Hudson Technologies, Inc. (NASDAQ:HDSN)
Q2 2016 Earnings Conference Call
August 02, 2016 05:00 PM ET
John Nesbit - IR
Kevin Zugibe - CEO
Brian Coleman - CFO
Gerry Sweeney - ROTH Capital
David Mandell - William Blair
Juan Molta - B. Riley & Company
Greetings, and welcome to the Hudson Technologies' Second Quarter 2016 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.
I would now like to turn the conference over to your host, Mr. John Nesbit of IMS. Mr. Nesbit, you may begin.
Good evening and welcome to our conference call for the second quarter. 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.
Let me 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 the best view of the industry and our businesses as we see them today, they are not guarantees of future performance. These statements involve a number of risks and assumptions and since these 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 affect our performance and other factors that could cause actual results to differ materially.
Okay. With that, I will now turn the call over to Kevin. Go ahead, Kevin.
Good evening and thank you for joining us. I hope all of you had a chance to review our second quarter 2016 earnings release issued this afternoon. This was a strong quarter for us, and we’re very pleased that built on our solid first quarter results to deliver record revenues, substantially improved margins and enhanced profitability during the second quarter of 2016.
Furthermore, subsequent to the quarter, we were awarded a substantial Department of Defense or DoD contract, and also received positive news from the government concerning the HFC antidumping case.
For the quarter, our revenue growth and margin improvement resulted primarily from higher average pricing on certain refrigerants including R-22 as well as some improved pricing on HFC base refrigerants. R-22 which is an older CFC remains the most widely used refrigerant and we saw price increases throughout the second quarter. Prices for R-22 have continued to move incrementally higher, and we are currently seeing R-22 priced at above $15 a pound and showing signs of further price improvement.
We’ve also seen continued growth in our reclamation business and believe there is a broader opportunity for reclamation as the industry responds to the annual reductions and ultimate elimination of R-22 production by the end of 2019. And to the expected phase down of HFCs which have been targeted due to their high global warming potential. With our ability to reclaim all HFCs, we believe they represent an even larger reclamation opportunity beyond the R-22 phase out.
As you remember during the 2015 selling season, we saw some margin compression related to pricing pressure from HFC based refrigerants, which are the replacement refrigerants for R-22, as well as to the older CFC refrigerants in use. Just last week, the United States’ International Trade Commission or ITC issued its final ruling on the antidumping petition related to HRC blends from China and confirmed by unanimous vote that imports of certain HFC blends from being sold at the low market prices have caused material injury to the U.S. HFC industry.
As a result of the vote, import duties on those blends will be imposed retroactive to February 1, 2016. We applaud the ITC’s decision in this matter. Moving forward, we anticipate that HFC base refrigerant will increasing be a volume growth area for our business as nearly all new equipment as well as the equipment that is replacing R-22 units uses HFC refrigerants.
From a customer standpoint, we are working closely with both existing and perspective customers to demonstrate our ability to meet their needs as phase down of virgin production of R-22 continues. We are also actively promoting our capabilities around reclaiming agencies. As the leading claimer in the industry, we believe our proprietary technology, which allows us to reclaim all refrigerant types together with our strong distribution network fully service facilities and our extensive geographic reach make us the best resource to our customers as they prepare for these phase outs.
Additionally, we are always looking for ways to diversify and expand our capabilities for our customer base. While we frequently work on individual federal government projects in the past, we haven’t had the opportunity to serve the prime contractor. In January 2015, we made a strategic acquisition of a West Coast based supplier of refrigerants and compressed gases in order to expand our knowledge in the industrial gas sector. This acquisition provided us with the complementary capabilities to subsequently bid on and ultimately win a large DoD contract, which we announced two weeks ago.
The contract is with the U.S. Defense Logistics Agency or DLA with an estimated maximum value of $400 million in sales to the DoD over a 10 year period. For the terms of the contracts, Hudson will act as the prime contractor which comprises a five year contract period with a five year renewal option. There is very exciting opportunity for our Company. And while the amount of revenue we receive will be determined by order levels, we believe this contract will contribute considerable future revenue and earnings growth.
We also believe that it’ll give us exposure to other federal government contracts where we’ll have the opportunity to act as the prime contractor. We’re very pleased with our second quarter results and encouraged by our new contract win. Our experience in established reputation in the industry combined with our ability to reclaim all types of refrigerants that enabled us to create a reclamation model that can address all future phase outs.
Those capabilities coupled with our ability to capitalize on new opportunities such as the DoD contracts, our competitive strengths that we believe will drive continued revenue growth and profitability.
With that, I’ll hand the call over to Brian to provide our detailed financial results.
Thank you, Kevin. Revenues for the second quarter increased 21% to $34.6 million as compared to the $28.6 million in the second quarter of 2015. The revenue increase was primarily driven by an increase in the price per pound of certain refrigerants. Gross margin increased to 30% as compared to 25% in the same quarter last year due primarily to increased pricing for R-22 refrigerants as well as some improved pricing for HFCs.
Operating expenses for the quarter declined to $2.3 million compared to $2.5 million in the previous year quarter. Net income for the quarter increased to $4.8 million or $0.15 per basic and $0.14 per fully diluted share compared to net income of $2.8 million, or $0.09 per basic and $0.08 per fully diluted share in the second quarter of 2015.
Our balance sheet remained strong. As at June 30, 2016, the Company had $58 million in inventory, down from $62 million in December of 2015. Our inventory levels typically declined during our sales season and then tend to increase toward the end of the season. At the end of the quarter, we had applications $20 million availability under our credit facility and approximately $48 million in working capital.
I will now turn the call back over to Kevin.
As we said before, the first three quarters of any year represent the refrigerant selling season. So far the 2016 refrigerant selling season has been strong. We’re encouraged by the growth opportunities being presented by the R-22 phase out as well as from the expected phase down in the next generation HFCs. We are focused on growing our leadership position in the reclamation space so that we remain positioned to capitalize on increasing worldwide concerns around global warming, which we believe will drive additional phase outs and the subsequent adoption of reclamation across all classes or refrigerants.
Finally, winning the DoD contract is very short-term for us, as it broadens our exposure in the government, as well as in the industrial gas sector. With our proprietary technology, longstanding industry relationships, and proven distribution network, we believe we are in a strong position to meet the needs of our customers and to adapt to ongoing changes in our industry.
Operator, we’ll now open the call for questions.
At this time, we will be conducting a question-and-answer session [Operator Instructions]. Before we begin the Q&A session, I would ask that you limit yourself to one question at a time, on initial questions, so time goes already [Operator Instructions]. Our first question comes from the line of Gerry Sweeney of ROTH Capital. Please proceed with your question.
A quick question on the press release you said revenue increased in quarter primarily related to increase in the price of certain refrigerates slightly offset by reduced volumes of certain refrigerants. I suspect that is there for a reason, but you general discussed on the prepared remarks. Could you elaborate a little bit more?
The increase was related pricing. Volume was down just slightly, but if you look at for the six month period, volumes actually up. Again we usually talk about this in the context of a nine month sale season. So, one particular quarter you might have higher volumes or lower volumes, but it's usually through the season that matters and the measuring point. And we typically expect to see that double digit volume growth in that 10% to 12% range, so this particular quarter the volume was down here but again for the six months were ahead.
And then on that note on the inventory side, inventories almost $58 million exiting Q2, actually up over the first quarter which a little, I don’t know size about, I am not necessarily trying to read anything into it. But is this -- are you collecting more R-22, is this other gases and inventory for different reasons, any thoughts on that front?
We get on overall basis our mix of refrigerants in inventory are similar, there is no particular trend per se. There will be as HFC continue to grow more HFCs and inventories. But really probably more but maybe just be the timing of the buy and obviously if we’re buying R-22 with the price increases compared to other periods, the prices will be higher as we reload our inventory.
I think that that was part of it. And finally one other quick one and I’ll just jump back in. With prices going up, lot is changing, traditionally it was 1Q was maybe the pre-buy, 2Q was pretty busy, third quarter trended down and fourth quarter very quiet. Has that changed at all? Are people shifting buying a smaller amounts maybe do we see more buyers in the third quarter, or is this traditional trend that’s going on?
We think the trend is still similar to as you described. We do think there may be a time when we might see people trying to do more just in time or spot buying only because as the price goes up there is more dollars required. But right now we haven’t seen anything in this particular season that would cause us to think there is any change.
Our next question comes from the line of David Mandell of William Blair. Please proceed with your question.
So as we think about the seasonality of the business, would it be normal to think of the R-22 prices starting to come down as this selling season wraps up in 3Q and goes quiet in 4Q? Or is that not the normal seasonality?
Again, what’s normal for certain gases and where they are in the revolution might be the case where a lot of times depending on the time of the year season ends and times of sea drift, 22 as it gets tighter and tighter one wouldn’t expect to see a drift in 22, just if there was an endless supply of it, I would. But since there is not I certainly wouldn’t expect it.
And then on the new contract, could you guys give us a sense of the profitability there, maybe your expectations for gross margins that they’ll be at the Company average level? And then will you guys have to add in a lot more operating expenses to service this contract?
In terms of this business, we obviously won’t know precisely until we see the mix, and the mix could change in any period of products and so forth. But with that said, we do think we’ll see this business drive something in the 20% plus gross margin basis. As it relates to let’s say operating margins and then SG&A, we think a lot of the gross profit dollars are going to fall to the operating line. There will be some incremental increases in SG&A but we don’t think they’ll be as material relations to the gross profit dollars that we see at this contract.
[Operator Instructions] Our next question comes from the line of Juan Molta of B. Riley Financial. Please proceed with your question.
Regarding gross margin, that 30% that you reported was higher than what you had said we could expect for the balance of the cooling season on the last call. And based on your prepared remarks, you mentioned it was due to higher pricing. I was wondering if you could comment the reclamation, increase in reclamation volumes contributed to the higher gross margin.
As it relates to current activity in reclamation it really starts to fall into our inventory towards the later part of the year. Reclamation typically lags the refrigerant sales by approximately three months. Now we would have benefited to some extent with regards to the reclamation that we received last year being sold in the first six months of this year. At the end of the day though, prices probably are higher than we would anticipated relative to our margin expectations. So price we think are higher than we thought they might be at this time. And as we said earlier, we think they’re going to continue to rise in the third quarter.
And I’ll make a follow up more industry related, in regards to people using R-22 alternatives the HFCs or other alternatives that are out there. And could you comment on that that type of customer behavior? And have you heard of any incidents or what’s your position there?
Even we started on the CFC phase out alternatives were always around even when you’re in 12 to 130 foray wasn’t directly, it should have been equipment to equipment, but we always anticipate that it would be the same thing. It was always a small percentage. This has been a bigger percentage couple of years ago, and it started to show itself and present itself in the industry more so than it did in the CFC phase out. But that tail back off again, not that they’re not out there and we expect that they will come back in, there is a place for them.
So, it's not necessarily that behavior to use, there is a lot of drop-ins, none of them are as good as 22 itself. But depending on the system, certain contracts as well up to spend the extra time and do the proper maintenance on the unit and drop the proper evacuation and charge it correctly. Some will put the drop-in in which won’t be as good even if that was if you get it perfectly and then they’ll do a bad job of it. But you’ll see our mix and match across, there would be a large portion of the industry that will follow and stick with 22 just like a lot of the industry stopped with our 12 during that phase out. So it's a mix and match, but we expected to see it and obviously I think you’ll see it continue to grow as 22 prices increase.
Our next question comes from the line of [Justin Putman] [Filantra] Investment Group. Please proceed with your question.
My question is just real quick on the DoD contract. Can you talk about timing for that project, or revenue, is that ground running or is that more of a 2017 event?
There’ll be some amount of revenues in the latter half of this year, but really the volume is going to be beginning in the second half of 2017. That will be the period when the current contract expires and our contract begins. But there is this transitional phase that goes off for approximately 12 months.
We have a follow up question from the line of Gerry Sweeney of ROTH Capital. Please proceed with your question.
On the R-22 reclaim, I know you spoke about the amount of reclaim is increasing. Anyway you could put a little bit more maybe quantitative aspect behind that comment? I mean is it up single digit, double digits, I mean that’s being test some of the restructure story going further. And I think people would appreciate maybe a little bit more of detail on that as we move towards in the next couple of quarters. So I was hoping maybe you could give us a little bit more feeling to it currently.
The returns are up over last year. The only thing we hesitate to talk about percentages because of the timing of a particular point in the season. So we’re really in the early stages, we just have a lot. But we’re in the early stages of the reclaim. When you really don’t start to see the pound coming in until April and May and even then it's not a lot. But again it may seem odd, you see a lot of returns in October and into November.
So we’re just getting into the strike now in terms of return, so we’re happy with what we see. We’ll definitely report on that as we did last year. It's how we ended up for the year. We still are waiting to see from the EPA how the whole industry last year as they post that publicly, but we haven’t seen that yet. So we’ll definitely be giving you an update, but we’re happy with what we’re seeing.
More inbound calls, et cetera, I mean just people looking for supply. Is that the -- any thoughts on that front?
I think we missed maybe the first part of your question, Gerry.
I was curious if we’re getting more inbound calls from people looking for potential supplies that are just at different tone to customers or more people knocking on your door, looking for gas.
You could see them reuse a disciplined approach to our customer base and distribution. The first and foremost point that’s for us is how many pounds are they returning, are they participating our reclaim program, those kinds of questions. We’re not inclined to support anyone out there that’s a broker or a trader or -- it's really, as we described on our few other calls in the past, I want to kind of grow relationship. We want to work with organizations who are looking to increase the return to gas to us and we want to guarantee the supply and an equal amount of supply in the following year, so that there is an incentive for them to work with us, an incentive for us to sell them R-22.
Then one last question. Dirty gas, I think we talked in the past from paying about half to virgin growing prices. Is that still a fair assumption, or is that [nitrogen] cut off?
We’ll follow that. We followed and doing it from the CFCs and now we’ve worked consistently and thus we have no plans to change that unless something else changes in the market.
There are no further questions in the Q&A portion of the conference. I would now like to turn the conference back over to management for closing remarks.
I would like to thank our employees, our long time shareholders and those that briefly joined us, for their continued support. Thank you everyone for participating in today’s conference call and we look forward to speaking with you after the third quarter results. Thanks.
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