Hudson Technologies, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unless stated otherwise, amounts are in U.S. dollars. Hudson supplies refrigerants and related refrigerant-management and on-site services. Results include Aspen Refrigerants (formerly Airgas-Refrigerants), acquired in October 2017; the prior-year comparison does not include Aspen.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $57.8m | $52.2m | $100.3m | $91.1m |
| Gross profit (loss) | ($26.1m) | $17.4m | ($18.2m) | $29.9m |
| Gross margin | (45.1%) | 33.4% | (18.1%) | 32.8% |
| Operating income (loss) | ($37.4m) | $13.9m | ($38.3m) | $23.3m |
| Net income (loss) | ($30.6m) | $8.5m | ($33.7m) | $14.3m |
| Diluted EPS | ($0.72) | $0.20 | ($0.79) | $0.33 |
- Revenue rose 11% in Q2 and 10% in the first half, primarily due to the acquisition. Excluding Aspen, management said revenue declined by $21m in Q2 and $38m in the first half, mainly reflecting lower refrigerant selling prices and volumes.
- Q2 cost of sales included a $34.7m inventory valuation adjustment: $17.6m related to the acquired inventory step-up and $17.1m from lower-of-cost-or-net-realizable-value write-downs. The filing also identifies $2.6m of acquired R-22 inventory step-up amortization in Q2 and $3.7m in the first half.
- SG&A was $10.6m in Q2 and $18.7m for six months, including $2.9m and $3.9m, respectively, of nonrecurring charges, mainly acquisition integration costs. Interest expense increased to $3.3m in Q2 and $6.6m in the first half, largely due to acquisition financing. The first-half tax benefit was $11.2m; the reported effective tax rate was 25%, versus 38% in 2017.
- Six-month operating cash flow was $8.7m, versus $0.7m in 2017. The company attributed the improvement despite its net loss to timing of receivables and payables, an IRS cash refund, and noncash expenses. Investing used $0.8m and financing used $10.6m; cash declined $2.7m to $2.3m.
Liquidity, debt and balance sheet
- At June 30, cash was $2.3m, working capital was $73.5m (down from $113.5m at year-end 2017), and inventory was $116.4m (down from $172.5m, substantially reflecting the write-down). Net accounts receivable was $37.9m.
- Total reported short- and long-term debt was $157.0m, versus $167.4m at December 31, 2017. The balance included $55.1m of short-term debt and $100.8m of long-term debt, net of deferred financing costs. The PNC revolver had $55m drawn and approximately $48.6m available; term-loan principal was approximately $104.5m.
- The company reported a 1.96:1 fixed-charge coverage ratio under the PNC facility. Its term-loan total leverage ratio was 10.11:1 at June 30, compared with the original 4.75:1 covenant maximum; the filing reports that lenders subsequently waived the June test.
Changes, outlook and material risks
- The October 2017 Aspen acquisition added scale but also substantial debt, interest, amortization and operating costs. Although reported sales increased, Hudson’s legacy business saw pronounced price and volume declines.
- Management described the second-quarter refrigerant pricing deterioration as challenging and expected the conditions behind the inventory adjustment to be temporary. It planned its annual goodwill impairment analysis for Q4 and warned that weaker future cash flows could lead to impairment.
- Management said it believed working capital needs could be met for the foreseeable future through expected operating cash flow and available PNC borrowing. It cautioned that refrigerant costs, lower-than-expected sales, operating expenses, expansion costs or unavailable financing could increase capital needs.
- Subsequent debt amendments materially changed lender terms. On August 14, the term lenders waived the June leverage test, raised the term-loan rate by 300 basis points effective July 1, and imposed a waiver fee and other conditions. On November 30, the term-loan covenant was reset, quarterly principal payments were increased to $525,000 from December 31, 2018, and a monthly minimum-liquidity requirement of $28m was added. The November term amendment also set a 5% exit fee, subject to stated reductions or waivers. A separate November PNC amendment replaced the fixed-charge coverage test temporarily with minimum EBITDA tests, raised revolver margins through September 30, 2019, and charged a $250,000 fee.
- Key risks include refrigerant price, demand and supply volatility; regulatory phase-downs of refrigerants; seasonality and weather; covenant compliance and refinancing; and potential goodwill or inventory impairment. Hudson disclosed that its disclosure controls were ineffective at June 30 due to a material weakness: insufficient competent finance personnel. Additional employees and consultants were hired in September, with remediation targeted by December 31, 2018.
Important facts for investors to verify
- Whether the inventory write-down reflected temporary market conditions or continuing pressure on selling prices, margins and inventory values.
- Actual liquidity and covenant compliance under the amended term-loan and PNC facilities, including the $28m minimum-liquidity test and EBITDA requirements.
- The full cost of amended debt terms, including higher interest, fees, scheduled repayments and any exit fee, and Hudson’s capacity to service and refinance its debt.
- Whether legacy-business revenue, refrigerant volumes and prices stabilize, and whether acquisition integration and projected cash flows support goodwill and intangible-asset carrying values.
- Whether the disclosed finance-staffing material weakness was remediated as planned and whether subsequent filings report any control deficiencies or financial restatements.