Hudson Technologies' CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Hudson Technologies, (HDSN)

Hudson Technologies, Inc. (NASDAQ:HDSN)

Q4 2013 Earnings Conference Call

February 26, 2014 17:00 ET

Executives

John Nesbett - Investor Relations, IMS

Kevin Zugibe - Chairman and Chief Executive Officer

Brian Coleman - President and Chief Operating Officer

Analysts

Philip Shen - ROTH Capital Partners

Steve Dyer - Craig-Hallum Capital Group

Operator

Greetings, ladies and gentlemen and welcome to the Hudson Technologies’ Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, John Nesbett of IMS. Thank you, sir. You may begin.

John Nesbett - Investor Relations, IMS

Good evening and welcome to our conference call to discuss Hudson Technologies’ financial results for the 2013 fourth quarter and year end. On the call today we have Kevin Zugibe, Hudson’s Chairman and Chief Executive Officer; and Brian Coleman, Hudson’s President and Chief Operating Officer. Kevin will review the company’s business operations and future growth strategies and Brian will review the financials. And immediately thereafter, we will take questions from our call participants.

I will now take a moment to read the Safe Harbor statement. During the course of this conference call, we will make certain forward-looking statements. All statements that address expectations, opinions or predictions about the future are forward-looking statements. Although they reflect our current expectations and are based on our best view of the industry and of our businesses as we see them today, they are not guarantees of future performance. These statements involve number of risks and assumptions. And since those elements can change, we would ask that you interpret them in that light. We urge you to review Hudson’s Form 10-K and other SEC filings for a discussion of the principal risks and uncertainties that affects our performance and the factors that could cause our actual results to differ materially.

With that, I will now turn the call over to Kevin. Go ahead, Kevin.

Kevin Zugibe - Chairman and Chief Executive Officer

Good evening and thank you for joining us. I hope all of you have had a chance to review our fourth quarter and 2013 year end earnings release issued this afternoon.

2013 is a difficult year to characterize as we saw several extreme dynamics impact our business. We began the year with record first quarter performance as our business model started to see the benefits from the R-22 phase-out as mandated by the Montreal Protocol. However, following the EPA ruling in April, which increased R-22 allowances for 2015 and ‘14, the aftermarket encountered pricing turbulence ultimately resulting in a 50% price decline in R-22. As we said before, we do our best to manage through the things we can’t control such as the EPA rulings and R-22 pricing while executing on the things we can control like customer relationships and driving sales during the selling season. Our strong sales volume in the latter part of the selling season allowed us to achieve an overall 4% growth in annual sales, which is a notable achievement given the challenging environment. However, it fell short of our stated goal to continue double-digit revenue growth, which dates back to 2003.

During the fourth quarter of 2013 as we saw a slight decline in revenues recording slightly higher revenues from refrigerant sales offset by a decrease in revenues related to our service business as certain service jobs started in the fourth quarter were completed during the first quarter of 2014. Overall, for the fourth quarter, we posted a net loss of $1.5 million or $0.06 per basic and diluted share as compared to net income of $3 million or $0.12 per basic and $0.11 per diluted share in the fourth quarter of ‘12. However, the quarter-to-quarter comparison is deceiving since the difference between the quarters is due almost entirely to our recognition in 2012 the non-cash deferred tax benefit of approximately $4.6 million, which should not reoccur in the fourth quarter of 2013. Therefore, the results for the quarter would have been similar without the tax benefit in the 2012 period.

Going forward, we do not expect to see unusual tax charges benefits and will likely be wrecking us in statutory rates. With the price volatility we experienced in 2013 compounded by inventory adjustments, there will be limited comparability between 2013 and 2014, particularly in the first quarter of 2014 through the fact that 2013 pricing of R-22 was twice as high as where it is today. We are in some ways pushing the reset button, but it is important to keep in mind that the refrigerant sales season is a nine-month season, not a quarter-to-quarter season. Because of the unusual action taken by the EPA with its April 2013 rule and the corresponding negative impact to our business. We have taken unprecedented actions to address the negative environmental impact resulting from the EPA’s rule. We have actively engaged decision and policy makers and expect that we will need to continue our efforts for the foreseeable future particularly while the 2015 to 2019 rulemaking is still pending.

Of note, we exited 2013 with some positive news as we previously reported in December the EPA issued the proposed rule for R-22 allowances for the 2015 to 2019 period. Under what the EPA refers to as it’s preferred option the EPA has proposed a five year straight line reduction scheduled beginning in 2015 with allowances of 30 million pounds, which is a 40% reduction from 2014 level and ending zero allowances by 2020. The public comment on the proposed rule ends in early March and the final rule is expected later this year. We are hopeful that the EPA will propose a more aggressive phase down in the final rule as many industry stakeholders have called on the EPA to adopt a more aggressive phase down schedule starting with 22 million allowances in 2015 and steadily dropping to zero by 2020.

In addition, at our request earlier this week 39 members of Congress sent a letter to the EPA urging EPA to be more aggressive in the final rule. Of note, the letter was signed by Senator Barbara Boxer, Chair of the Senate Environment and Public Works Committee and Henry Waxman, the lead Democrat on the House Energy and Commerce Committee. In the coming months we will continue directly making our case to senior administration officials in the White House on EPA.

Let’s focus for a minute on what we are working towards. Under the Montreal Protocol virgin R-22 production must be reduced to zero by no later than December 31, 2019 and the reclamation industry will then become the primary source of supply of R-22 until these systems come to the end of life.

We continue to believe that as the R-22 phase out progresses, the aftermarket demand will exceed the total allowances and reclaimed R-22 will bridge the supply gap. Additionally for 2020 the EPA projects the aftermarket demand to be 50 million pounds. Currently, there is approximately 10 million pounds of reclaims annually so we are expecting a significant growth in reclamation.

We have an extensive network to harvest recover infringements and are focusing on extending our network. In addition to the network we already have in place, we are developing and testing new proprietary technology to expand our reach to address the anticipated growth in reclamation. We are confident that market reliance on R-22 will create a significant opportunity for our company for many years to come. One area of our business which is beginning to gain some traction is our global energy services division. Over the last couple of years we have extended the breadth of our offerings to improve the real time optimization and core protection and diagnostics of energy systems in industrial plants and commercial facilities. The capability is a result of the software acquisition we completed just over a year ago and are now integrated with our existing system.

Data from these systems is sent to Hudson on a real time basis allowing our engineers to work directly with our customers to optimize their systems. This allows us to work directly with end users advising them continuously and becoming their one stop shop for energy efficiency and cost saving solutions. We expect meaningful growth in this area of our business this year with significant growth in the following years.

Additionally, our international work with the UN has resulted in the successful completion of industrial energy projects in South Africa and Vietnam. Currently, work continues with Thailand, Indonesia and Malaysia, where we are system energy experts working with the in country government agencies and industries to improve the energy efficiency of steam systems. At the same time, we remain focused on driving sales volume and serving our customers as we move towards the cessation of Virgin R-22 production in 2020. And we believe our position as a leading reclaimer of all types of refrigerant will play a key role in support of that mandate.

With that I will hand it over to Brian to provide our detailed financial results.

Brian Coleman - President and Chief Operating Officer

Thank you, Kevin. Revenues for the fourth quarter decreased slightly to $4.8 million as compared to $4.9 million in the fourth quarter of 2012. In the fourth quarter we saw slightly higher refrigerant sales volumes offset by slightly lower service revenues. Operating expenses for the fourth quarter remained about the same at $2.4 million, down slightly compared to $2.5 million in the previous year.

Net loss from the quarter was $1.5 million or a loss of $0.06 per basic and diluted share compared to net income of $3 million or $0.12 per basic and $0.11 per diluted share in the fourth quarter of 2012. The entire difference between the net loss of 2013 and a net income of 2012 was due to the company’s recognition of the non-cash deferred tax benefit of approximately $4.6 million, which did not reoccur in the fourth quarter of 2013. We do expect more normalized statutory tax rate for 2014 and beyond, but we still pick up the cash benefit to offset the expense due to the utilization of the net operating loss carry forwards associated with our $5 million deferred tax assets.

During the third quarter of 2013, we reported inventory write-down recording a lower of cost to market adjustment to our inventory of $14.7 million due to the decline in the R-22 pricing. As a result of the third quarter market adjustment, we expected it will take a quarter or two for the company return to more historical gross margins.

Revenues for the year ended December 31, 2013 increased 4% to $58.6 million as compared to revenues of $56.4 million in the prior year. The increase in revenues was primarily related to an increase in the average prices of certain refrigerants offset by slight reduction in the number of pounds sold. Revenues were also favorably impacted by an increase in the number of service jobs completed offset to a lesser extent by a decrease in the average price of those jobs compared to 2012. Excluding that $14.7 million lower cost to market inventory adjustment for 2013, Hudson achieved non-GAAP gross profit of $14 million and non-GAAP operating income of $6.2 million. Please refer to today’s press release for that reconciliation of GAAP to non-GAAP information.

Operating expenses increased slightly during the year to $7.8 million compared to $7.7 million in 2012 period. The increase is primarily related to an increase selling expenses offset by the reduction of certain payroll expenses. Net loss for the year ended December 31, 2013 was $5.8 million or $0.24 per basic and diluted share compared to net income of $12.8 million or $0.54 per basic and $0.49 per diluted share in 2012.

Now, I am turning to the balance sheet, as of December 31, 2013, the company $34 million in inventory a decrease from $40 million at December 31, 2012 is primarily related as a result of the inventory write-downs recorded in the third quarter of 2013. In light of extreme price volatility in ’13 we amended our credit facility with PNC in October and removed the fixed charge covenant calculation and replaced the covenant with an EBITDA covenant calculation. We appreciate PNC working with us during the difficulties we encountered as a result of the EPA’s rule this year or actually in ’13. We expect that our recently extended credit facility with PNC will be sufficient to meet our needs for the future as an EPA returns to a set down approach noted in the preferred option for the phase out of R-22. At the end of December 2013 we had over $8 million of availability under the credit facility and approximately $20 million of working capital.

At this point I would like to turn the call back over the Kevin for some final thoughts.

Kevin Zugibe - Chairman and Chief Executive Officer

As those of you who followed us for a while already you know we operate in a dynamic industry. The April 2013 ruling was a setback, but we are increasingly optimistic about the opportunities ahead of us and Hudson’s competitive edge comes from the agility of management and our employees in meeting the needs of our customers in spite of the unexpected changes that take place in our marketplace. Our proven skill set allows to further solidify our position as a leading provider and reclaimer of refrigerant as well as expert in the reliability and performance of large energy consuming systems.

Thank you for your interest in and support of our company. Operator we will now open the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Philip Shen with ROTH Capital Partners. Please proceed with your question.

Philip Shen - ROTH Capital Partners

Hi guys, thanks for taking my questions.

Kevin Zugibe

Hi good evening.

Philip Shen - ROTH Capital Partners

First question on the fourth quarter, can you talk to us about the gross margins in the quarter I know you had the impact of write-down in Q3, but what happened with the Q4 gross margins?

Kevin Zugibe

Mainly believe or not that shifting of the service revenues which we mentioned because the service revenues you have basically book all your expenses, we kind of have fixed cost primarily for the service were to perform, there is very little variable cost. The fact that the revenue shifted into January had a direct dollar-for-dollar impact on the gross profit dollar. So a lot of what happened here was just kind of timing on the completion of some of these jobs. The fourth quarter always is a very slow quarter, always a quarter where we obviously have all our fixed cost in but very little revenue. So it really skewed this margin percentage as a result really primarily that factor.

Philip Shen - ROTH Capital Partners

Okay. So as a result should we see disproportionately better margins in Q1 although you talked about another recovery might take sometime as well?

Kevin Zugibe

Well probably what’s going to happen is we’re going to see margin improvement let’s say sequentially. If you think about what happened last year it’s going to take a while, we take a few quarters to get back to more normal results. It’s difficult to pin the timing because the business is seasonal particularly with a strong second quarter we should see better margins than with the first quarter it’s difficult at times particularly this first quarter we’re starting the season a few weeks later than normal because of the crazy weather we had in the month of February probably just slowed the start down by few weeks particularly in the South and Southeast. So on an overall basis it’s just going to take a few quarters to get back to something normal that’s the kind of thing that typically – it’s a sequential development quarter-to-quarter.

Philip Shen - ROTH Capital Partners

Okay, great. As for R-22 pricing the last round of channel checks we did back in January suggested that we hit a bottom of pricing in December and pricing was closer to $68 per pound in January. Can you comment on where pricing may stand today and what your expectations are going into the cooling season, I know there is fair amount of inventory, is there any commentary on pricing would be helpful?

Kevin Zugibe

Yes, I think we noted a few times now that the channel checks are very good. So I would say the numbers that you’re seeing and hearing are in line with what we’re seeing and hearing. We’ve been saying that the number around seven but certainly there is a range of numbers out there. We report probably by now we would start to see a little development in the overall market but it really would be correspond to what we just talked about in terms of when the season kicks off. The season is kicking off a little bit later than let’s say normal, but it’s – again the fact that we had a cool February and cool weather in the South is a lot different outcome than the cool weather in the summer or cool weather in June spring. It just that – we still look in the top of the first inning of nine month season. So with volume we start to see price stabilization typically and so forth.

What are you seeing a little bit too on is and again we have to watch it closely to – we’re starring at it looking at the (indiscernible) in a market try and make sure we understand what’s happening. And what happens as Brian said it’s a season right so it’s not just the quarter so but if it’s not in the first quarter will likely to be moved to second that’s why they reverse sometimes for us depends on when the buying season is. But the difference is going into this year it’s a one different than we watch and we didn’t know what the effect would be so much of it because that will be – but the whole industry I would say the people in a position to buy (indiscernible), all got punched into some cluster. So they found themselves holding inventory at a higher number that they purchased first quarter say and second quarter now it’s lower number.

So it will be likely and we’re seeing and I guess is it’s just temperature if people trying to do more of just in time buying right now and we’re not 100% sure how this will work out – the South process, Southeast that’s colder than normal that’s when you would have gotten the first start but is it also they want a little of their shelves up yet but you’re not quite sure what’s going to happen on price again this year. So it doesn’t hurt us – it doesn’t scare us for the season how many pounds would be sold. But it’s the volume being a little hard right now because people are little reluctant to load their shelves because of what happened last year.

Philip Shen - ROTH Capital Partners

Okay. Thank you, Kevin. One last question and I’ll jump back in queue. Can you talk about the latest with EPA, I know you had in your prepared remarks, there is – it sounds like you are adding or increasing support by capital held. Do you have a sense for when the final goal maybe issued and do you feel like through this public commentary thus far, have you seen any consensus developed around one of the three options that the EPA has outlined, perhaps either enhance option to with only to drive down over three years as supposed to five or if you feel like the five-year option is the one that we are most likely going to end up with? Thank you.

Kevin Zugibe

Yes, it’s a good question. Just back up one second, we mentioned during this – we were actually very happy with earlier this week, 39 members of Congress signed a letter to urge the EPA to adopt a faster phase down schedule, I think just happened. We are working very hard in different channels trying to get them to do more than what they proposed in December. Now, we think what they proposed in December, we would get some – we think is accept 40% reduction is a big step. We felt they could do more. And we think that is the right message to say we see that there is too much supply of 22 out there and we are going to cut it back, but again trying to get everyone to understand that the reclamation market could step up to fill the need and also as other environmental impacts to 22. So we went to other avenues. So to give you an example, R-22 was phase down because of ozone depletion. Again, (indiscernible) ozone depletion phase out under the Montreal Protocol, that’s the only thing we say you dealt for. No one was talking global warming in those days.

Since then looking at it closer when you look at global warming gases and you look at the administration knowing they want to reduce climate pollutants and global warming gases, well, R-22 is 1,800 times greater emitter than CO2. So it’s more 1,800 times more pollutant than CO2. So, accelerating R-22 phase out from a global warming perspective if that’s what your goal is and you are trying to lower global warming to get ozone depletion, huge gas going to be phased out. So our goal was to show the administration, show Senators, show Washington that it’s still behind us on this. This is a low hanging fruit that you can drop. And we have proven over and over again reclamation to step up and pickup the voice. So, when you look at it, it’s a – if we built this business based on doing the best thing for the environment, more reclamation, less virgin production to better the environment and it’s not coincidentally better for Hudson’s performance. They go together. We optimize a system. We lowered the energy usage to lower global warming. Every one of our services come down that line. So we believe a 40% reduction was a good start in September. We believe they can really bring it down much lower. And one part of your question, the whole industry we meet with the alliance and the industry down there, we think the whole industry now – our industry is supporting dropping down more to the line of 22 million pounds as your base for ‘15.

And so since our industry is that – there is other players in here that I would say our industry could pressure on an EPA. So that’s our goal as to say we don’t want anyone else outside of our industry to put the pressure. We think our industry is behind cutting it down more than they are proposed – than their preferred method, but they did have in their proposed rule the 22 million pounds starting in ‘15 going down to zero by ‘20. We are pushing that for lower. And we are trying to get lower than that for sure, if we could, but that would be an enormous jump, go down to 22 to help, because reclamation can jump up and fill this voice. So we believe industry is behind us, which is down lower than their proposed rule and we think Washington helping the Senators keep letters to the EPA for global warming points are going to help that point.

Brian Coleman

Just one last thing to add as we said in the prepared remarks and Kevin just said, so far the voices of all said that EPA can go to the greatest reduction of what’s referred to as the preferred option and each of these options have these ranges. The public commentary will end on March 10 and it’s public, you all can access it, it’s a docket. If you don’t have links to it, John Nesbett can help you with that. But at the end of the day so far whether it be at the public hearing that was held about a month ago or (indiscernible) the voices are suggesting that the EPA could do even better than that 30 million, as Kevin said, goes to that 22 million for 2015.

Philip Shen - ROTH Capital Partners

Great. Kevin and Brian, thank you. I will get back in queue.

Kevin Zugibe

Good, thanks.

Operator

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum Capital Group. Please proceed with your question.

Steve Dyer - Craig-Hallum Capital Group

Thanks. Good afternoon guys.

Kevin Zugibe

Hey Steve.

Steve Dyer - Craig-Hallum Capital Group

Just a quick question on the inventory, what is your sense of inventory in the channel, I mean, there is always inventory in the channel, but what’s your sense as to sort of how that fits relative to historic norms? And then secondarily, what is your thought or feeling kind of on your inventory position entering the cooling season, too much, too little, just right? Thanks.

Brian Coleman

Sure. As it relates to inventories, the important piece of the puzzle is downstream inventories, the wholesaler level and contractors and the like. And part of as Kevin said last year, even though we moved a lot of volume in the latter half of the year more than we had the previous year, a lot of what we sold was in very small increments like again just in time. It didn’t appear to people where carrying more inventory or stockpiling, if you will, downstream. We do believe there is upstream stockpile at the producer level, but there only has been and there is a fair amount of that and that’s part of what’s included in EPA rule and might the EPA want to cut back the 22 allowances going forward. So to answer specifically from data from Hardy, which is an organization, it looks like what information is available is inventories are about the same as the past or slightly down. It doesn’t look like inventory is downstream or up at all.

As it relates to Hudson Technologies and your part of your question, every year we put together a budget. Every year, we try and estimate demand and customer needs and the like and we do try to carry inventory into the season to get ready, because it’s very difficult to meet customer demand in buying and so forth, because it’s kind of like (indiscernible) whether it be the initial stocking or really the restocking season, there is lots of phone calls, lots of deliveries and getting product in typical. So we typically will carry inventory in the third and fourth quarter for sales in that first and second quarter. And that’s been our philosophy for many, many years we have seen today.

Steve Dyer - Craig-Hallum Capital Group

Great. And then with respect to pricing, I understand particularly in this time of the year, pricing is not so much driven by supply and demand as much as it is as the producers are setting the price, it obviously behooves them to set it higher than lower, I don’t want to ask you to speak for them, but generally kind of what’s the chatter as to how they are thinking about the summer season?

Brian Coleman

Well, certainly all the producers have signaled that there is a value to 22 or a return to value of 22. At the end of the day, this goes back to that expression we said a few times it’s a nine-month season. I don’t think anyone is happy about what occurred last year. We know wholesalers, which are significant customer to the producers are very unhappy, because as Kevin mentioned, they would have bought inventory at high prices and the prices came down. And so there is nobody really happy and certainly we can’t speak for others or the producers, but they certainly couldn’t be overly happy about last year either. So at the end of the day, you think the actions will be different in ‘14 but it is still very early as we said it’s a nine-month season. So it’s hard to say, but we think prices are going to at some point stabilize and certainly producers are signaling there is a value in 22 now.

Steve Dyer - Craig-Hallum Capital Group

Alright, thank you.

Operator

Thank you. (Operator Instructions) It appears there are no further questions at this time. I would now like to turn it back to management for any closing comments.

Kevin Zugibe - Chairman and Chief Executive Officer

I’d like to thank everyone and want to thank our employees and our longtime shareholders for sure for their continued support. Thank you everyone for participating in today’s conference call and we look forward to speaking with you after the first quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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