Hudson Technologies, Inc. — Form 10-Q Summary
Period clarification: The request metadata says 2018 Q1, but the filing covers the quarter and nine months ended September 30, 2018 (third quarter and year to date). Unless noted otherwise, financial amounts below are in millions of dollars.
Business context and reporting period
Hudson provides refrigerant and industrial gas sales, refrigerant reclamation and related services, and on-site refrigeration-system services. The company operates as one reportable segment, primarily in the United States. Results include Aspen Refrigerants, formerly Airgas-Refrigerants (ARI), acquired October 10, 2017 for approximately $209 million; the comparable 2017 periods did not include ARI.
Financial results and liquidity
| Metric | Three months ended Sept. 30, 2018 | Three months ended Sept. 30, 2017 | Nine months ended Sept. 30, 2018 | Nine months ended Sept. 30, 2017 |
|---|---|---|---|---|
| Revenue | $40.5 | $24.7 | $140.8 | $115.8 |
| Gross profit (loss) | $7.7 | $5.1 | $(10.4) | $35.0 |
| Gross margin | 19.1% | 20.5% | (7.4)% | 30.2% |
| Operating income (loss) | $(0.4) | $1.5 | $(38.7) | $24.8 |
| Interest expense | $4.1 | $0.0 | $10.6 | $0.2 |
| Net income (loss) | $(13.9) | $2.1 | $(47.6) | $16.4 |
| Diluted earnings (loss) per share | $(0.33) | $0.05 | $(1.12) | $0.38 |
- Revenue and margins: Reported revenue rose 64% in the quarter and 21.6% year to date, mainly because of ARI. Excluding ARI, management said revenue declined $5.8 million in the quarter and $44 million year to date, reflecting lower refrigerant selling prices and lower volumes.
- Inventory charge: Second-quarter cost of sales included a $34.7 million lower-of-cost-or-net-realizable-value adjustment: $17.1 million for inventory and $17.6 million for the ARI acquisition-date inventory step-up. The filing also cites $3.7 million of expense from amortization of the acquired R-22 inventory step-up sold during the nine-month period.
- Operating costs and taxes: Nine-month SG&A was $26.0 million, including $6.1 million of nonrecurring charges, mainly ARI integration and related costs. Third-quarter income tax expense was $9.4 million; the company recorded a $10.3 million valuation allowance against deferred tax assets during the quarter. The nine-month tax benefit was $1.8 million.
- Cash flow: Nine-month operating cash flow was $35.3 million, compared with $12.1 million in 2017, despite the net loss. Management attributed the increase mainly to inventory timing and income-tax refunds. Investing cash use was $1.0 million; financing cash use was $37.9 million, including $36.1 million of net short-term debt repayment. Cash declined to $1.4 million from $5.0 million at year-end 2017.
- Balance sheet and liquidity: At September 30, cash was $1.4 million, receivables $23.2 million, inventory $106.5 million, current assets $134.6 million, and current liabilities $64.4 million. Working capital was $70.2 million, down $43.4 million from December 31, 2017. Inventory declined from $172.5 million at year-end. PNC revolver borrowings were $29.0 million, with approximately $43.5 million of availability and a $0.13 million letter of credit outstanding.
- Debt: Balance-sheet short- and long-term debt totaled $129.8 million, net of deferred financing costs. The term-loan principal was approximately $104.2 million and PNC borrowings were $29.0 million. Term loans mature October 2023; the PNC facility expires October 2022. Interest rates are variable. The filing estimates a 100-basis-point rate change would affect annual interest expense by approximately $1.3 million.
Material changes versus the prior comparable period
- ARI’s inclusion increased reported revenue, but underlying revenue declined as refrigerant prices and volumes weakened.
- Profitability deteriorated sharply, chiefly due to the inventory valuation charge, lower selling prices, higher interest expense following acquisition financing, acquisition-related costs, and the deferred-tax valuation allowance.
- Debt declined during the first nine months as cash from operations was used largely for repayments, while cash on hand remained low.
- The company’s term-loan leverage ratio rose to 12.44:1 at September 30, 2018 from 3.03:1 at December 31, 2017. The reported fixed-charge coverage ratio was 1.74:1, down from 6.47:1.
Outlook, risks, contingencies, and unusual items
- Financing and covenant amendments: On August 14, 2018, lenders waived the term-loan leverage covenant at June 30 and increased the term-loan rate by 300 basis points effective July 1; the amendment also imposed fees and an exit-fee structure. Subsequent to quarter-end, on November 30, lenders further reset leverage limits, increased scheduled quarterly term-loan payments to $525,000 beginning December 31, 2018, and added a monthly minimum-liquidity requirement of $28 million. The same date, the PNC amendment replaced its fixed-charge covenant temporarily with minimum EBITDA tests through June 2019, raised interest margins, and required a $250,000 fee. These subsequent amendments are material to assessing liquidity and covenant risk.
- The company said it expected to meet foreseeable working-capital needs with operating cash flows and PNC availability, but cautioned that unanticipated costs, weaker sales, or expansion costs could require earlier or additional financing, which might not be available on acceptable terms.
- Management cited refrigerant pricing, demand and supply availability, regulatory phase-downs, weather, seasonality, competition, and customer or supplier changes as risks. The business historically has seasonal sales peaks in the first nine months, and weaker fourth-quarter demand can result in losses.
- Goodwill was tested quantitatively at September 30 after declines in revenue, operating income, and share price; management concluded goodwill was not impaired. Goodwill was $47.8 million, including $46.9 million related to ARI.
- Disclosure controls were deemed ineffective at September 30 due to a material weakness: insufficient finance personnel to account for, review, and disclose transactions completely and accurately. The company hired employees and consultants and expected to complete remediation, including testing, by December 31, 2018.
- The filing reports no material changes in the legal proceedings previously disclosed and no off-balance-sheet arrangements. It provides no specific revenue or earnings guidance.
Important facts for investors to verify
- Confirm the reporting period: this is the September 30, 2018 quarter-end filing, not a first-quarter filing.
- Track refrigerant pricing, volumes, inventory reserves, and whether inventory can be sold at anticipated prices after the $34.7 million write-down.
- Review performance against the amended term-loan leverage and PNC EBITDA covenants, the $28 million minimum-liquidity requirement, and the availability of revolving credit.
- Assess the effect of higher borrowing costs, scheduled and potential excess-cash-flow repayments, and term-loan exit fees on liquidity and cash flow.
- Monitor progress in remediating the disclosed material weakness in financial reporting controls.
- Evaluate whether the deferred-tax valuation allowance or goodwill and other asset estimates change as operating results develop.