TECOGEN INC. — Q3 2016 Form 10-Q
Business and period: Tecogen designs, manufactures, sells and services natural-gas-fueled combined heat and power and chiller systems. This unaudited report covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are to December 31, 2015.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $6.62m | $4.68m | $17.38m | $17.16m |
| Gross profit / margin | $2.77m / 41.9% | $1.67m / 35.7% | $6.60m / 38.0% | $6.03m / 35.2% |
| Operating income (loss) | $249,493 | ($923,745) | ($1.04m) | ($1.86m) |
| Net income (loss) attributable to Tecogen | $207,868 | ($948,842) | ($1.10m) | ($1.93m) |
| Basic and diluted EPS | $0.01 | ($0.06) | ($0.06) | ($0.12) |
| Cash used in operating activities | Not reported by quarter | ($2.91m) | ($3.35m) |
Revenue mix: Q3 product revenue was $2.85m and service revenue was $3.77m. Nine-month product revenue was $7.53m and service revenue was $9.85m.
Liquidity and debt: At September 30, cash was $3.50m, working capital was $14.26m and current assets/current liabilities were $19.50m/$5.24m. Cash declined $1.98m from year-end. Total liabilities were $8.81m, including a $3.14m related-party senior convertible note (net of debt issuance costs); the note bears 4% interest and matures December 28, 2018, subject to its conversion and other terms. The company had not borrowed under its separate $2m related-party credit facility.
Changes and operating developments
- Q3 revenue increased 41.5% year over year, driven by higher cogeneration sales and installation and service-contract revenue. Nine-month revenue rose 1.3%: service revenue increased 17.0%, while product revenue declined 13.9%, primarily because of lower cogeneration sales.
- Gross margin improved in both comparison periods. Management attributed the improvement to product upgrades and improvements; Q3 operating income turned positive, though the company remained loss-making for the first nine months.
- Operating cash use improved year over year, but receivables increased by $2.66m and were a significant use of operating cash. Investing cash use included $2.0m invested in Ultra Emissions Technologies Limited (UET).
- Tecogen acquired the remaining Ilios shares in May through an exchange of 670,464 Tecogen shares and merged Ilios into the company. The noncontrolling interest was eliminated.
- In August, Tecogen invested $2.0m in UET by exercising warrants. Following UET’s additional capital raise, Tecogen’s ownership was 43%; the investment is accounted for under the equity method. The filing says Tecogen had not recorded UET income or losses as of September 30 under the agreed return-of-investment arrangement.
- A separate 50/50 joint venture with Tedom was formed to market a broader range of CHP products in the United States. It is accounted for under the equity method.
Outlook, risks and unusual items
- Management expected sales-volume growth to maintain or further improve gross margins, citing product improvements and lower-margin quarters rolling out of the trailing results. No quantified revenue, earnings or cash-flow guidance was provided.
- Product and installation backlog, excluding service contracts, was $12m: $4m of purchase orders and $8m of projects with completed customer approval and allocated funding but only a firm verbal commitment. The company cautioned that backlog may not predict future performance and its presentation may differ from industry peers.
- Management noted seasonal patterns in heating, cooling and service demand. It also identified future cash requirements, supplier expectations and potential financing as forward-looking matters; actual results may differ, and the filing directs readers to its risk factors.
- Turnkey projects are accounted for using percentage of completion. The company recorded an approximately $164,000 expected contract loss during the first nine months of 2016, versus none in the comparable 2015 period. Bill-and-hold revenue was $1.55m for the period reported in the note; the note does not clearly specify whether this amount is quarterly or year-to-date.
- On November 1, 2016, after the reporting period, Tecogen agreed to merge with American DG Energy, subject to customary conditions including approval by both companies’ stockholders. Each American DG share would convert into approximately 0.092 Tecogen shares. Completion was not assured.
- Disclosure controls were deemed ineffective due to material weaknesses: insufficient accounting expertise for complex reporting and limited personnel overseeing IT general controls and user access. The company reported no remediation changes during the quarter and said it planned to address the weaknesses as resources became available.
Investor verification points
- Assess whether the margin improvement and Q3 profitability are sustainable, given the nine-month operating and net losses.
- Monitor receivables, collections and operating cash burn, and compare reported backlog with orders actually received and revenue recognized.
- Review the convertible note’s related-party terms, conversion/dilution potential and maturity, along with the company’s future financing needs.
- Verify UET’s funding, commercialization progress, ownership and equity-method accounting, and the economics and performance of the Tedom venture.
- Track American DG merger approvals, final terms and completion conditions.
- Follow remediation of the disclosed material weaknesses and the company’s assessment of disclosure controls.