Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in or incorporated by reference into this Form 10-Q, including statements regarding our future operating results, future financial position, business strategy, objectives, goals, plans, prospects, and markets, and plans and objectives for future operations, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “targets,” “contemplates,” “projects,” “predicts,” “may,” “might,” “plan,” “will,” “would,” “should,” “could,” “can,” “potential,” “continue,” “objective,” or the negative of those terms, or similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. Specific forward-looking statements in this Form 10-Q include statements regarding the impact, if any, of the adoption of the ASU on our consolidated financial statements; the impact of the Coronavirus Disease 2019 (“COVID-19”) pandemic on our results of operations and any changes to inflation rates; exposure to significant interest, currency, or credit risks arising from our financial instruments; and sufficiency of our cash and cash equivalents, borrowing capacity, and cash generated from operations to fund our operations for the next 12 months. All forward-looking statements included herein are based on information available to us as of the date hereof and speak only as of such date. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The forward-looking statements contained in or incorporated by reference into this Form 10-Q reflect our views as of the date of this Form 10-Q about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results, performance, or achievements to differ significantly from those expressed or implied in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, performance, or achievements. A number of factors, including the impact of our business acquisitions in 2022 and 2021 on future results, the state of the U.S. economy in general, general economic conditions and the potential effect of inflationary pressures and increased interest rates on our cost of doing business, could cause actual results to differ materially from those indicated by the forward-looking statements and other risks detailed from time to time in our reports to the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual Report”).
Overview
We were incorporated in Nevada in July 2002 under the name BlueStar Financial Group, Inc. On July 16, 2013, we acquired all of the issued and outstanding membership interests of Quest Resource Management Group, LLC, or “QRMG”, held by Quest Resource Group LLC, or “QRG”, comprising 50% of the membership interests of QRMG, or the QRMG Interests. Our wholly owned subsidiary, Quest Sustainability Services, Inc., or “QSSI” (formerly known as Earth911, Inc.), held the remaining 50% of the membership interests of QRMG for several years. Concurrently with our acquisition of the QRMG Interests, we assigned the QRMG Interests to QSSI so that QSSI now holds 100% of the issued and outstanding membership interests of QRMG. On October 28, 2013, we changed our name to Quest Resource Holding Corporation, or QRHC. On October 19, 2020, QRMG acquired substantially all of the assets used in the business of Green Remedies Waste and Recycling, Inc., a leading provider of independent environmental services, particularly in multi-family housing, located in Burlington, NC. On December 7, 2021, QSSI acquired all of the outstanding membership interests of RWS Facility Services, LLC (“RWS”), a full-service management company engaged in the brokering of recycling, waste and sustainability solutions, located in Chadds Ford, PA.
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on and relates primarily to the operations of QRHC and QRMG (collectively, “we,” “us,” “our,” or “our company”).
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Three Months Ended March 31, 2023 and 2022 Operating Results
The following table summarizes our operating results for the three months ended March 31, 2023 and 2022:
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Three Months Ended March 31, |
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2023 |
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2022 |
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|
(Unaudited) |
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Revenue |
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$ |
74,113,703 |
|
|
$ |
71,522,168 |
|
Cost of revenue |
|
|
61,483,944 |
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|
|
60,273,753 |
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Gross profit |
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12,629,759 |
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|
|
11,248,415 |
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Operating expenses: |
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|
Selling, general, and administrative |
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|
9,417,436 |
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|
|
9,344,462 |
|
Depreciation and amortization |
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|
2,424,844 |
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|
|
2,364,862 |
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Total operating expenses |
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11,842,280 |
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|
|
11,709,324 |
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Operating income (loss) |
|
|
787,479 |
|
|
|
(460,909 |
) |
Interest expense |
|
|
(2,443,028 |
) |
|
|
(1,556,585 |
) |
Loss before taxes |
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(1,655,549 |
) |
|
|
(2,017,494 |
) |
Income tax expense |
|
|
368,504 |
|
|
|
166,815 |
|
Net loss |
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$ |
(2,024,053 |
) |
|
$ |
(2,184,309 |
) |
Three Months Ended March 31, 2023 compared to Three Months Ended March 31, 2022
Global Economic Trends
The global economy, including credit and financial markets, has experienced extreme volatility and disruptions, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, increases in inflation rates and uncertainty about economic stability. For example, the COVID-19 pandemic resulted in widespread unemployment, economic slowdown and extreme volatility in the capital markets. Similarly, the current conflict between Ukraine and Russia has created extreme volatility in the global capital markets and is expected to have further global economic consequences, including disruptions of the global supply chain and energy markets. Any such volatility and disruptions may have adverse consequences on us or the third parties on whom we rely. If the equity and credit markets continue to deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner or on favorable terms, more costly or more dilutive. Inflation can adversely affect us by increasing our costs, including salary costs. Any significant increases in inflation and related increases in interest rates could have a material adverse effect on our business, results of operations and financial condition.
Revenue
For the three months ended March 31, 2023, revenue was $74.1 million, an increase of $2.6 million, or 3.6%, compared to $71.5 million for the three months ended March 31, 2022. The increase for the quarter was primarily due to increased demand including the impact of heightened customer production levels and increased services from certain new and continuing customers, partially offset by lower levels of services at certain other customers and lower values for commodities.
Cost of Revenue/Gross Profit
Cost of revenue increased $1.2 million to $61.5 million for the three months ended March 31, 2023 from $60.3 million for the three months ended March 31, 2022. The increase was primarily due to the same reasons impacting the increase in revenue.
Gross profit for the three months ended March 31, 2023 was $12.6 million, an increase of $1.4 million, compared to $11.2 million for the three months ended March 31, 2022. The gross profit margin was 17.0% for the three months ended March 31, 2023 compared to 15.7% for the same quarter of 2022. The changes in gross profit and gross profit margin percentage for the quarter were primarily due to the net effect of the impact of increased services from certain new and continuing customers, change in the mix of services and relative gross profit margins from new and acquired customer base, reduced operations at certain other customers, and reduced values for commodities.
Revenue, gross profit, and gross profit margins are affected period to period by the volumes of waste and recycling materials generated by our customers, the frequency and type of services provided, the price and mix of the services provided, commodity price changes for recycled materials, the cost and mix of subcontracted services provided in any one reporting period, and the timing of acquisitions and integration. Volumes of waste and recycling materials generated by our customers is impacted period to period based on several factors including their production or sales levels, demand of their product or services in the market, supply chain reliability, and labor force stability, among other business factors.
Operating Expenses
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Operating expenses were $11.8 million and $11.7 million for the three months ended March 31, 2023 and 2022, respectively.
Selling, general, and administrative expenses were $9.4 million and $9.3 million for the three months ended March 31, 2023 and 2022, respectively, an increase of $72,974. The increase primarily relates to increases in labor related expenses mostly offset by reductions in professional fees.
Operating expenses for the three months ended March 31, 2023 and 2022 included depreciation and amortization of $2.4 million and $2.4 million, respectively, an increase of $59,982.
Interest expense was $2.4 million and $1.6 million for the three months ended March 31, 2023 and 2022, respectively, an increase of approximately $0.9 million, as a result of additional borrowing related primarily to the acquisition in 2022 and increases in base interest rates. We are amortizing debt issuance costs of $3.3 million and OID of $2.2 million to interest expense over the life of the related debt arrangements as discussed in Note 8 to our condensed consolidated financial statements.
Income Taxes
We recorded a provision for income tax of $368,504 and $166,815 for the three months ended March 31, 2023 and 2022, respectively. The provision for income tax is primarily attributable to state tax obligations based on current estimated state tax apportionments for states with no net operating loss carryforwards.
We recorded a full valuation allowance against all our deferred tax assets (“DTAs”) as of both March 31, 2023 and December 31, 2022. We intend on maintaining a full valuation allowance on our DTAs until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 to 24 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain DTAs and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change based on the level of profitability that we are able to actually achieve.
Net Loss
Net loss for the three months ended March 31, 2023 was $(2.0) million compared to net loss of $(2.2) million for the three months ended March 31, 2022. The explanations above detail the majority of the changes related to the change in net results.
Our operating results, including revenue, operating expenses, and operating margins, will vary from period to period depending on commodity prices of recycled materials, the volumes and mix of services provided, as well as customer mix during the reporting period, and the timing of acquisitions and integration.
Loss per Share
Net loss per basic and diluted share attributable to common stockholders was $(0.10) for the three months ended March 31, 2023 compared to net loss per basic and diluted share of $(0.11) for the three months ended March 31, 2022.
The basic and diluted weighted average number of shares of common stock outstanding were approximately 19.9 million and 19.2 million for the three months ended March 31, 2023 and 2022.
Adjusted EBITDA
For the three months ended March 31, 2023, Adjusted EBITDA, a non-GAAP financial measure, increased 6.7% to $4.0 million from $3.7 million for the three months ended March 31, 2022.
We use the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, stock-related compensation charges, and other adjustments, or “Adjusted EBITDA,” to evaluate our performance. Adjusted EBITDA is a non-GAAP measure that is also frequently used by analysts, investors and other interested parties to evaluate the market value of companies considered to be in similar businesses. We suggest that Adjusted EBITDA be viewed in conjunction with our reported financial results or other financial information prepared in accordance with GAAP. For the three months ended March 31, 2023, other adjustments included severance and project costs as well as certain administrative fees related to borrowings. For the three months ended March 31, 2022, other adjustments included recruiting costs and certain administrative costs related to borrowings.
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The following table reflects the reconciliation of net loss to Adjusted EBITDA for the three months ended March 31, 2023 and 2022:
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As Reported |
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Three Months Ended March 31, |
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2023 |
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2022 |
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(Unaudited) |
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Net loss |
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$ |
(2,024,053 |
) |
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$ |
(2,184,309 |
) |
Depreciation and amortization |
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2,508,967 |
|
|
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2,437,209 |
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Interest expense |
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2,443,028 |
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1,556,585 |
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Stock-based compensation expense |
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298,431 |
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258,638 |
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Acquisition, integration and related costs |
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477,601 |
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1,305,936 |
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Other adjustments |
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(85,593 |
) |
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195,858 |
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Income tax expense |
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368,504 |
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166,815 |
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Adjusted EBITDA |
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$ |
3,986,885 |
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$ |
3,736,732 |
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Adjusted Net Income and Adjusted Net Income per Diluted Share
Adjusted net income, a non-GAAP financial measure, was $0.6 million for the three months ended March 31, 2023, compared with $1.3 million for the three months ended March 31, 2022. We present adjusted net income and adjusted net income per diluted share, both non-GAAP financial measures, supplementally because they are widely used by investors as a valuation measure in the solid waste industry. Management uses adjusted net income and adjusted net income per diluted share as one of the principal measures to evaluate and monitor the ongoing financial performance of our operations. We provide adjusted net income to exclude the effects of items management believes impact the comparability of operating results between periods. Adjusted net income has limitations due to the fact that it excludes items that have an impact on our financial condition and results of operations. Adjusted net income and adjusted net income per diluted share are not a substitute for, and should be used in conjunction with, GAAP financial measures. Other companies may calculate these non-GAAP financial measures differently. Our adjusted net income and adjusted net income per diluted share for the three months ended March 31, 2023 and 2022 are calculated as follows:
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As Reported |
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Three Months Ended March 31, |
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2023 |
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2022 |
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(Unaudited) |
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Reported net loss (a) |
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$ |
(2,024,053 |
) |
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$ |
(2,184,309 |
) |
Adjustments: |
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Amortization of intangibles (b) |
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2,221,669 |
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2,174,455 |
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Acquisition, integration and related costs (c) |
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477,601 |
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1,305,936 |
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Other adjustments (d) |
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(76,326 |
) |
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— |
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Adjusted net income |
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$ |
598,891 |
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$ |
1,296,082 |
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Diluted earnings per share: |
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Reported net loss |
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$ |
(0.10 |
) |
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$ |
(0.11 |
) |
Adjusted net income |
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$ |
0.03 |
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$ |
0.06 |
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Weighted average number of common shares outstanding: |
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Diluted (e) |
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22,158,132 |
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21,715,982 |
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(a) Applicable to common stockholders |
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(b) Reflects the elimination of the non-cash amortization of acquisition-related intangible assets |
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(c) Reflects the add back of acquisition/integration related transaction costs |
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(d) Reflects adjustments to earn-out fair value |
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(e) Reflects adjustment for dilution as adjusted net income is positive |
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Liquidity and Capital Resources
As of March 31, 2023 and December 31, 2022, we had $9.8 million and $9.6 million in cash and cash equivalents, respectively. Working capital was $18.1 million and $19.7 million as of March 31, 2023 and December 31, 2022, respectively.
We derive our primary sources of funds for conducting our business activities from operating revenues; borrowings under our credit facilities; and the placement of our equity securities to investors. We require working capital primarily to carry accounts receivable,
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service debt, purchase capital assets, fund operating expenses, address unanticipated competitive threats or technical problems, withstand adverse economic conditions, fund potential acquisition transactions, and pursue goals and strategies.
We believe our existing cash and cash equivalents of $9.8 million, our borrowing availability under our $25.0 million ABL Facility (as defined and discussed in Note 8 to our condensed consolidated financial statements), and cash expected to be generated from operations will be sufficient to fund our operations for the next 12 months and thereafter for the foreseeable future. Our known current- and long-term uses of cash include, among other possible demands, capital expenditures, lease payments and repayments to service debt and other long-term obligations. We have no agreements, commitments, or understandings with respect to any such placements of our securities and any such placements could be dilutive to our stockholders.
Cash Flows
The following discussion relates to the major components of our cash flows for the three months ended March 31, 2023 and 2022.
Cash Flows from Operating Activities
Net cash provided by operating activities was $3.0 million for the three months ended March 31, 2023 compared with net cash used in by operating activities of $(0.4) million for the three months ended March 31, 2022.
Net cash provided by operating activities for the three months ended March 31, 2023 related primarily to the net effect of the following:
•net loss of $(2.0) million;
•non-cash items of $3.3 million, which primarily related to depreciation, amortization of intangible assets and debt issuance costs, provision for doubtful accounts, and stock-based compensation; and
•net cash provided by the net change in operating assets and liabilities of $1.7 million, primarily associated with relative changes in accounts receivable, accounts payable, and accrued liabilities.
Net cash used in operating activities for the three months ended March 31, 2022 related primarily to the net effect of the following:
•net loss of $(2.2) million;
•non-cash items of $3.3 million, which primarily related to depreciation, amortization of intangible assets and debt issuance costs, provision for doubtful accounts, and stock-based compensation; and
•net cash used in the net change in operating assets and liabilities of $(1.5) million, primarily associated with relative changes in accounts receivable, accounts payable, and accrued liabilities.
Our business, including revenue, operating expenses, and operating margins, may vary depending on the blend of services we provide to our customers, the terms of customer contracts, commodity contracts, and our business volume levels. Fluctuations in net accounts receivable are generally attributable to a variety of factors including, but not limited to, the timing of cash receipts from customers, and the inception, increase, modification, or termination of customer relationships. Our operating activities may require additional cash in the future from our debt facilities and/or equity financings depending on the level of our operations.
Cash Flows from Investing Activities
Cash used in investing activities for the three months ended March 31, 2023 was $(0.2) million. Cash used in investing activities for the three months ended March 31, 2022 was $(3.5) million and primarily related to the $3.1 million net purchase of the assets of a northeast-based independent environmental services company on February 10, 2022. Other investing activities are primarily from purchases of property and equipment and intangible assets such as software development costs.
Cash Flows from Financing Activities
Net cash used in financing activities for the three months ended March 31, 2023 was $(2.5) million, primarily from net repayments of $(2.3) million on our ABL Facility. Net cash provided by financing activities for the three months ended March 31, 2022 was $3.3 million, primarily from borrowings of $3.5 million from the Credit Agreement with Monroe Capital used to finance the February 2022 acquisition of an independent environmental services company. See Note 8 to our condensed consolidated financial statements for a discussion of the ABL Facility and other notes payable.
We made an additional $5.0 million principal payment on our Monroe Capital credit facility in May 2023.
Inflation
Although the overall economy has experienced some inflationary pressures, we do not believe that inflation had a material impact on us during the three months ended March 31, 2023 and 2022. We believe that current inflationary increases in costs, such as fuel, labor, and certain capital items, can be addressed by our flexible pricing structures and cost recovery fees allowing us to recover certain of the cost of inflation from our customer base. Consistent with industry practice, many of our contracts allow us to pass
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through certain costs to our customers or adjust pricing. Although we believe that we should be able to offset many cost increases that result from inflation in the ordinary course of business, we may be required to absorb at least part of these costs increases due to competitive pressures or delays in timing of rate increases. Although we have not been materially affected by inflation in the past, we can provide no assurance that we will not be affected in the future by higher rates of inflation and increases in interest rates.
Critical Accounting Estimates and Policies
Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. These areas include carrying amounts of accounts receivable, goodwill and other intangible assets, stock-based compensation expense, deferred taxes and the fair value of assets and liabilities acquired in asset acquisitions. We base our estimates on historical experience, our observance of trends in particular areas, and information or valuations and various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying value of assets and liabilities that may not be readily apparent from other sources. Actual amounts could differ significantly from amounts previously estimated. For a discussion of our critical accounting policies, refer to Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2022 Annual Report. Other than the adoption of ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) as discussed in Note 2 to our condensed consolidated financial statements, there have been no significant changes in our critical accounting policies during the three months ended March 31, 2023.
Recent Accounting Pronouncements
See Note 2 to our condensed consolidated financial statements.
Off-Balance Sheet Arrangements
We have no off-balance sheet debt or similar obligations. We have no transactions or obligations with related parties that are not disclosed, consolidated into, or reflected in our reported results of operations or financial position. We do not guarantee any third-party debt.