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spk05: Greetings, and welcome to the Sunlight Financial third quarter 2022 earnings call. At this time, all participants are in 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. Thank you. You may begin.
spk00: Good afternoon and welcome to Sunlight Financial's third quarter 2022 earnings call. After the close of the market today, we announced third quarter 2022 financial results and posted an earnings presentation to our investor relations website at ir.sunlightfinancials.com. If you're a vegan, 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 expectation or prediction of financial and business performance and conditions, and competitive and industry outlook. Forward-looking statements speak as of the date they are made, are subject to risks, uncertainties, and assumptions, and are not guarantees of performance. Sunnet 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 to Sunnet Financial's website and Sunlight Financial's SEC filings for a 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 the most directly comparable GAAP measures can be found in both our 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.
spk02: Thank you, Lucia. And thank you all for joining us as we discuss Sunlight Financial's third quarter 2022 operational financial results. Despite a challenging macroeconomic environment, Sunlight achieved record volumes in the third quarter, funding $835 million of solar and home improvement loans, up 31% year over year. Home improvement volume was particularly strong, with $135 million funded in the third quarter of 2022, more than double the third quarter of 2021 funded volume of $63 million. We're excited about the momentum we're seeing in this business as we expand our presence in this $400 billion market. Sunlight also continues to perform well on other key operational metrics. 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 over 22,000 borrowers in the third quarter. That's up 24% from the same period a year ago and a new quarterly high for the company. We also continue to grow and strengthen our contractor relationships, adding 126 new active contractors to our platform in the third quarter, bringing our total installer relationships to 1,880. As disclosed in September, the largest installer in our contractor advance program became insolvent, leading us to take a significant impairment. Subsequently, we completed a re-underwriting process for all installer partners in the contractor advance program. As a result of these credit reviews, we have taken a number of actions to mitigate our risk within this program, including reducing advance limits, reducing the advance rate per job, increasing pricing for installers in this program, and eliminating advance eligibility for certain installers. We also continue to proactively monitor installers in this program for changes in their risk profiles. As of quarter end, we had $64 million in advances outstanding, with the largest advance outstanding at $10 million and no other single installer greater than $7 million. As Ronnie will discuss in more detail, the rapid rise in interest rates and our increased reliance on the indirect channel will have a significant negative impact on our near-term financial performance. To mitigate the impact going forward, we've made substantial pricing changes. We've eliminated certain harder to finance products, and we are exploring a hedging program to protect us from interest rate volatility in the future. Despite higher interest rates impacting the cost of systems, homeowners buy solar to eliminate a portion of their utility bill. With average residential electricity prices up 25% since 2018, and up over 14% in just the last 12 months, residential solar remains an attractive value proposition. Additionally, the passage of the Inflation Reduction Act, which increased the ITC from 26 to 30%, provides increased certainty for the industry over the next decade. On the consumer side, the solar asset class continues to perform well, driven by a high-quality borrower who, by definition, owns their home, and is borrowing money for a financially responsible purpose. Some light loans in particular continue to outperform in terms of credit quality, as our loss rates for our 2018, 2019, and 2020 vintages are substantially lower than previous averages for the same respective vintages. While industry-leading credit quality has always been our focus, it has become even more valuable in the current economic environment. as low loss rates improve capital providers' yields, increase demand for our assets, and are 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.
spk06: Thanks, Matt. Sunlight generated total revenue of $33 million in the third quarter of 2022, up 10% from the third quarter of 2021. primarily driven by an increase in platform fee margin. Our total platform fee this quarter was 5.1%, up 80 basis points from 5.3% in the same period last year. The direct solar platform fee percentage was even higher at 5.5%, up from 5.0% in the third quarter of 2021. Adjusted net income for the quarter was a loss of $26.3 million. or a loss of 16 cents per fully diluted share relative to 11.6 million dollars in the third quarter of 2021. Adjusted EBITDA for the third quarter was a loss of 27 million dollars compared with 11.4 million dollars in the third quarter of 2021. Our third quarter 22 results were impacted by several key items. The first was a $37.2 million provision for losses expense primarily due to the contractor insolvency event Matt mentioned earlier, which also impacted our loan loss provision calculation. As a result of the installer's bankruptcy, we determined we were unable to collect on advances owed by that installer and took a non-cash charge of $32.4 million to our advances asset on the balance sheet and a related provision for losses expense on the income statement. This event also increased the average historical loss rate, driving incremental provision for losses expense this quarter. The second impact is related to goodwill. We recorded on the balance sheet at the time of the business combination. Due to challenges in the macroeconomic environment impacting the financial and market performance of the company and our peers, We believe the book value of Goodwill exceeded its implied fair value, so we recorded a non-cash Goodwill impairment charge of $384.4 million for the three months ended September 30, 2022. In addition, we also continue to see interest rate increases of unprecedented speed and magnitude, which have reduced our direct capital provider capacity and increased our reliance on the indirect channel thus far and will affect our ability to profitably monetize indirect channel loans originated earlier this year. As Matt mentioned, though, we have been addressing these market conditions by making significant price increases over the past several months and removing low APR products. We expect these actions to increase future asset yields by over 300 basis points relative to earlier this year. delivering compelling risk-adjusted returns for our capital providers and attractive margins for Sunlight. However, loans in the indirect channel will be sold at a loss in the near term until the impact of these pricing increases take effect. I'd also like to provide a short update on our liquidity and free cash flow. In the third quarter of 2022, free cash flow was $8.2 million, and we ended the quarter with $70 million of unrestricted cash and cash equivalents, and only $21 million of short-term debt on the balance sheet. In May, we received Board approval for an 18-month, $50 million share repurchase program. To date, we have purchased just over 3 million Class A shares for a total of $10.5 million, funded with excess cash on hand and operational cash flow. Due to interest rate volatility, and the negative impacts to Sunlight's near-term financial performance, we have chosen to preserve liquidity by holding excess cash on the balance sheet and have suspended share repurchases at this time. With that, I'll turn it back to Matt.
spk02: Thanks, Rodney. Despite a challenging macroeconomic environment, we continue to believe that Sunlight maintains an attractive position in a very compelling market and the current share price does not reflect the intrinsic value of the company. As a number of parties have approached the company with a range of strategic alternatives, Sunlight's board has commenced a process to explore, review, and evaluate potential alternatives that enable our business to continue to grow and maximize value for all stakeholders. With that, I'll turn it back to the operator for Q&A.
spk05: Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your cell phone keypad, and a confirmation tone will indicate that your line is in the queue. You may press star 2 if you would like to remove the 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 pull for questions. Our first question comes from the line of Philip Shen with Roth Capital. Please proceed.
spk03: Hey, guys. Thanks for taking my questions. Matt, I'd like to start with that last point that you just made, that you guys have been fielding inbounds from interested parties. I was wondering if you might be able to talk through what some of those potential combinations might look like. Are we seeing, you know, more regional banks, like a Fifth Third acquiring dividend? And that could be wrong, actually. Maybe I have Fifth Third categorized wrong as a regional bank. But maybe you can talk through, are they private equity companies? I know you have some backers there already. I know it might be tough to talk about, but what's your sense of timing and the interest that might be circulating? Thanks.
spk02: Great. Thanks for the question, Phil. So, first, I think it's important to note that both Sunlight's board and the management team believe that the stock is undervalued and it does not reflect the intrinsic value of the company. We've received inbounds and been approached by a number of parties who have discussed a range of scenarios or strategic alternatives. and we've retained an advisor to help us evaluate those and evaluate a range of options. As we get more information about those, we'll come back and certainly provide an update. But at this point, I can't provide any other specific details.
spk03: Okay, I can appreciate that. As it relates to your covenants for your revolver, I was wondering if you could remind us, Rodney, what those covenants are that are potentially at risk And what might be the timing around working with the bank to remain in compliance?
spk07: Thanks, Bill. Appreciate the question. We have a number of covenants for a revolving credit facility, and we comply. We've discussed in our press release how the macro environment and the rapidly rising interest rates will impact our financial performance in the near term. And to the extent these impact our debt governance, we'll work with our bank partners with whom we have very strong relationships.
spk03: Got it. And so maybe let's talk about the front end of the business. And, you know, you guys have talked about a lot of pricing actions. I think I count five. And so wanted to understand, you know, have you already gotten rid of the 0.99 and 1.99% loans in Do you anticipate 2023 with maybe not even having 2.99? And then on average, where do your dealer fees sit right now? Typically, they were about 20%. A lot of fees are now closer to 35% or even 40%. On a blended average, if it makes sense to talk about it this way, where do they stand now? And looking ahead, do you expect more price increases as well for your installer base?
spk02: Yeah, thanks. It's a great question. So we've undertaken a series of pricing changes really going back to the spring. And we've eliminated a number of the harder to finance low interest rate products. When you look at the cumulative effect of our pricing changes, we estimate that it is increasing the asset yield by about 3%. So a really substantial increase when you think about the combination of the interest rate and the dealer fee. And that 3% increase in yield, we think, positioned us very well to be able to ensure that our capital providers on a go-forward basis earn attractive risk-adjusted returns and will be able to earn compelling margins as well.
spk03: Got it. And so, you know, in terms of those capital providers and your financial partners, you talked about how their capacity has been reduced. If you think through the number of credit unions and other partners that you have and the amount that each one has been reduced, if you add it all up on a percentage blended basis, how much lower are we talking about? Is it 15%, 20% lower, maybe 50% lower? Good question, Phil. At a macro level,
spk07: you know, our depositories have seen rapidly rising loan-to-deposit ratios limiting their capacity. And so, as a result, for the near term, we expect to be more reliant upon our indirect channel. Now, that said, you know, due to the strong credit quality, we do believe we have an advantage versus our other originators as capital providers do seek, you know, better credit quality.
spk03: Right. So, Ron, to kind of put a final point on it, I mean, do you think you've lost access to 20% of the capital that you typically would have expected, or is there a way you can quantify it?
spk07: Yeah, so I guess what I'll say is, as you know, historically, we've been more reliant on the direct channel. You know, in the third quarter, we sold $42 million of loans in the indirect channel, and we funded you know, an additional 264 million. So we've got about 300 million of unsold loans in the indirect channel, and we expect to sell those in the fourth quarter. But the rapid rise in interest rates will negatively impact the margins on those loans. And so, you know, as we mentioned earlier, we've taken actions to significantly increase pricing over the past several months to improve margins on loans going forward.
spk03: Right. And for those indirect loans or channel loans, or the sales that you expect to the indirect channel, what kind of a loss should we expect there?
spk07: Yeah, so we're not providing any guidance at this time. That said, we have seen interest in the loans, and it will be a challenge, and we will take a loss in the fourth quarter. That said, again, we've taken some pricing actions to deliver higher margins going forward.
spk03: Thank you. When you think about your volume, and we're heading into the end of the year and into 2023, when do you think guidance might be possible to reinstate? Historically, you were able to kind of think through the – you know, future years in a relatively constructive way. But do you think we're just a quarter away from that, or do you think it could be longer before you feel comfortable putting either quarterly or annual guidance back in place?
spk02: Yeah, and Phil, we recognize that that's an important question for investors to have some insight into the business. You know, if you look at the third quarter here, absent what was a large impairment. We think the core business performed very well in the third quarter in line with their expectations. If you look at funded volumes, up significantly on sequential quarters and up significantly year over year, as well as really strong direct margins. Rodney spoke to some of the near-term challenges, and we pulled guidance because of the volatility in interest rates. And we do recognize, again, the importance to provide some clarity to the street And we do anticipate at some point in the future we will be re-implementing guidance, but we don't have specific timing on that right now.
spk03: Okay. Appreciate that, Matt. Thanks for taking all the questions. I'll pass it on.
spk01: Thanks, Bill.
spk05: Our next question comes from the line of Mahid Mandlioy with Credit Suisse. Please proceed.
spk01: Hey, thanks for taking our questions. Just building upon the previous questions, for Q4, should we not expect any direct contribution at all and 100% internet kind of flip versus what we saw in Q3? And actually, let's start with that and then I'll just follow up on the indirect business.
spk07: Yeah, no, thanks for the question, Maheep. So again, we're not providing guidance for the fourth quarter as discussed. And so, as we talked about earlier, we've seen challenges given the rapid increases in interest rates, and that has caused some impact to our financials in Q4, but we won't be providing any guidance there.
spk01: And have the economics for the indirect business changed versus what we saw in the past? Just trying to think of the platform fees on the indirect business. You saw as low as 3.3% in the last few quarters. Any clarity on that?
spk02: Yeah, Mahib, so it's, you know, when we think about it, I think there's probably two parts to think about. One is the existing loans in the pipeline, which we call the back book. You know, as we've highlighted, interest rates have moved rapidly, and we do expect to take a loss on those loans. That said, as we look about go-forward loans, as I mentioned earlier, significant, we've made significant pricing actions over the last several months, and we expect attractive margins on those loans going forward. And Rodney highlighted in his talking points earlier, we're also implementing a hedging program to help mitigate against interest rate volatility on a go-forward basis.
spk01: And then when do those kick in?
spk02: So typically, it takes three to four months for a loan to fund. And so we do think it'll take, and there's a tail to that. So it will take some time for the pricing actions that we've taken over the last several months to fully pull through and overwhelm that back book.
spk01: All right. And then just stepping back on the macro level, just given the Inflation Reduction Act and its higher tax credit for leases. Do you see more competition for loans going forward, or is the market shrinking, or any thoughts on demand growth under this IRA environment?
spk02: Yeah, so certainly interest rates are higher and it's an inflationary environment. That said, the significant increases in utility rates continue to make solar an attractive value proposition. Now, I highlighted earlier, year over year, utility rates are up 14%, and we believe likely to continue to increase and perhaps even accelerate. Plus, the investment tax credit Not only was it extended out a decade, which gives us some certainty and the market some certainty, but it also increased from 26 to 30 percent. So it provides even better economics to homeowners who want to go solar. So when we look at market growth and we look at the broader macro trends, we think solar is well positioned and home improvement is a large market. And we're really just getting started there. We've had tremendous momentum in the home improvement business as well. So we're really optimistic about the long-term trends here.
spk01: Just on the solar portion, leases get higher tax rates, right? Probably like 33% or even higher. With the tax rate adders, which is not available for the loans, how does that impact the dynamics over here? Is it possible for you to move to a leasing structure? Going forward, I'm just trying to think through the impact of loans versus leases here.
spk02: Thanks. So as we talk to homeowners and we talk to solar salespeople, they consistently continue to tell us that they like the loan product over lease products because of simplicity. By definition, these customers own their homes, and they tell us they want to own what's bolted to the roof. And they like the economics that they get with a loan. There are certainly cases where leases make more sense for an individual homeowner, but overwhelmingly the market today is loans versus leases. And despite some of the points that you made, we do believe that loans will continue to play, will continue to be the vast majority of the market going forward.
spk01: All right. Thanks for the questions. I'll jump back in the queue.
spk02: Thank you, Mihit.
spk05: Our next question comes from the line of Jeff Osborne with Cowan & Company. Please proceed.
spk04: Good evening. I wanted to dig into a couple of follow-ups on the prior questions. On the covenant side, you sort of shrugged that off. I just want to be crystal clear that the losses expected in Q4 and the ramifications to the cash balance, you don't anticipate tripping any covenants over the next quarter or two?
spk07: Yeah, so thanks for the question. So like we talked about earlier, you know, the loans that we sell in an indirect channel in the fourth quarter will be sold at a loss. And while again, you know, it may have an impact on those covenants, you know, to the extent that it does, we'll work with our bank partners with whom we have, you know, very strong relationships. We've been very transparent. We disclosed those covenants in the 10-Q, so it's all there. But just wanted to make sure that you had that information.
spk04: No, I appreciate it. It's all there. You just seemed to dismiss it, so that's why I was trying to get to the bottom of that. And then the pricing, you know, I think Phil had mentioned four or five price increases. Matt, you said you started in the spring. Were any of those more recent? I'm just trying to get a sense of how long you'll be selling loans at a loss, if that's expected, given that three- to four-month lag. Do we need to wait until maybe 2Q of next year to start seeing a positive attribution from the loan sales?
spk02: Yeah, so it's a good question. So we started making pricing changes and then eliminating products late in the spring. We've continued to take pricing actions up to and including into the fourth quarter to ensure that loans are priced appropriately. So there clearly is some lag from when a pricing change goes into effect when the customer is credit approved until the loan is funded. So there will be a tell there. But certainly loans that are funding more recently that were credit approved earlier in the year have the least favorable margins versus loans that were repriced over the last month or two.
spk04: I got it. And then I wanted to better appreciate the customer service side of your business. A bit of an oddball question, but I mean, you can go to the Better Business Bureau site and there's been a litany of complaints against your corporation, you know, largely due to the pink energy. Bankruptcy, I just want to understand, are you staffed up to go after these people and how you're dealing with loans given improper equipment that isn't working with now an insolvent company?
spk02: Yeah, it's a good question and something that we take very seriously. So there are a portion of customers who were installed but did not have their systems PTOed or connected to the grid. We've staffed up a team internally to help assist those customers get PTO and to help support them if they may have questions regarding their systems. So definitely something that we take seriously, and we've made good progress on helping a significant number of customers get PTO.
spk04: Got it. I've asked you this on prior calls, and you're a bit evasive on this topic as well, but is the duration of when someone signs a loan to getting glass on the roof, is that getting better or worse?
spk02: It's stayed fairly consistent. We've seen a little bit of compression more recently, but if we compare it to historical pull-through curves and the time versus 2019 or 2020, for instance, it has taken, even now, it does still take longer due to supply chain and some labor shortages. So, A little bit of improvement there, but it is elongated relative to historical averages.
spk04: Got it. My last one is two-parter. Has the hedging started? And if it started, is it fully in place or is it partially in place? Like, how do you sequence in hedging to, you know, cross the book?
spk07: Yeah, good question. So, just to clarify... On the direct side of the business, we don't take market risk as our price with the capital provider is locked at the time of the credit approval. On the indirect channel, as we've discussed in the past, we do have market risk from the time of approval until the loan is funded and ultimately sold. And we are working through a number of hedging alternatives to mitigate this risk going forward. It takes some time to get those programs established with the banks, but we expect that to be in place for new loans in the first quarter.
spk04: So loans that you offer in the fourth quarter, and then we'd see the financial ramifications of that three to four months later, so more like second quarter of next year is when things are a bit more normalized or no?
spk07: We won't give any guidance in terms of performance. What I will say, just to reiterate, is, you know, as we've seen, you know, the rapid rise in interest rates, we've made multiple price changes as Matt walked us through, and that's really increased the yield on the assets. As we think about, you know, risk-adjusted returns for capital providers as well as our margins, we do contemplate any cost of hedging into those. And so we, you know, we are establishing pricing to deliver, you know, strong margins, you know, in 23.
spk04: Yeah, that's all I have. Thank you. Yeah.
spk07: Thanks, Jeff. Thank you.
spk05: Thank you. Our next question comes again from the line of Philip Shen with Roth Capital. Please proceed.
spk03: hey guys thanks for taking the follow-ups um uh it's back on the covenants here and uh was wondering um uh rodney if you could share with us you know which covenant specifically is at risk uh you know is it a um yeah which ratio in particular because we're trying to figure out which one to monitor yeah yeah i mean they're standard profitability covenants um
spk07: So as you can see, there's standard covenants in there, and it's really around the profitability. And like I said, in the near term, given the sale of the indirect loans at a loss, if those covenants need to be addressed, we'll work with our bank partner through that. We've got really strong relationships there.
spk03: Okay, so it would be the debt coverage ratio?
spk07: No, so it would be more on the earnings side.
spk03: Got it. Okay. As it relates to, you know, we've published a bunch about how the loan market is slowing down. So I think Maheep was asking about how, you know, there are a bunch of adders and that's making lease more attractive because the loan financing does not have the ability to access those adders, which can get up to a 70% ITC. On the other side, we've been writing about how the originations for loans has been slowing down as well. And it's a long term. Matt, I think you highlight that you have confidence in the business. But as we get into Q1 and Q2, there is, we believe, a slowdown because salespeople have to adjust to the shock of, so many price increases in such a short period of time. And so how do you expect to deal with that slowdown? Are you seeing that slowdown as well? Can you see it in your leads or your leading data points where originations are slowing down? And so as you look into Q1 and Q2, would it be fair to say that thesis is True. Thanks.
spk02: Yeah, Phil, I definitely appreciate the question. You know, as we think loan versus lease, one thing that I think has been true over the last few years is loans tend to be simpler for salespeople to explain to homeowners, and that simplicity helps drive more customers to choose a loan over a lease. And so, again, we continue to hear from salespeople and from homeowners that they prefer to loan. It's going to be on their roof for 25 or 30 years. They prefer to have a loan and own that system versus lease it. It doesn't mean that there aren't cases where there are homeowners that prefer a lease for one reason or another. As we think about volume, I think there are probably a few things that I could point you to. First, if you look at our overall funded loan volume in the third quarter, You know, very strong loan volume up year over year and sequentially, and we've seen good growth there. We've also saw strong growth in our overall contractor relationships. And we've shared before, we don't think that that is the ultimate metric, but it does provide some indication of contractors' eagerness and willingness to work with Sunlight and the value proposition that we offer.
spk03: Okay. Appreciate the additional color. Thanks, guys.
spk05: Thanks, Phil. Thank you. Thank you, ladies and gentlemen. This concludes our question and answer session. Now I'd like to turn the call back to Matt Petteri for closing remarks. Great.
spk02: Well, thank you all for your questions and for your interest in sunlight. While there are certainly market challenges that will negatively impact sunlight in the back half of the year, We are excited to continue to execute on our growth plan, and we believe we're well positioned to generate long-term value for our stakeholders in this attractive market. Thank you for your time, and have a good evening.
spk05: Thank you. This concludes today's conference. You may now disconnect your lines. Thank you for your participation.
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