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Greetings, and welcome to the Sunworks First Quarter 2023 Results Conference Call. [Operator Instructions] And it is now my pleasure to introduce to you, Jason Bonfigt, Chief Financial Officer. Thank you, Jason. You may begin.
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 first quarter results of 2023 conference call. Leading the call today -- with me today is our President and CEO, Gaylon 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 this 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'll turn the call over to Gaylon.
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 the 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 Solcius 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 8 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 remained 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 first -- 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 31 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 application -- utility application rates and project completion time 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, Gaylon. 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 38.5% 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 at 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. Within other 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 $0.18 loss per share versus a net loss of $8.2 million in the prior year period or $0.28 per basic share. Cash from operations was negatively impacting the first quarter of 2023 due to the weather and utility approval delays as well as tighter financing terms for residential solar installations that Gaylon mentioned. As of March 31, 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 aftermarket offerings. And then on May 5, 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 22, 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 time lines, 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.
[Operator Instructions] And our first question comes from the line of Donovan Schafer with Northland Capital Markets.
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're already 2/3 of the way through the quarter. So I'm just curious if you can at least give us a sense of should we expect sequential improvement in the second quarter? If so, we're talking like a single-digit percentage growth or double-digit like kind of quarter-over-quarter. And if it's too soon to tell what -- 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 get -- catch up to 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? Just kind of what are the fact -- what's the Q2 -- how should we think about it? And then if it's too soon to really say anything, what are those factors?
Sure. I'll start. Let's start with the commercial business because I think that's a little easier to walk through. So we have continued to make improvements in the backlog in our commercial business. Backlog increased sequentially to $35 million. And as we get into the summer months, it's always a little bit stronger. We have less sort of 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 time lines. And that's -- I said we're not going to provide guidance there. But I'm not expecting the approval rates to be coming in for permits to improve dramatically over the next 4 to 5 weeks for the quarter. So I think it's -- I think there's going to continue to be some pressure in that residential business for most of the quarter.
Okay. And then for the full year, in the full year sort of 2023, in the past, I know you guys have talked about having sort of 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 at the current moment, you're driving some profitability measures and those can sometimes slow growth in the short term. So my question is, are you still sort of internally aiming for something on the order of 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?
If you look at our residential group, 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. With -- 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 the permit delays. But I think in the press release, I saw you have mentioned to kind of labor inefficiencies and Gaylon, 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 -- whether it's electricians or other people on staff that you don't want to let them go because once things pick back up again, you want to certainly be able to quickly use those resources. But are we at the similar level of kind of labor inefficiency at the moment or kind of utilization? Or have we seen improvement? Just curious how that -- where that's today relative to the quarter -- first quarter? Go ahead.
I was just going to -- sorry, it's Gaylon, I was just going to talk about the residential business…
And I would say, go ahead and talk about the residential business.
Okay. So I would expect some modest improvements, but the pressure that we saw in gross margin was pretty intense during the quarter. And I think in the absence of having a very healthy backlog in the residential business, we would have had to have made staffing significant staffing reductions. We don't feel -- we didn't feel comfortable with that because of the strength of the backlog and making sure that we have skilled labor to support the growth for the rest of the year. So I think the -- that is certainly with the challenges in California, they are going to be continued to be inefficiencies in Q2. And -- 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 I was going to ask kind of the same -- Jason, you answered what I was going to ask about gross margins in kind of what we should expect them to add back to. So nice to hear that they -- 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. Gaylon, 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 have to go to 100% direct in order to kind of have that be 100% conversion into your financials to see a 430 basis point improvement -- but in general.
I guess, correct me 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 Gaylon mentioned, we had roughly 40% of our originations come through the direct channel. Our short-term goals are to get that to be around 50%. And then I think -- so we'll be building traditional dealers and we'll be also building our direct force. So I don't expect significant changes in the short term on this percent of sales that we're talking about for residential. So that's sort of the -- that's because sort of the in 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 that a significant reduction there until we start to see originations for direct go well above 50%.
And the next question comes from the line of Tim Moore with EF Hutton.
I don't have as many questions as I normally [indiscernible] 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 because of bad weather. And then this quarter because of the NEM and the utility delay in the approvals, causing underabsorption 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. Again, that's a one-time adjustment, and we 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, we're targeting at the mid or high teens within our commercial business for gross margins. And then we -- 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.
That segues into my next question because I'm just thinking about things as a net selling margin 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 them together, what type of backlog do you think you need to hit a good inflection point for operating margin improvement? Do we need to get to USD 50 million to USD 60 million versus $35 million lately?
Yes. We believe that getting to -- so our focus is how do we generate positive cash flow out of that business, positive EBITDA because there isn't significant CapEx involved. So we believe that the way that we're pricing these jobs and from an execution standpoint, if we can get into the 50s into the 60 backlog, 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 I know nobody has a crystal ball on timing, but when do you think 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, supports the backlog of that size by the end of this year.
Our next question is a follow-up from Donovan Schafer with Northland Capital Markets. I just have 2 more questions, and then I will let you go. So the first question is looking at the improved liquidity position, that's a pretty significant improvement with the ERTC advance and the factoring agreement. And then I think it was nice to see that, that's -- 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 that was also nice to see. But my question is, 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 ATM or if you feel like 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.
I was just going to note the impact of the changes in milestone payments, just to put a number on that is significant and significant for all EPCs 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 a USD 5 million to USD 7 million depending on the volume at a given time, it's about USD 5 million to USD 7 million. So it's a fairly significant impact for us. This ERTC benefit certainly washes that out. I think as we -- 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. It is -- but is an option to us, if necessary. And we're also -- 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 Gaylon.
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 you eventually asked 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 2 months have all been around supporting the business and giving us the opportunity to continue to execute to attain that. And then what about getting to cash flow positive in some kind of horizon? Any sense around that? It's going to be so dependent on the utility approval time lines. We had forecasted it being much earlier than it will probably be based on those utility time lines haven't been so pushed out. It's hard to peg that. I would say that once we understand where the tail of that, that comes into place, it would be a lot easier for us to estimate this next 2 to 3 quarters' cash flow positions.
And then just my last question. I know you guys brought in someone to focus on EV charging kind of in the commercial segment. 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 historically with Public Works and commercial projects, a lot more sort of solar, heavy, solar focused, 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 on to that? Or are you doing some dedicated public works sort of EV charging installations where you're just rolling out a bunch of chargers. Kind of any kind of color or updates on how that initiative is going?
Yes. 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 solar -- I'm sorry, 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 yes, more to follow with regards to actual individual wins that are EV.
There are no further questions at this time. And I would like to turn the floor back over to Gaylon Morris for any closing comments.
Once again, thank you for joining our call. Should you have any questions, please feel free to contact us at IR at Sunworks USA and a member of our team will follow up with you. This concludes our call today. You may now disconnect. Thank you.