Stem, Inc.: Form 10-Q for the period ended Sep 30, 2023

Special Note Regarding Forward-Looking Statements

This third quarter 2023 Form 10-Q, as well as other statements we make, contains “forward-looking statements” within the meaning of the federal securities laws, which include any statements that are not historical facts. Such statements often contain words such as “expect,” “may,” “can,” “believe,” “predict,” “plan,” “potential,” “projected,” “projections,” “forecast,” “estimate,” “intend,” “anticipate,” “ambition,” “goal,” “target,” “think,” “should,” “could,” “would,” “will,” “hope,” “see,” “likely,” and other similar words.

Forward-looking statements address matters that are, to varying degrees, uncertain, such as statements about financial and performance targets and other forecasts or expectations regarding, or dependent on, our business outlook; the expected benefits of the combined Stem/AlsoEnergy company; our ability to secure sufficient and timely inventory from suppliers; our ability to meet contracted customer demand; our ability to manage supply chain issues and manufacturing or delivery delays; our joint ventures, partnerships and other alliances; forecasts or expectations regarding energy transition and global climate change; reduction of greenhouse gas (“GHG”) emissions; the integration and optimization of energy resources; our business strategies and those of our customers; our ability to retain or upgrade current customers, further penetrate existing markets or expand into new markets; our ability to manage our supply chains and distribution channels and the effects of natural disasters and other events beyond our control; the direct or indirect effects on our business of macroeconomic factors and geopolitical instability, such as the ongoing conflict in Ukraine; the expected benefits of the Inflation Reduction Act of 2022 on our business; and future results of operations, including adjusted EBITDA.

Such forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements, including but not limited to our inability to secure sufficient and timely inventory from our suppliers, as well as contracted quantities of equipment; our inability to meet contracted customer demand; supply chain interruptions and manufacturing or delivery delays; disruptions in sales, production, service or other business activities; general macroeconomic and business conditions in key regions of the world, including inflationary pressures, general economic slowdown or a recession, rising interest rates, changes in monetary policy, instability in financial institutions, and the prospect of a shutdown of the U.S. federal government; the direct and indirect effects of widespread health emergencies on our workforce, operations, financial results and cash flows; geopolitical instability, such as the ongoing conflict in Ukraine; the results of operations and financial condition of our customers and suppliers; pricing pressures; weather and seasonal factors; our inability to continue to grow and manage our growth effectively; our inability to attract and retain qualified employees and key personnel; our inability to comply with, and the effect on our business of, evolving legal standards and regulations, including concerning data protection and consumer privacy and evolving labor standards; risks relating to the development and performance of our energy storage systems and software-enabled services; our inability to retain or upgrade current customers, further penetrate existing markets or expand into new markets; the risk that our business, financial condition and results of operations may be adversely affected by other political, economic, business and competitive factors; and other risks and uncertainties discussed in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, Part II, Item 1A. “Risk Factors” of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2023 and June 30, 2023 and in our other filings with the SEC. If one or more of these or other risks or uncertainties materialize (or the consequences of any such development changes), or should our underlying assumptions prove incorrect, actual results or outcomes, or the timing of these results or outcomes, may vary materially from those reflected in our forward-looking statements. Forward-looking and other statements in this report regarding our environmental, social, and other sustainability plans and goals are not an indication that these statements are necessarily material to investors or required to be disclosed in our filings with the SEC. In addition, historical, current, and forward-looking environmental, social, and sustainability-related statements may be based on standards for measuring progress that are still developing, internal controls and processes that continue to evolve, and assumptions that are subject to change in the future. Forward-looking statements in this report are made as of the date of this report, and we do not assume any obligation to update any forward-looking statements after the date of this report, except as required by law.

You should read the following management’s discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and related notes included under Part I, Item 1 of this Quarterly Report on Form 10-Q. This discussion and analysis should also be read together with our audited consolidated financial statements and related notes, as well as the section entitled “Stem’s Management’s Discussion and Analysis of Financial Condition and Results or Operations” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. You should carefully read the sections entitled “Special Note Regarding Forward-Looking Statements” and “Risk Factors” herein to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements. Throughout this section, unless otherwise noted “we,” “us,” “our” and the “Company” refer to Stem and its consolidated subsidiaries.

Overview

Our mission is to maximize the economic, environmental, and resiliency value of renewable energy assets through our leading artificial intelligence (“AI”) platform. In order to fulfill our mission, we provide our customers, which include commercial and industrial (“C&I”) enterprises as well as independent power producers, renewable project developers, utilities and grid operators, with (i) an energy storage system, sourced from leading, global battery original equipment manufacturers (“OEMs”), that we deliver through our partners, including developers, distributors, and engineering, procurement and construction (“EPC”) firms, (ii) edge hardware to aid in the collection of site data and the real-time operation and control of the site plus other optional equipment, (iii) ongoing software platform and professional services to operate integrated energy storage, and solar systems, through our Athena® clean energy optimization (“Athena”) and applications. In addition, in all the markets where we help manage our customers’ clean energy assets, we have agreements to use the Athena platform to participate in such markets and to share the revenue from such market participation.

We operate in two key areas within the energy landscape: Behind-the-Meter (“BTM”) and Front-of-the-Meter (“FTM”). An energy system’s position in relation to a customer’s electric meter determines whether it is designated a BTM or FTM system. BTM systems provide power that can be used on-site without interacting with the electric grid and passing through an electric meter. Our software reduces C&I customer energy bills, increases their energy yield, and helps our customers facilitate the achievement of their corporate environmental, social, and corporate governance (“ESG”) and carbon reduction objectives. Through PowerTrack, our software maximizes energy output and minimizes asset downtime.

FTM, grid-connected systems provide power to off-site locations and must pass through an electric meter prior to reaching an end-user. Through Athena, our FTM storage systems decrease risk for project developers, asset owners, independent power producers and investors by adapting to dynamic energy market conditions in connection with the deployment of electricity and improving the value of energy assets over the course of their FTM system’s lifetime.

Through our February 2022 acquisition of AlsoEnergy, we combined our storage optimization capabilities with solar asset performance monitoring and control software.

Since our inception in 2009, we have engaged in developing and marketing software-enabled services, raising capital, and recruiting personnel. We have incurred net operating losses and negative cash flows from operations each year since our inception. We have financed our operations primarily through proceeds received from the merger with Star Peak Transition Corp., the issuance of convertible preferred stock, convertible senior notes, debt financing, and cash flows from customers.

Our total revenue grew from $99.5 million for the three months ended September 30, 2022 to $133.7 million for the three months ended September 30, 2023. We incurred net losses of $77.1 million for the three months ended September 30, 2023 and incurred net losses of $34.3 million for the three months ended September 30, 2022. Our total revenue grew from $207.5 million for the nine months ended September 30, 2022 to $294.1 million for the nine months ended September 30, 2023. For the nine months ended September 30, 2023 and 2022, we incurred net losses of $102.7 million and $88.8 million, respectively. As of September 30, 2023, we had an accumulated deficit of $734.8 million.

We expect that our sales and marketing, research and development, regulatory and other expenses will continue to increase as we expand our marketing efforts to increase sales of our solutions, expand existing relationships with our customers, and obtain regulatory clearances or approvals for future product enhancements. In addition, we expect our general and administrative costs and expenses to increase due to the additional costs associated with scaling our business operations as well as being a public company, including legal, accounting, insurance, exchange listing and SEC compliance, investor relations and other costs and expenses.

Acquisition of AlsoEnergy

On February 1, 2022, we acquired 100% of the issued and outstanding capital stock of AlsoEnergy. The transaction combines our storage optimization capabilities with AlsoEnergy’s solar asset performance monitoring and control software. Through AlsoEnergy, we provide end-to-end turnkey solutions that monitor and manage renewable energy systems through AlsoEnergy’s PowerTrack software. PowerTrack includes data acquisitions and monitoring, performance modelling, agency reporting, internal reports, work order tickets, and supervisory control and data acquisition (“SCADA”) controls. AlsoEnergy has deployed systems at various international locations, but its primary customer base is in the United States, Germany and Canada. The total consideration for the AlsoEnergy acquisition was $652.0 million, comprised of $543.1 million paid in cash, net of a working capital adjustment for an escrow recovery, and $108.9 million in the form of 8,621,006 shares of our common stock. We incurred $6.1 million of transaction costs related to the acquisition of AlsoEnergy, which were recorded in general and administrative expense during the nine months ended September 30, 2022. See Note 6 — Business Combinations, of the Notes to the unaudited condensed consolidated financial statements in this report for additional details regarding this transaction.

Key Factors, Trends and Uncertainties Affecting our Business

We believe that our performance and future success depend on several factors that present significant opportunities for us but also pose risks and challenges, including but not limited to:

Decline in Lithium-Ion Battery Costs

Our revenue growth is directly tied to the continued adoption of energy storage systems by our customers. The cost of lithium-ion energy storage hardware has generally declined over the last decade, notwithstanding increases in recent months. The market for energy storage is rapidly evolving, and while we believe costs will continue to decline over time, there is no guarantee. If costs do not continue to decline, or do not decline as quickly as we anticipate, this could adversely affect our ability to increase our revenue and grow our business. The United States Inflation Reduction Act of 2022 (the “IRA”) was signed into law in August 2022 and includes incentives and tax credits aimed at reducing the effects of climate change, such as a tax credit for stand-alone battery storage projects. The implementation of the IRA is expected to further reduce the cost of battery storage systems for certain customers; however, there are numerous restrictions and requirements associated with qualifying for the tax credits and other incentives available under the IRA, and the Company continues to assess how the IRA may affect its business.

Increase in Deployment of Renewables

Deployment of intermittent resources has accelerated over the last decade, and today, wind and solar have become a low cost fuel source. We expect the cost of generating renewable energy to continue to decline and deployments of energy storage systems to increase. As renewable energy sources of energy production are expected to represent a larger proportion of energy generation, grid instability rises due to their intermittency, which can be addressed by energy storage solutions. The IRA is expected to further increase the deployment of renewable energy assets. We are continuing to evaluate the IRA and its requirements, as well as the application to our business and our customers.

Competition

We are a market leader in terms of capacity of energy storage under management. We intend to strengthen our competitive position over time by leveraging the network effect of Athena’s AI infrastructure. Existing competitors may expand their product offerings and sales strategies, and new competitors may enter the market. Furthermore, our competitors include other types of software providers and some hardware manufacturers that offer software solutions. If our market share declines due to increased competition, our revenue and ability to generate profits in the future may be adversely affected.

Government Regulation and Compliance

Although we are not regulated as a utility, the market for our product and services is heavily influenced by federal, state, and local government statutes and regulations concerning electricity. These statutes and regulations, like the IRA, affect electricity pricing, net metering, incentives, taxation, competition with utilities, and the interconnection of customer-owned electricity generation. In the United States and internationally, governments continuously modify these statutes and regulations and acting through state utility or public service commissions, regularly change and adopt different rates for commercial customers. These changes can positively or negatively affect our ability to deliver cost savings to customers.

Customer Concentration

We depend on a small number of significant customers for our sales, and a small number of customers have historically accounted for a material portion of our revenue. While we are committed to diversifying our customer base, we may continue to derive a significant portion of our revenue from a small number of customers. Loss of a significant customer, the inability to close a significant contract at any time, or a significant reduction in pricing or order volume from a significant customer, could materially reduce our revenue in a given quarter and have a material adverse effect on our operating results.

Supply Chain Constraints and Risk

We rely on a very small number of suppliers of energy storage systems and other equipment. If any of our suppliers were unable or unwilling to provide us with contracted quantities in a timely manner at prices, quality levels, and volumes acceptable to us, we would have very limited alternatives for supply, and we may not be able find suitable replacements for our customers, if at all. Such an event could materially adversely affect our business, prospects, financial condition, and results of operations.

In addition, the global supply chain and our industry have experienced significant disruptions in recent periods. We have seen supply chain challenges and logistics constraints increase, including shortages of inverters, enclosures, battery modules, and associated component parts for inverters and battery energy storage systems available for purchase. In certain cases, this has caused delays in critical equipment and inventory, longer lead times, and has resulted in cost volatility. These shortages and delays can be attributed in part to macroeconomic conditions, such as labor shortages, rising inflation, rising interest rates, and a recessionary environment and geographical instability, including the ongoing conflict between Russia and Ukraine and rising tensions between China and the United States, among other factors. If these shortages and delays persist through the remainder of 2023, they could adversely affect the timing of when battery energy storage systems can be delivered and installed, and when (or if) we can begin to generate revenue from those systems. In addition, we have experienced and are experiencing varying levels of volatility in costs of equipment and labor resulting in part from disruptions caused by general global macroeconomic conditions, including inflationary pressures.

DevCo Joint Ventures

The Company, through an indirect wholly-owned development subsidiary, has entered into strategic joint ventures with qualified third parties to develop select energy storage generation projects (“DevCo Projects”), as more fully described above under Note 1 — Business, of the Notes to the unaudited condensed consolidated financial statements in this report. These projects require significant upfront investment by us and involve a high degree of risk. These projects require significant upfront investment by us and involve a high degree of risk. If a DevCo Project fails to reach completion or is significantly delayed, we could lose all or a portion of our development capital investment. See “We Face Risks Related to our DevCo Business Model” in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 for additional information about certain risks related to these DevCo Projects.

Parent Company Guarantees

In certain customer contracts, the Company previously agreed to provide a guarantee that the value of purchased hardware will not decline for a certain period of time, as more fully described above under Note 3 — Revenue, of the Notes to the unaudited condensed consolidated financial statements in this report. The Company accounts for such contractual terms and guarantees as variable consideration at each measurement date. The Company updates its estimate of variable consideration, including changes in estimates related to such guarantees, each quarter for facts or circumstances that have changed from the time of the initial estimate. As a result, the Company recorded a revenue reduction of $37.4 million in hardware revenue during the three and nine months ended September 30, 2023. Specifically, $16.9 million of the overall reduction in revenue is related to deliveries that occurred during the fourth quarter of 2022, $15.8 million is related to hardware deliveries that occurred during the second quarter of 2023, and variable consideration relating to current quarter hardware deliveries was constrained by $4.7 million.

The Company does not intend to provide such parent company guarantees in customer contracts going forward. Because these contractual terms and guarantees had not previously resulted in a revenue reduction in prior periods, and because the Company does not intend to provide such parent company guarantees in customer contracts going forward, the Company believes that excluding the impact of the $37.4 million reduction in revenue enhances the comparability to the Company’s adjusted EBITDA and non-GAAP gross profit in prior periods.

Non-GAAP Financial Measures

In addition to financial results determined in accordance with U.S. generally accepted accounting principles (“GAAP”), we use adjusted EBITDA and non-GAAP gross profit and margin, which are non-GAAP financial measures, for financial and operational decision making and as a means to evaluate our operating performance and prospects, develop internal budgets and financial goals, and to facilitate period-to-period comparisons. Our management believes that these non-GAAP financial measures provide meaningful supplemental information regarding our performance and liquidity by excluding certain expenses and expenditures that may not be indicative of our operating performance, such as stock-based compensation and other non-cash charges, as well as discrete cash charges that are infrequent in nature. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparisons to our historical performance and liquidity as well as comparisons to our competitors’ operating results. We believe these non-GAAP financial measures are useful to investors because they both (1) allow for greater transparency with respect to key metrics used by management in their financial and operational decision making and (2) are used by our institutional investors and the analyst community to help them analyze the health of our business. Adjusted EBITDA and non-GAAP gross profit and margin should be considered in addition to, not as a substitute for, or superior to, other measures of financial performance prepared in accordance with GAAP.

Non-GAAP Gross Profit and Margin

We define non-GAAP gross profit as gross profit excluding both amortization of capitalized software, impairments related to decommissioning of end-of-life systems and reduction in revenue, and including revenue constraint. We define non-GAAP gross margin as non-GAAP gross profit as a percentage of revenue.

The Company generally records the full purchase order value as revenue at the time of hardware delivery; however, for certain non-cancelable purchase orders entered into during the first quarter of 2023, the final settlement amount payable to the Company is variable and indexed to the price per ton of lithium carbonate in the first quarter of 2024 such that the Company may increase or decrease the final prices in such purchase orders based on the price per ton of lithium carbonate at final settlement. Lithium carbonate is a key raw material used in the production of hardware systems that the Company ultimately sells to customers. The total dollar amount of such purchase orders for the indexed contracts is approximately $52 million. However, as a result of the pricing structure in such purchase orders, the Company recorded revenue in the first quarter of 2023 of approximately $42 million, net of a $10 million revenue constraint, using a third party forecast of the lithium carbonate trading value in the first quarter of 2024. Because the Company had not before used indexed pricing in its customer contracts or purchase orders and had not previously constrained revenue related to forecasted inputs of its hardware systems, the Company believes that including the $10 million revenue constraint from the first quarter of 2023 into non-GAAP profit enhances the comparability to the Company’s non-GAAP profit in prior periods. Because the purchase orders are variable and depend on the specified price per ton of lithium carbonate at the time of final measurement in the first quarter of 2024, the Company may, pursuant to such purchase orders, ultimately adjust final revenue downward to $34 million, subject to market conditions upon settlement. The Company recorded the full cost of hardware revenue for these indexed contracts in the first quarter of 2023.

The following table provides a reconciliation of gross profit and margin (GAAP) to non-GAAP gross profit and margin (in millions, except percentages):

(1) Refer to the discussion of revenue constraint in “— Non-GAAP Gross Profit and Margin” above.

(2) Refer to the discussion of reduction in revenue in “— Parent Company Guarantees” above.

Adjusted EBITDA

We calculate adjusted EBITDA as net loss attributable to Stem before depreciation and amortization, including amortization of internally developed software, net interest expense, further adjusted to exclude stock-based compensation and other income and expense items, including the net gain on extinguishment of debt, revenue constraint, reduction in revenue, change in fair value of derivative liability, transaction and acquisition-related charges, litigation settlement, restructuring costs and income tax provision or benefit. The expenses and other items that we exclude in our calculation of adjusted EBITDA may differ from the expenses and other items, if any, that other companies exclude when calculating adjusted EBITDA.

The following table provides a reconciliation of adjusted EBITDA to net loss:

(in thousands)

(in thousands)

(1) Depreciation and amortization includes depreciation and amortization expense, impairment loss of energy storage systems, and impairment loss of project assets.

(2) Refer to the discussion of revenue constraint in “— Non-GAAP Gross Profit and Margin” above.

(3) Refer to the discussion of reduction in revenue in “— Parent Company Guarantees” above.

(4) Adjusted EBITDA for the three and nine months ended September 30, 2023 reflects other expenses of $6.6 million and $7.6 million, respectively. For the three months ended September 30, 2023, other expenses includes $5.6 million in accruals for sales taxes, $0.5 million for impairments, $0.3 million for expenses related to restructuring costs, and $0.2 million of other non-recurring expenses. For the nine months ended September 30, 2023, other expenses include $5.6 million in accruals for sales taxes, $0.5 million for impairments, $0.3 million of other non-recurring expense, and $1.2 million for expenses related to restructuring costs to pursue greater efficiency and to realign our business and strategic priorities. Restructuring expenses consisted of employee severance and other exit costs.

Financial Results and Key Metrics

The following table presents our financial results and our key metrics (in millions unless otherwise noted):

Bookings

Due to the long-term nature of our contracts, bookings are a key metric that allows us to understand and evaluate the growth of our Company and our estimated future revenue related to customer contracts for our energy optimization services and transfer of energy storage systems. Bookings represents the accumulated value at a point in time of contracts that have been executed under both our host customer and partnership sales models.

For host customer sales, bookings represent the expected consideration from energy optimization services contracts, including estimated incentive payments that are earned by the host customer from utility companies in relation to the services provided by us and assigned by the host customer to us. For host customer sales, there are no differences between bookings and remaining performance obligations at any point in time.

For partnership sales, bookings are the sum of the expected consideration to be received from the transfer of hardware and energy optimization services (excluding any potential revenues from market participation). For partnership sales, even though we have secured an executed contract with estimated timing of project delivery and installation from the customer, we do not consider it a contract in accordance with FASB ASU 2014-09 Topic 606, *Revenue from Contracts with Customers (“*ASC 606”), or a remaining performance obligation, until the customer has placed a binding purchase order. A signed customer contract is considered a booking as this indicates the customer has agreed to place a purchase order in the foreseeable future, which typically occurs within three (3) months of contract execution. However, executed customer contracts, without binding purchase orders, are cancellable without penalty by either party.

For partnership sales, once a purchase order has been executed, the booking is considered to be a contract in accordance with ASC 606, and therefore, gives rise to a remaining performance obligation as we have an obligation to transfer hardware and energy optimization services in our partnership agreements. We also have the contractual right to receive consideration for our performance obligations.

The accounting policy and timing of revenue recognition for host customer contracts and partnership arrangements that qualify as contracts with customers under ASC 606, are described within Note 2 — Summary of Significant Accounting Policies, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

The following discussion and analysis of our results of operations and our liquidity and capital resources include the results of operations for AlsoEnergy for the period from February 1, 2022. For additional information, including pro forma results of operations for the three and nine months ended September 30, 2022 calculated as if AlsoEnergy had been acquired as of January 1, 2022, see Note 6 — Business Combinations, of the Notes to the unaudited condensed consolidated financial statements in this report.

Components of Our Results of Operations

Revenue

We generate services and other revenue and hardware revenue. Services and other revenue is mainly generated through arrangements with host customers to provide energy optimization services using our proprietary software platform coupled with a dedicated energy storage system owned and controlled by us throughout the term of the contract. Fees charged to customers for energy optimization services generally consist of recurring fixed monthly payments throughout the term of the contract and in some arrangements, an installation and/or upfront fee component. We may also receive incentives from utility companies in relation to the sale of our services. Services and other revenue also include the sale of project assets.

We generate hardware revenue through partnership arrangements consisting of promises to sell an energy storage system to solar plus storage project developers. Performance obligations are satisfied when the energy storage system along with all ancillary hardware components are delivered. The milestone payments received before the delivery of hardware are treated as deferred revenue. In certain customer contracts, the Company previously agreed to provide a guarantee that the value of purchased hardware will not decline for a certain period of time, as more fully described above under Note 3 — Revenue, of the Notes to the unaudited condensed consolidated financial statements in this report. We separately generate services revenue through partnership arrangements by providing energy optimization services after the developer completes the installation of the project.

Cost of Revenue

Cost of services and other revenue includes depreciation of the cost of energy storage systems we own under long-term customer contracts, which includes capitalized fulfillment costs, such as installation services, permitting and other related costs. Cost of services and other revenue also includes the costs for the development and construction of project assets. Cost of revenue may also include any impairment of inventory and energy storage systems, along with system maintenance costs associated with the ongoing services provided to customers. Costs of revenue are recognized as energy optimization and other supporting services are provided to our customers throughout the term of the contract.

Cost of hardware revenue generally includes the cost of the hardware purchased from a manufacturer, shipping, delivery, and other costs required to fulfill our obligation to deliver the energy storage system to the customer location. Cost of hardware revenue may also include any impairment of energy storage systems held in our inventory for sale to our customer. Cost of hardware revenue related to the sale of energy storage systems is recognized when the delivery of the product is completed.

Gross (Loss) Profit

Our gross (loss) profit fluctuates significantly from quarter to quarter. Gross profit, calculated as revenue less costs of revenue, has been, and will continue to be, affected by various factors, including fluctuations in the amount and mix of revenue and the amount and timing of investments to expand our customer base. Over the long term, we hope to increase both our gross profit in absolute dollars and gross margin as a percentage of revenue through enhanced operational efficiency and economies of scale.

Operating Expenses

Sales and Marketing

Sales and marketing expense consists of payroll and other related personnel costs, including salaries, stock-based compensation, employee benefits, and travel for our sales and marketing personnel. In addition, sales and marketing expense includes trade show costs, amortization of intangibles and other expenses. We expect our selling and marketing expense to increase in future periods to support the overall growth in our business.

Research and Development

Research and development expense consists primarily of payroll and other related personnel costs for engineers and third parties engaged in the design and development of products, third-party software and technologies, including salaries, bonus and stock-based compensation expense, project material costs, services and depreciation. We expect research and development expense to increase in future periods to support our growth, including continuing to invest in optimization, accuracy and reliability of our platform and other technology improvements to support and drive efficiency in our operations. These expenses may vary from period to period as a percentage of revenue, depending primarily upon when we choose to make more significant investments.

General and Administrative Expense

General and administrative expense consists of payroll and other related personnel costs, including salaries, stock-based compensation, employee benefits and expenses for executive management, legal, finance and other costs. In addition, general and administrative expense includes fees for professional services and occupancy costs. We expect our general and administrative expense to increase in future periods as we scale up headcount with the growth of our business, and as a result of operating as a public company, including compliance with the rules and regulations of the SEC, legal, audit, additional insurance expenses, investor relations activities, and other administrative and professional services.

Other (Expense) Income, Net

Interest Expense, Net

Interest expense, net consists primarily of interest on our outstanding borrowings under our outstanding notes payable, convertible senior notes, and financing obligations and accretion on our asset retirement obligations.

Gain on Extinguishment of Debt, Net

Gain on extinguishment of debt consists of income recognized in relation to the prepayment of our outstanding borrowings under our outstanding convertible notes and the write-off of any unamortized debt issuance costs associated with such notes.

Change in Fair Value of Derivative Liability

Change in fair value of derivative liability is related to the revaluation of derivative feature within a revenue contract, whereby final settlement is indexed to the price per ton of lithium carbonate.

Other Income, Net

Other income, net consists primarily of income from equity investments and foreign exchange gains or losses.

Results of Operations for the Three Months Ended September 30, 2023 and 2022

(in thousands, except percentages)

*Percentage is not meaningful

Revenue

Revenue increased by $34.2 million, or 34%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase was primarily driven by a $31.3 million increase in hardware revenue primarily due to an increase in demand for systems related to both FTM and BTM partnership agreements. Services and other revenue also increased by $2.9 million primarily due to an increase in solar services subscriptions from existing and new customers.

Cost of Revenue

Cost of revenue increased by $63.7 million, or 70%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase was primarily driven by an increase in cost of hardware revenue of $61.4 million due to the increase in demand for systems. Cost of services and other revenue also increased by $2.2 million, primarily due to solar cloud service costs and amortization of internally developed software costs.

Operating Expenses

Sales and Marketing

Sales and marketing expense decreased by $1.6 million, or 12%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The decrease was primarily due to a decrease of $0.8 million in personnel related expenses and a decrease of $0.8 million in professional services and office-related expenses.

Research and Development

Research and development expense increased by $3.9 million, or 37%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase was primarily due to an increase of $2.4 million in personnel related expenses as a result of higher headcount and an increase of $1.5 million in professional services and other expenses.

General and Administrative

General and administrative expense increased by $3.9 million, or 22%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase was primarily driven by an increase of $5.6 million in business taxes related to state sales tax liabilities and an increase of $0.5 million in personnel costs driven by additional stock-based compensation expense, partially offset by a decrease of $2.2 million in office-related costs.

Other Income (Expense), Net

Interest Expense, Net

Interest expense increased by $1.9 million, or 75%, for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. The increase was primarily driven by an increase in interest on convertible notes of $2.4 million, partially offset by the accretion of the discount on short-term investments of $0.2 million, a decrease of $0.2 million in interest on financing obligations, and a decrease of $0.1 million in other interest expense.

Change in Fair Value of Derivative Liability

Unrealized losses relating to our derivative liability increased by $5.2 million for the three months ended September 30, 2023, as compared to three months ended September 30, 2022 due to the decrease in the price per ton of lithium carbonate.

Other Income, Net

Other income, net decreased by $0.2 million, or 17% for the three months ended September 30, 2023, as compared to three months ended September 30, 2022 primarily due to a decrease of $0.3 million in accrued interest income from investments, partially offset by and a $0.1 million increase in income from equity investments.

Benefit from (Provision for) Income Taxes

During the three months ended September 30, 2023, we recorded a benefit from income taxes of $46 thousand. During the three months ended September 30, 2022, we recorded a $19 thousand provision for income taxes.

Results of Operations for the Nine Months Ended September 30, 2023 and 2022

(in thousands, except percentages)

*Percentage is not meaningful

Revenue

Revenue increased by $86.6 million, or 42%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily driven by a $75.1 million increase in hardware revenue primarily due to an increase in demand for systems related to both FTM and BTM partnership agreements. Services and other revenue also increased by $11.5 million primarily due to an increase in solar subscription services revenue from existing and new customers.

Cost of Revenue

Cost of revenue increased by $114.5 million, or 61%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily driven by an increase in cost of hardware revenue of $107.8 million due to the increase in demand for storage systems. Cost of services and other revenue also increased by $6.7 million primarily due to an increase in solar cloud service costs and amortization of internally developed software costs.

Operating Expenses

Sales and Marketing

Sales and marketing expense increased by $2.4 million, or 7%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily due to an increase of $2.8 million in personnel related expenses as a result of higher headcount, partially offset by a decrease of $0.4 million in professional services and office-related expenses.

Research and Development

Research and development expense increased by $13.6 million, or 48%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily due to an increase of $9.7 million in personnel related expenses as a result of higher headcount and an increase of $3.9 million in professional services and other expenses.

General and Administrative

General and administrative expense increased by $4.4 million, or 8%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily driven by an increase of $5.6 million in business taxes related to state sales tax liabilities, an increase of $4.4 million in personnel related expenses as a result of higher headcount, and an increase of $0.6 million in additional office-related expenses, partially offset by a decrease of $6.2 million in professional services and other expenses.

Other Expense, Net

Interest Expense, Net

Interest expense increased by $1.7 million, or 20%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. The increase was primarily driven by an increase of $4.8 million in interest on our convertible notes, partially offset by the accretion of the discount on short-term investments of $2.2 million, a decrease of $0.8 million in interest on financing obligations, and a decrease in other interest expense of $0.1 million.

Gain on Extinguishment of Debt, Net

During the nine months ended September 30, 2023, we recorded a $59.4 million gain on extinguishment of debt driven by a $99.8 million payment to extinguish approximately $163.0 million aggregate principal amount of our 2028 Convertible Notes. The gain was partially offset by a $0.3 million loss on extinguishment of debt from repayment of our 2021 Credit Agreement.

Change in Fair Value of Derivative Liability

Unrealized losses relating to our derivative liability increased by $7.7 million for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022 due to the decrease in the price per ton of lithium carbonate.

Other Income, Net

Other income, net increased by $0.3 million, or 16%, for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022 primarily due to a $1.1 million increase in accrued interest income from short-term investments, a $0.6 million increase due to the reversal of previously recognized accretion expense on assets, and a $0.2 million increase in income from equity investments, partially offset by a $1.6 million realized loss on short-term investments.

(Provision for) Benefit from Income Taxes

During the nine months ended September 30, 2023, we recorded a provision for income taxes of $0.4 million primarily as a result of state income tax expense from the gain on extinguishment of 2028 Convertible Notes during the second quarter of 2023, which was partially offset by a partial release of our deferred tax asset valuation due to an acquisition during the first quarter of 2023. During the nine months ended September 30, 2022, we recorded a $15.2 million benefit from income taxes as a result of the partial release of our deferred tax asset valuation due to the acquisition of AlsoEnergy.

Liquidity and Capital Resources

Sources of Liquidity

Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, debt service, acquisitions, contractual obligations and other commitments. We assess liquidity in terms of our cash flows from operations and their sufficiency to fund our operating and investing activities. To meet our payment service obligations we must have sufficient liquid assets and be able to move funds on a timely basis.

As of September 30, 2023, our principal source of liquidity were cash, cash equivalents, and short-term investments of $125.4 million, which were held for working capital purposes and for investment growth opportunities. Our marketable securities generally consist of high-grade commercial paper, agency bonds, corporate debt securities, U.S. government agency securities, and treasury bills. We believe that our cash position is sufficient to meet our capital and liquidity requirements for at least the next 12 months.

Our business prospects are subject to risks, expenses, and uncertainties frequently encountered by companies in the early stages of commercial operations. The attainment of profitable operations is dependent upon future events, including obtaining adequate financing to complete our development activities, obtaining adequate supplier relationships, building our customer base, successfully executing our business and marketing strategy and hiring appropriate personnel. Failure to generate sufficient revenues, achieve planned gross margins and operating profitability, control operating costs, or secure additional funding may require us to modify, delay, or abandon some of our planned future expansion or development, or to otherwise enact operating cost reductions available to management, which could have a material adverse effect on our business, operating results, and financial condition.

In the future, we may be required to obtain additional equity or debt financing in order to support our continued capital expenditures and operations, which may not be available on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in new technologies, this could reduce our ability to compete successfully and harm our business, growth and results of operations.

Our long-term liquidity requirements are linked primarily to the continued extension of the Athena platform and supporting applications, including Athena PowerTrack and the use of our balance sheet to improve the terms and conditions associated with the purchase of energy storage systems from our hardware vendors. While we have plans to potentially expand our geographical footprint beyond our current partnerships and enter into joint ventures, those are not required initiatives to achieve our plans.

Financing Obligations

We have entered into arrangements wherein we finance the cost of energy storage systems via special purpose entities (“SPEs”) we establish with outside investors. These SPEs are not consolidated into our financial statements, but are accounted for as equity method investments. Through the SPEs, the investors provide us upfront payments. Under these arrangements, the payment by the SPEs to us is accounted for as a borrowing by recording the proceeds received as a financing obligation. The financing obligation is repaid with the future customer payments and incentives received. A portion of the amounts paid to the SPE is allocated to interest expense using the effective interest rate method. Furthermore, we continue to account for the revenues from customer arrangements and incentives and all associated costs despite such systems being legally sold to the SPEs due to our significant continuing involvement in the operations of the energy storage systems. The total financing obligation as of September 30, 2023 was $71.7 million, of which $17.4 million was classified as a current liability.

Notes Payable

2021 Credit Agreement

In January 2021, we entered into a non-recourse credit agreement to provide a total of $2.7 million towards the financing of certain energy storage systems that we owned and operated. The credit agreement had a stated interest of 5.45% and a maturity date of June 2031. We received an advance under the credit agreement of $1.8 million in January 2021. The repayment of advances received under the credit agreement was determined by the lender based on the proceeds generated by us through the operation of the underlying energy storage systems. On April 6, 2023, we repaid the remaining outstanding balance under the 2021 Credit Agreement with a portion of the proceeds received from the issuance of the 2030 Convertible Notes. The facility was terminated after the repayment in April 2023. See Note 9 — Notes Payable for additional details.

2028 Green Convertible Senior Notes

On November 22, 2021, we sold to Morgan Stanley & Co. LLC, Goldman Sachs & Co. LLC and Barclays Capital Inc, as initial purchasers (the “2021 Initial Purchasers”), and the 2021 Initial Purchasers purchased from us, $460.0 million aggregate principal amount of our 2028 Convertible Notes, pursuant to a purchase agreement dated as of November 17, 2021, by and between us and the 2021 Initial Purchasers. Our net proceeds from this offering were approximately $445.7 million, after deducting the 2021 Initial Purchasers’ discounts and commissions and the offering expenses paid by the Company. The 2028 Convertible Notes will accrue interest payable semi-annually in arrears and will mature on December 1, 2028, unless earlier repurchased, redeemed or converted in accordance with their terms prior to such date. Upon conversion, we may choose to pay or deliver, as the case may be, cash, shares of common stock or a combination of cash and shares of common stock. The 2028 Convertible Notes are redeemable for cash at our option at any time given certain conditions. Refer to Note 10 — Convertible Notes, of the Notes to the unaudited condensed consolidated financial statements in this report for additional details regarding this transaction.

On April 3, 2023, we used approximately $99.8 million of the net proceeds from the issuance of the 4.25% Green Convertible Senior Notes due 2030 (“2030 Convertible Notes”) to purchase and surrender for cancellation approximately $163.0 million aggregate principal amount of the Company’s 2028 Convertible Notes. See Note 10 — Convertible Notes, of the Notes to the unaudited condensed consolidated financial statements in this report for additional details.

2030 Convertible Notes

On April 3, 2023, the Company issued $240.0 million aggregate principal amount of its 2030 Convertible Notes in a private placement offering to qualified institutional buyers (the “2023 Initial Purchasers”) pursuant to Rule 144A under the Securities Act of 1933, as amended. The 2030 Convertible Notes are senior, unsecured obligations of the Company and bear interest at a rate of 4.25% per year, payable in cash semi-annually in arrears in April and October of each year, beginning in October 1, 2023. The notes will mature on April 1, 2030, unless earlier repurchased, redeemed or converted in accordance with their terms prior to such date. Upon conversion, the Company may choose to pay or deliver cash, shares of common stock or a combination of cash and shares of common stock. The Notes are redeemable for cash at the Company’s option at any time given certain conditions. See Note 10 — Convertible Notes, of the Notes to the unaudited condensed consolidated financial statements in this report, for additional details regarding this transaction.

The Company’s net proceeds from this offering were approximately $232.4 million, after deducting for $7.6 million of debt issuance costs primarily consisting of underwriters, advisory, legal, and accounting fees. The Company used approximately $99.8 million of the net proceeds to purchase and surrender for cancellation approximately $163.0 million aggregate principal amount of the Company’s 2028 Convertible Notes.

On March 29, 2023 and March 31, 2023, in connection with the pricing of the 2030 Convertible Notes, and on April 3, 2023, in connection with the exercise in full by the 2023 Initial Purchasers of their option to purchase additional Notes, the Company entered into Capped Calls (the “2030 Capped Calls”) with certain counterparties. The Company used $27.8 million of the net proceeds from the 2030 Convertible Notes to pay the cost of the 2030 Capped Calls.

Cash Flows

The following table summarizes our cash flows for the periods indicated (in thousands):

Operating Activities

During the nine months ended September 30, 2023, net cash used in operating activities was $205.2 million, primarily resulting from our net loss of $102.7 million, adjusted for non-cash items of $17.9 million and net cash outflow of $120.3 million from changes in operating assets and liabilities. Non-cash items primarily consisted of depreciation and amortization of $33.6 million, non-cash interest expense of $2.0 million related to debt issuance costs, stock-based compensation expense of $28.3 million, change in fair value of derivative liability of $7.7 million, non-cash lease expense of $2.2 million, impairment of energy storage systems of $2.3 million, provision for accounts receivable allowance of $1.8 million and net recognized loss on investments of $1.6 million, partially offset by a net gain on debt extinguishment, of $59.1 million, net accretion of the discount on investments of $1.7 million, and income tax benefit of $0.3 million, and other non-cash items of $0.5 million. The net cash outflow from changes in operating assets and liabilities was primarily driven by an increase in accounts receivable of $67.0 million as a result of increases in sales, an increase in inventory of $57.3 million to fulfill future deliveries, an increase in other assets of $17.9 million, an increase in contract origination costs of $4.2 million, an increase in project assets of $2.8 million, a decrease in accrued expenses and other liabilities of $28.9 million, and a decrease in lease liabilities of $2.1 million, partially offset by a decrease in deferred costs with suppliers of $30.6 million, an increase in accounts payable of $1.8 million, and an increase in deferred revenue of $27.6 million.

During the nine months ended September 30, 2022, net cash used in operating activities was $68.6 million, primarily resulting from our net loss of $88.8 million, adjusted by non-cash charges of $43.6 million and net cash outflow of $23.5 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of depreciation and amortization of $32.1 million, non-cash interest expense of $1.5 million, related to debt issuance costs, stock-based compensation expense of $20.4 million, impairment of energy storage systems of $1.3 million, non-cash lease expense of $1.7 million, provision for accounts receivable allowance of $1.9 million, net amortization of the premium on investments of $0.3 million and other non-cash items of $0.1 million, partially offset by an income tax benefit of $15.1 million and gain on sale of project assets of $0.6 million. The net cash outflow from changes in operating assets and liabilities was primarily driven by an increase in accounts receivable of $75.4 million due to increases in sales, an increase in other assets of $25.2 million, an increase in deferred costs with suppliers of $47.8 million for future hardware orders, an increase in inventory of $2.2 million, an increase in contract origination costs of $4.8 million, and a decrease in lease liabilities of $1.1 million, partially offset by an increase in accounts payable of $63.2 million due to timing of payments, an increase in accrued expenses and other liabilities of $38.3 million, and an increase in deferred revenue of $31.6 million.

Investing Activities

During the nine months ended September 30, 2023, net cash provided by investing activities was $120.3 million, primarily consisting of $135.5 million in proceeds from net sales of available-for-sale investments, partially offset by $1.8 million used for acquisitions, net of cash acquired, $2.9 million in purchases of energy storage systems, $10.1 million in capital expenditures on internally-developed software, and $0.4 million in purchases of property and equipment.

During the nine months ended September 30, 2022, net cash used in investing activities was $571.9 million, primarily consisting of $533.0 million used for our acquisition of AlsoEnergy, net of cash acquired, $22.5 million in net purchases of available-for-sale investments, $0.5 million in purchases of energy systems, $12.7 million in capital expenditures on internally-developed software, $3.0 million in capital expenditures on project assets, and $1.5 million in purchases of property and equipment, partially offset by proceeds from the sale of project assets of $1.3 million.

Financing Activities

During the nine months ended September 30, 2023, net cash provided by financing activities was $95.1 million, primarily consisting of net proceeds from the issuance of convertible notes of $132.6 million and proceeds from the exercise of stock options of $0.3 million, partially offset by the purchase of capped calls of $27.8 million, the repayment of financing obligations of $7.8 million, the repayment of notes payable of $2.1 million, and a redemption of non-controlling interests of $0.1 million.

During the nine months ended September 30, 2022, net cash used in financing activities was $6.8 million, primarily consisting of repayment of financing obligations of $7.6 million and payments for taxes related to net share settlement of stock options of $2.3 million, partially offset by proceeds from the exercise of stock options of $1.2 million, proceeds from financing obligations of $1.5 million, and investments from non-controlling interests of $0.4 million.

Contractual Obligations and Commitments

As of September 30, 2023, except for the 2030 Convertible Notes, there have been no material changes to our contractual obligations described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Off-Balance Sheet Arrangements

We are not a party to any off-balance sheet arrangements, including guarantee contracts, retained or contingent interests, or unconsolidated VIEs that either have, or are reasonably likely to have, a current or future material adverse effect on our unaudited condensed consolidated financial statements.

Critical Accounting Policies and Estimates

A summary of our critical accounting policies and estimates is presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Recent Accounting Pronouncements

As of September 30, 2023, there have been no material changes to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

For quantitative and qualitative disclosures about market risk affecting us, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Our exposure to market risk has not changed materially since December 31, 2022.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (“Disclosure Controls”) within the meaning of Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Our Disclosure Controls are designed to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Disclosure Controls are also designed to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

Based on management’s evaluation (under the supervision and with the participation of our CEO and our CFO) as of September 30, 2023, of the effectiveness of the design and operation of our Disclosure Controls, our CEO and CFO have concluded that our Disclosure Controls were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting during the third quarter of 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Internal Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Furthermore, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in business conditions or deterioration in the degree of compliance with policies or procedures.

Except as set forth below and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2023 and June 30, 2023, there have been no material changes to the risk factors disclosed in Part 1, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Our estimates of variable consideration related to revenue recognition in connection with guarantees that we have issued under certain customer contracts are difficult to estimate, and if our subsequent estimates differ significantly from initial estimates, we will be required to record an adjustment in a subsequent period.

Our estimates of variable consideration related to revenue recognition in connection with guarantees that we have issued under certain customer contracts are difficult to estimate, as they are based on some assumptions that may prove to be incorrect. For example, in certain customer contracts, the Company previously agreed to provide a guarantee that the value of hardware purchased by a customer will not decline for a certain period of time. Under these guarantees, if such customers were unable to install or designate the hardware to a specified project within such period of time, the Company would be required to assist the customer in re-marketing the hardware for resell by the customer. Such guarantees provide that, in such cases, if the customer resells the hardware for less than the amount initially sold to the customer, the Company will be required to compensate the customer for any shortfall in fair value for the hardware from the initial contract purchase price. The Company accounts for such guarantees as variable consideration at each measurement date. The Company updates its estimate of variable consideration, including changes in estimates related to such guarantees, each quarter for facts or circumstances that have changed from the time of the initial estimate. As a result of changes in its estimates, the Company recorded a reduction in revenue of $37.4 million during the three and nine months ended September 30, 2023. If our future estimates of variable consideration differ significantly from initial estimates, we would need to record an adjustment to earnings to reverse the revenue previously recognized.