Sunworks, Inc.

Greetings. Welcome to the Sunworks first quarter 2022 results conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keyboard, keypad. Please note this conference is being recorded. I will now turn the conference over to your host, CFO Jason Bonvick. You may begin.

Thank you, operator. I'm Jason Bonsit, Chief Financial Officer of Sunworks. On behalf of our entire team, I'd like to welcome you to our first quarter 2022 results conference call. Leading the call with me today is our President and CEO, Galen Morris. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risk described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. After conclusion of our prepared remarks, we will open the line for questions. With that, I'd like to go over to Galen.

Thank you, Jason, and welcome to those joining us today for our first quarter results conference call. Before we move into a discussion of our first quarter results, I'd like to begin with a high-level overview of the progress we're making to advance SunWorks' ongoing business transformation, together with those key areas of strategic focus that our team has prioritized. Demand within our residential end markets exceeded our expectations during the first quarter, as recent investments in marketing and business development capabilities resulted in strong new project originations, particularly in the West and Midwest regions. Demand within our commercial end markets took a pause in the first quarter as several customers deferred projects due to uncertainty related to NEM 3.0. Importantly, early in the second quarter, commercial activity has accelerated meaningfully while our pipeline of new project opportunities remains healthy. On balance, we anticipate an acceleration in quoting, bookings, and backlog across the business in the second quarter that should exceed both prior quarter and prior year levels. While the revenue story was positive in the first quarter, our margin capture was impacted by upfront investments in labor together with component cost inflation. In response to rising labor and supply chain costs, we introduced a series of price increases in the first quarter and are introducing additional increases in the second quarter. These price increases, together with a continued focus on reduced lead times, improved closure rates, and disciplined expense management, are expected to help offset many of the inflationary headwinds evident across the market. Although inflationary pressures exist in the solar industry, we believe that customers will continue to pursue solar investments in the face of rising utility rates. In March, the Department of Commerce received a petition filed by California-based solar module manufacturer Auxin Solar. The petitioner requested that the DOC review solar panel imports from Chinese companies working in Cambodia, Malaysia, Thailand, and Vietnam related to anti-dumping. Many in our industry, including SIA, our trade association, are concerned that the investigation could have an adverse impact on panel pricing and or availability for the U.S. solar supply chain, affecting everyone from panel producers and agencies to developers and IPPs. While these developments are potentially a headwind to the entire solar industry, reflecting a lack of support for the energy transition as a whole. We see no near-term impact from this investigation on our business. Beginning late last year, we began to build our solar module inventory above historical levels, a strategic action intended to mitigate supply chain risk in advance of growing customer demand. As part of this initiative, we expanded our direct and third-party supply relationships with both domestic and foreign partners. So while we couldn't have foreseen the potential for the DOC investigation on panel pricing and availability, our decision to create an inventory cushion during a period of pandemic-led supply chain volatility benefited us, ensuring a stable supply of comparatively low-cost panels to support rising customer demand. Currently, barring any significant additional supply chain issues, Between our existing modular inventory and contractual supplier commitments, we expect to have sufficient inventory to support anticipated customer demand well into Q2 23. Turning now to a discussion of our strategic priorities as we look at the remainder of 2022 and beyond. Market fundamentals, including rising utility costs, remain strong across our key geographic markets as residential and commercial adoption of reliable, low-cost renewable energy continues to accelerate. Sunworks is uniquely positioned to capitalize on this generational shift, leveraging our scale in what remains a highly fragmented market. Looking ahead, our team remains focused on five key strategic priorities. First, we remain focused on rapidly growing scale within the residential solar installation market, building upon our 2021 platform acquisition of Solscience. Over the next five years, we anticipate annual residential PV megawatts installed will increase by 50% from 2022 levels, driven by increased consumers' adoption of renewables. Within commercial, we expect the U.S. market will experience year-over-year double-digit growth in megawatts installed, supported by broad-based demand growth, together with the completion of planned and in-progress upgrades to grid interconnects. Our organic growth focus includes further expansion of our multi-channel sales force, the introduction of new products and solutions, together with a demand-led pricing model. While inorganic growth is not a near-term priority, we do continue to evaluate potential bolt-on acquisitions that could accelerate expansion within specific regional markets. Second, we remain focused on expanding the percentage of revenue derived from our direct sales channels. Historically, the company's residential segment has relied heavily on third-party sales channel partners to originate new business. Beginning in 2021, we launched an initiative to develop a more robust internal sales capability, one designed to increase project origination while reducing compensation expense. By the end of 2022, we expect that approximately 25% of our residential revenue will be originated from our direct sales force, up from a 10% run rate exiting 2021. Third, we intend to build and develop a lean operating culture, one that will adopt an increasingly efficient approach to sourcing and procurement, as well as project execution. This year, we intend to source more materials and equipment directly from U.S.-based original equipment manufacturers, while lessening our reliance on third-party distributors. We believe this approach will allow for improved surety of supply at a lower average cost. Fourth, even during a period of raw materials and labor inflation, we will seek to drive margin expansion. Margin expansion is central to our business transformation thesis and remains a significant catalyst capable of driving a positive re-rating in our equity. Multiple margin enhancing actions are currently underway in our business, including the implementation of programmatic price increases, targeted market share gains, optimization of our sales channel partner network and direct sales force, increased productivity resulting from recent headcount investments, and the adoption of lean principles to reduce costs and lead times and drive continuous improvement, which we would expect to reduce cancellation rates and improve margin. Finally, during this period of transformation, we will continue to maintain adequate liquidity to support the ongoing growth of the business. During the first quarter of 2022, we sold 2.8 million shares of common equity under an existing at-the-market agreement, resulting in net cash proceeds to the company of 7.8 million dollars. Cash proceeds were invested in working capital investments, including the purchase of additional inventory to support increasing demand, together with headcount investments as we build our direct sales force. With that, I will hand the call over to Jason for a view of our first quarter financial results.

Thank you, Galen. During the first quarter, our team continued to advance a multi-year business transformation designed to position Sunworks' solar business of scale across both domestic residential and commercial markets. Before we discuss our financial performance, please note that we have implemented a change in our segment reporting, one we believe will better reflect how we evaluate and manage our businesses. The primary change is that the previously reported summer segment is now separated into corporate costs and commercial solar, which will show the financial performance of our commercial, industrial, and public works business. We will not be able to provide year-over-year performance evaluation for the commercial solar and corporate overhead segments below gross profit. Our Solcia segment has been renamed to residential solar. Net sales, gross profit, bookings, and backlog all increased materially on a year-over-year basis in the first quarter, as strong residential demand more than offset lower connectivity. For the three months ended March 31, 2022, Sunworks reported total revenue of $31.2 million versus $6.2 million in the prior year period. The year-over-year growth was attributable mainly to increased contributions from the residential segment, which offset a revenue decline in the commercial solar segment. During the first quarter, residential and commercial revenues represented 87% and 13% of total revenue, respectively. Solar growth profit increased to $14 million in the first quarter versus $100,000 in the prior year period. The year-over-year variance is primarily attributable to the contributions from the Solstice acquisition. Additionally, improved estimating, cost management, and execution led to margin improvement in our commercial solar segment, despite the reduction in comparable period revenue. As a result of these impacts, gross margin increased to 45% in the first quarter, versus 1.5% in the prior year period. We reported an operating loss of $8.2 million in the first quarter versus a $4.8 million loss in the prior year period. The year-over-year variance was primarily attributable to $2.4 million of non-cash expenses associated with the Solstice acquisition and continued strategic investments in building our direct sales team and onboarding COGS Labor to support anticipated growth throughout the year. as well as the impacts of inflationary pressures. We reported a loss of $0.28 per basic share versus a net loss of $0.19 per basic share in the prior year period. Adjusted EBITDA was a loss of $5.6 million in the first quarter of 2022 compared to an adjusted EBITDA loss of $3.9 million in the first quarter of 2021. Turning to our view of our residential segment, which is our Solstice business, segment revenue increased 7.1% year-over-year on a pro forma basis to $26.4 million, driven by market expansion and executing our strategy of building a direct sales platform. In Q1 2022, approximately 10% of our revenue was generated through our direct sales channel platform, compared to less than 1% of our business prior to the acquisition. We have grown our direct sales force to over 250 representatives, within the past six months and are encouraged that our pipeline of opportunities from this channel is now approaching 20%. Segment EBITDA loss was $2.3 million driven by continuing investments in our direct sales function, expanding our direct labor force to meet growing demand, as well as inflationary pressures, which we expect to offset throughout the year through price actions and the positive effects of leverage. Within our commercial segment, revenue declined 22% year-over-year to $4.8 million, driven by a pause in recent orders given NEM 3.0 uncertainty. Our pipeline of opportunities is increasing, and we are encouraged that we have secured over $9 million of new projects at the end of Q1. Segment gross margin improved to 16.4% in the first quarter versus 1.6% in the prior year period. driven by the impacts of approved estimating and operational performance. The segment EBITDA loss was $1.5 million, primarily due to volume. Turning to our balance sheet, our cash and cash equivalents balance as of March 31, 2022, was $19.5 million, compared to $19.7 million at the end of the fourth quarter, 2021. Total inventory at the end of the first quarter was $14 million compared to $10 million at the end of the year 2021. Given the ADCVD issues Galen referenced earlier, we will continue to make investments in inventory from our expansive list of module suppliers and distributors who are not producing modules in the impacted countries. We have made both firm commitments and negotiated orders to be flexible with demand, and we believe that the sum of the commitments will support our demand into 2023. Operator, that concludes our prepared remarks. Let's open the line for questions as we begin our question and answer session.

Thank you.

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One moment please while we poll for questions. Our first question comes from the line of Donovan Schaffer with Northland Capital Markets.

Please proceed with your question.

Hi, guys. I like the new segmentation that you've put together. I'm curious if you can talk through kind of how we should look at that, you know, as investors or externally. Of course, it helps you managing for internal purposes and for performance assessment. But, you know, one thought, my initial thought is, the corporate segment might be something we would look at as sort of an isolated, an isolated overhead sort of, you know, metric or number where that's what needs to be absorbed with growth. And then maybe the CNI and the residential segments on their own could be, you know, break even without additional growth just from other, you know, in a normalized environment or, you you know, improving the customer acquisition costs through the direct sales effort. So I'm just trying to think about how, as looking at that externally, should we kind of look at that and think about those different pieces and how they're going to be addressed to, you know, reach, to progress towards profitability.

I can start.

I can start, Donovan. Good morning. Yeah, the Sunworks, the legacy Sunworks segment that we reported before was, I think it was difficult for external readers to understand that the commercial and industrial business and how that interplayed with our corporate overhead costs and the cost of being a public company. And as we moved into 2022, we said, hey, we want to move towards profitability and EBITDA positive in all of our businesses and And this was a reporting change that we made internally so that we can begin to evaluate our execution on that strategy. So what you see in corporate overhead costs today are really people that aren't tied necessarily into the day-to-day operations. They're, you know, this really the executive team, which is the lead marketing legal, myself and my team, and then Galen as well. So fairly small set of costs and of course our board overhead as well. So, I think it helps us from a comparability across when we evaluate our business and performance, and that was really why we changed the structure for the business.

Okay, and I guess maybe to kind of rephrase it a little bit, do you feel that the residential segment and the C&I segments, as you are now reporting them under this new segmentation, are they at a scale where with the other changes like the direct sales, improving direct sales on the residential side and improving margins through quoting and bidding on the CNI side, are those at a scale? I know you want to increase their scale, but are they already sort of at a scale where with those changes, they cover their own overhead? And so... the corporate overhead is kind of this isolated variable or is that reading too much into this?

I'll just add that we believe we have the resources, the leadership and the overhead resources in place to scale these business to be generating free cashflow.

Okay. Um, and then I want to ask about, you know, a lot has happened in the first quarter, just sort of, uh, you know, macroeconomically geopolitically and, Uh, you know, well, I guess real quick, first, just, you mentioned a 17% backlog increase in res and residential. Was that quarter recorder or year over year?

Just to clarify, that was just a sequential improvement. And again, and again, that was, that's really driven by it across all sales channels effectively. So we're seeing growth in our sales channel partner and the, and the result of the direct sales channel.

So in the middle of the first quarter, there's the invasion of Ukraine, and then there's also inflation is in the news every day. And those, I think, from just talking to people, a lot of people look at the Ukraine situation as just another proof point that we need to get off fossil fuels. I know inflation can be a powerful sort of sales pitch in terms of saying, purchase your system now, lock it in, and control against rising electricity rates. And so, you know, with inflation being in the headlines and everything. So are you seeing these items like these or maybe even other ones I haven't thought of actually translating into, you know, higher close rates or maybe more inbound calls from customers? Or is that part of where you're seeing the 17% backlog increase?

Are there certain key specific phenomena that are helping drive that?

I think there's a number of things that are contributing. And you mentioned a few of them, energy independence certainly being one of them and a theme that we pitch often. But at the same time, inflation is not only a pressure on people's finances from a cash availability standpoint, but also we see utility rates rising dramatically, sometimes in excess of the predictions of inflation. So I think it's still a very safe bet for people if they want to preserve the capital they have available to them. to move towards clean renewable energy versus depending on the grid. And I will say that everybody we're talking to on the lending side, on our competitors, the messages that we're hearing are very consistent with ours. We are seeing increased demand, not decreased demand. We are seeing more people reaching out to us, more referrals from neighbors and friends. And then, of course, our direct sales channel is – a mechanism that we haven't had before, and it's driving quite a bit of business in the front door as well. They have a telesales group that does a very good job of canvassing by phone, and then they've got a human out-in-the-streets type of group that's following a more traditional sales model, and between the two of those, we're definitely seeing an increase in customer demand.

Okay, and following up on the direct sales effort, so I know you had a significant headcount increase because of that. I think it was about 250 employees. I think most of them were added this quarter. And so I guess two-part question would be, one, how should we think of that in relation to, you know, selling and marketing as a percentage of revenue? Because, you know, there was an uptick there. But, of course, you know, when somebody's newly hired, they're not necessarily going to be There's a learning curve in terms of becoming a more and more effective salesperson. How should we expect that to trend? Related to that, do you expect significant or meaningful headcount additions through the rest of the year? Should we expect another 100 salespeople or so to be added before the end of this year, or is this kind of what you wanted to build up to train them and then improve the performance of this cohort, if you will?

I can start. So most of the sales reps that we're talking about are 1099s. So a majority of that growth is not really salary related or compensation related. There's a piece of that certainly embedded in as we're building the leadership for the inside sales group. But I would say that as you think about modeling out the rest of the year, you know, we'd like to be, we were in the residential segment, we were around 42% of sales We'd expect that to, to come down slightly throughout the year. I think historically we've been at the 38 to 40% range, but again, we're, we're going to continue to make these investments to build out this direct Salesforce. We think it's the right strategy for the company. And it's a good diversification play as well.

Okay. Um, And then I want to talk, I want to turn to, you know, now we're faced with the prospect of rising interest rates. And I know, I think you do a decent amount of cash sales, but, you know, I think you also do some lease and loan. Could you remind us kind of the lease loan cash mix of your residential sales? And if possible, you know, what, A lot of times with these, I think a lot of times with what's presented to a prospect or a customer, it's presented in, you know, what your monthly payments would be and comparing that to a utility rate. And so I'm curious if you can give us any sense for how much, you know, if it's $100 a month, $130 a month or whatever, how much would that increase? based on a 100 basis point increase in interest rates from the Federal Reserve.

Just going back to the first part of your question. The first part of your question is, what's our mix? We're predominantly loaned. We do offer all three options to our customers and they have that choice. But again, most of them move towards the loan, the loan equation.

Okay.

And then, yeah, if, you know, interest rates increase, you know, for your maybe most popular loan products, whatever maturity that is a seven year or whatever, Do you have a sense for the sensitivity of the monthly payments to rising interest rates?

I think the easiest way to put it is that we are confident that the utility rates and the customer demand is going to increase in the face of those changes. As you know, I'm sure we've We pay the lending companies a fee to keep the interest rates at a certain point. And in the end, if we end up paying a slightly larger fee, that fee gets passed on in the sales price of the product. So it isn't necessarily that the payment per month is going to go up necessarily or it's not going to go up literally with the increase, but rather the fee will be rolled into the project cost. I guess what I'm trying to say is there's a number of moving parts there. It's kind of hard for each individual homeowner with each individual homeowner's financial situation to kind of understand, even in a trend, what 100 basis points change would do. I mean, this is relatively unprecedented times from an inflation standpoint. I think everybody's trying to anticipate where things are going. We're staying focused on the strong demand despite inflation. the interest rate changes and the inflationary pressures. And we're right now, you know, at least for the short to medium term, it seems as though demand is being affected by the changes.

Okay. That's helpful. And then with modules, you know, if you guys are building up inventory and that seems like the right move, especially in this environment, Um, but I'm curious to know, you know, if you have some perspective there, since you're doing both, uh, you know, CNI projects and residential projects, when you're going out there in the market to procure modules and with what's going on with ADCVD, um, oxygen solar case, are you seeing any differences? Yeah. The narrative among analysts is sort of that it it's, you know, should be easier to get residential modules. and maybe harder to get larger modules. Are you seeing any sort of differences in procurement?

It's easier to build an inventory of one or the other?

I would say that we haven't had an incredible amount of difficulty in sourcing either. It has been more challenging, don't get me wrong. We are definitely making more phone calls and dealing with changing price that we didn't necessarily deal with with rates of change that we weren't used to dealing with. But right now, we're not having, it's not like we're out of luck on either commercial or the residential through the end of this year and well into 2023. That said, if the oxygen-solar situation becomes different come August when the decision is supposed to be made, the preliminary decision, that could change things. That could make it more difficult. But for now, the modules continue to flow. We are well committed with Tier 1 providers well into next year.

Okay. And then my last question, and then I'll take the rest offline, is just, you know, industry forecasters for the U.S. market seem to expect a pretty healthy surge for the CNI, you know, sector in kind of 2022, 2023. You know, some of it's this idea that I think that there have been more permitting and interconnect challenges on CNI. And so that's kind of created a bit of a, you know, bottleneck or a backlog that's accumulated. And then as that gets worked through, you get this real accelerated or kind of a more impressive surge on the CNI side versus even residential and utility. So I'm wondering, you know, is that something you expect that you guys could benefit from or does it only apply to projects that, you know, have already been constructed and are just waiting on the interconnects so that they can get, you know, counted among these forecasts? And, you know, you mentioned upgrades to grid interconnects. I'm wondering, you know, if that's kind of ties into the same, if that's related to the same issue, kind of how does that play out and what does that look like for you guys?

I think it is related to the question that you asked. The grid is maturing. And even though we hear all the time about instability and weaknesses, work is being done all the time to make the grid better. It may not be where we want it to be, but it is improving. And as it improves, that is beneficial for us as an installer who hooks up from the commercial, industrial, public works side. Additionally, solar is still a maturing market on the CNI side. And where you see that every day is permitting authorities becoming more comfortable with and understanding better and being more willing to standardize the requirements for permitting for commercial, industrial, and similar projects. So we are seeing an easing of pressures, even above and beyond just people going back to work after COVID and the permitting offices as such. We're actually seeing an easier time getting things through those offices because we're having to explain less. We as a vendor or a construction company better understand the individual requirements of the individual regulatory bodies and the AHJs and their requirements to become more standardized and less individual. So all of those are things that we're willing to make this an easier business for us to be in. Rising rates, of course, are going to drive demand. I see a lot of numbers that talk about 24, 25, 26 being the renaissance for commercial solar and really it taking off. We think it's going to be a little sooner than that, but we're certainly going to be well prepared for 24, 25, 26 when it really does take off.

Okay, great. Thank you very much, you guys. I'll take the rest offline. And we have reached the end of the question and answer session.

I'll now turn the call back over to Jalen Morris for closing remarks.

So once again, everybody, thank you for joining our call. Should you have any questions, feel free to contact us at IR, that's Indigo, Romeo, at filmworksusa.com, and a member of our team will follow up with you. This concludes our call today. You may now disconnect. Thank you.

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