Hudson Technologies - Q1 2024

Transcript

Operator (participant)

Please note, this conference is being recorded. I will now turn the conference over to your host, Jenn Belodeau. You may begin.

Jenn Belodeau (VP)

Thank you. Good evening, and welcome to our conference call to discuss Hudson Technologies' financial results for the first quarter 2024. On the call today are Brian Coleman, President and Chief Executive Officer, and Nat Krishnamurti, Chief Financial 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, are not within our control, we would ask that you consider and interpret them in that light. We urge you to review Hudson's most recent Form 10-K and other subsequent SEC filings for a discussion of the principal risks and uncertainties that affect our business and our performance, and other factors that could cause our actual results to differ materially. With that out of the way, I'll turn the call over to Brian Coleman. Go ahead, Brian.

Brian Coleman (President and CEO)

Thank you. Good evening, and thank you for joining us. Our 2024 selling season has kicked off largely as we expected, with our first quarter revenues reflecting a difficult comparison to the first quarter of 2023, which was characterized by higher pricing for certain refrigerants, as well as higher volume in 2023 from our DLA contract. As we detailed in last quarter's earnings release, in 2023, we saw the highest annual revenue generated by our DLA contract at $53 million for that year. That amount included approximately $20 million, which was evenly spread across 2023, related to increased DLA-specific program activities that may not be repeated in 2024.

During the first quarter of 2024, our industry saw pricing for certain refrigerants decline by approximately 20% as compared to pricing levels during the first quarter of 2023, with HFC prices currently at approximately $8 per pound. Pricing may be impacted by factors, including the current supply of certain refrigerants in the market and weather. The reduction in refrigerant pricing was slightly offset by increased carbon credit sales and increased service projects during the quarter. With the challenging pricing environment, our margin performance was below our long-term target. However, we delivered solid profitability. Based on the current pricing levels, we do not believe the long-term targets we set in 2022 for the full year 2025 will be achievable at this time.

We will address our long-term view as we progress through this sales season and will have more visibility once the EPA's final Refrigerant Management Rule is published, and we'll have the opportunity to evaluate its long-term impact. With that said, if current pricing levels continue for the balance of the 2024 selling season, we would anticipate full year revenue in the range of $250 million-$265 million, with gross margin below our targeted 35%. Given the ongoing step down in virgin HFC production, as supply tightens, we do expect to see an increase in the sales price for certain refrigerants, but the timing is difficult to predict. In the meantime, the lower pricing dynamic provides us the opportunity to replenish our inventory with lower-cost refrigerants that we could then sell later this year and certainly next year.

To be clear, we view the current pricing dynamic to be temporary in nature, and our longer-term expectation of higher prices, similar to the prior phase outs, remains the same. Our balance sheet is strong, with no debt, providing us with the financial flexibility as we move through 2024, and our industry navigates the continued and ongoing implementation of the AIM Act. Our selling season comprises 9 months, from January through September, and while it's still early, we believe the 2024 season will provide valuable visibility related to the ongoing HFC phase down and the expected corresponding supply-demand imbalance. Moreover, the EPA has referred to the proposed Refrigerant Management Rule as the third leg in the AIM Act implementation. We expect this proposed rule to be final in late summer of this year.

While we expect to see pricing increases as demand begins to outweigh supply due to the phase-down of HFC consumption allowances, it is difficult to predict exactly when this imbalance will occur and begin to drive increased HFC pricing. However, we and others in our industry firmly believe that it's not a question of if tighter supply dynamics will take place with resulting heightened pricing, but a question of when this dynamic will begin to kick in. With our established customer and vendor network, as well as our industry-leading reclamation technology, we believe Hudson is well positioned to benefit as virgin HFC refrigerant production is compressed and the industry begins to rely more meaningfully on reclaimed refrigerants to service the existing installed base of cooling and refrigeration equipment. The EPA's proposed Refrigerant Management Rule includes language mandating the use of reclaimed refrigerants for certain applications and equipment.

If the final rule is in line with the proposed rule, the industry will see the first federal requirement for the mandatory use of reclaimed refrigerants relative to specific sectors of the industry. These mandates may lead to a pricing differential between virgin source refrigerants versus reclaimed refrigerants, with reclaimed refrigerants priced at higher levels. This would be a much different pricing dynamic compared to what we've experienced over the past 20 years. Certain states are also implementing legislation or have proposals under consideration for the mandated use of reclaimed refrigerants. In 2025, for example, California has established a mandate for the use of reclaimed refrigerants in state-governed facilities.

Additionally, late last year, the EPA issued a final Technology Transition Rule, promoting the introduction of lower GWP systems for new construction starting in 2025, as well as a conversion of the current estimated installed base of 125 million HFC legacy systems over the next 20 years. Hudson is refrigerant agnostic, with the ability to provide any and all types of refrigerant and service any and all types of systems. So we are well positioned to serve our customers as the industry gradually transitions to next-generation refrigerants and equipment. Indeed, both legislative and regulatory environments are favorable to Hudson. In line with our support of the transition to more efficient and environmentally friendly cooling equipment and refrigerant management, we are actively involved in promoting the practice of refrigerant recovery, because without recovered gas, you have no opportunity to produce reclaimed refrigerants.

To that end, during the first quarter, we attended and presented at various industry conferences, including the Air Conditioning Contractors of America, HVAC Excellence, Plumbing, Heating, Cooling Contractors Association Conference, and Air Conditioning, Heating and Refrigeration Expo, to discuss the importance of recovering refrigerant during service calls. We take pride in being a thought leader and helping the industry transition to the new rules. As we navigate through the 2024 selling season, we remain focused on what we can control, meeting our customer needs today, while ensuring their seamless transition to next generation and lower GWP cooling technologies as our industry evolves. Now I'll turn the call over to Nat to review the financials. Go ahead, Nat.

Nat Krishnamurti (CFO)

Thank you, Brian. For the first quarter ended March 31, 2024, Hudson recorded revenues of $65.3 million, a decrease of 15% compared to revenues of $77.2 million in the comparable 2023 period. The decrease was primarily related to decreased selling prices for certain refrigerants and lower revenue from the company's DLA contract as compared to the first quarter of 2023, as expected. Gross margin was 33% for the first quarter of 2024, as compared to 39% in the first quarter of 2023. SG&A for the first quarter of 2024 was $7.9 million, compared to $7 million in the first quarter of 2023. SG&A has grown as the company invests more in personnel and IT costs.

We recorded operating income of $12.8 million in the first quarter of 2024, compared to operating income of $22.7 million in the first quarter of 2023. The company recorded net income of $9.6 million, or $0.21 per basic and $0.20 per diluted share in the first quarter of 2024, compared to net income of $15.5 million, or $0.34 per basic and $0.33 per diluted share in the same period of 2023. The company recorded $3 million of income tax expense in the first quarter of 2024, compared to a tax expense of $5.3 million in the first quarter of 2023.

The effective tax rates for future periods are expected to reflect an overall combined federal and state rate of 26%, subject to various temporary and permanent differences. Stockholders' equity improved to $238.6 million at March 31, 2024, as compared to $228.8 million at December 31, 2023. The company's availability, consisting of cash and revolver availability at March 31, 2024, was $82.5 million. As we generate additional cash flow in 2024, we expect to, one, ensure we have adequate inventory on hand, two, review any possible M&A opportunities, and three, consider potential share buybacks. We have strong liquidity, and our revolving loan credit facility provides us with a solid financial platform and flexibility as we look forward. I will now turn the call back over to Brian.

Brian Coleman (President and CEO)

Thank you, Nat. We maintain our positive longer-term view for the significantly higher sales prices and profitability from the continued and ongoing impact of the AIM Act. While 2024 may be a challenging year towards our long-term objectives, it should be noted we are still early in this year's season. Operator, we'll now open the call to questions.

Operator (participant)

Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Once again, please press star one if you have a question or a comment.

... The first question comes from Ryan Sigdahl with Craig-Hallum. Please proceed.

Ryan Sigdahl (Analyst)

Hey, good afternoon, guys.

Brian Coleman (President and CEO)

Hey, good afternoon.

Ryan Sigdahl (Analyst)

I want to start on pricing. I guess, what do you think are the main causes for the lackluster pricing to start the season this far? And then second to that, I guess, lower HFC pricing in 2024 benefits inventory replenishment. So I guess, why would that negatively impact 2025 gross margin targets of 35%? I would think that'd be positive.

Brian Coleman (President and CEO)

So, back to the first part of your question, the current pricing dynamic. We had always expected, prices to be higher around this time in connection with the overall implementation of the AIM Act. However, the counterbalance to that had been what type of stockpile might have come in, particularly in the 2021 year. Unfortunately, initially, let's say back in 2022, that data wasn't available, but more recently, and it's public to everyone, the EPA has published under something called the Data Hub, that in that 2021 year, it looks like we had imported and made available about 1.5 times the annual cap. So that, if you will, in that year, there's an extra half a year that we would consider a stockpile.

Furthermore, the EPA has provided the December 31, 2022 inventory data. Now, the total number looks like it's about 129% of the cap, and may therefore mean that some amount of stockpile has been sold out in that 2022 year, although we don't know for certain. So we definitely believe right now, and, and how long it may occur in this 2024 selling season, is the pricing is being affected probably because of this stockpile more than anything else. We obviously are gonna begin to see warmer weather. Warmer weather, without a doubt, creates further demand, and so forth. So that's the first part. The second part to your question, we're not saying that 2025, we're not going to get back to the targeted gross margins.

What we're simply saying for the moment is that we're taking down that 2025 target that we established. We still believe we're gonna get back to the longer-term targets of the gross margin of 35%. But for the current year, and the current year only, we provided guidance relative to the full year that basically is freezing pricing at, let's say, this $8 a pound HFCs that we're currently seeing today and running that through the balance of the year. So what we're trying to present is, if pricing for this year maintains exactly the way it is at this moment in time, these are the range of outcomes, and the gross margin for this year would be below that target.

But as we get through the rest of this year, and let's say we're into around September, we'll certainly know where pricing is for the year, and pricing may be higher. But more importantly, we'll also understand what the final refrigerant management rule is, and that will then allow us to provide more long-term guidance and likely, return to that more long-term gross margin target of 35%.

Ryan Sigdahl (Analyst)

Gotcha. Two clarification questions: What was DLA revenue in the quarter, and what was it last year? I'll maybe start with that, then one quick follow-up.

Brian Coleman (President and CEO)

Yeah, so the DLA, as we said, let's say, the last earnings call, should run at about $8 million a quarter. And right now, that's where we are, which would be $5 million lower, roughly, compared to 2023. And so that's what we expect. Now, it doesn't mean we can't sell more than that, but we were trying to call out what we think were more one-time surge type related purchases, but we may be wrong in that. And so right now, the first quarter ended up where we thought it would in terms of that more normalized, approximately $33 million annual run rate.

Ryan Sigdahl (Analyst)

And then, what was R-22 pricing in the quarter, and do you think you'll grow reclamation volume in your 2024 guidance for R-22? Thanks.

Brian Coleman (President and CEO)

Yeah, R-22, in a few instances, prices have come under $30 a pound, but in other instances, prices are over $30 a pound. So 22 right now isn't overly impacted in terms of price sensitivity, certainly not in the way that HFCs are, because again, back to 22 we don't believe there's any real material stockpiles out there.

Ryan Sigdahl (Analyst)

Great. Thanks, guys. Good luck.

Brian Coleman (President and CEO)

Thank you.

Operator (participant)

The next question comes from Josh Nichols with B. Riley. Please proceed.

Josh Nichols (Analyst)

Yeah, thanks for taking my question. First off, really good to see the company providing some additional detail about the quarter, and the outlook overall. Just for clarification, I know you mentioned there were some carbon credits and service sales in the quarter. Just so I could get a better idea, what were those, if you don't mind disclosing them, just so I could kind of help triangulate how things may be shaping up for 2Q?

Brian Coleman (President and CEO)

Yeah, they're, they're not very large dollars, hundreds of thousands of dollars versus millions of dollars, for example. But like, for example, the carbon market, overall, the prices for carbon offsets have continued to increase over time. Now, like everything else, things could go up or things could go down, but there's been a pretty strong consistency with increased prices for carbon offset projects as it correlates to California's mandated pricing for carbon. So each year, we tend to get, let's say, slightly higher margin when we execute a trade of a carbon instrument, but the dollars are relatively low. And the service business is running in that $7 million-$8 million total for the year. It's just that Q1 was up a little bit compared to last year, but not we're not talking millions of dollars.

Josh Nichols (Analyst)

Got it. And then, well, I admittedly, obviously, pricing for HFCs being down is gonna be a headwind, at least for the time being, and maybe that changes over the coming months. But while that is a potential headwind for the companies operationally speaking, I'm just curious, does that make things more attractive on the M&A front? Are there better pricing that you're able to get on potential acquisitions? Are you looking at larger deals and getting close to potentially the finish line for maybe closing something this year? I'm just curious your thoughts on the M&A environment overall.

Brian Coleman (President and CEO)

Yeah, we won't comment about exact timing, but your assumption that, let's say, folks could consider they have a pot of gold because, let's say, pricing in 2022 was 40% higher than where we are today, certainly they've come back to earth. So I do think your assumption that the negotiation is, let's say, slightly more favorable today than if we had executed something, say, 2 years ago or so. So the opportunities are there. The areas that we've always talked about are reclaimers. But as it relates to reclaimers, generally speaking, there would be fewer number and lower dollars. There may be opportunities in distribution. They would tend to, again, be few in number, but higher dollars. And then I think the wide-open space for acquisitions is in the contractor space.

Josh Nichols (Analyst)

Thanks for clarifying on that. And then, just for context, I know we're kind of only a month into what is typically the company's strongest quarter here in 2Q. But some of the headwinds get a little bit better. I know pricing may be a little bit softer, but if you just kind of think about it contextually, where pricing is. In the first quarter, right, revenue was down around 15% year-over-year, including that DLA contract headwind and pricing being down around 20%.

Fair to assume that, when we're looking at 2Q on an apples-to-apples basis, at least based on how things are today, that you'd see pricing down, but maybe it's down more like 10%-15% instead of 15%+, just because the comps are a little bit better in 2Q of 2023 versus 1Q?

Brian Coleman (President and CEO)

You're exactly right. It, going back to 2023, we started the year much higher than we started this year. But probably in about June of 2023, we were seeing those $8 pound prices that continued probably till about September-ish, and then we started to see a slight uptick, getting closer to 10. But that 10 really didn't kick in until September-ish. Almost no material impact to Q3. Had more of an impact on Q4.

Josh Nichols (Analyst)

That's it for me. Thanks, guys. I'll hop back in the queue.

Brian Coleman (President and CEO)

Well, thank you, too. Appreciate it.

Operator (participant)

If there are any remaining questions, please indicate so by pressing star one. The next question comes from Austin Moeller with Canaccord. Please proceed.

Austin Moeller (Analyst)

Hi, good afternoon, Brian and Nat. My first question here, what is the latest that you're hearing from the DLA on the potential for more advanced procurement in the second half? I mean, it sounds like they're currently purchasing at the rates that you expected in the first quarter so far, and you expect that run rate, but, I guess there's opportunity there for improvement in the second half, but I guess, what have they communicated to you?

Brian Coleman (President and CEO)

Unfortunately, there isn't a lot of visibility and/or communication because the contract is constructed as an indefinite quantity. So that's why we had to make an estimate on our side of what we thought might be more surge related or less potential recurring in the 2024 year. But to your point, and as we tried to say before, it doesn't mean we won't see some of that come back in the 2024 year, but we were trying to, let's say, level set expectations that, let's say, a $32 million-$33 million run rate on an annual basis, while higher than it used to be at around $25 million, it's less likely that we would see it in $40 million-$50 million, as we did in 2023.

Austin Moeller (Analyst)

Okay, that's helpful. And then just to follow up, do you expect that the tightening of HFC supply this year, combined with the requirements under the Refrigerant Management Rule for reclaimed in certain industrial units and other new units, to be what's really needed to permanently drive prices higher, just given where that inventory stockpile's at?

Brian Coleman (President and CEO)

... Well, we always look at the stockpile that it's a one-time event. You know, once the stockpile is sold, it's gone. And back to the current year, we do believe that the 40% overall reduction or 30% further from where we were last year, does create a drawdown on that stockpile. Does it use up all that stockpile or not in the 2024 year? That's the difficult thing to predict.

So you have that particular element, but then as it relates to the Refrigerant Management Rule, and again, depending on how the final rule comes out, once we start to get into a situation where there's a mandate for the use of reclaim, then we believe there's a potential departure of pricing all refrigerants irrespective of reclaim or virgin, and that possibly reclaim, because it'll have a demand, may be in a position to be priced slightly higher. Certainly, from an environmental footprint point of view, reclaim is more valuable than virgin if you wanna measure an ESG component to this, because under the American Carbon Registry, reclaimed refrigerants have about one tenth the carbon footprint.

So if you wanna calculate that delta and put a value on carbon, you could certainly put a value on reclaimed refrigerant should be priced higher as well. So part of the calculus to redetermine when we expect to be able to achieve, for example, a $400 million revenue target, goes back to, in some respects, how the EPA implements that Refrigerant Management Rule. Now, one of the things that we suggested, doesn't mean that the EPA will do it, but they did offer a comment, is to initiate the reclaim mandates earlier, but start at a lower percentage. So the way the proposed rule was constructed, the EPA started with a 100% demand, reclaim demand use in 2028. We suggested start in 2025 and work your way up to that 100% as an example.

So when we see the final rule, we'll then be able to evaluate how we think the reclaim side of our business model, which is the most profitable side, generally, our gross margin or profit profile on the sale of a pound of reclaim is twice as great as compared to virgin, how that will help impact our profitability and revenue growth.

Austin Moeller (Analyst)

Great, thanks for the color.

Operator (participant)

Okay, up next, we have Gerry Sweeney with Roth Capital. Please proceed.

Gerry Sweeney (Managing Director)

Good afternoon, Brian and Nat. Thanks for taking my call.

Brian Coleman (President and CEO)

Hello.

Good afternoon.

Gerry Sweeney (Managing Director)

Just a follow-up question on acquisitions. Most of my other questions have been answered, but, you know, obviously you discussed reclaim as distributors and contractors. If you had your choice, you know, where would you think the best option would be strategically for Hudson? From my perspective, I would think you would wanna be looking at the contractor space. And I know there's different dynamics around, you know, what comes first, but I'm just curious as to where you think would be best for the strategic positioning of Hudson.

Brian Coleman (President and CEO)

That's sort of a difficult question to answer. Each potential bucket has opportunities, but really, again, it goes back to our overall acquisition strategy. We've never tried to acquire anyone or anything and rely on synergies or rely on overall ability to absorb, you know, overhead or whatever the case may be. We've always tried to look at acquisitions in the context of one-on-one is more than two, or that there's a growth strategy associated with that particular target. And so, like we've said before, that we wanna look at their customer base and their offerings and understand if we could apply their offerings to our customer base, or in more times than not, add our offerings to their customers and then drive growth that way.

Ultimately, we've talked about this many times. If you really go back and look at how we did the Airgas acquisition, that was exactly the proposition. Airgas was mainly selling HFCs. We knew the long-term opportunity was HFCs. We knew there would be significant price growth in HFCs, but we were buying that EBITDA based on $2 and $3 pricing for HFCs, which we now at least are seeing $8, and then we thought we would see it higher than it is today. So that, that was part of the strategy. The also part of that strategy was that they really weren't procuring recovered gas from that customer base, whereas generally, our historical customer base, we do a buy and sell relationship. And so that we felt that it was an opportunity to be able to acquire more gas as well.

So that's how we're gonna look at any and all acquisition going forward, irrespective of what bucket they're in. And we do think that there's going to be opportunities for acquisitions that will fit that growth model.

Gerry Sweeney (Managing Director)

Okay, I got you. All right, that's it for me. I appreciate it. Thank you.

Brian Coleman (President and CEO)

Well, thank you too, Gerry.

Operator (participant)

Okay, we have a follow-up coming from Ryan Sigdahl with Craig-Hallum. Please proceed.

Ryan Sigdahl (Analyst)

Hey, just one follow-up. A lot of questions around M&A, but with your stock at this valuation, I guess why not just buy back your own stock instead?

Brian Coleman (President and CEO)

Again, we could do that, but we've always said that that's sort of the third option. The first option we always had talked about is inventory, but I think we mentioned this in the year-end earnings call. We don't see the need for more dollars in inventory, let's say, when you compare what we believe the inventory balance to be at December 31 of 2024 compared to 2023. So that's kind of, let's say, locked down from a working capital point of view. So then you're back to two remaining buckets, acquisitions and buyback. Acquisitions, we still believe the return on those dollars should be far greater than any return we would have on buying back our stock.

Now, our current ABL precludes us from buying back our stock, but we do believe if we went to our lender, we would be able to get a waiver for that. But at the end of the day, at the moment, we're, let's say, focused more on the acquisition opportunities.

Ryan Sigdahl (Analyst)

Just a clarification, you don't have anything drawn on the revolver, but it still restricts you from buying back stock?

Nat Krishnamurti (CFO)

Correct.

Brian Coleman (President and CEO)

Correct. So unfortunately, the way any of these ABLs are constructed, they're encumbering your assets irrespective of your borrowings. And typically, the way these are constructed is they preclude any cash outflows that are not going to the business itself. And so that's typically an ABL will, even though you have no outstanding balance, will restrict you both on dividends and buybacks. But as I said, I think there's an opportunity, if we choose, to go to the lender and get a waiver for that.

Ryan Sigdahl (Analyst)

Appreciate the clarification. Thanks, guys.

Brian Coleman (President and CEO)

Thank you.

Operator (participant)

We have reached the end of the question-and-answer session, and I will now turn the call over to management for closing remarks.

Brian Coleman (President and CEO)

Thank you, operator. I'd like to thank our employees for their continued support and dedication to our business, and both our longtime shareholders and those that recently joined us, for their support. We look forward to speaking with you after the first quarter results. Sorry, after the second quarter results, sorry about that, and have a good night, everybody.