Sunrun Inc (RUN) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Sunrun Incorporated Q2 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Miss Charlotte Coultrap-Bagg, Director of Investor Relations. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and thank you for joining us.

Before we begin, please note that certain remarks we make on this conference call constitute forward-looking statements. This includes, but is not limited to, statements related to our financial and operating guidance and expectations regarding our business's future growth rates and key operating metrics, as well as our ability to raise capital, manage cash flow, cost and liquidity, leverage our platform services and deliver on planned innovations and investments in addition to expectations regarding the growth of the industry, background economic trends and the industry's legislative and regulatory environment.

Although these statements reflect our best judgment based on factors currently known to us, forward-looking statements, by their nature, address matters that are, to different degrees, uncertain and actual events or results may differ materially. Please refer to the Company's filings with the SEC, including the form 8-K filed with today's press release and our Form 10-Q for Q2 2016, which have 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.

Our SEC filings are available on the investor relations section of the Company's website and on the SEC's website. These forward-looking statements are being made as of today, and we disclaim any obligation to update or revise them. If this call is reviewed after today, the information presented during this call may not contain current or accurate information.

With that, let me turn it over to Lynn.

Thank you, Charlotte. Good afternoon. Thanks for joining us.

We continue to believe that the long-term growth rate for the residential solar is 20% to 30%. Having been in this business for almost a decade, we have seen significant quarterly and even annual fluctuations above and below this range. But the macro drivers sustaining this level of growth are powerful and persist.

We think that the reactions to recent results are too severe and are not appreciating the longer-term attractiveness of rooftop solar to consumers and its important role in building a modern energy infrastructure.

The United States is accelerating its shift to clean energy. In 2015, new solar capacity in the US exceeded that of natural gas and in the first quarter this year, solar made up almost 2/3 of new installed capacity. New York recently announced a new renewable portfolio standard of 50% renewables by 2030. In the presidential race, clean energy is a top three economic plank. We know that technology will drive increasing consumer choice in energy and when consumers have choice, they choose rooftop solar. Putting energy generation where it's most efficient, right where it's consumed, creates the best outcomes for energy users and for the grid.

New technology and access to our 100,000 plus and growing customer base will open up new business models. Retail electricity is a $400 billion annual market undergoing a true disruption through innovation and consumer choice. At the same time, I do also want to address a few things happening in the industry that are creating distorted year-over-year growth comparisons and short-term challenges in converting leads to interconnected customers.

Sunrun has a strong operating plan in place to execute through this, but this is what we see happening across the industry. First, let's remember we're comparing this year's growth with last year's exceptionally fast growth. Our industry is now approximately twice as large as it was only 18 months ago. Part of this exceptional growth was created by aggressive customer acquisition across the industry to capture customers ahead of the expected ITC expiration.

Growth was further boosted by market openings like Nevada. As we've previously discussed, from the start of the year, these drivers have reversed causing short-term headwind. This has also set up a tough growth comp for the back half of the year.

Second, homeowners are smart. They are smart enough to know that they have a better option than utility electricity and they are smart enough to want to understand how changes and rates will affect them before making a long-term purchase commitment.

The evolution of NEM with time of use rates is going to power industry growth in California, but it requires significant customer education in the early days. This is hard without clarity around the ultimate rate structures and is temporarily challenging customer conversion.

We do have confidence that consumer demand is there and will convert when there is more certainty. Here is one example supporting this thesis. One of our platform businesses is the number one digital lead generator for the industry. And in the month of July, we are seeing 40% year-over-year increase in the number of unique homeowners who are interested and qualified for solar in the State of California.

Furthermore, we estimate that there are five times more solar-ready homes today in California than are currently installed. And this factors in FICO, shading, roof-face, and energy bills. It also doesn't include new housing starts, improving panel efficiency, lower cost, time of use plus storage, electric vehicles, which add load equal to 2 kilowatts per panel or more and the future opportunity to bring solutions to the rental market. We remain bullish on California growth and unit economics.

Third, there is significant attractive growth beyond California. California and Hawaii homes use less electricity on average thanks to climate and efficiency and have lower energy spend per household than almost anywhere else in the country. This means that in other states system sizes are often larger which further reduces unit cost. As solar beats utility rates on a per unit basis in a growing number of states, we expect to see attractive economics and strong additional growth in demand.

Fourth, over the years, we've seeing hype cycles around different financing mechanisms for solar as this asset class matures. Sunrun has remained steadily focused on the most prudent long-term products that offer customers the most value. Ed will take a few moments to review the value of leasing versus owning, but the more important business model evolution is being overlooked and has narrowed debate over loan versus lease.

Residential solar product solutions can change far more rapidly and could be deployed locally at much smaller scale than competing utility energy offerings. Connected home energy management, storage and other advanced technologies will be bundled to add greater value in solar alone. And these are best accessed in a monthly billing model with a dedicated service provider.

For customers who want to purchase systems, we will go back and add products and wraparound services, but we believe the best customer value will continue to be delivered through a long-term and continuous relationship with a trusted service provider. This technology shift will continue to differentiate the national service providers from local installers, who won't have the scale and resources to offer broader smart home energy management services on their own and bring scaled solutions to the grid.

The residential solar industry is repositioning to a more stable and healthier model that sets the stage for sustained long-term value creation. Especially during this time of industry transition, Sunrun has an opportunity to differentiate ourselves through consistent focused execution and to deliver near-term cash flow positive growth.

Even after pruning certain activities that were not on a near-term path to meet this criteria, this year, we will increase our market share and expect to deliver growth in deployments of 35%. Underlying that growth is the strong performance from our direct business, with a first-half growth rate of 160% and an expected back-half growth rate of approximately 60% year-over-year excluding Nevada.

We expect to generate customer value for the dollar per watt, or approximately $7,000 per customer, in the back half of the year. We are well on our way with our Q2 results of $51 million in aggregate in net present value creation through deployments of 65 megawatts and NPV of $0.94 per watt. We believe we can achieve these goals in the current market environment.

With this enormous opportunity ahead of us, Sunrun's strategy to deliver the industry's most valuable and satisfied customer base has four pillars. First, customer value: our customers experience is our proudest achievement. We've created a high quality sales and installation experience and a strong value proposition that pays off for decades, with predictable customer payment performance, referrals, smooth home transfers and low customer care costs. We believe our customer net promoter scores are industry-leading. The quality of our assets continues to support our low-cost debt which has some of the most attractive trends in the industry.

Second, drive NPV: we've always prioritized unit level NPV and becoming cash flow positive and this has not changed.

Third, platform leverage: our channel business continues to offer a way to reach incremental customers that meet our targets. In the current environment where industry leaders are spending less on brand and customer awareness, local installers are seeing moderate share gains.

We've been able to take advantage of this dynamic and acquire customers from our leading distribution channel's local solar partners. Our platform services business leverages our infrastructure investment across other industry participants as well as strategics who have large existing customer base and find the residential solar industry attractive.

Fourth, a low-risk nonrecourse capital structure. We have a strong capital structure. Our strong asset performance enables durable access to project finance that turns our customer net present value into upfront cash proceeds with predictable and attractive advanced rates. Our value creation goal is simple: have upfront proceeds surpass upfront costs and realize the remaining net present value over time.

Finally, we continue to invest in innovation. Hawaii is the first market with a concrete solar plus stores savings proposition and we're seeing strong consumer interest in our BrightBox offering and are in position to scale it. We have multiple battery supplies lined up for next year and tax equity funding to support the offering. With storage, we will take the same approach that has served us well with modules and inverters.

We will stay agnostic to select from the best and most cost-effective technology providers, combine technology with financing to offer a valuable no hassle package that earns customer trust, bring this to market through a range of channels, including national consumer brands, and deliver an exceptional experience. Rather than focusing on hardware or a single distribution strategy, our anchor for innovation will continue to be the consumer and the value they seek from a better choice in their home service provider.

I will now turn it over to Bob.

Thanks, Lynn.

In the second quarter, deployments were up 54% year-over-year to 65 megawatts. Our cash and third-party loan mix was up slightly to 16% from 14% in Q1 and we expect it to stay in this approximate range, mid-teens to 20%, for the second half of the year. We believe this range is a reasonable representation of consumer preference.

As Lynn described, we have a detailed action plan that has led us to pull back our level of investment in a few areas where we did not believe we had a clear and consistent near-term path to achieving our net present value goals. As we continue to drive down our costs and NPV targets can be readily met, new market growth opportunities will become a higher execution priority.

Our channel partner strategy provides us with the flexibility to adjust resources to manage investment levels, costs, and respond more rapidly to changes in the market. We adjust this mix dynamically when and where we can reach incremental pockets of demand at our targeted NPV. We still expect the mix of Sunrun built deployments to increase in 2016 and our channel partner mix to decrease somewhat.

However, we also continued to add or expand attractive channel partnerships, especially as some of our competitors are finding access to capital to be more challenging. While we expect the trend to be a moderate decline in channel partner deployment mix to approximately 20% over time, the trajectory can fluctuate quarter-to-quarter since we do not manage to a mix target. We instead prioritize unit level margin and mutually beneficial partner relationships.

For the rest of the year, we are projecting Q3 deployments at 72 megawatts and cumulative 2016 deployments in the range of 270 megawatts to 280 megawatts, which is down 2% to 5% from earlier guidance, primarily from reduced investment in less attractive channels. In Q2, total creation costs were $3.67 per watt, an improvement of $0.44, or 11% from pro forma Q1 2016 levels, which excluded canceled bookings and cost related to our Nevada exit.

Based on our progress in the first half of 2016 and looking ahead, we are increasingly confident we will meet or exceed the $0.65 per watt improvement to $3.46 total creation cost in Q4 2016 described in more detail on the last earnings call.

Now let's look quickly at the components of creation cost in more detail. As a reminder, our cost stack is not directly comparable to those of peers because of our channel partner business. Blended installation cost per watt, which includes both solar projects deployed by our channel partners as well as by Sunrun, improved by $0.17 from Q1 to $2.80 per watt. Separately, Sunrun built install costs were $2.27 per watt, an improvement of $0.09 from Q1.

Looking ahead, we see several favorable near-term trends. Equipment prices are falling from panel manufacturing overcapacity. Lower cost string inverters that include rapid shutdown capability are becoming available and will allow us to replace much higher cost inverters for some applications.

Sunrun built installed growth rates have moderated from the incredible 2 to 3 times year-over-year levels we experienced over the last several quarters when we were a smaller business, requiring less forward capacity investment. With these positive tailwinds, we believe that Sunrun built installation cost of $2 per watt is within reach in the next few quarters and is highly competitive with other solar peers.

In Q2, our net bookings were 74 megawatts, up 21% year-over-year. In the second half of 2015, we and the industry, experienced tremendous order growth driven by many factors, including aggressive lead generation investment and sales leverage to pull forward demand due to the anticipated expiration of the investment tax credit in 2017.

These factors drove the scaling of Sunrun built installation capacity to the 2 to 3 times prior-year levels, which required investment to expand our branch network as rapidly as possible. During this period, our bookings volumes began to increasingly exceed deployment capacity. As we have worked through this large increase in orders from the second half of 2015 through the first half of 2016, we have seen a somewhat lower rate of orders converting to deployments than in the past.

This puts pressure on our first-half reported net bookings, which included both newly originated business in the period and orders from all periods including earlier periods that were canceled during that time. While cancellations result from a number of factors, we believe there were a couple that affected the conversion rate in the first half of 2016 which are temporary.

The first is reduced customer urgency to complete a project since the ITC was extended and the second is that we had longer cycle times in some of our newest and fastest-growing markets. Looking forward, we don't see these impacts continuing and we are also taking additional steps to improve our order to installation process, so we believe orders will convert at a higher rate.

Also, with more moderate industry growth expectation enabling a tighter matching of installation capacity with demand, plus shorter cycle times, we expect deployments will again more closely track with the prior quarter's net bookings beginning as soon as next quarter.

In Q2, our sales and marketing costs were $0.78 per watt, an improvement of $0.13 over Q1. We expect some continuing improvement in customer acquisition costs over time. Most importantly, we're building durable proprietary customer acquisition channels that increasingly enhance our competitive advantage.

This includes the industry's leading digital lead generator, our 100,000 and growing satisfied customers who are creating a virtuous cycle of customer referrals, our national retail partnerships like Costco, and our unique platform capabilities that allow strategic partners to easily offer our services to their large customer bases.

Next, G&A cost per watt declined to $0.33, a $0.02 decrease from Q1, and will continue to improve as volume increases over the remainder of the year. We're tightly managing costs in this area which have been largely flat for the last several quarters excluding transaction costs for project financings.

Finally, when we calculate creation costs, we subtract the GAAP gross margin contribution realized from our platform services. This includes our distribution racking and lead generation businesses, as well as solar systems we sell for cash or with a third-party loan. We achieved platform services gross margin of $0.24 per watt, an improvement of 100%, or $0.12 over Q1.

These businesses all had an outstanding quarter, as their combined revenue grew to $77 million, an increase of 102% year-over-year. Their combined gross margin percentage also improved from 9% a year ago to 20%, and we expect this to remain relatively consistent for the remainder of the year.

After some headwinds in Q1 from our Nevada market exit, our Q2 2016 NPV rebounded strongly to $0.94 per watt and we remain on target to reach our goal of $1 per watt in the second half of the year. With our higher project value and lower costs, we generated $51 million of aggregate NPV in Q2. Q2 project value of $4.61 per watt was 2% above our expectation of approximately $4.50 per watt for this year.

Importantly, price increases earlier in the year have held, so our expectation for project value per watt remains within a few percentage points of $4.50 for the second half. As a reminder, project value is very sensitive to modest changes in geographic channel and tax equity fund mix.

Over the longer run, we expect project value will decline slightly but costs should decline more. As we drive our creation costs down to levels consistently below upfront asset financing proceeds, we expect to become structurally cash flow positive.

Now let me turn it over to Ed.

Thanks, Bob.

I want to open by briefly addressing the relative attractiveness of loans and leases from a first principles value perspective. This analysis excludes the many softer customer benefits of leases such as their pay-for-performance nature. There are more tax benefits available to commercial owners like Sunrun than to homeowners who purchase directly.

This means leases can be a better proposition both for lessors and lessees. First, both the homeowner and the commercial owner today receive a $30 tax credit when purchasing a solar system for $100. As such, each pay $70 on a net basis.

However, unlike homeowners, a commercial owner receives an incremental tax benefit worth at least $6. This is because commercial owners are allowed to deduct $85 of basis for federal income taxes and $100 of basis from state income taxes. These incremental losses effectively make the tax credit for commercial owners approximately 36%. The benefits to a commercial owner of accelerated depreciation add further to this advantage.

Second, under current law, the relative tax advantages to commercial owners will grow in years to come. This is because the tax credit for homeowners steps down more quickly and is ultimately phased out in 2022. For example, in 2020, commercial owners will be able to claim the 30% tax credit under commence-construction rules, while homeowners will only receive 26%. In 2022, commercial owners can receive a 22% tax credit versus zero for homeowners.

Thereafter, commercial owners would enjoy a 10% tax credit and homeowners zero. As such, leased systems provide more value today for both solar developers and for customers and this advantage should grow with time. Nevertheless, loan systems likely provide more upfront proceeds to a developer than lease systems. This is because the loan company funds the equity tranche in loans, whereas developers fund the equity tranche in leases.

The additional cash proceeds from loans are particularly attractive to cash-constrained solar developers, who may, as a result, push loans at a customer who might otherwise prefer a lease. Because we have stayed focused on what our customers want, and we see continued demand for leases, we have not seen our lease versus loan mix change materially. We continue to plan to use our strong capitalization to ensure that we can provide the products that homeowners want.

Moving on, I am pleased to report that Sunrun's access to capital remains strong, both at the parent and asset levels. Over the last quarter, we increased our corporate working capital facility by $45 million to $250 million. This expansion was done on the same pricing as when we originally closed the facility just prior to our IPO.

In addition, our access to project capital remains strong. Principally, this is because our assets continued to perform excellently and our transactions perform as well. Over our nine-year operating history, we continued to have collected $0.99 for every dollar billed.

We have had thousands of homeowners move and we have, on average, retained over 99% of contract value in that process, even when including challenging assignments such as foreclosures and bankruptcies. Homeowners who move into these homes need electricity we can provide it to them at a discount.

Finally, we size our transactions appropriately. All our senior debt facilities are generating at least 50% more cash flow than our non-recourse lenders require, which is in all cases, both above forecast and conservative.

It's also true we sweat the details. For example, over the years, we have been careful to retain significant depreciation in our project finance transactions. With a federal net operating loss carry-forward of $569 million at the quarter end, we believe it is not necessary to tax-effect our retained value. We conservatively structure our debt transactions to include substantial principal amortization and to have longer dated maturities. We generally target five- to eight-year maturities, which mitigates refinancing risks and also provides potential upside.

For our debt facilities that don't fully amortize before maturity, we target debt balances at maturity that are about 20% less than what credit agencies require today for a BBB or investment grade credit rating. We fix our interest rates based on the underlying customer contract, not the term of the initial credit facility, neutralizing the impact of any increases in interest rates.

We also structure our transactions to ensure low-cost debt. For instance, we believe our careful structuring was key to our achieving an interest rate on our recently closed SREC credit facility that is more than 300 basis points below the closest market comparable. Thoughtful structuring has also contributing to our industry-leading debt advance rates and credit spreads.

Our project capital availability is unchanged since last quarter, with run rate through the first quarter of 2017 for tax equity and the second quarter of 2017 for debt, including executed tax equity term sheets. We continue to expect total finance proceeds for lease systems of approximately 70% to 75% of reported project value. Finally, I'd love to close by highlighting that our steady-as-she-goes strategy has allowed us consistently to add to our net earnings assets, which have increased 50% over the second quarter of 2015.

With that, I will turn it back over to Lynn for guidance.

Thanks, Ed.

In Q3, we expect to deploy 72 megawatts, with our focus in the back half continuing to be delivery of $1 a watt in customer net present value. We expect to deploy between 270 and 280 megawatts, representing year-over-year annual growth of approximately 35% at the midpoint.

This is a 2% to 5% reduction versus our previous guidance and should represent a market share gain. As we have stressed throughout all our earnings calls, we will operate the business to cash flow and cost metrics required to optimize NPV for our shareholders and not just deployments.

With that, we'll open it to questions. Thank you.

(Operator Instructions)

Patrick Jobin, Credit Suisse.

Thanks for taking the question and congrats on the quarter, guys.

Thanks, Patrick.

First question, just on capital. How do we think about advance rate progression in the quarter itself and over the next few quarters? I find your comments interesting on reaching positive cash flow territory. Just any more color on timing on that would be helpful.

This is Ed. I can first tackle your question on advance rate. Over the coming quarters, as I suggested, we expect a reasonably steady advance rate of approximately 70% to 75% of project value. Over a many-year extended period, we would expect those numbers to increase, but over the near-term, we are confident in that projection.

In terms of the timing of our becoming cash flow positive, we are not setting a target at a particular quarter, but as Bob suggested, we are confident that as our costs continue to decline, particularly faster than any reductions in project value, that goal is within reach.

Got it. And then I just, two questions, two follow-up questions. One, the biggest debate with investors is the discount rate. Is it 6.9% like you highlighted last call? Is it 8.2%, 8.3% which a competitor has done in the back leverage type of transaction? Where do you think the market is today for the assets? I guess that's the first question.

And then just a housekeeping item. Should we think about the margin of system sales, so cash sales or systems sold to a third-party loan to approximate the 20% gross margin that you reported in the platform business or are there other gross margin drivers there from your other businesses that distort the economics of cash sales? Thanks.

This is Bob. I will do the gross margin question first. So the answer is that, historically, for the other businesses, not the cash systems sales business, we have seen gross margins in and around 8% to 10% range on average. The 20% gross margin that we are seeing blended right now is driven a lot by the cash system sales mix. We think the gross margin can be in that range or potentially better over time.

And Patrick, to answer your other question, this is Ed. I think we continue to believe that the appropriate discount rate for levered cash flows, meaning those that are junior to, call it, a 65% to 75% debt advance rate, is approximately 10%. That's generally in keeping with the unlevered discount rates that we've talked about in the past.

Got it. Thanks guys.

Thanks, Patrick.

Stephen Byrd, Morgan Stanley.

Hello, good afternoon. Wanted to discuss, at a high level, the degree of competition that you are seeing. Is it becoming more crowded or are you actually seeing the reverse in terms of folks pulling back or are you not seen really any change in terms of the competitive playing field?

I think we are seeing, there's a couple things that are happening. I think it's been pretty steady. Nothing new to report in this quarter necessarily than previous quarters. There are different dynamics in our different businesses. One of the reasons why we like the channel business as a complement is that it really does reach incremental customers, so we find that the buying behavior of people tends to be, if I am going with a local partner, I am shopping maybe with a couple different local partners.

If I'm going with a national provider, I'm maybe going to talk to a couple national providers. So we reach more by having that channel partner outlet. And so, as we've seen some of our competitors who also serve that market have some capital constraints, that's been an increasingly nice piece of our business, almost to our surprise, over the last quarter. But it's going to persist in this segment at home owner market. And then on the direct side, I think, the competitive dynamic is fairly consistent.

Understood. Thank you. And then, just regulatory uncertainty. It's been a topic discussed in many forums. I'm just curious beyond this quarter or next quarter, but just broadly, when you look at your customer behavior, you obviously have a lot of touch points with customers. In terms of regulatory uncertainty in decision-making, could you just expand on that a little bit? I know you've talked about that before but I just wanted to get your take in terms of that. There's a lot of debate about degree to which customers are ready to pull the trigger on solar.

Are you talking more from a customer demand standpoint, Stephen? Is that your question?

Yes, just in terms of the lack of clarity in some states in terms of treatment of solar, whether that filters into decision-making. Do you see a pause among some customers in terms of making a decision because of concerns about how they will be treated by the utility, by the regulator, or is that subsiding somewhat?

I think the question is less about how they are being treated by the regulator and more about how do you explain in clear terms what the savings proposition is? For the most part, you don't see consumers saying I saw what happened in Nevada. Will have that happen here? That's not a common occurrence.

What is more common, what is hurting conversion, particularly in California right now, is when a consumer wants to sign up but doesn't know what rate to compare the rate you are offering to. It's a hard sell. And frankly, I think that's probably one of the reasons why the cash sale percentage has been up higher in California than lease systems. It just makes sense. When people see a rate, they want to know the rate to compare it to.

So I think, in our history, so we have been doing this for, it's our 5th public quarter, but we've been operating the business for 40 quarters now and so we've just seen these fluctuations when there's no certainty. So you just look at a market like a New Jersey, like a California, you have periods of time where it's been flat for the year, you have periods of time where it's down.

But the underlying drivers that are going to deliver savings to consumers are still there and that's retail rates keep going up and our costs keep going down and that's why we're confident in this 20% to 30% long-term growth rate of the industry. We don't think that's going anywhere.

Great, thank you. I will let other folks ask you, just one last question on storage. You mentioned that as well in your remarks. Just wanted to check in terms of where you see applicability. Is this something that's, over what timeframe is this going to become significant? What kind of milestones in terms of improvements of economics or other milestones that we should be looking for for storages to become more significant?

Sure. So first of all, today, we're getting there in Hawaii. Our BrightBox offering today to the consumer, we just launched. We talked about it last quarter. There is very strong demand there and that offering has zero upfront cost to homeowners and is cheaper right now and is not exporting the power to the grid at all. That is really the first market where just from a natural forces consumer saving standpoint, that storage is working.

I think you still have other markets that are more niche where people are just interested in it from a novelty or technology concept, but it's really the kind of, at least in the residential, the scale application is really Hawaii right now. To the extent time of use rates come into play, it will certainly be likely that it becomes a good value proposition in California. And that's another one of the reasons why we think some of the concerns around, oh is California saturated? Is it only going to be smaller systems?

I think we're just only at the very beginning of the development we are going to see in California. And because of the time of year and because of the opportunity to add storage to the mix. And then finally, I think the other thing, the early trend we're seeing is that regulators are starting to ask utilities to first invest in DERs as opposed to infrastructure capacity. You're seeing that in California, you are seeing that in New York.

And that starts to be very interesting. So I think there's a lot of R&D efforts that some of the larger players, like ourselves, are engaging in to figure out what are the business models of the future with storage? So something most likely will emerge out of that. I also like to point out, from a big picture standpoint, the infrastructure and investment we are about to make in the country is about $1 trillion over the next 10 years, and I really like our prospects of trying to find a profitable business model in that opportunity.

Great. Thank you very much.

Brian Lee, Goldman Sachs.

Hello, everyone. Thanks for taking the questions. Just had a couple around the volume growth here for yourself and for the market given what seems to be, as you alluded to, some maybe confusion, uncertainty, just lack of visibility and also on a delta between different players here.

So maybe for you first, the recent share gains, can you give us some sense of how sustainable you think they are and then with the Tesla SolarCity deal on the horizon, if you see any of their synergies or maybe go-to-market shifts that potentially could happen and impact the competitive landscape going forward? If you could maybe comment on that to any degree. Thanks.

Sure. Thanks, Brian. Absolutely. I think I'd point first to just the fact that the penetration level is still 1% of homes and the macro divers are still amazing and that's not going anywhere. A couple of things just on leading indicators that I can give you guys, just things that we look at.

And we have good insight into the market because remember, we see all our channel partners, we have our platform services business. So we have a distribution company, we have a racking company, we have a lead company. So we sell to the industry. So we have pretty good indicators about share and demand.

And I think the anecdote I cited in the script I think is very relevant. If we just look at digital searches for people in California who are qualified, who have a home and are qualified for solar, it's up 40% year-over-year. And so I think when you see there's a little bit that's conversion challenge right now because, again, people are waiting, they're a little more cautious. It's a long-term decision, but that's a pretty strong indication that the demand is there.

I think the other thing we're seeing is that when we look at the, as Bob mentioned, we did pare back some of our acquisition channels and things that were more expensive and didn't convert as quickly in this market environment we're in. But when we look at the acquisition channels in the market that we've really prioritized, our year-over-year growth rates in our direct business are well north of 30%.

And so that's why it gives us confidence that this industry is a 20% to 30% growth for us in particular and we're really pleased with the market share gains. I think the other thing on the market share gains we've seen and that I'm most proud of is that I think we are taking those share gains in the higher PV markets.

So I really believe that, again, consistent with our strategy, is we're driving towards NPVs. So we're going to get our advantages in the higher PV markets. We're going to take share there that's going to drive more shareholder value and I think that's hopefully backed up by the fact that our project values are far superior to that of our peers. So not only are we taking share, but we are taking share in the markets where it's harder to take share in objectively.

On the Tesla side, I think, most importantly, I think, again, I like to stay into the big picture because I think that's what drives long-term value and to have another ally in fighting for an individual's right to produce power and have Tesla as an ally, is very powerful. So them helping to educate the market, them helping on the regulatory front, they held a net metering rally recently. That is going to be a huge advantage to Sunrun and our peer companies.

I think, again, retail energy is a $500 billion annual market, and it certainly isn't winner take all. And so we like them doing the education and helping us out. I think, on solar and batteries, that is definitely the future of the world. The future of the US energy, probably the world. And there's just a ton of innovation happening at global scale in this area. And we really want to benefit from all the innovation that is happening and don't necessarily like the risk and reward of being tied to a single technology.

So we don't think you need to be vertically integrated to offer a nice streamline product to a consumer. We're already doing that in Hawaii with BrightBox. So in short, I think we love having them in the market, we love another strong brand, well capitalized company. We think it's terrific. And we like our prospects going head-to-head with them.

Okay, great. Thanks. I appreciate that color. Maybe just to drill down into it a bit more and put some quantification around it, if I take the midpoint of your guidance for the year, the growth is decelerating to something like 15% year-on-year exiting Q4.

I know the back half of last year had some robust volume growth due to some of the factors you talked, but just wondering how to think about the growth rates into 2017 given that implied run rate exiting the year. And then with respect to your 20% to 30% growth rate commentary for the market, is that the right level to think about for next year and would you anticipate you're above that level given the markets up 20% to 30% if that is the view for next year? Thanks.

Thanks, Brian. Your math, I believe, is correct. I think a couple things. The first one is when you look at our back-half growth rate in our direct business in installs, it 60% year-over-year. So remember, again, we have the partner business in there. We don't manage it to a megawatt number; we manage it to a margin contribution, so that's important to know that that's underlying it.

I should also say that 60% is pro forma for Nevada too, so you can see. And if you recall, there was strong performance in Nevada in the back half of the year. So I think if you, that plus the fact as I go back to my earlier comment on just gross bookings, the 30% plus rate we are seeing in gross bookings in the channels and markets we are prioritizing, we think that gives us confidence in this long-term growth rate of 20% to 30%. But I think at this stage, we are not making a comment on the 2017 growth rate percent.

Okay. Thanks a lot.

Krish Sankar, Bank of America Merrill Lynch.

Hello. Thanks for taking my question. I had a few of them. The first one, either for Ed or Lynn, is with the whole industry seeing a shift more towards cash sales alone than away from leases. You guys seem to be not too concerned around that.

Looks like your commentary has been really consistent from the last quarter which is somewhere in the high-teens or 20% of the mix exiting this year. I want to find out, where do you think that mix could be either for Sunrun or the industry in general a couple of years from now? And what does it mean to the business models for residential solar companies? And then I had a follow up.

This is Ed. Thanks for the question. We believe that the mix of leases and loans that we are experiencing, which was 16% in the quarter, but we said call it 15% to 20% depending on the quarter, we believe that is reflective of consumer preference. We think that, to a certain extent, the increased numbers of loans is being driven by companies seeking additional upfront cash, not necessarily by consumer preference.

So in that regard, we don't see it as a likely long-term trend. We certainly don't think it influences the business. It's certainly also the case that, where we do so a system with a loan, that's profitable for us as well. As Bob underscored, the gross margin in our cash sales business is approximately 20% that's also industry-leading. So we feel good about that.

But pulling back, we think that the consumer preference that we are seeing today should hold and, as I indicated earlier, there are certain changes to the tax credit coming over the coming years that I think actually might push the needle significantly back towards leases.

I really do think that we sometimes see people writing oh, there's low entry barriers all moving to loan and we believe that couldn't be further from the trend. That's what we were trying to get across a bit in the script is that that may be happening a little bit right now because people are contorting or maybe there's a little more capital available in that segment of the market.

But longer-term, we fundamentally believe this sale is going to have, storage is going to have energy management, it's going to be actively managed. We're going to be bringing scale solutions to the grid with our energy resources and so it will very much move more towards consolidation.

Got it. Got it. That's very helpful. Just two other quick follow-ups. On the cash sales and loans, are you seeing more with your partners or on the Sunrun built side or is that kind of equal across both spectrums? And the other thing is, you guys mentioned the industry could grow 20% to 30%. I think last earnings call, you said you guys wanted to grow 30% at least for the next 10 years.

Trying to figure out, so does your growth profile for Sunrun over the next few years include some amount of share gain in addition to the underlying market growth, and if so, is this share gain coming from many of the smaller installers? Are you guys getting it from the top five players out there? Thank you.

Thanks, Krish. I believe that our, I don't know, I don't have all of the insight into our channel partner's loan versus cash mix, although I suspect it looks very similar to ours because they have both products to offer. And just getting back to us financing, one of the reasons why we think it is a true reflection of demand, the kind of 20%/80% split, is that we offer all of them. So we don't incentivize necessarily, we don't have a quota on how many cash systems we can sell.

So our salespeople, believe me, will find the thing that's easier for them to sell. And so because our channel partners have access to our financing for the lease plus their cash business, I would suspect that the mix looks fairly similar.

The other question on the growth rate, the growth of our direct business, our growth integrated business, is outpacing the channel business. So that's where our market share gains are coming from. Just again to hit the stats on that, first-half growth rate in our direct installs was 160% year-over-year, back-half is 60%, again, excluding Nevada in the back of the year. So that is share gains. And, as I mentioned, share gains in the most attractive markets.

So we are not here commenting on the 2017 growth rates for us relative to the market. I think what we are committed in is that the market does have the demand characteristics and the room to run at 20% to 30% for a very long period of time, but as we've seen this year, there can be fluctuations from quarter-to-quarter and even from year-to-year. So we just don't think about it on that short term of a timeframe.

Got it. Thanks, Lynn.

Colin Rusch, Oppenheimer.

Thanks so much. Could you talk a little bit about what's going on with the distribution business? Obviously, there's been some material changes in prices on equipment. How much do you think that impacted your gross margin in 2Q? And what's your expectation for elevated spreads in that business as we go through the back half of the year?

Let me make sure I answer your question. I don't think we believe there will be any material changes in the margin in that business. I think the margins have held up fine in that business, so even though panel prices have come down, they've held reasonably well. And so we believe that, that business has grown this year, again, underscoring that the market does have growth; the broader market does have growth. So it's a nice steady business for us and it really helps us offset some of our costs in our own direct business.

Okay. And then, as you look at your history of having a really disciplined approach to the technology that you include in your portfolio, how much do you think that is helping you at this point as you look at back leverage and working through a number of the financing options that you have for funding growth?

This is a diversity of hardware of choice that we use. Is that your question?

Yes. You could even extend that into the geographic mix.

Got it.

Diversity is generally helpful provided that the company's you're diversifying to are strong. So, it varies between panels and inverters. In the panel side, it is a lot about upfront quality analysis. It's the same on the inverter side. The credit strength of the companies we take into account. Right now, we have a very diverse set of both panels and inverter manufacturers. We're happy with that mix and feel very bullish about equipment, the equipment that we like, the equipment that we can get financed and the cost of all of that over the coming year.

Okay. Thanks so much you guys.

Thank you.

Matt Tucker, KeyBanc Capital Markets.

Good afternoon and congrats on the quarter. I wanted to circle back to the regulatory environment. You touched on it from the customer perspective, but could you just update us on how you feel the regulatory environment is trending overall as the debate over solar continues in several states?

Great question. I mean, it's been a relatively calm year. We've seen recent expansions of net metering, even in places like Berkshire Energy's home state. We have seen Maryland add full net metering for community solar. And no major reductions in the course of the year. We're obviously engaged actively in the current process in Arizona, but it's hard to predict anything there, particularly before the elections in November.

And generally speaking, I think regulators are appreciating that distributed resources are valuable, that solar is something to encourage, and that rooftop solar is very popular. We are hopeful that next year we will, or soon we will see grandfathering come to Nevada. The commissioner in Nevada who oversaw the preceding that ended net metering there has said the governor is not going to reappoint him, which also shows the political support for rooftop solar as well.

So we obviously continue to work very carefully and cautiously on the policy front, but particularly, before the start of next year, we don't see very much is likely to occur. And then obviously, with the election, if it goes the right way, we think there might be really significant upside and if it goes the other way, we just withstood the biggest down sweep by Republicans that we've seen in all time. So I think that would be fine as well.

Thanks, Ed. That was helpful. I guess following up on that, could you comment on NEM 2.0 and how you see that impacting you guys?

Sure. Go ahead.

I think the modest changes to net metering in California continued to create more savings than in most places. In fact, the off-peak power rates in California are certain to be higher than the average rates in most states that we do business in.

We expect that if time of use rates are developed and put into place in any significant way, it will probably create an opportunity for storage, both for new customers and probably existing customers. And so we're optimistic about it. As Lynn mentioned in this transition period where they don't know exactly what the rates are going to be, it's a little bit more challenging to explain to homeowners exactly what the savings potential is.

But we're very confident there will be savings. We are working on and making good progress in how to explain it to customers and are excited for the day when the rate structures are finalized and we can rollout potentially new products as a result.

Great. Thanks, Ed. And then, Lynn, I think earlier in your prepared remarks, you were commenting on kind of the versatility of solar and alternative or innovative products and services that can be paired with solar. Could you elaborate a little bit on that? Maybe provide some specifics and comment on any products or services that Sunrun is developing or offering or are these more kind of third-party offerings that you do as complementary to yours?

The first one that we're commercialized with is BrightBox, of course, which is the battery plus the PV. I think that there's nothing to comment about that's going to yield some sort of financial results in the very near term. But what's exciting about it is really all the R&D efforts that are going on and the fact that regulators are increasingly saying wow, there is a cost benefit. There is a benefit here to tapping DERs before investing in infrastructure.

So you are increasingly, I think, seeing them ask the utilities to do that and so there are a number of pilots that are happening that you have seen out there. We personally don't have anything publicly announced, but there are a number of pilots that are happening out there that I believe are going to uncover new revenue models and help encourage and accelerate adoption of the DERs.

And frankly, that will be nice because it also de-risks the business from a regulatory standpoint as we start to get revenue streams that are complementary to the utility or more mandated at the regulatory side. So nothing that you're going to see really short term in our financials outside of the BrightBox offering that we have, but really encouraging that distribute that's happening.

Great. Thanks, Lynn. I will leave it there.

Vishal Shah, Deutsche Bank.

Hello. Thanks for taking my question. Lynn, I just wanted clarify your guidance, the revised guidance, what percentage of megawatts in the guidance come from the channel business versus sort of developed and how would the mix shift, because I remember last quarter, you mentioned that you expected California market to pick out how the (inaudible) and it looks like the NEM 2.0 is impacting decision making process so are you seeing the stronger growth in other markets, which is offsetting from the slowdown in California?

I think I got both there. So California growth and channel versus direct mix. On the channel versus direct mix, we're not breaking it out. I think Bob had some comments in his section that said it kind of fluctuates a bit. We still think it decreases as a percentage.

I shared with you the direct growth rates on the back half of the year at 60% so year-over-year ex Nevada so I think you could probably get close to it. But we just aren't going to break that out going forward because it's just not how we manage the business.

Is it fair to say that your channels business is growing a little faster than you previously expected at the beginning of the year?

More than at the beginning of the year. Yes, that's fair. But not faster than the direct business, no.

Of course.

And then, in terms of what the California growth rate is versus the other markets, I think we're not going to get that level of granular. I think the California growth rate, I did highlight that year-over-year 40% number of just interested homeowners in that California piece of the business and that is not hugely far off from what we are seeing in our business.

Again, is it fair to say that some of the other markets are growing a bit faster than you were expecting which is sort of offsetting some of the weakness that you are continuing to see in California?

I think we're just not going to get into the market-by-market growth details. I think if you look at, you can kind of pull that from GTM where the markets are at.

Okay. Sounds good. Then the other question, as you look at the cost structure for you, the creation costs of, it looks like there's the potential beyond a lower QR number and sort of your competitors are starting to raise prices. You can sort of assume that the strength continues even in 2017. What kind of NPV targets should we be thinking about for 2017 and assuming that your profitability will continue to improve from the second half levels in 2017?

Got it. You're asking for forward-looking NPV guidance. I think that $1 a watt for the back half of the year is our target, and that's our target. And then going forward, we're going to continue to make judgments. Some markets are going to be above that, some of the markets where we have scaled operations in. We may enter new markets where there's a ramp time. So it's too early to call with the overall number is. But we have, the way we think about this business is we look at every acquisition channel, every market.

We have an NPV target in it and currently, in this market, in particular, all of those need to be on a path to near-term cash flow positive, which would imply that NPV number of somewhere around $1 at our current proceeds level. So, too early to call exactly what the market looks like next year, how much market expansion we are doing, but the $1 or more in the back half is what we are expecting.

Sounds good. Thank you.

Thank you.

Sophie Karp, Guggenheim Securities.

Good afternoon and thank you for taking my question. I wanted to touch base on the storage projections that you guys are discussing and the comments that you made that you're about to raise a tax equity fund for storage roll-out in places like Hawaii. Are you expecting comfortable IRRs for investors in tax equity funds that are back in storage versus your conventional product? And do you expect any pressures with respect to your ability to raise funds for this new product?

Great question. We have support in our existing closed funds for storage and the cost of capital against our products that include storage is no different than those that don't have storage. So it's really just demonstrating safety and long-term performance through independent studies which we have done and so we're comfortable with the runway that we have on the project finance side for storage.

Yes, and I would just add, in terms of the projections on the megawatts and the financial projections we provided today, they do not include anything material from storage.

Thank you. And to circle back to the regulatory climate in places like California, how are consumers reacting to comments that are made by some CTUC members? Or I think President Picker was quoted in the press saying that people cannot expect rates to stay constant. Is it causing any sort of longer-term moral crisis among consumers or people are generally not paying attention to that?

I think the article you are referring to, there was an article with one anecdote from someone who probably wasn't even correctly describing their savings. So I wouldn't read too much into that and I also don't think that those comments are even probably seen by homeowners. But the reality is the long-term trend of energy rates is clearly up. It's clearly up in California, that's intuitive to everybody.

Sure, there will be some variation from quarter or year-to-year or rate structures, but when you're able to save 20% or more, you are very comfortable and customers can be comfortable. I think they just want to understand what the new framework is, and until then, we are explaining to them that, look, there is some variation, but even if it doesn't go the way we think, it's going to be very attractive, probably almost 20% savings anyway. So we feel good about that and I don't expect that as influencing consumer behavior.

Thank you.

Julien Dumoulin-Smith, UBS.

Good afternoon. Thanks for taking the question.

Good afternoon, Julien.

Just to follow up a little bit more and I don't mean to dig too much on California, but can you describe a little bit about the trend with respect to NEM 2.0 as you hit it by specific utility service territory? I know I'm digging even further here, but (multiple speakers) I mean just broad strokes. Yes.

Well, we'll email you an Oracle login.

Fair enough. I will let that one lie then. But if we can then, with respect to Arizona, fixed rates versus demand charges, obviously, it just seems to be getting some more attention in the state. How are you thinking about that and any potential acceleration or ahead of a change in NEM tariffs in 2017? Are using that take place now, given the fact the rate cases are filed and pending? Maybe, again, state specific trends, but also talk about that fixed versus variable, or fixed versus demand charge.

The trend nationwide has definitely been that demand charges are being rejected. We have seen numerous proposals for demand charges and they have been universally rejected. It is understood by most regulators that homeowners don't even understand them, wouldn't even know how to alter their behavior, and that, honestly, it's unclear even provide correlated compensation to the grid.

I think we are probably seeing that be also understood in Arizona. The final stages of the initial UNS rate case are probably occurring as we're having this conversation. So we're monitoring it carefully. But it would surprise me, anything is possible, but it would surprise me if we see demand charges and it would absolutely surprise me if we see it as a trend.

In terms of whether or not there is pull forward in Arizona demand, that isn't my understanding. Arizona Public Service is kind of the only major utility that we operate in in Arizona, even if there would be changes to rate structures in that service territory, they wouldn't occur until July of next year. So I think that's probably a premature consideration.

Got it. Okay, great. And then just perhaps going back to another debate that was taking place on the call around the merits of the cash and loan side of the business in the 20% margins you were talking about earlier, why not emphasize that more and tilt more of the business in that direction, given positive cash margins, desire to trend towards cash flow positive, et cetera?

One point I do want to point to is that that 20% gross margin in that business includes both the cash and the distribution business. So I just want to make that clear as well. But the reason is because we are consumer first. That's what's going to serve us well.

The people who give the consumer the greatest value, deliver the best experience, are, we think, the long-term winners. And we believe that in our leasing business. We're pretty, in terms of just our ability to target the more attractive markets, do well there, and receive the amount of proceeds level we do, we think that can be cash flow positive. So we're going to continue to, we are not capital structure constrained in terms of which products we offer. So we're going to let the market decide.

Got it. All right, fair enough. Thank you, guys.

Thank you.

Thank you. And I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Lynn Jurich for any closing remarks.

I think that's it. Great questions, guys, as usual, and we look forward to speaking with you all again soon.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.