Mar 5, 2015
Operator
Greetings, and welcome to Hudson Technologies’ fourth quarter 2014 earnings conference call. [Operator instructions.]
It is now my pleasure to introduce your host, Mr. John Nesbett of IMS.
Thank you, Mr. Nesbett.
You may begin.
John Nesbett
Good evening, and welcome to our conference call to discuss Hudson Technologies’ financial results for the 2014 fourth quarter and year-end. On the call today, 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’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. These statements involve a number of risks and assumptions and, since those elements can change, we would ask that you interpret them in that light.
We urge you to review Hudson’s Form 10-K and other SEC filings for a discussion of the principal risks and uncertainties that affect our performance and other factors that could cause our actual results to differ materially. Okay, with that, I’ll turn the call over to Kevin.
The floor is yours, Kevin.
Kevin Zugibe
Good evening, and thank you for joining us. I hope all of you had a chance to review our fourth quarter 2014 earnings release issued this afternoon.
Revenue in the fourth quarter was strong, mainly due to higher R-22 pricing, increases in refrigerant volume and service revenues, as well as increases as a result of our November acquisition of Polar Technologies. As we’ve said previously, our industry was looking for clarity around R-22 [Virgin] production levels and the associated step down to the complete phase out of production.
The EPA’s October final rule established the R-22 allowances for the 2015 to 2019 time period finally provided certainty to the industry as to the path that the EPA is taking to limit and ultimately eliminate the production of Virgin R-22 refrigerant. As a result of the announcement and as expected, we have seen price increases of approximately 20% for R-22 since the final rule and over the long term, expect to see further price increases of R-22.
Gross margins in the fourth quarter held steady, and we expect to see increased gross margins as the 2015 selling season gets underway. Lastly, our service revenue increased over 20% in 2014 as compared to 2013.
We continue to have long term growth expectations for our service business, and after a number of years of stable revenues, we believe that we are starting to see expansion in this business. As mentioned above, this quarter included two major developments for our business: the EPA’s October rule establishing the final R-22 allocations and our acquisition of a reclamation business and assets in Polar Technologies in early November.
Let me briefly recap the details of the EPA’s final R-22 allocation rule and how it affects Hudson. The final rule established R-22 allowances for 2015 through 2019 and provides a nearly 60% reduction from 2014 levels to 22 million pounds, with further annual step down reductions leading to no production after 2019.
Our customers now better plan for the elimination of Virgin R-22 production, which we believe will encourage the adoption of R-22 reclamation as the primary source of supply. As the leading reclaimer in the marketplace, this is an exciting development for us.
We view the reclamation of R-22 as well as the reclamation of the next-generation refrigerants as an important market opportunity and believe we are well-positioned to drive both organic and inorganic growth. To enhance our efforts to capture a larger share of the reclamation market, during the fourth quarter, we acquired the reclamation business and assets of Polar Technologies.
Polar, who we believe was the fourth largest reclaimer in the industry, has been a respected competitor, reclaiming approximately 8% or more of the total reclamation market annually. The Polar acquisition brings a solid customer base made up of refrigerant wholesalers who serve as HVAC contractors in the continental U.S.
and Puerto Rico. Specifically, the acquisition gives us a local presence in California and Puerto Rico, two important markets where we previously had limited exposure.
Furthermore, the acquisition gives us additional reclamation capacity to serve what we believe will be increased demand for reclaimed refrigerants. This acquisition expands our customer base and we believe represents a long term growth opportunity for our company, solidifying our leadership position in the reclamation industry.
Taking a broader view of the overall refrigerant industry, Hudson has the capability to reclaim all types of refrigerants, and we believe we will also see increased opportunities for the reclamation of the next-generation HFC refrigerant gases as those gases begin to be phased out. The announced Obama Administration initiative to promote a phase down of HFCs acknowledges that refrigerant management, including reclamation, is an important way to reduce climate damaging emissions, and we believe we are well-positioned to assist our customers throughout this next transition.
We continue to look for new opportunities to expand our reclamation network to meet the anticipated growth in demand for recovered refrigerants and will continue to evaluate strategic partnerships as well as additional complementary acquisitions. To that end, in January 2015, we completed an acquisition of a small West Coast based supplier of refrigerants and cylinder service, further expanding our presence in the Pacific Coast region.
With that, I’ll hand it over to Brian to provide our detailed financial results.
Brian Coleman
Thank you, Kevin. Revenues for the fourth quarter increased 69% to $8.1 million, as compared to $4.8 million in the fourth quarter of 2013.
During the quarter, we saw a higher selling price of certain refrigerants, increases in the volume of refrigerants, and continued growth in our service revenue. Additionally, our top line increased as a result of our November acquisition of Polar Technologies.
Operating expenses for the fourth quarter were $2.9 million, compared to $2.4 million in the previous year quarter. During the fourth quarter of 2014, the company recorded nonrecurring expenses related to the acquisition of Polar Technologies of $163,000 and noncash charges related to the issuance of employee stock options of $679,000.
Net loss for the quarter was $1.1 million or $0.03 per fully diluted share, compared to a net loss of $1.5 million or $0.06 per fully diluted share in 2013. Our balance sheet is very strong, and as of December 31 of 2014, the company had $37 million in inventory, an increase from the $34 million at December 31, 2013.
The increase is primarily related to inventory acquired as part of the Polar Technology acquisition and our preparation for the 2015 selling season. At the end of the quarter, we had $15 million of availability under our credit facility and approximately $32 million of working capital.
I’ll now turn the call back over to Kevin.
Kevin Zugibe
We have spent many years developing the relationships, distribution network, and proprietary technology and equipment to capitalize on the market opportunity before us. With the EPA final rule in place, our industry has clarity around the phase down that will eliminate R-22 production in 2020, leading to increased demand for reclamation as the sole source of R-22 supply.
With our leadership role in the reclamation market further enhanced by our recent acquisition, we believe we are in an excellent position to benefit from the changing marketplace. Thank you for your interest in and support of our company.
Operator, we’ll now open the call to questions.
Operator
[Operator instructions.] Our first question comes from the line of Steve Dyer of Craig-Hallum.
Steve Dyer
You talked a little bit about pricing being up 20% since the ruling. Would you anticipate that that’s largely going to be kind of the prevailing price throughout this year?
Do you expect some ebbs and flows based on the weather we get this summer?
Kevin Zugibe
Well, at this point, right now, we thought it was a very good sign that it jumped up. We thought it would once we got a little clarity, and that it was clearly going to be that steep of a reduction.
But again, we’re in the winter right now. It’s actually still very cold.
It’s been colder than normal anyway. We look at it as a nine-month season.
We’ll get a lot more visibility as we get a little bit of temperature out here, but right now, it doesn’t look like it has any sign of retraction. We think there’s a good chance that it will continue going up.
So, how high it will go, we don’t know, but our thoughts are it will go up once we see some warmer weather coming. But we thought it was a good start before it jumped.
Steve Dyer
And with that, do you have any sense of demand and how that is sort of shaping up again? I know it’s freezing cold and so forth, but are you hearing anything from your customers in regards to that?
Kevin Zugibe
I wouldn’t say we have any feeling on it. We’ve had higher volumes in the fourth quarter after the rule, but again, a lot of people in the know here in our industry took the opportunity, we believe, when the prices came, they thought also the prices will come up, so they jumped a little bit of volume.
It’s insignificant compared to the overall for the year coming, but we can’t tell either way. Weather is going to dictate a lot of it, but we can’t tell at this point.
We haven’t seen any signs it’s going to be weak, but you can’t tell if it’s going to be a gigantic year as far as volume until you get some weather.
Steve Dyer
Can you let us know, kind of from a model line perspective, how much of a contribution we should expect from your two acquisitions from a revenue perspective this year?
Brian Coleman
The Polar acquisition wasn’t really material to our results, so you could think of it in the context that its revenues were less than 10% of our revenues. And the other acquisition was smaller than that.
So the overall, contribution from both acquisitions is not material on the bottom line. Both are profitable operations.
It’s likely over time the offerings that those two businesses had would be increased or enhanced or modified because of the products and services we offer. So their baseline is low relative to ours, but we do expect growth in their businesses as they become integrated in our operations.
Steve Dyer
And then one follow up on a couple of new initiatives that we’ve seen. Last week, we picked up something about how you’ve launched a smart energy basically chiller optimization solution.
Could you talk a little bit about that? Is that anything to get excited about near term?
And then also, the [unintelligible] rolloff. I think 2015 is the year that’s going to start to show some traction.
Kevin Zugibe
Basically, the whole energy off that we have that we’ve been putting together, we’ve always seen that has some strength to it in the sense some of the biggest users, number one or number two energy users, almost every facility is your air conditioning or refrigeration system. So massive energy users.
We have processes that we could save the customer a ton of money. We can do it real time, from a distance, where it comes over the internet to our sites.
Now, we’ve integrated all of our services. We are one of the largest steam experts for the Department of Energy, same type system, same type facilities.
We’re integrating these online, so the package is much more substantial now. And the actual offering is, again, much more accessible for someone to get involved in than the large installation than it would have been years ago.
So as we come up with larger companies, multiple sites, this was a good time to let them know about this. We’re getting a lot of traction on that alone, that we put that out, and we’re pretty excited about it.
Probably wouldn’t be near term, but long term, we think that’s incredibly exciting for us. Again, one of the biggest things it identifies is these chillers and refrigeration systems, the large ones, are low [unintelligible], another opportunity to sell refrigerant, reclaimed refrigerant, clean up the systems, every one of the services and products we have.
So it wasn’t a guess as to why it was needed. So, that was just a way of bundling it that we think is pretty exciting.
So yeah, long term, we think that’s pretty exciting.
Operator
Our next question comes from the line of David Mandell with William Blair.
David Mandell
Given the higher refrigerant prices in the quarter, I would have expected gross margins to be a tad higher sequentially, improve a little more sequentially. Were my expectations too high?
Or was there kind of mix holding down gross margins?
Brian Coleman
It was probably several different factors. So, the price increase happened during the quarter and had a couple of increases.
So you don’t capture the whole price increase in the quarter. You capture those price increases typically in the following quarter.
Certainly, for GAAP accounting, when you have acquisitions, the valuation of inventory, which was a big part of the acquisition, you’re not allowed to have big gains in sales of product based on valuation, so that affects it. Also, overall, the fourth quarter tends to be the lowest amount of revenue and volume of any quarter in every year.
So, there’s a lot of little factors here at the end of the day, but back to, I think [unintelligible] said in the presentation, we do obviously expect those margins to be higher in 2015.
David Mandell
And then on the stock option expense, was that related to the acquisition, or is that a different one-time type item?
Brian Coleman
So, the stock option expenses, in many respects, were related to the acquisition as part of the completion of the acquisition and as part of the integration plan. So many employees shared in that.
Operator
Our next question comes from the line of Gerry Sweeney with Roth Capital.
Gerry Sweeney
Now that the EPA is out of the way with that announcement and you’ve always talked about mix shifting more towards the reclaimed business, can you touch upon how that will develop? I know you think it’s going to be a year or two, but how’s that going to develop, what processes you’re going to put in place to maybe encourage that development and maybe give us a little bit of a roadmap on that front?
Kevin Zugibe
I guess you could start to say that it comes from the bottom up in a lot of respects. Historically, contractors who are the person who needs to perform the initial recovery of the refrigerant, would have possibly not spent a lot of time on the recovery side of it, because the economics weren’t there.
And so now, with the value 22, and I think a permanent psychological understanding that R-22 really is going to go away, and it’s going to go away at kind of an accelerated basis relative to where people might have thought, we think the combination of the psychology and the economics is going to enhance behavior. The recovery could have been looked upon as a cost center.
It should start to be looked upon as a profit center. So probably first and foremost starts there, and then what we obviously need to do is to encourage and make the return of the dirty gas as simple and easy and drive as much economics down to reward that behavior.
And we expect to start to see and build off of this psychology, particularly in the 2015 reclamation season, which will begin when we get warmer weather, typically beginning May/June of any year.
Operator
Our next question comes from the line of Craig Hoagland of Anderson Hoagland.
Craig Hoagland
Hi, I was just wondering, is it too early to comment on how the producers may be approaching the market, now that they have a limited amount of production they’re going to make between now and 2019?
Kevin Zugibe
Again, as soon as the EPA rule came out, we saw across the board from producers to anyone in the chain came up in pricing, so that was a good sign. So they came up indicating that they obviously want to bring it up.
As they get cut back, obviously we would expect them to bring [up] their prices, as they have less product to sell. We can’t tell at this point.
Obviously, again, it’s still such a cold time up to this point that we can’t get a real good indication how fast they would go to ramp, but we think their indication, we believe, as soon as the EPA came out, we thought for sure that they would come up in price, and they did. And we would think, as it gets warmer out again, they’ll continue that up to whatever point that they feel comfortable bringing it to.
We can’t put a [stamp] on, say, where and how fast it goes, but we would think it’s going to be, because they have less gas to sell, and to keep their customers happy out there, I would think they’re going to pick specific customers and it’s going to be a higher price.
Operator
Our next question comes from the line of Shawn Boyd with Next Mark Capital.
Shawn Boyd
Just wanted to clarify one thing on the refrigerant side services. Did I hear that revenues were up over 20% for the year versus 2013?
Kevin Zugibe
Yes.
Shawn Boyd
And moving now to the Polar acquisition, if that added 8% market share, and as I recall, you guys had 16% to 17% market share before, I’m looking at this as expanding your total area market by roughly 50%, or adding another half to it. And then of course I actually want to think about your volumes increasing by that amount.
Now, certainly it takes time. So, number one, am I looking at it the right way?
And number two, what kind of timeframe should we think about in expanding your product offering, getting it out to that whole market, and possibly having your volumes up by that 50%?
Kevin Zugibe
In terms of, let’s say, integration, the first part of the integration is making sure the quality is there and making sure the customer service is there. And the business itself, and the customers are very similar to what we were doing for many, many years, as they had been.
The employees of Polar have been very good. We’re really happy with that as well.
Now we’re on that stage where we’re looking to enhance how they’re operating and so forth, and then sooner after that stage of expanding new offerings to add to what we do, add it to their customer base. So all this really should happen before we get into the heavy part of the season this year.
So we should be able to reap the benefits, we should be able to maintain and grow the volumes that we’ve acquired through the Polar acquisition. So we should really see the benefit of the acquisition this year.
Shawn Boyd
So, again, just to be clear, we’re talking about a 50% increase here?
Kevin Zugibe
I think your numbers are off, the relative relationship between Polar and Hudson, but they’re not that far off. But certainly, at the end of the day, we’ve become the largest, we believe, in the industry, in terms of total market share of reclamation.
Brian Coleman
And again, the increase you’re saying, that’s in the reclamation area. A ton of our revenues are from product sales or refrigerant sales.
Theirs are primarily all related directly to reclamation.
Shawn Boyd
Got it. And last question is you’ve done two acquisitions now, relatively small, but just wondering, you’ve got the means and the interest, obviously.
Are there other accretive acquisitions that you think we could be looking at here in the first part of the year, or do you think you’ve got enough from a bandwidth standpoint we’d see a pause?
Kevin Zugibe
[unintelligible] the first part of the year. We’re finishing up integration of these acquisitions first.
The most important thing is we’re going to integrate them. We want to not just make them efficient, we want to add really strategically to what we do, internal Hudson, to all these locations.
We want to take some of the things that they did that was pretty creative and really can be quite additive to our locations. So we want to take advantage of all of that, and the synergies between the companies first.
We’re always close to opportunities, and we’ve been looking at it for years. So even these, we knew these for years.
The timing wasn’t right. A lot of things had to come together for this to happen.
We didn’t, just for the sake of the acquisition, want to do it. We saw a lot of clarity coming our way for the first time, and the EPA final rule added an awful lot to that.
So, with that, that now allows us to go get closer to some of the other potential acquisition targets, but we’re not close to doing something. We’re analyzing things, we’re looking, as we integrate this, we just want to get this integration, both these integrations, very efficient and optimized before we would ever do something else.
But it doesn’t mean we’re not looking at other things. They would take a while as we analyze it, but yeah, we think acquisitions could be good now that we have some clarity in the industry.
Shawn Boyd
And one more if I may. Refrigerant [unintelligible] services.
If that grew 20% in the year, that’s kind of jumping to a different trajectory as to what I was thinking in the past. Was there something in particular in the fourth quarter that pushed that up, or should I start thinking about a much higher growth rate?
What kind of growth rate are you targeting for that business going forward?
Kevin Zugibe
We suggested to the shareholders that you should expect from us this 10% to 12% kind of overall growth rate. Obviously, when you’re starting with a smaller number, it’s a lot easier as a percentage to show a higher growth rate.
But we do think that over time, this business can gallop and double, triple, quadruple, that there’s a lot of opportunity. Probably the place that we need to execute, that obviously allowed that to happen, is on the sales and marketing end.
There may be acquisitions in the future, but internally, on the sales and marketing end, adding resources, we think, will help us to accelerate the growth there.
Operator
Our next question, a follow up from Craig Hoagland of Anderson Hoagland.
Craig Hoagland
I was just wondering if you could comment on the relative margins between your wholesale distribution business, your services business, and your reclamation business, so we can understand it further. If they’re accelerating, is that accretive to operating margins, or is it neutral, or would it be dilutive?
Brian Coleman
It wouldn’t be dilutive, and it may not appear to be accretive. And I’m sorry for kind of the evasion, but what dominates the revenues is the product sales.
And reclamation and the sale of Virgin refrigerants just dominate that top line. And then to add to this whole discussion of price increases, then that [unintelligible] even more.
So the [unintelligible] business is profitable. The margins in the service business are very good.
Let’s say they’re higher than the traditional historical blended margins of the mid-20s, let’s say. And we wouldn’t expect, as we grow the business, to erode margins at all.
So at the end of the day, it will contribute to the gross profit dollars, absolutely.
Craig Hoagland
And you still expect reclamation gross margins to be higher than the other two activities?
Kevin Zugibe
Reclaimed refrigerant margins are higher, obviously, than Virgin margins. But the service business and the reclaim business are both in a way very good.
You can look at them as service businesses with generally higher margins than distribution or resale. So they’re both [good].
Operator
[Operator instructions.] Ladies and gentlemen, we have no further questions at this time.
I would like to turn the floor back over to management for closing remarks.
John Nesbett
Well, I’d like to thank all of our employees, our long time shareholders, and those who have recently joined us for their continued support. Thank you, everyone, for participating in today’s call, and we look forward to speaking with you after the first quarter results.
Thank you.