urban-gro, Inc. (NASDAQ:UGRO) Q3 2023 Earnings Call Transcript November 12, 2023
Operator: Hello, and welcome to the Urban-gro, 2023 Third Quarter Earnings Conference Call. As a brief reminder, all participants are currently in a listen-only-mode. [Operator Instructions] Please note that this conference call is being recorded, and a replay will be made available on the company's website following the end of the call. At this time, I'd like to turn the conference over to Dan Droller, Investor Relations at Urban-gro. Sir, please go ahead.
Dan Droller: Good afternoon, and thank you for joining us. Today's call will be led by Brad Nattrass, Chairman and Chief Executive Officer; and Richard Akright, Chief Financial Officer. I'd like to remind our listeners that remarks made during this call will include discussion of non-GAAP metrics, including adjusted EBITDA and backlog. These items should not be utilized as a substitute for Urban-gro's financial results prepared in accordance with GAAP. A Reconciliations of our GAAP net loss to adjusted EBITDA are available in our press release and in our Form 10-Q filed with the Securities and Exchange Commission and can be accessed from the Investor Relations section of our website at ir.urban-gro.com. On this call, we may state management's intentions, beliefs, expectations or future projections.
A landscape architect reviewing a blueprint of a landscaping project.
These are forward-looking statements and involve risks and uncertainties. Forward-looking statements on this call are made pursuant to the safe harbor provisions of the federal securities laws and are based on Urban Growth's current expectations. Actual results could differ materially. As a result, you should not place undue reliance on any forward-looking statements. Some of the factors that could cause actual results to differ materially from these contemplated by such forward-looking statements are discussed in the periodic reports Urban-gro files with the Securities and Exchange Commission. These documents are available in the Investors section of the company's website and on the Securities and Exchange Commission's website. We do encourage you to review these documents carefully.
Lastly, a copy of our earnings press release and a webcast replay for today's call may be found on the Investor Relations section of our website, which again is at ir.urban-gro.com. With that, I'll now turn the call over to Brad.
Brad Nattrass: Thank you, Dan. Good afternoon, everyone, and thank you for joining us today. Slightly over a year ago, we launched the diversification initiative, focused upon leveraging our professional services tend to efficiently seek and build out additional revenue streams for the company. I'm excited to report that we continue to execute and gain momentum on this strategy as Urban-gro has evolved into a multi-sector focused professional services consulting firm. With more than 140 architects, interior designers, engineers, construction managers, project managers, horticulturists and others on our team. We have successfully expanded our operating focus beyond our core controlled environment ag practice to include clients across multiple centers, including industrial, commercial, hospitality, recreation, education and health care.
In regards to our third quarter performance and consistent with expectations, we marked another sequential improvement in both revenues and adjusted EBITDA. Revenue of $20.9 million, a sequential improvement of $2.1 million or 11% came very close to exceeding our all-time quarterly high of $21.1 million reached in Q1 '22. The adjusted EBITDA loss was $1.3 million, a sequential improvement of $0.7 million. And while our significant revenues this quarter resulted in retiring 27% of our Q3 beginning backlog, we signed enough new contracts to drive our backlog entering the fourth quarter to $84 million, a 6% sequential increase. Despite the ongoing headwinds within the CEA sectors, our diversification strategy has served as a source of strength to the company.
Our team is now more efficiently adapting to the shifting environment and we continue to focus on optimizing the productivity of our professional services employees as we work towards a period of more marked revenue acceleration. Although we made some difficult decisions to right-size our staff earlier in the first half of the year, we feel comfortable at current levels given the demand that we see. Now turning to current sector trends. Sector diversification is most definitely assisted in insulating our business from the broader weakness that the cannabis and vertical farming segments are working through. Although the CEA sector remains an important component of our future growth, our success is no longer fully dependent on its success. We've evolved into and are now regarded by our clients as a professional services consulting company that offers turnkey design, build and equipment integration solutions to multiple markets.
Consistent with the second quarter, more than two-thirds of our revenue this quarter was generating in the sectors outside of CEA and included a combination of new projects with both existing and new clients and continues to include top-tier companies and some Fortune 50 clients as well. In the CEA sector, our equipment revenues continue to be compressed by the weak cannabis market. During the first nine months of '23, we have experienced a period-over-period decline of more than $20 million of 18% margin business. While it's impossible to ignore the negative impact that this has had on our financial performance. Our diversification has enabled us to keep our experienced team strong and intact. And as a result, we remain well positioned in the sector, and we'll be ready to handle the surge in demand when the cannabis market rebounds.
This being said, in the interim, we're still seeing steady activity and are expecting to continue to sign design-build contracts in a variety of states. For Urban-gro today and apart from our cannabis clients lacking access to much needed capital, the primary block to more rapidly increasing our business in this market is one that we cannot control. However, it's also one that will continue to slowly dissipate. There are a number of legalized states, like New York, Alabama and Georgia, among others, for example, that have paused the awarding of licenses due to regulatory and legal delays within their state. We have a significant number of clients with projects in these states, some of which have already completed design, but we're confident the move forward of the construction build stage where these delays are resolved and licenses are received.
This is evidenced in the third period where we had two such clients move forward to construction, and we'll continue to announce these successes as contracts are signed. As it relates to our European entity, the size and quality of the company's European pipeline is the strongest it's been since opening the entity since June of '22. While the cannabis markets abroad continue to show green shoots in multiple countries, our European business will still take time to sustainably scale its operations. I was in Europe last week, meeting with both clients and the team, and I can assure you that they remain diligently focused on driving strong returns. Now shifting to our guidance through the fourth quarter '23, demonstrating our ongoing commitment to deliver sequential growth on both the top and bottom line, we anticipate revenues to be approximately $30 million, which I'd add would be a new record for us by more than 40%, and we expect to realize breakeven to slightly positive adjusted EBITDA, which would mark an important shift back to positive cash flow and subsequently meeting our goal that we've been working hard to achieve this past year.
In closing, the company continues to remain closely in line with the interest of our shareholders. In addition to the open market equity purchases made by myself and other directors in the second and third quarters, totaling about 1.5% of shares outstanding. My leadership team demonstrated their commitment as well, led with a 50% commitment for myself, each Executive Vice President and Officer of the company voluntarily opted to take a stock brand in lieu of up to 50% of their base salary during the third quarter. The key takeaways here. First, our Board as well as our leadership team and their teams continue to strongly believe in the future of the company. Second, our diversification strategy is working. It continues to gain momentum, and we have alignment on our goals across our organization.
And third, we're doing everything in our power to maintain this positive momentum. Thank you. And with that, I will now turn the call over to Dick.
Dick Akright: Thanks, Brad. In the third quarter of 2023, we generated revenue of $20.9 million, which represents a sequential improvement of $2.1 million or 11% over the $18.8 million of revenue generated in the second quarter of 2023 and an $8.6 million or 69% improvement over the $12.4 million of revenue generated in the prior year period. The increase in revenue over the prior year period was driven by a $9.4 million increase in organic growth of construction design build revenue, reflecting increases in the number of projects and average size of projects that we are working on in sectors outside of CEA. This increase was offset by a decrease in equipment systems revenue, which, as Brad discussed earlier, we attribute to the ongoing softness in the cannabis sector.
Gross profit was $2.9 million or 14% of revenue in the third quarter of 2023 compared to $2.9 million or 15% of revenue in the second quarter of 2023 and $2.6 million or 21% of revenue in the prior year period. The decrease in gross profit margin for both of these comparative periods was driven by the impact of revenue mix where we experienced a substantial increase in lower margin construction design build revenue as well as a decrease in higher-margin equipment systems revenue. Operating expenses were $6 million in the third quarter of 2023, which, on a sequential basis, is a decrease of $0.8 million. Operating expenses in the third quarter of 2023 are $3.5 million less than operating expenses of $9.5 million in the third quarter of 2022.
The prior year quarter included a onetime business development expense of $3.3 million. But even excluding this one-time expense, operating expenses decreased $0.2 million on a year-over-year basis. Both of these decreases are associated with the company's expense optimization and resource reallocation initiative. Net operating expenses were $0.3 million in the third quarter of 2023 compared to nonoperating expenses of $1.8 million in the prior year quarter. Net loss was $3.4 million or a negative $0.29 per diluted share in the current quarter compared to a net loss of $8.7 million or a negative $0.081 per diluted share in the prior year period. Adjusted EBITDA improved by $0.7 million sequentially to negative $1.3 million in the third quarter of 2023, which is an improvement of $1.0 million compared to the prior year period.
The sequential improvement in our adjusted EBITDA was driven by lower operating expenses, as previously discussed. For the first nine months of 2023, we reported total revenue of $56.5 million compared to $49.7 million in the first nine months of 2022, representing an increase of $6.8 million or 14%. Net loss was $14.0 million compared to a net loss of $11.1 million, and adjusted EBITDA was negative $6.8 million compared to negative $2.2 million in the prior year comparable period. This decrease in adjusted EBITDA was predominantly due to the combined impact of an increase in general and administrative expenses of $3.2 million and a reduction in gross profit of $2.4 million. Turning to our balance sheet. We ended the third quarter with $4.8 million of cash and no bank debt.
To support the strong performance of our construction operations, subsequent to September 30, we entered into a nondilutive asset-based lending facility in order to better manage our working capital. To date, the facility remains undrawn. Our total backlog as of September 30, 2023, was approximately $84 million, reflecting an increase of $5 million or 6% on a sequential basis and $17 million or 25% versus the prior year. This backlog is comprised of $77 million in construction design build, $5 million of professional services and $2 million of equipment systems contracts, and we continue to be encouraged by the increasing number of sectors that make up our backlog. As communicated on past calls, our backlog remains a realistic and trusted indication of our future business.
Supported by our increasing backlog and pipeline, we remain confident that our cash position, combined with our asset-based nondilutive lending facility, will provide us the necessary flexibility to manage through the macroeconomic market circumstances. We continue to remain focused on our execution and returning to positive adjusted EBITDA. That concludes our prepared remarks. Operator, please open the call for questions.
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