TECOGEN INC. — 2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017; comparative period is fiscal 2016. The financial statements received an unqualified audit opinion. The auditor did not express an opinion on internal control effectiveness.
Business context
Tecogen designs, manufactures, sells and services natural-gas-fueled combined heat and power (CHP), chiller and water-heating systems. Its Products and Services segment is complemented by Energy Production, which sells energy from systems it owns and operates under long-term customer contracts. The latter segment was added through the May 18, 2017 acquisition of American DG Energy (ADGE), so 2017 results include its operations only from May 19 onward. At year-end, the company reported 81 operational energy systems.
Financial performance and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Revenue | $33.20 million | $24.49 million |
| Gross profit / gross margin | $12.95 million / 39.0% | $9.30 million / 38.0% |
| Operating income (loss) | $225,152 | ($997,451) |
| Net income (loss) attributable to Tecogen | $47,436 | ($1.10 million) |
| Operating cash flow | ($591,256) | ($2.72 million) |
| Cash and cash equivalents at year-end | $1.67 million | $3.72 million |
Revenue grew 35.6%. Products revenue rose 21.2% to $12.99 million, services revenue rose 19.0% to $16.38 million, and ADGE contributed $3.83 million of energy-production revenue. The filing attributes improved gross margin to product efficiencies and the addition of energy production. Operating expenses increased 23.6% to $12.73 million, including higher administrative, selling and research costs. Earnings per share were $0.00 in 2017, versus a $0.06 loss in 2016.
Working capital was $12.95 million, down from $14.44 million. Operating cash use improved year over year, but cash declined primarily following the $3.15 million repayment of the Michaelson note. Investing activities provided $1.51 million, including $971,454 cash acquired with ADGE and return of Tecogen’s $2 million Ultratek investment; financing activities used $2.97 million.
Total assets were $50.67 million and total liabilities were $16.98 million at year-end. The balance sheet included $850,000 due to a related party, bearing 6% interest and due May 25, 2018, plus $52,265 related-party interest payable. The $3.15 million Michaelson convertible note was repaid and cancelled in December. Liabilities also included a $7.73 million unfavorable ADGE customer-contract liability; this is not conventional borrowing. The company signed a term sheet for a potential revolving credit facility of up to $10 million, subject to due diligence and a definitive agreement.
Material changes, outlook and risks
- Acquisition and dilution: Tecogen acquired ADGE for consideration valued at approximately $18.86 million, primarily 4.66 million newly issued Tecogen shares. The acquisition added contracted energy revenue, $13.32 million of goodwill and significant energy-system assets. Management expected synergies, but cautioned that integration benefits were not assured.
- Backlog: Product and installation backlog increased from $11.1 million to a reported $15.7 million in MD&A and risk disclosures. The Business section gives $15.6 million, so the filing contains a small discrepancy. Backlog excludes service and energy-contract revenue and may change with customer financing, permitting or project modifications.
- Cash needs: Management believed existing resources and operating cash flows would meet working-capital needs for the next 12 months, while also stating growth could require additional debt or equity financing. No binding commitment for the proposed $10 million facility was disclosed.
- Contract economics: ADGE’s acquired contracts generally price energy at a discount to local utility rates. The filing says electricity rates had fallen below levels anticipated when many contracts were signed, contributing to off-market contract terms and weaker expected profitability. Customer energy use, utility rates, weather and contract renewals can affect revenue and returns.
- Controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2017, identifying a material weakness related to limited staffing and IT security and user-access controls. A company-wide system was being implemented; remediation was not reported as complete.
- Legal and other unusual items: In litigation concerning the ADGE merger, the court dismissed federal securities claims but retained state-law fiduciary-duty claims. Damages were unspecified and an unfavorable outcome was not reasonably estimable; Tecogen said it would defend the case. Tecogen also terminated the TTcogen joint venture and dissolved the automotive-focused Ultratek venture; it recovered its $2 million investment, reacquired the Ultera license and purchased remaining assets for $400,000.
- Other risks: Management gave no quantified earnings or revenue guidance. Risks include dependence on incentives and utility interconnection rules, volatile energy-price spreads, supplier concentration, long sales cycles, product and warranty exposure, and uncertain commercialization of automotive emissions technology. Cannabis-related sales were less than 5% of 2017 revenue, but federal enforcement policy created uncertainty. The company reported no income-tax provision and maintained a full valuation allowance against deferred tax assets.
Important facts for investors to verify
- Reconcile the $15.6 million versus $15.7 million backlog disclosure and assess conversion timing, customer commitments and permitting or financing contingencies.
- Review ADGE contract-level economics, the unfavorable contract liability, and realized integration savings and segment profitability.
- Confirm repayment of the $850,000 related-party loan, availability and final terms of any revolving credit facility, and whether further financing or share issuance is required.
- Track remediation of the disclosed material weakness and assess the reliability of revenue recognition, including unbilled turnkey work and bill-and-hold sales.
- Monitor the remaining merger-related state-law litigation and the company’s guarantees of former ADGE subsidiary obligations.