Good morning, everyone. My name is Christine Cho, and I'm the clean tech equity research analyst here at Barclays. Next up, we have Stem, a company that provides clean energy solutions through its storage, software, and EV charging offerings. And with us, we have Bill Bush, CFO, and Prakesh Patel, Chief Strategy Officer. Good morning.
Morning. Thanks for hosting us.
Yeah. Well, thanks for coming. So we're going to do a fireside chat with some questions I've prepared. I think we would start off on the hardware side.
Sure.
We've seen a bit of hardware cost deflation over the last several months. Could you talk about when those lower equipment prices might start making their way through your costs, your COGS? And how should we think, that is going to impact top line and margins, and what kind of lag?
Yeah. So we have started to see reductions in price from our primary suppliers. And I think that's a reflection of the, you know, coming oversupply situation, which many analysts have predicted, which we've been talking about for a number of years now, and so we're starting to see that. I think the initial price reductions are probably a little bit less than some of the major prognosticators are suggesting, and we'll start to see that in, you know, kind of effectively in a reduction in revenue in as early as 2024. 'Cause that's. You know, we're signing purchase orders today for deliveries in mid to late 2024 with those new price targets.
So you'll see. You know, we think we'll be able to offset that through an increase in sales, but for sure, I mean, if you're paying less, you're going to, I mean, on a per dollar basis, you're going to recognize less revenue. And, you know, one of the things I think that we're seeing generally is, you know, increasing the quality of the manufacturers as well. So you're seeing more companies that are selling DC blocks, and that gives us the ability, I think, to, you know, for us, push forward the Modular ESS solution, which is a combination of the electronics and then the DC block side of the equation. It gives us the opportunity to sign more services, which is really what we're trying to drive to.
So when you think about the business just generally, you know, particularly as we've moved up the size curve, we're going to continue to see, you know, on the straight hardware business, which has been true across many businesses like that, you're going to see less margin there. But through the Modular ESS, we should be able to, and we're starting to see this now through contracts that we're signing, is we'll be able to sign more services revenue because our customers, many of whom, you know, are making, you know, $100+ million investments, have procurement engines. And so we're doing less of that procurement and more of the services, which would include things like designing the system, helping them with the warranties, negotiations, and things like that, which provides the opportunity to write a service contract.
So I actually do want to come back to the Modular ESS later. Maybe just moving over to targets, like, financial targets that you guys have put out.
Sure.
You know, you've said that you would like to hit EBITDA breakeven sometime in the back half of this year. How confident are you that this is going to be achieved, and how do we think about, you know, EBITDA growth beyond that?
So, yeah, so our goal has been, and we've been pretty clear about this, is that we'll be EBITDA positive in the second half of 2023, and we're on track to achieve that goal. So we feel very confident about where we are, where the business is trending. I think you've seen, you know, the numbers improving, you know, sequential, quarter-over-quarter, sequential increases in software across both storage and solar within our business. And so I think that is really what is going to be, you know, one of the primary indicators of, you know, long-term growth strategy. So now, a little, almost a year ago, we had an analyst day, and we talked about growth rates over that three-year time period, and we're on track to achieve that. So, you know, we feel very confident with the numbers that we've published.
We actually published a new deck this morning to the extent that folks saw that with a little bit more disclosure around how we're going to achieve some things like that.
So, just talking about those growth rates. So the growth rates that you've provided is a 75% CAGR between 2022 and 2025 for services revenue.
Mm-hmm.
And I think you kinda talked about this with, you know, your modular ESS kinda coming up, but-
Yeah
... you know, this is a very high number.
Sure.
So can you talk about how this is going to be achieved? And to the extent that you can, I would also be very curious, because, you know, CAGRs are multi-year.
Yeah.
Is it front-end loaded? Is it back-end loaded? Is it ratable?
Well, if you look at how we performed over the past few years, we've been delivering substantial growth, even on the hardware revenue side. You know, our long-term view was that part of the business, we're looking to throttle around 30, 35% compound annual growth rate. Compare that to the industry that's expected to grow anywhere from 40%-50% per year through 2025. So our message there was really around, we're going to shift the focus of the business increasingly away from the lower margin components, like hardware, and drive greater services. So the way we do that, and we can talk about that when we get into the Modular ESS, is wrapping a suite of services and helping our customers integrate these disparate hardware components on-site.
And, and we're doing that today, multi-billion-dollar pipeline around services offerings. And, and then on the software side, you know, we provided some new disclosure this year, where we disaggregated the solar software, storage software, and, and project services. And if you look at the trend there for both solar and storage software, we've been consistently delivering double-digit quarter-on-quarter growth. So, the other trend that's working in our favor on the storage side is the singular project size is dramatically upticked. If you look at in Q2 as an example, relative to last year, it's been a 2x increase in average system size. So as these systems, and as an example, we announced it deal as a multi-hundred megawatt-hour transaction for, for a single customer.
As these sites activate, you're gonna see substantial upticks in storage software. On the solar side, last quarter, we had 29% quarter-on-quarter growth in bookings for that business. So, we're seeing the impacts of the UFLPA wane and seeing a return to growth there. So we feel very good around that long-term guide.
Okay. Actually, maybe as a follow-up to that comment of, you know, your hardware targets are lower than the market target, and you're trying to de-emphasize that-
Yeah.
Could it, could it actually be lower than the 30%-35%? And would you consider that like a win?
Yeah, I mean, our emphasis and we've expressed this in the way we drive the commission on the sales force, the way we target conversations with customers and our product offerings, has been around driving consistent growth in gross profit dollars. So if that means we're growing hardware revenue less, which is, you know, call it low single-digit margin revenue, at the expense of accelerating the 30%-80% gross margin software services, we'll make that trade all day. So...
So then just moving over to sort of the Modular ESS that you started to provide, which is, you know, a great offering that you guys provide if the customers want to procure the software. Prior to that, the customers had to buy the hardware from you in order to get the software. So can you talk about how that's progressing, what sort of opportunity that is for you? And then I would also sort of love to know how we should think about how much of the bookings that could be, you know, on a go-forward basis.
Sure. So I think the Modular ESS really represents an opportunity for customers to have choice. Today, if you buy, you know, whether it's Tesla, Sungrow, you have to have both... You know, they made the choices about the electronics, what the DC block is. So if you think about, you know, Sungrow as an example, they generally are buying DC blocks from companies like EVE and REPT, just generally. And if you don't like those for whatever reason, you have a particular preference toward one thing, it's hard to get out of that. And so the opportunity is for our customers to choose that, both the electronics, which really drive the interconnection, and then the DC block.
And so for us, it gives us an opportunity to make sure that we continue to have a service component, which is really where, you know, where we have traditionally played, and at the same time, make sure that there's an opportunity for us to provide software. So we never, you know, historically, we never looked at the, you know, say, the delivery of hardware as key to our mission, but it did enable software. And so to the extent that our customers are willing to work with us in a slightly different way, you know, we're willing to do that as well. I mean, we don't, you know. And I think when you think about the purchase of hardware, it's a, it's a fairly... I mean, it's two things are true about it. One, it's, it's a low-margin sale, and, and second, it's a lot of working capital.
So the ability for us to not have to, you know, push that working capital through our balance sheet is a real positive. And so, which is why we talked about having increase in cash balances, and by the end of the year, and over time, we think that the business, in general, is going to generate more cash as a result of two things, one being EBITDA positive, and second, pushing less hardware through the business. So-
I'd put a finer point on it. You know, our target is at a minimum 25% of the businesses is modular ESS in the front of the meter side versus the fully integrated offering, hardware, software.
When you say 25% of the business-
Of the front of the meter.
Yeah.
Of the front of the meter business, are we talking revenues, bookings, like?
We kind of... If you think about bookings, yes, like, right now, we're running at around 95, 90%-95% FTM bookings. I think that'll change with the EV opportunity, i.e., that the percentage will decline, but FTM is gonna continue to be the the bigger part of the business. But what Prakesh is talking about is saying that the 25% of that, call it, of the 90% will be modular ESS, and we have the pipeline to back that up. You know, we're working with customers to be able to do that today, and so we feel really confident with that, which is in part why for this year, when you look at the guide towards the bookings, the midpoint of bookings is $1.5 billion.
It's about a $400 million or so increase in bookings year-over-year, and that reflects us recording Modular ESS sales. So that—meaning that the booking won't have the hardware component, but you'll see that in both CARR and in contracted AUM .
And so the 25%, you think that you could hit that in like, I don't want to put words in your mouth, but like the next 12, 18, 24 months?
Oh, I think faster than that, yeah.
Faster than that? Okay.
Yeah, because that's... So that's exactly where, when we're talking about. You know, so because if you look at 2022 to 2021, that was almost a 2.5x increase in bookings. This year, you know, we're talking about a 40% or so increase. That's reflective of us not selling as much hardware. That change in growth rate.
Right.
It's the 30% and the 75%-
Yeah.
-basically.
Okay.
Yeah.
Do we think that that's gonna continue to trend higher, the 25%?
I think so. I mean, particularly given what you're seeing in the marketplace is an increase in system size, and I think you're also seeing, you know, situations where investors who are gonna... You know, you think about like a 200- or 300-MWh project... talking about a significant amount of money, over $100 million in capital. And I think in those cases, you're going to see investors and ESA project developers have a much stronger opinion about what they're going to want to do from a procurement standpoint. I mean, it's not likely to expect that somebody's going to have, you know, a multi-billion dollar pipeline and just say, "Oh, yeah, you go ahead and you figure that out. You know, I'm not going to have you involved in that at all." I don't think that's a realistic assumption.
I mean, the other way I phrase it is, we're intentionally trying to self-select out of the lower margin hardware opportunities. But, as I mentioned earlier, our sales force is economically incentivized to do that, right? If they're getting paid on gross margin, don't chase the low margin opportunities. Target customers. A good example where we're seeing great uptake and really favorable margin environment is the munis and co-ops. We announced a fairly large deal with Ameresco in the last quarter. Some of the direct pay and other provisions that the IRS is clarifying in the Inflation Reduction Act, driving accelerated interest from munis and electrical co-ops. And these are entities, when you look at them versus a large investor-owned utility, they have fewer engineers on staff. They can't build the software themselves.
They're not at a scale where they could procure hardware directly, so they benefit from us aggregating their buying power. And so we're seeing much better margins in that segment of the market. Those are the opportunities we'd rather chase than a, than the project that, you know, low single-digit margins on the hardware.
Speaking of size, prior to the ES, the modular offering that you started to provide, would you say that the way you were offering your products and services kind of was a hindrance to you getting larger projects? Because the customers maybe didn't want to buy the hardware from you. Would you say that that was an impediment that you kind of have somewhat removed?
Yeah, I don't think so. I mean, we are accessing a different component of the market, folks that have, you know, more mature supply chain capabilities. But it's really around... We never really targeted that market, and that included things like software tools for market trading or other elements. There's been substantial interest in the we have been covering. So it's just been continuing to expand the market opportunity, and we've seen growing acceptance from utilities in deploying more storage assets, greater demand in that segment of the market. It's been naturally just growing with the market. It's not like we couldn't access it before.
I mean, because if you, if you think about the market generally, it's been growing around a 50% CAGR, which means in, you know, the size of the average project is increasing, and so we're increasing our offering at the same time as the market-
Mm-hmm
It is increasing. So I don't think it was ever an impediment, because depending on how far back you go, many of the customers didn't have a sense yet of what was the appropriate battery set for them, and they were making smaller investments in projects, particularly on the BTM side. And once we jumped over to the FTM side, the system sizes became significantly larger, and that drives different behaviors on the customer side, meaning that they have procurement, they have opinions about which DC blocks that it makes the most sense for them.
And then I just kind of wanted to move over to your services side of the business. You know, I think this is maybe a little bit of an,
Mm-hmm
a part of your offering that's a little less understood or underestimated.
Right.
Would be curious for you to expand. It would be great for you to expand just kind of what it is that you're doing.
Sure
... and, you know, how we should think about how you get paid off of those services.
Yeah. So if you think about a project life. This is on the storage side, then we can talk about the solar business as well, where they've had a fairly robust service offering already when we acquired AlsoEnergy. But on the storage side, we've always provided a lot of subject matter expertise as an early pioneer in the sector. So we help customers with things like developing the appropriate interconnection application to make sure there's no hiccups on your project timeline, the hardware selection and negotiating the warranty for the expected use case. Later on in the project timeline, there's also requirements to register those assets within the ISO, the back end billing and settlement around market trades. So each of those components.
And we have capabilities like a NOC that can asset manage these systems, help customers deploy O&M services and the like. And when we look across our customer base, whether that's asset managers or EPC firms or project developers, each of those have different capabilities that they want to develop in-house or have no plans to do so. So what we've been doing recently is executing service agreements with them. "Okay, you'd never want to build a supply chain capability around it. We'll handle that for you. Here's the rate card for that." That includes negotiation of warranty, inventory management, et cetera. Rather than each developer or customer of ours having their own NOC to manage those assets, we can aggregate them and discuss O&M on their behalf.
That's more efficient, and we have a history of doing that since our inception. So it's really looking at our customers, what they don't want to build, how we can provide it at scale in a more efficient way, and charging them for that. So that's the business model.
Okay. And then, as with many companies in the space, bookings is highly scrutinized. So can you talk about why bookings has become more lumpy?
Mm-hmm.
And does that translate into revenue becoming-
I think the easy answer to that is no. So we can give you some of the background in terms of that. But that's, you know, a change in booking date doesn't have any impact on when that project actually goes forward. I think from our standpoint, one of the reasons why bookings have become a bit more lumpy than they maybe were in the past is a combination of two effects. One is size of the systems themselves, so we're signing larger and larger contracts than we did before. And second, I think, you know, and Prakesh touched on this, that our sales force is incented on gross margin. And so I think one of the things that's true about public companies, you know, obviously, you're reporting a certain number.
Everybody knows. Yeah, everybody knows it's June 30th is coming up, and, you know, that's when deals get done at, you know, at rates that are not super interesting necessarily to us as a company. And so one of the things, by changing the incentive compensation to the sales force, we're pressuring less on the particular quarter and focusing more on the overall tenor of the business and what it looks like from a margin standpoint. So it's really important for us to make sure that the deals that we're signing are, you know, sustainable from a long-term standpoint, and that they fit into the overall financial model. And because we're super focused on making sure that we're EBITDA positive, not just this year, but also in future years. And so the way the time period associated with these contracts is it's...
You know, depending on whether it's a BTM contract, a solar contract, they're all, you know, forward-looking. I mean, a minimum standpoint, you're signing a contract which will hit revenue in six months and possibly a year and a half, and maybe even two years from now, depending on what's happening and the size of the project. So you don't wanna handicap yourself for a project which is gonna become a revenue event in a year and a half, to take... You know, to make sure you hit a bookings number, which is not a revenue event. And so, just to be super clear, bookings are not revenue. And so for us, making sure that those contracts fit into the financial model is way more important, and so you're gonna see some lumpiness.
Having said that, though, we're really comfortable with $1.5 billion, which is the midpoint of the bookings guidance for the year.
I mean, the other point on this, conversion, you know, your question around lumpiness and revenue. If you look at the Ameresco deal we announced last month or so, in that press release, we talked about how it's expected to commission in early 2024. That's a dramatically accelerated timeline.
Yeah.
You know, so it doesn't necessarily tie to the booking gigs.
Yeah.
Yeah.
Yeah, that'll probably be one of the fastest FTM projects we've owned.
Actually talking about the lag times. Realize that the Ameresco one is an accelerated one, but generally, the lag times between bookings and revenue conversion has gotten longer in the last year or so. Is this primarily because of interconnection and permitting? What about equipment shortages we're hearing on the inverter and transformer side?
Yeah.
Any update here on whether or not you expect the lag times to shorten, lengthen, or stay the same?
I think they'll stay the same. I think that you're seeing there's some legislative initiatives that are moving forward, either through the FERC or locally within the state organizations, around getting interconnections done quicker. So I think that that'll have a positive impact. We'll see how, you know, near term that effect is, but for sure, interconnection is, and always has been, an issue with every single power project, whether it's a renewable project or otherwise. And so I think you're gonna continue to see that, you know, because the utilities are not necessarily incented to go fast. I mean, their role is really as a guardian, you know, of the grid, and they're gonna go slower as a result of that.
Whereas, like, we're and other, you know, companies like ours, we're trying to push them to go faster, and so, you know, we'll see what the impacts of those are gonna be. But in general, if you think about the projects, BTM projects are 6-12 months from when the contract is signed, FTM projects between 12 and 24 months. And so that's a long time, and it has been like that now for a while, so we haven't seen any dramatic changes.
I'm more optimistic about the FERC action. I mean, the you know, proposed rulemaking they announced last month, it includes financial penalties to the ISOs for not meeting service levels or timelines for interconnection. California, the PUC already introduced what they think is compliant with the FERC guidance, and that's expected to roll out in 2024, as well. It'd be effective in California ISO. So to the extent it propagates across all the grid territories, that should help project timelines. The other thing I'd mention is when we look at individual territories, we're not seeing extended project timelines. What's really happened is the average has moved up because we've started to expand the geographies where we're pursuing projects post-IRA.
So whereas before we weren't active in states like Michigan or Nevada or Arizona, those are new territories that in many instances, the permitting individual entities, it's the first time they're allowing a big storage system to come into their grid. So that's a necessary education process. But we've seen consistently in every new market we enter, that those timelines come down. So existing markets like California, Massachusetts, New York, Texas, those aren't expanding, but the average has gotten larger or expanded because of the geographic.
What about on the equipment side? Are there any shortages that we should be aware about?
I think there have been. I think a lot of those though are being resolved. I mean, particularly when you think about the batteries, I think some of our customers, more on the solar side, we're talking about some inverter shortages. We're not an acquirer of inverters for solar, so we don't have any direct knowledge around that, but we've certainly heard that. But I think that, you know, we don't—and I think Prakesh touched on some of the numbers around solar, the growth in that business. So I don't see any dramatic issues. Transformers have been a problem for some storage projects, but I don't think that's gonna be an issue for us.
Then maybe just turning to the financials. You guys ended 2Q with about $140 million of cash on the balance sheet, and you said that you plan to end the year with no less than $150. So just this would kind of assume that, you know, working capital isn't a huge drag. Just kinda walk us through the back half of the year.
Yeah. So I mean, I think what that says in general is we expect to generate cash in the fourth quarter, and part of that's because we expect to be EBITDA positive. So some of that, you know, is baked into there. But in general, you know, if you look at the balance sheet and start thinking about what's happening in terms of, you know, systems and how we're managing cash flow, we expect to have, you know, the, say, the storage part of the business be a lesser drag on the balance sheet. So we're gonna convert some of the receivable inventory that are on the balance sheet as of the end of the second half into cash this quarter.
And so we're well on our way to being able to do that, and so we feel really confident that we can hit a minimum of $150. And then going forward, we think the business is gonna be a cash generator. And so, you know, and that's gonna be a combination of generating EBITDA and having less direct procurement of batteries. So the combination of those two things should generate more cash, all things being equal, to the business, and so we should end up in a better cash position in the future.
And the other thing, you know, we didn't talk about when we were, when you were referencing the supply chain, is this tremendous amount of capacity that's been that started being built in the U.S. and announced, has resulted in a supply response in China. And many of the OEMs we're talking to have already stood up more lines, added more capacity. And so not only are we seeing the potential for a steeper price declines, but better payment terms. And so, you know, from that perspective, separate from the Modular ESS strategy, we expect less working capital drag when you're not having to flow deposits in advance of hardware delivery.
Maybe last question from me. You guys are, you know, have primarily been in the domestic market to date, but you announced a 300 MW project, solar project in Hungary. How do we think about your plan for international expansion, and what are the competitive advantages you have as you enter a new market?
Yeah, the business we acquired, AlsoEnergy, was always, you know, fairly well distributed internationally. About 25% of their business was in countries like Germany, Spain, broader Europe, and as well as Asia. So, you know, that deal was out of that business segment. On the storage side, we have worked with, when we were a private company, many of our investors, like a Mitsui, in deploying the first virtual power plant in Japan, like Copec in deploying the first South American virtual power plant in Chile. But our focus today is really being measured around driving greater profitability and the fact that the IRA just presents a tremendous opportunity in the US.
So, you know, we may look at growth opportunities internationally for storage, but it would be capital light, leveraging our partners. There are tremendous opportunities. If you look in the UK or many of these geographies, storage absolutely pencils. There's less professional management teams, less mature software platforms, so we're quite optimistic. But I think for us, it's really around driving EBITDA, driving free cash flow growth before we look to reinvest proceeds of that in market expansion.
Well, this concludes all of my questions on the fireside chat today. Thank you so much, Prakesh and Bill, for joining me.
Absolutely. Thank you.