SPRU - NYSE

Good afternoon, and welcome to the Spruce Power’s Second Quarter 2023 Conference Call. As a reminder, today’s call is being recorded. [Operator Instructions] For opening remarks and introductions, I would like to turn the call over to Bronson Fleig, Head of Investor Relations for Spruce Power. Mr. Fleig, please go ahead.

Thank you. Good afternoon, and welcome to Spruce Power’s conference call to discuss results for the second quarter of 2023. With me today are Christian Fong, our Chief Executive Officer; and Sarah Wells, our Chief Financial Officer. Our call this afternoon will include statements that speak to the company’s expectations, outlook or predictions of the future, which are considered forward-looking statements within the meaning of federal securities laws. These forward-looking statements are subject to risks and uncertainties, many of which are beyond our goal, which may cause our actual results to differ materially from those expressed in or implied by these statements. Similarly, out of our control is the timing of some of the processes that we will discuss today, which could impact the expectation-related statements you will hear shortly. We are not obliged to revise or update any forward-looking statements except as may be required by law. Please refer to our disclosures regarding risk factors and forward-looking statements in today’s earnings release, our annual report on Form 10-K and our other Securities and Exchange Commission filings. A copy of our press release has been posted to the Investor Relations page of our website for reference. The U.S. non-GAAP financial measures discussed in this call are reconciled to the U.S. GAAP equivalent and can be found in the press release that we issued this afternoon. With that, I will turn the call over to our CEO, Christian Fong. Christian, go ahead.

Thank you, Bronson, and thanks to everyone for joining us on the call today as we discuss our strong second quarter results and progress on 2023’s initiatives that extend our core business of distributed generation solar power. For those new to Spruce, we have 3 primary businesses. First, we create and sell clean electricity through our growing solar power portfolio. Second, we deliver power services to our customers with servicing creating strong margins and business development opportunities. Third, we profit through participating in the related environmental commodities markets. This year, we kept our differentiated customer strategy rather than carry a high cost sales force, we add customers through the acquisition of existing power portfolios with long-term purchase contracts and leases. It’s simpler, it’s flexible, and it’s allowed us to have arguably the lowest customer acquisition costs in the industry. We demonstrated the strength of that growth strategy by expanding our portfolio of home solar assets and contracts by over 40% with the acquisition of the Spruce Power 4 portfolio. With the transitional tasks associated with our merger with XL Fleet mostly complete and the first full quarter of Spruce Power 4 in the books, what we’re showing today are the result of a clean quarter. I want to break my comments into 3 focus areas. The first will be operations and then growth initiatives and then capital markets. Okay, operations. Of course, Spruce is not a financing company. We actually make and sell a product and provide services to our customers. We are an operating company, and so our goal is operational excellence. Our company facilitates the solar electricity consumed by about 80,000 households across 18 states. For these families to enjoy zero emission electricity that’s reliable and cost advantaged, our Spruce servicing team delivers best-in-class excellence in its execution of customer billing, collections and support, asset management, system repairs and the complex technology that links all of that together for a smooth customer experience. The ultimate measure of operating excellence then is customer satisfaction. Our second quarter customer satisfaction score was 70% right in line with our 70% target and up substantially year-on-year from 53% in the second quarter of 2022. This is our third consecutive quarter of meeting our target, helped by several million dollars of technology and personal investments we made in customer operations. In Q2, we rolled out customized changes to our billing system, serviced by SMS text and a completely re-tooled customer home transfer process to bring that to a 5-star level. We continue to strive for an even better experience for our customers. Our customer focus groups have given us valuable feedback this year. They aren’t asking for the latest and greatest technology. No AI-driven computer systems or a flashy mobile app with streaming data. On one hand, we’re going to keep building a solid IT backbone, developing technology and asset management tools at the pace of about $2 million per year. Yet on the other hand, AI technology is incapable of empathy. Our customers place the highest value on direct interaction with our well-trained U.S. based service team, real people and real interactions. So we are also pleased to announce a new pilot program to place our own field services teams in our highest asset density areas, starting in the Northeast. Field services will lock in our own labor force, which will both give faster O&M to our customers and create more human interactions. That person-to-person service is key to building Spruce as a trusted brand to deliver additional products such as home batteries. Spruce is a clean energy producer. So let’s take the production numbers. Our Q2 performance ratio, which is the production compared to the theoretical maximum of the installed solar panels was 95%. We achieved this despite impact from the Canadian wildfire smoke through the quarter as well as negative weather in California in June. Our weather adjusted performance ratio was a strong 103% and 103%, Spruce’s asset management team is strongly outperforming the projections we get from top independent engineering firms who review our portfolios at the time of their acquisition. The strong physical performance of our portfolio leads to strong financial performance, too. Cash inflows were solid this quarter. And while there are still some legacy XL Fleet issues that tie of, we delivered a clean quarter that shows Spruce Power’s financial performance. Last quarter, we spoke to a current run rate of $110 million to $130 million of annual business cash inflows primarily coming from our portfolio of home solar assets and contracts. In the middle of the cash funnel, our cash flows remaining after OpEx, SG&A and debt interest. In that, we expect an annual range of $35 million to $45 million, ultimately leading to between $5 million and $15 million of net cash flow after principal payments. That’s the exact same level as we discussed last quarter that is we are affirming that financial framework. Long-term, our primary operations driver is our professional team. Last quarter, we announced Sarah Wells as CFO, also Spruce’s longtime Chief Legal Officer, John Norling, assumed the responsibilities of Board Secretary and sole leadership of the legal department. More importantly, we are deepening our management team with strong hires of experienced directors and team leads. New leadership and bench strength in FP&A, M&A, collections, treasury and litigation gives us our best cross-team collaboration ever. Related to team growth this fall, the executive team will move into our new Denver headquarters and our Houston servicing group will expand its office footprint by about one-third. It’s not a hiring binge, just Spruce’s staff shifting back to in-office work for better productivity and career development. Now let me shift gears to talk about our growth and capital strategy. As I mentioned before, Spruce has a growth strategy that gives us what is arguably the lowest customer acquisition costs in the industry. Not only do our costs continue to stay low, Spruce’s M&A team finds deals that generate impressively high cash-on-cash returns for years into the future. So instead of talking about onetime sales margins, we think in terms of multiples on our investments and our stability grows with a portfolio that has over 12 years average contract life remaining. Spruce’s growth isn’t the sugar rush of onetime sales. We think investors are better served by the muscle building nutrition of recurring high-margin cash flows. In Q2, we focused on integrating the portfolio we bought at the end of Q1, the Spruce Power 4 portfolio, which increased our rooftop solar assets and contracts by about 44%. In this initial quarter under our ownership, we actually saw the portfolio’s customer payments perform about 5% better than our initial expectations due to the underlying PPA contracts, many of which are indexed to the rapidly escalating retail electricity rates in California. We’re now looking at our next growth acquisition. In July, we signed a letter of intent to acquire a portfolio of approximately 2,400 home solar systems, all with long-term customer contracts from a publicly traded counterparty. We hope to close in the next few weeks, though, of course, can’t comment on specifics and nothing is certain until the ink is dry. However, we can say that the transaction is underwritten to meet our mid-teen levered return target, and we’re excited that it brings us past 75,000 home solar assets and contracts. We expect to fund the equity portion of the acquisition with cash on hand and non-recourse senior debt. It’s worth noting that after the banking secure this spring, the debt markets have bounced back fast, and we’re seeing an abundance of debt offered to us at attractive terms. One last point on growth. We have two areas of organic growth that are picking up pace. The first involves actually increasing the cash flow from our home power systems we already own by more efficient participation in the Environmental Commodities Markets or by acronym, ECM. Our ECM business is finding more efficient ways to mint and sell renewable energy credits from our assets around the nation. In Q2, we saw a strong uptake in value and cash flows leading to a quarter-on-quarter growth of close to 10% on a GAAP basis. The second area of organic growth is increased natural demand for retrofit battery installation really for the first time. Spruce has offered that product for a couple of years but the economics of a battery lease or sale was a tough sell. What we’re seeing is that adjacent to California’s new net metering rules there is real demand for home battery storage from our California customers. We aren’t internally budgeting material battery lease revenue for the rest of 2023 yet as we finish the business infrastructure to begin taking advantage of it. We’re working on partnerships to more quickly address that demand and also see our new field services initiative as an important long-term way to meet the demand. So just to wrap up on organic growth. Even though as we execute on our strategy of acquiring portfolios of assets, we’re excited to see and meet opportunity for increasing revenue per customer. On capital, we have plenty of cash and even in the current debt markets with higher interest rates, we believe we are fully funded to achieve our near-term goal of reaching a customer contract portfolio of 90,000 by the end of 2024. One final point before handing the call to Sarah. Every quarter, we have any number of choices of how to deploy the capital to which you’ve entrusted us. Naturally, an acquisition is the top choice if the portfolio is solid and the price will yield attractive cash returns. With the Board authorization of our share repurchase program in May, we began to purchase our own stock. In our view, that stock is priced far below its fair value and is a great buy for investors, including ourselves. We bought about 1.9 million shares in Q2 and just keep going. Through August 4, we’ve repurchased about 3.6 million shares for about $3.2 million. I want to bring you to a conversation we have every day here. Why is our stock sitting at $1? Based on institutional feedback from the buy side, conversations with research analysts and investment banks, they cite the overhang of having so many shares outstanding that even strong company value gets obscured by the math of a huge share count. It’s not a function of operations, but of the unique way we became a public company. Maybe it’s just math, but fortunately, it’s within our control. So last week, our Board authorized a plan to consider a 1-per-8 reverse stock split. This week, we filed the preliminary proxy with the SEC. And in the next couple of weeks, we plan to call a shareholder meeting in early October for approval. If shareholders approve, a reverse split is intended to get us well above the dollar level necessary to maintain our NYSE listing. With that, I’ll hand the call over to Sarah to walk through the financials.

Thanks, Christian. Before getting to quarterly results, I’d like to quickly address a few housekeeping items that impacted our financial reporting. Consistent with the prior two quarters, legacy XL businesses, Drivetrain and XL Grid, are presented as discontinued operations within our financials. These legacy businesses were divested in the first quarter of 2023, and we do not expect any material expenses going forward related to discontinued operations. Our continuing operating results still reflect certain expenses related to XL Fleet, notably legal expenses related to the previously disclosed SEC inquiry and related shareholder lawsuits. We are working to close these legal matters, but we do expect to incur future associated costs. As we stated in our 10-Q, we believe the allegations in both the SEC inquiry and shareholder suits are without merit. And the company is vigorously defending itself. At this time, we cannot estimate the timing of resolution of these matters nor the impact of any related liabilities. Also, as Christian mentioned, the Spruce Power 4 portfolio acquisition closed in late March and second quarter results fully reflect this investment. However, please recall that GAAP accounting treatment for the Spruce Power 4 portfolio acquisition places the majority of cash flow stream from the portfolio in the cash flows from the investing section of our consolidated payment of cash flows. This item is denoted as proceeds from investment related to SEMTH master lease agreement. However, note that operating costs and interest expenses tied to our senior debt supporting Spruce Power 4 are reflected in the statement of operations. Moving to Q2 financial results, second quarter revenue, which consisted exclusively of Spruce-related revenue was $22.8 million compared to $18.1 million in the first quarter of 2023. Revenue was higher sequentially due to more spent hours across our fleet. That’s just normal seasonality as well as quarter-on-quarter improvement in our portfolio’s weather-adjusted performance ratio and the resulting impact to our PPA contracts. Second quarter OpEx, which includes both SG&A and portfolio O&M and excludes depreciation was $19 million compared to $17.6 million in the first quarter. Portfolio O&M expense increased to $3 million in the second quarter from $1.9 million in the first quarter. The sequential increase is tied to accelerated activity in our meter upgrade campaign as we replace legacy meters across our fleet to maintain the most efficient fleet possible. SG&A expense increased modestly to $16 million in the second quarter from $15.7 million in the first quarter. Integration costs tied to our public merger process tailed off and largely concluded in the quarter. However, SG&A continues to be impacted by certain legacy XL Fleet corporate items, namely legal expenses associated with the previously disclosed SEC inquiry and shareholder lawsuits. Collectively, integration costs and legal expenses totaled close to $5 million for the quarter. Excluding these expenses, core Spruce OpEx will be closer to $11 million in the quarter, which we believe offers a clear view of OpEx for a standalone Spruce Power. On a GAAP basis, net income from continuing operations was $1.8 million compared to a $15 million loss in the first quarter of 2023. Adjusted EBITDA totaled $9.5 million, adding in the cash flow from the Spruce Power 4 portfolio, which is called in our financials, proceeds from investment in lease agreement brings the total to $13.8 million. This compares favorably to $5.7 million in the first quarter. In measuring the value of our long-term solar assets and contracts, we have provided metrics of growth and net portfolio values, which represents the present value of the remaining net cash flows of our rooftop systems and contracts discounted at 6%. As of June 30th, gross portfolio value was $929 million. After adjusting for non-recourse debt and cash balances, our net portfolio value was $477 million. Next, I will speak to our capital and liquidity position. As of June 30, 2023, we had cash, cash equivalents and restricted cash of approximately $192 million. This compares to $205 million at the end of the first quarter of 2023. The sequential decrease is primarily attributable to the seasonal timing of semiannual mezzanine debt payment and portfolio expenses. The total principal balance of long-term debt was $644 million as of June 30, 2023. As a reminder, all of our debt is non-recourse project-level debt that is supported by our long-term contracts. In the current rate backdrop, we think our debt is attractively priced due to weighted average cost of approximately 5.6%. And because our variable rate senior debt facilities are mostly hedged by interest rate swaps, our overall debt is 97% fixed rate with the swap tenor extending well beyond the life of the loan. Spruce’s earliest debt maturity is in August 2025. To-date, we have primarily utilized non-recourse project-level debt to fund acquisitions. For context, these facilities have typically been structured with tenures of around 7 years. Though the underlying contracts and associated payment stream will extend well beyond the tenure of the debt facilities, this structure is typical in project finance debt markets. Given the nature of our long-lived cash flows, we are confident that we will be able to refinance our debt facilities upon maturity. We have strong relationships with current and prospective lenders in renewable power debt markets, where we see the appetite for residential solar as robust. Moving next to capital allocation, as Christian mentioned, every quarter, we have any number of choices of how to deploy the capital. In addition to debt repayment, during the second quarter, we purchased approximately $1.6 million of our own stock through our share repurchase program. We believe this opportunistic investment represents tremendous value. Our repurchase program does not require us to purchase a specific amount of shares. However, we believe that the market value of our shares is well below the intrinsic value of the company. Every share purchased is accretive to our per share metrics. So, we have stayed active. And from the start of the program through the end of last week, we have cumulatively repurchased approximately 3.6 million shares for $3.2 million. I will now hand the call over to the operator for Q&A. Operator, please open the line for questions.

[Operator Instructions] Your first question comes from Joseph Osha with Guggenheim. Your line is open.

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

Sure. Hi Hillary. Thanks for joining. When we think about – and I will call it organic, the organic growth portion of being the owner and operator. So, there is two ways to do it. Of course, one is just to increase revenues. And when we think about increasing revenues from the current portfolio, we have two mechanisms to do that. One of them is pretty active right now, and that is the emergence of additional SREC or environmental commodities markets really around the country. And that is through our Environmental Commodities Markets group, ECM. And that’s what we touched on as being a quarter-on-quarter 10% growth. That – those markets are increasing. It’s added revenue directly from the portfolios that we already own. Then looking on into the future, you can up-sell to customers, added sales and that was the battery that we are starting to see quite a bit of demand out of California. And so the additional sales to the customers would then increase, and that would be thinking of it not as increasing the revenue from like a system, but from – think of it as a portfolio of customers and underlying homeowners that would purchase additional products. That’s the first way. The second way, of course, is simply to manage our costs and to make sure that on an ongoing basis, the per unit cost that we have on servicing or owning the systems continues to go down, and that just increases the net margins. Our intent is to do both the – we are seeing the increase in revenue. And as we increase the size of the service portfolio, that’s where just scale starts to kick in, and we see decreased per unit costs as well.

Great. And then just when you think of building to the 90,000 customer target that you guys have. Just wondering if you could provide an update on kind of the competitive landscape and any color you could share on the pipeline of potential deals?

Yes. As usual, we don’t speak to any specific line items on our pipeline report that we would have internally. We do mention this non-binding LOI, letter of intent that we signed. Clearly by even mentioning on the call, we are signaling a level of confidence that we are nearing a closing in the next couple of weeks. Anything can happen, deals are deals. But that would get us to around 75,000 home solar assets and contracts. We started at around 51,000 or so at the beginning of the year. So, when we talked about going from – let me just do the shorthand here, 50,000 to 90,000, and we are thinking we need to add about 20,000 per year with the large Spruce Power 4 acquisition, largest in our history, record size. That got us like a full year’s growth from 50,000 to 70,000 plus. And so as we look at in Q3, the potential of adding about 2,400 systems and landing at 75,000, we are well on pace to get to 90,000 by the end of the year, I am sure some folks will say, we will want you just go ahead and raise your target and have the team go buy even more price premature for that, though we are just confident because we do have bilateral negotiations going. We have got bids out currently. And so rather than talk about any of them one-by-one, let me just affirm that we are still confident that we have enough runway in time and seeing enough deals to still feel good about that 90,000 target. Hilary, you can kind of asked the second question like competitive landscape for the licensing, I can’t figure out why other folks aren’t buying because the returns that we are getting are so strong for our shareholders and we are really happy with that. And we are just always kind of looking over a solar just saying, who else might jump in. The reality is that buying things is hard. M&A is not an easy business. Integrating is not an easy business. We have spent the last 5 years developing that called, muscle memory of how to bid being a low execution risk counterparty. People know that we are good for our handshake that when we say we are going to do something, we actually have the means and the expertise to do it. We believe that makes us the preferred buyer in M&A especially in residential solar. And so we continue to see things. Yes, there are other folks that are competing, and yes, our scale, our expertise and I would like to think our reputation as counterparties enable us to be the preferred buyer for a lot of potential sellers.

Great. Thank you.

Your next question comes from Jordan Levy with Truist Securities. Your line is open.

Hello. It’s Henry on for Jordan here. Really great to see the inflection, the positive earnings this past quarter, I know you mentioned the recent merger, but any other additional color you can provide on some of the core drivers behind that?

Yes, sure. We saw really strong production from our assets in the quarter. As Christian mentioned in the prepared remarks, our weather-adjusted performance ratio was above 100%. And so our assets are operating really well. That paired with normal seasonality drove the top line. On the cost side, we still have some legacy XL costs coming through mainly legal costs, but all of the integration costs that we saw with the merger, like the people comps, all the back has mostly rolled off. And so we are really excited about this inflection and to continue to build on our improvements on the bottom line.

Awesome. Thanks for that. And then I know you noted you have been active kind of in the share repurchase program in the quarter and then going forward. And so I would love to get any color on the kind of the balance you see with acquisition opportunities, obviously, the buyback and anything else you see kind of going through the end of this year and then into 2024. Thank you.

Sure. Going forward, the repurchase is always going to be part of our chest to drive shareholder value. I don’t see that going away. We do view the program as two-fold. First, it has to offer value. And if that’s happening, then secondly, we also benefit with Spruce acting as an incremental buyer of our own stock. So, I see the repurchase program and the reverse like kind of all working towards that same goal.

And I had just to put numbers on. It was a $50 million program. So, we have still got $46-point-some million of dry powder in that program.

Thank you.

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