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UGRO Urban-gro

Participants
Bradley Nattrass Chairman and Chief Executive Officer
Dick Akright Chief Financial Officer
Michael Layman Emerald Shoals
Alan Brochstein New Cannabis Ventures
Colin Ferrian MJResearch
Call transcript
Operator

Hello and welcome to the urban-gro Fiscal Year 2021 First Quarter Earnings Conference Call. [Operator Instructions] Note that this conference call is being recorded at the company’s request and will be made available on the company’s website following the end of the call. At this time, I’d like to remind our listeners that remarks made during this call may state management’s intentions, beliefs, expectations or future projections. 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-gro’s current expectations and 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 on 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 encourage you to review these documents carefully. I would now like to turn the call over to Mr. Bradley Nattrass, Chairman and CEO of urban-gro. Mr. Nattrass, please proceed.

Bradley Nattrass

Thank you, Jessie and good afternoon and good evening to those on the east coast. We appreciate you joining us and we are honored to again have so much growing interest in urban-gro. I am excited to speak with you today and also answer questions about our progress in Q1 as we continue to deliver strong results and execute on our strategic plan. My name is Bradley Nattrass, I am the Co-Founder, Chairman and CEO of urban-gro. And joining me on the call today is our Chief Financial Officer, Dick Akright, who you will hear from a little later.

For those new to the story, urban-gro is a global horticulture company that engineers, designs and integrates complex environmental equipment systems into controlled environment ag facilities. Further for operating facilities, we offer a managed services platform that leverages our expertise and provides our clients with a suite of service solutions focused on increasing crop yields, preventing downtime and driving business continuity.

We are based in Lafayette, Colorado and in our eighth year, we have 49 employees. Of which approximately two-thirds are what we refer to as experts, professional engineers, mechanical, plumbing, agricultural, controls engineers, masters plant science, horticulturist and environmental scientists, overall, a group of individuals who have a strong history of growing multiple crop types. It’s the skill set and the expertise acquired from working on more than 300 controlled environment ag facilities that sets us apart and provides a competitive advantage. From our clients perspective, it’s our willingness to solve the toughest issues that they face that attracts them to urban-gro, whether it be an underspecified mechanical system that needs to be optimized by our mechanical engineers in order to properly keep the environment controlled or an acquisition situation, the need for the acquirer to efficiently integrate the facilities of the company that are acquiring through our energy and to shore the optimization audit or perhaps a severe pest outbreak that requires our plant scientists to travel out and not only solve the issue, but then design an integrated pest management program to proactively prevent further outbreaks. It’s this dedication to working side by side with our clients that allows us to maintain current relationships, attract new business and is driving our continued revenue and market share growth.

As you can see from our release this evening, we continue to deliver results our momentum from the second half of last year has continued to strengthen in Q1 and it further validates the strength of our team and our ability to execute.

For the third consecutive quarter, we again achieved record quarterly revenues positive adjusted EBITDA and backlog which as a reminder is signed contracts have not shipped yet. Further and for the first time we also had positive income from operations in Q1.

Moving forward in ‘21, we are in a position of strength as we execute on marketing opportunities in both controlled environment ag markets cannabis and food. After primarily working in the legalized cannabis space since our inception, our acquired massive knowledge from working around the most valuable crop in the world has given us a great entry point into food. And as such, not only are we continuing to capture more market share in the global cannabis market, we are also successfully expanding our reach within the food focused vertical farming market as well.

As we increase top line revenues while driving to increase margin as well, our focus continues to revolve around the following three growth initiatives in both controlled environment ag markets.

First, aggressively expanding our services offerings both prior to the facility build-out and after the facility is operational; second, it’s launching an end-to-end turnkey facilities solution; and third, expanding our global reach.

First, we continue to build out our managed services offering, which is branded gro-care. And gro-care, it leverages our team of experts that I talked about earlier on our acquired expertise to provide a suite of important services to our clients’ operating facilities. Through a monthly subscription model, this program offers solutions that combined, strengthen yield results, prevent downtime and drive business continuity.

We expect the demand for this offering to be strong. We provide enhancements and solutions that ultimately help our clients do what they are best at grow plants and grow profits.

Second, we continue to make progress in the development of our turnkey facility offering, where it was just a few targeted acquisitions we will have the capability to deliver operation-ready high performance facilities to our clients.

In addition, these synergistic, accretive and service-focused acquisitions will also complement our existing business by providing a cascading effect on revenue and margins. Number three and finally, we are making solid progress with our expansion into Europe and we will definitely open our European office as soon as permitted. We believe Europe represents a tremendous opportunity that at least from a cannabis perspective is similar to where the U.S. and Canadian markets were 4 to 5 years ago. In Q1, we signed two commercial agent representation agreements and we are already working on multiple opportunities as a result of those agreements. With that, I will now turn the presentation over to Deck to present our results for the first quarter of ‘21. And after he finishes, we will move into the Q&A session. Dick, please take it from here?

Dick Akright

Alright. Thanks, Brad and good evening, everyone.

Before I begin, I want to point out that both Brad and I will be discussing some non-GAAP metrics on the call, specifically adjusted EBITDA. We define adjusted EBITDA as net income or loss determined in accordance with GAAP, excluding the effects of certain operating and non-operating expenses, including but not limited to interest expense, impairment of investments, unrealized exchange losses, stock-based compensation and depreciation and amortization of assets.

So, with that disclaimer, I will get started.

First, I want to say I am really excited to go over our results with you today. They are evidence of our continued progress and successful execution of our business strategy and they clearly reflect that we are continuing to grow in a smart and meaningful way. We entered the year with a lot of momentum from the second half of 2020 and we were able to capitalize and continue with that growth in the first quarter of 2021. With that, we are pleased to report the following record results. Total revenue was a record for the third quarter in a row. We had revenue of $12 million in the first quarter of 2021 as compared to the two previous record quarters of $9.2 million and $8.4 million in Q4 and Q3 of 2020 respectively. The current quarter revenue represents an increase of 182% from revenue of $4.3 million in Q1 of 2020. The increases in revenues have been primarily driven by increases in the shipment of complex environmental and cultivation equipment systems from contracts that have been signed in 2020.

During the first quarter of 2021, we realized our first ever quarter of positive income from operations of $153,000. This compares to a loss from operations of $1.4 million for the first quarter of 2020 and losses of $256,000 and a loss of $149,000 in Q4 and Q3 of 2020 respectively. Adjusted EBITDA was also a record for us of $0.5 million versus a loss of $0.9 million in the same period last year or an improvement of $1.4 million. Adjusted EBITDA was $0.2 million and $0.3 million in Q4 and Q3 of 2020 respectively.

Our backlog at the end of Q1 was a record $15.2 million that was an increase from the previous record $14.6 million at December 31, 2020. This continued backlog growth despite us achieving record revenues in the quarter is the result of our sales team continuing to sign contracts that will deliver strong revenues for us in the future.

While the product mix has an impact on when we will recognize this future revenue, historically, the majority of our backlog is retired within the next 6-month period.

Our net loss in the first quarter of 2021 was $1.6 million and that compared to a net loss of $1.7 million in the first quarter of 2020.

Although that net loss numbers on a year-over-year basis are comparable, the net loss in the first quarter of 2021 includes $1.7 million of non-recurring non-operating expenses, while the net loss in the first quarter of 2020 only includes $0.3 million of non-recurring non-operating expenses. This past quarter’s non-recurring non-operating expenses of $1.7 million are primarily related to amounts associated with the pay-down and termination of a high interest rate debt facility and interest expense associated with the conversion of bridge financing into common equity commensurate with and as a condition of the February equity offering. The elimination of these non-operating expenses will positively impact our net income results in future periods.

Turning to the balance sheet, I want to point out that cash as of March 31, 2021 is $50 million and we only have $1 million of low interest rate debt remaining. We intend to grow our existing business in a profitable manner in order to grow our current cash position and be able to take advantage of a variety of opportunities that we anticipate will become available to us. The net proceeds from our equity offering in the first quarter of 2021 were $58 million.

With these funds, we paid off $6 million of debt and repurchase $3 million of common stock with that common stock now being available to us to use in connection with future acquisitions.

As Brad previously discussed, we are focused on growing the higher margin components of our revenue mix and expanding our reach through key initiatives.

We will continue to focus on reducing operating expenses as a percentage of our revenues as we execute our growth plans.

We have come a long way in improving our results and this quarter is a great example of the results of those efforts.

We will continue to be focused and work hard to deliver value to our shareholders in 2021 and beyond. In closing, we are incredibly pleased with these results and our continued momentum.

We have now achieved three consecutive operating cash flow positive quarters. With that, let me turn the call back over to Brad.

Bradley Nattrass

Thanks, Dick. Great job. Dick and I are now ready to take your questions.

So Jessie, please proceed with the next portion of the call.

Operator

Absolutely. [Operator Instructions] Thank you.

Our first question comes from Michael Layman with Emerald Shoals. Please proceed with your question.

Michael Layman

Hi, good afternoon, Brad.

You mentioned in your last quarterly report that you had a backlog of $14.6 million.

Your new backlog is $15.2 million. How should we understand that number? And further, have you worked through that Q1 backlog in Q2 so far? Thank you.

Bradley Nattrass

Hi, Michael. Thank you. Dick. Will you please take that one?

Dick Akright

Yes, thanks and thanks for the question, Michael.

Just to start off with, again, we defined backlogs as signed contracts that we have yet to recognize revenue on. Generally, we will recognize the majority of our reported backlog over the course of 6 months although that changes based on the revenue mix of those signed contracts, but we expect – so what we had at the end of 2020, the majority of those we worked through in the first quarter, but not all of them. And again, it just – it takes us about 6 months to work through the vast majority of those amounts.

Bradley Nattrass

And if I may, I will add to that on the back end. I personally feel this is the most solid indication of future performance, Michael, so definitely something to watch in future quarters.

Operator

Thank you.

We will move on to our next question which comes from the line of Alan Brochstein with New Cannabis Ventures. Please proceed with your question.

Alan Brochstein

Hey, thanks for taking my question and congratulations on the quarter.

Bradley Nattrass

Thanks, Alan.

Alan Brochstein

So, you have possibly $50 million in cash. And I imagine part of this would be earmarked for M&A. I am just curious what types of things are most appealing to you in that regard and kind of what the market looks like right now in terms of pricing for any sorts of acquisitions?

Bradley Nattrass

Perfect, thanks, Alan.

We have a great cash position. And we found our niche in the growing controlled environment ag market and that’s the services side.

And so we are looking for accretive, synergistic, cash flow positive, service-focused acquisitions, acquisitions of companies that will allow us to access customers sooner than we are today. It will also result – have a resulting cascading revenue and profit effect if we are engaging earlier to utilize their services and then to integrate our solutions in as well. I also look at the acquisition opportunity to enter new markets, especially in times like this during COVID when it’s tough to travel internationally.

So, acquisitions to enter other regions around the world that will allow us to more rapidly enter a market as opposed to starting or an opening an office and starting from scratch.

In terms of pricing of these acquisitions, right now, it’s all favorable. There is a lot of private companies that would love the opportunity to be on the NASDAQ and to be a part of something larger to be a part of a company that has tremendous momentum right now, not just in cannabis, but as discussed earlier in food-focused vertical farming as well.

We have focused on indoor over the last 7 years.

So, indoor cannabis, whether retrofit facilities or new builds or indoor food-focused vertical farms.

We will also look at acquisition opportunities to expand that reach as well in the years ahead.

Alan Brochstein

This is great. And then this quarter your gross margins ticked up from Q4, I don’t know if that was seasonal or any sort of change in pricing. I knew that they were down from a year ago because of new equipment sales. I wanted to ask you just going forward, how volatile you expect the gross margin to be if you have a long-term target there? And then also secondarily, this quarter did show more springs in the equipment business right now. It’s the rest of your business that you are trying to grow. Was this – can you kind of walk through what happened in Q1?

Bradley Nattrass

Perfect. Dick, will you take the first part of that please regarding the margins?

Dick Akright

Yes. Certainly, as we saw such a large increase in our systems revenues in the quarter, which do have lower gross margins for us that was going to impact or bring down our average gross margin for the quarter and we certainly saw that and expected it because just we had a strong backlog, such a strong backlog of the equipment systems at the end of last year, some of which as we had indicated were the HVAC systems that we are finally seeing the results of the revenue from and we disclose that in our 10-K. And those certainly are kind of on the lower end of our systems margins, so that decrease in margin had been expected for us in the first quarter and again, we just had a very strong performance from a product perspective. Kind of going into the second part of your question, would we expect that to kind of continue? I am not expecting that to continue in terms of a decrease going forward. I’d like to believe we have stabilized from the standpoint of seeing where that gross margin is, but it does depend a little bit on the types of the exact kind of configurations of systems that we will have, but certainly with adding in our services revenue, increasing those going forward here that will help to improve and net average margin for us. Brad, then you want to take the other part of that?

Bradley Nattrass

Yes, you bet. If services was down in Q1 and as we have those 30 plus experts, engineers and such, it’s a very consultative sale that we are engaged in and trade shows in 2019 played a key role actually larger than we would have expected at the time, but a large role in securing new customers and new clients.

And so with the travel restrictions last year, we didn’t have those trade shows and we didn’t have a large marketing budget, but we do now have that proper funding. At the start of this year, we switched our focus over to a digital marketing strategy really focusing on social and SEO. And we also focused on signing those commercial agent models, where we can partner with individuals in certain countries that we can’t travel to. And both of those moves have really had a profound impact. But over and above that, the services does ebb and been flow with the stage that we are at in contracts. We register those revenues when the funds come in, sort of correlates where we are at or what stage we are at in the design process.

So some of that is just tied to the stage we are in. But also, as we have seen over the last week or actually the last 24 hours, as consolidation happens, there will be an increasing focus on the service side and the gro-care side of urban-gro in terms of integrating new facilities into a larger organization and helping our clients grow plants, grow profits as we stated it.

Operator

Thank you.

Our next question is coming from the line of Colin Ferrian with MJResearch. Please proceed with your question.

Colin Ferrian

Thanks for taking question guys. Alan got my first two checked off, but maybe given your comments there, Brad, could you expand just a little bit more on how shareholders should think about services revenue? Maybe as they are correlated with equipment sales, it seem like you are noting that as more equipment sales come in, there is a bigger opportunity for services revenue?

Bradley Nattrass

Yes.

I think first of all, thanks for the question, Colin.

First of all, when you look at revenues, urban-gro, when we acquired the MEP from a couple years ago impact engineering, one of the reasons we made that acquisition was to enter the mechanical space.

And so in 2020, we started performing a lot more peer review. There is a lot of underspecified mechanical out in the controlled environment ag marketplace.

And so with these peer reviews we can pinpoint how we can help them improve and then – but these systems are $0.5 million to $3 million.

So I think you are going to see our equipment systems rapidly grow as well.

So for me, I am not really looking at revenues, I am looking at margin dollars from both equipment or services. Also, another example is companies are expanding in a specific country in different states or different countries throughout the world.

Some of them are focusing on building a specific size of facility.

And so perhaps we will do a design one-time before MEP and interior cultivation design. But then there will be 5 plus facilities that are buying equipment for that one design.

And so you will see the equipment revenues drive there as well. But we are really focused on the back end on the gro-care side to just stay sticky with our clients for the length of their growth.

We have that expertise and we have definitely seen a demand in our clients wanting to utilize and access that expertise.

And so now we are monetizing that.

Operator

Thank you.

Our next question is coming from Alan Brochstein with New Cannabis Ventures. Please proceed with your question.

Alan Brochstein

Yes. I appreciate that color on the margins and the additional color you just shared. Are you able to disclose just the ballpark of what your targeted gross margin is on gro-care or put it in a ballpark compared to your current levels?

Bradley Nattrass

Yes, absolutely. Dick, will you share just the margins overall, I guess on both design and equipment systems, the range please?

Dick Akright

Sure, yes, Alan. From the standpoint of the services, yes, we are typically targeting 30% to 60% margins. Gro-care certainly fits in kind of to the mid to upper piece of that range, because it is a nice recurring revenue component for us. From the equipment systems that we have, we are kind of in the mid-teen to low 30% range. Again, it kind of depends on the type of equipment system that’s being ordered and then our consumables which are really recurring revenue in nature, those have been around the kind of low to mid-20% range.

Bradley Nattrass

And I will add to that, if I may. When I often refer to complex environmental equipment systems and I do because those are systems that require our engineers to get involved in the design process whether it’s environmental controls or mechanical systems, it’s not off-the-shelf projects or products, it’s systems that require dozens or hundreds of hours in order to properly fit for a facility.

Operator

Thank you.

Our final question is coming from Michael Layman with Emerald Shoals. Please proceed with your question.

Michael Layman

Thanks, again, everyone and thanks again for taking the time today.

Just to recap on the gross margins and the net loss, what can you improve on in 2021 to help cut that net loss and continue to grow revenues? Thanks.

Bradley Nattrass

Thanks, Michael. Deck, please take this one as well.

Dick Akright

Sure. And Michael thanks again for the question.

You know, from our standpoint we are highly focused on well increasing net revenue and then increasing the associated gross margin that goes along with it really goes a long way from our standpoint.

With the backlog and just with what we are seeing from the standpoint of opportunities down the road, we see that as a big piece with regard to being able to decrease or frankly eliminate our net loss.

Additionally, with the debt repayment that we did and what happened with bridge financing that went away in the first quarter, now that our non-recurring, non-operating expenses are out of the way, we are really highly focused on what’s going to happen at the operating income level. Because basically, we are expecting that to really drop down to the bottom line.

So, most on increasing the revenue and then doing whatever we can to increase our margins. But – and then with that kind of just maintaining or reducing our operating expenses as a percent of revenue, that’s going to be the real way we impact the bottom line in this business going forward.

Operator

Thank you.

We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mr. Nattrass for any additional closing comments.

Bradley Nattrass

Thank you, Jessie. And yes, I would like to leave you with a few more positive aspects of where we are and where we are going at urban-gro. I am grateful for your time this evening as well as your interest and very much value your ongoing support.

We continue to have record quarters with revenues, adjusted EBITDA and backlog and I am confident that the initiatives that Dick and I discussed on the call will continue to drive future momentum and also drive future profits for the company. The controlled environment ag opportunity, it’s strengthening for both cannabis and food and our acquired expertise has positioned us fantastically to take advantage and capitalize.

Our sales team is definitely delivering.

Our operations team is fulfilling. And our leadership team is driving future growth. We focus on expanding our reach weekly both organically and through acquisitions and we are also looking at strongly investing and facilitating our recurring revenue service and turnkey facility offerings.

We are and we fully expect to continue to deliver sustainable value to our clients and our shareholders and we truly believe that it’s just the beginning. That’s a great time to be investing in urban-gro. Thank you all again for your interest and have a wonderful evening.

Operator

Ladies and gentlemen, this does conclude today’s teleconference and webcast. Once again, we thank you for your participation and you may disconnect your lines at this time.