Sunrun Inc. (RUN) Q3 2022 Earnings Call Transcript

Greetings and welcome to the Sunrun third quarter 2022 earnings conference call. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Patrick Jobin, Senior Vice President of Finance and Investor Relations. Please proceed.

Thank you, operator. 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 Mary Powell, Sunrun's CEO; and Danny Abajian, Sunrun's CFO. Ed Fenster, Sunrun's Co-Founder and Co-Executive Chair is also on the call today and will be participating in the Q&A session that follows prepared remarks. And now let me turn it over to Mary.

Thank you, Patrick. Wow, what a quarter it has been. I've been looking forward to this call to update you all on what this team has accomplished. We have more than delivered what we said we would, significantly exceeding our guidance on net subscriber value, hitting the midpoint of our volume guidance despite disruptions from hurricanes and achieving a scale of over $5 billion in net earning assets. Sunrun is now serving 760,000 customers, plus nearly 10,000 households in our multifamily housing projects, which are poised to expand significantly under the Inflation Reduction Act; providing incredible socioeconomic and clean energy benefits. All of this while continuing to lead on innovation. For instance, just yesterday, we announced our latest partnership on leveraging our clean energy assets to build a more sustainable and resilient solution for Puerto Rico. The macroeconomic environment presents tremendous opportunity for us as our clean energy-as-a-subscription model allows customers to leverage and stack the latest innovative energy technologies to power their homes and cars while providing them an opportunity to save money. At the same time, the macroeconomic environment has provided an opportunity for us to demonstrate the power of quick decisive action and stellar execution as we laser focus on profitable growth. In the quarter, we delivered strong results and continued to execute on making Sunrun even faster, better, and stronger in all dimensions of the fundamentals. First, we are delivering record cost efficiency and expanding net subscriber value even as we invest in innovation and differentiation. We grew installation volumes in Sunrun's direct business sequentially, with a growth rate 3 times the rate of headcount additions as installation crew efficiency increased by nearly 30%, and I am tremendously proud of what our team is doing in the field each day for our customers. We also maintained strong overhead cost discipline, with G&A expenses declining more than 6% compared to last year and reaching an all-time low of approximately $1,100 per new customer, a 20% improvement year-over-year, showing the benefits of our scale and disciplined approach to sustainable growth. We have been adapting to higher interest rates and strategically adjusting pricing as necessary while still providing a strong customer value proposition. This is against a backdrop of rapidly accelerating utility prices and a long-term trend of deteriorating reliability, particularly in California. As a result of our team's strong execution, we delivered significantly improved net subscriber value in Q3 of over $13,000, exceeding guidance, even when excluding the benefit from the passage of the Inflation Reduction Act, and we are guiding to continued increases in our margins for Q4. Second, we are driving strong profitable growth. We grew new installations by 17% year-over-year, deploying 256 megawatts, exceeding the midpoint of our guidance. We achieved this despite devastating hurricanes in Puerto Rico and Florida that allowed many of our existing customers to power through safely, but impacted sales and installation activities for a number of weeks. Clearly, if not for the hurricanes, volumes would have hit the top end of the range. We are on track to deliver approximately 25% growth for the full year. Third, we continue to innovate and increase our differentiation. Just this week, the Board of the Puerto Rico Electric Power Authority approved a groundbreaking virtual power plant contract. Sunrun has continued to lead in the deployment of virtual power plants, adding recurring sources of cash flow we can share with our customers and most importantly, helping to increase the reliability and affordability of the entire electric system. This is another postguard from the future of the tremendous opportunity in front of us to embrace radical collaboration and to increase the efficiency and reliability of our energy systems around the country. This quarter was a powerful demonstration of the value of our existing network solar and battery systems, providing more than 1-gigawatt hour of energy back to California's grid system cumulatively over 8 days, helping to prevent rolling blackouts during the recent heat wave. We also provided more than 350,000 hours of backup power to thousands of customers in Puerto Rico and Florida during grid outages following the hurricanes. We also were excited during Q3 to celebrate the unveiling of Lunar Energy, a clean energy technology company that Sunrun invested in to accelerate whole home electrification. Lunar's first product will be an integrated next-generation combined battery inverter and software offering. We are excited by its launch in 2023. Our electric vehicle charger has also been very well received by our customers. We are benefiting from and helping enable the transition to electric vehicles by providing our customers the ability to run their vehicles on renewable, independently generated affordable energy. Customers who drive electric vehicles need larger systems. These solar and battery and EV resources are incredibly valuable for homeowners and the energy system alike. Our Ford partnership continues to deliver strong initial results. Approximately 1,000 orders for the Ford Charge Station Pro have been placed thus far, with thousands of additional initial conversations and a high mix of customers wanting the additional bidirectional home backup capability. Shifting gears, let's talk about some policy updates. On the federal side, we were, of course, thrilled to see Congress take bold action to address climate change by passing the Inflation Reduction Act and effectively extending the investment tax credit for 10 years and reinstating it back to the 30% level. We were also very encouraged to see the focus on expanding solar to more low-income communities, multifamily properties, and to encourage the adoption of electric vehicles. We believe Sunrun will be uniquely positioned as the leading national provider of solar and storage energy subscription offerings to expand our clean energy services and make it accessible to even more communities. As I mentioned in my opening comments, we also see tremendous opportunity in the legislation to build even greater socioeconomic impact through our work with multifamily housing. Today, I am proud that Sunrun already serves nearly 10,000 households in low-income multifamily housing, and we want to dramatically increase the impact we can make in these communities. On California's pending NEM proceeding, there isn't much to update beyond the chatter everyone is hearing that we may see a new proposed decision within a few weeks. Californians have spoken loud and clear over the last year that they care passionately about their ability to generate, store, and use their own clean energy without being penalized for doing so. Furthermore, repeatedly over the last year, we have seen the value of these customers and their clean energy technology which are providing to all other customers of the grid by sharing their energy back with the grid during some of the highest price periods and when the grid was literally at a potential point of failure. Therefore, we remain steadfast in our hope that the commission's forthcoming revised proposal will not just continue to support this consumer-led revolution but will in fact accelerate it. With more radical collaboration between distributed energy resources and utilities, we can demonstrate a more durable, resilient, cost-effective, and clean energy grid for all. Keeping solar accessible to all communities in California is imperative for the state to achieve its clean energy goals. Accelerating distributed solar and storage is also critical for California's economy and for grid reliability. For all of these reasons, we do remain hopeful of a reasonable structure so that the entire grid can benefit from advances in technology and customer-generated stored and shared energy. On trade, we continue to navigate the dynamic environment. The current bureaucratic process from the Customs and Border Patrol continues to cause delays in the timely release of modules currently sitting at the ports for us and many in the industry, following the implementation of the WRO and subsequent UFLPA regulations. We continue to source high-quality modules and are maintaining adequate supply for current needs, although we would like faster actions to reduce import delays. We support UFLPA enforcement that prevents labor content from entering the United States while also facilitating legitimate trade with unnecessary delays so that the industry can deploy clean energy, meet consumer demand, and help the United States achieve its climate goals. There is no time to waste. In conclusion, Sunrun has the right strategy and the right team in place to navigate these uncertain times. Our value proposition continues to increase as utility rates escalate rapidly and consumers demand affordable, clean, and predictably priced energy. Whether continued interest rate increases or a recession, Sunrun's opportunity to deliver value to our customers and our financial partners remains incredibly strong. As always, before turning it over to Danny, I want to express my appreciation for the team I work with every day and all the Sunrun employees working so hard to create a company that is faster, better, and stronger for our customers and communities, setting the highest standards for ourselves, putting people front and center, analyzing mistakes even when winning and crushing it on the fundamentals of sustainable, profitable growth, customer obsession, and innovation. Never has our cause felt more urgent. I still appreciate the Sunrunners and customers who are so key to all that we can achieve together. Over to you, Danny.

Thank you, Mary. Today, I will cover our operating and financial performance in the quarter, along with an update on our capital markets activities and outlook. Turning first to results for the quarter. In the quarter, customer additions were approximately 35,800, including approximately 25,500 subscriber additions. Our subscriber additions were 71% of our total customer additions in the period, hovering around prior levels during the year. Our recent sales activities and the benefits from the tax credit adders in the Inflation Reduction Act, which are only available to the solar subscription model, indicate the mix of customer additions is likely to shift toward subscribers more significantly in the quarters ahead. Solar energy capacity installed was approximately 256 megawatts in the third quarter of 2022, a 17% increase from the same quarter last year. Our Q3 installations exceeded the midpoint of our guidance range. Excluding installation downtime owing to Hurricanes and Ian late in Q3, we would have been close to the high end of our guidance range. We saw strong customer demand for our products and services in Q3. While we are still adding customers to our pipeline, the increased pace of installations is allowing us to gradually work down our pipeline, which is slightly over 1/4 at the end of Q3, down slightly from the prior quarter. We aim to manage sales and installation activities to maintain a pipeline that optimizes our resource planning and customer experience. We now have installed over 47,000 solar and battery systems. We expect that as we introduce additional battery suppliers and work through our pipeline, battery installations will grow rapidly in the quarters ahead and attachment rates will increase meaningfully. However, current battery supply conditions and longer install cycle times have resulted in lower battery attachment expectations in the near future. Today, we are prioritizing allocation of batteries in key markets where they are needed the most for grid reliability concerns. We ended Q3 with approximately 760,000 customers and 640,000 subscribers, representing 5.4 gigawatts of network solar energy capacity, an increase of 21% compared to the prior year. Our subscribers generate significant recurring revenue with most under 20- or 25-year contracts for the clean energy we provide. At the end of Q3, our annual recurring revenue, or ARR, stood at $969 million with an average contract life remaining of over 17 years. In Q3, subscriber value was approximately $43,400 and creation cost was approximately $30,200, delivering a net subscriber value of nearly $13,300 compared to our prior guidance of over $10,000. Total value generated, which is the net subscriber value multiplied by the number of subscriber additions in the period, was $338 million in the quarter. The significant adjustments we made to pricing over the last 6 months are driving the majority of our margin expansion from prior quarters. In addition, this quarter, our subscriber value reflects the benefit of a 30% tax credit as opposed to 26%, provided by the passage of the Inflation Reduction Act. Excluding this extra tax credit value, net subscriber value still significantly exceeded our prior guidance of over $10,000. Systems placed in service in Q1 and Q2 also benefited from the retroactive increase to the tax credit to January 1, 2022, but we opted not to recast prior quarters net subscriber values nor to reflect this benefit in our Q3 results. The magnitude of net subscriber value increase from Q2 to Q3 is significant. If you look at this on an unlevered IRR basis instead of NPV, the increase equates to an improvement in unlevered IRR of over 200 basis points. We remain vigilant in optimizing overall sales activities and adjusting our pricing and product mix to deliver profitable growth through a rising interest rate environment. These moves are already producing positive results, which you can see in Q3. We will continue to evaluate our customer offering based on incumbent utility rate changes, inflation, and the interest rate environment. Turning now to gross and net earning assets and our balance sheet. Gross earning assets were $11.5 billion at the end of the third quarter. Gross earning assets is the measure of cash flows we expect to receive from customers over time, net of operating and maintenance costs, distributions to tax equity partners and partnership flip structures, and distributions to project equity financing partners discounted at a 5% unlevered capital cost. Net earning assets were nearly $5.1 billion at the end of the third quarter, an increase of $465 million or over 10% from the prior quarter. Net earning assets is gross earning assets plus cash less all debt. Although we did not recast prior net subscriber values, as previously mentioned, net earning assets benefited from the retroactive tax credit increased by approximately $40 million in Q3, with more expected in upcoming periods. Even excluding this benefit, we saw strong growth in net earning assets driven by our net subscriber value improvement. We ended the quarter with $956 million in total cash, an increase of $93 million from the prior quarter. We continue to maintain a robust project finance runway. As of today, closed transactions and executed term sheets provide us with expected tax equity capacity to fund at a 30% tax credit over 340 megawatts of projects for subscribers beyond what was deployed through the third quarter. Sunrun also had over $700 million in unused commitments in its $1.8 billion nonrecourse senior revolving warehouse loan available at the end of the quarter to fund nearly 300 megawatts of projects for subscribers. This strong capital runway allows us to be selective in timing our capital markets activity. Turning now to our outlook. Demand for our product offering remains resilient as we provide customers with affordable, clean, and reliable energy. We are prioritizing strong unit margins by optimizing our sales mix and increasing pricing even while we deliver robust growth. We now expect growth in solar energy capacity installed to be approximately 25% for the full year. We expect net subscriber value to increase sequentially in Q4 and total value generated to be greater than $1 billion for the full year 2022, an increase from our prior guidance of greater than $900 million. We will provide views on 2023 on our Q4 earnings call after we finalize our annual operating plan. At this point, our focus is on delivering profitable growth, efficient operations, and strong unit margins while navigating a rising interest rate environment. But simply, with inflation and increasing interest rates and pending regulatory resolution in California, a focus on a disciplined strategy is paramount. Our discipline has served Sunrun well for the last 15 years, and we believe it will serve the company and our stakeholders as well in the current economic paradigm. Turning briefly to our capital markets activities and outlook. While the pace of interest rate increases has been unprecedented in recent history, we have anticipated the resulting higher financing costs and raised prices against rapidly increasing utility rates. We remain in a strong position to respond to further volatility in interest rates as inflationary effects continue to attract customers to our product, one that improves the financial health of households by lowering electricity costs and providing long-term price certainty. We currently observe our capital cost in the mid-6% to mid-7% area. Consistent with this cost of capital range, we now expect advance rates on our newly deployed portfolios to be between 75% and 85% of contracted subscriber values, which are discounted at a 5% rate. This advance rate range is a decline from our previously indicated ranges of 85% to 95% last quarter and 95% to 100% at the start of the year. As a reminder, the numerator in advance rate includes proceeds received, net of fees from all sources, including tax equity and project level nonrecourse debt. As you may recall, several years ago, we used to report subscriber value and gross earning assets figures using a 6% discount rate and updated it to 5% when we saw capital costs fall below 4%. We generally prefer not to update the discount rate frequently to enable ease of comparison across quarters. Instead, we provide advance rate ranges that reflect current interest rates, which allows investors to gauge the obtainable net cash unit margins on our deployments. If capital costs remain elevated heading into 2023, we may adjust the discount rate assumption in our metrics and update our advance rate range accordingly. As we've shared before, we regularly enter into interest rate swaps to hedge capital costs on our newly installed customers. We are principally exposed to interest rate fluctuations between customer origination through shortly after installation. Upon installation, our systems are financed with project level nonrecourse debt financing. Nearly all of this financing is insulated from near-term interest rate fluctuations as our debt is either fixed coupon long-dated securities or floating rate debt that has been hedged with interest rate swaps. We ended Q3 with over 90% of our project level debt with effectively fixed interest rates, with $2.6 billion in fixed-rate securitization debt and $3.1 billion of floating rate commercial bank debt benefiting from the long-term fixed rate swaps. Our playbook for navigating difficult and rapidly changing capital market conditions is one I passionately developed leading our project finance efforts for over a decade prior to assuming the CFO role. The long-standing relationships we have cultivated with many capital providers in multiple markets, our reputation as a high-quality sponsor, and the consistently strong payment performance trends of our customers through multiple economic cycles makes me confident we will continue to deliver the capital necessary to fuel growth, both in expansionary and recessionary times. With that, let me turn it back to Mary.

Thanks, Danny. I could not be more confident in the strength of the Sunrun team to execute on our mission and adapt to the changes around. We have an enormous opportunity ahead of us to become the trusted beloved provider of clean, affordable, and reliable energy across America, and we'll continue to focus all efforts on operating efficiently and growing profitably while building for massive scale to lead the market forward. Before we open the line for questions, I want to again express my deep and sincere appreciation for the big-hearted ambitious team of employees at Sunrun, the customers we are blessed to serve, and the many partners who work with us every single day to deliver on our mission. With that, operator, let's open the line for questions.

We have a first question from Brian Lee at Goldman Sachs.

Kudos on the solid execution on the quarter here.

Thanks, Brian.

Brian, thank you.

Two questions kind of interrelated. But I guess, first off, you mentioned several times throughout the discussion about the ITC bonus adders. I know almost not even dry yet, but can you kind of walk us through the upside scenarios and maybe how your discussions with your tax equity partners are evolving now in this new landscape, maybe how the economics actually show up for you, whether it's higher subscriber value? Is it just more customer growth with the increased tax equity capacity? Just trying to understand the puts and takes as you take advantage of potentially 20 or 30 percentage points more on ITC.

Yes. I guess Ed will start, and I'll layer on.

Sure, Brian. So I think, absolutely, we expect to raise tax equity financing against the adders. As you're aware, there are a few buckets of adders for customers in certain low-income for systems that benefit significantly from American-made equipment and from systems deployed in what are considered energy communities, which is a definition that relates to the percentage of people in a place that work for energy industry companies and/or related unemployment metrics. The regulations have not yet been written on exactly how all that is going to qualify. And so we're reticent to provide estimates for the exact sort of average investment tax credit percentage that we will achieve other than we are expecting that it can be significantly increased above 30%. It would manifest in the reported financials as an increase in subscriber value through a greater upfront tax equity contribution.

Okay, great. That's super helpful. And then I guess, just related to that, I know maybe you don't want to give the exact number, but if I back out the price increases you were articulating over the past couple of quarters, it seems like the ITC 30% adjustment added maybe $1,500 or so to the reported subscriber value this quarter. So it would have been maybe $11,000 to $12,000, still well ahead of guide. Is that the right way to think about it? And you already sort of answered this, but once you have clarity on the ITC adders, is it just going to be sort of a fluid assumption each quarter on that portion of subscriber value? Are you going to try to fix it at some sort of average level that you're targeting? Just trying to understand how much more upside you get from that potential adjustment.

Yes. On the first part of the question, I'll take that. The ITC adders add about greater than $1,000 per customer. So I think you're probably doing the right math there in thinking through it. And just the extra 4% benefit, just as a reminder, the folks who might not be as familiar, is calculated on fair market value, which is meaningfully less than contracted subscriber value for folks trying to do that similar math.

On the second part of the question, I can take that. I think we need to understand, first, with the qualification, the exact qualification criteria are. And then I think once we're actively selling in the marketplace and have some experience with it, we'll be able to update folks with a view of how it's trending and where it might go. But I think that's preliminary. I think it's still probably a couple of quarters in the future before we'll be at the place where, one, we know what the rules are; and two, we've established a track record that we can easily forecast against and share with folks. But again, it is our expectation that between those several adders, we could move the tax credit significantly above 30%. Some of the adders are easier to operationalize quickly. Maybe the energy communities or the communities, as an example. Some may be a slow build over time. For instance, the use of American-made equipment, it's our expectation that between the ITC adder for American-made equipment and some of the direct manufacturing subsidy in the IRA, we will see an increase in American-built products. Obviously, that also doesn't happen overnight. But over a 10-year period, it could be very significant.

We have the next question from the line of Julien Dumoulin-Smith with Bank of America.

So just running with Brian's thought process here a little bit further, how does that $13,000 evolve, right? Basically, how do you think about that, not just in the next quarter where you have a lot of visibility but really going into next year? You've got pricing, you've got this ITC, you've got REX as a mix. Just talk about that a little bit further. And then ultimately, related, I'm just going at the same time, how do you think about providing some more explicit cash guidance? Good liquidity updates today, but just more explicit cash conversation and conversion.

Right. Yes. On the first part of that, the greater than $13,000, again, we've said increased sequentially over Q4. We haven't, obviously, on this call, guided 2023 and including the component of adders we just went through is a little bit premature to talk specific numbers to have a little trend into Q1. But again, increasing sequentially in Q3, there will be, obviously, the 30% level carrying into Q4, and primarily the rest is driven by pricing increases we have already made that have yet to make its way into realization on install. So that's kind of the picture for the balance of the year. And remind me, your second question was on cash.

Yes.

On cash generation, we are guiding toward improved subscriber margins and have provided advance rate guidance. Together, these factors offer a strong indication of cash unit margins. Regarding overall cash guidance for next year, we will continue to monitor the situation throughout the year, addressing supply chain and policy issues as they unfold. By then, we should have a clearer outlook for next year.

Yes. And the only thing I would layer on it's Mary. The only thing I would layer on top is like as you can see and what we've been talking about is Sunrun getting faster, better, stronger and focused on crushing it on the fundamentals. So absolutely, as we think about the next quarter, the next year, that is going to continue to be our focus. And as usual, we'll talk more about 2023 on our next call.

Got it. But no cash guidance per se or just explosive affirmation about future cash needs right now?

No.

We have the next question from the line of Andrew Percoco with Morgan Stanley.

Just a follow-up on the two prior questions a little bit on pricing power. So obviously, you're benefiting from some of these prior pricing actions that you've taken in the third and fourth quarter. I think you provided a pretty helpful slide in your investor presentation just showing kind of where you guys price versus some of the incoming utilities. Can you just provide an update on where that stands today after these pricing changes? And how much headroom is left if you continue to see interest rates rise or talent costs rise as well?

Yes, that's a great question. We are currently offering our customers a substantial range of savings. In response to your question, we are indeed providing savings. Utility rates are continuing to rise, and energy costs remain under pressure. Therefore, we strongly believe that our value proposition is robust, and we are always strategically evaluating where we can make improvements. Additionally, it's important to remember that our customer value proposition has several facets. We offer peace of mind and long-term price certainty, which are highly valued. We also enable our customers to maintain power during outages. This is all happening in the context of rising utility rates, which are increasing in many states where we operate. Moreover, there is considerable anxiety among customers who are uncertain about future price hikes or, in some areas, the reliability of their power supply. We believe these factors provide us with the necessary room to navigate our strategy effectively.

Understood. That's very helpful. And then one more on just panel availability. Where do you guys stand today in terms of panel availability? And if the UFLPA issues aren't resolved in the coming weeks and months, could it be a headwind to '23 growth despite the strong kind of tailwinds on the fundamental side from the customer demand standpoint?

Yes. So on the last call, we said we had a dip below. So if I track through the history, it was greater than 100 days. We had said on the last call less than 100 days. The number today is around 60 days of supply. And just to frame that up, that compares to a normal target of around 75 days. So we are close to our target. We continue to see equipment come in on the module side. So we don't have concerns with addressing the demand. And we're looking forward, like planned our procurement sourced from multiple geographies and planned our procurement in line with the volume we expect to see delivered through the business.

We have the next question from the line of Colin Rusch with Oppenheimer.

Can you talk a little bit about the strategy around the virtual power plant? Obviously, there's an awful lot of value that you guys are providing in some geographies. Could you talk about strategy for changing that offering and how you price that?

Yes. Thanks for the question. We are so excited. And I know as you saw and we highlighted, we just announced our contract in Puerto Rico, which, again, we're just thrilled about because it's just so important from a grid reliability and stability perspective for residents in Puerto Rico. But it also is yet another, as I said, post guard from the future of what is possible, candidly, all over the United States of America. So we're really pleased to continue leading in the context of this kind of innovation and leveraging our energy assets, particularly the combination of clean stored energy assets around the country to provide significant value. From being consistent with our overall comments that we've always talked about relative to grid services, we've always seen that it can add close to $2,000 per subscriber of net present value over the life of the asset. So again, it's really valuable because it provides real value to the customers who are participating in the programs. And it also then provides value to Sunrun in the context of aggregating and leveraging those assets from a grid perspective. And again, we've had so many examples of that. And also just in this quarter as well, we also announced the ISO New England program. But I would say no greater example of the value here to the grid than what we just went through in California in the context of the heat wave when there were absolutely record prices. And our customers were providing energy back to the grid and saving every other customer that is a grid customer money because of the value provided. So again, yes, it's an area I've talked a lot about. I have a lot of passion about it, radical collaboration. Let's get to a better improved grid for all. So we expect that to continue to accelerate in the coming years.

And then with the IRA pass and all the different elements that you can stack up here and the movement on electricity prices, can you talk a little bit about where you're at in terms of potentially adding incremental geographies? And how you go about deciding where to expand into?

Yes. We continuously evaluate our go-to-market strategy. From a geographic standpoint, we've, first and foremost, looked at the opportunity where we're already operating and the overlap between what we preliminarily believe to be the geographies or the census tracts that might qualify for the adder. So definitely have an early leg up there in terms of go-to market, taking advantage of the opportunity to serve those communities where we already operate. And then we constantly monitor markets for potential entry. I'd say the factors we look for are obviously geographic resource, local subsidy, and utility power prices in those areas so we could deliver a compelling value proposition. As far as the IRA and its impacts on potential changes in geography or opening up more geographies, we'll probably talk about that more as the guidance becomes more clear.

We have the next question from the line of James West with Evercore ISI.

So curious, Mary, you talked about the supply chain for batteries still being a bit challenged in attachment rates, not being where you would expect them to be as the supply chain kind of comes into a more balanced situation. I'm curious, new customers as you're acquiring them and they're not attaching batteries because they don't have them, are they doing the work for batteries later? Is there opportunity to go back? How is that process playing out there? Or are they just saying, 'Just give me solar,' I want solar batteries.

Yes, great question. So again, it also really harkens to why we're so excited about Lunar and our investment there, which definitely is looking more strategic every single day. So we're really excited about having that next-generation storage inverters, software solution that will also help us unlock that customer demand. So yes, we view that we could be at an attachment rate that is obviously significantly higher than we are if and when we get to having a lot more supply. That said, the desire for solar energy is, again, still very compelling for so many customers. And so in many cases, we absolutely do keep track. If a customer says, 'Hey, I really want to have storage later,' we obviously maintain that relationship so that we can provide it when it becomes available. So yes, as it becomes available, we expect to see a very significant uptick in our attachment rate. And then yes, over time, it provides an opportunity to go back and add it on to existing customers.

Okay. That makes perfect sense. Then secondarily for me, I know California signed a new law requiring online automated permitting platforms similar to the SolarAPP, which you guys have worked with for years. Are there movements like that afoot in other states at this point?

Well, I think really speaking to SolarAPP, I know Secretary Grand Home at DOE has been a real proponent of the SolarAPP and has been initiating conversations about it all over the country. So yes, we were encouraged by California passing that legislation. And yes, we're seeing those kinds of changes provide nice incremental improvements in the process to again help bring down the timeline and the cost of the time from the customer signing to the time of installation. So we saw that as a positive movement in that direction. And again, we're really also very pleased and supportive of the efforts at the national level to also agitate around greater adoption of the SolarAPP.

We have the next question from the line of Mark Strouse with JPMorgan.

I might be splitting hairs here a bit, but I just want to make sure I'm not missing anything. With the volume growth for the year, approximately 25%, I believe on the last call you were saying 25% or greater. Is that just a function of the hurricane? Or are you signaling something else there?

Yes. I think I would say, generally, we provide guidance we're comfortable with, particularly in this climate. Looking at the recent hurricanes that did imply there in the remark is a few megawatts impact in the quarter. And looking out at the balance of the year, it's a Q4, right? Weather can be more volatile in the quarter. So just kind of taking into account normal seasonal effects, I don't think there's a demand implication in there.

Yes. And again, just to hit that point, again, these weren't like your average hurricanes because, of course, we always do anticipate some weather impacts in the context of our work and our planning. But the level of devastation, as I think you all know, in Florida, this was an event that really sort of took our folks out of any activities for about a few weeks in both jurisdictions with a lot of growth, in particular happening in Puerto Rico.

Of course. Yes, that makes sense. Given your scale and operational history, you are likely in a better position than your peers to discuss trends in default and delinquency rates. Danny, while you are communicating with your capital providers, are you receiving recognition for improvements or stabilization in those trends, or do you believe there is still potential for further progress?

Yes, I believe that there is significant potential in the overall market. This asset class has been established for 15 years, and we provide a product with a term of up to 25 years. We expect to continue generating strong performance data at the project level as we move through this 25-year period. Regarding the latest trends, we are not observing any unusual patterns in default rates, so everything appears stable from a credit underwriting standpoint in the capital markets. We anticipate increasing our deal sizes, which will help strengthen relationships and attract more participants to the market over time as we maintain regular access. Overall, we expect this trend to remain positive in the long run.

We have the next question from the line of Maheep Mandloi with Credit Suisse.

First, I just wanted to catch up on Slide 13, where you kind of broke down the advanced ratios. Just doing the math, it seems like there's still the advantages of creation. So just wanted to understand how should we think about that next year, say, rate increase a little bit over here? And this probably goes back to the previous question on cash needs that you're trying to tackle from a different point of view.

Yes, I had some difficulty hearing you. Let me attempt to address your question, and if I miss the mark, please feel free to jump in. Regarding advance rates, we reduced them from the previous range to a new range of 75% to 85%, which aligns with the 6.5% to 7.5% range for the cost of capital that we are currently observing in the interest rate environment. This considers long-term borrowing costs, and I’ve already shared my perspective on how the Fed will handle short-term borrowing costs during this rate hike cycle. We focus on 7- to 10-year long-term borrowing costs, and the advance rate guidance we provided reflects that within a range. We notice some price differences between the commercial bank market and the ABS market, where we have established significant access to both and are managing the interest rate environment from the perspectives of credit spread and capital availability. We understand the liquidity conditions in each market and are developing the best solutions based on current market dynamics. As for the outlook for next year, we review it on a daily basis. As we've mentioned, we are becoming increasingly adaptive to interest rates on a daily and weekly basis, considering utility inflation and adjusting our business and unit margins to maintain strong performance across various rate environments.

Yes. And this is Ed. I just might mention a week ago, we did look at the sort of future interest rates market. And the way it's pricing, the market anticipates there being less than a 20% chance of long-term rates increasing more than 100 basis points. And against that backdrop, we feel good about the advance rate estimates that we have provided in the stack.

Got it. And the advance rate, like if I look at the proceeds, that's way above the creation cost, and that's probably kind of contributing to the higher cash generation guidance for the full year. But just to understand for next year, as you get higher tax credit be fair to assume that the advance sales would be way above the creation cost even for next year?

Yes. As the average tax credit increases, the advance rate should also rise, which will be reflected in the increased subscriber value due to the higher tax credit.

We have the next question from the line of David Peters with Wolfe Research.

To add to the previous question, you mentioned that 75% to 85% reflects the current environment. However, if conditions were to deteriorate, even though you have pricing power, it may not completely counterbalance the situation. What would be the point at which it becomes more challenging to sustain your strong growth without seeking additional capital?

Yes. It depends on the direction of interest rates and inflation, which are also affecting utility rates and the rising prices of goods. When considering the long-term picture of interest rates and utility rates, there is a significant correlation that we expect to persist. Currently, the market suggests a low chance of rates increasing much further. Following the Fed's announcement today, long-term interest rates have remained relatively stable. We will observe how things develop in the coming days as the market processes this news, but the initial response has been stable. Additionally, a review of various economic indicators, beyond the official CPI data, points to an upcoming decline in inflation, which aligns with trends in the rates market and the probabilities mentioned earlier.

Okay, I think you touched on this in the prepared remarks, but regarding the growth in net earning assets from one quarter to the next, how much of that was due to the higher ITC? I believe some of it was a catch-up from previous periods. I'm trying to understand what that growth was excluding that increase.

Yes, about $40 million is due to the one-time benefit from the ITC realization of assets we placed into service before the quarter. The rest is attributable to the higher net subscriber values and increased pricing related to installs, which further contribute to the metric. Those are the two main factors. Additionally, in Q3, we also achieved a higher ITC level in the metric.

We have the next question from the line of Kasope Harrison with Piper Sandler.

Danny, I wanted to explore something you mentioned in your prepared remarks regarding the strategic focus for next year. It seems like you're emphasizing disciplined capital allocation by maximizing unit margins, especially considering the uncertain market environment. Is that an accurate reflection of your focus for the upcoming year? Additionally, could you elaborate on some of the decisions you plan to make to enhance margins? Will this involve cost reduction or a continuation of higher pricing? Any insights would be appreciated.

Yes, we are definitely prioritizing strong unit margins. Our guidance suggests approximately 25% growth in volume for the year, and we aim to continue generating robust volume growth. As we've consistently stated, we view long-term industry growth trends to be around 15% to 20% annually, and that perspective remains unchanged. However, we will be focusing on achieving stronger unit margins. Mary, would you like to add anything to that?

No. I think it just gets back to sort of what I've talked about in terms of crushing it on the fundamentals. So we feel like we're in a really good position, really good place in terms of demand, really good place in terms of our leadership on innovation. And again, we see that we still have some continued headroom. But yes, it's that focus on crushing it on the fundamentals of strategic profitable growth, customer obsession, innovation, and growing.

That's helpful. As a follow-up, I'd like to refer back to Slide 13 in the presentation, which was very informative. Could you elaborate on working capital? I understand that it's notoriously difficult to predict. However, could you explain how we should approach changes in working capital during both normal times and recessionary periods? I'm trying to determine a way to model the impact you might experience in any given year.

Yes. There are two main points to discuss. The first is backlog. Previously, we indicated that we were trending toward a backlog of about two quarters, but this has now been reduced to around one quarter. It seems that the backlog has decreased slightly over the past few weeks. Currently, we have about a quarter's worth of customer backlog. As our business continues to grow and the backlog increases, our spending on installations, permits, and various soft costs will lead to working capital consumption, which we have observed due to the strong growth rates we've experienced recently. The second point is related to inventory. We have seen a significant increase in our inventory levels to support this growth. Additionally, supply chain issues have contributed to this. Over the last three quarters, we have maintained an inventory balance that exceeds our targets, which has been a contributor to working capital cash consumption in the business recently.

We have the next question from the line of Philip Shen with ROTH Capital Partners.

Given the rising interest rates, it seems that demand for loans may be significantly decreasing, which could lead to a much slower first half of next year for the entire industry. With the decline in loans, a lease could potentially benefit from this situation. Can you discuss how you anticipate demand for your lease business to grow, particularly with the ITC adders? Also, could you share your thoughts on whether you expect a significant shift in the mix between leases and loans in the next two years, favoring leases?

Yes, I'll summarize briefly, and then Danny can add more. We share your perspective. The Inflation Reduction Act offers incentives that are best utilized through a leasing model for customers, many of whom lack the tax capacity to benefit from those advantages. We strongly believe this model is well-suited for that purpose. Additionally, as I mentioned earlier, having adopted solar myself about 14 years ago and multiple times since, I see the value in treating energy as a subscription service. It provides a low-friction, stress-free way for customers to access advanced technology in their homes at an affordable price. We observe trends moving in this direction and will consider them when we prepare for the next quarter and set our guidance for the following year. Now, Danny.

I would like to provide more insight into our near-term perspective before the additional factors take effect. Based on publicly available data on lease pricing, we are confident that we have been adjusting our pricing significantly ahead of changes in loan pricing. This adjustment has contributed to the current mix we observe in the business, particularly when looking back over the last three quarters, where we have maintained a range of 70% to 75%, with minor fluctuations each quarter. Looking ahead, we anticipate that as loan pricing catches up and with higher APRs, there will be a significant shift towards the leasing or subscription model in the coming quarters.

Great. And then as a follow-on there, historically, for the overall industry loan versus lease mix has been maybe 70% loan, 25% lease, with the balance being cash. In a couple of years, could we see that maybe 50-50? Or do you think that's too far a stretch? Or could we even completely invert a few years' time? Of course, a lot depends on where rates go. But knowing what you know now, could we see 50-50 in 2 years?

Yes. From a high-level perspective, I believe it presents a very attractive value proposition. When considering the idea that this could gain traction across America, the ability to combine all these different products and innovations into a subscription model is compelling. I have always thought this model is very strong, regardless of other trends we observe. Customers who understand it are drawn to it. If we examine the data closely, we see a strong correlation between what salespeople are promoting and what consumers ultimately purchase. While I don't think we're ready to commit to specific future percentages, we see this business model and value proposition as very appealing for customers wanting to integrate various technologies. Sunrun offers more than just solar; we also provide EV charging, storage solutions, and advanced control systems like the SPAN panel. As we progress in this direction, the model presents numerous compelling features.

We have the next question from the line of Joe Osha with Guggenheim Partners.

Two questions. First, kind of following on Phil's question there, I'm thinking about this potential shift from loan to lease PPA. Typically, in ABS markets, we've seen third-party price kind of 50, 60 bps outside of loans, but things are changing. So I'm just wondering how you all think about, given what Phil mentioned and then other impacts of the IRA? How do you think about how we might see those transactions priced relative to loan going forward? And then I have a follow-up.

Yes. I believe there are some technical factors at play. If you examine the loan product and its pricing, you will find that many investors in this asset class focus on prepayment rates and speeds. Given the increase in mortgage rates and overall interest rates, we would expect prepayment rates to have declined, as the incentive to refinance solar loans has diminished, which could lead to differences in relative value for loan investors. On the loan side, those are the dynamics to consider. Additionally, credit spreads for loan securitizations have widened, and this general widening may be more pronounced than we anticipated for leases. We have previously mentioned our access to both the ABS market and the commercial banking market, where liquidity dynamics and fundamentals can vary over time. Therefore, we are working to achieve the best possible cost of capital as we aim to term out our deployed portfolios in the market.

Yes. And I think the one thing, Joe, I might add to that, it's Ed, is that I think like in the commercial bank market, if you were pricing a transaction today, including hedging costs, it would have a 6 handle on it, which would be inside of where the ABS market is. So I think there are 2 questions at hand, right? One is like how are loans and leases financing in the ABS market? And the secondary question of like, is that even the market that you want to be executing in right now? The other thing I would mention, obviously, is the pretax cost of tax equity is below the senior debt cost for either product. And so when you think about the weighted average cost of a lease or a loan, you don't want to forget that component either.

Yes, that's a valid observation, particularly regarding the debt and ABS market. Ed, you actually anticipated my second question quite well. There are numerous changes occurring, especially in how the tax equity market operates, with the introduction of direct pay and transferability. Where do you believe the tax equity internal rates of return are headed ultimately, specifically for tax equity investors? Is there a possibility that they might decrease?

I don't think tax equity IRRs have changed much over the nearly 20 years I've been observing the market. There are a few reasons for this. First, the pricing isn’t based on risk. It’s mainly due to the requirement to provide a pretax return in the safe harbor, which results in an after-tax return that is usually higher than what the asset itself would demand. This dampens the fluctuations. Additionally, accelerated depreciation becomes more beneficial when interest rates rise because it allows tax equity investors to defer their income tax payments. This aspect gains value in a high inflation and interest rate environment. Furthermore, in most high-interest rate situations, banks tend to earn more, leading to an increased supply of tax equity. Regarding transferability, this will definitely contribute to market supply. Currently, we still expect to primarily pursue traditional tax equity because in that market, you tend to get more than $1 for your investment tax credit, as you also provide depreciation value. In a transferability context, there is no depreciation advantage, so it’s likely someone would pay less than $1 per investment tax credit. Therefore, I believe the stronger unit economics will exist in the traditional market. However, for certain off-the-beaten-path projects or innovative structures, transferability might attract interest.

We have the next question from the line of Sophie Karp with KeyBanc.

Congrats on the solid trend here.

Thank you, Sophie.

I have a couple of questions. First, I want to revisit Lunar. Can you provide the investment thesis on Lunar? Is the equipment the company will offer similar to what competitors have on the market or are planning to launch? Why do you find it advantageous to invest instead of maintaining a neutral, technology-agnostic stance?

I am very optimistic about this investment. Thank you for the question. It is undoubtedly a next-generation technology. We see it as a way to expand our access to significant technology for the ongoing electrification revolution. It's not about switching to one provider, as that is not our plan with Lunar. We view it as a strong strategic investment on its own, and coincidentally, we will benefit from what they produce. From two perspectives, it's a solid investment because we have a high-caliber team developing technologies for home and transportation electrification, which is powerful. With our large customer base and high demand, the prospect of adding another technology to our offerings is very exciting. We value our partnerships with other storage vendors and plan to maintain and develop those. The growing consumer demand suggests there is room for more technology for our consumers, which we embrace. We have strong confidence in Kunal and his team, and we are excited about their product roadmap and the potential new technologies that may become available. This is a significant opportunity for us, especially as we approach 2023 and 2024, when we anticipate some constraints in the market. We are thrilled about having proprietary access to the technology that Kunal and his team are working on.

Yes, reflecting on the decision to start the company, we had spent years proposing feature requests to manufacturers of inverter battery electrification, and we felt that the features and specifications we truly wanted, which we knew would reduce our costs and boost customer demand, were not being addressed. Our belief was that, by leveraging our customer relationships and installations, we could gain better insights into how to detail and develop these products. The aim was definitely to create a unique product. Additionally, as Mary pointed out, we recognized that having more battery supply, especially for us, would be beneficial. Lunar faces competition from various companies in high-margin sectors, making it a strong standalone investment. For all these reasons, we found it to be an intriguing strategic move, particularly since we had identified a solid partner and management team.

My other question is about capital allocation. Given the current dislocation in the equity and debt markets and how your debt trades, does it make sense to consider buying it back?

Yes. I think we've discussed the interest rate and inflation environments. We are prioritizing the strength of our balance sheet and liquidity during this time rather than focusing on the trading levels of the convert and the related opportunities.

Yes, I think that ends the queue. Appreciate everyone joining in touch.

Thank you all.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session and conference call. You may now disconnect your lines at this time. Thank you for your participation.