May 1, 2019
Operator
Greetings, and welcome to Hudson Technologies First Quarter 2019 Earnings Conference Call. [Operator Instructions].
As a reminder, this conference is being recorded. It is now my pleasure to introduce Jen Belodeau, Thank you, Jen.
Please go ahead.
Jennifer Belodeau
Good evening, and welcome to our conference call to discuss Hudson Technologies' financial results for the first quarter of 2019. On the call today, we have Kevin Zugibe, Chairman and Chief Executive Officer; and Brian Coleman, President and Chief Operating Officer.
I'll now take a moment to read the safe harbor statement. During the course of this conference call, we will make certain forward-looking statements.
All statements that address expectations, opinions or predictions about the future are forward-looking statements. Although they reflect our current expectations and are based on our best view of the industry and of our businesses as we see them today, they are not guarantees of future performance.
Please understand that these statements involve a number of risks and assumptions, and since those elements can change and in certain cases, they're not within our control, we would ask that you consider and 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 businesses and our performance and other factors that could cause our actual results to differ materially.
With that out of the way, I will turn it over to Kevin. Go ahead, Kevin.
Kevin Zugibe
Good evening, and thank you for joining us. As many of you have come to understand, the refrigerant industry is truly an ever evolving landscape.
Buying patterns change, new refrigerants and equipment are introduced or phased out and refrigerant pricing can fluctuate dramatically based on the producers' outlook. At Hudson, our management team, which includes industry veterans from ASPEN Refrigerants has more than 30 years' experience navigating the highs and lows of the marketplace and perhaps the most consistent trend in our industry is that demand for refrigeration and cooling systems continues to grow.
There is continuing demand for systems that keep food fresh while it's transported and when it arrives at stores and there is ongoing demand for residential and commercial cooling systems to keep us comfortable at home and at work. So despite the fact that our industry is currently working through a challenging period, at Hudson our experience tells us to remain agile and innovative as we focus on growing our business and also leaves us confident in the long-term opportunities ahead.
Air conditioning and refrigeration systems will be around for decades to come and Hudson provides every gas needed for the efficient functioning of these systems. It's not always easy to be patient through difficult market dynamics, but we remain focused on executing our growth strategies and expanding our customer base by leveraging our strong distribution network to provide any refrigerant any place at any time.
As we expected, our 2019 selling season has started with continuation of the just-in-time buying pattern our customers initially in the latter part of the first quarter in 2018 and maintained throughout the 2018 selling season. During the first quarter of 2019, we saw incremental pricing declines for most refrigerants and to a lesser extent a volume reduction compared to the 2018 period, resulting in an 18% decrease in revenue as compared to the first quarter of '18.
We're entering the warmer spring season and expect to see volumes begin to come back as we move into the heart of the 9-month refrigerant season. Pricing and weather are elements of our business that are external forces encountered in any refrigerant sales season.
So we're focused on applying our many years of experience in navigating the forces within our control. Hudson is a leader in the growing refrigeration and cooling sector and the market for refrigeration and cooling systems remains strong.
We remain optimistic about the long-term opportunity in front of us and believe we have a competitive advantage in the marketplace because of our long-standing experience and 3 key strategic advantages. First is our strong distribution network, which puts us at 2 key points in the supply chain.
Second is our ability to sell all refrigerants from legacy gases like CFCs, today's commonly used HCFCs and HFCs as well as tomorrow's next-generation HFOs. And finally, our patented technology enables us to reclaim with unparalleled speed and efficiency to become leading producer, supplier of phased-out refrigerants.
We have proven our ability to evolve and innovate to address changing market dynamics, and we remain focused on executing and improving these capabilities so that we're in the best position to drive growth. 2019 marks the final year of R-22 production.
No new virgin production will be permitted starting on January 1, 2020. JPMorgan has published data that indicates that our 50 million R-22 testing units operating in the U.S.
and this total does not include millions of units in the refrigeration, large commercial and industrial sectors. With that data in mind, we believe that demand for R-22 refrigerant will have a 20-year duration similar to what we've seen with the preceding phaseout of CFC refrigerants.
We anticipate once R-22 production is eliminated, the industry will begin to see a supply-demand imbalance that will create a significant opportunity for us. And our ability to reclaim and resell R-22 will position Hudson to fill the demand in an environment where R-22 will be in short supply.
On our March 6 call, we noted the price of R-22 was at approximately $9 a pound and the price has remained stable with a modest increase since then. While it's still early in the 2019 season, the initial price weakness would indicate that the allowance holders are not seeing or anticipating a near-term tightening in supply.
While this may impact our 2019 season, Hudson expects that with the eventual removal of virgin supply the R-22 market will begin to behave in a true supply-demand manner and as a result expect less volatility in pricing. Our diverse portfolio of refrigerants includes ASPEN's HFC strength, which complements our HFC R-22 and CFC sales, and we are preparing for the future demand for HFO refrigerants, which are designed to ultimately replace HFCs.
We are optimistic about the momentum we've seen around the regulation and phasedown of HFC refrigerants and believe that a phasedown of HFCs will lead to the establishment of an allocation system and a tightening in the supply-demand balance that will likely result in increased pricing for these refrigerant. As systems are upgraded, HFC sales are representing a growing percentage of our revenues.
And with the projected installed base, we see HFC as a tremendous long-term growth opportunity for our company. As we move through 2019, we remain focused on implementing strategies to grow our leadership position.
We're focused on increasing our marketing efforts, expanding our portfolio products and services to appeal to a broader customer base and reducing expenses. We've been through challenging market periods before, and our ability to innovate and evolve are characteristics that have allowed us to grow and develop a stronger business model.
We have the people, the technology and the distribution network to leverage and grow our leadership position. Now I'll turn the call over to Brian to review the financials.
Go ahead, Brian.
Brian Coleman
Thank you, Kevin. For the first quarter ended March 31, 2019, Hudson recorded revenues of $34.7 million, a decrease of 18% compared to the $42.4 million in the comparable 2018 period.
Gross margin for the first quarter was 20% compared with gross margin of 19% in the first quarter of 2018. We reported operating income of $200,000 in the first quarter of 2019, an improvement compared to the operating loss of $900,000 in the first quarter of 2018.
Our DLA contract continues to grow, and we saw revenue contribution of approximately $5.4 million in the first quarter of 2019. Operationally during the first quarter, we continued executing on several cost efficiency initiatives that were implemented during the fourth quarter of last year.
And we completed the process of closing our national reclamation facility. During the first quarter of 2019, the company recorded a net loss of $4 million or a loss of $0.09 per basic and diluted share as compared to a net loss of $3.1 million or a loss of $0.07 per basic and diluted share in the same period of 2018.
The first quarter of 2018 net loss was reduced by $1 million benefit related to the Tax Cuts and Jobs Act of 2017 with no such benefit recognized in the first quarter of 2019. Our balance sheet is strong with working capital of $59 million, which was slightly lower than past year's due to the recent adoption of the change in lease accounting.
Inventory at March 31 was $100 million. And as Kevin mentioned earlier, we are now moving through the second quarter of 2019 and into the warmer seasonal weather, so we expect that we'll begin to see more meaningful declines in our overall inventory balances.
As previously announced, during the fourth quarter of 2018, we secured definitive amendments to our term loan and revolving credit facility and are compliant with our covenants. For the year ended December 31, 2019, the term loan leverage ratio is set at 5.7x, which was derived from slight increases in revenues over 2018, mainly as a result of expected higher volumes in 2019 when compared to 2018.
During the first quarter of 2019, our unadjusted EBITDA improved over $1 million when compared to the first quarter of '18, and we expect the trend to continue for the rest of 2019, which we expect will allow us to be compliant with our leverage ratio covenant. We have strong liquidity and expect to generate more than $20 million in excess cash flow for 2019 period.
Lastly, at March 31, 2019, we had approximately $37 million of availability. I'll now turn the call back over to Kevin.
Kevin Zugibe
Thanks, Brian. Hudson remains a leader in the refrigerant reclamation business with the expertise, innovative technology and a well-established distribution network necessary to drive growth.
In this growing market, we are confident that we have the right team and possess the necessary tools to capitalize on this large opportunity in front of us. I'd like to thank you all for your support of Hudson.
And now Brian and I and our CFO, Nat Krishnamurti, will take your questions. Operator, please open the call for questions.
Operator
[Operator Instructions]. We are showing no questions at this time.
I would now like to turn the call back for closing remarks.
Jennifer Belodeau
Operator, keep on trying for Q&A. Is there a technical difficulty?
Operator
I can have more of a look. One moment.
Kevin Zugibe
Jen, is there a texting or e-mail mechanism?
Jennifer Belodeau
It is enabled. Did you just enable it, operator?
Operator
Yes.
Jennifer Belodeau
Okay, could you re-queue, please?
Operator
Your first question comes from Steve Dyer with Craig-Hallum.
Steven Dyer
That's better. Can you guys hear me?
Kevin Zugibe
Yes, we got worried there for a minute.
Steven Dyer
I have been hitting one for half hour. Couple questions.
First of all within the quarter, I guess, the last several weeks maybe, I guess, second quarter, our checks are suggesting HFC prices potentially spiked here just sort of on speculation around a new antidumping lawsuit. Are you able to comment on that, what you're seeing?
If so, how much that could sort of help margins here in the second quarter?
Kevin Zugibe
Well, we can say, your channel checks are correct. It did jump in April.
But, again, it's all over the place right now. It's really -- certainly, we can never state we think it's sustainable.
We don't understand why it jumped to the level it did, it has come back some recently. So it's all -- seems to be all over the place.
If it stayed like that, it would have been, yes, very good for the quarter, but there is no sign that it will stay there. So we're just watching it day by day, like probably you are too.
Steven Dyer
Got it. Okay.
And then just as it relates to inventory, I was a little bit surprised to see that it was only down $2 million quarter-over-quarter, obviously, you sold through well more than that. Just curious about your -- sort of your overall philosophy around sort of liquidating down inventory.
You didn't appear to be in a big hurry, I guess, this quarter. But just help us frame up how you're thinking about that throughout the rest of the year?
Kevin Zugibe
Yes. So you're correct.
And the real reason that we want to be careful about not lowering our inventory as much as we may consider, let's say, at March 31 is because April, May, June should be very strong volume months. So we want to make sure that we are prepared with the proper inventory by refrigerant, by location and so on down the line.
So we did not anticipate and normally would not anticipate a material change between Q4 and Q1. I think in other years, and you may have seen at times even a higher balance at March.
But based on the way we are managing our inventory, we should expect to see lower dollars in inventory, that probably will be the case in June as well. And certainly, by the third quarter bring it down to probably the lowest dollar amount.
And then bringing it back up to some extent in Q4. But at the end of the day, we should easily achieve more than $20 million of free cash just coming out of inventory for the 2019 period.
Steven Dyer
Okay, got it. And last one from me, and I'll pass it over.
A month of the quarter down already. I know you don't like to give too much in the way of forward guidance.
But any just general commentary as to what you're seeing in April? I know Minnesota here may not be the best parameter as to if it's warming up or not.
But generally are you starting to see the pickup you had hoped for here in the second quarter?
Kevin Zugibe
Well, I think the good news for all of us is that, we still believe inventory levels are low. We definitely feel that the inventory levels by our customers are lower today than they would have been a year ago.
So as there is any movement with regards to warm weather in different parts of the country, and definitely certain parts of the country have already warmed up, we are seeing activity. So April, let's just say, seems to be positive, certainly while the pricing on the HFCs maybe temporary, any price increases are generally helpful to us.
So, so far things are fine, but obviously, most of the overall demand because much of refrigerant demand is AC related is going to be when it's warm in Chicago and New York and so forth and that typically won't happen until late May.
Operator
Your next question comes from Gerard Sweeney with Roth Capital Partners.
Gerard Sweeney
Circle back into HFCs and your commentary on the pricing is all over the place. I mean, how much you can comment on this, but I want to maybe flush it out a little bit more.
It's my understanding there was some type of circumvention of trade case filing from the previous HFC trade case in June of 2016, and specifically naming some Chinese suppliers as well as distributors within the U.S., and they had I think traditionally been the lowest price sellers in the country. With potential trade case floating out there and retroactive type of tariff, any thoughts on what that could do to the market or why you think this is still going to be all over the place?
Kevin Zugibe
Well, historically, we have always tried to describe pricing relative to supply-demand. And we know back to 22 for the moment that hasn't always been the case, but that was mainly because we had 3 people controlling 90% of the allocations.
With regards to HFCs, there's a lot of volatility and speculation about this case. As the weeks progress and, let's just say, over the next 4 weeks, we should have some initial indication from the ITC as to whether they're even going to proceed.
So that in itself could be a gate that changes dynamics and so forth. Also to the extent there is a case, and it gets to the finish line, it could take a year possibly for all that to work itself out.
So right now certainly people are reacting to the filing of the case, but we look at some of these things as temporary, not necessarily permanent, and we've seen volatility before around regulation and court cases. And so we're being cautious about where the market really is going to end up.
Gerard Sweeney
Okay. That's fair.
And then also you mentioned, I think, some small increases or marginal increases in R-22. Is that -- who's driving that?
Is that from some legacy producers? Or is this just a market wide type increase, just want to see where that was coming from if possible?
Kevin Zugibe
Well, the producers generally lead the price. So if the price is going to go down, generally the producers will lead it and the prices are going to go up, generally they will lead it.
But, again, I think holders of inventory still believe that there is going to be some degree of shortage this year, which, therefore, we would believe that there should be higher prices as we get through the season.
Gerard Sweeney
Got it. And this -- my channel check had always indicated and -- if I talk to them, they may not have the same customers that you do.
But some of them indicated some of the larger purchaser -- some of their larger purchasers in the past have yet to return to the market. They believe they sort of stock up when things got -- when there was a belief that the market was getting very tight on the R-22.
Do you still have some larger guys that have been staying out of the market and if you do, give any indication from them as to when they could return or what their inventory looks like?
Kevin Zugibe
Well, I think all we've ever really seen is not so much that people stockpiled like to acquire a year or 2's worth of supply because it's less likely that the producers will allow that because the producers will always trying to suggest they will sell to customers based on prior practices and volumes, and not oversell. But what we definitely ran into, as noted by some of your channel checks is in that '17 period when the prices were high, a lot of folks did buy and a lot of folks ended up carrying that high-priced inventory into 2018, and in some, respects, because of that they probably didn't sell as much 22 because they were upside down to some extent.
It's likely all of that problem is gone by now. So that it's likely that whoever may not have bought last year because they were upside down on inventory, are likely buyers this year.
But we never really saw a lot of people that supposedly would have had multiple years of stockpile buying in, let's say, '16 or '17.
Gerard Sweeney
Got it. And then just one more, and I'll jump back in line.
DLA contract. Where the margins on that even if you're going to be qualitatively provide a little background on what those margins are in that business?
Kevin Zugibe
We've always said that we felt that the margins in that business would be at about 20%, like a true distribution margin business, the good thing is that the government doesn't buy any legacy refrigerants. The federal government got out of almost all the ODS systems in the early 2000.
So they're mainly buying -- they buy refrigerants, mainly HFCs and then generally industrial gas transactions are lower-margin transactions as well. So we still believe that, that's a reasonable number.
We certainly would look to try to find ways to get more margin out of that business, but probably won't be overly successful with that.
Gerard Sweeney
Got it. You had mentioned 20% before, but I just wanted to double check.
So I appreciate that.
Operator
[Operator Instructions]. Your next question comes from Ryan Merkel with William Blair & Co.
Ryan Merkel
So first, just want to clarify on R-22 prices. Are you saying that the reason the prices are $19 today, is that because the OEMs are influencing supply either from stockpile and, I guess, still some modest virgin production?
You don't think it's a demand issue. It doesn't sound like you think it's necessarily a downstream supply problem.
So am I understanding that right?
Kevin Zugibe
That's correct. And we do know that these OEMs do have a stockpile, although we think 1 producer may be out of the stockpile now and out of their allocation for this year.
But that leads to more remaining.
Ryan Merkel
Okay. Because I was a little surprised to hear your thought that R-22 prices could rise later this year as maybe supply-demand actually comes into balance, or I guess, imbalance.
So you're leaving that as a possible scenario. But by 2020, with this uncertainty, we think that could be the latest that R-22 prices sort of normalize?
Kevin Zugibe
Well, whenever we were trying to game out the overall demand and game out the stockpile, we always felt that somewhere around late '18 into '19 would be the period that the stockpile would go away. Now we do believe the replacement rates are slightly higher than what we were originally thought, like closer to 7%, then, let's say, 5% to 7% based on the JPMorgan data that we've seen.
But we definitely still feel that if it doesn't happen this year, then next year for sure the stockpile should be gone.
Ryan Merkel
Okay. And then I haven't asked this question in a while and I'm not sure where we stand.
But sticking with R-22, are you primarily selling reclaim gas at this point? Are you selling any virgin R-22 at all?
Kevin Zugibe
We're probably at the point where we're selling very little virgin gas.
Ryan Merkel
Okay, that's fair. Okay, and then just lastly, I think gross margins are tracking so far versus what you thought pretty accurately.
So as we get into the season, are you still comfortable with sort of mid-20s gross margin, is that still an achievable target?
Nat Krishnamurti
Yes, yes, this is Nat Krishnamurti here. Yes, we are comfortable with low to mid-20s at this point for the rest of the year.
Operator
Thank you. There are no further questions at this time.
I would like to turn the floor back over to Kevin for closing comments.
Kevin Zugibe
Well, I would like to thank all of our employees, our long-term shareholders, and those that recently joined us for their support. Thanks, everyone, for participating in today's call, and we look forward to speaking with you after the second quarter results.
Thank you.