Hudson Technologies, Inc. (HDSN) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Hudson Technologies' Fourth Quarter Year-end 2021 Earnings Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, John Nesbett, Investor Relations for Hudson Technologies. Sir, the floor is yours.

Thank you. Good evening, and welcome to our conference call to discuss Hudson Technologies financial results for the fourth quarter and year-end 2021. 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 and 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 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 for the factors that could cause actual results to differ materially. Okay. With that, I will now turn the call over to Brian Coleman. Go ahead, Brian.

Good evening, and thank you for joining us. We're pleased to have closed 2021 with record fourth quarter and full year results. Our strong fourth quarter performance reflected significant revenue growth, enhanced margins and improved profitability. It is important to note that our fourth quarter has historically been our weakest quarter, given that it falls outside our traditional 9-month selling season, which takes place from January through September. However, after the close of the selling season this year, the industry saw a continued strength in the average selling price of certain refrigerants, which drove our unusually strong fourth quarter performance. Looking forward, we are energized to carry the momentum we built throughout 2021 into 2022. To provide some pricing perspective, the average selling price of many refrigerants increased sequentially from the third quarter to the fourth quarter. We had not expected fourth quarter pricing to increase, but rather remain stable as it has traditionally done. Instead, pricing for certain refrigerants steadily trended upward throughout 2021. As we enter the 2022 season, we believe this pricing behavior will continue, particularly as the AIM Act phasedown of HFCs begins. Assuming this pricing trend continues for the 2022 selling season, we could see revenues exceeding $270 million in 2022. If we look to Europe as guidance for pricing relative to the initial steps taken under HFC phasedown there, we could expect to see a doubling in price for HFC refrigerants from the 2021 levels in the next few years. While we can't be certain pricing will reach those levels or the timing of any such increase, but over time, if we reach those levels, we could see our revenues reach $350 million with an operating income of over $70 million. Moreover, such a pricing dynamic should be a stimulus for growth and reclamation, which has not been factored in into this basic analysis. As we move through 2022 and beyond, we expect to see gross margin performance at the low 30% level as we expect to acquire HFC refrigerant inventory at higher price points than reflected in the 2021 full year. As reclaim volumes increase, we could begin to see gross margin improvement greater than the expected low 30% levels because we acquired gas for reclamation at lower cost as compared to virgin purchases. That said, we wouldn't expect to see a reclamation benefit to gross margin until the 2023 season. In a favorable development, last week, we announced that we have completed the refinancing of our debt. Nat will go into more details on this. But in short, we've entered into a new $85 million term loan and increased our ABL facility to a total of $90 million. This new debt structure will meaningfully improve our cost of capital and interest expense with an approximate 3% reduction in the overall effective interest rate. Refinancing our debt and securing ample availability for the future is a key development for Hudson, reflecting our strong operating model and improving performance. With our visibility today, we believe 2022 will be a year of tremendous opportunity for Hudson related to our strong market positioning, particularly as the industry begins to comply with the AIM Act as well as other legislative initiatives. To recap, the AIM Act has introduced a mandate 10% step-down in the production and consumption allowances for virgin HFCs in 2022 from the original baseline. The AIM Act requires further phasedowns of virgin HFC production over the next 15 years with a cumulative 40% reduction in the baseline scheduled to take place in less than 2 years. Reclamation will be critical to maintaining necessary HFC supply levels to ensure an orderly phasedown. As a leading reclaimer, we believe this will enable Hudson to act as an HFC supplier while also supporting the transition away from the production of virgin HFCs. We have the ability to process and reclaim all refrigerant gases, including CFCs, HCFCs, HFCs and HFOs. So our reclamation capabilities provide a long-term market opportunity. In the near term, the installed base of HFC equipment continues to expand, and as virgin supply tightens, we expect the demand for HFCs will drive accelerated reclamation activity to fill the anticipated supply gap. With our industry-leading reclamation capabilities, long-standing customer relationships and efficient distribution network, we are well positioned to enable the efficient transition to greener refrigerants. We've also previously mentioned CARB or California Air Resources Board initiatives. Currently, CARB has proposed a requirement that OEMs use a minimum 10% reclaimed refrigerant in the factory charged equipment, and we've been actively pursuing opportunities to assist OEMs in meeting this requirement. To that end, in January, we were excited to announce that Hudson will supply reclaimed refrigerant to AprilAire for use in their healthy air solutions for homes. We are thrilled to work with AprilAire as they take an early adopter approach to incorporating reclaimed refrigerant into their products. Hudson was founded on a commitment to sustainability and in conjunction with AprilAire our focus on recovering, reclaiming and reusing refrigerants can reduce waste and greenhouse gas emissions and create maximum economic value for used refrigerants. Hudson represents approximately 35% of refrigerant reclamation activity in the U.S., which positions us to not only support the phasedown of HFC refrigerants, but also as a key source in the circular economy of refrigerants. We are energized by the opportunities we're seeing to grow our business and to provide our services to better benefit the environment. Now I'll turn the call over to Nat to review the financials. Go ahead, Nat.

Thank you, Brian. For the fourth quarter ended December 31, 2021, Hudson recorded revenues of $37.8 million, an increase of 71% compared to $22.1 million in the comparable 2020 period. The growth is related to increased selling prices for certain refrigerants during the quarter. Gross margin was 45% for the fourth quarter of 2021 compared to 25% in the fourth quarter of 2020. The improved gross margin is primarily attributable to higher selling prices in the quarter, which in the context of our FIFO approach to inventory favorably impacted our gross margin performance. As we move through 2022, we expect gross margin performance for the full year to be in the lower end of the 30% level. SG&A for the fourth quarter of 2021 was $7 million or 18.4% of revenue as compared to $6.5 million or 29.2% of revenue in the fourth quarter of 2020. The slightly higher SG&A cost was driven by higher payroll costs and professional fees. We recorded operating income of $9.3 million in the fourth quarter of 2021 compared to an operating loss of $1.7 million in the fourth quarter of 2020. The company recorded net income of $6.2 million or $0.14 per basic and $0.13 per diluted share in the fourth quarter of 2021 compared to net loss of $4.7 million or a loss of $0.11 per basic and diluted share in the same period of 2020. Looking at full year 2021, Hudson reported revenues of $192.7 million, an increase of 31% compared to revenues of $147.6 million in 2020. Gross margin for 2021 was 37% compared to 24% for the full year 2020. The company recorded net income of $32.3 million or $0.74 per basic and $0.69 per diluted share for full year 2021 compared to a net loss of $5.2 million or a loss of $0.12 per basic and diluted share in full year 2020. The company's leverage ratio was 1.93:1 for the trailing 12 months ended December 31, 2021, declining significantly from a leverage ratio of 5.84:1 for the trailing 12 months ended December 31, 2020, mainly as a result of the improved financial performance in 2021. Subsequent to the close of the fourth quarter, the company announced it has entered into a new $85 million term loan agreement with TCW Asset Management Company LLC, and has amended its existing revolving credit facility to increase the overall facility to $90 million, which comprises of TCW participating in a first-in last-out, or FILO term loan of $15 million and Wells Fargo continuing to manage the facility, providing up to another $75 million in borrowing capacity. In conjunction with entry into the new term loan facility and amended revolving credit facility, the company's pre-existing term loan was repaid in full and terminated. Increased revolver availability provides the company with better opportunities to procure inventory for the upcoming selling season. Future cash flow opportunities, such as the potential for increased pricing that Brian mentioned, enables the company to pay down its debt at an accelerated rate, as has always been our philosophy. At closing, our excess availability under our credit facility was approximately $54 million. We have strong liquidity, and our term loan and revolving loan credit facilities and partners provide us with a solid financial platform and flexibility as we look forward. I will now turn the call back over to Brian. Brian?

Thanks, Nat. As we enter the 2022 selling season, we're excited about the opportunities ahead and focused on growing our leadership position in the refrigerant and reclamation industry. Operator, we'll now open the call to questions.

[Operator Instructions] First question is coming from Gerry Sweeney with Roth Capital.

A couple of questions for you. Just curious how the HFC recovery in the market is going. Do you have any sort of planned strategies maybe to maximize this opportunity? In the past, sometimes it's been a little bit of a challenge. Just curious how you're going to look at the market on a go-forward opportunity?

So I'd say, yes, in the past, the overall reclamation volumes were less than we expected. We certainly expected more compliance to the law. We also expected that some amount of economics would help drive the change behavior. With regards to this particular phasedown, the HFC phasedown, there's a lot of differences that we might have seen in the past. First off, environmental organizations are seeking ways to help improve reclamation. They see it as an opportunity to the extent that reclaim can grow faster than expected then the virgin production phasedown could maybe accelerate as well. So there's that side of the equation. Certainly, now that we have a requirement in the State of California and uncertain what the federal level might do, but a requirement for OEMs to use a small percentage of reclaim in their factory charge, that should incentify OEMs to help participate in the growth of reclamation so that there's adequate supply to meet their compliance needs. The other thing that we feel strongly about relative to this opportunity is even at the producer level, at some level, when we get to the far end of the phasedown we'll see a limit on HFC virgin production. But some of that HFC production is likely going to be needed to help grow HFOs. So if there is inadequate virgin HFCs at that time, reclamation certainly could help in that process as well. So there's a lot of different factors in this particular phaseout as compared to the prior phaseout. So we are looking forward to an opportunity to see significant growth and reclamation and not necessarily driven by regulation but really driven by business, the participants in this industry across the board, including reclaimers.

There's more stakeholders, it's what it sounds like from everyone from the local HVAC company all the way to the producers. Is that a fair way of looking at it?

Yes. We'd say just about anybody in the chain would want to see growth and reclamation, and we expect in some level they're going to participate in that. And then the other thing, if you think about it, right now, you could argue HFCs are a very large percentage of the overall installed base here in the United States, is it in the 80%, 85% range probably something in that kind of range and that means that 80% or 85% of the installed base is going to have to change out of HFCs over, let's say, the next 10, 15, 20 years. And that's a tremendous opportunity for recovery and reuse as we work our way through this overall change to more environmentally friendly refrigerants.

Got it. Are there, changing gears a little bit just to the HFC pricing, obviously, there's moving parts with AIM Act, but there's also been supply chain issues. Do you know if any of the pricing increases or pricing pressure was a result of supply chain or any insight into that? Or is it just driven purely by the AIM Act?

It's probably both. Certainly, supply chain issues existed throughout last year, whether it be raw material costs or just transportation costs, delays in transportation, and they're likely going to continue, at least for the foreseeable future, let's say, the first half of this year, possibly, there might be improvement towards the back half. But also as it relates to now the overall reduction in availability relative to demand, we're starting to see price increases just from a supply-demand imbalance.

And then a final question for me, and I'll jump back in line. Curious, several years ago, you -- there was a little bit of a pre-buy opportunity for some refrigerants. And then the market shifted a little bit more towards a little just-in-time inventory. Are you seeing any shift in buying patterns this year for refrigerants?

Not necessarily, but I do think there might be a hybrid this year as folks may be more concerned about availability and as a result, may look to stock a little bit more product earlier than later. At the end of the day, I wouldn't necessarily expect to go back to the old days like the pre-2017 period where there was a tremendous stocking that would have occurred in Q1. It's probably going to be a little bit more than we saw last year, but I don't think we're ever going to go back to the old days.

[Operator Instructions] The next question is coming from Ryan Sigdahl from Craig-Hallum Capital Group.

Curious on the $270 million revenue that you mentioned for 2022. Curious, 2 questions on that. One, what is the current price assumption we're using for R-22 and R-410A. And then secondly, are you assuming volume is at least directionally flat, up, down from 2021?

Yes. So when it comes to some of the target that we've talked about, we're assuming volume is flat. We're also assuming no material change with regards to supply side, meaning reclaim versus virgin because those circumstances would only make the results better than what we've reflected thus far or talked about thus far. So as it relates to pricing, R-22 pricing is definitely at the $30 level now and seems to be fairly constant at that level and maybe slightly higher. It is possible it could go higher, but we typically had folks think about the $30 level because that's the kind of sustainable level we saw with CFCs. With regards to HFCs, you're now seeing pricing above $10 a pound, probably $10 to $12 a pound, depending on the refrigerant, of course, but certainly a significant jump that occurred throughout the 2021 year.

And then just -- so I caught it. I think you mentioned low 30% gross margin expectation for 2022. How do you compare that, I guess, looking at your 2024 target? I believe it implies kind of a 30%-ish gross margin, still the right assumption there on year? Can you contrast the 2?

Yes. What we're trying to suggest right now is we certainly did better on a gross margin basis relative to more FIFO inventory than a sustainable level. We think that low 30% is the sustainable level. But we also think we could do better than that now to the extent that we see growth in reclaim volume, and that probably will start to happen in somewhat the later years. So we are expecting growth in HFC reclaim in 2022. But because the used gas return comes in on the back half of the year typically relative to the season, you're usually going to see that growth go into inventory in 2022 and -- see the margin improvement until 2023 when you sell out that reclaimed gas. So as we continue to update activities, we'll be updating on what's happening with reclamation opportunities. And to the extent we're pursuing more relationships like AprilAire and organizations that are looking to find ways to grow reclamation. We're excited about that opportunity because the margins typically on reclaimed gas that we acquire are higher than the virgin supply side.

Then just on OpEx, how should we think about -- historically, it's been fixed good or bad and conditions? How should we think about that going forward with kind of the HFC phaseout and the current supply chain issues we have?

Yes. I would say it's pretty flat. We probably maintain the same type of SG&A that we've historically done.

One more just on the debt refinance. Can you talk through kind of the lenders you were considering in the process and I guess, how you decided on TCW Asset Management? I know you had quite a few issues with the previous lender. So curious how this one went around.

Sure. So we tasked a fairly broad net out into the marketplace with lenders that would look somewhat similar to TCW. At the end of the day, we spent time with a small group and then really, it's just the relationship with TCW personnel, the types of questions they were asking, the way they wanted to get into the business and understand it better, made them a leader in the overall process. The nice thing about working with them is the folks that we spent all this time over many months, many different due diligence questions and reviews are the same team that's going to continue with this investment. So a lot of times, you'll work with lenders where you have new business folks and they hand it over to another group to maintain the relationship. But in this case, it's the same folks for both pieces of the puzzle. So we're really happy with the relationship. They have, I think, a very strong reputation in the industry. So we're looking forward to a very long relationship with them.

This concludes today's Q&A portion of the call. I'd like to turn the call back to management for closing remarks.

Well, thank you, operator. I'd like to thank our employees for their continued support and dedication to our business. I want to again thank our long-time shareholders and those that have recently joined us for their support. Thank you, everyone, for participating in today's conference call, and we look forward to speaking with you after the first quarter results. Have a good night, everybody. Thank you.

Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.