Good morning, and welcome to the Tecogen Third Quarter 2022 Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to our host, Jack Whiting, General Counsel and Secretary. Thank you. You may begin.
Morning. This is Jack Whiting, General Counsel and Secretary of Tecogen. Please note this call is being recorded and will be archived on the investor section of our website at tecogen.com for two weeks. The press release regarding our third quarter 2022 earnings and the presentation provided this morning are available in the investor section on our website as well. I'd like to direct your attention to the Safe Harbor statement included in the earnings press release and the presentation. Various remarks that we make about the company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q under the caption Risk Factors, which are on file with the Securities and Exchange Commission and available in the Investor section of our website under the heading SEC Filings. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. Therefore, you should not rely on any forward-looking statements as representing our views as of any date subsequent to today. During this call, we will refer to certain financial measures not prepared in accordance with GAAP.
A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is provided in the press release regarding our third quarter 2022 earnings and in the Investor section of our website. I'll now turn the call over to Benjamin Locke.
Thank you, Jack. As the agenda on slide 4 indicates, we'll start with a brief company overview, followed by a detailed review of our third quarter 2022 results. We will then discuss the key takeaways from the earnings and turn the call over to the operator for questions. As a reminder, this presentation will be available for download in the Presentation section of our Investor page on our website. Turning to slide 5, I'd like to provide a short overview of Tecogen's core businesses. Tecogen sells and maintains clean and efficient energy systems that provide resiliency and energy savings to customers while reducing greenhouse gas emissions for a cleaner environmental footprint. Our solutions help industries and facilities reach their environmental goals for carbon reduction while also providing resiliency to grid outages.
Tecogen has deployed thousands of these systems, and we have a steady recurring revenue stream through our 11 service centers that provide long-term operations and maintenance services for Tecogen cogeneration and chiller systems. Turning to slide 6. Our distributed generation systems can operate as microgrids for power generation and grid resiliency, as shown on the left here. These features are increasingly important as the grid becomes increasingly burdened, congested, and costly. In addition to our distributed generation system, Tecogen offers clean cooling solutions for commercial and industrial facilities. Our chillers, shown in the middle of this slide, provide customers with lower operating costs and a reduced greenhouse gas footprint compared to traditional cooling solutions. We've had particular success with our clean cooling products for use in controlled environment agriculture. These indoor grow operations use a tremendous amount of power to maintain precise grow conditions.
Our chillers substantially reduce the amount of electric capacity needed to operate the facility, while simultaneously providing cooling and heat for facility heating and dehumidification. Our success in the controlled environment agriculture market has led us to expand our business development efforts to extend the scope of our participation in CEA facilities in the food production sector. I will talk more about this effort later in the call. Before I turn the call over to Abinand, for a review of our third quarter numbers, I'd like to remind investors of our three main revenue streams shown here on slide seven. Our Product revenue consists of sales of cogeneration units, microgrid systems, chillers, and associated equipment to a range of markets and customers. Our Service revenues primarily consist of our contracted operations and maintenance services with a small component of installation services.
Our energy production revenue stream is from energy sales, including sales of electricity and thermal energy produced by our equipment on-site at customers' facilities. With that, I'd like to turn the call over to Abinand to review our numbers in more detail, and then I'll have some additional comments on takeaways from the quarter and comments about our expectations for the rest of 2022. Abinand.
Thank you, Ben. Q3 revenue was $6.6 million, compared to $5 million during the same period in 2021. This 31.9% increase was mostly due to the increase in Product revenue, but all segments showed growth. I will discuss the revenue by segment in more detail in a later slide. Our cash balance at the end of the quarter was $2.9 million, which was slightly higher than at the end of Q2 2022. Gross margin decreased to 44% from 47% compared to 2021 due to the higher cost of materials. Some of the orders that shipped in Q3 had higher margins because of the price increases instituted earlier in the year.
We plan to be making further adjustments to price over the upcoming quarters. Operational expenses were 4.3% lower compared to Q3 2021 at $3.11 million. This was partially due to a reduction in bad debt reserves, and the R&D expenses were higher due to costs associated with the development of the Hybrid-Drive Air-Cooled chiller. The operating loss was $214,000, and the net loss was $257,000 or $0.01 per share. The higher net income in Q3 2021 was due to the Employee Retention Credit and the forgiveness of the Paycheck Protection Program. EBITDA loss was $141,000, and adjusted EBITDA loss was $74,000. In Q3 2021, EBITDA income was $1.5 million, and adjusted EBITDA was a loss of $197,000.
Q3 2021 was favorably impacted by the Employee Retention Credit. Performance by segment. Products revenue increased by 71%. In particular, the chiller revenue increased 329%. Our product margin decreased from 45% to 35% in Q3 2022 due to the increased cost of materials, partially offset by price increases. Service revenue increased 9% compared to Q3 2021 due to the increased number of service contract and price increases associated with those contracts. Our service margin increased to 52% from 48%. Energy Production revenue increased by 6%. Energy production margin increased to 50% compared to 47% quarter to quarter. The overall gross margin was 44%. I will now hand the call back to Ben to talk about the earnings takeaways.
Thanks, Abinand. Turning to slide 11, I'll discuss what I feel are the important takeaways from the quarter. I think the biggest takeaway, of course, is the revenue growth, up 32% over Q3 of 2021. This was driven by increases in product sales with an even mix of cogeneration and chiller product. As you've seen through the press releases throughout the quarter, we continue to make progress in key market segments such as controlled environment agriculture, multi-unit residential buildings, and large schools or other municipal buildings. Some of these sales are directly attributable to new sales partnerships established earlier this year. In particular, we were pleased to receive a multi-unit order from a large ESCO. This is the first order from this ESCO, and we are expecting additional orders as the relationship builds.
Next, we are starting to get more definition on the new investment tax credit for both our cogeneration and chiller systems. The new ITC is worth up to 40% because our products satisfy the domestic content requirements and may be transferable to third parties. Importantly, the new ITC has a direct pay alternative for nonprofits and municipalities. We, like many others in the clean energy industry, are awaiting the final details from the IRS and how the ITC can be monetized by our customers. We expect this guidance next month. Another important takeaway occurred after the quarter ended, but the collaboration with the Gas Technology Institute announced Tuesday will help bring our Hybrid Drive AC chiller through testing in anticipation of commercial launch later in 2023.
We expect to continue our ongoing effort to work with various gas companies to establish pilot demonstrations for the hybrid drive after the GTI testing is complete. I hope to have more announcements in this regard in the coming months. Lastly, we ended the quarter with a backlog of $6.9 million of product, and product backlog as of yesterday was $9.35 million. As you can see in the chart, it's a good mix of our core markets such as CEA and multi-unit residential. As a reminder, we do not include our recurring service and Energy Production revenues in our backlog calculation. Turning to slide 12, I'd like to provide a bit of color on our business development efforts in the controlled environment agriculture space.
As we had mentioned earlier in the year, one of our focus areas is the controlled environment agriculture, where we have already sold over 13,000 tons of cooling to cannabis facilities and are planning on expanding our offering to food crop facilities. The energy intensity of each type of CEA facility varies depending on the required level of climate control. In all cases, there is a tremendous energy use for grow lights, and in many cases, there is both a cooling and dehumidification load. Our solution offers up to 50% reduction in utility energy expenses, especially in cases where there is a large need for cooling and dehumidification. The exhaust generated can also be used to boost plant growth by upwards of 30%.
We already have equipment in multiple food crop facilities and are starting to specify sites to utilize the CO2. Turning to slide 13. To further our CEA ambitions, we established a new business unit. We are creating a new brand known as NetZero Greens for CEA-grown produce, and we are working on identifying where we can add value. We anticipate developing a simple-to-install modular package for growers to handle their energy needs with the lowest carbon footprint for facility sizes from a single container upwards of a multi-acre controlled environment agriculture farm. The focus will be on having the lowest energy intensity and carbon footprint while also being able to alleviate grid capacity constraints or in some cases, operate off grid entirely. As slide 14 indicates, we have already begun testing our real-time optimization algorithms for reducing energy costs for CEA facilities.
The same technology for real-time grid controls will also be applied to our Hybrid-Drive Air-Cooled chiller and other products. The graphic on the left shows a snapshot of the utility grid mix from the ISO New England. Using the carbon intensity of the grid, our algorithm blends power sources, in this case solar, utility, and engine, to optimize the cost of operation and greenhouse gas mix. Working in partnership with growers, we plan to pilot this technology in grow facilities by building a small-scale prototype. The next step will be to determine the business model for expansion into CEA and build the financing mechanisms to develop this segment. In conjunction with the investment tax credit, our offering provides growing facilities a way to reduce operational costs, increase yield, and receive a tax incentive to build clean and efficient facilities using our products.
Finally, I'd like to revisit the pathway to growth, shown on slide 15, that we've been focused on to grow the company. First, we continue to make progress with our chillers for facilities seeking clean cooling solutions where we are the best technology for energy savings and resiliency, particularly when the existing electric grid can't meet the facility's power requirements. Next, as I mentioned with the GTI collaboration, we are on track in developing our next generation Hybrid-Drive Air-Cooled chiller. The hybrid drive will substantially expand our sales potential in many markets, particularly CEA, and we expect to showcase it in February at the 2023 AHR Expo in Atlanta, which is the largest HVAC trade show in North America. We also continue to see promising opportunity for our technology as a foundation for clean and efficient microgrids.
We have shown that a cost-effective combination of our clean cooling systems, combined with our grid resilient microgrid systems, is an effective solution for facilities requiring affordable and reliable power. We expect grid supply constraints to continue as the nation's aging electric grid becomes further burdened and overloaded due to increased electricity demand. As I mentioned earlier, the new ITC contained in the Inflation Reduction Act can result in as much as a 40% tax credit for our systems. Finally, as discussed, we established a new business unit focused on controlled environment agriculture. Given projected population growth and the impact of climate issues on food production, the need for intensive farming techniques in controlled environments is expected to grow substantially.
As a result of our interactions with numerous industry participants in the CEA market, we believe that Tecogen can have additional opportunities to provide equipment and services that addresses the energy-intensive requirements of CEA facilities. We are focused on additional roles that Tecogen can play in developing, maintaining, and operating CEA facilities, and hope to have more updates for investors as our discussions with participants in the CEA market progresses. In conclusion, I hope to continue showing results against these goals, and I look forward to providing updates over the next few months. With that, I'd like to turn it over to the operator for questions.
Thank you. At this time, we'll conduct our question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, to ask a question, press star one on your telephone keypad. Our first question comes from Bill Church with TGRA Capital. Please state your question.
Yes, good morning. Thank you. My question has to do with.
Hi, Bill. Good morning to you.
Hi. Good morning. My question has to do with the CEA market and if this includes vertical farming. I'm thinking some of the Canadian companies, Crop One and so forth.
With CEA, yes, it does include vertical farming. It can include any, anywhere where everything from a greenhouse with a controlled, you know, without just greenhouses that don't just open windows to anything that, you know, is completely enclosed and have, you know, full climate control. Right now, most of our facilities have been non-vertical farms, but the energy requirements are pretty much, you know, similar whether it's vertical or whether you're, you know, having a single layer. Our energy solutions can be applied to vertical farming with no issue.
Yes, you know, I was thinking about that. I've been doing some research on some of these Canadian companies specifically that have raised a lot of capital in the last year or two, and I guess that would be applicable up in Canada where the weather is not quite as conducive to growing as it is here. It looked like that's an interesting opportunity, so thank you.
Yeah. We actually have some equipment at a cucumber farm in Canada.
Ontario.
Yeah, in Ontario. Yeah.
Oh, wow. Okay. Okay.
Yeah. I think the crops that again, of course, we've talked about the cannabis stuff, but the food crops that we've been involved with, again, we mentioned the cucumber one. I think the leafy greens is probably the one where we've got again, from the fruit crop standpoint, the most exposure in. That's the one we're seeing a lot of potential expansion into and is very conducive to vertical farming and all these intensive growing techniques. Again, what the common denominator on all these things are, Bill, of course, is the energy needed to do it. Where the grid is and can the grid give you enough? If they can't, what are you gonna do?
Yeah. Okay. Good. Thank you very much.
Yeah. Nice to talk with you, Bill.
Thank you. Once again, to ask a question, press star one. Our next question comes from Alex Blanton with Clear Harbor Asset Management. Please state your question.
Hi. Thank you.
Hi there, Alex.
Ben, congratulations on a very good quarter and the increase in the backlog.
Thank you.
I like the fact that you put a link to the quarterly report on the homepage of the website. That's really a very good thing to do because it makes it easy to find the numbers.
Sure. I'm glad you found that, and I'm glad it was helpful.
Very good. On the CEA industry, do you have some references that we could go to learn more about that industry, like trade organizations, industry associations? Do you have anything like that?
Yeah. Well, I think, Alex, I'll answer it this way, which is, you know, a lot of the art and the technology that goes into intensive grow facilities like CEA is shared within the cannabis space. You know, the growers and as some of the others were talking about the hydroponic growing, the intensive growing is really being done by the cannabis folks. That's my only way of saying, our exposure to all of those things is by proxy via our cannabis trade show interactions. In fact, next week is a big one. Next week is called MJBizCon. You probably don't know it, but it's probably one of the
M?
MJBizCon. It's one of the leading cannabis shows in the country each year. Of course, we're gonna be there. It's in Las Vegas. We'll have a whole team of people there. It's not just to make inroads in business development in cannabis, which of course we're gonna be doing, but it's also going to be to build on these relationships with the growers and the greenhouse providers and the guys providing money into these facilities. Because again, they're not just investing in cannabis, they're investing in leafy greens, they're investing in cucumbers and some of these other things. Even though it's a cannabis-focused event next week, we fully anticipate rubbing elbows with the guys that we wanna be rubbing elbows with in the CEA space.
MJBizCon? Are you talking B-I-Z?
B-I-Z. MJBizCon. Yeah. Yeah. You might even get an email from us, Alex, 'cause we're gonna do a, you know, a pre-show email thing, and I'll make sure that you're on it. You can see what our booth number is, et cetera. Yeah, MJBizCon is probably the biggest cannabis trade show in the country.
Okay, thank you. The new ESCO, could you give us a little more color? How did you get that relationship? Why did they take you on? What's the potential from that relationship and so on?
Well, thank you for noticing that, Alex, 'cause it actually is. It's actually a very good development for us. It is indeed an ESCO that we had not been working with previously. In fact, an ESCO that was, for whatever their reasons were at the time, you know, using a competitive product. But that situation doesn't exist anymore. They've decided that they wanna focus on using Tecogen products and focusing their efforts on developing projects around Tecogen products. Now we had this initial order with them that we announced, I guess it was the September, Abinand, right?
Yeah.
For a few units. We fully anticipate more orders from them. In fact, our sales efforts with them are quite collaborative, very collaborative. It's a really good development for us, where we have somebody that was, in the past, maybe not someone that could drive sales for us, but now is very much driving sales for us. You throw in the ITC, you know, Alex, and we've got a pretty good winning proposition. It's not just those folks. You know, we established some new relationships on the chiller side of things too. You know, different reps, different sales agents. I don't wanna name drop. I can't right now, but you'll be seeing sales coming forward with these new sales relationships that we've developed.
That's hugely important because again, Alex, I think as you know, what we do best is do technical support of sales. To the extent that we've got our partners out there selling and knocking on doors and doing all that, and we're doing the backup work, that's a good place for us in terms of our resourcing.
Oh, thank you. One more question. On the pricing side, you mentioned that your your margins were affected by material cost increases. I assume there's labor and freight too. To what extent are your prices constrained by fixed price contracts that might be in the backlog that going forward will have a lower effect because you're pricing new contracts with up-to-date costs?
It's a spot on question, Alex. I'll answer and maybe Abinand can give some color. You're right. You know, we committed to pricing on some things and our pricing is good, you know, for thirty days. You know, sometimes you wanna give flexibility in that to allow a project to succeed. Right projects are now going forward with lower margins 'cause the pricing was what it was a few months ago when it was going forward. But we're slowly getting all those price increases up to speed. You know, new proposals going out are getting the new pricing.
You're exactly right, Alex, that come 2023, our hope is that the adjustments that we've made in our pricing will now reflect to the proposals that are out there in the market and get our margins right back up to where they ought to be. It's a challenge, Alex. I don't need to tell you know, about what the supply chain issue is. It's not just me, it's the entire world of inflation and price increases and lead times, et cetera. I don't wanna complain about all those things. We have to deal with it. I think we're dealing with it pretty good in terms of timing our price increases and making sure that our inventory levels are so that we can maintain our delivery times for backlog.
Anything to add, Abinand Rangesh?
Yeah. The only thing I was gonna add is usually, like, as you saw in this quarter, right? We saw a little bit of a increase in margin compared to last quarter. It-- there's gonna be part of the next couple of quarters that will have the full new price. Some of them might have slightly lower prices. Just the. But we're starting to see material prices level off. But more fundamentally, what has happened with the investment tax credit is it allows us to actually raise prices further than where we are today, just because of the fact that a customer is gonna get a 40% discount on an overall project. That gives us a little more pricing flexibility than earlier.
Hopefully we can even if we see a little bit of a, you know, some of the projects in the next quarter or so that might have slightly lower margin as we get into second and third quarter, once the guidance from the IRS comes out, we'll be able to raise prices commensurate with making sure we get our margin where they were last year.
Thank you. Any problems with supply chain shortages?
Oh, how much time do you have? Yes is the answer. But again, without going into it in detail, that's not really needed here, we're managing it. We're finding alternative vendors. The long lead time items we're getting on top of, and importantly, we don't want those delays working into our own delays to our customers, right? We wanna be able to meet all of our commitments to our backlog, and at this point, we can't because we've been planning it. That's not to say it's been without headache, but we're there. Hey, Alex, I wanted to mention something else about service, about margins and service in particular. Just so you know, you know, all of our service contracts have escalators that are tied to CPI.
As inflation has driven CPI up, so goes our service contracts. That's self-adjusting, which is nice. You know, it's not like the products where we have to initiate a price increase and go to our customers with that. The service contract have those escalators all built in. We feel pretty confident that the inflationary effects are not gonna affect our service margins.
Yeah, that's terrific. That's good news. The transcript of this call will be available on your site?
Yeah.
I think it takes 24 hours.
I think it takes some time, but eventually it will be, Alex. We'll make sure you get it.
Yeah, because that'll be very good to have. Okay, thank you very much.
All right.
It looks like we're doing-
Thanks, Alex. Yeah. Bye-bye.
Thank you. Just a reminder, to ask a question at this time, press star one on your telephone keypad. To remove yourself from the queue, press star two. Our next question comes from Michael Zuk. Please go ahead.
Hi, Mike.
Good morning, everybody. Ben, could you give us an update on the challenges and opportunities still in New York City?
Sure. Yeah, of course. You know, New York City is still a great opportunity for our equipment, if you put aside maybe some political things that go on there. Electric rates are still high. You know, gas it has gone up, but that's fine. As you know, Mike, we naturally hedge with gas because if gas goes up, you know, the gas that they would have needed to run their boilers would have gone up, and of course, we're supplying heat to them as well. So we're naturally hedged with gas. Of course, the gas prices going up drives electric rates up, which creates the natural environment for our equipment. New York still remains to be a prime opportunity for us.
We've had a couple of orders there this quarter. There's this mandate that they have, Local Law 97. You might have heard us talk about it before, that requires people to reduce their carbon footprint of their building by certain amounts each year. In 2025 or 2026, I suppose they're gonna start handing out parking tickets, and you're gonna have to start paying those parking tickets. Our cogeneration systems, you know, help that situation. It reduces your carbon footprint. Even though there's not, you know, incentives, and even though there's not, you know, all the support that used to be for cogeneration back in the day, the natural market forces for cogeneration are very strong in New York, and we still continue to have sales there.
To change the subject slightly, how competitive is our equipment if we have the opportunity to use hydrogen as a stoker fuel?
Well, that's a question. You know, the hydrogen question has come up a lot. The way I always think about it, Mike, is, you know, I'm gonna burn what comes out of the pipeline. If the pipeline gets to the point where they've got a 5% hydrogen injection, that's fine. I can live with that as long as, you know, all the other equipment at the end of that pipeline can burn that fuel, so can I. If they start filling the pipeline with so much hydrogen that all those other appliances can't burn it, well, I'm just like them, right?
The assumption I have is that the hydrogen addition to the pipeline is gonna be somewhere where it can handle it and appliances can handle it, 10%-15%, perhaps. I'm just fine with that, and I'll go along with that. But I'm not gonna be developing, just so you know, Mike, I mean, you can take my word on this, I'm not developing a 100% hydrogen engine here, because I'm fundamentally believing that the pipeline gas that comes out and the percentage of hydrogen that goes into that is gonna be fine with me 'cause it's gonna be fine with every other appliance at the other end of the pipeline.
Gotcha. What's the status on opportunities in California?
Yeah. Well, you know, interesting you ask that. You know, California, you know, the distributed generation in California is a little tricky because they don't like, you know, fossil fuel burning generation assets. Our chillers, I think are where we continue to really focus on in California because you don't have to get an interconnect permit for the chiller. You have to get an air permit, but of course, we have our Ultera emissions, so we're not too concerned about that. The opportunity in California, in the near term is still with chillers. Mike, we're trying to understand some of the aspects of the, again, this Inflation Reduction Act had a whole lot of incentives for microgrid controllers. That's, you know, the green cabinet on our box is a microgrid controller.
If I wasn't getting the ITC, because we're CHP, I'd get that ITC through the backdoor of my microgrid controller. I think there's gonna be more opportunity there, but again, we really need to see the IRS guidance on how they're gonna lay it out and what the opportunity is to see if we might even be able to do more, in California than we're doing now.
The only thing I wanted to add on that, Mike, was the hybrid drive is likely also unlock some projects in California, just because of the fact that you could treat our hybrid drive chiller as a electric chiller with a gas backup or a gas chiller with an electric backup. In that sense, you know, California, at least the way the regulations seem to be moving, is they seem okay with using, you know, diesel generators for peak demand events and those kind of things. Using a chiller that could run on a renewable source or a clean grid when it's available, and then basically maybe using the engine for just short periods of time could be a good way for clients to save money, but not necessarily have an issue with running a engine-driven product.
The second piece is there are still various cannabis opportunities that are still being developed in that space that we're starting to see some potential there, so which might also create some other opportunities that we haven't always seen in California.
Well, again, congratulations on the progress that's being made, especially in the CEA area and with the new electric chiller. I look forward to continued progress. Keep up the good work. Thanks.
Appreciate it, Mike. Take care.
Thank you. There are no further questions at this time. I'll turn the floor back over to Benjamin Locke for closing remarks.
Yeah. Thank you all for joining our call. Our next call won't be until our year-end call in March, but I anticipate that we'll have further updates as the months go on, particularly in our core markets and our CEA space. Thank you for all your investors. I'm feeling really confident about our prospects for the future, and I hope to share them with you going forward.
Thank you. This concludes today's conference. All parties may disconnect.