STEM - NYSE

Thank you for standing by. This is the conference operator. Welcome to the Stem Second Quarter 2023 Earnings Conference Call. As a reminder, all participants are in a listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Mr. Ted Durbin, Head of Investor Relations for Stem. Please go ahead.

Thank you, operator. This is Ted Durbin, Head of Investor Relations at Stem. Welcome to our second quarter 2023 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 our 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 portion of our website at www.stem.com. John Carrington, our CEO, and Bill Bush, CFO, will start the call today with prepared remarks. Mike Carlson, COO, Prakesh Patel, Chief Strategy Officer, and Larsh Johnson, CTO will also be available for the question and answer portion of the call. And now I will turn the call over to John.

Thank you, Ted. Good afternoon, and thank you all for joining us today. Beginning with Slide three, we will cover six items today to include our second quarter results, commercial traction, business updates highlighting our continued execution, and technology advancements that I'm excited to share with everyone. Bill Bush, our Chief Financial Officer, will discuss our financial results as we close the first half of 2023 and more details on our full year guidance, which we are reaffirming. Now let's turn to Slide four on our second quarter 2023 results and highlights. The Stem team delivered another strong quarter with revenue of $93 million up 39% versus the second quarter 2022, which was above the midpoint of our guidance range. Our higher margin services revenue grew 31% year over year and 11% sequentially. Contracted annual recurring revenue, or CAR, was up 5% versus the first quarter of 2023. And lastly, our GAAP gross margin was 13% and our non-GAAP gross margin was 18% in line with our full year guidance. We are reaffirming full year 2023 guidance, including our continued expectation of achieving EBITDA positive in the second half of this year. Bookings increased by 5% year over year to $236 million. We are seeing much larger deal sizes as we expand our presence in the front of the meter market segment. In fact, our average project size has roughly doubled over the last year. A great example of our execution in FTM was the Ameresco award we announced today and we'll cover later in the discussion. One knock-on effect of our success in growing larger scale projects is a more lumpy cadence of bookings from quarter to quarter. As a result, some deals slipped past the quarter close and our bookings in Q2 fell short of our target. But the momentum in recent contract executions and the pipeline for second half gives us confidence to reaffirm our full year bookings target of $1.4 billion to $1.6 billion. The overall demand environment is very strong and we continue to see opportunities to close significant deals in the second half of this year. Finally, our AI driven technology, Athena, continues to receive third party recognition of its differentiation and value. In fact, we received seven accolades in the past year from respected third parties on our technology and innovation leadership. Please turn to Slide five. We continue to see solid growth in our high margin services revenue, which was up 11% sequentially. Our software revenue grew 10% sequentially, driven primarily by continued storage software revenue growth, as well as improving solar growth. Storage software also benefited from stronger market participation revenue this quarter. Consolidated gross margins improved by nearly 100 basis points year-over-year, driven by an accelerating rate of systems commissioning, strong solar revenue growth, and increased market participation revenue. Demand remains very strong for our solutions as customers and partners have better visibility into their project economics. Now that the IRS has clarified some key provisions in the Inflation Reduction Act. Moving to Slide six, we're proud to announce today that we were recently awarded a significant standalone energy storage project with Ameresco, one of the fastest growing electric cooperatives in the US. The 313 megawatt hour installation will help their customer balance power needs while integrating renewable resources to create a more resilient and responsive power system. Our scope of work includes energy storage hardware, professional services, and a 20-year Athena contract. I'll also note that this project follows on the heels of a separate deployment with Ameresco and Holy Cross in Colorado. That one recently won a top project award with Environment and Energy Leader. This is another example of our history of execution and a significant contribution from repeat business to our bookings momentum. We believe the Ameresco project demonstrates two key trends. First, we are increasingly competitive in large-scale front-of-the-meter storage deployments. And secondly, our competitive strength in the cooperative and municipal utility market will continue to drive additional sales momentum. In particular, the direct pay provisions in the IRA and the recent IRS guidelines are accelerating engagement and interest by several co-ops and munis in deploying energy storage. We expect upside to our initial software offering as the customer expands its wholesale market trading activities. This is a dynamic we've seen in other markets where we've added services and value for customers over time. On the solar side of the business, we're seeing continued strength with a 39% year-over-year increase in backlog, in addition to solid growth in services revenue, and AUM. While the utility-scale portion of the business continue to combat supply chain and labor challenges in the first half of 2023, we remain focused on this high-growth segment of the market and providing more innovative products and services. A solid proof point is the recently announced 304-megawatt win in Hungary, a direct output of our focus on this key segment. Now turning to Slide seven regarding our AI technology leadership. The technology team continues to make exciting progress and receive global recognition. In June, our Athena platform was recognized as the winner of Best Predictive Analytics Platform in the Sixth Annual AI Breakthrough Awards, a program that honors excellence and innovation in multiple AI and machine learning categories. We were incredibly proud to have Athena recognized as a leading innovative software solution driving the clean energy transition. In July, Stem received the Top Product of the Year award in the Environment and Energy Leaders Awards Program, an organization that commends excellence in products delivering significant energy and environmental benefits. These awards recognize what our customers experience as differentiated economics and sustainability benefits based on industry-leading predictive analytics, trained on years of experience operating solar, storage, BTM, and FTM assets in multiple markets and utility jurisdictions. Moreover, these awards clearly highlight the fact that we have built one of the leading clean energy intelligence platforms in the industry, as recognized by subject matter experts in the artificial intelligence and software space. Please turn to Slide eight on our utilization of new AI tools into our processes. There's been a lot of buzz around new and exciting developments in AI, and the fact is many AI technologies are not new and certainly not new to STEM. These technologies and capabilities have been a foundation of our software and our approach since the company's inception. That said, our software engineering team is leveraging the latest advancements in generative AI tools, are integrating advances in AI to enhance our asset management capabilities and enable significant efficiencies in software code development. This is yet another example of our leadership in bringing artificial intelligence tools to the energy sector. Earlier this year, our software developers started integrating generative AI tools into their workflow, and as a result, our developers have seen up to a 50% improvement in their coding productivity. Today, we're rolling out this approach across our dev teams and evaluating additional applications for these powerful tools to accelerate our product roadmap. Looking forward, STEM engineers are building a pilot Athena chat bot that leverages our extensive knowledge base to offer asset operators powerful and flexible prompt-based tools that enable improved asset performance, as well as an early, efficient identification of operational incidents. These tools will enable operators to accelerate root cause analysis, initiate corrective actions, and optimize performance. Athena's asset performance and optimization is anchored in best-in-class availability, paired with unmatched economic outcomes. Generative AI promises to unlock new trading insights for business analysts and energy traders, creating further distance between us and other competitive offerings in the market. With our coding productivity gains from leveraging AI tools, we anticipate generative and predictive AI to help customers access STEM subject matter expertise at scale. Growing our professional services offerings is a key area of our focus, and our teams are engaging with several customers to execute on this strategy. And now I'll turn the call over to Bill.

Thanks, John. Starting on Page 10 with our results for the second quarter of 2023, as John highlighted, we reported revenue of $93 million, which was a 39% increase versus the $67 million we generated in the second quarter of 2022. Revenue grew 48% for the six months ended June 30, reflecting the consistent momentum of the business. The second quarter revenue performance was also above the midpoint of our guidance. While most of the revenue growth this quarter came from additional storage sales, we also realized significant growth of $5 million in solar sales, representing a 32% year-over-year growth. We also recognized $16 million of high margin services revenue, representing 17% of total revenue for the quarter and a sequential increase of 11%, continuing our momentum in this important part of the business. Our GAAP gross profit was $12 million, and GAAP gross margin percentage was 13%, up from 12% in the same quarter last year. Non-GAAP gross margin was $16 million, up from $11 million, a 45% increase in the second quarter last year due to higher sales and improved margins. On a percentage basis, non-GAAP gross margin was 18% in the quarter, up from 17% last year due to higher services gross margins. We continue to execute on our initiatives to achieve greater operating leverage and drive down our cash OpEx as a percentage of revenue. We expect cash OpEx as a percentage of revenue to be less than 25% for the full year 2023, as we continue to access lower-cost geographies and focus on cost discipline. We continue to scale for growth with a focus on system enhancements to allow for increased productivity and tighter integration across our worldwide workforce. Since the acquisition of AlsoEnergy, we've increased our headcount in India by 50%, providing significant operating leverage. Net income was $19 million versus a net loss of $32 million in the same quarter last year. The year-over-year change was primarily driven by a one-time $59 million gain on the extinguishment of debt due to the repurchase of a portion of the company's 2028 convertible notes in the second quarter of 2023. Adjusted EBITDA was a negative $9 million for the second quarter versus a negative $11 million in the same quarter last year, as we remain on track for our full-year adjusted EBITDA guidance, including our continued expectation to achieve positive adjusted EBITDA in the second half of 2023. Cash exiting the second quarter of 2023 was $138 million, down from $206 million in the prior quarter. Sequential changes in cash was driven by outflows of approximately $102 million for purchase of battery hardware that will soon convert to revenue upon deployment during a very active delivery cycle, primarily expected in the second half of 2023. We continue to closely monitor and manage our receivables, which increased this quarter. We expect our receivables balance to normalize in the coming quarters. These outflows were partially offset by approximately $105 million of net proceeds from the net deleveraging green convertible senior notes offering completed in April of 2023. Together, these factors led to a net reduction in cash of approximately $68 million. Based on our current forecast, we expect to exit the year with no less than $150 million of cash and cash equivalent. This forecasted increase in cash throughout the second half of the year is driven by higher adjusted EBITDA, planned collections and accounts receivables, and continuing operating leverage. In addition, we are seeing improved pricing and payment terms with our supply chain partners and expect the utilization of cash to further decline as we continue these negotiations for supply in 2024 and beyond. Turning now to Slide 11 for a look at our operating metrics; backlog increased 88% year-over-year and increased 10% on a sequential basis to $1.4 billion. The largest driver of the backlog increase was a $236 million of bookings in the quarter. End market customer demand remains strong, and we are confident in our ability to continue to deliver strong results. Our AUM on the storage side of the business grew from 3.5 gigawatt hours at the first quarter of 2023 to 3.8 gigawatt hours in the second quarter of the same year. That's a 9% increase, driven by our strong commercial movement. Our operating AUM on the solar asset performance monitoring side of the business ended the quarter at 26 gigawatts, up 400 megawatts, or approximately 2%. The solar industry in particular, the supply chain, is beginning to recover, and the increase in AUM is evidence of this momentum. I also want to highlight that we've been successful at migrating customers from our legacy applications on to our core Powertrack platform. Turning now to Slide 12 in our 2023 guidance, as John mentioned earlier, we are reaffirming our guidance for the full year 2023. We are focused on converting backlog to revenue, continuing to improve our operating leverage while reducing working capital usage. We have organized the company to achieve our goal of achieving or reaching EBITDA positive in the second half, and believe that the continued execution by our teams and the strengthened customer demand will support that goal. With that, let me turn the call back to John for some closing remarks.

Thanks, Bill. Wrapping up on Slide 13 with our key takeaways; we closed the second quarter and first half of 2023 with strong execution and financial performance. Revenue was above the midpoint of guidance, with robust momentum across the following four bullets on the slide; strong in-market demand with several large projects executed and in our pipeline, double-digit quarterly growth in services revenue with a significant project services and software-only deals in the pipeline, continued recognition by third parties of our best-in-class Athena AI capabilities, and high confidence in the cadence of cash inflows exiting the year with a strong balance sheet and positive EBITDA expected in the second half of 2023. In summary, we reaffirm our full year 2023 guidance. With that, I want to thank our key stakeholders, our customers, our channel partners, our suppliers, and shareholders. And when I reflect about how far we've come, it's all about the global team at STEM. So a big thank you for the continued execution and commitment to our success. We have a lot to be excited about for the balance of the year and continue to execute on our mission and values. And now let's open the line for questions, please.

We will now begin the question and answer session. [Operator instructions] The first question comes from James West with Evercore ISI. Please go ahead.

Hey, good afternoon, everyone. John, I'm curious, you went through a little detail here on the roadmap for Athena and leveraging generative AI, which we see a lot of companies doing. But you guys are kind of first here in the storage area, the software area of storage. Could you maybe elaborate on that product roadmap that you highlighted? Are these new applications, are they enhancements to additional applications? Kind of what's the framework and how are you thinking about that roadmap?

Yeah, hi, this is Larsh Johnson. Let me take a stab at that. So generative AI is actually going to be a terrific complement to the products that we currently offer and leveraging the experience we have with predictive analytics. And what you see in the generative case is often that bot function that helps the human operator, that helps the human administrator of a system to understand defects or performance questions, analyze issues and that sort of thing. And as mentioned, we also see that helping the trading operators who are using the predictive analytics and our automated bidding and trading capabilities to optimize market performance and so forth. So this digital assistant, if you will, is the best use case that we see today for generative AI. I think there are probably going to be many more, but that's certainly where we're focused today.

Okay, that's very helpful. Thanks, Larsh and then maybe one for Bill. With the guidance kind of unchanged despite a pretty solid guidance, at least for revenue in the second quarter, is this just a matter of the guidance is pretty wide and you're being conservative here or did things slip into the next year? Is there anything to be aware of with the guidance staying the same?

Thanks for the question, James. I think that we're in a good position. And I think, which is what we said in the past, first two quarters are the lighter from a revenue standpoint quarters. And, we've still got quite a bit of ways to go for the year and so I think we feel pretty comfortable. The midpoint is $600 million on the revenue side, and we feel quite comfortable with that number.

The next question comes from Brian Lee with Goldman Sachs. Please go ahead.

Hey, guys, good afternoon. Thanks for taking the questions. Kudos on the solid execution here. I guess the first question I'd have is just around the timeline for reaching positive on adjusted EBITDA. I know that's been a big focus of the team here throughout this year and into the second half of the year. So I didn't know if you had, at this point in the year, better visibility around, tracking to that in 3Q or 4Q or just any general updates around the progress toward that target.

So thanks, Brian, for the question. This is Bill. As we've mentioned a couple times in this call, we're very comfortable with the guidance in terms of achieving EBITDA positive in the second half. And so I would say I think we're on a good track for that in terms of a lot of things that we've done generally, with the business where we've talked about the increase in headcount in India. So really a lot of cost control and cost maintenance. We've done a lot of work in terms of the underlying, say, really the systems of the business such that we can be as productive as possible. There's been a lot of work done, just in terms of making sure that our processes are in the best possible position. And we're fortunate in that the commercial side of the business is doing really well. There's just a lot of really solid end market demand for the company. That certainly was shown in the bookings of last year, almost $1.1 billion in bookings for the full year. And, at the midpoint this year, we're saying $1.5 billion, and that's, of course, reflective of some of the additional software only contracts that we're going to do. So, yeah, so we think that we're in a great position, the second half is the much bigger part of the year. 75% of the revenue comes from that that time. And so, when you -- when we look at where we are from a cost standpoint, and we look at what we're expecting from a revenue standpoint, we're very confident that we can meet that goal.

Yeah, I'd add, Brian, we've got, I think, very solid visibility into the existing bookings that are scheduled for delivery in the second half and the hardware is secure, it's ready for delivery and we're the cadence on that weekly with Mike Carlson leading the process with the deployment team, so we feel good about the second half guidance and obviously reaffirmed it.

Okay, great. I appreciate that. And, maybe since John, you did bring it up. This has become a bigger and bigger theme across the renewables tech landscape this year, reversal of last year where everyone was talking about inflation and shortages. Now we're talking about what do you have an inventory? When can you take advantage of hardware cost deflation and the like? And so I know you guys have hardware pretty much secured through next year. If I recall, what's the opportunity here as you look into the supply chain to start benefiting from hardware cost deflation trends on the battery side? When could that start showing up in your numbers? And how does that kind of manifest? Would that be the ability to just drive higher volumes? Or are you going to be able to maybe get some margin capture on the hardware side? Just how are you thinking about it and maybe the timeframe for that?

Yeah, I'd say a couple of things on that. As we mentioned the previous call, we spent a fair amount of time in China with a variety of different suppliers. And I think we, with our modular ESS strategy, will enable us to be maybe more competitive on that front. We certainly know the working capital will come down as well, Brian, so we like that equation. I'd say that, you know, the deflation piece, it depends on your delivery timeline. You see a little of that right now. Lithium's kind of bouncing around. But at an aggregate, our view is we want to make sure we're with the highest quality suppliers that can prove low cost roadmap and we feel like we're working with some very good suppliers. We do think we'll see improvement of terms than what we had in the past. I think that would probably reconcile more into 2024 than it would maybe in the second half of this year. But we are getting a few different spot deals coming in, so you could see some of that this year still.

Okay, I appreciate that. So, it does sound like in 2024 you can start to benefit from some of that, even in the first half of the year.

We'll see. I just think that we have a good line of sight of what we need hardware now for the second half. So, next year, we're starting to have more and more of those discussions. So, I don't want to commit that you're going to see a significant deflation and a margin flip next year. We'll talk about that in the first quarter. But, as we see it today, we do feel like next year could be, and the years following, could be more compelling from the terms that we've had to this point.

Hey, Brian, this is Bill. One thing I also wanted to mention, too, you mentioned, or you said it in your question, that we've both been fully contracted out through 2024. We actually are not fully contracted through 2024. So, to the extent that you see a near-term price reduction, we'd be able to take advantage of that. So, as you know, the second half of the year is where we're buying and placing most of our batteries. So, it's an opportunity for us to capture, to the extent that price decreases do come through, be able to capture some of that for ourselves and our customers.

Okay. That's great. I appreciate that additional color there. I'll pass it on. Thanks, guys.

The next question comes from Thomas Boyes with TD Cowen. Please go ahead.

Thanks for taking the questions. Maybe first, I know your focus for storage is U.S.-based, but I wanted to talk about the approach maybe internationally, given the large solar award in Hungary. Are you targeting other countries in Europe specifically, given the Net

Yeah, Thomas, thanks for the question. A couple things on that front. We've said it times in the past, maybe the best international market will be the U.S., as it stands, because of the Inflation Reduction Act. We are closely monitoring Europe. We do have a team there that led this Hungary win out of Berlin. So, we're well-positioned, I think, as that unfolds. And we're not opposed to going international, but we just feel like, really, the U.S. is a primary focus given the second half and obviously, we'll update our plans on international expansion going into next year. But we do have a decent-sized team that are very deep, particularly around the solar side and we're coming up to speed on the storage side. So, we're monitoring it. If there's an opportunity, we'll go wherever the best opportunities are and we just got to see how that unfolds.

Great. Appreciate it. And then, as my follow-up, could you just talk about maybe the composition of the bookings for this quarter? Were there specific markets that had shown strength that you could highlight?

Yeah. Hey, Thomas. This is Bill. So, I think there's a couple of spots that continue to be strong areas for us. And I would kind of coming East to West, and this is on the storage side, and I'll talk about solar in a second after that, but certainly, the New England area, New York, Massachusetts, Maine, those are areas that have really done quite well for us here in the past. Of course, Texas is a major market that we're very involved in. We're starting to see some activity in the Midwest, in Illinois, and some other places in that area and then, of course, California. So, those are the major for us, those are the major storage markets and even as I say that, one of the biggest bookings that we had this quarter was in Colorado. So, I think that we're pretty happy with the way solar or, excuse me, storage in general is spreading across the country. And I think we'll be the beneficiary of that, having been able to move, demonstrated movement across a large number of geographies. On the solar side, we continue to see a lot of strength across the U.S. and even into some of the international markets with a particular focus on Europe. The Hungary booking or the Hungary sale is good evidence of that. And so, I think that we're going to continue to do well there.

Maybe if I could just sneak one more in there. Just because you had mentioned Massachusetts, I know that you've had some pretty impressive market share growth there for the past 18 months. Can you maybe talk to us about what's driving that specifically?

Yeah. Most simplistically, the Mass Smart program is driving that. So, the Commonwealth of Massachusetts passed that program now, call it two years ago, maybe a bit more. And that market continues to be really strong. And in the same way, I think New York is reflective of that as well, where there's a program that was put forth. It was accepted by the legislature and you're starting to see significant activity by companies, a good example of that is NineDot, which is one of our significant customers, very focused on installing battery storage systems in urban areas with a focus on New York City. So, I think you're just going to continue to see a lot of deployments across markets like that, that need to have energy at the point where it's being used as distributed energy resources or DERs. I think you're going to see more and more of that as we go.

The next question comes from Sean Milligan with Jenny. Please go ahead.

Hey, guys. Good quarter. I was hoping that you could talk a little bit about the outlook for software-only contract awards over the back half of the year. Obviously, when you look at the 2025 guidance that is out there, you'd expect an uptick in software-only awards. And you mentioned it when you brought up the $1.5 billion bookings number Bill. But just trying to get an understanding of how you think that evolves for you here over the next kind of six months.

So, thanks for the question. And I'll let Mike jump in on this as well because it's kind of in his area. I think that one of the things that we're going to see, and this kind of rolls out of that modular ESS solution, you're going to see more software-only contracts that we sign. And a lot of that is because as we move up the size curve, and we've talked about this in the past, many of our customers already have, say, DC block relationships. And so, we are less involved in the purchase of that equipment than maybe we had been in the past. And I think that's a reflection of the maturation of the market in general and so, I think you're going to see more and more of that. I think it goes well into our controls background, very similar to what we do on the solar side of our business, where nobody's really calling us, asking us to procure panels for them, as an example, or inverters. So, I think it's the melding of the two businesses. I don't know, Mike, if there's any…

No, I agree. And I think the other thing is we've launched this July 01, some of the software and services only. We're getting a lot of feedback from the market, both Greenfield and Brownfield, that are looking to either retrofit what's already out there for an optimized performance. Or, as Bill said, they're starting to put the supply chain into various subcategories and buy vertically focused solutions. So, this gives us the opportunity to make sure we're maintaining where the market goes. We've got that opportunity on both sides, and we're positive on the initial -- we've been just 30 days into it, but the initial responses from some of the discussions have been good.

Great. Thanks. And then, John, you mentioned market participation revenue during the quarter. Obviously, I know it doesn't seem like it was overly meaningful, but I think that that's upside to kind of the long-term guidance that you've given, right? So, I was hoping you could talk a little bit about maybe percentage of assets or something that are participating in markets where you're seeing upside from that revenue stream, and then maybe what the outlook is for that moving forward.

Yeah, we don't really break it out specifically. I will say the outlook, I think, will continue to be strong. It is interesting. You're seeing more grid operators, utilities, others that want to pull from these assets. So I think it's just kind of a learning curve, but we are really -- it's not a material portion of the software revenue, although it is very strong gross margins. It's 80% plus. So, we're excited about it. We'll continue to update everyone on the calls on how we're doing there, but I would say that I think the general fact that it's being utilized more is very positive. It's what we expected the assets to be used for all the way back when we did our roadshow. So, it's good to see it getting some traction.

And then, one more if I can sneak it in, but you guys kind of gave an expectation for cash at the end of the year. That obviously follows a couple of robust quarters in terms of revenue in 3Q and 4Q. I was just hoping you could kind of refresh us on how maybe working capital should trend throughout a year. So, like, looking into the first half of next year, do you start to see the benefit of those, 3Q, 4Q revenue in terms of flowing through the working capital lines? Just trying to get a sense of like….

Absolutely. We've been building receivables here for a little bit. They grew again this quarter, and we would expect to start seeing the benefit of those sales, really over the next six to nine months. And so, that's how we feel pretty confident because more typically the cycle has been that we would be collecting cash in the first half and spending it. And this year, I think what we're going to flip that a little bit, and we're going to collect more cash in the second half than maybe where we had before, which gives us the ability to still build receivables while maintaining the cash balance. So, I think we're feeling pretty confident about that. We're looking very closely to our customers in terms of the payment cycles and we feel good that that number, that we can meet that number and potentially even beat it.

The next question comes from Julien Dumoulin-Smith with Bank of America. Please go ahead.

Hey, good afternoon, guys. This is Cameron Lockridge [ph], actually, on for Julian. Look, I wanted to just go back to the question that was just asked, actually, just about working capital and how we should think about it at the start of '24. Presumably, just given the revenue ramp that's implied by your guidance, your long-term guidance, we should probably see an even bigger uptick in just working capital investment in the front half of '24. So, just kind of maybe walk me through or walk us through how you're thinking about that and again, like if inventories are up, $150 million-ish, $140 million-ish this year in the first half, can we think about something larger than that in the first half of '24?

No, we definitely would not expect to see that. I think one of the things that -- and I should have said thanks for the question, too. But one of the things I think that, we've talked about, and this is where the modular ESS comes in, is that the terms and conditions under which those sales will be made will be very different than what the traditional business has been. So we're kind of morphing the way capital will be used in the business so that it's more efficient and that, effectively will need less cash to run the business going forward. So, which is why we started that initiative, it's why in part it's why it's quite popular with some of our customers. And so when you look at the numbers, we've said that, we expect hardware, which is the primary user of working capital, to grow at a 30% rate, which means that for 2024, hardware is probably going to have a slower rate of growth than it did in this year. But across the three-year span, this year we're going to grow hardware. If you just look at the numbers, you're going to grow -- we're going to grow hardware by quite a bit. Last year, we were a little bit over $300 million, and we're going to do around $500 million this year. So you're going to see, call it a 60%-odd growth in hardware sales. We don't expect that for next year and so that, say that slowing rate of growth will do two things. One, I think it will allow us to take advantage of better hardware margins and sell, relatively less hardware to do it. So I think when we think about the working capital side of the business, we would expect -- we would not expect the kind of numbers that you're talking about in terms of inventory growth. And so as a result, we should be able to maintain, our cash balances into 2024.

Got it. That's helpful. Thank you very much. And then just flipping over to software and thinking about margins there, margin progression, can you just kind of walk us through, broad strokes, how the software versus services margins look today, on a relative basis to each other, and how you expect that to trend in the back half into 2024?

Sure. So straight software margins today are 80% plus, and they've been that way for quite some time. The services margins trend lower than that, they're in more in the 40% to 50% range, depending on whether you're talking solar or storage. But still, obviously, quite good margins and I think you can see the sequential growth that we've had in both the solar and storage services over the last few quarters. And so we continue to book more and deliver more value there for our customers. But we don't see, margin decline or decrease in any of those aspects. So we're quite confident that we're going to continue to increase the amount of services and software that we're able to sell to our clients and that's, of course, one of the main drivers of our ability to achieve EBITDA positive, is continuing to increase the amount of services that we do at any point in time.

Perfect. All right, guys, thank you. That's all from me. I'll turn it back.

[Operator instructions] The next question comes from Kashy Harrison with Piper Sandler. Please go ahead.

Hey, everyone. Thanks for taking the questions. This is Luke on for Kashy. As far as the software service revenues, it looks like the year over year growth dropped down to about 30% compared to 47% in the first quarter. Wondering if there's any sort of interconnection issues that could potentially be going on here and how we should be thinking about that in the back half of the year?

Yeah, interconnection continues to be a problem, Luke. I think that and I think you see that in a couple of different aspects of the business. Certainly one on the project side of the business where we've invested some capital in getting projects into NTP. We've seen some slowdowns there and I think that's been particularly true in markets like New York and Texas, where we've seen just in general slowdowns. And I think I think one of the things we've consistently said, which is that interconnections haven't gotten better, but they haven't gotten much worse. I think probably in New York they did get a little bit slower. And so that's definitely going to have an impact on us over time. There was a new rule that was passed in New York, and there have been a couple of situations there that are giving some of the regulators pause. And as a result of that, I think timeframes are going to be impacted by that. But I would say in large part, for us, we're going to continue to be able to increase the total amount of services and software that we sell in at any point in time. So, I think I've been in renewables now for almost 15 years, and I was chuckling with a colleague the other day, complaining about interconnections and thinking that's been the same problem for the last 15 years. So, I think one of the things is certainly impacting is the success of renewables being installed in any particular geography at any time. So, that's something that we continue to work and are with our various partners on the regulatory side, folks that are that are working with the local agencies to do what they can to improve the tariffs associated with interconnection. But it's definitely an issue, has been for a long time, and probably will continue to be.

Okay. Thanks for that. That's helpful. And then on the hardware gross margin side, I know you said, you're kind of looking to do less of that, but you also mentioned projects are getting bigger. So how should we think about the push and pull between larger FTM projects, but also, trying to be less involved with the FTM projects?

Yeah, that's really where the modular ESS comes in. That's exactly the push point right there. As the systems get larger, more than likely, we will not be supplying the DC blocks to those projects. And that those developer partners are what we would call, basically fully integrated, and that they have sourcing mechanisms and sourcing relationships. So what we're going to be doing is selling controls, selling software, and potentially selling inverters and less DC blocks.

Okay. Thanks. I will pass it on.

Perfect. Thanks for the time.

The next question comes from Kailash [ph] with Northland Securities. Please go ahead.

Hey guys, good quarter. I just wanted to speak a little bit about the PJM market and how you guys seeing that playing out in 2024 and 2025?

Hi, this is Prakash. The PJM market is one where we're focused on the BTM or solutions for the commercial industrial segment. There's strong demand there given the fact that energy prices have picked up. There's been higher, generally a greater focus by corporates around driving energy efficiency. So there's good demand there, but it's not a major component of our overall pipeline or booking mix at the moment.

Sure. But just as a follow-up, since you spoke about distributed energy resources, I was just wondering if STEM's products are open ADR certified or is that relevant for you?

Yeah, very much so, and we have a number of open ADR connections with our utility partners that are part of our VPP operations. So very often this summer during some of these heat waves, we've been using open ADR signals from utilities to dispatch the virtual power plants that we operate with storage for a number of different utilities around the country.

Sure. That's it.

This concludes the question-and-answer session. I would like to turn the conference back over to John Carrington for any closing remarks. Please go ahead.

I want to thank everyone again for joining us on our second quarter 2023 earnings call, and we look forward to speaking with you during our third quarter earnings call.