Tecogen Inc. (TGEN) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Tecogen Third Quarter 2017 Results Conference Call. If you'd like to listen to the webcast and view the presentation, please go to the Investor Relations section of our website, and under News and Events, you'll find a link to the webcast. At this time, all participants are in a listen-only mode. A question-and-session will follow formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bonnie Brown, CAO, Treasurer and Secretary. Thank you, Ms. Brown, you may begin.

Thank you, Bob. Good morning and thank you all for joining our third quarter earnings call. On the call with me today are John Hatsopoulos and Ben Locke, our co-CEOs; Robert Panora, our President and Chief Operating Officer; and Jeb Armstrong, our Director of Capital Markets. Before we begin, I'd like to read our Safe Harbor statement. This conference call and any accompanying documents contain forward-looking statements within the meaning of the safe harbor provisions of the U.S. Private Securities Reform Act of 1995. Forward-looking statements can be identified by words such as anticipate, intend, plan, goal, seek, believe, project, estimate, expect, strategy, future, likely, may, should, will and similar references to future periods. Examples of forward-looking statements include, among others, statements we make regarding expected operating results such as revenue growth, gross profit and backlog; and strategy for growth, product development and market position. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include among others the following: decrease in interest in our products, the elimination of incentives and rebates related to our products, competing technological developments, issues in the research, development and commercialization of new products, Tecogen's inability to obtain sufficient funding and such other factors as discussed throughout the Risk Factors section of Tecogen's 10-K that was filed with the SEC on March 31, 2017 and can be found at www.sec.gov. Any forward-looking statement made by us in this conference call and any accompanying documents is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise. I'll now turn the call over to John Hatsopoulos for some opening remarks.

Good morning, ladies and gentlemen. As some of you that have been with us for a long time know, our business vacillates from quarter to quarter and day to day. And right now, today is one of the best periods of our short life. Not only is our backlog well over $16 million, and Ben Locke will give you the exact amount, but our cash in the bank is $2.8 million and we are expecting momentarily to receive from our - the dissolution of ULTRATEK on which, by the way, we have all the signatures of the shareholders and their approval, so we'll get another $1.6 million. So, you add this up we'll have something like $4.4 million in cash, so that we can have enough money to fulfill all the orders that we're receiving. On our backlog, by the way, we don't include the backlog of ADG, which is many years to come. With that, I'd like to ask the man that really runs the operations, Ben Locke.

Thank you, John. The third quarter of 2017 was very important for Tecogen, and that it was the first full quarter integrating American DG financials into Tecogen's financials. As I will cover in a few minutes, we are realizing many of the benefits we expected from the acquisition. As the agenda on Slide 4 indicates, I'll start by reviewing the company's performance and financial results for the quarter along with recent achievements and accomplishments. Bob will then give an overview of our emissions technology development, followed by Bonnie with more detail on the financials. I will then have some final remarks on future opportunities we expect to see as the year comes to an end and we look forward to 2018. Then we'll take questions. But first, I would like to start off our call by reminding those who may be new to our company about Tecogen's core business model shown on Slide 5, heat, power and cooling that is cheaper, cleaner and more reliable. Our proprietary technology for improving efficiency, emissions and grid resiliency is truly disruptive to the traditional methods of heating, cooling and powering buildings and infrastructure. And with the acquisition of American DG completed in Q2, we have added the on-site utility business to Tecogen, making us a completely vertically integrated clean technology company able to offer equipment design, manufacturing, installation, financing and long-term maintenance service. As the third quarter results show, the ADG fleet contributed solid revenues with good margins that supplemented Tecogen's earnings for the quarter. Turning to Slide 6, we're quite pleased to see the financial benefit of a full quarter of ADG supplementing the performance of Tecogen. Total revenues were a record $8.5 million for the company as compared to $6.6 million in the third quarter of 2016 and $7.6 million last quarter, which only had about half of the quarter ADG revenues included in it. Product sales dropped for the quarter as compared to the third quarter of 2016, which was a record quarter at the time, and last quarter. But this is mostly result of timing of shipments, where the customers were not ready to accept delivery of some equipment until after the quarter ended and is not indicative of any negative trends with sales. As John mentioned, this is reflected in our backlog growth, which I will talk about in just a few minutes. Service revenue showed good growth, coming in at $4.5 million for the quarter as compared to $3.8 million in the third quarter of 2016 and $3.7 million last quarter. This is a result of increased installation activity for our turnkey projects. ADG's contributions to the revenues was a bit under $1.6 million as compared to $774,000 in the second quarter, which are only at about half the quarter numbers. This revenue contribution is consistent with our expectations and helped dampen the effects of lower product revenues in the quarter. Gross profit for the quarter was a record $3.3 million versus $2.8 million in the third quarter of 2016 and $3 million last quarter, again a result of the ADG contributions. Although selling and R&D expenses increased by about $225,000 for the quarter, and we incurred about $37,000 in residual merger related expenses, our operating income was approximately positive $86,000 for the quarter, compared to $249,000 in the third quarter of 2016 and a loss of $246,000 last quarter, which included the bulk of the merger related costs for the ADG transaction. This, of course, does not include non-quantifiable costs of the transaction such as management time and focus, which can now be better implemented on overall company growth. Adjusted EBITDA was $296,000 for the quarter as compared to $64,000 for the second quarter. As a reminder, it has been ADG's practice when reciting earnings to show non-GAAP EBITDA such the on-site business model is capital intensive and depreciation is a substantial part of the financials. Despite a considerable reduction in the depreciation basis that occurred as a result of the acquisition, it is still helpful for investors to see the non-GAAP EBITDA for the consolidated company. Margins for the quarter came in at 38.3%, which consisted of slightly lower product and service margin of around 35%, but helped by ADG's margin contribution of about 53%. The lower product and service margin is the result of product mix as well as higher installed revenue for the quarter, which is typically lower than service and product margins. The bottom line is a net income of around $27,000. This makes four out of the past five quarters of profitable operation for the company, with the second quarter of 2017, in which we completed the ADG transaction being the exception. Our goal is to continue this trend of profitability, as we look toward to 2018 and beyond. And as John mentioned, while it's not stated in our earnings release, our current cash balance is approximately $2.8 million, and once the ULTRATEK dissolution is completed as John described, we'll receive an additional net of $1.6 million of additional cash, putting us in a comfortable position from a balance sheet standpoint. Turning to Slide 7, I'd like to spend some time reviewing our achievements for the quarter. As you may have seen from some of our recent press releases, we're making strong headway with our Tecochill product for indoor growing facilities. In the third quarter alone, we announced sales of five chillers total to two different cannabis-growing facilities in Massachusetts and three chillers to a cannabis growing facility in Florida. We also sold two CHP systems to a cucumber grow facility in Ontario. The Tecochill product line in particular is ideally suited to meet the needs of indoor growers, because not only does it leverage the relatively low cost of natural gas to power the cooling process instead of expensive electricity, all of the free engine waste heat can be recovered and used to offset the heat needed to meet the dehumidification requirements of these grow facilities. And as an added benefit, the units can provide a virtually pollution-free stream of CO2 to aid in plant growth, thanks to Tecogen's patented Ultera emissions technology. Farmers of high-value crops such as cannabis invest a tremendous amount of capital each growing cycle. It's not simply a matter of efficiency and operating cost savings, but also reliability. These orders are indicative of the increasing awareness and interest in our product, and we expect additional orders in the coming quarters as these grow facilities are established in different states. We have also seen an increase in our full turnkey installation segment. It is often the case with residential buildings that they ask for factory responsibility for all aspects of a CHP project, including construction and contracting. While this entails generally low construction margins for these projects, it also ensures that these projects are completed as designed with the projected savings met, which is sometimes a risk when outsourcing construction to a third party. It also ensures healthy long-term service revenues, which typically have good margins for the company when the installation is done properly. And of course, our backlog continues to grow as we receive more orders. And I'll come to that in just a minute. Turning to Slide 7, with regard for drivers for additional growth, we continue to expand our base of ESCO partnerships. As we announced earlier this year, Tecogen was contracted to perform feasibility and design studies for over 1 megawatt worth of new projects with a leading energy service company, or ESCO. These projects are still on track and although state and local approvals take time, we expect them to result in equipment orders in early 2018. We have also developed a similar batch of projects with a different leading ESCO for upwards of 900 KW of CHP for various buildings contracted with this ESCO. And pending similar state and local approvals, we expect orders for those later in 2018. Additionally, we commissioned two sites in the third quarter with two smaller ESCOs, who generally focus on one to two-unit projects. This is the third project with one of those ESCOs and the second with the other. Lastly, we are working with a project financing group on several large projects initially projected to be over 2 megawatts in total. Of course, we will provide more detail on these projects as they close, but suffice to say, our activity with ESCOs is growing as we had hoped, mainly due to the time and effort of our business team here at Tecogen. Next, as I mentioned, we are keeping track of upcoming state approvals for new indoor growing facilities. As other states such as California issued permits for indoor growing, we are working with engineering and construction companies to specify our equipment in the design. Moving to the ADG fleet, Bob and his team continue to make progress improving the fleet operation and profitability. While the team has made remarkable progress over the past year on top-level improvements, the work now requires more in-depth analysis. But nonetheless, it is continuing to improve the fleet, albeit at a more modest rate. And of course, we are continuing to identify ways to save the money, the company money in the long run and adjust to the consolidated company, including implementation of new internal software systems, which will ultimately improve our operational efficiency. We are also continuing to invest in our sales team. We have extended our sales agent network considerably in the first half of the year, allowing us more opportunities for projects via commissions rather than direct hires. We are also exploring advanced sales acceleration tools to help generate new leads and streamline lead qualification and project development. We will continue to invest in the sales team going forward, as it has shown in the past 12 to 18 months to be the best way to grow the business. Turning to our emissions technology, there are three main areas, where we will focus attention in order to establish a business model that can monetize our proprietary Ultera technology. I'll review this briefly, then Bob will provide more details. First, we are near completion of the prototype retrofit of a fork-truck emission system with some exciting results. Next, we completed the installation of an emissions package on the stationary generators seeking California air permits. And lastly, we're determining next steps to commercialize our technology for automotive applications. Again, Bob will give more detail on these efforts in a few minutes. Turning to our backlog on Slide 8. Our backlog at the end of the quarter was $14.5 million, a quarter-end record as compared to $11.9 million in the third quarter of 2016. And current backlog as of Wednesday, November 8, yesterday, stands at $16.8 million, well above our guidance to maintain backlog over $10 million. So, with that, I'd like to turn it over to Bob for more detail on our emissions technology development. Bob?

Good morning, and thank you, Ben. My discussion today will cover our three emissions technology programs that I've been reporting on regularly. Specifically, I will first discuss the research grant awarded to Tecogen from the propane industry for adapting the Ultera technology to propane fueled fork trucks. Second, I will discuss our progress in bringing online the special generators in Southern California that were retrofitted with the Ultera emissions system such that our customer could operate these units without annual hourly limitation. Lastly, I will review what's happening with ULTRATEK, a subsidiary to adapt the Ultera technology to gasoline-powered vehicles. As we reported in our October 26 press release, the investors in Tecogen have agreed to dissolve the venture. This was due to unresolved differences concerning business strategy. As such, I'll provide a summary of where the research program stands and then I'll recap the status of the dissolution process, and describe what future scenarios might look like. Let's begin with the fork truck. As announced last year, the Propane Education and Research Council, PERC, has provided the company with a research grant to demonstrate Ultera's emissions reduction capability in a propane fueled fork truck. The project has significant 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 to a large extent because of this issue. This market loss has occurred despite significant disadvantages of the battery systems. They are more costly and often unable to complete a full shift, because of energy storage limitations. The program commenced this January, and this proof-of-concept phase is scheduled to be completed at the end of this year. From the program onset, industry interest was strong because of the acute importance of managing emissions in the indoor setting. As such, we were able to quickly secure a commitment from a major fork truck maker to support the Tecogen engineering team and to supply a fork truck with our testing. The truck was received in the first quarter and we have completed testing to characterize its baseline emissions profile. The baseline testing confirmed our expectations, that is, most of the emissions output from the fork truck was during times when the truck is very active, lifting and so forth. During these periods, emissions control is significantly compromised, a familiar problem and one for which the Ultera process was designed to remedy. Our expectations therefore are that our technology can be very impactful to the emissions profile of the fork truck. Our primary effort over the past four, five months has been the integration of the Ultera system into the truck. For this program, we have worked hard to make this integration well refined. As a result of these efforts, the finished system is compact and integrated into the truck without being outwardly visible or obtrusive. Slide 9 shows the fork truck's exhaust system as received from the factory, and below, that same view after the Ultera upgrade. As shown, the Ultera system fits very well into the space. And we were careful to utilize well-known components from the auto-industry, repurposed as the building blocks for the Ultera retrofit kit. Consequently, they can be well characterized in terms of cost and reliability, very important considerations, when the system is scrutinized by the industry. We are now just beginning our testing, and we hope to have results in the upcoming weeks. And I want to point out that executives from the manufacturer and PERC are tentatively planning to visit Tecogen in December to review the prototype operation first hand. My second topic is the upgrade to a group of generators in Southern California, which I have discussed in the past. The project concerns a customer owning a group of natural gas-fueled generators that need to be operated frequently. As the run hours exceed the max allowed for the emergency generators, the units must meet the standards for continuous operation. These are the same standards as our cogeneration products, where we have been successfully permitted. However, the simple generator receives no heat recovery credit in setting its emissions level under the standard. As such, the emission levels required to permit these engines are the lowest we are aware of and have not yet been achieved by any engine. As reported before, a sample generator was purchased in 2015 and outfitted at Tecogen with the Ultera system. It worked very well, and the customer proceeded to apply for permits for this test generator and also for the existing on-site units to be retrofitted. After the facility staff overcame - after the facility staff of our customer overcoming some unrelated technical issues with the final generator, we are pleased to report that all the generators at the facility have been retrofitted with the Ultera system and commissioned for their normal intended use. In formal testing using our portable emissions analyzer has confirmed that all units are compliant to the Southern California standard. We anticipate the customer will now, in fact he must source test the units in the very near future, probably in the upcoming month, at which time we will have independent confirmation of our emissions reduction capability applied to this very stringent application. As I've said in past calls, we're very pleased to be near the goal of permitting these engines of various sizes and brands to this most difficult emissions standard. However, we want to report a regulatory setback that may limit the market potential for Ultera, at least to some degree in California. In a recent California Public Utility Commission action, fossil-fueled generators, except bio-fuel sourced, have been prohibited from being eligible for utility funded demand response programs. We struggled to understand the logic here, as peak shaving with clean generators helps to support the grid for more base-loaded solar power at a very low cost without significant greenhouse gas impact. Nevertheless, this is the situation. It does not prohibit peak shaving, whereby the customer schedules operating time to directly curtail the facility's demand charges. That application would still exist, and I think it's actually the most lucrative application. As far as we know, no other states have precluded fossil fuel generators from participation in these demand response programs. Now our ULTRATEK discussion, beginning with a review, ULTRATEK was formed in January 2016 to adapt Tecogen emissions after-treatment technology, Ultera to gasoline automobiles. The opportunity was created, of course, because of the Volkswagen scandal. The focus of the scandal was diesel engine emissions, which is not a suitable application for Ultera. However, the reporting as it expanded raised significant questions about gasoline vehicles as well. These questions did not involve dishonest testing in any way, but rather concerned the validity of the certification tests. The prescribed tests, which are completed under a controlled laboratory setting, were considered to greatly understate real-world driving. The Ultera technology was well-suited for gasoline vehicles, and hence the opportunity was evident to us. Over several rounds of funding, approximately $13 million was raised from investors, with Tecogen ownership settling in at about 43%. Over the course of 18 months, we tested the Ultera system on gasoline automobiles from Europe and from the U.S. utilizing the AVL Test Center in California. The results were as we had hoped. The Ultera process was highly effective in reducing emissions, both in the standard certification tests, but also in conditions outside the narrow boundaries of these tests. These would be conditions simulating aggressive driving or driving uphill or with a load in the vehicle. During 2017, we published our results in the SAE International Proceedings, which provided a peer-reviewed scientific forum for showcasing the technology. This year we met with several companies in the industry, both suppliers and automakers as well as regulators, from which we gained important feedback about where Ultera might fit commercially. The technical team was also engaged in developing our patent portfolio. During the year, we obtained several Ultera related patents and completed applications for four new ones. The strategy disagreement arose from two schools of thought as to what we should do next. On one side, most of the investors advocated for the termination of this development effort as the technology was considered proven and we can now - we should now focus on finding a commercial partner. The contrary opinion held by Tecogen is that the value of the technology is much greater if we have taken the extra step of developing a refined prototype showing a practical design, the cost and reliability of which can be accurately assessed. In the end, we could not reach a compromise and it was unanimously decided to dissolve ULTRATEK and distribute the unspent funds per the terms of the shareholders' consent agreement approving this action. As part of this disbursement, Tecogen will receive its invested funds of $2 million in cash, and the sole exclusive IP that it licensed to ULTRATEK. Tecogen will then purchase for all the non-cash assets of ULTRATEK, including all intellectual property for $400,000. The IP includes two awarded patents, four patent applications, and all the data and knowhow associated with the emissions testing performed at AVL. As we mentioned in the press release, and John of course mentioned earlier, the outcome is a positive one for Tecogen. We have added a net of $1.6 million to the balance sheet while gaining complete rights to the technology, including the valuable knowledge accumulated over 18 months of successful research. The dissolution process is proceeding rapidly per Luxembourg law, where the company is registered. We are confident the paperwork and disbursement will be sorted very soon, as we have gotten all the necessary signatures from all parties involved. So, the process now is a legal one that's I think very routine and straightforward. This will allow Tecogen to move forward to raise funds to continue the ULTRATEK program, perhaps under a similar arrangement although we have not made any decisions to the structure of the research entity that we might form. With that, I'll turn the call over to Bonnie Brown.

Thank you, Bob. I'd like to start with a discussion regarding the merger with ADG and how it is presented in the financial statements of Tecogen for those who may not have joined our second quarter call. Since ADG became a wholly owned subsidiary of Tecogen as of May 18, ADG's operations are included in and consolidated with Tecogen's operations as of that date. Said differently, revenues and cost of sales for our new energy production revenue stream includes the operations of ADG only after May 18, essentially six weeks in Q2 and a full quarter for Q3. Also, the purchase accounting has not been finalized and balance sheet values are presented as provisional pending completion of the necessary valuations and analyses. Moving on to the quarter, Slide 11 contains some of the highlights of the year-on-year financial results for the third quarter. First, total revenues increased by 28.5% compared to the same period last year. Product revenues alone fell 14.9% compared to the same period last year, with a 30% decrease in sales of cogeneration modules and a 176% increase in chillers and heat pump sales. Total service revenue grew 20% compared to the same period last year and continued its steady growth, delivering well over half of our product and service revenues for the quarter. Service contract and parts revenue were flat on a year-over-year basis. These long-term contract maintenance and service agreements account for a substantial piece of the company's total revenue, providing a reliable annuity-like revenue stream. We also have our new energy production revenue stream from our ADG subsidiary, which added $1.6 million to our total revenues for the quarter. This revenue stream adds an important second source of annuity-like revenue with its long-term contracts. Product gross margin was 37% for Q3 2017 compared to 40% for Q3 2016. This decline is due to the product mix in the respective quarters, with chillers accounting for a higher percentage of the product mix in Q3 2017 as compared to 2016. Service margin declined to 34% compared to 43.5% from the same period last year. Installation projects, which carried a lower margin than service maintenance contracts, were a higher percentage of the product mix than in the same period last year, bringing the service margin down as a whole on a comparative basis. Combined product and service gross margin up 35% for the third quarter of 2017, can be used as a comparable to Tecogen's historical pre-merger business, which was 42% for the same quarter in 2016. Energy production activities from the ADG fleets provided 54% margin, bringing our consolidated gross margin to 38.3% for the quarter and consolidated gross profit to $3.3 million from $2.8 million for the same quarter last year. Gross margin improvement and expense reduction programs continue as management focuses on maintaining and improving these margins in the future. Net income per share, basic and diluted, was $0 for the third quarter of 2017 versus $0.01 reported in the same period of the prior year. Other comprehensive income of $39,000 represents an unrealized gain due to market fluctuations of the shares of EuroSite Power Inc., owned by our subsidiary, ADG. This gain represents the fluctuation of market price from quarter-to-quarter with an unrealized gain or loss recorded as other comprehensive income or loss at the end of the period, in accordance with GAAP's mark-to-market rules. Turning to Slide 12, which presents historical adjusted EBITDA trends, we achieved positive non-GAAP adjusted EBITDA for the quarter, as Ben discussed earlier, approximately $296,000 as compared to $383,000 for the same period in 2016, a decrease of $87,000, which is essentially due to the increased selling expenses of $136,000 and increased R&D expenses of $88,000. Over the trailing four quarters, adjusted EBITDA was approximately $730,000. This chart shows that we have sustained the step-up and profitability that was achieved in the third quarter of 2016. At the same time, we've invested heavily into the company's future through increased investments in selling and R&D activities over the first nine months of the year. Turning to Slide 13, let's review the graphical charts to track our metrics using the trailing 12 month's model. Starting with the chart in the upper left corner, total revenue for the trailing four-quarter period is at $30 million, including the energy production revenue and $27.7 million without energy production. The energy revenue is represented by the small gray right most bars in the chart circled in red. Because energy revenue only represents earnings of about four months and this chart represents annual revenues as a trailing four quarters metric, this revenue appears insignificant for now. This is the introduction of ADG's revenue contribution, which will grow with time. The chart in the upper right corner illustrates the growth trend of our gross margin. As you can see, on a trailing four-quarter basis management delivered a gross margin of 39.5%, at the top of management's targeted range. We expect cost controls and sales initiatives to continue to deliver these margins. In the lower right corner is a chart of operational expenses. Although higher in absolute terms, operational expenses improved 2.2% year-over-year as a percentage of revenue, dropping to 37.3% of revenue for Q3 2017 compared to 38.2% for Q3 2016. Management's cost control effort continues and remains a focus going forward. There are three components to the rise in expenses. First is the consolidation with Tecogen of the costs associated with ADG's operations. Second is the increased investment in R&D and selling expenses. And third are the onetime costs associated with the ADG merger, which were approximately $37,000 in this quarter. And finally, in the lower left corner is our weekly backlog chart, currently at $16.8 million as of yesterday. This backlog is well ahead of management's goal to exceed $10 million in product and turnkey service revenue. Additionally, ADG's estimated undiscounted future energy production revenues, which are not included in backlog figures, exceeds $50 million stretching over the next 15 years. And likewise, backlog does not include service contract revenues. The targets of the company remain the same. Management works to meet these goals and deliver these gross margins and backlog targets that we have continued to maintain through this period. Now I'll turn the call back to Ben to conclude our discussion.

Thanks, Bonnie. As I mentioned earlier in the call, we are quite pleased with the third quarter results. The contribution of ADG revenues allowed us to maintain profitability despite slippage in some shipments out of the quarter. Having this flexibility makes it easier to stage product shipments without the pressures and occasional inefficiencies of meeting quarterly deadlines. We expect robust product orders in the coming quarters as we continue to make good progress with our direct sales efforts, interactions with ESCOs, and continuing need for our chiller systems. We expect sustained and mostly predictable revenues and margins from the ADG fleet. The first full quarter of ADG revenues demonstrated the acquisition was beneficial to Tecogen in many ways. And as the integration continues, we hope to build on their contributions. Next, we will continue to grow our revenues and margins through our core business of product sales and service. Our CHP systems are becoming increasingly acknowledged and specified as the best technical choice for CHP in our size range. Our chillers are becoming the standard design for indoor growing facilities, and our relationships with key partners continue to grow and expand. And environmental pressures and grid resiliency concerns continue to support the trend towards Tecogen products. We have demonstrated tremendous financial growth over the past few quarters, culminating in our record revenues this quarter. We are planning on continued success going into 2018, including making renovations to our building to facilitate a larger production area needed for increased product manufacturing. While we have not outgrown our building yet, we have the ability to reconfigure office and administrative space to accommodate more production area to support our expected growth. It is truly an exciting time for Tecogen. And we hope that our new and existing investors will realize the full potential of our technology and success going forward. With that, I'd like to turn it over to the operator for questions.

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Amit Dayal with Rodman & Renshaw. Please proceed with your question.

Thank you.

Good morning, Amit.

Good morning, guys. How are you doing?

Great. Thank you.

Just to begin with, maybe if you could talk about what we're doing to maybe revive some of the weakness in the cogeneration sales?

Yeah, Amit, I tried to say in my remarks. I don't see it as a weakness at all. It is quite cyclical, the - particularly with our turnkeys, Amit. If you can imagine a turnkey sale, as I mentioned before, involves Tecogen contracting and doing all the construction ourselves. So, for example, in the third quarter we had that big spike in cogen sales. Some of those installations are finishing up, so it really is kind of timing. I don't see it being a trend at all. I expect to see our cogen sales to be right back, where they normally are in the coming quarters. So, it's - it's not something I'm worried about, and I don't think it's anything that any of you guys should be worried about.

Understood. That's good to hear. And then again on the margin side, last quarter we saw some sort of installation related costs driving or pressuring margins a little bit. We saw it again this quarter. I thought this would probably be only be for a onetime thing that we would see last time, but it looks like, it's persisting. Any color on where margins will trend relative to how the backlog mix is looking like?

Well, I fully expect to maintain our range of margins that we always try to between 35% and 40%; and agreed, yes, on the low end of that. And you're right, it is an artifact of - we're doing installations. And as anybody knows, doing construction is a low-margin business. But we generally accept that and are okay with that, because as I mentioned, having these - doing all the construction ourselves really does ensure that the installation is done right, which more importantly means we're going to get five, 10, 15 years of really good margin service revenues, because we won't be having to clean up the mistakes that might have been made if we weren't involved in the construction. So, yes, we have a slug of installations that are kind of going through the system right now, pulling down the margins a little bit. Also, the product mix, the margins are a little bit different for each of our products. Obviously, we're trying to get our margins up on every product. But those things kind of came together, not in a really bad way this quarter, but just in a way that brought it down a little bit to around 35%. But again, I don't think that - I don't think you're going to see a trend of that going down any further. I think we're always going to be in that trending area of 35% to 40% with our margins, particularly as our product sales kind of rebound a little bit.

Understood, perfect. What plans do we have for ULTRATEK going forward? I know you just dissolved everything. You're probably digesting all of that. But are you looking to pause over here for a little bit or are you actively looking for new partners to potentially work on this?

I think - well, first and foremost, we're just trying to get the administrative task of, and the legal task of getting ULTRATEK dissolved in place and get all parties sorted out. And then, as Bob indicated, once that's done, which we expect to be soon, quite soon, certainly the end of this year, if not in weeks. Then we'll have, as Bob said, the intellectual property that evolved ULTRATEK as well as free control or complete control about what our next steps are. So, we had contemplated next steps for testing. And again, once the transaction is complete, I think in 2018 we can probably share with shareholders what our plan is to do. As Bob indicated, the next step is to do some prototype development and to get that tested, and so we believe a very important next step for ULTRATEK, so that when we do go to potential partners or manufacturers or whoever we're going to commercialize it, we'll have something that really answers a lot of their questions right in front of them, and it won't call for them to ask us more questions to do more development work. So that's my long way of saying, I think, we'll be able to articulate a plan for you in the coming weeks and months, but the first order of business is to get the ULTRATEK dissolution. Again, there's nothing - no risk in that. It's just a legal and administrative process we have to go through.

Great, understood, just…

Ben, this is John Hatsopoulos.

His name's Amit. This is Amit.

What's that? You and Ben, I wanted to tell you that our goal is to make this as a spinout like we did at Thermo Electron, because we'll continue with all the patents that we have and the four pending patents that we have. We have tremendous technology behind it. And we'll continue very actively. As a matter of fact, I think over the next few weeks you'll see the creation of probably a spinout that addresses this market for emission control of vehicles.

Understood. Thank you for that, John.

Your last one?

Just one last one for me, guys, in regards to the opportunities with the ESCOs, they look pretty significant. I am assuming they're not part of your backlog right now, right?

It's a great question. The first one I mentioned, which we had been contracted earlier in the year to do scoping studies, et cetera. And as I said in my remarks, we expect those product sales in the beginning of 2018. Those are indeed in our backlog.

Okay.

Some of the other projects with the other larger ESCO I mentioned, haven't been entirely scoped out yet to the point where I'm comfortable putting it in backlog. And as a reminder, what we consider backlog is, obviously, if we have a purchase order that's backlog. But also included in backlog are orders that are essentially in place, it's just that a PO is imminent. So those latter orders are not in the backlog. So, when we do get more clarity on them and believe me, you'll be first to know it, all of our investors will be informed when we get those orders. They'll be included in our backlog.

So, roughly, out of the 5 megawatts you potentially have, one is in backlog and three are still pending, roughly?

Yeah, that's correct.

Okay. Okay.

And I should say it's a mix of products, and that - with both those ESCOs, it's a mix of our InVerde, it's a mix of our Tecopower, it's a mix of our chillers, different components, which is actually very good that these ESCOs are recognizing that there's different tools that they can apply to their projects based on the customer and the economic returns of them.

Understood. Thank you so much.

Sure. Thank you, Amit.

Thank you. Our next question comes from the line of Patrick Murphy with Maxim Group. Please proceed with your question.

Hi, Patrick.

Hi. When can we look for the impact of the Ultera emissions to come through? Is this a 2018 or is this more of a 2019 event?

Well, I'll let Bob describe a little bit in more detail, but I will just say that there's kind of two distinct events that could occur to some type of monetization. One is with the fork trucks and one is with the ULTRATEK. And as I've said in the past, the fork truck is nice, because it is you can imagine a faster time line towards work, developing some type of business arrangement, whether it'd be with a fork truck company, whether it'd be any other type of partnership. You can imagine that happening a little bit quicker. And as Bob said, we expect to be meeting with those folks this year to talk about next steps. In terms of the ULTRATEK, maybe I'll let Bob talk a little bit about that.

Yeah. Is that what you were referring to? Which of those three programs were you referring to?

Well, I guess both of them, the fork truck and ULTRATEK.

Right, and so the time line on the fork truck, as like Ben said, I think in December we're going to meet with the manufacturer and PERC. And then, I think, we'll have some clarity on that. And we have to show them that we can do what we said we can do in person. And then I think the next step will be, hopefully, some sort of partnership to build maybe some prototypes, but I don't know yet. On the automotive side, we have a pretty good idea. And we've met with some subcontractors to do this. We have to create a very tight vehicle that has the Ultera implemented into it in a very practical, compact, low cost way; and that will require about a year-and-a-half, we think. And we have a good idea of who we're going to work with and how that's going to happen. But I have not - I don't want to mention that yet, because I haven't got a contract yet with those folks.

Okay, and then on ULTRATEK, would there be an increase in operation costs, if you brought that in-house?

You mean the cost of the research or…?

Yes.

I don't think the process will be any different than what we've done. Much of the work is subcontracted out to these engineering folks like AVL. In this case, it's a different company. But the - it's a subcontracted effort, and the costs will be higher than perhaps Phase 1 was, because we're actually building something more substantial. In terms of what's being done in-house at Tecogen that cost was borne by the ULTRATEK subsidiary, so it wasn't any cost on our P&L, if that answers your question.

Yeah, that's…

By the way, I would like to add to this, that we have a whole list of investors that want to participate in this venture. And as a matter of fact, I made more enemies than I've ever made in my 60 years of people that did not - were not allowed to participate in the investments for the emission control. The problem was that the investors that of ULTRATEK up to now insisted that we have somebody that has a very close connection with the automotive industry. And that's why we did not allow other investors, even though they're terrific investors and they've been very long-term investors to participate. The second question that came in, and it surprised the heck out of me, is that in Europe you're allowed to do a rights offering on any product or technology that you have. In the United States, you're not, because a lot of our shareholders are not high-net-worth individuals, and they're not allowed to participate. Therefore, we could not do a rights offering that we only give rights to wealthy people and not rights to less wealthy people. So, if we do a spinout, which every intention is to do so, then we will have to face this again. Thank you.

Thank you. And then just one more quick housekeeping item. Are there any residual merger related costs remaining?

Yes, we do expect to have some more costs associated with the merger.

Okay, great. Thank you very much.

Thanks, Patrick. Do we have any more questions, operator?

Our next question comes from the line of Roger Liddell with Clear Harbor Asset Management. Please proceed with your question.

Hi there, Roger.

Hello. First, a quick comment, I applaud the focus on the texture that we received today on the ESCOs. That is an area that should be of considerable interest to prospective investors as well as current ones. And so, I hope that there will be comparable focus in future quarterly calls on the evolving ESCO relationships. My question involves grid resiliency. We have two unwelcome things that have happened recently, and looking back to earlier 2017, a welcome one. What I mean is the hurricanes and Florida, I don't know enough about Texas and its electric pricing issues, but Florida certainly the electric infrastructure got hammered. And I should like to think that there would be a tailwind, no pun intended, for not just CHP, but also the chillers in nonagricultural purposes and also for heat pumps. Puerto Rico, could there be any opportunity - a direct, identifiable opportunity created by that problem? The more welcome one is Con Ed and the New York City - I'm sorry, New York State, REV proceedings and consequences from the New York Public Service Commission. So, could you sketch out, are we seeing, are we likely to see any meaningful bump as a consequence of hurricane activity and the REV process and playing out through Con Ed?

Yes, great questions, Roger. I'll handle the yours - the latter part of your question first, which is the REV thing that's playing out in New York. And we're quite involved with that. As you can imagine, it's important to us - for us to be able to contribute to that discussion. There are a number of things in place with REV that have consequence to us, not the least of which is the ability or the potential ability of CHP to be able to export. Even if you don't monetize that export, it's got value to us. So that's just one of many issues that are kind of being discussed under the REV proceedings. And us directly as well as us in some industry groups, and NYSERDA and the like are involved in that. And I think it's going to have a good outcome for us. It's a process and we got to work through it. Back to your original question about the hurricanes and the terrible tragedy that's been going on as a result of natural disasters, in the near - we've - I'll start with Puerto Rico. We've got some sales agents in Puerto Rico. We don't give that exclusive to anyone, so there are project developers down there. But certainly, we've been in close contact with as all of these things have unfolded. And CHP is not an immediate solution to those things. Standby generators are what people immediately need in those things. But I think, what we're seeing now is people looking at CHP, and maybe they wouldn't have accepted the ROI in the past. Let's say, you're a hotel and you're looking at a - it's a high electric rate, as you know, Roger. But also, the fuel prices are quite high down there. So, the spark spread isn't as big as you'd think, because they're working off of propane or what have you. And as a result, maybe putting in a CHP system or a chiller system might have an ROI of five or six years, which might be above their threshold. But now, as they really recognize the resiliency piece and as anything goes, until you've actually experienced it and you start to realize the importance of resiliency. I think, we're going to see a softening in a lot of the - our core metrics in Puerto Rico, and in Texas, and in Florida as people really start to value this resiliency piece. So, I think we're not getting orders today, because of those things, but what we are seeing is some of the discussions we've been having in the past starting to be rekindled, because they see the resiliency having enough value to warrant maybe a little bit longer of an ROI. And we're being very active in that regard, Roger. We're - again, we've been talking with the Puerto Rico sales agents about this and rejuvenating some projects that might have been mothballed, because of longer ROI. We're doing the same in Texas and in Florida. And I mean, I hate to see our business benefit from such terrible events like that, but ultimately, it underscores resiliency, as your question started off with. And it's very valuable, and I think that's something that our products are going to, hopefully, help people out with.

Yeah. Thank you.

Thank you.

Thanks, Roger.

[Operator Instructions] Our next question comes from the line of Michael Zuk with Oppenheimer Company. Please proceed with your question.

Good morning, everybody. I have an IT question and a financial question.

I can't wait for the IT question, Mike.

The IT question is, it looks more and more that in electric grid management that blockchain technology is beginning to enter that area. Is that a type of technology that we will eventually employ?

Well, you caught me flat-footed on that one, Mike. You stumped me. Tell me what blockchain technology is, if you can, briefly.

Well, basically, it enables you to gather disparate information and to apply that disparate information in a methodical way so that you can, in live time, increase the monitoring and the efficiency of operating units to coordinate them between each other. For instance, if you have like the Stevens series of installations, where you have different buildings, some of which may or may not be connected. It will enable you to very efficiently monitor all of the systems in total and individually and to transfer, if necessary loads from one system to another system seamlessly without having the intervention of an individual making the decision.

Yeah, Ron, I mean...

Michael.

Mike, sorry. I'm trying to think how that would apply to us. But the demand response programs that our cogeneration systems do participate in act sort of like that, but I don't know that it's quite - there's no human interaction. But there is - it's heading that way, where units will be dispatched not by a phone call and not by an e-mail, but they might be done by some automated system. And the inverter system we have is going through a next generation of certification to the [UL Standard] [ph], and the new standard has something very interesting in it. It's based on what happened in Germany. That inverter will have to ride through different scenarios that could be caused by too much DG on the grid. But the second phase two years from now or whenever, it's not this year, a few years out, is that that inverter has to communicate with the utility. And the utility will be able - this includes solar systems, and we would be included as well - we'll have to be constantly, there will be some automated way of telling us to maybe back off or increase and so forth, if it causes crises in the grid - if there's some overload situation coming or something like that. So, I don't know if that, I think that's the closest thing I can come up with to describe what you're asking, Mike.

I think there's a white paper out there that I've got access to. I'll forward it to you, and you can take a look at it.

Very good, very good, very good.

And then secondly a question, I guess, for Bonnie on the liability - on the condensed balance sheet. We have unfavorable contract liability, which I think came from ADG. And then, in the non-GAAP financial disclosure line, we have depreciation and amortization. And I guess, my question is how much of the depreciation and amortization is going toward the amortization of that unfavorable contract liability, and will that be a straight line, or will it be more of a fluctuating amortization?

It will fluctuate. It will decrease as time goes on, as contracts run out. So, I believe it was somewhere in the neighborhood of 160 as the offset to depreciation.

And the average amortization will be over a period of what, 9 or 10 or 11 years, based on the contract length?

Right. It's going to be based on the contract life. So, it could go out as far as 15 years; some of them do. But - and that will be the furthest out.

And amortization is done on a per-contract and not an aggregate basis?

That's right.

Okay. Well, so in other words, that will be a long-term benefit for us in the reporting of non-GAAP financial items?

Yes, for sure, yeah.

Just wanted to clarify that.

Okay.

That's all I have. Congratulations. It looks like [Multiple Speakers] on all fronts.

Thank you, Mike.

Thanks again, Mike.

Thank you. Our next question comes from the line of [Tom Aur] [ph], who's a private investor. Please proceed with your question.

Hey, good afternoon, guys. How are you?

Hi, Tom. Doing, great.

Hi, Tom.

Hey, Ben, John, Bob. Hey, a couple of things on ULTRATEK. So, I'm just looking back at when the partnership was formed, I think in December 2015. And if I recall, the investors bought - they put money in, they bought a bunch of Tecogen stock. I think it was 800,000 or 900,000 shares. Now we've had a strategy disagreement with those investors. We dissolved the partnership. Do we have any kind of an agreement with them with respect to them potentially exiting their Tecogen stock, the 900,000 shares they bought? Are they free to sell it? Do we know if they're going to sell it? What's our sense there?

Tom, this is John. To start with, I apologize. My hearing was never that good, but right now my two-year-old grandson has managed to give me some kind of a cold, and neither my speech nor my ears are working well. There is no agreement whatsoever. And as a matter of fact, some of the investors even disagreed among themselves. Some of the investors were interested in continuing this process, because we had from automotive companies all acceptance that that technology works. What they were looking for is a prototype that can fit under the hood. And the disagreement, by the way, was do we want to try right now to go to them and ask them to make that prototype at their expense, or we want to do it at our expense. Thank goodness, we're in good financial position right now. And on the advice of one of our Board members whose name is Ahmed - I forget his last name.

Ghoniem.

Ghoniem. Ghoniem. Is that he felt that we would lose a lot of our rights if we asked the automotive companies to make a prototype. And this is where the disagreement came in. The people that bought the shares - the reason I'm telling you all this is they're still very positive on this venture. And as a matter of fact, if we do a spinout, eventually they might also be allowed to invest in the spinout, if there are some complications, financial complications that I'm not allowed to talk about with a small debt that we have with one of our investors. But they're not negative. And as a matter of fact, two of them you know very well, and both of them are in a spar right now in Switzerland, and they have both assured me - I talked to them last week - and they both assured me that they have no interest in selling anything.

All right, fine. But we don't have a signed agreement. The reason why I asked is this. Tecogen's stock is down 30% for the year. The backlog has never been better. The orders have never been better. The deal with ADG is consummated, and yet the stock is just constantly under pressure. Nobody ever seems to want to buy it, no matter what. So, I mean, somebody doesn't like it. I can only say this, look, as just - if I'm just looking at this, not knowing much to me, the dissolution of the ULTRATEK partnership is extremely disappointing. It's not a positive. I mean, we invested almost two years of time in it and have come away with nothing. We had a $13 million valuation on a potential joint venture that's now a zero valuation. You have to reconstitute it. It's probably another one to two years before you get to any kind of a place where you can generate revenues. We're looking at four years all in. That to me is a major disappointment. So, I know you've got the cash on the balance sheet, but I just look at this as a big, big negative. I mean, I really do. And I think that's - I think that's part of the reason why the stock is under a lot of pressure.

Tom, this is John Hatsopoulos. I don't agree with you. And as a matter of fact, you should speak with Ahmed. And if you want me, I can have Ahmed call you. We have four patents applied for. That's why we paid the $400,000 for to retain them, which strengthened our position dramatically. As you know, automotive companies don't move as fast as they should. And as a matter of fact, they do everything they possibly can, not to move on. So, having money for - to develop this is not a problem. Not only we have our own money to do it, but also, we have a whole lineup of investors that are interested in investing in this. And we never...

I get that, but here is the thing. As you know, your edge in technology, proprietary edge lasts for only so long. And so now we've lost - so two years have gone away, and then another two years, and we're a small cap. And before you know it, you lose your edge. So, what's really super attractive today and is patented and is cutting edge, if you don't generate any revenues out of it, before you know it, somebody else finds it or figures it out or someone bigger comes along. I'm just saying that it's just disappointing point of - I think this is a real potential home-run ball for the stock. And almost two years have come by and we haven't generated a penny and we have no visibility on when we'll drive any revenues for this thing. That to me is very disappointing, so I just think it's still theoretical. You can have all the patents you want, but if someone isn't paying for them or you're not licensing the technology, it doesn't be any good.

Yeah. To start with, let me answer it, then I'll let the experts answer you. We as you probably know, these patents are insured with Lloyd's of London. And if anybody tries to copy our patents or violate our patents, Lloyd's is committed to defend us at their own expense. With that, maybe Ben or Bob want to add something to it.

Well, the only thing I was going to add is that - well, Tom, I mean, we know you quite well and happy to talk with you more about it, but I think you're going to be surprised. I think, you're going to be pleasantly surprised, when we - I mean, these are our crown jewels, our emissions technology. It's a lot of work, a lot of work by Bob, a lot of work by Ahmed, a lot of intellectual property, a lot of interest. We've made good progress so far, and if you think about it, all the progress we made at AVL with our vehicle result, we couldn't have done it if we hadn't embarked on what we did with ULTRATEK in the past 18 months. And now, that's all coming back to us in our control. And so, I think we're in a good position. And I can understand your frustration, of course, I do. I look at the share price too. But I think having it under our control and bringing it to a commercial reality in some way, shape or form under our own beliefs and strategy is the best way to go. And I think the fork truck is going to provide our investors and yourself with some more near-term gratification that this is getting somewhere. That's the beauty of the fork truck, as it is something more near-term. So anyways, I can understand your frustration. I appreciate it, but I think we're going to be in - I think, you'll be pleasantly surprised.

I add to this that the forklift will be added to the automotive technology. When we do and if we do a spinout, both the forklift and the automotive will be together, which we couldn't otherwise. And the forklift has much less time to start giving some returns to us than the automotive industry, as far as I'm concerned. Maybe Bob disagrees.

No, you're spot-on. You're spot-on.

Thank you. Our next question comes from the line of Alex Blanton with Clear Harbor Asset Management. Please proceed with your question.

Hi there, Alex. Thanks for waiting patiently.

Can you hear me?

Yeah, we can hear you just fine. Thanks.

Okay, great. On that last point, I disagree also with what the point that was made. You've got the testing done, AVL testing. And that would have had to been done regardless of what happened with the joint venture. I mean, it's going to take time to test and prove out the concept. And so, you...

Except that we didn't have the capital to do that on our own, Alex, at the time.

That's right. But what I was saying is that the person who made that comment didn't take that into account that you're going to have to spend a year-and-a-half testing the product, regardless of whether or not this joint venture survives. So, it's not true that there was a delay. Not true.

Okay, I agree with that.

On the selling in the stock and the lack of buying, it is very low volume. I mean, very little dollar volume changes hands every day most of the time. So, there isn't really a lot of selling. It's very minor selling and it's just a lack of buying. And that is probably due to the fact that there isn't anybody following the stock. Now, you have a hard time finding any estimates at all, never mind a consensus estimate for this company. There's nobody writing on it, there's nobody recommending it, and that is why there's no one buying it. That's pretty simple. Now, I have a question, and you really need to find somebody who's willing to follow a small company. The Street analysts really don't like to do it, because the volumes are low, and they can't really generate any commissions, so they don't bother. But you need to find someone who's really interested in the technology, in environmental impacts, which this has a great deal of favorable environmental impact, someone who believes in that, who is also a sell-side analyst, who can tell people about this company. Because most - I'd say almost all investors have never heard of it, and that's why the stock is low.

Yeah, we do have two analysts, I believe following it, but...

Who are they?

Bob, why don't you let Jeb?

Yeah, Jeb is here. Jeb is…

Jeb's the one that can [create the level for you] [ph].

Good morning, Alex. Actually, afternoon.

Hi.

We do have two sell-side analysts covering us already, both of whom have been on the call H.C. Wainwright and Maxim both cover us.

I missed that, because I got on the call really late, so I missed it. Who is it? Wainwright?

Wainwright and Maxim, so we already have two sell-side coverage.

Oh, Maxim, okay.

Yes.

All right. We need some larger companies doing it. My question really is this.

We can certainly talk about that, Alex.

And I don't know, if anyone's asked this or not, but do you have the capacity to expand your production dramatically? Should you get these orders without expanding your plant and spending money doing it?

Yeah, Alex, this is Ben speaking again. Absolutely, and I kind of alluded to that in the call. I mean, the first - I'm not sure if you've been to our building, but we've got office space.

I have…

Yeah, yeah. So, we've got office space in the front and office space in the back. And not all of it is utilized. It's been kind of ad-hoc. But now that we're looking at making more production, we're going to reconfigure things here, or at least start planning the reconfiguration of it to give our manufacturing floor more space. And we don't need to do anything drastic for that. We don't - certainly don't need another building. So, I think this next stage of growth, we're covered here in our building. If we were to experience the next stage beyond that, a real growth spurt, there are other things we can do. You could start getting more construction going on, but still within our building. I don't think we're at the limits of this building yet. And certainly, there's second shifts and all that, that in a pinch you could go to. And we do that a little bit right now, having folks work a little bit more extra time. So, we've got a few levers to pull to handle this increase in activity, right here where we are.

Well, doesn't that mean that those costs, the facility costs, are fixed? And therefore, if you get greater production and sales out of that same space, you're going to have a positive effect on margins, correct?

You got it.

Because fixed costs are not going to go up, at least not that…

Yeah, we don't plan on putting in any marble or anything expensive when we do this renovation. You know what, Alex, we do things on a budget with one goal in mind and that's productivity, so I think you're right.

Thank you.

Thanks, Alex.

Thank you. There are no further questions at this time. I'd like to turn the floor back to management for closing comments.

Thank you all for joining us on this call. I think we set our record revenue and commensurately set a record length for our conference call. I appreciate all of you for joining us, and we'll talk to you soon.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.