Q3 2023 Sunworks Inc Earnings Call
Participants
Jason Bonfigt; CFO; Sunworks, Inc.
Mark Trout; CEO; Sunworks, Inc.
Donovan Schafer; Analyst; Northland Securities
Philip Shen; Analyst; Roth MKM
Presentation
Operator
Greetings, and welcome to Sunworks third-quarter 2023 results conference call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce Jason Bonfigt, Chief Financial Officer. Thank you. You may begin.
Jason Bonfigt
Thank you, operator. I'm Jason Bonfigt, Chief Financial Officer of Sunworks. On behalf of our entire team, I'd like to welcome you to our third-quarter results of 2023 conference call. Leading the call with me today is our President and CEO, Mark Trout.
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 Securities and Exchange Commission. Except as 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 Mark.
Mark Trout
Thank you, Jason, and welcome to those joining us today.
As detailed in our third-quarter earnings release issued earlier today, the last several months have continued to be a challenging period for both Sunworks and the residential solar industry at large. We continue to believe in the long-term economics of residential solar and storage, particularly as the demands of a growing population weigh on our nation's aging electricity infrastructure, which we believe will result in structurally higher utility rates for customers over time.
During the third quarter, the combination of higher interest rates, less favorable residential solar economics in California following the NEM 3.0 transition, continued to weigh on us and the industry at large, resulting in lower new 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 rightsize our cost structure, including several rounds of reductions in force.
We have retrenched and focused on markets where we believe we have volume and efficiencies to stabilize and maintain an appropriate cost structure. We continue to improve our internal processes with significant focus on customer cycle time improvement, installation crew efficiency, and cost management. We are seeing improved conditions in supply chain availability and material pricing, which we anticipate continuing into the next quarter or two.
Turning now to a discussion on our commercial solar energy business. Our commercial business had an outstanding third quarter, as revenue more than doubled on a year-over-year basis, while gross profit margin rate increased to more than 16% in the period.
Customers in the commercial and industrial space, as well as the municipal markets, continue to seek out EPCs who have deep industry expertise and who have the capacity to install. This sector should continue to grow throughout 2024 and into 2025 as the economics of solar and storage in C&I space continue to improve. The growth in the EV charging sector continues to grow, and Sunworks is positioned to capitalize on that growth. This market has been a strategic focus for us at Sunworks, and we are gaining traction as a significant EPC in commercial EV charging solutions.
Looking ahead, we will remain focused on our strategic growth priorities, building regional market leading positions while implementing market-based pricing coupled with targeted cost reductions that put us closer toward achieving a positive EBITDA consistent with our long-term objectives. Given the tailwinds of the Inflation Reduction Act, as well as the increased demand in the commercial space, we anticipate being well positioned to capture the momentum in our business entering into 2024. As before, the market opportunity for solar remains significant across our geographic footprint, positioning Sunworks to play a leading role in the transition toward affordable, clean, and independent energy production.
With that, I'll hand the call over to Jason for his remarks.
Jason Bonfigt
Thank you, Mark. Beginning with a summary of our third-quarter financial performance, Sunworks generated total revenue of $28.7 million in the third quarter of 2023, a decline of 29.5% versus the prior year period, as positive momentum within our commercial segment was more than offset, given the ongoing market challenges within our residential segment which Mark referenced earlier.
While higher interest rates have increased the total cost of rooftop solar for homeowners, we continue to believe the long-term macro trends of solar to be favorable to consumers and businesses. Similar to last quarter, higher rates remain a headwind for our business. As a result, residential segment revenue was $20.3 million, a 44.5% year-over-year decline.
Within our commercial solar segment, we continue to execute on our strategy to diversify our customer base and operate at scale. Revenue increased to $8.3 million, over double the prior year. Total gross profit was $8.2 million, or 28.5% of sales, compared to $19.5 million, or 47.9%, in the prior year quarter.
Several factors contributed to the reduction in gross margin. First, approximately 28% of our revenue was derived from our commercial segment, versus approximately 10% in the prior year. The commercial segment's model is less focused on sales and marketing and, as a result, has a lower gross margin profile.
Additionally, gross margin within the commercial segment improved from 1% in the prior year quarter to approximately 16% in the current year quarter due to improved operational execution and higher volume. Offsetting this improvement is underabsorption of labor costs in our residential business, as lowered originations led to underutilized labor capacity.
Throughout Q3 and into Q4, we took action to strategically reduce markets that are not operating at scale. This strategy will allow us to focus our sales and marketing in key markets with favorable economics and the ability to scale operations. Since the end of Q2, we have reduced our labor costs by approximately $6 million annually.
During Q3, we identified tripping events within our residential segment, including the negative impact of rising interest rates and due to our market capitalization. As a result, we incurred a $26 million non-cash impairment charge to the goodwill associated with the acquisition. As a result, we incurred a $26 million non-cash impairment charge to the goodwill associated with the Solcius acquisition.
We generated a net loss of $36.4 million in the third quarter of 2023, or $0.84 per share, versus a net loss of $5.4 million in the prior year period, or $0.16 per share. Included in the net loss in the quarter is the goodwill impairment, which represented $0.60 per share.
Adjusted EBITDA was a loss of $8.5 million during the quarter.
As of September 30, 2023, the company had cash and cash equivalents of $2.4 million.
Operator, that concludes our prepared remarks. Please open the line for questions as we begin our question-and-answer session.
Question and Answer Session
Operator
(Operator Instructions) Donovan Schafer, Northland Capital Markets.
Donovan Schafer
Hey, guys. Thanks for taking the questions. So I first just want to ask if you can give us any color on what you are expecting currently for the fourth quarter. Do you think you would be, just directionally, up sequentially, down sequentially? And if you could break it out by residential versus C&I, that would be great. Thank you.
Jason Bonfigt
[Hello], Donovan. It's Jason. Yeah, I think we're still -- the backlog in our residential business has declined to about $35 million at the end of the quarter. So the business in Q4 will coincide likely with the backlog reduction year over year. Within our commercial business, we've been building throughout the year that the backlog and the business -- the backlog did end the quarter at about $30 million. But that's giving us nice visibility into the next several quarters.
And I would say that we're still very optimistic about the pipeline of opportunities that we're -- and the award of contracts that we're looking to close here in the next one to two months. So we think that that business is going to be operating at a better scale in the coming quarters.
Donovan Schafer
Okay. And then as a follow-up question, if we're talking about -- I appreciate the update on the cash position. Could you talk us through, maybe in the next few quarters, how you think about managing overall working capital, like liquidity position, if you've got a certain goal or target around what kind of cash burn rate you might have, again, over the next few quarters, how you navigate and manage that? That would be great.
Jason Bonfigt
Well, I think we have a few levers when it comes to cash. The first positive lever is -- a lot of the times and when we're signing contracts on these large commercial contracts, those will come with deposits. That could be anywhere from 5% to 15% of the contract value. So that could be material for us.
But that's -- again, those tend to be lumpy, and that would likely be over the next one to two quarters. Within our residential business, you actually have the benefit of working capital improvements or benefits as your business declines because you're still collecting on contracts from customers that you've recognized revenue in previous quarters. So that's certainly an option for us as well and one that we're actively managing.
Donovan Schafer
Okay. And then with the -- I guess for the backlog conversion rate, I mean, you talked about it coming down for residential. It does look like if I look back a year ago, you could take the prior quarter's backlog and figure that something like 60% to 70% of that, talking about residential, would convert in the next quarter. But this quarter, it looks like it's down to about 40% of converting the backlog.
Is that kind of a new run rate that we're at with the way the market is right now? Or is that something we should expect to rebound and head back up towards the 60%, 70%? And if so, over what time period?
Jason Bonfigt
Yeah, I think there were some anomalies over the course of the next year with many of the challenges that we had in California with utilities and jurisdictional approvals post-NEM 3.0. So I think we're still managing through that period. We're seeing the approval queues shrink dramatically and reverting back to historical norms. So I think as you look at our backlog and the conversion, that should revert to historical norms as well.
Donovan Schafer
Okay. And if I could squeeze one more in. I just -- it caught my eye, the mention of IPP customers in the C&I space. Can we just get an update and maybe some more color there in terms of what the opportunity is? How big projects are you potentially -- are you in a position to potentially win there? I mean, if we're talking about 100-megawatt-plus projects or just any color there would be great.
Mark Trout
Donovan, this is Mark. I can probably take this one, Jason.
But I think when you think about it, our sweet spot is probably not quite up to 100 megawatts yet. So we're seeing some of those come through. But as we look to expand and also diversify in some of the markets there, we're definitely trying to stay in the flow of deals and where the EPC demands are coming from. So that's not off the table by any means, but our sweet spot seems to be just under that.
Donovan Schafer
Okay. Thank you. I'll take the rest of my questions offline.
Operator
Philip Shen, Roth Capital Partners.
Philip Shen
Hey, guys. Thanks for taking my questions. I wanted to follow up on the liquidity and cash flow question. Specifically, can you talk about what the cash burn was for Q3? You didn't have financial statements with your release. And then, what do you expect it to be for Q4?
And then, how do you expect -- and then, I didn't hear the cash position. So what was it at the end of Q3, and how do you expect that to trend as we go through Q4? Jason, you were talking about working capital improvements. So I was wondering if you could quantify what the inventory and AR positions were at the end of Q3, and how much that could translate to cash as well in Q4.
Jason Bonfigt
Sure. We ended the quarter at $2.5 million of cash. I believe our Q2 was right around $4 million. We did have a capital raise in that quarter, and we also had proceeds from our ATM that's on file with the SEC as well. So that was a positive from a cash flow perspective. So the delta is the cash burn in the business.
Working capital was relatively flat, and the EBITDA loss was about $8.5 million, as we believe that many of the actions that we've taken from a headcount perspective and consolidating some of these markets will reduce this cash burn. And then, as well as the commercial business, the revenues are growing and we're approaching positive EBITDA in that business. So that's going to be a tailwind for us as well.
We did have, in our filing that inventory, we still have about $10 million of AR. And I would say there's a couple opportunities in there. We have older accounts that we're just working to clean up so that we can get the PTO within our residential business. There's several million dollars in that category that we're actively targeting to bring in cash.
And then, we have effectively an underutilized factoring line right now that we're looking to expand or to add more customers into that population. That will allow us to free up some cash flow as well.
Inventory during the quarter was about $16 million. Again, we have quite a few of the modules that are available for our commercial business, so we're not having to make those purchases right now. So that's going to be a benefit to working capital as well.
And then, within our residential business, we are still managing just in time when it comes to inverters and module purchases. So there's not a lot of opportunity, frankly, in our residential inventory. But I think there is in our commercial business.
Philip Shen
Got it. Thanks for the detail. And then, as it relates to that factoring line, you said it's underutilized. Can you talk through how much capacity there might be and then how much more you might want to expand that by?
Jason Bonfigt
Our factoring line is about $2.5 million. I don't have the number in front of me of what it was utilized at the end of Q3. I believe it was $1.5 million, but I'll have to follow up with you if that's not the correct number. It will be stated in our queue.
We think there's opportunity to expand that facility by $1 million to $2 million. And certainly, I think the business levels that we're going to be operating at could support that. So we're targeting that as well.
Philip Shen
Okay. Thank you. And then looking at margins for Q4, I heard the commercial margins for Q3, you improved year over year, I think, from 1% to 16%. But I didn't hear the resi margins for Q3. Can you share what they were and then what you expect both segments to be in Q4? Thanks.
Jason Bonfigt
Q3 gross margin in our residential business was about 33.7%. That is down historically just driven by the fact that we've had many of these markets that have been underutilized and we have underutilized crew capacity. We've made, as we mentioned on the call and our prepared remarks, many reductions, over $6 million, in the past four to five months. That's going to help us drive margin improvement within the residential business.
And then, we're starting to see some lower cost procurement and materials coming through as well, so that will give us a little bit of lift here probably at the end of Q4. But again, I think we're making a lot of these changes in some of these markets and not all of the benefits we baked in in Q4. So I think this is a gradual recovery into next year.
Philip Shen
Okay. So margins in Q4 could be similar to what you saw in Q3. Is that a fair way of thinking about it?
Jason Bonfigt
Within our commercial business, I think there might be a little bit of upside there relative to the 16%. We're targeting, when we're quoting with our customers and holding our operations teams accountable, to manage above 20%. So over the long term, we'd like to see some improvements there. And then, in our residential business, I think there'll be some lift in Q4, but not materially.
Philip Shen
Right. Okay, great. You talked about exiting a few markets. Can you talk about which ones you left? And then, of the remaining revenue mix on a go-forward basis expected, what's the mix of California for your business going forward, for the resi business only? So the California resi mix versus the next biggest one. Thanks.
Mark Trout
Hey, Phil. It's Mark. In terms of some of the markets, what we did is we closed down a couple that were underperforming, underutilized. We had a shift in a few of our dealers as a result of the NEM 3.0 change in California. And so I think what you're seeing is that transition that you're probably seeing across the industry back from loans to more of a TPO kind of model in California. And we're going through that just like everybody else.
So California, as we shift back over to probably more TPO, is going to probably come back, we're expecting. Maybe not to its pre-NEM 3.0 levels quite this year, but we do expect that to come back. California, we are still active in. We're going to remain active there.
And then, really, some of the markets that we've exited have been where they've been; less focus from our direct sales team and more focus from dealers. And as dealers have lost some of their volume, we've chosen to reduce our EPC footprint. I think there's a list of those in the earnings announcement.
Philip Shen
A list of the markets you exited?
Mark Trout
A list of the ones we're staying in.
Philip Shen
Staying in, okay. So is California about 50% of your business still, or is it a little bit less or more?
Mark Trout
It's actually less of our business right now. We're seeing actually a shift in some of the other markets have really come on strong. And that's probably due to AR focus as well as there was a lot of backlog. Frankly, I think that all of us felt in the lead up to NEM 3.0. And we've been working down that backlog, it kind of created a normal slowing right after NEM 3.0, and so that's just kind of bouncing back.
Philip Shen
Right.
Mark Trout
So we're probably about 30% California right now, if I do some quick math.
Philip Shen
Okay. So given your commitment to stay in California and given the transition to NEM 3.0 and storage, what's your bookings momentum currently? Is it still down on a year-over-year basis? When do you expect your originations to perhaps be up year over year? Sunrun has talked about maybe breakeven near term, but I know others are having trouble or a harder time. So just curious, do you see that in Q2 of next year, maybe Q3? Or could it be sooner? Thanks.
Mark Trout
Yeah. So I think what we're looking at right now is our fall-off is stabilized, and we're actually operating on a month over month that seems pretty consistent. So I would assume, and I don't want to bring weather into the occasion here, but I would assume that we see stable through the rest of Q4 and maybe a little bit of uptick as we add some more TPO offerings.
And then, I think Q1 will be stable in California, and we'll see something tick up in Q2. A lot of that is due to, I think, the rush to get signatures before NEM 3.0 came out is over, of course. And now, the consumers are back to normal, so to speak. We saw some of this in the NEM 1.0 to NEM 2.0 transition, where it took a couple of quarters for, frankly, the consumers to return to normal. And that's what we're seeing right now.
Philip Shen
Got it. And storage attach rates for the originations you have today, are you at that 85% level, or do you think it's more like 30%? Is storage basically the ticket to these originations now?
Mark Trout
In California, that's going to continue. So we are looking at -- yeah, for California, that's pretty normal.
Philip Shen
Okay. Great. I could keep on going, guys. I know I've monopolized a lot of the time. Hopefully it's helpful for people and for you guys. I'll pass it on, but I have a few others. If there's nobody else, I might jump back in. Thanks.
Operator
There are no other questions in the queue. I'd like to hand the call back to Mark Trout for closing comments.
Mark Trout
Great. Well, thanks, everybody. And once again, thanks for joining the call today. Should you have any questions, please feel free to contact us. Our email address is ir@sunworksusa.com. A member of our team will follow up with you. And this will conclude our call today. You may now disconnect.
Operator
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful day.
