urban-gro, Inc. (NASDAQ:UGRO) Q4 2022 Earnings Call Transcript

urban-gro, Inc. (NASDAQ:UGRO) Q4 2022 Earnings Call Transcript March 30, 2023

Operator: Hello, and welcome to the urban-gro 2022 Fourth Quarter Earnings Conference Call. As a brief reminder, all participants are currently in a listen-only mode. Following the presentation, there will be a question-and-answer session for those on the teleconference line. 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 call over to Dan Droller, Executive Vice President of Corporate Development and 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 Dick 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. Reconciliations of our GAAP net loss to adjusted EBITDA are available in our press release and in our Form 10-K filed with the Securities and Exchange Commission, and those can be accessed from the Investor Relations section of our website. On this call, we may state management’s intentions, beliefs, expectations or future projections.

These are forward-looking statements that 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-gro’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 filed 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 at ir.urban-grow.com. With that, I’ll now turn the call over to Brad.

Brad Nattrass: Thank you, Dan. Good afternoon, everyone, and welcome. I’ll begin today’s call by providing an update on the state of our business, including a focus on our execution, results, market conditions and vision. This will be followed by Dick reviewing our financial results in greater detail, and then we’ll open the call for your questions. 2022 was a successful year of evolution for urban-gro, punctuated by a fourth quarter performance that signals were well on our way to returning to revenue levels more aligned with our expectations, but we also remain laser-focused on getting back to positive adjusted EBITDA. Despite headwinds encountered in the cannabis sector, our team advanced our business forward by executing on our sector diversification strategy and expanding both our service capabilities and the geographies in which we operate.

During the year, we added new capabilities and expertise to our business, both organically and through the acquisition of Colorado-based Emerald Construction Management and Texas-based DVO engineering. Not only did we further strengthen our leadership team with these acquisitions, we also appointed a new COO experienced in CEA design build solutions, and we opened our first global office in the Netherlands. All of this is made possible by our unique model, which encompasses our talented team of professional experts, integrated solutions and sector diversification, altogether, differentiating us as a company that can continue to deliver growth in a turbulent environment. And this growth, the successful diversification that we underwent this past year was evident in our record signed contract backlog of $93 million at the end of 2022, representing a sequential quarterly increase of nearly 40% and more than three times the backlog that we reported at the end of 2021.

This alone speaks to the incredible progress that we’ve made in transforming this business into a fully integrated and value-added engineering, procurement and construction company. To put even more emphasis on what this record backlog needs for urban-gro, it’s over three times as large as our company’s market capitalization, a sign that we have a bright future ahead of us within all of the sectors that we serve. We’re unmatched in terms of our capabilities applicable to clients within the indoor CEA industry and our single point of accountability that we provide to all of our clients, both CEA and commercial is proving to be an extremely valuable point of differentiation. The backlog we reported today, which is made up of nearly 90% construction design build strongly suggest that others are taking notice of this and seeking us out of their trusted and preferred solutions provider.

We remain in growth mode and are focused on scaling up our business as quickly and as efficiently as possible. Briefly touching on our results. We posted revenues of $17.3 million for the fourth quarter and $67 million for the full year 2022. While I’m pleased that we exceeded our fourth quarter revenue guidance, these results still don’t accurately reflect the full growth potential of our comprehensive business model, which truly is being obscured by the pullback in cannabis CapEx equipment spending. The driving force behind our ability to achieve this revenue performance of amid this softener lies in the business decisions made over the last 2 years to position our company as a diversified solutions provider, and the success is represented by the numbers.

In the fourth quarter, construction design build revenue increased by $11.5 million, and professional services revenue increased by $0.3 million year-over-year, with both increases being driven by the synergies we’re creating with our strategic acquisition. While our focus on diversification began to have a material impact near the end of the year, this growth was unfortunately offset by a $13.3 million year-over-year decrease in cultivation equipment revenue. Adjusted EBITDA for the fourth quarter was negative $1.66 million, generally in line with our guidance of approximately negative $1.5 million. This represents our continued investment in both the scaling of our team to service our strong backlog entering 2023 and further in our European operations and the capabilities that we now bring to the market in that region.

For the full year 2022 adjusted EBITDA was negative $3.9 million. As it pertains to our balance sheet and ensuring that we remain in a strong and agile position, we head into 2023 with approximately $12 million of cash and no bank debt. The decrease in cash of $6.6 million is primarily attributed to the adjusted EBITDA loss in the quarter, cash payments associated with the onetime business development expense reported in the third quarter and cash used to acquire DVO Engineering. Moving on, I’ll now shift to updating on our most recent acquisition, current sector trends that we’re seeing and our outlook for 2023. Following the November 2022 close of the DVO Engineering acquisition, the integration of our full end-to-end engineering capabilities is proceeding nicely.

This accretive and synergistic transaction has increased our professional services revenues and margins. And as anticipated, is further providing cross-selling opportunities to existing clients and contracts. The demand for our professional services and turnkey design build solution remains strong, continues to increase rapidly as evidenced by our backlog. Moving to current sector trends. The commercial or non-CEA sector continues to bridge the short-term gap led by continued softness in the cannabis sector, and we have a pipeline of projects that are strong, qualified and growing by the week In fact, we are not only signing a single project contracts with our clients, but in some instances, we’re signing long-term master services agreements as well, which will bring repeat project opportunities to the company in the future.

Supporting the strength of our go-to-market strategy with a single point of accountability across all aspects of our clients’ projects, in the fourth quarter, we signed over $30 million of new design-build contracts, all with financially strong clients. In the CEA sector, while we continue to see increasing demand in signed contracts with a variety of produce focused clients, mostly tied to engineering services work, challenges do continue for our cannabis-focused clients. For urban-gro, the impact of the cannabis sector weakness is very transparent to address. There are approximately 9 key states that have approved the legalization of cannabis. However, the award of the licenses has been tied up with regulatory delays. Diving deeper, we absolutely remain busy in these states and have signed and continue to sign engineering, architecture and design contracts.

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But after the documents are complete, the projects are essentially pausing until there is an official license award by the state. When their licenses are eventually awarded, we do expect a large proportion of our clients to move forward and sign design build contracts and subsequently equipment contracts 3 to 6 months after. This model and assumption has proven to be accurate in the state of New Jersey. When licenses were awarded, key clients began moving forward. Notably, in December, the first of our clients move forward and urban-gro secured a $20 million design build contract. The project kicked off later in the first quarter this year, and we’re working diligently to bring our clients’ vision to life and have them operational by year-end.

So it’s not a matter of if it’s simply a matter of when. And until these regulatory delays are worked out, we expect our clients’ capital expenditures to remain soft. This being said, outside of cultivation, it’s important to note that our clients continue to expand their retail presence. And in response to client demand, in the fourth quarter, we expanded our offering to also include retail dispensaries. This has proven successful as in the last 6 months we’ve been engaged to work on more than a dozen dispensaries across the country, some of which were also for full design build contracts. Finally, regarding our ongoing investment into the European CEA market, while demand from produce focused clients remain suppressed due to the impact of drastically higher energy prices, we’ve been excited by the forward momentum in the cannabis sector and the design contracts signed as a result.

Further and most exciting is the market development in Germany with adult use legalization and the pending requirements to supply the market with cannabis growing in country. Although we’re still a few quarters from generating positive cash flow in our European entity, this progress gives me great confidence that the investments we’re making in the business are positioning urban-gro for sustainable and consistent global growth over the long term. Now I’ll provide our full year outlook and associated cadence. For the full year 2023, we anticipate consolidated revenues to be within a range of $100 million to $120 million. And we expect adjusted EBITDA to be within a range of negative $3 million to slightly positive. Our clients want to work with us.

They recognize the value urban-gro is bringing to the industry to meet their needs and they’re signing contracts. But it’s important to note that today’s uncertain economic environment could potentially impact project timing. As it specifically relates to the weakness in CapEx spending in the cannabis sector, we anticipate positive sector expansion will resume later in the second half of 2023. I’d like to emphasize that achieving positive adjusted EBITDA is our primary near-term corporate priority, but this is also balanced against our needs to continue supporting the growth of our business, evidenced by our expanding backlog. We remain good stewards of our balance sheet, and we’ll continue to invest in the business in ways that we expect will reward our shareholders.

To help inform your modeling, we’re also providing some additional color on our near-term expectations and the cadence for the year. For the first quarter of 2023, we expect revenue dollars to come in slightly below that of the fourth quarter of 2022 due to the delayed kickoff of two key design build projects that ultimately began in March. By virtue of this lower revenue, we expect first quarter adjusted EBITDA to also be below that of the fourth quarter 2022. That said, as we look at the quarterly cadence for the year and the strength and timing of our backlog, we expect to deliver sequential quarterly growth beginning in the second quarter through the balance of 2023, both in terms of revenue and adjusted EBITDA in order to meet our full year guidance that we’re introducing today.

In closing, as we look more broadly to 2023, we are focused on continuing to scale and integrate our operations to service the increased demand that is reflected in our record $93 million backlog. We continue to see strong momentum in our design build and professional service solutions across all sectors. And although early, we do anticipate a recovery in the cannabis sector later this year and a corresponding increase in our equipment sales as well. Today, we’re a stronger, more durable and more diverse company than we’ve ever been. And we remain committed to driving efficiencies in our model, leveraging our professional services to our diverse client base and optimizing the targeted investments we continue to make in the business, all centered on returning to positive adjusted EBITDA as soon as possible.

Thank you. And with that, I’ll now turn the call over to Dick.

Richard Akright: Thanks, Brad. Revenue was $17.3 million in the fourth quarter of 2022 compared to $19 million in the prior year period. This decrease was driven by a decrease in equipment systems revenue of $13.3 million, primarily reflecting significantly reduced equipment demand in the U.S. cannabis market because of ongoing state-level regulatory delays in the license awarding process, as well as the lack of movement of key industry financial support models such as the SAFE Banking Act. This decrease was partially offset by the accretive acquisition of Emerald Construction Management in April in ’22 with an $11.5 million increase in construction design build revenue, as well as incremental professional services revenue of $0.3 million associated with the acquisition of DVO in November of 2022.

Gross profit was $3.2 million or 19% of revenue in the fourth quarter of 2022 compared to $4.9 million or 26% of revenue in the prior year period. This represents a decrease of $1.7 million, correlating to the decrease in revenue. The decrease in gross profit margin was driven by the lower margin construction design build revenue from the Emerald acquisition. Operating expenses were $6.2 million in the fourth quarter of 2022 compared to $5.6 million in the prior year period, representing an increase of $0.6 million. The increase in operating expenses was driven by increased headcount related to the acquisitions of Emerald and DVO in 2022 and in support of our future growth. Non-operating expenses were $1.3 million in the fourth quarter of 2022 and included an impairment loss of $1 million related to settlement of a litigation receivable and $0.4 million in expenses recognized from fully guaranteeing the remaining contingent consideration associated with the 2WR acquisition.

Net loss was $4.2 million or a negative $0.39 per diluted share in the fourth quarter of 2022 as compared to net loss of $0.6 million or negative $0.06 per diluted share in the prior year period. Adjusted EBITDA was negative $1.66 million in the fourth quarter of 2022 compared to positive $0.5 million in the prior year period. The decrease in adjusted EBITDA was driven by lower revenues and gross profit as well as strategic investments and operating expenses to drive growth. On a full year basis, we reported total revenue of $67 million compared to $62.1 million in the prior year, representing an increase of 7.9%. This increase in revenue was driven by the acquisitions of Emerald and DVO in 2022 and 2WR in 2021. Construction design build revenues and increased services revenues from these acquisitions were offset by decreased equipment systems revenues related to reduced equipment demand in the U.S. cannabis market.

Gross profit was $14.2 million or 21% of revenue compared to $14.8 million or 24% of revenue in the prior year. This decrease in gross profit dollars and margin was the result of changes in the overall revenue mix. Operating expenses were $26.8 million as compared to $15 million in the prior year. Operating expenses in 2022 included a $3.3 million onetime business development expense related to satisfying a lighting issue encountered by a major customer. Remaining increases in operating expenses were driven by increased headcount associated with the acquisitions of 2WR, Emerald and DVO, expansion into Europe and preparing for our planned future growth. Non-operating expenses were $3 million compared to $1 million in the prior year and include impairment losses of $2.7 million.

Net loss was $15.3 million compared to a net loss of $0.9 million and adjusted EBITDA was negative $3.9 million compared to positive $2.7 million in the prior year comparable period. Now turning to our balance sheet. Our capital structure remains in excellent condition. We entered 2023 with $12 million of cash on our balance sheet and no bank debt, which provides us the necessary flexibility to manage through the macroeconomic market circumstances while simultaneously fueling our growth strategy. Moving to reported backlog. Our total backlog as of December 31, 2022, was approximately $93 million and is up from the $67 million that we reported at the end of the third quarter of 2022. This backlog is comprised of $82 million in construction design build, $6 million of professional services and $5 million of equipment systems contracts.

While there are several variables that influence the change in backlog, the two primary factors are signed orders and revenue recognized from signed orders during a stipulated period. Because our backlog relates to capital expenditure commitments made by our customers, the dollar amount of signed customer orders in individual periods can fluctuate materially. Revenue recognition is then dependent on delivery of these orders. That concludes our prepared remarks. Operator, please open the call for questions.

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Q&A Session

Operator: Thank you. At this time, we’ll be conducting a question-and-answer session. Our first question comes from Eric Des Lauriers with Craig-Hallum Capital Group. Please proceed with your question.

Eric Des Lauriers: My first one is on the commercial side of your business. I was just wondering if you could provide a bit more color on some of the trends that you’re seeing there. And if you’re able to help us quantify how much of the guide or backlog is commercial projects versus CEA? Thank you.

Brad Nattrass: Thanks, Eric. Yes, for sure. As I had talked about on the last quarterly call, the strength of our balance sheet gave us the opportunity to increase the number of contracts, also the size of contracts that Emerald Construction was executing with these commercial clients. And that continues to be the trend. I mentioned in the call that we’re signing new contracts weekly. And these are varying in size from – there may be a minimum of $1 million to a maximum size right now of a little over $10 million. And when you look at the total backlog of $93 million at the end of the year, about 80% of that is CEA and about 20% of that is commercial. And as we proceed into the year, I would estimate that by the end of ’23, about two thirds of our business will be in CEA and about a third will be in the commercial segment.

Eric Des Lauriers: Okay. Great. That’s very helpful. And then with regards to the cannabis rebound that you’re expecting in the second half, could you just provide a bit more color on that, perhaps help us understand the visibility that you have into such a rebound? I know you mentioned New Jersey as an example of some of these projects that may have been delayed a bit and that perhaps you might have seen a conversion from design build into some equipment sales. Just kind of help us understand what visibility you have into the rebound in cannabis-related revenues in the second half? Thank you.

Brad Nattrass: Okay. Thanks, Eric. Our business in the cannabis segment remains predominantly east of the Mississippi. And when I talk about a rebound in the sector, it’s all about the regulatory issues that some of these states are in the middle of and in turn, delaying the award of licenses to our clients, that part opening up. So in New Jersey, they worked through the awarded licenses and the clients that we have been working with on architecture and design, they then were able to access their funding when they were awarded a license and they move forward and signed a design build contract with urban-gro. As it relates to sales, your equipment sales, you’re absolutely right, Eric, in the design build model about 3 to 6 months in the clients who are at the juncture where they’ll make a decision on the equipment for the entire facility, whether it’s mechanical, that will be typically the first because it’s the longest lead time.

But then benching, lighting, air environmental controls. And we would have been working with those clients for a couple of quarters before that, providing them with a variety of options and have worked with them to choose a holistic solution for that facility depending on their budget. That continues to – to be the trend as well with the groups before we sign the design build contract. So looking now at the other states that are working through the regulatory issues, Alabama, Georgia, Missouri, even Florida, working through awarding additional licenses, clients in those centers, we’re working with them. There’s probably a couple of dozen clients amongst those states. And when those licenses are awarded, we’re very confident based upon the service levels that we’ve provided that we will be able to move to that design build state.

So as we progress through 2023, at our quarterly calls, we’ll be excited to share a lot more design build successes, and it will be evidenced by a continued growth in our backlog that we report each quarter.

Eric Des Lauriers: Okay, great. Appreciate the color. Thank you.