Spruce Power Holding Corporation (NYSE:SPRU) Q4 2022 Earnings Call Transcript

Spruce Power Holding Corporation (NYSE:SPRU) Q4 2022 Earnings Call Transcript March 23, 2023

Operator: Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spruce Power Fourth Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Bronson Fleig, Head of Investor Relations for Spruce Power. Please go ahead.

Bronson Fleig: Thank you. Good afternoon, and welcome to Spruce Power’s conference call to discuss results for the fourth quarter and full year 2022. With me today are Christian Fong, our Chief Executive Officer; and Donald Klein, our Chief Financial Officer. Our call this afternoon will include statements that speak to the company’s expectations, outlook or predictions of the future, which are considered forward-looking statements. 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 control is the timing of some of the processes we will discuss today, which could impact the expectation related statements you will hear shortly.

We are not obliged to revise or update any forward-looking statements, except as maybe 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 non-GAAP financial measures discussed in the 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 will turn the call over to our CEO, Christian Fong. Christian, go ahead.

Christian Fong: Thanks, Bronson, and thanks to everyone for joining us on the call today. Welcome to our first earnings call as the new Spruce Power. Although our Q4 and full year 2022 financials will reflect the results of the divested operations of XL Fleet, as we speak to you today, the transformation to Spruce Power is largely complete. Last quarter, we talked about our post-merger path being three steps that is finishing the strategic review of the legacy XL businesses; then transitioning the management team; and finally, resuming growth through portfolio acquisitions. With the exit from legacy XL businesses, our sole business now is owning, operating and servicing rooftop solar installations. I resumed the CEO role on February 1st, and the company is led predominantly by the executive team that builds Spruce Power over the last five years.

Our name has changed and our headquarters moved to Denver. In all regards, we are a pure-play residential rooftop solar company. Finally, we hit the ground running on portfolio growth. We announced earlier today that we acquired a portfolio of over 22,000 customers, more on that in a moment. Bottom line, we executed the plan we described last fall and our future has never been brighter. Strategically, Spruce starts 2023 in a position of strength with a stable portfolio that generates significant recurring revenue. Importantly, during turbulent economic times, we have access to substantial growth capital. We started 2023 with over $200 million of cash. Furthermore, our common stock when properly valued by the market can be used to fund future growth.

Simply put, cash is king, and we have it. Including today’s portfolio acquisition, we own rooftop solar assets and contracts in 18 states, powering over 70,000 homes. We also provide billing, maintenance and renewable energy credit services to third-party clients for another 7,500 customers. We are among the top five owner-operators of U.S. residential solar companies based on 2022 revenue. With our highly differentiated growth strategy, we believe we can eventually move into the top three. What do we do differently? We don’t directly originate or installed rooftop systems. Instead, we purchased entire portfolios of rooftop assets from developers and other asset owners. Origination and installation are labor, sales and capital intensive. Our model enables us to achieve scale more quickly by buying systems cheaper and faster than we can build, and we don’t tie up working capital.

We think recent capital markets volatility highlights the stability of asset ownership versus other pass-through origination models. Importantly, our rooftops are not passive financial holdings. There are opportunities to increase revenue. We can sell through our existing customers’ add-on technologies that are a part of what we call the Home Power Systems 2.0 that if customers start with solar, then add other products like battery storage, smart grids, and consumer power components, as systems get complex, we can offer management of residential energy data, renewable energy credits, and other services that move customers toward greater savings and greater energy independence. For now though, Spruce’s growth is being driven by acquisitions of systems and customers.

Furthermore, the recurring revenue and high margins of rooftop solar have enabled access to plentiful non-recourse project debt. We started 2023 confident that we had access to capital sufficient for growth to well over 100,000 rooftops. We set a near-term goal of over 80% growth by the end of 2024. That goal would take us to over 90,000 rooftops, creating meaningful scale. From a strategic standpoint we expand our customer and geographic base, from a financial standpoint we expand the operating margins on the entire portfolio, even while preserving capital for future growth. The large acquisition announced today in one step gets us halfway to our goal of 90,000 rooftops, well ahead of schedule. Rooftop solar is a customer-oriented industry, so we also intend to differentiate customer experience.

We are committed to creating the best customer experience possible, which we believe also requires a great customer facing employee team. We are dedicating resources to elevating both the customer experience and the quality of our team. We’ve built a Texas based customer experience team, invested in supporting technology, leading to substantial improvements in customer satisfaction ratings. In 2022, we went from 54% customer satisfaction in the first quarter to 81% in the fourth quarter. Our customer experience improvements were driven by a strong service team committed to building their technical knowledge and deepening internal collaboration. At our recently launched Spruce University, more than half the company is now working toward a Spruce Solar certification.

We expect this more knowledgeable staff to provide better, faster, and smarter answers for our customers. As a result, they should also be more effective at selling appropriate products for future upgrades. And to better attract talent, we raised our minimum wage from $15 to $17. Because our interface with customers increasingly depends on technology, we are upping investment in customer-facing systems. In February, we launched an efficient, new billing system. It gets monthly invoices to customers nearly a week earlier than the old system and provides our customers with a single sign in online interface to access their account. We expect meaningful improvements in customer satisfaction and cost savings because today only 5% of our customer interactions are through virtual tools.

Customer service is still primarily the alive personnel. There are trade-offs, of course, personalized service can lead to deeper customer interactions. If feedback from our customers is unambiguous, they want the speed and efficiency that come from technical tools, that’s why we are working hard in 2023 to build those capabilities for an even better customer experience. Now, let me get specific in outlining Spruce Power’s goals for 2023 and 2024. First, we started 2023 with the goal of growing our customer portfolio by about 80% in the next two years, which would take us over 90,000 rooftops. Beyond customer count growth, we’re also looking for growth in the average number of products and services each customer uses, which improves both our share of wallet and share of mind, as customers make decisions about their home power.

Since we grow through acquisition, we have a rate of return hurdles too and target an equity IRR in the teens for new acquisitions. Second, we want to maintain a balanced use of capital, especially when it comes to our mounting positive cash flow. Over the next two years, we expect to allocate 10% to 20% of our EBITDA to capital improvements for upgrades to individual systems, as well as building out the stronger customer service technologies. Beyond these critical investments, our approach to capital allocation will emphasize maximum flexibility for growth on a per share basis. We may allocate cash flows to future acquisitions, debt repayment, or other measures that we feel best enhance returns to our shareholders. Third, we aim to steadily improve financial performance.

The primary financial performance metrics that we manage toward are EBITDA and free cash flow. We also watch a handful of secondary metrics. First, the subscriber value of the owned portfolios, recurring cash flows, which we report on a quarterly basis. Secondly, our net debt level relative to EBITDA. Let’s examine our goals for each of these. For EBITDA and cash flow, we intend to build long-term value for shareholders by growing predictable recurring cash flows with high credit quality customers. For subscriber value, we enable you to easily compare us to our residential solar peers by reporting the net present value of the future cash flows from our own portfolio using a 6% discount rate currently. For net debt-to-EBITDA, this size adjusted measure is the ratio of our debt balance net of our cash and interest rate swap value divided by EBITDA.

Over time, we intend to reduce this metric from the current 6.8x. However, considering recent turbulence in the banking sector, we may also seek better terms or transparency from our debt partners. Please keep in mind when valuing us that our debt is entirely non-recourse project debt with first maturity is still at least three years out. Our debt was struck at attractive rates across the whole debt structure we are paying a composite rate of about 5.5%, and I want to emphasize that we have zero corporate recourse debt. Let me make one final note on financial performance. We intend to grow recurring EBITDA by investing in redeploying cash flow into acquisitions with high IRR, yet knowing that our cash flow can also pay down debt, we always have the two good options of either growing per share cash flows, or strengthening our balance sheets.

Both are good near-term outcomes. Beyond financial performance, you should also evaluate our performance in customer experience. We finished 2022 with an average customer satisfaction or what we call CSAT, average CSAT score of 62% for the full year. We ended the year with an extraordinary fourth quarter score of 81%. Our 2023 goal is a full year CSAT exceeding 70%. We intend to drive improvement by investing in new employee tools, continued staff training, and we also expect to steadily improve externally reported reputation scores. Also look for wise use of new technology. Nearly 100% of our portfolio CapEx is for technologies that improve customer experience, especially as residential power shifts from a home infrastructure product to the interactive experience of a consumer good.

We have two big projects underway. First, we are implementing improved asset level monitoring systems. We have already upgraded about 65% of our original 3G based monitoring to 4G and 5G or WiFi meters. Second, we are building our own integrated enterprise technology stack that enables our customers to interact with their Spruce Home Power System. We expect to complete both projects by the end of 2024. As we look ahead, my confidence in our 150 strong person team has never been greater. I laid out hard but achievable goals, and I know our team is up to the task. If we succeed, which we fully intend to do will create substantial value for both our customers and our shareholders. Before I turn the call to Don to review financials, I want to discuss the exciting portfolio acquisition we announced earlier today.

We acquired a portfolio of approximately 22,500 residential solar contracts across 10 U.S. states. We called this portfolio the SEMTH Portfolio. SEMTH consists of cash flows generated by high quality residential solar systems. The systems were originated by the home builder Lennar and its legacy residential solar platform SunStreet. This is our first large scale acquisition as public company and the largest in our corporate history. It grows our system ownership by 40% literally overnight, demonstrating the power of our strategy to drive step change growth. We believe this deal immediately and substantially increases the value of Spruce. The SEMTH Portfolio has strong underlying cash characteristics with clear line of sight to substantial recurring customer collections of about $23 million annually.

The portfolio is highly profitable. Underwritten portfolio EBITDA for 2023 of about $18 million lead to an attractive rate of return with an unlevered IRR of about 10%. It also improves our visibility for long-term recurring revenue with its nearly 15-year average contract life averaging up our existing portfolios to approximately 13 years. Finally, credit risk is solid. Customers credit resembles our existing portfolio with an average customer FICO score of 738. The SEMTH acquisition is a great step forward for Spruce as we started as a publicly traded company, but it’s far from our last deal. We believe there’s a compelling set of growth opportunities in our market. Reiterate what I said last quarter, we can’t normally comment on specific opportunities we’re pursuing, but we do continue to expect a stair step function in growth as we pursue both large and small portfolios in the quarters ahead.

With that, I’ll now turn the call over to our CFO, Don Klein to walk through the financials. Don, go ahead.

Donald Klein: Thanks, Christian. Before we discuss our fourth quarter results, I’d like to walk through a few items that impacted our financial reporting. As Christian mentioned, with the completion of the acquisition of Spruce and transitioned to solar, we announced that we were pursuing a strategic alternatives for our Drivetrain business. In December, we exited the Drivetrain business including the sale of a portion of the business, which closed in January. We also explored alternatives for the XL Grid operations, which primarily consisted of World Energy Efficiency Services. In January, we completed the sale of World Energy. Because of these exits, both are treated as discontinued operations in the fourth quarter. The related operating results are presented as a single line in our income statement, loss from discontinued operations.

For the fourth quarter, our revenues and continuing operating results reflect the results of Spruce as well as certain corporate functions of the legacy XL operations. This gives a clear picture of our results from continuing operations, but note that the results include restructuring charges and costs that we expect to run off in 2023 as we finish up integration of the two businesses. Starting in Q1 2023, results will more fully reflect operations of Spruce Power rooftop solar business. With that, let’s move on to results. Fourth quarter revenue, which consisted exclusively of Spruce related revenue was $18.1 million, compared to $5.1 million in the third quarter of 2022. Third quarter revenue had only 21 days of contribution from Spruce. Keep in mind that fourth quarter is typically a lower revenue generating quarter for us due to weather related impacts on solar production.

Fourth quarter selling, general, administrative expenses were $28.6 million, compared to $27 million last quarter and $11.6 million in the fourth quarter of 2021. Fourth quarter SG&A includes approximately $3.8 million in legal fees related to the previously disclosed class action complaints and SEC investigation. It also includes restructuring related charges of $8.4 million related to our integration and transition efforts. Adjusted EBITDA totaled $3.5 million compared to negative $8.3 million in the prior year quarter. As of December 31, 2022, we had cash, cash equivalents and restricted cash of approximately $240 million. This compares to $272 million at the end of the third quarter of 2022. The sequential change in cash includes approximately $9 million used for debt repayment and approximately $8 million for the buyout and distributions of tax equity partnerships.

The total principle balance of long-term debt as of December 31 was $533 million. As noted at the time of the acquisition of Spruce, our leverage is in line with industry average for the sort of business we operate. All our debt is non-recourse and backed by our long-term contracts that provide annuity like cash flows. The debt is very attractively priced with a weighted average interest cost of only approximately 5.5%. Our mezzanine debt is fixed rate, while our variable rate senior debt is approximately 97% fixed through interest rate swaps. Again, it’s worth noting that our first maturity is not until April 2026, providing ample flexibility to manage future capital structure and financing costs. In measuring the value of our long-term solar contracts with customers, we have provided metrics on gross total subscriber value, which represents the present value of the remaining net cash flows of our rooftop systems and customer contracts discounted at 6%.

As of December 31, gross total subscriber value was $741 million. Now, we’d like to open the call for any questions. Operator, please go ahead.

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Q&A Session

Operator: Thank you. Your first question comes from the line of Joseph Osha with Guggenheim Securities. Your line is now open.

Joseph Osha: Hey, there? Can you guys hear me, okay?

Christian Fong: We can, Joe.

Joseph Osha: Hey, so thanks for this. That was really interesting. I got a couple of questions here. First, when you buy a portfolio like the one you just bought. Does that typically come? Are you bringing the existing debts along with it? And if so, what opportunities exist as you bring this business onto your platform to potentially refinance that debt?

Christian Fong: So we did assume the non-recourse project debt for this portfolio of $125 million was the €“ was that loan €“ single tranche senior loan. And this €“ it is more rare to assume the debt, but that in some ways is a function of what the capital markets and the debt markets had been, when we made previous acquisitions, where because of our size. We were often able to get such attractive debt that it was more favorable to get a debt released and put new debt on. That’s been our MO in the past. But clearly with the increase in rates recently debt that is on was favorable to leave on and as a result we could make sure that we negotiated and successfully assumed that debt.

Joseph Osha: Okay. And you’ve shared with us kind of a target IRR unlevered I assume for your portfolio. So kind of the logical question would be what is the current number and perhaps target in terms of your cost of that capital?

Donald Klein: Sure. Well, let’s start with the overall cost of debt that we’ve got in the portfolio right now, and it’s between 5.5% and 5.6%, for the entire stack. Let me say it, in a bit of a debt perspective, we are often seeing spreads in kind of the 2.25% to 2.50% range, similar to what some of our other public peers have experienced. I think the recent turbulence may test to that, but we don’t have anything further beyond that. I think what’s important to note, Joe, is that because we are acquiring the portfolios, it’s the €“ to a return in the teens, we simply can adjust the bids and the cost that we’re paying for the equity portion. And so the there’s a natural buffer as debt cost change to still be able to get the yields that we’ve been targeting by adjusting the pricing in a similar way that, I suppose, an originator would adjust their pricing to a customer and pass that through.

So in that similar way, we’ve been able to maintain the yields or the returns on the assets.

Joseph Osha: Okay. Would you go €“ I mean, so now you’ve got $470 million €“ $475 million in nonrecourse project debt, which is a pretty chunky number, right? Let’s assume for a minute that this Mosaic deal gets off the runway for some kind of halfway reasonable pricing here. Could we see you guys try to take this increasing sort of portfolio of business and go out and perhaps refinance the whole thing and debt or ABS markets if the pricing was reasonable?