Earnings Transcript for KNRLF - Q2 Fiscal Year 2021

Operator: Good afternoon. My name is Collin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Kontrol Technologies Q2 2021 Financial Results Report Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, we will conduct a question-and-answer session from the audience during the Q&A session. [Operator Instructions] I would now like to turn the conference over to Antonio Meschino from Senior Management, Corporate Communications. Please go ahead.

Antonio Meschino: Thank you and welcome, everyone. The CEO of Kontrol Technologies, Paul Ghezzi; and its CFO, Claudio Del Vasto are hosts for today’s meeting and will provide management comments. Before we begin, please be reminded that certain statements and information included in the management discussion and analysis, and financial statements, and press releases or any other presentations, including information related to future financial or operating performance, and other statements that express the expectations of management or estimates of future performance constitute forward-looking statements. For more information on the company’s forward-looking statements, and risk factors, please reference the management discussion and analysis as well as our financial statements for Q2 2021. For all public information filings, please visit sedar.com. Thank you. I would like to turn the conference over to Paul Ghezzi, CEO of Kontrol Technologies. Paul, you may begin.

Paul Ghezzi: Hi, everyone. And welcome to the Kontrol Technologies Q2 2021 financial statement call. I’m joined on the call by our CFO, Claudio Del Vasto, who will summarize our financial results for Q2. Following that, I’ll provide an update and we’ll have some time for Q&A. We continue to execute on our strategic plan with strong year-over-year growth and quarter-over-quarter growth driven by stable recurring revenues, new customer wins and record earnings performance, with positive net income in the second quarter. In addition to revenue and earnings growth, we continue to operate the financial discipline and exited Q2 with a strong balance sheet and working capital position. I'll have a general corporate update following the presentation of the key financial metrics for Q2. I'll now pass it over to Claudio Del Vasto to present our financial results in more detail.

Claudio Del Vasto: Thanks, Paul. Hello, everyone. This is Claudio Del Vasto, CFO of Kontrol energy. I'm pleased to provide you with a short briefing on our Q2 financial results. As Paul noted, we delivered strong second quarter and first half 2021 results. Revenue and earnings were up and we are experiencing significant balance sheet strengthening. Revenues for the second quarter of 2021 were $4.2 million, an increase of 83% from the same quarter in the prior year, and up 26% over the first quarter of 2021. Revenue for the six months ended June 30, 2021 were $7.5 million, up 49% over the same period in the prior year. I'm happy to report that we generated positive net income in the second quarter of 2021 for the first time in Kontrol's history. Adjusted EBITDA for the second quarter of 2021 was $1.1 million, an increase of 175% from the same quarter in the prior period. Adjusted EBITDA for the six months ended June 30, 2021 was a record, totaling $2.2 million, an increase of 246% from the same period in the prior year. In regards to the balance sheet, our net working capital and equity position improved significantly. Notable factors were as follows. We closed an $8.5 million equity private placement with institutional investors. We paid off a $3 million of senior secured debt obligation in advance of the maturity date. We extended unsecured debentures of 860,000 that were maturing April 25, 2021. It was extended to October 31, 2022. Our net working capital balance was $8.9 million as at June 30, 2021. Conversions of convertible debentures to common shares totaled 631,000 for the six months ended June 30, 2021. Reduced debt levels and associated interest costs have a direct benefit to net income and cash flow. Conversions save the company 8% of interest per annum and the principal obligation is eliminated from the balance sheet. The payoff of the $3 million senior secured debt obligation results in nominal future interest savings of approximately $400,000. Subsequent to the second quarter, the company announced the completion of the acquisition of Global HVAC & Automation Inc. Subsequent to the second quarter, the company received the final $800,000 from the Ontario Together Fund for our BioCloud technology. I will now turn it over to Paul.

Paul Ghezzi: Thank you, Claudio. Overall, we remain on track for the best financial year in our history, driven by organic growth, technical innovation and the recent acquisition of Global HVAC & Automation. Kontrol anticipates full-year revenue for 2021 will be approximately $38 million, up from $13 million in 2020 and anticipated 2021 adjusted EBITDA of approximately $3.7 million. Kontrol does not segment its revenues on its financial statements, but we can say that BioCloud has been accretive to revenue and earnings, and we anticipate this will continue, as we look to scale the technology. I'm going to talk about the Global acquisition and then the Steelcase announcement. We completed the Global acquisition in July. Global is a leader in the installation of complex heating, cooling ventilation and automation systems. What attracted us to the Global acquisition was the significant order book of $155 million for the next three years, and the fact that Global mainly operates as a one-time project company. We believe that through the introduction of our recurring software and service platform synergies, we'll be able to drive recurring revenues into the Global operating business over time. The purchase price for Global was approximately 4x normalized EBITDA and this includes performance incentives to be vet by the existing management to reach that level. By adding recurring revenue to the business, we can deliver a higher return on investment and return on invested capital. Our acquisition philosophy, which has served us well to-date is to acquire customers and cash flows for a reasonable, multiple valuation and innovate technology in-house. Then we seek to add recurring revenues to improve the acquisition metrics in our favor. We have already commenced the introduction of our asset service platform to Global's customer base, and anticipate delivering the first revenues from that initiative in Q3 2021, which would be recurring in nature. As Global was acquired at the end of July, we will see the addition of Global to the financial statements in Q3. Steelcase partnership announced today. As many of you are aware Steelcase is a global leader in the office furniture and workspace solutions business. Based in the U.S. they generate approximately $2.6 billion in annualized revenues with over 800 dealers in North America. They trade on the NYSE under symbol SCS. We announced today an exclusive partnership to market the BioCloud technology across its dealer network, which gives us access to an impressive and established customer base across North America. Steelcase shares our passion for safer spaces and creating workplace environments that focus on getting employees back to the office safely and getting work back to normal. The Steelcase partnership announced today was approximately 10 months in the making. There is a process that comes with working with large organization and that -- organizations, and that process has its own timelines. In other words, large opportunities take time and patience to mature. We look forward to our presentation with Steelcase on August 17th in Toronto. And we also look forward to a great partnership. Global supply chain. Overall, we are finding slight improvements in the global supply chain, but processors and chips remain a challenge. Our approach with these challenges is to align our supply chain partners and to manage lead times with our customers. Other important applications for BioCloud, including supporting. BioCloud has helped place Kontrol on the world stage, and we are working on many significant opportunities. And in the case of larger organizations, we don't have control over the timing of those. Those include sporting applications, government and larger corporate organizations. We'll have more news on those in the coming weeks and months. Climate change and the move to net-zero 2050. Since the beginning of our journey as a business, we have been sharing the relevance of the building sector as a major contributor to the global greenhouse gas emission challenge. Buildings currently contribute up to 40% of greenhouse gas emissions, and in the next decade, will consume 50% of the world's energy. Morgan Stanley in their research refers to the period we are currently in as the building technology supercycle. Climate change, sustainability, government policy and building inefficiencies are just some of the factors cited for the greater adoption of smart building technologies. In this regard, for the past number of years, Kontrol has been formalizing a new approach to carbon credits and accelerating how our customers can adopt building technology to reduce energy consumption and emissions. We are pleased to announce that we'll be launching Kontrol carbon credits in late Q3 based on an energy efficiency certificate platform, a word that is often referred to as a white carbon credit. And EEC is a tradable asset, which provides proof that a certain percentage of energy savings has been achieved relative to baseline. EECs are related to achieving a minimum energy savings in kilowatt hours, which provides a corresponding carbon emission reduction. These savings are calculated as accumulative savings over the lifetime of the product or the investment. Each project that saves energy, which is not mandatory, and is in surplus of the prevailing practice for a specific vertical, is an admissible project. In Canada, projects such as conservation, building improvements, energy monitoring and control, and replacement of inefficient equipment by highly efficient solutions and products are deemed eligible projects. EECs are environmental attributes that can be registered and tracked on special commodities registries and are tradable on the carbon credit market. Kontrol will formalize the opportunity to provide customers with EECs and trade those EECs for the customer with third-party partners. To date, this would be the only kind of this type of program in North America, inside of what is being provided by the local utilities. And this represents a new accretive innovation from Kontrol that will benefit our customers in their mandate to reach net-zero by 2050. Our goal is to be the leading originator and transactor of energy efficiency credits in North America in 2022. We will schedule a formal launch date and provide more details on this innovative program by the end of Q3. In conclusion, before we take some questions, we are bullish about the business of Kontrol Technologies in aggregate, our current technology innovation and the innovation we'll be adding in the coming months and years. We are a well-diversified business with a blue chip customer base and corporate partners, and we continue to innovate important technologies. We look forward to the second half of 2021 and the continued execution of our strategic plan. Over to you, operator.

Operator: Thank you. Ladies and gentlemen, we'll now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jeffrey Campbell from Alliance Global. Jeffrey, please go ahead.

JeffreyCampbell: I wanted to start with the Steelcase announcement. First, are you going to supply completed BioCloud units to SCS in market or will SCS participate in any BioCloud manufacturer assembly?

PaulGhezzi: Thanks, Jeff, for the question. So as currently determined, because Steelcase is North America based with operations in Canada and the U.S., there is less of a requirement for a made in the U.S. So the deal right now is that we provide completed units that are sold to customers through their distribution network. It has come up as a question that, what if we were forced to manufacture in the U.S. to meet, let's say, a certain customer demand? What if that became a barrier? And there's a growing relationship with Steelcase where I think they could be of assistance in helping us do that. But today does not come up as a major issue, because they are across North America with our distribution network.

JeffreyCampbell: That's helpful. Any sense of the addressable market that SCS envisions and wanting to partner with BioCloud?

PaulGhezzi: So, we look at it from the perspective -- and it's really interesting for us and what this means to us. So I think we're just over 20 distributors now, fairly spread out regional. And when you're starting a technology, you want to be in all kinds of different markets. If you take the Steelcase distribution network, you're basically taking our network to a 40x with their platform. So we're very excited by that. So I think from an addressable market perspective, we really look at it from how many distributors are out there. Then from a customer base perspective their customers are the Fortune 1000 and well diversified. So it's hard to quantify that. But if you just take the distribution or dealer network, it's a 40x of where we are today.

JeffreyCampbell: Okay. And last one on this point. Considering their broad net in the workplace furniture space, I just wanted to know, are there any potential sales conflicts between SCS and your ability to sell directly through the Global HVAC acquisition?

PaulGhezzi: Yes. That's a good point. So I think one of the trade-offs in working with a large company with a big network is, you're really partnering to work together. And so for us, the way we look at this is, as we just added not only an amazing company with amazing network but also a marketing power well beyond control. And so we think from that perspective, we're not in competition. It's a win-win. They've got offices here across Canada. We're actually presenting the first presentations at their Toronto based office. So in partnerships, we look at this as win.

JeffreyCampbell: Okay. My next couple of inquiries regards the reseller agreement with Marshall Communications. And I was wondering, should we think of Marshall as the primary conduit for Kontrol sales to the U.S. government after your early attainment of GWAC status? Or whether it’d be parallel sales trends to the government market?

PaulGhezzi: Yes, so Marshall is a group of ex-military vets with deep ties. They're there already -- the important thing is they're already selling reselling various products. They've been very successful. When we met with them a number of months ago, we zeroed in on two important products. One is our SmartSuite technology, which is building energy management light for various applications. And that could have a strong military application if you think about remote bases and the need to consistently conserve energy with data and analytics. And the other one that became important was BioCloud from their contract perspective. So they have deep ties into the government and we need them to open those doors to work with us to make the communications, and they've got a pretty good pedigree in doing that.

JeffreyCampbell: Okay. And overall it appears that the Global acquisition expanded your ability to sell internally, whereas the Marshall and the Steelcase agreements are widening the sales net using third party networks. Do you have objectives for the in-house sales versus the third party sales as a percentage of total sales? Or is it sort of, we love all of the above and let's see what happens?

PaulGhezzi: Yes, no, we love them all, the more revenue is better. But the way we think about internal organic growth is above 30% with an existing customer base, where we're cross selling. The example of Global is, for whatever reason, because they were comfortable, because they didn't do a lot of it before, they were not using asset management based service with recurring revenue. That's something that they valued, but that's something that we value. And we've already got three opportunities on the go with them. And those are very high gross margin, sticky types of services. They're open to that. And so I would say those are really the opportunities that we can generate internally. As we widen our net, I think Steelcase is a great example, Marshall is a great example of casting a wider net and getting into other scalable opportunities. What we look for with a partner, what's important to us is not a onesie or twosie, is they have to have scale for us to invest the time. And I would say, the Marshall relationship is probably like six months to build, Steelcase 10 months. The importance of that is, good arrangements with key partners take time, especially if they have scalable size.

JeffreyCampbell: And my last area is a couple of questions on Global. Can you remind us what internalizing building automation installations will entail, meaning is this a capacity currently within Kontrol or is this something you're going to develop?

PaulGhezzi: Yes, great question. So, part of any HVAC system, heating, cooling ventilation is the automation of that. So, we call that building automation. And building automation is all the controls that manage things in real time. So to-date, Global has been using a third party contractors outsource that. We have an automation team that will take over the primary role of adding that to buildings, and there's always some low value worth items that you may subcontract. But we're going to bring more of that in house. And it's the same with a service platform, the more that we bring in house. If those are margins that are external to Global right now we're going to internalize those, and that should make the acquisition have a lot more value over time for Kontrol.

JeffreyCampbell: And you may have just partially answered this next question, though I'm going to asking it you anyway. Is instituting this capability motivated primarily as a cost reduction or margin enhancement provide a one stop shop for both HVAC installation and software, building management, or maybe both?

PaulGhezzi: Yes, that's -- you’ve kind of hit the nail on the head in terms of the industry and how the industry is consolidating. So, if we think about this industry, HVAC service software automation used to be 10-years ago all walled off from each other and separate. And what we're seeing right now, and what we're part of that, Kontrol is bringing those in house under one unified service platform and package so that if you're doing the install, you're also doing the monitoring, close installation, and you're also doing a service work, and the service work and the monitoring feed each other. And then as you're doing that, you're looking to scale into more buildings and more [effect of those]. And the entire industry is consolidating that way. But what's interesting about the industry it’s primarily private and regional. So from a consolidation perspective, if we can, look at Global, we've done the acquisition in Ontario, we're now looking at the U.S. and creating a regional presence on the Eastern Coast. But the ideology is the same as that to bring everything into one unified platform and then consolidate regionally.

JeffreyCampbell: And my last question, I think you just touched on it. But I just wanted to confirm it. How has the Global acquisition affected your geographic market exposure, if any?

PaulGhezzi: So I would say, it's reinforced where we are. They're primarily Ontario based. It's brought us a set of customers we did not have, which are, what I would call larger project customer opportunities, typically in the $7 million to $12 million range, where we were primarily more on the smaller retrofit $2 million and below. It's brought us a new customer base that we can sell our technology into. So, overall, we think from a perspective of revenue growth and pollination, we're in a brand new customer base with lots of new opportunities.

JeffreyCampbell: Okay. Great. Thanks very much for all the color. It was very helpful.

Paul Ghezzi: All right, thank you. Okay. Thank you, operator. That concludes our time for questions. We appreciate everyone joining us.

Operator: Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.