May 1, 2013
Executives
John Nesbett - Investor Relations Kevin Zugibe - Chairman and Chief Executive Officer Brian Coleman - President and Chief Operating Officer
Analysts
Philip Shen - ROTH Capital Partners Greg Garner - Singular Research Gunnar Hansen - Sidoti & Company Bob Johnson - Satuit Capital Michael Needleman -Preservation Asset Management
Operator
Greetings, and welcome to the Hudson Technologies first quarter 2013 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr.
John Nesbett of IMS. Thank you, you may begin.
John Nesbett
Good afternoon, and welcome to our conference call to discuss Hudson Technologies' financial results for 2013 first quarter. On the call we have Kevin Zugibe, Hudson's Chairman and Chief Executive Officer; and Brian Coleman, Hudson's President and Chief Operating Officer.
Kevin will review the company's business operations and future growth strategies, and Brian will review the financials, and immediately thereafter we will take questions from our call participants. I'd like to take a quick 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, our predictions about the future are forward-looking statements.
Although they reflect our current expectations that are based on our best view of the industry and of our 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 you interpret them in that like.
We urge you to review Hudson's Form 10-K and other SEC filings for a discussion of the principal risk and uncertainties that effect our performance and other factors that could cause our actual results to differ materially. With that, I would now like to turn the call over to Kevin Zugibe.
Go ahead Kevin.
Kevin Zugibe
Good evening, and thank you everyone for joining us today. We are very pleased to again report record first quarter results, both in terms of revenue and profitability.
These results reflect the long-term earnings potential for our company, its production of virgin R-22's phase out by the end of 2019. Most notable development in the first quarter was EPA's issuance to the final rule, establishing virgin R-22 allowances for 2013 and '14.
The agency set those allowances at £63 million and £51 million respectively for 2013 and '14, which includes £6.5 million additional for only those two years, related to litigation as they gave the original rule. The issuance of this final rule, set of litigation and now provide certainty to our customers concerning the continued phase out of R-22.
Please refer to the link included in this evening's press release, which summarizes this rule. The issuance of this final rule also gives us the ability to focus on our long-term strategy.
The next step in the R-22 phase out is for the EPA to issue a rule for the final five years of the R-22 virgin production, covering the years 2015 to '19. As expected that a draft will be issued later this year or early next year with the final rule being issued in late 2014.
We expect that the EPA will continue to use a step-down approach, which has been demonstrated with current rule with annual reductions in production through 2019, when virgin R-22 production will be eliminated. As virgin R-22 production phases out, recovered and reclaim refrigerants will need to fill the increasing supply gap, thereby driving growth in the reclamation market.
Over the past 12 months, we have seen and continue to see significant growth in our wholesaler reclamation programs, growth that has been driven by economics, product offerings and education. As a largest reclaimer, our reclamation programs are designed to provide attractive economics for everyone within the distribution chain and to secure our customers needed supply for the next year.
While this behavioral change is still in its beginning phase, we are confident and we will continue to see growth in the reclamation market over the long-term. With that in mind, we've been focused on enhancing our product and service offerings to build upon our leadership position in the reclamation market.
From a business development perspective, we are providing incentives and innovative programs to our customers that encourage them to return more used R-22 as a way to help ensure that their future needs will be met. I know that a lot of you are curious in what if any impact of EPA's final rule had on R-22 pricing.
Our view is that at this point, final rule has had a little impact on pricing. The three major producers, who together represent approximately 87% of the market, have not announced any pricing adjustment since the issuance of the final rule.
While we've seen a slight softening in the price of R-22 from some of the smaller producers and suppliers by approximately 10%, we believe that this softening is largely due to the weather. As you may have noticed, the month of April was cooler than average in many places across the country, thereby delaying the start of the air conditioning systems.
As a result, we have not seen our customers begin to restock, which typically begins when the average temperatures increase. We believe that any softening in refrigerant prices is related more to the weather than to any impact to the final rule.
We are still early in the season and we believe that with the onset of warmer weather, 2013 can certainly result in a strong year for us. As the season progresses and seasonal demand rises, we believe that on a overall basis the pricing dynamics established by the three main producers will have the greatest effect on our revenues and profitability.
As you all know, we have achieved very favorable gross margin levels, when compared to our targeted 35% margins over the past few quarters largely due to the pricing growth in virgin R-22. Over the long-term, we expect that reclamation will further drive enhanced gross margins in our business.
We are only three years into the 10-year phase out process for virgin R-22. Consequently, we are in the early stages of reclamation development, which we have a very long tail.
In the near term, as we continue to develop and grow our reclamation business, gross margins will be tied more directly to the sales price of R-22. And will fluctuate with each increase or decrease in the pricing from the producers of virgin R-22.
Primarily, because of the cool spring, it is difficult at this moment to predict where pricing and volume will be to the season, but it is possible that the margins during the balance of this year will be closer to targeted margin levels. We are pleased with our achievements in the first quarter.
We continue to work with end-users, contractors and wholesalers to develop and enhance reclamation offerings and are continuing to grow our reclamation volumes from these offerings. We believe we're in excellent position to capitalize on the opportunities being presented, as our marketplace continues to change and we look forward to the EPA's final rulemaking of virgin R-22 production for 2013 to '19.
We have confidence in our offerings and have expectations for the long-term opportunities of our business. With that I'll hand it over to Brian to provide the detailed financial results.
Brian Coleman
Thank you, Kevin. Revenues for the first quarter increased to $22.9 million as compared to $14.9 million in the first quarter of 2012.
Increase in revenue was primarily related to an increase in the average price per pound of certain refrigerants sold, slightly offset by reduction in volume. The volume difference of approximately 10% has attributed to the cool weather this year compared to much warmer March of last year.
For the quarter, net income was $4.5 million or $0.18 per basic and $0.17 per diluted share, compared to net income of $2.5 million or $0.11 per basic and $0.10 per diluted share in the first quarter of 2012. Now turning to the balance sheet, as of March 31, 2013, the company had $51.5 million in inventory, $32.9 million of working capital and over $16 million availability under our credit facility.
We continue to manage our future growth through reinvestment of earnings back into our inventory, which includes more reclaimed refrigerants due to the growth in the reclamation. We expect that our forward inventory turnover rate will be similar to the past ranging from 1.2 to 1.5 times.
Consequently, we're expecting to continue see increases in our inventory balance. We are pleased to be working with PNC and our ability to grow our credit facility with them.
We believe our cash flows in the facility will support us through the anticipated revenue growth for the foreseeable future. At this point I'd like to turn the call back over to Kevin for some final comments.
Kevin Zugibe
Our most recent results were a strong indicator of the long-term opportunities we expect to see related to the virgin R-22 phase out. As I said earlier, we know that virgin production of R-22 will end by December 31, 2019, and we expect that reclamation is a long way to grow.
We have strategically positioned our company to benefit through the growth in reclamation as we remain a consistent resource for our growing customer base. Thank you for your interest in and support of our company.
Operator, we'll now open the call for questions.
Operator
(Operator Instructions) Our first question comes from the line of Philip Shen with Roth Capital Partners.
Philip Shen - ROTH Capital Partners
So we've conducted some channel checks on where R-22 pricing is today, and our results were that pricing has remained firmed post EPA kind of rule, between $13 and $15 per pound. From your perspective, first of all is that true for you guys?
And secondly, how do you expect pricing to trend as we go through this cooling season?
Kevin Zugibe
That is true. We have seen few people out there, we mentioned some small people out there in the marketplace with slightly lower prices, but a big three haven't adjusted price.
We think unlike what they are going to adjust price. We look at last year and the three of them had 87% of 55 million.
The three of them again have 87% or about 63 million, so the overall dynamics, relative divergence supply doesn't really change. Right now, we're starting to see a pickup in the weather.
Things have started to warm up, but we had a cooler March and we had cooler April. So it's just really kind of getting into the seasonal, so we're not expecting any material changes on price, but as we get in the season we'll know.
Philip Shen - ROTH Capital Partners
I'd like to in my follow-up talk about inventory. How many years of R-22 inventories do you think is out there in the industry?
And how long do you think it takes the inventory to kind of work through all of this inventory? And in fact, currently who has this inventory, other speculators for instance.
Kevin Zugibe
There probably are many speculators or a material amount of speculators. From a functional perspective, the three producers have sort, if you will, corner the market for many years within in this allocation system going back all the way to about 2003.
And for own intents and purposes, they pretty much had anywhere from maybe a low of about 80% to 83% up to about 87% to 88% of the total. So this pretty much controlled this for a long time, it's not their interests to see someone else corner of the market, if you will.
In terms of the natural stock rate, we will call it, let's say, maybe two pieces to your question, like the natural inventory and stock pile. We don't think anyone really carries a significant amount of inventory, meaning let's say, one year's worth of inventory or more normally.
Many of the purchasers of R-22 go through a cycle of cooling season, then they need to gear up their warehousing and their refrigerants to the heating season. Then they comeback into the cooling season, which is kind of why it seems a bit odd maybe that we sell a lot of refrigerant in the first quarter, it's because probably most people had completed their shelves from the prior year and they're working backup their inventory.
And then we get through that restocking season, which happens sometime usually in the second quarter. So you have that normal cycle and we don't see anything, let's say, abnormal one way or another good or bad thought on that cycle.
Then it's at the end of the day the last piece maybe to the question is other stock piling. And it's difficult to say how much of that existed and currently exists.
The place where it's possible to have existed would be with the allocation holders. We go back to that 2009 year, where there really wasn't a restriction relative to the overall market demand for R-22 production even though it was within allocation system.
But at the time in 2009, the larger producers and really everyone in the industry had a very, very poor refrigerant sales year that year probably the big three were in that 50% decline in revenues, which in theory means they would have produced with normal anticipation of sales. And therefore could have created stock piles, but we'd never know really know the answer to that question.
So in terms of normal inventory, we don't see anything unusual in terms of some kind of speculators in the marketplace. We don't see that and probably stock piles would reside in the hands of few number of people.
Operator
Our next question comes from the line of Greg Garner with Singular Research.
Greg Garner - Singular Research
I wanted to ask you about the gross margin, it's higher than I had expected, is it proper to assume or correct to assume, I'd say that some of the products that the R-22 sold might have been purchased before the first no action assurance letter in early 2012, might that have been a reason for this to be gross margin higher or is there something else going on here, if you can help me there?
Brian Coleman
It's probably sort of two things happened this year that it would be kind of slightly different than last year. We obviously were somewhat wiser coming into the 2013 year, possibly compared to how we might have been coming into the 2012 year, because we have seen what the no action no assurance letters were.
And if you look at last year our activity in some of the conference calls we talked about that we were buying product, let's say, earlier in the 12 years than we might have normally in the past. So that certainly gave us some advantages.
The other thing that probably was a little bit different this year relative to last year is the surprise that everyone really had about the pricing change in 2012 and the time it took to kind of get in the marketplace, the shock that came from with no action assurance letters and the pricing. Whereas this year the pricing didn't quite happened as quickly, but it took hold quicker maybe this year.
So it's probably combination of few things. But at the end of the year or end of the quarter we obviously benefited from all these different variables slightly relative to maybe the first quarter of last year.
Greg Garner - Singular Research
But we're still at the high-end of the range right now and with the 50% I mean the change in pricing only being above 50% it just seemed like this was a higher gross margin than would be expected. So the guidance was about 35% to 40%, is that correct?
Brian Coleman
That's right 35% and it would more and so was certainly better. Again, back to all this, the comment I think Kevin made earlier, the pricing that the producers create in the marketplace really has an effect overall on the margins.
And how they move and how quickly they move price.
Greg Garner - Singular Research
And it's my follow-up question, if I could just move to just the distributors who are in contact with the retail contractors, I think Kevin you mentioned how the reclamation program is improving towards more buy-ins coming in, is that something you're talking more on a general basis or do they happened in the first quarter, which it seems like it would be a little bit early for that to occur and just overall is there any change in that, what you're hearing from those distributors in reality towards bring in the dirty gas?
Kevin Zugibe
We have seen it's been pretty consistent since the start of last year, we've seen growth in reclamations. So the 2011 to '12 we've seen a significant growth, which it was.
We've already seen a significant growth from '12. So yes, we will always get reclamation any time of the year, more so in the summer time, but the early season, it gets warmer down south, we start getting more gas from wholesalers.
And we're clearly seeing a significant increase from first quarter of last year. So the thing is really, our programs nothing has changed.
We had a backed up on our buy prices on gas. We haven't backed up anything different, in fact, they are better than they were.
So all we're doing is we keep going down the south enhancing our offering and the prices consistently going up from the distributors and to the contractors, he would have no reason to see something negative now, I mean his prices haven't changed. Again, I think they all see the growth in the reclamation right now.
If they're paying, they are wholesaler out there that's not paying and kind of keeping the profits, well, he has probably not seen the growth in reclamation. But the ones that are and working with us to grow the reclamation where they are passing some money down, yeah, we're seeing a consistent growth in that and we think it's going to continue.
Operator
Our next question comes from the line of Gunnar Hansen with Sidoti & Company.
Gunnar Hansen - Sidoti & Company
But I guess, just to kind of follow-up with some of the distributors and some of the incentive programs. Any kinds of indication of what percentage, that some of the distributors are actually paying to reclaim the gas?
Kevin Zugibe
Probably, not quite 50% at this point, right. It's hard to say.
It's not like the majority, I think they would be, but I will tell you looking at our numbers that we tracked for how many years and specific distributor, it's noticeable to us the difference in the volume depending on what they are sending down to the contractors. So we see a direct correlation, so it is a direct correlation.
So it's not us just thinking that they will get more, we could see year-by-year and our largest distributors, now were almost insignificant a couple of years ago. They are working with us passing down the benefits of our program, passing down some of the money to them, we've seen the growth.
So it's hard. So some of them clearly have the same program that we're offering the same program to other people who basically keeping the profits and they're not seeing the growth.
So it's hard to say what percentage is that, it's very hard for us to tell, but as Brian said it, I don't think it's much more than 50%.
Gunnar Hansen - Sidoti & Company
And I guess just last question. The EPA's issuance of the final rule, I mean that's not going to kind of impact any of the program incentives that you guys have for the new term here?
Kevin Zugibe
No. All I can tell you is that the only thing that would make us back up something is that if you saw something crazy happen on price.
And we can't see it happening, but we're not about to do anything on price, we haven't seen it in the marketplace. But again if something crazy happens, then we would think to do that, but other than that, no.
We don't see anything. In fact, we see enhancing and going through this year.
Operator
Our next question comes from the line of Craig Hoagland with Anderson Hoagland.
Unidentified Analyst
I am Brian. Could you comment on the incidents of dry shift units you're seeing in the industry, is that still a common occurrence?
Kevin Zugibe
I mean, it's still, I guess in offering, if that's the right way. It's early in the season for those with that kind of activity right now this year.
So it would be hard to say if this year is going to be the same as last year and vice versa. Certainly, when we'll have the second quarter, we'll have a better feel for that, but definitely, it's an offering that's still out there.
It's hard to say, how much of an impact it will have this year, because it's still too early.
Unidentified Analyst
And as a follow-up, could you just talk for a minute about your joint venture in Europe and put that in the context of Hudson?
Kevin Zugibe
We are cleaning and selling products in Europe right now. Predominantly R-22, reclaimed R-22, serving that market.
We're still working through different operational things mainly logistics, what are the rules and regulations in Europe, they're much different than here. We're focused on that right now, more than some of the other service or offerings.
But as we get through this year, we're expecting to see growth on both refrigerants and services we offer them.
Unidentified Analyst
And would you expect that at some point to be big enough that you might break it out from your other results?
Kevin Zugibe
We do, yes, and since we don't own it and control it, it will be a minority sub.
Operator
Our next question comes from the line of Bob Johnson of Satuit Capital.
Bob Johnson - Satuit Capital
Kevin, I wanted to go back to the comment that you made in regard to the EPA rules, in which they made an allowance due to the loss the $6.5 million, but for just two years. So that looks to me like in '15 there is going to be a very sizeable drop.
So if we start at £51 million, take of £6 million that's approximately £45 million, and then that's got to be allocated down to zero over four years. So that I'm assuming or inferring that the £6.5 million is aside from the base decline rate that they were maybe thinking about to get to zero.
So in fact, there is going to be a very significant drop in 2015, am I reading this correctly?
Kevin Zugibe
That would be the debt on our belief. And we're not kind of waiting to see if it happens.
We're going to be pushing down there and we are as often as we can, because we want to make sure it's very clear that £6.5 million maybe they have to do it, maybe they will force their hand to do it. They can makeup for this.
We think it will be cutback significantly starting in '15, that's what our belief is. We can't imagine, why they wouldn't, but again sometimes things happen that we don't see.
And so they came up with this year's rule more than we thought it should have been. And we think they should take the chance to rectify this for '15 to '19, and we think they will.
So I think you are right that it should be a significant drop.
Operator
Our next comes from the line of Michael Needleman with Preservation Asset Management.
Michael Needleman -Preservation Asset Management
Can you just remind us of what you believe the total gallons needed for this calendar year might be in your opinion?
Kevin Zugibe
The EPA figures in the original rule that when you read the proposed rule and different appendices that they've added would have been a number of let's say a 100 million or more. Now we're not entirely sure that that number is right, some people in the industry at 70 million.
It's hard to tell what exactly the number is. But we definitely think the number is much higher than the 63 million.
We would think probably most people in industry think that some of the producers have made a statement to that effect also, relative to the announcement when it came out, the rule from the EPA. Probably more clarity is going to be with this rule making that will come up for the 2015 to '19.
And in that proposed rule, which may come out late this year, if it doesn't come out late this year, then it will probably come out in the first quarter of next year. There should be some detailed work and analysis performed by the EPA, an updating of their business model to give us a much clearer answer to that question.
Michael Needleman -Preservation Asset Management
And the second part of the question, even though I have one just quick follow-up, is what currently is your production as far as gallons is concerned in approximate if you can give that information out?
Kevin Zugibe
So in terms of the reclamation market, we say that we have about 20% of the overall market. Now that isn't our capacity, we don't really disclose exactly what our capacity is, but we say we run at one shift and we certainly could run two shifts.
When the EPA did a study for this industry on capacity, EPA believed that there was sufficient capacity to mange, I think it's over £30 million annually in reclamation, we would certainly support that view. So we have a long way to go in terms of growth in reclamation and capacity.
Michael Needleman -Preservation Asset Management
And just if I can, in terms of the other players in the reclamation business, from my understanding I guess they are 20 somewhat players in this whole field that you guys are dealing in. Is there another significant player of reclamation close to you in terms of size of production that you are aware of?
Kevin Zugibe
First of all, I think it's probably close to 35 active EPA-certified reclaimers. Certainly, there is two companies out there.
Airgas, a fair amount of reclamation, we are not sure of their size, but they would be large. And there's a private company National Refrigerants, and also would be large in size.
But it's hard to say exactly what their overall market volumes are and so forth. That information is unavailable.
Operator
Ladies and gentleman, at this time I would like to turn the floor back to management for any closing comments.
Kevin Zugibe
First, I'd like to thank our employees for their continued support, and all the shareholders who have shared our vision. And so I want to thank everyone for participating in tonight's conference call.
And we look forward to speaking with you after the close of our second quarter. Thank you very much.
Operator
Thank you. Ladies and gentleman, this concludes today's teleconference.
You may disconnect your lines at this time. Thank you for your participation.