Sunworks, Inc.

Greetings and welcome to the Sunworks first quarter 2023 results conference call. At this time, all participants are in a listen-only mode. A brief 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. As a reminder, this conference is being recorded. And it is now my pleasure to introduce to you Jason Bonfit, Chief Financial Officer. Thank you, Jason. You may begin.

Thank you, Operator. I'm Jason Bonfit, Chief Financial Officer at Sunworks. On behalf of our entire team, I'd like to welcome you to our first quarter results of 2023 conference call. Leading the call today 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'll open the line for questions. With that, I'll turn the call over to Galen.

Thank you, Jason, and welcome to those joining us today. The first quarter was a challenging period for Sunworks as we managed through inclement weather conditions in many of our primary geographic markets, which impacted the timing of project completions. We also experienced disruptions created by net energy metering transition in California and the tightening credit market negatively impacted working capital. For those not familiar, net energy metering, or NEM, is utilized in California to allow consumers to participate in selling unused solar power generated from their power systems back to the grid. This power sharing relationship is the defining incentive that has led many households to invest in rooftop solar. In December of 2022, the California Public Utility Commission, or CPUC, issued a final decision to update its NEM policies, which adversely impacted the economic benefits of residential and commercial solar by lowering the export rate or the price at which a consumer sells their power back to the utility by approximately 75%. While the reduction in the export rate is significant, the cost of solar relative to current electricity bills and ongoing inflationary pressures on future utility rates are expected to continue to justify the economics of solar consistent with our long-term market view. Additionally, homeowners may augment their solar systems with batteries to ensure that excess power generated during the day offsets their power needs during the evening peak pricing period. In advance of the well-publicized NEM transition, customers who submitted their solar applications through solar providers, including Solstice and Sunworks, by the April 14th deadline are expected to qualify under the prior, more economically beneficial NEM 2.0 regulations. This change in regulation by the CPUC resulted in a surge of applications prior to the mid-April 14th deadline, the mid-April deadline that has caused significant delays, with the average utility interconnection application wait time increasing from less than a week to the eight weeks or more we are currently experiencing. In plain terms, this backlog of applications contributed to a short-term spike in new project demand, but extended interconnection application approval wait times have resulted in delays to project permitting and completion. With these project delays, in-process component inventories have stayed on our books longer than is typically the case, resulting in higher working capital balances and slower cash conversion cycle times. While our first quarter results were clearly challenged, Demand conditions remain strong across our end markets through April, giving us optimism for improved results as we move throughout the year. In the first quarter, our residential solar segment revenue and backlog increased 14.6% and 12.7% respectively versus the prior year period. Order rates increased at an accelerated pace, given an influx of new applications for rooftop solar installations ahead of the NEM deadline. California represented more than 50% of our new residential originations in the first quarter. Direct sales contributed to more than 40% of new originations in the period versus 18% in the first quarter of 2022, contributing to a 450 basis point decline in segment selling and marketing costs as a percentage of revenue. As before, we continue to employ a disciplined pricing strategy into a period of rising demand. Within our commercial solar energy segment, revenue and backlog increased more than 64 and 119% respectively versus the prior year period. First quarter results included an order for a 1.5 megawatt rooftop and carport solar installation with a 2,000 kilowatt hour energy storage system located in Southern California with a Fortune 250 company. The $5 million order represents an important strategic entry point with a large corporation with a nationwide footprint. The project, which will commence in the third quarter of 2023 and should conclude in the first quarter of 2024, is expected to provide significant long-term energy savings for the customer, consistent with their renewable energy objectives. Turning to a discussion of our balance sheet and liquidity. Following the banking crisis earlier in the year, and as several other solar companies have gone out of business, credit markets have tightened for rooftop solar financing. Historically, milestone payments have been provided by lenders at various stages of the project's life cycle. Lenders are reducing risks by shifting payments to later stages of the project, negatively impacting working capital. During the second quarter, we took coordinated actions to enhance our liquidity and reduce our fixed overhead costs. Our liquidity enhancing actions, which Jason will discuss in more detail shortly, increased our available liquidity position by $8 million in May of 2023. This cash infusion, together with the nearly $3 million of cash on hand we had as of March 31st, will help to further bolster our liquidity profile as we navigate the current operating environment. Following the NEM transition in April 2023, we anticipate CPUC utility application rates and project completion times should normalize over the next quarter. In that scenario, we expect working capital requirements to stabilize and capacity utilization to improve. As before, the market opportunity for solar remains significant across our geographic footprint, positioning SunWorks to play a leading role in the transition towards affordable, clean, and independent energy production. With that, I will hand the call over to Jason for a review of our first quarter financial results.

Thanks, Gail. Beginning with our summary of our first quarter financial performance, SunWorks generated total revenue of $38.1 million in the first quarter of 2023, an increase of 22% versus the prior year period, reflecting growth across the company's residential and commercial markets. As we highlighted previously, weather delays in our primary markets delayed roughly $7.8 million of revenue from being recognized in our residential segment. Gross profit was $11.9 million, or 31.3% of sales, compared to $13.2 million, or 38%. in the prior year quarter. The main drivers of the year-over-year reduction was primarily driven by lower labor utilization in our residential segment, again, an impact of the weather-related challenges we experienced. Specifically, our residential gross margin declined to 37.9%, an 800 basis point decrease year-over-year. And in our commercial segment, a write-down of inventory to lower cost or market drove gross margin to 4.5%. Without this non-cash impact occurring, the business would have generated approximately a 17% gross margin higher than the previous year quarter. With another income, we realized a $3.7 million gain. The year-over-year variance was primarily attributable to a $5.1 million net benefit associated with the company qualifying for the employee retention tax credit, then partially offset by a loss on sale of excess module inventory. We reported a net loss of $6.4 million in the first quarter of 2023, or 18 cents loss per share, versus a net loss of $8.2 million in the prior year period, or 28 cents per basic share. Cash from operations was negatively impacted in the first quarter of 2023 due to the weather and utility approval delays, as well as tighter financing terms for residential solar installations that Galen mentioned. As of March 31st, 2023, the company had cash and cash equivalents of $3.4 million. During April, 2023, the company received proceeds of approximately $1.5 million from sales of common stock and registered at the market offerings. And then on May 5th, 2023, we entered into accounts receivable factoring agreement based on the company's commercial customer receivables with the ability to advance up to $2.5 million at any point in time. And then subsequently on May 22nd, 2023, the company entered into a trade purchase agreement with regards to its ERTC receivable with proceeds netting of $5.7 million. The company intends to use the proceeds from these finance activities to support elevated near-term working capital requirements. and the continued effects of protracted utility approval timelines, which are expected to normalize over the coming months. Operator, that concludes our prepared remarks. Please open the line for questions as we begin our question and answer section.

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

One moment, please, while we poll for any questions.

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

Hey, guys. I'm happy to see the liquidity improvements, the kind of proactive moves it looks like you guys have taken there. after the close of the quarter, I'd like to first ask about kind of the outlook for the second quarter. You know, we're already two-thirds of the way through the quarter. So I'm just curious if you can at least give us a sense of, you know, should we expect sequential improvement in the second quarter? You know, if so, are we talking like a single-digit percentage growth or double-digit, you know, like kind of quarter over quarter? And if it's too soon to tell, if you could kind of elaborate on what's happening in this kind of last month of the quarter that causes that uncertainty, whether it's trying to rush and catch up to your backlog projects and squeeze as much as you can in before the close of the quarter, or uncertainties around customer eligibility, getting them grandfathered under NEM 2.0. What's the Q2? How should we think about it? If it's too soon to really say anything, what are those factors?

Sure. Let's start with the commercial business because I think that's a little easier to walk through. We have continued to make improvements in the backlog in our commercial business. Backlog increased sequentially to $35 million and as As we get into the summer months, it's always a little bit stronger. We have lesser weather-related issues in the commercial business. So we're anticipating sort of moderate growth there. Within residential, we had a lot of challenges in Q1 that we talked about with weather. And then I would say that Q2 has been almost a comparable impact on the business with regards to what's happening in California with approval timelines. And we're not gonna provide guidance there, but I'm not expecting the approval rates to be coming in for permits to improve dramatically over the next four to five weeks for the quarter. So I think there's gonna continue to be some pressure in that residential business for most of the quarter.

Okay, and then,

you know, for the full year, in the full year, so 2023, in the past, I know you guys have talked about having sort of, you know, a very high level, kind of an overall 20 to 30% year-over-year growth kind of bogey that you shoot for just in terms of the idea of hitting scale to absorb overhead. And at the same time, I know, you know, at the current moment, you're driving some profitability measures, And those can sometimes slow growth in the short term. So, you know, my question is, are you still, are you still sort of internally aiming for something on the order of, you know, 20, 30% growth in this year over last year? Or is that, do you see that as realistic in light of kind of the profitability measures?

I mean, so growing up in the last year, if you look at our residential group, even, even though we had a difficult quarter, against our plan, we still exceeded revenue in the first quarter of last year by almost 15%. So I think that performance is indicative of our year-over-year ability to perform. Like I said, the challenges we've had have been against what we were anticipating and the revenue levels that we were budgeting for and working against from a cost basis standpoint. They aren't necessarily have been a challenge against growth year-over-year.

Okay. And then I think this probably kind of ties in with the commentary around, you know, the permit delays. But I think in the press release, I saw you mentioned to kind of labor inefficiencies and Galen, I think you kind of referred to this as like capacity utilization. Just curious if like kind of where we stand as of today, are you at that same level of kind of utilization where there's, you know, whether it's electricians or other people on staff that, you know, you don't want to let them go because, you know, once things pick back up again, you want to certainly be able to quickly, you know, use those resources. But are we at the similar level of kind of labor and efficiency at the moment or kind of utilization? Or have we seen improvements? Just curious how that where that's today relative to the quarter.

First quarter. We'll see. Oh, go ahead.

I was just going to, sorry, Galen, I was just going to talk about the residential business.

And I was going to say, go ahead and talk about the residential.

Okay. So I would expect some modest improvements, but the pressure that we saw in gross margin was pretty intense during the quarter. And, you know, I think in the absence of having a very healthy backlog in the residential business, who would have had to make made staffing, uh, you know, significant staffing reductions. No, we don't, we don't feel, we didn't feel comfortable with that because, because of the strength of the backlog and making sure that we have filled labor to, to support the growth, uh, for the rest of the year. So I, I think there, that is, you know, certainly with the challenges in California. there are going to continue to be inefficiencies in Q2. But I think as we get into the second half of the year, we're expecting some of these variables to improve, and we should be able to get gross margins improvement as well back to at least to where we were last year.

On the commercial side of the business, the staff utilization is 100-plus percent right now. It's exactly where it needs to be.

okay great and then um i was going to ask kind of the same jason you answered what i was going to ask about gross margins if again kind of what we should expect them to head back to so nice to hear that they there's there hasn't been any sort of a structural change that would create a new normal sort of gross margin below the mid 40s like what you had last year so that's nice kind of same question for sales and marketing You know, Galen, you commented, I think it was a 450 basis point improvement that you're getting through the direct sales channel. And it seems like I'm guessing that's not blended. You're just saying within the sales that come through the direct channel have the 450 basis point improvement. So you'd have to go to 100% direct in order to kind of have that be 100% conversion into your your financials to see a 40, 450 basis point improvement. Um, but in general, you know, I guess Craig, if I'm wrong on that and how should we expect that to kind of trend as a percentage of revenue sales and marketing expenses kind of for this year?

So we, as Galen mentioned, we had, we had roughly 40% of our, um, of our originations come through the direct channel. Our short-term goals are to get that to be around 50%. We'll be building traditional dealers and we'll be also building our direct force. I don't expect significant changes in the short-term on this percent of sales that we're talking about for residential. That's sort of the investment.

That's because sort of the investment costs offsetting the benefits kind of in the near term?

There's always an investment in direct force. There's also a commission structure that's in place for direct, just like other sales channels have. It's just on a revenue basis, it's slightly lower. So I think until we... you're not going to see a significant reduction there until we start to see originations for direct go well about 50%. Okay.

Okay. Well, I'll let someone else ask some questions, and I'll jump back in the queue.

Thanks, guys. Thank you.

And the next question comes from the line of Tim Moore with EF Hutton. Please proceed with your question.

Thanks, and I don't have as many questions as I normally would because I asked a handful on Tuesday after the press release of the results, but maybe starting off, just to kind of put this in perspective for everybody to grasp it, most of the gross margin headwind in the March quarter was probably because of bad weather, and then this quarter because of NAM and the utility delay, the approvals causing under-absorption too. Do you think that you can get back on a track to be at 40% plus gross margin in the September quarter if the weather and utility delays get behind you by then?

So I think we have to look at that on a segment basis or commercial versus our residential business because the commercial business is growing as well and that has a lower margin profile. So I think really the one-time hit that we had in our commercial business was the write-down of inventory. You know, again, that's a one-time adjustment. We wouldn't expect that to occur again unless if module pricing really deteriorates, which would then help other parts of our business. But I think as we're thinking about the rest of the year, you know, we're targeting that, you know, the mid-high teens within our commercial business, for gross margins. And then, you know, our internal targets are certainly to get back into the mid-40s in our residential business. And I think that blend or that mix of revenue should support a greater than 40%. But there are caveats to that, depending on the mix of the business.

Understood. That segues into my next question, because I'm thinking about things as a net selling margin, you know, after... the selling and marketing expense because you're getting such good leverage out of that as your direct sales force grows to 50% of originations for residential. But just maybe on commercial and public works combined, if I'm thinking of them together, what type of backlog do you think you need to hit a good inflection point for operating margin improvement there? Do you need to get to 50 to 60 million versus 35 million lately?

Yeah, we, we believe that getting to, you know, we're, so our focus is how do we generate positive cashflow out of that business positive EBITDA because there isn't, there isn't significant, uh, CapEx involved. So we believe that, you know, the way that we're pricing these jobs and from an execution standpoint, if we can get into the, into the fifties, into the 60, um, backlog that, that backlog usually represents approximately a year's worth of revenue. And that would be supportive of us of generating that positive EBITDA.

Great. And, you know, I know nobody has a crystal ball on timing, but when do you think that could be? You think that could be by the end of calendar next year, the backlog getting that big?

The pipeline of opportunities we have available to us right now, if we were able to execute on them, um, supports the backlog of that size by the end of this year.

Oh, great.

That's helpful clarity. I appreciate it. And that's it for my questions. Thank you.

Our next question is a followup from Donovan Schaefer with Northland capital markets. Please proceed with your question.

Hey guys, I just have two more questions and then I will, uh, So the first question is, you know, looking at the improved liquidity position, you know, that's a pretty significant improvement with the ERTC advance and the factoring agreement. And then, you know, I think it was nice to see that that's, you know, as a result of that, it looks like you really only tapped the ATM to a pretty minimal extent at the low share prices. So, you know, that was also nice to see. But my question is, you know, I'm curious if you could talk more about how you see yourself like holding the kind of using these different levers, if you expect to lean more on the factoring or, you know, ATM, or if you feel like, you know, between these things and the working capital reversal, you'll be in good standing there and maybe any thoughts around when you think you could get to, like, a cash flow positive situation?

Yeah, we should have noted.

Go ahead, Jason.

Sorry, Galen. I was just going to note the impact of the changes in milestone payments, you know, just to put a number on that is significant and significant for all EPCs, you know, moving from, with some lenders 30% to 50% last year receiving at sort of the time of sale, to moving that more towards construction and PTO, that has resulted in $5 million to $7 million, depending on the volume at a given time, it's about $5 million to $7 million. So it's a fairly significant impact for us. This ERTC benefit certainly washes that out. I think as we, you know, so we have a lot of tools, I think, at our disposal. We, of course, have the ATM. We don't want to continue to dilute our shareholders, but it is an option to us if necessary. And we also have other assets that are unencumbered across the company, including mostly inventory, which is roughly $20 million at the end of the quarter. So we will be exploring other solutions that could help us raise additional liquidity, and that could make us an even stronger financial position. So I think there's more that we're working through there. So I'll hand it over to Galen.

I was going to say that the considerable residential backlog is something that could be very quickly converted into cash if the utility approval situation improves as it eventually has to. So there's basically a large bag of money sitting just outside of our reach And it's close. And the liquidity situation, the efforts that we've made over the last two months have all been around, you know, supporting the business and giving us the opportunity to continue to execute to attain that.

And what about getting to cash flow positive, you know, some kind of a horizon? Any sense around that?

It's going to be so dependent on the utility approval timelines. We had forecasted it being much earlier than it will probably be based on those utility timelines having been so pushed out. It's hard to peg that. I would say that once we understand where the tail of that comes into place, it would be a lot easier for us to estimate the next two to three quarters cash flow positions.

Okay, great. That's helpful. And then just my last question, I know you guys brought in someone to focus on EV charging kind of in commercial segments. Yes. Yeah, I think you were at Intersolar kind of talking about that back in January or February, whenever that was. And so I'm just curious if there have been kind of any updates there because I think of you guys as, you know, historically with Public Works and, you know, commercial projects, a lot more sort of solar-heavy, solar-focused. You know, putting a lot of panels up on roofs and government buildings and things like that. But have you, is the EV business, the charging, is a lot of that just adding EV chargers onto that? Are you doing some, you know, dedicated, you know, public works sort of EV charging installations where you're just rolling out a bunch of chargers? Any kind of color updates on how that initiative is going?

Yeah, I'm very happy with that initiative. We have a bogey on that for several million dollars in sales this year, and I think that we're going to get very close to that. We are not only selling EV chargers as an upsell, if you will, with regards to our existing customer base and the work we would usually bid, but we're also starting to sell EV charger-only projects allowing EV chargers to lead the business conversation versus solar, which is exciting for us. I think that the EV charger market is going to grow exponentially over the next several years. And our goal is to be able to be a part of that growth curve. And so, yeah, more to follow with regards to actual individual wins that are EV charger specific or EV charger led, but they're in the pipeline and there's some that are close.

Okay, fantastic. All right, well, thanks, guys. I'll take the rest of my questions offline.

Thank you, Don.

There are no further questions at this time, and I would like to turn the floor back over to Galen Morris for any closing comments.

Sorry, I was on mute. Once again, thank you for joining our call.

Should you have any questions, please feel free to contact us at IR at SunworksUSA.com. and a member of our team will follow up with you. This concludes our call today. You may now disconnect. Thank you.