TECOGEN INC. — Q3 2014 Form 10-Q
Business context and period. Tecogen designs, manufactures, installs and services natural-gas-fueled combined heat and power systems, chillers and related products. This unaudited report covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. The company reports one business segment and consolidates its 65%-owned Ilios subsidiary.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $4.18 million | $2.89 million | $12.93 million | $9.74 million |
| Gross profit / margin | $1.09 million / 26.1% | $1.09 million / 37.8% | $3.86 million / 29.9% | $3.02 million / 31.0% |
| Operating loss | $1.47 million | $1.41 million | $3.75 million | $3.53 million |
| Net loss attributable to Tecogen | $1.45 million | $1.39 million | $3.72 million | $3.34 million |
| Loss per share, basic and diluted | $0.09 | $0.11 | $0.25 | $0.25 |
Q3 revenue grew 44.3%, with product revenue up 40% and service revenue up 46%; higher installation activity drove most of the service increase. Nine-month revenue rose 32.7%, led by product growth of 38.7% and service growth of 29.2%. Despite higher sales, gross profit was nearly flat in Q3 and the gross margin fell 11.7 percentage points. Management attributed the margin pressure to older, lower-margin products and a warranty upgrade program that it said was not expected to recur. Operating expenses increased, including public-company-related general and administrative costs; the 2013 comparison also included $320,924 of aborted public offering costs.
Research and development expense was $889,240 for nine months, versus $809,746. Management cited emissions-control and InVerde product development. No income-tax benefit was recorded because tax benefits from losses were fully reserved.
Cash, liquidity and capital
- Cash and cash equivalents were $2.45 million at September 30, 2014, down from $7.71 million at December 31, 2013. A further $585,038 was held in restricted short-term investments, principally as performance-bond collateral.
- Cash used in operating activities was $3.80 million for the first nine months, versus $1.47 million in 2013. Inventory rose $1.56 million to $4.91 million, and accounts receivable rose to $4.52 million; the filing cites production needs, turnkey projects and timing of billing and collections.
- Working capital was $7.02 million, compared with $5.57 million at year-end. Management said the increase largely reflected reclassification of the $3 million convertible note from current to long-term after the resale registration statement became effective.
- The company repaid $2.95 million of related-party demand notes during the first quarter. It had a $3 million senior unsecured convertible note, bearing 4% interest and due in December 2016, convertible at $5.40 per share. The note is held by Michaelson, which the filing treats as a related party. A $3.5 million line of credit from Co-CEO John Hatsopoulos was available only upon specified events and, after conditions were met, was not expected to be drawn absent a separate event of default.
- Financing activities included $2.34 million of net proceeds from common stock and restricted stock sales. The May 2014 public offering raised approximately $3 million gross before placement-agent fees and other offering expenses.
Outlook, risks and other notable matters
- Management expected sales-volume growth and more turnkey projects to improve gross margins, but gave no quantified earnings or revenue guidance.
- Management said existing resources were expected to cover short-term working-capital needs, while warning that growth would require additional capital, including potential equity financing. Inability to raise capital could constrain growth and require reduced operating costs.
- Backlog at September 30 was reported as $14.2 million: $9.9 million in received purchase orders and $4.3 million in projects with completed internal approvals and firm verbal commitments but orders still in process. The company cautioned that backlog is not necessarily indicative of future results.
- Performance-bond exposure included a $583,073 restricted investment and a separate approximately $1.055 million letter of credit supported by the Co-CEO’s personal collateral. The bonds could be drawn if Tecogen failed to complete projects as contracted. Operating lease commitments totaled $5.00 million through 2024.
- Disclosure controls and procedures were deemed ineffective due to material weaknesses: insufficient accounting expertise for complex reporting matters and limited personnel overseeing IT general controls. No remediation changes had been made as of September 30.
- Subsequent events: Benjamin M. Locke was promoted to Co-CEO on October 29, 2014. On November 3, special committees were appointed to negotiate a possible purchase of Ilios minority interests; no terms were agreed and completion was uncertain.
Investor verification priorities
- Track operating cash burn, collections and inventory needs against the reported cash balance and the company’s stated need for future capital.
- Assess whether margins recover as older products and the warranty upgrade program roll off, and whether turnkey growth improves profitability.
- Distinguish purchase-order backlog from the $4.3 million of verbally committed projects, and monitor conversion, timing and project costs.
- Review the convertible note’s repayment, conversion and default provisions, and the conditions governing access to the related-party credit line.
- Follow remediation of the disclosed financial-reporting and IT-control material weaknesses.
- Confirm the status and terms, if any, of the proposed Ilios minority-interest acquisition and the performance-bond obligations.