Telkonet Inc

OTC:TKOI

Earnings Call Transcript 2021-Q3

[Operator]

Good afternoon, and welcome to Telkonet's Third Quarter 2021 Earnings Conference Call. As a reminder, today's conference is being recorded. Before I turn the call over to Jason Tienor, Telkonet's President and CEO, I would like to read the following statement. Certain statements including in this conference call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks and uncertainties such as competitive factors, technological development, market demand and the company's ability to obtain new contracts and accurately estimate net revenues due to variability in size, scope and duration of projects and internal issues in the sponsoring client. Further information on potential factors that could affect the company's financial results can be found on the company's registration statement and on its reports on Forms 8-K filed with the Securities and Exchange Commission. Telkonet is under no obligation to update items discussed today to reflect subsequent developments. Lastly, I'd like to remind everyone that an audio replay of today's teleconference will be available for the next 14 days. Please refer to today's press release for applicable phone numbers and conference ID to access the replay. With that, I would like to turn the call over to Jason Tienor, Telkonet's President and CEO, to discuss the results. Mr. Tienor, you may begin.

[Jason Tienor, executive]

Thank you, operator. Good afternoon, and thank you for joining us for Telkonet's 2021 third quarter earnings call. We appreciate your interest in Telkonet and our ongoing operations, and we look forward to answering any questions you might have today. We'll begin by providing you with a summary of Telkonet's past year's activities and continue with Gene Mushrush, Telkonet's Chief Financial Officer, providing a financial summary for the third quarter and year-to-date. We'll end by opening the call for any questions you might have prior to closing. As you might assume, the past 2 years have been extremely difficult across the globe. With the emergence of COVID on the global stage in early 2020, Telkonet's earlier 2019 rapid growth was brought to a sudden halt. The disastrous impact that the pandemic has had on the world has spread throughout every facet of our daily lives. Beginning in 2020, COVID created havoc within industries across the globe with one of the largest being hospitality. Due to travel restrictions, business closures, societal fear and others, hospitality saw such significant losses that an estimated 1/3 of the U.S. hotels closed for some period of time, and some of the largest franchisors shuttered operations in an effort to stem growing losses. Because hospitality represents greater than 60% of Telkonet's revenue, this initial effect of the pandemic had an enormous effect on Telkonet's performance. Throughout 2020, Telkonet weathered additional continued impacts to our business, including the necessity to move staffing to remote work, backlog business being consistently delayed due to the lack of demand in funding and the inability to secure labor for developments due to the ongoing health and governmental restrictions and many more. Regardless, we were able to continue product development, effectuate an increased push in sales and marketing to position our business predominantly for the eventual market recovery and dedicated efforts to improving business processes, organization and efficiencies. Much of this effort was thanks to several factors, including loyal and dedicated staffing, solid partner and vendor relationships and a number of beneficial government programs, including being a fortunate recipient of the PPP funding. Another ongoing activity during this time were our efforts to locate and secure a strategic transaction that would allow Telkonet to grow more quickly and take advantage of the synergies, creating a more valuable enterprise and increase shareholder value. As we moved into 2021, we had an [ air ] of cautious apprehension as vaccines become available, the initial difficulties of dealing with the pandemic seemed to be managed and the pandemic itself deemed to be on the decline for the first time. Business closures were reduced to over field, social distancing replaced stay at home, and travel once again began to increase. While the initial outlook for business in 2021 wasn't exceptional, we had hoped for growing improvements from the year earlier. It was already understood that budgets were limited due to the prior year's performance, investments frozen due to lack of demand and uncertainty of the future, and the pandemic remained a concern. But we began to see life in solved opportunities and interest in new projects. While we continue to operate in a less-than-ideal environment, new sprouts of business were emerging, and for the first half of 2021, Telkonet operated in an almost continual trend of improving business. Though not reminiscent of 2019, we maintained a slight edge over the performance of the prior year. Via our growing pipeline, positive year-over-year revenue growth, improved margins and operating expenses due to efficiencies created over the prior year, Telkonet begun an albeit slow but improved performance. Unfortunately, the third quarter has demonstrated some of the long-lasting effects of the pandemic and its ongoing impacts. The pandemic has generated several initial and some potential improvement, shifts in societal norms and behaviors. If you've been watching the news, you most already are aware of the volume of businesses that have changed their operating models from staffing and commercial offices to operating hybrid modes of split work weeks between office and remote to simply moving to fully remote working environments. These businesses range from some of the largest in the world, including Apple, Microsoft, Google and GE, to small businesses across the globe. This loss of a central location or office is decreasing [indiscernible] business travel to visit headquarters or the requirements of group meetings demanding attendance that is a key driver to a certain percentage of business travel. Well, according to STR, a global hospitality analytics company, the hospitality industry has seen a recovery of 69.6% of occupancy, a figure that has not been seen since August of 2019. Experts say that business travel is almost entirely absent from that game. This may seem unimportant but according to the American Hotel & Lodging Association, more than half of a hotel's revenue is derived from business travel. As stated by Lou Carrier, President of the Distinctive Hospitality Group, business travelers use hotels, go to restaurants and retail, engage in sports entertainment and get economic systems firing on all cylinders. We may have a leisure traveler engine firing on 2 or 3 cylinders, but a business traveler engine is firing on all 8. Next, you may have also heard of the term called the Great Resignation which is the term for employees voluntarily leaving their jobs in search of more money, greater flexibility or simply increased happiness. According to NPR, 4 million people quit their jobs in April of 2021 alone. And as late as September of this year, we saw that figure once again. The impact of this on today's business is staffing shortages causing lost revenue to business, i.e., hotels, thus reduced budgets to make improvements in property and operations. Also, businesses have begun to offer a response to decrease the number of staff departing, including reduced travel to increase employee happiness, which impacts Telkonet's largest target market from the demand side as well. Lastly, 1 enormous effect recognized during the pandemic was that the increase in the use of video conferencing and other communications tools during normal business operations has been enormously successful, demonstrating to businesses minimal impact on operations while substantially benefiting on savings of business travel, commercial property and other costs. As mentioned earlier, this paradigm shift in businesses' approach to the requirements of business travel could have a long-lasting impact on the hospitality industry that, as of yet, cannot be foreseen or confirmed. As we've seen thus far in 2021 through the third quarter, these impacts are still influencing the expenditures in Telkonet's core market. In addition to the resurgence of COVID through the Delta variant and the resultant lockdowns and additional travel bans, these shifts in traditional operations continue to affect Telkonet's recovery in unpredictable ways on an extremely erratic time frame. As mentioned earlier in the year, they seem to have less impact in the hospitality recovery, but the third quarter and continuing into late in the year, they are showing greater emphasis and caution and are maintaining scheduled spending. A bright note to the comments about the pandemic results of shifting to [indiscernible] is that when 1 door closes, another opens. Hospitality has demonstrated this in the manner that they've approached the evolution of business travel and the impact on their business. One new model is offering hotel rooms to business users to operate as a remote office from their home. A store's co-working space that allows remote workers to no longer have business offices, but may need to leave the house and get outside due to distractions, to locate elsewhere for a small fee, providing value for both hoteliers and the business guest. Also hotels have begun the package greater amenities for business guests to entice their patronage and ultimately build greater loyalty now and into the future when travel regains. Thus, as we approach the end of the year, the third quarter's performance has demonstrated difficulties within the industry. We know that these impacts are not always alone as we have and are seeing a shakeup in our industry with some competitors leaving the industry entirely and others being marketed for sale or already having been sold to other entities due to the market and business impacts. As most of you are already aware, Telkonet is moving through a transaction that has been approved by our shareholders, joined resources with a larger international hospitality technology provider, and strengthen our business in technology and [indiscernible] market. Through synergies, including purchasing and manufacturing efficiencies already being seen, access to international markets and relationships due to an expanded combined sales team, business efficiencies through operational synergies and many other benefits, Telkonet will be entering a new chapter in our history, one that is expected to provide substantial returns to our shareholders and provide the potential to place Telkonet on an entirely new playing field with international operations, firm financial stability and new management with existing technology and industry expertise. This new transition is extremely exciting, and we look forward to talking further about it in the future. In closing, I'd like to share a bit about our improved outlook looking forward. As you heard, 2021 has been very erratic and unpredictable. That being said, we've continued to see our pipeline grow to currently $83 million. We've been able to take advantage of new processes, developments and sales and marketing efforts to recognize several marquee partnerships to tighten our agreements and to improve our returns through them. These same efforts -- through these same efforts, we've been able to form relationships with the largest of hospitality franchises, owners and operators and several substantial individual properties. We've also ensured that we're not tethered solely to the hospitality industry as we look forward in this time frame to recovery in new paradigm [ cases ]. We've continued to extend our commercial relationships within the military industry and have been fortunate to work through several potential projects that have already demonstrated returns for 2022. We've also continued to expand our growth within education, and amongst other successes, have locked down on a substantial project looking forward to the end of this year. We've also been working with both domestic and international casinos, resorts, boutique hotels as these seem to have more budget availability due to the growth of leisure travel. Demonstrated by our success with the Resorts World mega project in Las Vegas and its sister in New York, Telkonet continues to demonstrate our leadership and technology within the markets we serve and our adaptability and customizability to the greatest array of systems and automations available. While we still see difficulties ahead regarding the current environment of manufacturing, i.e., component procurement and transportation, we feel that these short-term hurdles, while having an impact on pace and size of growth for 2022, will not halt an improved performance, especially with the new evolution of Telkonet as a business with our partner, VDA. With that said, I'd like to thank you for your time today and hand the call over to Gene Mushrush, Telkonet's Chief Financial Officer, for his comments. Gene?

[Richard Mushrush, executive]

Thank you, Jason. Ladies and gentlemen, good afternoon, and thank you for joining us. Today, I will be summarizing our 2021 third quarter and year-to-date financial results. For the quarter ending September 30, 2021, total revenues of $1.5 million represented a 35% decrease compared to the prior-year period. Hospitality revenues decreased 36% to $1.3 million. Educational revenues decreased 20% to $107,000. Governmental revenues decreased 77% to $22,000, while multiple dwelling unit revenues increased 855% to $34,000. And health care revenues were unchanged at 0. Product revenues decreased 37% to $1.3 million. Revenues derived from channel partners decreased 45% to $930,000 compared to the prior-year period. The decrease was primarily driven by 2 customers. International revenues decreased 86% to $70,000. This decrease in international revenues was primarily driven by 1 single customer. Recurring revenues decreased by 14% to $164,000 when compared to the prior-year period. Backlogs were approximately $3.1 million and $2.7 million at September 30, 2021 and 2020, respectively. Gross profits for the 3 months ended September 30, 2021, decreased 46% to $589,000 when compared to the prior-year period. The decrease was primarily attributable to a decline in revenues of $786,000 and an increase in the use of installation subcontractors of $90,000, partially offset by decreases in logistical expenses of $70,000 and inventory adjustments of $30,000. For the 3 months ended September 30, 2021, the actual gross profit percentage decreased by 9% to 40% compared to the prior-year period. Tariffs imposed on Chinese imports resulted in an adverse impact of approximately 8% on the actual gross profit percentage for the 3 months ended September 30, 2021, unchanged when compared to the prior-year period. Tariffs will fluctuate based upon volume of goods imported, which is contingent upon inventory supply and demand. Operating expenses for the quarter were $1.5 million, a 16% decrease compared to $1.8 million for the same period in 2020. The variance is primarily attributable to decreases in royalty fees of $570,000 and payroll taxes of $100,000, partially offset by the increases in salaries of $97,000, trade shows of $90,000, public company fees of $70,000 and legal fees of $140,000. The payroll decrease was primarily the result of an employee retention credit allowed under the CARES Act, which is a refundable payroll tax credit that encouraged businesses to keep employees on the payroll during the COVID-19 pandemic. We incurred an operating loss and reported a negative adjusted EBITDA, a non-GAAP measure, of $891,000 and $879,000, respectively, for the quarter ended September 30, 2021. This compared to an operating loss and a negative adjusted EBITDA of $672,000 and $656,000, respectively, for the same period prior year. Year-to-date total revenues of $4.6 million represented a 14% decrease compared to the prior-year period. Hospitality revenues decreased 14% to $3.9 million. Educational revenues decreased 55% to $220,000. Governmental revenues decreased 17% to $145,000, while MDU revenues increased 112% to $317,000, and health care revenues increased 100% to $48,000. Product revenues decreased 15% to $4.1 million. Product revenues derived from channel partners decreased 10% to $3.2 million compared to the prior-year period. The decrease was not driven by any specific customer. International revenues decreased 25% to $470,000 when compared to the prior-year period. And this decrease was primarily driven by 1 customer, offset by increases in 2 others. Recurring revenues decreased 5% to $533,000 compared to the same period prior year. Year-to-date gross profits increased 3% to $2.4 million versus the prior-year period. This increase was primarily attributable to decreases in material costs of $460,000, logistical expenses of $170,000 and inventory adjustments of $110,000, partially offset by a decrease in revenues of [ $729,000 ]. For the 9 months ended September 30, 2021, the actual gross profit percentage increased by 8% to 52% compared to the prior-year period. Tariffs imposed on Chinese imports resulted in an adverse impact of approximately 4% on the actual gross profit percentage for the 9 months ended September 30, 2021, compared to approximately 7% for the prior-year period. Year-to-date operating expenses fell 7% to $4.3 million compared to $4.6 million last year. The variance is primarily attributable to decreases in royalty fees of $500,000, a 401(k) employer match of $50,000, sales and use taxes of $40,000 and payroll taxes of $440,000, partially offset by increases in salaries of $40,000, trade shows of $90,000, public company fees of $100,000, legal fees of $410,000 and audit fees of $80,000. We incurred an operating loss and reported a negative adjusted EBITDA of $1.9 million and $1.8 million, respectively, for the 9 months ended September 30, 2021. This compared to an operating loss and a negative adjusted EBITDA of $2.3 million and $2.2 million, respectively, for the same period prior year. We reported $2.6 million in cash and equivalents at September 30, 2021, compared to $2.9 million at September 30, 2020. We reported a working capital surplus measured as current assets less current liabilities of $1.6 million at September 30, 2021, compared to a surplus of $2.5 million at September 30, 2020. Cash used in operations was $1.3 million for the 9 months ended September 30, 2021, compared to cash used in operations of $796,000 for the same period prior year. The working capital changes during the 9 months ended September 30, 2021, were primarily a result of a $534,000 decrease in net inventories; a $233,000 increase in contract liabilities; a $235,000 increase in accrued liabilities; a $106,000 decrease in the income tax receivable; an $85,000 increase in accounts payable, partially offset by a $474,000 increase in prepaid expenses; and a $77,000 increase in contract assets. As of September 30, 2021, we had a total borrowing base of $646,000, an outstanding balance of $266,000 and a cash management services reserve of $50,000 resulting in availability of approximately $330,000 on the credit facility compared to a total borrowing base of $1.1 million, an outstanding balance of $65,000 and the cash management services reserve of $50,000, resulting in availability of approximately $963,000 in the credit facility at September 30, 2020. Due to COVID-19, the hospitality industry, our largest market that generally accounts for a majority of our revenue, has suffered as much as any over the past 18 months. Persistent cases, the emergence of new virus strains and a loss of vaccine [ wake ] inertia has extended the uncertainty of the pandemic's length and severity. Despite certain social distancing restrictions being lessened or eliminated, business travel, which comprises the largest source of hotel revenues, remains limited. Business travel is not expected to return to pre-pandemic levels until at least 2023, according to an STR forecast, until group business and international demand returns. U.S. hospitality -- U.S. hotel occupancy rates will not exceed 50% in 2021. Moreover, full recovery of revenue per available room is unlikely to return to pre-pandemic levels until the end of 2024. The company has received 2 loans under the Paycheck Protection Program as part of the CARES Act enacted on March 27, 2020. In April 2020, the company entered into an unsecured promissory note for approximately $913,000 for the first PPP loan. In February 2021, the first PPP loan granted to the company in the original amount of $913,000 plus accrued interest of approximately $8,000 thereon was forgiven in full. In April 2021, the company entered into an unsecured promissory note with Heritage Bank under a second draw of the PPP. In September 2021, Heritage Bank confirmed that the second PPP loan granted to the company in the original principal amount of $913,000 plus accrued interest of approximately $3,000 thereon was forgiven in full. The loan forgiveness amounts are accounted for as gains on debt extinguishment and recorded as separate components of operating activities in the convinced -- consolidated statement of cash flows in accordance with the generally accepted accounting principles. The company has a $2 million credit facility with Heritage Bank, which is secured by all of the company's assets. The company is currently in compliance with the financial covenants and the loan agreement for the credit facility. However, based on the company's current level of operations and forecasted cash flow analysis for the 12-month period subsequent to the date of this filing, without further cost-cutting measures, working capital management and/or enhanced revenues, the company believes it is reasonably likely that it will reach the covenant to maintain a minimum unrestricted cash balance of $2 million at some time during the remaining 2021 calendar year. Violation of any covenant under the credit facility provides Heritage with the option to accelerate repayment of the [indiscernible], terminate its commitment to extend further credit and foreclose on the company's assets. On September 30, 2021, the company entered into a 12th amendment to the Heritage Bank loan agreement to extend the revolving maturity date to December 31, 2021, unless earlier accelerated under the terms of the agreement. In addition, subject to certain conditions as specified in the amendment, Heritage Bank consents to the proposed transaction with VDA Group S.p.A and acknowledges and agrees that certain events occurring in connection with the transaction, including the change of control of the company resulting from the transaction, do not constitute events of default as defined in the loan agreement. At a special meeting held on October 27, 2021, the company's stockholders approved the following proposals: number one, an amendment to the company's amended and restated articles of incorporation to increase the company's authorized shares of common stock from approximately 190 million to 475 million; and number two, the issuance of shares of company common stock and the warrant and warrant shares to VDA Group S.p.A, an Italian joint stock company. With the approved proposals, the company anticipates closing a transaction during the fourth quarter of this year, whereby VDA will contribute $5 million to the company in exchange for the issuance to VDA of approximately 163 million shares of the company's common stock, and a warrant to purchase approximately 105 million additional shares of common stock. Post close, VDA will own approximately 53% of the issued and outstanding common stock on a fully diluted as exercised and converted basis, and could own as much as 65% if it fully exercises the warrant. Effective upon the closing, the majority of Telkonet's Board of Directors will resign, and the vacancies resulting from those resignations will be filled by individuals designated by VDA and appointed by the remaining Board members. For additional details regarding the terms of the stock purchase agreement dated August 6, 2021, between the company and VDA, please refer to our Form 8-K filed on August 10, 2021. In closing, thank you for your interest and to our shareholders, specifically. Thank you for your continued support. I will now turn the call back to Telkonet's President and Chief Executive Officer, Jason Tienor.

[Jason Tienor, executive]

Thank you, Gene. With that, I'd like to hand the call over to our operator to receive any questions that you might have. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of [ Brian Nelson ], private investor.

[Unknown Attendee]

Jason, that was a mouthful this afternoon. The phone call was kind of breaking up a little bit in there. Did you say you have a certain amount in the pipeline that I missed?

[Jason Tienor, executive]

Yes. We've actually had a large and growing pipeline over 2021, where it had stalled through most of the year in 2020, as you can imagine. There wasn't a lot of activity with most of the hospitality owners and developers actually having closed their operations. But in 2021, we have seen activity, and especially earlier in the year, we were closing business and we were trending up. The second half of the year has started to stall for a variety of reasons, the inability for developers to develop projects due to lack of resources and transportation and resource costs, lack of labor and inability to actually perform the projects that they have in the pipe. But what we've seen in the latter 45, 50 days is that a lot of that has started to move again. The Delta variant caused a bit of a blip for a little bit. But I think when people saw that it wasn't a full-fledged onslaught, again, with a consistent lockdown that we had seen last year, that kind of got past it. But now we're really just dealing with the manufacturing and industrial issues with regards to performing work in today's world. Like I said, if you've watched anything about shipping into the ports here in the U.S., a lot of our own developers have the things that they're looking for in order to move their projects forward stalled out on the ocean, waiting to get their equipment to their resources in-house. That being said, they're still trying to move forward. Our RFPs still continue to grow. And we are seeing light at the tunnel -- at the end of the tunnel where 2022 should be a decent growth year as long as we can resolve all of the manufacturing component procurement and shipping issues.

[Unknown Attendee]

Right. I thought you put a dollar amount on it, right? Maybe you didn't, but...

[Jason Tienor, executive]

We've grown to about $83 million in our pipeline since last year, and that's even a growth over 2019, which was the best year that we've had. So it's been fantastic in that point, but moving it from that point...

[Unknown Attendee]

I've never even seen an $83 million number, and I've been an investor for years, so that's fantastic.

[Jason Tienor, executive]

Yes. No, it's typically been in the high -- mid- to high 60s, and even in 2019 when we were touching 70s. So people are continuing to move stuff through the pipeline and the benefit that we've seen over the last 2 years is that we haven't seen a lot of business fall out. The same issues that we're recognizing, our competitors are recognizing as well. So our customers have been loyal, and they have stayed with us through the difficulties of the last 2 years.

[Unknown Attendee]

Yes, agree. That's what I wanted to hear. I just -- I caught what I wanted to hear. And again, I've seen -- as I travel with business, too, I'm seeing a lot of hotels going up, new ones, too. So hopefully, we'll see some more of that action.

[Jason Tienor, executive]

Again, agree.

[Operator]

[Operator Instructions] Thank you. This concludes our conference question-and-answer session. I'll now turn the floor back to Mr. Tienor for any final comments.

[Jason Tienor, executive]

Thank you once again, operator, and thank you to everyone for joining Telkonet's Third Quarter 2021 Earnings Call. Once again, we look forward to sharing more developments with you in the very near future. If you do have any remaining questions, please feel free to reach out to [e-mail] or call [phone]. I hope everybody wish -- I hope everybody has a great afternoon, and we look forward to speaking with you again soon.

[Operator]

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