Sunworks, Inc.
Q1 2018 Earnings Call Transcript

Published: 16 May 2018

[Operator:]

Greetings. And welcome to the Sunworks’ First Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Rob Fink of Hayden IR.

[Rob Fink:]

Thanks operator. Good afternoon everyone and thank you for joining the Sunworks’ first quarter 2018 earnings conference call. Participating on the call today are Chuck Cargile, CEO; Paul McDonnel, CFO; and Phil Radmilovic, Corporate Council -- Controller, excuse me. Before we start, I would like to remind everyone that during this call, management’s remarks contain forward-looking statements which are subject to risks and uncertainties, and management may make additional forward-looking statements during the Q&A session. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by the forward-looking statements because of certain factors not limited to general, economic, business conditions, competitive factors, changes in business strategy, or development plans, the ability to attract and retain qualified personnel, and changes in legal and regulatory requirements. In addition, any projections as to the company’s future performance represent management’s estimates as of today, May 15th, 2018. Sunworks assumes no obligations to update these projections in the future as market conditions may change. This afternoon, the company issued a press release with financial information and commentary as well as their quarterly 10-Q. We encourage you to review both to augment the information provided on this call. I would now like to turn the call over Sunworks' CEO, Chuck Cargile. Chuck?

[Chuck Cargile:]

Thank you, Rob. Good afternoon everyone and thank you for joining our call. The sun is shining here at headquarters in California and we believe that's an appropriate metaphor for our outlook at Sunworks. We continue with the transformation of the business and are at the midway point of the second quarter of our fiscal year. We believe the sun is indeed shining on Sunworks. Today, we reported results for the first quarter of 2018. Paul and Phil will discuss the financial details in a few minutes. From my perspective, there were no surprises in the quarter. After our significant cleanup efforts in the second half of 2017, I appreciate having a quarter with no surprises. We already took advantage of several opportunities to highlight our expectation of a seasonally slow first quarter in terms of revenue and profit. Specifically, we spoke of it during our presentation at the ROTH Capital Conference on March 12th, which was also webcasted, on our Q4 earnings call on March 28th, and then lastly, when we announced our new financing on April 27th. Although our first quarter installation activity was slowed by the wet rainy season in California, we were successful in several other fronts. I'll discuss these successes in three different categories. First, I'll touch on progress we made in terms of new project bookings and the outlook for revenue and other financial metrics. Second, I will address success in our continued focus on internal controls and improvement in business processes. And third, I'll provide more specifics on the information we announced in the latter part of April related to our financing and changes to our Board of Directors. First, we continue to win new projects at an impressive pace. We booked $37.5 million of new projects in the first quarter. Much of this is scheduled for installation in 2018. These new projects add to the robust backlog we already had when we entered the year. In fact, we currently have more than $60 million of backlog scheduled for installation in 2018. Although scheduled installations are often subject to delays and uncertainty, we have good visibility of the revenue growth over the next three to four quarters. As noted in our press release, we believe we're in a good position to generate more than $72 million in revenue in the remainder of the year, which would result in a double-digit increase year-over-year. We also continued to reduce our cost structure. We narrowed the amount of the loss in Q1 of 2018 compared with the prior year despite the lower revenue. The lower cost structure puts us in a solid position to report positive adjusted EBITDA for the remainder of 2018 and probably enough to offset the Q1 2018 loss, resulting in a profit for the full year. Second, we continue to implement better processes and internal controls. Specifically, our focus has been on new project proposals and estimate. In short, we want to make sure that when we make a proposal to a customer, our estimated costs are well thought and ensure an adequate profit margin for Sunworks. Even if that means we lose a project because of pricing, we have the discipline to do that. We want profitable revenue growth not growth at the expense of profit and cash flow. Then once we've won a new project, we continue to heighten our focus on project management and execution including managerial oversight and reporting. I'm encouraged by the progress the team is making in this regard. Although we still have some lower margin projects in our backlog that will drag near-term margins, our new proposals and work-in-progress lead us to believe gross margins and resulting profitability will increase sequentially throughout the remainder of the year. In the first quarter, our gross margin was relatively low compared to what we will expect going forward, but it rebounded from the abnormally low margins in the second half of last year. The reason for the rebound is that we didn't have to record a large number of adjustments resulting from inaccurate estimates. In addition the estimated gross margin on project proposals we presented in 2018 for our non-residential business is in the low to mid-20% range. The gross margin on non-residential projects we've won in 2018 is also about 20%. And it's worth noting that our residential business normally delivers higher gross margins than ACI and public works. So, in short, we have evidence supporting that our controls and procedures should lead to continued improvement in profit margins. The third item I would like to mention is our financing and the changes in our Board of Directors. On April 27th, we announced that we'd secured a loan for $3.7 million. As you can see in the balance sheet attached to this press release, at the end of the first quarter, we had approximately $2 million of cash, cash equivalents, and restricted cash. Although we anticipate generating positive cash for the remainder of this year, we wanted to ensure that we had adequate liquidity to execute on our large backlog. From my perspective, a cash raise involving equity was a non-starter. At the time we signed the financing agreement, our share price was below a $1, it was 34% below where it is today. A share offering would have been dilutive and would have cost 3 million warrants that were issued in 2015 to reprice at the dilutive price level. Such extreme dilution was not a viable option. In order to secure the loan, two of us on the leadership team agreed to participate with the lending group from CrowdOut Capital. CrowdOut contributed $3 million; I contributed $500,000; and Kirk Short, our President of Commercial Operations contributed $250,000. We believe this cash will give us cushion to execute on our projects and position us to continue the growth we're currently anticipating. In addition, we believe it provides us with greater security to avoid any future dilutive equity offering for at least as long as the warrants are outstanding which is February of 2020. We also announced a further cleanup of our capital structure by converting 100% of our 1.5 million preferred shares to common shares at a 1

[Paul McDonnel:]

Thank you, Chuck. Good afternoon everyone. As we discuss the financial results for the first quarter of 2018, it is important to acknowledge the role that our Corporate Controller, Philip Radmilovic has played in the improvements to Sunworks' financial and operational reporting systems and processes. His efforts have enhanced our team's ability to more accurately estimate and big projects, track costs, monitor performance, support better decision-making, and improve margins on the new projects booked. I'm glad that he's participating on the call with us today. For the first quarter of 2018, total installation revenue was $13.4 million, a decrease of approximately $6.3 million compared to the $14.3 million reported in the first quarter of the prior year. The $13.4 million in revenue recognized during the quarter consists of ACI revenue of $7.8 million or 58% of our total revenue for the quarter compared to $8.8 million or 61% for the same quarter in the prior year. It is important to note that public works' revenue was included in the 2017 $8.8 million ACI revenue amount just mentioned. Public Works' revenue was not tracked separately until the second quarter of 2017. Residential revenue was $4 million or 30% of our total revenue compared to $5.6 million and 39% of our revenue for the prior year. Public Works' revenue was approximately $1.6 million for the first quarter of 2018 or 12% of our revenue. To provide some context to reported revenue, I want to explain that Sunworks' previously recognized revenue for ACI and public works' projects as a percentage of a project's completion. The percentage of completion method of accounting recognized revenue and profit for a project by comparing actual results incurred relative to the total approved construction budget while also considering the estimated remaining cost to complete a project. A new revenue recognition standard known as ASC 606 became effective at the beginning of 2018 and has replaced the old percentage of completion method of accounting. Over the past several months, the Sunworks' finance team has designed and implemented processes to recognize revenue as a customer obtains control of the goods or services promised in the contract that are consistent with the requirements of ASC 606. The cost of uninstalled materials is excluded from Sunworks' recognition of profit. Materials delivered to a job site are not considered to be a measure of progress as they have been in the past. Sunworks' more disciplined approach to incurring cost with a stronger correlation to active construction is a better use of working capital, cash flow, and a better business practice. For a more detailed explanation of these changes, I refer you to note three; revenue from contracts with customers from the notes to the condensed consolidated financial statements included in the 10-Q just filed. Operationally, job progress is now monitored by a team consisting of those persons with direct firsthand knowledge of each project. The team meets at a minimum monthly and includes a combination of members from construction, operational, and financial expertise. The team is also supported by detailed job cost data. So, why is this important? It's important because of its impact on operations, profit recognition, and working capital. In reviewing the balance sheet as of March 31st, 2018, Sunworks has over $6.5 million of material inventory. This is Sunworks' highest inventory balance in its history. This inventory is a result of purchasing solar modules or panels in anticipation of the tariff that was announced in January. The vast majority of this inventory is required for larger jobs for which construction is expected to start over the remainder of the year. Procedurally, we will not ship this inventory until it is needed at the job site, then and only then, this inventory by accounting definition will become revenue. However, materials shipped to the site are excluded from our recognition of profit. Over the next several quarters, inventory will decline, revenues will be recognized, but all of the gross profit will be recognized as the customer obtains control of the goods and services not because of the total costs incurred against the construction budget as in prior periods. This process, although new in 2018, is in compliance with the new accounting rules and is more consistent with the better business practices that we have embraced and implemented over the last several months at Sunworks. Gross profit for the quarter was $2.4 million or 17.9% of revenue, a significant improvement from last quarter's $1 million gross profit and 5.4% margin, but less $2.8 million of gross profit and 19.4% margin from the first quarter of 2017. Total operating expenses excluding depreciation and stock-based compensation for the first quarter of 2018 were $3.8 million compared to $5.1 million in the first quarter of 2017. This represents a 25% decline from the same quarter in the prior year. Reducing the overhead burden without compromising the ability to operate effectively has been and continues to be an emphasis of ours. Additional overhead reductions were made during the first quarter of 2018, the full benefit of which has not yet been experienced. While we continue to drive costs out of overhead, future reductions in comparison to the prior year will be far less as we get further into 2018. Stock-based compensation was $232,000 during the quarter compared to $217,000 in the prior quarter. This non-cash expense will increase in the second quarter with the changes to the Board of Directors Chuck described. The former Chairman's restricted shares vest upon his retirement, resulting in a second quarter one-time non-cash expense. Depreciation decreased slightly as a result of the sale of unnecessary fixed assets resulting in a small gain on sale. The net loss for the quarter the first quarter of 2018 was $1.7 million or $0.07 per share compared to a net loss of $2.9 million or $0.14 per share in the year ago quarter. Turning to our balance sheet, our unrestricted cash and cash equivalents was $1.6 million at the end of March 2018 compared to $6.4 million at December 31st, 2017. Cash decreased by $4.8 million for the quarter compared to a decrease of $6.8 million in the year ago quarter. Working capital decreased by $3 million, primarily the result of the operating losses and the principal payments for equipment and acquisition notes payable and the one-time impact of the adoption of ASC 606 and its net adjustment to contract assets and contract liability accounts on the balance sheet. Managing cash and working capital is a critical priority for us even after the $3.75 million infusion announced in late April. We came into the year with abnormally high prepaid deposits for inventory and transit and inventory on hand. During the first quarter, the inventory in-transit at the end of the year was received and the prepaid deposits eliminated. The strategy of purchasing or committing to purchase solar modules prior to the 2017 year end was pursued into late son works from the uncertainty created by the impending tariff ruling for solar modules. Now as inventories are converted to cash and as we move into the more active spring and summer construction months, the strain on cash should eventually ease as we complete profitable projects. Before the additional $3.75 million in debt financing finalized in April, our outstanding debt at the end of March consisted of $1.8 million from acquisition or equipment financing and $149,000 comfort related to a convertible note that bears no interest. I will now turn the call back to Chuck.

[Chuck Cargile:]

Thanks Paul. To summarize we acknowledge that we're in the early stages of the transformation of Sunworks and we will continue our relentless progress forward. We're pleased to have the slow first quarter behind us and are poised for better financial results. Although it is difficult to predict the quarterly timing of installation revenue, we have line of sight to generate more than $72 million of revenue in the remaining quarters of 2018, which will represent a double-digit percentage increase compared with the full year 2017. More importantly, we expect to leverage its growing revenue to generate positive adjusted EBITDA for the full year of 2018. And lastly, we are determined to generate positive cash flow for the remainder of 2018. I started this call by referencing the sun shining on Sunworks. I believe it is and we're building something special. For the shareholders who've stayed with us during this transformation, I thank you for your support and patience and for those of you who are new to Sunworks, I thank you for your confidence in the direction we're going. Speaking on behalf of the Sunworks team, we're dedicated to delivering the return on your investment. I'd now like to turn the call -- open up the call for questions. Operator?

[Operator:]

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Philip Shen from ROTH Capital Partners. Please proceed with your question.

[Philip Shen:]

Hi everyone thanks for the questions. I thought perhaps we could start a bigger picture with the California Energy Commission decision recently passed or made. Can you talk about how that might change your overall residential strategy? And can you also speak to how you think this might impact leases versus loans? Do you -- for example do you think because this is a building code, the panels have to be installed. I believe at the time of at the time of certification for occupancy. So, is there a situation where perhaps the leasing opportunity becomes diminished because the -- before the home can be sold, you actually have to have the certificate is what I'm thinking, but want to see if you had a view on the lease versus buy and the potential impact from the decision as well? Thanks.

[Chuck Cargile:]

You're welcome. So, that's a lot of questions involved in one topic. Let me hit on a little bit of it. First, as I said, it's encouraging for the industry as a whole, about 25% of our business is residential and it's an area that we're committed to stay and continue to grow. So, it was -- we were happy to see that it's less than a week old, the news, so I can't say that we've completely baked it into or into any kind of new strategy or incremental strategy. And as I said I don't see it having an immediate impact on our business, but long-term and because we are in it for the long-term, we see it as a -- certainly as a positive and it could be a good precursor to other states doing the same thing. So, all in all, we see it as a positive thing in terms of the ownership question. In brief conversations as we've talked about it we think it will push to more ownership -- direct ownership, which as you know, Phil, has been our strategy and our sweet spot from the start. Even when others were not in that same position we were. So, any time there's a positive movement to direct ownership it enhances our credibility for the position that we've had from the start. So, I think at this point you probably know a lot more about the decision than I do, but that hopefully summarizes a little bit of our thoughts.

[Philip Shen:]

Great Chuck. Yes, that's helpful. Moving on to your guidance, I think you guys switch the profitability marker from a more general statement of [Indiscernible] in 2018 to something more specific -- positive EBITDA for 2018. Is there anything -- is there a reason why you kind of moved away from the prior kind of outlook and just kind of talk to us about the thinking beyond that?

[Chuck Cargile:]

Yes, so, there is a bit of a subtle movement there for a reason and that is as Paul mentioned in his prepared remarks, one of the aspects that Jim Nelson had in his employment agreement was restricted shares that vest upon on retirement. So, when Jim retired last month that accelerated vesting and we'll have about a $640,000 equity hit in Q2. And so when we've given guidance for Q2 and for full year, obviously, we didn't anticipate that until last month. And so when I move the marker from operating income which is where I would normally focus on earnings per share. Because I hadn't contemplated that before, I now mentioned as adjusted EBITDA where we would exclude the equity comp expense. The other thing that we will probably do in Q2 although it's something I generally prefer to avoid at all costs, but we'll provide a pro forma number that shows the direct impact that came from the transaction. So, it would be the cost that came by getting the financing and then also the cost that came from the equity hit for those the accelerated vesting in the restricted shares. So, that's really the basic reason for it is to allow us to continue to talk about the underlying profitability of the business going forward without with while still acknowledging that we have that equity hit.

[Philip Shen:]

Great. And the other piece there is the cost of the financing, I think, you talked about $95,000, don't recall if you mentioned it in the prepared remarks, but what should we factor into our Q2 estimate in terms of the cost of that new line?

[Philip Radmilovic:]

Yes. So, we expect there's about a $117,000 of debt issuance costs that are going to be recorded as net against that debt on the balance sheet, but going forward in Q2 and going forward on the income statement, we expect an incremental $172,000 in quarterly interest expense and that's made up of the interest on the principal balance of about $108,000, the amortization of those debt issuance costs of about $14,000 and then accrual for the exit fees of about $50,000.

[Philip Shen:]

Okay. Thanks Paul. That helps.

[Chuck Cargile:]

That was actually Phil.

[Philip Shen:]

That was Phil, okay. Phil, thank you. And then in terms of margins, you gave us a sense for the margins in the backlog, I think about 20% per ACI. Can you -- as a company for modeling purposes help us understand what the margin profile on a blended basis might be for Q2, Q3, and Q4 as we kind of go through the year?

[Chuck Cargile:]

Sure. So, we still have a good deal of old projects flushing through the backlog as I mentioned before. And I think -- so we've got to flush those out. But with the change in our focus, the new projects are actually coming in at a little bit higher margin. So, if you think of the different buckets, as of today, we have about say $55 million or $56 million of non-residential projects that are in that scheduled backlog and those projects blend -- are in the high teens -- gross margins in the high teens. The residential projects are generally in the high 20% range. So, a combination of the normal residential if you will and the ACI that's in backlog already would generate approximately a 20% gross margin, maybe a little bit higher, but right around 20% -- I think around 20% would be what you should consider for a model. The outstanding proposals that we have, have a blended rate in the low to mid-20% range. So, as we flush through the backlog, I anticipate a gradual escalation from 17.9% that we had in the first quarter of this year to the low 20s overtime.

[Philip Shen:]

Okay Chuck, that's great. Thanks. Last quarter you talked about the potential for some of your national accounts business to become more prominent. Can you update us on how that effort is going?

[Chuck Cargile:]

Sure. Yes. Maybe up maybe a good thing Phil, would be off all headed from the higher level maybe talk about the makeup of the new sales in total. And I'll talk specifically about national accounts as part of that, but that might answer future questions -- come as well. So, we did about $37.5 million new projects as we put in the release and talked about in the call. And the good news on that is most of that is scheduled for installation in 2018. And as I've said time and time again that the project timing is always ripe with uncertainty, so some of it may slip from 2018 to 2019, but they're seldom canceled, they just might move a little bit. So, we're less confident in predicting the quarters, but we have good visibility to the total amount. And then I like to think of in addition to national accounts I like to think of our three growth vectors public works, national accounts, and geographic expansion. And I think we had a real good quarter on two of the three fronts. We had a strong -- really strong quarter on public works. A little more than half of the new projects that we booked went public works including the aforementioned 8 megawatt project with the Fresno Unified School District. And then specifically on national accounts that you asked about we had a good quarter again in national accounts and we have a really good pipeline. We have a project with a -- we've got another project with the National Hotel chain that we've done several projects with multiple projects with a large commercial developer whose name we're not allowed to mention, but a number of orders there with a couple more probably coming this quarter. And another project with one of the world's largest wholesale developers that we've talked about before another one in the quarter. So, I think all in all, the national accounts approach is working out very well for us.

[Philip Shen:]

Okay, great. Thanks Chuck. One last one and I'll pass it on. As it relates to a lot of the Board changes, people coming off, coming on. I think you've added three new ones, you have Rhone Resch who's a great leader in this space on your Board. Just talk to us about what's going on there with the changes? And I know you spoke to some of this in your prepared remarks, but what do you see ahead? And how this dynamic and very well-qualified Board can serve you?

[Chuck Cargile:]

Yes, thanks for that. So, there's a couple different pieces to it. And first as you know, we ended last year or at the end of last year, we had eight members of our Board of Directors and then over the course of the year, there's been quite a large change out and most recently, as part of the loan, the senior lenders were allowed to recommend or appoint -- they were actually allowed to appoint a Board member. Now whoever they propose had to be mutually agreed upon by our Board of Directors. And so they introduced us to Josh Schechter that was their suggestion. And each of our Board members met with Josh and wholeheartedly supported him joining our Board. Josh is the individual investor with a long history of serving on public company Boards. I think in short he brings shareholders' mentality to the boardroom, which is always good. In addition most recently as I guess yesterday, we announced that Stan Speer has joined our Board and we had the press release yesterday, so I won't repeat Stan's excellent credentials. But now we've completed all the changes to the Board. We have a total of five members now; four of whom are independent. And what I love about is that the skill sets of those four are very complimentary amongst each other. A great combination of solar industry, domain knowledge, you mentioned Rhone and Daniel Gross who came on our Board late in the first quarter, both known experts in the solar space and now we've combined that with financial expertise and financial transformational experience and a keen focus on shareholder value. So, I think as a management team and also for our shareholders, we're very fortunate to have such a strong Board.

[Philip Shen:]

Yes. Indeed you guys are. It’s a great Board. I will pass it on. Thanks Chuck.

[Chuck Cargile:]

You're welcome.

[Operator:]

[Operator Instructions] Our next question comes from the line of Jim McIlree from Chardan Capital. Please proceed.

[Jim McIlree:]

Thanks. Good afternoon. The residential revenue was a little bit lighter than prior quarters, was there anything special going on to account for that?

[Chuck Cargile:]

Yes I think I don't see that. I thought about a lot -- we've talked about a lot, we focused on it with our residential team here and frankly, Jim, we don't think it's anything outside of what is going on in the overall residential industry here in California. It's been much, much slower over the last six months and certainly slower than it was a year ago at this time. So, I think that's why the news last week from the Energy Commission was especially heartening because it has been an area that's been beaten up pretty bad. So, I'm pleased that we had made the changes that we made over the course of 2017 to have a stable financial model because even with the lower revenue, we're still able to generate a profit in the group and we're seen better bookings this quarter. So, I think we'll see escalation in revenue this quarter versus Q1 and hopefully that will continue through the summer months.

[Jim McIlree:]

Okay. And of the greater than $72 million that you expect to recognize in revenue for the remainder of the year, can you break that down into how much of that is coming from the projects that were bid prior to the changes that have taken place?

[Chuck Cargile:]

Not exactly. Yes, not exactly, but pretty close to it. And maybe the one I do know exactly is the $55 million that's in -- there's $55 million of that that's already in backlog today. So, some of that $55 million would have been prior to the second half of last year when we started making these changes, but I don't know exactly how much of that is.

[Jim McIlree:]

All right. Well, that's close enough. I think that's what I was looking for. And then take into account the changes in the in the accounting treatment. Can you articulate what your goals are for inventory turns in receivable days outstanding? And when you think you might achieve that think?

[Paul McDonnel:]

The initial goals obviously are to reduce the inventory balances on hand and that will begin toward the end of the second quarter depending upon the shipment and the construction readiness of the various projects. But we would like to see our inventories roughly 25% of what they're currently at. There is some need to secure inventories as we engineer products or projects and to make sure that we have a supply of modules that are specified and consistent with the approval process that we have to go through. So, we sometimes have to tie up inventories earlier. In that case, if our inventories normally could run between a $1.5 million and $2 million at the current run rate, that would be ideal. I'd have to back into the turn calculation and unable to do that off the top my head sitting here. As far as the day sales outstanding, as we align the revenue or the billing process with the milestones that are associated with each contract, we would like to see that dropped to somewhere in the area of 45 to 50 days if possible. That's a rough estimate at this point in time.

[Jim McIlree:]

All right.

[Paul McDonnel:]

Our converging cash cycle has been over 100 days -- at times up to 110 days and we need to cut that significantly.

[Jim McIlree:]

And then Chuck, you didn't really talk a lot about geographic expansion. Would you?

[Chuck Cargile:]

Sure. So, we had our first big win in Massachusetts is the most noteworthy item for Q1 and I'm -- of the areas that we've put our direct resources in, that's the one that has started to show the most promise. So, we've booked the 700 kilowatt project there for over a million dollars and I think we've got some other really good opportunities there. So, I'm pleased with Massachusetts. We haven't gained ground in Florida. That's been a little bit disappointing because that was the first one that we put someone in. And so that when we have to scratch our heads on, see what we need to do differently in order to be more successful. And then I think I mentioned in the in the year end call which wasn't that long ago that we've done we have a number of proposals outstanding in the State of New Mexico. So, now it looks to me like Massachusetts and New Mexico are going to move faster than the progress that we've made in Florida and Texas.

[Jim McIlree:]

Okay, that's helpful. Thank you very much. Good luck with everything.

[Chuck Cargile:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Chuck for closing remarks.

[Chuck Cargile:]

Thank you all for joining us today and for your interest in sun works and thank you especially to the employees of Sun works for your dedication and efforts to drive our company to greater heights of achievement. Thank you all.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.