SolarCity (SCTY +0.00%) announced results for its second quarter on July 29, and the amazing growth rate continues. The highlights:
- The most ever solar capacity was installed,189 MW, up 78% from 2014 and 24% from the first quarter.
- The company added $1.6 billion in contracted long-term revenue payments, double the amount from year-ago quarterand up 54% sequentially.
- The total cost per watt installed decreased, though installation costs increased slightly.
There were three key things that stood out as most important for investors to understand. Let's take a closer look.
1. AnotherCo?
The solar industry seems to have recently fallen in love with terms that end in "Co," and SolarCity has jumped on board. However, the addition of its new metrics under the "DevCo" and "PowerCo" headings are meant to simplify and make it easier to understand the company's business.
Source: SolarCity shareholder letter.
In short, the DevCo part of SolarCity markets, sells, and installs the solar systems, while the PowerCo holds the portfolio of installed assets, pays the costs of debt and maintenance, and collects the cash flows from customer payments. The DevCo can then use the excess cash from the PowerCo to develop new assets or return it to shareholders, depending on the dynamics and needs of the business. For now, that's clearly reinvesting for growth.
It may seem like an oversimplification (and it's definitely not the only thing you need to understand), but in essence this description breaks the business into its two distinct parts: the cash-flow generating asset base that is the PowerCo, and the DevCo, the growth engine that is the sales and installation business. By viewing the business through this high-level perspective, it should put into better context how expenses are tied to growth, versus maintaining assets, and how that will drive profitability and predictable cash flows over the long term.
Here's a look at the cash the PowerCo has produced over the past 12 months:
Source: SolarCity shareholder letter.
2. Using more asset-backed debt to fund growth
As I wrote about in the earnings preview, SolarCity is likely to continue to add more debt in the coming years to support its incredible rate of growth. The very long term of its contracts -- payments over 20 to 30 years -- means that for the foreseeable future, SolarCity's growth rate will require more cash than operations currently generates. Eventually, that situation will change once the company's customer base and monthly cash flows reach a certain level.
The key, of course, is keeping the cost of debt low enough to generate an acceptable rate of return, and also minimizing the impact of shareholder dilution from secondary stock offerings and convertible debt.
The company has begun using two debt instruments recently to do just that: solar asset-backed debt in the form of solar bonds available to retail investors, and larger asset-backed securitized debt for institutional investors. Just yesterday (July 28), the company announced that it will offer $123.5 million in asset-backed securities, providing further liquidity for growth. The key is how well the company can keep its cost of debt low to maximize its return.
3. Increasing costs a product of investments in sales growth, not expenses from growing contract base
One of the biggest concerns people have with SolarCity is how quickly the company's operating costs are growing. Total operating costs are up 81% since last year, while revenues increased only 67%. The problem, of course, is that if expenses continue to outpace revenue growth, the current GAAP losses and negative cash flows will never reverse.
Using the PowerCo and DevCo breakout the company will report going forward, we're able to see how operating costs are allocated to the PowerCo.
The good news is, the PowerCo's expenses are growing slower than revenues. Since September 2014, PowerCo asset revenue has increased 66%, while operating expenses, interest, and operating costs of revenue increased 44%. Operating cash flow at the PowerCo more than doubled from $18.9 million in the quarter ended in September 2014 to $38.7 million in the second quarter. Available cash, which is the total after all debt servicing, non-cash charges, and depreciation and amortization, was $41.66 million, up 93% from the September quarter.
In other words, the acceleration in operating costs is tied to the growth engine that is the DevCo. These expenses must grow before sales, since the company must hire new sales and customer-service staff and train them, and acquire the property they will work from, before they can begin driving new sales. The changes in SolarCity's cost per watt help demonstrate this point:
The general trend is a decline, with sales and general and administrative cost increases every few quarters as the company expands into a new market, adding headcount and increasing marketing spend. But once those new markets and employees start producing, costs again begin to decline.
The company's move to break out PowerCo revenue and expenses from the business helps show how costs are allocated and makes it easier to see whether expenses are increasing where they should, or where they shouldn't.
Final thoughts
These are the three key things that really stood out to me, but there's more to keep an eye on. SolarCity also announced a big push in the small and medium-sized business market, which it says is high-growth and underserved. With more than 20 million small businesses, it's a big market, but only time will tell how well this approach plays out, and there's a different risk profile than with residential utility customers.
The company continues to focus on cost containment, as the falling costs per watt installed show, but total costs are likely to continue increasing as SolarCity keeps expanding into new markets and moves closer to production of its own solar panels. The company spent four times more on R&D last quarter than a year ago, and it's likely it will continue to invest there as it moves into manufacturing. The move into manufacturing will also alter the cost structure some as well, but it's expected to be a net benefit, driving down product installation costs on a per-watt basis.
It's not clear just how much longer costs will increase at the current rate, but at least the company now gives us the ability to break sales-related costs apart from the operation and maintenance of the asset and contract base. It may not make things look either better or worse, but it certainly makes it easier to see where management is investing and how that's affecting the top and bottom line.
