Tecogen - Q3 2023

Transcript

Operator (participant)

Greetings. Welcome to Tecogen's Q3 2023 conference call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note, this conference is being recorded. At this time, I'll turn the conference over to Jack Whiting, General Counsel and Secretary. Mr. Whiting, you may now begin.

Jack Whiting (General Counsel and Secretary)

Good morning. This is Jack Whiting, General Counsel and Secretary at Tecogen. Please note this call is being recorded and will be archived on the Investors section of our website at tecogen.com. The press release regarding our Q3 2023 earnings and the presentation provided this morning are available in the Investors section of our website. I'd like to direct your attention to our Safe Harbor statement included in the earnings press release and presentation. Various remarks that we may make about the company's future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's most recent annual report on Form 10-K and quarterly reports on Form 10-Q under the caption Risk Factors, which are on file with the Securities and Exchange Commission and available in the Investors section of our website under the heading SEC Filings. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. Therefore, you should not rely on any forward-looking statements as representing our views as of any date subsequent to today. During this call, we will refer to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles, or GAAP.

Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is provided in the press release regarding our Q3 2023 earnings and in the Investors section of our website. I'll now turn the call over to Abinand Rangesh, Tecogen's CEO, who will provide a review of the Q3 activity and results, and Roger Deschenes, Tecogen's CAO, who will provide additional information regarding Q3 financial results. Abinand?

Abinand Rangesh (CEO)

Thank you, Jack. Welcome to Tecogen's Q3 2023 earnings call. In the last couple of calls, I laid out our objectives and plan. I'll start by giving an update on where we are with regards to meeting these objectives. Roger will then take us through the financials, and then I will wrap up with our next steps. Revenue is up every quarter this year. The Adjusted EBITDA loss has also narrowed. In fact, if service margins were where they were last year, we would have shown a net profit. Inventory is also down compared to Q2, although we still have work to do to reduce this further.

Service margin is down predominantly because a number of systems were put into service around the same time, and certain components, such as engines and exhaust heat exchangers, have had to be replaced all at the same time, significantly increasing expenses associated with service. This is expected to recover by Q2 next year. To strengthen our balance sheet, we established a $1.5 million credit facility with two of our board members. We received favorable terms on the credit facility, and it gives us additional working capital and cash needed for our factory move next year. Our present cash position is now over $1.1 million. We have drawn $500,000 into the credit facility. Our cash position is lower than anticipated due to delays in collecting customer deposits. In this high interest rate, conservative lending environment, customer financing is taking longer.

We expect to collect more of these deposits over the upcoming months. Our backlog is slightly lower than at the end of Q2. I'll discuss our marketing efforts and the sales pipeline in the next slide. We believe that there are substantial orders that are in the pipeline, so we expect the backlog to increase again shortly. The backlog is still predominantly indoor agriculture, with a small mix of education and residential. The last item I want to mention is that our board has approved management to prepare the paperwork for shareholder approval for a reverse split with a view to uplist on a national listed exchange. We will likely hold a special meeting of the shareholders in early 2024 to discuss the various reverse split options and have the shareholders vote on the matter.

The board will then consider the various parameters, including the share price at the time, public float, and shareholder viewpoints, before deciding to undertake a reverse split and an uplist. Our marketing efforts have been focused on segments where we have a clear competitive advantage. Our objective is to find developers who can integrate our products into customer projects. The two key approaches we have taken are informational articles and targeted trade publications. These include Vertical Farm Daily, High Strength magazines, Industrial Process Cooling magazines, et cetera. The aim is to educate end customers and attract developers to integrate our products into their projects. The second approach we have taken is a direct outreach to contractors and design-build firms that specialize in niches such as food and beverage plants. Our overall sales pipeline for the 10 months to date is 16% higher than last year.

By year-end, we expect it will be 20% higher. Although some key markets have a significant anti-gas sentiment, we believe that in some of the market niches we are targeting, we have a sufficient advantage that we should see conversion of the pipeline into sales. I'd like to do a quick recap of our products and our business before we continue to the financials. We have three value propositions for end customers. The first is power generation and resiliency. This is electrical cogeneration for energy savings, and in some cases, for backup power in the event of a blackout. We use a natural gas engine to generate electricity and use the engine heat to produce hot water for the building.

We are twice as efficient as an equivalent fossil fuel power plant, as we are able to use the heat and have a much lower greenhouse gas footprint. The second is our clean cooling products. These products generate chilled water and hot water simultaneously. In applications that require climate control, such as healthcare, controlled environment agriculture, et cetera, we are the cheapest source of producing cooling and humidity control. Typically, the highest cooling load occurs in summertime, when natural gas prices are lowest, so we also offer customers substantial energy savings. In addition to energy savings, our chillers require very little electricity to operate, so are ideal for applications where utilities are unable to supply sufficient power. As with electrical cogeneration, our greenhouse gas footprint is cleaner than an equivalent electric chiller and boiler combination, since most fossil fuel power plants are not utilizing the waste heat.

Our electrical cogeneration and clean cooling products benefit from up to 40% Investment Tax Credit that reduces the payback substantially. Our third value proposition to customers is our long-term service and asset management services. Our service centers provide end-to-end maintenance and allow customers to maximize their energy savings. Our typical maintenance contracts run for longer than 10 years and sometimes provide ancillary services to maintain balance of plant. This is an area that our strategy will focus heavily on. We plan to increase the range of services that we offer and increase the number of sites we service. We have three revenue segments. Our products revenue consists of sales of Cogeneration units, Microgrid Systems, and Chillers to a range of markets and customers. Our services revenue primarily consists of our contracted operations and maintenance services.

Our energy production revenue stream is from energy sales, including sales of electricity and thermal energy produced by our equipment on-site at customer facilities. I'll now hand over to Roger to summarize our financial results.

Roger Deschenes (CAO)

Thank you, Abinand, and good morning. I'll begin with a review of our Q3 2023 results. Our top-line revenue was $7.1 million in the most recently concluded quarter, which compared to $6.6 million in the similar quarter of 2022, which represented an increase of 7.5%, and this is due primarily to increased services revenue. Our net loss for the Q3 of 2023 was $482,000 or $0.02 per share, which compares to a net loss of $257,000, or $0.01 per share for the third quarter of 2022. Gross profit remained flat despite higher revenue, and this is due to the decrease in the services margin.

Our operating expenses increased 6% to $3.3 million from $3.1 million, and this is due primarily to incremental costs resulting from the Aegis acquisition, which is primarily payroll and related benefits, business insurance, depreciation and amortization, which in total increased the operating expenses by approximately $190,000. Moving over to the Adjusted EBITDA reconciliation. For the Q3 of 2023, the EBITDA loss was $307,000, and the Adjusted EBITDA loss was $182,000.

As mentioned earlier, the depreciation and amortization expense increased in the nine months ended September 30, 2023, and this is due to the addition of several vehicles and the amortization of the customer contract intangible asset which were recognized as part of the Aegis acquisition. These additions to our assets increased depreciation and amortization expense by approximately $62,000 in the Q3 of 2023. Moving next to the performance by segment. Overall, products margin increased to 43.2% in the third quarter of 2023, from 3.5% in the Q3 of 2022. We have seen some recovery in margin, products margin, due to the price increases that were instituted early in 2023 and the product mix shift during the quarter.

Services revenue increased 25% quarter-over-quarter. Existing contract revenue increased 5%, and the balance of the increase was from the recently acquired Aegis service contracts. Services margin was lower quarter-over-quarter by approximately 13%. This was driven primarily by increased service costs associated with engine and exhaust heat exchanger replacements. As Abinand discussed earlier, and we just discussed in last quarter's call, we have a number of systems that went to service at approximately the same time, which are now requiring the replacement of these expensive components, which should, when they're completed, result in increased runtime hours and revenue going forward. We expect margin to recover by the second quarter of 2024. Our energy production revenue remained flat quarter-over-quarter, and the margin decreased slightly by 1%. I'll now hand the call over to Abinand to discuss margin improvement efforts and summarize.

Abinand Rangesh (CEO)

Thank you, Roger. As mentioned last quarter, our approach to increasing margin is gonna come from multiple avenues. With regards to product margin, we have seen some improvements already, but we need to go further to keep ahead of material cost increases due to the long project development cycles. We will be increasing prices for some of our products in 2024. We are in the process of analyzing which parts can be common across our product lines to minimize inventory variation and also improve our purchasing power. We're also looking at places where we can reduce complexity of our products. With regards to service margin, we have raised prices on contract renewals and will continue to do so. Utility rates have increased substantially in many of the regions we operate in, and we believe we can raise our service prices commensurate with utility rate increases.

We are also quoting billable work for customers to service items that are required for our equipment to interface with the building. For example, billable work to service pumps and heat exchangers. This will not only increase runtime, but benefit the customer savings, and additionally, is an added source of high margin revenue for the company. We are working on increasing service intervals by increasing oil reservoirs, so engines can run longer between preventative maintenance intervals. This will allow us to have more revenue per technician. We're also continuing to look for ways to extend the life of critical components like cylinder heads and exhaust heat exchangers. In particular, we're looking for ways to eliminate chances of premature failures for such components. We're continuing to improve our runtime algorithms to reduce wear and tear, so that engines can run longer between service intervals.

I'd like to summarize by saying that we're continuing to focus on freeing up cash and stabilizing the business. We're continuing to work on the revenue on the backlog, and as you've seen from the marketing, our pipeline is now larger than it was before. Now, we just need to work on converting this pipeline into purchase orders and deposits. We're also working with various finance companies to help make it easier for customers to purchase our products. Lastly, we're focusing on increasing margin for both services and our products. I'm pleased to see that revenue has grown again this quarter. We've also put into place non-dilutive financing to strengthen our balance sheet. There continue to be challenges ahead of us, but I believe that we are addressing these one step at a time, and we'll see steady increases in the health of the business over time.

In fact, four board members have bought over 189,000 shares in the last quarter alone, showing that there's a strong belief in the future prospects of Tecogen. I'll now open the floor to questions.

Operator (participant)

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question at this time, please press star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. Thank you. Our first question is from the line of Sameer Joshi with H.C. Wainwright. Please proceed with your questions.

Sameer Joshi (Senior Equity Research Analyst)

Good morning, everyone. Thanks for taking my questions.

Abinand Rangesh (CEO)

Morning, Sameer.

Sameer Joshi (Senior Equity Research Analyst)

Good. Good. Excuse me. Just on revenue growth, nice to see sequential growth over the last few quarters. Do you expect this trend to continue? And, how should we read this 16%-20% increase in pipeline? How should we read that into 2024 conversion?

Abinand Rangesh (CEO)

So that is a very good question. I think if the conversion ratios remain the same, right, in theory, we should see an increase in revenue continuing. The real issue that we are working through as a company right now is that with. As I mentioned, there's very conservative lending going on right now, and with the high interest rates, people tend to defer capital projects. So what we're working on is how do we make this easier for customers to actually purchase our products, make it possible for these projects to convert faster? So our hope is definitely that revenue will continue to rise, and we'll continue to grow as a company.

But, you know, on the product side, because it's such a capital-intensive product, we just need to be also aware that the interest rate environments, the anti-gas sentiment, can slow down some of these conversions. But we're seeing some very, very good leads. There are some very large projects that are in that pipeline that are specified with our equipment. So it's really, it's not necessarily a matter of if these things will convert, it's a matter of when they'll convert. So it's really our job to work on making these faster. The other area, of course, that in terms of revenue, that we continue to really focus on, is the service side, because that is something that's much more predictable, and that's something that can grow much faster, if not only once all these engine replacements are done.

If we can get runtime up, service revenue should increase as well, both from pricing increases as well as runtime increases. Then the billable work that we're working on should also increase service revenue. So that's a little more predictable as well. So there's two areas. I think from your modeling perspective, essentially what you had before is probably a reasonable estimate. If there are big changes to any of this, we will give investors an update between now and when we release year-end earnings.

Sameer Joshi (Senior Equity Research Analyst)

Understood. Just digging down deep a little bit deeper, how does this price increase that you're planning and already implemented further act as a headwind for customers that are facing higher interest rates? I think that's a price increase for them as well.

Abinand Rangesh (CEO)

Yeah. So it's—I mean, that's a great question. I think in some of the products, right, we do still have. The price increase on its own is not necessarily, I think, gonna drive people from moving to use our products, 'cause we're already substantially more expensive than an equivalent product, but we're also offering a substantial saving as well. I think the real issue is how to turn this into a way that the customer essentially is paying for the product just from the savings alone. And-

Sameer Joshi (Senior Equity Research Analyst)

Mm-hmm.

Abinand Rangesh (CEO)

So this is where sort of building in and working with the right kind of financing companies to help us do that is going to make it easier, without necessarily slowing down deals. So I think this is sort of a work in progress with regards to making that happen. But, I mean, the price increases, we're really keeping in line with inflation and keeping in line with where our competitors are raising prices. So it's not, you know, huge jumps in prices at this point. We're really talking increases with regards to where inflation is at. And, you know, and the increases are actually lower than the price that utilities are increasing their rates at. So I think, in theory, the customer saving should actually be higher than what they're seeing in terms of product increases.

Sameer Joshi (Senior Equity Research Analyst)

Understood. Another clarification on service margin improving only by Q2 of 2024. The replacement is ongoing, and shouldn't we see margins improve incrementally from now through 2024, or should we see a jump in 2024? Like, how should we look at the margins from the services?

Abinand Rangesh (CEO)

You're likely to see it, probably more like a jump in, because there's a whole slug of units that were put in around the same time, and we're sort of working our way through the replacements of the engines as well as the exhaust heat exchangers. And especially with COVID and a lot of the supply chain disruptions that we had in the last couple of years, some of these things are a little behind as well in terms of where they need to be in terms of the replacement cycle. So once we get through all of that, we should be in a position to see a margin increase.

Sameer Joshi (Senior Equity Research Analyst)

Okay. And then just broadly, you did mention backlog in ag and education, municipal. Apart from the pipeline that you are currently addressing, are you trying to get into other verticals, or opportunistically looking for things that might emerge?

Abinand Rangesh (CEO)

So I think really what we're trying to do is to focus on certain key market segments. So one is definitely the process cooling in a number of different areas, because those are applications where the chiller runs year-round, and hence, the savings are much higher for both the customer and our revenue, as well as our service margins will also be very good in those kind of applications. And there are also applications where customers are gonna use the hot water year-round. So it typically tends to be a pretty good area to be in. We haven't. Beyond the cannabis industry, we haven't done a whole lot in that space yet, but we're hoping to be doing more in that, 'cause a lot of the industrials do use hot water.

The other markets that we continue to just build on is the multifamily. We do still continue to see projects in New York and Boston and the sort of high utility rate areas. We are continuing to talk to engineers, work with engineers on that. Even with headwinds in places like New York, there's still a huge benefit from the financial standpoint. So we are seeing projects that continue to be there, just not as much as we would have done in, you know, a couple of years ago. The other areas that we are looking at is places where, again, there might be an air-cooled chiller replacement. We're continuing to push for products into those where the customer has some kind of a dehumidification load or humidity control load. So those don't have to be industrial.

They could be an air conditioning type load, but they would be anywhere where they're doing a humidity control type application. So there are some new verticals we're pushing into, but we're not—you know, we're, we're being relatively measured about which ones we get into at any one time, 'cause a lot of it is gonna come down to having the right firms that can design around our products... the right developers who can actually put those products in, and those relationships take a while to build up. So we're, we're talking to quite a few of them, but we're not expanding into all of the verticals that I just mentioned at, at the same time.

Sameer Joshi (Senior Equity Research Analyst)

Understood. Thanks, Abinand, for taking my questions. Good luck.

Abinand Rangesh (CEO)

Thank you, Sameer.

Operator (participant)

Thank you. As a reminder, if you'd like to ask a question today, you may press star one from your telephone keypad. Our next question is from the line of Alex Blanton with Clear Harbor Asset Management. Please proceed with your questions.

Alex Blanton (Senior Analyst)

Hi, good morning.

Abinand Rangesh (CEO)

Morning, Alex.

Alex Blanton (Senior Analyst)

I want to talk about the service margins that you expect to recover by second quarter. If we annualize that improvement starting in the Q2, would that alone produce a profit? It looks to me like it would, because if you go back, let's say your service revenues expand to $13 million next year, or on a 12-month basis, and you raise the margin to 52% from 44%. That would add about $2 million on it. I'm really talking nine months, not a year. Assuming nine months, if your nine months this year were to be $13 million and you're in 52%, it would add $2 million to the pretax, and on an annual basis, $2.7 million, which on a net basis would be almost $0.10 a share. So that would bring you pretty much to break even, it seems to me.

Abinand Rangesh (CEO)

That's exactly right. And in fact, the service margin decline, it's sort of that the increase in expense, it's actually a double hit to the company because the way the cogeneration services are billed, it's actually done on a run hour basis. So for every hour, the cogeneration system runs, the customer pays a maintenance fee. So if the machine is down for service for any extended period, or some of these bigger engine replacements things that are pending, then they actually reduce the run hours. So not only are you seeing a decline in revenue, you're also seeing an increase in costs. So you're getting squeezed on both ends here.

The $3.8 million that we did in service this quarter would have been in excess of four million if everything had the engines, they were all - we had the ability to replace everything in one shot. The other piece is, of course, the margin would have increased as well. So we'd have seen a significant increase in, you know, we would have actually seen a profit this quarter alone if the service had been where it was. And then on top of that, right, as I mentioned, the billable side of things, there's a lot of money to be had on that side of the business as well. So the service improvements alone would make a significant difference to getting Tecogen profitable.

Alex Blanton (Senior Analyst)

Okay, thank you. I don't really have any more questions right now, but can we talk offline right after the call?

Abinand Rangesh (CEO)

Sure. Yeah, feel free to give me a call on my cell.

Alex Blanton (Senior Analyst)

Okay, yeah, I will do that. Thank you.

Operator (participant)

Thank you. At this time, there are no additional questions, I would turn the floor back to management for any further remarks.

Abinand Rangesh (CEO)

Thank you very much for attending the conference call and continuing to be supportive of Tecogen. I look forward to sharing more results with everybody as we continue to make progress. Thank you.

Operator (participant)

Thank you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.