Hudson Technologies, Inc. (NASDAQ:HDSN) Q3 2018 Earnings Conference Call December 5, 2018 5:00 PM ET
Jennifer Belodeau - Vice President, IMS Investor Relations
Kevin Zugibe - Chairman and Chief Executive Officer
Brian Coleman - President and Chief Operating Officer
Steven Dyer - Craig-Hallum Capital Group LLC
Gerard Sweeney - ROTH Capital Partners
Greetings, and welcome to Hudson Technologies Third Quarter 2018 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, Jennifer Belodeau from IMS Investor Relations. Please go ahead.
Thank you. Good evening, and welcome to our conference call to discuss Hudson Technologies financial results for the third quarter of 2018. On the call today we have Kevin Zugibe, Chairman and Chief Executive Officer; and Brian Coleman, President and Chief Operating Officer of Hudson.
I’ll 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 that are based on our best view of the industry and of our businesses as we see them today, they’re not guarantees of future performance.
These statements involve a 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 affect our performance and other factors that could cause our actual results to differ materially.
With that, I’ll turn the call over to Kevin. Go ahead, Kevin.
Good evening, and thank you for joining us. Before we get started with our prepared remarks about the quarter, I want to take a moment this evening to recognize our nation’s collective loss of President George H. W. Bush. Among President, Bush’s many achievements was his signing of the Clean Air Act of 1990, Title VI, which sought to protect the ozone layer.
The 1990 Clean Air Act specifically require the EPA to regulate ozone depleting substances like chlorofluorocarbons, or CFCs, and hydrochlorofluorocarbons, or HCFCs. This legislation and the resulting refrigerant phase out paved the wave for the development of reclamation and directly impacted away we at Hudson thought about our business and our opportunities for the future.
During the past few days, we see and heard about many of President Bush’s legislative accomplishments. And while we may be a bit biased, we count the Clean Air Act of 1990 as one of the most important elements of a distinguished legacy.
Now turning to our third quarter and nine months results. As you know, 2018 has been a challenging year for Hudson, as well as our entire industry. That said, we were very pleased to have recently announced definitive amendments to our credit facilities. The amendment process was lengthy and we appreciate the patience and support shown by our shareholders while we completed that process.
With the amendments in place, we believe we now have the financial flexibility and liquidity to drive improved operating performance, as we move through 2019 and beyond. Additionally, with the amendments in place, we filed our Form 10-Qs for the period ended June 30, 2018, and also for the period ended September 30, 2018, and have regained listing compliance with NASDAQ.
As we previously pointed out, our 2018 selling season was characterized by more just-in-time buying pattern, significantly reduced pricing for most of the refrigerants we sell and cooler seasonal temperatures. Despite these headwinds, it’s important to note that we were able to achieve $35 million in cash flow from operations during the first nine months of 2018 and surpassed our target level for cash flow.
Additionally, we’ve reduced our debt by $37 million this year-to-date and had $45 million of availability at September 30, 2018. So while 2018 selling season was very disappointing, our customer – our company remains fundamentally strong and positioned to drive sales and margin improvement in 2019.
In the 2018 season, there were several elements that negatively impacted our performance. First, rather than buying ahead and stocking their shelves for the season, the majority of our customers adopted a just-in-time model, purchasing refrigerant only when necessary and this pattern continued throughout the year.
We believe this buying behavior was a consequent of the – consequence of the 2017 price fluctuations. In 2017, many customers saw prices going up and bought products early in the season – earlier in the season than normal to get ahead of the possible further increases only to see the prices drop and devalue their inventory.
This year, buyers were much more cautious with their inventory levels. And we believe that inventory levels in the chain will be lower at the end of the year than they were at the end of last year.
Secondly, pricing for nearly all refrigerants consistently decreased during the 2018 season through the second quarter, but has since remained relatively stable. Finally, spring in the North – in the Northeast was unseasonably cool this year, delaying the start of the cooling season. So from the start, we faced unprecedented price constriction and volume declines and never gained any meaningful momentum.
So what will drive price and volume in the 2019 season? From an R-22 perspective, the phase down of R-22 production will be in its final year, with allowable 2019 production set at just 4.5 million pounds and no new virgin production permitted starting on January 1, 2020. And JPMorgan’s 2018 HVAC Annual Review and Outlook published in April 2018, they estimate that there were approximately 50 million residential and light commercial R-22 systems installed in the U.S.
So with an average lifespan of 20 years, even with an approximate replacement rate of 17 – of 7% per year, R-22 systems will be in use for many years to come. As we get closer to the final phase-out date, R-22 pricing should increase, as demand outpaces the level of R-22 production. We saw this happen with the CFCs. And while it wasn’t always linear, prices eventually moved higher and stayed there.
Through our existing inventory and through our ability to reclaim and sell recycled R-22 into the marketplace, we remain optimistic that we’re well-positioned to benefit from the tightening of the supply demand dynamics starting next year.
Likewise, with our acquisition of ARI, we increased our capabilities as a supplier of HFC refrigerants and significantly expanded our customer base. With this acquisition, we now also have presence further down the supply chain, selling to industrial customers, municipalities and large manufacturing plants.
We believe that the HFC business will continue to be a price competitive business, but now that we have moved to nearly all of the higher-cost HFC inventory, we should have more stable margins with these refrigerants.
To give you a sense of the overall pricing dynamics, since our second quarter conference call in August, R-22 pricing remains in the $10 to $11 per pound range. As difficult as this year has been with our visibility today, we believe pricing has stabilized and that our margins should improve as we replace higher-priced inventory with lower-priced product. Likewise, market dynamics and customer behavior this year have better prepared us to more effectively address just-in-time buying patterns if they continue in 2019.
Now, I’ll turn the call to Brian to review the financials. Go ahead, Brian.
Thank you, Kevin. For the third quarter ended September 30, 2018, Hudson recorded revenues of $40.5 million, an increase of 64%, compared to $24.7 million in the comparable 2017 period. The increase in 2018 period is primarily related to the inclusion of revenues from Aspen Refrigerants, which we acquired in October 2017.
Excluding the impact of ARI, revenues for the third quarter of 2018 decreased by $5.8 million, compared to third quarter 2017. This decline was attributable to a decrease in the selling price per pound of certain refrigerants, which accounted for $2.3 million of the decrease, as well as a decrease in the number of pounds of refrigerants sold, which accounted for $3.5 million of the decrease.
Our government contract continues to progress and we saw revenue contribution of approximately $4.4 million from our DLA contract in the third quarter. The company recorded a net loss of $13.9 million, or a loss of $0.33 per basic and diluted share in the third quarter of 2018, as compared to net income of $2.1 million, or $0.05 per diluted share in the same period of 2017.
Included in the $13.9 million third quarter loss are approximately $9 million in non-cash charges related to a deferred tax reserve and approximately $2 million in non-recurring charges related to the acquisition and integration of ARI.
Non-GAAP adjusted net loss for the quarter ended September 30, 2018 was 0.5 or $0.5 million, or a loss of $0.01 per basic and diluted share, compared to non-GAAP adjusted net income of $3.8 million, or $0.09 per diluted share during the third quarter of 2017. Adjusted EBITDA was $5 million for the third quarter of 2018, as compared to adjusted EBITDA of $3 million for the third quarter of 2017.
Looking at the first nine months of 2018, Hudson reported revenues of $140.8 million, an increase of 22%, compared to the $115.8 million in the comparable 2017 period. Revenues for the 2018 period included revenues from ARI. Excluding the impact of ARI, revenues for the first nine months of 2018 decreased by $44 million from the comparable 2017 period.
The decline was attributable to a decrease in selling price per pound of certain refrigerants sold, which accounted for a decrease in revenues of $29 million and a decrease in the number of pounds of certain refrigerants sold, which accounted for a decrease in revenues of $15 million.
The company’s net loss for the first nine months of 2018 was $47.6 million, or a loss of $1.12 per basic and diluted share, which included a non-cash inventory write-down of approximately $35 million, an approximate $9 million non-cash tax effect from the reserve allowance and approximately $6 million in non-recurring charges related to the acquisition and integration of ARI, as compared to net income of $16.4 million, or $0.38 per diluted share for the first nine months of 2017.
Non-GAAP adjusted net loss for the nine months ended September 30, 2018, which excludes any inventory write-downs was $1.1 million, or a loss of $0.03 per diluted share, compared to non-GAAP adjusted net income of $18.2 million, or $0.42 per diluted share during the first nine months of 2017.
Adjusted EBITDA was $12.6 million for the first nine months of 2018, as compared to adjusted EBITDA of $28.9 million for the first nine months of 2017. A detailed reconciliation of these items is presented in today’s release.
Following the close of the quarter, we announced definitive amendments to our term loan and revolving loan credit facilities. For the term loan, we reset maximum total leverage ratio financial covenants through December 31, 2019 with no further fees. For the revolving credit facility, we replaced the existing fixed charge coverage ratio through June 30, 2019, with an EBITDA covenant. The minimum fixed charge coverage ratio of 1:1 will recommence with the quarter ended September 30, 2019. The interest rate also increased by 125 basis points to current market levels.
We are very pleased with these new amendments. We have strong liquidity and these new facilities provide us with a solid financial platform and flexibility as we look into the coming years. Additionally, on November 30, 2018, we filed our Form 10-Q for the period ended June 30, 2018, together with the Form 10-Q for the period ended September 30, 2018. With those filings, we regained compliance with periodic filing requirements of the NASDAQ market.
As Kevin mentioned, during the first nine months of 2018, despite challenging market conditions, we generated approximately $35 million of positive operating cash flow, surpassing our full-year 2018 cash flow target. Additionally, we paid down approximately $37 million of debt and had approximately $45 million of availability at September 30, 2018.
I’ll now turn the call back over to Kevin.
Thanks, Brian. Hudson is a longstanding leader in their refrigerant reclamation business. And together with our talented Aspen team, we are optimistic about the opportunities in front of us. Operator, we’ll now open the call to questions.
At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Steven Dyer. Please proceed with your question.
Look forward into next year, do you have any sense of the ordering patterns? Do you anticipate it’s going to remain sort of just-in-time going forward, or any reason to think that people will take a little bit more inventory than perhaps they did this year?
We’re planning for – going into the season for that just-in-time approach to continue. There’s no indication from our customers thus far that they’re going to change their buying behavior. As we thought and recently reaffirmed, it does seem that quite a number of our customers had negative outcomes in 2017 and they’re still mindful of that. And therefore, they’re managing their inventory much more tightly than we’d seen, let’s say, in 2017 and 2016 and prior.
But at some level that may be a good thing. In that, we do think that their inventory levels today are lower than what they might have been a year ago. So that there shouldn’t be a lot of excess inventory or normal inventory levels in the chain at this time of year compared to historical levels.
Got it. And then you touched on it a little bit in the prepared remarks. But as it relates to inventory, both the total amount as well as the cost basis of what you have. I mean, as of 9/30, is it safe to say that you’re pretty much where you want to be with respect to liquidating some of the higher-priced inventory from last year, or is there more to go here in the fourth quarter?
I’d say, we feel that way probably with the HFCs clearly, and we brought them down considerably. And I think we’re going into next year and almost really gone on the higher-cost layers. 22 will still be somewhat of a carryover to 2019, so – and we’re working that down. But yes, on 22, probably a little higher, but not so much on HFCs.
Got it. Okay. Could you talk a little bit about HFCs for a bit. A lot of what this – what the trade commentary and so forth depending what you read still seems as though, there is some dumping. Are you seeing that? And prettier taken what it’s doing to pricing in the environment right now?
What we’ve seen, clearly, there was a significant drop over the year and how much inventory is in, difficult to say. Pricing seems to have stabilized since the second quarter, and we’ll never call something at the bottom, because you never know if China is going to do something odd and drop more. But we don’t see it right now, it seems we’re – we’ve hit a low point really historical low.
And so we’re not even suggesting that, now it will start creeping up. But we would guess it’s going to – from our vantage point, it will stay level here in 2019 for HFC. Again, anything can happen from China what we’re seeing. We don’t see it getting worse from here at this point. It seems like we hit the bottom there.
Okay. And then last one for me. I think you said the DoD [sic] [DLA] contract about $4 million, a little over $4 million in revenue in the quarter. I know that was never going to be sort of a linear contract, but just maybe your take on how that is ramping? Is it sort of in line with your expectations? And at what point do you feel like that may get to the level that you would expect based on kind of the nature of the 10-year deal? Thanks.
Yes. We probably would say that the revenues in Q3 were a little disappointing, because we had continued growth or increases each quarter that we started to operate here. We had a slight decline compared to Q2, but there’s nothing particular to cause that necessarily. The ordering or the frequency of the ordering is not predictable. We still believe we’re going to get on that $20 million annual run rate and then find ways to grow it further.
A lot of the administrative problems have slowly diminished. We had a lot of various issues on the administrative side. We think we work through probably nearly all of them, there’s still a few things that have to be worked on. But all that probably should get cleaned up by the end of this year. That should then allow us to do more marketing of the contract going into next year. So we still have optimism to grow this on an annual basis.
And then just one point of clarification, Brian, with respect to the $20 million. I think, the 10-year $400 million contract would imply $40 million, but maybe you’re – maybe I’m thinking about a different sort of timeframe or run rate level?
No, we never thought it would be $40 million for 10 straight years. We always felt that you would have to grow into this, and we felt that was an opportunity to market this to grow into it. We did think that we would get on a run rate of about $20 million. We were expecting to get closer to $5 million in Q3 of this year and we didn’t quite get there. But we still have the optimism we’re going to get there.
Right. He thought 20 – we’re saying $20 million this year. We’re optimistic of it growing from near – every year to set aside. So it’s still the whole $400 million, it’s still sitting there for us. And bringing other agencies and starting the marketing once the administrative problems were over. We believe we can start ramping that up and getting much higher than the $20 million per year from 2019 on.
Gotcha. Thanks, guys.
[Operator Instructions] Our next question comes from the line of Gerry Sweeney with ROTH Capital Partners. Please proceed with your question.
Hey, good afternoon, guys. Thanks for taking my call.
Steve got most of my questions – my main questions. But just a little bit of a follow-up on the inventory on your R-22 side. I think, you mentioned that there was going to be a carryover some of the higher-priced inventory until next year. Is this a function of maybe some lower sales in Q3 and potentially Q4 than you originally anticipated? I was under the impression right or wrong that I thought most of it would have been gone by next year?
No, not at all. It really relates to the Aspen acquisition. I don’t remember if it was visible to everybody. I think, it was that, we never expected to sell out the R-22 inventory for Aspen until the end of 2019. So it’s really because of the acquisition and how much R-22 inventory Aspen had that there’d still be a carry into next year.
Okay. That makes sense. I was probably looking at even higher-cost inventory than that. But I mean, part of that Aspen inventory was already written down or from the original step up. So is that a fair way of looking at it?
Well, first off, all the inventory, let’s say, was written down, whether it be Aspen, Hudson, HFC, 22 or whatever. But as it relates specifically to the inventory that was written down, primarily Aspen’s R-22 is what’s going to go into 2019, but it is already written down, if you will.
You’ll still have margin, but you won’t necessarily have the normal margin when you have a write-down to net realizable value. There’s restrictions on how low you can write it down and so without a line.
So it will have some impact on gross margins in the 2019 year, but hopefully, not too material or meaningful.
Got it. And it also obviously – you had the dirty gas coming in probably about $5 per pound. That we won’t really start seeing shift the income statement until all that Aspen inventory is out. Is that the way to look at it as well?
Yes. In other words, Aspen is really going to benefit in the 2020 and beyond because of all the reclaim that’s been coming in here now that’s sitting behind on FIFO basis.
So Hudson, for sure, it’s going to have a much lower cost basis next year in 2022, just because we’re buying reclaimed product in the $4, $5 range. So Aspen will have a little bit lag in that regard.
Got it. And then circling back to Q3 a little bit. Obviously, sales were a little bit lighter than people anticipated. We’ve seen this on the preannouncement that you put out before. But was the market – my channel checks were showing sales going longer into the quarter than a lot of – this was on the reclaim side with private guys going longer in the quarter than they had seemed historically.
But as they said to me, they had to work to sell some of those gas and they were probably holding the line at $10 to $11, but there were some sales below that, maybe guys freeing up inventory for working capital purposes. How does that sort of jive with what you were saying? Were you holding that line at $10 to $11 million, and did that cost you some sales? Just want to get a feel for what was happening in the market?
We definitely lost a lot of sales from a competitive point of view, but those periods of time would have been April, May, June, then certainly, a period in July. But really, probably the latter half of this third quarter, August, September, we wouldn’t have, let’s say, walked away from a competitive point of view.
The real issue of the consensus, let’s say, miss that we talked about when we presented the revenue figures before was volume. We thought we had a shot at catching up a lot of volume in Q3 for things that we would have lost, let’s say, in Q1 and Q2, and that never materialized, and we thought there was a shot at people changing their behavior in Q3 and go back to more normal stocking as opposed to just-in-time.
I’m not sure exactly what the commentary you have with other folks. But just to give you another example, we had a pretty strong October, because people didn’t have an inventory and it was still warmer in a lot of geographies in October relative to historical levels, too. So definitely, the season has stretched out longer. But part of it too is that, we think inventory levels for most of our customers are very low relative to norms.
So hence, I mean that – even at strong October sort of intense or improved your thought process on why the – you believe the channel is becoming unstocked or destocked fully? Is that fair?
Yes. But it’s just a whole conversation with our customers. I mean, they’re – you’ve – all you sort of hear in a very general way is not tying up working capital, I’m not going to get caught with a commodity – words like that that you can understand, which then leads to less inventory being carried.
Got it. That makes sense. I appreciate it. Thanks, guys.
Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Kevin Zugibe for closing remarks.
Okay, I’d like to thank our employees, our longtime shareholders and those recently joined us for their support. Thanks, everyone, for participating today on the conference call. We look forward to speaking to you after the fourth quarter. Thanks.
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.