Sunworks, Inc.

Greetings. Welcome to SunWorks' second quarter 2023 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 keypad. Please note this conference is being recorded. I will now turn the conference over to Jason Bonfit, Chief Financial Officer. Thank you. You may begin.

Thank you, Operator. I'm Jason Bonfit, Chief Financial Officer of Sunworks. On behalf of our entire team, I'd like to welcome you to our second quarter results of 2023 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 Securities and Exchange Commission. Except as 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'd like to turn the call over to Galen.

Thank you, Jason, and welcome to those joining us today. As detailed in our second quarter earnings release issued earlier today, The last several months have been a challenging period for both Sunworks and the residential solar industry at large. Even so, we believe the long-term economics of solar remain highly attractive, particularly as the demands of a growing population weigh on our nation's aging electricity infrastructure, resulting in structurally higher utility rates for customers over time. During the second quarter, the combination of higher interest rates, less favorable residential solar economics in California following the NEM 3.0 transition, together with utility permitting delays, resulted in lower installation activity and reduced fixed cost absorption in the period. During a transitional period for our residential business, we've maintained an opportunistic pricing strategy in accordance with current demand conditions. At the same time, we've taken decisive action to further right-size our cost structure, including a reduction in force beginning in the third quarter 2023. Since launching our direct sales initiative in the fourth quarter of 2021, we've continued to gain significant traction in the market. Recall that customer acquisition costs within the direct sales channel are materially less than through our third-party agency channel. To that end, direct sales represented 45% of all originations in the second quarter versus 23% in the prior year period. In July, we were pleased to appoint Mark Trout as Group CEO of Solsius, Sunworks' wholly owned residential solar business, effective July 10, 2023. Mark brings more than 35 years of senior commercial development, and operational experience to SunWorks, including deep sector expertise within the residential solar and advanced technology industries. Previously, he served as chief technology officer for both Sunrun and Vivint Solar, where he led the implementation and execution of all IT and product technology initiatives, including solar product innovation. At Solsius, Mark will provide his structural and systems expertise to our residential channel while driving continued improvements in efficiency quality, and customer satisfaction. We are excited to have Mark join the team at a pivotal period for the company. Turning now to a discussion of our commercial solar energy business. Our commercial business had an outstanding second quarter as revenue nearly doubled on a year-over-year basis, while gross profit margin increased more than 1,000 basis points to 26.5% in the period. Our track record of strong project execution has started to garner the attention of large commercial organizations, including several independent power producers, many of whom have multiple installations across the United States that represents promising new entry points for us. Our ability to deliver a turnkey project on schedule and at or below budget is a key point of differentiation for us in the markets we serve, one that resonates with our customers. Our inbound indications of interest and commercial project awards that are waiting for utility approvals and studies have increased materially in recent months, both in reference to our traditional solar market installations, but also in battery storage systems and EV installations, which represent new areas of opportunity for us. In response, we've onboarded new creative financing options to secure the business while building a pipeline of opportunities supportive of future backlog growth. Looking ahead, we intend to stay on course for our strategic growth priorities, building market-leading positions in regional centers while driving programmatic cost reductions that reduce our cash burn and put us closer toward achieving positive EBITDA consistent with our long-term objectives. Given the strength in our backlog, together with ongoing development activities, we anticipate our financial performance in the second half of 2023 will be stronger than the first half of the year, positioning us to rebuild momentum in our business entering 2024. 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'll hand the call over to Jason for his remarks.

Thank you, Galen. Beginning with a summary of our second quarter financial performance. Sunworks generated total revenue of $34.6 million in the second quarter of 2023, a decline of 4.8% versus the prior year period. Its strength within commercial was more than offset by weaker performance in residential, which Galen referenced earlier. While higher interest rates have increased the total cost of rooftop solar for homeowners, we continue to offer a suite of financial products that, over time, will help homeowners save money relative to their utility bills. Even so, higher rates remain a headwind for our business and the industry. In advance of the well-publicized NEM 3.0 transition in California during April 2023, customers accelerated their decision to go solar, resulting in a pull-forward demand from the second quarter. As we move further away from the April transition, we anticipate further stabilization in new originations. One factor that remains a challenge involves the significant delays in the average utility interconnection application approval timelines in California, which remains our largest market. Approval queues have approached four months from approximately one week last year. As we move further away from the NEM transition, we would expect application approval timelines to normalize. Total gross profit was $11.4 million or 33% of sales compared to $16.6 million or 45.5% in the prior year quarter. The combination of execution improvements and higher volume within our commercial segment drove their gross margin to improve to 26.5% during the quarter. Offsetting this improvement was under absorption of labor costs in our residential business as California utility approvals caused disruption and excess costs throughout the quarter. As we enter Q3, we are focused on margin improvement in residential as we realize labor cost savings and as utility approval queues revert to historical timelines and as we exit underutilized markets in which we're not operating at scale to drive an acceptable margin profile. We reported an operating loss of $11.4 million in the second quarter versus a loss of $7.5 million in the prior year period. Adjusted EBITDA was a loss of $9.9 million, better than our guided range of between $10 million and $11.5 million loss that we provided on August 2nd. We generated a net loss of $12.7 million in the second quarter of 2023 or 34 cents per basic share versus a net loss of $7.6 million in the prior year period, or 23 cents per basic share. As of June 30th, 2023, the company had cash and cash equivalents of $4.6 million. During the second quarter, we took action to further bolster our liquidity to support the long-term growth of the business by financing our ERTC receivable raising equity, and securing a factoring line of credit for our commercial receivables. Furthermore, on August 9th, we announced the completion of an equity offering, which resulted in net proceeds of $3.2 million, which is earmarked for general corporate purposes. Operator, that concludes our prepared remarks. Please open the line for questions as we begin our question and answer session.

Thank you. If you would 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 would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Philip Shen with Roth MKM. Please proceed.

Hey, guys. Thanks for taking the questions. I wanted to start off with CNI. You know, it sounds like you're having some traction there. I was wondering if you could talk us through how long you expect to see this strength. Do you expect this to continue through Q3 and 4 and perhaps even through 2024? Our sense is that things are actually accelerating with CNI. I was wondering if you are seeing something similar as well. Thanks.

I think the C&I industry is growing, is getting more and more strong. I expect to see that business, let's just say I expect to see the C&I market grow considerably over the next 18 months. It's not nearly as impacted by the certain parameters that are impacting the residential market. And, you know, if you look at, like, Wood Mac studies and things like that, that they all kind of fall in line with that same idea that the commercial business is going to improve over the next 18 months and then beyond that.

Great. Thanks, Galen. And is part of the reason driven by, like, was CNI a little bit slower earlier this year because of the waiting for the IRA guidance and with the guidance now? largely out, have things freed up as a result. And can you also talk about margins? Do you expect the margins for this segment to kind of remain in this kind of mid-20s level? Thanks.

The IRA, certainly the guidance and understanding the domestic content adders and such have had an impact. I think that there was a negative impact earlier in the year, and there still is to some extent. a headwind with regards to the utility approvals. Not just the utility approvals for the residential side are definitely a burden, but rarely do they require any sort of a study or any sort of a follow-up activity by the utility that could take serious amounts of time. We have many, many contracts that we are not calling backlog yet. that are sitting in approval queues at the utilities right now. So that has been the number one headwind so far. With regards to margins, I think the margin in this past quarter was a little bit optimistic in that our public works division had a few projects that were a little bit slower. We actually thought the revenue for the quarter was going to be higher, but the public works projects are very large and they come in at significant dollars of profit, but lower margin numbers. So the ongoing margin profile is closer to the low 20s.

Okay, got it. Shifting over to Rezi, you talked about right-sizing the business, and what do you think the right – Do you see a bottom yet in terms of growth? Do you see acceleration at some point around the corner, or do you think you need to hunker down for a little bit of time here? When do you think you could start growing well again? Could it be in Q4, maybe in Q1 of next year, or maybe the visibility is a little bit tough to figure out? Thanks.

Yeah, I'd say the biggest challenges we've had over the last six months have been where the sales are coming from. And we've had to make some decisions on where we're going to operate our warehouses and our installation activities based on changes in the origination markets. So what you're seeing right now is, I think, a dip in our front end of our business because we are reevaluating where we operate. We are closing down a couple of our locations, have closed down a couple of our locations. And we're looking at new areas that might make more sense for us to move into, such as Florida or maybe the Northeast. So I think the key for us is to be deeper, meaning to sell more in those key markets that we're going to stay in, and then to look really hard at what key markets should we be in that we're not in. But the thesis for the residential group, especially for 2024, is still a growth thesis.

Okay, and so on that thought, what kind of growth are you anticipating? You know, I know you haven't provided official guidance, but just, you know, if you can broad sketch it, you know, for us, just directionally, are you thinking plus 5% growth or maybe plus 50% growth, you know, ballpark, you know, what are we looking at?

Jason, do you want to take that? You've been a little bit closer to the forecasts.

Sure. I think we're always planning on following sort of what the Wood Mac is suggesting the growth rates will be. So I think we're still in the low, in the high single digits. I think, you know, we're still working through which markets we're going to be exiting in and which markets we may be pursuing over the next couple quarters. So it's probably a little early. to gauge that. Our really focus is not necessarily on growth. It's about improving our gross margin and generating EBITDA as a business. And frankly, we think by shrinking in some of these markets that have weighed on margins, that's going to be more beneficial in the long run to the company.

Got it. Thanks, Jason. So Given that thought there, what markets are you – and sorry if I missed this earlier in the remarks, but can you share which markets you might be de-emphasizing and then which ones you might want to go deeper in? I think Galen just mentioned the Southeast. And then finally, as it relates to capital and the balance sheet, I was wondering if you could talk through – the plan for receivables and just cash in general. I think the receivables have kind of ramped up a little bit to maybe 40 days in Q2, and that's compared with your prior levels in the 20 to 30 days. And so just wondering if you could comment on that working capital line item and then in terms of cash in general overall. Thanks.

Sure, I'll take the back half of that question first. So, yes, AR has increased. A function of that is there's two elements to that that we're managing. One is we have more cash customers than we had in the past. That's lent itself to slightly higher AR balances. And then also we have the financing partners that we utilize typically are clawing back at faster rates on the funds. So we may have recorded revenue and finished completion, but we're just waiting on PTO in our markets, specifically California. And that's waiting on that PTO. And then for that funding back from the lenders is a reason why you see those AR balances rising. So we think over time as, California begins to, or the utilities in California begin to catch up on the submissions and the backlog there, we would expect to see some improvements in AR over time. Specifically in working capital, we are managing inventory levels almost at an adjusted time basis. Module availability is dramatically improved. Pricing has improved as well. So we'll continue to manage that fairly tightly. And really, again, the focus on cash is all about right-sizing the workforce, exiting the markets that we just can't be fully utilized in and have good leverage out of. So that's really our plan for the next quarter.

Great. And the first part of the question was on which markets you guys might be de-emphasizing and deepening in. Thanks.

I think in general, there's a few markets in the south, southwest, and then one in the southeast. We won't cover the exact markets, but that we're just not seeing the right amount of originations right now to support having facilities there. I think that's probably the most that we'll share.

Okay. Got it. I know I asked a lot here.

Thanks for taking the questions, and I'll pass it on. Thank you, Phil.

Our next question is from Donovan Schaefer with Northland Capital Markets.

Please proceed.

Hey, guys. Thanks for taking the questions. I want to ask first on originations. With having your own direct channel and then a third-party channel, gives you a kind of maybe more comprehensive view on what's happening with consumers. And so I'm curious, you know, from that, if you can give any color on what's driving, if the lower originations, if that's more, fewer leads coming in at the top of the funnel, or is this, are there low, are you getting lower reduced close rates maybe because You get the leads in still, but then when you kind of put together comparing what pricing you can offer them on a monthly basis versus what they pay, maybe it doesn't pencil out as well, so it ends up being drop-off in the close rate. There's a kind of equal contribution from both.

Just kind of curious for some more color there. I'll start this.

Hi, Donovan. I would say that in general, we have seen originations decline post NEM 3.0. We had many of our partners were repositioning into other markets. There's also changing sale dynamics of how you Talk to customers. You're maybe selling a PPA product or a third-party ownership product versus a loan. And then the economics certainly are still beneficial over time in California, but it have deteriorated relative to NEM 2.0. So I think a lot of this is a transition. And so in general, we've seen a slowdown. So I think there's many factors to answer that. you know, as part of answering that question.

Okay. And then for permitting or, you know, getting to the process of utilities in California, yeah, this seems to be a pretty important issue. And you talked about thinking the second half of the year is going to be stronger than the first half. So I'm wondering, you know, now we're about halfway into the third quarter. Is there anything, you know, and you guys talked about, you know, you know, the delays they're getting as wide as four months. Are we still kind of around four months, or have you begun to see an improvement in that utility permitting aspect? Kind of where do we sit now in the middle of the third quarter?

Sure.

So we're at four months. Sorry, Galen.

Go ahead. No, go ahead, Jason.

So we're at four months today. So when I look at the utility approvals that are coming in, they're coming in from the date of the transition to NEM 3.0. So there was just a massive surge in originations and applications that came in just leading up to the deadline. And we believe they're working through sort of those last submissions. So we've probably crested at this point, and we gradually, at some point, they've worked through all these applications and we start to see timelines begin to normalize. We just haven't seen that yet, but we did expect it to happen during Q3.

And then if I could get another question in. So it did catch my attention in the release and then in the prepared remarks. referencing IPPs as potential customers on the CNI side of the business. Correct me if I'm wrong, but I believe, or that would be kind of news to me, I don't believe in the past you've done projects that would reach that scale of what we typically think of as an IPP. So is this kind of a new avenue that you guys are pursuing and I guess what size projects would that get you up to? Does this involve kind of a step change for you where you could become involved in, you know, 100 megawatt projects and the like? Just, you know, very interesting development there. So if you can give any additional color, that'd be great.

So over the last six months, we've made some significant changes in the direct sales team on the commercial side, the folks on the commercial side that sell for us. And some of the newer people that we brought on board have some really strong relationships with developers and IPPs. And we are certainly quoting projects now that are larger than we've looked at consistently in the past. I would say we're not really in the double-digit megawatt category yet, but five, six, seven megawatt projects are certainly projects that we're looking at and evaluating consistently. We could certainly go a little bit larger than that, but beyond that, there becomes all kinds of debonding concerns and other issues that would be a little bit more challenging for us.

Okay, that's helpful. Great. Well, thanks, guys. I'll take the rest of my questions offline. Thanks. Thank you, Donovan.

We have reached the end of our question and answer session.

I would like to turn the conference back over to Galen for closing comments.

Thank you.

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