Hudson Technologies Inc (HDSN) 2008 Q4 法說會逐字稿

Greetings, and welcome to the Hudson Technologies fourth quarter 2008 earnings call. As a reminder, this conference is being recorded. (Operator Instructions.)

It is now my pleasure to introduce your host, Mr. John Nesbit. Thank you, Mr. Nesbit. You may now begin.

Good morning, and welcome to our conference call to discuss Hudson Technologies financial results for the fourth quarter and year end 2008. On the call 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'll take a moment now to read the Safe Harbor statement. Statements contained herein which are not historical facts constitute forward-looking statements involving a number of known and unknown risks and uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed by such forward-looking statements.

Such factors include, but are not limited to, changes in the markets for refrigerants, including unfavorable market conditions adversely impacting the demand for and the price for refrigerants, the Company's ability to source refrigerants, regulatory and economic factors, seasonality, competition, litigation and the nature of supplier and customer arrangements which become available to the Company in the future, adverse weather conditions, possible technological obsolescence of existing products and services, possible reduction of the carrying value of long-lived assets, estimates of the useful life of its assets, potential environmental liability, customer concentration, the ability to obtain financing and other risks detailed in the Company's periodic reports filed with the Securities and Exchange Commission. The words "believe," "expect," "anticipate," "may," "plan,", "should", and similar expressions identify forward-looking statements.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. With that, I'll now turn the call over to Kevin. Go ahead, Kevin.

Good morning, and thank you, everyone for joining us today on Hudson Technology's fourth quarter and year end 2008 earnings conference call. 2008 was, by far, the best year in our history, with record revenues and profits, capping off five years of double digit revenue growth. For 2008, we recorded total revenues of $33 million, representing a 23% increase over 2007, and achieved an earnings per share of $0.35.

As we review the year and the fourth quarter of 2008, I think it is important to point out the seasonality of our business, where typically the first and second quarters are the strongest as customers prepare for the warmer spring and summer weather. Revenue and profits are not as high in the third quarter, and in the fourth quarter, we typically post our lowest sales volume and profit. In 2010, the refrigerants and reclamation industries will undergo a significant shift. As promulgated by the EPA, virgin HCFC refrigerants will receive a significant reduction in the number of available pounds to be supplied to the after market. This is the second phase-out that our industry has faced. In the early 1990s, the United States determined to phase out the use of all ozone depleting chemicals, which included CFCs and HCFCs. The first phase-out involved CFCs, which caused the most damage to the ozone layer, and their production was phased out by 1996.

We are now in the second phase-out of HCFCs, with a major reduction in HCFC production being put in place in 2010. HCFCs, primarily R-22 refrigerants, are everywhere. More than 70% of all units around the US utilize HCFC refrigerants. For example, R-22 is a refrigerant in your home central air conditioning system. It's used in large office buildings and in large industrial facilities as well. Simply stated, most homes, offices, buildings, factories or shopping centers that need to cool people or things are using HCFCs for that cooling, and chances are they're using R-22. We have spoken previously about the upcoming phase-out in the production of new or virgin HCFCs that will begin in January 2010, and I'd like to re-emphasize the importance of this phase-out to the dynamics of our industry. Currently at least 60% of the more than $1 billion refrigerant after market is comprised of HCFC refrigerants.

Today, nearly all residential and light commercial units are R-22 systems. In addition, most of the large tonnage chillers in operation today, which make up our core market require, and will continue to require, HCFC refrigerants to operate and run efficiently. These chillers typically have an average lifespan of 20 years or more. Even if refrigerant prices continue to rise, the increased refrigerant cost is immaterial to the overall cost of replacing the system. Taking this into consideration, the system cost, the lengthy lifespan and the pressures of today's economy on operating budgets, it's not likely that our customers will replace their existing HCFC systems with new systems designed to operate with new refrigerants. Instead, we believe that HCFCs will still be needed throughout the entire HCFC phase-out period and beyond to service the installed base, ensuring a strong market for these refrigerants for a long time to come. And that is where we anticipate the market will seek an alternative supply option in the form of reclaimed HCFC refrigerants. This belief is being mandated by the EPA.

In late December, the EPA published proposed new regulations that, effective January 1st, 2010, would limit the amount of new HCFC refrigerants that can be produced and imported to the US to 80% of the total US demand estimated by the EPA. In this regard, the EPA is expecting that reclaimed refrigerants will fill the 20% supply gap, which would amount to a more than 300% increase in the demand for reclaimed product in 2010. This market dynamic presents a growth opportunity for our reclamation business. Before the announced phase-out, there has not historically been enough economic incentive for people to reclaim their used or dirty HCFC refrigerant or to sell the used HCFC refrigerant back to Hudson, but prices are increasing as the phase-out of the virgin HCFC approaches. Over the course of the past year, the price of virgin refrigerant has climbed. This price increase means that contractors and distributors have more incentive to return the used gas and realize an economic benefit. We recently announced our new platinum program designed to assist our customers in maximizing the recovery and reclamation of HCFC refrigerants. Through our platinum program, our customers have the option to sell the their used refrigerant back to Hudson or have Hudson reclaim and return the used refrigerant to them. Through our state-of-the-art reclamation facility in Champagne, Illinois, our customers have access to reclamation, cylinder maintenance, repackaging and return of HCFCs.

We have been getting an excellent response to this program. As many of you know, this is not the first time Hudson has been through a phase-out. In the mid '90s, CFC refrigerants, such as the R-12 that used to be in your car air conditioning system, were phased out. We learned a lot from that phase-out, and there are some very important differences with the upcoming phase-out, which makes this situation even more attractive for Hudson. First, in the mid '90s, Hudson was a new entrant to the market. We are now an established leader with an excellent infrastructure, including our Champagne, Illinois facility, which is also only one of three ARI certified refrigerant testing laboratories in the Nation. Second, the overall market opportunity for this phase-out is over two times larger than the last phase-out. Third, Government at the time did not have sufficient restrictions on illegal imports. Today, the Government has very strong enforcement against the illegally imported gas, which will prevent additional supplies and help maintain the forecasted shortfall in supply. In addition, the proposed regulations for the phase-out supports reclamation by expecting reclaimed refrigerant to full the supply gap.

Finally, it's important to understand that Hudson has the technology and capability to clean and recycle all types all refrigerants, including the new generation of HFC refrigerants that will replace the phased-out refrigerants. We are positioned to gain from the phase-out of HCFCs because we're able to reclaim, package and resell them, and we are positioned to gain from the new generation refrigerants, not only from sales through our traditional distribution network, but also because we can reclaim, package and resell the HFC refrigerants as well. This provides a good segue into why we are also positioned to benefit from developments in Washington. The Obama Administration is very supportive of climate legislation that is expected to reach the floor of the Senate this spring. Such new legislation would help us in a few ways. First, it will likely call for the phase-out of HFCs, which is the next generation of refrigerants that have been replacing CFCs and HCFCs and will eventually represent almost 100% of the overall market. For example, in the 1990s when R-12 CFC refrigerant was phased out, the newer cars that were produced using R-134A and HFC refrigerants.

As a result of this climate bill, R-134A and all of the next generation refrigerants may be phased out. Strategically, we have always expected and hoped there would be continuing Federally mandated phase-outs of refrigerants, and if legislation is ultimately passed to phase out HFCs as well, it would be very beneficial to the long-term opportunity for our reclamation business. Second, Hudson is an aggregator of refrigerants and has generated carbon credits, which is another big push of the Administration. Hudson is a participant member and registered as an offset aggregator on the Chicago Climate Exchange. The Chicago Climate Exchange issues tradable carbon financial instrument contracts to owners and aggregators of eligible projects. Additionally, Hudson's performance optimization technology has the capability of identifying and quantifying energy savings, as well as determining the exact amount of CO2 reduction a facility is achieving. This is extremely valuable to our customers, who need to track that amount in order to be eligible and monetize the carbon credits.

Let me spend a minute on the economy. We are keeping a close eye on the economy's impact on our business and monitoring it closely. Currently, it is just too early in the refrigerant sales season to say how much, if at al,l our seasonally strong first half of the year will be impacted by the current economic climate. We will have more clarity as we get into our seasonally strongest second quarter. I'll now hand it over to Brian to provide our detailed financial results.

Thank you, Kevin. As Kevin mentioned, our fourth quarter is our slowest, typically representing approximately 10% of our annual revenues due to the seasonality of our business. Revenues for the quarter were $2.9 million, compared to $2.7 million in the same period of 2007. Gross profit margins declined slightly to 23% in the fourth quarter of 2008, compared to 27% in the fourth quarter of 2007. The lower gross margin as compared with last year's fourth quarter, is primarily because of a decline in our R-Side service revenues. The Company reported an operating loss of $1 million for the fourth quarter, compared to an operating loss of $653,000 for the fourth quarter of last year. During the fourth quarter, we had increased compensation, coupled with professional fees and other expenses, some of which are non-recurring, associated with positioning the business and launching the platinum program to capitalize on the upcoming HCFC phase-out. Overall, we had an exceptional year. Revenues increased 23% for the year, to $33 million, primarily because of an increase in refrigerant revenues of $6.6 million, minimally offset by a decrease in R-Side service revenues of $310,000.

The increase in refrigerant revenue is primarily related to an increase in the sales price of refrigerants sold in the 2008 period. Gross profit margins increased to 34% for the 2008 fiscal year, compared to 25% in 2007. Operating income also increased to $5.4 million in 2008 compared to an operating loss of $2.4 million in 2007. The Company reported net income of $6.7 million or $0.35 and $0.33 basic and diluted earnings per common share for the year ended December 31, 2008. Compared to a net loss of almost $2 million or $0.09 per basic or diluted common share last year. The increase in net income for 2008 is mainly attributable to the increase in gross profit from an increase in refrigerant revenues, in the absence of a $4.3 million charge to compensation expense that was recorded in 2007, as well as an increase in the income tax benefit recorded in 2008 when compared to 2007. As an aside, last night, Bloomberg misposted our fourth quarter 2008 earnings per share. We've been told that they've corrected that mistake. So for those of you that utilize Bloomberg, we just want to bring that to your attention.

We continue to have a large net operating loss carried forward, or NOLs. The tax benefits associated with NOLs are recognized to the extent that we expect to recognize taxable income. Due to the NOLs, the Company will record tax expense in future periods, but will not pay taxes to the extent that we utilize our NOLs. Finally, as most of you know, we positioned ourselves to build our inventory during the seasonally slow third and fourth quarters in a year to support our revenue growth for the following year. This strategy has helped us provide double-digit revenue growth over the past few years. Hence, at the end of 2008, our inventory stood at $23.6 million, and we had $12.9 million outstanding and $2.1 million available under our current credit facility. As we move through the seasonally strong first half of 2009, the inventory balance will come down, and our accounts receivable will increase. We are very pleased with our financial performance for 2008, and we look forward to the future with optimism to 2010 as we enter the industry's second phase-out period for the most widely used refrigerants in our industry. Operator, we'd like to open the call to questions.

Thank you. Ladies and gentlemen, we'll now be conducting a question-and-answer session. (Operator Instructions.) Our first question is coming from the line of Pete Castellanos with Glacier Asset Management.

Hey, Brian and Kevin.

Good morning.

Can you guys hear me?

Yes.

Hey, listen. You know, first of all, I didn't see the Bloomberg -- what was the variance in the Bloomberg report?

I believe they reported the fourth quarter EPS as $0.09 loss.

Oh, I see. Okay. And it was actually --

It should have been reported as a $0.04 loss.

Okay. And then the other thing is, the inventory buildup is kind of dramatic, and your cautionary notes -- I'm trying to match up that inventory buildup with your cautionary notes about the first part of the year.

I'm sorry. Your question is what? I'm sorry.

The inventory buildup -- the inventory buildup was rather dramatic. Again, our strategy towards inventory is that we're always looking to purchase our inventory in the third and fourth quarter, and we do that in anticipation of the refrigerant sales season, which is in the first and second quarter of the year. Now, one of the things that we've experienced obviously, as reported on our revenues, is we have seen price appreciation, and so obviously the replacement cost for inventory on a dollar per dollar basis, would be higher in a situation where you have price appreciation.

The strategy we've taken each year and clearly has resulted in double digit revenue growth, is we have the option always to say we'll carry more cash and less inventory, but again, we certainly wouldn't have seen the growth we have if we continued that way. So what we did is, we take our cash, we put it into our inventory at the right times of the year with what we've opened up as far as a channel to get the gas, which we're pretty proud of, and we see that potentially growing for us. So our focus is to say, how do we at the right price get the right gas, and how do we increase our customer base to move that gas? So, again, we're at a point where we think our plan has been working pretty consistently for years, and it will always show this at this time of the year, the highest inventory level. And it will come down from here as the season opens up.

And, Kevin, I guess what I was trying to get at was, I'm trying to match up your cautionary statements earlier in the call, where you said you're not sure about the year, and you're not -- and the economy, and yet your inventory buildup is -- is that a cautionary buildup, or how would you characterize that as -- concerning -- how would you characterize that buildup in terms of aggressive, moderate?

We would say, I guess, to use your words, we would use the word "moderate," meaning we pretty much utilize a moderate approach to building up inventory. We didn't do anything extraordinary this year versus other years.

And, again, when you're looking at the economy, a couple of things can affect us, and -- well, more than a couple. But the couple that can affect us specifically, if you look at the change-out of units which happens every year to new refrigerants, one of the things of having the availability of this gas that's going to be phased down starting in January is the fact that there's probably going to be a change somewhat in this industry now to say, "Hey, units that I was destined to changed, that I planned on changing to the new refrigerants, so get rid of 22, go to something else" probably wouldn't happen right now. The cost of 22 in the unit compared to the capital cost of replacing that unit is really minimal. So you won't change a unit because the cost came up. So what I think what we're going see -- we believe anyway, we'll see -- is that people will hold off on changing that unit out. If that's the case, the older units that would have normally been changed by this point won't be. So there will be more use of 22 in the future. So we, in no way want to get ourselves caught short of having enough 22, and we have to take advantage of the times we can buy it, which is near the end of the year. So again, we put ourself in a position to get good buys on refrigerant, and we're not convinced necessarily that this year is not going to sell like that. That's for sure.

One other question, and I'll jump back in the queue, but what -- nowhere -- I can't find anywhere in the K the average selling price. Do you list that anywhere, your average price for gas for the year?

No. No, we don't list that anywhere.

Is there a reason for that, or --

We don't provide detail specifically to the pounds sold or the dollars sold. We report the revenues in the aggregate.

Yes. I mean, is there a reason for that? Because it would be very helpful to us. We're trying to separate volume growth from price growth, and --

Well, we've described that in the MD&A. Much of the growth this past year was, in fact, price growth. One of the things that had occurred in 2007 is, we had sales to a particular customer -- actually a large customer that we declined to sell to in 2008 and rather sell to, let's say, more customers in smaller volumes. So as a result, there was a slight drop-off in overall volume compatibility in '08 to '07, but we've had revenue growth, which would be primarily related to price increases.

Okay. Thanks very much, guys.

Thank you. (Operator Instructions.) Our next question is from the line of Liz [Gilbert] with Kayne and Partners. Please go ahead with your question.

Hi, good morning. Could you talk a little bit more about what it is about your technology that allows your customers to achieve the carbon reductions you were talking about with regards to the carbon credit exchange and that kind of thing?

Yes. First of all, if you look at the energy usage profile across the US, usually the number 1 or the number 2 user of energy, primarily electricity, is the AC or refrigeration system in most large buildings, factories, petro chems, and so you have this large user of electricity, yet probably 75%, 80% of those units are running significantly inefficient. And to make it worse, it's usually the refrigerant circuit. In there a problem, whether right level, whether a contaminant in there or other specific problems that we can point out that's causing the inefficiencies. So what we did is we developed and patented technology years ago that we've been using with the largest facilities in the country to nail down their inefficiencies, and we find a big portion of that in the refrigerant circuit. So a couple things happen there. We can nail it down with our service technicians, but we can also identify the other problems on the unit that they can fix. So at the end of the day, we show them basically, these are your inefficiencies.

This is how much from a dollar point of view it's costing you. But more importantly, now it comes right on the screen, this is basically the reduction in CO2 that you'll be saving by making these corrections. So what they end up getting is a printout and an actual real number of it certified to say, "This is your savings environmentally to basically CO2 emissions that you can use to get carbon credits." So that's the proof they need to actually document -- again, these are enormous numbers, and you see -- actually some of our press release that we have put out of some of the biggest facilities in the country, we've always listed the dollar number that we saved them. Now we'll be able to say, "What is the CO2 reduction that we've also saved them by doing that?"

Okay. Thank you.

There are no further questions at this time. I would like to turn the floor back over to management for any concluding comments.

Okay. Thank you. In conclusion, we're very pleased with our record performance for 2008. We delivered record revenues, operating income and net income. We experienced solid growth for the fifth year in a row, and made considerable progress positioning ourselves for the upcoming phase-out. So again, thank you for joining us today on the call. And we look forward to reporting on the Company's first quarter 2009 results in the coming months. Thank you.

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