Sunworks' (SUNW) CEO Jim Nelson on Q2 2016 Results - Earnings Call Transcript

| About: Sunworks, Inc. (SUNW)

Sunworks, Inc. (NASDAQ:SUNW)

Q2 2016 Earnings Conference Call

August 10, 2016 10:00 AM ET

Executives

Rob Fink - IR

Jim Nelson - CEO

Tracy Welch - CFO

Analysts

Jeff Osborne - Cowen and Company

Jim McIlree - Chardan Capital

Alex Silverman - Special Situations Fund

Carter Driscoll - FBR

Philip Shen - ROTH Capital Partners

Gregg Hillman - First Wilshire Securities Management

Operator

Good day, everyone and welcome to today’s program, the Sunworks Second Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions]

It is now my pleasure to turn the conference over to Mr. Rob Fink at Hayden IR. Please go ahead, sir.

Rob Fink

Thank you, operator. Good morning, everyone and thank you for joining Sunworks Second Quarter 2016 Earnings Conference Call. Joining me on the call today are Jim Nelson, Chief Executive Officer, and Tracy Welch, Chief Financial Officer.

Before we start, I would like to remind everyone that in this call, management’s prepared remarks contains forward-looking statements which are subject to risks and uncertainties, and management may make additional forward-looking statements during the question-and-answer 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 as a result of certain factors not limited to general, economic and 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, August 10, 2016. Sunworks assumes no obligations to update these projections in the future as market conditions may change. This morning, the company filed its 10-Q with the SEC and issued a press release announcing its financial results. Participants on this call who may not have already done so may wish to look at those documents, as we provide a summary of the results on this call.

So now, I would like to turn the call over to Jim Nelson, Sunworks CEO. Jim, the call is yours.

Jim Nelson

Thank you, Rob and good morning to all. Thank you for joining our second quarter earnings call. During the second quarter of 2016, we extended the strong momentum that began in 2015. We have catapulted Sunworks into an industry leader with a recognizable always [ph] expected brand in both the commercial and residential markets. The results of this quarter speak to the efforts and dedication of our team to meet our commitments to our customers and our shareholders and the market adoption of our solar solutions. There are many reasons to be enthusiastic about our business right now, and our prospects for the future. Sunworks is proactively working to leverage our readership, our brand equity and our successes to further enhance our position in this growing market.

First, given the near and long-term opportunities we see in the solar industry, we are making investments in our sales organization and operational infrastructure, aimed at driving sales growth, while simultaneously reducing unit costs and improving the quality of our service. Our focus is on recruiting highly capable seasoned solar professionals with established track records who are comfortable with performance based compensation. By further increasing our sales presence, we believe we will be able to accelerate our growth for the remainder of 2016 and beyond.

We have also invested in infrastructure to drive our growth, including new residential offices in South Bay and Chico, with the objective of expanding our footprint in the residential market segment. Design centers such as the one we opened in Rocklin will also help to bring additional revenue and awareness of Sunworks’ brand and reinforce our reputation as the industry leader. We are currently seeking locations for additional centers.

We are also experiencing growth from our Rapid Rack division. Rapid Rack is a proprietary racking system that is becoming increasingly accepted as the premier installation process and promises to create numerous additional opportunities for revenue going forward. We recently saw an example of this with installer Boviet Solar USA decision to Rapid Rack as their preferred racking system. Approximately $600,000 of the revenue in the second quarter is directly attributable to the Rapid Rack division. And we are confident that that number will dramatically increase in future quarters. Rapid Rack not only serves as a way to diversify our revenue, but it also provides us with a competitive advantage by delivering faster, attractive, more efficient and cost-effective installations to our customers.

In addition to investing in organic growth, we continue to prudently evaluate strategic and accretive acquisition targets that meet our stringent criteria. As we have discussed, we are looking for complementary businesses that can accelerate our growth within our current footprint as well as others that can expand our market and geographical reach. We look for companies that meet our growth parameters and profitability profile. But just as importantly, we look for companies that have a strong management team that share our corporate values. We have been in discussions with multiple companies over the last few months and while we have chosen not to pursue some of these, we are in ongoing discussions with key candidates that could have substantial strategic benefit to our organization.

I would like to make the distinction between our strategy and that of what is commonly known as the rollout. We think a very disciplined approach to our acquisition strategy and we’ll continue to seek the most prudent opportunities that both enhances our business and also maximize the return on invested capital. While we believe there is currently a great consolidation opportunity in the solar industry, it only benefits us, if we acquire companies under the right circumstances and with the appropriate acquisition cost. When we identify accretive target and its specific benefits to us, especially differentiated technology or established presence in a new and vibrant region, we will act quickly, but we will actually have great patience in ensuring that all our criteria are met.

Looking ahead, we recognize that battery storage is a key to the future of solar. We love what solar can do for the world. So when we add economical battery storage to the equation, it will change the world. Currently, however, the economics of battery technology are not sufficient to facilitate its widespread adoption as is the case with solar. We believe the revolutionary developments in the solar industry will be in storage and we are taking action now to position ourselves as the leader in helping customers achieve grid independent as early as possible under the correct economic circumstances. We've made numerous battery installation and continued to deepen our existing relationships with manufacturers of key storage technologies [indiscernible] train our employees on how to incorporate storage products in our sales process as part of the total solar solution. We believe this approach will give us the ability to continue to be pioneering our request to be the best help our customers can get out of their solar investments.

Turning to our mix of business during this quarter, our commercial and agricultural markets were approximately 80% of total sales during the second quarter. This is a result of an extremely strong quarter in commercial side of our business and high referral rates from existing customers. The growth of commercial business outpaced our growth in residential and we expect this trend to continue in the near-term, as we capitalize on the growing momentum we're driving to commercial markets. Our residential business was relatively in line with our expectations, but we do have initiatives in place to accelerate sales in this market that will scale in the second half of this year and into 2017. Gross margins for this quarter came in at approximately 30%, just under 30%, even though our commercial business tends to carry slightly lower gross margins. We believe that even as our commercial businesses expand and the average project size increases, we will be able to maintain gross margins close to 30%.

In summary, we’re extremely pleased with our results for the quarter and our outlook for the future. Delivering on our commitments to our customers and the investment community remains a key component of our business model. Given the strong first half of this year, our robust backlog of 43.5 million, we are increasing our full-year guidance by at least 10%, expecting revenues to range from 110 million to 115 million of revenue. This guidance suggests revenue growth of at least 105% compared to our 2015 results with significant bottom-line improvement as well. We are confident that current landscape is rich with opportunities for continued growth.

With that, I will turn the call over to our CFO, Tracy Welch, for a discussion of the financial results for the quarter and year-to-date.

Tracy Welch

Thanks, Jim and good morning, everyone. I’d like to begin with a review of the financial results for our second quarter ended June 30 of this year. The second quarter, it was a record quarter for us with total revenues of $31.5 million, up 186% over the $11 million reported for the second quarter of 2015 and approximately 60% sequential growth over the first quarter this year. Our revenue increased primarily as a result of the inclusion of Elite Solar’s operations plus significant year-over-year organic sales growth in our existing business. As Jim stated, the sales of commercial and agricultural markets were exceptionally stronger in the second quarter and represented approximately 80% of our total revenue with the remainder in the residential side.

Gross profit was 9.2 million or 29.4% of revenue for the three months ended June 30, 2016. This compares to 3.5 million, gross margin rate of 31.4% for the three months ended last year, end of June last year. The 2% decline in our year-over-year gross margin percentage was due primarily to the higher mix of commercial projects, which tend to have a tighter margin in the residential side. And as the projects increase in size, the margins tend to go down slightly. As Jim indicated, looking forward, we expect our gross margins to remain near the 30% range.

Turning to the operating expenses for the second quarter, they totaled 8.1 million compared to 3.3 million for the second quarter of 2015. Selling and marketing expenses were 1.7 million or 5% of revenue, compared to approximately 1.2 million or 11% in the second quarter 2015. General and administrative expenses were 4.6 million or 15% of total revenue in the second quarter of 2016, compared to 2 million or 18% of total revenue in the second quarter of last year. G&A expenditures increased primarily due to expenses related to our higher sales volumes, including the addition of Elite Solar.

Stock-based compensation expense for the second quarter of this year was $1.8 million, which is primarily exclusively non-cash stock compensation, with most realized -- most of this is related to the issuance of shares in connection with the first milestone of restricted stock grants that were given to key employees after our first acquisition. The milestone was achieved in 2 million in operating income for the trailing four quarter period. The next two milestones are 3 million and 4 million and we anticipate that these will be achieved in the second half of this year.

Total operating expenses were 26% of revenue in the second quarter 2016 versus 30% in the second quarter of 2015. If we take out the non-cash stock-based compensation expense, our second quarter operating expenses were 20%. Our other expenses for the second quarter of 2016 were 358,000, which is primarily non-cash interest expense. In the second quarter of 2015, we had 266,000 of other expense, which was also primarily non-cash interest expense. Our net income for the second quarter of 2016 was $744,000 or $0.04 per basic share and $0.03 per diluted share. This compares favorably to a loss of 122,000 or $0.01 per basic and diluted shares for the second quarter of 2015.

Looking at the first six months, our revenue for the first half of the year more than tripled to $51 million, compared to $16.7 million in the first half of 2015. Again, this increase was due, in part, mostly to inclusion of the Elite Solar’s operations as well as strong organic growth in both the commercial and agricultural markets. Gross profit for the first half was 15.1 million, which was up 280%, compared to 5.4 million in the first of 2015. Gross margins for the first half were 29.6% of revenue, compared to 32.4% in the first half of 2015. And this is due -- the increase is due primarily to higher mix of commercial and agricultural business, compared to a year ago. Net income year-to-date was $366,000 or $0.02 per basic and diluted shares for the six months. This compares to a loss of $1.5 million or $0.09 per basic and diluted shares in the first half of 2015.

Now, let's talk just briefly about the non-GAAP measured, adjusted EBITDA, we included that in our press release. For the quarter, we had a net income of $744,000. If we add back the non-cash items, including gains on change in fair value derivative liabilities, stock-based compensation, depreciation, interest expense and taxes, this results in an adjusted EBITDA of $2.9 million for the second quarter of 2016. Compared to second quarter of 2015, that same calculation resulted in 190,000. So, on a per share, which is -- so the increase is the quarter over -- 2016 over 2015, $2.7 million difference. If we look at it on a shared basis, from second quarter this year, that's $0.14 per basic share and $0.12 per diluted share, compared to $0.01 in 2015. If we do the same calculation for the first half of the year, on a per share basis, the adjusted EBITDA is $0.15 per basic share and $0.13 per diluted share in 2016, compared to a loss of $0.05 per basic share and diluted shares in the first half of 2015.

Now, let's take a quick look at our balance sheet. Our cash and cash equivalents were just under $8 million, $7.7 million, compared to cash of $12 million at the end of 2015. Even with our significant growth in revenue, we have managed to maintain a very healthy cash position.

And with that, I’d like to turn the call back over to Jim.

Jim Nelson

Thanks, Tracy. In conclusion, it's a great time to be in the solar business. We are proving quarter-after-quarter that our business model works. Our company’s values compel us to put the customer first, provides the best value in the industry and to do what we say we will do, both for the customers and for the investment community and for our employees. We look forward to more success by helping people take their power back.

With that, I’ll turn the call over to the operator for questions and answers.

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Jeff Osborne with Cowen and Company. Please go ahead.

Jeff Osborne

Hey, good morning guys. Congratulations on the strong results and outlook. Just a couple of questions from my end. Maybe two for you Tracy and I have three more strategic bigger picture questions for Jim. Just Tracy, as we think about the modeling, how do we think about the cadence between the third and the fourth quarter for the revised full-year guidance, just given the seasonal nature of your business, is the fourth quarter going to be up sequentially from the third quarter or do you have a lot of big chunky commercial projects that should be modeled in for the third quarter, and maybe more flattish results for the fourth quarter?

Tracy Welch

Well, historically, third quarter has always been our best. We do tend to get a bit of weather delays and difficulties in the fourth quarter as well as the holidays, but we think -- third quarter we still think will be stronger than the fourth quarter, but projects coming on, could make fourth quarter very strong as well.

Jeff Osborne

Good to hear. And then you mentioned the additional milestones that the Sunworks folks, the original Sunworks I guess would receive in the second half, do you have any sense of, I know, it's not price dependent, execution dependent, but any thoughts in terms of how we should model OpEx as it relates to the stock-based comp?

Tracy Welch

Those were set, what we take in the charge was based on the stock price the BP were granted. So there is no, the stock price doesn't impact what we say to the charge. We think there are two more milestones and we think we will achieve both of those in the second half. Timing wise, I don't know if it's going to be each month, one milestone in each quarter or what, but I think they will both be achieved in the second half.

Jeff Osborne

So in terms of this quarter being 1.8 million, is that a pretty consistent number that we should think about, maybe spread out between the two quarters in the second half to be conservative.

Tracy Welch

Yes.

Jeff Osborne

Got it. And then maybe for Jim, just a couple of questions for you. Certainly very strong commercial results, can you just maybe touch on some of the dynamics in residential, in particular in California. We've heard from some of your competitors and just our own conversations with folks that the shift, the time of use raised in 2018 and beyond has been a bit of a challenge for some sales organizations. Is that something that Abe and the team have adapted to or maybe just touch on that? And then you also alluded to in residential, having some new initiatives kicking in, in the second half, I don't know if that’s in response to [indiscernible] or some other program, but if you can address both of those, that will be helpful.

Jim Nelson

Sure. So as we mentioned in the call, residential was basically in line with what we have predicted for this year, but we felt our infrastructure for residential to accommodate greater sales and so our initiatives are to undertake additional ways of bringing in sales and bringing in some key people to drive them. And so our anticipation is that we’ll be able to grow, the market is still growing of course and some of the bigger companies wanted to grow off of them, very, very large base and our residential business is much smaller and we feel that we can grow substantially off of that smaller base. And the way to do it of course is to bring in experts that at selling residential. We think we have some improvement to do in residential, although we think our infrastructure and operations are second to none. It's really bringing in some sales support to drive our growth.

Jeff Osborne

Got it. Look forward to seeing you execute on that. And then just the last question I had is over the last couple of calls, you talked about looking at various different M&A alternatives situations across the US on different pockets of sustained growth. Can you just update us on where you’re at with some of those discussions, I guess what's the gating factor from an expansion perspective, is it capital, is it terms, what lack of comfort on the regulatory front and new geographies, just any thoughts would be helpful?

Jim Nelson

Right, sure. Thanks for that question, it’s a good one. Our perspective there that we think there is a great opportunity for consolidation within the industry and there are some outstanding companies out there. Some of the companies just want too much money, and frankly this is not the go-go days, when people could get one-time sales and call it good and feel good about it, the companies that paid those prices for acquisitions are either in bankruptcy or suffering from those acquisitions and we just won’t do it that way. We are in serious discussions with a couple of companies that we talked about last time that where we waited to see how their results would come out for the first six months.

And again, you’re right, Jeff that we’re looking at them across the country and hoping to expand our footprint into more of a national situation. Again, I’ll go back to what I said during the call. Many people have said to me, well, your rollup. No, we are not, rollup implies that you just go out and buy anything that’s available just to increase your scale quickly. Our organic growth is growing at close to 100% and so when we acquire a company, it's not so much to create scale quickly because we are already creating scale quickly, and to give us some kind of additional advantage or new region or new technology or whatever it might be, and so we are very selective about them. And again, we’re in some serious conversations, we hope to have something to announce very soon.

Jeff Osborne

Perfect. Look forward to. Appreciate the time. Thank you.

Operator

And we’ll take our next question from Jim McIlree with Chardan Capital. Please go ahead.

Jim McIlree

Thanks. Good morning and congratulations on the results. Can you talk a little bit about the geographic breakdown either in installation or backlog between California and Nevada, and if there is any, what you've done in Oregon so far?

Jim Nelson

Sure. Of course, in Nevada, we're not doing really any residential business right there, right now. We have a robust commercial business, but it’s less than 5% of our business in Nevada and Oregon is just getting started. We have contracts in Oregon, but it's a very small part of our business. So the vast majority of our business and backlog is in California still.

Jim McIlree

Great. Thanks. And Tracy, I just want to make sure I understand the stock comp and the milestone, in response to Jeff's question, I think you said that the milestones, you had two more milestones and did you say that in total, these milestones would be worth about 1.8 million in stock comp?

Tracy Welch

So they are all equal, so each one of them would be 1.8 million.

Jim McIlree

Each one would be 1.8. Okay. So if you hit both -- if they hit both milestones, you have an additional 3.6 million of stock comp expense this year? Okay, great. Thank you.

Tracy Welch

There are no more answers to that.

Jim Nelson

I ought to mention just something about that, of course, those stock grants were issued with vesting against performance and that was two years ago and we gave them objectives that we thought were way out there at that time that would be really stretched to get through in a timely way. And now, of course, with our growth in profitability, we’ve blown passed them or blowing passed them relatively quickly. They’ve of course been fully disclosed along the way in all of our filings and so this is no surprise, it's just the fact that we've come up with - we’ve grown fast and so it’s a function of our success that now they come due, so it’s compensation to the people who have really made this happen.

Jim McIlree

Jim, you talked a little bit about Rapid Rack, what’s the marketing channel for that product as an independent product?

Jim Nelson

We are able to go direct to very large installers both on the utility side and on the commercial side; this is a ground mount system, and - so it is all direct to be EPCs.

Jim McIlree

And there has no, to-date there has been no objection that somebody doesn't want to use product from potential competitor?

Jim Nelson

Not so far, I suspect that we’ve had people who do compete against us come to want to use the racking system and frankly we don't offer to people who compete directly against us. But, nobody has avoided using it so far because we compete with them.

Jim McIlree

And then lastly…

Jim Nelson

Frankly, also Jim, I have to mention, we see an increase in utility scale people using that product simply because it saves money to use, also we have a strong international demand for that product, specifically Mexico that's international.

Jim McIlree

Lastly, the split, commercial, agriculture and residential, it sounds to me like the commercial agriculture is still strong that it's going to stay at, I don’t want to say 80%, so let’s just say these really high levels for the rest of the year and the residential programs that you’ve implemented really aren't going to have an impact until next year, am I hearing that correctly?

Jim Nelson

I think that's probably a decent bet, and if I were seriously sandbagging, I would say absolutely. I think we’ll actually pick it up in residential in the second half of this year but I think it is a safe bet to say that commercial is going to be very strong the rest of the way and residential continues to come on.

Jim McIlree

Actually I do have one more, Tracy, as you scale up to the second half numbers, so what do you need, you need like 60 million or so in the second half of the revenue, what does that do to the sales and marketing, and G&A expenses? Like how much more do you need to spend in order to scale up that kind of revenue level?

Tracy Welch

I think we were already pretty much scaled up to that, I think we really build the business to achieve, we announced guidance earlier this year of over 100 million and that's what we've been working towards and we've kind of built the machine if you will to accommodate that. So there really other than really, you get some variable costs as we grow some of the business and one thing that we see increasing is commissions and we’re happy to pay commissions when we bring - when our salespeople bring in additional sales, so we’ve got the team in place, there shouldn't be much in the way of additional cost associated with book for growing it where we need to get to that 110 to 115 million.

Operator

[Operator Instructions] We will take our next question from Alex Silverman with Special Situations Fund. Please go ahead.

Alex Silverman

So the vast majority of my questions have been asked and answered but just to clarify, 30% gross margin is sort of a good number to use for at least the next couple of quarters and if I'm understanding this roughly 6 million plus or minus of cash OpEx per quarter?

Jim Nelson

Yes and yes. I think that's right, if you look at this last quarter, we had an increase in OpEx, about half of that I would say was really sales related, higher commissions and automobile expense and so forth, things associated with people going out selling the product. We think that we can probably ease back, find redundancies within our overhead and we are busy doing that but I think that in terms of modeling I think those are probably pretty good numbers.

Alex Silverman

And then last question, what was the mix in the year ago quarter in that 11 million a year ago between resi and commercial?

Jim Nelson

We think it was about 60/40.

Alex Silverman

40 being commercial?

Jim Nelson

Residential. 60 commercial.

Alex Silverman

So there was some growth from about 4.5 million and 6.5 million year-over-year.

Jim Nelson

Yes, right.

Tracy Welch

I mean the resi business is still growing, it is still not as quickly as commercial business.

Operator

We will take the next question from Carter Driscoll with FBR. Please go ahead.

Carter Driscoll

Maybe just talk about the and I’ve heard from - I would say the large installers referring some of their own internal issues. Can you characterize the transition may be to some of the smaller players like yourself, is localization an advantage for you, is it the transition from kind of leasing PPA to direct ownership and lower model may be have the right product, I guess, trying to get a characterization of why players such as yourself continue seemingly to take share from some of the national players?

Jim Nelson

It's a great question and I can talk about it for a half an hour but I’ll try to be brief. You’ve hit on two of the really important things, this is a local/regional business, so when somebody like SolarCity comes in, they have to compete against us and we are really good and they don't have an advantage as a result of being a national scale company. So as long as our costs are in line, as long as we have great customer service and are dedicated to doing what's right in providing great value, we have a sustainable competitive advantage in place. And I think that's part of the reason we win. That’s especially true, not only on the residential side but especially through on the commercial side, where so many of these local commercial organizations depend upon what their neighbors have done. And so when we go in and do a great job for someone they go out and talk to their neighbors it or somebody calls them up and says who do [indiscernible] and the result is that we have had a compounding effect of our referral business on the commercial side, so we are becoming or tending to become a really preferred vendor on the commercial side because there are servers.

So, the localization is very important. The second thing you mentioned too is just the whole financial business model. A lot of things that some of the bigger competitors have done is complicated the business model and the result of complicating the business model, they’ve tried to do something that was appealing to Wall Street creating that recurring revenue and they did so indifference to what was best for the customer and my argument is that if you do something that’s right for Wall Street and indifference to what is right for the customer you're not going to do what's right for either in the long run. So our approach has been look, in the long run if you do what's right for the customer provides great value, do what you say you will do and so forth; in the long run value will follow. And we believe that we are going to get credit for that at some point and so I also believe that that's what is happening in the competitive market that people see that they’re shifting over from these leases which are not as good economically to ownership and we are already waiting for them there.

Carter Driscoll

Is that maybe masking what is still relatively healthy growth in resi solar, is that shift and that maybe some of the larger players don't have will you say the right financial models or don't have the right incentives for the customers versus the Street itself? I mean obviously there is a slowdown from faster growth rates, but I guess I'm trying to figure out what we're falling from to and how much of the transition is potentially impact the growth rate in domestic solar and residential?

Jim Nelson

I think you're right on, I think that really does mask an incredible market which is the solar market. The market is growing rapidly still and it is a historical opportunity, you don’t come across these types of opportunities very often but despite the fact that it is that way you see a lot of carnage among the companies that have positioned themselves quarterly or just have misread the market. And it is obviously highly competitive as well. Of course we've developed our technology but we're really focused in the last two years on last two and a half years on building our integrator. And we’ve really focused on the basics of the business, we think that when you run the business in a basic way in a way that this business should be run, we are going to be able to continue to take advantage, obviously we’re growing faster than the market is growing but the market is growing so fast that even growing at market rates is going to continue to tell the business and the ideas to get profitable and to be as profitable as possible while growing at this rate and frankly we intend to do that.

Carter Driscoll

Maybe just last question from me. On the storage side, what do you think needs necessarily to change to move the economics and obviously jus the system costs going down, but I mean is it change in the way that maybe utilities are demanding that they get paid on the residential side, maybe disrupting the way that they engage with a residential customer, obviously it’s seem to be a much better economic opportunity for the commercial side I want to get thoughts on where also commercial storage might be heading over the next couple of years and probably it’s de minimis penetration right now and maybe as the right product solution out there today but maybe just get your take on maybe contrasting resi and commercial and then where you think the adoption rate might come from, still relatively miniscule install base?

Jim Nelson

I think if you think about this as solar in the early 2000s you probably got to good parallel, where the economics just weren't right yet and I think that’s where we are, economics will always drive widespread adoption and short of economics widespread adoption will not happen. There are circumstances in which storage currently works but as you say it is very minimal, penetration is minimal, I think that before it really takes off it is going to have to take a new technology solution that I know hundreds of millions and billions of dollars have been poured into figure out new technology but everything that’s done in storage right now is built for a very limited number of customers who can afford it and who are going to buy it in spite of the fact that it is not particularly economical. And so, when you see - I really have high regard for what Tesla [indiscernible] are all doing but at some point it's going to be the next generation technology that is going to drive widespread adoption and whoever does that is going to make a trillion dollars.

Carter Driscoll

You imagine it would be battery-based or some other technology?

Jim Nelson

If I knew that I would be controlling there. I really don't know the answer and I know being associated with the University of California at Santa Barbara and some of their efficiency and technology programs, I know they're working on some interesting solutions, as are many of the other places around the country and somebody is going to come up with it and I know there are battery and other solution and something is going to work.

Operator

And we will take over next question from Philip Shen with ROTH Capital Partners. Please go ahead sir.

Philip Shen

First one here is on margins, I know you've talked about 30% the general target and generally and historically commercial margins are lower relative to resi, I was wondering if you guys can just update everybody on what those margins where by segments or give us a ballpark figure and how that might be changing if it all looking ahead?

Jim Nelson

Yes, so we think that residential is probably in the 33 to 35% range and that would put commercial on the 28% range. And we think that's probably going to be consistent going forward. Our approach to selling commercial Phil, is that we feel that we’re selling value and we don't need to compete so much on types because we have a great solution, we have a great designing team, great service and so forth. And obviously there are circumstances in which we are going to have some pressure down, we saw $10 million system at once, it is going to get the a 22 to 23% margin instead of 30% margin but we really think that over time we’re going to be able to sustain that close to a 30% margin or 28 some odd percent margin. And of course there is residential growth relative to commercial, we are going to be able to balance it out, so our real target is stay close to 30%.

Philip Shen

Shifting to an earlier topic that we are discussing, you were talking about the competitive dynamics in each segment and how you can compete and how you’re in business localization was something that you highlighted as something really important to win business. But as you consider M&A opportunities to grow and become national, how do you maintain that advantage of localization with the national footprint, it seems that some of the existing problems that you highlighted first and the larger players was that they were not local enough, so if you can provide some color on that would be…

Jim Nelson

Absolutely, it’s a great point and one that we have to anticipate given that we believe in the localization and yet we are trying to expand our footprint. And the answer is that we think we can be the big company but still your neighborhood solution if you will and frankly part of the strategy is you and I have talked about over the years is that we really wanted to create a critical mass within our regional footprint here in California. So that we had good qualities and procedures, scales so we have critical mass, so that from there we can replicate what we do here elsewhere. We think we are the best in our region and we think we can replicate our success here elsewhere as the best in the another given region. So there are only certain benefits to being a bigger company or a national company, one is you get really good players doing that, two is obviously you have a purchasing footprint but the real advantage of course is to have - to be more competitive on the local basis, we think we are the best in this region, we think we’re going to be the best in other region by replicating it. And we think it is consistent with a go forward strategy.

Philip Shen

In terms of storage I know you touched on it earlier, how much storage or how much of your backlog is storage today. And then how do you expect that to trend, do you see an inflection point or given your comments earlier it seems like it just might be a slow and steady climb, so your thoughts on that would be helpful.?

Jim Nelson

It’s that, as you say the slow, steady increase but the fact is that, it’s negligible right now, probably 2% or 3%. We think we’re in the process of being trained by - well we’re already in partnership with Tesla, we’re looking to be trained by both [indiscernible] and so we’re obviously focusing and emphasizing more on the storage side and looking for opportunities and we think in the long run that's going to trend up. We want to be - as we are a solar we want to be technology agnostic but be experts in storage solutions. And the smartest guy in our company is our chief engineer and he is always on top of the newest advances and so we are going to stay on top of that and as it becomes more and more economically use storage we are going to right there. So it is an incredible focus of our company, we know that's going to be a big thing going forward.

Philip Shen

One last one from me, as it relates to inverters, can you update us on by segment what do you use, you focus on or do you have a high mix of SMA on the resi side, are you guys anything or [indiscernible]? Thanks.

Jim Nelson

The ones we use are selective SMA primarily in commercial and SolarEdge in residential almost exclusively.

Operator

We will take the next question from Gregg Hillman with First Wilshire Securities Management. Please go ahead.

Gregg Hillman

Can you talk about expanding in Southern California, I was just wondering if you’ve done a successful de novo expansion in California, where you’re growing in an area where you have no presence before, you haven't done an acquisition, whether you have a model that works because are you an – for example, in Southern California do you have the right management team there and was that a result of an acquisition or was that kind of de novo start up in Southern California?

Jim Nelson

In Southern California we bought a company called MD Energy and we feel really good about the management team there right now and they are building out that business effectively. We think we are going to do particularly well in the second half there with those strong backlog. We have opened up de novo markets, so for example Tulare, we just opened up an office, we are looking opening up another office in the Central Valley and also in the Bay Area we have opened up an office in San Jose. So, yes, and particularly - it’s been particularly successful in Central Valley so far.

Gregg Hillman

And then you moved to I think design centers earlier, you have one and you're going to do another one, can you tell me what they are about, what they do?

Jim Nelson

I'll give you a great example, last night we had an event and I went over at the end of the event and the guys came up and said in this event we‘ve sold two and we’re going to sell another system on Thursday. And so people come in to see what solar is all about and if they don't feel comfortable having people come to their homes, they can come in and sit down at a table with an agent and he can pull up their electrical bill or they can pull up the home itself and take a look at the roof and be able to figure out exactly how their system might work and do all the work for them right in front of them. And it tends to be way that they can touch the product and get familiar with it and feel comfortable with it right on the spot and it is a revenue generator and a great place to be able to meet people that we’re working on both commercially and residential.

Gregg Hillman

And then, the Rack that you alluded to earlier smart rack or some kind of rack, do you contract out for that?

Jim Nelson

We contact the manufacturing but the design of course is ours and we have a patent on it, we are patterned and we do all the installation in house but we have somebody manufacturing for us.

Gregg Hillman

And then Jim, I think in the last call you mentioned, you commented on the analyst guidance, I think you said that [indiscernible] was too conservative for 2016 and I was just wondering what basically what the party line is right now in terms of commenting on analyst guidance and particularly 2017 do you have any comments on the guidance, the current guidance out there from Cowen or others?

Jim Nelson

We don't, we haven't commented on 2017, we haven't come up with guidance on 2017. But we anticipate doing that by November sometime.

Gregg Hillman

And the early guidance you’re giving yourself, you just upped the revenue guidance?

Jim Nelson

So far that's what we have done. Yes. The other guidance says that we will be profitable and so rather revenue plus profitability we promised that we will give guidance to profitability this year, we are confident the next year will be more profitable.

Gregg Hillman

And do you have your ducts lined up financially to do a larger acquisition?

Jim Nelson

That's a complicated question and I guess by saying that I would say not really at this point and frankly part of what we would like to be able to do is use our stock as currency, our stock price does not - doesn't really jump justify using a lot of stock to do a major transaction right now so the result is we continue to grow rapidly on a organic basis and do smaller acquisition as we continue to build but I think that by doing that we are still going to end up doing extremely well and get some traction so that we will be able to do a much bigger transaction. Also, we are talking to a number of people about the substantial debt facility that will allow us to do and of course when we talk about a substantial transaction, I'm thinking in terms of buying somebody as big as us, but in terms of buying somebody at 50 million in our target of 15 to 50, yes, we could do that.

Gregg Hillman

And then finally about the regulatory environment in California, I think there is reverse metering right now in California that the hit forces utilities to buy back your excess electricity. And I was wondering if there is any action of the utilities to have that negated legislatively or administratively or somehow like the [indiscernible] so to speak?

Jim Nelson

I mean yes, there was an effort but it got extended and we've moved into 2.0 and so there have been some adjustments in how they do it but it’s on for the foreseeable future.

Gregg Hillman

The reverse metering in California?

Jim Nelson

Yes, revere metering in California.

Gregg Hillman

And has there been any positive development in other states when they get more favorable before you pass it a regulatory development ?

Jim Nelson

In the data of course it went the opposite way but there is positive element to that were a lot of people out there working it and getting the net metering law reversed up there so that we can again go into residential there. And there a number of states of course where net metering is healthy and encourages solar and those are the states that we would target.

Operator

At this time, I will now turn the program back over to James Nelson for any additional or closing remarks.

Jim Nelson

Just want to thank you all very much for joining our call. We feel great about where we are, it is the type of thing, when I was in private equity we used to look for companies that were doing great but still had some work to do and that's where we are, we think we are doing great, there are some things that we can do better and we will and we commit to really great performance coming forward. So thank you for joining us and thanks for all your support.

Operator

This concludes today's program. Thank you for your participation, you may now disconnect.

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