As filed with the Securities and Exchange Commission on June 1, 2010

Registration No. 333-166925

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Heritage-Crystal Clean, Inc.

 

 

 

 

2175 Point Boulevard,

Suite 375

Elgin, Illinois 60123

(847) 836-5670

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

 

Joseph Chalhoub

President and Chief Executive Officer

Heritage-Crystal Clean, Inc.

2175 Point Boulevard, Suite 375

Elgin, Illinois 60123

(847) 836-5670

(Name, address, including zip code, and telephone number,

including area code, of agent for service)

 

 

Copies to:

 

 

 

 

Approximate date of commencement of proposed sale to the public:  As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

SUBJECT TO COMPLETION, DATED JUNE 1, 2010

 

2,750,000 Shares

 

Heritage-Crystal Clean, Inc.

 

Common Stock

 

 

We are selling 2,750,000 shares of our common stock, par value $0.01 per share. Our common stock is traded on The NASDAQ Global Market under symbol “HCCI.” On May 27, 2010, the last reported sale price of our common stock on The NASDAQ Global Market was $8.35 per share.

 

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 9 to read about factors you should consider before buying our common stock.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

We have granted the underwriters an option for a period of 30 days to purchase up to 412,500 additional shares of our common stock on the same terms and conditions set forth above. See the section of this prospectus entitled “Underwriting.”

 

The underwriters expect to deliver the shares to purchasers on or about          , 2010.

 

William Blair & Company

 

 

 

The date of this prospectus is          , 2010

 

Table of Contents

 

 

You should rely only on the information contained or incorporated by reference in this prospectus or to which we have referred you. We have not authorized anyone to provide you with information that is different. Offers to sell, and solicitations of offers to buy, shares of our common stock are being made only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus and the information in the documents incorporated or deemed to be incorporated by reference in this prospectus is accurate only as of the respective dates those documents were filed with the Securities & Exchange Commission, regardless of the time of delivery of this prospectus or any sale of our common stock.

 

This prospectus contains forward-looking statements that are based upon current management expectations. All statements other than statements of historical facts included in this prospectus, including statements regarding our future financial position, economic performance and results of operations, as well as our business strategy, budgets, and projected costs and plans and objectives of management are forward-looking statements. Generally, the words “aim,” “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “should,” “will be,” “will continue,” “will likely result,” “would” and similar expressions identify forward-looking statements. These forward-looking statements are based on current expectations, estimates and projections, many of which are by their nature inherently uncertain and beyond our control and involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements or industry results to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. These risks, uncertainties and other important factors are further described in “Risk Factors” and include, among others:

 

 

Because forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. You are cautioned not to place undue reliance on such statements, which speak only as of the date of this prospectus. Actual results of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict.

We urge investors to review carefully the section of this prospectus entitled “Risk Factors” in evaluating the forward-looking statements contained in this prospectus. The information in this release should be read in light of such risks and in conjunction with the consolidated financial statements and the notes thereto which are incorporated by reference. Unless required by law, we do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date of this prospectus, to reflect the occurrence of unanticipated events or for any other reason.

 

You should rely only on the information contained in this prospectus and information incorporated by reference not included within. We have not, and the underwriters have not, authorized any person to provide you with different or inconsistent information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date of this prospectus, unless the information specifically indicates that another date applies. Our business, financial condition, results of operations and prospects may have changed since such dates.

 

Market data and certain industry forecasts used herein were obtained from internal surveys, market research, publicly available information and industry publications. While we believe that market research, publicly available information and industry publications we use are reliable, we have not independently verified market and industry data from third-party sources. Moreover, while we believe our internal surveys are reliable, they have not been verified by any independent source.

 

Unless otherwise indicated or unless the context requires otherwise, all references in this prospectus to “Heritage-Crystal Clean,” the “Company,” “we,” “us,” “our,” or similar references, mean Heritage-Crystal Clean, Inc. and its consolidated subsidiary, Heritage-Crystal Clean, LLC.

 

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission, or the SEC. You may read and copy any document we file at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The internet address of the SEC’s website is www.sec.gov. Such reports and other information concerning Heritage-Crystal Clean can also be inspected at the offices of Heritage-Crystal Clean at 2175 Point Boulevard, Suite 375, Elgin, Illinois 60123 and can also be retrieved by accessing our website at www.crystal-clean.com. Information on our website is not part of this prospectus.

 

This prospectus, which is a part of a registration statement on Form S-1 that we have filed with the SEC under the Securities Act of 1933, as amended, or the Securities Act, omits certain information set forth in the registration statement. Accordingly, for further information, you should refer to the registration statement and its exhibits on file with the SEC. Furthermore, statements contained in this prospectus concerning any document filed as an exhibit are not necessarily complete and, in each instance, we refer you to the copy of such document filed as an exhibit to the registration statement.

 

The SEC allows us to incorporate by reference information we file with it, which means that we can disclose important information to you by referring you to other documents. The information incorporated by reference is considered to be part of this prospectus. We incorporate by reference the documents listed below, except to the extent that any information contained in such filings is deemed “furnished” in accordance with SEC rules:

 

 

 

We also intend to provide our stockholders with annual reports containing financial statements audited by our independent auditors.

 

We will provide each person to whom this prospectus is delivered a copy of any or all of the information that has been incorporated by reference in this prospectus but not delivered with this prospectus, upon written or oral request at no cost, by writing or telephoning us at the address set forth below.

 

Heritage-Crystal Clean, Inc.

Attention: Corporate Secretary

2175 Point Boulevard, Suite 375

Elgin, Illinois 60123

(847) 836-5670

 

PROSPECTUS SUMMARY

	•	Non-hazardous Program for Parts Cleaning. In our non-hazardous program for parts cleaning, we provide our customers with an alternative solvent that is not included in the EPA’s definition of hazardous waste due to its increased flashpoint, and we educate each participating customer to prevent harmful contaminants from being added to the solvent during use. Because of the reduced solvent flammability, as long as the customer doesn’t add toxic or flammable contaminants during use, neither the clean solvent that we supply nor the resulting used solvent generated by customers participating in our non-hazardous program for parts cleaning is classified as hazardous waste by the EPA and as a result can be managed as non-hazardous waste. After we collect the used solvent from customers participating in our non-hazardous program for parts cleaning, we recycle it via distillation for re-delivery to our parts cleaning customers, while at the same time minimizing the burdensome hazardous waste regulations faced by our customers. In order to most efficiently operate our non-hazardous program for parts cleaning, we have built a solvent recycling system at our Indianapolis hub capable of recycling up to 6 million gallons per year of used solvent generated by customers participating in our non-hazardous program.
	•	Product Reuse Program for Parts Cleaning. Rather than managing used solvent as a waste, we have developed a program that uses the solvent as an ingredient in the manufacture of asphalt roofing materials. Used solvent generated by customers participating in our product reuse program for parts cleaning is sold as a direct substitute for virgin solvent that is otherwise used in the asphalt manufacturing process. Because the used solvent is destined for reuse, it is not deemed a waste, and therefore it is not subject to hazardous waste regulations. To enhance the marketing of these programs, in the past 20 years we and our predecessor Heritage Environmental Services have voluntarily obtained concurrence letters from more than 30 state environmental agencies to validate this approach.

	•	We expect that the used oil we will collect from our customers will supply a significant portion of the used oil to be processed at the re-refinery because this service is needed by almost all of our current and target customers. Our network of 62 branches provides us with an opportunity to efficiently collect used oil from a broad geographic area for re-refining.
	•	We believe that a strong demand for re-refining capabilities exists since we estimate that only 20% of the one billion gallons of used oil collected in North America is routed to re-refining due to a lack of used oil re-refining capacity.
	•	Re-refining is a preferred approach to used oil management based on a variety of environmental considerations, including resource recovery and reuse, energy efficiency and pollution prevention. Re-

		refining of used oil recovers more of the economic value of the resource than alternative methods such as burning for energy recovery.

	•	We have extensive experience with the design, construction and operation of used oil re-refineries as several members of our management were significant contributors to the development of approximately 75% of the used oil re-refining capacity in North America while employed at Safety-Kleen, Inc.

Common stock offered by us in the offering		2,750,000 shares
Common stock to be outstanding after the offering		13,555,186 shares(1)

Use of proceeds		We estimate that our net proceeds from the offering will be approximately $21.0 million, based on an assumed public offering price per share of $8.35 (the last reported sale price of our common stock on The NASDAQ Global Market on May 27, 2010). We currently intend to use the net proceeds from the offering to fund a portion of the construction costs for our used oil re-refinery facility in Indiana. See “Use of Proceeds.”

Nasdaq Global Market symbol		“HCCI”

(1)		The number of shares of common stock to be outstanding after the offering is based on 10,805,186 shares outstanding as of May 27, 2010 and:

	•	excludes 889,654 shares of common stock issuable upon the exercise of outstanding options at a weighted average strike price of $10.76; and
	•	excludes 971,197 and 66,430 additional shares of common stock that are reserved for future grants, awards or sale under our 2008 Omnibus Stock Incentive Plan and our Employee Stock Purchase Plan of 2008, respectively.

														First Quarter Ended
		Fiscal Year												March 28,				March 27,
		2007				2008				2009				2009				2010
														(Unaudited)
		(Dollars in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Sales		$	89,734			$	108,143			$	98,398			$	23,756			$	24,005
Cost of sales			22,920				29,430				26,040				7,497				6,006
Cost of sales — inventory impairment			2,182	(1)			2,778	(2)			—				—				—
Gross profit			64,632				75,935				72,358				16,259				17,999
Operating costs			43,573				53,497				51,940				12,239				12,495
Selling, general, and administrative expenses			15,583				20,220				17,137				3,852				4,364
Proceeds from contract termination(1)			(3,000	)			—				—				—				—
Operating income			8,476				2,218				3,281				168				1,140
Interest expense			1,408				408				3				—				—
Loss on disposal of fixed assets — net			—				—				159				—				—
Income before income taxes			7,068				1,810				3,119				168				1,140
Provision for income taxes(3)			—				2,618				1,326				68				478
Net income (loss)			7,068				(808	)			1,793				100				662
Preferred return			1,691				339				—				—				—
Net income (loss) available to common stockholders		$	5,377			$	(1,147	)		$	1,793			$	100			$	662
Net income (loss) per share available to common stockholders:
Basic		$	0.75			$	(0.11	)		$	0.17			$	0.01			$	0.06
Diluted		$	0.74			$	(0.11	)		$	0.17			$	0.01			$	0.06
Weighted average shares outstanding (thousands):
Basic			7,178	(4)			9,985				10,700				10,685				10,713
Diluted			7,229	(4)			9,985				10,772				10,754				10,793

														First Quarter Ended
		Fiscal Year												March 28,				March 27,
		2007				2008				2009				2009				2010
														(Unaudited)
		(Dollars in thousands, except per share data)
PRO FORMA DATA (UNAUDITED):
Net income (loss)		$	7,068			$	(808	)		$	1,793			$	100			$	662
Pro forma provision for income taxes(3)			2,898				497				—				—				—
Return on preferred and mandatorily redeemable capital units			1,730				372				—				—				—
Pro forma net income (loss) available to common stockholders		$	2,440			$	(1,677	)		$	1,793			$	100			$	662
Pro forma net income (loss) per common share:
Basic		$	0.34			$	(0.17	)		$	0.17			$	0.01			$	0.06
Diluted		$	0.34			$	(0.17	)		$	0.17			$	0.01			$	0.06
OTHER OPERATING DATA (UNAUDITED):
EBITDA(5)		$	11,350			$	5,848			$	7,430			$	1,045			$	2,169
Average sales per working day		$	356			$	422			$	388			$	395			$	399
Number of branches at end of fiscal period			48				54				58				58				62

		As of March 27, 2010
		Actual				As Adjusted(6)
		(Unaudited)
		(Dollars in thousands)
BALANCE SHEET DATA:
Cash and cash equivalents		$	1,403			$	22,403
Total assets			55,655				76,655
Total debt			—				—
Total stockholders’ equity			44,731				65,731

(1)		In fiscal 2007, we received $3.0 million from the termination of a contract with a customer of our used solvent who had failed to meet its volume purchase obligations. We recorded cost of sales of $2.2 million to reduce solvent inventories to net realizable value in connection with this settlement.
(2)		In fiscal 2008, we recorded an impairment charge, reducing the reuse solvent and used oil inventory value by $2.8 million. This charge was due to a sharp decline in crude oil prices which resulted in the market value for our reuse solvent declining below the historic (FIFO) values.
(3)		On March 12, 2008, the date of our initial public offering, we reorganized our corporate legal structure from a limited liability company to a corporation. As a limited liability company, we were not subject to Federal or state corporate income taxes. Therefore, net income did not give effect to taxes for periods prior to the reorganization and initial public offering. For comparison purposes, we have presented pro forma net income, which reflects income taxes assuming we had been a corporation since the time of our formation and assuming tax rates equal to the rates that would have been in effect had we been required to report tax expense in such years.
(4)		The weighted average common shares outstanding reflects the 500-for-1 exchange of common units for common stock and the issuance of 1,217,390 shares of common stock in our reorganization that occurred prior to our initial public offering in March 2008. We have included the redeemable common capital units outstanding prior to the reorganization in the calculation of basic and diluted earnings per share as the effect of excluding them would have been anti-dilutive. In accordance with FASB guidance, shares of common stock that are mandatorily redeemable are excluded from the calculation of basic and diluted earnings per share. We have deducted earnings attributable to mandatorily redeemable units from income available to common unit holders.

(5)		EBITDA represents net income before income tax expense, interest income, interest expense, depreciation and amortization. We have presented EBITDA because we consider it an important supplemental measure of our performance and believe it is frequently used by analysts, investors, our lenders and other interested parties in the evaluation of companies in our industry. Management uses EBITDA as a measurement tool for evaluating our actual operating performance compared to budget and prior periods. Other companies in our industry may calculate EBITDA differently than we do. EBITDA is not a measure of performance under GAAP and should not be considered as a substitute for net income prepared in accordance with GAAP. EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

	•	EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;
	•	EBITDA does not reflect interest expense or the cash requirements necessary to service interest or principal payments on our debt;
	•	EBITDA does not reflect tax expense or the cash requirements necessary to pay for tax obligations; and
	•	Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements.

														First Quarter Ended
		Fiscal Year												March 28,				March 27,
		2007				2008				2009				2009				2010
		(Dollars in thousands)
Net income (loss)(a)		$	7,068			$	(808	)		$	1,793			$	100			$	662
Interest expense			1,408				408				3				—				—
Provision for income taxes			—				2,618				1,326				68				478
Depreciation and amortization			2,874				3,630				4,308				877				1,029
EBITDA		$	11,350			$	5,848			$	7,430			$	1,045			$	2,169

(a)		On March 12, 2008, the date of our initial public offering, we reorganized our corporate legal structure from a limited liability company to a corporation. As a limited liability company, we were not subject to Federal or state corporate income taxes. Therefore, net income does not give effect to taxes for periods prior to the reorganization and initial public offering.

(6)		The summary balance sheet data as of March 27, 2010 is presented on an as adjusted basis to give effect to the receipt by us of net proceeds from the sale of common stock offered by us in the public offering but before the application of the net proceeds, based on an assumed public offering price per share of $8.35 (the last reported sale price of our common stock on The NASDAQ Global Market on May 27, 2010).

 

Investing in our common stock involves a high degree of risk. You should carefully consider the following factors, as well as other information contained or incorporated by reference in this prospectus, before deciding to invest in shares of our common stock. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment in our common stock.

 

Risks Relating to Our Business

 

Our results of operations and financial condition have been and could in the future be materially adversely impacted by the economic downturn.

 

The economy has experienced a severe and prolonged downturn as a result of the deterioration in the capital markets and related financial crisis which has adversely impacted our customer base, which is primarily composed of companies in the automotive repair and manufacturing industries. The overall levels of demand for our parts cleaning products and supplies and other services are influenced by fluctuations in levels of end-user demand, which depend in large part on general macroeconomic conditions in the U.S. and the regional economic conditions affecting our branches. Many of our customers are heavily dependent on general economic conditions, including the availability of affordable energy sources, employment levels, interest rates, financial credit availability, consumer confidence and housing demand. Downturns in these general economic conditions can significantly affect the business of our customers, which in turn affects demand, volumes, pricing and operating margins for our services and products. Both our customers and suppliers have felt the impact of the economic downturn. During the recent economic downturn, our customers sought ways to reduce their costs which in turn have reduced their demand for our services. Our customers and suppliers may face severe financial difficulties causing them to cease some or all their business operations or to reduce the volume of products they purchase from us in the future. We may have accounts receivables owing from customers who may not be able to honor their obligations to us. Failure to collect a significant portion of amounts due on those receivables could have a material adverse effect on our results of operations and financial condition.

 

Adverse economic and financial markets conditions may cause our suppliers to be unable to provide materials and components to us or may cause suppliers to make changes in the credit terms they extend to us, such as shortening the required payment period for our amounts owing them or reducing the maximum amount of trade credit available to us. Such changes could adversely affect our liquidity and could have a material adverse effect on our results of operations and financial condition. If we are unable to successfully anticipate changing economic and financial market conditions, we could be adversely affected.

 

In addition, a substantial or prolonged material adverse impact on our results of operations and financial condition due to the recent economic downturn could affect our ability to satisfy the financial covenants in our bank credit facility, which could result in our having to seek amendments or waivers from our lenders to avoid the termination of commitments and/or the acceleration of the maturity of amounts that may be outstanding under our bank credit facility. The cost of our obtaining an amendment or waiver could be significant, and could substantially increase our cost of borrowing over the remaining term of our bank credit facility. Further, there can be no assurance that we would be able to obtain an amendment or waiver. If our lenders were unwilling to enter into an amendment or provide a waiver, all amounts outstanding under our bank credit facility would become immediately due and payable

 

Our operating margins and profitability may be negatively impacted by the volatility in crude oil, solvent, fuel and energy costs.

 

Our business is dependent on the widespread availability of certain crude oil products such as solvent and fuel for operating our fleet of trucks. Changes and volatility in the price of crude can adversely impact the prices for these products and therefore affect our operating results. The price and supply of fuel and solvent is unpredictable and fluctuates based on events beyond our control, including geopolitical developments, supply and demand for oil and gas, actions by OPEC and other oil and gas producers, war and unrest in oil producing countries, regional production patterns and environmental concerns.

Increased costs of crude can significantly increase our operating costs. Because solvent is a product of crude oil, we are also susceptible to increases in solvent costs when crude oil costs increase. The market price of crude has been volatile and rose substantially from 2004 to 2008 before falling significantly in late 2008. During this period of rising crude costs, we experienced increases in the cost of fuel, solvent and other petroleum-based products. We have in the past been able mitigate the increased fuel and solvent costs through the imposition of price increases and energy surcharges on our invoices to customers. However, because of the competitive nature of the industry, the recent economic downturn and the terms of customer contracts, there can be no assurance that we will be able to pass on future price increases. Due to political instability in oil-producing countries, oil prices could increase significantly in the future. A significant increase in fuel or solvent costs could lower our operating margins and negatively impact our profitability. We currently do not use financial instruments to hedge against fluctuations in oil, solvent or energy prices. If this volatility continues, our operating results could also be volatile and adversely affected.

 

In addition, a significant portion of our inventory consists of new and used solvents. Volatility in the price of crude oil has in the past impacted and can significantly impact in the future the value of this inventory and our operating margins. For example, in the fourth quarter of fiscal 2008, we generally experienced a sharp decrease in the cost of crude oil and related commodities which caused a decline in the market value of our solvent and used oil inventory and we recorded a $2.8 million non-cash inventory impairment charge on that portion of the Company’s solvent and oil inventory that is held for sale, reflecting the lower market value of such inventory. Additionally, we recorded $1.7 million in additional expense to reflect the lower value of the solvent inventory held for use in the Company’s service programs. Further, because we apply a first-in first-out accounting method, volatility in solvent and oil prices can significantly impact our operating margins. If volatility in the price of crude oil continues, our operating results will be difficult to predict and could be adversely affected. Moreover, the impact of crude oil price volatility on our business and financial results will likely increase when we enter the used oil re-refining industry.

 

We may not be able to build and operate a used oil re-refinery as planned and it may cost more than anticipated which could harm our business.

 

We have recently announced plans to build a used oil re-refinery. The development of the re-refinery is in its early stages and we may be unable to construct the re-refinery on the current timetable or as currently contemplated. There can be no assurance that we will develop a commercially successful re-refinery or that unforeseen market conditions will not adversely impact the construction, operation or profitability of the re-refinery. The development of a used oil re-refinery is a new business for our company and requires a different employee base and skill set than that required for our current business. These new skill sets include chemical engineering, design and operational management of the re-refinery. Although our management team has operated re-refineries for other companies, we cannot assure you that we will have sufficient expertise to develop a re-refinery within the budget contemplated or that it will operate within the performance parameters currently contemplated for the re-refinery. Further, the development of the re-refinery will require time and resources, including the attention of our management, which could divert our management from other activities and may impair the operation of our existing business.

 

The development of the re-refinery could take longer than expected, cost more than expected or not perform as anticipated. For example, the use of subcontractors or the costs of materials such as steel to construct the facility may be more expensive than we anticipate leading to project cost overruns. In addition, the construction and operation of a re-refinery is highly regulated. We have not yet obtained all of the required permits to build the re-refinery and the permit process is ongoing. We may be subject to delays or even cancellation of the project if we are unable to obtain permits on terms acceptable to us.

 

We currently expect that the development and construction of the re-refinery will cost approximately $40 million. In addition, during our development of the re-refinery, we expect to expand our used oil collection services in preparation for servicing the re-refinery, and we estimate that during fiscal 2010 and 2011 we will incur roughly $1 million and $1.5 million of net expense, respectively, related to this roll out. We currently expect to use the net proceeds from the offering to pay a portion of the costs needed to develop the re-refinery and expect to obtain the remaining funds needed from borrowings under our credit agreement.

Alternatively, we may consider issuing additional equity as a source of financing. If we are not able to borrow sufficient funds or obtain other sources to complete the re-refinery, we may not be able to complete the re-refinery which could have a material adverse effect on our business. Even if we secure adequate financing, our investments in this project may limit our ability to pursue other opportunities in the future.

 

Even if we are able to build a used oil re-refinery, the used oil re-refinery may not generate the operating results that we anticipate and may lead to greater volatility in our revenue and earnings.

 

We may not be able to realize the expected benefits from developing and operating a used oil re-refinery. If we complete the construction of the re-refinery, the subsequent operation of the plant creates different and additional risks compared to our historic service businesses. We may experience difficulty securing sufficient used oil feedstock to run the re-refinery at anticipated rates and have to pay more for the feedstock or reduce our operating rates. We may also have difficulty selling all of the lubricating base oil that we produce. Our costs for used oil feedstock and the prices that we can sell the lubricating base oil and byproducts made by the re-refinery are determined by competitive market factors including the world price of crude oil, prices for natural gas, and the lubricating oil prices posted by major refiners, none of which we control. In addition, we may experience increased downward pricing pressure when compared to suppliers of virgin lubricating base oil, which has historically sold at a premium to re-refined lubricating base oil. Our estimates of revenue and profitability for the re-refinery could prove to be erroneous or could be impacted by changes in these market factors. In particular, if crude oil prices come down, we expect that we would experience a reduction in our margins from used oil re-refining as well as potential inventory charges related to material held for processing or sale. Even if prices decrease, the costs required to collect and process the used oil may not decrease. If crude oil prices rise, we expect that the feedstock prices for our re-refinery would also increase. If the prices we charge for our re-refined oil and the costs to collect and re-refine used oil do not move together or in similar magnitudes, our profitability may be materially and negatively impacted. Any volatility in the price of crude oil could also cause volatility in our operating results.

 

Our operation of a re-refinery exposes us to risks related to the potential adverse environmental impact of a spill or other release at the re-refinery, the loss of permits, the risk of explosion or fire or other hazards, the risk of injury to our employees or others, as well as the negative publicity due to public concerns regarding our operation. While these risks are in some respects similar to risks that we have experienced in our traditional service businesses, the magnitude of exposure may be greater due to the nature of the used oil re-refining industry and the greater volumes, temperatures and pressures involved. While we may maintain some insurance that covers portions of these exposures, in many cases the risks are uninsurable or we will not choose to procure insurance at levels that will cover any potential exposure.

 

Any problem or perception of a problem with our re-refining project could have a material adverse impact on our revenue and earnings and lead to a loss of stockholder and/or research analyst confidence in our business and could result in a sudden and significant reduction in our stock price.

 

Further consolidation and/or declines in the U.S. automotive repair and U.S. manufacturing industries could cause us to experience lower sales volumes which could materially affect our growth and financial performance.

 

Our business relies on continued demand for our parts cleaning and waste management services in the U.S. automotive repair and U.S. manufacturing industries, which may suffer from declining market size and number of locations, due in part to the current economic downturn, the potential bankruptcies of U.S. automobile manufacturers, international competition and consolidation in U.S. markets. Industry trends affecting our customers, including the continued trend of U.S. manufacturing moving offshore and the influx of inexpensive imported automotive aftermarket products, has caused our customers’ business to contract which could reduce the demand for our parts cleaning and other services and products and have a material adverse impact on our business. As a result, we may not be able to continue to grow our business by increasing penetration into the industries which we serve, and our ability to retain our market share and base of sales could become more difficult.

We conduct business in an industry that is highly regulated by environmental, health and safety, transportation, and employment laws and regulations. If we do not comply with these laws and regulations, we may be subject to involuntary shutdowns and/or significant financial penalties and negative response from our customers.

 

The sale, handling, transportation, storage, recycling and disposal of industrial and hazardous waste, including solvents used in parts cleaners, used oil and containerized waste are highly regulated by various legislative bodies and governmental agencies at the federal, state and local levels, including the EPA, the Department of Transportation, and the Occupational Safety and Health Administration, or OSHA. Any failure by us to maintain or achieve compliance with these laws and regulations or with the permits required for our operations could result in substantial operating costs and capital expenditures for equipment upgrades, fines, penalties, civil or criminal sanctions, third-party claims for property damage or personal injury, cleanup costs and/or involuntary temporary or permanent discontinuance of our operations. There currently exists a high level of public concern over hazardous waste operations, including with respect to the siting and operation of transfer, processing, storage and disposal facilities. Part of our business strategy described above is to increase our re-refining capacity through either the construction of a new facility or the expansion of existing facilities and branch operations in growth markets. Each of these efforts would require us to undergo an intensive regulatory approval process that could be time consuming and impact the success of our business strategy. Zoning, permit and licensing applications and proceedings, as well as regulatory enforcement proceedings, are all matters open to public scrutiny and comment. Accordingly, from time to time we have been, and may in the future be, subject to public opposition and publicity which may damage our reputation and delay or limit the expansion and development of our operating properties or impair our ability to renew existing permits which could prevent us from implementing our growth strategy and have a material adverse effect on our business, financial condition or results of operations.

 

If current environmental laws and regulations are changed, we may be forced to significantly alter our business model, which could have a material adverse effect on our financial performance.

 

A change in any of the environmental, employment, health and safety laws and regulations under which we operate could have a material adverse effect on our business and prospects. For example, the EPA currently excludes waste used as an ingredient in the production of a product from being defined as hazardous waste. Our product reuse program for parts cleaning operates under this exclusion and provides an advantage by excluding our customers’ used solvent from being regulated as hazardous waste. Similarly, under our non-hazardous program for parts cleaning, we provide our customers with a different solvent that has a higher flashpoint than traditional solvents. The resulting used solvent is not considered to be hazardous waste so long as our customers ensure that no inappropriate contaminants were contributed to the used solvent.

 

If the EPA were to broaden the definition of hazardous waste to include used solvents generated by our customers under our product reuse and/or non-hazardous programs for parts cleaning, the value of our offerings may be significantly reduced which could have a material adverse effect on our financial performance. Examples of changes by the EPA that could adversely affect our services include, but are not limited to, the following:

 

 

In addition, new laws and regulations, new interpretations of existing laws and regulations, increased governmental enforcement or other developments could require us to make additional unforeseen expenditures. We are not able to predict the impact of new or changed laws or regulations or changes in the ways that such

laws or regulations are administered, interpreted or enforced. The requirements to be met, as well as the technology and length of time available to meet those requirements, continue to develop and change. To the extent that our costs associated with meeting any of these requirements are substantial and cannot adequately be passed through to our customers, our earnings and cash flows could suffer.

 

We face intense competition in the industrial and hazardous waste services industries.

 

The markets for parts cleaning, containerized waste management, used oil collection, and vacuum truck services are intensely competitive. While numerous small companies provide these services, Safety-Kleen, our largest competitor, has held substantial market share in the parts cleaning industry for the last four decades and has developed a significant market share in used oil services, including used oil re-refining, and containerized waste management. Safety-Kleen and some of our other competitors have substantially greater financial and other resources and greater name recognition than us. Our business growth, financial performance and prospects will be adversely affected if we cannot gain market share from these competitors, or if any of our competitors develop products or services superior to those offered by us. We could lose a significant number of customers if Safety-Kleen, or other competitors, materially lower their prices, improve service quality or develop more competitive product and service offerings.

 

In addition, companies involved in the waste management industry, including waste hauling, separation, recovery and recycling, may have the expertise, access to customers and financial resources that would encourage them to develop and market services and products competitive with those offered by us. We also face competition from alternative services that provide similar benefits to our customers as those provided by us. In addition, new technology regarding the treatment and recycling of used solvent and used oil may lead to functionally equivalent or superior products becoming available, which may decrease the demand for our services and products or cause our products and services to become obsolete.

 

We could be subject to involuntary shutdowns or be required to pay significant monetary damages if we are found to be a responsible party for the improper handling or the release of hazardous substances.

 

As a company engaged in the sale, handling, transportation, storage, recycling and disposal of materials that are or may be classified as hazardous by federal, state, or other regulatory agencies, we face risks of liability for environmental contamination. The federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”), and similar state laws impose strict liability on current or former owners and operators of facilities that release hazardous substances into the environment, as well as on the businesses that generate those substances or transport them to the facilities. As a potentially responsible party, or PRP, we may be liable under CERCLA for substantial investigation and cleanup costs even if we operate our business properly and comply with applicable federal and state laws and regulations. Liability under CERCLA may be joint and several, which means that if we were found to be a business with responsibility for a particular CERCLA site, we could be required to pay the entire cost of the investigation and cleanup, even though we were not the party responsible for the release of the hazardous substance and even though other companies might also be liable. Even if we were able to identify who the other responsible parties might be, we may not be able to compel them to contribute to the remediation costs, or they might be insolvent or unable to contribute due to lack of financial resources.

 

Our facilities and the facilities of our customers and third party contractors may have generated, used, handled and/or disposed of hazardous substances and other regulated wastes. Environmental liabilities could exist, including cleanup obligations at these facilities or at off-site locations where materials from our operations were disposed of, which could result in future expenditures that cannot be currently quantified and which could materially reduce our profits. Our pollution liability insurance excludes certain liabilities under CERCLA. Thus, if we were to incur liability under CERCLA that was not covered by our insurance and if we could not identify other parties responsible under the law whom we are able to compel to contribute to the liabilities, the cost to us could be substantial and could impair our profitability, reduce our liquidity and have a material adverse effect on our business. Although our customer service agreements typically provide that the customer is responsible for ensuring that only appropriate materials are disposed of, we could be exposed to third party claims if customers dispose of improper waste, and we might not be successful in recovering our damages from those customers. In addition, new services or products offered by us (such as the re-refining of

used oil) could expose us to further environmental liabilities for which we have no historical experience and cannot estimate our potential exposure to liabilities.

 

Our fixed cost structure may result in a greater loss or reduced earnings.

 

Our North American network, including our facilities, fleet and personnel, subjects us to fixed costs, which makes our margins and earnings sensitive to changes in revenues. In periods of declining demand, our fixed cost structure may limit our ability to cut costs, which may put us at a competitive disadvantage to firms with lower cost structures, or may result in reduced operating margins and operating losses.

 

We carry inventory of used solvents generated by customers participating in our product reuse program for parts cleaning.

 

Our inventory of used solvent has fluctuated and it may continue to fluctuate. If we are unable to sell our reuse inventory, we may be required to take a charge to inventory and we may incur additional costs for storage and/or disposal which would adversely impact our operating results. In addition, while we sold enough used solvent to satisfy speculative accumulation requirements of the EPA for fiscal 2010 and prior years, we may not in future years.

 

Our ability to achieve our business and financial objectives is subject to our ability to expand our non-hazardous programs for parts cleaning.

 

For our business to grow we may need to expand our non-hazardous program for parts cleaning. Unlike used solvent generated by customers participating in our product reuse program for parts cleaning (which must be resold for reuse as an ingredient), used solvent generated by customers participating in our non-hazardous program for parts cleaning can be recycled by third party recyclers or by us. We have constructed a solvent recycling system at our Indianapolis hub to recycle used solvent generated by customers participating in our non-hazardous program and we may also undertake similar projects in the future. Any unanticipated costs in operating our solvent recycling system could have a material adverse effect on our operating results and require us to seek an alternative means to recycle or dispose of used solvent.

 

The operation of our solvent recycling system may be considered inherently dangerous and injury to individuals or property may occur, potentially subjecting us to lawsuits. If we fail to operate our solvent recycling system as anticipated, our business and operating results could suffer. In addition, we may decide to alter or discontinue certain aspects of our business strategy at any time, or offer new product lines which may not be profitable and could materially and adversely affect our financial condition and results of operations.

 

We depend on the service of key individuals, the loss of whom could materially harm our business.

 

Our success will depend, in part, on the efforts of our executive officers and other key employees, including Joseph Chalhoub, our President and Chief Executive Officer, Gregory Ray, our Chief Financial Officer, Vice President, Business Management and Secretary, John Lucks, our Vice President of Sales, Tom Hillstrom, our Vice President of Operations and Glenn Casbourne, our Vice President of Engineering. These individuals possess extensive experience in our markets and are critical to the operation and growth of our business. If we lose or suffer an extended interruption in the services of one or more of our executive officers or other key employees, our business, results of operations and financial condition may be negatively impacted. Moreover, the market for qualified individuals is highly competitive and we may not be able to attract and retain qualified personnel to succeed members of our management team or other key employees, should the need arise. We do not maintain any key man life insurance policies. One of our key growth strategies is our construction of a used oil re-refinery. Given their past experience in the development of re-refinery facilities in the U.S., the retention of the members of our management team is particularly critical to our ability to develop the re-refinery as planned. The loss of any of these individuals could adversely impact our ability to compete and operate the re-refinery.

 

In addition, our operations and growth strategy rely on the expansion of our business through the creation and growth of new and existing branches. In order for us to create and grow new and existing branches properly, we must continually recruit and train a pool of hardworking and motivated sales & service representatives, or SSRs, to develop new customer leads, as well as support our existing customer base. If we

are not able to retain and recruit a sufficient number of SSRs, or we experience an increase in the turnover of existing SSRs, we may not be able to support the continued growth of our business, which could have a material adverse impact on our financial performance.

 

We operate our business through many locations, and if we are unable to effectively oversee all of these locations, our business reputation and operating results could be materially adversely affected.

 

Because we rely on our extended network of 62 branch locations to operate independently to carry out our business plan, we are subject to risks related to our ability to oversee and control information reporting from these locations. If in the future we are unable to effectively oversee and control information reporting from our branch locations, our results of operations could be materially adversely affected, we could fail to comply with environmental regulations, we could lose customers, and our business could be materially adversely affected.

 

Our insurance policies do not cover all losses, costs or liabilities that we may experience.

 

We maintain insurance coverage, but these policies do not cover all of our potential losses, costs or liabilities. We could suffer losses for uninsurable or uninsured risks or in amounts in excess of our existing insurance coverage which would significantly affect our financial performance. For example, our pollution legal liability insurance excludes costs related to fines, penalties or assessments. Our insurance policies also have deductibles and self-retention limits that could expose us to significant financial expense. Our ability to obtain and maintain adequate insurance may be affected by conditions in the insurance market over which we have no control. The occurrence of an event that is not fully covered by insurance could have a material adverse effect on our business, financial condition and results of operations. In addition, our business requires that we maintain various types of insurance. If such insurance is not available or not available on economically acceptable terms, our business could be materially and adversely affected.

 

We are subject to potential warranty expense and liability claims relating to our services and products.

 

We offer our customers specific guarantees that we will be responsible for all expenses resulting from any spill that occurs while we are transporting, processing or disposing of customers’ used solvent and other waste. Accordingly, we may be required to indemnify our customers for any liability under CERCLA or other environmental, employment, health and safety laws and regulations. We may also be exposed to product liability claims by our customers, users of our parts cleaning products or third parties claiming damages stemming from the mechanical failure of parts cleaned with solvents and/or equipment provided by us. Although we maintain product liability insurance coverage, if our insurance coverage proves inadequate or adequate insurance becomes unreasonably costly or otherwise unavailable, future claims may not be fully insured. An uninsured or partially insured successful claim against us could have a material adverse effect on our business, financial condition and results of operations.

 

Our focus on small business customers causes us to be subject to the trends and downturns impacting small businesses, which could adversely affect our business.

 

Our customer base is primarily composed of small companies in the automotive repair and manufacturing industries. The high concentration of our customers that are small businesses exposes us to some of the broad characteristics of small businesses across the U.S. Small businesses start, close, relocate, and get purchased or sold frequently. In addition, small businesses tend to be more significantly affected by economic recessions than larger businesses. This leads to a certain amount of ongoing turnover in the market. As a result, we must continually identify new customers and expand our business with existing customers in order to sustain our growth. If we experience a rise in levels of customer turnover, it may have a negative impact on the profitability of our business.

 

We obtain services from our largest stockholder, Heritage and its affiliates, which we refer to collectively herein as Heritage, and our inability to replace these services in the future on economically acceptable terms could materially adversely affect our business.

 

We obtain certain services from Heritage including disposal and product analytical services and workers’ compensation insurance. Heritage beneficially owned 31.4% of our outstanding common stock as of May 27, 2010.

If the services that we receive from Heritage become unavailable from Heritage, to the extent that we are unable to negotiate replacements of these services with similar terms, we could experience increases in our expenses.

 

Litigation related to personal injury from exposure to solvents and the operation of our business may result in significant liabilities and affect our profitability.

 

We have been and in the future may be involved in claims and litigation filed on behalf of persons alleging injury predominantly as a result of exposure to hazardous chemicals that are a part of the solvents that we provide. In addition, the hazards and risks associated with the use, transport, storage, and handling and disposal of our customers’ waste by us and our customers (such as fires, natural disasters, explosions and accidents) and our customers’ improper or negligent use or misuse of solvent to clean parts may also expose us to personal injury claims, property damage claims and/or products liability claims from our customers or third parties. As protection against such claims and operating hazards, we maintain insurance coverage against some, but not all, potential losses. However, we could sustain losses for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Due to the unpredictable nature of personal injury litigation, it is not possible to predict the ultimate outcome of these claims and lawsuits, and we may be held liable for significant personal injury or damage to property or third parties, or other losses, that are not fully covered by our insurance, which could have a material adverse effect on our business.

 

We are dependent on third parties to supply us with the necessary components and materials to service our customers. We are also dependent on third party transport, including rail, recycling and disposal contractors.

 

In the operation of our business, we supply a large amount of virgin solvent and parts cleaning equipment to our customers. We do not maintain extensive inventories for most of these products. If we become unable to obtain, or experience delays in the transportation of, adequate supplies and components in a timely and/or cost-effective manner, we may be unable to adequately provide sufficient quantities of our services and products to our customers, which could have a material adverse effect on our financial condition and results of operations.

 

We, and our third party transporters, ship used oil and containerized waste collected from our customers to a number of third party recycling and disposal facilities, including incinerators, landfill operators and waste-to-energy facilities. We generally do not have long-term fixed price contracts with our third party contractors, and if we are forced to seek alternative vendors to handle our third party recycling and disposal activities, we may not be able to find alternatives without significant additional expenses, or at all, which could result in a material adverse effect on our financial performance. In addition, we could be subject to significant environmental liabilities from claims relating to the transport, storage, processing, recycling and disposal of our customers’ waste by our third party contractors and their subcontractors.

 

A system failure could delay or interrupt our ability to provide services and products and could increase our costs and reduce our sales.

 

Our operations are dependent upon our ability to support our branch infrastructure. Our business operates through 4 hubs that service our 62 local branches. Any damage or failure that causes interruptions in our operations could result in the loss of customers. To date, we have not experienced any significant interruptions or delays which have affected our ability to provide services and products to our customers. The occurrence of a natural disaster, technological, transportation or operational disruption or other unanticipated problem could cause interruptions in the services we provide and impair our ability to generate sales and achieve profits.

 

We may be unable to manage our growth.

 

In our first nine full years of operation, sales have increased at a compound annual growth rate of 24% from 1999 to 2009 although we experienced a 9% decrease in our sales from 2008 to 2009. Our growth to date has placed and may continue to place significant strain on our management and its operational and financial resources. We anticipate that continued growth, if any, as well as our plans to enter the used oil re-refining industry, will require us to recruit, hire and retain new managerial, finance, sales, marketing and operational personnel. We cannot be certain that we will be successful in recruiting, hiring or retaining those personnel. Our ability to compete effectively and to manage our future growth, if any, will depend on our

ability to maintain and improve operational, financial and management information systems on a timely basis and to expand, train, motivate and manage our work force. If we continue to grow, we cannot be certain that our personnel, systems, procedures and controls will be adequate to support our operations.

 

Expansion of our business may result in unanticipated adverse consequences.

 

In the future, we may seek to grow our business by investing in new or existing facilities, making acquisitions, entering into partnerships and joint ventures or constructing new facilities such as the used oil re-refinery. Acquisitions, partnerships, joint ventures, investments or construction projects may require significant managerial attention, which may divert our management from our other activities and may impair the operation of our existing businesses. Any future acquisitions of businesses or facilities or the development of a new business line could entail a number of additional risks, including:

 

 

As a result of these and other factors, including the general economic risk associated with the industries in which we operate, we may not be able to realize the expected benefits from any recent or future acquisitions, new facility developments, partnerships, joint ventures or other investments.

 

Our business is subject to inclement weather and this may have a significant adverse effect on our financial performance.

 

A significant portion of our business includes periodic service visits to our customers. Inclement weather in the geographic areas in which our branches operate may result in a significant number of cancelled service visits, which may result in lost sales and profits.

 

We may not be able to protect our intellectual property adequately.

 

We rely upon know-how and technological innovation and other trade secrets to develop and maintain our competitive position. We rely, to a significant extent, on trade secrets, confidentiality agreements and other contractual provisions to protect our proprietary technology, and such agreements may not adequately protect us. Our competitors could gain knowledge of our know-how or trade secrets, either directly or through one or more of our employees or other third parties. Although we do not regard any single trade secret or component of our proprietary know-how to be material to our operations as a whole, if one or more of our competitors can use or independently develop such know-how or trade secrets, our market share, sales volumes and profit margins could be adversely affected.

 

In the event we become involved in defending or pursuing intellectual property litigation, such action may increase our costs and divert management’s time and attention from our business. In addition, any potential intellectual property litigation could force us to take specific actions, including, but not limited to, the following:

 

 

Climate change laws or regulations restricting emissions of “greenhouse gases” could result in increased operating costs and a decreased demand for our services.

 

On June 26, 2009, the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009 (“ACESA”), which would establish an economy-wide cap-and-trade program to reduce U.S. emissions of carbon dioxide and other greenhouse gases (“GHG”) that may contribute to warming of the

earth’s atmosphere and other climatic changes. ACESA would require a 17 percent reduction in GHG emissions from 2005 levels by 2020 and just over an 80 percent reduction of such emissions by 2050. Under this legislation, the EPA would issue a capped and steadily declining number of tradable emissions allowances to certain major sources of GHG emissions so that such sources could continue to emit GHGs into the atmosphere. These allowances would be expected to escalate significantly in cost over time. The net effect of ACESA would be to impose increasing costs on the combustion of carbon-based fuels such as refined petroleum products, oil and natural gas. The U.S. Senate has begun work on its own legislation for restricting domestic GHG emissions and President Obama has indicated his support of legislation to reduce GHG emissions through an emission allowance system. Also, on December 15, 2009, the EPA published its findings that emissions of GHGs present an endangerment to public health and the environment. These findings allow the EPA to adopt and implement regulations that would restrict emissions of GHGs under existing provisions of the federal Clean Air Act. Accordingly, the EPA has already proposed two sets of regulations that would require a reduction in emissions of GHGs from motor vehicles and, also, could trigger permit review for GHG emissions from certain stationary sources. In addition, on September 22, 2009, the EPA issued a final rule requiring the reporting of GHG emissions from specified large GHG emission sources in the United States, including petroleum refineries, on an annual basis, beginning in 2011 for emissions occurring after January 1, 2010. The adoption and implementation of any regulations imposing GHG reporting obligations on, or limiting emissions of GHGs from, our equipment and operations could require us to incur costs to reduce emissions of GHGs associated with our operations.

 

Risks Related to our Common Stock

 

The price of our shares of common stock may be volatile.

 

The trading price of shares of our common stock may fluctuate substantially. In particular, it is possible that our operating results may be below the expectations of public market analysts and investors, including the results of our planned entry into the used oil re-refining industry, and, as a result of these and other factors, the price of our common stock may decline. These fluctuations could cause you to lose part or all of your investment in shares of our common stock. Factors that could cause fluctuations include, but are not limited to, the following:

 

 

The stock markets, in general, periodically experience volatility that is sometimes unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline.

 

The small public float for our shares may make it difficult to sell your shares and may cause volatility in our stock price.

 

A substantial portion of our shares of common stock are closely held by certain inside investors and our common stock has experienced limited trading volume since our initial public offering. As of May 27, 2010,

Heritage beneficially owned 31.4% of our common stock, Fred Fehsenfeld, Jr., the Chairman of our Board and an affiliate of Heritage, beneficially owned 9.4% of our common stock and directors and executive officers beneficially owned 41.9% of our common stock. At our direction, the underwriters have reserved for sale to Heritage and the related trusts of Mr. Fehsenfeld, at the public offering price, shares representing the same percentage of shares being sold in the offering as each of Heritage and Mr. Fehsenfeld currently holds of our outstanding common stock. These shares are being offered to Heritage pursuant to the participation rights agreement between us and Heritage under which Heritage has a right to purchase shares in the offering so that its percentage ownership interest in our common stock does not decrease. See “Relationships and Transactions With Related Persons — Transactions with Related Persons.” Mr. Fehsenfeld has requested a similar opportunity to participate in the offering, and we have agreed to direct the underwriters to reserve shares in response to Mr. Fehsenfeld’s request. If Heritage and the related trusts of Mr. Fehsenfeld purchase all of the shares reserved for sale to them in the offering, Heritage and Mr. Fehsenfeld, after taking into account the shares purchased by the related trusts in the offering, will maintain their respective ownership interests in our common stock. Consequently, our public float is expected to remain small for a public company, the availability of our shares may be limited and you may encounter difficulty selling your shares or obtaining a suitable price at which to sell your shares. In addition, as a result of the small float, you could experience meaningful volatility in the trading price of our common stock.

 

If securities or industry analysts do not publish research or reports about our business or publish negative research, or our results are below analysts’ estimates, our stock price and trading volume could decline.

 

The trading market for our common stock may depend on the research and reports that industry or securities analysts publish about us or our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock or our results are below analysts’ estimates, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

Heritage and Mr. Fehsenfeld have significant influence over our company, and their control could delay or deter a change of control or other business combination or otherwise cause us to take actions with which you may disagree.

 

As of May 27, 2010, Heritage beneficially owned 31.4% of our outstanding common stock and Fred Fehsenfeld, Jr., the Chairman of our Board and an affiliate of Heritage, owned an additional 9.4% of our outstanding common stock. If Heritage and the related trusts of Mr. Fehsenfeld purchase all of the shares reserved for sale to them in the offering, Heritage and Mr. Fehsenfeld, after taking into account the shares purchased by the related trusts in the offering, will maintain their respective ownership interests in our common stock. As a result, Heritage and Mr. Fehsenfeld will continue to have significant influence over our decision to enter into any corporate transaction and with respect to any transaction that requires the approval of stockholders, regardless of whether other stockholders believe that the transaction is in their own best interests. This concentration of voting power could have the effect of delaying, deterring or preventing a change of control or other business combination that might otherwise be beneficial to our stockholders.

 

We are required to evaluate our internal control under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and could have an adverse effect on our stock price.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish a report by our management on our internal control over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Each year we must prepare or update the process documentation and perform the evaluation needed to comply with Section 404. During this process, if our management identifies one or more material weaknesses in our internal control over financial reporting, we will be unable to assert such internal control is effective. Ensuring that we have adequate internal financial and accounting controls and procedures

in place is a costly and time-consuming effort that needs to be re-evaluated frequently. We and our independent auditors may in the future discover areas of our internal controls that need further attention and improvement, particularly with respect to any businesses that we decide to acquire in the future. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could harm our ability to operate our business. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Investor perception that our internal controls are inadequate or that we are unable to produce accurate financial statements on a timely, consistent basis may adversely affect our stock price. Failure to comply with Section 404 could also potentially subject us to sanctions or investigations by the Securities and Exchange Commission, or SEC, NASDAQ or other regulatory authorities.

 

We have incurred and will continue to incur increased costs as a result of being a public company.

 

As a public company, we have incurred significant legal, accounting and other expenses that we did not incur as a private company. We incur costs associated with our public company reporting requirements. We have incurred costs associated with corporate governance requirements, including requirements under Sarbanes-Oxley, as well as rules implemented by the SEC and NASDAQ. These rules and regulations have increased our legal and financial compliance costs and made some activities more time-consuming and costly. Further, we may need to hire additional accounting, financial and compliance staff with appropriate public company experience and technical accounting knowledge. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. Any of these expenses could harm our business, operating results and financial condition.

 

We do not currently intend to pay cash dividends on our common stock to our stockholders and any determination to pay cash dividends in the future will be at the discretion of our Board of Directors.

 

We currently intend to retain any profits to provide capacity for general corporate uses and growth of our business. Our Board of Directors does not intend to declare cash dividends in the foreseeable future. Any determination to pay dividends to our stockholders in the future will be at the discretion of our Board of Directors and will depend on our results of operations, financial condition and other factors deemed relevant by our Board of Directors. Consequently, it is uncertain when, if ever, we will declare dividends to our stockholders. If we do not pay dividends, investors will only obtain a return on their investment if the value of our shares of common stock appreciates. In addition, the terms of our existing or future borrowing arrangements may limit our ability to declare and pay dividends.

 

Provisions in our certificate of incorporation and bylaws and under Delaware law could prevent or delay transactions that stockholders may favor.

 

Our company is incorporated in Delaware. Our certificate of incorporation and bylaws, as well as Delaware corporate law, contain provisions that could delay or prevent a change of control or changes in our management that a stockholder might consider favorable, including a provision that authorizes our Board of Directors to issue preferred stock with such voting rights, dividend rates, liquidation, redemption, conversion and other rights as our Board of Directors may fix and without further stockholder action. The issuance of preferred stock with voting rights could make it more difficult for a third party to acquire a majority of our outstanding voting stock. This could frustrate a change in the composition of our Board of Directors, which could result in entrenchment of current management. Takeover attempts generally include offering stockholders a premium for their stock. Therefore, preventing a takeover attempt may cause you to lose an opportunity to sell your shares at a premium. If a change of control or change in management is delayed or prevented, the market price of our common stock could decline.

 

Delaware law also prohibits a corporation from engaging in a business combination with any holder of 15% or more of its capital stock until the holder has held the stock for three years unless, among other

possibilities, the Board of Directors approves the transaction. This provision may prevent changes in our management or corporate structure. Also, under applicable Delaware law, our Board of Directors is permitted to and may adopt additional anti-takeover measures in the future.

 

Our certificate of incorporation provides that the affirmative vote of at least seventy-five percent (75%) of our total voting power is required to amend our certificate of incorporation or to approve mergers, consolidations, conversions or the sale of all or substantially all of our assets. Given the voting power of Heritage, we would need the approval of Heritage for any of these transactions to occur.

 

Our bylaws provide for the division of our Board of Directors into three classes with staggered three year terms. The classification of our Board of Directors could have the effect of making it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of us.

 

We estimate that our net proceeds from the sale of our common stock in the offering will be approximately $21.0 million, or $24.2 million if the underwriters exercise their option to purchase additional shares in full, based on an assumed public offering price per share of $8.35 (the last reported sale price of our common stock on The NASDAQ Global Market on May 27, 2010), after deducting the underwriting discount and $0.6 million of estimated offering expenses payable by us.

 

We currently intend to use the net proceeds from the offering to fund a portion of the costs required to develop and construct our used oil re-refinery facility in Indiana. We believe that additional capital of approximately $19.0 million will be needed for capital expenditure to complete the re-refinery, or $15.8 million if the underwriters exercise their option to purchase additional shares in full, based on an assumed public offering price per share of $8.35 (the last reported sale price of our common stock on The NASDAQ Global Market on May 27, 2010). We expect to obtain this additional capital from our existing bank credit facility as well as from cash flow from our operations. Our credit facility currently restricts our ability to incur or be obligated to make more than $10 million of capital expenditures in a fiscal year, provided that, pursuant to an amendment dated May 14, 2010, $42 million of capital expenditures with respect to the re-refinery would not be subject to this $10 million limitation.

 

It is possible that we may delay or cancel the re-refinery project for one or more reasons including, without limitation, a significant drop in the price of oil or a determination that the re-refinery will not generate the benefits to our growth that we currently anticipate. If we delay or cancel the re-refinery project, we intend to use the net proceeds from the sale of our common stock in the offering for general corporate purposes, including to fund working capital and other capital expenditures as well as fund potential acquisitions.

 

The common stock of Heritage-Crystal Clean began trading on The NASDAQ Global Market under the symbol “HCCI” on March 12, 2008. Prior to our initial public offering of our common stock on March 12, 2008, there was no public market for our common stock. The information in the following table indicates the high and low sales prices for Heritage-Crystal Clean’s common stock from March 12, 2008, the date of our initial public offering, to May 27, 2010, as reported by NASDAQ.

 

 

 

 

On May 27, 2010, the closing price of our common stock on the NASDAQ Global Select Market was $8.35 per share. On May 27, 2010, there were 196 stockholders of record of our common stock. Several brokerage firms, banks and other institutions (“nominees”) are listed once on the stockholders of record listing. However, in most cases, the nominees’ holdings represent blocks of our common stock held in brokerage accounts for a number of individual stockholders. As such, our actual number of stockholders would be higher than the number of registered stockholders of record.

 

Our Board of Directors sets our dividend policy. Our Board of Directors does not intend to declare cash dividends on our common stock in the foreseeable future. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business, but we may determine in the future to declare or pay cash dividends on our common stock. Any future determination as to the declaration and payment of dividends will be at the discretion of our Board of Directors and will be dependent upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory and any contractual restrictions on the payment of dividends, including the restrictions contained in the agreements governing our then outstanding indebtedness and any other factors our Board of Directors deems relevant. Our bank credit facility currently restricts the payment of dividends by us.

 

The following table sets forth our capitalization as of March 27, 2010:

 

 

 

You should read the data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes appearing elsewhere in this prospectus and incorporated herein by reference.

 

 

 

 

 

 

 

 

You should read the following selected consolidated financial information together with our consolidated financial statements and the related notes incorporated herein by reference and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. We refer to the first twelve weeks of each fiscal year as the “first quarter.” Accordingly, the first quarters of fiscal 2009 and 2010 ended March 28, 2009 and March 27, 2010, respectively. Our results for the first quarters ended March 28, 2009 and March 27 and balance sheet data as of March 27, 2010 are unaudited. We have derived the statement of operations data for each of the years ended December 29, 2007, January 3, 2009 and January 2, 2010 and the balance sheet data at January 3, 2009 and January 2, 2010 from our audited financial statements incorporated herein by reference. We have derived the statement of operations data for each of the years ended December 31, 2005 and December 30, 2006 and the balance sheet data at December 31, 2005, December 30, 2006 and December 29, 2007 from our audited consolidated financial statements not included in this prospectus.

 

 

 

 

 

 

 

 

 

 

You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere and incorporated by reference in this prospectus. 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. We undertake no obligation to update any of the forward looking statement. Factors that could cause such differences include those described in “Risk Factors” and elsewhere in this prospectus. Certain tabular information may not foot due to rounding.

 

Overview

 

We are a leading provider of industrial and hazardous waste services to small and mid-sized customers who are engaged in vehicle maintenance or manufacturing activities. We offer a broad range of services desired by these customers including parts cleaning solvent management, and the removal and management of a variety of regulated wastes. We operate from a network of 62 branch facilities providing service to customers in 39 states.

 

Our sales are generated primarily from providing parts cleaning and waste removal services for our clients, which accounted for approximately 94.6% of our sales for fiscal 2009. We also generate a minimal amount of sales from the sale of used oil, which accounted for the remaining 5.4% of our fiscal 2009 sales. The sale of used solvent generated by customers participating in our product reuse program for parts cleaning is not accounted for as sales, but rather as a reduction in our net cost of solvent under cost of sales. We define and measure same-branch sales 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 sales per working day by dividing our sales by the number of non-holiday weekdays in the applicable fiscal year or fiscal quarter.

 

We have established prices for our services, based on the relevant business variables for each service. With respect to our parts cleaning services, our pricing reflects the type of parts cleaning machine we provide (if any), the frequency of service visits, and the quantity and grade of solvent or other cleaning chemistry required. For our other services, our pricing typically reflects the nature and quality of the waste materials removed. Our customer agreements typically provide for annual renewal and price increases.

 

Our cost of sales includes the costs of the materials we use in our services, such as solvent and other chemicals, depreciation on the parts cleaning machines we own and provide to customers, 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 cost of sales, whether placed in inventory or sold to a purchaser for reuse. Increased costs of crude oil, a component of solvent, can increase cost of sales, although we attempt to offset such increases with increased prices for our services.

 

Our operating costs include the costs of operating our branch system and hubs, including personnel costs (including commissions), and 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.

 

Our selling, general, and administrative expenses include the costs of performing centralized business functions, including sales management at or above the regional level, billing, receivables management, accounting and finance, information technology, environmental health and safety and legal. Our selling, general, and administrative expenses have increased as a result of the ongoing costs of being a public company.

 

In the first quarter of 2010, we announced our plans to develop a used oil re-refinery. The re-refinery is being designed to process up to 50 million gallons per year of used oil feedstock and produce up to 30 million

gallons per year of lubricating base oil. The estimated capital cost of the project is approximately $40 million and the re-refinery is expected to begin operating at partial capacity during 2012.

 

Our History

 

The history of our business activity dates back to the late 1980s, when Heritage Environmental Services established a division to concentrate on the service needs of smaller customers. This division, known as Crystal Clean, began providing parts cleaning and used oil collection services to customers in Indianapolis, Indiana, and gradually expanded to several other cities in the Midwest. During the 1990s, the Crystal Clean division expanded into markets in Texas and Louisiana as the result of a business venture with a major branded motor oil company. By the late 1990s, the Crystal Clean division was offering services to small to mid-sized customers in roughly a dozen metropolitan areas. In 1999, the parent of Heritage Environmental Services and Joseph Chalhoub, our current Chief Executive Officer, agreed to form a new company, Heritage-Crystal Clean, LLC, and to contribute the business assets of the Crystal Clean division to this new company. Mr. Chalhoub invested in the new Company and recruited a team of seasoned industry professionals to join our company and implement plans for growth.

 

On March 11, 2008, we completed a reorganization, initial public offering and direct placement. In connection with the reorganization, initial public offering and direct placement we:

 

 

Critical Accounting Policies

 

Critical accounting policies are those that both are 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.

Accounts Receivable and Allowance for Doubtful Accounts

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Consistent with industry practices, we require payment from most customers within 30 days of invoice date. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on analysis of customer creditworthiness, historical losses and general economic trends and conditions. We perform periodic credit evaluations of our customers and typically do not require collateral. We have an estimation procedure, based on historical data and recent changes in the aging of these receivables that we use to record reserves throughout the year. In the last eight years, our provisions for doubtful accounts have averaged less than 0.8% of sales. We do not have any off-balance sheet credit exposure related to our customers.

 

Inventory

 

Inventory consists primarily of new and used solvents, new and refurbished parts cleaning machines, absorbents, accessories, repair parts and used oil. 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. In the first quarter of fiscal 2007 we reported an impairment charge and reserved an associated excess reserve, reducing the reuse solvent inventory by $2.2 million. This was due to the supply contract termination as described in more detail below in our Results of Operations section. In the fourth quarter of fiscal 2008, we reported an impairment charge, reducing the reuse solvent and used oil inventory by $2.8 million. This was due to a sharp decline in crude oil prices which resulted in the market value for our reuse solvent declining below the historic (FIFO) values. In fiscal 2009, we depleted our excess inventory of reuse solvent and correspondingly eliminated the reserve. We continually monitor our inventory levels at each of our distribution locations and evaluate 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.

 

Share Based Compensation

 

We follow Financial Accounting Standards Board (“FASB”) guidance that requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. This statement was adopted using the prospective method of application, which requires us to recognize compensation cost on a prospective basis. For share-based awards granted after January 1, 2006, we recognized compensation expense based on estimated grant date fair value. See “Fiscal 2009 versus Fiscal 2008 and Fiscal 2008 versus Fiscal 2007 — Selling, general, & administrative expenses” for a description of compensation expenses related to the stock options that were granted and which vested in connection with the offerings and the acceleration of vesting of common units granted to employees under our Key Employee Membership Interest Trust.

 

Impairment of Long-Lived Assets

 

Long-lived assets, such as property and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. No triggering events occurred during fiscal 2009 or the first quarter of 2010 and therefore impairment has not been tested.

New Accounting Pronouncements

 

Revenue Arrangements with Multiple Deliverables

 

In September 2009, the FASB ratified guidance for revenue arrangements with multiple deliverables. In absence of vendor-specific objective evidence (“VSOE”) or other third party evidence (“TPE”) of the selling price for the deliverables in a multiple-element arrangement, it requires companies to use an estimated selling price (“ESP”) for the individual deliverables. Companies shall apply the relative-selling price model for allocating an arrangement’s total consideration to its individual elements. Under this model, the ESP is used for both the delivered and undelivered elements that do not have VSOE or TPE of the selling price. The proposed effective date of the draft abstract is for fiscal years beginning on or after June 15, 2010, and will be applied prospectively to revenue arrangements entered into or materially modified after the effective date. Since we will apply the requirements of this guidance on a prospective basis, we are continuing to evaluate its effect on our consolidated financial statements.

 

Fair Value Measurements and Disclosures

 

In January 2010, the FASB issued revised guidance which requires additional disclosures about items transferring into and out of Levels 1 and 2 in the fair value hierarchy. The revised guidance also requires additional separate disclosures about purchases, sales, issuances, and settlements relative to Level 3 measurements, and clarifies, among other things, the existing fair value disclosures about the level of disaggregation. This pronouncement is effective for interim and annual financial periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements relative to Level 3 measurements, which are effective for interim and annual financial periods beginning after December 15, 2010. We adopted these amendments in the first quarter of 2010 and the adoption did not have a material impact on the disclosures of our consolidated financial statements.

 

Subsequent Events

 

In February 2010, the FASB issued amended guidance regarding subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and we adopted these new requirements upon issuance of this guidance.

 

On May 6, 2010, our shareholders voted and approved at our annual meeting an amendment to the Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Common Stock from 15,000,000 to 18,000,000. The amendment to the Amended and Restated Certificate of Incorporation was filed on May 14, 2010.

Results of Operations

 

General

 

The following table sets forth certain operating data as a percentage of sales for the periods indicated:

 

 

 

 

First Quarter of Fiscal 2010 Compared to First Quarter of Fiscal 2009

 

Sales.  For the first fiscal quarter of 2010, sales increased $0.2 million, or 1.0%, to $24.0 million from $23.8 million for the first fiscal quarter of 2009. We implemented a price increase in the fourth quarter of 2009 which contributed to some of the growth and we are also starting to see more revenue generating activity from our customers. Within the first fiscal quarter of 2010, the sales trend was positive, with sales increases for each successive four-week accounting period as opposed to declining sequential period sales in the first fiscal quarter of 2009.

 

At the end of fiscal 2009, we were operating 58 branch locations compared with 54 at the end of fiscal 2008. In the first fiscal quarter of 2010 we opened four new branches; and we now operate through 62 branch locations. There were 58 branches that were in operation during both the first fiscal quarter of 2010 and first fiscal quarter of 2009, which experienced flat same-branch sales over the course of these two fiscal quarters.

 

Cost of sales.  For the first fiscal quarter of 2010, cost of sales decreased $1.5 million, or 20.0%, to $6.0 million from $7.5 million for the first fiscal quarter of 2009. Cost of sales as a percentage of sales

decreased to 25.0% in first fiscal quarter of 2010, from 31.6%, in the first fiscal quarter of 2009. We recorded costs of approximately $0.9 million during the first fiscal quarter of 2009 that related to declining crude oil prices. These costs in the first fiscal quarter of 2009, reflect the decline in the value of virgin solvent inventory held at our locations for use in our service programs which is valued at the lower of cost or market. In the first fiscal quarter of 2010, we recorded a benefit of $0.3 million to our cost of sales arising from increasing crude prices because we sold our reuse solvent at higher gross margins. The increase in crude prices during the first fiscal quarter of 2010 allowed us to sell reuse solvent at higher prices than the inventory value established at the end of 2009 when crude price and associated solvent products were at lower levels. In addition, solvent products that we use in servicing our customers were valued higher at the end of the first fiscal quarter of 2010 as they were returned by our customers for recycling.

 

Operating costs.  For the first fiscal quarter of 2010, operating costs increased $0.3 million, or 2.5%, to $12.5 million from $12.2 million for the first fiscal quarter of 2009. Cost cutting measures such as workforce efficiencies which were taken in fiscal 2009 to compensate for the decline in sales, continue to reduce our operating expenses; however the costs of diesel and transportation fuel surcharges were above the first fiscal quarter of 2009 levels. Additionally, we incurred branch labor, collection truck and facility costs in connection with new branches opened in the first fiscal quarter of 2010.

 

Selling, general, & administrative expenses.  For the first fiscal quarter of 2010, selling, general and administrative expenses increased $0.5 million, or 13.3%, to $4.4 million from $3.9 million for the first fiscal quarter of 2009. The increase was due to specific accrual adjustments for property taxes in the first fiscal quarter of 2009 and expense related to a sales tax audit in the first fiscal quarter of 2010. Additionally, the allocation of the Management Incentive Plan “MIP” bonus pool was increased in the first quarter of 2010 because it is aligned with the profitability of operations.

 

Interest expense.  There was zero interest expense in both the first fiscal quarter of 2010 and 2009 due to no debt outstanding during the fiscal quarters ending March 27, 2010 and March 28, 2009, respectively.

 

Provision for income taxes.  For the first fiscal quarter of 2010, the provision for income taxes increased $0.4 million, to $0.5 million from $0.1 million for the first fiscal quarter of 2009. The increase was a result in the increase in taxable income. Our effective tax rate in the first fiscal quarter of 2010 was 41.9%, compared to 40.5% in the first fiscal quarter of 2009. Our effective tax rate in the first fiscal quarter of 2010 was slightly elevated compared to the first fiscal quarter of 2009 due to a higher blended state income tax rate.

 

Fiscal Year 2009 Compared to Fiscal 2008

 

Sales.  For fiscal 2009, sales decreased $9.7 million, or 9.0%, to $98.4 million from $108.1 million for fiscal 2008. Fiscal 2009 reported sales for 52 weeks compared to fiscal 2008 which reported sales for 53 weeks. The effect of the U.S. recession caused many of our customers to produce less waste and to put off deferrable services to a greater degree than we have seen in past recessions, and this eliminated our sales growth.

 

At the end of fiscal 2009, we were operating 58 branch locations compared with 54 at the end of fiscal 2008. There were 54 branches that were in operation during both the fiscal years of 2009 and fiscal 2008, which experienced a decline in same-branch sales of $11.6 million, or 10.7%. Excluding the 4 branches in this group that gave up customers to new branch openings, the remaining 50 branches experienced a decline in same-branch sales of $8.9 million, or 9.1%.

 

Fuel surcharges decreased sales year-over-year by $1.1 million in fiscal 2009. This decrease was a direct result of lower energy prices as compared to fiscal 2008.

 

Cost of sales.  For fiscal 2009, total cost of sales decreased $6.2 million, or 19.2%, to $26.0 million from $32.2 million for fiscal 2008. Cost of sales as a percentage of sales decreased to 26.5%, from 29.8%, in fiscal 2008. Although our cost structure has returned to levels seen prior to 2008, we recorded costs of approximately $1.0 million during the first quarter of 2009 that was related to the decline in the price of crude oil. For the remainder of fiscal 2009, we were able to benefit from the sale of reuse solvent inventory that was marked down to market value at the end of fiscal 2008 due to the decline in reuse solvent values. This benefit,

however, was not as great as the benefit from the first three quarters of fiscal 2008 when we sold reuse solvent at prices in excess of their carrying inventory value. During the fourth fiscal quarter of 2008, the steep decline in solvent values led to reductions in the value of these solvent inventories. As a result, we incurred a $2.8 million non-cash inventory impairment charge related to valuing our reuse solvent and used oil inventory which is held for sale to market value, as a result of the decline in crude oil prices. We also recorded unusually high solvent costs of approximately $1.7 million during the fourth quarter of fiscal 2008 that were also related to the decline in crude oil prices. These increased costs reflect the revaluation of reuse solvent recovered from customers and virgin solvent inventory held at our locations for use in our service programs, both of which must be valued at the lower of cost or market. In total, declining inventory values in the fourth fiscal quarter of 2008 led us to incur approximately $4.5 million of cost. Although there was an increase in energy prices in the first half of 2009, compared to last year, the volatility in solvent prices has been much less, with correspondingly smaller impact on our financial results.

 

Operating costs.  For fiscal 2009, operating costs decreased $1.6 million, or 3.0%, to $51.9 million from $53.5 million for fiscal 2008. Although certain cost cutting measures such as workforce efficiencies were taken earlier in fiscal 2009 to compensate for the decline in sales, operating costs as a percentage of sales increased 3.3% due to the reduced leveraging of fixed costs. Additionally, we incurred branch labor, collection truck and facility costs that are associated with new branches opened early in fiscal 2009. Diesel fuel decreased along with the reduction in energy prices in fiscal 2009 compared to fiscal 2008.

 

Selling, general, & administrative expenses.  For fiscal 2009, selling, general and administrative expenses decreased $3.1 million, or 15.3%, to $17.1 million from $20.2 million for fiscal 2008. The decrease was due to $3.2 million of expense for employee stock options which were granted at the time of our initial public offering in March 2008 and vested immediately along with the vesting of certain Key Employee Membership Interest Trust “KEMIT” units in fiscal 2008. Additionally, in fiscal 2009, the allocation of the Management Incentive Plan “MIP” bonus pool was reduced because it is aligned with the profitability of operations. This was partially offset by the fact that in fiscal 2009, we incurred a full year of public company costs compared to only three full quarters in fiscal 2008 along with the loss on disposal of fixed assets.

 

Interest expense — net.  For fiscal 2009, interest expense decreased by $0.4 million, or 99.3%, to approximately zero from $0.4 million for fiscal 2008. The decrease was due to the reduction in our total debt outstanding in connection with our initial public offering in March 2008 in which the proceeds were used to pay down debt.

 

Provision for income taxes.  For fiscal 2009, provision for income taxes decreased $1.3 million, or 50.0%, to $1.3 million from $2.6 million for fiscal 2008. Our effective tax rate in fiscal 2009 was 42.5%, compared to 144.6% in fiscal 2008. In fiscal 2008, we incurred a one-time charge to earnings of $2.2 million reflecting the net deferred tax assets and deferred tax liabilities at the time of the reorganization of the LLC to a ‘C’ corporation as described above in “— Our History.” This charge did not reoccur in fiscal 2009.

 

Our overall effective tax rate in fiscal 2009 was slightly elevated primarily due to a revised higher expected blended state income tax rate. The higher expected blended state income tax rate increased as a percentage of income due to some states that base their state tax rates primarily on gross receipts.

 

Fiscal 2008 Compared to Fiscal 2007

 

Sales.  For fiscal 2008, sales increased $18.4 million, or 20.5%, to $108.1 million from $89.7 million for fiscal 2007. Fiscal 2008 reported sales for 53 weeks compared to fiscal 2007 which reported sales for 52 weeks. This is somewhat less than the sales growth we reported in prior quarters, and reflects the impact on our business of the start of the economic recession.

 

At the end of fiscal 2008, we were operating 54 branch locations compared with 48 at the end of fiscal 2007. There were 47 branches that were in operation during both the fiscal years of 2008 and fiscal 2007, which experienced same-branch sales growth of $14.8 million, or 18.1%. Excluding the 5 branches in this group that gave up customers to new branch openings, the remaining 42 branches experienced same-branch sales growth of 18.3%.

Fuel surcharges increased sales year-over-year by $0.9 million in fiscal 2008. These increases occurred primarily in the last half of fiscal 2008 to mitigate higher costs for virgin solvent, diesel fuel and transportation. Fuel and transportation costs decreased over the final months of the year as did surcharges billed to our customers. Solvent prices also declined, and we incurred charges to our cost of sales for inventory impairment on product held for sale as well as reductions to the lower cost on inventories used in operations.

 

Cost of sales.  For fiscal 2008, total cost of sales increased $7.1 million, or 28.3%, to $32.2 million from $25.1 million for fiscal 2007. Cost of sales as a percentage of sales increased in fiscal 2008 to 29.8% from 28.0% in fiscal 2007. We incurred a $2.8 million non-cash inventory impairment charge during fiscal 2008 related to valuing our reuse solvent and used fuel oil inventory which is held for sale to market value, as a result of the decline in crude oil prices. Beyond this inventory impairment charge, we also recorded unusually high solvent costs of approximately $1.7 million during the fourth fiscal quarter of 2008 that were also related to the declining prices. These increased costs reflect the revaluation of solvent recovered from customers and virgin solvent inventory held at our locations, for use in our service programs, both of which must be valued at the lower of cost or market. During the fourth fiscal quarter of 2008, the steep decline in solvent values led to reductions in the value of these solvent inventories. In total, declining inventory values in the fourth fiscal quarter of 2008 led us to incur about $4.5 million of cost.

 

Benefits we gained earlier in the first three quarters of fiscal 2008 by selling reuse solvent at higher prices than lower, historical cost were more than offset by the lower cost of market adjustment of reuse solvent and used oil inventory in the fourth quarter of fiscal 2008. In the first quarter of fiscal 2007, we received $3.0 million from the termination of a contract for our used solvent with a customer who had failed to meet their volume purchase obligations in 2006. We recorded an impairment charge of $2.2 million in fiscal 2007 to reduce solvent inventories to net realizable value in connection with this settlement.

 

Operating costs.  For fiscal 2008, operating costs increased $9.9 million, or 22.8%, to $53.5 million from $43.6 million for fiscal 2007. Operating costs, including branch labor and collection truck costs, increased as a percentage of sales as the improved efficiency in our branch network due to our gaining route density and scale in established markets was more than offset by increased diesel fuel and transportation costs.

 

Selling, general, & administrative expenses.  For fiscal 2008, selling, general and administrative expense increased $4.6 million, or 29.8%, to $20.2 million from $15.6 million for fiscal 2007. Selling, general and administrative expenses included employee share-based compensation charges of $3.2 million related to employee stock options granted at the time of our initial public offering which vested immediately and also related to the vesting of certain Key Employee Membership Interest Trust “KEMIT” units and additional costs associated with being a public company which include among others, Board of Directors compensation and insurance, incremental legal and accounting fees and Sarbanes-Oxley consulting services.

 

Proceeds from Contract Termination.  In the first quarter of fiscal 2007, we received $3.0 million from the termination of a contract for our used solvent with a customer who had failed to meet their volume purchase obligations. We recorded cost of sales of $2.2 million to reduce solvent inventories to net realizable value in connection with this settlement. Please refer to the above discussion related to cost of sales — inventory impairment for more information.

 

Interest expense — net.  For fiscal 2008, interest expense decreased by $1.0 million, or 71.0%, to $0.4 million from $1.4 million for fiscal 2007. The decrease was due to our reduction of total debt outstanding using the cash proceeds received from our initial public offering in March 2008.

 

Provision for income taxes.  In connection with our initial public offering, we reorganized our corporate legal structure from a limited liability company to a ‘C’ corporation. As a limited liability company, we were not subject to federal or state corporate income taxes and as such had not incurred any historical taxes. For comparison purposes, we have presented pro forma net income, which reflects income taxes assuming we had been a corporation since the time of our formation and assuming tax rates equal to the rates that would have been in effect had we been required to report tax expense in such years. A one-time charge to earnings of

$2.2 million was recorded in the first fiscal quarter of 2008 reflecting the net deferred tax assets and deferred tax liabilities at the time of the reorganization of the LLC to a ‘C’ corporation.

 

Quarterly Results

 

The following table sets forth our unaudited quarterly consolidated statement of operations data for the fiscal years 2008 and 2009 and the first quarter of fiscal 2010. Our fiscal year ends the Saturday closest to December 31. Fiscal year 2008 consisted of 53 weeks and fiscal year 2009 consisted of 52 weeks. Our convention with respect to reporting periodic financial data is such that each of our first three fiscal quarters consist of twelve weeks while our last fiscal quarter consists of sixteen or seventeen weeks. The unaudited quarterly information has been prepared on the same basis as the annual financial information and, in management’s opinion, includes all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the information for the quarters presented. Historically, our sales and operating results have varied from quarter to quarter and are expected to continue to fluctuate in the future. These fluctuations have been due to a number of factors, including those identified in this prospectus under the caption “Risk Factors.” Our operating results for any historical quarter are not necessarily indicative of results for any future period.

 

 

 

 

Liquidity and Capital Resources

 

Cash and Cash Equivalents

 

We had $1.1 million of cash and cash equivalents at the end of fiscal 2009 and $1.4 million at the end of the first quarter of 2010. Our primary sources of liquidity are cash flows from operations and funds available to borrow under our bank credit facility. Prior to fiscal 2008, we had historically financed our operations primarily through the private placement of preferred equity securities, borrowings from banks and investors and through funds from operations. In March 2008, we raised net proceeds of $33.2 million from an initial

public offering and concurrent direct placement. These net proceeds include offering costs of $0.9 million paid prior to fiscal year end 2007 and include approximately $1.0 million of offering costs paid subsequent the initial public offering. The proceeds were used to reduce borrowings under our bank credit facility, which included $10.9 million borrowed in March 2008 used to pay preferred members for an accrued return on preferred units as part of the reorganization described above under “Our History.”

 

Our bank credit facility provides for borrowings of up to $30.0 million. On December 14, 2009, we amended the bank credit facility to extend the maturity date of the bank credit facility to December 14, 2012 and increased the available borrowings from $25.0 million to $30.0 million. Amounts borrowed under the bank credit facility are secured by a security interest in substantially all of our tangible and intangible assets. There is a maximum amount of $1.0 million of standby letters of credit that can be issued and the issuance of the standby letters of credit reduces the amount of total borrowings available. As of March 27, 2010 and January 2, 2010, $0.2 million and $0.2 million of standby letters of credit were outstanding, respectively. As of March 27, 2010 and January 2, 2010, $29.8 million and $29.8 million were available under the bank credit facility, respectively. Under the terms of our bank credit facility, borrowings will bear interest at the prime rate plus 25 basis points, unless the total leverage ratio is greater than or equal to 2.75 to 1. If the total leverage ratio is greater than or equal to 2.75 to 1, the rate would be the prime rate plus 50 basis points. We also have the option to lock in a portion of our borrowing at the prevailing LIBOR rate plus a variable margin of between 2.0% and 3.0% depending on our leverage ratio. The bank credit facility requires us to consult with the bank on certain acquisitions and includes a prohibition on the payment of dividends. In addition, our bank credit facility contains a number of financial covenants that are based on our EBITDA for the trailing fiscal year, including a maximum total leverage ratio of 3.25 and a minimum interest coverage ratio of 3.5. In addition, the bank credit facility requires that we maintain a minimum tangible net worth of an amount equal to $42.0 million plus 75% of our aggregate net income after taxes earned each quarter subsequent to December 14, 2009, taking into account certain additional calculations and limits our capital expenditures to $10.0 million for any fiscal year. The weighted average effective interest rate for amounts outstanding was 3.25% and 6.58% at January 2, 2010 and January 3, 2009, respectively. We did not have any amounts outstanding under our bank credit facility during the first quarter of fiscal 2010.

 

In the first quarter of 2010, we announced that we were planning to develop a used oil re-refinery. The re-refinery is being designed to process up to 50 million gallons per year of used oil feedstock and produce up to 30 million gallons per year of lubricating base oil. The estimated capital cost of the project is approximately $40 million and we expect that the operation of the re-refinery will increase our working capital requirements by $5 million to $10 million. Our credit facility restricts our ability to incur or be obligated to make more than $10 million of capital expenditures in a fiscal year, provided that, pursuant to an amendment dated May 14, 2010, $42 million of capital expenditures with respect to the re-refinery would not be subject to this $10 million limitation. The re-refinery is expected to begin operating at partial capacity during 2012. As of March 27, 2010, $0.9 million has been spent and capitalized in connection with our construction of the re-refinery. During fiscal 2010 and 2011, we plan to roll out additional used oil collection routes to increase the volume of used oil that we collect and we estimate that we will incur roughly $1.0 million to $1.5 million of net expense, respectively, related to the roll out.

 

At January 2, 2010, our working capital was $16.8 million compared to $19.2 million at January 3, 2009. This decrease was mostly due to a decline in accounts receivable of approximately $2.7 million and a decline in inventory of $0.8 million. Also during the year, accounts payable declined by $1.0 million, which was partially offset by the increase in cash of $0.8 million. At March 27, 2010, working capital was $17.2 million. The increase is due to higher accounts receivable balances reflecting the increase in sales and higher inventory value due to rising crude oil prices.

 

Capital expenditures and software costs for fiscal 2007, 2008, 2009 and the first quarter of fiscal 2010 were $9.0 million, $5.2 million, $9.7 million and $1.4 million, respectively. In the first quarter of fiscal 2010, $0.3 million has been spent and capitalized in connection with our re-refining project. During fiscal 2009, we acquired the industrial real estate in which we were a tenant in Indianapolis, Indiana for $3.5 million. Approximately $3.7 million of the capital expenditures in fiscal 2009 were for purchases of parts cleaning machines compared to $3.4 million in fiscal 2008 and $3.5 million in fiscal 2007. The remaining $2.5 million

in fiscal 2009 was for other items including office equipment, leasehold improvements, software and intangible assets, compared to $1.8 million in fiscal 2008 and $0.7 million in fiscal 2007. The increase in fiscal 2009 compared to fiscal 2008 also includes $0.6 million spent on the exploration and development of our proposed used oil re-refinery. Otherwise, capital expenditures in fiscal 2009 compared to fiscal 2008 and fiscal 2007 were mostly flat in our parts cleaning and containerized waste business. Fiscal 2007 capital expenditures include $4.8 million for the completion of our solvent recycling tower.

 

Net cash provided by operations was $9.5 million, $4.7 million, $10.3 million, $3.1 million and $1.6 million in fiscal 2007, fiscal 2008, fiscal 2009 and the first quarter of fiscal 2009 and 2010, respectively. The increased net cash provided reflects our increased net income and reductions of our accounts receivable and inventory balances, share-based compensation and prepaid and other current assets. The net cash provided by operations in fiscal 2007 reflects the termination of a contract and one-time benefit.

 

Net cash used in investing activities was $9.0 million, $5.2 million, $9.7 million, $1.3 million and $1.4 million in fiscal 2007, fiscal 2008, fiscal 2009 and the first quarter of fiscal 2009 and 2010, respectively. The increase in fiscal 2009 from fiscal 2008 was primarily due to the capital expenditures for our purchase of the industrial real estate in Indianapolis, Indiana and amounts spent on the exploration and development of our proposed used oil re-refinery. The decrease in fiscal 2008 compared to fiscal 2007 was primarily due to the higher capital expenditures in fiscal 2007 for our solvent recycling system.

 

Net cash provided by (used in) financing activities was $(0.4) million, $0.4 million, $0.2 million, $0.1 million and $0.1 million in fiscal 2007, fiscal 2008 and fiscal 2009 and the first quarter of fiscal 2010, respectively. In March 2008, we raised net proceeds of $33.2 million from an initial public offering and concurrent direct placement. These net proceeds included offering costs of $0.9 million paid prior to fiscal year end 2007 and include approximately $1.0 million of offering costs paid subsequent the initial public offering. The proceeds were used to reduce borrowings under our bank credit facility, which included $10.9 million borrowed in March 2008 used to pay preferred members for an accrued return on preferred units as part of the reorganization.