Sunrun Inc. (RUN) Q1 2024 Earnings Call Transcript

Good afternoon, and welcome to Sunrun's First Quarter 2024 Earnings Conference Call. Please note that this call is being recorded and that 1 hour has been allocated for the call, including the question-and-answer session. I will now turn the call over to Patrick Jobin, Sunrun's Senior Vice President, Investor Relations. Please go ahead.

Thank you, operator. Before we begin, please note that certain remarks we will make on this 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 that these statements are being made as of today, and we disclaim any obligation to update or revise them. During today's call, we will be discussing certain non-GAAP financial measures which we believe can provide meaningful supplemental information for investors regarding the performance of our business and facilitate a meaningful evaluation of current period performance on a comparable basis with prior periods. These non-GAAP financial measures should be considered as a supplement to and not as a substitute for, superior to or in isolation from GAAP results. You will find additional disclosures regarding the non-GAAP financial measures discussed on today's call and our press release issued this afternoon and our filings with the SEC, each of which is posted on our website. On the call today are Mary Powell, Sunrun's CEO; Danny Abajian, Sunrun's CFO; Ed Fenster, Sunrun's Co-Founder and Co-Executive Chair; along with Paul Dickson, Sunrun's President and Chief Revenue Officer, are also on the call for Q&A session. A presentation is available on Sunrun's Investor Relations website, along with supplemental materials. An audio replay of today's call, along with a copy of today's prepared remarks and transcripts, including Q&A, will be posted to Sunrun's Investor Relations website shortly after the call. We have allocated 60 minutes for today's call, including the Q&A session. And now let me turn the call over to Mary.

Thank you, Patrick, and thank you all for joining us today. We are starting the year with solid momentum in the business as our storage-first margin-focused strategy is delivering strong results. In the first quarter, we beat the high end of both our storage and solar installation guidance, set new records for storage attachment rates and delivered another quarter of strong net subscriber values. Our installation productivity and success in driving our storage-first strategy is delivering strong results. At the same time, sales activities in Q1 did grow slightly slower than initially expected, coming in at 13% sequential growth in our direct business. While less than initially anticipated, this level is still consistent with our historical seasonal norm. We continue to prioritize margins over volumes, and we believe this approach will result in the highest long-term value for our shareholders. We are reiterating our full year storage capacity installation guidance and we are reducing our full year solar installation capacity outlook to down 15% to flat from our prior guidance range of down 5% to up 5%. We expect 2024 will be a strong year in terms of total value generated, which will grow by over 10%. Most importantly, we are reiterating our cash generation guidance of a Q4 annualized level of $200 million to $500 million. We are confident in achieving strong growth in installation activities throughout the year as the fundamental demand drivers of our business continue to be robust. Utility rates continue to rise, while storage and solar equipment costs are declining, and our operating efficiency continues to improve. Customers remain eager for clean, affordable and resilient energy to power their lives. In the beginning of 2023, we oriented the business to be storage-first, which increases the customer value proposition and lays the foundation for future value creation from grid services. This strategy has also allowed us to capitalize on regulatory changes better than others in the industry. In Q1, we installed storage on 50% of our new customers, up from a 15% attachment rate in the prior year. We installed 207-megawatt hours of storage in Q1, almost triple the year-ago quarter. Storage systems provide increased customer value through enhanced resiliency and control while providing higher margins for Sunrun. Our fleet of networked storage capacity has reached 1.5 gigawatt hours with 102,000 systems installed. Based on industry data, we represent about half of new storage installations in the United States and are gaining. In 2023, we were under 20% share of residential storage deployments across the U.S. And by Q4, we were approximately 45%. Our fleet is growing in significance and is already at a scale that could replace multiple polluting peaker power plants. For instance, these resources could power a city like San Francisco for multiple hours and do so daily as batteries are recharged from the sun. While still in the early stages of commercializing these resources, we just announced two new record-setting grid service programs. For the second year in a row, Sunrun will set a national record for the largest number of residential solar plus battery systems enrolled in a virtual power plant. Last year, we did a 30-megawatt program with PG&E. This year, we are launching a statewide demand-side grid support program that is about twice the size with more than 16,000 Sunrun customers. We also have now enrolled nearly 1,800 customers in our Puerto Rico virtual power plant. Our resources have been dispatched nearly a dozen times, helping to prevent rolling blackouts and keeping the power on for all Puerto Ricans, not just our customers. The fact that we are running these two successful programs shows that VPPs can rapidly scale all across the country. Last month, a Brattle Group study concluded that virtual power plants could save California consumers $550 million per year. We also continue to innovate with AI, enhanced customer experiences, new products, adding batteries to existing systems, EV charging and of course, our early renewal opportunities. The team is busy innovating to extend Sunrun's differentiation in the market even as we dial up our focus on efficiency and cash generation. We are making clean, affordable, and reliable energy accessible to families all across America with the most pro-consumer offerings and delivering the best customer experience and service in the industry. Being the chosen trusted provider to deliver this clean energy future is critical. As a testament to our approach, our customer Net Promoter Scores at the time of installation continued to increase, exceeding 75 points this quarter. We are driving this great customer experience and investing in innovation while also dramatically increasing operating efficiencies. Our crew labor productivity has improved by 5% compared to the prior year even as we more than tripled our mix of more complex battery jobs. Our efficiency gains installing systems with batteries are particularly impressive, improving 30% year-over-year. Overall headcount in our installation organization is down 5 percentage points more than the change in volumes. In addition, general and administrative costs have declined slightly year-over-year and continue to be a fraction of that of our peers, even as we accelerate the pace of innovation, highlighting the tremendous scale advantages we derive and sizable barriers to entry in this space. We are also driving increased efficiency and improved quality throughout the organization from leveraging artificial intelligence. We have already started using AI to improve the speed and accuracy of system design, pipeline management, and material handling. We are increasingly encouraged by how AI can improve our operating efficiency and customer experience even further. Growth in AI and the voracious energy consumption that comes with it will drive even greater need for Sunrun's fleet of solar and battery systems. The International Energy Agency forecasts power demand from data centers in the U.S. will increase 60 terawatt hours by 2026 to account for nearly 6% of total U.S. electricity demand. Electric grids will need to procure more power to meet this need, especially at peak times, and distributed flexible renewable resources will be one of the solutions. Much of this growth is also coming from companies who are eager to use clean energy to meet their environmental objectives. Before handing the call over to Danny, I want to take a moment to celebrate some of our people who truly embrace the power of solar energy to make a real difference in our world. Thank you to our leading teams in Houston, Texas, our top-ranked installation crew, led by Jonathan, and our direct-to-home sales team in the quarter based on safety, quality, battery attachment rates, and customer experiences. They were all in Texas this quarter. Thank you all for your contributions and leadership at Sunrun. With that, let me turn over the call to Danny for our financial update.

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. We have now installed over 102,000 solar and storage systems with storage attachment rates reaching 50% of installations nationally during the first quarter of 2024. We expect storage attachment rates to remain around this level throughout the remainder of the year. This higher mix of storage has driven improvements to our net subscriber value as backup storage offerings carry higher margins. During the quarter, we installed 207-megawatt hours of storage capacity, well above the high end of our guidance and almost triple the same quarter last year. Our total network storage capacity is now over 1.5 gigawatt hours. In the first quarter, solar energy capacity installed was approximately 177 megawatts, also above the high end of our guidance range of 165 to 175 megawatts. Customer additions were approximately 24,000, including approximately 22,000 subscriber additions. Our subscription mix reached 93% of deployments in the period, an increase of 92% from the prior quarter and the highest level in many years. We ended Q1 with approximately 957,000 customers and 803,000 subscribers representing 6.9 gigawatts of network solar energy capacity, a 16% increase year-over-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 Q1, our annual recurring revenue, or ARR, stood at over $1.4 billion, up 30% over the same period last year. We had an average contract life remaining of nearly 18 years. In Q1, subscriber value was approximately $50,800, and creation cost was approximately $38,900, delivering a net subscriber value of $11,891. This strong result was from increased efficiency and a beat on volumes. Our Q1 subscriber value and net subscriber value now reflect a blended investment tax credit of over 35% benefiting from expanded eligibility for the Energy Community's ITC adder and the portion of our deployed systems eligible for the low-income adder. Total value generated, which is the net subscriber value multiplied by the number of subscriber additions in the period, was $262 million in the first quarter. Our present value-based metrics are presented using a 6% discount rate, but our financial underwriting already accounts for our current cost of capital, which was in the 7.6% area in Q1. As a reminder, to enable ease of comparison across periods, we generally do not update the discount rate frequently. Instead, we provide advanced rate ranges that reflect current interest rates enabling investors to calculate the obtainable net cash unit margins on our deployments. In addition, we provide a pro forma net subscriber value using the capital costs observed for the quarter. At a 7.6% discount rate, net subscriber value was $6,593, and total value generated was $145 million. We expect additional tailwinds to net subscriber value in future periods from the following variety of factors: more favorable business mix, increased realization of ITC adders, and lower costs from hardware price reductions, labor efficiency, and operating leverage from strong sequential volume growth. In Q1, we recognized a weighted average ITC of approximately 35%, the equivalent of approximately half of our systems qualifying for the energy communities or low-income adder. During the quarter, the government expanded the qualification criteria for the energy communities adder. Approximately 35% of our current installation is now qualified compared to 13% before the expansion. While the energy community adder expansion was favorable, our expectation for the portion of our systems that qualify for the low-income adder going forward has been lowered from 26% to 18% given the current inefficiencies in the program design and implementation. While we continue to receive proceeds from the energy communities adders, proceeds from the awarded low-income adders are delayed given the slow government process. Proceeds from domestic content adders are expected to be realized in the coming quarters. Guidance on what will qualify for the domestic content adder has been issued, but we are still awaiting further clarity from additional rule-making processes sometime this year. Combined, these adders could represent up to $450 million or more in additional annual run rate cash proceeds. We continue to see decreasing prices for key hardware components, which are gradually flowing through our reported costs as we finish consuming our higher-cost inventory. On a like-for-like basis, for a 7.5 kilowatt solar with backup battery system, by the end of this year, hardware costs are expected to decline by over 18% or nearly $2,500 per system from their peak in the second quarter of 2023. These beneficial trends may be obscured by an increasing mix of storage, which carries higher net margins but will increase hardware and install costs and therefore, increase creation costs. Additionally, we are monitoring recent developments with certain U.S. manufacturers petitioning for new tariffs. Modules, however, represent less than 10% of our total creation costs, and the history of various trade disputes has demonstrated the impact has been manageable as global supply chain is dynamic over time. Turning now to gross and net earning assets and our balance sheet on Slide 13. Gross earning assets were $15 billion at the end of the first quarter. Gross earning assets is the measure of cash flows we expect to receive from subscribers over time, net of operating and maintenance costs, distributions to tax equity partners and partnership flip structures, and distributions to project equity financing partners all discounted at a 6% unlevered capital cost. Net earning assets were $5.2 billion at the end of the first quarter, up approximately $200 million from the prior quarter. Net earning assets is gross earning assets plus cash less all debt. Net earning assets doesn't include inventory or other construction and progress assets or net derivative assets related to our interest rate swaps, all of which represent additional value. The value creation upside we expect from future grid services opportunities and selling additional electrification products and services to our customer base, including our storage retrofit offering, are not reflected in these metrics. We programmatically enter into interest rate hedges to insulate our capital costs from adverse near-term fluctuations. The vast majority of our debt is either fixed coupon long-dated securities or floating rate loans that have been hedged with interest rate swaps. As such, we do not adjust the discount rate used in net earning assets to match current capital costs for new installations. We ended the quarter with $783 million in total cash, a decrease of $205 million compared to the prior quarter. Q1, which is typically the weakest quarter for cash generation due to volume seasonality, was further impacted by one-time costs from financing activities we completed in the quarter, as we discussed on last quarter's call, as well as delayed timing of incentive monetization. Cash generation was negative $311 million in Q1, which included approximately $317 million of one-time costs and timing-related items as we have outlined on Slide 14. Excluding these items, adjusted cash generation was positive $6 million in the quarter. The financing activities we opted to pursue in Q1 resulted in $107 million of one-time cash impact. These included fees paid for the 2030 convertible debt issuance and purchase of the cap call to mitigate dilution, fees paid on the extension of our recourse working capital facility, and fees paid on the extension of our nonrecourse warehouse facility and an associated reduction to the facility's advance rate. In Q1, we made a significant transition from traditional tax equity where all cash is typically provided at or just before installations to tax credit transfer where funds for tax credits often come quarterly in arrears. This transition was primarily responsible for a reduction in Q1 tax equity proceeds of approximately $181 million. We are working to close new funding that will resolve the working capital headwind, all of which we expect to close before the end of the quarter. In Q1, we deployed systems that are expected to contribute $30 million in cash generation from the low-income ITC adder. While many systems have met all conditions, monetization remains delayed given the timing of government processes. Later this quarter, we are expecting to monetize the receipt of delayed ITC adders through a combination of additional tax equity funding and debt proceeds. Turning to our capital markets activity. As we discussed last call, we were very active in Q1 arranging capital to support our growth and further optimize our balance sheet by extending maturities. It is prudent to extend facilities early to navigate potential and unexpected macroeconomic conditions and volatility. In February, we successfully extended and upsized our nonrecourse revolving senior warehouse facility to support our scale. This facility funds assets temporarily before we raise long-term financing, principally in the asset-backed securitization market. We increased the size by $550 million up from $1.8 billion to $2.35 billion and extended the maturity by approximately 3 years from April 2025 to February 2028. The effective credit spreads increase of 50 basis points was commensurate with recent movements in the securitization market for term out transactions with similar advance rates. The facility continues to have a diversified set of nine relationship lenders. We also achieved certain other improved terms that afford more flexibility to fund our anticipated future products and geographic mix. Our team also continues to execute tax equity transactions including structures that facilitate ITC transfers to a deepening pool of large buyers. As we discussed on the last few calls, the traditional tax equity market has been tighter recently which we believe is resolving now that tax equity investors have adapted their approaches to structuring deals in this new environment. In addition, we continue to build an active pipeline to sell tax credits to corporate buyers for ITCs that are generated when systems are placed into service. As of today, closed transactions and executed term sheets provide us with expected tax equity capacity to fund over 331 megawatts of projects or subscribers beyond what was deployed through the first quarter. We expect to expand this runway during Q2. Sunrun also had $593 million in unused commitments available on its nonrecourse senior revolving warehouse loans at the end of the quarter. This unused amount would fund approximately 214 megawatts of projects for subscribers. Our strong debt capital runway allows us to be selective in timing transactions. Since the start of the year, we have closed two ABS transactions. Sunrun's industry-leading performance as an originator and servicer of residential solar assets continues to provide deep access to attractively priced capital. In February, we closed an ABS transaction with a private credit investor and arranged subordinated debt financing on the portfolio. The $361 million nonrecourse senior debt was rated A-by Kroll and was priced with a 232.5 basis points spread. This demonstrated yet another improvement in capital costs, with spreads declining from our last securitization in September that was priced with a 240 basis point spread. We placed a $109 million subordinated loan on the portfolio as well. The all-in full stack weighted average cost of capital on this portfolio was approximately 7.5% and resulted in an accumulative advance rate as measured against our contracted subscriber value metric of over 80%. The use of private credit investors shows the strong interest in our assets from a growing and broad set of investors. In April, we closed a $230 million securitization to refinance existing debt on a portfolio of seasoned assets. The nonrecourse senior debt was rated A by Kroll and was priced at a credit spread of 195 basis points, a 37.5 basis point improvement from our private securitization in February and 45 basis points lower than our securitization in September 2023. The latest execution represents the lowest spread achieved for similarly rated transactions across the sector since 2021. The portfolio is jointly owned by National Grid and Sunrun following their project equity investment in 2017. With National Grid receiving the majority of cash flows through 2042, including the significant net cash proceeds from this refinancing. Importantly, however, this transaction highlights our continued deep access to capital at improving terms and demonstrates the favorable market for refinancing seasoned assets we have originated and serviced. This bodes well for the significantly sized portfolios of seasoned assets that we will refinance in the coming years. Moving to the parent capital side. During Q1, we took actions to extend maturities and optimize our current balance sheet. In February, we closed an extension of our recourse working capital facility. We reduced the size from $600 million to $447.5 million with an option to upsize the facility to $477.5 million, prior to September 30, 2024. We amended the facility to extend the maturity from January 2025 to November 2025. We also included a feature that will further extend the maturity to March 2027 should we meet the requirements for this provision, which include addressing the maturity of the convertible notes due in February 2026. Also in February, we issued $483 million in convertible notes due in 2030. Since the issuance of the 2030 convertible notes, we have repurchased another $82 million of our 2026 convertible notes. To date, we have now spent $175 million to repurchase over $205 million of these notes. Less than half of the 2026 notes now remain outstanding. We will continue to be disciplined and selective with repurchases, given alternative high-yielding capital uses. Our intent is to maintain a strong and healthy balance sheet. The recourse financing and bond repurchase activity in Q1, including all related fees, increased our cash by $102 million and increased our debt by $125 million. With continued repurchases of the 2026 convertible notes or retirement as far as maturity, we expect net recourse debt to be a little changed. We have also prudently extended maturities while mitigating dilution with the capped call. When we think about our balance sheet, we prioritize a strong cash position and use of asset-level nonrecourse debt financing. This strategy provides the lowest cost capital to finance cash flow-producing assets backed by high credit consumers and to use parent recourse debt that is appropriately sized and balances maturity dates, cash interest costs, and flexibility. Turning now to our outlook on Slide 17. The underpenetrated nature of our market gives us confidence we can sustain robust growth throughout this decade. In this strong long-term demand backdrop, our priority is to generate cash by continuing to increase customer values through growing storage adoption and other high-value products and services and by reducing costs by further driving efficiencies across the business. While sales activities in Q1 were slightly less than we previously anticipated, we are seeing strong demand signals and expect a material pickup to occur in Q2, leading to an inflection point with meaningfully higher installations in the second half. Storage capacity installed is expected to be in the range of 215 to 225-megawatt hours in Q2. This represents 105% to 115% growth year-over-year. For the full year, we are reiterating our guidance for storage capacity installed to be in a range of 800-megawatt hours to 1 gigawatt hour, reflecting 40% to 75% growth year-over-year. Solar energy capacity installed is expected to be in a range between 190 and 200 megawatts in Q2. At the midpoint, this represents 10% growth from Q1. Because of the pulling of demand in California in early 2023, year-over-year comparisons are less relevant in Q2. We are confident that Q1 volumes will mark the low point in the year and we expect robust sequential growth into the rest of the year. For the full year, we expect solar energy capacity installed year-over-year growth to be in the range of down 15% at the low end to flat at the high end. This updated range reflects recent sales activities and outlook. We believe this guidance still represents market share gains underpinned by the strength of our subscription offerings and our disciplined go-to-market approach. Our growth in the value we create with this volume will be much larger. We continue to forecast subscriber values will increase by greater than 10% in 2024 as we increase our mix of higher value offerings and input cost declines, resulting in growth in total value generated of greater than 10% in 2024. Turning to Slide 18. We remain committed to driving meaningful cash generation as we execute our margin focus and disciplined growth strategy. We are reiterating our cash generation outlook. We are guiding cash generation to be positive on a quarterly basis for the remainder of the year, with cash generation in Q4 at an annualized run rate of $200 million to $500 million. This run rate will be expanded upon on an annual basis into 2025. We have outlined our current set of assumptions underpinning this outlook on the bottom of Slide 18. The most notable variable is the realization of the domestic content adder. The low end of the guidance range assumes no domestic content adders while the high end assumes these adders are obtained. We currently expect a large portion of our storage systems to qualify for the domestic content adder. With that, let me turn it back to Mary.

Thanks, Danny. I want to again express my appreciation to the entire Sunrun team. Your continued commitment providing our customers and communities with clean, affordable energy to power their lives, and to create value for all of our stakeholders is what drives us forward. Our rapid transition to a storage-first company is extending our differentiation, driving enhanced margins and delivering the best value to customers. Operator, with that, let's open for the questions.

Our first question comes from the line of Brian Lee with Goldman Sachs.

First one was just on the reduction in solar volume outlook for the year here. It appears, I guess, strategic, you said earlier in the slides, just kind of focusing on profitable growth in storage, but then you also alluded to some market-related weakness, I guess, sales activity being a little bit slower. Can you maybe parse those two pieces out? How much of it is market related? How much of it is strategic on your own part? And then were there specific areas that you kind of pinpointed had the weakness or the nonstrategic sort of focus that you wanted to pull back from? And then I had a follow-up.

Sure. Thanks, Brian. Great to hear from you. Yes, so to be clear, we really see Q1 marking the bottom, and we feel confident in the uptick in our outlook for the year. And you're absolutely right. As we have said, we continue to focus on our goals around profitability and cash generation and really being very strategic on volume. And with that, I would turn it, Paul, why don't you give a little bit more detailed response to some of Brian's questions?

Yes, great question. So we underwent kind of a final evaluation of our market economics and the various routes that we have generating volume and did a final cut of volume that did not meet our target return threshold. And so we underwent that exercise, which is a component of the volume adjustment. The other thing that we're seeing in the market is kind of this like new entrants kind of this ankle biter finance provider that comes in with aggressive pricing and it's been somewhat distracting to various channel partners or affiliate partners that we work with. And while we don't see any sustainable approach in their business model, and we've made a business practice in the past of purchasing their portfolios when they're unable to operate them because of the uneconomical approach that they take, there has been some distraction for our affiliate business.

Understood. Yes, that's super helpful. And then just...

Brian, just one last point on that. Just again, I'm sure you did notice it, but storage volume was retained, and we are really thrilled with the storage attachment rates and with our ability to retain that volume, which is very positive from a bottom line perspective.

Yes, absolutely. It seems like the reallocation of any resources or capital should further derisk the storage number. That's awesome. Maybe one for you, Danny, and then I'll pass it on. Slide 18, this is super helpful, just kind of giving us some context low to high end. I know there's been a lot of questions between how do you get to 200 versus how you get to 500. If I look at this slide and a lot of the data you provided during the quarter on where you're tracking, it seems like you're already tracking at or ahead of the low end, the $200 million annualized based on these three bullets. Can you help us understand kind of the frame of going from 36 to 40 capital cost 8% to 7.5%. Like how much of is each of those buckets worth? I wouldn't presume it's 100, 100, 100, but is it that simple where if you get capital costs down to 7.5%, you get storage attached up 10%. Each one of those is worth 100 maybe just kind of helping to quantify what each of those buckets is worth to the cash flow generation.

Yes. Great question. And we absolutely did want to break this out as to what assumptions are associated with opposite ends of the range as we've been getting a lot of questions around that. So we wanted to be responsive to that. As far as the magnitude of each of those primary drivers in the middle of Slide 18, capital costs are always capital costs, so not in order, but capital cost quarter point is between $40 million to $50 million depending more on the volume in the period, and that will range through the year as we grow volume. And this is most relevant to the Q4 exit rate. I would say it's probably closer to $50 million. And then the point of ITC adders is probably south of $50 million, maybe somewhere in a plus or minus $40 million range per point. And then storage attachment rate, I don't have the exact translation, but I would say the first two are more meaningful at this point, given we're in a smaller range on storage attachment rate relative to where we started.

Our next question comes from the line of Moses Sutton with BNP Paribas.

So the tax credit receivable of $181 million, is this transferability credit sold outside of a TE fund? Or is it still going through the typical cash flow to fall essentially partially replaced a tax equity proceeds that you would have gotten from some of those banks? And what could delay the $181 million maybe further than 2Q?

Yes, the general expectation is to be caught up by the end of Q2. There are several reasons for the delay, but primarily it involves the timing of when the credit is sold from the fund to the buyer. In traditional tax equity structures, the tax equity bank would typically accept the credit and provide an advance around the time of installation. However, currently, the tax credit buyer is purchasing in arrears, which can lag behind the installation time. As we transition to structures that don't include a traditional tax equity bank, the upfront monetization of that tax credit is not occurring to the extent it once did. The timing can also vary depending on when the individual buyer transfers proceeds for the purchase, which can happen monthly, quarterly, or annually. We are noticing a shift toward more frequent payments, specifically monthly and quarterly, compared to the annual payments that were common with one of our recent funds. The frequency of payment is a significant factor, as it pertains to both the base tax credit of 30% and the adders. The situation is primarily driven by timing, and, as mentioned in our prepared remarks, traditional tax equity banks are adapting to these new structures, which is leading to improvements in the working capital dynamics.

That's very helpful. And I guess, unrelated to timing, are you seeing any reduction in the tax equity capacity that your specific you normally use because Nova is increasing its participation in the market, maybe those banks want to limit their aggregate exposure to resi solar? Just thinking through if that's a possibility.

I think we're seeing generally, we're seeing capacity in the process of expanding radically. I think the biggest thing we see is just the value that we now provide to corporate buyers who basically are getting up to 10%, high single-digit type of discount. Immediately, they can put that coupon on their taxes. And I think we're going to see a large storm of repeat buyers come in once they figure out how to do this and get comfortable. And I think that's driving the expansion. We've noted traditional tax equity now for a couple of quarters to be tight. I think that dynamic still presents to some degree. But I think as we're moving to hybrid structures, net-net, we're seeing a big expansion in capacity.

Our next question comes from the line of Kashy Harrison with Piper Sandler.

So maybe the first question is for Danny. Please correct me if I'm wrong, but I believe you mentioned $40 million for the ITC point related to the domestic content adder. What should we specifically look for once the Department of Treasury issues guidance that would indicate this is fully derisked?

And you're referencing the domestic content or?

Yes, for the domestic content, yes.

Yes. I believe it's about eligibility and the basis of calculation. As we've previously mentioned, we are already sourcing batteries that are produced domestically. The module supply is in progress. As we secure the domestic supply that we expect to be technically eligible, the rulemaking regarding how to specifically attribute elements in the calculation will be important. Currently, we don't have complete clarity on this. Therefore, we are working within a certain range. We hope that once we receive additional guidance, we will be able to narrow that range. Although it's been a hope for too long, we are optimistic that clarity will come soon.

I am wondering if qualifying requires just batteries, or do you also need batteries and modules to meet the criteria?

Yes, we have a preliminary view that for most battery installations, the batteries should qualify us. However, we still need to review all the details to confirm that perspective. For solar only, we will need the module and, in some instances, we might also require an inverter. There may be additional combinations involving balance of system components, such as racking, on the solar-only side to meet the minimum threshold.

I appreciate the insight. My second question is about the newer entrants with unprofitable offerings. I understand the focus on cash and volumes, which is certainly the right approach. However, I am curious about how you evaluate the risk that some of these challenges might persist or worsen in the third or fourth quarter. I just want to ensure we aren't facing another call in August with another guidance reduction on the solar front.

Yes, great question. I think we feel really confident about the guidance that we're providing on the volume side and that we're taking a conservative view with the guidance range adjustment. I think in the history of the business, we've seen kind of irrational behavior in different segments throughout time as different areas have gained attraction. So we've seen really low install prices. We've seen really attractive sales commissions, and now we're seeing it in capital providers. And so it's something we have a lot of confidence in our ability to navigate. I think the key component for us is the affiliate partner business we have deep and strong relationships with a few key partners and continue to see robust opportunities with them. The rest of our business is captive sales force that's largely insulated from this competitive risk.

Our next question comes from the line of Andrew Percoco with Morgan Stanley.

So I guess just to start out, and apologies if this has been asked already, but I think it's clear that some of your peers in the space are coming under some pressure here. And I'm just curious if you've seen any impacts to your ability to find non-recourse project level capital. Have the conversations changed at all? Have the terms changed at all in those deals as a result of some of the disruptions you're seeing across the space?

Yes, that's a good question. We undergo underwritings focusing on asset quality, which has been excellent, along with our servicing levels. We are also evaluated on sponsor quality, and we have consistently met and exceeded those requirements. To highlight this, we recently discussed the extension of our nonrecourse warehouse loan, which now stands at approximately $2 billion with nearly 10 lenders. Many of these lenders have increased their commitments since February. This group is well aware of our performance, and we have two strong recent data points, one being in the public market with a seasoned pool of assets that have been maintained effectively over the past 7 to 8 years and are performing well. We also managed to secure a lower spread compared to our prior private market transaction concluded in February. This indicates a growing participation in the private credit market. Additionally, we continue to have a strong track record and success in executing deals in the public ABS market, with no significant issues in that area.

Over the company's history, like a flight to quality mindset has generally benefited us.

Yes, definitely. Okay. That all makes sense. And maybe as a second follow-up question, maybe more of a strategy question. But just kind of curious what you see in terms of battery retrofit opportunities. Now that battery supply is more readily available, costs have come down a lot. Obviously, growth in solar has slowed a little bit. Is there an opportunity to just go back to some of your customers in that batteries? And what would that look like from a cash perspective? Would that impact? Would that be positive or negative to near-term cash generation?

Yes, that's a great question. We completely agree and, in fact, at the beginning of the year, we launched a storage retrofit program that is performing very well. We also initiated the first phase of our renewal pilot and launched a repowering program in combination with the storage retrofit. We see a significant opportunity to focus on and expand the storage aspect of our business. Additionally, as I mentioned, another considerable benefit is that it adds more value from a grid services perspective over time, as every solar customer we connect to storage gains the potential to participate in grid services programs. We are very optimistic about this. We have rolled out various programs, are seeing positive numbers and uptake, and we are excited about the potential impact. This further supports our confidence in our storage strategy.

Our next question comes from the line of James West with Evercore ISI.

Mary, I understand your confidence that we have reached the lowest point and that Q1 represents this low for the year. Could you provide some insight into which states you operate in are experiencing the most growth and recovery, as well as those that are recovering more slowly?

Yes. I think we continue to see really robust return to volume in California and believe that we're gaining market share inside that market, which is really strategic for us, obviously, from a solar volume perspective, but as well from a future grid service perspective. Another really exciting market for us is Texas, and we've been having geographic expansion inside the state and are quite excited about that market as well. So those are two really promising big growth markets for us. The third I would list is Illinois as well.

Got it. Okay. That makes sense. And then maybe just a quick follow-up. Danny, you provided some information about the declines in equipment costs and mentioned they are still working through some higher-cost inventory. By the end of the year, I believe you indicated a decrease of 18% from the peak. Does that account for all the higher-cost inventory still being in the field and not yet out of your inventory?

Yes. As you track our inventory balance, you may have noticed a significant decrease. We expect that by the second quarter, we will largely realize the benefits from the lower-cost purchases we made late last year and this year. However, there will still be some residual recognition in the third quarter. We are almost complete with the expense recognition of the lower-cost equipment we have been acquiring in the second quarter.

Our next question comes from the line of Praneeth Satish with Wells Fargo.

So if we think about 2025, it seems like many of the assumptions that you laid out for your cash generation forecast between the low and high end seems like many of those assumptions will play out in 2025 between battery supply shifting domestic, getting more clarity from treasury, and maybe interest rates coming down a bit. So I mean, I recognize you're not giving 2025 guidance right now. But maybe if you could just talk about the puts and takes to consider as we look out another year to cash generation.

Yes. I believe the initial assumption is regarding the adders. We currently have energy community and low-income initiatives in progress. There has been some reallocation among the categories, and overall, we've seen that percentage increase since last quarter. With domestic content, it's only a matter of time before we see the benefits, depending on how much upside we realize and over what timeframe. We have been cautious in our approach to domestic content, but we anticipate that it will be a significant factor as we move into 2025. Regarding interest rates, we are projecting them to remain in the range of 7.5% to 8%. We are not expecting a significant decrease in interest rates. Base rates have increased, and we have seen improvements in credit spreads, maintaining this range over the last few quarters. Continuing with this cost of capital range into 2025 should support our anticipated cash generation. Additionally, we aim to maintain and gradually increase our storage attachment rate, while also focusing on penetrating markets with currently low storage adoption. We will strive to enhance our performance in this area as we approach 2025.

Great. And just to make sure we clarify one thing, the batteries that we have been installing over the course of the year are those that we expect will qualify for the domestic content adder. So while you cannot monetize those until the guidance is sufficient, and obviously confirms our expectations that would then make retroactive adders possible for the 2024 installations. Now there could be puts and takes and delays in getting that retroactive credit, but we do not need to wait for domestic content and batteries to show up; we are already installing those that we expect are likely to qualify for the guidance.

Got it. That's helpful. Staying on batteries, you're currently at a 50% attach rate and it seems you're expecting that to remain flat for the rest of the year. Why is it not expected to increase? What would need to happen for that rate to reach 60% or higher? It looks like you might be nearing the maximum attach rate in California, so what needs to change to improve the rates across the rest of the country?

Well, I think as we talked about, we continue to see storage attachment rate increasing. Yes, as we look to the future, I think over time, we could absolutely see them go above 50%. But what we've been looking at is landing when you look at like the entire country and all of the markets we're in, landing at about that percentage. But absolutely, like my view from a grid perspective is that you'll start to see other parts of the country moving towards a more different tariff schemes that might make storage more attractive for customers as well as grid reliability issues that will make storage more attractive for customers. But again, we also see a tremendous like attach rate storage program as well. So we're really excited about the opportunity to also go back to our existing customer base and attach storage.

Our next question comes from the line of Joseph Osha with Guggenheim Partners.

Kind of two related questions. First, looking at the adjusted Q1 '24 cash generation number. I see that you're talking about an adjusted number that's flat there, not to be a stick in the mud. You did have a nice tailwind issuing this 2030 converted, not taking the '26 back in. So I guess what I'm asking first question is are you asserting here that on an ongoing basis, do you think Q1 cash generation can be flattish? And then I have a follow-up.

One clarification is that proceeds from the issuance of the new convertible would not be included in our cash generation calculations, as we do not credit corporate capital raises in that figure. Although the cash balance increased due to this transaction, it did not impact the cash generation number because we excluded it. However, the transaction did incur $51 million in fees, which we are including in the pro forma. Additionally, we have various other items to consider, such as the warehouse facility, advance rates, and related fees. Looking at the pro forma, two-thirds of it consists of tax equity and tax credit transfers amounting to $181 million, along with an added $30 million from the low-income ITC. We anticipate recovering most or all of that by the end of the quarter, which suggests significant cash generation to help offset the costs.

Okay. And then just as a follow-on, we spent a lot of time talking about this annualized 200 to 500 number, which is great. But it's not going to help as much if we just give it all back in Q1 '25. So I guess what I'm trying to understand is that you put in your comments that there's going to be positive Q3 '23 to Q3 '24 generation. How should we think about that level of Q4 to Q4, Q1 to Q1, future poising? What should we think about the sustainable annualized rate of cash generation? Because again, the Q4 number is great. But if we give it all back in Q1 of '25, it doesn't help.

Yes. We believe that the annualized run rate delivery will be sustainable and not driven by timing. This is the most crucial point. There will be normal fluctuations. Historically, our results show seasonal variations. However, over a trailing four-quarter period, we expect to maintain that number or trend line. While deal timing and seasonality will still play a role, when we take a broader view over four quarters, that reflects the annualized run rate thinking and framework we are applying to the guidance.

I would also add that we are implementing several initiatives such as our retrofit program and our renewal program, which we are considering in relation to how we can use these programs to support typically low quarters from a seasonal viewpoint. This is also something we're thinking about and addressing strategically as we prepare for the first quarter of 2025 and beyond.

Our next question comes from the line of Philip Shen with ROTH MKM.

First one is on the impact of AI-based load growth on your business. For example, ERCOT power forwards have moved up 60% in the last 12 months. CAISO has been similar. When do these flow through, I mean the retail pricing and affect your pricing power?

Yes, that's a great question. From our perspective, strategically, we see the load growth as directionally positive, primarily due to impending capacity challenges at both the utility and regional levels. We believe that expanding our fleet of storage and solar assets will offer significant value and become a crucial resource. In terms of rate implications, we haven't observed anything indicating that the utility grid infrastructure will economically strengthen. There is substantial investment required at the transmission, project, and distribution levels. Consequently, we anticipate real pressure on utility rates going forward, which also opens up opportunities for Sunrun and our assets to be part of the solution.

Great. Shifting to the impact of new entrants in the lease market. I was wondering if you could give us a little bit more color. You've shared some in the past. Have you felt this increased competition offset by Nova and SunPower situations? Is there anything that has changed in the sense that these new market entrants, which are mostly corporate or PE-backed have started to enter into an asset class that was previously very fringy or not institutional quality?

Yes. I think for us, we continue to see them operate kind of how we've seen it historically. I think they're trying to figure out the business model. When you look at owning assets for 25 years and forecasting out service costs and understanding asset ownership, consumer experience, customer service, there's a lot to managing these assets, and we are extremely confident having financed dozens of billions of dollars of this stuff that we know how to price it. And while we see annoyances from these partners, we don't view it as like a durable threat. We view it as some short-term frustration to volume.

Our next question comes from the line of Colin Rusch with Oppenheimer.

Can you speak to the performance of your VPPs from a monetization perspective versus your internal expectations when you guys enter into that market?

Yes. We're really pleased. As I described, again, we've got enrolled 16,000 Sunrun customers in the CalReady program that we rolled out, 1,800 on the PowerOn Puerto Rico. Our growing experience with good services increases our conviction that we can realize $2,000 or more in per customer NPV from these assets.

And then as you see higher storage attach rates, are there meaningful adjustments to your inverter storage hardware mix that you're looking at coming down the pipe? And are there meaningful new products that you're looking forward to being able to integrate that could impact your unit economics?

Yes. From a core hardware perspective, we feel very confident about the diversity of our major components and the products we are using. We continue to project and observe a steady decline in costs for these core products. On the innovation front, we are excited about many new products entering the market. Sunrun's strong distribution network positions us as a preferred choice for customers. We believe we are well-placed to adopt the best and most innovative new products that arise and have been conducting trials with different offerings. As the markets and products evolve, we anticipate incorporating these innovations more widely into homes.

Yes. And of course, we're looking forward to the deployment of Lunar and their storage capabilities, and we're already working with Lunar on their grid share capabilities, which are quite powerful.

Our next question comes from the line of Maheep Mandloi with Mizuho.

Just a question on the systems and products business. I saw the gross margins were a bit weaker in the quarter, which probably led to the lower platform margins. Just trying to understand the drivers there and how should we think about the platform contribution going forward, especially after the distribution business sale you talked about a month ago?

During the quarter, we decided to wind down our AEE distribution business, which resulted in a one-time noncash charge of $22 million due to inventory impairment. This significantly impacted the gross margin for the period. However, we have kept the higher margin and value-generating elements of that business, which should help improve margins moving forward. When we consider the overall line item, it encompasses our distribution business, cash sales, and our home upgrade business, which is supplementary to solar installations. Specifically looking at the cash system sales, that gross margin remains a strong double-digit figure.

Got it. I appreciate that. Regarding cash generation, looking at your Slide 14, the orange bar for the second to fourth quarter seems to align more with the $200 million cash generation expected by the end of the fourth quarter. Is that accurate? Or could we possibly see some improvements to those figures starting in the second quarter as well, considering the various strategies you mentioned?

Yes. What you see on the bar chart in the bottom left of Slide 14 represents what you're looking for. It's a directional overview, illustrating the return of a significant amount of working capital that we incurred in Q1, which we expect to return in Q2. Then in Q3 and Q4, we aim to move closer to the exit rate that aligns with our guidance range. That’s the general picture I have. I'm not sure if I missed part of your question.

It appears that for Q4, there’s an indication of approximately $50 million in cash generation. Does this align with the $200 million figure, or is the exit run rate different from the Q4 number?

Yes. Within the $200 million to $500 million range is what's implied there.

Our next question comes from the line of Dylan Nassano with Wolfe Research.

Mary, you briefly hit on the early renewal program in your opening remarks. I was just wondering if you had any more color you could share on how that program has been progressing since your last update?

Yes. As I mentioned, we are using this year to explore various strategies for renewals and plan to scale as we move from 2024 into 2025. We have completed the early renewal program, which had a 70% positive interaction rate, and we are now starting our repowering and renewal pilots with add-on storage, which will launch in May. In our next call, we will provide an update on this initiative. We are very encouraged by our initial rollout and are looking forward to seeing the uptake as we prepare to scale at the end of this year.

And I would just add, I'd take this as kind of like us beginning more of a concerted focus around understanding our portfolio that's now close to reaching 1 million customers and investing in providing additional products and services like the battery to these homes. And as we focus on that opportunity that's in front of us, I think there's a lot of cash generation addition that can come as we effectively manage the portfolio.

That concludes the time that has been allocated for Q&A. You may now disconnect.