Earnings Transcript for KNRLF - Q3 Fiscal Year 2021

Operator: Good afternoon. My name is Kelsey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kontrol Technologies Q3 2021 Financial Results Report Conference Call. [Operator Instructions] The CEO of Kontrol Technologies, Paul Ghezzi; and the CFO, Claudio Del Vasto, are your hosts for today's conference call and will provide management comments. Before we begin, please be reminded that certain statements and information included in the management's discussion and analysts and financial statements and 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 analysts and our financial statements for Q3 2021. For all public information filings, please visit the www.sedar.com. Thank you. I would now like to turn the conference over to Mr. Paul Ghezzi, CEO of Kontrol Technologies. Mr. Ghezzi, you may begin your conference.

Paul Ghezzi: Hi, everyone, and welcome to the Kontrol Technologies Q3 2021 Financial Statement Call. I'm joined on the call by our CFO, Claudio Del Vasto, who will summarize our financial results for Q3. I'm excited to share our milestone quarter in which we delivered record revenues, EBITDA and net income. We have clearly demonstrated the ability to add significant growth with profitability. We continue to drive strong organic growth supported by heightened demand from our expanding blue-chip customer base. Kontrol is uniquely positioned to capitalize on the ongoing building modernization super cycle, and I look forward to continued momentum as we execute on our operating strategy through the remainder of 2021 and into this next phase of growth ahead as we work to deliver sustainable value for our shareholders. In addition to revenue and earnings growth, we continue to operate with financial discipline and exited Q3 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 Q3. 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 Technologies. As Paul noted, we delivered record third quarter results. Revenue, earnings and cash flow from operating activities were all significantly higher than prior periods. So we're very pleased with third quarter and year-to-date performance. I'll provide a very short briefing on Q3 financial results. Revenues for the third quarter were $21.5 million, an increase of 614% from the same quarter in the prior year. Revenues for the 9 months ended September 30 were $29 million, up 260% over the same period in the prior year. We generated positive net income for the second consecutive quarter. Net income for the third quarter was $2.8 million. Adjusted EBITDA for the third quarter was $2.8 million, an increase of 224% over the same quarter in the prior year. Adjusted EBITDA for the 9 months ended September 30 was $5 million, an increase of 234% from the same period in the prior year. Cash flows from operating activities for the 9 months ended September 30 were $4.8 million. We improved our financial position through debt reduction that totaled $4 million for the 9 months ended September 30, 2021. In summary, Kontrol delivered strong revenue and earnings performance, driven by growth across our platforms as we continue to strengthen our balance sheet. I'll turn it back over to Paul.

Paul Ghezzi: Thank you, Claudio. Overall, we remain on track for our best financial year in our history, driven by expanding technology solutions, organic growth and the recent acquisition of Global HVAC & Automation. We are experiencing tailwinds in the business driven by the convergence of government policy, stakeholder activism and corporate social responsibility. Buildings across North America are responsible for approximately 40% of GHG emissions. In the next decade, buildings globally will consume approximately half of the world's energy supply. Certainly, this underscores the importance and necessity for enhanced intelligence to operate better, safer and more sustainable buildings. The Global acquisition, we've been able to integrate Global into our operating platform while delivering record net income. This reflects our ability to acquire a good value and manage the P&L with discipline. We believe that through the introduction of our recurring revenues in software and service will be able to drive those revenues into Global with a higher margin. By adding recurring revenues to the business, we can deliver a higher return on investment and return on invested capital. BioCloud. We continue to experience strong demand for BioCloud. And from our customers in Europe and outside of North America, we are being advised of a fifth wave that may be potentially impacting the global economy. We are pleased to announce and share today multiple positive BioCloud detections of the SARS-CoV-2 virus. This is a major accomplishment for BioCloud as we have collected significant data over an extended period of time that can now be shared with our respective partners, customers and applicable government agencies. BioCloud is accretive to revenues and earnings and represents good organic growth and internal innovation. We continue to make great progress, and we believe we are in the beginning stages where every building in the world will have an early viral and pathogen detection system. BioCloud is not a medical device and does not require Health Canada or FDA approval. We continue to wait for Health Canada -- for Health Canada update. And as previously stated, we neither control the timing nor the process. When we have a confirmation, we'll update the market. We believe that BioCloud is in an enviable position of technology validation through all the testing performed to date. And as we evolve the BioCloud technology, we'll continue to update the market. Without a doubt, BioCloud has moved us into the global stage and has been the catalyst to numerous global partnerships with many more to come. We are pleased to announce that we are starting our first carbon credit program in Q4 or project in Q4, with many more to follow. Adding carbon credit monetization to our platform has delivered numerous new opportunities for our building technology value proposition. Supply chain. The supply chain across our business remains an ongoing challenge, as it does for the majority of businesses. Lead times on components have improved slightly, but it's difficult to predict with any certainty when those will be back to normal. We work closely with our customers and suppliers on a daily basis to best manage our supply chain. Corporate outlook. Kontrol updated its guidance for 2021 fiscal year following the strong performance in Q3. Revenue is estimated to be in the range of $43 million to $46 million for the year, up from its previous $38 million estimate and compared to $13 million in 2020. Adjusted EBITDA is estimated to be in the range of $6 million to $7 million, up from the previous $3.7 million estimate and compared to $2 million in 2020. The company anticipates seasonality in the month of December around project cutoff and revenue recognition and provides its updated outlook as a range to take into account the potential impacts of the seasonality. In conclusion, we want to take some time to thank all of our staff, our customers and our partners. We are delivering record financial performance while executing on our vision for a more sustainable future for all. We are excited about our business, our current innovation and the innovation we'll be adding in the coming months and years. We look forward to the continued execution of our strategic plan. Thank you. Operator?

Operator: [Operator Instructions] Your first question does come from Jeffrey Campbell from Alliance Global.

Jeffrey Campbell: I've actually got 4 questions, if that's all right.

Paul Ghezzi: Sure. Fire away.

Jeffrey Campbell: Kontrol's offering has broadened over -- quite considerably over the past couple of quarters. You're now involved in equipment installation on manner of software monitoring, equipment maintenance, not to mention BioCloud and emissions trading export. So I was wondering, with Global now in the mix, are you prioritizing Global's backlog and the potential for smart building cross-selling? Or are you still actively seeking opportunities to start smaller with analytics and grow applications in the building over time?

Paul Ghezzi: Thanks for the question. So that's a good question. We look at our avenues into a building as multiple avenues. So we can enter a building on a software platform and scale into a project or we can enter a building on a project and add our software. And the same is true for BioCloud and HVAC systems. So the approach that we take is cross-sell to customers, look for new customers and entry points and not specifically focus on any one entry point in particular, but whatever is available from the customer. And that's, I think, unique to Kontrol in terms of our size and scale. So if we think about a much larger competitor to Kontrol, they may have to compete on an entire portfolio for that scale to make sense for them. We can enter 2 or 3 buildings, be profitable on that entry point, but scale into the rest of the portfolio. And I think that's been a big advantage for us in the market.

Jeffrey Campbell: I appreciate that. I'm wondering if you could talk a little bit about the new VR -- VRV, VRF offering, which Kontrol recently completed in installation. Just high level, can you expand on what the technology displaces and its cost benefits? And is this more of a customer-driven or customer education effort moving forward?

Paul Ghezzi: Yes. So what I can say is it's really the first time in the last, I would say, decade that I've seen customers facing real pressure on emissions. And that pressure is coming -- it used to be the industrial sector, was highly regulated. Regulation is coming into building. So for example, New York right now is forcing more GHG emission reporting and also penalties. And we see that regime sweeping across Canada, where if you're a building owner and you're emitting more than your allotment, you're going to be taxed. That tax discussion is really driving sustainability from the perspective of what goes inside the building, a traditional HVAC system. So a VRV, VRF system can be up to 30% more efficient than the most efficient traditional HVAC system. And we're seeing customer interest from the perspective of I need to get more sustainable, I need to reduce my GHG burden and I need to avoid penalties. And really, that's what's driving the market. So our approach is to go to our customers with a turnkey design build solution where we're not only installing, but we're part of the design and then we're part of the maintenance and part of the reporting with the software. And I think if either next 10 years -- the last 10 years have been about efficient HVAC systems. The next 10 years are going to be what we can do beyond that. So we're very excited about that opportunity. We completed our first installation. And what we basically found is we could leverage that installation with lower manpower, lower hours, which, of course, means higher margins. And I think you'll be hearing more from us on VRV and VRF and [high risk].

Jeffrey Campbell: Great. Appreciate that. As Kontrol has moved up market in Canada with global and lighter Skyline Group as an example. And with the growing regulatory support you just mentioned, is any less urgency or ambition to move into the U.S. market?

Paul Ghezzi: We're very excited about the U.S. market. And right now, we're generating roughly 10% of our revenues from the U.S. market. The approach that we're taking is a two-pronged approach. One, looking for a strategic acquisition, and we have a number on the go. These would be smaller software acquisitions that have large building footprints. So we think that's a great way to scale into the market. That was somewhat slowed down because of COVID, inability to travel and do a small software deal, but we're working on that now. And the other approach is to take our existing customer stock in Canada and look for those asset managers, portfolio managers and owners that have buildings in the U.S. And that would take our SmartSuite and technology platform across the border. So we are working on that as well. We see the U.S. as our natural market in terms of building scale. There's no comparison to Canada. But we've also been very careful, and this is a philosophy of Kontrol is don't go open an office in the U.S. and take $2 million out of your P&L if you don't have a good customer base that you're ready to scale into. And so that's a give and take in our P&L. But we've been very happy with that approach. It's kept us profitable and I think we can grow -- we can still grow into the U.S. using that approach.

Jeffrey Campbell: Okay. And my final question is regarding your statement today that the carbon capture programs adding to opportunities and building technology. I just wondering if you could expand on that a little bit.

Paul Ghezzi: So what we've been able to do now is say to our customers, not only can we give you a technology solution that reduces your energy and your emission footprint, but we can monetize those together. That has never been done in our market. So traditionally, in the what we would call the energy efficiency market, the utilities have controlled the monetization of carbon credits. Our program is indirect competition with the utility where we're carving those out, taking them to an open market and sharing with our customer. So it's the first time that our customers have been able to move away from a utility type solution to a much more private market solution. And that has them excited. So the 2 speak to each other. If we can drive more technology solutions, we can generate more carbon credits and vice versa.

Operator: Your next question is from Sid Rajeev from Fundamental Research Corp.

Sid Rajeev: Congratulations on the strong performance. I should say that revenue -- blue [indiscernible] estimates to be more precise, 30% higher than our estimates. It seems like revenue was also higher than your estimates. Is it primarily because of new clients or you were able to get more revenue out of existing clients?

Paul Ghezzi: So thank you, Sid. So it's really a couple of things. One, we try and be conservative in our outlook and then we try and execute into that. Two, we are seeing certainly a lot of tailwinds in terms of the industry, in terms of government policy, stakeholder activism, corporate sustainability. Energy costs, as you know, have just spiked incredibly. So buildings are seeing right now a 40% energy increase over the next 12 months, couple that with the potential of a carbon tax on buildings, has the wind at our back. So we're very fortunate that, that policy has aligned with our technology, and we think this is just the beginning of this massive trend, which Morgan Stanley refers to as the building modernization super cycle. So I think it's a combination of those 2 things.

Sid Rajeev: I see that the gross margins have been fluctuating quarter-over-quarter. How do -- how should we forecast this line item maybe going into 2022, what would be your normalized gross margins?

Paul Ghezzi: Yes, great question. So I think the addition of global SKUs [add] a little in this quarter. The way we look at our business is 30% to 35% gross margin business, which is a combination of projects, software and service. That's a very healthy margin in our industry. It allows you to take on large projects with customers in the $10 million range. It also allows you to take on smaller software projects and that merged gross margin is really representative of the leaders in the industry, which we're emulating. So we're -- we're very optimistic about hitting those targets on a normalized basis.

Sid Rajeev: Got it. And in terms of revenue projections, what percent of the existing revenue is recurring?

Paul Ghezzi: That's a great question. So because of the addition of Global, there's a large SKU there. So we're at approximately 20%, whereas before, we were at 40%. On the other side of that, Global gives us a very large platform to scale into on a recurring revenue basis. And I think we can get that number up.

Sid Rajeev: Got it. Just one more question on the CapEx, $1.6 million in product development, 9 months, any guidance on that? And I believe acquisitions are always -- you see looking at acquisitions, but can we expect near-term acquisitions?

Paul Ghezzi: So we're always -- we like to take a strategic approach to acquisitions. One thing we're known for is not overpaying. We like to find good value. We've been able to close approximately 4x to 5x EBITDA on all of our acquisitions. And I think the value of not overpaying is reflected in our balance sheet and our P&L. So we're very proud of that. So we do have a number that we're looking at kicking the tires. And I think strategically, the U.S. is our next target. In terms of the other question, remind me of what...

Sid Rajeev: Sorry, that's the product development.

Paul Ghezzi: Yes. Okay. So yes, got it. So there's a number of products that we have. We have the SmartSite, SmartSuite and BioCloud. And so the product development costs really across those 3 platforms. Our anticipation on those is those will come down as the products are maturing. And so if we look at next year, we're looking at about approximately $1 million of product development in 2022.

Operator: There are no further questions at this time. Mr. Ghezzi, you may proceed.

Paul Ghezzi: All right, operator, thank you very much. Thank you, everyone, for joining the call. We appreciate you spending time with us, and we look forward to continue to deliver fantastic growth on revenue, earnings and net income. And if you'd like to connect with us info@kontrolcorp.com is the e-mail. That wraps up the call for today. Thank you very much.

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