2013 10-Q Q3


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended
September 7, 2013
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________________to _________________

Commission File Number 001-33987

HERITAGE-CRYSTAL CLEAN, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
26-0351454
State or other jurisdiction of
 
(I.R.S. Employer
Incorporation
 
Identification No.)

2175 Point Boulevard
Suite 375
Elgin, IL 60123
(Address of principal executive offices)  (Zip Code)

Registrant’s telephone number, including area code: (847) 836-5670


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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).   Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o
 
Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

On October 15, 2013, there were outstanding 18,418,593 shares of Common Stock, $0.01 par value, of Heritage-Crystal Clean, Inc.



1



Table of Contents

 
 
 
 
 
 
 
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 
 


2



PART I

ITEM 1. FINANCIAL STATEMENTS

Heritage-Crystal Clean, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share and Par Value Amounts)
(Unaudited)
 
September 7,
2013
 
December 29,
2012
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
30,888

 
$
47,766

Accounts receivable - net
32,006

 
23,338

Inventory - net
27,979

 
27,231

Deferred income taxes
158

 
759

Income tax receivables - current

 
648

Other current assets
4,908

 
2,821

Total Current Assets
95,939

 
102,563

Property, plant and equipment - net
78,791

 
72,246

Equipment at customers - net
18,859

 
17,946

Software and intangible assets - net
9,702

 
4,555

Goodwill
7,754

 
1,801

Total Assets
$
211,045

 
$
199,111

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 

Current Liabilities:
 
 
 

Accounts payable
$
18,953

 
$
16,509

Accrued salaries, wages, and benefits
4,020

 
2,544

Taxes payable
1,481

 
1,066

Current maturities of long-term debt and term loan
2,389

 
1,803

Other accrued expenses
2,842

 
2,512

Total Current Liabilities
29,685

 
24,434

  Term loan, less current maturities
18,250

 
18,250

  Long-term debt, less current maturities
850

 
828

  Contingent consideration, less current portion
185

 
451

   Deferred income taxes
6,430

 
5,757

Total Liabilities
$
55,400

 
$
49,720

 
 
 
 
STOCKHOLDERS' EQUITY:
 
 
 

Common stock - 22,000,000 shares authorized at $0.01 par value, 18,312,211 and 18,068,852 shares issued and outstanding at September 7, 2013 and December 29, 2012, respectively
$
183

 
$
181

Additional paid-in capital
145,059

 
141,612

Retained earnings
9,497

 
7,598

Total Heritage-Crystal Clean, Inc. Stockholders' Equity
154,739

 
149,391

Noncontrolling Interest
906

 

Total Equity
155,645

 
149,391

Total Liabilities and Stockholders' Equity
$
211,045

 
$
199,111

 
See accompanying notes to financial statements.

3




Heritage-Crystal Clean, Inc.
Consolidated Statements of Income
(In Thousands, Except per Share Amounts)
(Unaudited)


 
 
 
Third Quarter Ended,
 
First Three Quarters Ended,
 
 
 
September 7,
2013
 
September 8,
2012
 
September 7,
2013
 
September 8,
2012
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
Product revenues
 
$
32,302

 
$
31,348

 
$
87,766

 
$
84,505

 
Service revenues
 
35,301

 
30,718

 
103,394

 
90,341

Total revenues
 
$
67,603

 
$
62,066

 
$
191,160

 
$
174,846

 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
Operating costs
 
$
55,698

 
$
52,718

 
$
160,185

 
$
146,963

 
Selling, general, and administrative expenses
 
7,051

 
5,575

 
20,691

 
17,569

 
Depreciation and amortization
 
2,224

 
1,904

 
6,246

 
5,587

 
Other expense (income) - net
 
138

 

 
231

 
(3
)
Operating income
 
2,492

 
1,869

 
3,807

 
4,730

Interest expense – net
 
97

 
112

 
310

 
445

Income before income taxes
 
2,395

 
1,757

 
3,497

 
4,285

Provision for income taxes
 
1,061

 
723

 
1,526

 
1,762

Net income
 
1,334

 
1,034

 
1,971

 
2,523

Income attributable to noncontrolling interest
 
26

 

 
72

 

Net income attributable to Heritage-Crystal Clean, Inc. common stockholders
 
$
1,308

 
$
1,034

 
$
1,899

 
$
2,523

 
 
 
 
 
 
 
 
 
Net income per share: basic
 
$
0.07

 
$
0.06

 
$
0.10

 
$
0.15

Net income per share: diluted
 
$
0.07

 
$
0.06

 
$
0.10

 
$
0.15

 
 
 
 
 
 
 
 
 
Number of weighted average shares outstanding: basic
 
18,272

 
18,060

 
18,174

 
16,412

Number of weighted average shares outstanding: diluted
 
18,585

 
18,412

 
18,494

 
16,783


 
See accompanying notes to financial statements.



4



Heritage-Crystal Clean, Inc.
Consolidated Statement of Stockholders’ Equity
(In Thousands, Except Share Amounts)
(Unaudited)


 
Shares
 
Par
Value
Common
 
Additional Paidin
Capital
 
Retained Earnings
 
Total Heritage-Crystal Clean, Inc. Stockholders' Equity
 
Noncontrolling Interest
 
Total Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 29, 2012
18,068,852

 
$
181

 
$
141,612

 
$
7,598

 
$
149,391

 
$

 
$
149,391

     Mirachem Acquisition

 

 

 

 

 
834

 
834

     Net income

 

 

 
1,899

 
1,899

 
72

 
1,971

     Issuance of common stock - acquisitions
151,322

 
1

 
2,229

 

 
2,230

 

 
2,230

     Issuance of common stock – ESPP
23,521

 

 
335

 

 
335

 

 
335

     Exercise of stock options
7,192

 

 
76

 

 
76

 

 
76

     Share-based compensation
61,324

 
1

 
807

 

 
808

 

 
808

Balance at September 7, 2013
18,312,211

 
$
183

 
$
145,059

 
$
9,497

 
$
154,739

 
$
906

 
$
155,645

 

 
See accompanying notes to financial statements.



5



Heritage-Crystal Clean, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)

 
 
First Three Quarters Ended,
 
 
September 7,
2013
 
September 8,
2012
Cash flows from Operating Activities:
 
 
 
 
Net income
 
$
1,971

 
$
2,523

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 


 
 

Depreciation and amortization
 
6,246

 
5,587

Bad debt provision
 
446

 
694

Share-based compensation
 
808

 
763

Deferred taxes
 
1,274

 
781

Other, net
 
33

 
51

Changes in operating assets and liabilities:
 
 

 
 

Increase in accounts receivable
 
(8,547
)
 
(12,691
)
Decrease in income tax receivable
 
648

 
1,120

Decrease (increase) in inventory
 
36

 
(5,155
)
Increase in other current assets
 
(2,087
)
 
(1,454
)
Increase in accounts payable
 
1,439

 
3,883

Increase (decrease) in accrued expenses
 
2,375

 
(152
)
Cash provided by (used in) operating activities
 
$
4,642

 
$
(4,050
)
 
 
 
 
 
Cash flows from Investing Activities:
 
 

 
 

Capital expenditures
 
$
(10,625
)
 
$
(18,518
)
Business acquisitions, net of cash acquired
 
(10,195
)
 

Cash used in investing activities
 
$
(20,820
)
 
$
(18,518
)
 
 
 
 
 
Cash flows from Financing Activities:
 
 

 
 

Proceeds from Term Loan
 
$
750

 
$

Payments on Term Loan
 
(750
)
 
(250
)
Payments of notes payable
 
(688
)
 
(415
)
Payments of contingent consideration
 
(423
)
 

Proceeds from issuance of common stock
 
335

 
65,843

Proceeds from the exercise of stock options
 
76

 
1,583

Borrowings under revolving credit facility
 

 
28,180

Payments on revolving credit facility
 

 
(28,180
)
Cash (used in) provided by financing activities
 
$
(700
)
 
$
66,761

Net (decrease) increase in cash and cash equivalents
 
(16,878
)
 
44,193

Cash and cash equivalents, beginning of period
 
47,766

 
2,186

Cash and cash equivalents, end of period
 
$
30,888

 
$
46,379

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Income taxes paid
 
$
218

 
$
519

 Cash paid for interest, net of capitalized interest of $84 and $65, respectively
 
354

 
230

Supplemental disclosure of non-cash information:
 
 

 
 

Payables for construction in progress
 
$
466

 
$
1,497

  Business acquisition, note issued
 
1,235

 

  Business acquisition, common stock issued
 
2,230

 

See accompanying notes to financial statements.

6



HERITAGE-CRYSTAL CLEAN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 7, 2013

(1)    ORGANIZATION AND NATURE OF OPERATIONS

Heritage-Crystal Clean, Inc., a Delaware corporation and its subsidiaries (collectively the “Company”), provides parts cleaning and hazardous and non-hazardous waste services to small and mid-sized customers in both the manufacturing and vehicle service sectors.  The Company's service programs include parts cleaning, containerized waste management, used oil collection, vacuum truck services, and waste antifreeze collection and recycling.  The Company also owns and operates a used oil re-refinery through which it recycles used oil into high quality lubricant base oil and byproducts. The Company also sells recycled antifreeze products. The Company's locations are in the United States. The Company conducts its primary business operations through Heritage-Crystal Clean, LLC, its wholly owned subsidiary, and all intercompany balances have been eliminated in consolidation.

The Company’s fiscal year ends on the Saturday closest to December 31.  The most recent fiscal year ended on December 29, 2012.  Each of the Company's first three fiscal quarters consists of twelve weeks while the last fiscal quarter consists of sixteen or seventeen weeks.  

In the Company's Environmental Services segment, product revenues include sales of solvent, machines, antifreeze, and accessories to customers; and service revenues include drum waste removal services, servicing of parts cleaning machines, vacuum truck services, and other services.  In the Company's Oil Business segment, product revenues include sales of re-refined base oil, byproducts, and used oil; and service revenues include revenues from collecting and disposing of waste water. Due to the Company's integrated business model, it is impracticable to separately present costs of tangible products and costs of services.

(2)    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires the use of certain estimates by management in determining the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period.  Significant items subject to such estimates and assumptions are the allowance for doubtful accounts receivable, valuation of inventory at lower of cost or market, valuation of goodwill and other intangible assets, and income taxes.  Actual results could differ from those estimates.

Revenue Recognition

The Company derives its revenues primarily from the services it performs and from the sale of processed oil from its used oil re-refinery. Parts cleaning and other service revenues are recognized as the service is performed. Product revenues are recognized at the time risk of loss passes to the customer. The risk of loss passes to customers at various times depending on the particular terms of the sales contract in force with each individual customer. Common thresholds for when risk of loss passes to the customer are at the time that product is loaded onto the shipping vessel or at the time that product is offloaded at the customer’s receiving location. Revenues are recognized only if collection of the relevant receivable is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable.

Operating Costs

Within operating costs are cost of sales. Cost of sales in the Environmental Services segment includes the costs of the materials the Company sells and provides in its services, such as solvents and other chemicals, cleaning machines sold to customers, transportation of inventory and waste, and payments to third parties to recycle or dispose of the waste materials that the Company collects. The Company’s used solvent that it retrieves from customers in its product reuse program is accounted for as a reduction in net cost of solvent under cost of sales, whether placed in inventory or sold to a purchaser for reuse. If the used solvent is placed in inventory it is recorded at lower of cost or net realizable value. Cost of sales in the Oil Business include the costs paid to customers for used oil, transportation out to customers, and costs to operate the used oil re-refinery, including personnel costs and utilities.


7



Operating costs also include the Company's costs of operating its branch system and hubs. These costs include personnel costs (including commissions), facility rent and utilities, truck leases, fuel, transportation, and maintenance. Operating costs are not presented separately for products and services.

Acquisitions

The Company accounts for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, and contingent consideration be recorded at the date of acquisition at their respective fair values. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred and restructuring costs to be expensed in periods subsequent to the acquisition date. The Company records a preliminary purchase price allocation for its acquisitions and finalizes purchase price allocations as additional information relative to the fair values of the assets acquired becomes known.

Identifiable Intangible Assets

The fair value of identifiable intangible assets is based on significant judgments made by management. The Company may engage third party valuation appraisal firms to assist the Company in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require the Company to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies and also include, but are not limited to, future expected cash flows to be earned from the continued operation of the acquired business and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates, or actual results. Acquisition-related finite lived intangible assets are amortized on a straight-line basis over their estimated economic lives. The Company evaluates the estimated benefit periods and recoverability of its intangible assets when facts and circumstances indicate that the lives may not be appropriate and/or the carrying value of the asset may not be recoverable. If the carrying value is not recoverable, impairment is measured as the amount by which the carrying value exceeds its estimated fair value.

Fair Value of Financial Instruments

The Company uses a three-tier fair value hierarchy to classify and disclose all assets and liabilities measured at fair value on a recurring basis, as well as assets and liabilities measured at fair value on a non-recurring basis, in periods subsequent to their initial measurement. These tiers include: Level 1, defined as quoted market prices in active markets for identical assets or liabilities; Level 2, defined as inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, model-based valuation techniques for which all significant assumptions are observable in the market, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3, defined as unobservable inputs that are not corroborated by market data.

The Company’s financial instruments consist primarily of cash and cash equivalents, trade receivables, trade payables, notes payable, contingent consideration, and term debt.  As of September 7, 2013 and December 29, 2012, the carrying values of cash and cash equivalents, trade receivables, trade payables, notes payable, and contingent consideration, are considered to be representative of their respective fair values due to the short maturity of these instruments. Term debt is representative of its fair value due to the interest rates being applied.

Goodwill

Goodwill is measured as a residual amount as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. The Company tests goodwill for impairment annually in the fourth quarter and in interim periods if changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company's determination of fair value requires certain assumptions and estimates, such as margin expectations, growth expectations, expected changes in working capital, etc., regarding future profitability and cash flows of acquired businesses and market conditions. In the fourth quarter of fiscal 2012, the Company tested goodwill for impairment and determined goodwill not to be impaired. The Company intends to test goodwill for impairment in the fourth quarter of fiscal 2013.


8



The change in the carrying amount of goodwill by segment from December 29, 2012 to September 7, 2013 is as follows (in thousands):

 
 
Oil Business
 
Environmental Services
 
Total
 
 
 
 
 
 
 
Balance at December 29, 2012
 
$
1,801

 
$

 
$
1,801

   Mirachem Acquisition
 

 
809

 
809

   RFTI Acquisition
 

 
3,227

 
3,227

   RTI Acquisition
 

 
1,917

 
1,917

Balance at September 7, 2013
 
$
1,801

 
$
5,953

 
$
7,754


(3)    BUSINESS COMBINATIONS

On December 31, 2012, the Company, through a new Delaware subsidiary, Mirachem, LLC, purchased substantially all of the operating assets of Mirachem Corporation. Since 2004, Mirachem Corporation had provided the Company with cleaning chemistry used in the Company's aqueous parts cleaning service. The Company made an initial payment of approximately $2.5 million in cash at the time of closing and provided a note payable for an additional $0.8 million over two years.

In a separate transaction, the Company acquired from a third party additional aqueous technologies in exchange for a 20% interest in Mirachem, LLC. The Company has an option to repurchase this 20% interest, and the holder of this 20% interest has a right to sell the interest to the Company after January 1, 2016, at a price based on the trailing EBITDA of Mirachem, LLC, subject to potential modifications.

The Company completed these transactions in order to secure the supply of its aqueous parts cleaning chemistry which, together with the Company's patented aqueous parts cleaning equipment, should provide the Company with a strong platform from which to compete in the aqueous parts cleaning market.

On June 26, 2013, the Company purchased substantially all of the operating assets of Recycling Fluid Technologies, Inc. (RFTI), which was based in Battle Creek, Michigan. RFTI 's business consisted of collecting waste antifreeze and recycling the waste antifreeze, producing a line of high quality antifreeze products which were sold for use in vehicle engine applications. The Company purchased RFTI for $4.9 million in cash and $1.2 million of the Company's common stock, or 82,000 shares.

On July 19, 2013, the Company purchased substantially all of the operating assets of Recycle Technologies, Inc. (RTI), which was based in Wood Dale, Illinois. RTI's business and operations were very similar to the business and operations of the former RFTI, which is described above. The Company purchased RTI for $2.9 million in cash at the time of closing, $0.4 million in the form of a note payable, and $1.0 million of the Company's common stock or 69,322 shares.

The acquisitions of RFTI and RTI provide the Company with a presence in the antifreeze recycling market.


9



The following table summarizes the estimated fair values of the assets acquired and liabilities assumed, net of cash acquired, related to the each acquisition (in thousands):
 
Mirachem
 
RFTI
 
RTI
 
 
 
 
 
 
Accounts Receivable
$

 
$
364

 
$
203

Inventory
476

 
188

 
121

Property, Plant, & Equipment
218

 
1,283

 
793

Intangible Assets
2,710

 
1,390

 
1,340

Goodwill
809

 
3,227

 
1,917

Accounts Payable
(139
)
 
(91
)
 

Non-controlling interest
(834
)
 

 

Total purchase price, net of cash acquired
$
3,240

 
$
6,361

 
$
4,374

Less: common stock issued

 
(1,230
)
 
(1,000
)
Less:  note issued
(835
)
 

 
(430
)
Less: working capital adjustment

 
(211
)
 
(74
)
Net cash paid
$
2,405

 
$
4,920

 
$
2,870


The Company is continuing to evaluate the purchase price allocations. Preliminary purchase price allocations are tentative and subject to revision as the Company finalizes appraisals and other analyses. Final determination of the fair values may result in further adjustments to the values presented above. The Company has consolidated the acquisitions into its financial statements as part of the Environmental Services segment.

Unaudited Pro Forma Financial Information

The pro forma financial information in the table below presents the combined results of the Company as if the Mirachem, RFTI, and RTI acquisitions had occurred January 1, 2012 (in thousands, except per share data). The pro forma information is shown for illustrative purposes only and is not necessarily indicative of future results of operations of the Company or results of operations of the Company that would have actually occurred had the transactions been in effect for the periods presented. This pro forma information is not intended to represent or be indicative of actual results had the acquisition occurred as of the beginning of each period. Additionally, certain one-time transaction expenses that are a direct result of the acquisitions have been excluded from the quarter and first three quarters ended September 7, 2013 and September 8, 2012.
 
 
Third Quarter Ended,
 
First Three Quarters Ended,
 
 
September 7, 2013
 
September 8, 2012
 
September 7, 2013
 
September 8, 2012
Total Revenues
 
$
67,944

 
$
64,046

 
$
194,070

 
$
180,112

Net Income
 
1,371

 
1,062

 
2,146

 
2,743

Income per Share
 
 
 
 
 
 
 
 
     Basic
 
$
0.07

 
$
0.06

 
$
0.12

 
$
0.17

     Diluted
 
0.07

 
0.06

 
0.12

 
0.17




10



(4)    ACCOUNTS RECEIVABLE

Accounts receivable consisted of the following (in thousands):

 
September 7,
2013
 
December 29,
2012
Trade
$
32,295

 
$
24,026

Less allowance for doubtful accounts
(1,338
)
 
(1,244
)
Trade - net
30,957

 
22,782

Related parties
792

 
410

Other
257

 
146

Total accounts receivable - net
$
32,006

 
$
23,338


The following table provides the changes in the Company’s allowance for doubtful accounts for the first three quarters ended September 7, 2013 and the fiscal year ended December 29, 2012 (in thousands):

 
September 7,
2013
 
December 29,
2012
Balance at beginning of period
$
1,244

 
$
698

Bad debt provision
446

 
1,122

Accounts written off, net of recoveries
(352
)
 
(576
)
Balance at end of period
$
1,338

 
$
1,244


(5)    INVENTORY

The carrying value of inventory consisted of the following (in thousands):
 
September 7,
2013
 
December 29,
2012
Oil
$
13,534

 
$
11,549

Solvents
8,561

 
10,076

Machines
2,537

 
2,470

Drums
1,808

 
1,859

Other
1,736

 
1,518

Total inventory
28,176

 
27,472

Less: Machine refurbishing reserve
(197
)
 
(241
)
Total inventory - net
$
27,979

 
$
27,231

 
Inventory consists primarily of used oil, processed oil, catalyst, new and used solvents, new and refurbished parts cleaning machines, drums, accessories, and absorbents. Inventories are valued at the lower of first-in, first-out (FIFO) cost or market, net of any reserves for excess, obsolete, or unsalable inventory. The Company continually monitors its inventory levels at each of its locations and evaluates inventories for excess or slow-moving items. If circumstances indicate the cost of inventories exceed their recoverable value, inventories are reduced to net realizable value.



11



(6)    PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment consisted of the following (in thousands):
 
September 7,
2013
 
December 29,
2012
Buildings and storage tanks (a)
$
48,252

 
$
45,813

Machinery, vehicles, and equipment (a)
30,967

 
30,040

Leasehold improvements (a)
1,992

 
3,180

Land (a)
835

 
414

Construction in progress
11,631

 
4,658

Total property, plant and equipment
93,677

 
84,105

Less accumulated depreciation
(14,886
)
 
(11,859
)
Property, plant and equipment - net
$
78,791

 
$
72,246

 
 
 
 
 
September 7,
2013
 
December 29,
2012
Equipment at customers
$
45,404

 
$
41,884

Less accumulated depreciation
(26,545
)
 
(23,938
)
Equipment at customers - net
$
18,859

 
$
17,946

_______________
(a) Fiscal 2013 numbers include preliminary fair values of assets acquired in the acquisitions described in Note 3 that may be adjusted as additional information becomes known.

(7) SOFTWARE AND OTHER INTANGIBLE ASSETS

Following is a summary of software and other intangible assets (in thousands):
 
September 7, 2013
 
December 29, 2012
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Customer relationships(a)
$
5,379

 
$
484

 
$
4,895

 
$
1,729

 
$
274

 
$
1,455

Software
4,457

 
2,749

 
1,708

 
4,296

 
2,635

 
1,661

Patents, formulae, and licenses(a)
1,822

 
331

 
1,491

 
1,059

 
262

 
797

Non-compete agreements(a)
1,297

 
622

 
675

 
777

 
510

 
267

Other (a)
1,132

 
199

 
933

 
539

 
164

 
375

Total software and intangible assets
$
14,087

 
$
4,385

 
$
9,702

 
$
8,400

 
$
3,845

 
$
4,555

_______________
(a) Fiscal 2013 numbers include preliminary fair values of assets acquired in the acquisitions described in Note 3 that may be adjusted as additional information becomes known.
 
Amortization expense was $0.2 million for the third quarter ended September 7, 2013 and $0.2 million for third quarter ended September 8, 2012. Amortization expense was $0.6 million for the first three quarters ended September 7, 2013 and $0.5 million for the first three quarters ended September 8, 2012. The weighted average useful lives of software; customer relationships; patents, formulae, and licenses; non-compete agreements, and other intangibles were 10 years, 14 years, 15 years, 5 years, and 8 years, respectively.

The expected amortization expense for the remainder of fiscal 2013 and for fiscal years 2014, 2015, 2016, and 2017 is $0.3 million, $1.0 million, $0.9 million, $0.9 million, and $0.8 million, respectively. The preceding expected amortization expense is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, disposal of intangible assets, accelerated amortization of intangible assets, and other events.


12



(8)    ACCOUNTS PAYABLE

Accounts payable consisted of the following (in thousands):
 
September 7,
2013
 
December 29,
2012
Accounts payable
$
18,667

 
$
16,202

Accounts payable - related parties
286

 
307

Total accounts payable
$
18,953

 
$
16,509


(9)    DEBT AND FINANCING ARRANGEMENTS

Bank Credit Facility

On February 5, 2013, the Company entered into an Amended and Restated Credit Agreement ("Credit Agreement") that allows for up to $40.0 million in borrowings. As of both September 7, 2013 and December 29, 2012, the Company's total borrowings were $19.5 million, under the term loan which has a maturity date of February 5, 2018. The remaining portion of the credit facility is a revolving loan which expires on February 5, 2018. There were no amounts outstanding under the revolver at September 7, 2013 and December 29, 2012.

During the third quarter and first three quarters of fiscal 2013, the Company recorded interest of $0.1 million and $0.3 million on the term loan, respectively. The Company capitalized less than $0.1 million for various capital projects during the first three quarters of fiscal 2013. During the first three quarters of fiscal 2012, the Company recorded interest of $0.4 million on both the term loan and revolving credit facility, of which less than $0.1 million was capitalized for various capital projects.

The Company's weighted average interest rate as of September 7, 2013 and September 8, 2012 was 2.5% and 2.8%, respectively. The Company's effective interest rate as of September 7, 2013 and September 8, 2012 was 2.6% and 2.9%, respectively.

As of September 7, 2013 and December 29, 2012, the Company was in compliance with all covenants under the Credit Agreement. As of September 7, 2013, and December 29, 2012, the Company had $0.3 million of standby letters of credit issued, respectively, and $17.4 million and $19.7 million was available for borrowing under the bank credit facility, respectively. The actual amount available under the revolving loan portion of the Credit Agreement is limited by the Company's total leverage ratio.
    
Notes Payable

At September 7, 2013 and December 29, 2012, the Company had outstanding notes payable related to business acquisitions of $2.0 million and $1.4 million, respectively, of which $1.1 million and $0.6 million were recorded as current maturities.
 
(10)    SEGMENT INFORMATION

The Company reports in two segments: "Environmental Services" and "Oil Business." The Environmental Services segment consists of the Company's parts cleaning, containerized waste management, vacuum truck service, and antifreeze recycling activities. The Oil Business segment consists of the Company's used oil collection and used oil re-refining activities.

No single customer in either segment accounted for more than 10.0% of consolidated revenues in any of the periods presented. There were no intersegment revenues.
    
Operating segment results for the third quarters and first three quarters ended September 7, 2013, and September 8, 2012 were as follows (in thousands):

13



Third Quarter Ended,
September 7, 2013
 
 
 

Environmental
Services
 
Oil Business
 
Corporate and
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
Product revenues
 
$
3,498

 
$
28,804

 
$

 
$
32,302

 
Service revenues
 
33,176

 
2,125

 
 
 
35,301

Total revenues
 
$
36,674

 
$
30,929

 
$

 
$
67,603

Operating expenses
 
 
 
 
 
 
 
 
 
Operating costs
 
26,790

 
28,908

 

 
55,698

 
Operating depreciation and amortization
 
1,160

 
790

 

 
1,950

Profit before corporate selling, general, and administrative expenses
 
$
8,724

 
$
1,231

 
$

 
$
9,955

Selling, general, and administrative expenses
 
 
 
 
 
7,051

 
7,051

Depreciation and amortization from SG&A
 
 
 
 
 
274

 
274

Total selling, general, and administrative expenses
 
 
 
 
 
$
7,325

 
$
7,325

Other expense - net
 
 
 
 
 
138

 
138

Operating Income
 
 
 
 
 
 
 
2,492

Interest expense – net
 
 
 
 
 
97

 
97

Income before income taxes
 
 
 
 
 
 
 
$
2,395

Third Quarter Ended,
September 8, 2012
 
 
 

Environmental
Services
 
Oil Business
 
Corporate and
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
Product revenues
 
$
2,638

 
$
28,710

 
$

 
$
31,348

 
Service revenues
 
29,501

 
1,217

 
 
 
30,718
Total revenues
 
$
32,139

 
$
29,927

 
$

 
$
62,066

Operating expenses
 
 
 
 
 
 
 
 
 
Operating costs
 
24,985
 
27,733
 

 
52,718

 
Operating depreciation and amortization
 
1,084
 
665
 

 
1,749

Profit before corporate selling, general, and administrative expenses
 
$
6,070

 
$
1,529

 
$

 
$
7,599

Selling, general, and administrative expenses
 
 
 
 
 
5,575
 
5,575

Depreciation and amortization from SG&A
 
 
 
 
 
155
 
155

Total selling, general, and administrative expenses
 
 
 
 
 
$
5,730

 
$
5,730

Other income - net
 
 
 
 
 

 

Operating income
 
 
 
 
 
 
 
1,869
Interest expense – net
 
 
 
 
 
112
 
112
Income before income taxes
 
 
 
 
 
 
 
$
1,757



14



First Three Quarters Ended,
September 7, 2013
 
 
 

Environmental
Services
 
Oil Business
 
Corporate and
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
Product revenues
 
$
9,020

 
$
78,746

 
$

 
$
87,766

 
Service revenues
 
98,278

 
5,116

 
 
 
103,394

Total revenues
 
$
107,298

 
$
83,862

 
$

 
$
191,160

Operating expenses
 
 
 
 
 
 
 
 
 
Operating costs
 
77,129

 
83,056

 

 
160,185

 
Operating depreciation and amortization
 
3,320

 
2,228

 

 
5,548

Profit (loss) before corporate selling, general, and administrative expenses
 
$
26,849

 
$
(1,422
)
 
$

 
$
25,427

Selling, general, and administrative expenses
 
 
 
 
 
20,691

 
20,691

Depreciation and amortization from SG&A
 
 
 
 
 
698

 
698

Total selling, general, and administrative expenses
 
 
 
 
 
$
21,389

 
$
21,389

Other expense - net
 
 
 
 
 
231

 
231

Operating income
 
 
 
 
 
 
 
3,807

Interest expense – net
 
 
 
 
 
310

 
310

Income before income taxes
 
 
 
 
 
 
 
$
3,497


First Three Quarters Ended,
September 8, 2012
 
 
 

Environmental
Services
 
Oil Business
 
Corporate and
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
Product revenues
 
$
7,813

 
$
76,692

 
$

 
$
84,505

 
Service revenues
 
86,886

 
3,455

 
 
 
90,341
Total revenues
 
$
94,699

 
$
80,147

 
$

 
$
174,846

Operating expenses
 
 
 
 
 
 
 
 
 
Operating costs
 
73,053
 
73,910
 

 
146,963
 
Operating depreciation and amortization
 
3,195
 
1,956
 

 
5,151

Profit before corporate selling, general, and administrative expenses
 
$
18,451

 
$
4,281

 
$

 
$
22,732

Selling, general, and administrative expenses
 
 
 
 
 
17,569
 
17,569

Depreciation and amortization from SG&A
 
 
 
 
 
436
 
436

Total selling, general, and administrative expenses
 
 
 
 
 
$
18,005

 
$
18,005

Other income - net
 
 
 
 
 
(3)
 
(3)

Operating income
 
 
 
 
 
 
 
4,730
Interest expense – net
 
 
 
 
 
445
 
445
Income before income taxes
 
 
 
 
 
 
 
$
4,285



15



Total assets by segment as of September 7, 2013 and December 29, 2012 were as follows (in thousands):

 
 
 
September 7, 2013
 
December 29, 2012
Total Assets:
 
 
 
 
Environmental Services
$
75,212

 
$
57,092

 
Oil Business
98,277

 
87,222

 
Unallocated Corporate Assets
37,556

 
54,797

 
 
Total
$
211,045

 
$
199,111


Segment assets for the Environmental Services and Oil Business segments consist of property, plant, and equipment, intangible assets, accounts receivable, goodwill, and inventories. Assets for the corporate unallocated amounts consist of property, plant, and equipment used at the corporate headquarters, as well as cash and net deferred tax assets. Presentation has been adjusted as of December 29, 2012 to allocate accounts receivable to each segment, compared to previous presentation in which accounts receivable were listed as Unallocated Corporate Assets.

(11)    COMMITMENTS AND CONTINGENCIES

The Company may enter into purchase obligations with certain vendors. They represent expected payments to third party service providers and other commitments entered into during the normal course of our business. These purchase obligations are generally cancelable with or without notice, without penalty, although certain vendor agreements provide for cancellation fees or penalties depending on the terms of the contract.

The Company has purchase obligations in the form of open purchase orders of $13.8 million as of September 7, 2013, primarily for used oil, solvent, machine purchases, disposal and transportation expenses, and capital expenditures.

The Company may be subject to investigations, claims or lawsuits as a result of operating its business, including matters governed by environmental laws and regulations.  When claims are asserted, the Company evaluates the likelihood that a loss will occur and records a liability for those instances when the likelihood is deemed probable and the exposure is reasonably estimable.  The Company carries insurance at levels it believes are adequate to cover loss contingencies based on historical claims activity.  When the potential loss exposure is limited to the insurance deductible and the likelihood of loss is determined to be probable, the Company accrues for the amount of the required deductible, unless a lower amount of exposure is estimated. As of September 7, 2013 and December 29, 2012, the Company had accrued $0.3 million and $0.2 million related to loss contingencies, respectively.

(12)    INCOME TAXES
 
In fiscal 2011, as a result of temporary differences related to the tax treatment of the federal bonus depreciation, the Company recorded a gross Net Operating Loss ("NOL") of $44.7 million, which will expire in 2031. The balance remaining on the NOL as of September 7, 2013 was $44.1 million. As of September 7, 2013, the remaining deferred tax asset related to the Company's state and federal NOL was a tax effected balance of $16.3 million.

The Company recognizes windfall tax benefits associated with the exercise of stock options directly to stockholders' equity only when realized. Consequently, deferred tax assets are not recognized for NOLs resulting from windfall tax benefits. At September 7, 2013, deferred tax assets do not include $0.8 million of excess tax benefits from share-based compensation.

The Company's effective tax rate for the third quarter of fiscal 2013 was 44.3% compared to 41.1% in the third quarter of fiscal 2012. The Company's effective tax rate for the first three quarters of fiscal 2013 was 43.6% compared to 41.1% in the first three quarters of fiscal 2012. The rate increase is attributed to a higher projected state income tax rate, as well as permanent book to tax differences having a greater effect on the rate in fiscal 2013 than in the same period in fiscal 2012.

The Company establishes reserves when it is more likely than not that the Company will not realize the full tax benefit of a position. The Company had a reserve of $0.2 million for uncertain tax positions as of September 7, 2013 and December 29, 2012, respectively. The gross unrecognized tax benefits would, if recognized, decrease the Company's effective tax rate.


16



(13)    SHARE-BASED COMPENSATION

The aggregate number of shares of common stock which may be issued under the Company’s 2008 Omnibus Plan ("Plan") is 1,902,077 plus any common stock that becomes available for issuance pursuant to the reusage provision of the Plan.  As of September 7, 2013, the number of shares available for issuance under the Plan was 777,741 shares.

Stock Option Awards

A summary of stock option activity under this Plan is as follows:
Outstanding Stock Options
Number of
Options
Outstanding
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining
Contractual Term
(in years)
 
Aggregate
Intrinsic Value as of Date Listed
(in thousands)
Options outstanding at December 29, 2012
629,048

 
$
10.76

 
5.40

 
$
2,607

   Exercised
(7,192
)
 
10.59

 
 
 
 
Options outstanding at September 7, 2013
621,856

 
$
10.76

 
4.72

 
$
2,757

 
Nonvested Stock Options
 
Number of Options
 
Weighted Average Grant-Date Fair Value Per Option
Nonvested stock options at December 29, 2012
 
39,403

 
$
3.24

   Less: Shares vested during period
 
(39,403
)
 
3.24

Nonvested stock options at September 7, 2013
 

 
$


The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing model.  This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

On March 25, 2013, stock options issued on March 25, 2009 became fully vested. These options had vested equally over four years beginning on the first anniversary following the grant date. In the first three quarters of both fiscal 2013 and 2012, less than $0.1 million was recorded as expense related to these stock options.

Restricted Stock Compensation/Awards

Annually, the Company grants restricted shares to its Board of Directors. The shares become fully vested one year from their grant date. The fair value of each restricted stock grant is based on the closing price of the Company's stock on the date of grant. The Company amortizes the expense over the service period, which is the fiscal year in which the award is granted. On May 3, 2013, the Company granted 18,666 restricted shares for service in fiscal 2013. Expense related to the Board of Directors' restricted stock in the first three quarters of fiscal 2013 and 2012 was $0.2 million and $0.2 million, respectively. As of September 7, 2013, there was $0.1 million unrecognized expense associated with these awards, which will be recorded throughout fiscal 2013. The 11,493 shares that were granted to the Board in fiscal 2012 vested on May 4, 2013.
 
In March 2011, the Company granted 92,909 restricted shares to certain members of management under the Company's 2010 Long Term Incentive Plan (LTIP).  These restricted shares are subject to a graded vesting schedule over a three year period starting January 1, 2012.  In October 2011, the Company granted 12,783 restricted shares based on the completion of the front part of the used oil re-refinery. As of September 7, 2013 and December 29, 2012, there was approximately $0.1 million and $0.4 million of unrecognized compensation expense related to these awards, respectively. The Company continues to record compensation expense through the vesting period of these awards. In the first three quarters of fiscal 2013 and 2012, the Company recorded expense of approximately $0.3 million and $0.2 million related to these awards, respectively.

In February 2012, the Company granted 59,502 restricted shares to certain members of management under the Company's 2011 LTIP. These restricted shares are subject to a graded vesting schedule over a three year period starting January 1, 2013. There was approximately $0.4 million and $0.7 million of unrecognized compensation expense remaining related to these awards as of September 7, 2013 and December 29, 2012 respectively. In the first three quarters of fiscal 2013 and 2012, $0.2 million and $0.2 million of compensation expense was recorded related to these awards, respectively.

17




On February 7, 2013, the Company granted 10,000 restricted shares to a member of management based on the performance of the individual in fiscal 2012 and having met certain goals. The restricted shares are subject to a graded vesting schedule over a three year period. Based on the relevant guidance, the Company determined that the service inception date was prior to the grant date, and therefore the Company began accruing compensation expense related to these awards in fiscal 2012. There was approximately $0.1 million of unrecognized compensation expense remaining related to this award as of September 7, 2013 and December 29, 2012. In each of the first three quarters of fiscal 2013 and 2012, less than $0.1 million and $0.1 million of compensation expense was recorded related to this award, respectively.

In February 2013, as part of management's annual compensation for fiscal 2013, the Company approved a plan to grant certain members of management restricted shares in the future based on the Company's performance in fiscal 2013. Based on the relevant guidance, the Company determined that the service inception date for these awards was prior to the grant date and therefore began accruing compensation expense in fiscal 2013, based on the Company's assessment as to the probability that the performance criteria would be achieved. As such, there was approximately $1.5 million in unrecognized compensation expense remaining related to these awards as of September 7, 2013. In the first three quarters of fiscal 2013, $0.3 million of compensation expense was recorded related to these awards.
        
The following table summarizes information about restricted stock awards for the period ended September 7, 2013:
Restricted Stock (Nonvested Shares)
 
Number of Shares
 
Weighted Average Grant-Date Fair Value Per Share
Nonvested shares outstanding at December 29, 2012
 
141,269

 
$
17.11

Granted
 
28,666

 
15.26

Vested
 
(69,782
)
 
16.55

Nonvested shares outstanding at September 7, 2013
 
100,153

 
$
16.97


Employee Stock Purchase Plan

As of September 7, 2013, the Company had reserved 45,036 shares of common stock available for purchase under the Employee Stock Purchase Plan of 2008.  In the first three quarters of fiscal 2013, employees purchased 23,521 shares of the Company’s common stock with a weighted average fair market value of $15.06 per share.


(14) EARNINGS PER SHARE

The following table reconciles the number of shares outstanding for the third quarters and first three quarters of fiscal 2013 and 2012, respectively, to the number of weighted average basic shares outstanding and the number of weighted average diluted shares outstanding for the purposes of calculating basic and diluted earnings per share (in thousands, except per share data):
 
Third Quarter Ended,
 
First Three Quarters Ended,
 
September 7, 2013
 
September 8, 2012
 
September 7, 2013
 
September 8, 2012
Net income
$
1,334

 
$
1,034

 
$
1,971

 
$
2,523

Less: Income attributable to noncontrolling interest
26

 

 
72

 

Net income attributable to Heritage-Crystal Clean, Inc. available to common stockholders
$
1,308

 
$
1,034

 
$
1,899

 
$
2,523

 
 
 
 
 
 
 
 
Weighted average basic shares outstanding
18,272

 
18,060

 
18,174

 
16,412

Dilutive shares for share–based compensation plans
313

 
352

 
320

 
371

Weighted average diluted shares outstanding
18,585

 
18,412

 
18,494

 
16,783

 
 
 
 
 
 
 
 
Net income per share: basic
$
0.07

 
$
0.06

 
$
0.10

 
$
0.15

Net income per share: diluted
$
0.07

 
$
0.06

 
$
0.10

 
$
0.15



18



ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Disclosure Regarding Forward-Looking Statements

You should read the following discussion in conjunction with our consolidated financial statements and related notes in our Annual Report on Form 10-K filed with the SEC on February 27, 2013. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from our expectations. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They use words such as "aim," "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "project," "should," "will be," "will continue," "will likely result," "would" and other words and terms of similar meaning in conjunction with a discussion of future or estimated operating or financial performance. You should read statements that contain these words carefully, because they discuss our future expectations, contain projections of our future results of operations or of our financial position or state other “forward-looking” information. Forward-looking statements speak only as of the date of this quarterly report. Factors that could cause such differences include those described in the section titled “Risk Factors” and elsewhere in our Annual Report on Form 10-K for fiscal 2012 filed with the SEC on February 27, 2013. Except as required under federal securities laws and the rules and regulations of the SEC, we do not have any intention, and do not undertake, to update any forward-looking statements to reflect events or circumstances arising after the date of this quarterly report, whether as a result of new information, future events or otherwise. As a result of these risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements included in this quarterly report or that may be made elsewhere from time to time by, or on behalf of, us. All forward-looking statements attributable to us are expressly qualified by these cautionary statements. Certain tabular information may not foot due to rounding. Our fiscal year ends on the Saturday closest to December 31. Interim results are presented for the twelve week periods and thirty-six week periods ended September 7, 2013 and September 8, 2012, each referred to as "quarter ended" or "third quarter ended" or "third fiscal quarter" and "first three quarters" respectively.

Overview

We provide parts cleaning, containerized waste management, used oil collection, vacuum truck services, antifreeze recycling, and we own and operate a used oil re-refinery. We are the second largest provider of industrial and hazardous waste services to small and mid-sized customers in both the vehicle maintenance and manufacturing services sector in North America, and we have the second largest used oil re-refining capacity in North America.  Our services help our customers manage their used chemicals and liquid and solid wastes, while also helping to minimize their regulatory burdens.  We operate from a network of 74 branch facilities providing services to customers in 42 states. We conduct business through two principal operating segments: Environmental Services and Oil Business.

Our Environmental Services segment revenues are generated primarily from providing parts cleaning services, containerized waste management, vacuum truck services, and antifreeze recycling. Revenues from this segment accounted for approximately 56.1% of our total company revenues for the first three quarters of fiscal 2013. In the Environmental Services segment, we define and measure same-branch revenues for a given period as the subset of all our branches that have been open and operating throughout and between the periods being compared, and we refer to these as established branches. We calculate average revenues per working day by dividing our revenues by the number of non-holiday weekdays in the applicable fiscal year or fiscal quarter.

Our Oil Business segment consists of our used oil collection and used oil re-refining activities, which accounted for 43.9% of our total company revenues in the first three quarters of fiscal 2013.

Our operating costs include the costs of the materials we use in our services, such as solvents and other chemicals, transportation of solvents and waste, and our payments to other parties to recycle or dispose of the waste materials that we collect. The used solvent that we retrieve from customers in our product reuse program is accounted for as a reduction in our net cost of solvent under operating costs, whether placed in inventory or sold to a purchaser for reuse. Increased costs of crude oil, a component of solvent, can increase operating costs, although we attempt to offset such increases with increased prices for our services. Operating costs also include the costs of operating our branch system and hubs, including personnel costs (including commissions), facility rent, truck leases, fuel, and maintenance. Our operating costs as a percentage of sales generally increase in relation to the number of new branch openings. As new branches achieve route density and scale efficiencies, our operating costs as a percentage of sales generally decrease.


19



We use profit before corporate selling, general and administrative expenses ("SG&A") as a key measure of segment profitability. We define profit before SG&A as revenues less operating costs and depreciation and amortization from operations.

We operate a used oil re-refinery located in Indianapolis, Indiana, through which we recycle used oil into high quality lubricant base oil and byproducts. We supply the base oil to firms that produce and market finished lubricants. Our used oil re-refinery had an original input capacity of approximately 50 million gallons of used oil feedstock per year with an expected production of about 30 million gallons of base oil per year when operating at full capacity. We are in the process of expanding the annual input capacity of the Indianapolis re-refinery to 75 million gallons, which we believe will allow us to improve our utilization of resources and the operating results of our Oil Business segment. We expect the additional capacity to be added incrementally over the remainder of 2013 and the first half of 2014 with the entire amount of additional capacity in place by mid-2014. During the third quarter, we were able to achieve some of the additional capacity referenced above. This allowed us to produce base oil at a rate above the original capacity during the third quarter. We estimate the capital cost of the expansion project will be approximately $20 to $25 million through fiscal 2014. We anticipate that we will use existing cash and cash equivalents to fund the expenditures for the re-refinery expansion project.

In the first quarter of fiscal 2013, through a new Delaware subsidiary, Mirachem, LLC, we purchased substantially all of the operating assets of Mirachem Corporation. Since 2004, Mirachem Corporation had provided us with cleaning chemistry used in our aqueous parts cleaning service. We made an initial payment of approximately $2.5 million in cash at the time of closing and provided a note payable for an additional $0.8 million over two years.

In a separate transaction, we acquired from a third party additional aqueous technologies in exchange for a 20% interest in Mirachem, LLC. We have an option to repurchase this 20% interest, and the holder of this 20% interest has a right to sell the interest back to us after January 1, 2016, at a price based on the trailing EBITDA of Mirachem, LLC, subject to potential modifications.

We completed these transactions in order to secure the supply of our aqueous parts cleaning chemistry which, together with our patented aqueous parts cleaning equipment, should provide us with a strong platform from which to compete in the aqueous parts cleaning market. We have consolidated Mirachem, LLC into our financial statements as part of the Environmental Services segment.

On June 26, 2013, we purchased substantially all of the operating assets of Recycling Fluid Technologies, Inc. (RFTI), which was based in Battle Creek, Michigan. RFTI's business consisted of collecting waste antifreeze, recycling the waste antifreeze, and through the recycling process producing a line of high quality antifreeze products which were sold for use in vehicle engine applications. We purchased RFTI for $4.9 million in cash and $1.2 million of our common stock, or 82,000 shares.

On July 19, 2013, we purchased substantially all of the operating assets of Recycle Technologies, Inc. (RTI), which was based in Wood Dale, Illinois. RTI's business and operations were very similar to the business and operations of the former RFTI, which is described above. We purchased RTI for $2.9 million in cash at the time of closing, $0.4 million in the form of a note payable, and $1.0 million of our common stock or 69,322 shares.

The acquisitions of RFTI and RTI provided us with a presence in the antifreeze recycling market. The financial results of our antifreeze business are included in the Environmental Services segment.

Critical Accounting Policies

Critical accounting policies are those that are both important to the accurate portrayal of a company’s financial condition and results and require subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

In order to prepare financial statements that conform to accounting principles generally accepted in the United States, commonly referred to as GAAP, we make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes.  Certain estimates are particularly sensitive due to their significance to the financial statements and the possibility that future events may be significantly different from our expectations.

We have identified the following accounting policies as those that require us to make the most subjective or complex judgments in order to fairly present our consolidated financial position and results of operations. Actual results in these areas could differ materially from management's estimates under different assumptions and conditions.

20




Acquisitions

We account for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, and contingent consideration be recorded at the date of acquisition at their respective fair values. It further requires acquisition-related costs to be recognized separately from the acquisition and expensed as incurred and restructuring costs to be expensed in periods subsequent to the acquisition date.

Identifiable Intangible Assets

The fair value of finite lived intangible assets may be based on significant judgments made by management. We sometimes engage third party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies and also include, but are not limited to, future expected cash flows to be earned from the continued operation of the acquired business and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates, or actual results. These intangible assets are amortized on a straight-line basis over their estimated economic lives.

Goodwill

Goodwill is measured as a residual amount as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. We test goodwill for impairment annually and in interim periods if changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. Our determination of fair value requires certain assumptions and estimates regarding future profitability and cash flows of acquired businesses and market conditions. In fiscal 2012, we tested goodwill for impairment. Our tests indicated that the fair values were substantially in excess of carrying values and thus did not fail step one of the goodwill impairment test. However, due to the inherent uncertainties associated with using these assumptions, impairment charges could occur in future periods.



21



RESULTS OF OPERATIONS

General

The following table sets forth certain operating data as a percentage of revenues for the periods indicated (dollars in thousands):
 
For the Third Quarter Ended,
 
For the First Three Quarters Ended,
 
September 7,
2013
 
September 8,
2012
 
September 7,
2013
 
September 8,
2012
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
 
 
   Product revenues
$
32,302

47.8
%
 
$
31,348

50.5
%
 
$
87,766

45.9
%
 
$
84,505

48.3
 %
   Service revenues
35,301

52.2
%
 
30,718

49.5
%
 
103,394

54.1
%
 
90,341

51.7
 %
Total Revenues
$
67,603

100.0
%
 
$
62,066

100.0
%
 
$
191,160

100.0
%
 
$
174,846

100.0
 %
Operating expenses -
 
 
 
 
 
 
 
 
 
 
 
   Operating costs
$
55,698

82.4
%
 
$
52,718

84.9
%
 
$
160,185

83.8
%
 
$
146,963

84.1
 %
   Selling, general and administrative expenses
7,051

10.4
%
 
5,575

9.0
%
 
20,691

10.8
%
 
17,569

10.0
 %
   Depreciation and amortization
2,224

3.3
%
 
1,904

3.1
%
 
6,246

3.3
%
 
5,587

3.2
 %
   Other expense (income) - net
138

0.2
%
 

%
 
231

0.1
%
 
(3
)
 %
Operating income
2,492

3.7
%
 
1,869

3.0
%
 
3,807

2.0
%
 
4,730

2.7
 %
   Interest expense – net
97

0.1
%
 
112

0.2
%
 
310

0.2
%
 
445

0.3
 %
Income before income taxes
2,395

3.5
%
 
1,757

2.8
%
 
3,497

1.8
%
 
4,285

2.5
 %
Provision for income taxes
1,061

1.6
%
 
723

1.2
%
 
1,526

0.8
%
 
1,762

1.0
 %
Net income
1,334

2.0
%
 
1,034

1.7
%
 
1,971

1.0
%
 
2,523

1.4
 %
Income attributable to noncontrolling interest
26

%
 

%
 
72

%
 

 %
Net income attributable to Heritage-Crystal Clean, Inc. common stockholders
$
1,308

1.9
%
 
$
1,034

1.7
%
 
$
1,899

1.0
%
 
$
2,523

1.4
 %

Revenues

For the third quarter of fiscal 2013, revenues increased $5.5 million, or 8.9%, from $62.1 million in the third quarter of fiscal 2012 to $67.6 million in the third quarter of fiscal 2013. For the first three quarters of fiscal 2013, revenues increased $16.3 million, or 9.3%, to $191.2 million from $174.8 million in the first three quarters of fiscal 2012. Revenues in the Environmental Services segment increased through increased volume and improved pricing. In addition, Oil Business revenues increased as a result of the increase in volume of base oil and re-refinery byproducts sold in the first three quarters of 2013, compared to the first three quarters of fiscal 2012, when we began initial sales of base oil and the re-refinery was in the start-up phase. Overall for the first three quarters of 2013, the increase in base oil sales volume was offset by lower base oil prices compared to the first three quarters of 2012. The average spot market price for the Group II base oil product we produce declined approximately 16% from the third quarter of fiscal 2012 to the third quarter of fiscal 2013.

Operating expenses

Operating costs

Operating costs increased $3.0 million, or 5.7%, from the third quarter of fiscal 2012 to the third quarter of fiscal 2013. Operating costs decreased as a percentage of revenues compared to the prior year as a result of our ability to leverage fixed costs as we grew our business. Operating costs increased $13.2 million, or 9.0%, from the first three quarters of fiscal 2012 to the first three quarters of fiscal 2013. In the first three quarters of fiscal 2013, the increase in operating costs was primarily a result of increased production volumes in the Oil Business compared to the first three quarters of fiscal 2012.

The sale of used solvent generated by customers participating in our product reuse program for parts cleaning is not accounted for as revenues, but rather as a reduction in our net cost of solvent under operating costs. Sales of reuse solvent had

22



a negative impact during the third quarter of fiscal 2013 of less than $0.1 million compared to a negative impact of $0.2 million in the third quarter of fiscal 2012. Reuse solvent sales provided a benefit during the first three quarters of fiscal 2013 of $0.3 million compared to a negative impact of less than $0.1 million in the first three quarters of fiscal 2012.
 
Selling, general, and administrative expenses

Selling, general, and administrative expenses increased $1.5 million, or 26.5%, from the third quarter of fiscal 2012 to the third quarter of fiscal 2013. The increase is due to higher expenses for incentive compensation and new headcount, selling, and administrative costs incurred by the businesses acquired in fiscal 2013, and by higher acquisition-related expenses.

Selling, general, and administrative expenses increased $3.1 million, or 17.8%, from the first three quarters of fiscal 2012 to the first three quarters of fiscal 2013. Overall, selling, general and administrative expenses as a percentage of revenues increased to 10.8% in the first three quarters of fiscal 2013 from 10.0% in the first three quarters of fiscal 2012. The increase in selling, general, and administrative expenses as a percentage of revenues is primarily due to higher personnel costs and acquisition-related expenses.

Interest expense

Interest expense for the third quarter of fiscal 2013 was $0.1 million, compared to interest expense of $0.1 million in the third quarter of fiscal 2012. Interest expense for the first three quarters of fiscal 2013 was $0.3 million, compared $0.4 million in the first three quarters of fiscal 2012. The decrease in interest expense in the first three quarters of fiscal 2013 was a result of higher average debt outstanding in the first three quarters of fiscal 2012 from our bank revolver, compared to the first three quarters of fiscal 2013 when our only bank debt outstanding was the Term A loan. In each of the first three quarters of fiscal 2013 and 2012, we capitalized less than $0.1 million in interest.

Provision for income taxes

Our effective tax rate for the first three quarters of fiscal 2013 was 43.6% compared to 41.1% in first three quarters of fiscal 2012. The rate increase is attributed to a higher projected state income tax rate, as well as permanent book to tax differences having a greater effect on the rate in fiscal 2013 than in the same period in fiscal 2012.

Segment Information

The following table presents sales by operating segment (dollars in thousands):
 
 
 
For the Third Quarter Ended,
 
Increase
 
 
 
 
 
 
 
 
 
 
 
 
 
September 7, 2013
 
September 8, 2012
 
$
 
%
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
Environmental Services
$
36,674

 
$
32,139

 
$
4,535

 
14.1
%
 
Oil Business
30,929

 
29,927

 
1,002

 
3.3
%
 
 
Total
$
67,603

 
$
62,066

 
$
5,537

 
8.9
%
 
 
 
For the First Three Quarters Ended,
 
Increase
 
 
 
 
 
 
 
 
 
 
 
 
 
September 7, 2013
 
September 8, 2012
 
$
 
%
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
Environmental Services
$
107,298

 
$
94,699

 
$
12,599

 
13.3
%
 
Oil Business
83,862

 
80,147

 
3,715

 
4.6
%
 
 
Total
$
191,160

 
$
174,846

 
$
16,314

 
9.3
%

In the third quarter of fiscal 2013, Environmental Services revenues increased $4.5 million, or 14.1%, from $32.1 million in the third quarter of fiscal 2012 to $36.7 million in the third quarter of fiscal 2013. In the first three quarters of fiscal 2013, Environmental Services revenues increased $12.6 million, or 13.3%, compared to the first three quarters of fiscal 2012. Revenues grew in all Environmental Services product lines which included parts cleaning, containerized waste, vacuum truck services, and antifreeze recycling. We continued to add customers through the expansion of our branch network and increased penetration of markets at our existing branches. In addition we realized revenue growth from a combination of higher pricing and volume. We also experienced increased revenues from our acquisitions of $1.9 million for the first three quarters of 2013.

23




At the end of the third quarter of fiscal 2013, the Environmental Services segment was operating in 74 branch locations compared with 71 at the end of the third quarter of fiscal 2012.  There were 70 branches that were in operation during both the third quarters of fiscal 2013 and fiscal 2012. Same branch sales increased $3.1 million, or 9.7%, in the third quarter of fiscal 2013 compared to the third quarter of fiscal 2012 for these branches. Excluding the three branches in this group that gave up customers to new branch openings, the remaining 67 branches experienced an increase of $3.0 million, or 9.9% from the third quarter of fiscal 2012 to the third quarter of fiscal 2013. On a year-to-date basis, same branch sales increased $9.8 million, or 10.4%, for the 70 branches that were in operation during both years. Excluding the three branches in this group that gave up customers to new branch openings, the remaining 67 branches experienced an increase of $9.7 million, or 10.9%, for the first three quarters of fiscal 2013.

In the third quarter of fiscal 2013, Oil Business revenues increased $1.0 million compared to the third quarter of fiscal 2012 due to increased volumes at the used oil re-refinery. During the third quarter of fiscal 2013, we fed approximately 12.2 million gallons of used oil into the re-refinery and sold approximately 7.2 million gallons of base oil. The increase in volume allowed us to overcome lower base oil selling prices, compared to the third quarter of fiscal 2012. The average spot market price for the Group II base oil product we produce declined approximately 16% from the third quarter of fiscal 2012 to the third quarter of fiscal 2013. In the first three quarters of fiscal 2013, Oil Business revenues increased $3.7 million, or 4.6%, as the used oil re-refinery was running at a higher capacity throughout the first three quarters of fiscal 2013 compared to the first three quarters of fiscal 2012. During the first three quarters of fiscal 2013, we fed approximately 33.5 million gallons of used oil into the re-refinery and sold approximately 20.2 million gallons of base oil.

Segment Profit (Loss) Before Corporate Selling, General and Administrative Expenses ("SG&A")

The following table presents profit (loss) by operating segment before corporate SG&A (dollars in thousands):
 
 
 
For the Third Quarter Ended,
 
Increase (Decrease)
 
 
 
 
 
 
 
 
 
 
 
 
 
September 7, 2013
 
September 8, 2012
 
$
 
%
 
 
 
 
 
 
Profit before corporate SG&A*
 
 
 
 
 
 
 
 
Environmental Services
$
8,724

 
$
6,070

 
$
2,654

 
43.7
 %
 
Oil Business
1,231

 
1,529

 
(298
)
 
(19.5
)%
 
 
Total
$
9,955

 
$
7,599

 
$
2,356

 
31.0
 %
 
 
 
For the First Three Quarters Ended,
 
Increase (Decrease)
 
 
 
 
 
 
 
 
 
 
 
 
 
September 7, 2013
 
September 8, 2012
 
$
 
%
 
 
 
 
 
 
Profit (loss) before corporate SG&A*
 
 
 
 
 
 
 
 
Environmental Services
$
26,849

 
$
18,451

 
$
8,398

 
45.5
 %
 
Oil Business
(1,422
)
 
4,281

 
(5,703
)
 
(133.2
)%
 
 
Total
$
25,427

 
$
22,732

 
$
2,695

 
11.9
 %

*Includes depreciation and amortization related to operating activity but not depreciation and amortization related to corporate
selling, general, and administrative activity. For further discussion see Note 10 in our consolidated financial statements included elsewhere in this document.

Environmental Services profit before SG&A increased 43.7% in the third quarter of fiscal 2013, as compared to the third quarter of fiscal 2012 in part due to increased revenues of 14.1%. For the first three quarters of fiscal 2013, Environmental Services profit before SG&A increased 45.5% on increased revenues of 13.3%. Revenues grew as a result of increased pricing and volume. During the first three quarters of fiscal 2013, we also improved our leveraging of fixed costs, which resulted in increased margin. During the first three quarters of fiscal 2012, we added various sales and service resources which have grown in productivity and contributed to segment sales growth and profitability. In addition, in the first three quarters of fiscal 2013, our new Mirachem subsidiary contributed $1.1 million to our profit before corporate SG&A in this segment.

Oil Business profit before corporate SG&A decreased $0.3 million in the third quarter of fiscal 2013, from $1.5 million in the third quarter of fiscal 2012, to $1.2 million in the third quarter of fiscal 2013. In the first three quarters of fiscal 2013, Oil Business profit before corporate SG&A decreased $5.7 million to a loss before corporate SG&A of $1.4 million. The decline in profitability in the Oil Business compared to the first three quarters of fiscal 2012 was primarily the result of the decreased average selling price of base oil, which was experienced across the industry, continuing a trend that began in the second half of fiscal 2012. The improvement from a loss before corporate SG&A in the first half of fiscal 2013 to a profit before corporate

24



SG&A of $1.2 million in the third quarter of fiscal 2013 was due to improved efficiency resulting from increased throughput capacity at our re-refinery. This higher throughput capacity allowed us to take advantage of leveraging fixed costs in this segment.

FINANCIAL CONDITION
 
Liquidity and Capital Resources

Cash and Cash Equivalents

As of September 7, 2013 and December 29, 2012, cash and cash equivalents were $30.9 million and $47.8 million, respectively.  Our primary sources of liquidity are cash flows from operations and funds available to borrow under our term loan and revolving bank credit facility.

Debt and Financing Arrangements    

On February 5, 2013, we entered into an Amended and Restated Credit Agreement ("Credit Agreement") that allows for up to $40.0 million in borrowings. As of both September 7, 2013 and December 29, 2012, our total borrowings were $19.5 million, under the term loan which has a maturity date of February 5, 2018. The remaining portion of the credit facility is a revolving loan which expires on February 5, 2018. There were no amounts outstanding under the revolver at September 7, 2013 and December 29, 2012.

During the third quarter and first three quarters of fiscal 2013, we recorded interest of $0.1 million and $0.3 million on the term loan, respectively. We capitalized less than $0.1 million for various capital projects during the first three quarters of fiscal 2013. During the first three quarters of fiscal 2012, we recorded interest of $0.4 million on both the term loan and revolving credit facility, of which less than $0.1 million was capitalized for various capital projects.

Our weighted average interest rate as of September 7, 2013 and September 8, 2012 was 2.5% and 2.8%, respectively. Our effective interest rate as of September 7, 2013 and September 8, 2012 was 2.6% and 2.9%, respectively.

As of September 7, 2013 and