SolarCity Corp Earnings: Shining the Light on Losses

Leading solar-system company SolarCity Corp (SCTY.DL) reported third-quarter earnings after market close on Thursday, October 29, and the company's stock is getting crushed, setting it up for a pounding when the market opens for trading on Friday. 

The company reported a pretty wide GAAP loss in the quarter despite the usual strong growth in systems deployed, and a drop in its cost-per-watt measure. Management also disclosed that it's planning a substantial focus on cutting expenses in coming months, which will slow the growth rate, but improve cash flows and reduce losses. The company reduced guidance for next quarter, as well, citing concerns about potential weather in December, and a large number of commercial projects scheduled that month. 

Is SolarCity doing well, or doing badly? Let's take a closer look at the company's earnings release and presentation, and dig into the numbers. 

Putting a spotlight on GAAP and non-GAAP metrics 
GAAP -- or generally accepted accounting principles -- numbers are very important, because they require companies to report financial results within constraints in order to limit potential manipulation to mask poor performance. And based on the GAAP results, SolarCity's numbers are pretty ugly:

As you can see, SolarCity reported a net loss of $215 million in the quarter on $113 million in revenue. That's right -- the company's losses were almost twice total GAAP revenue in the period. Net losses were almost equal to total operating expenses, with sales and marketing expense actually $15 million higher than total sales. 

But this is where GAAP can be deceiving, because SolarCity generated significantly more value than the $113.8 million in revenue it could recognize under GAAP accounting:

Source: SolarCity presentation. 

That's only part of what GAAP leaves out:

The contracts that SolarCity's sales and marketing teams signed this past quarter added $1.2 billion to the company's portfolio. Total remaining payments are now worth $8.9 billion over the next 20 years. Those future cash flows aren't represented by GAAP. Don't get me wrong -- I'm not saying they should be. After all, they aren't guaranteed until they are paid, and future revenue doesn't pay today's expenses. 

Contrast that with the results just reported by SunPower Corporation (SPWR -0.87%). SunPower reported a GAAP net loss in the quarter of $56 million, and $380 million in revenue, significantly below last year's $663 million in sales and $32 million profits. On a non-GAAP basis, SunPower said it had $441 million in sales and $20.5 million in profits. SunPower stock closed up more than 11% following its earnings release, based on the market's acceptance of its non-GAAP results. 

Don't get me wrong: I'm not saying SunPower's non-GAAP results should be dismissed out of hand. To the contrary, with proper context, non-GAAP earnings are important to understanding a company's performance. I'm just pointing out that the market's perception is pretty important, and right now, the perception is that SolarCity isn't performing well. 

Addressing the big concern about profits and cash flow 
Over the past few years, SolarCity has invested huge sums into geographical expansion and growth, making it by far the largest solar installation and service company in the U.S.. And as you can see in the GAAP results, those costs each quarter have been higher than the revenues that come in. This is reflected in the lumpiness in the company's cost-per-watt results:

Source SolarCity presentation.

SolarCity has been able to steadily reduce the per-watt costs in toto, but almost entirely through installation efficiencies. Sales costs have steadily increased as the company has expanded into new markets, and while that has led to massive growth, management acknowledged on the earnings call that it's time to ramp down that investment in sales growth in order to get to better cash-flow results.

This quarter, sales costs-per-watt have jumped a whopping 60% over the past two years. And as you can see in the slide above, sales costs alone are now higher than the company is projecting for total sales, general, and administrative expenses per-watt by 2017. 

Management is taking steps immediately to start cutting the SG&A cost-per-watt, but they made it clear on the earnings call that the company wasn't going to slash costs. Instead, the lower costs will be a product of taking its foot off of the growth accelerator, and to be more selective about future geographical expansion. 

The downside? The company is now projecting to install just under 900MW of capacity in 2015, down from the 920MW-1,000MW guidance at the end of the second quarter. That's strong growth, but only part of the impact. After several years of almost doubling sales annually, management is guiding for "only" 40% growth in 2016. 

Looking ahead 
SolarCity can be hard to figure out. I get it. After all, GAAP results are pretty important, and losses are losses. However, it's important to strike a balance between GAAP and non-GAAP metrics that give additional -- often needed -- perspective on the business, the economics, and the bigger picture. 

What's the endgame behind the plan to slow expansion? Management said the company would be cash-flow positive by the end of 2016 -- a noteworthy achievement that the company says would be sustainable going forward once achieved. It's something that Mister Market would have to view as a positive. 

The bottom line? Company executives have made it clear for some time now that the big cost increases have been variable and discretionary, and not required to maintain the portfolio of long-term contracts and systems. SolarCity's PowerCo segment -- which manages the assets and collects payments -- has generated $112 million in net cash over the past 12 months. So that part of the business -- with $9 billion in long-term contracts -- is already cash-flow positive. 

Going forward, management is convinced it can now be more selective with expansion, and let cash flows and expenses reach an inflection point in 2016, where cash flows come out ahead. They say cash is king. If SolarCity can get to cash-flow positive in the next year, that would be a pretty huge step forward.