urban-gro, Inc. Q1 FY2024 Earnings Call

Hello, and welcome to the urban-gro First Quarter 2024 Earnings Conference Call. Please note that this conference call is being recorded today, April 30, 2024, 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 call over to Christian Monson, urban-gro's Executive Vice President and General Counsel. Sir, please go ahead.

Good afternoon and thank you for joining us. Today's call will be led by Brad Nattrass, Chairman and Chief Executive Officer; and Dick Akright, Chief Financial Officer. I'd like to remind our listeners that remarks made during this call will include a 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. 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. It can be accessed from the Investor Relations section of our website. On this call, we may state management's intentions, beliefs, expectations or future projections. These are forward-looking statements and involve risks and uncertainties. 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 such forward-looking statements are discussed in the periodic reports urban-gro files with the Securities and Exchange Commission. Lastly, a copy of our earnings press release and website for replay for today's call may be found on the Investor Relations section of our website. With that, I will now turn the call over to Brad.

Thank you, Christian, and good afternoon, everyone. And thank you for joining us today. What a phenomenal day for the cannabis industry. As I'm sure most of you are now aware, a few hours ago there were credible reports indicating that the US Drug Enforcement Agency is supporting the Department of Health recommendation to reclassify cannabis from the most stringent Schedule I to the less stringent Schedule III, providing a long-awaited catalyst for the cannabis industry. While there still is a review period to complete with the expected removal of the 280E-related tax burden from the DOJ addressing state-run programs through a guidance memo, we believe many cannabis operators will realize significant increases to their working capital that in turn could be reinvested in their business infrastructure to refresh existing facilities and build out new ones. For the last two years, I'm proud to sit on the board of the National Cannabis Roundtable alongside CEOs from some of the leading multi-state operators in this space. The tireless dedication of MSL leaders like these and the lobbying efforts from organizations like NCR have paved the way for our industry and the exciting wins along the way. As it relates to what this news and the subsequent final approval of rescheduling means for urban-gro's future, it's significant. With over 1000 projects completed in the cannabis market over the last eight years and with 120 employees, including architects, engineers, construction managers, and horticulture professionals, urban-gro is the leading professional services firm in the cannabis industry that refreshes existing operations, designs and builds new dispensary and cultivation facilities and further procures and integrates cultivation equipment solutions. The successful rescheduling of cannabis is a long-awaited catalyst that we've anticipated to reinvigorate an industry that has been facing strong headwinds for the last couple of years. I'm excited to report that in the first quarter, we had positive cash flow from operations and in turn delivered our strongest quarterly adjusted EBITDA results in two years. This improved performance is attributed to both the diversified revenue streams that we've been seeking and building out as well as our focused efforts throughout 2023 to reduce operating expenses on a go-forward basis. Today, our multi-sector focused professional services and design-build firm operates out of offices in three states and Europe, and our targeted markets extend from the cannabis and vertical farming sectors to also include light industrial, commercial, hospitality, recreation, education, and healthcare sectors. Looking at the highlights from our first quarter performance, both revenue of $15.5 million and a slight adjusted EBITDA loss of $0.3 million beat our quarterly guidance. The $3.1 million year-over-year improvement in adjusted EBITDA was driven by a combination of reduced operating expenses and strengthening margins. The margin growth in the first quarter was tied to both increased productivity from our professional services providers, as well as the strengthening of our returns delivered by our construction business, and further backlog remains strong at $99 million. As a result, we are maintaining our guidance to recognize more than $84 million in revenue for the full year 2024 and to generate positive adjusted EBITDA. I'll further note that this does not take into consideration today's rescheduling-related developments, as there are still unknowns, including timing, that need to be clarified. Looking at market trends, diversification has most definitely assisted in insulating our business from the previously discussed headwinds that we've been facing within the cannabis and vertical farming sectors for the last couple of years. Consistent with the sector breakout in 2023, in the first quarter, approximately 72% of our revenues came from the commercial sectors that we serve and 28% from Controlled Environment Agriculture. In the commercial sector, our client base continues to be comprised of top-tier companies that include Fortune 50 and 500 firms, and revenues recognized in the quarter were from a combination of ongoing and new projects. In the cannabis sector, while the market sentiment has been stronger than it has been in more than a year, especially after today, we're actively engaged with clients on multiple fronts. However, cautious optimism has been the status quo for operators so far this year. In the interim, while we wait for the rescheduling narrative to play out in the months ahead, we're expecting to see steady activity and to continue signing both services and construction contracts in legal markets across the US as operators work through persistent state-level regulatory and legal delays. This being said, in addition to today's announcement, there are a couple of key additional catalysts that could result in a significant and sustained positive change in momentum for our business. First, on the federal level, the prospects of successfully passing a banking-related bill by year-end continues to be discussed. This would potentially include a Capital Markets clause that allows plant-touching businesses to list on the larger public market exchanges, providing a more efficient path for them to access capital and create greater liquidity, as this would attract institutional investors that can participate via these exchanges or provide capital directly to the issuers. Second, at the state level, progress continues to be made on legalization in multiple states. We maintain our position that the most impactful change would be in Florida, the nation's third most populous state and one of the fastest-growing in the country. Now that it's confirmed to be on the ballot in November, a successful vote to allow adult-use recreational sales would have a profound and sustained impact for Florida operators and we anticipate for urban-gro as well. In closing, supported by our $99 million backlog, our qualified pipeline, the recognition of last year's $8 million general and administrative expense reduction, and today's positive regulatory developments, we believe that we are well positioned to continue building momentum through the end of the year and beyond. Thank you, and with that, I will now turn the call over to Dick.

Thanks, Brad. In the first quarter of 2024, we generated revenue of $15.5 million, which represents a sequential improvement of $0.5 million or 4% over the $15.0 million of revenue generated in the fourth quarter of 2023 and a $1.2 million or 7% decrease over the $16.8 million of revenue generated in the prior year period. The decrease in revenue over the prior year period was driven by a $0.4 million decrease in construction design-build revenue, which reflected a decrease in the number of projects and average size of projects during those periods. Equipment Systems revenue decreased by $0.4 million and services revenue decreased by $0.3 million, which corresponds to the historical downturn in the cannabis industry. Gross profit was $3.1 million or 20% of revenue in the first quarter of 2024 compared to $1.7 million or 11% of revenue in the fourth quarter of 2023 and $2.1 million or 17% of revenue in the prior year period. The increase in gross profit dollars and margin percentage from both of these comparable periods was driven by the impact of improved margins in Services and Construction design-build revenues, as we experienced improvements in the delivery of services projects and started work on higher-margin construction design-build projects during the current quarter. Operating expenses were $5.2 million in the first quarter of 2024, which on a sequential basis is a decrease of $1.2 million and on a year-over-year basis is $2.7 million less than operating expenses of $7.9 million in the first quarter of 2023. Both of these decreases are associated with the Company's expense optimization and resource reallocation initiative. Net loss was $2.1 million or a negative $0.18 per diluted share in the current quarter compared to a net loss of $5.1 million or a negative $0.48 per diluted share in the prior year period. Adjusted EBITDA improved by $2.7 million sequentially to negative $0.3 million in the first quarter of 2024. This marks an improvement in adjusted EBITDA of $3.1 million compared to the prior year period. The improvement in our adjusted EBITDA for both periods was driven by lower operating expenses as previously discussed. Turning to our balance sheet, we ended the quarter with $0.7 million in cash and a balance on our line of credit of $2.0 million. With the support of the working capital line of credit that we put in place in December, we currently do not see the need to bring new dilutive capital into the company. Our total backlog as of March 31, 2024, was approximately $99 million, reflecting a decrease of $11 million or 10% on a sequential basis. This backlog is comprised of $93 million in construction design-build, $5 million of professional services, and $1 million of equipment systems contracts. Breaking the backlog out by sector, 76% is with clients in the Controlled Environment Agriculture (CEA) sector, and 24% is with clients in the commercial sector. Supported by our backlog and pipeline, we remain confident that our cash position, combined with our $10 million line of credit, will provide us the necessary flexibility to manage through various macroeconomic scenarios. We continue to remain focused on our execution and returning to positive adjusted EBITDA on an ongoing basis. That concludes our prepared remarks. Operator, please open the call for questions.

The first question today is coming from Eric Des Lauriers from Craig-Hallum.

Great. Thanks for taking my questions. So the first one is regarding technical difficulties.

Apologies. Apologies Eric, your line is really bad quality. We'll reconnect with you. Brad, it's okay, I'll move on to the next question.

Hopefully, you can hear me better. I will leave the CEA question for Eric. But just curious, on Florida, Brad, if you're obviously that's for adult use a ballot vote now. It's still a big hurdle to get 60% of the vote. But are you seeing now that it's up for vote, are you seeing operators come in engaging more in your services as it looks a build-out? Is it the potential vote in Florida or is still kind of muted interest from that standpoint to wait to see if this does pass in Florida from adult use side of things? Just curious on kind of the operators kind of emphasis for moving forward now and building out potential ahead of some of these states.

Thanks, Scott, for the question. Yes, Florida, it is a hurdle at the 60%. There's a lot of confidence that will be achieved. But the heavy work starts now, and the groundwork for people to donate to the path that Trulieve has created in the state with a lot of the other multi-state leaders, so they can get the word out and keep pushing hard. The polls are trending higher than 60% at this time from what I've heard. But again, it's early stage, and it's important to give so we can fight that fight. In terms of uptake, yes, there's a very positive uptake in the state so far. The conversations on many fronts that we've been having are preparing to be in a good place from an equipment standpoint. Some equipment needs to be ordered 4 to 6 months in advance. Others are entering the design stage for new facilities and then proceeding to the build, but absolutely a very positive uptake in the state so far.

I appreciate color there. Thank you. And then just focus on guidance you guys are giving guidance of more than $84 million in revenue for 2024 with the projects and the backlog and focus. Can you provide a little more cadence to kind of the remaining of the 2024 year? Obviously, you had some delays from Q4. I assume those projects are recognized here in Q1, but just kind of step us through the year as you see your backlog move second half kind of loaded from the cadence standpoint to meet your revenue guidance?

Yes. First, addressing the three projects that we discussed on the Q4 2023 call. All three projects are active; two of them are recognizing revenue in Q1 and the third has begun recognizing revenue for us in the second quarter. So those are all on track. We remain cautiously optimistic. We believe that we've turned the corner, and I'm excited about where we're moving. We are trying to under-promise and over-deliver in setting expectations. We're off to a good start in Q1. The backlog remains strong. Of course, we'd like to see it start to appreciate and increase again, but we're in a very good place. We feel good, especially with the right-sizing of the company regarding SG&A. We've lowered the break-even level for the company, so that feels good as we're going forward, and we can keep growing the business as demand increases.

Perfect. I appreciate the detail. Congrats on the DEA moving forward today, so thanks.

Thank you. It looks like Eric Des Lauriers from Craig-Hallum has reconnected, and we will try his line again. Eric, your line is live.

All right. Great. Thank you. Is this any better?

It's a little bit better.

Yes. All right. I'll give it a try. If this doesn't work, we'll just take the questions offline. So, on the DEA, I was anticipating this for the day. I was wondering if you could provide us sort of an overview on the typical timing of one of your projects from your cannabis operators. What's the sort of timing for a project to go from discussion phase to pipeline to backlog and revenue? I was really looking to kind of understand how quickly you'll be able to add visibility into potential bona fide backup in capital expenditures in the cannabis industry. Thanks.

Perfect. Eric, first of all, it depends on the size and zoning and where we're located, state, city, and county, and those requirements around the country. But typically, they could take as long as 2 years, depending on the size, or as short as 9 months. On average, it's about a year and a half. From initial discussions, we move into the design stage which includes architecture and engineering, and the cultivation design. Civil and structural are all part of the engineering side too. Once we have a whole set of CDs, it's put out to bid. Clients usually will look at multiple bids in which we're participating. If awarded, we immediately move forward. We can cut weeks, sometimes months off, if we're proactively involved at certain stages. But overall, I'd say 9 months to 2 years is a reasonable average without delays.

And how long would you take to see that there is an increase in CapEx coming sort of industry-wide?

I think on the Q2 earnings call, looking at backlog at that point, from a services standpoint, a new contract that we've signed will be a strong indicator. The early indicators will be on services and equipment. Today's announcement already generated stronger interest and good discussions with clients, with some signatures today already.

That's very good to hear. And I just have one more question. Gross margin expansion you called out increased productivity from architects, engineers and an increase in construction margins. Could you expand on that? I'm wondering if there were projects in Q1 that went themselves to higher productivity or higher construction margins. Ultimately what I'm wondering is we expect productivity levels to remain somewhat steady going forward because there's something we feature fluctuate quarter-to-quarter?

Dick, I'll let you take that one please.

Thanks, Brad. Eric, yes, with regard to we expect kind of that same type margin. It certainly was a very high margin for us in the first quarter of 2024. I don't necessarily expect that it's going to be exactly that high on a go-forward basis. It was very low in the fourth quarter of 2023 due to some additional costs, and we weren't able to pass all those on to our customers. Some construction projects did get started in Q1 at very nice margins for us, but we expect some fluctuations going forward. Our overall gross profit and margin still depend on the revenue mix.

It has been almost 2 years since we completed the acquisition of the construction company. There were some legacy projects tied to that acquisition that have been problematic. Those are pretty much finished now. Improvement has been made since then. In the middle of 2023, we unified all acquired companies onto the same ERP, which has allowed us to implement stronger internal controls. We are definitely trending in the right direction.

Good afternoon. Let's talk a little bit about the commercial business. What are you seeing in terms of demand for the commercial business? Has it continued to be robust and have you been able to continue to expand the services you can offer for that division?

We haven't expanded the services at all at this point. Demand has remained strong. The one area where we're watching closely is the length of time between verbal contracts awarded and actual signatures. That hasn't gotten worse, but it hasn't improved either. However, we aren't losing clients or opportunities, so it’s just a timing issue. Our pipeline remains strong and very qualified.

Are you seeing your top accounts giving you larger contracts going forward?

We have seen progress over the last year, but not in Q1. We're hitting many solid singles in Q1, but no significant increases in size. We do have some larger contracts close but no signatures yet. Overall, we believe we'll secure them. Overall in Germany, it’s slow and steady. They made an announcement with social licenses to start. There’s no requirement for significant facility designs yet. Demand remains weak in Europe, but we believe we're right-sized for current opportunities. We know there's a future in the European cannabis market, and while there were no new contracts signed in Q1, we did sign some nice service contracts in Q2 so far. Thank you. Operator, if there are no other questions, that does conclude today's conference. You may disconnect your lines at this time. Have a wonderful day.