first-half revenue was $80.7 million. Management attributed most of the increase over the very small reported 2013 figures to consolidating Quest. Quest itself reported sales of $42.3 million for Q2 and $80.3 million for the first half, up from $32.3 million and $62.9 million, respectively, in the comparable 2013 periods. QRHC also reported sequential revenue growth of 11.4% in Q2, primarily from new customers.
- Profitability: Q2 gross profit was $3.5 million (8.3% margin); first-half gross profit was $6.8 million (8.5%). Operating losses were $936,000 for Q2 and $1.55 million for the first half. Net losses were $1.83 million and $3.32 million, respectively; loss per share was $0.02 and $0.03. The prior-year reported margins are not comparable because the business mix changed with Quest consolidation. Against pro forma 2013 consolidated results, gross margin was lower: 8.3% versus approximately 8.8% in Q2 and 8.5% versus approximately 10.1% for the first half.
- Cash flow: First-half operating cash use was $3.87 million, compared with $2.05 million in 2013; investing cash use was $490,000. Financing provided $4.88 million, including $2.5 million of line-of-credit proceeds and $2.385 million from an equity offering. Cash increased to $3.20 million from $2.68 million at year-end.
- Liquidity and debt: Working capital was negative $3.39 million at June 30. The company had $5.25 million drawn on its revolving credit facility and $4.10 million available to borrow. The facility was amended to extend maturity to May 31, 2015 and add a $5 million accordion feature; QRHC and Earth911 became guarantors, and Earth911 pledged 50% of Quest’s membership interests. The company also carried related-party secured convertible seller notes with $22 million principal, 7% interest and a July 2016 maturity; their net carrying value was $18.25 million after discount. Total liabilities were $49.81 million.
- Other metrics: Q2 interest expense was $890,000 and first-half interest expense was $1.77 million. First-half depreciation and amortization was $1.91 million, including amortization of acquired intangibles. Management-reported non-GAAP EBITDAS was $435,000 for Q2 and $936,000 for the first half. The filing reports 97.05 million common shares outstanding at June 30.
Material changes versus prior periods
Comparisons with reported 2013 revenue and margins are substantially affected by the change from equity-method accounting to full consolidation of Quest after its acquisition. On a pro forma basis assuming Quest had been consolidated in 2013, revenue increased, while gross margin declined. QRHC’s net loss narrowed year over year, but operating cash use increased. Interest costs rose in Q2, principally due to the seller notes and amortization of their discount. Weighted-average shares also increased materially, mainly reflecting the acquisition shares and subsequent equity issuance.
Outlook, commentary and risks
- Management expected 2014 gross margins to average above Q4 2013 levels, with recycling, waste and commodity programs generally ranging from 5% to 20%; margins vary with service mix, volumes, pricing, commodity indices and subcontractor costs. The filing provides no specific revenue or earnings guidance.
- Management said operations may require additional cash until positive operating cash flow is achieved. Growth and potential expansion could strain financial, management and operating resources.
- Key stated sensitivities include commodity prices, service mix, customer volumes, receivables growth, cost control, integration and execution of expansion plans. QRHC also had a full valuation allowance against deferred tax assets of $7.53 million and said realization of tax-loss carryforwards was not reasonably assured.
- QRHC issued 1.19 million shares and warrants for $2.385 million in April 2014. At quarter-end, 3.291 million warrants were outstanding; options and convertible notes also represented potential dilution. The filing identifies no known legal proceedings expected to have a material adverse effect. Management reported disclosure controls were effective at the reasonable-assurance level.
Important facts for investors to verify
- Quest’s underlying revenue growth, customer additions and margins, distinguishing operational growth from consolidation effects.
- Whether QRHC can reduce operating cash use and fund working-capital needs, given the current working-capital deficit and accounts-receivable growth.
- Availability and borrowing-base conditions under the Regions facility, its May 2015 maturity, and compliance with amended covenants and guarantees.
- Cash interest and principal obligations on the $22 million related-party seller notes, as well as potential conversion and equity dilution.
- Whether acquired goodwill and intangible assets remain recoverable; goodwill was $58.34 million at June 30, 2014, following a significant impairment recorded in 2013.