Tecogen Inc. (TGEN) Q3 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Tecogen Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] For your information, this conference is being recorded. A recording of this conference call will be available for playback approximately one hour after the end of the call and will remain available until Thursday, November 17, 2016. Individuals may access the recording by dialing 877-344-7529 from inside the U.S., 855-669-9658 from Canada, or 412-317-0088 from outside the U.S. Enter the replay conference number 10094780, followed by the pound sign. Now, I would like to introduce Ariel Babcock, Tecogen's Director of Investor Relations.

Thank you. Good day and thank you all for joining us on our third quarter earnings conference call. Speaking on the call today are John Hatsopoulos and Benjamin Locke, our Co-CEOs. Also joining us today with prepared remarks are Robert Panora, our President and Chief of Operations and David Garrison, Tecogen's Chief Financial Officer. During the call, we will be referencing slides posted on the Investor Relations section of our Web site at Tecogen.com. Before we begin, I would like to remind you that this presentation includes forward-looking statements within the meaning of Section 27A of the Securities and Exchange Act of 1933, and Section 21E of the Securities and Exchange Act of 1934. Such statements include declarations regarding the intent, belief or current expectations of the company and its management team. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that can materially and adversely affect the actual results as identified from time to time in the company's SEC filings. Forward-looking statements provided herein are as of the specified date and not reaffirmed or updated at any time. I will now turn it over to John, Co-CEO, for some opening remarks. John?

Ariel, thank you very much. Ladies and gentlemen, I would like to take pride and thanks to the team headed by Ben Locke and Bob Panora, for their wonderful success they are making of Tecogen. It appears and I hope it's going to continue for years to come. And with that, Ben can give you heck of a lot of better information than I can and with that I would like Ben Locke to take over.

Thanks, John. So I would like to start off the call by reminding those who may be new to the company about Tecogen’s core business model shown on slide 4. Heat, power and cooling that is cheaper, cleaner and more reliable. Our proprietary technology for improving efficiency, emissions and great resiliency is truly disruptive to the traditional methods of heating, cooling, and powering buildings and infrastructure. Tecogen’s clean energy technology has been revolutionizing distributed generation for residential, commercial and industrial customers for over two decades. This is an exciting time for Tecogen and our shareholders. The third quarter of this year saw Tecogen achieve several important milestones that will set the stage for long-term success of the company. Turning to Slide 5. First and most significantly, we obtained not only cash flow positive results for the quarter but achieved profitability of just over $200,000 and as I will detail later in the call, we achieved this through significant margin improvements, not just through increased revenue. Second, as announced last week, we entered into an agreement to acquire American DG Energy, which subject to shareholder vote and SEC approval, will create a vertically integrated, merged company with dependable annuity type revenues from ADG assets, adding to the existing revenue streams of Tecogen. I will address the key areas of importance of the merged company in just a few minutes. And lastly, we have made great progress with regard to our Ultera emissions technology. We received research grant funding from the Propane Council to demonstrate the viability of our emissions technology in fork trucks. This program which is not part of the ULTRATEK automobile project, aims to develop a retrofit emissions system for fork trucks to reduce their emissions to levels acceptable for air quality and indoor work environments. This work will build off of and supplement ongoing activity within ULTRATEK emissions technology project. Also we obtained air permits for our Ultera retrofitted standby generators in the South Coast air quality management district. This district has the strictest emissions regulations in the entire country, if not the world. And if once source tests are complete, we will be the first natural gas engine to be permitted under these strict emission limits. Bob will provide more detail on both these endeavors later in the call. So on Slide 6, I would like to go on a little detail and point out the key developments that have allowed our sales team to become more successful for this quarter and expecting success through the fourth quarter and into 2017. First, we are seeing very positive reception of our newest product offering, the InVerde e+, and our new equipment monitoring package built around GE Equipment Insight. The new e+ with improved efficiency, better economics, quieter operation, lower turndown and rapid black-start for emergency standby capability, along with other improvements, reinforces our goal of providing customers with the most advanced clean energy technology available. There are no other engine driven CHP systems in our class that can match these attributes. Next. Our cloud-based monitoring capability using the GE Equipment Insight system allows both customer and our Tecogen service experts the ability to monitor and analyze equipment performance in real time. It also gives customers a portal and dashboard to instantly view savings and operating metrics, reinforcing the equipment's value proposition. Turning to sales. We are continuing to see strong repeat business with our core project partners. These partners are a mix of mechanical and/or electrical contractors, ESCOs, property management companies and visionary project developers that see the benefits of our advanced CHP systems and Microgrid technology over any type of system. A new market for our gas engine driven chillers is also emerging. The advent of indoor growing facilities for new markets such as medical marijuana and hydroponic growing facilities, have stimulated the need for chillers that do not require significant amount of expensive 3-phase power for large electric chillers. And because of our clean emissions from a CO and NOx standpoint, the CO2 exhaust from our engines can actually be piped into the growing area which accelerates the growth rates of the plants and eliminates the need for growers to purchase expensive canisters of CO2 currently used. While we did not ship many chillers in the third quarter, we currently have ten chillers and heat pumps in our backlog with many more projects in the development stages. Similarly, we are seeing increased awareness in sales of the products offered through our joint venture, TTcogen. Initial sales are focused around the smaller 35 kw CHP system but as we build new relationships and expand existing relationships, we expect to increased sales of the larger megawatt systems as well as sales in the biogas applications which were not possible with the existing Tecogen equipment. So turning to Slide 7. I will review the key financial metrics for our company, revenues, margin and sales backlog. Our revenues were a little over $6.6 million for the quarter compared to $4.7 million in the third quarter of last year. This revenue increase is due to a 53% growth in product sales over the prior year quarter, primarily attributable to increased co-generation sales. We also a 34% increase in service revenues over the prior year quarter. Our gross profit for the quarter was approximately $2.77 million compared to $1.67 for the third quarter of 2015. Operating expenses for the quarter decreased 2.6% from the third quarter 2015 to a little over $2.5 million. And keeping with our goal to deliver full year operating expense near $10 million. We continue to believe our effort to keep OpEx contained is paying off and we are on track to reach this goal. All of these improvements contributed to an increase in our overall gross margin to 41.9%, compared to 35.7% in the third quarter of 2015. This is well above management's targeted range of 35% to 40% gross margin and is a direct result of product enhancements, manufacturing efficiencies and overall cost saving measures. And most importantly, as I previously mentioned, we achieved the bottom line positive net income of just under $208,000. This milestone is a result of substantial effort by management to get better performance out of every aspect of our business. From sales to service, manufacturing to engineering, we have put Tecogen in a position for continued success going forward. Moving on to the backlog on Slide 8. Backlog at the end of the third quarter was $11.4 million and as of Monday, November 7, backlog of products and installations was at $13.1 million, well above management's goal of maintaining backlog above $10 million. Note that this backlog is for Tecogen products only and does not include service nor does it include any orders received by TTcogen for Tedum products. The backlog for TTcogen is starting to grow and we expect to get more detail on it in the coming quarters as it becomes material to Tecogen revenues. Dave will give some more details on the financials in a few minutes but needless to say we are pleased with the results of the quarter and hope to build on it in the coming quarters. Turning to Slide 9. I would like to now discuss the recent announcement of Tecogen's acquisition of American DG in a stock for stock merger. As many of our investors know, American DG has been a customer of Tecogen's equipment and maintenance service since they were spun out in 2005. Since then ADG has grown their North American fleet to 92 systems totaling 5445 kilowatts of installed capacity with total approximate lifetime contract value of $203 million. In 2015, ADG undertook an initiative to scale back on short-term growth plans and focus on improving operation and profitability of their existing fleet with the goal of optimizing margins, improving cash flow and overall stabilization of the balance sheet. As the results of ADG's past few quarters indicate and further emphasized by the results released this morning, ADG has made tremendous improvements along these lines. Many of the improvements in ADG's operations were a direct result of more interaction with Tecogen engineers and ADG operations from early 2015 to now, to help diagnose and fix their fleet. In the past, Tecogen's service technicians would just provide maintenance on the CHP units and were not involved in the engineering and operations of their systems. In 2015, ADG began outsourcing the complex engineering and diagnostics of these systems to Tecogen. As a result, through the dedication and reinvigorated efforts of the ADG staff, the fleet has made tremendous strides. While there is still more that can be done to further improve the ADG fleet, it became clear that the synergy between the two companies were compelling and the prospect of a merged company became a priority for Tecogen. So as detailed in the press release last week, both boards of Tecogen and ADG unanimously approved a definitive agreement where each share of American DG stock will be exchanged for 0.092 shares of Tecogen stock, pending stockholder and SEC approval. We see four areas that the merger will benefit both Tecogen and ADGs shareholders. First, there are many areas of operating cost improvements such as duplicative auditing and corporate expenses. The merger also allows far more efficient service of the ADG fleet, for example in the past a Tecogen technician would travel in a Tecogen vehicle to the site to perform maintenance on the CHP unit. And a separate ADG technician in an ADG vehicle would travel to the site to perform maintenance on what's called balance of plant, which is the ancillary heat exchangers, pumps and other equipment ADG maintains to keep the system in good working order. The merged company will allow more efficient deployment of service from a time and travel standpoint. Similarly, having a consolidated inventory will improving purchasing economic and shipping cost. We expect to identify other areas for operational and administrative cost savings as we move forward with the integration. A second aspect of the merger will have a beneficial impact on Tecogen's financials as the associated depreciation values of each side. Currently, ADG has very good cash flows and margins from their fleet but because of depreciation, the financial picture is not compelling. When the merger occurs, an asset revaluation will occur which will significantly decrease the depreciation expense on the fleet. So on Tecogen's book, the fleet will have a much healthier financials then they did on American DG's books. Third, with full control of the sites, Tecogen can now contribute even more technical guidance and engineering effort to improve site operation and profitability. We anticipate even better cash flows from the ADG fleet than already dramatically improved cash flows we have seen in the past quarters. Last and most compelling, is the steady, [predictable] [ph] revenue streams that Tecogen will have from the ADG fleet. This revenue stream along with our steady service revenue stream will help dampen the ebbs and flows of the sales cycle to provide a more predictable cash flow and financials for the company. As the press release indicated, on a combined basis, approximately half of the company's annual revenue is expected to be from stable, long-term contracted sources. In conclusion, we believe that the acquisition of American DG will substantially enhance Tecogen's prospects going forward as a vertically integrated, technically advanced company. I would like to now turn it over to Bob for more discussion on our progress with the Ultera emissions technology, followed by Dave who will give some more details on the financials. I will then wrap up with some final remarks before we take questions. Bob?

Good morning, and thank you, Ben. I will be updating listeners on the technology development today in three areas. First, I will discuss our progress on bringing online the special generators in the Southern California that were retrofitted with the Ultera emissions system, such that our customer could operate these units without annual hourly limitation. Second, I will discuss the research grant awarded to Tecogen last month from the propane industry for adapting Ultera technology to propane fueled fork trucks. Lastly, I have an update regarding the progress made by our subsidiary ULTRATEK in the automotive application of Ultera. In our previous earnings reports we discussed a So Cal project that concerns a customer owning equivalent natural gas fuel generators that need to be operated frequently. As the run hours exceed the maximum allowed for emergency generators, the units must the standard for continuous power generation. These are the same standards as our co-generation products where we have successfully permitted. However, the simple generator receives no heat recovery credit in sending its emissions level under the standard. As such, the emissions levels required to meet these engines are the lowest we are aware of anywhere and not have been achieved by any engine. As reported before, a sample generator was purchased in 2015 and fitted at Tecogen with the Ultera system. It worked extremely well and the customer proceeded to apply for permits for this test generator and also for their existing on site units that would be retrofitted. Last October, the phase two order was received for Tecogen to ship the test generator to the customer and complete the retrofit in the others. The PO was for about $0.5 million. The test generator and retrofit kits were shipped in Q4 of last year. Events unrelated to the project, however, delayed the program for the first part of this year. However, the delay now has ended and the project is again proceeding in earnest. We are pleased that the generators have received their permits to operate as been said, and we will be proceeding to, with onsite retrofit work over the next few months. The operating permits require a third party source test to be completed within 180 days of commissioning. The customer will schedule the order and timing of the test but we would anticipate the generator that we ship from our factory already fully equipped with the Ultera system to be the first on that schedule, most likely in Q4. I want to reiterate the significance of the successful outcome of this program, achieving these limits is essentially the same as a fuel cell, will enable simple generators to be applied without hesitation to demand-response and [piece saving] [ph] applications. An important milestone for the Ultera technology. Moving on to October 18 announcement regarding fork truck application for Ultera. As announced, the Propane Education and Research Council, PERC, has provided the company with a research grant to demonstrate Ultera emissions reduction capability in a propane fueled fork truck. I want to point out that the technology rights for the fork truck application reside with Tecogen and were specifically excluded from our agreement with our automotive focused subsidiary, ULTRATEK. The project has significant benefit potential for this industry as these vehicles generally operate indoors where health concerns are magnified. In recent years, the market share for propane trucks has been eroded by battery operated versions and to a large extent because of this issue. This market loss has occurred despite significant disadvantages of the battery systems. That is they are more costly and often unable to operate a complete full shift because of energy storage limitations. We have received strong interest from the industry and have obtained written commitment from two leading manufacturers to work with us in a development effort. The program will start in the beginning of 2017 and is scheduled to be completed in nine months. Our task at hand is to demonstrate the emissions impact of a fork truck equipped with the Ultera device. The truck will be supplied by one of the partners. The work will be completed at the Tecogen facility in Waltham and again it should complete in nine months. I want to mention that the market size for propane trucks is approximately 70,000 units per year in the United States and that’s the propane ones. The electric ones are also pretty close to that number and of course worldwide it's a very big market. ULTRATEK is the next topic that I want to cover. ULTRATEK is of course the 50% owned, Tecogen subsidiary formed in January whose purpose is to demonstrate the emissions after-treatment process on gasoline-powered vehicles. This work has been funded primarily by strategic investors in Europe and of course is related to the heightened awareness of pollution brought on by the Volkswagen scandal. In our last call and the one previous, I pointed out that this story has not subsided and that it was still actively being reported. That assessment remains accurate today as the follow-up continues with major developments being reported even in the last week. For the Ultera process, the fit of course is for gasoline engines, as I have said before. This category has not been implicated in any improper testing. However, there was a growing awareness that the pollution output measured in a controlled laboratory dry cycle significantly under represents the true emissions output of vehicles of this type of real world driving. As such, there was an expectation that the certification process will be altered in some aspect to correct this short coming. The Ultera strengths are well suited to this issue because the system provides robust performance, especially in the extreme edges of operation of that being high acceleration-deceleration, heavy loading, so forth. Recently, we remain aware that our assessment that the shortcomings are the existing certification methods would eventually be modified to include some sort of supplemental on road testing was indeed validated. In fact, over the next few years the EU certification will phase in a portion of the process to include on-road testing. The test protocol specifically applies to the EU 60 emission regulation which will implement real driving emissions or RDE in 2017 to 2020 timeframe. A Reuters news story from October 14 articulates that the stress the RDE protocol will cause automakers, General Motors, Renault and Volkswagen. These makes have announced that their highly advanced small engines, both diesel and natural gas -- I am sorry -- both diesel and gasoline, may not be viable when subject to the RDE test. This will result in a return to larger, less efficient engines that are less susceptible to the emissions irregularities that would be exposed by RDE. Thus, we are encouraged by this development as it sets a highly positive regulatory environment for our technology without requiring a special effort on our part. We are hopeful that the RDE type of protocol will be incorporated into our domestic certification process at some point. During our last call I discussed that we would begin a second phase of vehicle testing at AVl involving two vehicles. One with European emissions package not sold here, the other European but with a U.S. certified emissions system. The testing was completed as scheduled, just wrapping up at the end of October. We were successful in accomplishing our goals for this second phase. The Ultera device was fine tuned and more accurately sized for the test vehicle, providing us with excellent documentation of the system's effectiveness through a wider range of simulated driving conditions. We were able to showcase its effectiveness with the type of vehicle, highlighted in the Reuters news story as being problematic. A very small high-powered, NC engine vehicle featuring a very small high-density engine with these advanced features for fuel economy. We have scientific paper related to our ULTRATEK project and process. Specifically two abstracts several months ago, were accepted by the Society of Automotive Engineers or SAE, as topics for upcoming conferences in early 2017. The data from this second phase testing was included and highlighted in fact in the first paper draft submitted last week for the SAE peer review. That paper will be for an April conference. We will provide our draft to the second conference later this month. With this second phase completion in the SAE papers, we will have a solid foundation to move forward to engage the industry and we look forward to updating you on our progress in the future. That concludes my discussion. I will turn the call now to David Garrison to discuss the financials.

Bob, before you do this, this is John Hatsopoulos, maybe you should mention how much cash we have in this partnership, so people don’t worry that we run out of money.

I wish I had that number in fact, but I would say it's roughly $12 million. Something like that that’s still on hand, yes.

So, we are very well capitalized.

Yes.

That’s the point I was trying to make. Thank you.

Well, thanks, Bob. Here is some highlights from the year on year financial results. Total revenues increased 41% compared to the same prior year period and 16% on a sequential basis. Product revenues grew 53% compared to the same prior year period and 18% on a sequential basis. The volume of the co-generation modules showed steady growth with a special increase in the new InVerde e+ modules. Total service revenue continued its steady growth delivering well over half of our revenues for the quarter. The company posted a 10% increase in service contract and parts revenues on a year-over-year basis. This increase was the 15th consecutive quarter of year-over-year quarterly contracts service revenue growth. Year-over-year comparisons, adjusted for the seasonality of that cogen service revenue. These long-term contracted maintenance and service agreements accounts for nearly one-third of the total company's revenue providing a reliable annuity like revenue stream. Cost of sales in products realized many benefits from the improvement implemented with the e+ line of InVerde. The new product has cost effective manufacturing processes that will further reduce costs with the continued growth in volume. Service costs continued improvement as the installation group focused on higher value added services coupled with operational efficiencies from our maintenance and service experts. With combined gross margins of over 40% and product margins at 40%, management is at the high point of our target range and the highest quarterly gross margin achieved since the start of public reporting in 2013. Gross margin improvement and expense reduction programs continue as management focuses on maintaining these strong margins in the future. And of course, to note, we were profitable for the first quarter since public reporting began in 2013 as well. Looking at the graphic charts that we track our metrics. Starting with the chart in the upper left hand corner, total revenue for the trailing four quarter period is $21.6 million, a year-over-year decline, while the quarterly revenues have been improving over the past nine months, we expect the recent growth cycle to continue into next year and in the longer-term, benefitting from our other joint venture initiatives. The chart in the upper right illustrates the growth in our gross margin. As you can see on a trailing four quarter basis, management delivered a gross margin of 38%, solidly in our targeted range of 35% to 40%. We expect cost controls and sales initiatives to continue to deliver margins growing to the top of that range. In the lower right is a chart of our operational expenses. Management's efforts to lower operating expenses has been producing results. Our goal of delivering approximately $10 million in operating expense for the full year remains solidly in place. Finally, in the lower left, the backlog chart plots our weekly backlog, currently at $13.1 million, as of Monday, November 7. This backlog is well ahead of management's goal to exceed $10 million in product and turnkey service revenue. As a reminder, backlog does not include the service contract revenues or the sales of Tedum products by the TTcogen team. The targets of the company remain the same. Management works to meet its goal to continue delivering gross margins in the 35% to 40% range, maintain a backlog of product installation sales above $10 million, and deliver stable operating expenses or approximately $10 million on a 12-month basis. And with that, I will turn it back to Ben Locke for closing remarks.

Thanks, Dave. In closing, I would like to thank Tecogen's shareholders for their dedication and patience as we shape the company for future success. I am encouraged by the accomplishments we have all achieved in all aspects of our business. We have a great team of engineers, service technicians, sales professionals and business leaders that have contributed to reaching the success our shareholders expect. Going forward, we expect to build on the achievements of the third quarter. Our relationship with strategic partners for CHP projects are strong and will continue to contribute repeat sales. No other CHP products can provide the technological innovation and economic savings of our products. Our reputation and history as a provider of reliable power and turnkey installation and service of CHP systems is unmatched. Our addressable markets quadrupled with the addition of TTcogen equipment and additional chiller market applications. We have substantially improved our operating expenses and cost of goods sales which has improved our product margins. We have reached an agreement with the American DG to acquire a fleet of assets that provide a steady reliable stream of cash generation for many years going forward. And lastly, we are positioning Tecogen to maximize the potential of our Ultera emissions technology. Whether it be through our stationary engine retrofit projects, as evidenced by or south coast air permit success, our PERC funded fork truck program which had cleared the fine channel to commercialization, or our ULTRATEK automotive joint venture with game changing economic and environmental impacts. It is clear that our patented emissions technology will ultimately contribute substantial financial gains for the company going forward. And as I stated at the beginning of our call, it's a great time to be a Tecogen shareholder. I am excited to welcome American DG shareholders to our family when we finalize the merger approval process. Lastly, we owe much of our success to the vision and insightfulness of our founders, John and George Hatsopoulos, who have personally invested and guided us so we can reach this point. Without their perseverance, we would not have reached the milestones that we outlined today. With that, I would like to turn over to the operator for questions.

[Operator Instructions] Our first question comes from Sameer Joshi of Rodman & Renshaw. Please go ahead.

Congratulations on a great quarter. As far as the American DG merger goes, do you expect any regulatory challenges for ultimately closing the deal?

We really don’t. We haven't had any pushback from anybody up to now and we think, unfortunately, it's a 40 page filing with the SEC. But after that, hopefully we will be well on our way.

Okay. And in terms of revenues, should we expect chiller revenues to be lumpy or do you expect them to be low going forward because it has been lumpy as you know, but going forward do we expect them to be at this level.

Yes. The chiller revenues, they follow a seasonal cycle. Most folks want to get their chillers replaced before the cooling season starts in April-May timeframe. So the smart ones get their orders in the fourth quarter and then the guys that drag their heel get their orders in the first quarter and then, of course, for us to get them in. So it's lumpy in that aspect, Sameer. You know we see the trickle of orders start to come in in the third quarter. We typically see a fair amount in the fourth quarter. As I mentioned, we have got a bunch in the backlog already. And then the intent is to get them built, tested and delivered, so they could be installed by the cooling season. That’s for the northeast. California, it is a little more steady but that’s generally your answer there.

And as far as the fork truck opportunity goes, how close are you to revenues. I mean I know it is just the beginning for you given the PERC funding, but after nine months do you think you will actually have one of these partners that you are working with, like receive orders from them.

Yes. I think that certainly is too soon to tell. Bob and his team are looking forward to getting the project done with PERC. And one aspect of the project that is exciting, as Bob mentioned, we did receive letters of support for two fork truck manufacturers and we are going to get a fork truck from one of them. So that allows us for a lot of interaction with them as the testing goes one. And if we are successful, presumably we will be able to talk with them about some type of business arrangement. But what that might look like is too early to tell right now.

And one last one from me. As far as European regulatory market for RDE is concerned, how quickly do you think, 2017 to 2020, but when do you see yourself being a player in that sector.

I think, this is Bob Panora, thanks for the question. I think it's a little too early to tell as well it has to really unfold with dealer conversations, with suppliers, and we are not there yet. But I think the fact that they want to be faced with this problem I think will help a lot with the interest. And then we will see where they have the biggest problems. But we really haven't got to that point so [early] [ph] to say.

And I would say that it's been the stated objective of ULTRATEK to get the data and have an unassailable compilation of that data. And working with AVL is part of that strategy. They are a very reputable automotive testing facility. The SAE paper is a significant validation that our data will be accepted because the most important aspect as you might imagine in approaching any type of business arrangement with this, whether it's with a automobile manufacturer or component supplier, the most important thing is to make sure our data is unassailable and verified by all accounts. So that’s the task I had hand for Bob and they have done an admirable job getting there thus far. And I think 2017 is going to be an exciting time as we start to consider the business arrangements for ULTRATEK.

One thing I want to add to this is that this, and I know that we have said it before but I am repeating it to remind everybody that this technology is fully patented and insured by Lloyd's of London. So it's not as if companies can go and copy and tell us like they did years ago at [Thermoelectron] [ph]. Sue us, you will run out of money. In this case, it's Lloyd's of London to run out of money. So we are fully protected on our patents and our technology.

Our next question comes from Amit Dayal of Rodman & Renshaw. Please go ahead.

Congrats on all the progress. It looks like a lot of interesting catalyst building up over here. I will just limit myself to one question and a follow up with you after. On the gross margin improvement, you look really impressive. My question is, are these sustainable and then what does the American DG merger do to the gross margin?

Sure. I would start to answer that and I will ask Dave to fill in areas that need more detail. But achieving this margin, it wasn’t a fluke. I will tell you that. We have had a lot of product improvements. We have done a lot of work with the supply chain, with our vendors, with our manufacturing process. All of which are geared towards the margins higher on our products. So I think these margins are sustainable. Of course they are going to vary from time to time but I think this is the range of margins that we have been shooting for and we hope to going forward. Now turning to the ADG margins. The ADG margins are quite healthy. The work that ADG had done in the past few quarters to improve each of their sites performance and get more run time, has done a lot towards getting good margins. Where ADG just had a trouble financially is the depreciation associated with those sites was quite high. So once you included depreciation, the gross margin was very low. But on a pure cash flow basis, on a non-EBITDA, a non-GAAP EBITDA cash flow basis, very good margins. And I think they are going to be consistent with the margins that we are already having here at Tecogen.

Great. Just one more from my side. Any TTcogen sales in the third quarter?

Any TTcogen sales?

Yes.

Yes. We have sold a few units. Some are in the stages of, and as you can imagine, we don’t build them here, they are built by our European partner. So we had some sales orders in the third quarter. They arrived here and now they are going to be dispatched to the sites to be installed. And we have an additional backlog, again we have not disclosed the backlog of TTcogen yet. It's still kind of in the early stages. As I mentioned, most of the orders in the near-term are going to be these 35 kw units. And there was a natural pent up demand for those things because as we in our natural course of Tecogen sales come across buildings or 100 kilowatt unit is oversized, would only run 3,000-4,000 hours a year, perfect for these 35 kw. So it was a natural built up market for 35 kws. It was kind of the first areas for us to investigate and we are having a lot of traction there. And I expect in the coming quarters, I will probably be giving more color to what the sales volume is for TTcogen and the backlog, just not quite there yet.

Our next question comes from Alex Blanton of Clear Harbor Asset Management. Please go ahead.

Just a comment at the beginning, I don’t know it's my equipment of yours but the sound keeps cutting out every couple of minutes for a brief second, so you miss numbers and things like that when that happens. I don’t know why that’s happening.

We will talk with our call service and make sure that is fixed.

Cool. Now you mentioned that OpEx was down and of course this effected your margin and your profits. So what's the limitation on that? New sales, product sales are at 53%, [indiscernible] about 10% but operating expenses down. How long can you keep that going before you have to raise that operating expense and what's the target on the percent of sales for that item.

Alex, this is Dave Garrison. Right we don’t measure or think about operational expenses that way. We have a team right now that is not at what we would consider a capacity problem looking forward. So we don’t expect that to rise in the near term. Obviously, if other areas of the company accelerate dramatically we would consider expanding those rolls and that would possibly increase the operational expenses. But again at this time and in the near term, we are very focused on keeping those costs at that level.

I understand that but eventually it will have to go up. So I was wondering what is your target percent of sales for that.

Yes. We are not going to provide any projections on that.

Okay. All right. Secondly, the merger American DG, is that going to be accretive?

Yes.

Will be accretive, how much can we look at there?

Alex, it's too early to tell. As you might know the process, reaching the deal was an important milestone. Now it becomes the kind of climb of Everest to get the SEC approvals, to get the necessary documentation together. And I don’t think we want to be putting anything out there until that’s all done.

Okay. What kind of revenue did they have? What's going to add to revenue?

Their revenues -- you can look at their filing this morning, but it's around $1.5 million per quarter. I think it was a little over 1.5 this quarter.

What's this filing you are talking about?

Oh, ADG released their earnings this morning.

Okay.

Yes. We are not giving you inside information because it's public already and at 1 o'clock we have an ADG conference call, which you are more than welcome to participate and we will cover a lot of these questions at that time.

Do you have the dial in number for that?

You can look at the press release, Alex. It's all in there. I mean we are going to [indiscernible] Tecogen stuff here.

Alex, this is John Hatsopoulos. Maybe we don’t have you on the ADG mailing list, we will make sure as soon as I leave this room to send that to you right away.

Okay. Thank you. Now the margin, the gross margin you mentioned, I wasn’t quite clear on what you said. After you have combined, the gross margin will be consistent, looks like you have?

I think so. I can't say within exact points but, yes, we don’t expect any substantial deviation.

Okay. I kind of [indiscernible] alluded it all, okay. And what do you feel is a longer term -- I mean you have reduced cost now and talked about more efficient processes for manufacturing. Do you have a target for gross margin? What's possible there?

Yes. Alex, we have consistently given our guidance on what our target is for gross margin between 35% and 40%...

No, but you are above that now because you have improved your processes. So obviously that target is out the window. Isn't that...

I wouldn’t say it's out the window.

You have said for the mix. Mix could affect it. But aside from that, I mean you are above that now. So where are you going?

Well, at this point we are not going to change our outlook for margin. I think we are comfortable with what we have stated and if we feel it's time to change our outlook, we will do that.

Okay. It's kind of like your backlog target. You are way about it but you are still maintaining the same target. So it's kind of out of date. The other thing, on ULTRATEK you mentioned major developments in the last week and then you mentioned something, a Reuters news story. Is that what you are talking about, the major development or is there something else?

Let me, I will try to answer questions, it's Bob Panora. Hi, Alex. We were thinking or hoping that from the industry, people we talk to, that there would be added pressure on regulators to make the testing more difficult. In other words by including driving on real roads where you couldn’t really prepared the test, which would make the emissions of vehicles less good and perhaps lead to problems. And the major development that’s happened Alex is that the Europeans, as we had rumors, they actually have adopted what they call RDE, which is real driving experience, whatever it was to RDE. And that will be phased in over the next three where vehicle manufactures will have requirement of a on-road test with portable equipment in the trunk, so to speak, where they will have to show the performance. And they have publicly, these three vehicle manufacturers have publically expressed their concern through that Reuters news article on October 14 where they are saying, if our trend has been to very small, high density, power density engines that are turbocharged, so on and so forth to get very, very good gas mileage. They are saying that’s going to reverse that. We are not going to be able to use those type of engines anymore. We are going to have to go back to bigger displacement, naturally aspirated engines that will not pollute as much but they are going to use a lot more fuel on the road. So that’s a great news for us because our anticipation of that has happened with this, real driving requirement has been put into the regulation. And that’s an opportunity for us because that’s where we shine. I hope I answered your question, Alex.

Alex, if you don’t mind we are going to take -- since we are getting close to the top of the hour here, we are going to move on and I would be happy to follow up with you offline if you have further questions. Operator, next question, please.

Our next question comes from [Michael Cook] [ph] of Oppenheimer. Please go ahead.

This question is, I guess directed to you, Ben. What's the current status of the Ilios project? What are we doing there and what plans do you have to expand that effort?

Sure. Ilios is doing quite well. In Ilios, it's kind of fallen into the sales channel, very similar to our chiller sales. Because the water source unit that we have talked about in the past, I am sure you know, provides chilling to the building as well as the heat. It ends up being a candidate for buildings that are looking to supplement their chilling. So we are having good success with that. Sometimes in Ilios lead with lead to a chiller lead, which is good. Sometimes a chiller lead can lead to an Ilios application if they need something undersized. So that’s my long way of saying that Ilios product sales are doing well. The fleet is absolutely growing. I would like it to grow a little quicker but being somewhat of a new product there, you meet with a little bit of more work on the engineering community to accept and spec it in. So that’s my long answer of saying, Mike, that the Ilios is still doing quite well.

I should add that it's now part of Tecogen.. it's not a separate company anymore. So we have merged it in the revenues of Tecogen.

And one follow up on Ilios. What's the mix between power sources? Between natural gas and propane. And are you emphasizing one over the other?

Yes. I think it's mostly propane because, again, the value proposition for it is, you tell them that we are going to put this unit here and you are going to use two-thirds less propane that what we are using before. If that was two-thirds less gas, that would be an okay number, but natural gas is under $1/therm typically, propane is upwards of $3/therm. So you are telling these folks that they are going to reduce their propane build from $80,000 a year down to $30,000 a year. So it finds itself in markets where propane costs are very high and that leads you to all sorts of great places to travel otherwise I don’t get to go there. Like the Caribbean Islands and places where propane costs are very high.

[Operator Instructions]

We have to move on pretty soon, we have the ADG conference call. If there is one more question we will do it over the next three or four minutes and that’s about it.

[Operator Instructions] Our next question is a follow up from Alex Blanton. Please go ahead.

I just wanted to mention on that Reuters news story, you might want to put that on your Web site so it's available to everybody because it sounds like that’s a major development.

Yes, I agree with you. I thought about that as I was doing the script last night and we will look to do that.

Yes. Right. We expect, Alex -- it's a good comment. We expect to have several updates to our Web site in the near future. So we will absolutely make sure that gets up there.

Thank you, everyone.

Thank you, everybody. Thank you very much. I apologize for shutting it off at this point because we got to get moving for our next meeting.

Thank you very much, everyone. I would like to thank everyone for participating. This concludes today's conference call. You may now disconnect.