Earnings Call Transcript - STEM Q1 2024

Operator, Operator

Greetings, and welcome to Stem, Inc. First Quarter 2024 Results Conference Call. It is now my pleasure to introduce your host, Mr. Ted Durbin, Head of Investor Relations. Thank you. Mr. Durbin, you may begin.

Theodore Durbin, Head of Investor Relations

Thank you, operator. This is Ted Durbin, Head of Investor Relations at Stem. Welcome to our first quarter 2024 earnings call. Before we begin, please note that some of the statements we will be making today are forward-looking. These matters involve risks and uncertainties that could cause our results to differ materially from those projected in these statements. We, therefore, refer you to our latest 10-Q and other SEC filings. Our comments today also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures can be found in our earnings release. We will be using a slide presentation today. Our earnings release and presentation are on the Investor Relations section of our website at www.stem.com. John Carrington, our CEO, and Bill Bush, CFO, will start the call today with prepared remarks. Prakesh Patel, Chief Strategy Officer, will also be available for the question-and-answer portion of the call. And now, I'll turn the call over to John.

John Carrington, CEO

Thanks, Ted. Good afternoon, and thank you all for joining us today. Beginning with Slide 3 in our agenda, we will cover our first quarter results, product announcements, and business updates. Then Bill will discuss our financial results in greater detail. Now, let's turn to Slide 4 on our first quarter 2024 results and highlights. We continue to execute on our three guiding principles in the first quarter. We delivered record non-GAAP gross margin and near breakeven performance on operating cash flow. We also accelerated our pace of annual recurring revenue activations. And finally, we launched another software-only product offering. We are on a solid foundation to continue delivering against our financial targets for the full year 2024. In the first quarter, we recorded $25 million in revenue, down 62% versus the first quarter 2023. Revenue this quarter was negatively impacted by a $33 million adjustment as a result of some legacy contract guarantees from 2022 and the first half of 2023, which were further impacted by accelerating market conditions, including extended project timelines and declining battery prices. It's important to note this change had no impact on our cash flows in the quarter and is the result of a legacy contract structure, which, as previously committed, we have not offered such guarantees to customers since the first half of 2023. We achieved a record non-GAAP gross margin of 24% this quarter due to a higher mix of software and services revenue. In particular, our high-margin solar revenue was up 16% year-over-year and storage software wins drove AUM up 66% year-over-year. GAAP gross profit was negative $24 million, primarily driven by the net revenue reduction. Bookings in the first quarter were $24 million. As a result of our expansion to large-scale front-of-the-meter storage projects, the timing of our bookings has become increasingly variable on a near-term basis. Our average project size has tripled over the past two years and we have a substantial number of projects in advanced stages of negotiations or that are expected to close in the near-term. Given this strong commercial momentum, we remain confident in achieving our $1.5 billion to $2 billion bookings target for the full year 2024. Contracted annual recurring revenue, or CARR, was up 25% versus the first quarter of 2023. In the quarter, we implemented a proactive effort to upgrade the backlog to focus on the most profitable opportunities, which caused a slight reduction in CARR. This underscores our unwavering focus on driving cash flow generation against our full year target of more than $50 million for 2024. Adjusted EBITDA came in at a negative $12.2 million versus negative $13.7 million in the same quarter last year. Excluding the impact of the revenue adjustments, adjusted EBITDA improved despite a lower revenue base compared to the prior year, reflecting our focus on operating efficiency and gross margin improvement. Lastly, operating cash flow was roughly breakeven this quarter, a $35 million improvement over the same quarter last year. We are updating our revenue guidance solely to reflect the non-cash adjustment and otherwise reaffirming our guidance across our key metrics, including $5 million to $20 million of adjusted EBITDA and more than $50 million of operating cash flow for the full year of 2024. Importantly, we are confident that we can achieve these goals and continue to grow our business without the need for additional equity issuance. Bill will provide more details on our financial results later in the call. We're also announcing today our next-generation PowerTrack Asset Performance Management suite for clean energy portfolios.

William Bush, CFO

Thanks, John. Starting on Page 8 with our results for the first quarter of 2024. As John mentioned, revenue in the quarter was negatively impacted by an approximate $33 million non-cash adjustment as a result of battery hardware price guarantees we made to gain a foothold in the public power and large front-of-the-meter markets. These contracts gave customers certain price protection on their hardware purchases. Since we entered into those contracts in late 2022 and the first half of 2023, interconnection timeframes have extended in key markets, while the price of lithium-ion batteries has fallen significantly in 2024 due to the impact of new manufacturing supply entering the market. The price protection provisions resulted in additional non-cash adjustments to the revenue tied to those projects. In the third quarter of 2023, we adjusted our revenue based on the estimates of the non-cash variable consideration embedded in those contracts. Given the protracted project timelines and decline in battery prices, we have updated our estimate of the non-cash variable consideration, which had the effect of reducing our revenue by an additional $33 million this quarter. Importantly, this adjustment has no impact on our operating cash flow in the current quarter. We have not issued such guarantees since June 2023, and we reiterate our commitment to not issue any hardware price guarantees in the future. We are actively advancing projects under fixed-price contracts based on current market conditions that we expect will consume approximately 50% of the remaining batteries subject to these guarantees. We expect that these transactions will close in Q2 and Q3 of this year and will not be subject to future adjustment post-close. Overall, these transactions should enable us to convert accounts receivable into cash more quickly, providing us greater confidence in our free cash flow generation goals. Following these transactions and the $33 million adjustment, the remaining batteries subject to guarantees are currently valued at approximately $50 million. We intend to integrate these batteries into projects, which we expect will be available for sale in the second half of 2024 and be operational in the second half of 2025. We will continue to evaluate the economics of these transactions based on the then-current conditions. To the extent that we are not able to integrate the remaining batteries into future projects or market conditions further deteriorate, we may update our estimates of the non-cash variable consideration embedded in those contracts. This may result in one or more future impairments. These were exceptional offerings that allowed us to enter and quickly build a leadership position in an attractive market segment, where we have executed over $1 billion in bookings. In addition, we expect that these projects will give us a long-dated revenue stream of high-margin recurring software revenue. Now, on to our other financial results. GAAP gross margin was a negative 95% and was down as a result of the non-cash variable consideration adjustment to revenue I described earlier. We achieved record non-GAAP gross margin this quarter of 24% versus 19% in the first quarter of 2023. The year-over-year increase in non-GAAP gross margin was due to an increased mix of higher-margin solar products and more favorable supply costs. Overall solar revenue increased 16% year-over-year and solar revenue was up 15%. Non-GAAP gross margin was adjusted to exclude the impact of the reduction in revenue. Adjusted EBITDA excludes the impact of the reduction in revenue and was a negative $12.2 million in the first quarter, keeping us on track to achieve our EBITDA goal for the full year. We continue to stay disciplined on operating expenses and reaffirm our target cash OpEx as a percentage of revenue for 2024, which we expect to be between 10% and 20%. Finally, operating cash flow was a negative $600,000, representing a year-over-year improvement of $35 million and a sequential improvement of almost $2 million. We continue to improve our working capital management and remain dedicated to generating positive operating cash flow without the need to raise additional equity or equity-linked securities. Turning now to Slide 9 for a look at our operating metrics. Contracted backlog was $1.6 billion at the end of the quarter compared to $1.9 billion at the end of the fourth quarter 2023, representing a 16% sequential decrease. The decrease in the contracted backlog in the quarter was driven by a proactive effort to upgrade the profitability profile of the backlog, focusing resources on the most compelling opportunities. We canceled around $257 million of contracts that were lower margin or expected to utilize working capital based on this review. We realized bookings of $24 million. The year-over-year and sequential decrease in bookings was largely driven by increased variability on a quarterly basis due to our focus on larger utility scale projects. As underscored by John, we continue to see strong commercial momentum and remain confident in our bookings goal for the year. We reiterate our overall guidance in the $1.5 billion to $2 billion range and have sufficient pipeline to meet that goal. First quarter 2024 CARR decreased to $89.3 million, down from $91.0 million as of the end of the fourth quarter 2023, a 2% sequential decrease. The decrease in CARR was due to the previously mentioned backlog review that resulted in the cancellation of about $3.5 million of annual contract revenue. Storage AUM grew 5% sequentially to 5 gigawatt hours from 5.5 gigawatt hours in the fourth quarter of 2023. Solar AUM ended the quarter at 26.9 gigawatts, down 600 megawatts sequentially or approximately 2%. As part of the backlog review, we performed a comprehensive review of both storage and solar AUM. That review resulted in a small reduction in storage AUM that was offset by new bookings in the quarter and a net reduction in solar AUM. Turning now to Slide 10 and our 2024 guidance. We are adjusting our full year revenue guidance downward dollar for dollar with the $33 million reduction in revenue we recognized this quarter. We are affirming our guidance across all other key metrics. With that, let me turn the call back to John for some closing remarks.

John Carrington, CEO

Thanks, Bill. Wrapping up on Slide 11 with our key takeaways. We are building a solid foundation for continued growth. We had strong performance with a record non-GAAP gross margin of 24%, delivered near breakeven performance for operating cash flow, and are solidly on the path to our EBITDA target for the full year 2024. In addition, we took several actions to enhance the profitability and pace of cash flow generation, including trimming the backlog of lower margin opportunities. I am most excited by the continued strong momentum in our software business with an increase of 42% expected in the conversion of contracted annual recurring revenue for the balance of 2024 as a result of our activities in Q1 2024. This acceleration of ARR activation is a key focus of the organization and, as we highlighted in our prior quarter call, represents a substantial value unlock. At this run rate, there is approximately $65 million of annual gross profit embedded in the full year 2024 CARR. In addition, we continue to add software-only wins, signing up sophisticated renewable asset managers and energy market trading firms. The momentum in our software offerings is augmented by our accelerating pace of new product releases. We announced today the introduction of our next-generation PowerTrack Asset Performance Management suite, which we expect to further build on the strong uptake of our software-only offerings evidenced in the recent release of PowerBidder Pro. We continue to invest in our India Center of Excellence, which is driving enhanced productivity across our software development teams. We expect to continue the rapid pace of new product introductions, cementing our leadership position in the industry. Before I close for questions, I wanted to announce a couple of people updates. Larsh Johnson, our Chief Technology Officer, retired on April 18. Larsh shared his personal path forward with me almost two years ago, and since then, we've been working together on a succession plan to ensure a smooth transition with a particular focus on our software strategy. We hired Albert Hofeldt to serve as SVP of Technology, who has extensive experience in shipping SaaS solutions and, in particular, building robust utility-scale software for next-generation distributed generation assets. Larsh and Albert have been working closely together in developing the transition and strategy for the Stem technology team. Eight years ago, Larsh joined Stem to lead the company's hardware and software engineering teams, driving the evolution of our Athena platform. Larsh has helped to scale our global technology team and has extensive industry knowledge. Customer engagement has been instrumental to Stem's growth and recognition. Larsh will continue to consult for the company, supporting key product initiatives. We wish Larsh and his family all the best in the next chapter, and he will always be part of the Stem family. During our last earnings call, I also mentioned that we were initiating a search for a Board member with software expertise. I'm thrilled to announce that Gerard Cunningham has joined the Stem Board effective April 19. Gerard brings extensive experience in the technology, software services and, most importantly, the AI sector. He founded several companies in the data science space and most recently was a partner at McKinsey, where he co-founded and led the global clean technology practice in addition to launching the AI for sustainability initiative. Gerard was also a leader of McKinsey's digital business building practice. With that, I want to thank shareholders, employees, customers, channel partners, and suppliers. Now, operator, let's open the line for questions, please.

Operator, Operator

The first question comes from the line of James West with Evercore ISI.

James West, Analyst

So understanding that you kept your revenue guidance and most of your guidance generally the same except for the non-cash charge, a lot of it is back-end loaded here. I'm curious about the confidence that you have in hitting those revenue targets that you've outlined, given interconnection delays and hookup delays and things like that. Are these projects that you have line of sight on? Or could these projects slip?

William Bush, CFO

This is Bill Bush. I think we're very confident in the revenue goals that we've laid out. And the reason for that confidence is based on the projects themselves. While I would agree it is possible that we could have some shifting, there are also other projects which we could move in. We've got the ability to, I wouldn't say mix and match, but we certainly have the ability to hit the goals with the pipeline that we have. We're quite confident where we are. The first quarter is always a tough quarter because it's small. And that's been true for a long time. This business has always been pretty cyclical, and it hasn't really changed. The only thing that has changed is the size of the projects we're working on, which we've talked about at length in other calls. I think what you're seeing is a bit more variation. We certainly saw that in terms of bookings this quarter. Ultimately, we're focused on positive EBITDA and generation of cash flow, and we're doing reasonably well with that this quarter. I think the operating cash flow of negative $600,000 in the quarter is an accomplishment for us. And certainly, where we are from an EBITDA standpoint is actually ahead of where we expected. All things equal, I think the business is on track to achieve the goals that we laid out.

James West, Analyst

That's very helpful, Bill. As a follow-up, are you noticing if the permitting and interconnection challenges are becoming longer, stabilizing, or possibly improving?

William Bush, CFO

I think that interconnection and permitting have always been a problem. This year, in particular, I think we've seen some additional slowdowns compared to what we've seen in prior periods. But on the other side of that, I would say other things can happen as well. For example, the United project, which we've discussed at length, is starting to come online. From that standpoint, it became a booking, a revenue event and now a software event in a year. One of the things we've talked about is shifting the business away from projects where the customer has less control over interconnection. We've moved much more into municipal power and public power markets, which have different interconnection schemes than some classic C&I projects. I think, generally, the news is not great for C&I projects in terms of interconnection, but that's becoming a smaller part of our overall business, and that's how we're combating that negative headwind.

Operator, Operator

Next question comes from the line of Jon Windham with UBS.

Jonathan Windham, Analyst

Great. I was wondering if you could just sort of help talk through your sales strategy and points of differentiation going into the utility scale market a bit more, on the storage side and how you line up with competitors.

Prakesh Patel, Chief Strategy Officer

Jon, this is Prakesh Patel. The way we differentiate ourselves in the market is through the project economics that we deliver for customers using our software. We consistently talk about in prior quarters and provide examples of how our software delivers much better project returns than competitive solutions. There is a multipronged approach to driving that uptake, either by engaging with asset owners and helping them specify or push down to project developers, or engaging with project developers and engineering firms and helping them through the bankability as well as advancing their projects. One of the things we talked about this quarter is that we've dramatically accelerated the activation of our storage projects. If you look for the balance of 2024, that's about a 42% uplift from what we anticipated at the beginning of the year. A lot of that is blocking and tackling to help those customers move through advanced interconnection timelines.

Jonathan Windham, Analyst

Got it. If you could clarify, I have an accounting question regarding the $33 million non-cash charge. How does that work? Is it related to a reduction in accounts receivable?

William Bush, CFO

That's right. Exactly. It's a reduction in accounts receivable, a reduction in revenue.

John Carrington, CEO

Yes, let me just add on to that to give everybody a quick explanation of the revenue adjustment. We've been focused on converting contracts from accounts receivable to cash. There was a significant reduction in project values as a result of deteriorating market conditions, but we did transact with our customers to resolve about 50% of the hardware subject to these guarantees. We expect to close those in the second and third quarter of this year and have updated the value of the remaining hardware. This legacy guarantee structure enabled our rapid growth into the utility scale market and it resulted in over $1 billion of executed customer contracts. Those contracts will drive significant recurring software revenue, which I just wanted to add.

Operator, Operator

Next question comes from the line of Andrew Percoco with Morgan Stanley.

Andrew Percoco, Analyst

I guess I just wanted to start with a few questions on the backlog cleansing effort that you guys are doing. First, when were these projects booked? Were there changes to the customer, maybe credit quality or creditworthiness? Or was it just more underwriting related to the margin profile?

William Bush, CFO

Let me start with the last question first. This is Bill Bush on the line. We are done. But I would also say that we're constantly reviewing the components of the deal. We've done a lot of things in the last 1.5 years that have driven us toward a positive EBITDA outcome. This is just one of those efforts. We cleansed the AUM on the solar side. These projects were canceled for a combination of reasons. They had low margin profiles, were in territories where we didn't have enough leverage or concentration, or customers that we believed to be non-core to the total business. We're trying to maximize leverage across our team and focus on projects that generate cash for the business.

John Carrington, CEO

I'd add, Andrew, that I think a lot of these were areas that maybe we didn't see as prospective markets that we could scale. Getting rid of those one-offs, which are high cost to serve, was the right thing to do for the business. That project is complete.

Andrew Percoco, Analyst

And my second question would just be on margins. Adjusted margins were pretty strong in the quarter. So can you help us think about the cadence for the remainder of the year on margins and cash flow as well?

William Bush, CFO

I think as it has been for a while, the first quarter gross margin is typically the strongest. You recall last year we were at 19%, and we ended the year at a total of 15%. We’re trending in the right direction from where we started with a gross margin of 24%. Obviously, as we ship more hardware, the margin is going to decline, but software is becoming a larger part of the business. The continued improvement in cash flow, along with cost controls, positions us well. We feel confident in achieving our goals.

Operator, Operator

Next question comes from the line of Thomas Boyes with TD Cowen.

Thomas Boyes, Analyst

Maybe the first one, great to see the PowerTrack announcement. I wanted to get more insight into the go-to-market strategy for the solution as it's deployed to customers exiting the year. Are you focusing primarily on hybrid deployments? Or is the flexibility to address both solar and storage important?

John Carrington, CEO

Yes, Tom, it's John here. The PowerTrack APM suite is really a software-only solution for managing storage, solar, and hybrid energy asset portfolios. Our customers have asked us to build a platform not currently available in the market. We're doing much quicker development aligned to our customers’ needs. The interest in the PowerTrack APM is strong, and we expect to have it available this summer for demos and more broadly by the end of the year.

Prakesh Patel, Chief Strategy Officer

Tom, this is Prakesh. This solution can work in existing operating storage assets as well. So it's applicable for both brownfield and newbuild opportunities, allowing us to grow software services without waiting for interconnection approvals.

Thomas Boyes, Analyst

I appreciate the color there. Maybe I wanted to dig into the solar AUM decline. Was this really for those legacy contracts that ended up not making the transition from the initial pruning effort?

Prakesh Patel, Chief Strategy Officer

Yes, it's really what Bill laid out earlier. We reviewed for subscale customers that were difficult to serve, lower margin contracts, or those that would tie up additional working capital.

Operator, Operator

Our next question comes from the line of Justin Clare with ROTH MKM.

Justin Clare, Analyst

Yes. Can you hear me?

William Bush, CFO

Now we can.

John Carrington, CEO

Yes.

Justin Clare, Analyst

Great. I wanted to ask about the impact on ARR. If you took the write-down and lowered the value of ARR, would that impact cash flows you'd anticipate collecting this year? Are there offsetting factors that would essentially offset this?

William Bush, CFO

When we look at backlog, we're always evaluating its durability from a margin standpoint. The evaluation we did was targeted toward that. If we can refresh that backlog with better projects, I believe we can replace it with more favorable than what went away. We've reaffirmed the $1.5 billion to $2 billion in total bookings. It's essential to see how quickly we can collect on that AR.

Justin Clare, Analyst

Got it. And what stage are the development projects you mention? Have you signed PPAs for those projects? Are those planned for sale in 2024? And what is their contribution to your cash flow expectations?

William Bush, CFO

The projects are in development. They are expected to be sold this year. Some may COD this year, but most will likely COD in 2025. Those projects are going to contribute to cash this year.

Operator, Operator

Our next question is from the line of Brian Lee with Goldman Sachs.

Brian Lee, Analyst

I had to hop around on a couple of calls this afternoon, so I might have missed a few things. On the contracts you canceled, did you specify the range of those low-margin contracts?

John Carrington, CEO

Yes, Brian, this is John. The contracts we considered out of scope were below the gross margin targets we set for the business. We also looked at installations and per megawatt hours to determine value. The flexibility of our model allows us to pivot if local or state legislation changes.

Brian Lee, Analyst

Understood. And regarding the hardware revaluations, what is the thought process around the $50 million still potentially needing to be revalued?

William Bush, CFO

When we looked at variable consideration, we're constantly reviewing all potential contributors. This is a management decision based on underlying project values and the equipment's role. I wouldn't disagree that there's more risk in that remaining $50 million, but we have a strong pipeline to place it.

Brian Lee, Analyst

Okay. That's helpful. Could you remind us how you're approaching pricing and cost management on the hardware side without doing those legacy guarantees?

William Bush, CFO

We aren't issuing guarantees anymore, and we're getting closer to contract signing dates for when customers need equipment. This leads to quicker conversions from bookings to revenue. As we adapt our business model from BTM to FTM, the shift will ease timelines from bookings to revenue, especially software.

John Carrington, CEO

From a contract level, we're currently about 40% contracted for 2024.

Brian Lee, Analyst

I appreciate all that color and the additional percentages are helpful.

Operator, Operator

Next question comes from the line of Joe Osha with Guggenheim Partners.

Joseph Osha, Analyst

I wanted to clarify that you're aiming for a CARR of $115 million to $130 million. What should that reflect in terms of an ARR at the end of the year you think?

William Bush, CFO

I don't think we've given that specific guidance, Joe. I apologize, but I will go to your next question.

Joseph Osha, Analyst

Can we assume the rate of conversion will improve?

William Bush, CFO

In the fourth quarter presentation, we visualized CARR and ARR. While we didn't provide specific numbers, we indicated we are working to increase the rate of ARR conversion.

Operator, Operator

Next question comes from the line of Kashy Harrison with Piper Sandler.

Kashy Harrison, Analyst

First one is on the GAAP gross margins for software and services. It appears to have improved year-over-year and quarter-over-quarter as well. Can you speak to what the driver was of that improvement? And how sustainable do you believe the current software gross margins are?

William Bush, CFO

We believe it is sustainable. The principal drivers are the newer software contracts coming online and the older host customer systems fading. The continued growth in the solar part of the business also contributes.

Kashy Harrison, Analyst

That’s helpful. Regarding bookings of $23.8 million, that's a notable drop from $36.4 million last year. Could you share context on what happened with bookings this quarter?

John Carrington, CEO

John Carrington here. It is indeed lumpier as we've expanded into larger scale front-of-the-meter projects, which has impacted our booking timings. Our project size has tripled over the past two years, and we have a substantial number of projects in advanced negotiations or expected to close soon. We're confident in achieving our $1.5 billion to $2 billion bookings target for the full year, but landing project agreements quarterly is tougher as they scale up.

Operator, Operator

There are no further questions at this time. I would like to turn the floor over to John Carrington for closing comments.

John Carrington, CEO

Thank you, Ranju. I want to thank everyone for joining our first quarter earnings call. We look forward to speaking with you during our second quarter earnings call, which will take place in August.

Operator, Operator

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