TECOGEN INC. annual report, FY2018

Business Context and Reporting Period

Tecogen Inc. designs, manufactures, sells and services natural-gas-fired combined heat and power, chiller and water-heating systems. Its two segments are Products and Services and Energy Production, the latter selling energy under long-term customer contracts through acquired subsidiary American DG Energy (ADGE). This Form 10-K covers the fiscal year ended December 31, 2018; comparisons are with fiscal 2017. The company reported 81 operational energy systems at year-end, with approximately 5,035 kW of electrical capacity.

Financial Performance and Position

• Revenue comprised $12.62 million of products, $16.86 million of services and $6.40 million of energy production. Products and Services generated 82.2% of consolidated revenue; Energy Production generated 17.8%.
• Cash and cash equivalents were $272,552 at year-end, down from $1.67 million. Working capital was $13.17 million, versus $12.95 million; current assets were $26.37 million and current liabilities $13.20 million.
• Accounts receivable reached $14.18 million and unbilled revenue $4.89 million. Management attributed the operating cash outflow principally to increased receivables, unbilled revenue and inventory.
• The Webster secured revolving facility provides up to $10 million through May 2021, subject to eligible collateral and covenants. Year-end borrowings were $2.12 million gross (reported at $2.01 million net of unamortized issuance costs on the balance sheet); the stated year-end interest rate was 7%. The company reported compliance with covenants.
• Total liabilities were $21.87 million and total assets $49.90 million. The filing reports no separate gross-margin percentage by segment; Energy Production gross profit was $2.60 million.

Material Changes Versus 2017

• Revenue grew 8.1%, while gross margin fell 1.1 percentage points. Product revenue declined 2.8%: lower cogeneration sales were partly offset by stronger chiller sales. Services revenue rose 2.9%; energy-production revenue rose to $6.40 million, but the 2017 comparison includes ADGE only from its May 2017 acquisition date.
• The company recorded a $4.39 million goodwill impairment related to Energy Production. Management cited shortening customer-contract terms without replacement or growth, lower-than-expected cost savings and profitability improvements, and the acquisition-date share-price peak.
• Operating expenses rose 50.3% to $19.13 million, primarily because of the impairment and increases in administrative, selling and research-and-development costs. R&D spending rose to $1.30 million from $0.94 million.
• Operating cash use increased to $3.86 million. Investing cash flow included $2.00 million of proceeds from an energy-asset transaction; financing cash flow included revolving-credit draws and repayments.
• Tecogen acquired the remaining 50% interest in TTcogen in March 2018. It also launched an in-house CHP Insight monitoring system and reported successful permitting of Ultera-equipped generators for unrestricted operation in the Los Angeles region.

Outlook, Risks and Unusual Items

• The filing provides no specific revenue or earnings guidance. Management said existing resources, operating cash flows and the revolving credit line were expected to meet working-capital needs for the next 12 months, while also warning that growth may require additional debt or equity capital.
• Product and installation backlog was reported as $16.6 million at year-end, versus $15.6 million in the Business section and $15.7 million in MD&A and the risk discussion. Backlog excludes maintenance and energy-contract revenue and may change with customer financing, permitting or project-specification delays.
• After year-end, Tecogen completed energy-system and contract sales for approximately $5 million in March 2019; it had also agreed to a $2 million transaction in December 2018, finalized after year-end. Tecogen retained billing, asset-management and operating/maintenance roles and agreed to certain minimum-collection guarantees. The filing expects additional goodwill impairment associated with the disposed income-producing assets.
• Key risks include low cash and continued operating cash burn, customer contract run-off and utility-rate sensitivity, dependence on incentives and interconnection approvals, competition, supplier concentration, long and variable sales cycles, and potential need for financing. Management identified a material weakness in IT security and user-access controls; disclosure controls and internal control over financial reporting were not effective at year-end. An ERP and control-remediation effort was in progress. The external auditor did not attest to internal-control effectiveness.
• The ADGE merger litigation was dismissed in full in November 2018. The company disclosed guarantees related to former subsidiary EuroSite Power, including approximately $202,359 of equipment-financing principal subject to a payment guarantee; management did not consider payment probable. The filing also reports potential warranty, performance and construction-delay obligations.
• The audited financial statements received an unqualified opinion. Tecogen reported a $140,600 year-end product-warranty reserve. It also held EuroSite Power securities valued at $236,167 at year-end.

Important Facts for Investors to Verify

• Reconcile the disclosed backlog comparison and determine how much of the $16.6 million is expected to convert to revenue and cash, given rising receivables and unbilled revenue.
• Review borrowing availability, collateral eligibility, interest costs and covenant headroom under the Webster facility, including the effect of the post-year-end asset sales.
• Assess the economics and remaining terms of ADGE customer contracts, contract renewals and the implications of selling systems while retaining service and collection-guarantee obligations.
• Track remediation of the disclosed material weakness and implementation of the ERP system; the filing says the auditor did not provide an internal-control attestation.
• Evaluate the assumptions behind the $4.39 million goodwill impairment and the expected further impairment following the 2019 asset dispositions.