Sunrun Inc. - FORM 10-Q - August 11, 2016

Attached files

file	filename
EX-32.1 - EX-32.1 - Sunrun Inc.	run-ex321_9.htm
EX-31.2 - EX-31.2 - Sunrun Inc.	run-ex312_8.htm
EX-31.1 - EX-31.1 - Sunrun Inc.	run-ex311_7.htm
EX-10.4 - EX-10.4 - Sunrun Inc.	run-ex104_732.htm
EX-10.3 - EX-10.3 - Sunrun Inc.	run-ex103_733.htm
EX-10.2 - EX-10.2 - Sunrun Inc.	run-ex102_911.htm
EX-10.1 - EX-10.1 - Sunrun Inc.	run-ex101_912.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-37511

Sunrun Inc.

(Exact name of registrant as specified in its charter)

Delaware

26-2841711

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

595 Market Street, 29^th Floor

San Francisco, California 94105

(Address of principal executive offices and Zip Code)

(415) 580-6900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	o		Accelerated filer	o

Non-accelerated filer	x	(Do not check if a smaller reporting company)	Smaller reporting company	o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

As of August 8, 2016, the number of shares of the registrant’s common stock outstanding was 103,072,725.

Table of Contents

		Page
Item 1	Financial Statements (Unaudited)	2
	Consolidated Balance Sheets	2
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income (Loss)	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36

	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 5.	Other Information	61
Item 6.	Exhibits	61
	Signatures	62

Sunrun Inc.

Consolidated Balance Sheets

(In Thousands, Except Share Par Values)

	June 30, 2016			December 31, 2015
	(Unaudited)
Assets
Current assets:
Cash	$	207,220		$	203,864
Restricted cash		10,037			9,203
Accounts receivable (net of allowances for doubtful accounts of $977 and $1,641 as of June 30, 2016 and December 31, 2015, respectively)		56,572			60,275
State tax credits receivable		—			9,198
Inventories		88,207			71,258
Prepaid expenses and other current assets		12,380			5,917
Total current assets		374,416			359,715
Restricted cash		6,117			8,094
Solar energy systems, net		2,282,729			1,992,021
Property and equipment, net		53,348			44,866
Intangible assets, net		20,602			22,705
Goodwill		87,543			87,543
Prepaid tax asset		278,602			190,146
Other assets		33,487			29,502
Total assets(1)	$	3,136,844		$	2,734,592
Liabilities and total equity
Current liabilities:
Accounts payable	$	93,681		$	104,133
Distributions payable to noncontrolling interests and redeemable noncontrolling interests		8,515			8,144
Accrued expenses and other liabilities		52,015			49,146
Deferred revenue, current portion		65,745			59,726
Deferred grants, current portion		14,383			13,949
Capital lease obligations, current portion		11,371			8,951
Long-term non-recourse debt, current portion		6,368			4,722
Lease pass-through financing obligation, current portion		4,301			3,710
Total current liabilities		256,379			252,481
Deferred revenue, net of current portion		579,590			559,066
Deferred grants, net of current portion		212,768			220,784
Capital lease obligations, net of current portion		16,916			15,042
Recourse debt		242,400			197,000
Long-term non-recourse debt, net of current portion		505,918			333,042
Lease pass-through financing obligation, net of current portion		139,873			153,188
Other liabilities		12,165			7,144
Deferred tax liabilities		278,661			190,146
Total liabilities(1)		2,244,670			1,927,893
Commitments and contingencies (Note 13)
Redeemable noncontrolling interests		163,520			147,139
Stockholders’ equity:
Preferred stock, $0.0001 par value—authorized, 200,000 shares as of June 30, 2016 and December 31, 2015; no shares issued and outstanding as of June 30, 2016 and December 31, 2015		—			—
Common stock, $0.0001 par value—authorized, 2,000,000 shares as of June 30, 2016 and December 31, 2015; issued and outstanding, 102,826 and 101,282 shares as of June 30, 2016 and December 31, 2015, respectively		10			10
Additional paid-in capital		654,229			642,229
Accumulated other comprehensive loss		(5,909	)		(921	)
Accumulated deficit		(41,472	)		(87,249	)
Total stockholders’ equity		606,858			554,069
Noncontrolling interests		121,796			105,491
Total equity		728,654			659,560
Total liabilities, redeemable noncontrolling interests and total equity	$	3,136,844		$	2,734,592

(1)

The Company’s consolidated assets as of June 30, 2016 and December 31, 2015 include $1,651,594 and $1,363,615, respectively, in assets of variable interest entities, or VIEs, that can only be used to settle obligations of the VIEs. Solar energy systems, net, as of June 30, 2016 and December 31, 2015 were $1,579,222 and $1,305,420, respectively; cash as of June 30, 2016 and December 31, 2015 were $53,415 and $44,407, respectively; restricted cash as of June 30, 2016 and December 31, 2015 were $283 and $757, respectively; accounts receivable, net as of June 30, 2016 and December 31, 2015 were $18,627 and $12,965, respectively; and prepaid expenses and other current assets as of June 30, 2016 and December 31, 2015 were $47 and $66, respectively. The Company’s consolidated liabilities as of June 30, 2016 and December 31, 2015 include $559,311 and $540,464, respectively, in liabilities of VIEs whose creditors have no recourse to the Company. These liabilities include accounts payable as of June 30, 2016 and December 31, 2015 of $11,045 and $11,025, respectively; distributions payable to noncontrolling interests and redeemable noncontrolling interests as of June 30, 2016 and December 31, 2015 of $8,465 and $8,063, respectively; accrued expenses and other liabilities as of June 30, 2016 and December 31, 2015 of $86 and $175, respectively; deferred revenue as of June 30, 2016 and December 31, 2015 of $398,083 and $374,736, respectively; deferred grants as of June 30, 2016 and December 31, 2015 of $112,035 and $115,726, respectively; and long-term non-recourse debt as of June 30, 2016 and December 31, 2015 of $29,597 and $30,739, respectively.

The accompanying notes are an integral part of these consolidated financial statements.

Sunrun Inc.

Consolidated Statements of Operations

(In Thousands, Except Per Share Amounts)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Revenue:
Operating leases and incentives	$	45,394		$	34,458		$	79,934		$	56,766
Solar energy systems and product sales		77,144			38,232			141,347			65,601
Total revenue		122,538			72,690			221,281			122,367
Operating expenses:
Cost of operating leases and incentives		38,608			27,067			76,708			48,444
Cost of solar energy systems and product sales		61,600			34,624			119,112			59,954
Sales and marketing		43,716			33,976			86,904			58,902
Research and development		2,373			2,492			4,836			4,779
General and administrative		23,614			19,677			46,862			39,983
Amortization of intangible assets		1,051			1,051			2,103			1,593
Total operating expenses		170,962			118,887			336,525			213,655
Loss from operations		(48,424	)		(46,197	)		(115,244	)		(91,288	)
Interest expense, net		13,063			8,433			24,578			15,563
Loss on early extinguishment of debt		—			431			—			431
Other expenses (income), net		30			1,019			(502	)		1,318
Loss before income taxes		(61,517	)		(56,080	)		(139,320	)		(108,600	)
Income tax expense (benefit)		3,210			(6,215	)		3,210			(6,215	)
Net loss		(64,727	)		(49,865	)		(142,530	)		(102,385	)
Net loss attributable to noncontrolling interests and redeemable noncontrolling interests		(97,370	)		(57,405	)		(188,307	)		(91,930	)
Net income (loss) attributable to common stockholders	$	32,643		$	7,540		$	45,777		$	(10,455	)
Less: Net income allocated to participating securities		—			(7,540	)		—			—
Net income (loss) available to common stockholders	$	32,643		$	—		$	45,777		$	(10,455	)

Net income (loss) per share available to common stockholders
Basic	$	0.32		$	—		$	0.45		$	(0.41	)
Diluted	$	0.31		$	—		$	0.44		$	(0.41	)
Weighted average shares used to compute net income (loss) per share available to common stockholders
Basic		101,969			26,215			101,621			25,322
Diluted		104,768			26,215			104,494			25,322

The accompanying notes are an integral part of these consolidated financial statements.

Sunrun Inc.

Consolidated Statements of Comprehensive Income (Loss)

(In Thousands)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net income (loss) attributable to common stockholders	$	32,643		$	7,540		$	45,777		$	(10,455	)
Other comprehensive income (loss):
Unrealized gain (loss) on derivatives, net of income taxes		165			2,861			(5,633	)		1,069
Less interest expense on derivatives recognized into earnings, net of income taxes		(120	)		(356	)		(645	)		(356	)
Comprehensive income (loss)	$	32,928		$	10,757		$	40,789		$	(9,030	)

Sunrun Inc.

Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

	Six Months Ended June 30,
	2016			2015
Operating activities:
Net loss	$	(142,530	)	$	(102,385	)
Adjustments to reconcile net loss to net cash used in operating activities:
Noncash losses		2,510			431
Depreciation and amortization, net of amortization of deferred grants		46,564			32,673
Bad debt expense		414			739
Interest on lease pass-through financing		6,019			7,177
Noncash tax expense (benefit)		3,210			(6,215	)
Noncash interest expense		5,335			4,443
Stock-based compensation expense		8,647			6,421
Reduction in lease pass-through financing obligations		(9,491	)		(10,379	)
Changes in operating assets and liabilities:
Accounts receivable		3,884			(4,216	)
Inventories		(16,839	)		(13,890	)
Prepaid and other assets		(2,760	)		(8,615	)
Accounts payable		(9,889	)		22,751
Accrued expenses and other liabilities		3,218			6,209
Deferred revenue		3,295			20,254
Net cash used in operating activities		(98,413	)		(44,602	)

Investing activities:
Payments for the costs of solar energy systems, leased and to be leased		(332,472	)		(257,806	)
Purchases of property and equipment		(8,208	)		(4,688	)
Business acquisition, net of cash acquired		(5,000	)		(14,575	)
Net cash used in investing activities		(345,680	)		(277,069	)

Financing activities:
Proceeds from state tax credits, net of recapture		9,123			5,120
Proceeds from recourse debt		257,400			143,000
Repayment of recourse debt		(212,000	)		(49,224	)
Proceeds from non-recourse debt		189,746			10,200
Repayment of non-recourse debt		(16,543	)		(5,732	)
Payment of debt fees		(12,277	)		(2,801	)
Proceeds from lease pass-through financing obligations		12,805			52,034
Contributions received from noncontrolling interests and redeemable noncontrolling interests		239,621			155,662
Distributions paid to noncontrolling interests and redeemable noncontrolling interests		(18,257	)		(13,717	)
Proceeds from exercises of stock options, net of withholding taxes on restricted stock units and issuance of shares in connection with the Employee Stock Purchase Plan		3,616			2,387
Offering costs paid related to initial public offering		(437	)		(4,722	)
Payment of capital lease obligations		(6,416	)		(1,472	)
Change in restricted cash		1,068			(4,608	)
Net cash provided by financing activities		447,449			286,127

Net increase (decrease) in cash		3,356			(35,544	)
Cash, beginning of period		203,864			152,154
Cash, end of period	$	207,220		$	116,610

Supplemental disclosures of cash flow information
Cash paid for interest	$	10,676		$	3,118

Supplemental disclosures of noncash investing and financing activities
Costs of solar energy systems and property and equipment included in accounts payable and accrued expenses	$	15,586		$	4,777
Distributions payable to noncontrolling interests and redeemable noncontrolling interests	$	8,515		$	6,463
Vehicles acquired under capital leases	$	10,914		$	5,255
Noncash purchase consideration on acquisition of business	$	—		$	18,718

The accompanying notes are an integral part of these consolidated financial statements.

Sunrun Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Note 1. Organization

Sunrun Inc. (“Sunrun” or the “Company”) was originally formed in 2007 as a California limited liability company, and was converted into a Delaware corporation in 2008. The Company is engaged in the design, development, installation sale, ownership, and maintenance of residential solar energy systems (“Projects”) in the United States.

Sunrun acquires customers directly and through relationships with various solar and strategic partners (“Partners”). The Projects are constructed either by Sunrun or by Sunrun’s Partners and are owned by the Company. Sunrun’s customers enter into a power purchase agreement (“PPA”) or a lease (each, a “Customer Agreement”) which typically has a term of 20 years. Sunrun monitors, maintains and insures the Projects. The Company also sells solar energy systems and products (such as panels and racking) to customers.

The Company has formed various subsidiaries (“Funds”) to finance the development of Projects. These Funds, structured as limited liability companies, obtain financing from outside investors and purchase or lease Projects from Sunrun under master purchase or master lease agreements. The Company currently utilizes three legal structures in its investment Funds, which are referred to as: (i) lease pass-throughs, (ii) partnership-flips and (iii) joint venture (“JV”) inverted leases.

Sunrun acquired Clean Energy Experts, LLC (“CEE”), a consumer demand and solar lead generation company, in April 2015, to support the growth of the business, including reducing costs of obtaining customer leads externally. As a result of the acquisition, the Company also sells a portion of solar leads generated to customers.

The Company completed its initial public offering in August 2015 and its common stock is listed on the NASDAQ Global Select Market under the symbol “RUN”.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2015. The unaudited consolidated financial statements are prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which are considered of normal recurring nature) considered necessary to present fairly the Company’s financial results. The results of the six months ended June 30, 2016 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2016 or for any other interim period or other future year.

The consolidated financial statements reflect the accounts and operations of the Company and those of its subsidiaries, including Funds, in which the Company has a controlling financial interest. The typical condition for a controlling financial interest ownership is holding a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as variable interest entities (“VIEs”), through arrangements that do not involve controlling financial interests. In accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 810 (“ASC 810”) Consolidation, the Company consolidates any VIE of which it is the primary beneficiary. The primary beneficiary, as defined in ASC 810, is the party that has (1) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb the losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. The Company evaluates its relationships with its VIEs on an ongoing basis to determine whether it continues to be the primary beneficiary. The consolidated financial statements reflect the assets and liabilities of VIEs that are consolidated. All intercompany transactions and balances have been eliminated in consolidation.

Reclassifications

Certain prior period amounts have been reclassified to conform to current period presentation. In addition, the Company adopted Accounting Standards Update (“ASU”) 2015-03, Interest—Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs and ASU 2015-15, Interest—Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangement. The impact of the Company’s adoption of the ASUs on the prior period consolidated balance sheet was as follows (in thousands):

	December 31, 2015
	As Previously Reported		Adoption of ASU			As Reclassified
Prepaid expenses and other current assets	$	6,696	$	(779	)	$	5,917
Other assets		32,277		(2,775	)		29,502
Long-term non-recourse debt, current portion		5,408		(686	)		4,722
Recourse debt		194,975		2,025			197,000
Long-term non-recourse debt, net of current portion		337,935		(4,893	)		333,042

Use of Estimates

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company regularly makes significant estimates and assumptions, including, but not limited to, the estimates that affect the collectability of accounts receivable, the valuation of inventories, the useful lives and estimated residual values of solar energy systems, the useful lives of property and equipment, the valuation and useful lives of intangible assets, the fair value of assets acquired and liabilities assumed in business combinations, the effective interest rate used to amortize lease pass-through financing obligations, the valuation of stock-based compensation, the determination of valuation allowances associated with deferred tax assets, the fair value of debt instruments disclosed and the redemption value of redeemable noncontrolling interests. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable. Actual results may differ from such estimates.

Segment Information

The Company has one operating segment with one business activity, providing solar energy services and products to customers. The Company’s chief operating decision maker (“CODM”) is its Chief Executive Officer, who manages operations on a consolidated basis for purposes of allocating resources. When evaluating performance and allocating resources, the CODM reviews financial information presented on a consolidated basis.

Revenues from external customers (including, but not limited to homeowners) for each group of similar products and services are as follows (in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Operating leases	$	32,980	$	22,915	$	58,307	$	40,047
Incentives		12,414		11,543		21,627		16,719
Operating leases and incentives		45,394		34,458		79,934		56,766
Solar energy systems		35,878		7,028		66,070		12,834
Products		41,266		31,204		75,277		52,767
Solar energy systems and product sales		77,144		38,232		141,347		65,601
Total revenue	$	122,538	$	72,690	$	221,281	$	122,367

Fair Value of Financial Instruments

The Company defines fair value as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses valuation techniques to measure

fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. FASB establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2—Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

Level 3—Inputs that are unobservable, significant to the measurement of the fair value of the assets or liabilities and are supported by little or no market data.

The Company’s financial instruments include cash, receivables, accounts payable, accrued expenses, distributions payable to noncontrolling interests, derivatives, and recourse and non-recourse debt.

Recently Issued Accounting Standards

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09 Revenue from Contracts with Customers (Topic 606), to replace the existing revenue recognition criteria for contracts with customers and to establish the disclosure requirements for revenue from contracts with customers. The core principle of this standard is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. This ASU is effective for the Company for annual reporting periods beginning after December 15, 2017 including the interim reporting periods within that fiscal year, and early adoption is permitted. Adoption of this ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. The Company is currently evaluating this guidance and the impact it may have on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, to specify that inventory should be subsequently measured at the lower of cost or net realizable value, which is the ordinary selling price less any completion, transportation and disposal costs. This ASU is effective for interim and annual periods beginning after December 15, 2016. Adoption of this ASU is prospective. The Company is currently evaluating this guidance and the impact it may have on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases. Under the new guidance, lessees will be required to recognize for all leases (with the exception of short-term leases) a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The accounting for lessors is largely unchanged. However, the new guidance now defines what qualifies as sales-type and direct financing leases, as well as the related accounting. This ASU is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. The Company is currently evaluating this guidance and the impact it may have on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation. The new guidance will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It will also allow an employer to repurchase more of an employee’s shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. This ASU is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The Company is currently evaluating this guidance and the impact it may have on the Company’s consolidated financial statements.

Note 3. Fair Value Measurement

At June 30, 2016 and December 31, 2015, the carrying value of receivables, accounts payable, accrued expenses, and distributions payable to noncontrolling interests approximates fair value due to their short-term nature. The carrying values and fair values of debt instruments are as follows (in thousands):

	June 30, 2016				December 31, 2015
	Carrying Value		Fair Value		Carrying Value		Fair Value
Lines of credit	$	374,300	$	374,300	$	197,000	$	197,000
Syndicated term loans		189,730		189,730		169,344		169,344
Bank term loan		51,932		52,079		30,739		32,692
Note payable		34,819		34,682		32,781		32,568
Solar asset-backed notes		103,905		113,730		104,900		110,103
Total	$	754,686	$	764,521	$	534,764	$	541,707

At June 30, 2016, the fair value of the Company’s lines of credit, syndicated term loans, and bank term loan due in September 2022 approximates their carrying values because their interest rates are variable rates that approximate rates currently available to the Company. At December 31, 2015, the fair value of the Company’s line of credit and syndicated term loans approximates their carrying values because their interest rates are variable rates that approximate rates currently available to the Company. At June 30, 2016 and December 31, 2015, the fair value of the Company’s bank term loan due in April 2022, note payable and asset-backed notes are based on rates currently offered for debt with similar maturities and terms. The Company’s fair value of the debt instruments fell under the Level 3 hierarchy. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market.

The Company determines the fair value of its interest rate swaps using a discounted cash flow model which incorporates an assessment of the risk of non-performance by the interest rate swap counterparty and an evaluation of the Company’s credit risk in valuing derivative instruments. The valuation model uses various inputs including contractual terms, interest rate curves, credit spreads and measures of volatility.

The Company determines the fair value of its warrants issued using the Black-Scholes option-pricing model. The significant unobservable input used in the fair value measurement of the warrant liability was the expected volatility of the Company. Generally, increases (decreases) in the expected volatility of the Company would result in a directionally similar impact to the measurement of the Company’s warrants.

At June 30, 2016 and December 31, 2015, financial instruments measured at fair value on a recurring basis, based upon the fair value hierarchy are as follows (in thousands):

	June 30, 2016
	Level 1		Level 2		Level 3		Total
Derivative liabilities:
Interest rate swaps	$	—	$	9,070	$	—	$	9,070
Warrants		—		—		15		15
Total	$	—	$	9,070	$	15	$	9,085

	December 31, 2015
	Level 1		Level 2		Level 3		Total
Derivative liabilities:
Interest rate swaps	$	—	$	921	$	—	$	921
Warrants		—		—		557		557
Total	$	—	$	921	$	557	$	1,478

Note 4. Inventories

Inventories consist of the following (in thousands):

	June 30, 2016		December 31, 2015
Raw materials	$	83,741	$	62,967
Work-in-process		4,466		8,291
Total	$	88,207	$	71,258

Note 5. Solar Energy Systems, net

Solar energy systems, net consists of the following (in thousands):

	June 30, 2016			December 31, 2015
Solar energy system equipment costs	$	2,148,251		$	1,846,103
Inverters		217,931			177,202
Initial direct costs		93,185			68,280
Total solar energy systems		2,459,367			2,091,585
Less: accumulated depreciation and amortization		(254,470	)		(212,671	)
Add: construction-in-progress		77,832			113,107
Total solar energy systems, net	$	2,282,729		$	1,992,021

All solar energy systems, construction-in-progress, and inverters have been leased to or are subject to signed Customer Agreements with customers. The Company recorded depreciation expense related to solar energy systems of $22.5 million and $16.5 million for the three months ended June 30, 2016 and 2015, respectively, and $42.9 million and $32.0 million for the six months ended June 30, 2016 and 2015, respectively. The depreciation expense was reduced by the amortization of deferred grants of $3.4 million and $3.5 million for the three months ended June 30, 2016 and 2015, respectively, and $7.4 million and $7.1 million for the six months ended June 30, 2016 and 2015, respectively.

Note 6. Indebtedness

As of June 30, 2016, debt consisted of the following (in thousands):

							Unused		Annual
	Carrying Values, net of						Borrowing		Contractual	Interest	Maturity
	debt discount						Capacity		Interest Rate	Rate	Date
	Current		Long Term		Total
Recourse debt:
Bank line of credit	$	—	$	242,400	$	242,400	$	6	Varies (1)	3.70% - 5.75%	April 2018
Total recourse debt	$	—	$	242,400	$	242,400	$	6