TECOGEN INC. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Tecogen designs and sells natural-gas cogeneration and cooling systems and, following its May 18 acquisition of American DG Energy (ADGE), also sells energy through long-term customer contracts. The statements include ADGE only from the acquisition date, so reported year-over-year comparisons are not fully comparable.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $7.59 million | $5.69 million | $14.44 million | $10.76 million |
| Gross profit | $2.99 million | $2.10 million | $5.90 million | $3.82 million |
| Gross margin | 39.3% | 37.0% | 40.9% | 35.5% |
| Operating loss | $246,000 | $386,000 | $168,000 | $1.29 million |
| Net loss attributable to Tecogen | $294,000 | $416,000 | $249,000 | $1.31 million |
| Loss per share, basic and diluted | $0.01 | $0.02 | $0.01 | $0.07 |
- Q2 revenue increased 33.5%; first-half revenue rose 34.1%. Products and services drove the increase, with additional energy-production revenue of $774,000 recorded after the ADGE acquisition.
- Management attributed improved first-half Products and Services margins to production material-cost savings and product development. Energy Production margin was 57.3% for the post-acquisition period, which management said benefited from seasonality and a retroactive rate change that reduced fuel costs.
- First-half operating expenses were $6.07 million, up from $5.12 million. G&A included $119,000 of acquisition costs; the operating loss also included $243,000 of depreciation and amortization.
Liquidity, cash flow and balance sheet
- At June 30, cash and cash equivalents were $3.32 million, versus $3.72 million at year-end 2016. Working capital was $14.27 million, down from $14.44 million.
- First-half operating cash use was $892,000, improving from $1.43 million in the prior-year period. Investing activities provided $374,000, including $971,000 of cash acquired with ADGE; financing activities provided $114,000 from option exercises. Cash declined by $404,000 overall.
- Total assets were $55.59 million and total liabilities were $22.36 million. Current liabilities were $8.46 million. Debt included an $850,000 related-party loan due May 25, 2018, bearing 6% interest, and a $3.15 million senior convertible related-party note. The filing does not provide a clear value for other conventional borrowings.
- Receivables were $8.87 million, unbilled revenue $3.24 million and inventory $6.10 million. Management linked the inventory increase in part to used equipment purchased from ADGE.
Material changes, outlook and risks
- ADGE acquisition: Tecogen acquired all outstanding ADGE shares in a stock-for-stock merger on May 18, issuing 4.66 million shares valued at $18.75 million and assuming equity awards valued at about $115,000. The acquisition added contracted energy sales and 93 operational energy systems to the combined business. The purchase-price allocation remains provisional and includes $12.57 million of excess purchase cost over fair value of net assets and a $10.30 million net unfavorable contract liability.
- Reported versus pro forma results: For the first half, unaudited pro forma combined revenue was $16.58 million and net loss was $1.29 million, assuming the companies were combined from the start of 2016. These figures are informational and not indicative of actual results.
- Backlog and outlook: Product and installation backlog, excluding service contracts, was $14 million: $8 million in purchase orders and $6 million in projects with completed internal approvals, allocated financing and firm verbal commitments. Management cautioned backlog may not predict future performance. No quantified earnings or revenue guidance was provided. Management expects inventory to fluctuate with production and customer delivery needs and notes seasonal variation in heating, cooling and service demand.
- Contract economics: ADGE customer agreements generally run 10–15 years and price energy at a negotiated discount to local utility rates. Management disclosed that falling utility rates had reduced expected profitability on many acquired contracts; the related unfavorable contract liability is subject to amortization and valuation estimates. Contract expirations may reduce revenue and require Tecogen to remove equipment at its own expense.
- Controls: Management concluded disclosure controls were not effective because of material weaknesses in IT general controls and revenue-recognition controls at the recently acquired ADGE subsidiary. Remediation was planned as resources became available.
- Contingencies: A federal class action challenges merger disclosures and alleges fiduciary-duty breaches. Defendants moved to dismiss; Tecogen said it considers the suit without merit and will defend it. Claimed damages are unspecified. Tecogen also guarantees certain former ADGE subsidiary obligations, including approximately $310,000 of equipment-financing principal; management did not consider payment probable and recorded about $10,000 for the non-contingent guarantee obligation.
- Unusual item: A $224,000 unrealized loss on EuroSite Power securities reduced comprehensive income; the investment was valued using Level 3 inputs.
Important facts for investors to verify
- How ADGE’s full-period contribution, integration costs and contract profitability compare with the partial-period results reported here.
- Whether management remediates the disclosed IT and revenue-recognition control weaknesses, and whether revenue recognition or acquisition accounting estimates change.
- The terms, maturities and potential dilution associated with the related-party loan and convertible note.
- ADGE contract renewal and expiration schedules, removal obligations, and sensitivity of energy revenue and margins to utility rates, fuel costs and weather.
- Progress and outcome of the merger-related litigation, and the final valuation and segment allocation of acquisition assets and liabilities.