Earnings Call Transcript - UGRO Q1 2022

Operator, Operator

Hello, and welcome to the Urban-gro, 2022 First Quarter Earnings Conference Call. As a brief reminder, all participants are currently in a listen-only mode. Following the presentation, there will be a question-and-answer session for those on the teleconference line. 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 call over to Dan Droller, Executive Vice President of Corporate Development and Investor Relations at Urban-gro. Sir, please go ahead.

Dan Droller, Executive Vice President of Corporate Development and Investor Relations

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. Following our prepared remarks, we will open up the call to questions for those on the teleconference line. 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. Reconciliations of our GAAP net loss to adjusted EBITDA are available in our press release and in our Form 10-Q filed with the SEC, and 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. Forward-looking statements on this call are made pursuant to the Safe Harbor Provisions of the Federal Securities Laws and are based on Urban-gro's current expectations and 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 filed 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 encourage you to review these documents carefully. Lastly, a copy of our earnings press release may be found on the Investor Relations section of our website at ir.urban-gro.com. In addition, a webcast replay for today's call will be available on the Events section of our IR site. With that, I would like now to turn the call over to Brad, Chairman and CEO.

Brad Nattrass, Chairman and Chief Executive Officer

Thank you, Dan. Good afternoon, everyone, and welcome. I'll begin today's call by providing an overview of our business, including an update on our results, execution and vision, as well as share a few updates on key developments thus far in the second quarter. 2022 is off to a very strong start, and Q1 marks yet another record quarter for our business, with record quarterly revenues and our seventh consecutive quarter with positive adjusted EBITDA. Driven by organic growth of almost 50% and incremental services revenue from the acquisition of the architect firm 2WR, our revenue nearly doubled versus the first quarter of 2021. The performance of the 2WR assets continues to exceed expectations and the integration of our services and equipment offering into the existing pipeline continues to drive significant revenue opportunities for the company. A couple of weeks ago, we celebrated a significant milestone with the closing of the Emerald Construction Management acquisition. Not only will this transaction be immediately accretive to earnings. It further expands our full suite of in-house service offerings to include Construction Management services and also adds complete design-build capabilities to our platform. I'm incredibly excited as it not only bolsters our project pipeline, but it also simultaneously further diversifies our revenue stream to include sectors outside of Controlled Environment Agriculture, also known as CEA. We firmly believe that this transaction represents the future of Urban-gro, fulfilling our vision of providing value-added design, engineering, procurement and construction management, or altogether EPC services. With vast experience and deep expertise in CEA, we're offering our clients full service, a la carte and complete turnkey single point of responsibility design build solutions. As our respective teams have already been partnering prior to close, we look forward to a smooth integration process over the next several months and the announcement of some exciting new commercial projects that we're in the midst of hearing. For operating facilities, we continue to focus on building out our managed services offering, branded gro-care, the highly advantageous recurring revenue model that utilizes our in-house knowledge base to provide operators with the expertise to assist them with training, on-site and remote troubleshooting, remote monitoring and also ongoing maintenance programs. The strength behind both the managed services offering and the company as a whole is our people. We're fundamentally a high-touch, service-oriented company comprised of an extremely deep bench of experts. With the addition of Emerald, we now set that approximately 125 employees, of which a little over 80 are those whom we highly regard as specialists or experts in their respective areas. They are the architects, engineers, cultivation designers, remote on-site project managers and superintendents and a collection of horticulturists and plant scientists who have a strong history of growing multiple crop types. It is clear that these experts are Urban-gro’s strongest IP. And it's the holistic integration of these skill sets and the expertise acquired from working on more than 500 projects within the indoor CEA, industrial and health care sectors that provide immense value to our clients and define our competitive advantage. We have capabilities to tackle projects globally and bring our clients best-in-class services to maximize their investment and achieve their cultivation goals. From a financial perspective, Q1 was a fantastic quarter for the company. We achieved first quarter revenues of just over $21 million, which represents growth of a little over 75% versus Q1 of 2021. We generated positive adjusted EBITDA of approximately $0.4 million, which marks our seventh consecutive quarter of positive adjusted EBITDA. We continue to maintain a strong balance sheet entering Q2. And after spending $3.8 million on a treasury stock buyback in Q1, we have a cash position of just over $27 million, zero debt and a backlog of $22 million. These results speak to our client-centric focus and our ability to deliver a world-class level of service to a single point of responsibility across all aspects of their operations. This is not only Urban-gro’s value proposition, it's the foundation of our success to date, which includes delivering such strong growth amid a fluid operating environment and changing industry dynamics. From a growth perspective, we're focused on three key areas; one, geographic expansion; two, expansion within the CEA's food-focused vertical farming sector; and three, continued expansion of our service capabilities, not only within the CEA sector but further diversification of revenue through our growing client base in the industrial and health care sectors as well. The second area of focus is expansion within the controlled environment agriculture sector and more specifically, food-focused urban vertical farming. Our services capabilities and the equipment we help to procure are plant agnostic. So, working with one of the most valuable crops in the world has given us a great entry point into produce. We have immense capabilities to service the indoor food-focused sector and see strong momentum in both the North American and European markets. To that end, since the start of 2022, our team has signed seven project contracts with five indoor vertical farming operators in North America. We expect our project with Urban Health Farms in Europe to launch in the coming months as they complete their site selection processes for their first quants. In all, as reported before, this exclusive engagement provides for Urban-gro to deliver up to 20 full design-built turnkey facilities across Europe. The third and final area of growth includes continued expansion of our service capabilities within the CEA sector and further diversification of revenue with further expansion in health care and industrial sectors. Through thoughtful strategic acquisitions, we've created a full suite of value-added capabilities and services. The evolution of Urban-gro is now a reflection of the vision that I set out to build a bit over a year ago. Today, I'm proud to affirm that Urban-gro is the global leader in providing in-house turnkey services to the indoor CEA market. This engineering, procurement, and construction approach, also known as EPC, provides Urban-gro opportunities to diversify our offerings beyond the ancillary cannabis market to be utilized more broadly in food-focused vertical farming, health care, and industrial sectors as well. The added value of our experience and expertise with indoor CEA provides enormous value to clients in the global indoor CEA sector, regardless of the crop title. And we're working with CEA clients for the life of their grows. We're there from the preconstruction cultivation and planning stage through the crop and asset protection operational support via gro-care where we aim to dominate in the design-build of midsized indoor CEA facilities. As an EPC, we are now able to address a larger market and capitalize on opportunities in adjacent markets where the companies we've acquired have built relationships, expertise, and trust. This has translated to demonstrated execution with large corporate clients that we will continue to foster as Urban-gro evolves as an EPC. The strategic acquisitions of 2WR and Emerald Construction Management have accelerated access to these opportunities and serve as a key attribute in our acquisition rationale. From an operational perspective, our expanded diversification allows us to ensure that we keep our teams fully optimized and, more importantly, completely efficient by maximizing our billable hours. By utilizing our architects, engineers, and designers across multiple sectors, we can allocate resources based on the demand variances in each market segment as these business cycles ebb and flow. In the short run, this helped us absorb overhead. But in the long run, having access to interesting and challenging projects will attract the best talent and support long-term growth for our amazing team. As it relates to guidance for full year 2022, we've had a great quarter, but we also want to be mindful of the uncertainty in the current broader macroeconomic environment, including inflationary pressures, tightening labor market and also specific aspects of the cannabis industry. While we're not immune to these factors, we remain bullish on our strategy in 2022, and interest levels in our solutions remain elevated in our addressable markets, including crop agnostic, indoor, CEA, commercial and health care sectors. While we continue to closely monitor how these factors are impacting our clients and manufacturing partners as well. At this point, we're maintaining the annual guidance that we provided two months ago on our 2021 earnings call; revenues greater than $110 million and adjusted EBITDA of greater than $5 million. In closing, I’m ecstatic with the acquisitions that we've made and how we've rapidly and efficiently evolved over the last year. We're focused on advancing our diversification strategy, which will, in turn, reduce our exposure to any one segment, market or region, and we expect this will help to insulate us and reward our company and our shareholders in the quarters and years to come. With that, I'll now turn the call over to Dick.

Dick Akright, Chief Financial Officer

Thanks, Brad. Our financial results continue to demonstrate our strategy to grow in a smart, meaningful and cash flow positive way. We built upon our momentum and generated another quarter of record financial results in the first quarter of 2022. Revenue was $21.1 million in the first quarter of 2022, compared to $12 million in the prior year period, representing an increase of $9.1 million or 76%. This $9.1 million increase was driven by a $5.7 million increase in equipment systems revenue and a $3.4 million increase in services revenues. The increase in equipment systems revenue is tied to growth of new and existing clients and is continued evidence of the underlying quality and growth potential of that business. The increase in services revenue is primarily attributable to the acquisition of the 2WR entities at the end of July of 2021, which will continue to enhance our reported services revenue numbers on a go-forward basis. Gross profit was $4.9 million or 23% of revenue in the first quarter of 2022 compared to $2.6 million or 22% of revenue in the prior year period. This represents an increase of $2.3 million or approximately 100 basis points as a percent of revenue. The increase in gross profit dollars and margin percentage was driven by an increase in equipment systems revenue dollars than the prior year period and an increase in high-margin services revenue, primarily again due to the 2WR acquisition. Operating expenses were $5.8 million in the first quarter of 2022, compared to $2.5 million in the prior year period, representing an increase of $3.3 million. This increase in operating expenses was driven primarily by increased headcount to support current and future growth initiatives, including costs associated with the 2WR acquisition. Net loss was a negative $0.7 million in the first quarter of 2022, which compared to a net loss of $1.6 million in the prior year period or an improvement of $0.9 million. Adjusted EBITDA was $0.4 million in the first quarter of 2022, which compares to $0.5 million in the prior year period. Adjusted EBITDA was driven by growth in gross profit, including the contribution from the acquisition of 2WR, offset by strategic investments in operating expenses to drive growth. Moving to reported backlog. Our total backlog as of March 31, 2022 was $22 million, comprised of equipment backlog of $16 million and services backlog of $6 million, which compared to $30 million as of December 31, 2021, which was comprised of approximately $25 million of equipment and $5 million of services backlog. While there are several variables that influence the change in backlog, the two primary factors are signed orders and revenue recognized from signed orders during a stipulated period. Because our backlog generally relates to capital expenditure commitments made by our customers, the dollar amount of signed customer orders in individual periods can fluctuate materially. Revenue recognition is then dependent on delivery of these orders. Backlog as of March 31, 2022 is sequentially lower from the $30 million we reported at the end of 2021. We believe that this is a result of several variables that are impacting the timing of purchases for clients as Brad discussed above. But for now, we believe this to be transitory and are keeping a close eye on it, as our service revenue continues to expand. Nonetheless, as indicated by our backlog entering Q2, we are now anticipating that revenue generation has shifted out due to the rapidly changing macroeconomic environment. And although it is early in the quarter, we believe that our second quarter 2022 revenue will be below that of first quarter 2022. However, as Brad noted above, our full year annual guidance remains intact. Now turning to our balance sheet, our capital structure is in excellent condition. After repurchasing $3.8 million of our stock in Q1, our cash position entering Q2 is $27.1 million, and we have no debt, which provides us the necessary flexibility to manage the macroeconomic market circumstances while we fuel our growth strategy, including potential additional M&A targets. In summary, we are incredibly pleased with our financial results this past quarter, and look forward to continuing to execute for the year, with our growing team of experts. That concludes our prepared remarks. Operator, please open the call for questions.

Operator, Operator

Thank you. At this time, we'll be conducting a question-and-answer session. Your first question comes from Eric Beder with SCC Research. Please proceed with your question.

Eric Beder, Analyst

Good afternoon and congratulations on a solid start to the year.

Brad Nattrass, Chairman and Chief Executive Officer

Thanks, Eric.

Eric Beder, Analyst

When you look at the increased marketing spend and the other pieces here, what has been driving your customers to add on with you? What has been the key piece here going forward that we should be focusing on in terms of driving additional revenue going forward and giving you that confidence to maintain the guidance even with the backlog where it is.

Brad Nattrass, Chairman and Chief Executive Officer

Eric, our service levels, I think we uplifted and have made some strong acquisitions that have greatly increased our service delivery. We're delivering phenomenal service to our clients, and they're asking us, 'Hey, can we work together? We're initially making contact with clients probably 16 months, 18 months prior to facility start-ups. We have a long road to help clients, avoid making mistakes, and share our learnings with them on best case efficiencies for their facility or methods that they should use. We're not a manufacturer. But we work with a lot of manufacturers. So we're able to also share with them a variety of solutions in each category as we specify procure and integrate equipment systems. I think it's just that pathway over 18 months, the chance to have multiple relationships in our organization with theirs that allows us to extend. One example is supply chain issues. I think we've done a great job helping our clients avoid supply chain issues. And we're prevalent in this industry and many industries. But if mechanical or cooling systems are going to take six or seven months versus three, it's okay, because we're touching the client earlier, and we're able to just engage in that process a little bit quicker than they are. To answer the second part of your question, the guidance that we gave, it also includes organic and eight months of Emerald construction management. And then, in the short period that we've owned Emerald, what we've learned is there's tremendous upside with that organization, a 37-year-old family company. They've taken it as far as they could, but now with opening new job racks with the strength of our balance sheet, you hear me talk more about commercial now and the design build of CPG companies distribution centers, these are relationships that Emerald had before the acquisition by Urban-gro. Our balance sheet, the strength of our balance sheet allows us to do more projects in that space as well. So the majority, of course, of the business is focused on CEA, but that other sector, that diversification that I talked about, it's key because we can ensure that our billable hours are maximized, and we’re efficiently using our assets, our designers, engineers, and architects across many projects as the industry ebbs and flows.

Eric Beder, Analyst

Okay.

Brad Nattrass, Chairman and Chief Executive Officer

Did I get all of the answers?

Eric Beder, Analyst

I think so.

Brad Nattrass, Chairman and Chief Executive Officer

Okay, good.

Eric Beder, Analyst

No, I think that’s it. Did the backlog not include anything from Emerald, since you completed that at the end of Q1 when you did not own Emerald?

Brad Nattrass, Chairman and Chief Executive Officer

Yeah, that is correct. And something to point out on the backlog, Eric, it did decrease, of course, right, from $30 million to $22 million. But when you look at the service component, in Q4 the backlog is $5 million in services at the end of Q1 and it increased 20% to a little over $6 million. And we continue to sign service contracts, which eventually, if we're doing our job right, turns into the equipment contracts eight months plus down the road. On equipment, as we've talked before, and it's very important that we said for the last year and a quarter focused on backlog, it's a great indication of future business. And here we are with it down this quarter. However, when it comes to equipment and finding equipment contracts, it's just a matter of timing. And sometimes, those contracts can push into the following quarter quite easily. But I think it's important that we keep focusing on backlog and look at it quarter-to-quarter over an extended period of time for sure to see how the ebbs and flows.

Eric Beder, Analyst

Okay, guys, good luck for the rest of the year.

Brad Nattrass, Chairman and Chief Executive Officer

Thank you. I appreciate it.

Operator, Operator

Your next question comes from Anthony Vendetti with Maxim. Please proceed with your question.

Anthony Vendetti, Analyst

Thank you. Just a little bit of a follow-up on the backlog, and then I had an additional question. So, obviously, you had a little bit of a beat in revenue here. And as you mentioned, backlog did decrease. Do you feel that the revenue beat was a little bit of a pull-forward from this current quarter that we're in now, the second quarter, or is it more just a timing thing in terms of the way you signed up deals and what you were able to pull from backlog based on what you were able to recognize as revenue? Maybe just kind of give a little more color around that that would be helpful? Thanks.

Brad Nattrass, Chairman and Chief Executive Officer

Sure. Thanks, Anthony. First of all, revenue is demonstrating a positive trend. As our services backlog increases, it indicates that we are adding new clients and moving in the right direction. At the end of Q4, we had a backlog of $30 million, and we hope to replenish that with signed contracts this quarter and surpass that $30 million because typically equipment shipments occur within one to two quarters. We did ship strong equipment in Q1, and we'll complete the remaining shipments in Q2, but we did not have the anticipated contracts signed for equipment in Q1. Equipment timing is variable, and timelines can shift based on when the client or manufacturer is ready to confirm, which can cause delays that affect financial quarters.

Anthony Vendetti, Analyst

Okay. So, maybe that takes me to another question before I get to my last question. Can you discuss the pipeline? Specifically, I'm curious about the level of customer interest and whether there are customers close to signing contracts but haven't yet, meaning they're not part of the backlog. Did your pipeline of customers or dollars grow in the first quarter?

Brad Nattrass, Chairman and Chief Executive Officer

That's a great question, Anthony. While we don't report on it, our pipeline gives us confidence in our future backlog and recognized revenue. Earlier in the call, I mentioned our collaboration with Emerald over the past few months on some design build projects, which reinforces our confidence in our pipeline. We feel very optimistic about our prospects in the CEA space, particularly in food and cannabis, as well as our opportunities outside of that in the CPG, industrial sector, and healthcare.

Anthony Vendetti, Analyst

Okay. Good. And the last question was regarding urban health farms, the agreement for the European vertical farms. Is that a little bit on hold? Is there any impact on that business due to the war in Ukraine or just an update on that particular business at this point?

Brad Nattrass, Chairman and Chief Executive Officer

Yes, it's definitely not on hold, but it's definitely taking longer than anticipated, and that's why we didn't choose to give a number or investment or a forecast when we announced it in Q4 last year. But the fact that we are moving forward, opening our office in the Netherlands, hiring a Managing Director with that deep two-decade-plus experience in horticulture and automation for horticulture facilities, and building out the team there, continuing to aggressively look for service acquisitions as well. So it's a good strong indication that we believe that opportunity will begin to blossom. For Urban Health Farms themselves, they signed the deals with the end users. They have looked at multiple sites in multiple countries and then we step in and then do the full design build of those facilities. So as soon as we signed our first contract, I've committed in the past and I maintain that we'll definitely announce it, Anthony, because I think it's a great initiative and a great step forward for Urban-gro in Europe.

Anthony Vendetti, Analyst

Okay. Great. Thanks. I’ll hop back in the queue. Appreciate it.

Brad Nattrass, Chairman and Chief Executive Officer

All right. Thank you.

Operator, Operator

Your next question comes from Aaron Grey with Alliance Global Partners. Please proceed with your question.

Aaron Grey, Analyst

Hi. Good evening, and thanks for the question. So first one for me. Just talking about diversification and mix beyond CEA, can you talk about how you're looking at that today? Obviously, you've had some acquisitions, I want to just think about on the go forward maybe the right mix that you would like given you do have a reliance on build-out, which can be a little bit cyclical. So just how you think about diversification and then how M&A kind of plays into that, especially off the back of the buyback of $4 million recently and how you look to utilize that capital for stock repurchases versus potentially M&A for diversification? Thank you.

Brad Nattrass, Chairman and Chief Executive Officer

Thank you, Aaron. I'll take the first part, Dick and then I'll pass it on to you for the stock buyback portion. Aaron, when we made these acquisitions of profitable service companies, the three that we've made so far or two in the last year, our 30-plus year family or partnership businesses. And while the majority of their businesses is in CEA, they also have built relationships outside, as I mentioned, with the CPG group, a healthcare group, hotel chains, like there's groups they've had really strong relationships with, and we didn't want to shut that down because the margin profile is the same regardless, if it's in CEA or non-CEA, until the acquisition of Emerald, it wasn't material. We didn't feel that it was material until we had completed the tri-factor of engineering, architecture, and now construction management so we could launch the brand as an EPC company, a more mainstream, well-known type business model. And now with the addition of Emerald, that number will be material. In terms of breakout between CEA and non-CEA, it's a little bit early to nail that down for this year. But I would say, it's probably definitely I would say, probably 20% or less of non-CEA of this year's business. But as we progress into the future in 2023, and beyond, I don't see that percentage changing significantly, because of the design build opportunities that we're bidding on now in both vertical farming and cannabis as well. So, the percentage won't change much because both sides are rapidly growing. And we're not done either, Aaron. We still have an aggressive appetite for acquisitions of accretive synergistic, profitable service companies. And by bringing these skill sets on, we're entering new markets, globally, we're able to perhaps access client contracts that we don't have today, and then also feel the demand. The word I mentioned 125 employees. We also have said that we have two dozen that have 18 to 24 open job requisitions right now as well for architects and engineers. So we're hiring to meet the demand right now in front of us. Dick, do you want to take it from there and maybe add on if you'd like, or talking about the buybacks?

Dick Akright, Chief Financial Officer

Yes, sure. And Aaron, from the standpoint of the buybacks, certainly, with the way we looked at things, a good opportunity, a unique opportunity from the standpoint of reducing some of the outstanding shares, knowing that we were in the process of an acquisition and therefore, basically kind of protecting the shareholder base from the standpoint of just on a net effect basis, maintaining where the outstanding shares were going to be once the acquisition was complete. So, given that and where the stock price was, I just saw it as a unique opportunity to make those treasury share repurchases. And then like I said, when we were ready to kind of close the acquisition, we kind of have that and that availability out of the marketplace, and then when we issued the shares, which we have been doing as part of all of our acquisitions, part cash, part stock, part contingent earn-out, but then when we issued the shares, it really kind of maintained things where they were from the standpoint of the total outstanding shares. So, from our standpoint, good from the standpoint of really protecting our shareholder base, basically issuing those shares and then not having any kind of dilution to shareholders from kind of pre-acquisition. So that was really kind of the thought basis on it.

Aaron Grey, Analyst

Okay. Great. I think great color. That was really helpful. Second question for me. I know we touched on this last call, but a couple of other hydroponics players. I announced today talked about an even tougher environment through 2022 than it might have previously been expected. I know you guys are a little bit more insulated from that because you didn't have that exposure to those West Coast states. But some other states were talked about including Michigan and otherwise. So I just want to go back to just off the cost of the backlog coming down a bit in this quarter, just how you're looking at the build-out environment within the U.S.? And then also with some of the new states coming online, specifically like in New Jersey, where they have given the 100 conditional licenses or roughly 100, mostly cultivation and processing. Where are you standing with those new applications and potentially bringing those clients to make sure you capitalize on those new adult-use market opportunities? Thank you.

Brad Nattrass, Chairman and Chief Executive Officer

I'll take that, Aaron. Our messaging is crucial in the upcoming quarters. We are building something much bigger than just an ancillary cannabis company. As a services company, we have some insulation, and our global reach is enhanced by our intellectual property. However, we're not a manufacturer, wholesaler, or distributor. Our focus is on providing a range of services, as well as selecting, procuring, and integrating equipment for various client facilities and dispensaries in the U.S. Both Emerald and 2WR operate with dispensaries, and we now offer complete design-build dispensaries as well. We aim to tap into the growth opportunities in the Northeast, Midwest, and New England. We've been preparing in those states even before licenses were issued. As we're not a distributor, our approach isn't to simply sell goods on a transactional basis. Our clients include new single-state operators or multi-state operators expanding into new territories. Regardless of what's happening in neighboring states, we are targeting these new facilities and dispensaries as clients. This model also applies to Europe, where we're currently operating in specific countries and enhancing our team to provide a full-service delivery model. The European cannabis market paused during the pandemic due to insufficient momentum, but now it's reviving with increased demand for our services from the 500 facilities we support. Additionally, we engage with global vertical farming companies in both the U.S. and Europe. We are establishing and managing a substantial business, and the diversification I've referred to will be a key part of my messaging. It's about maximizing billable hours and maintaining close relationships with our clients throughout the lifecycle of the facilities, ensuring they continue to choose us in the future. I've addressed your question, Aaron, but let me know if you'd like me to elaborate further.

Aaron Grey, Analyst

No, that was great, Brad. Much appreciate and I’ll go back into the queue.

Brad Nattrass, Chairman and Chief Executive Officer

Okay. Awesome. Thank you.

Operator, Operator

Your final question today comes from Eric Des Lauriers with Craig-Hallum Capital Group. Please proceed with your question.

Eric Des Lauriers, Analyst

Great. Thanks for taking my question and congrats on a solid quarter here. So services, both in the quarter and with the backlog certainly a bright spot here. Looking at the past two quarters and that kind of backlog conversion, I suppose a bit of a housekeeping question here. It's looking like we're seeing a higher percentage of that backlog converts in the next quarter. Is that just a coincidental thing in the past two quarters, or is there any structural reason for greater conversion of the backlog to revenues compared to the equipment business backlog? Thanks.

Brad Nattrass, Chairman and Chief Executive Officer

Thanks, Eric.

Dick Akright, Chief Financial Officer

I appreciate your question, Eric. The conversion of our backlog into revenue is influenced by the type of equipment we have. For instance, HVAC equipment typically has longer lead times, so if they are in the backlog, they won’t necessarily translate into sales in the upcoming quarter. However, items like lighting or benching that can convert more quickly will contribute to revenue in the next quarter or two. This varies the percentage of revenue we see from the backlog at the beginning of the period. In the first quarter, we did see some lighting and venting convert into revenue. Generally, we analyze how much of our backlog becomes revenue over time, which has typically ranged from about 65% to 78%. From our view, there was nothing unusual in the quarter; the nature of the backlog was simply more favorable at the start. This tends to fluctuate.

Eric Des Lauriers, Analyst

Yes. And then so for the services backlog, obviously, no HVAC type supply chain issues there. Should we expect a general higher percentage of service backlog to convert in the subsequent quarter than there is for equipment systems?

Dick Akright, Chief Financial Officer

It historically for us has been with the acquisition of the 2WR entities that it's been a higher percentage of that backlog that then became revenues in the subsequent quarter, partly because with obviously the services, you're not dependent on a third-party vendor to really supply you with any kind of material. So as long as the customers want to move forward on a basis with that type of service that we do provide, whether it's drawings to architecture with regard to completing a facility and moving forward, then that can all go pretty quickly, a little bit of an interactive process with the customer from the standpoint of them giving our architects and designers feedback on a facility, but you don't have some of the certainly supply chain issues that can hit you from the standpoint of the equipment side of things. So that's tended to be a higher percentage conversion.

Eric Des Lauriers, Analyst

I appreciate the comments regarding our diversification with 2WR, particularly in hospital and industrial projects. I understand the revenue synergies from more CEA-type projects that 2WR engages in. In the case of these hospitals and industrial projects, should we view them mainly as service revenues, or do you see potential for product sales and equipment systems revenue synergies as well?

Dick Akright, Chief Financial Officer

Eric, they'll be service focused.

Brad Nattrass, Chairman and Chief Executive Officer

From an EPC standpoint, we can bring our engineering in there. We can handle the construction management site, where we're managing the GCs, but we don't want to take that risk of general contracting. But at this time, we don't have any intentions of selling equipment to the building systems especially the expertise we've built is all on cultivation of CEA and not the off-the-shelf project, products like lights, but the more custom environmental systems like mechanical or environmental controls and irrigation distribution systems that require our engineers or our designers to design and culminate with construction documents. So it pays money and good, strong ease and in stock. But that's EPCs one, the value-added EPC for us is that expertise in specifying, procuring and integrating in cannabis and food.

Eric Des Lauriers, Analyst

Yes. Okay. Yes, makes sense. I appreciate the clarification. Just one more for me, if I can. So gro-care, I understand it's certainly early days there. But could you provide just any kind of update to the street here on the overall reception that you've had so far for gro-care? Thank you.

Dick Akright, Chief Financial Officer

Yes, absolutely. That's a great question, and I look forward to when it becomes significant enough to report on regularly because it’s very important. It matters to the company as it adds value not only for our clients but also for shareholders and our business overall. This is a long-term focus that will require further investment. We are always looking for ways to grow the business and meet client needs. This is a perfect fit because we are in regular contact and leveraging our expertise to help clients avoid mistakes and provide training. With all of our services consolidated, I believe we will be more efficient in making it significant more quickly, but it remains a top priority for us.

Eric Des Lauriers, Analyst

I appreciate that. Thank you.

Dick Akright, Chief Financial Officer

Thank you.

Operator, Operator

That is all the questions we have for today. Please reach out to investors@urbangro.com with any additional questions. I will now turn the call back over to Mr. Nattrass for closing comments.

Brad Nattrass, Chairman and Chief Executive Officer

Great. Thanks. I appreciate it all. I'm grateful for your interest and ongoing support. We're dedicated to delivering sustainable long-term value for shareholders and of course, our clients. If you have more questions, please reach out to ICR or Dan Droller here internally. And again, thanks for your time. Have a wonderful evening.

Operator, Operator

This concludes today's conference. Thank you all for your participation. Have a great day.