SolarCity Corp. (NASDAQ:SCTY.DL) reported earnings on Aug. 9, delivering what management called "notable sequential improvement in its operating metrics." At the same time, the company also reported sales costs that have remained naggingly high (even with the sequential improvement), and "only" increased megawatts installed in the quarter by 6% from last year. But from a top-line perspective, it's hard to hate 80% revenue growth, built on the compounding benefit of all those long-term contracts that customers have signed over the past year.
It may seem like the results don't particularly matter, with the merger with Tesla Motors (NASDAQ:TSLA) pending shareholder approval of both companies. But if you're a Tesla investor, or a SolarCity shareholder who will become a Tesla investor if the merger happens, SolarCity's operating and financial performance absolutely matters. Let's take a closer look at SolarCity's Q2 earnings results.
How SolarCity did last quarter
SolarCity's revenue increased 80% in the quarter, while total operating expenses increased 51%. Sales and marketing expense, at $114.5 million, makes up 43% of total operating expense and, on a quarterly basis, is best compared against the company's megawatts booked and, to a lesser extent, its MW installed results. MW booked increased 42% in the quarter, while the company installed 201 MW, a 6% increase from last year.
It's important to note that quarterly install and deployment metrics can be a bit lumpy, due to several factors including weather, the mix of commercial/industrial business versus residential, to name the major ones.
SolarCity also reported a sequential improvement in its sales and installation costs measured on a per-watt installed basis:
Yet even with the sequential improvement in lower sales cost, SolarCity saw its installation and general/administrative expenses increase on a per-watt basis sequentially. Furthermore, its total costs per watt were also higher in the second quarter than they have been in at least two years.
What they're doing about those higher costs
On the earnings call, CEO Lyndon Rive pointed out the sequential 27% drop in sales costs, and said that they expect to see them fall again in the third quarter. In short, it sounds like it's largely a product of better sales leverage. But it's what the company has done since earnings that is likely to have a bigger impact on operating expenses.
On Aug. 17, the company issued a Securities and Exchange Commission filing that said:
On August 16, 2016, SolarCity Corporation (the "Company") adopted and began implementing initiatives to realign the Company's operating expenses to match the Company's reduced guidance for Megawatts Installed. The realignment is expected to be completed by the end of 2016. The Company expects to incur restructuring charges ranging from approximately $3 million to $5 million, consisting primarily of severance benefits. A substantial portion of such charges are expected to be incurred in the second half of fiscal 2016. The actual timing and costs of the realignment may differ from the Company's current expectations and estimates.
To align with the Company's cost-cutting measures described in Item 2.05 above, Lyndon Rive, our Co-Founder and Chief Executive Officer, and Peter Rive, our Co-Founder and Chief Technology Officer, requested that the Company reduce their annual salary from $275,000 to $1 per year for their services, and, effective as of August 16, 2016, the Compensation Committee of the Board of Directors of the Company reduced the annual salaries of Lyndon Rive and Peter Rive to the minimum amount permitted by law.
Without reading too much into a short release, when restructuring involves $3 million to $5 million primarily of severance benefits, it's not a stretch to connect that move to a reduction in the size of the company's sales and marketing.
Tesla merger, new products
Potentially the most interesting things management talked about on the call were SolarCity's plans to launch a solar product aimed at homeowners who need to replace their roof, a market of roughly 5 million homes each year.
President and CFO Tanguy Serra said that around 10% of the customers they meet with have roofs that need to be replaced. However, Rive and Musk both stressed that it's not these customers they are looking to target with this new offering which is expected to be available in 2017, but instead all the homeowners who aren't even considering solar today, because they know their roof will need to be replaced in the next several years.
And while this is a product that could be a huge differentiator that significantly expands the addressable market for SolarCity, the company has yet to even shown a proof of concept to the market. So, it's probably too early to get excited just yet.
Musk said the following about the potential cost benefits of the merger with Tesla, which is expected to produce $150 million in cost benefit between the two companies:
Obviously, when you combine two companies there is some level of overlap. And then at the product level there is some level of overlap with the solar battery solution. If you have two separate companies, you have to have two separate operating systems. You've got to have separate communication systems interfacing with two separate server networks. ... You've got to do two installation businesses instead of one. So, I would say that $150 million (in expected cost savings post-merger) is a very conservative number.
Also, Musk reminded listeners that he, both Lyndon and Peter Rive, and JB Straubel, a Tesla executive and SolarCity board member, were recusing themselves from the vote and that a majority of votes held by other shareholders would be required to approve the merger.
While not guaranteed to be approved, it's very likely that shareholders will approve the merger. After all, confidence in Elon Musk as a visionary leader is a big reason why a lot of people have chosen to invest in both of these companies.
But whether the merger does go through or not, SolarCity's biggest challenge is getting its sales costs in line, as management committed to do near the end of 2015. There's some good news on that front, as they fell on a per-watt basis sequentially and were only up about 3% in real dollars from last year. At the same time, 42% growth in bookings should improve sales leverage in future quarters, as those orders are installed and start generating revenues.
Factor in the just-announced reorganization plans and it sounds like management remains serious about addressing its cost structure while still driving sales growth. For long-term investors (whether it's a stand-alone SolarCity or combined with Tesla), getting its sales cost structure back in line with revenue and sales growth remains critically important to the company's future.