urban-gro, Inc. (NASDAQ:UGRO) Q3 2023 Earnings Call Transcript

urban-gro, Inc. (NASDAQ:UGRO) Q3 2023 Earnings Call Transcript November 12, 2023

Operator: Hello, and welcome to the Urban-gro, 2023 Third Quarter Earnings Conference Call. As a brief reminder, all participants are currently in a listen-only-mode. [Operator Instructions] Please note that this conference call is being recorded, and a replay will be made available on the company’s website following the end of the call. At this time, I’d like to turn the conference over to Dan Droller, Investor Relations at Urban-gro. Sir, please go ahead.

Dan Droller: Good afternoon, and thank you for joining us. Today’s call will be led by Brad Nattrass, Chairman and Chief Executive Officer; and Richard Akright, Chief Financial Officer. I’d like to remind our listeners that remarks made during this call will include discussion of non-GAAP metrics, including adjusted EBITDA and backlog. These items should not be utilized as a substitute for Urban-gro’s financial results prepared in accordance with GAAP. A Reconciliations of our GAAP net loss to adjusted EBITDA are available in our press release and in our Form 10-Q filed with the Securities and Exchange Commission and can be accessed from the Investor Relations section of our website at ir.urban-gro.com. On this call, we may state management’s intentions, beliefs, expectations or future projections.

A landscape architect reviewing a blueprint of a landscaping project.

These are forward-looking statements and involve risks and uncertainties. Forward-looking statements on this call are made pursuant to the safe harbor provisions of the federal securities laws and are based on Urban Growth’s current expectations. Actual results could differ materially. As a result, you should not place undue reliance on any forward-looking statements. Some of the factors that could cause actual results to differ materially from these contemplated by such forward-looking statements are discussed in the periodic reports Urban-gro files with the Securities and Exchange Commission. These documents are available in the Investors section of the company’s website and on the Securities and Exchange Commission’s website. We do encourage you to review these documents carefully.

Lastly, a copy of our earnings press release and a webcast replay for today’s call may be found on the Investor Relations section of our website, which again is at ir.urban-gro.com. With that, I’ll now turn the call over to Brad.

Brad Nattrass: Thank you, Dan. Good afternoon, everyone, and thank you for joining us today. Slightly over a year ago, we launched the diversification initiative, focused upon leveraging our professional services tend to efficiently seek and build out additional revenue streams for the company. I’m excited to report that we continue to execute and gain momentum on this strategy as Urban-gro has evolved into a multi-sector focused professional services consulting firm. With more than 140 architects, interior designers, engineers, construction managers, project managers, horticulturists and others on our team. We have successfully expanded our operating focus beyond our core controlled environment ag practice to include clients across multiple centers, including industrial, commercial, hospitality, recreation, education and health care.

In regards to our third quarter performance and consistent with expectations, we marked another sequential improvement in both revenues and adjusted EBITDA. Revenue of $20.9 million, a sequential improvement of $2.1 million or 11% came very close to exceeding our all-time quarterly high of $21.1 million reached in Q1 ’22. The adjusted EBITDA loss was $1.3 million, a sequential improvement of $0.7 million. And while our significant revenues this quarter resulted in retiring 27% of our Q3 beginning backlog, we signed enough new contracts to drive our backlog entering the fourth quarter to $84 million, a 6% sequential increase. Despite the ongoing headwinds within the CEA sectors, our diversification strategy has served as a source of strength to the company.

Our team is now more efficiently adapting to the shifting environment and we continue to focus on optimizing the productivity of our professional services employees as we work towards a period of more marked revenue acceleration. Although we made some difficult decisions to right-size our staff earlier in the first half of the year, we feel comfortable at current levels given the demand that we see. Now turning to current sector trends. Sector diversification is most definitely assisted in insulating our business from the broader weakness that the cannabis and vertical farming segments are working through. Although the CEA sector remains an important component of our future growth, our success is no longer fully dependent on its success. We’ve evolved into and are now regarded by our clients as a professional services consulting company that offers turnkey design, build and equipment integration solutions to multiple markets.

Consistent with the second quarter, more than two-thirds of our revenue this quarter was generating in the sectors outside of CEA and included a combination of new projects with both existing and new clients and continues to include top-tier companies and some Fortune 50 clients as well. In the CEA sector, our equipment revenues continue to be compressed by the weak cannabis market. During the first nine months of ’23, we have experienced a period-over-period decline of more than $20 million of 18% margin business. While it’s impossible to ignore the negative impact that this has had on our financial performance. Our diversification has enabled us to keep our experienced team strong and intact. And as a result, we remain well positioned in the sector, and we’ll be ready to handle the surge in demand when the cannabis market rebounds.

This being said, in the interim, we’re still seeing steady activity and are expecting to continue to sign design-build contracts in a variety of states. For Urban-gro today and apart from our cannabis clients lacking access to much needed capital, the primary block to more rapidly increasing our business in this market is one that we cannot control. However, it’s also one that will continue to slowly dissipate. There are a number of legalized states, like New York, Alabama and Georgia, among others, for example, that have paused the awarding of licenses due to regulatory and legal delays within their state. We have a significant number of clients with projects in these states, some of which have already completed design, but we’re confident the move forward of the construction build stage where these delays are resolved and licenses are received.

This is evidenced in the third period where we had two such clients move forward to construction, and we’ll continue to announce these successes as contracts are signed. As it relates to our European entity, the size and quality of the company’s European pipeline is the strongest it’s been since opening the entity since June of ’22. While the cannabis markets abroad continue to show green shoots in multiple countries, our European business will still take time to sustainably scale its operations. I was in Europe last week, meeting with both clients and the team, and I can assure you that they remain diligently focused on driving strong returns. Now shifting to our guidance through the fourth quarter ’23, demonstrating our ongoing commitment to deliver sequential growth on both the top and bottom line, we anticipate revenues to be approximately $30 million, which I’d add would be a new record for us by more than 40%, and we expect to realize breakeven to slightly positive adjusted EBITDA, which would mark an important shift back to positive cash flow and subsequently meeting our goal that we’ve been working hard to achieve this past year.

In closing, the company continues to remain closely in line with the interest of our shareholders. In addition to the open market equity purchases made by myself and other directors in the second and third quarters, totaling about 1.5% of shares outstanding. My leadership team demonstrated their commitment as well, led with a 50% commitment for myself, each Executive Vice President and Officer of the company voluntarily opted to take a stock brand in lieu of up to 50% of their base salary during the third quarter. The key takeaways here. First, our Board as well as our leadership team and their teams continue to strongly believe in the future of the company. Second, our diversification strategy is working. It continues to gain momentum, and we have alignment on our goals across our organization.

And third, we’re doing everything in our power to maintain this positive momentum. Thank you. And with that, I will now turn the call over to Dick.

Dick Akright: Thanks, Brad. In the third quarter of 2023, we generated revenue of $20.9 million, which represents a sequential improvement of $2.1 million or 11% over the $18.8 million of revenue generated in the second quarter of 2023 and an $8.6 million or 69% improvement over the $12.4 million of revenue generated in the prior year period. The increase in revenue over the prior year period was driven by a $9.4 million increase in organic growth of construction design build revenue, reflecting increases in the number of projects and average size of projects that we are working on in sectors outside of CEA. This increase was offset by a decrease in equipment systems revenue, which, as Brad discussed earlier, we attribute to the ongoing softness in the cannabis sector.

Gross profit was $2.9 million or 14% of revenue in the third quarter of 2023 compared to $2.9 million or 15% of revenue in the second quarter of 2023 and $2.6 million or 21% of revenue in the prior year period. The decrease in gross profit margin for both of these comparative periods was driven by the impact of revenue mix where we experienced a substantial increase in lower margin construction design build revenue as well as a decrease in higher-margin equipment systems revenue. Operating expenses were $6 million in the third quarter of 2023, which, on a sequential basis, is a decrease of $0.8 million. Operating expenses in the third quarter of 2023 are $3.5 million less than operating expenses of $9.5 million in the third quarter of 2022.

The prior year quarter included a onetime business development expense of $3.3 million. But even excluding this one-time expense, operating expenses decreased $0.2 million on a year-over-year basis. Both of these decreases are associated with the company’s expense optimization and resource reallocation initiative. Net operating expenses were $0.3 million in the third quarter of 2023 compared to nonoperating expenses of $1.8 million in the prior year quarter. Net loss was $3.4 million or a negative $0.29 per diluted share in the current quarter compared to a net loss of $8.7 million or a negative $0.081 per diluted share in the prior year period. Adjusted EBITDA improved by $0.7 million sequentially to negative $1.3 million in the third quarter of 2023, which is an improvement of $1.0 million compared to the prior year period.

The sequential improvement in our adjusted EBITDA was driven by lower operating expenses, as previously discussed. For the first nine months of 2023, we reported total revenue of $56.5 million compared to $49.7 million in the first nine months of 2022, representing an increase of $6.8 million or 14%. Net loss was $14.0 million compared to a net loss of $11.1 million, and adjusted EBITDA was negative $6.8 million compared to negative $2.2 million in the prior year comparable period. This decrease in adjusted EBITDA was predominantly due to the combined impact of an increase in general and administrative expenses of $3.2 million and a reduction in gross profit of $2.4 million. Turning to our balance sheet. We ended the third quarter with $4.8 million of cash and no bank debt.

To support the strong performance of our construction operations, subsequent to September 30, we entered into a nondilutive asset-based lending facility in order to better manage our working capital. To date, the facility remains undrawn. Our total backlog as of September 30, 2023, was approximately $84 million, reflecting an increase of $5 million or 6% on a sequential basis and $17 million or 25% versus the prior year. This backlog is comprised of $77 million in construction design build, $5 million of professional services and $2 million of equipment systems contracts, and we continue to be encouraged by the increasing number of sectors that make up our backlog. As communicated on past calls, our backlog remains a realistic and trusted indication of our future business.

Supported by our increasing backlog and pipeline, we remain confident that our cash position, combined with our asset-based nondilutive lending facility, will provide us the necessary flexibility to manage through the macroeconomic market circumstances. We continue to remain focused on our execution and returning to positive adjusted EBITDA. That concludes our prepared remarks. Operator, please open the call for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question is coming from Eric Des Lauriers of Craig-Hallum. Please go ahead.

Eric Des Lauriers: Great. Thank you for taking my questions. First one is on the nondilutive asset-backed facility. Certainly, great to hear that you guys get some added balance sheet flexibility here. Could you just provide some more details on whether that’s the overall size of the facility? What assets is this backed by? Just any more detail you can provide on that facility would be great.

Brad Nattrass: Thanks, Eric. Dick, do you want to take that, please?

Dick Akright: Sure. Eric, yes, it’s a facility really backed by the receivables and primarily backed by the construction receivables. We’ve seen a large increase in that asset base for us as that construction operations sector has really grown for us. The facility we entered into is for up to $8 million lending on that. And then like I said, it’s really based on receivables based.

Eric Des Lauriers: And then is that a revolving facility? Were you able to sort of pay that down as needed or, yes.

Dick Akright: Yes. It’s not a term facility. So it is a kind of borrow as-needed basis from the standpoint of what we do under that facility. So we’ll only incur interest as we have borrowing against that.

Brad Nattrass: All right. We look at it to support the growth expected here in the quarters ahead.

Eric Des Lauriers: Yes, that’s great to hear. And again, great to see that added flexibility. My next question is on G&A. It’s very nice to see these costs coming down here. Obviously, you guys are doing a good job kind of keeping a lid on that. I understood there’s some deferrals to stock-based compensation over cash. How should we think of that G&A line, maybe excluding stock-based comp going forward, whether that’s just kind of Q4 or sort of into 2024? As the business does ramp going forward, is this something that we should see? Should we see G&A sort of going up commensurate with revenues or with gross profit? Or are these sort of more permanent cost cuts that you’ve done? I guess if you could just provide some more color on some of the cost cuts that you’ve made so far and how to think of those going forward?

Brad Nattrass: Thanks, Eric. I’ll start, Dick, then I’ll turn it to you for the detail. As I’ve communicated on past calls, Eric, we are and acknowledge we’re top end loaded. When we made the acquisitions, we moved the leaders of those companies into senior EVP roles within the company. One of the reasons we made the acquisitions we did was to hire that specific skill set or talent. And so as we grow, as we start to deliver $30 million, $50 million-plus quarters, we do not anticipate needing to add any more senior management, EVP or hire. So it will be a nice evolution into the future. We didn’t want to cut into the muscle when we cut earlier this year. So it was a sacrifice that we’re willing to make in order to maintain the brain power for future quarters. Dick, do you want to jump in on the detail.

Dick Akright: Yes. And I’d add to that, Eric, and this kind of goes to our adjusted EBITDA reconciliation. So in the current year, one of the items that we have included in G&A that we’ve talked about before is because of the growth we were seeing, we felt it necessary to put in a retention incentive program for 2023. That will not be in place going forward. That’s going to be a reduction for us going into 2024. But to kind of reiterate with what Brad said, we really feel that with the staffing we have right now, we can handle much more revenue than we have in place today on a quarterly basis. We’re seeing the number of jobs, the jobs that we have of a much larger size dollar amount, and we’re able to handle that without really increasing the number of staffing that we have. So even though the G&A will go up some, it won’t be anywhere near proportionate to the growth in the revenue we’re going to see.

Eric Des Lauriers: All right. It’s great to hear. Thank you for taking my questions.

Dick Akright: Thank you.

Operator: Thank you. The next question is coming from Brian Wright of ROTH Capital Partners. Please go ahead

Brian Wright: Thanks. Good afternoon. I wanted to dive a little bit temper on that G&A reduction in place. I can tell you because like for the quarter, there were some deferrals where people were buying stock in either regular salary. So I’m seeing in the fourth quarter that refers unless that’s being extended. So I just wondered that like for that line, I kind of understand what’s the incremental increase in the quarter in the fourth quarter?

Brad Nattrass: Yes, Brian. As you’ve indicated, there was a reflective reduction in G&A because of that salary option taken as stock by people. There was a little bit of it in Q2. It was primarily in Q3 so that does mean we’re going to see a little bit of an increase in G&A in the fourth quarter. I mean, just to kind of clarify, we’re not talking millions of dollars here or anything because of what people did. The total was right around $200,000 in terms of what people took as a reduction of their salary and stock instead. So there is going to be an increase in G&A related to that, but we’re also going to see some other savings taking place in the fourth quarter to basically keep our G&A, although as projected right now slightly over where Q3 is not significantly over where Q3 is.

Brian Wright: Great. Thank you so much for the additional color on that. I just — maybe the key out, but I just haven’t seen it yet. And so we wanted to think about just like end markets as far as the backlog and where the end market, how you would kind of allocate the backlog from tremendous end market perspective between however you want to do a health care versus CEA versus, you name it, but just some insights on to how to think about the industries of the backlog.

Dick Akright: Sure, Brian. Brian, whereas our quarterly revenues more than two-thirds were non-CEA. Our backlog still are the majority of it, more than two-thirds is in the controlled and farming space. We anticipate growth on both sides. But on the non-CEA side, these contracts are typically shorter in length. And when they sign, they immediately want us to start executing whether it’s design or on the construction side. The CEA contract, especially now is we’re focused on the projects that we are signing, they’re larger and they’re more extensive with design and build. Those can spread out over six quarters, sometimes even as long as eight quarters.

Brian Wright: Great. Thank you for that color. I’m kind of like torn because I choose your commentary about the $30 million in quarterly revenue and even $50 million optionality to get into those levels. So I’m assuming you see things that we don’t see, right, as far as kind of that optimism. But then if I choose to that’s great on the positive side. But then if I look at just like that ramp sequentially third quarter from the little $21 million up to the around $30 million for the fourth quarter. So is there like, how can we get comfort with that kind of ramp in the fourth quarter?