June 2008 Interview with: Heritage-Crystal Clean, Inc., (HCCI-NASDAQ) Chief Financial Officer & Vice President of Business Management, Gregory Ray - featuring: their parts cleaning, hazardous and non-hazardous waste services to small and mid-sized customers in both the manufacturing and automotive service sectors.

Heritage-Crystal Clean, Inc. (HCCI-NASDAQ)

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Heritage-Crystal Clean Is One Of Only A Few Companies That Focuses On The Needs Of Small And Mid-Sized Businesses Such As Manufacturers And Auto Repair Shops That Need To Collect, Remove And Discard Hazardous Waste



Industrial Goods
Waste Management
(HCCI-NASDAQ)

Heritage-Crystal Clean, Inc.

2175 Point Boulevard, Suite 375
Elgin, IL 60123
Phone: 847-836-5670



Gregory Ray
Chief Financial Officer & Vice President of Business Management

Interview conducted by:
Lynn Fosse, Senior Editor
CEOCFOinterviews.com
Published – June 13, 2008

BIO:
Gregory Ray is the Chief Financial Officer and Vice President of Heritage-Crystal Clean, Inc., and he has been with the company since shortly after it was organized in 1999. He recently led the company’s successful initial public offering. Mr. Ray has been involved with the environmental services industry for roughly 25 years. Prior to joining HCCI, he served as Vice President of Business Management for Safety-Kleen Corp., where he was responsible for a $700 million revenue business that included used oil collection, parts cleaning, and hazardous waste services. Prior to that, Mr. Ray helped establish the business of Evergreen Oil, a leading North American used oil re-refiner based in California.

Company Profile:

Heritage-Crystal Clean, Inc. provides parts cleaning, hazardous and non-hazardous waste services to small and mid-sized customers in both the manufacturing and automotive service sectors. Our service programs include parts cleaning, containerized waste management, used oil collection, and vacuum truck services. These services help our customers manage their used chemicals and liquid and solid wastes, while also helping to minimize their regulatory burdens. Our customers include businesses involved in vehicle maintenance operations, such as car dealerships, automotive repair shops, and trucking firms, as well as small manufacturers, such as metal product fabricators and printers. Heritage-Crystal Clean, Inc. is headquartered in Elgin, Illinois, and operates through more than 50 branches serving over 36,000 customer locations.

CEOCFO: Mr. Ray, what is the vision for Heritage-Crystal Clean?

Mr. Ray: “The vision that we have had since we started in 1999 was to become a significant player in the environmental services business with a focus on the needs of small and mid-sized customers. The environmental service business we address involves the collection and removal of discarded, spent and hard-to-handle materials from small businesses across the United States. This is an industry that we know fairly well. Sometimes this is characterized as the ‘hazardous waste’ business, but it transcends that regulatory definition. In this industry there are many companies or vendors that focus on the needs of large customers that generate big quantities of waste materials; chemical plants and refineries, for example. However, there are relatively few companies like ours that have made it a special focus to try to deal with the unusual and unique needs of smaller customers, businesses who often are looking for higher levels of service and more advice or guidance regarding the appropriate ways to manage their waste. They need to know how to comply with the regulations that state and federal agencies have developed to try and protect the environment from harm caused by mismanagement of these waste materials. Therefore, we are targeting those smallest customers.”

CEOCFO: Give me an example of a typical customer and what you might be doing for them.

Mr. Ray: “A classic customer would be an automobile shop, a place you would take your car for some sort of maintenance work; it could be a car dealer or a corner gas station that does vehicle maintenance. Their service techs, when they are working on your car, might be taking out parts to work on them, and they need to clean oil and grease off of those parts. Therefore, they would use a solvent and a parts cleaner to wash the parts off so that they could repair them. We provide parts cleaning services: we will provide the machine, deliver new solvent, and take away the used solvent. While they are working on your car they might also remove dirty antifreeze or used oil or used oil filters, and we can take these back to our facilities and redirect them to the proper recycling outlets. If they are painting your vehicle as part of a repair job, they will end up with waste paints, and we will provide them with paint thinners and pick-up the waste that results and take that for energy recovery. Another typical customer would be a manufacturer such as a metalworking business. They might have not only some of the same kinds of waste that an automotive shop might have (for example used oils from machinery and equipment and waste paints), but they might also have other waste chemicals in small quantities. They would also need to discard or have recycled those waste chemicals. We can address the full range of waste material that they generate, analyze them with the customer, figure out what the best thing is to do with them and handle them efficiently.”

CEOCFO: What do you do with the waste material?

Mr. Ray: “We view ourselves as the service provider to help the customer figure out what these wastes are and get rid of them, and to accomplish this we built a reverse distribution network that is quite efficient. We operate out of 54 branch locations and we service our customers from these branch locations. We have reps that are going out and characterizing the waste, helping the customer label it, helping them with the hazardous waste paperwork or other manifesting documents or shipping papers. We then bring the collected material back into our branches, and then we are promptly reshipping it to one of our four operational hubs. Those hubs then consolidate the material and in almost all cases we are shipping it on to somebody else, another company that we have evaluated and audited and that we feel does a good job of recycling that particular material or waste. Our used oil would go to one of several companies that we work with who recycle and reprocess the used oil, either turning it back into lubricants or fuels. The used oil filters that we pick up go to one of the scrap metal recyclers that we work with who are able to use the scrap metal in the remanufacture of steel. The hazardous waste that has high energy value we will ship to one of several vendors we work with who take that material, blend it, and make a supplemental fuel that is used in a cement kiln. We are always shopping for the best outlets for these materials, and even though each one of our customers gives us very small quantities, by servicing tens of thousands of customers, we are accumulating large volumes. We are usually a good customer for these third-party facilities, so they will be competitive on price for us, and we develop solid relationships and are able to establish some good long-term deals as a result – an arrangement that hopefully translates back to good programs for our small customers.”

CEOCFO: Do you tend to have long-term contracts with your customers, and what is your retention rate?

Mr. Ray: “Our typical arrangement is that our customers sign up on a standard service agreement that we use. It has an automatic renewal, so it is a one-year agreement that renews automatically and most of our customers are very comfortable just letting that run and renewing on an evergreen basis. We don’t report a figure for customer retention. We do track parts cleaning machine retention, or actually the inverse, which we call the ‘pull rate.’ This pull rate has been in the neighborhood of 15% to 20% for many years. You can translate that into something that is like an 80% retention rate, but that is not a true measure of customer retention, because if a customer has three machines and decides to downsize to two machines, that affects this pull rate but it doesn’t mean we have lost the customer.”

CEOCFO: What is the competitive landscape for you, and why are people choosing Heritage-Crystal Clean?

Mr. Ray: “The largest competitor and one that has been dominant for many years is a company called Safety-Kleen. Safety-Kleen virtually invented this business; starting in the late 1960’s they developed and rolled out a nationwide parts cleaning service, and over the next couple of decades they added on a number of other environmental services to the same small customer set. Safety-Kleen grew from a very small company based in Milwaukee to a national powerhouse in this industry, exceeding a billion dollars in sales by about 1998. They were publicly traded for many years and were very much a darling of Wall Street because of their great financial track-record. Safety-Kleen fell victim to a hostile takeover in 1998; the acquiring company was Laidlaw Environmental Services, or ‘LES.’ Subsequently the management of LES that had taken over Safety-Kleen led the company into bankruptcy and it later turned out that the management of LES had been guilty of egregious financial misstatements, and some members of their management team got into significant trouble. Quite a few of our senior managers had worked for Safety-Kleen prior to the LES takeover; these people were very experienced in the industry and didn’t want to continue with Safety-Kleen following the LES acquisition. Therefore, in some respects Heritage-Crystal Clean formed and grew at the time when Safety-Kleen was on a decline.

In terms of why customers choose our services over Safety-Kleen or other competitors, there are a number of factors that differentiate us. One of them is that our parts cleaning service is designed to reduce the regulatory burdens experienced by our customers. Traditionally in parts cleaning services, when customers end up with dirty solvent, most companies have managed that dirty solvent as a hazardous waste under the federal regulations. By managing the solvent as hazardous waste, they impose a regulatory burden on customers.  For each waste shipment, the customer must complete a hazardous waste manifest and has to get back copies of that manifest by tracking them to the end disposal facility. They also need to get EPA Identification numbers, and they are subject to various reporting requirements, and waste minimization plans. There is a wealth of complexity that enters a small customer’s life when he starts generating hazardous waste and being subject to the state and federal regulations. What Heritage-Crystal Clean has developed (and we continue to be very proud of) is a program where we still give customers solvent and they use it for cleaning, but it doesn’t end up requiring them to deal with all the hazardous waste bureaucracy. We accomplish that through two programs. One of them is our Reuse Program, where we take the customer’s solvent and instead of managing it for disposal or to a recycling plant, we take that used solvent and we are able to resell it as an ingredient in another company’s manufacturing process. We have customers who can take the used solvent and use it in making roofing asphalt products, and the result of that is from a regulatory perspective the used solvent when it leaves the first customer, for example the auto shop, is not considered a waste. Therefore, it keeps that customer out of the hazardous waste regulatory scheme as far as that solvent is concerned. This may sound a little like a loophole but it is not, it is just what the EPA would like to see done with used materials: that they are recovered for reuse.

In order to demonstrate the legitimacy of this approach, we go to the states where we operate this program and we get the state environmental agencies to issue a concurrence letter. This is where they look at how we are running our program and they agree that it is correct. We have concurrence letters from about thirty-five states now. The other way that we help our customers get out of hazardous waste regulations in parts cleaning is with our Non-Hazardous Program, where we deliver to them a higher flash point solvent, and if they don’t throw any hazardous waste in, then that used solvent doesn’t end up being regulated as a hazardous waste. When we remove the used solvent from their premises, they are able to avoid some of the most onerous hazardous waste paperwork. Customers really like that, especially those small customers I described as our focus, because they typically don’t have a person on staff who has been trained to do environmental compliance. Usually those responsibilities fall on the shoulders of a maintenance manager or production manager who is not really comfortable dealing with all the EPA rules. Therefore, if we can minimize or eliminate these burdens, it is a real relief for them. We take this low burden approach not only with our parts cleaning service, but with our other services. We typically design them in ways where we think of the customer’s needs first. Figuring out ways to way to reduce the regulatory burden is important – eliminating bureaucracy saves our customers money in terms of their overall operation.”

CEOCFO: You became a public company in March; why was this the time?

Mr. Ray: “The vision we had when we started this business in 1999 was to grow to a scale where we were able to be a viable public company. Our management team and our board supported the idea that long-term we should be a public company, not only as a good approach to the way that our company would be structured from a capital perspective, but also because as a historically high-growth company, we wanted our employees to be able to participate in owning stock and we wanted to be able to offer stock option plans. This was something that we had always envisioned as an important part of our long-term plan. The questions in our minds for a number of years were: ‘are we ready yet?’, ‘is the market ready to support our business?’ and ‘are we at a scale that we can absorb the public company costs and continue to be successful?’ We had retested that annually for the last several years, and last year was the first time that we thought that the market was going to be receptive. Our story was well established in terms of our track record of growth, and we felt that we had reached a scale where we could have a meaningful and successful IPO. After a conference with our investment bankers and our board, we felt like it was the right time - that we were able to cross that threshold - and so we took a shot at it. March of 2008 was a very difficult time for public offerings. I am not sure but I think we may have been one of only three companies to have a successful IPO during the month and I think that speaks to the quality of our business, the interest that investors have in the kind of company that we have built, and our potential to continue to grow. It is a credit to our investment banking and support team for the IPO that we were able to have a successful IPO in such a difficult market.”

CEOCFO: What is the financial picture of the company?

Mr. Ray: “Our financial situation is strong. We have been growing for the last several years on a very regular basis; our top line growth is in the neighborhood of twenty percent a year. It is a fairly good track record of consistent and stable growth. We have shown good steady growth quarter after quarter. It is our hope that we will continue this pattern and that we will continue to see top-line and bottom-line growth in the years ahead.”

CEOCFO: Where do you see growth coming from?

Mr. Ray: “There are a couple of ways we get our growth today; some of our growth comes from geographic expansion. We have opened new branches regularly. I believe that year-over-year we have grown by about six branches in the past year. We also have very strong same-branch sales growth (that is a comparable metric to the one often used in retail when they talk about same-store growth). Our same-branch sales growth in the last year has been in the neighborhood of 17%, so that means that we are still finding lots of opportunities to find new customers within our existing branches. One way that we grow is expanding our market share, another is selling additional services to existing customers: both of those are important for us to grow. In addition, in the market that we are in, customers have accepted some reasonable price increases, which is an element of our revenue growth. Because part of what we do is transportation, you can appreciate that in the last year (when there have been unprecedented increases in energy and fuel costs), we have had to raise our prices and our customers have accepted that.”

CEOCFO: Why should potential investors be interested and what might investors overlook about Heritage that they should understand?

Mr. Ray: “We have had a very solid historical track record for several years at Heritage-Crystal Clean: delivering steady growth at the top-line and steady annual improvements at the bottom-line. Our profits are expected to be impacted in the current year by our public company costs, including the cost of complying with Sarbanes Oxley and filing registration documents, but long-term we will strive for growth. Equally important, we have a management team that has many years of industry experience prior to forming Heritage-Crystal Clean. Most of our senior managers worked for Safety-Kleen and most of them had important roles in building Safety-Kleen into a successful large company. To borrow a term that the investment bankers use, we have great ‘scalability,’ most of our senior managers have run larger divisions and have worked for significantly larger businesses than they are working for today. For example, John Lucks, our VP of Sales, was responsible for the formation and success of a $300 million industrial waste business during his tenure at Safety-Kleen. We don’t see a substantial risk that our management team is going to plateau and be unable to achieve the next level of growth. In terms of risks that some investors might not appreciate from a legal perspective, I would direct anybody who is interested in investing to review our Prospectus that was recently filed with the SEC in connection with our IPO, as it describes risk factors related to the business. I would be hard-pressed to point to a single one that I think is the most important or most likely to be overlooked. I previously commented that we are affected by energy prices, and this may continue to be an important factor in our future. I also point out that in our industry, that we are not at all uncomfortable being the number-two in size for parts cleaning behind Safety-Kleen. Obviously, in any industry where there is a large dominant player, you have to take that into consideration. Recently Safety-Kleen has filed their own S-1 that indicated their intention to consider an initial public offering; we don’t see that in and of itself having a meaningful affect on us but we don’t know what their further plans might be.”

CEOCFO: Final thoughts; what should people remember most about Heritage-Crystal Clean?

Mr. Ray: “We have a deeply experienced and successful management team that has delivered successive growth for a long time.”

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“The vision that we have had since we started in 1999 was to become a significant player in the environmental services business with a focus on the needs of small and mid-sized customers. The environmental service business we address involves the collection and removal of discarded, spent and hard-to-handle materials from small businesses across the United States. This is an industry that we know fairly well. Sometimes this is characterized as the ‘hazardous waste’ business, but it transcends that regulatory definition.” - Gregory Ray