Hudson Technologies Inc (HDSN) 2018 Q1 法說會逐字稿

Greetings, and welcome to the Hudson Technologies First Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Nesbett of IMS. Please go ahead, John.

Good evening, and welcome to our conference call to discuss Hudson Technologies financial results for the 2018 first quarter. 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 and are based on our best view of the industry and of the business as we see them today, they are 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 will now turn the call over to Kevin. Go ahead, Kevin.

Good evening, and thank you for joining us. Our 2018 selling season is certainly off to a slow start, which resulted in first quarter performance significantly below our expectations.

As we discussed on our fourth quarter earnings call about 2 months ago, selling season began sluggishly with just-in-time buying pattern rather than preseason stocking activity we typically see. Additionally, during the quarter, we saw declines in both price and volume for most of the refrigerants we sell. The just-in-time buying approach coupled with cooler-than-normal weather and price declines contributed to our weak revenues and gross margin performance for the first quarter.

We've been in this business a long time, and while we've previously seen price and/or volume declines in one refrigerant or another during certain time periods, the start of this year's season has been challenging. Many in our industry have been hesitant to stock inventory because last season, they saw increased pricing early in the season followed by declines later in the season for all refrigerants, resulting in lower-than-normal margins for our customers. Additionally, the prolonged cool weather provided no stimulus for buyers because until the actual customer turns on their system, there's limited urgency in the demand for service or refrigerants.

Only recently have we begun to see warmer, more seasonable temperatures in the north and northeast. And as you would expect, demand has improved. While we believe the demand will increase with the warmer weather, we are concerned with the overall pricing dynamics particularly in the near term. To provide more specific details, since we last spoke to you in early March, R-22 pricing has declined roughly 20% to approximately $11 to $12 per pound today.

Conversely, HFC pricing started to increase in late 2017 and continued to increase through February of 2018 because producers in China raised prices, claiming shortages similar to the pricing behavior we saw from those producers last year. These increases were short-lived and were followed in March by HFC price reductions that completely erased the prior price increases. Moreover, we have seen further HFC price reductions continuing through April. Given these pricing headwinds, we no longer expect to achieve the revenue, gross margin or GAAP earnings per share targets in 2018 that we identified in our fourth quarter 2017 earnings release and conference call.

Assuming the refrigerant pricing remains at current levels, we expect revenues for 2018 to be approximately $230 million and GAAP gross margins should remain in the upper teens with non-GAAP gross margins approximately 3% higher than GAAP. We have every reason to expect that refrigerant demand will return to more normal levels, but we are resetting our performance targets based primarily on lower sales price expectations. Despite a disappointing start and our concern around this year's 9-month refrigerant season, we remain very optimistic about the long-term opportunities in the markets in which we operate.

Hudson has been in this business for many years, and we've experienced and managed through other turbulent seasons. Our acquisition of ASPEN has significantly strengthened our overall expertise by bringing on board extremely seasoned management and associates with extensive experience. It has also diversified our customer base and enhanced our product offerings, providing us with greater flexibility as we navigate this year's selling season.

The ongoing phaseout of HCFC refrigerants and the expected future phasedown of HFC refrigerants continue to represent tremendous growth opportunities for Hudson. This year, less than 9 million pounds of R-22 will be permitted to be produced, and 2019 will be the last year of virgin production. We've had prior experience and have demonstrated success managing the shift from one class of gas to the next, and we see many similarities with the current phaseout of HCFCs and the previous phaseout of CFCs, which saw pricing go significantly higher. One aspect of the current HCFC phaseout which has consistent characteristics with the previous CFC phaseout is that although we expect to see significant price increases in the long term, the growth is certainly not linear with corrections and rebounds on the way to a higher price.

R-22 pricing has trended lower in the short term. But over the longer term, R-22 should see significantly higher prices and we believe will reach approximately $30 a pound. Likewise, the expected phasedown of HFCs should follow a similar trajectory and we believe represents an even larger opportunity as there will be a broader installed base of HFC equipment. As we move through the balance of 2018, our focus remains on meeting the needs of our customers and growing our leadership position to capitalize on future opportunities as our industry evolves to new equipment and refrigerants.

Now I'll turn over the call to Brian to review the financials. Go ahead, Brian.

Thank you, Kevin. For the first quarter ended March 31, 2018, Hudson recorded revenues of $42.4 million, a 9% increase compared to $38.8 million in the comparable 2017 period. The increase was primarily related to the acquisition of ASPEN Refrigerants. Excluding ASPEN, revenues in the first quarter of 2018 decreased $17.5 million compared to the first quarter of 2017, primarily due to a decrease in both price and volume of refrigerants sold.

GAAP gross profit for the quarter was $7.9 million or 19% of sales compared to $12.5 million or 32% in the first quarter of 2017. GAAP net loss for the first 3 months of 2018 was $3.1 million or a loss of $0.07 per basic and diluted share compared to GAAP net income of $5.7 million or $0.14 per basic and $0.13 per diluted share in the first 3 months of 2017. We also provide non-GAAP information, which add back various items including the noncash amortization of inventory step-up, acquisition expenses and stock-based compensation. A detailed reconciliation of these items is presented in today's release.

On an adjusted non-GAAP basis, gross profit for the quarter was $9 million or 21% of sales. Non-GAAP adjusted net loss for the first quarter was $1 million or a loss of $0.02 per diluted share compared to non-GAAP adjusted net income of $6.1 million or $0.14 per diluted share for the first quarter of 2017. Adjusted EBITDA was $2.9 million for the quarter ended March 31, 2018 as compared to adjusted EBITDA of $10.5 million for the prior year quarter.

Our balance sheet remained strong with working capital of $111 million. Inventory at March 31 was $171 million. As Kevin mentioned earlier, since our 2018 selling season is off to a slow start, we didn't see as much inventory move during the quarter as we would have expected. We do anticipate that as we move through the 2018 and the 2019 years, we will begin to see more meaningful declines in overall inventory balances of approximately $10 million annually and that in 2019, we should see an increase in inventory turns as we begin to rely on a greater percentage of reclaimed product of R-22 for sale to serve the R-22 demand.

From a cash flow perspective, in 2018, our noncash charges net of capital expenditures and taxes should provide at least an $8 million increase in cash flow compared with our GAAP results. In addition to the inventory delevering, we should see at least an additional $9 million in cash flow from a onetime tax benefit from changes in the tax law. As of March 31, 2018, we have approximately $57 million of availability in our revolving credit facility with PNC.

I'll now turn the call back over to Kevin.

While we have had a disappointing start to the 2018 selling season, our management team is focused on using our combined industry experience and expertise to steer the company through this challenging time. With our acquisition of ASPEN, we are now a much larger business, and this scale has benefited us by providing a larger and more diverse customer base, increased reclamation capacity, additional bench strength to our management team and an enhanced base of experienced sales and operational employees. We are optimistic about the long-term market opportunity and believe we are well positioned to grow our leadership role in the refrigerant reclamation industry.

On a personal and sad note, Chuck Harkins, our Vice President of Sales and Marketing for over 20 years, due to health reasons, will be leaving Hudson as of this Friday, May 11. Chuck has been with the company since 1995. He's played a large part in the growth of Hudson, and I know I speak for all of us here at Hudson when I thank him for his many years of dedicated service and for his contributions to our growth and success. Chuck has built a strong Hudson sales team. But we have also acquired an equally strong team with the ASPEN group, which has allowed us to internally reallocate Chuck's responsibilities. Most importantly, our thoughts and prayers are with Chuck and his family as he focuses on his health.

Operator, we'll now open the call to questions.

(Operator Instructions) Our first question today is coming from Ryan Merkel from William Blair.

So first question for me. I guess, how (inaudible) to happen to get R-22 prices back into the low 20s? And if the answer is you need the supply to get cut, I guess, I wonder, with that only 1.5 years away here going to 0, why wouldn't we see supply-demand at least pushing up prices a little bit here? I guess, it's concerning that we're at $13 and we're not just seeing a little bit more lift as we get closer to 2020.

Well, clearly, we think the demand is going to come with the warm weather, for one. And as of last week, feeling some weather across of the country, we clearly saw increase in demand. Price in the past, any time we've seen a retraction, which we've seen a couple of them as most recently, a bigger one was in 2013, by the next year, went right pass it and it started going flat again. We said in '14, it [came past] it again. So once whatever it was that backed it off, this time there were a couple reasons why it backed and that was we talked about in the first quarter last year the producer putting the gas then the cool spring. That's what started down that path, then people got burnt as far as distributors did. So again, we just have to rebound off that demand. We'll correct things. Once demand is going again and volumes move, then the market starts acting like the market again and then you'll see price increases. We feel very confident in that.

And maybe one other thing to add, much like what happened in '14, in the prior year in '13, there was a jump in the substitute products. At that time, we saw about an increase to the 20% market share in '13. The same sort of pattern also happened last year with the jump in the substitutes. So far this year, we don't see any real demand for substitutes. Our belief will be that there will not be much increase or any increase in substitute demand, and it should retract to single digits as we've seen before.

So it sounds like sort of a perfect storm of the bad weather and then people getting burned last year so they're not buying now. But it's transitory and you still think that R-22 prices are going to rise with demand and as we get closer to the production going to 0. Is that fair?

Yes. And again, on this year, we -- the HFC was a different reason, had more with the Chinese imports and the pricing from that. So we got hit with a couple of different things. So we did have a perfect storm.

Okay. And then on the revenue guidance, the $230 million, I think it's fair to extrapolate the pricing that you're seeing today -- maybe that's a bit conservative. But I guess my question is now that we're seeing better demand, wouldn't the price start to pick up here? And are you seeing that?

It depends. Again, we won't get ahead of it that way on the price. In '14 when we saw this happen, it seemed to lay level the whole year. So -- even though demand started to pick up at a level then it started coming up the following year. So it's just hard. Could it this year? It could. Hoping it does. We don't want to get ahead and think and say it's going to, though.

Okay. And then just lastly, I'll pass it on, can you give us a free cash flow target for 2018?

We should be at least at about a $30 million total. That's coming from both operations and from the delevering of the balance sheet.

Our next question is coming from Gerry Sweeney with Roth Capital.

On that guidance for $230 million, is that implying R-22 at $11 to $12? Or is it at a different number?

It should be in that range of $11 to $12. I mean, the $11 number right now is less frequent. We put the $11 in there because we've seen a little bit of it, but it should be in that kind of range. So back to our revenue, reduction in guidance is 100% coming from pricing.

Got it. And then just I haven't had a real opportunity to dig through the numbers, but I'm surprised inventory only dropped on the balance sheet by, I think, a little over $1 million in the first quarter. Is that a function of -- I mean, were you still acquiring some inventory at that point of the year? Just -- or is there some nuance there that I didn't...

Yes, no, we definitely we're -- I mean, back to, let's say, our expectations. Our expectations, obviously was to sell a lot more volume in the first quarter as we normally would have. Now ASPEN normally sells less in the first quarter than we do as a percentage. But in either case, we expect to sell more volume. As we said on the call in early March, we were anticipating having the ability or, frankly, needing to have the inventory because we thought once the demand came, we would attempt to catch up our overall revenue targets. Now what's affecting us meeting those revenue targets is maybe a pricing dynamic. But we still think the demand should be fairly reasonable, similar to other years, things like that. So we need to have the inventory to meet that demand for the second and third quarter.

Okay. Got it. And then -- I apologize, I just lost my train of thought here. On the expense side, is there any way to -- I mean, any levers? Obviously, I mean, you've got -- pardon me, you've got some levers on the working capital side. What about on the expense side? Is there -- can you bring in some of the expenses for the rest of the year, manage that a little bit to maybe drive some profitability? Or are you just -- you don't think we're there yet and need that?

Yes -- no, in terms of expenses, we try to be reasonable with any growth rates, first off. Secondly, we're now getting into the final stages of the transition. So that -- we're on the last leg of IT, let's say, support, coming from Airgas within the overall transition services agreement. I think we've communicated with everyone on the phone before that we expected this to be completed in this quarter as we speak. So once that last leg is put together and we're working off of one accounting system and the like and we are engaging additional integration work, there may be some additional synergies and things like that. But we've also said that synergies was not the primary target for the acquisition, but that synergies typically do come. So we would expect some of that.

Our next question is coming from Steve Dyer from Craig Hallum.

With respect to the $20 million or so haircut you kind of gave for revenue guidance, given that you're about halfway through the second quarter, would you anticipate the bulk of that sort of happens in Q2? Or are you thinking more ratably over the cooling season?

Probably Q3 is going to be stronger now based on what's happened so far. If this year continues to be like hand to mouth kind of, then historically, our Q3 would generally not be a strong quarter because people would be thinking about beginning to destock and put cooling equipment in -- or heating equipment in, excuse me, let's say in September or whatever. Possibly now that means they're going to have to continue to buy refrigerants July, August and into September maybe even, which we would not normally see. So it's probable that our third quarter will end up being stronger as a result of all this, but this change in weather last week has definitely helped with pickup in demand.

So the bulk of the $20 million, I guess, shortfall, if you will, versus your original guidance, most of that or a lot of that is going to be reflected in Q2, would you say?

Well, a lot of it comes from Q1, and then certainly some of it comes into Q2, yes.

Got it. And then if you could just maybe refresh our memory around the debt covenants and the terms of it. I know it's 4.75 to 1 in trailing EBITDA, but I don't have sort of the combined company EBITDA in Q3. So I mean, I think based on the assumptions around margins and revenue, that's going to put your EBITDA probably somewhere in the low- to mid-20s. I guess -- I don't know the cadence of sort of your free cash flow or how you're thinking about it throughout the year. But any commentary you could sort of provide around your comfort level around the covenants and ability to work around those?

Sure. I mean, so I think we've shared with everyone that we're -- our intent is to take the free cash flow and just lower our debt. And we've demonstrated that, for example, at the end of last year. We lowered our debt from excess cash flow. So that's our #1 goal no matter what, continue to lower overall debt. In terms of our covenant, we tried to set our covenant at 4.75 to give us cushion for any particular anomalies. We're now just over 4% on -- or 4x on the leverage. So we are certainly getting closer to that. Our intent is to operate the business so that we don't have a covenant violation. We had covenant violations in the past, 2013 and 2009. We spoke with our lenders at the time when we had them. Mainly it was market conditions and price declines that are temporary, as we've seen in these past quarters here. So to the extent that whatever the circumstances may be, we expect to work with our lenders and so forth. But as of right now, the leverage ratio is about a little over 4.

Got it. That's helpful, Brian. And then just lastly, the tax refund, have you received that since the end of the quarter? Or what's the timing around that?

We've seen -- collected at least about 2/3 of the total. There will be probably another collection in early third quarter, middle of this year sometime, probably not in the second quarter, but it'll be probably in the early third quarter.

Our next question today is coming from Sarkis Sherbetchyan from B. Riley FBR.

So just a question really surrounding reclamation expectations for this season, obviously with the pricing, where it is given today's environment. How do you influence behavior to go more towards reclaimed gas instead of, let's say, more virgin or from the current inventory levels?

Well, certainly, again, we've always said economics should help encourage behavioral changes. And when the prices are lower, our economics of the contractors are, in fact, lower. Based on the EPA report, we now know that for the 2017 year, as we thought we might, we do represent 35% of the overall reclamation market and that's also true for R-22. Back to our plans and part of the reason for the acquisition of ASPEN, because ASPEN does work further downstream than we have historically, we do still feel that they're closer to the sources of where the potential gas could be recovered. They would be aware of, for example, of entities, system owners that are converting from 22 to a new HFC product, for example, and being in a position to historically supply that HFC product. Now we're working with their sales teams in creating actually buying groups to think more about the buying side as well as the selling side. So we think while the economics are not in our favor at the moment with lower prices, we think the sales strategy that ASPEN had can lead to additional reclaim if properly invested and nurtured the relationship on the buy side.

That's certainly helpful color. And then if I just kind of look through the nonrecurring expense, I think it was almost $1 million for this quarter. Can you help us understand what that breakout was, maybe what components it relates to, and then if you expect to have kind of some of those going forward?

Yes, I think what you're seeing now is a dwindling, on a relative basis, quarter-over-quarter. Most of this -- it's just a hair under $1 million, is in the whole support function for the IT exercise that we're going through. As I said, we're going to be completing that in this second quarter. It's likely that the total costs in the second quarter are going to be lower than the first quarter. Although they may not be materially lower. But certainly, by the third quarter, there should be some residual, very nominal dollars, we think, spent in this area. And then certainly, by the fourth quarter, there should be almost 0.

And just one more, if I may. Can you help us understand how the DLA contract is progressing and/or how the revenue services side is progressing, especially into the selling season?

Well -- so as we've said, for the quarter, the DLA was roughly $3.8 million. And we think we're still on track for the year to do 15 or plus possibly. Seems to be going well. It's -- again, it's different than our normal business. We had things to learn originally, but it's coming along smoother and smoother. And yes, we're saying for this year, we should be doing 15-plus. For the services, in general, services actually seem good for different reasons and not necessarily because of heat. Sometimes when you have some -- a good hit of -- a good spike in temperature, systems fail and we'd be out for the larger systems. This came from different reasons, preplanned outages that our service seems to be -- or I'd say service seems to be very solid this year. It's the one area that we're actually happy with.

Our next question today is coming from Matt Sherwood from Silver Creek Partners (sic) [Cooper Creek Partners].

So I guess there's just been some concerns just in light of some of the questions that were asked about covenants and the shelf filing that you're looking to do an equity raise to get your leverage ratio in line. Are there levers that you could pull -- first of all, a covenant waiver. But forgetting about that, are there levers you could pull with inventory? And do you think an equity raise would be a necessary piece of your strategy?

Yes, we haven't been thinking equity raise at all. We didn't file a shelf for that reason. It's something we've done. It's the fourth time we've done it. That was the first chance once the financials were prepared that we could have filed it. And so this was just put it in line. We always are looking for opportunities. You never know when they're going to come. This is just standard, and nothing to do at all with, hey, we're going to raise capital at this point or we're going to do an equity raise. So it didn't come from that end at all.

Great. And then last one on the inventory. Do you have an opportunity to further reduce inventory? I know there's ability to put some inventory back to Airgas if you -- if need be. And you also have the ability to buy less virgin gas should you desire to do that. How do you look at the opportunity there?

Well, again, so we'll always be working to -- I'm not sure what you meant by selling back or putting back inventory to Airgas. I wasn't quite following you on that question.

Yes, there is no...

Yes, that's why I'm asking, maybe you can repeat it, just what you meant by that because...

Okay. I thought I saw that in the purchase agreement, but that's fine. Do you have an ability to buy less virgin gas here to reduce inventory if you thought that was the right strategy to sort of shore up your balance sheet further?

Yes -- no, absolutely. As we said earlier, our goal is to lower the overall dollars in inventory. That comes from sales, obviously; and then to the extent that we don't need to reload the volumes that we have, and that's what our expectation is, is that the overall dollars will decline because the overall pounds in inventory will decline. And back to, let's say, if we're focused solely on R-22, we'll no longer be in a position, frankly, to buy a lot of virgin R-22 anyway because R-22 virgin supply is dwindling. Certainly, the annual allocations are significantly lower than what they were. Also, we do think a lot of the stockpile is gone. And we think that when we get through this year and have reasonable demand, there won't be much stockpile available for next year. So overall, we do expect lowering our inventory volumes, and that results in a reduction in dollars tied up into inventory.

Yes, I'm wondering when you said the other line about the sale, if you're talking about in the stock purchase agreement, the sale -- it was actually at closing, where it just lowered the purchase price. There was nothing up for sale. It was just lowered our purchase price at closing. So you wouldn't see it as a sale, and it was a onetime thing at the time when they took inventory, and that was what we arranged just before closing and at closing again. All that did was lower the purchase price.

Fair enough. And then last one. I guess, you talked about the stockpile being lower and some of the positive long-term dynamics in the industry. I guess, does this year's lower run rate of earnings change your outlook for your sort of longer-term earnings power in 2019 and 2020? And I guess, how should we look at longer-term earnings power if we look through this sort of challenging year?

Well, again, you started with the stockpile. I don't think anything's changed from our opinion. This was -- yes, we [lowered people's shelves] early. But if demand is demand this year, meaning if the heat comes and we're selling throughout the whole 9-month season as far as the latter half of the 9-month season, we -- it'd be similar to volumes that we would've thought. So we don't know of the stockpile. We don't know of -- that it's there actually. We just assume it's there -- one producer has some. But -- so we think everything is exactly as we talked about. So this was just a slower start to the year in our eyes.

Yes, and we've seen -- every season is in isolation, and it's a 9-month season. There's nothing right now that's happening today that we feel has any permanent impairment or change in '19 and beyond. So any, for example, discussion about what we projected with guidance has all been focused -- a change to that has all been focused on 2018. We haven't discussed 2019 or beyond because there's nothing that tells us there's a permanency in change in outlook with regards to what's happening right now.

Ladies and gentlemen, we've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

I'd like to thank all of our employees, our long-time shareholders and those that recently joined us for their continued support. Thanks, everyone, for participating on today's call. We look forward to speaking after the second quarter results. Thank you.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.