Telkonet, Inc. (OTCQB:TKOI) Q3 2020 Earnings Conference Call November 16, 2020 4:30 PM ET
Jason Tienor – President and Chief Executive Officer
Richard Mushrush – Chief Financial Officer
Conference Call Participants
Good afternoon, and welcome to Telkonet’s Third Quarter’s Earnings Conference Call. As a reminder, today’s conference is being recorded.
Before I turn the call over to Jason Tienor, Telkonet’s Chief Executive, I would like to read the following statement. Certain statements included in this conference call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks and uncertainties such as competitive factors, technological development, market demand and the Company’s ability to obtain new contracts and accurately estimate net revenues due to variability in size, scope and duration of projects and internal issues in sponsoring the client.
Further information on potential factors that could affect the Company’s financial results can be found in the Company’s registration statement and on its reports on Forms 8-K filed with the Securities and Exchange Commission. Telkonet is under no obligation to update items discussed today to reflect subsequent developments.
Lastly, I would like to remind everyone that this call will be recorded and will be made available for replay via a link available in the Investor Relations section of Telkonet’s website at www.telkonet.com.
With that, I would like to now turn the call over to Jason Tienor, Telkonet’s President and CEO, to discuss the results. Mr. Tienor, you may begin.
Thank you, operator. Good afternoon, and thank you for joining us today for Telkonet’s third quarter 2020 earnings call. We appreciate your continued interest and support, and we look forward to discussing the results of our third quarter with you.
As I am sure you’ve heard before and will hear again, 2020 has been a difficult year all around for most businesses. Due to COVID itself and the economic turmoil it’s caused, the impact on the travel industry overall and by association, the hospitality business, resulting travel bans and the associated requirement to quarantine limiting travel, closure of schools and the ensuing educational spending impacts and the loss of jobs and its overall impact on consumer spending.
These impacts and many more have caused undeniable damage to economies, financial markets, industries and businesses. While programs like the Payroll Protection Program, or PPP, have helped to dampen some of the effects, the overall result and business results has been ultimately unavoidable. This being said, the responsibility of any company is to minimize the impact of negative conditions on its business while maximizing opportunities and positioning the business for ultimate growth and success overall.
The third quarter demonstrated our solid progress in recovering from the industry’s depths beginning during the first quarter of 2020. Recognizing the highest quarterly revenues yet in 2020, the third quarter not only beat last year’s third quarter, but it also provided 75% growth quarter over prior quarter based on an almost doubling of product revenue.
While Q3 revenue and sales demonstrated solid improvement in both market dynamics and performance, the final EBITDA for the quarter might suggest otherwise. In order to fully understand the quarter’s financials, we need to share a couple of outlying factors. Telkonet has been involved in for several months in patent litigation regarding some facets of our technology.
As a result, we are recognizing accrued liability within the third quarter financials in expectation of a final outcome of these discussions. Due to this, the company realized a $600,000 non-cash expense during the third quarter. In addition, as a result of this litigation, legal expenses were one of the largest operating expenditures for the quarter at approximately $100,000.
When you review the third quarter EBITDA, about $650,000 loss, you recognized that the company’s quarterly performance would have been positive if not for these two one-time events. Understanding this, we can identify that the quarter itself had several high points. We completed our best quarterly sales efforts for the year with greater than 20% quarter-over-quarter growth in a worsening pandemic. Roughly, 17% of those sales were produced by one key relationship in a growing international sales channel for Telkonet.
For the first time ever, more than 90% of Telkonet’s quarterly sales were completed through our channel partners, demonstrating the strength and growth of this key strategic initiative. Through a stringent effort and in cooperation with one of Telkonet’s best integration partners, the company was able to win a $1 million project covering several phases through the Resorts World franchise, successfully unseating an incumbent competitor.
Along with a returning of educational market environments and continued growth of our efforts with our ESCO partner in the military space, we’ve begun to see trends of a returning industry. While these trends are not obvious, stable or insured, they’ve enabled us to better understand the opportunities where they might exist and adjust our business accordingly. We continue to hold these insights moving forward and expect improved visibility based on the analysis of our increasing data in continuously changing situation.
In addition to our ongoing sales efforts throughout the quarter, the company has continued to practice caution as we navigate the economy as it stands today. Through continued cost cutting initiatives as well as an ongoing audit of all expenses, we’ve been able to manage cash flow and minimize burn resulting in only a $200,000 reduction in cash on hand from the end of last quarter and a total of $400,000 reduction in cash from the end of last year.
Some of these initiatives included a continuous enforcement of office restrictions, an ongoing ban on all non-priority travel, implementing staff furloughs and salary reductions throughout the quarter in recognition of the ongoing slowdown of target markets and depressed market conditions and continued increasing efficiencies, including improved inventory management, staffing levels and ongoing expense management.
The results of these actions throughout the third quarter resulted in the reduction of SG&A to less than $1 million once the one-time expense of an accrued patent liability has been removed, leading to a stable cash position in addition to our highest-ending AR balance at $1.6 million at quarters end and a strong inventory level of $1.5 million. All this being done at one of our highest margin percentages ever of 49%, a 26% increase over prior year and doubling over the prior quarter.
And while strong financials are important in weathering the difficulties of the current economy, the ongoing efforts and development of the organization is what positions the company for success as we enter the recovery phase of this difficult period. Some of the most impactful and important advances within the organization this year have occurred during the third quarter.
They include the release of our newest thermostat, the Touch Combo, which created the industry’s first multi-wireless thermostat extending room automation in new and expanded markets, and truly enabling the growth of intelligent automation capabilities in commercial markets, the release of a new vertically integrated support tool, connecting Telkonet’s complete customer experience from sales to support under one comprehensive platform and increased push to move all customers onto a new managed cloud and engaged with new cloud licensing and support contracts as Telkonet completes the divestiture of its legacy systems.
And finally, the continued expansion of ESCO opportunities in the military market, expanding on the existing rollout of 5,000 homes on Telkonet’s first complete military-based deployment. While all of these efforts have produced encouraging results for the third quarter, we are continuously pushing to return to the growth and profitability we ended 2019 with.
With that being said, we are still moving forward positively with the strategic conversations started more than a year ago. Based on the progress of late, we hope to have more to share in this regard in the near future and we will continue to push forward to provide even greater opportunity as we enter 2021.
With that said, I’d like to thank you for your time today and hand the call over to Gene Mushrush, Telkonet’s Chief Financial Officer. Gene?
Thank you, Jason. Ladies and gentlemen, good afternoon and thank you for joining us. Today, I will be summarizing our 2020 third quarter and year-to-date financial results. For the quarter ended September 30, 2020, Telkonet reported revenues of roughly $2.2 million, relatively unchanged prior to the same period prior year. Product revenues increased 3% to $2.1 million when compared to the prior year. Product revenues derived from value added resellers and distribution partners were approximately $1.7 million, an increase of 1% compared to the prior year period.
For the three months ended September 30, 2020, hospitality revenues increased 7% to $1.9 million, government revenues increased 500% to a $100,000, education revenues decreased 60% to $60,000 and multiple dwelling unit revenues decreased 97% to approximately zero. Two customers accounted for approximately 67% of the product revenues for the current quarter.
For the three months ended September 30, 2020, international revenues increased $380,000 to $470,000 when compared to the prior year period. This increase in international revenues was primarily driven by one customer.
Recurring revenues decreased 6% to $190,000 compared to the same period prior year. Backlogs were $2.7 million and $3.6 million at September 30, 2020 and 2019 respectively.
Gross profits for the quarter were $1.1 million up 26% from $865,000 last year. The gross profit percentage increased 10% to 49% as well. The increase was primarily attributable to an increase in revenues of $40,000 combined with decreases in material cost of $100,000, use of installation subcontractors of $90,000 and salary expense of $80,000 partially offset by an increase in the inventory reserve of $110,000.
Tariffs imposed on Chinese imports resulted in an adverse impact of approximately 8% on the actual gross profit percentage for the three months ended September 30, 2020 compared to approximately 7% for the prior year period.
Operating expenses for the quarter were $1.8 million, a 10% increase compared to $1.6 million for the same period in 2019. The variance is primarily attributable to a $600,000 expense related to a probable settlement of a patent infringement lawsuit and a $70,000 increase in legal fees, partially offset by decreases in expenses incurred with third party engineering consultants of $110,000, the 401(k) employer match of $30,000, salary expense of $220,000, marketing and advertising expense of $60,000, and finally sales and commissions of $40,000.
The decrease in salary expense is primarily attributable to furloughs and/or pay reductions implemented at the beginning of the third quarter in response to the impact of COVID-19.
We incurred an operating loss and reported a negative adjusted EBITDA, a non-GAAP measure of $672,000 and $656,000 respectively for the quarter ended September 30, 2020. This compared to an operating loss and a negative adjusted EBITDA of $737,000 and $719,000 respectively for the same period prior year.
Telkonet reported year-to-date revenues of $5.3 million, a 38% decrease compared to $8.5 million for the same period prior year. Product revenues decreased 40% to $4.8 million when compared to the prior year period. Product revenues derived from value-added resellers and distribution partners were $3.6 million, a decrease of 43%. Year-to-date, all major industry sectors decreased when compared to the prior year.
Hospitality revenues decreased 30% to $4.1 million, government revenues decreased 81% to $170,000, education revenues decreased 56% to $380,000, and finally, multiple dwelling unit revenues decreased 64% to $130,000.
For the nine months ended September 30, 2020 international revenues decreased $360,000 to $620,000 when compared to the prior year period. The decrease in international revenues were primarily driven by non-repeatable revenues from three customers in 2019 and limited international revenues so far in 2020.
Recurring revenues decreased 1% to $562,000 compared to the same period prior year. Year-to-date gross profits were $2.3 million down 29% from $3.3 million last year. However, the actual gross profit percentage increased 6% to 44%. The gross profit decrease was primarily attributable to a decline in revenues of $3.2 million partially offset by decreases in material costs of $1.3 million, logistical expenses of $240,000 inclusive of import tariffs, use of installation subcontractors of $370,000 and salary expense of $200,000.
Tariffs imposed on Chinese imports resulted in an adverse impact of approximately 7% on the actual gross profit percentage for the nine months ended September 30, 2020, which is consistent with the prior year period.
Year-to-date operating expenses fell 14% to $4.6 million compared to $5.4 million last year. The variance is primarily attributable to decreases in expenses incurred with third party consultants of $340,000, certification expenses of $40,000, trade shows of $200,000, audit fees of $70,000, marketing and advertising expenses of $100,000, salary and recruitment of $480,000 and sales commissions of $140,000 partially offset by a $600,000 expense related to a probable settlement of a patent infringement lawsuit and $80,000 increase in temporary staffing.
We incurred an operating loss and reported a negative adjusted EBITDA of $2.3 million and $2.2 million respectively for the nine months ended September 30, 2020. This compared to an operating loss and a negative adjusted EBITDA of $2.1 million and $2 million respectively for the same period prior year.
We reported $2.9 million in cash and equivalents at September 30, 2020 compared to $3.5 million last year. As of September 30, 2020, we had a total borrowing base of $1.1 million and outstanding balance of $65,000 and a cash management reserve of $50,000 resulting in the approximate availability of $963,000 on our credit facility compared to a total borrowing base of $1.7 million and outstanding balance of $910,000, the cash management services reserve of $50,000 resulting in the approximate availability of $742,000 at September 30, 2019.
We reported a working capital surplus measured as current assets less current liabilities of $2.5 million at September 30, 2020 compared to a surplus of $4 million last year. Working capital changes during the first nine months of 2020 were primarily a result of a $913,000 increase in a note payable related to the Paycheck Protection Program loan, a $701,000 decrease in net account receivable, a $442,000 decrease in cash, a $275,000 increase in other accrued expenses offset by a $559,000 decrease in the amount outstanding on our line of credit.
The COVID-19 pandemic continues to impact on a global level. Both the health and economic aspects of the pandemic are highly fluid and the future course of each is uncertain. We cannot predict whether the outbreak will be effectively contained on a sustained basis nor the severity and duration of its impact. If the outbreak is not effectively and timely controlled, our results of operations, financial condition and cash flows may continue to be materially and adversely impacted as a result of the deteriorating market outlook, the global economic recession, weakened liquidity or other factors that we cannot foresee.
The company’s sales and gross profits have decreased significantly resulting from a contraction and commercial demand for our products, a lower revenue conversion rate in our existing pipeline and significant one-off transactions from customers in 2019 that have not been and are not expected to be repeated in 2020.
Due to travel restrictions, social distancing, and shelter-at-home edicts, the hospitality industry, our largest market that generally accounts for a majority of our revenues has suffered as much as any. According to data from STR and Tourism Economics, full recovery in U.S. hotel demand and room revenue remains unlikely until 2023 or 2024 respectively. For the remainder of 2020, Ernst & Young estimates that international travel is likely to contract anywhere between 58% to 78% for the year.
In response to the pandemic and its effects on the company’s operations and financial results, the company has taken and is continuing to take a number of actions to preserve cash. These actions include suspending the use of engineering consultants, canceling all non-essential travel and postponement of filling any vacant positions. In early April of 2020, management made the decision to furlough certain employees, instituted pay cuts for certain other employees and suspended the company’s 401(k) match through the end of 2020.
On April 21, 2020, the company entered into an unsecured promissory note, dated as of April 17, 2020 with Heritage Bank of Commerce under the Paycheck Protection Program, SBA 7(a) loan in the amount of $913,000. With the receipt of the PPP loan, the company was able to bring back the furloughed employees, restore payroll to prior levels and delayed the suspension of the 401(k) match.
However, the pandemic continued to impact the company’s operations and financial results consequently, in late June of 2020, management once again made the decision to furlough certain employees, institute pay cuts for certain other employees and suspend the company’s 401(k) match through the end of 2020. The furloughs and pay cuts continued through September 2020, at which time management determined it was necessary to discontinue the furloughs and pay cuts in order to retain necessary personnel for the company’s ongoing operations.
At September 30, 2020, the PPP loan balance was approximately $913,000 and is presented as current debt on the balance sheet gross of any possible forgiveness. For PPP loan recipients who do not apply for forgiveness, the loan payment deferral period expires 10 months after the applicable forgiveness period ends. No assurance is provided that the company will obtain forgiveness of the loan in whole, or in part. See Note G and Form 10-Q filed today for a summary of the loans terms, including eligibility for forgiveness.
The company used the proceeds of the PPP loans to support its ongoing operations and currently expects to draw on its cash reserves and utilize the credit facility to finance its near-term working obligations. The credit facility provides us with needed liquidity to assist in meeting our obligations. The company is currently in compliance with the financial covenants for the credit facility. However, continued operating losses will deplete these cash reserves and could result in a violation of the financial covenants.
Based on the company’s current level of operations and forecasted cash flows for the 12-month period subsequent to the date of this filing, the company believes it is likely that it will breach the covenant to maintain a minimum unrestricted cash balance of $2 million at some time during 2021. Consequently, a violation provides Heritage Bank with the option to accelerate repayment of amounts borrowed, terminate its commitment to extend further credit, and foreclose on the company’s assets. The occurrence of any of these events would have a material adverse effect on our business and results of operations.
The company plans to discuss the possibility of a waiver or a change to the financial covenant with Heritage Bank in the near-term. Any covenant waiver or amendment could lead to increased costs, increased interest rates, additional restrictive covenants, and other lender protections. There is no assurance, however, that the company will be able to obtain a covenant waiver or amendment.
The company is currently in settlement discussions related to a patent infringement lawsuit. Based on these discussions, the company determined the likelihood of a settlement to be probable, and as a result, as of September 30, 2020, the company recorded, at its best estimate, a current liability of a $100,000 included in accrued liabilities and a non-current liability of $500,000 included in accrued royalties long-term in the condensed consolidated balance sheet for these settlement related costs.
The corresponding expense is recorded in the selling, general and administrative line of the Condensed Consolidated Statements of Operations. The payment of such estimated settlement-related cost is expected to have a material and adverse impact on the company’s results of operations and liquidity. There is, however, no assurance that the lawsuit will be settled, and if settled, the amount of any costs. See Note I, Commitments and Contingencies of Form 10-Q for a discussion of the patent infringement lawsuit.
In closing, thank you for your interest and to our shareholders specifically thank you for your continued support.
I’ll now turn the call back to Telkonet’s President and Chief Executive Officer, Jason Tienor.
Thank you, Gene. I’d now like to hand the call back to our operator to take any questions you might have. Operator?
At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is with Ed Stein. Please proceed with your question.
Hello, Ed. How are you?
Okay. I’m very impressed that you guys have done as well as you’ve done. Boy, I’ve been involved with other companies who aren’t doing quite as well. I know you just said that we can look at the details of the patent infringement suit in the materials. But just very simply, are we accused of infringing on somebody else’s patent infringing? Or are we claiming that somebody else infringed ours?
Yes. No, it’s somebody else claiming that we’ve infringed upon their patent, it’s a patent from, say, 20 years ago, that was acquired by what we call a patent-trolling firm. That’s a company that doesn’t actually manufacture, build or sell anything. But they’ve just claimed patents through the acquisition from a company that’s no longer in existence. And they then move out into the market to try to find anybody that has any type of – I hate to use the word infringement because unfortunately it’s a patent that we feel that we don’t – they actually have a lineup of several patents and we believe that there’s an arguable measure that we could dispute with them.
But the problem is that the costs are moving through those efforts would be similar to the costs of the discussions we’re currently having. As such, we have strategically decided to move ahead with the discussions as they stand, and we believe we’re on the closing yard line of having this handled. So it’s actually a plus, plus for both firms involved and we look forward to putting it behind us.
Great. Are you finding that the demand for an interest in our products and technology as I know it’s not as many interested parties? But are there still a lot of folks who are using it and impressed with it and trying it out?
Absolutely. One of the benefits for the technology that we provide is it still adds value even during the market considerations that we’re currently sitting under. If you think of it, when you look at what we sell from an energy management standpoint and largely occupancy-based, you’re looking at a large number of hotels in the industries that we market most to i.e. domestically here in North America and South America, that they’re actually closing down their operations with us leaving their facilities entirely unoccupied. While those facilities still have to consume energy in order to appropriately heat or cool, thereby removing humidity and leaving very small opportunity to do damage to the property even though they’re closed. Well, that’s exactly what the platform that we provide does for them.
So in these discussions throughout this time, we’ve been able to point to the benefits of our technology still assisting them. While that being said, you still have to understand that a lot of these operators, they have very little cash to work with during this time. So we’re trying to use the data that we have, the waves of reopenings that have taken place and certain regions to be able to identify where we’re going to recognize success and position all of our efforts into those particular areas.
That’s one reason why you’re seeing the opportunities that we saw during the third quarter, i.e. international being large for us, also one of the largest construction projects taking place in the U.S., the Resorts World Las Vegas Hotel that we won. Those are two areas of new developments as well as international sales that we’ve identified that has far more activity during this timeframe, and we continue to focus our efforts there.
Now as I said during the presentation, this leaves no assurances that that will continue moving forward. The stability in the same areas that we’ve identified will remain the same. As we’ve all seen, there is very little control or understanding of what’s taking place now with regards to this virus and where it’s attacking and when it’s attacking. But we’re trying to adjust with it and identify where we can be successful and then focus our efforts there.
I’m impressed. Keep up the good work.
I appreciate it. Ed, take care of yourself. Stay healthy.
At this time, there are no further questions. I would like to turn the floor back over to Mr. Tienor for concluding comments.
Thank you, operator, and thank you again for all of you joining us here today. We appreciate your continued interest in Telkonet and our efforts. We do look forward to sharing further news with you in the very near future. If you have any further questions, please feel free to contact us at (414) 302-2299 or by emailing firstname.lastname@example.org. Thank you again. Please stay healthy and have a great afternoon.
This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.