It might seem hard to call it "disappointing" when a company reports sales grew 120% in a quarter, or that it nearly doubled the size of its customer base over the past year, but that's what Mister Market is seeing today with SolarCity's (NASDAQ:SCTY.DL) fourth-quarter earnings, released after the market close on Feb. 18. The highlights:
- 502 MW deployed in 2014; short of company guidance of 505 MW-520 MW.
- Added $3 billion in future contract payments in 2014.
- Residential MW deployed grew 106% in 2014.
- Cost-per-watt fell, but sales and marketing costs skyrocketed.
And while for the most part the company gave investors another stellar quarter of growth, there are a few things we need to keep an eye on. Here's a closer look at the key takeaways.
Growth remains incredible, but...
SolarCity's residential business seems to be firing on all cylinders:
Steady and consistent growth in residential has been the key driver for SolarCity thus far, and in no part due to the company's flexible finance offerings and tightly run installation and support process. However, the commercial business hasn't gone as smoothly:
As the chart above clearly shows, commercial installations haven't proven to grow in the same manner as residential. But before we immediately assume that SolarCity has a "problem" here, it's important to realize that these kinds of projects are orders of magnitude larger than a residential installation, with a lot more red tape involved. It's also important to note that -- even though a much smaller part of the business -- commercial installations do account for a measurable percentage of sales.
So while SolarCity fell short of its guidance on megawatts installed, this is probably more of a forecasting problem than any structural business problem. CFO Brad Buss addressed this on the earnings call:
In addition, we have been affected by commercial deployments for the last two quarters as you all well know. And as such we are going to include in future guidance only commercial contracts that are finalized, have been started in the quarter and have a very high probability of being complete and installed in the quarter.
Furthermore, guidance will be given as a "bottom-up" single number going forward, instead of the range that we have seen in the past.
Sales and marketing costs
Another potential red flag in the quarter was the notable increase in sales and marketing costs as a percentage of sales:
As you can see, the company's sales expense is increasing rapidly up 14% on a cost-per-watt basis in the fourth quarter from Q3. In real terms, sales and marketing expense is skyrocketing, up 245% to $238 million in 2014, versus $97 million in 2013. CEO Lyndon Rive addressed this in the earnings release:
Sales costs increased to $0.57 per watt due to a planned uptick in investment to expand our sales headcount and infrastructure ahead of our 2015 ramp as well as seasonal softness in bookings. Large increases in sales investment often do not yield payoff in the same quarter and may temporarily lead to higher costs per unit in the period incurred.
There will be periods when SolarCity's sales and marketing expense jump. However, it's important that this continues to translate to sales growth, and over time begins to trend lower as a percentage of sales.
Falling into the GAAP
Frankly, SolarCity's financial model can be a challenge to really understand without some patience and understanding of GAAP versus non-GAAP finances. The thing is, this isn't with intent, but more a product of the company's funding sources, and the various financing options its customers can choose from. Due to all of these aspects, it can take months after an installation is complete before the company can draw down the cash from that installation, even though the company has already bought the equipment, put gas in the vans, and paid its employees for their work.
The point? It can be misleading to look at a single quarter without the context of a longer period of results.
A good example from this quarter could be the negative 17% margin the company reported on system sales and components. Any way you slice it, negative 17% margins isn't a sustainable result, but according to management, this was driven by a number of things, including one-time charges related to legacy sales from Silevo that closed in the quarter, the allocation of indirect overhead expense (that can affect GAAP but not cash margins), and non-cash amortization, also tied to the Silevo acquisition. It's probably not worth getting too caught up in a single quarter's result. On the flipside, if these negative margins remain as system sales grow versus operating leases, that would be a real concern.
While evaluating the company's financials can take a little bit of work, there don't appear to be any signs of imminent doom, but rather a few lumps that the company says time will smooth out. The increasing sales and marketing costs are worth watching, but if management is playing it straight, these costs as a percentage of sales should decline this year, much as we have already seen general and administrative and installation costs per watt already fall.
It's also worth keeping an eye on the gross margins of system sales, versus operating leases. If what management is saying plays out, sales growth in this segment will actually lead to margin expansion, as indirect costs are spread over more system sales. Furthermore, Silevo's negative impact on margin shouldn't be an issue going forward as the company has worked through its legacy sales.
Even with a few speedbumps, SolarCity continues to expand and grow at an incredible rate, even as the competition gets tougher. As things stand today, the company has almost all of its financing in place for 2015's expansion, and the Silevo manufacturing facility is on track to open in about one year. If the things management is telling us about the areas of concern play out, the long-term trends will reveal that, and shareholders will be rewarded for their patience.