Once again, SolarCity (NASDAQ:SCTY.DL) is delaying reporting full fourth-quarter results, a week after an initial delay. Last week, management said accounting related to acquisitions and overhead allocation would delay complete GAAP financial results until today, but today only brought an explanation of the accounting challenges SolarCity faces, not the actual numbers.
Thus far, the market has given SolarCity a pass and the stock is only down slightly today but continuing accounting problems are never good for a company. Below, I'll explain what SolarCity's problems are and why they might be understandable, but still concerning, for a company with its growth rate.
SolarCity's overhead allocation problem
The problem SolarCity has had over the last two years is that overhead costs like warehouse rent, safety services, and fleet expenses that get applied to an individual solar system's cost weren't being allocated correctly. These are not operating expenses like sales, general, and administration expenses, but rather costs that are involved in building systems but difficult to easily assign to a specific project.
What SolarCity wants to do is take these total non-direct overhead costs it can allocate and divide by direct costs to get an overhead rate per direct expense, or burden rate. This makes an easy way to spread costs like a warehouse, which isn't a direct cost to any specific project, around to many projects.
The problem is that the direct expenses or denominator in the equation wasn't calculated correctly and more costs were associated to leases than there should have been.
The fix will reduce the amount associated with leases and therefore the amount capitalized on the balance sheet by 2.5% to 3%. On the conference call, management said the reduction would be $16 million-$20 million in 2013 and $20 million-$23 million for 2012.
These costs don't disappear, though; they'll now be allocated to system sales. This increases expenses on the income statement immediately and will result in a bigger loss for 2012 and 2013. The bigger loss now will be offset by lower costs over the next 30 years.
There should be some concern that accounting controls didn't catch this, but it's also a challenges companies often face in allocating overhead. Allocation methods vary across businesses and in a high-growth business like SolarCity, it's not terribly surprising to see mistakes pop up.
Retained value doesn't change?
If you're looking at the numbers today and seeing a larger loss and lower lease assets, you may think that retained value might change as well. But SolarCity has been clear that retained value won't change and there's good reason.
Retained value is a calculation of cash flows after a system is built and doesn't include overhead costs that are already spent. In essence, retained value would be the hypothetical value of SolarCity if it shut down operations today and eliminated all costs outside of keeping current systems up and running.
Here's where the challenge valuing SolarCity comes in. Retained value is giving a future value for lease assets but does nothing to account for operating costs to sell that system and doesn't account for the value of cash sales, which are currently a negative margin for SolarCity.
What's the future of leasing versus cash?
One of the issues I have with SolarCity right now is that its value is almost 100% built on selling solar leases, not cash sales. The loss SolarCity is taking on its cash sales highlight that challenge.
If the market shifts from leases to cash sales or loans, losses will likely grow. The shift is likely if the investment tax credit falls in 2017 as expected or accelerated depreciation rules are changed, which has been discussed. SolarCity has built efficiencies in financing that other solar companies are trying to follow, but there's questions about whether it's building systems at a lower cost than competitors and the loss on cash sales highlights that.
More questions than answers today
The hope is that SolarCity can file audited restatements for 2012 and 2013, along with Q4 results by March 18, so we'll see if that deadline can be hit.
The other thing investors need to ponder is whether the negative margins on cash sales is concerning long term. Q4 saw higher cash sales than management initially anticipated and if commercial and residential customers shift to buying systems instead of leasing them, then SolarCity will see lower margins in the future as well.
Today gave more questions than answers and it may be a while before investors get the full picture from Q4.