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Sunrun Inc  (NASDAQ:RUN)
Q4 2018 Earnings Conference Call
Feb. 28, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and welcome to the Q4 Sunrun Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Patrick Jobin, Vice President of Investor Relations. Sir, you may begin.

Patrick Jobin -- Vice President, Finance & Investor Relations

Thank you, operator; and thank you for those on the call for joining us today.

Before we begin, please note that certain remarks we will make on this conference call constitute forward-looking statements. Although we believe these statements reflect our best judgment based on factors currently known to us, actual results may differ materially and adversely. Please refer to the Company's filings with the SEC for a more inclusive discussion of risks and other factors that may cause our actual results to differ from projections made in any forward-looking statements. Please also note, these statements are being made as of today, and we disclaim any obligation to update or revise them.

On the call today are Lynn Jurich, Sunrun's Co-Founder and CEO; Bob Komin, Sunrun's CFO; and Ed Fenster, Sunrun's Co-Founder and Executive Chairman. The presentation today will use slides which are available on our website at investors.sunrun.com.

And now, let me turn the call over to Lynn.

Lynn Jurich -- Chief Executive Officer

Thanks, Patrick. We are pleased to share with you Sunrun's fourth quarter and full-year financial and operating results along with progress against our strategic priorities. In the fourth quarter, we added more than 14,700 customers, representing 115 megawatts of deployments; again, breaking the record for the highest quarterly volume in the Company's history. We generated $116 million of net present value and created NPV per watt of $1.21 or over $9,600 per customer. In 2018, we executed our full year volume, NPV margin and cash generation targets. We grew deployments over 15% in the year. We added almost 50,000 customers growing our total customer base by 29% and closed out the year with about 233,000 customers.

We are excited about the year ahead. We are introducing guidance for growth to accelerate in 2019, unit margins to expand further and cash generation to grow by more than 50% to over $100 million. These strong financial and operating results can be achieved while continuing to invest in our customer experience and product leadership.

By the end of 2018, we had installed nearly 5,000 Brightbox systems and we expect Brightbox installations to grow in the triple-digits in 2019. We have already launched the service in eight states and it represents over 10% of our direct business and more than 25% in California. Brightbox provides customers with backup power, ability to manage time-of-use pricing and offers Sunrun additional revenue strength through energy services. It also protects us against attempts by incumbents to undermine the value of residential solar.

Today, we announced a large expansion with the Home Depot, further demonstrating the advantages of being the category leader. We will offer our solar and Brightbox battery service at Home Depot stores in 15 states, including California. We expect installations arising from the new stores to ramp throughout the year.

As David Wallace-Wells articulates, the slowness of climate change is a fairy tale. Not only is it happening faster than expected, its extreme weather events are destroying the very electric grid we rely on. We need to take action quickly. Sunrun is helping our country decarbonize through our rapidly growing customer base and pioneering work building the grid architecture of the future. Consumer preferences for clean energy they can control and rapid advancements in battery technology mean that households will increasingly get a major portion of their energy onsite.

The available market size, our leadership position and declining costs support our 200,000-plus solar customers turning into millions, independent of regulatory structures. However, there is even more opportunity for Sunrun and our country's ability to decarbonize if we advance grid architectures that incorporate the full value these assets can provide. Therefore, we are designing our footprint of energy assets to provide ongoing value to utilities and grid operators, as well as our individual customers. Most importantly, this will help us create a 100% clean energy future for Americans, a model for the rest of the world whether or not you have solar panels on your roof.

Demonstrating our success with these initial efforts, Sunrun wanted won its bid to provide 20 megawatts of energy capacity from Sunrun's Brightbox home solar and battery service to ISO New England beginning in 2022. We expect to deliver this capacity from approximately 5,000 New England customers. Our participation in this capacity market is the first time in the United States that a home solar and battery storage has directly participated alongside centralized power plants in the wholesale market. This signals a transformational shift away from the traditional, more polluting centralized electricity model toward the system powered by local clean energy like home solar and batteries.

While the size of the award is small compared to our large and growing customer base, is meaningful, because it suggests the future as utilities and regulators recognize the value of our assets can provide to the grid. This also represents an incremental source of revenue for Sunrun, which would be upside to our current customer value. We conservatively estimate grid services such as the capacity market in New England could represent over $2,000 in customer NPV. Our market share and density advantages will be an ongoing competitive advantage in accepting these opportunities.

Today, we also published our second annual Impact Report. Sunrun is a company that is committed to leading in ESG and sustainability. Our approach is to benefit everyone, our customers, our employees and the communities in which we operate, as well as our business and financial partners. I'm proud that Sunrun has prevented 3.7 million metric tons of CO2. We've also saved households over $300 million in electricity costs.

A few other key highlights to point out for 2018; we committed to and achieved 100% gender pay parity, we implemented a robust supplier Code of Conduct and we committed to developing 100 megawatts of solar for affordable multi-family housing over the next decade.

I'll now turn the call over to Bob Komin, our CFO, to review Q4 performance and discuss guidance in more detail.

Bob Komin -- Chief Financial Officer

Thanks, Lynn. Customer NPV in the fourth quarter was approximately $9,600 or $1.21 per watt. For the full year 2018, NPV per watt was $1.08, in line with our target levels despite the headwinds from tax reform and tariffs, with continuing investments in growth and product leadership. Project value per customer was approximately $34,900 or $4.38 per watt in Q4. As a reminder, project value is very sensitive to modest changes in geographic, channel and tax equity fund mix.

Turning now to creation cost on Slide 9. In Q4, total creation costs were approximately $25,300 per customer or $3.17 per watt. Similar to project value, creation cost can fluctuate quarter-to-quarter. Creation costs per watt were down 4% year-over-year. We expect creation cost to show modest declines for the full year 2019, even as we deploy more Brightbox battery systems. As a reminder, our cost tax is not directly comparable to those of peers because of our channel partner business.

Blended installation cost per watt, which includes the cost of solar projects deployed by our channel partners, as well as installation costs incurred for Sunrun-built systems, improved by $0.13 year-over-year to $2.48 per watt. Install costs for systems built by Sunrun were $1.96 per watt. We expect the adoption rate of Brightbox batteries to continue to increase, which will carry a higher per watt cost, but also a higher project value.

In Q4, our sales and marketing costs were $0.65 per watt. Our total sales and marketing unit costs are calculated by dividing costs in the period by total megawatts deployed. A higher mix of direct business results in higher reported sales and marketing cost per watt, and it also means that there will be lower blended installation costs per watt over time due to the higher mix of direct business installations at a lower cost per watt. For the full year 2018 compared to 2017, sales and marketing costs were higher and blended install costs were lower by approximately $0.18 per watt. In Q4, G&A costs were $0.22 per watt and $0.08 or 28% improvement year-over-year, demonstrating the benefits of operating leverage as the market leader.

Finally, when we calculate creation costs, we subtract the GAAP gross margin contribution realized from our platform services. This includes our distribution, racking and lead generation businesses, as well as solar systems we sell for cash or with a third-party loan. We achieved platform services gross margin of $0.17 per watt, in line with recent trends. In the fourth quarter, we deployed 115 megawatts. Our cash and third-party loan mix was 16% in Q4, also in line with recent levels. We expect this mix to be in the mid-to-high teens in 2019.

Turning now to our balance sheet. We ended the year with $304 million in total cash, a $29 million increase from last quarter. For the full-year 2018, we increased our total cash balances by $63 million without increasing our parent level debt by monetizing the tax attributes of systems we deployed and raising project level non-recourse debt, which is solely secured by cash flows from the underlying systems. We expect cash generation to increase to over $100 million in 2019. Quarterly cash generation can fluctuate due to the timing of project finance activities, but this represents our best view based on our plans for the year.

We define cash generation as the change in our total cash less the change in recourse debt. Also, please note that our cash generation outlook excludes any strategic opportunities beyond our current plans, along with ITC safe harboring activities, which we may undertake. You'll note the net income to Sunrun was slightly negative in the quarter, but positive for the year. We expect net income will also be positive for the full-year 2019.

Moving on to guidance on Slide 10. We are issuing full-year guidance of 16% to 18% growth in deployments, an increase in unit economics of $1.10 per watt or greater in NPV. In the first quarter, we expect deployments to be in the range of 83 megawatts to 85 megawatts.

Now, let me turn it over to Ed.

Edward Fenster -- Executive Chairman

Thanks, Bob. Today I plan to recap our December asset-backed security issuance and discuss our capital strategy for 2019. I will also review net earning assets and capital inlay. Over the last decade, strong asset performance has led the cost of capital for residential solar assets to improve steadily. That said, general market turbulence in November and December, when we priced our $322 million ABS transaction, bucked the trend a little.

Despite the imperfect market conditions, we are pleased to have exceeded our cash guidance for 2018. Although the cost of debt wasn't all that we had hoped, we achieved the lower yields and a substantially higher advance rate than the other residential solar lease securitization in market at the time. The print suggests that our capital cost advantage versus competitors is amplified during imperfect market conditions. First for the industry, our transaction is also fully amortizing and in about five years callable, thereby both reducing risk and preserving refinancing upside for the future. The note priced at a yield of 5.55%, but by January it had already traded up in the secondary market to a yield of 5.16% and market conditions continue to improve.

In December, we also closed a subordinated loan against the same asset pool as the ABS transaction. This loan is similar in nature to the National Grid project equity transaction, but structured as non-recourse debt. The loan is callable after the underlying tax equity fund slip affording us refinancing upside at that time. The total advance through tax equity, the ABS transaction and the subordinated loan implies an advance against 20-year project value in the 95% to 100% range, consistent with our prior comments. Looking forward, we still see the opportunity for higher advance rates and lower capital cost when refinancing seasoned assets. We expect to execute such a transaction by midyear.

For the full year 2019, we remain confident we can achieve more than $100 million in cash flow. We also expect that number can grow in years to come. I note this view of our free cash flow is presented before considering the impact of any inventory pre-purchasing we may do to preserve access to the investment tax credit at 30% rate into 2020 and beyond, given the high expected return on capital associated with such purchase. As the year progresses and our financing plans take firmer shape, we will update our outlook for cash generation accordingly.

Moving to Slide 11. At quarter-end, net earning assets was $1.4 billion, an increase of $222 million or 19% year-over-year. Cash was $304 million, an increase of $63 million or 26% year-over-year. Net earning assets is our way to describe the value of the cash flows to Sunrun shareholders after payments to financing counterparties. Turning finally to our pipeline, our debt and tax equity capital commitments already provide us runway well into Q3.

And with that, I'll turn the call back over to Lynn.

Lynn Jurich -- Chief Executive Officer

Thanks, Ed. Let's please open the line for questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from Michael Weinstein with Credit Suisse. Your line is now open.

Michael Weinstein -- Credit Suisse -- Analyst

Hi, guys. Very good print on the growth for this year, that's expected. One thing I wanted to ask you about was the Comcast deal. And maybe you can give us an update on how that's going. I think you were expecting 6,000 to 8,000 customers this year through that. And I'm wondering if you can compare the cost per customer at Comcast to whatever the mechanics of the deal is or with Home Depot.

Lynn Jurich -- Chief Executive Officer

Sure. One of the things we're excited about in terms of the guidance and what we think underscores that our acquisition mix is getting ever more attractive is that we're expanding the margin. So we finished this year with $1.08 in NPV and we're expecting north of $1.10 in 2019 and that's despite a pretty heavy ramp in Home Depot. You might imagine that you spend early to get the stores up and ramp before you start to realize some of the benefit there. So despite that headwind for the beginning part of the year, we're still going to exceed the margin. So I think we like both channels, we like where the mix is, where the mix is coming out. In terms of Comcast in particular, not a ton of update from the last call. We restructured the deal in order to make it just be more specific and work better for both parties in 2019. It's progressing as expected. If they end up hitting those numbers, then they will execute into the warrant and we look at the value of that and include that plus the lead fee and still think it's a competitive acquisition channel for us. And Home Depot as well, just given the comments that I issued earlier around despite the early ramp, we're still going to hit expanding margins for the year.

Michael Weinstein -- Credit Suisse -- Analyst

Got it. And when I look at -- those customer acquisition costs, is that showing up in the sales and marketing line on slide 14? Is that where I should see that? I'm just curious?

Lynn Jurich -- Chief Executive Officer

Let me just make sure that the slide is -- not looking at the slide (inaudible). Yes, correct, if you look at the acquisition costs on the key operating metrics, correct.

Michael Weinstein -- Credit Suisse -- Analyst

So at some point we'll see the lower customer acquisition costs in these two channels start to reduce those sales and marketing costs? And I think you said also during the call that there was a interplay between that and installation costs.

Lynn Jurich -- Chief Executive Officer

Correct. Yeah, let me explain that a bit. What will happen is that, the retail channels and the Comcast channels are fulfilled through our direct business. When we shift more to the direct business, you see the sales and marketing cost increase, but you see a similar decrease in the installation cost. The reason is because through the channel business, we capitalize everything, the channel spends money to acquire the customer and so we're buying the project, it's capitalized and that would go into the installation line. And so what you will actually see in that sales and marketing line is a slight increase in the year because of that mix shift hit direct, but the overall, to Bob's point, the overall creation cost tax should see a slight decline. So there is a little bit -- versus our peers, there's a little bit of noise in that given our multi-channel model. Thanks for asking that question.

Michael Weinstein -- Credit Suisse -- Analyst

Yeah, that's very helpful. Thank you. I'll see to the next person.

Lynn Jurich -- Chief Executive Officer

Thanks, Michael.

Operator

Thank you. Our next question comes from Colin Rusch with Oppenheimer. Your line is now open.

Colin Rusch -- Oppenheimer -- Analyst

Thanks so much, guys. Obviously you've demonstrated some of the value of being able to increase services from existing footprints. But can you talk a little bit about the growth opportunity and the cadence of opening new markets as you go through the balance of 2019?

Lynn Jurich -- Chief Executive Officer

Yes, new markets in terms of geographies (inaudible) Our current plan on hitting those growth targets does not anticipate entering any new markets; it's just growth in our existing markets. The incremental revenue opportunities we're really excited about for the long-term are the ability to both sell energy service to our customers, but then also sell energy services to the utility, and that was the announcement we made with the ISO New England capacity award just this quarter.

Colin Rusch -- Oppenheimer -- Analyst

Yeah, OK. So you're not expecting to enter any new markets in 2019 or you're just not guiding to any growth from those markets? I just wan to clarify that.

Lynn Jurich -- Chief Executive Officer

Yeah, precisely our guidance does not contemplate any new geographic market expansion.

Colin Rusch -- Oppenheimer -- Analyst

Okay. And then, just in terms of cost reduction on the non-module and non-equipment costs with installations, can you talk a little bit about where you're seeing opportunities to start trimming and optimizing some of those costs as you go through the balance of this year?

Lynn Jurich -- Chief Executive Officer

Absolutely. So first there is puts and takes in that number. One that you'll see we're -- as we've discussed in Bob's section, we're going to see a slight decline overall in that number and that is despite the fact that we're increasing the attachment rate of the Brightbox. So the cost of that battery is going into that line. So where we expect to see the positives are really around operating efficiencies. We still -- so the battery prices have really not come down much; they will, but right now it's still pretty immature supply chain. And so where we're going to see the benefits is really around operating leverage and installation efficiencies.

Colin Rusch -- Oppenheimer -- Analyst

Okay. I'll take the rest of it offline. Thanks so much.

Operator

Thank you. Our next question comes from Brian Lee with Goldman Sachs. Your line is now open.

Brian Lee -- Goldman Sachs -- Analyst

Hey, team. Thanks for taking the questions. Maybe first one just on the quarter. The operating lease revenue was up a healthy mid-teens percentage sequentially. It's a bit better than we've seen seasonally over the past couple of years. Just wondering, can you help us fair it out how much of that driven by volume growth versus mix, and wondering I guess how much of the (inaudible) volumes are helping that revenue line item here?

Bob Komin -- Chief Financial Officer

So if you're including incentives in the lease revenue number, Brian, that number is higher, the ITC revenues recognized in Q4 and Q3 have been higher and they've been in the past. So that's a big part of the reason that the lease revenue line has been increasing. And that's just due to the type of fund structure that we have in place. So with the financing obligation funds, we get to recognize the ITC revenues and it comes through with lease and incentive revenue. So I want to make sure that I know whether you're looking at it including incentives or whether you're looking at the revenue number excluding the incentive component.

Brian Lee -- Goldman Sachs -- Analyst

Yeah, just looking at the GAAP reported numbers, so all-in. So that ITC color is helpful. Should we be thinking about that as being highly variable into 2019? You don't know what you'll actually monetize on what fund in Q3 and Q4 of next year, so it could be a different dynamic or is this something that is a multi-year dynamic that we'll see extend out for the next couple of years?

Edward Fenster -- Executive Chairman

Hey, Brian. It's Ed. I think, obviously, as the year progresses, we can add or change our financing strategy. So it's difficult to predict fund mix that far in advance. That said, the transaction that was driving the higher ITC revenue in Q3 and Q4 of this year is materially complete and I would expect the revenue to be between $15 million and $25 million over Q1 and Q2 of next year as that transaction comes to completion, at which point I would expect it is most likely that we would return to the more traditional partnership flip structures, which result in increased income at the bottom of the P&L on the net loss attributable to the non-controlling interest line.

Brian Lee -- Goldman Sachs -- Analyst

Okay. No, that's helpful. Yeah, that will help us fine-tune the revenue model for next year. Maybe just second question on the battery side of the business and then I'll pass it on. Can you talk a little bit about the supply availability and sort of where you're positioned supply chain wise? I know some of your peers have talked about component shortages and battery supply availability issues. It doesn't sound like you're necessarily too worried about that based on the triple-digit growth expectation or target you have for 2019. But maybe if you could, just level set us there in terms of how you're positioned from a supply availability perspective? And then related to that, just the strategy around Brightbox, is this all a new-build strategy at the moment or are you embracing a retrofit strategy as well against the installed base just given how many 200,000-plus homes you now installed that, just trying to get a sense for what the kind of mix is on the battery side of the business. Thanks, guys.

Lynn Jurich -- Chief Executive Officer

Thank you. Great question. There are -- we do not anticipate any supply constraints. So we believe we're well positioned. A lot of that again is another advantage to be in the market leader. We can have good leverage with suppliers. So it's not something we're currently experiencing, and we're also really encouraged by all the innovation. You might expect, we're in conversations with a number of different manufacturers and we are optimistic that those innovations in that cost will come through. But again, this plan is anticipating supply that we're confident we have and no real cost improvement in the battery. So that's all upside for the future. In terms of the retrofit versus the new build, it is exclusively new build in that number. We will offer retrofit. We have not announced that or launched it yet. And the reason is that it's just much more cost effective, and we've been on a new build. And so that's where we've been focusing, but going back for the retrofit opportunity is a real opportunity for us in the future certainly.

Brian Lee -- Goldman Sachs -- Analyst

Thank you. I'll pass it on.

Operator

Thank you. And our next question comes from Julien Dumoulin-Smith with Bank of America. Your line is now open.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Hi, this is actually Eric on for Julien. Congrats on the quarter. First question, would you be able to talk about the year-on-year direct business growth both for fourth quarter 2018 and full year 2018 and how you see that going forward?

Lynn Jurich -- Chief Executive Officer

We have not typically broken that out. And the reason that we don't is because it's just not how we manage the business. We manage the business regionally to what is the most cost effective and strategic value chain. So what we can say is that the direct business did grow quickly last year. We do expect that it will grow quicker, more quickly than the guidance, than the baseline guidance. But beyond that, we're not going to break it out anymore, because it's just not how we manage the business.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Understood. And in terms of the Home Depot partnership ramping over 2019, presumably that should have more of a growth contribution into 2020, is that the right way to think about this?

Lynn Jurich -- Chief Executive Officer

The partnership, I think, certainly we expect 2020 would be -- have solidly more volume than 2019. However, we are in the stores, it will take some time to ramp, but we should see a nice contribution from it in-year as well; they will just be more weighted toward the back-half.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Got you. So we should still be expecting a portion of the guidance, growth guidance to come from Home Depot in 2019 just some more. Okay. And then, last question, in terms of the ITC Safe Harbor, would you view that as upside to the 16% to 18% growth range?

Edward Fenster -- Executive Chairman

So, this is Ed, hoping to answer the question. So if we -- Safe Harbor equipment that will be to extend the margin and/or growth rate in 2020 or 2021. It wouldn't have an effect on the 2019 megawatt growth rate. The comment, I think, I was trying to make in the prepared remarks was just that if we do execute a very large pre-purchase of equipment, it could consume some equity capital. And in the cash guidance, we are not contemplating that at the moment.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Right. So I'm just thinking more so 2020 and beyond. If you expect growth in the direct business to sustain from 2019 into 2020, so with 16% to 18%, would you see an ITC Safe Harbor supporting beyond that range of growth in 2022 through 2023 potentially, from a broad perspective? I know you guys obviously have not provided guidance for those years.

Lynn Jurich -- Chief Executive Officer

Yeah, certainly we have strong belief that the long-term growth rate in this market can be 15% to 20% for a decade. And we support that in our investor materials looking bottoms-up. And so we definitely certainly stand by that.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Okay. Thank you.

Lynn Jurich -- Chief Executive Officer

Maybe one thing worth pointing out on that is that, the Safe Harbor is a distinct advantage for the solar-as-a-service model, as compared to the homeowner model, because only commercial entities are able to take advantage of that Safe Harbor program. So we would expect that our competitive position would increase in subsequent years vis-a-vis the long tail of solar providers that are enabled to offer that service, as well as the size of our balance sheet, which enables us to safe harbor potentially a larger amount than our peers.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Got it. Much appreciated. If I could get one last question, sorry for this. In terms of the battery retrofit opportunity, do you have any view on potential pricing of that thus far? I know you've discussed upfront payments in Florida, but could we potentially see early -- effectively early renewals of contracts?

Lynn Jurich -- Chief Executive Officer

So your question was battery retrofit market size and contract renewals, did I get that correctly? Can you repeat it?

Eric Du -- Bank of America Merrill Lynch -- Analyst

Right. So with the battery retrofit in terms of how you would price the battery retrofit, I know in Florida, you guys charge a portion of it upfront for the new installations. I was just wondering if there's any potential opportunity for an effective early renewal of the contract win, including the battery like a 20-year contract on the date you retrofit.

Lynn Jurich -- Chief Executive Officer

We should get you on our product team. No, I think that's certainly a great idea. One comment I wanted to make that I had neglected to make earlier on Brian Lee's question on the retrofit. We do believe -- because we are in conversations with suppliers, we do believe that there will be shortly pretty (inaudible) on a cost perspective ways to retrofit people's batteries. So from a customer value standpoint and the customer experience standpoint, we are waiting and eagerly tracking those technologies to come to market. In terms of the opportunity to add a battery and extend the contract, I think, absolutely, I think that could be something we would, that we would certainly explore.

Eric Du -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Lynn Jurich -- Chief Executive Officer

Thanks.

Operator

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back over to Lynn Jurich, CEO, for any closing remarks.

Lynn Jurich -- Chief Executive Officer

Well, thank you, everyone. Thanks for listening and hope you have a great evening.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program and you may all disconnect. Everyone, have a great day.

Duration: 34 minutes

Call participants:

Patrick Jobin -- Vice President, Finance & Investor Relations

Lynn Jurich -- Chief Executive Officer

Bob Komin -- Chief Financial Officer

Edward Fenster -- Executive Chairman

Michael Weinstein -- Credit Suisse -- Analyst

Colin Rusch -- Oppenheimer -- Analyst

Brian Lee -- Goldman Sachs -- Analyst

Eric Du -- Bank of America Merrill Lynch -- Analyst

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