Stem, Inc. (STEM) Earnings Call Transcript & Summary

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 Busch, CFO; and Prakesh Patel, Chief Strategy Officer. Good morning.

Thanks for inviting us.

Yes. Well, thanks for coming. So we're going to do a fireside chat with some questions I have prepared. And we would start off on the hardware side. 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 cost -- your COGS? And how should we think that is going to impact top line and margins? And what kind of lag?

Yes. So we have started to see reductions in price from our primary suppliers. And I think that's a reflection of the coming over supply situation, which is -- which many analysts have predicted, which we've talked and 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 that are suggesting. And we'll start to see that in kind of effectively in a reduction in revenue in as early as 2024. Because that's -- we're signing purchase orders today for deliveries in mid- to late 2024 with those new price targets. So you'll see, we think, be able to offset that through an increase in sales. But for sure, I mean if you're paying less, you're going to -- on a per dollar basis, you're going to recognize less revenue. And one of the things I think that we're seeing generally is 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 -- for us, push forward the modular ESS solution, which is a combination of the electronics and then the DC block side of the equation and 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, particularly as we've moved up the size curve, we're going to continue to see on the straight harbor 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 are making $100-plus 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 warranty negotiations and things like that, which provide us 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 like financial targets that you guys have put out. 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 EBITDA growth beyond that?

So we -- yes, 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 and where the business is trending. I think you've seen the numbers improving 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 one of the primary indicators of long-term growth strategy. So -- now a little -- almost a year ago, we had an Analyst Day, we talked about growth rates over that 3-year time period, and we're on track to achieve that. So 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 rate that you've provided is a 75% CAGR between 22% and 25% for services revenue. And I think you kind of talked about this with your modular ESS kind of coming up. But -- this is a very high number. 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 CAGRs are multiyears. 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. Our long-term view is as that part of the business, we're looking to throttle around 30%, 35% compound annual growth rates. Compare that to the industry that's expected to grow anywhere from 40% to 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 we're doing that today, a multibillion-dollar pipeline around services offerings. And then on the software side, we provided some new disclosure this year, where we disaggregated the solar software, storage software 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 than a 2x increase in system size. So these systems -- and as an example, we announced [indiscernible] a multi-hundred megawatt hour transaction for a single customer. And so as these sites activate, you're going to 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 [indiscernible] 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 your hardware targets are lower than the market target, and you're trying to deemphasize that. Could it actually be lower than the 30% to 35%? And would you consider that like a win?

Yes. 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 offering has been around driving consistent growth in gross profit dollars. So if that means we're growing hardware revenue less, which is, call it, low single-digit margin revenue at the expense of accelerating the 30% to 80% gross margin software services, we'll make that trade all day.

So then just moving over to sort of the modular ESS that you started to provide which is 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 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 a -- whether it's Tesla, Sungrow, you have to have both -- they made the choices the electronics and what [indiscernible]. So if you think about Sungrow as an example, they generally are buying DC Box from companies like EBE and RePG just generally. And if you don't like those for whatever reason, you have a particular preference to 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 we have traditionally played and at the same time, make sure that there's an opportunity for us to provide software. So we never -- historically, we never looked at 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, we're willing to do that as well. I mean we don't -- and I think when you think about the purchase of hardware, it's a fairly -- I mean, it's 2 things are true about it. One is it's a low-margin sale. And second, it's a lot of working capital. So the ability for us to not have to push that working capital through our balance sheet is a real positive. And so -- which is why we talked about having an increase in cash balances 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 2 things: one, being EBITDA positive; and second, pushing less hardware for the business.

I put a final point on it. Our target is at a minimum of 25% of the business is this modular ESS in the front of the meter side versus the fully integrated offering hardware software.

When you say 25% of [indiscernible] -- the front of the meter business, are we talking revenues, bookings like...

What kind of -- if you think about bookings, like right now, we're running at around 95%, 90% to 95% FTM bookings. I think that will change with the EV opportunity, i.e., that the percentage will decline, but FTM is going to continue to be the bigger part of the business. But what Prakesh is talking about is saying that the 25% of that [indiscernible] 90% will be modular ESS. And we have the pipeline back up. We're working with customers to be able to see that today. And so we feel really confident with that. And 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 a record in modular ESS sales. So meaning that the booking won't have the hardware component, but you'll see that in both car and in contracted AUM.

And so the 25%, do you think that you could hit that and like I don't want to put words in your mouth, but like the next 12, 18, 24 months?

I think it'll come faster than that.

Faster than that. Okay.

Yes. So that's exactly when we're talking about [indiscernible] because if you look at '22 to '21, that was almost a 2.5x increase in bookings. This year, we're talking about a 40% or so increase. That's reflective of us not selling as much hardware. That change in growth rate.

It's at 30% [indiscernible].

Okay. And do we think that, that's going to 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 situations where investors who are going to -- you think about like a 200 or 300-megawatt hour project, you're 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 say, 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 is going to have multi-billion dollar pipeline and just say, yes, you go ahead and you think of that out. I'm not going to be 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 help select out of the lower-margin hardware opportunities. As I mentioned earlier, our sales force is economically incentivized to do that, right? If they're getting hit on gross margin, don't chase the low margin opportunities, target customers. A good example where we're seeing great uptick 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 A and other provisions that the IRS clarified in the Inflation Reduction Act driving accelerated interest for Munis and electrical Co-ops. And these are entities when you look at them versus a large investor utility, they have fewer engineers on staff. They can't build it out for 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 in the project at low single-digit margins on the hardware.

Speaking of size, prior to the ESS, the modular offering that you started to provide. Would you say that the way you're offering your products and services kind of was [indiscernible] getting larger project 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 some of removed?

Yes. I don't think so. I mean we are accessing a different component of the market, folks that have 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 the [indiscernible] continue to expand the market opportunity. And we've seen growing acceptance from utility 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.

Yes. I mean, because if you think about the market generally, it's been growing around a 50% CAGR, which means the size of the average project is increasing. And so we're increasing our offering at the same time as the market 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 size has become 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. I think this is maybe a little bit of a part of your offering that's a little less understood or underestimated. So 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 and how we should think about how you get paid off of those services?

Yes. So if you think about the project life -- and 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. On the storage side, we've always provided a lot of subject matter expertise as an early pioneer in the segment. So we help customers with things like developing the appropriate interconnection application to make sure there's no hiccups on your project time line, the hardware selection and negotiating the warranty for the expected use case later on in the project time line, 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 those service units with them, okay, you never want to build the supply chain capability around it, we'll handle that for you. Here's the rate card for that. That includes negotiation with warranty, inventory management, et cetera. Rather than each developer or a customer of ours having their own knock to manage those assets, we can obligate them and discuss O&M on their behalf. That's more efficient, and we have a history of doing that at their 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.

As with many companies in the space, bookings is highly scrutinized. So can you talk about why bookings has become more lumpy? And does that trend lead into revenue becoming so lumpy as well?

I think the easy answer to that is no. We can give you some of the background there that's a change in booking date doesn't have any necessary 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 2 effects. One is size of the systems themselves. So we're signing larger and larger contracts than we did before. And second, I think we're -- I mean Prakesh touched on this, that our sales force is incented on gross margin. And so I think one of the things is true of the company is, obviously, you're reporting a certain number, everybody knows, it's June 30 is coming up. And that's when deals get done 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 tenure 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 sustainable from a long-term standpoint and that they fit into the overall financial model. I mean because we're super focused on making sure that we're EBITDA positive, not just this year, but also in future years. And since the way the time period associated with these contracts is it's -- depending on whether it's a BTM contract, a solar contract, they're all forward-looking. I mean, at a minimum standpoint, you're signing a contract, which will hit revenue in 6 months and possibly 1.5 years and maybe even 2 years from now, depending on what's happening and the size of the project. So you don't want to handicap yourself for a project, which is going to become a revenue event in 1.5 years 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 going to see some lumpiness. But we're -- having said that, though, we're really comfortable with $1.5 billion, which is the midpoint of business guidance for the year.

I mean the other point on this conversion, your question around lumpiness in 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 time line. And so it doesn't necessarily tie to the booking kits.

Yes. Yes, that will probably be one of the fastest FTM projects around.

So actually talking about the lag times. Realize that the Ameresco is an accelerated one. But generally, the lag time between bookings and revenue conversion has gotten longer in the last year or so. Is this primarily because of interconnection and [indiscernible] permitting? What about equipment shortages were hearing on the inverter and transformer side? 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 will have a positive impact. We'll see how 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 going to continue to see that because the utilities are not necessarily incented to go fast. I mean there -- they were really as a guardian of the grid, and they're going to go slower as a result of that. Whereas like we're -- and other companies like ours, we're trying to push them to go faster. And so we'll see what the impacts of those are going to be. But in general, if you think about the projects, BTM projects are 6 to 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 proposed rulemaking they announced last month, it includes financial penalties the ISOs for not meeting service levels or time lines for interconnection. California, the PVC already introduced, what they think is compliant with the FERC guidance. And that's expected to roll out in 2024 as it would be effective in California ISO. So to the extent it propagates across all the grid territories, that should help project time lines. The other thing I mentioned is when we look at individual territories, we're not seeing extended project time line. 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 in many instances, the permitting entities, it's the first time they're allowing a big store 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 time lines 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 are being resolved. I mean, particularly when you think about the batteries there, 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 we don't -- and I think Prakesh touched on around 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 going to 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 million. So just this would kind of assume that working capital is into a huge drag. So just kind of walk us through the back half of this year.

Yes. So I mean, I think what that says in general is we expect to generate cash in the fourth quarter. And part of that is because we expect to be EBITDA positive. So some of that is baked into there. But in general, if you look at the balance sheet and start thinking about what's happening in terms of systems and how we're managing cash flow, we expect to have, say, the storage part of the business to be a lesser drag on the balance sheet. So we're going to 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 million. And then going forward, we think the business is going to be a cash generator. And so and that's going to be a combination of generating EBITDA and having less direct procurement of batteries. So the combination of those 2 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.

The other thing we didn't talk about 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 for better payment terms. And so 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 have primarily been in the domestic market to date. But you announced a 300-megawatt project -- solar project in Hungary. How do we think about your plans for international expansion? And what are the competitive advantages you have as you enter new markets?

Yes. The business we acquired, AlsoEnergy was always fairly well distributed internationally, about 25% of their business was in countries like Germany, Spain, Broader Europe and as well as Asia. So 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 presented a tremendous opportunity in the U.S. So we may look at growth opportunities internationally for storage, but it would be capital like leveraging our partners. There are tremendous opportunities. If you look in the U.K. or any of these [indiscernible] storage absolutely [ pencils ], there's less professional management teams, less mature software platforms. And 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 that in market.

Well, this concludes my questions on the fireside chat today. Thank you so much, Prakesh and Bill, for joining me.

Absolutely. Thank you.