Sunworks, Inc.

Greetings. Welcome to the Sunworks Inc. Third Quarter 2022 Results Conference Call. At this time, all participants are on 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 keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Jason Bonsig, CFO. You may begin.

Thank you, Operator. I'm Jason Bonsig, Chief Financial Officer of Sunworks. On behalf of our entire team, I'd like to welcome you to our third 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 risks described in our periodic reports filed with the SEC. Except as otherwise required by law, we undertake no obligation to update our forward-looking statements. Following our prepared remarks, we will open the line for questions. With that, I'd like to turn the call over to Galen. Thank you, Jason, and welcome to those joining us today. During the third quarter, our business benefited from a combination of strong residential solar demand, strategic price actions, disciplined expense management, and market share gains. As household electricity bills continue to rise, order rates for new residential rooftop solar installations accelerated on a year-over-year basis, contributing to robust organic revenue growth in the third quarter. While customer financing costs have increased in tandem with higher interest rates, originations during the quarter were at record levels, as the economic case for residential solar remains highly compelling, particularly for customers who value independent, reliable access to renewable energy. To help illustrate this point, let's use a real-world example. Currently, the average residential electric bill in California, our largest market, is more than $1,550 annually, or nearly 50% higher than it was a decade ago. Even as electricity prices have risen meaningfully, grid reliability has declined, leaving many households and businesses to explore alternative options. Consumers want more control over how they source energy, They want choices. The average residential installation will typically cost between $25,000 to $30,000, including the benefit of tax credits financed over a 15- to 25-year period. By installing solar, a homeowner can, in most cases, use their system to offset their electricity usage 100% and have a system which will support future consumption growth. Over the past year, the cost of solar has increased for the first time in the industry's existence. Financing rates have increased by more than 5%, and low interest rate products are being limited by the loan providers. Inflationary pressures for labor and key componentry have pressured the economics of solar. Despite these headwinds, many homeowners continue to see an immediate reduction in their utility bills, but the economic benefits compound over time as the cost of solar remains fixed compared to the rising costs of retail rates from traditional utilities. Even after accounting for higher financing costs, the long-term economic case in favor of residential solar remains well intact. And with inflation at the highest level since 1982, we take the view that households will continue to look for ways to lock in sustainable energy cost savings. To that end, our total backlog increased 116% year over year to $110 million at the end of the third quarter, driven by broad based origination growth across both residential and commercial end markets. Importantly, in the face of rising demand, we have been able to pass along several strategic price increases this year. Given the anticipated impact of these recent price actions, our backlog margins are the highest we have seen in several quarters, which should support improved margin capture beginning in the fourth quarter and into 2023. Fortunately, Supply chain conditions improved during the third quarter versus what we experienced earlier in the year. Given expectations of continued demand growth, we invested heavily in panel and component inventory during the third quarter to support a growing backlog of project activity. Although easing in the supply chain conditions is encouraging, we recognize this situation can easily reverse, particularly given the current geopolitical climate. With this in mind, we will continue to prioritize working capital investments in critical componentry, positioning us to mitigate material sourcing risks. As we discussed on our prior calls, we intend to shift an increasing proportion of our current sourcing from foreign manufacturers or third-party distribution channels toward U.S.-based original equipment manufacturers, an approach that we expect to provide improved surety of supply over time. By the end of 2024, we intend to source a significant share of our panel and component inventory from U.S.-based producers. Turning now to a high-level overview of our third quarter results. Total revenue increased 30% year-over-year to $40.7 million, as robust residential demand more than offset near-term softness in commercial activity. Within our residential solar segment, total watch installed during the third quarter increased by nearly 50% on a year-over-year basis, driven by strong new contract origination sourced through our direct sales force. Our direct sales force, which now includes more than 600 agents in 14 metro markets, represented 23% of total residential solar segment revenue in the period versus less than 5% of segment revenue in the prior year period. More importantly, I'm pleased to report that we delivered positive residential segment EBITDA in the third quarter. At a strategic level, our business transformation continues to advance meaningfully. Customer retention is up, given a higher volume of installation. Order cancellations have declined. We're expanding in the direct sales channel, which reduces costs and puts us closer to the customer. We're using intelligent, data-centric pricing strategies to optimize margin capture. And we're refining our sourcing and procurement model to ensure uninterrupted access to high performance, quality, componentry across multiple markets. Looking ahead, I'm positive on the outlook for our business, even as concerns around an impending recession become the consensus view. Today, the domestic solar industry has the technology to provide affordable, reliable electricity to every home and business in America. Sunworks remains a pioneer in the renewable energy revolution, one well-positioned to capitalize on the underserved, fragmented residential and commercial solar markets where we built a leading position. It is an exciting time at Sunworks. Thank you for your continued interest in and support of our business. With that, I will hand the call over to Jason for a review of our third quarter results. Thank you, Gail. During the third quarter, our team executed ahead of plan across several key operational metrics while driving significant growth in revenue, orders, and backlogs. For the three months ended September 30th, 2022, we reported total revenue of $40.7 million versus $31.2 million in the prior year period. The year-over-year growth in revenue was attributable mainly to increased contributions from the residential solar segment, which went from a growth in installation volumes and improved pricing. Commercial solar energy revenue declined $3.8 million compared to the prior year period, primarily driven by lower order intake in the preceding periods. During the third quarter, residential revenue was 92% of our quarterly revenue, while commercial revenue represented the balance. Total gross profit increased to $19.5 million in the third quarter, 2022, versus $13.7 million in the prior year period. We'll note that the current quarter benefited by an accounting estimate change in our residential segment of $1.8 million related to the capitalization of costs incurred on projects that are in progress and expected to be completed in the coming months. The year-over-year variance was primarily attributable to growth in customer acquisition and operational improvements throughout the business, including increased focus on accuracy in estimating, quoting, and improved execution partially offset by inflationary pressures on materials and labor. We reported a third quarter net loss of $5.4 million, or a loss of 16 cents per basic share, versus a net loss of $6.5 million in the prior year period, or a loss of 24 cents per basic share. The year-over-year variance was primarily attributable to lower amortization expense associated with the Solstice acquisition and lower stock compensation expense, partially offset by inflationary pressures on materials and labor, as well as investments to support anticipated growth in each of the company segments. Adjusted EBITDA was a loss of $3.7 million in the third quarter, compared to a loss of $3.3 million in the prior year quarter. Turning to our view of our residential solar segment, which is our Celsius business. Segment revenue increased 57% year-over-year to $36.7 million, driven by growth across all sales channels. Total residential lots installed increased 50% year-over-year in the third quarter. Direct sales represented approximately 22% of total revenue installed during the third quarter versus less than 4% in the prior year period. The residential segment generated positive EBITDA of $1 million, driven by strong end market demand, recent price increases, and improved operating leverage. Total residential backlog increased 18% sequentially to approximately $70 million in the third quarter, driven by growth in both direct and dealer originations. Within our commercial segment, revenue declined 48% year-over-year to $4.1 million, primarily based on lower revenues low order activity in 2021 and earlier this year. The commercial segment generated an EBITDA loss of $2.6 million in the third quarter, primarily due to lower volume. Turning to our balance sheet, during the third quarter we raised $7.3 million under our at-the-market equity program to support strategic growth. At the end of the third quarter, we had no debt and $14.5 million in cash to support the ongoing growth of our business. Networking capital increased by $5 million sequentially as a result of investments in inventory. Total inventory at the end of the third quarter was $26.9 million compared to $12.4 million in the prior year period. As Galen mentioned earlier, we believe investments in componentries are prudent use of capital at this time given a combination of strong underlying customer demand and a global supply chain that, while improving, remains in flux. In summary, we remain well-capitalized to support growth. We've made the necessary inventory investments to support a growing pipeline of customer demand, and we have a strong backlog of higher-margin project work to support us in the fourth quarter and into 2023. Operator, that concludes our prepared remarks. Please open the line for questions as you begin our question and answer session.

Thank you. And at this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.

And one moment, please, while we poll for questions. And our first question comes from the line of Philip Shen with Roth.

Please proceed with your question.

Hey, guys. Thanks for taking my questions. First one I have is on the loan financing and Can you remind everybody what percentage of your residential business is financed by loans versus cash? And I recall you guys don't have a lease product, but wanted to explore and get your perspective on with the substantial number of price increases and dealer fee increases by the loan companies, how is that impacting Your business in Q1 and Q2, I know you highlighted that your originations for Resi were up 48% year-over-year. But as you think about what you've seen so far in Q4 and then what could come ahead, how is your sales force adapting to the meaningfully higher dealer fees and the higher rates and the removal of the lower APR products like the 0.99% and 1.99%? Are you guys considering a lease at all? I know there's a lot there. Thanks for providing some comment on that. Thanks.

Sure, I can. Good morning, Phil. I can start answering that question. So historically, Solstice has offered lease and loan products depending on the economics at the time. We do offer both loan and lease products today. And there is, but that's predominantly been loan products over the past several years. We are seeing more gravitation into leases and into cash. Cash has been typically less than 5% of our business in the past. We see that, we're going to see that grow over the next year and we are beginning to bring on more of these providers as well to be competitive and to make sure that we're offering the best products to our dealer channel and our customers. And from an origination standpoint, so we're continuing to grow our our direct sales force. We talked a lot about that during the prepared remarks. It's grown to over 600 reps today and it's becoming a meaningful portion of our business. So we're expecting to continue to grow that. We are seeing pressures on originations, certainly throughout the year and with several increases coming. I think that will put more pressure on the economics of solar in certain markets. But as Galen said, the economics of solar are still in our favor, and we believe offering more leased products will likely make us more competitive in the coming months.

Great. And that makes sense. And so if you were to think about Q1 and Q2, how would you think through how either installations or even originations might – grow on a year-over-year basis or even sequentially? Thanks.

It's a little early.

I think it's early to tell. I think the best guidance that we can probably give is to say that lease products morph from 5% to 10% of our business, maybe to 25% mid-next year. It's difficult to give perspective on originations. We are evaluating certain markets and evaluating if it makes sense for us to remain in those markets. And so we're really focused on which markets are cost effective and ones that we can grow in the future. So I think we'll see how this develops in the coming quarters with originations. Obviously, with recessionary fears, you know, that could impact our business. But again, we're just really paying attention to our cost structure making sure we're prudent and making sure we're growing in the right markets. Let me add real quick. From an installation volume standpoint, we're entering the year with a very significant backlog, and we've been putting a lot of time and energy into revamping our processes to make us faster and to reduce the likelihood that a contractor will end up turning into an installation. So we're very optimistic about Q1 and Q2 because not only have we not yet seen very much pressure on originations, but we have significant backlog and we're installing faster.

Great. That's really helpful. Thanks, Galen. On the backlog, can you give us a split between Resi and commercial for the $110 million? I know Resi is more of a turn business, but just curious. with this end of Q3 snapshot in time, what that might look like?

Backlog for commercial businesses was about $40 million, about $110 million. And that's significantly, I think we started the year, beginning of the year was closer to about $18 million. So we're starting to see some good traction there on the commercial side of the business.

Great. And then Presumably residential is the rest of it. Correct me if I'm wrong there. And then finally, Jason, you were highlighting that you guys are exploring some markets that could be shut down or you're evaluating the rationale given the economics. If you feel comfortable sharing which regions that might be that would be fantastic. But if you don't feel comfortable with that, can you talk through maybe some of the ingredients that are resulting in that region or part of the world or country that is making it less desirable? So is it a low retail electricity price combined with poor net metering and then the rising loan prices? So what's the kind of set of characteristics that we can kind of lean on to help understand what the pattern might be?

I think that's fair. I would add in what has been happening from a retail rate perspective and increases that consumers are seeing from traditional utilities. And we're also very focused on our timelines for install and servicing our customers. And we want to make sure we understand the various jurisdictional and the AHJ requirements in those different markets because some of those markets may have very, very long lead times and you can certainly not fulfill in a fast enough rate and it can be a cash burden to the company as well. So maybe that's one sort of new ingredient that we would share with you that we haven't talked about previously.

Got it. Thanks. And then one last one. In terms of lease partners, Historically, who did Solstice work with, and then who might you guys be working with on a go-forward basis, and how many partners ultimately do you think you'll have? Do you think you'll have more than one, or do you think you'll focus your lease business with just one partner? Thanks.

Certainly, we can – I don't always like to talk about the companies that we're working with on the calls. We can sort of take that offline. Traditionally, it's been one or two. We've had one lease product since I joined the company last October. We've expanded that to a second one in the last few weeks, and we'll be looking to add one to two more in the coming months.

Great. Okay. Thanks for the questions, guys, and I'll pass it on. Thank you, Bill.

And our last question comes from the line of Donovan Schaefer with Northland Capital Markets. Please proceed with your question.

Hey, guys. Congratulations on the solid quarter. I want to ask just about the Inflation Reduction Act. It's obviously kind of something we've all been talking about a lot lately, but looking at your third quarter results, is it fair to say that this doesn't really reflect anything there and now you've uh these results don't really reflect any of those sort of tailwinds um but you've probably started having some conversations maybe on the cni side with people that are kind of factors all that in so i'm curious just if you have incremental kind of color insights on how you see the inflation reduction act playing out kind of for your residential and your cni business you know over the coming um uh you know in 2023 and kind of thereafter

This is Gail. I'll start. On the CNI side, let's start with the CNI side. On the CNI side, our current strategy is to provide every proposal with a prevailing wage and a non-prevailing wage cost so that the customers can see the impact of waiting for some of the rules to change, specifically in California with 2143. And where we can, we're demonstrating to them that there would be a cost, there would be a IRA, ITC savings, but the savings probably would not offset the prevailing wage and employment costs. So we are discussing that and walking through that with the commercial customers on a case-by-case basis. We do expect, as we get closer to the end of next year, as the IRS releases their guidance for the ITC, to see a short-term uptick in completed sales and to use those pressures to push people along with the decision-making process. That reminds me, one note, when Jason talks about our backlog on the commercial side, that is contracted, signed, negotiated, contracted work. That does not include work that has been verbally or written awarded, but in which we're still in contract negotiations, in which there is quite a bit of volume in that bucket as well, but we don't take credit for that until the contracts have been signed. On the residential side, I'll let Jason get into it a little bit more particular, but We have not yet seen a tremendous amount of change based on the IRA Act, but we are starting to see an increasing number of lease providers approaching us, wanting to work with us, and I think that the reason is the ITC, the additional ability for them to capture a large amount of money.

Okay, that's helpful. That makes sense. And then for the direct sales channel, you know, the sales mix from that was 24% of your total revenue in the quarter versus I think it was, in my notes, it looks like it was 15% last quarter. So, you know, that's a really nice improvement sequentially. And it looks like it's, I'm guessing that's kind of being reflected in the drop in sales and marketing expense as a percentage of revenue. Do you have a goal for, for how high you'd like to get that mix, just something you're kind of targeting, because there's probably benefits to not doing 100% direct sales either, because you want kind of different levers to pull and you want to keep those relationships going. So I'm curious if there's kind of an idealized mix that you're targeting, and then if you get to that idealized mix, where do you think that could send sales and marketing expenses as a percentage of total revenue? I think it's 36% this quarter. Anything there that would be helpful?

At a high level, we don't have a targeted percentage down to a single digit. But as the economics of both channels evolve, we're going to continue to look at it. There's no intention of moving entirely direct. You know, if I was to pull a number, what I've been giving thought to over the last few months is probably 50% from a direct sourcing and 50% from our various channel partners, which as we grow, means growth in both organizations, significant growth in both groups. So I think there's a lot of opportunity there. And you're absolutely right. There's certain risks that are involved in going entirely direct. It's harder to move into new markets. You can't leverage the relationships and the hard work other people have already done in finding. And you're always competing with somebody or multiple somebodies, whereas when you're in a channel relationship, a lot of those dynamics have already been handled, absorbed, and the sales folks in that area already understand their market. So there's a lot of good reasons to stick with a healthy channel partner relationship.

Okay. That's helpful. And then For the CNI segment, you know, you got the 8.2 million in orders during the quarter. And, you know, as Jason pointed out, the backlog has increased quite nicely since the first quarter. You know, it's more than doubled. So, yeah, 16 million in Q1. And, you know, now you have 40 million. So I'm curious if you can kind of remind us or even just, you know, if you could take, for example, the, you know, orders this quarter. Or you can maybe look at that backlog kind of an aggregate. If you can give us a sense of when you think that would start to flow through revenue. And also just if there have been any changes in the types of kind of CNI projects you're getting there in the backlog. Are these kind of your traditional agricultural and public works projects, you know, mostly in California? Or does the $8.2 million you got this quarter, does that reflect some additions in other markets and the East Coast and stuff? And if the project sizes are changing at all, if you're moving to larger CNI projects, smaller CNI projects, anything there would be very helpful.

There's a number of parts of that question. Let me just try and get through them. The CNI side of the business, the public works projects, is a larger percentage of the backlog than they have seen traditionally. And as such, those are larger projects. That's pushing our average project size. So that's actually a really good thing. We're excited about that. The larger projects, that's where we really can leverage our advantages over smaller companies that we compete with. With regards to that mix, we don't anticipate seeing that change. If anything, we expect to see more of those larger public works projects come through.

And right now, almost everything is . Okay.

Well, and just the time, I guess the timing of, is that like kind of a one-year lag? Yeah.

Right now, we're deep in the budgeting process, and I would say that most of the backlog is going to convert into revenue in the coming 14 months, and we'll continue to build the backlog.

Okay.

I think you'll see it, Donovan. I think you'll see a steady build in the revenue, but it's not like there will be sort of one core that's just a step-level change.

okay to build throughout the next several quarters okay okay um and then the other thing i wanted to ask about is um kind of ev charging and batteries i think you know i can't remember i know i think i kind of i i confused and second-guessed myself on this with you guys sometimes but i think if I recall correctly, you've sort of been considering or looking at doing, you know, doing EV charging charger installations. I think both Resi and CNI haven't done a lot of that yet. And I think you do the battery, but not a lot. So I'm curious if that's kind of been changing, if you've, if there's any updates on moving towards higher attachment rates and you know, further kind of efforts or initiatives or anything around bringing in EV charging to kind of dovetail with solar installations?

On the residential side, we are currently selling EV chargers and batteries. The attach rate is not as high as we'd like it to be, but it is growing. And we're primarily doing those through a particular motor manufacturer, and they are part of a system that the customer buys and everything has the same brand name. On the commercial side of the business, we just recently brought on board a resource for business development to help us transition our business. The goal being to also originate projects for which the origination basis is commercially recharging. And right now we offer and install commercial EV chargers on many of our projects, but the reason we're talking to that customer and the reason we're in the project is because of the solar. And what we'd like to see moving forward is also originate projects that are EV chargers specifically and EV charger only. We see a lot of money going into the market from federal and state and local incentives. There's an awful lot of opportunity there for any mobile company to expand its efforts into its sales and market development efforts into commercial and fleet EV charging solutions. On the battery side, we also offer batteries with pretty much every project that we did. Whether the customer asks for them or not, we walk through the value proposition of commercial battery systems. And we have installed several, but... We're also going to be looking in 2023 at how we can move from a solar origination company to a solar, a battery, and an EV origination company.

Okay, great. Thanks. Very helpful. And then my last question, I was going to ask, because this Berkeley Labs came out with a study. They do these sort of periodic studies to show the demographics. for people who get rooftop solar installed. The most recent one, I think it came out last week, and the trend keeps moving down to lower and lower income. The median household income is now at $110,000. That's a median that could definitely be two income earners in a household. I think it was $130,000 a year ago or maybe that was a pre-pandemic number but either way the trend seems to you know really be favoring the type of like kit installations that you guys try to do where it's this fast you know velocity installation to try and do two a day and it's a predetermined kind of inverter panel package so i'm just curious like are you seeing Is this panning out in what you guys are seeing on the ground in terms of like maybe, and maybe comparing notes with, I don't know if you compare notes with competitors or things, seeing faster growth in these kind of smaller, I think it was kind of like the Trader Joe's customer like installation where it's a quality product, you know, but it's a lot more affordable. You're not doing kind of McMansions or like luxury homes. Are you seeing more growth in that? end of things versus the luxury stuff. I'm just curious if that's kind of panning out for you guys as people who talk to kind of boots on the ground.

Yes. Well, we probably installed, you know, 600 houses, 550 houses a month. The average system size has increased slightly, not slightly, it's increased up to over seven kilowatts. But seven kilowatts is still a reasonable rooftop. So still given the size of the wattage of panels that are available these days with modules, We have certainly closed some much larger projects, some that are even commercial-sized, put on residential compounds, if you will. But for the most part, I would say that the health, the growth area in our industry will continue to be people who see the value of solar as a way to offset their utility costs versus a green badge on their roof that shows their political or

of social intentions.

Okay, great. That's helpful. I'll take the rest of my questions offline. So I appreciate you taking our questions and congratulations on the quarter, you guys. Thank you.

And we have reached the end of the question and answer session. I'll now turn the call back over to Galen Morris for closing remarks.

So thank you, everybody, for joining us today. If there's any questions or concerns or follow-up actions, feel free to reach out to us at IARC.com. Thank you so much.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.