Hudson Technologies, Inc. (HDSN) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to the Hudson Technologies' Second Quarter 2019 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] I'll now turn the conference over to your host, Ms. Jennifer Belodeau. Thank you, Ms. Belodeau. You may begin.

Thank you. Good evening and welcome to our conference call to discuss Hudson Technologies' financial results for the second quarter of 2019. On the call today we have, Kevin Zugibe, Chairman and Chief Executive Officer; and Brian Coleman, President and Chief Operating Officer. 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 our businesses as we see them today, they are not guarantees of future performance. Please understand that these statements involve a number of risks and assumptions, and since those elements can change and in certain cases, they're not within our control, we would ask that you consider and 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 businesses and our performance and other factors that could cause our actual results to differ materially. With that out of the way, I'll turn it over to Kevin. Go ahead, Kevin.

Good evening, and thank you for joining us. Our industry continued to see challenges in the second quarter as we encountered downward price movements, changes in customer buying behavior and cooler than average temperatures, particularly in the north and northeast regions of the US, where much of the comfort cooling air conditioning systems reside. This year's pricing pressures mainly related to R-22 refrigerant due to the apparent selloff of stockpiles. Some of the larger allocation holders are experiencing poor market conditions in Europe, which we believe has apparently driven them to lower the price of R-22 in the US in an attempt to move more volume and alleviate a portion of the negative financial impact they're seeing from outside the US. On a favorable note, as we anticipated, sales volume increased meaningfully during the second quarter, despite the cooler weather in the quarter and we're pleased to see the temperatures have warmed up in recent weeks to more seasonal levels. While our second quarter results are not where we'd want them to be, we remain confident about the long-term opportunities for our company, which are tied to the fact that demand for refrigeration and cooling systems continues to grow. In the U.S. food refrigeration is considered a non-negotiable essential and comfort cooling for homes and businesses is increasingly viewed as a necessity for most of the population. With Hudson's competitive position in two points in the supply chain, our long-standing customer relationships, established distribution network and ability to provide all types of refrigerants anywhere and anytime, we're optimistic about our long-range prospects. We're confident that demand for air conditioning refrigeration systems will continue to grow and we're focused on growing Hudson's leadership role as a comprehensive provider of all types of refrigerants including legacy gases such as CFCs, commonly used gases such as R-22 and HFCs and next generation HFO products. Furthermore, as the industry conducts phase out of certain refrigerants in favor of promoting more environmentally friendly products, our proprietary technology reclaims all of these gases more quickly and efficiently than any competitor, an advantage that positions us as a leading producer, supplier of phased out as well as currently produced refrigerants. As we move through the back half of 2019, we draw closer to the end of R-22 production. In June of this year, one of the three largest allocation holders notified their customers that they have discontinued the sale of R-22. This information reinforces our belief that stockpiles are dwindling and possibly by the end of this cooling season the industry may have worked through its stockpiles. Upon the elimination of R-22 stockpiles, we expect that the R-22 market will operate within a traditional supply demand model and that the negative price influence we have seen during the past two seasons will be alleviated. It's important to note that the pricing pressures for the last two seasons was created by the three largest allocation holders, which we believe related to market dynamics and it had not nothing to do with R-22 demand in the US. Rather we believe these pricing pressures were associated with shortfalls in other areas of our businesses. Given the existing installed base of R-22 equipment and with the elimination of virgin production, we expect to see a shortfall in the supply of R-22. And we believe our ability to reclaim and resell R-22 creates a tremendous opportunity to position Hudson to address the anticipated supply shortage and become the leading producer of R-22. Currently, we're seeing R-22 pricing of approximately $9 per pound. While this pricing dynamic has negatively impacted our 2019 selling season to date. We expect that the R-22 market will demonstrate more traditional supply demand behavior once production is stopped, which will result an increase pricing for R-22. We have faced pricing and weather challenges during both the 2018 and the 2019 selling seasons. If we've learned anything in our 30 years in the refrigerant industry is to focus on the elements of our business within our control. With the addition of Aspen, we've enhanced our portfolio of product offerings and expanded our competitive positioning in the supply chain, which has increased sales volume. We have proven our ability to innovate our business model, elevate our technology and leverage our distribution network and customer relationships as the situation demands. Hudson is a seasoned company that has come from challenging market periods before and we remain intent on focusing our efforts on growing our leadership position in the refrigerant industry. Unfortunately, as a result of the company's second quarter performance primarily related to the lower price of R-22 when compared to 2018, we fail to comply with the financial covenants contained in our term loan facility and our revolving credit facility. Brian will provide more detail around this situation. But in short, we don't believe that the covenant defaults relate to a liquidity issue or relate to a leverage issue under the current covenant structure. In other recent development, Hudson & Airgas completed the working capital adjustment process that arose from our acquisition of ARI, which resulted in Airgas agreeing to a cash payment to Hudson in the amount of $8.9 million. We're pleased to have this matter finally and favorably resolved. We're confident that as we sell through the higher price layers within our FIFO inventory and continue to drive increased sales volume, the end result will be a significant increase in the gross margin of the business. Now I'll turn it over to Brian to review the financials. Go ahead, Brian.

Thank you, Kevin. For the second quarter ended June 30, 2019 Hudson recorded revenues of 56 million, a decrease of 3% compared to the 57.8 million in the comparable 2018 period. The average selling price for certain refrigerants on a quarter-over-quarter basis declined by approximately 19%, offset by 12% increase in sales volume. Revenue from our contract with DLA increased by approximately 2.3 million in the second quarter and represented 6.8 million in revenues. During the second quarter of 2019, we recorded lower costs or net realizable value adjustments to our inventory of 9.2 million, primarily attributable to the remaining R-22 purchased in connection with the acquisition of ARI. Due to the impact of these items, net loss for the second quarter was 13.8 million, or $0.32 per basic and diluted share, compared to a net loss of 13.6 million or $0.72 per basic and diluted share in the second quarter of 2018. SG&A expense for the second quarter 2019 was 6.8 million, a 3.8 million reduction from 10.6 million in the second quarter of '18. The decrease in SG&A is attributable to a 2.5 million decrease in professional fees pertaining to the integration and services associated with the ARI acquisition. With remaining portion of the decrease primarily due to reduced payroll expenses, advertising and other professional fees in the second quarter 2019. Following the close of the quarter Hudson and Airgas completed the working capital adjustment process that arose from Hudson's acquisition of ARI, including the settlement of related litigation. As a result, Airgas agreed to a cash payment to Hudson in the amount of $8.9 million. This coupled with a significant recent cash collections, as is customary during this time of year, will increase our liquidity and contribute to our continued strategy of paying down our debt obligations. As Kevin mentioned earlier, the company failed to comply with the financial covenants in our term-loan and our revolving credit facility at June 30, 2019. We are currently in default under those agreements. Other than the financial covenants, the company has fully complied with all of its debt payment and other obligations on a timely basis and had over $21 million of availability pursuant to the borrowing-base formula in its revolving credit facility as of June 30, 2019. As such, the company does not believe the covenant default relates to a liquidity issue but relates to a leverage issue under the current covenant structure. We're working closely with our lenders to secure waiver and amendment to weigh the covenant defaults and we set the financial covenants under both the term-loan and revolving credit facility. The lenders do have the right to declare all amounts under these facilities to be immediately due and payable and there could be no assurances that the company will be able to pay any such waivers or amendment. We were at a similar position last year with our lenders and while there are no guarantees, we believe that the company, its advisors and the lenders and their advisors can reach an agreement on these matters. I will now turn the call back over to Kevin.

Thanks Brian. While it can be challenging at times, we believe the refrigerant industry is a dynamic marketplace with tremendous opportunities for companies agile and innovative enough to evolve along with it. Hudson has successfully navigated this changing industry for many years and we believe we have the right people, products, relationships and technology to increase our leadership position in the refrigerant and reclamation business. Thank you all for your continued support of Hudson. And now Brian I will take your questions. Operator, please open the call to questions.

Thank you. Our first question comes from the line of Steve Dyer of Craig Hallum. Please proceed with your question.

Thanks. Good afternoon. Volume shipment up 12% in the quarter year-over-year, obviously, pretty impressive, particularly given the weather, is that in your view sort of inline with the industry or do you feel like you were may be pushing some inventory through there? Or any color on that would be great.

It's hard to say how we might compare to the industry. We actually don't necessarily believe folks would have seen increases in volume in second quarter because of reports from wholesalers and the like. But anything is possible. But, for us, it is a twofold parts to the answer. One is, certainly last year we were concerned about our position, where our inventory and our lenders and so forth, and we probably walked away from some quotes or sales that we could have completed. This year, obviously, we were past all that and we have obviously have been informing our lenders on a monthly basis of our financial condition. So they were well aware of where we're going to end up relative to Q2 in the covenants and the like. But as we've been saying, for many, many years. We do believe, we have strategies to grow volumes at a double-digit rate. We obviously need some cooperation from weather. And it makes it a little bit harder for us to achieve that when our customers are buying more just in time. It's difficult to predict out, how the season will play out. But we still have that confidence, we still try to build strategies on an annual basis to achieve that kind of growth level. And again, we did achieve it in probably one of the more difficult weather quarters. We really didn't see any warm weather in the North and Northeast until nearly the last week of June. So it was probably a pretty good achievement.

Got it. And then just as it relates to that inventory, and I know it's a little bit of a moving target because prices seem to keep drifting. But how long do you expect it to sort of take to reset that FIFO inventory such that the gross margins normalize there?

Well, I believe, we told all the shareholders on previous calls that we expect it by about May of this year, that Hudson will be out of all of the high price inventory it had when it had to write-down in '18. And in fact, that's the case. And we're now beginning to release layers that are in the $4 or $5 kind of ranges. Because almost all of our Hudson inventory now relates to reclaim and that's roughly where we are the market on the buy price for use gas. As it relates, unfortunately though to Aspen because with the Aspen acquisition, we had to purchase the stockpile of 22. We knew or projected that that stockpile would continue to run into early next year and unfortunately that is the case. So what's happened here is because we've had roughly, let's say, a $2 pound reduction in the sale price from this time last year, we've had to have about a $2 pound reduction in that remaining inventory. And nearly all of that adjustment is now reflected in the second quarter. So, again, as we said in our prepared remarks that we do expect prices of 22 to increase because we do believe the stockpile is dwindling. Certainly, there's no more virgin allocations left for next year. So we are optimistic the prices of R-22 will go up but even if they don't go up and they stay where they are today we probably now have right sized that Aspen R-22 inventory relative to cost basis and write downs.

Got it. That’s helpful. DLA revenue pretty impressive in the quarter. Is that a level, do you think that you can sort of build and grow off over? Is that somewhat lumpy and it's going to be up and it's going to be down on, this just happen to be a good quarter?

Well again, as we'll never know the future for sure. But our plan was exactly where it's headed. And we thought we can absolutely bring this up quarter-after-quarter or year-after-year. And we're probably on a run rate of a little over 25 million a year now. And the goal is to continue growing. So I think our DLA group has done a very good job bringing new agencies in, smoothing out the program. And I think we should see continued growth.

And maybe just to add, you would have heard in prior quarters us referring to some administrative problems and things like that, relative to the initiation of the contract. We worked through many of these problems, and the program is now smoother. And now is the time for us to now sort of seek to grow the program now that we've worked through all those little glitches on the administration side.

Got it. Just a couple of quick balance sheet questions and then I'll pass it on. So your inventory in the quarter excluding the impairment was down $16 million, but looks like that basically stayed the same, cash basically stayed the same, where did those proceeds go?

From the P&L side, we didn't generate cash relative to our increased interest rates and debt service and so forth. So, that really ate into what cash we generated but we had a little bit more borrowings during the period. We're going to come out of that cycle though. We originally thought we would generate about $20 million of free cash flow. We're not going to generate that level, but certainly with the cash award that we have with Airgas, we'll probably end up being in the mid-teens for the year. So you'll start to see the debt coming down and availability increase over the remainder of the year.

Got it. Okay. I'll hop back in the queue. Thank you.

[Operator Instructions] Our next question comes from the line of John Stoltzfus of Oppenheimer & Company. Please proceed with your question.

Thank you for taking my call. I'm just want to get a general sense for what you are thinking in terms of operations, how much inventory are you are likely to hold to meet customer expectations, considering that such a wild fluctuation in price? Could you serve, I'm just curious, obviously, you've come through this period where you bought a lot of inventory in the acquisition. But, what would be a run rate level and have your thoughts changed as to how much you would like to keep an inventory going forward?

So, I believe what we have said recently is, we are not buying inventory in the same manner we would have historically. When referring to, historically, would have bought a fair amount of inventory in the third and fourth quarters for sales that should have occurred in the first and second quarter. And what happened is, we followed that pattern for decades and last year first quarter, our customers almost across the board went from buying inventory in Q1 and then restocking in Q2 to solely just-in-time buying. That put us at extreme exposure for all the pricing corrections that occurred last year and in some respects the negative impact to last year's write downs were twice as bad as they could have been if our customers had not changed their buying habits. So what we did going into this year, we would have told everyone that we are managing our inventory, working capital levels and expecting high returns on inventory and not going as long, let's say, in exposure to price risk as we would have previously. And it mainly matches our buying habits, mainly now match the customer buying habits in that just-in-time model. Two other things to your question; One is, because we bought a stockpile of 22, liquidating that stockpile frees up cash and then obviously brings the inventory levels down. We still believe we've got a fair amount to go on bringing cash dollars out of inventory, because the second part to that is, when we release high-priced inventory, we're generally replacing the same pound for half the cost. So, we expect this year -- at the end of the year that the dollars in inventory will be lower than the dollars were last year and probably that will again occur in 2020 that the December 2020 balance for inventory will probably be lower than that of December of '19. And probably that inventory dollars will be the right amount of dollars in inventory to manage the business. Now, things could change, obviously, depending if we have an HSC phase out and all these other factors. But that's our current view in long-term view relative to inventory dollars.

So we should expect obviously higher inventory turns going forward. The other question, I'm curious, does the current covenant violation situation -- does that impact business development? And are you seeking alternatives to maybe get out from that situation besides what you're doing with the current lenders?

It doesn't really impact the operations of the business, because again, it's not a liquidity issue, we've got tons of liquidity and so. Certainly, we should and have publicly said that we will be looking to seek new lenders in this back half of '19. That is our intention. But we also need to resolve the matter with the current lenders relative to a wavier and amendment to get that behind us. So there's multiple things and options we're looking at. And but it could be a-- it just definitely requires a waiver amendment, but also could include new lenders as well.

[Operator Instructions] Our next question comes from the line of -- our participant has removed himself. At this time, I would like to turn the conference back over to management for closing remarks.

Okay. I'd like to thank our employees, our longtime shareholders and those that have recently joined for their support. Thanks everyone for participating in today's call. We look forward to speaking to you after the third quarter results. Thanks.

This does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful rest of your day.