Spark Power Group Inc. (SPG) Q2 2022 Earnings Call Transcript

Spark Power Group Inc.  (TSE: SPG) Q2 2022 earnings call dated Aug. 12, 2022

Corporate Participants:

Richard Perri — Executive Vice President and Chief Financial Officer

Richard Jackson — President and Chief Executive Officer

Analysts:

Jeff Petherick — Integrated — Analyst

Unidentified Participant — — Analyst

Presentation:

Operator

Good day, ladies and gentlemen, and welcome to the Spark Power Corporation Investor Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Richard Perri, CFO. Sir, the floor is yours.

Richard Perri — Executive Vice President and Chief Financial Officer

Good morning and thank you for joining us today. Welcome to our 2022 second quarter conference call. I am joined today by Richard Jackson, Spark Power’s President and CEO; and Tom Duncan, Chief Operating Officer. Today’s call will highlight the company’s second quarter performance. Richie Jackson will begin today with remarks on second quarter business highlights followed by my financial review of the previous quarter and ending with a brief Q&A session.

Before handing things off to Rich, I remind you that our presentation contains certain forward-looking statements that are based on current expectations and are subject to several uncertainties and risks and actual results may differ materially. Further information identifying risks, uncertainties and assumptions and additional information on certain non-IFRS measures referred to in this call can be found in disclosure documents filed by the company with the Securities Regulator Authorities and available on sedar.com. Further, these forward-looking statements are made as of the date of this call, Friday, August 12, 2022 and except as expressly required by applicable law, Spark Power assumes no obligation to publicly update or revise any forward-looking statement whether a result of new information, future events or otherwise.

I now invite Rich Jackson, President and CEO of Spark Power to provide his business updates to everyone on today’s call. Thank you.

Richard Jackson — President and Chief Executive Officer

Thank you, Richard. Good morning and thank you for attending Spark Power’s 2022 second quarter earnings conference Call. To start off, I would like to extend my appreciation to our stakeholders for continuing confidence in our team. We have been navigating through challenging headwinds for some time. But I’m quite pleased to say that we’re on the right track.

Our second quarter was an encouraging one. We achieved record high revenue growth and grew the business with several new customers. We strengthened our partnership with Alberta’s largest electricity transmission provider and saw positive business results based on our performance improvement measurement.

In Q2, we saw solid revenue and improving gross margin performance in our Technical Services segment, reflecting strong demand in both the Canadian and U.S. markets, an impact of the hard work and focus on margin improvements in Spark’s operating units. Through the execution of our comprehensive performance improvement program, we managed to increase profitability through initiatives designed to expand margins and optimize our SG&A. One such initiative included the consolidation and closure of underperforming branches based on market density and profitability. To date, 6 branch locations have been closed or absorbed by other Spark branches and further markets remain under review.

Related to these initiatives and being rooted in the realities of our current environment, management has taken steps to reduce the size of the footprint and therefore related costs of Spark’s new head office facility in Oakville, Ontario. We’ve also closed out the final Founder transition, which is a part of our SG&A reduction and cost initiatives.

Other Q2 Spark Power business highlights include the launch of liquidity improvement measures in Q2 that also includes the potential sale of non-core under-utilized assets in Q3. This includes the potential for optimizing some of our larger fleet assets, reduction of excess inventories and the sale of under-utilized tools and equipment as part of our integration effort. While it’s promising to see our upward momentum continued to grow from Q1 into Q2, there’s still some heavy lifting to do for us to get to where we believe we should be moving in and moving forward. While we continue to work hard on our overall integration effort to put Spark in a position to grow in a growing market, we are also cognizant that there are significant macro level trends to contend with.

We continue to focus on integration and are well on our way to the One Spark operating model, which will help deliver business stability, scalability and profitability for the long term. This integration of acquired companies and streamlining of business processes, org structure and the underlying technology will allow Spark to deliver on our operational strategy and deliver premium solutions for our customers. We began making these changes in 2021 and expect to have our integrated organization fully in place by early 2023.

It is rewarding to see the progress that we’re making. And I would like to acknowledge the tireless efforts of our employees over the past 6 months. Our employees across North America continue to contribute to our progress on our success, and once again, thank you to the investment community for your confidence in Spark Power. I look forward to what’s ahead for the second half of the year. I’ll now turn the call back over to Spark’s CFO, Richard Perri to share our Q2 financial results. Richard?

Richard Perri — Executive Vice President and Chief Financial Officer

Thank you, Rich. Q2 was another positive step to reestablishing a consistent earnings pattern in our business and demonstrating our ability to execute our plans to deliver long-term value creation for all stakeholders. I’m happy to report year-over-year adjusted EBITDA growth for the quarter of 16.9% excluding the impact of unrealized gains on derivatives. As expected, we also posted strong sequential growth quarter-on-quarter for both revenues and adjusted EBITDA margins as we continue to execute on our plans to improve margin realization and rightsize our cost base. This is in line with the upper end of the range we provided in the corporate update issued in June.

More specifically, I’m pleased to see the improvement in profit growth across our portfolio and in particular from our technical services and renewable segments. Demand for the company’s key offerings across all markets remain strong and we are seeing the benefits of the various margin enhancement initiatives lifting gross margins to 27.5% for the quarter, which is up by 380 basis points from prior quarter. In parallel, with the focus on gross margins, we are aggressively addressing our cost structure and have executed over CAD6 million of annualized SG&A reductions through the end of Q2. Overall, we are seeing strong momentum in the business as we enter Q3 and we will continue to drive profitable growth across the portfolio.

During the second quarter, we reported record high revenue of CAD72.9 million as compared to CAD65.4 million in Q2 2021 and CAD70 million in Q1 of this year, representing increases of 11.6% and 4.1% respectively. Revenue growth was related to increased demand and volumes in our Canadian technical services business and sustained growth in our renewables and sustainability segments. In our technical services segment, revenues were up CAD6.4 million as compared to Q2 of last year, representing an increase of 15.4% over the prior year. The growth reflects strong project work in Eastern Canada, consistent with Q1, combined with higher time and material service work in the U.S.

Our renewables segment continues to deliver sustained growth with revenues increasing by CAD1.7 million or 8% as compared to Q2 of last year, tied to a surge in solar demand in the U.S. market, somewhat offset by softer demand in the overall Canadian market.

Lastly, our sustainability segment continues to post consistent revenue results with growth of 12.1% for the 6 months ended June 30 over the same period last year. This reflects the growing demand for environmental attributes in the market.

Gross margin excluding non-cash depreciation and amortization was 27.5% in Q2 2022, up 380 basis points from Q1, but down 100 basis points to prior year, primarily due to cost inflation. The significant improvement over last quarter is directly tied to the following factors; price actions implemented to counteract cost of inflation, an intentional shift in mix away from larger scale lower margin projects to more transactional service work which carries higher margins, and tighter execution of work in the field. While we remain optimistic about our ability to continue to unlock margin expansion opportunities, we are monitoring the macroeconomic and social factors closely and building contingency plans to mitigate any adverse impacts of ongoing rapid inflation, rising interest rates and/or COVID-19 disruptions.

SG&A costs, exclusive of the impact of depreciation and amortization were CAD12.9 million, down CAD0.9 million or 6.5% from Q1 2022. Relative to prior year, SG&A costs as a percent of revenue were down 120 basis points from Q2 2021. Corporate SG&A costs in particular were down by CAD1 million as compared to Q2 2021 primarily due to lower staffing costs. In the quarter, the company continued to execute targeted cost actions to restructure our field operations and rightsize our corporate overhead costs. Through Q2, the company has executed over CAD6 million of annualized SG&A reductions, which represents approximately 20% of total SG&A headcount. We expect the benefits to be fully realized over the next several quarters. The company recorded a one-time charge of CAD1.9 million in the quarter related to such restructuring costs. In parallel with the work on cost initiatives, we are on track with our first go live on our new ERP platform for Q3 which will pave the way for further operational efficiencies as we roll out the new systems across the organization over the next 6 to 9 months. The company’s reported adjusted EBITDA for Q2 is CAD10.4 million or 40.3% of revenue, up from CAD7.4 million or 11.4% of revenue from the second quarter of 2021. This includes unrealized gains on derivatives of CAD2 million in the quarter. Excluding unrealized gains on derivatives, adjusted EBITDA was CAD8.4 million or 11.5% of revenue in Q2 as compared to CAD7.2 million or 10.9% of revenue in the prior year. The significant increase in unrealized gains on derivatives reflects the early returns on our latest power purchase agreement, which came into effect in the quarter. The gains represent the increase in forward market rates relative to our favorable contract rates in such agreements. During the second quarter, the company increased working capital in support of record revenue levels through the ramp up of our busy season. As a result, cash flow from operations was a use of CAD9.1 million in the quarter. Capital expenditures in the quarter were CAD0.6 million but we anticipate higher levels of expenditures, as we roll out our new ERP platform as well as complete the leasehold improvements for our new head office. Related to the new head office, we took possession of the space in the quarter and satisfy the requirements of IFRS 16 to record the leased asset and liability which you will see in the balance sheet. The lease agreement includes a 6-month fixturing period to complete the leasehold improvements, after which rent payments will begin. During the quarter, the company paid CAD4.1 million of debt repayments to its lender under its term debt facility and principal payments of CAD2.1 million for vehicle and premises lease liabilities. The net result of cash flows was an increase in bank indebtedness of CAD14.5 million in the quarter. At the end of the second quarter of 2022, total debt outstanding to our lender increased by CAD10.8 million to CAD87.5 million as we utilize our operating line to support working capital needs through our busy season. In closing, I am pleased with the focus and commitment of the organization to deliver a strong quarter on the top line while we shift our focus to enhancing the quality of earnings moving forward. We are seeing the early returns from the important work focused on margin expansion, improving revenue mix and cost rationalization initiatives. We will continue to execute with urgency and rigor to position the business for long-term profitable growth. I’m also encouraged by the level of support from our lender over the last several months and the progress made in our discussions to amend the terms of our existing credit facility to provide more flexibility as we execute the next stage of the company’s longer-term growth strategy. We will aggressively pursue all opportunities to strengthen our balance sheet, improve liquidity and scale our operations for sustained profitable growth. With that, this concludes our prepared remarks. I will now turn the call over to our operator for questions. Thank you.

Questions and Answers:

Operator

Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Your first question for today is coming from Jeff Petherick. Please announce your affiliation, then pose your question.

Jeff Petherick — Integrated — Analyst

Good morning, this is Jeff Petherick from integrated in the U.S here. Just a question on the bank indebtedness that bumped up from Q1 to Q2, is that all related to the credit line in working with your lenders. And so the increase the availability of liquidity.

Richard Jackson — President and Chief Executive Officer

Thanks, Jeff for the question. And so the answer is yes. It all relates to our operating line. And it’s important to note, if you step back and look at the end of Q1, we had a rights offering where we raised upwards of CAD40 million in the capital markets. Part of those proceeds were used to draw down our operating line. In addition to settling some outstanding debt. So as of March 31, our operating line had materially come down. The plan was always to then reinvest that back to support working capital needs through Q2 in our busy season.

Jeff Petherick — Integrated — Analyst

Yeah. Okay. All right. That makes sense. And you paid off some long-term debt in the quarter.

Richard Jackson — President and Chief Executive Officer

Correct.

Jeff Petherick — Integrated — Analyst

Okay. All right, that’s all I had. Thanks.

Richard Jackson — President and Chief Executive Officer

Thanks, Jeff.

Operator

[Operator Instructions] Your next question for today is coming from Paul [indecipherable]. Please announce your affiliation, then pose your question.

Unidentified Participant — — Analyst

Yeah, hi, Paul [indecipherable] from [indecipherable] Capital. Could you give us any financial metrics around the new contract specifically the Alta’s one you just announced.

Richard Jackson — President and Chief Executive Officer

Hi, Paul. Richard Jackson. I’m sorry, did you say, AltaLinko one.

Unidentified Participant — — Analyst

Yeah.

Richard Jackson — President and Chief Executive Officer

Yeah so the AltaLink, just to give you some context, AltaLink has been a customer for us for several years and we engage with them on ongoing reoccurring period agreement. So usually they run 3 years with options to run a 4th and a 5th. So we’ve been doing that since we acquired the Orbis business back in 2018, that business is within the regulated utility segment and is really focused on substation maintenances and some construction projects. The overriding financial margins on that we typically run that segment in the low to mid 20 gross margin with a core group of SG&A to support that in Western Canada. I don’t know if that addresses your question.

Unidentified Participant — — Analyst

Yeah. That helps on the margin side. Okay. I need to work back from there. Okay. Just another question if I could CAD1.9 million in reorg costs across the quarter, could you kind of split that out a little bit and maybe specifically you mentioned something about the 3 original founders and what their role is going forward.

Richard Perri — Executive Vice President and Chief Financial Officer

Yeah. Hey, Paul. It’s Richard Perri here. So the restructuring costs would be inclusive of all of the actions that are sort of being executed primarily focused on SG&A headcount as we have discussed, that would also include the point that Rich made in his comments regarding the final stages of the founder sort of transition from the day-to-day operations of the business. They for sure would be part of the CAD1.9 million restructuring charge that was taken.

Unidentified Participant — — Analyst

Thank you very much.

Richard Jackson — President and Chief Executive Officer

Thanks, Paul.

Operator

[Operator Instructions] We do have follow-up question coming from Jeff. Jeff, your line is live.

Jeff Petherick — Integrated — Analyst

Yeah, you guys mentioned that there is still some work to be done on the ERP platform. And so you expect some elevated costs in the coming quarters. Is there a dollar amount that you guys are expecting to have to spend there?

Richard Jackson — President and Chief Executive Officer

Yeah, thanks, Jeff, for the follow-up. So for sure, we have been incurring cost as we have been developing the new system and prepping it for rollout as we move forward here through the balance of the year into the early part of the New Year. There will be some additional cost that will continue to come through, but I would say that we have incurred a fair amount up to this point, those cost, of course, a lot of them. third-party development costs will have been capitalized that will start to flow-through through amortization once we start to hit the go lives, which will be staged as I mentioned in my comments starting in Q3 through the balance of this year and into the start of next.

Jeff Petherick — Integrated — Analyst

Okay. And any, I mean it’s not a significant capital investment that you need to make there remainder. I mean I know that ERP can be more of a headache on the implementation side prior to full launch,

Richard Jackson — President and Chief Executive Officer

Yes. So we don’t anticipate material additional capital investments there. I think we are well through a lot of the heavy lifting on the development side and then we’ll be into the rollout, inevitably, there will be some costs of course, as we are working across the organization in order to have the go lives and also to support post go live but we don’t anticipate any material incremental dollars on the capital side.

Jeff Petherick — Integrated — Analyst

Yeah. Good. Okay, all right, thank you.

Operator

Ladies and gentlemen, that does conclude today’s question and answer session. I would like to turn the floor over to Richard Perri for any closing remarks.

Richard Perri — Executive Vice President and Chief Financial Officer

Thank you. As we wrap up here for sure, we would like to thank you for taking the time this morning to join us for our progress update on the business. We are cautiously optimistic that we have the business moving in the right direction and we are absolutely poised to take full advantage of the market opportunities both in Canada and the U.S. We appreciate the ongoing support, and as Rich mentioned in his opening comments, we absolutely sort of acknowledge and appreciate all the great work that is being done across our business and by every single team member to ensure that we are continuing to take positive steps and really setting up this business for long-term success. I hope you have a great rest of the summer and we will be talking soon in the next 90 days. Thank you.

Operator

[Operator Closing Remarks]