Greetings. Welcome to the Hudson Technologies' Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Jennifer Belodeau. You may begin.

Thank you. Good evening and welcome to our conference call to discuss Hudson Technologies' financial results for the third quarter of 2023. On the call today are Brian Coleman, President and Chief Executive Officer; and Nat Krishnamurti, CFO. 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 our business 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, in certain cases are not within our control, we would ask that you consider and interpret them in that light. We urge you to review Hudson's most recent Form 10-K and other subsequent SEC filings for a discussion of the principal risks and uncertainties that affect our business and our performance and the factors that could cause actual results to differ materially. With that out of the way, I’ll turn the call over to Brian Coleman. Go ahead, Brian.

Good evening and thank you for joining us. We delivered solid third quarter results, which included continued profitability and strong cash flow to close out our traditional nine-month cooling season. That said, as we expected on a comparative basis, third quarter of 2023 revenue margin decreased relative to the significantly strong revenue margin performance achieved in 2022. The primary driver for the comparative decrease was a 27% decline in the sales price for certain refrigerants when compared to the third quarter of 2022. As we detailed previously throughout most of 2022, we saw substantial sale price increases without a corresponding increase in inventory price. Conversely, the 2023 cooling season was characterized by both a challenging pricing environment and lower sales volume for the nine-month season. Specifically for the nine-month period, we saw a decline of approximately 17% in the sale price of certain refrigerants as compared to the first nine months of last year. In addition, the late arrival of warmer weather to many parts of the U.S., which impacted demand for certain refrigerants, slightly impacted volume unfavorably for this season. Even with the significant pricing headwinds, we achieved our gross margin of 40%, which is slightly higher than our long-term targeted gross margin levels. Margins were favorably impacted again this quarter, similar to what we saw in the second quarter this year, from higher margin carbon sales and from sales related to the DLA contract. Without those additional contributions, gross margins would have been closer to 38%. As we mentioned last quarter, we are tracking toward the highest annual revenue from our DLA contract. From our vantage point, we remain comfortable with our long-range gross margin target of 35%. Our ability to consistently deliver strong profits and operating cash flow allowed us to aggressively pay down our debt during the last several quarters, and that progress culminated with the full repayment of our term loan during the quarter. Notably, we are very pleased to achieve the full repayment well ahead of our March 2027 maturity date, and we anticipate that the elimination of this debt will enable us to further reduce our interest expense and improve our balance sheet. As you know, our industry is preparing for the unprecedented 40% baseline reduction in virgin HFC production and consumption allowances, which will be effective at the start of 2024. We believe that the current phasedown represents a significant opportunity for our business. With the current install base of HSC equipment, which is currently estimated at 125 million units, the aggressive reduction in virgin HFC production is expected to meaningfully impact the supply landscape, creating enhanced demand for reclaimed refrigerants over time to fill what is anticipated to become a substantial gap between HFC supply and demand. Additionally, the reclamation industry is positioned to benefit as the regulatory environment around refrigerants and cooling equipment becomes more stringent. There are ongoing efforts on both the state and federal levels to require tracking and detailed reporting designed to keep track of refrigerants from cradle to end of life as a means to deter the practice of venting and to encourage reclamation. Many of you have likely seen the EPA's rules issued in early October. The first was the finalization of the technology transition rule, and the agency also published a long-awaited proposed refrigerant management rule. We are encouraged by the bold initiatives that the EPA has taken around the proposed refrigerant management rule, particularly those that outlined potential mandates for the use of reclaimed refrigerants by OEMs for new systems, and the use of reclaimed refrigerants in servicing activities. These proposed initiatives will require a significant increase in reclaimed volumes, particularly for higher GWP, HFCs, such as 404A and 410A. I want to stress that the refrigerant management rule is a proposed rule, which is currently making its way through the commentary process, but we are pleased with the aggressive stance set forth by the EPA. It's encouraging to see a broader proposed regulatory focus addressing venting deterrence, which should also increase the pool of refrigerant that can be recovered, and also promotes the adoption of lower GWP cooling technology and the use of reclaimed refrigerants. Hudson has an advantage as the industry shifts, because we've long been a proponent and a practitioner of the circular economy of refrigerants and proper refrigerant management. Importantly our technology is agnostic. We've been recovering and reclaiming refrigerants since the early 1990s, and our technology works with any and all types of refrigerant, from legacy CFCs and HFCs to today's HFCs and to future HFOs. Our operational model can essentially provide a closed loop in which refrigerant is sold into the market for new equipment or for servicing cooling systems, and later, when service is required or the system reaches end of life, the gas is recovered and returned to Hudson for reclamation without any admission to the atmosphere. So we believe that we are uniquely positioned with our proprietary reclamation technology as well as our system optimization and conversion services to grow our leadership role in the shift of lower GWP refrigerants and cooling technologies. Longer term, we believe industry stakeholders will increasingly embrace the environmental benefits of using reclaimed refrigerant, which is nearly a zero GWP gas. Our ability to reclaim refrigerant is dependent on recovering refrigerant, and we have focused on working with customers who share our commitment to the circular economy for refrigerants. We have also been very active at industry forums and conferences promoting our vision for the adoption of sustainable and responsible refrigerant management among our industry partners. Recent events and discussions that we have attended include the Greenbuild Conference, the Allied Air Conference, and several state plumbing heating cooling contractors' association meetings. In July, Hudson's EMERALD Refrigerant, our Reclaimed Refrigerant brand, was named top product of 2023 by Environment Plus Energy Leader, an awards program that recognizes excellence in products and projects that deliver significant energy and environmental benefits. We also recognize the importance of participating in global efforts to raise awareness and accelerate the global transition to efficient and climate-friendly cooling alternatives. In early October, Hudson announced that we joined the Cool Coalition, a global multi-stakeholder network assembled by the United Nations Environment Program, that connects a wide range of key participants from government, cities, international organizations, businesses, finance, academia, and civil society groups to facilitate knowledge exchange, advocacy, and joint action toward climate-friendly cooling alternatives. And I just returned from Nairobi, where last week Hudson participated in the 35th meeting of the parties of the Montreal Protocol on substances that deplete the ozone layer. We're pleased to have these opportunities to share our expertise and interact with other stakeholders on a global level. As we move through the balance of 2023, we remain focused on continuing to be a reliable resource to our customers by providing sustainable and responsible refrigerant management support. The fourth quarter of any given year is historically our lowest revenue and gross margin quarter, as we saw in 2022, with significantly lower sales volume as the cooling season ends, and many of our customers have moved their focus to heating applications. We believe that 2024 will represent an inflection point for the HFC market, and we are confident that our industry-leading reclamation technology, distribution network, and optimization conversion capabilities provide a strong foundation to grow our company and extend our leadership position as our industry embraces more sustainable and environmentally friendly practices and products to meet the growing worldwide demand for cooling and refrigeration solutions. This is an exciting time for our company and our industry, and we look forward to expanding the reach of our products and services as our industry continues to evolve. Now, I'll turn the call over to Nat to review the financials. Go ahead, Nat.

Thank you, Brian. For the third quarter ended September 30, 2023, Hudson recorded revenues of $76.5 million, a decrease of 15% compared to revenues of $89.5 million in the comparable 2022 period. The decrease is primarily related to decreasing selling prices for certain refrigerants, partially offset by increased refrigerant sales volume and revenues from the company's DLA or Defense Logistics Agency program during the period as compared to the third quarter of 2022. Gross margin was 40% for the third quarter of 2023 compared to 49% in the third quarter of 2022. As expected and previously communicated, gross margin has begun to moderate as the gap between inventory cost and sales price narrows to more historical levels. Third quarter gross margin was favorably impacted by increased DLA and carbon credit revenue, and we remain comfortable with our long-range gross margin target of 35%. SG&A for the third quarter of 2023 was $6.8 million compared to SG&A of $7.2 million recorded in the third quarter of 2022. We recorded operating income of $23.1 million in the third quarter of 2023 compared to operating income of $36.3 million in the third quarter of 2022. The company recorded net income of $13.6 million or $0.30 per basic and $0.29 per diluted share in the third quarter of 2023 compared to net income of $29.4 million or $0.65 per basic and $0.62 per diluted share in the same period of 2022. During the third quarter of 2023, the company recorded $3.4 million of non-recurring costs, primarily related to the write-off of deferred financing costs with respect to the full and final payoff of the company's term loan, which are included as interest expense in the company's statements of income. Excluding these non-recurring costs, Hudson achieved non-GAAP adjusted net income of $16.1 million or $0.35 per basic and $0.34 per diluted share in the third quarter of 2023. A reconciliation of net income and earnings per share to non-GAAP adjusted net income and non-GAAP adjusted earnings per share is included in today's press release. Just a note related to net income. As Brian mentioned earlier, during the third quarter, Hudson paid off its remaining $32.5 million in term loan debt, an achievement we reached more than three and a half years ahead of the March 2027 maturity date. Over the last 15 months, we have repaid $100 million in term loan debt, saving the company over $10 million of annualized interest. We're pleased to have been able to pay off the term loan debt significantly ahead of schedule and anticipate that the elimination of this debt will enable us to further reduce our interest expense and improve our balance sheet. In addition, after the end of the third quarter, we paid off the remaining $5 million of revolver debt we had outstanding. The company's effective tax rate for 2023 and future periods will reflect a statutory tax rate of approximately 26.1%, excluding certain temporary and permanent tax adjustments. While the nine months ended September 30th, 2022 period reflected an effective tax rate of 11.9% due to the release of the company's valuation allowance at that time. During this three months ended September 30, 2023, the company generated $21.9 million of cash flow from operations, compared to $26.1 million during the three months ended September 30th, 2022. Stockholders' equity improved to $225 million at September 30, 2023, as compared to $175 million at December 31, 2022. The company's available liquidity, consisting of cash and revolver availability at September 30, 2023, was $71 million. As we continue to generate additional cash flow in 2023, we expect to ensure we have adequate inventory on hand and consider other opportunities as they arise. We have strong liquidity, and our revolving loan credit facility provides us with a solid financial platform and flexibility as we look forward.

Thank you, Nat. Our third quarter performance provided a solid close to the 2023 cooling season. As I said earlier, we believe the unprecedented 40% step down in the HFC baseline production and consumption allowances represents a tremendous opportunity for our company and its reclaim capabilities to bridge the anticipated gap of the HFC supply and demand. We remain focused on our commitment to providing sustainable products and services, which will allow safe and efficient cooling and refrigeration, utilizing more environmentally friendly alternatives. Operator, we will now open the call to questions.

Thank you. At this time, we will be conducting a question and answer session. Our first question comes from Gerry Sweeney with ROTH Capital. Gerry, please proceed.

Good afternoon. Brian and Nat, thanks for taking my call.

Good afternoon, Gerry. Hello.

Could you talk a little bit about the HFC reclaim activity at Hudson, as well as potential opportunities to increase just overall reclaim industry, reclaim activity, vis-a-vis the EPA rulings that are being worked out?

So, we typically report our annual reclaim numbers at the end of the year. And the reason we've done that historically, while the refrigerant sales typically wind down in Q4, our recovery comes in pretty strong. All the way through, our refrigerant sales wind down in Q3, the recovery and reclamation activity continues through most of Q4. Part of it is the accumulation of refrigerants held by contractors. But we're now entering that season where larger systems are being turned down and retrofits and conversions occur. So we'll be reporting on that at the end of the year. But so far, it's been a strong reclaim year. Moving to the other part of your question and the refrigerant management rule, the EPA is really taking a significant move to mandate the use of reclamation both at the OEM level and at the servicing level. And the anticipated demand in the future, depending on the type of refrigerant and the CO2 equivalent, is certainly in some instances as low as maybe a six-time growth from where we are today to possibly as high as a tenfold growth where we are today. Particularly, what we think will be interesting to see is how allowance holders will treat higher GWP refrigerants like 404A or possibly 410A, and whether they'll be willing to continue to produce them and whether or not that then becomes an opportunity for the higher GWP gases to really be served 100% with reclaimed refrigerants. These kinds of things we don't really know today, how all of this will progress, but likely we'll see trends occurring throughout 2024 and into 2025 about how folks will think about higher GWP refrigerants versus lower GWP HFC refrigerants. So I hope I answered your question, Gerry.

Yes. And just on the higher GWP refrigerants, correct me if I'm wrong, but the 404A, it's a higher impact to the environment. So it uses up more allowances. So, from an economical point of view, producers would want to produce less of that and more of a lower GWP gas so they can produce a higher volume of that. Is that correct if I articulated it correctly or clearly?

Yes. No, I think you're exactly right. So to be specific, 404A is like 4,001. 134A is closer to 1,000. A refrigerant that's likely going to get a foothold over the next five years is R32, and that's about 675. So say in another way to what you just described, if you're going to make, let's say, 134A, you could probably make close to four pounds compared to one pound of 404A. So should 404A be priced at four times 134A as an example, or just not make it at all? And these are things we just don't know yet. As I just said a moment ago, we'll start to see trends in 2024 and then certainly by 2025, we'll have a better understanding of how people will think about things. And to go back, this is why this particular phase-out has many differences compared to the ODS phase-outs. One particular difference here is even with a 40% reduction in the HFC consumption allowances for next year, all new equipment for the most part will be HFC-based being installed. Whereas, with 2022, the equipment was phased out ten years before the refrigerant was. So there's a lot of differences there. But again, the big difference here is it's not a refrigerant phase-out; it's a CO2E phase-out.

Got it. Excuse me, second kind of question, gross margins 40% above your long-term goal of 35%. And I do see prices down in terms of refrigerant prices down. So you would assume, if you're collecting gas and paying 50% of the price, you would assume somewhat of a lower gross margin depending on the inventory rolls. But can you walk me through maybe the 40% gross margin, how impactful with the carbon credit sales and the DLA project versus, I guess, some of the other gas sales so we get a little bit clearer picture of what's going on there?

Well, as we said, without those two groups of sales, gross margins would have probably been closer to 38%. DLA right now, we're seeing a tremendous amount of activity, much more so than we've ever seen before. This is now the second quarter that we reported their revenues are up, and we're likely headed towards a record annual revenue volume with the DLA, which we'll report at year-end. Carbon sales just kind of come and go. They're not overly material, but because the offset market has been pretty strong in terms of pricing the margins on that transaction when you complete them, which could take some time, could be higher than what they might have been historically. So at some point, we're not sure how our inventory costs will compare to pricing. But if there was a stable pricing environment, then our costing should increase relative to the sale price, which then should take us on to something closer to an overall blended 35% gross margin. If we see price increases like we saw in 2022, then we could do much better on the gross margin level. And certainly, if we see the growth and reclamation as anticipated in the refrigerant management rule from the EPA, then our mix would change, and then we would have higher or more volume refrigerants that we reclaimed versus distributing product we bought from a producer. The margins on reclaimed typically are closer to 50%, which would help improve that overall blend.

Got it. Helpful. I'll jump back in line. I appreciate it.

Thank you.

The next question comes from Ryan Sigdahl from Craig-Hallum Capital. Please proceed.

Hey, Brian, Nat.

Good evening.

Curious, the decline in refrigerant pricing, I think it was down a little bit sequentially as well. But can you talk through what you're seeing in the industry and what you think drove that as we get closer to 2024? A little surprised when we saw it dip a little lower at the tail end of the season here?

Yes, so we think as it relates starting back to Q3 of last year, like the very tail end, let's say the month of September, we saw prices starting to come down and possibly that allowance holders overestimated what demand might be in the second half of the year relative to the first half of the year. And they may have found that they had extra allowances, so they started to lower the price. We think that philosophy for the allowance holders continued into the beginning of the 2023 year. And unfortunately, Q1's weather was not as warm as Q1's weather in 2022. So if you're in a situation where you need to sell, you're likely going to be forced to sell at a lower price. And we saw the lower pricing condition continue pretty much through most of the nine-month season going from somewhere above $10 a pound to probably a low of about $8 a pound in general for HFCs. Recently, we've seen a little rebound in HFC pricing as we exit Q3 starting into Q4. We feel pretty good about where the pricing is at the moment. It's headed back towards that $10 a pound price that we sort of started the year at. And so we just think next year is going to be a whole new year to start over, in some respects. Most of the customers that buy refrigerant are not going to buy until, let's say, March of next year, April of next year, once they get out of the heating equipment and start to get into the cooling equipment. And likely the overall psychological impact of a 40% reduction will somehow be reflected in pricing starting in Q1 of 2024.

With the price headwinds this year, you're still putting up surprising upside to the margins. I guess keeping at 35% or a little better. But without those price headwinds, I would think it would have been even better in the quarter. So, I guess, can you talk through structural margins in the business, in the industry? You mentioned the one-timers, but even at 38%, that's solidly better with those price headwinds. So any extra color on the margin?

Again, I think we have done a pretty good job going back a few years. We started the initiative of trying to create more of a value proposition with not all customers, not all buyers of refrigerant, because many buyers of refrigerant are just looking for a cheap price. But we focused on working with customers that had the opportunity to support recovery and reclamation to support the principles we have around lifecycle refrigerant management. And as a result, I think the strength of the relationship helps in some respects relative to other customers who are just focused on price. We think that's going to be important as we enter 2024. I think, and certainly I can't say that this is true, but I think that those folks that were focused on price are going to have a hard time getting access to the supply next year, or certainly having a hard time to buy in a manner by which they previously did so. So we're happy with our customer base. We try to grow the customer base. We try to introduce reclamation and recovery programs to customers. We spent a lot of time this year going downstream to contractors to help educate them on the importance of recovery, to give them best practices, to help speed up the recovery once they have that opportunity. So we feel pretty good, I mean really good, I guess about our relationship with our customers and our ability to translate that into value and profitability.

Good. Then just switching over to the carbon credit opportunity, we're hearing more excitement in the industry around that opportunity. Any quantitative metrics you can share about growth in your carbon credits and how you think about the opportunity over the next few years?

We actually don't necessarily think the carbon markets have a growth opportunity for Hudson. We're currently participating in two types of markets. One is a mandatory market relative to the state of California, but the protocol that is related to refrigerants is solely attributable to the destruction of CFCs. And as you know, CFCs and CFC equipment haven't been installed or manufactured since 1994. We just feel that that protocol and the availability of CFCs are sunsetting. And so to the extent that there are no more CFC systems at some point, then the protocol really will have no material value. On a voluntary basis, currently there's a protocol that supports the reclamation of HFCs, but because it's voluntary, it likely is going to go away when the mandate for uses of reclaimed refrigerants are put in place because then it's not really a voluntary process; it's a mandated process. And typically when that's the case, the voluntary protocol goes away. So we don't know what will happen with these different protocols, but the ones that we currently operate in likely will diminish or possibly go away in time. Alternatively, new protocols could be established, and then there could be a new opportunity if and when they were established.

Helpful. Thanks. Good luck, guys.

Thank you.

The next question comes from Austin Moeller with Canaccord. Austin, please proceed.

Hi, Brian. Good evening.

Good evening.

So just a question here. Do you expect that the contractors in the HVAC industry are adequately prepared to increase the amount of reclamation that's going on and the number of cylinders being sent to reclaimers by the second or third quarter of next year? Or do you think that it could potentially be quite chaotic just given the 40% virgin production cap?

Historically, participants in our industry are less prepared than we would think they should be, and likely that's the case for next year. However, what we have been doing particularly for this calendar year and probably started the second half of last year is trying to create more awareness and participate in educational seminars and training seminars geared for contractors. So I think the folks that we've been able to touch and reach and speak to, and folks that listen to the playbacks and things like that should be prepared. You raised a good question, cylinders and access to cylinders. There may be some reclaimers that will have difficulties getting access to cylinders and supporting greater recoveries. We already use a pretty substantial reusable fleet, which recovery cylinders are reusable steel as opposed to disposable. And so while we can't say that there won't be some shortages on cylinders next year, particularly if there's a significant growth in reclamation, I think our position with cylinders and the availability of access to getting cylinders possibly would be better than most others in the reclamation industry.

And do you expect that your current number of laboratories and your footprint is sufficient to meet the uptick in reclamation? I know you've talked about adding chips.

You're correct. We're still waiting for the 2022 data should be out very shortly, but as it goes back to the 2021 data, if you look at the totality of the reclaimed pounds, 2021 was lower than some of the peak years by a few million pounds industry-wide. So today, let's say reclaimers on average are probably reclaiming fewer pounds than what was the peak period. But even back to the peak period, the EPA has done studies on our industry that would have said that there was enough capacity to more than triple the volume. We've always talked about we could always go to a second shift if we needed on a reclaimed capacity. We've been investing each and every year in more lean production processes, but also automation, particularly around the handling of cylinders so that when a cylinder comes in the door within two business days, it goes out. And a lot of the automation that we're adding would correlate to how the propane industry evolved in the mid to late 90s with the general swap programs that you see today and how to refurbish and move steel through a plan to their fill lines and so forth. So we spent a lot of time and energy. We think we'll be able to meet any growth in capacity. We certainly do expect to have additional CapEx dollars, but typically our CapEx is $5 million annually or less. And likely that kind of trend I would expect to continue unless there was something meaningful in a change of what we decide to do.

Okay, great. Thanks for the details.

We have reached the end of the question and answer session. I will now turn the call over to management for closing remarks.

Thank you, operator. I'd like to thank our employees for their continued support and dedication to our business. I want to again thank our long-time shareholders and those that recently joined us for their support. We look forward to speaking with you after the fourth quarter results and have a good night, everybody. Thank you.

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.