Sunlight Financial Holdings, Inc.

Q2 2022 Earnings Conference Call

8/15/2022

spk08: Greetings and welcome to Sunlight Financial second quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Lucia Dempsey, head of investor relations. Please go ahead.
spk01: Good afternoon and welcome to Sunlight Financial's second quarter 2022 earnings call. After the close of the market today, we announced second quarter 2022 financial results and posted an earnings presentation to our investor relations website at ir.sunlightfinancial.com. Before we begin, I'd like to remind everyone that this webcast may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, beliefs, estimates, plans, and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Forward-looking statements include, but are not limited to, Summit Financial's expectation or prediction of financial and business performance and conditions, and competitive and industry outlooks. Forward-looking statements speak as of the day they are made, are subject to risks, uncertainties, and assumptions, and are not guarantees of performance. Summit Financial is under no obligation and expressly disclaims any obligation to update, alter, or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. The company also refers participants on this call to the press release issued by the company and filed today with the SEC. The supplemental presentation posted at the Summit Financial's website and Sunlight Financial's SEP filings for discussion of the risks that can affect our business. Additionally, during today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to their most directly comparable GAAP measures can be found in both the press release and the supplemental presentation. Joining me today are Matt Pateri, Sunlight Financial's Chief Executive Officer, and Rodney Yoder, Sunlight Financial's Chief Financial Officer. Matt will provide an operational update on the quarter, and then Rodney will share additional detail on our financial results. Following these prepared remarks, we will open the call to Q&A. It is now my pleasure to turn the call over to Matt Pateri.
spk04: Thank you, Lucia, and thank you all for joining us as we discuss Sunlight Financial's second quarter 2022 operational and financial results. I'm pleased to report strong second quarter results, including record high results in the number of metrics and free cash flow generation of nearly $9 million. In the second quarter, Sunlight funded $716 million of solar and home improvement loans, a new quarterly record, and $50 million higher than our funded loans in the second quarter of 2021. Home improvement volume was particularly strong. with $112 million funded in the second quarter of 2022, more than double the second quarter of 2021 funded volume of $45 million. We're excited about the structural momentum we're seeing in this business as we expand our presence in the rapidly growing $400 billion market. We persistently see incredibly strong customer demand despite the inflationary environment, with record numbers of credit applications for both solar and home improvement financing. I'm pleased that installers remain highly engaged with our platform, selling our products with strong success and reinforcing the value we provide to homeowners. Solar Loans in particular have been resilient in this market as customers routinely achieve cost savings relative to their utility bills, which nationally are up 12.7% on average from June 2021 to June 2022. That's nearly 50% above the headline rate of inflation. Sunlight continues to perform well on key operational metrics as well. We remain a leading financing choice for contractors and homeowners as our Orange platform provides a fast and frictionless process for financing solar installations and home improvement projects. We funded loans for nearly 21,000 borrowers in the second quarter, up 11% from the same period a year ago, and a new quarterly high for the company. Average loan balances are also increasing yet again, driving incremental revenue for sunlight without any additional expense. This is driven by a combination of larger systems, increased related add-ons, and potentially higher prices. In particular, solar loans this quarter averaged $45,000, once again the highest yet for the company, and up 12% relative to the second quarter of 2021. Despite lingering challenges with battery supply, Sunlight's battery attachment rate increased to 14% in the second quarter. While this is lower than 2021, we believe that battery storage rates will increase over time as battery shortages abate and EV adoption increases, supported by government incentives. We're pleased to have an additional 165 active contractors on our platform in the second quarter, bringing our total installer relationships to over 1,750. While our industry leading credit quality and partnerships with depository institutions provide sunlight strategic advantages and our direct channel margins are stable, current marketing conditions will negatively impact our indirect channel in the second half of this year. To that end, we had a pipeline of loans that were allocated to a new capital provider to be sold following their merger with the bank. However, the delay and ultimate cancellation of that merger caused us to shift the sale of approximately $85 million of funded loans from the second quarter into the second half of the year, and will also increase our near-term reliance on the indirect channel. In addition, we expect the recent rise in interest rates and increased volatility in the capital markets to negatively impact indirect channel margins in the second half of the year, as Rodney will discuss in more detail. To address market conditions, we have implemented price increases on new credit applications and eliminated several harder to finance products. We believe these pricing actions will deliver normalized platform fee levels in 2023. A key differentiator that highlights the strength of our business model, especially in this challenging environment, is our industry leading credit quality. As we announced in June, Sunlight's credit loss rates are significantly better than our peers. Our relentless focus on credit quality supports capital providers as they focus on attractive risk-adjusted returns and is an important lever to attract and maintain a strong network of capital providers. With that, I'd like to turn the call over to Rodney Yoder, Sunlight CFO.
spk07: Thanks, Matt. Sunlight generated total revenue of $32 million in the second quarter of 2022, up 18% from the second quarter of 2021. primarily driven by an increase in platform fee margin. As Matt discussed, our industry-leading credit quality supports capital provider demand for Sunlight Loans, leading to increased platform fee margins year-over-year. Our total platform fee this quarter was 4.7%, up 70 basis points from 4.0% in the same period last year. The direct solar platform fee percentage was even higher, at 5.4%, up 110 basis points from 4.3% in the second quarter of 2021. Adjusted net income for the quarter was $2.3 million, or one cent per fully diluted share, relative to $9.3 million in the second quarter of 21. Adjusted EBITDA for the second quarter was $6.8 million, compared with $11.5 million in the second quarter of 21. Although gross profit increased by $4 million relative to the second quarter of last year, revenues were impacted by the $85 million of unsold funded volume that shifted to the second half of this year, as Matt mentioned earlier. In addition, we had higher costs in a number of areas, including approximately $4 million of public company expense we did not incur as a private company in the second quarter of 21. and additional $1.1 million for compensation, benefits, and other expenses. We also recorded a $3.6 million increase in loan loss provisions for contractor advances, primarily related to a single contractor. Overall, our advance program has contributed to our success winning new and deepening existing relationships with solar installers. To date, we have advanced over $1 billion in contractor advances while experiencing minimal losses, and we expect losses in the future to remain very low. Due to these higher expenses, adjusted EBITDA margins decreased from 43% in the second quarter of last year to 21% in the second quarter of 2022. While the company continues to perform strong operationally and our direct channel margins are stable, the increased reliance on the indirect channel and the rapid change in market conditions will impact our indirect channel platform fees in the second half of 2022. As a result of market conditions, the sudden loss of a new capital provider, and the lead time for implemented price changes to take hold, we are reducing guidance metrics for 2022 as follows. Total funded loan volume of $2.8 to $3 billion. Total revenue, $130 to $140 million. And adjusted EBITDA of $35 to $40 million. We believe this is a near-term impact to our long-term business strategy and look forward to resuming strong adjusted EBITDA growth and normalized adjusted EBITDA margins in 2023 and beyond. I'd also like to provide an update on our funding strategies. We consistently work closely with our capital providers to support their liquidity and risk-adjusted return requirements, ensuring they are consistently receiving high-quality assets. In the second quarter of this year, we added a new capital provider to our platform, and we regularly evaluate additional funding sources to maintain a healthy pipeline to support our growth. As we've noted, Sunlight operates a profitable business model and generates significant cash flow. In the second quarter of 2022, free cash flow was $8.9 million, representing a very attractive EBITDA to free cash flow conversion rate. The company is also well capitalized and maintains strong liquidity with nearly $70 million of unrestricted cash and cash equivalents and only $21 million of short-term debt on the balance sheet, underscoring our cash generative capital light business model which is particularly valuable in this environment. Given our strong cash flow generation and capital life business model, we announced in May that we received board approval for an 18-month, $50 million share repurchase program. As of August 11th, we have purchased over 1.5 million Class A shares for a total of $5.6 million, funded with excess cash on hand and operational cash flow. We are happy to return capital through programmatic repurchases while ensuring the efficient use of capital to drive shareholder return. With that, I'll turn it back to Matt.
spk04: Thanks, Rodney. Before we turn to Q&A, I'd like to highlight that we are pleased with the recent passage of the Inflation Reduction Act, which currently includes $300 billion in clean energy investments, $60 million of which is specific to growing the renewable energy infrastructure. We are particularly excited about the 10-year ITC extension, which provides a 30% residential solar tax credit through 2032 and additional credits for low-income communities. We see this as significant support for further growth in residential solar and will help even more homeowners save money with solar and home improvement energy efficiency upgrades. In addition to progress on the macro level, Sunlight's unique advantages are driving value today and will for years to come. Sunlight serves two large, rapidly growing ESG-focused markets, residential solar and home improvement. Our proprietary point of sale platform, Orange, is unmatched in the industry and fuels our ability to scale quickly with minimal incremental costs. We operate a capital light balance sheet, taking on limited consumer credit risk. and reducing reliance on debt and equity financing to support our growth. This is an extremely valuable feature of our business model, not just for this current environment, but for years to come. And lastly, this marks our 14th consecutive quarter of recording positive adjusted EBITDA, which is a testament to our consistently profitable cash-generative business. While we focus on growth and expansion, we do so with profitability in mind, ensuring we generate strong returns to the business and drive value for our shareholders over the long term.
spk08: Ladies and gentlemen, at this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Your first question comes from Philip Shen with Roth Capital. Please proceed with your question.
spk02: Hey, guys. Thanks for taking my questions. First one's on the $85 million. I wanted to get a little more color on what happened with the bank and why they decided not to take on what you had originated. And, you know, for example, was it based on assets that were maybe not high enough return for them? I think some of the 1.99% and 1.49% products. And if so, Do you see a path where, over time, you have to move on from the 199 and 149 offerings? Thanks.
spk04: Phil, thanks for your question. So that was the result of a partnership that we entered into with a company that was merging with a bank. And so their inability to complete that transaction and fulfill all of the closing obligations prevented them from merging. And as a result, they were unable to purchase our loans. So it was completely independent of anything from Sunlight or our assets. I'll tell you, we consistently get positive feedback, both from that partner and from others in the market about the credit quality of our loans and the attractiveness of the loans in the space. But unfortunately, in this scenario, it was a situation where they were unable to close the merger and therefore unable to execute the deal.
spk02: Got it. So what kind of risks do you see ahead for more of these challenges where your bank partners don't take on some of the assets that you're originating? Thanks.
spk04: So this was a unique scenario where we started to point loans to this partner that we expected to close their transaction. Just to give you a little bit more context, this transaction received approval, or this merger received approval from the OCC as recently as the beginning of July. So it had significant momentum. We expected it to close, and they expected it to close. Unfortunately, when it didn't close, we had the $85 million in loans that Rodney mentioned, as well as additional loans in the pipeline, which is why we'll shift those loans to the indirect channel. And so one of the strengths of our model that we've highlighted in the past is that we have these depository relationships and we have the indirect channel, which allows us to flex up and flex down and roll out new products. On the direct side, while if you look across the industry, you do see increased loan to deposit ratios across the industry. I'll tell you, our capital providers continue to have a lot of interest in our products. And we've been able to, with some of the recent pricing changes that we've been able to make We've been able to increase their yields to ensure they're getting attractive risk-adjusted returns and continue to earn healthy margins for ourselves. So as we look out the rest of the year, while we expect pressure in the indirect channel as a result of market conditions, we expect the direct channel to maintain consistent margins to what we've experienced historically. So we continue to have a lot of optimism around that, and we think that the benefit of that channel provides us real long-term strategic value.
spk02: Okay. Thanks, Matt. As it relates back to the 199 and 149 products, the coupons seem to be below treasuries, which seem like that could be tough and maybe a source of margin compression. What's your view on those products? Do you think you'll maintain them? And if you don't, if you remove them, do you think there could be margin expansion EBITDA growth as a result of that?
spk04: It's a great question. As we've seen significant changes in the capital markets on the indirect side, and I'll tell you, we've seen those even over the last 45 days, which is why we've made some of the price changes that we've made and we've eliminated some products. Some of the products that we've eliminated are the lower interest rate products. that are harder to finance. And so we think these are the right prudent actions. We think the product suite that we have now, and especially the pricing that we have now, is appropriate based on the market. But we're constantly, as good risk managers, as a team that's focused on ensuring assets are priced appropriately, we're constantly evaluating that. And if market conditions change or if our view on the market changes, we'll of course take additional actions.
spk02: Okay, thanks. As it relates to pricing, you guys increased pricing recently, and it seems like some of your funding partners may also be increasing pricing for you guys. Do you see more price increases ahead for your customer base, maybe in Q3 or Q4?
spk04: Yeah, I think where we are right now, we think that the pricing changes that we've made are appropriate to ensure that new loans that we're credit approving have healthy risk-adjusted returns for capital providers and provide us with a healthy margin. But we'll continue to monitor that, and to the extent of which we need to make additional changes, we'll certainly do so. As Rodney mentioned, in the near term, we do expect pressure on the indirect margins But with the changes that we've made, we expect to be back to historic levels on indirect margins in 2023. Okay.
spk02: And one last one for me. Thank you for taking all the questions. For the $3.5 million loan loss provision, that was on, I think, working capital advances, right, with contractors. And I think you mentioned to a single contractor. So, was wondering philosophically if you still think this is the best way to go, and can you share what happened with that contractor? You know, how unique of a situation is it, or do you think it might be a pattern for us to expect ahead? Thanks.
spk06: Yeah, thanks, Phil, for the question. Yeah, so, yeah, we did take a reserve, you know, for 3.6 million incremental potential losses for a single installer as part of our installer advanced programs. We like this program, and we don't expect to take any further one-time charges. That said, we monitor each installer and reevaluate on a variety of factors, including financial stability. And so this is one instance, but again, we've advanced over $1 billion program to date with minimal actual losses. So this is a This is a really good differentiator for us in terms of attracting new and maintaining and deepening relationships with our installers, getting volume commitments, and improving margins. So we like it.
spk02: Great. Yeah, so it seems like it's, you know, of the billion with minimal losses, are we talking about, like, sub-1% or, like, low single digits?
spk06: Yeah, it doesn't even show up on the calculator. It's very, very small.
spk02: Okay, good. Thanks for taking the questions. I'll pass it on.
spk08: Your next question comes from Jeff Osborne with Cowan & Company. Please proceed with your question.
spk05: Good evening. A couple questions on my end. On the indirect side, I was wondering, you know, percentage of funded loans in the second half. How should we think about that? And then what do you anticipate for 2023?
spk04: Jeff, thanks for the question. So while we don't provide guidance for channel mix or margins specific to the direct or indirect channel, the updated guidance that we did give is implied or includes what we expect the mix and the margins to be. So we're not giving specific guidance there, but if you look at our funded loans and our revenue, you can get to the overall blend. As we mentioned, as Rodney mentioned, we do expect higher reliance in the near term in the indirect channel. But we also have a number of new capital providers in the pipeline that we expect to bring online. And in fact, we brought a new direct capital provider online and launched that partnership in the second quarter. Got it.
spk05: And then you mentioned, Matt, as one of the three reasons for the lower guidance Rodney did on the lead time to flow through on new pricing. What is that lead time to flow through? How should we think about the changes being made during the quarter and when that'll flow through? You've talked a lot about 23 returning to normal, but does that happen early in the year or more on average at the midpoint?
spk04: Yeah. So we've made a number of pricing changes. We've made some of the product changes that we talked about recently. And we expect as we get into 2023 that margins will return to historical levels. So, you know, I think we're not pinpointing a quarter or a time at this point. But I think based on the conversations that we've had in the market, based on the pipeline that we have, as well as the pipeline of new capital providers, we think we'll return. We think this is a near-term impact based on some of the market volatility and some of the dislocation. And we think we've now been pricing new credit to a place where they'll execute at historic margins.
spk05: Got it. Maybe another way of asking a question without getting into the margins. Is there an elongation of time from the top of the funnel to glass on the roof for you guys when a loan is put in the Orange system to when it's funded? Is that still longer? I know you've highlighted that on prior calls.
spk04: Yeah, we have. So I think starting in the middle of last year, we started to see an elongation from credit approval to funded loans. Earlier this year, we said that we started to see some green shoots, and I think more recently that hasn't materialized. And so we do expect that those pull-through rates and the timing will return closer to normal, but we really think the supply chain needs to get healthy, and we don't think it's fully there yet. We need to see less pressure around labor which is both impacting installers getting installation crews and the glass actually on the roof and is also impacting the ability for them to get permits. And so it's continuing to keep those cycle times longer than they've been historically. So we are seeing that. That's taken into account as we're talking about margins and timing. We're looking at those pull-through curves and the funding curves and pulling that all the way out.
spk05: Got it. My last question, and I don't expect this answer, but maybe just any anecdotal comments would be helpful. Are you seeing any change in behavior of consumers around prepayments? Typically, my understanding is within the first 18 months of your funded loan, they have the opportunity to take the tax credit and pay down the loan and then re-amortize it. Are people elect to do that and keeping the tax credit for themselves?
spk04: So I think what we've seen to date is asset quality and prepayment speeds have remained very strong. One of the reasons we focused on credit was that we knew as we go through credit cycles and other economic cycles that consumer behavior can change. And so focusing on the highest credit quality customers not only helps us have very strong credit quality, but it also helps to ensure that we get strong prepayments. And so far, we continue to see that to be the case.
spk05: That's great to hear. Thank you.
spk08: Your next question comes from Maheep Mandloy with Credit Suisse. Please proceed with your question.
spk03: Hey, thank you for taking the question. This is Chamni on behalf of Maheep. I wanted to understand your direct channel funded loans were down 7% year over year. Could you talk to a little bit about what you're seeing on the ground? And sort of also looking ahead, how soon can you expand your facilities with your direct lenders to sort of reduce the impact of the indirect mix? Thank you.
spk04: Sure. Thanks, Shandi. So, you know, when we think about direct and indirect, You know, the impact in the direct channel is a result of the partnership that I mentioned earlier and the fact that those loans will be funded through the indirect channel. And I think more broadly, I think it's important to note we're seeing very strong demand at the top of the funnel. In June and in July, we had record credit approvals. And so we continue to have a lot of confidence in the long-term growth and the long-term opportunity.
spk07: Yes.
spk06: The only thing I would add, Matt, is, you know, in the context of if you think about pull-through rates starting to elongate in the back half of last year, certainly as we go into, you know, the remainder of this year, you know, you'll see more comparable results combined with the fact that you just brought up with really, really strong credit approvals at the top of the funnel. So we do expect to see sequential growth, you know, throughout the remainder of this year.
spk03: Thanks. Just one other follow-up. Is there some sort of demand slowdown baked into your full-year guidance, just given that, you know, we're going to see the 10-year sort of tax credit extension become available? And, you know, is that also part of the guidance?
spk04: Yeah. So, I mean, I think where we are today, we're – Really excited for the president to sign the Inflation Reduction Act and extend the ITC by 10 years and increase it from 26% to 30%. But because that has not yet passed, that's not implicit. On sales is getting salespeople out and selling solar. And so certainly... You know, there could be some near-term benefit by the ITC, but we think that the real benefit to this extension is the fact that it provides long-term certainty, and it allows installers to invest in their sales crews, expand to new geographies, and get the solar message out to more homeowners. So, you know, we're certainly excited there could be some near-term pickup, but it's really that long-term value that we're most excited about.
spk03: Thank you so much. I'll pass on.
spk08: Ladies and gentlemen, we've reached the end of the question and answer session, and I'd like to turn the call back to Matt Pateri for closing remarks.
spk04: Great. Thank you, Hector, and thank you all for joining us this evening. This concludes our second quarter 2022 earnings call. We really appreciate all of your questions and your interest in sunlight. And while there have been market challenges that are negatively impacting us in the back half of this year, we are very excited about the long-term growth plan that we're executing, our capital light business model, the fact that it generates significant cash in what is a very rapidly growing market. Thank you for your time this evening. Have a great night.
spk08: This concludes today's conference. You may disconnect your lines at this time.
spk04: Thank you all for your participation.
Disclaimer

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