Mar 1, 2017
Executives
John Nesbit - IMS Kevin Zugibe - Chairman and Chief Executive Officer Brian Coleman - President and Chief Operating Officer
Analysts
Ryan Merkel - William Blair Gerry Sweeney - ROTH Capital Steve Dyer - Craig Hallum Mark Gomes - Pipeline Data LLC
Operator
Greetings, and welcome to the Hudson Technologies Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode.
A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. John Nesbit of IMS.
Thank you Mr. Nesbit, you may begin.
John Nesbit
Good evening and welcome to our conference call to discuss Hudson Technologies’ financial results for the 2016 fourth quarter. 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 call participants. Let me 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, or predictions about the future are forward-looking statements.
Although they reflect our current expectations and are based on the best view of the industry and 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 these 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'd now turn the call over to Kevin. Go ahead, Kevin.
Kevin Zugibe
Good evening and thank you for joining us. I hope all of you had a chance to review our fourth quarter 2016 earnings release issued this afternoon.
As most of you know our fourth quarter is historically our slowest quarter, as seasonal volume demand for refrigerant typically falls off during this time period. During the fourth quarter 2016, we saw a slight increase in revenue compared to last year’s fourth quarter.
Looking at the full year, 2016 was another very strong year for us with record revenues, increased operating margins and significantly improved profitability. Our nine month selling season was particularly strong and we benefited throughout the season from increases in the average selling price of R-22 refrigerant.
As the R-22 refrigerant phase out progresses, we are continuing to see increased interest in our reclamation solution. EPA predicts market demand for R-22 a 50 million pounds by 2020.
And we’ve remained confident that reclaimed R-22 is the best solution to meet the demand. During 2016, we did experience a year-over-year increase in reclaim volumes of R-22 of 14%.
While we are expecting somewhat higher reclaim volumes for R-22. We’re encouraged by the growing downstream interest in our reclamation.
For several years, we’ve reported the contractors were not being paid or in many cases were being charged to return recover R-22. In addition, despite the phase out, many distributors in the supply chain were not concerned that there would be a tightening of the supply version R-22.
However, during the third quarter of 2016, for the first time feedback from companies and the supply chain confirmed that the ability of R-22 is tightening and as such may not been able to get sufficient supply. During the fourth quarter, we have enhanced out sales strategy to educate our customers and the importance of harvesting R-22 for their needs in 2018 and beyond.
Our industry saw further developments in October 2016 with a global agreement reached by the parties to the Montreal Protocol for amendment that provides for a phase down of next generation hydrofluorocarbon or HFC compounds to begin in 2019. HFCs are the primary alternatives to CFCs and HCFs and have zero impact on the ozone layer but they do have higher global warming effect.
Hence the global community is calling for an HFC phase out. The U.S.
is now evaluation the best offers for complying with the amendment. And with both industry and regulatory support, we believe the amendment will occur in the near to mid-term.
Use of HFC refrigerant is expanding because currently nearly all equipment as well as the equipment that is replacing R-22 units use HFC refrigerant. Therefore we believe the HFC reclamation opportunity maybe larger than the current R-22 opportunity.
We look forward to implying our reclamation capabilities to assist with the systematic and global phase out of HFCs and to support our industry that develops and promotes next generation refrigerants, equipment and technology. Another element of the phase out that I’d like to touch upon today is our impact on domestic job creation.
As part of the R-22 phase out, the U.S. put in place an allocation system for the production and import of R-22 and we believe that a similar system will be established in connection with the phase down of HFCs.
When refrigerants such as R-22 and HFCs are phased out, these allocation systems benefit U.S. producers and reclaimers and domestic production grows with the introduction of next generation products and restrictions on foreign imports.
Likewise phase out to create job expansion opportunities in the sectors that are developing in manufacturing equipment. And these replacement products we acquire more skilled technicians as our technologies expand.
There are many economic as well as environmental opportunities represented by the phase downs and be the development and use of next generation refrigerants and equipment. So our industry and Hudson welcome these regulatory developments.
On another note, we’re pleased with the progress we made with our recently announced Department of Defense contract. We’ve been meeting with the various government departments, who will have access to our products and severs via the contract.
And we look forward to beginning to execute under the contract in the second half of 2017. Our fourth quarter came in largely as expected and we are very pleased to have delivered strong full year results, thanks to a robust selling season.
We continue to build on the capabilities and long standing relationships and we believe we are uniquely positioned to play a key role as our industry continues the transition to the development and use of next generation climate and ozone friendly technology in refrigerant. We are encouraged by the price and demand of R-22 refrigerant, which should drive earnings and reclamation growth for the foreseeable future.
As we have exited 2016 and entered to 2017 sales season, we have seen R-22 prices increase to over $20 a pound. We are encouraged by this trend and are anticipation further price increases.
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 7% to $7.8 million as compared to $7.3 million in the fourth quarter of 2015.
The revenue increase was primarily driven by an increase in the volume of certain refrigerants offset by a reduction in service sales. Gross margin was 13% as compared to 90% in the same quarter last year, primarily due to the change in mix of revenues in 2016 as compared to 2015.
Operating expenses for the quarter increased to $3.9 million compared to $3.1 million in the previous year quarter. The increase is primarily due to an increase in professional fees and certain state and local non-income taxes.
Net loss for the quarter was $1.9 million or a loss of $0.05 per basic and diluted share compared to net loss of $1 million or a loss of $0.03 per basic and diluted share in the fourth quarter of 2015. Our balance sheet remained strong.
In December 2016, the compared raised approximately 48 million of net proceeds through an underwritten public offering which was temporarily used to pay down our existing credit facility, bringing our cash balance to 34 million at December 31st, 2016. The capita raise provides us with a solid platform as we continue to evaluate strategic M&A opportunities to support the long growth of our business.
At the end of the quarter, we had approximately 98 million in working capital. I’ll now turn the call back over to Kevin.
Kevin Zugibe
Our 2016 refrigerant selling season was very strong providing the progress and success of our company. We believe the ongoing phase out of R-22 and the future phase down of next generation HFCs anticipated to begin in 2019 represent an excellent growth opportunity and we remain advocates of all reclaimed refrigerant as a preferred choice for system owners as we transition to the next generation refrigerants and equipment.
We fully support the recent agreement to amend the Montreal Protocol that we view as a job’s bill which will likely drive additional phase outs and the subsequent adoption of reclamation across all classes of refrigerants. With our long term experience in the industry, our proprietary technology and well established distribution network, we believe we are uniquely positioned to assist customers as they continue to adapt to the evolving refrigerant marketplace.
Operator, we’ll now open the call for questions.
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Ryan Merkel of William Blair.
Please proceed with your question.
Ryan Merkel
Thanks. Hey guys.
Kevin Zugibe
Hello, Ryan.
Ryan Merkel
So first, could you…
Kevin Zugibe
Operator, do we lose Ryan?
Operator
Yes. I would to reiterate our audience.
[Operator Instruction] Yeah, Ryan, please proceed with your question.
Ryan Merkel
Alright, not sure what happened there. So I wanted to see if you could expand on the mix impact for gross margins and then service sales were down, could you just give us how much they were down and what’s happening there?
Kevin Zugibe
So back to the mix, for the most part, once you get passed a particular dollar amount relative to revenues, every incremental dollar on service sales is gross profit dollars. So because the gross profit or because the service sales were down this quarter compared to last year, we end up having more heavily weighted refrigerant sales to the total sales.
So as a result the refrigerant sales don’t provide the same gross profit and we have fixed cost in the service business. That’s really the reason and the only reason why the gross profit margin is down on a comparative basis.
We don’t think it’s a permanent trends, it’s just was a temporary trend and it’s more obvious in the fourth quarter when there is very little of refrigerant sales in general and all of our cost have really picked.
Ryan Merkel
And how much was the service sales down in the quarter?
Kevin Zugibe
I believe it was about 300,000 in the quarter.
Ryan Merkel
Around 300,000, okay. And then in the last call, you guys said you know gross margin for 2017 should be in the high 20s, you wanted to just reiterate if that’s still the case and would it higher if we had R-22 prices rising as rapidly as we did in 2016, is that really what we’re thinking about?
Kevin Zugibe
So when we spoke about this at the end of the third quarter, we suggested that we reset back to how we describe the refrigerant sales season for ‘16 that we would opportunities to say 30% gross margins. But as you are expressing, if prices increase and increase at a quicker rate, then there is the possibility that our gross margins would be higher.
That’s really in a way what did happen in ‘16 through that nine months sales season instead of the gross margins let’s say being up to 20s we actually are the arrogate for that nine months with that 31%. So we’re saying the same thing could happen this year but until we see - get into the season and see the progression of price increases which we’re already seen price increases of R-22 that will help us better understand where the gross margins will land.
Ryan Merkel
So maybe if you could be more specific what’s exactly the range you think of outcomes for gross margin for 2017?
Kevin Zugibe
We still stick right now with that up to 20 to 30, but I think as you said it just a moment ago, we’ll say the same thing that if we see acceleration in the increase the price of 22 then there is the possibility for be higher than that.
Ryan Merkel
Got it. Okay, thanks, I’ll get back in line.
Operator
Our next question comes from the line of Man Gurnani [ph] of B. Riley Financial.
Please proceed with your question.
Unidentified Analyst
Hi, guys. Just talking Juan’s part just for today’s call, he will be on the next one.
So I guess my question is where you seeing prices for R-22 headed towards, you said over $20; is it closer to maybe 25, maybe less than that?
Kevin Zugibe
Well, right now we are very early in the season, so we’re seeing positive price increase let’s say going from 18 to now over 20. It’s difficult to say how quickly and how much of price increases will occur.
Obviously volumes begin to build starting now but more importantly the second quarter is the strongest in terms of volume season. So it’s difficult to say where we are going but right now we see higher prices and we believe we’re going to see higher prices in the foreseeable future.
Unidentified Analyst
Okay. And do you see in the budget cuts that you know the Trump administration has put in place for the EPA, you see that’s effective the business at all?
Kevin Zugibe
We don’t for couple of reasons; one is the EPA being the administrator of the step down of 22 or the phase out. They have been out of this since the end of 2014 when they put the final five year rule.
And so they were - we were nervous about the EPA what they did years ago trying to get them the facts whether it’s the stock file information whatever it was. Once they go that, once they put the final rule, they are gone.
So we don’t look toward the EPA at that point. EPA would come in more as we get down the path for allocation - I am sorry, when they get an allocation system the HFCs.
But again as we believe that our job is built for sure, we believe it will be a major benefit to get that and came for U.S. producers, manufacturers to get NFC phase out.
But for the R-22 where most of our margin comes from today, the EPA is nothing to do with it anymore.
Unidentified Analyst
Okay, alright, that’s all the questions I have. I’ll get back in line.
Operator
Our next question comes from the line of Gerry Sweeney of ROTH Capital. Please proceed with your question.
Gerry Sweeney
Hey good afternoon, Kevin and Brian.
Kevin Zugibe
Hello Gerry.
Gerry Sweeney
I want to talk about volume of reclaim activity volume of reclaim, you know I know in the third quarter you did mentioned it was a little bit below or a little bit below where you are expected and sounded like they are carried into the fourth quarter. You also talked about spending some more marketing dollars in the fourth quarter to sort of get the word out there.
Where is reclaim activity today and are you starting to see any labor in the fourth quarter, obviously this is I think one of the pressure points on a go forward basis, so I want to see where it is right now?
Kevin Zugibe
So in the fourth quarter, we pretty much finished the year as the year was developing. And so - at the third quarter when we spoke, we’re saying hey, you know this growth and our reclaim volumes but we were thinking that the growth might be higher.
And we are originally thinking the growth could be let’s say 20% in 2016. We are now in a period though the beginning of 2017 where you’re not really going to see any reclaim activity.
The reclaim of volumes start let’s say one quarter after refrigerant sales. So the actual purchasing and use of refrigerant downstream is going to happen in April, May and June and then the returns really don’t start until May and then they continue all the way through typically to the end of November.
So there’s always this let’s say one quarter or ninety day lag. So there’s really no information currently to indicate one way or another how the 2017 reclaim year will play out.
But what we did as you mentioned and we brought up on the call at the end of the third quarter is we did take the time and this is being the right time of the year to do it to sit down with our customers and provide our observations about the supply side and provide our observations and correlate to what they’ve experienced particularly in the third quarter of last year where customers were telling us that they were experiencing shortages of virgin supply. And we’ve reminded them that it’s important if they’re looking for a future supply and that the virgin supply is going to go to zero by end of 2019, that they are support and develop growth and reclamation.
And so we’ve had more of a constructive dialogue in that area. We believe through these efforts.
We’re going to see growth again in 2017 relative to our reclaim volumes.
Gerry Sweeney
Okay, got it. And how is Q1 shaping up in terms of sales.
I’ve got a bunch of channel checks, well two things from channel checks prices are but here dirty gas, there’s a dog fight for a very tight market across the board. I also hear distributors want to buy gas now and I hear some people want to hold off on selling it to later under our specialist but distributors want to now because it’s going to be more expensive later.
But I guess the question is how are your sales going there’s X amount of supply out there, are you changing any of your sales patterns or you seeing any changes in the market as this gas gets tighter?
Kevin Zugibe
Look as we start this any season, that’s what we always say the nine month season, it’s difficult for us to tell. First quarter isn’t because somebody needs the gas, so it’s because do I load my selves of early and get ready for it, so again the price as you said might be part of the reason they would do it.
And then they start really needing the gas in the second quarter. So any years could be different, it could be early buying, it could be buying in June, it’s difficult to tell when they will jump on it, a need or in advance.
So this is like a typical year first. It feels like probably most year first quarter can be I won’t say it’s predictable but there’s a certain amount of buying, I would say it’s a crazy amount of buying.
I don’t forget the feeling everyone is loading their shelves because they think 22 is going to be double in price in the second quarter. But it doesn’t feel like they’re waiting either, so it feels like a good year more like we’re kind of hoping it to be.
Pricing seems to be a good price for us. So like we’re seeing the first quarter but again I would never look at it and say that tells us a lot of where the markets going for sure, because it’s just the people who want to get ahead of the season at this point, so we can’t quite tell but we like where it’s going right now.
Brian Coleman
And maybe just to add Gerry, you know we said this probably for over a decade now, as we enter every season we’re anticipating double-digit volume growth, typically that’s in that neighborhood of 10% to 12%. We’ve continued to achieve that we achieve that again last year.
So when we look at this particular sales season that’s our expectation for the 2017 season and there’s really nothing to tell us that we’re not going to achieve our goal.
Gerry Sweeney
You know, Brian, if you may on the double-digit volume growth and you have said that consistently, would that include R-22 or would that - is it potential for R-22 volumes to decline but and be made up by other gases?
Brian Coleman
Look, as a relief to the industry really in terms of the installed base all new units are HFC based and then as we have the phase out of the R-22 and let’s just say about 5% coming offline every year R-22 systems they are also being replaced by HFCs. So relative to the overall industry, let’s say the only growth is really coming from the HFCs.
So most of the volume growth that we do get comes in that HFC area at times there are some amount of growth in R-22 where we do expect through to see more growth in R-22, it’s starting in the 18 and 19 years as there is more supply side coming from reclaim versus virgin. That’s really more of a period of time where there’s an opportunity for our volumes to grow in R-22 as opposed to currently where most of the growth is coming from the HFC side.
Gerry Sweeney
Okay. I appreciate it.
Thanks again and obviously 2016 was a great year, so I appreciate your time.
Operator
Our next question comes from the line of Steve Dyer of Craig Hallum. Please proceed with your question.
Steve Dyer
Thanks, good afternoon, guys.
Kevin Zugibe
Hi Steve.
Steve Dyer
Just kind of following through on previous question, as you look forward to this year, which is sort of the bigger lever or driver in your success, is it price of R-22 or is it reclamation volume. How do you sort of think about the interplay between those two and if something went wrong or right which of those two would sort of matter the most to your model?
Kevin Zugibe
Is still really the price size, I think we’ve tried to describe this in the past. In these earlier periods, we’re benefiting obviously from higher price in the way and reclaim volumes are sort replacing that.
It’s not really until the 18 and 19 years that more of our results will be benefited from the volumes growth of R-22 a specifically the volume growth in reclaim. So really this season is mostly are - will likely be driven by the pricing relatives R-22.
Steve Dyer
Got it, okay. And then as you think about the DoD contract in the second half of the year, do you have a sense for how we should think about kind of the cadence of revenue there coming on in other words is do you expect it be a pretty readable layer in or do you not expect to start small and really 18 is sort of a first full year, any color there would be great?
Kevin Zugibe
So be back to the DoD contract, we don’t know specifically how the volumes will play out. So we’ve suggested for you to be thinking about the first year and that 12 month period as maybe a $20 million spend year.
There doesn’t appear to be anything particular that affects that spend in terms of seasonality. So is it possible that it’s $5 million, $5 million, $5 million, $5million for the four quarters, is that possible?
That’s possible. Maybe though the first month there might be a little less volume just as we continue to go through the transition and implementations, but maybe not, so it’s hard to get your question right now.
These will definitely be things we’re going to report on when we get into for example reporting at the end of our second quarter, we’ll have some inclination of what’s happening there. Certainly when we go to report at the end of the third quarter of 2017, we’ll have a much better feel.
And then as each quarter progress, we’ll better understand activity and is there really any quantity up or down one period versus another. Right now, we don’t think so.
Steve Dyer
Okay. That’s very helpful.
And then last one for me as you look at sort of the M&A environment you’re kind of I think I was looking, you made some very prudent decisions in the past. Anything sort of there in terms of what looks interesting or where you’re looking or what you’re finding if anything?
Kevin Zugibe
In terms of M&A activities, we are always inquisitive and we’ve been inquisitive certainly all of last year. We do have some long term strategies we think about.
But as you know from historical activities, we typically don’t provide any updates or disclosure until something is completed. So we definitely have things in mind.
There is definitely opportunities out there, but there’s really no updated this time.
Steve Dyer
Okay. Fair enough.
Thanks, guys.
Kevin Zugibe
Yeah.
Operator
[Operator Instructions] Our next question comes from the line of Mark Gomes of Pipeline Data LLC. Please proceed with your question.
Mark Gomes
Hi, thanks for taken time. Just to ask from previous questions a different way, what kind of price range for 22, have you incorporated into your guidance?
Kevin Zugibe
We haven't really set a specific target for pricing, so we are expecting some incremental increases in price. It was difficult to get back to your question in terms of guidance or whatever the case may be, is nobody knows how and when a price increase will occur.
Does it occur earlier or later in a particular season, it could be all over the place, some price increases are effective immediately, some price increases could lag 30 to 60 days. So that's why there's a loose range here, but we are expecting price increases, the price has gone up already from $18 to over $20 we believe for the foreseeable future, there will be price increases.
But exactly what day, what month, what quarter no one really knows the answer to that question.
Mark Gomes
Right. Now I understand that completely certainly your guidance has to compensate and had a modeling effort, in that modeling effort that actually take a crack at 22 pricing, so I hope and maybe you can provide a little bit of color in terms of roughly what range of pricing might be incorporated in your models there?
Kevin Zugibe
I think we spoke to this already as prognosticating price in the future is not healthy since no one could prognosticate that. We have provided an overall gross margin target, but that on a mix of all that products, not just 22.
We sell forty plus refrigerants. We have services business.
We have an industrial gas business now, so we're prognosticate our consolidated gross margin that's the best indicator we think for anyone.
Mark Gomes
Understood, great. Last question if you could just provide a little bit more color on your competitive environment specifically to the barriers entry that you see in your business as the go forward into 2017-2018 and beyond?
Thank you.
Kevin Zugibe
Well, I guess specifically if you went toward the reclamation market, again our answer probably changes a lot over the years, in the beginning we thought, we had it was a technology differential where we had the fastest most efficient distillation machine say that separated us, got started as we went down the path whether it was one of only three certified laboratories in the country we had it, and then you start adding all of the other ancillary areas whether it's high static testing to I mean we want forever the number of things in a one stop shop. But probably as you went for someone stepping in here that they have to do with the all of those things, but then when you have the length of time of a relationships, your customer relationships, that's also might be probably the best one we have.
So it's hard for me to say, but there's a lot of things not just about spending money and putting in infrastructure in, I put a plant up and here I can compete. Yeah, I got to tell you, we have a very good relationship for a lot of years with some of our best customers, so it's all of them together.
I'm excited last if going forward.
Mark Gomes
Great. Thanks for the time taken.
Kevin Zugibe
Thanks.
Operator
[Operator Instructions] There are no further questions over the audio portion of the conference. I would not like to turn the conference back over to management was closing remarks.
Kevin Zugibe
I’d like to thank all of our employees, our long time shareholders and those that are recently joined us for their continued support. Thanks everyone for participating on today’s conference call.
And we look forward to speaking with you after the first quarter. Thanks.
Operator
This concludes today’s conference. Thank you for your participation.
You may disconnect your lines at this time. Have a wonderful rest of your night.