HYR.L Regulatory News (HYR)

19 April 2012

Hydrodec Group plc

("Hydrodec", the "Company"or the "Group")

Results for the year ended 31 December 2011

The Board of Hydrodec Group plc, the cleantech industrial oil re-refining group (AIM:HYR), is pleased to announce the audited results for the year ended 31 December 2011.

Financial Highlights

• Revenues increased 26% to US$22.4 million (2010: US$17.8 million)

• Gross unit margins up 31% at US$0.25 perlitre (2010: US$0.19per litre)

• Cash outflow from operations* down 23%to US$3.5 million (2010: US$4.5 million)

• £2 million debt financing secured and £5.5 million equity financing raised to support growth initiatives

*including non-operating growth expenditure of US$0.8 million (2010: US$0.6 million)

Operational Highlights

• SUPERFINETM sales volumes at 20.3 million litres (2010: 20.2 million litres), with H2 volumes up 15% on H1

• Improved customer portfolio into new geographicand application markets

• Diversified feedstock procurement

• Further improvements in plant reliabilityand efficiency

• Significantly strengthened US management team

• Agreement for first operating JV in Japan signed

Management

• Appointment of new Chief Executive Officer, Chief Operating Officer, Head of Corporate Development and President of Hydrodec Japan

2012 Current Trading

• First quarter SUPERFINETM sales volumes of 6.0 million litres (Q1 2011: 5.2 million litres)

• Revenues and margins significantly up on same period last year

Neil Gaskell, Chairman, commented: "I am pleased with the progress the Company has made during 2011 and look forward with confidence to 2012 as the new management team, led by Ian Smale, brings its experience and abilities to continuing our performance improvement and making a fresh start to Hydrodec's longer term growth."

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Description of the Business

The Group's technology is a proven highly efficient oil re-refining andchemical process which is being initially targeted at the multi-billion US$ market for transformer oil used by the world's electricity industry. The Group takes spent oil, including polychlorinated biphenyl ("PCB") contaminated oil, as the primary feedstock, which is then processed at its two plants enabling 99 per cent or greater recovery of oil for reuse while also eliminating PCBs, a toxic additive banned under international regulations, without environmentally harmful emissions.

Chairman's Statement

2011 was a year of good progress for the Group. During the year the business improved steadily, operationally, commercially and financially especially in the US. By the year end, this stronger performance had given us confidence that the business is now on a more stable commercial platform, with further scope to grow.

Although the business continues to make a loss, revenues, gross unit margins and cash generation at the plants were all significantly better in 2011. The net cash outflow from operations continued to fall despite increasing expenditure for developing the business. This improving trend is continuing in 2012 and this will contribute to some of the investment in growth this year.

I am delighted to welcome the new management team, led by Chief Executive Ian Smale, who, together with Mark McNamara and Paul Manchester, are joined by David Robertson as Chief Operating Officer, Takuichi Murachi as Head of Japan and Lee Taylor as Head of Corporate Development.

In its first 90 days, the team has made an immediate difference, rapidly establishing an authoritative style that has continued to improve operational performance, while reinvigorating the momentum of development throughout the Group. Ian Smale's first statement as Chief Executive outlines his view of the opportunities and the challenges for the Group and the Board is confident that your business is in very capable hands.

I believe that having faced the challenges of 2009/10, and delivered a good performance in 2011, the Group has now entered a period of transformation that will bring both improved commercial operations at our existing plants and, as plans mature, exciting development opportunities for the Group.

Neil Gaskell

Chairman

Chief Executive's Report

It is with great pleasure that I provide my first report as Chief Executive of Hydrodec. Since joining the Company in January 2012, I and my new senior management colleagues (David Robertson, Chief Operating Officer, and Lee Taylor, Head of Corporate Development) have had an opportunity to better understand the Company, its technology, our people, the markets in which we operate and the opportunities for the future.

Although we were not with the Company in 2011, I would like to report on last year's financial and operational performance, but also reflect on the position of Hydrodec when we joined, the early decisions and changes we have implemented and some initial thoughts on our intended direction of travel for the business.

We have found a company built on a unique, proven technology with considerable global potential. The value of its environmentally friendly chemical process technology lies not just in the eradication of polychlorinated biphenyls (PCBs), but also in the extremely low carbon footprint of the operations and near 100 per cent recovery factor from contaminated or used oil.

It is easy to forget that Hydrodec has already achieved far more than many technology start-ups. Since admission to AIM in 2004, it has established increasingly commercial operations and grown revenues every year for seven years. The Company is full of good people who have built a solid platform for growth while learning difficult lessons about developing a new technology business model in an established commodity industry. The new management team is confident that these strengths and our shared experience can make Hydrodec a genuinely sustainable, cleantech oil re-refining company of significant scale.

Driving a "fresh start to growth" through three distinct business models

There are three distinct business models that capture Hydrodec's current scope of business as well as support its growth potential: the virtual "closed-loop" in the US; waste and liability management, tailored particularly for Japan; and technology incubation in Australia.

The drivers of our existing business are both a liability management service provided to electrical utilities for their used transformer oil, and a premium product re-refined by Hydrodec and sold back to the industry as a competitive and sustainable alternative to new mineral oil. The "closed loop" model combines both of these elements in a strategy that provides a one-stop solution for the electrical utility sector, which has traditionally separated disposal of their waste transformer oils and procurement of new oil for power generation and transmission. This was the original business proposition for the Company and has been refreshed recently in the US especially to enhance feedstock supply.

We believe that deepening the relationship with the utilities by providing a genuine alternative to incineration, as well as competing effectively into a growing US market for transformer oil (up 6 per cent pa. over the last two years, reversing a previous decade of decline) offers major growth potential and a long term opportunity to invest in further production capacity. Momentum to support this has been developing during 2011, and is continuing into 2012.

Second, a waste and liability management model is focused on the destruction of PCBs and Japan where use of re-refined oil is not as widely accepted as in the US. Product sales are a separate activity in this model although a "closed loop" exists to supply and receive contaminated oil from an associated transformer hardware "washing" activity. Importantly, excess volumes are available for export where the price setting mechanism will be the international clearing price into a growing market in Asia which now accounts for more than 50 per cent of the global transformer oil market and is currently growing at 6-8 per cent pa. Longer term, the option to reduce import dependency would seem to be an attractive and logical option for Japan as a whole and the Hydrodec process is the only non-destructive technology approved by the Japanese government.

In Japan, the relationship with the Company's strategic partner, Kobelco-Eco, is developing constructively. We continue to define the scale and potential attractiveness of the business opportunity, however, progress is slow and not always for reasons within our control. We will be intervening directly to further empower our contribution to the joint venture and leverage this unique alternative to incineration more expeditiously during 2012.

In Australia, the current business is sub-scale, but commercial - in part due to a government subsidy. Due to the size of the Australian market, organic growth options in the transformer oil market exist but appear to be limited, however the technology base offers considerable opportunity to expand beyond PCB treatment. Recent management changes will permit developing Australia as the technology incubator where we can invest with renewed focus on our longer term future. The first area of development will be into paraffinic lubricants where previous tests have shown great promise. We are developing the strategies to accelerate testing and trials to shorten development time, and would consider working with third-parties if this will improve the opportunity.

Financial and operating review

2011 was a year of consolidation, building on the improvements of the previous year. Revenues increased a further 26 per cent to US$22.4 million (2010: US$17.8 million) driven by higher pricing from improved product and customer mix and more favourable market conditions. Gross unit margins increased 31 per cent to US$0.25 per litre (2010: US$0.19 per litre). The second half showed a marked improvement at US$0.28 per litre (H1 2011: US$0.21 per litre).

Sales volumes of our premium quality, environmentally friendly SUPERFINETM transformer oil and SUPERFINETM base oil were broadly unchanged at 20.3 million litres (2010: 20.2 million litres). Again, the second half of 2011 reflected a strong improvement on the first half of the year with revenues and volumes increasing 22 per cent and 15 per cent respectively.

Much of the improvement in the second half can be credited to the strengthening of the management team in the US. Greater experience in value and supply chain management has proved beneficial as the Company refines its procurement, sales and marketing offerings away from transactional business to more structured relationships. The same approach will be applied to the Young facility in Australia, as acceptance of our SUPERFINETM transformer oil grows in the market place.

Diversification of the supply channel has been a key objective, and supplies in the US from the small number of ex-service equipment disposal companies reduced significantly to around 43 per cent last year from 71 per cent in 2010. Conversely supplies direct from utilities in the US increased from 8 per cent to 23 per cent. Both reflect success of an increased focus on the procurement strategy. We expect to further develop our feedstock pipeline during 2012 and thereby drive our utilisation rates at the plants.

The Group has continued to expand its customer portfolio into new geographical and application markets for its SUPERFINETM transformer oil and base oil products. In the US, our export volumes grew significantly to 27 per cent of total sales. We gained 23 new customers in the US with a total of 38 customers supplied during the year. We also significantly increased the proportion of product sold directly into US utilities (11 per cent of US sales). Demand for SUPERFINETM continues to exceed production.

In Australia, 80 per cent of our sales are as base oil to one major domestic customer. Export volumes represent a small fraction of total sales.

Cash

The Company's cash performance improved with the cash outflow from operations decreased 23 per cent to US$3.5 million (2010: US$ 4.5 million). Second half outflow reduced to US$1.2 million (H1 2011: US$2.3 million), including US$0.4 million spend on growth expenditure (e.g. in Japan), further demonstrating the improving trend.

Hydrodec raised a total of £7.5 million during the year, with debt funding of £2 million secured in June and £5.5 million in a share placing in November.

Refinery utilisation and margins

A change in operational philosophy has challenged the assumption of feedstock being the constraint on performance and potential. "Level loading" presumes that plant capacity is the only real constraint on the business, particularly if there is confidence in the availability of used oil. The impact of this strategy has been marked with a more flexible approach to feedstock procurement accessing more diverse and increased supply which has continued into 2012. The improving feedstock supply has had a knock on impact on plant utilisation, especially during the second half of last year, and this trend continues into 2012. Overall utilisation of existing capacity last year averaged 60 per cent, but grew steadily in the second half of the year at 64 per cent.

With the Group's operations gaining momentum, it is increasingly important to communicate how industry pricing benchmarks affect our margin. There are elements of our margin within our control and these are actively managed; however we will increasingly look to measure our performance against apparent industry benchmarks that reflect the business environment within which we work, and this we believe will be helpful. The lead indicator for sales pricing, and hence revenue, is provided by ICIS, where our product is most closely related to their "Pale 60" naphthenic base oil US posted price. The indicator for feedstock cost is less well correlated (and impacted by Australia where we are able to charge a dechlorination fee in some instances). Given that a major alternative use of used transformer oil in the US is as an ingredient in diesel fuel-blending, the Platts New York Harbour (NYH) Ultra-low Sulphur No 2 Diesel index provides a useful marker as to trends.

On this basis a little more than 50 per cent of the margin improvement in 2011 can be attributed to self-help rather than the business environment, although this is an inexact science.

Japan

Good progress continued to be made during 2011 although perhaps inevitably following the tragic events early in the year and the impact on the electrical utilities in particular, it has been slower than expected. The formal joint venture agreement in respect of the first plant was signed in July and we have recruited Takuichi Murachi as our President of Hydrodec Japan. Murachi-san has previously held senior positions within Mitsui & Co, Toyo Engineering and most recently as President and then Chairman of Veolia's water division in Japan. He will provide Hydrodec with a real presence in Japan and allow us to better play our part in the development of the joint venture.

While the construction and commissioning of the first plant will not be completed until next year, we remain convinced that the potential scale of the market and opportunities for Hydrodec within the joint venture are very material. However the pace of development is a concern and we are investigating how to re-invigorate the joint venture so that it can more quickly deploy our technology in this market.

As previously reported, when combined with the treatment of contaminated oil resulting from the flushing process, we understand that there may be at least 600 million litres of contaminated used transformer oil in Japan, and a total market potential in excess of a billion litres. Our process remains the only non-incineration process licensed for use.

Technology and new applications

Given the extremely low carbon footprint of the Hydrodec process, together with the near 100 per cent recovery factor from contaminated or used oil, we have begun a process to obtain a carbon accreditation. If successful, this will be a further validation of the sustainability of SUPERFINETM and a significant addition to our marketing offer. A proper quantification of the Hydrodec methodology has been initiated and will hopefully report in 2012.

In a similar vein, while we are effectively operating with the direct endorsement of one major original equipment manufacturer for SUPERFINETM, we are targeting further endorsements in 2012. There is also progress with the US Environmental Protection Agency ("EPA") on a licence for treatment of PCB contaminated oil in excess of 50 parts per million. An effective endorsement from the EPA will add to the volumes of used oil available to Hydrodec, but also lend further credibility to the Hydrodec process in the US, and potentially elsewhere internationally.

Looking beyond the market for transformer oil, the wider opportunity offered by the Hydrodec technology remains very exciting, especially in paraffinic lubricants used in industry and mining sectors. We plan to make a managed investment in product development which can leverage on Hydrodec's experience and existing technology, as well as previous test and laboratory data; we will not need to start from scratch.

Provision

As I have reviewed the business in general, and in particular the appropriate business model, we have identified some stocks of transformers and hardware at Young dating from the plant's original function, ownership and potential business strategy. The "hardware" is limited in scope, safe and securely stored, but will no longer fit as an activity within the revised scope of the business in Australia. While about US$0.5 million has been received and treated as revenue in the past, costs for treatment and disposal have been re-assessed by management and this is reflected in the 2011 accounts. We have also made an additional provision of US$0.7 million for future losses on their disposal. The material will be treated as part of on-going operations or disposed of once the optimum disposal strategy has been decided upon.

Current trading and 2012 outlook

Trading in the first quarter of 2012 has continued to reflect increasing demand for the Group's premium grade oils and a continuation of the positive trends seen in the second half of last year. Sales volumes, margins and revenues all recorded significant increases over the same period last year and exceeded levels achieved by the business previously. First quarter sales volumes are 6.0 million litres, up 12.5 per cent on the previous quarter and 14.9 per cent up on the first quarter of 2011. Gross unit margins and revenues are substantially up on the same quarter last year, and plant utilisation is up to 73 per cent so far this year.

While it is too early to declare victory on the operational capacity of the business, it does give management confidence that the stability of plant operations, enhancements in the procurement, sales and marketing processes and most importantly key additions in people, skills and capability will continue to leverage our existing positions and provide some momentum and upside in the immediate and short term. This creates a more robust platform from which the business can consider a fresh start to growth, something we will be developing through the course of this year.

Beyond our immediate focus on the safety and integrity of our operations, we will drive utilisation and cash generation from our operations moving the Company closer to cash positive operations and a material contribution to our overhead. As described, the management team are increasingly confident that the US operation offers a material opportunity to grow based on our evolving alternative to incineration and a better understanding of the scale of the supply market as well as an apparently growing demand for new product. In Japan, we remain convinced of the opportunity offered by the regulatory framework and the scale of the potential business, but we will investigate how to accelerate progress on delivering an operation. In Australia we will now start to develop the extensions of our technology that offer real potential to extend the scope and range of what might be possible. We are also reviewing other markets and opportunities where deploying the Hydrodec technology might be a potentially attractive business proposition, whether that is directly, in partnership or through licensing.

I would like to thank the Board for their confidence in the new management team and the Company's potential, and we will continue to invest in the capacity to enable this fresh start to growth during 2012.

Ian Smale

Chief Executive

Consolidated statement of comprehensive income

For the year ended 31 December 2011

Consolidated statement of financial position

For the year ended 31 December 2011

Consolidated statement of cash flows

For the year ended 31 December 2011

Consolidated statement of changes in equity

For the year ended 31 December 2011

Notes to financial statements

For the year ended 31 December 2011

1. Accounting policies

Basis of preparation

The financial information set out in this announcement does not constitute the Group's statutory accounts, as defined in Section 435 of the Companies Act 2006, for the years ended December 31 2011, or December 31 2010, but is derived from the 2011 Annual Report. Statutory accounts for 2010 have been delivered to the Registrar of Companies and those for 2011 will be delivered in due course. The auditors have reported on those accounts; their reports were unqualified, however they included a reference to an emphasis of matter in 2011 with regard to going concern, and the reports did not contain statements under section 498(2) or 498(3) of the Companies Act 2006.

The accounting policies used in completing this financial information have been consistently applied in all periods shown. These accounting policies are detailed in the Group's financial statements for the year ended 31 December 2010 which can be found on the Group's website.

Going concern

The financial statements have been prepared on the going concern basis, which assumes that the Group will have sufficient funds to continue in operational existence for the foreseeable future.

Plant operating performance continues to steadily improve and the Group has prepared its internal forecasts for the next 12 months on this basis. However, there are planned levels of expenditure for growth pursuant to the strategy review outlined in the Chief Executive's Report. As these plans become firm, growth expenditure will be matched against the need for, and availability of, funding. In the event that these plans were not undertaken the Group can reduce its cost base to the level appropriate for existing operations. Therefore the Directors consider the going concern basis appropriate.

2.  Revenue and operating loss

Revenue and assets for both years are wholly attributable to the Group's sole activity of the treatment of used transformer oil and the sale of SUPERFINETM oil, which are deemed to be continuing activities.

Comparative figures for 2010 have been revised to re-apportion overheads more accurately between operating costs and cost of sales to reflect the current basis of operations of the group.

2.1 Geographic analysis

All revenue comprises amounts earned on amounts receivable from customers. During the year two customers in the USA each accounted for more than 10% of the Group's total revenue. Revenue recognised during the year and the amounts outstanding at the year-end in respect of those customers were as follows:

2.2 The loss on ordinary activities before taxation is stated after charging/(crediting) the following amounts:

2.3 Total operating costs charged for the year were:

This represented the provision of goods and services across the following functions:

3.  Finance costs

4.  Loss per share

The calculation of the basic loss per share is based on the loss attributable to ordinary shareholders divided by the weighted average number of shares in issue during the year.

The weighted average number of shares used in the calculations are set out below:

In 2010 and 2011, the share options and warrants were anti-dilutive and diluted earnings per share is the same as basic. The calculation of the weighted average number of shares excludes shares which are now held by a member of the Group and in respect of which votes may not be cast at a general meeting and also shares held by the Employee Benefit Trust.

5. Non-current liabilities - borrowings

In November 2007, the Company issued a £13,800,000 convertible unsecured loan note by private placement, convertible at the loan note holder's option into ordinary share capital of the Company at a fixed price of 19p, subject to anti-dilutive conditions for subsequent share issues at below market price. Under the terms of the issue, the conversion price is revised for subsequent issues of share capital at discounts in excess of 10 per cent. to the prevailing 5 day share price average.

At 31 December 2011, the current conversion price was 14.64p (2010: 14.64p) per share. Loan notes areconvertible into ordinary shares at any time prior to 1 November 2012. Those elements not converted into shares by this date are repayable, at the Company's determination, between 1 November 2012 and 31 October 2014. Due to the convertible nature of this instrument it contains a loan element and equity element. Over time the loan element, as reflected above, increases such that the instruments repayment value of £12,790,000 would be reached assuming non conversion on 31 October 2014. 

Interest is charged at a fixed rate of 8% per annum on the value of the unconverted loan. Management recognise that the 8% interest rate is below market rate for this type of financial instrument and the fair value of the liability component was calculated using estimated interest rates for an equivalent non- convertible bond. The internal rate of return for the convertible bond has been assessed using comparable internal rates of return by the Group for other income streams. The residual amount representing the equity conversion option, is included in the equity reserve in shareholders funds.

During the year, no loan notes (2010: USD nil) were converted into share capital of the Company.

On 14 June 2011, the Company issued £2,000,000 of non-convertible fixed rate secured loan notes. The notes are secured by mortgage deed over Group assets. Interest is payable at 10 per cent per annum due in March and September of each year. The notes are due for repayment in full at par on

31 July 2014.

6. Share capital

The Company issued the following ordinary shares during the period:

VIN Australia Pty Ltd, a member of the Group holds 54,500,000 ordinary shares in Hydrodec Group plc pursuant to the acquisition of Virotec International plc in 2008. Votes in respect of these shares, and a further 2,173,333 shares issued pursuant to that acquisition, may not be cast in a general meeting of Hydrodec Group plc and as such they are treated as if they were treasury shares on consolidation.