Q2 2023 Spruce Power Holding Corporation Earnings Call

Good afternoon, and welcome to the spruce power second quarter 'twenty twenty-three conference call. As a reminder, today's call is being recorded all participants are in listen only mode.

For opening remarks, and introductions I would like to turn the call over to brought in flag head of Investor Relations first Bruce power. Mr. Flag. Please go ahead.

Thank you good afternoon, and welcome to Spruce Towers conference call to discuss results for the second quarter of 2023 with me today are Christian Fong, our Chief Executive Officer, and Sarah Wells, Our Chief Financial Officer. Our call. This afternoon will include statements that speak to the company's expectations outlook or predictions of the future.

As you consider forward looking statements within the meaning of federal Securities laws.

These forward looking statements are subject to risks and uncertainties many of which are beyond our control, which may cause our actual results to differ materially from those expressed in or implied by these statements. Similarly out of our controls the timing of some of the processes, we will discuss today, which could impact the expectation of our latest statements you will hear shortly we are not obliged.

To revise or update any forward looking statements, except as may be required by law. Please refer to our disclosures regarding risk factors and forward looking statements in today's earnings release, our annual report on Form 10-K, and our other Securities and Exchange Commission filings a copy of our press release has been posted to the Investor Relations page of our website for reference.

The U S. non-GAAP financial measures discussed in this call are reconciled to the U S. GAAP equivalent and can be found in the press release that we issued this afternoon with that I'll turn the call over to our CEO Christian Fong Cristian go ahead.

Thank you, Brian and thanks to everyone for joining us on the call today as we discuss our strong second quarter results and progress in 2023 initiatives that extend our core business of distributed generation solar power for those new to spruce. We have three primary businesses first we create and sell clean electricity through our growing solar powered poor.

Polio second we deliver power services to our customers with servicing creating strong margins and business development opportunities third we profit through participating in the related environmental commodities markets.

This year, we've kept our differentiated customer strategy rather than carry a high cost sales force, we add customers through the acquisition of existing power portfolios with long term purchase contracts and leases.

Simpler, it's flexible and it's allowed us to have arguably the lowest customer acquisition costs in the industry. We demonstrated the strength of that growth strategy by expanding our portfolio of home solar assets and contracts by over 40% with the acquisition of the spruce power core portfolio.

With the transitional tasks associated with our merger with XL fleet, mostly complete and the first full quarter of spruce power or in the books. What we're selling today are the result of a clean quarter.

I want to break my comments into three focus areas. The first will be operations, and then growth initiatives and then capital markets.

Okay operations of course spruce is not a financing company, we actually make and sell a product and provide services to our customers. We are an operating company and so our goal is operational excellence our company facilitates the solar electricity consumed by about 80000 households across 18 states for these.

Families to enjoy zero emission electricity that is reliable and cost advantaged, our spruce servicing team delivers best in class excellence in its execution of customer billing collections and support asset management system repairs and the complex technology that links all of that together for a smooth customer experience.

The ultimate measure of operating Excellence, then is customer satisfaction, our second quarter customer satisfaction score was 70% right in line with our 70% target and up substantially year on year from 53% in the second quarter of 2022. This is our third consecutive quarter of meeting our target helped by several million.

As a technology and personnel investments, we made and customer operations in Q2, we rolled out customized changes to our billing system service by SMS text and a completely retooled customer home transfer process to bring that to a five star level, we continue to strive for an even better experience for our.

<unk>, our customer focus groups have given us valuable feedback this year. They are asking for the latest and greatest technology, No AI, driven computer systems or a flashy mobile app with streaming data on one hand, we're going to keep building a solid backbone developing technology and asset management tools at the pace of about $2 million.

Per year, yet on the other hand, AI technology is incapable of empathy, our customers place the highest value on direct interaction with our well trained U S. Based service team real people and real interactions. So we are also pleased to announce a new pilot program to place our own field services team.

<unk> and our highest asset density areas starting in the northeast field services will lock in our own Labor force, which will both get faster O&M to our customers and create more human interactions that person to person service is key to building spruce as a trusted brand to deliver additional products such as <unk>.

On batteries.

Bruce as a clean energy producer so let's hit the production numbers, our Q2 performance ratio, which is the production compared to the theoretical maximum of the installed solar panels with 95%. We achieved this despite impact from the Canadian wildfires smoke through the quarter as well as negative weather in California in June .

Our weather adjusted performance ratio was a strong 103% at 103% spruce is asset management team is strongly outperforming the projections, we get from top independent engineering firms, who review our portfolios at the time of their acquisition.

The strong physical performance of our portfolio leads to strong financial performance to cash inflows were solid this quarter and while there are still some legacy XL fleet issues. The tie off we delivered a clean quarter that showed spruce powers financial performance last quarter, we spoke to a current run rate of 110 million to $130 million.

Of annual business cash inflows, primarily coming from our portfolio of home solar assets and contracts in.

In the middle of the cash funnel, our cash flows remaining after opex SG&A and that interest.

And that we expect an annual range of 35% to $45 million ultimately leading to between five and $15 million of net cash flow after principal payments.

That's the exact same level as we discussed last quarter that as we are affirming that financial framework.

Long term our primary operations driver is our professional team last quarter, we announced their wells as CFO also spruces longtime chief legal officer, Jon Norling assumed the responsibility of the board Secretary installed leadership of the legal Department more importantly, we are deepening our management team with strong hires of experienced directors and team.

<unk> new.

New leadership and bench strength in F. PNA M&A collections Treasury and litigation gives us our best cross team collaboration ever.

Related to team growth. This fall the executive team will move into our new Denver headquarters and our Houston servicing group will expand its office footprint by about a third it's not a hiring Ben's just spruce. This staff shifting back to in office work for better productivity and career development.

Okay.

Now, let me shift gears to talk about our growth and capital strategy as I mentioned before Bruce has a growth strategy that gives us what is arguably the lowest customer acquisition cost in the industry not only do our costs continue to stay low spruce is M&A team finds deals that generate impressively high cash on cash returns for years into the future.

So instead of talking about one time sales margins, we think in terms of multiples on our investments and our stability grows with the portfolio that has over 12 years average contract life remaining spruce is growth isn't the sugar rush of onetime sales. We think investors are better served by the muscle building nutrition of recurring.

<unk> high margin cash flows.

In Q2, we focused on integrating the portfolio we bought at the end of Q1, the spruce power for portfolio, which increased our rooftop solar assets and contracts by about 44%.

In this initial quarter under our ownership, we actually saw the portfolio as customer payments perform about 5% better than our initial expectations due to the underlying PPA contracts many of which are indexed to the rapidly escalating retail electricity rates in California.

We're now looking at our next growth acquisition in July we signed a letter of intent to acquire a portfolio of approximately 2400 home solar systems, all with long term customer contracts from a publicly traded counterparty we hope to close in the next few weeks, though of course can't comment on specifics and nothing is.

Certain until the ink is dry however, we can say that the transaction is underwritten to meet our mid teen Levered return target and we're excited that it bring us past 75000 home solar assets and contracts, we expect to fund the equity portion of the acquisition with cash on hand, and nonrecourse senior debt.

It's worth noting that after the banking scare this spring the debt markets have bounced back fast and we're seeing an abundance of debt offered to us at attractive terms. One last point on growth. We have two areas of organic growth that are picking up pace. The first involves actually increasing the cash flow from our home power systems, we already own.

By more efficient participation in the environmental commodities markets or by acronym ECM.

Our ECM business is finding more efficient ways to mint and sell renewable energy credits from our assets around the nation.

In Q2, we saw a strong uptake in the value and cash flows leading to quarter on quarter growth.

<unk> to 10% on a GAAP basis.

The second area of organic growth as increased natural demand for retrofit battery installation really for the first time spruce is offer that product for a couple of years, but the economics of a battery lease or a sale with a tough sell what we're seeing is that adjacent to California's new net metering rules. There is real demand for home battery.

George from our California customers, we arent internally budgeting material battery lease revenue for the rest of 2023, yet as we finished the business infrastructure to begin taking advantage of it.

We're working on partnerships to more quickly address that demand and also see our new field services initiatives as an important long term way to meet the demand.

So just to wrap up on organic growth, even as we execute on our strategy of acquiring portfolios of assets. We're excited to see a neat opportunity for increasing revenue per customer.

On capital.

We have plenty of cash and even in the current debt markets with higher interest rates. We believe we are fully funded to achieve our near term goal of reaching a customer contract portfolio at 90000 by the end of 2024 one.

One final point before handing the call to Eric every quarter, we have any number of choices of how to deploy the capital to which you've entrusted us naturally an acquisition as the top choice. If the portfolio is solid and the price will yield attractive cash returns with the board authorization of our share repurchase program in May we began to purchase our own stock.

In our view that stock is priced far below its fair value and is a great buy for investors, including ourselves. We bought about one 9 million shares in Q2, and just keep going through August 4th we've repurchased about three 6 million shares for about $3 2 million.

I want to bring into our conversation we had everyday here.

Our stock sitting at a buck.

On institutional feedback from the buy side conversations with research analysts and investment banks. They cite the overhang of having so many shares outstanding that even strong company value gets obscured by the math of a huge share count.

Not a function of operations, but if the unique way we became a public company, maybe it's just math, but fortunately it's within our control. So last week, our board authorized a plan to consider a one for eight reverse stock split. This week, we filed the preliminary proxy with the SEC and in the next couple of weeks, we plan to call a shareholder.

Meeting in early October for approval, if shareholders approved a reverse split is intended to get us well above the dollar level necessary to maintain our NYSE listing.

With that I'll hand, the call over to Sarah to walk through the financials.

Thanks, Christian before getting into quarterly results I would like to quickly address a few housekeeping items that impacted our financial reporting.

And as I said, what the prior June quarter legacy XL business, the drivetrain and XL, Greg are presented as discontinued operations within our financials.

These legacy businesses were divested in the first quarter of 2023, and we do not expect any material expenses going forward related to discontinued operations. Our continuing operating results reflect certain expenses related tax healthy, notably legal expenses related to the previously disclosed SEC inquiry.

And related shareholder lawsuit, we are working to close these legal matters, but do you expect to incur future global costs.

As we state in our 10-Q, we believe the allegations in the SEC inquiry and shareholders are without merit and the company is vigorously defending itself.

At this time, we cannot estimate the timing of resolution of these matters, nor the impact of any related liabilities.

Also as Christian mentioned this race power for portfolio acquisition closed in late March and second quarter results fully reflect this investment. However, please recall that GAAP accounting treatment for this very powerful our portfolio acquisition places the majority of cash flow stream from the portfolio in the cash flows from the investing section of <unk>.

Our consolidated statement of cash flows.

And as you noted.

<unk> from investment related to <unk> Master lease agreement. However, note that operating costs and interest expense tied to our senior debt supporting spruce powered for are reflected in the statement of operations.

Moving to Q2 financial results.

Second quarter revenue, which consisted exclusively experience related revenue was $22 8 million compared to $18 1 million in the first quarter of 2023 revenue was higher sequentially due to more set hours across our fleet that is just normal seasonality as well as quarter on quarter improvement in our portfolios weather adjusted.

Performance ratio and the resulting impact to our PPA contracts.

Second quarter, Opex, which includes both SG&A and portfolio O&M and excludes depreciation was 19 million compared to $17 $6 million in the first quarter.

Portfolio O&M expense increased to $3 million in the second quarter from $1 9 million in the first quarter.

<unk> increase is tied to accelerated activity in our meter upgrade camp home as we replace legacy meters across our fleet to maintain the most efficient fleet possible.

SG&A expense increased modestly to $16 million in the second quarter from $15 $7 million in the first quarter <unk>.

Integration costs tied to our public merger process tailed off and largely concluded in the quarter. However, SG&A continues to be impacted by certain legacy ex healthy corporate items, namely legal expenses associated with the previously disclosed SEC inquiry and shareholder lawsuit.

Collectively integration costs and legal expenses totaled close to $5 million for the quarter.

Excluding these expenses core spruce, opex will be closer to $11 million in it.

<unk>, which we believe offers a clear view of Opex for a standalone spruce power.

On a GAAP base net income from continuing operations was $1 8 million compared to a $15 million loss in the first quarter of 2023.

Adjusted EBITDA totaled $9 $5 million, adding into cash flow from the spruce power for portfolio, which is call. It in our financials proceeds from investment in lease agreements, bringing the total to $13 $8 million.

This compares favorably to $5 7 million in the first quarter.

In measuring the value of our long term solar assets and contracts, we've provided metrics on growth and net portfolio values, which represent the present value of the remaining net cash flows of our rooftop systems and contracts discounted at 6%.

As of June 30th gross portfolio value with $929 million.

After adjusting for non recourse debt and cash balances, our net portfolio value was $477 million.

Next I'll speak to our capital and liquidity position.

As of June 32023, we had cash cash equivalents and restricted cash of approximately $192 million. This compares to $205 million at the end of the first quarter of 2023. The sequential decrease is primarily attributable to the seasonal timing of semiannual mezzanine debt payment and portfolio.

Got it.

The total principal balance of long term debt was $644 million as of June 32023, as a reminder, all of our debt is nonrecourse project level debt that is supported by our long term contracts in.

In the current rate backdrop, we think our debt is attractively priced with a weighted average cost of approximately five 6% and because our variable rate senior debt facilities are mostly hedged by interest rate swaps. Our overall debt is 97% fixed rate with the swap tenor extending well beyond the license alone.

First is earliest debt maturity is in August 2025 to date, we have primarily utilize nonrecourse project level debt to fund acquisitions for.

For context. These facilities have typically been structured with tenures of around seven years, none of the underlying contract and associated payment streams will extend well beyond the tenure of the debt facilities. This structure. It's typical in project finance debt markets.

Given the nature of our long lived cash flows we are confident that we will be able to refinance our debt facilities. Upon maturity, we have strong relationships with current and prospective lenders and renewable power get markets, where we see the appetite for residential solar as robust.

Moving next to capital allocation as Christian mentioned every quarter, we have any number of choices of how to deploy the capital. In addition to debt repayment during the second quarter, we purchased approximately one $6 million of our own stock through our share repurchase program.

We believe this opportunistic investment represents tremendous value.

Our repurchase program does not require us to purchase a specific amount of shares. However, we believe that the market value of our shares is well below the intrinsic value of the company.

Every share purchase is accretive to our per share metrics. So we have stayed active and from the start of the program through the end of last week, we have cumulatively repurchased approximately three 6 million shares for $3 $2 million.

I will now hand, the call over to the operator for Q&A operator, Please open the line for questions.

Thank you at this time I would like to remind everyone in order to ask a question. Please press Star then the number one on your telephone keypad.

Your first question comes from Joseph Osha with Guggenheim. Your line is open.

Hello. This is actually Hilary on for Joe and I, just first wanted to touch on your comments during our prepared remarks on extracting the extra value off the existing system and just wondering if you could share any color in terms of how we should kind of expect to see you extract any incremental value there.

Sure Larry Thanks for joining.

When we think about I'll call it organic the organic growth portion of being the owner and operator. So there's two ways to do it of course, one is just to increase revenues and when we think about the increasing revenues from the current portfolio. We have two mechanisms to do that one of them is it is pretty active right now and that is the merchants.

Of additional SRAM core environmental commodities.

It's really around the country and.

That is through our environmental commodities markets group ECM.

And Thats why we touched on it as being a quarter on quarter, 10% growth.

Those markets are increasing its added revenue directly from the portfolios that we already own then looking on into the future you can upsell to customers added sales and that was the the batteries that.

So we're starting to see quite a bit of demand out in California.

So the additional sales to the customers with an increase and that would be thinking of it not as increasing the to the revenue from like a system, but from thinking of it as a portfolio of customers.

And underlying homeowners that would purchase additional products. So that's the first way the second way of course is simply to manage our costs and to make sure that on an ongoing basis the per unit costs that we have.

Servicing or owning the systems continues to go down and that just increases the.

Net margins are intended to do both.

We're seeing the increase in revenue.

And as we increase the size of the service portfolio.

Scale starts to kick in and we see decrease per unit cost as well.

Okay.

Great and then just.

Building to the 90000 customer target that you guys have just wondering if you could provide an update on kind of the competitive landscape and any color you could share on that pipeline of potential deals.

Yes.

As usual, we don't speak to any specific line items.

And our pipeline report that we would have internally.

You mentioned this.

Non binding.

Lowy letter of intent that we signed.

Clearly, but by even mentioning on the call we're signaling a level of confidence that that we're nearing a closing in the next couple of weeks anything can happen deals or deals.

But that would get us to around 75000 home solar assets and contracts.

We started at around 51000 or so at the beginning of the year. So when we talked about going from.

Just do the short hand here 50 to 90, and we're thinking we need to add about 20000 per year with the large spruce tower for.

Acquisition largest center history record size that got us.

Like a full year's growth from 50 to 70, plus and so.

As we look at in Q3, the potential of adding.

About 2400 systems and landing at 25 75000.

We're well on pace to get to 90 by the end of the year.

I'm sure some folks will say well want to just go ahead and raise your your target.

Have the team go buy isn't more probably premature for that though we are just confident because we do have bilateral negotiations going we've got bids out currently.

And so rather than talk about any of the one by one let me just affirm that we are still confident that we.

Yes.

Have enough runway in time and seeing enough deals to still feel good about that 90000 target.

Great.

Hilary you kind of asked the second question let me.

<unk> landscape for the life of me I cant figure out why other folks arent buying because the returns that we're getting are so strong for our shareholders and we're really happy with that and we're just always kind of looking over our shoulders, saying who else might jump in the reality is is that buying things as heart M&A, it's not an easy business in.

<unk> is not an easy business. We spent the last five years developing that muscle memory.

How to bid being the being a low execution risk counterparty people know that we're good for a handshake that when we say we're going to do something we actually have the means and the expertise to do it we believe that makes us the preferred buyer and M&A.

Especially in residential solar and so we continue to see things.

Yes, there are other folks that are competing and yet our.

Our scale our expertise.

I'd like to take a reputation as counterparties enable us to be the preferred buyer for a lot of potential sellers.

Okay.

Great. Thank you.

Your next question comes from Jordan Levy with <unk> Securities. Your line is open.

Hi, Bill it's Henry on for Jordan here really great to see the inflection to positive earnings. This past quarter. I know you mentioned the recent merger, but any other additional color you can provide on some of the core drivers behind that.

Yes sure.

We saw really strong production from our assets in the quarter as Christian mentioned in the prepared remarks, our weather adjusted performance ratio was above 100% and so on.

Our assets are operating really well.

Paired with normal seasonality drove the top line on the cost side, we still have some legacy XL costs coming through mainly legal costs.

All of the integration costs that we saw with the merger like the people cost although that has mostly rolled off and so we are really excited about this inflection and to continue to build on our improvements on the bottom line.

Awesome. Thanks for that and then I know I know.

You noted you've been active.

The share repurchase program in the quarter, and then going forward and so I'd love to get any color on the kind of the balance you see.

With acquisition opportunities, obviously, the buybacks anything LTC kind of going through the end of this year and then into 2024.

Sure.

Going forward the repurchase is always going to be part of our cash to drive shareholder value I don't see that going away. We do view the program is twofold first.

Has to offer value and if that's happening and then secondly, we also benefit with serious acting as an incremental buyer of our own stock. So I see the repurchase program and the reverse split kind of all working.

Towards that same goal.

And Henry just to.

Put numbers on that it was a $50 million program. So we still got 46 point some.

Million of dry powder in the in that program.

Thank you.

There are no further questions at this time I will now turn the call back over to Bronson flag for closing remarks.

Thank you operator, and thank you again for joining us today and for your continued support if you have any questions. Please contact me or our Investor relations team.

This concludes our call today you may all now disconnect.

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