Beyond Revenue and Profits: The Most Important Things From SolarCity Corp. Results

SolarCity Corp. (SCTY.DL) reported financial results for the fourth quarter and full year 2015 after the market closed on Feb. 9, and in after-hours trading, shares are down more than 25% at this writing. Based on history, the stock is almost guaranteed to fall by a lot when trading opens on Feb. 10. The company reported strong sales growth in 2015, but also huge losses and weak guidance for Q1, and it looks like that weak guidance has the market rattled.

Revenue and earnings are certainly important to follow, but understanding SolarCity's business, how it recognizes sales, and how its costs are structured, may be just as important to understanding how the company will make money for the long-term. 

Let's take a closer look at SolarCity's financial results and forward guidance focusing on key metrics that investors need to understand.

How SolarCity makes money
SolarCity installs and maintains residential solar systems that it primarily sells on long-term contracts. Since the company collects monthly payments over the 20 years most contracts are written for, it recognizes only a small part of the full economic value of each system that it installs every quarter. 

But the company still has to buy solar panels, pay the sales staff and installers who generate and implement new system sales, and cover the operating costs to support existing customers. 

And since SolarCity is relatively young and investing heavily in growth today, its costs are far larger than GAAP revenues, making for very big GAAP losses:

Numbers in millions. Source: SolarCity release.

Numbers in millions. Source: SolarCity release.

This may look like an unsustainable business model (and it is to a certain degree), but there's more to understand. Let's take a closer look at key metrics that help explain the big picture. 

Key metrics 
SolarCity installed 272 megawatts of solar systems in the fourth quarter, up 54% from Q4 2014. And while it recognized only $115.5 million in revenue in the quarter, the company estimates that those systems will generate $890 million in gross value over the next 30 years:

Source: SolarCity presentation.

This is based on payments over the term of the contracts in place (in green) as well as anticipated cash flows from renewals (gray) when those contracts expire. SolarCity estimates Q4's deployments will generate $3.64 per watt in economic value over the next 30 years. 

At the same time, costs on a per-watt basis continued to fall:

Excludes R&D and Capital Expenditures. Source: SolarCity presentation.

The math works out like this: SolarCity paid $2.71 per watt last quarter for the solar systems it deployed and estimates that it will collect $3.64 per watt on them over the next 30 years.

Here's another key piece of the puzzle: SolarCity paid $457 million in sales and marketing expense in 2015. Those costs are the driver behind the company's revenue growth. But at the same time, they are unnecessary to maintain that $890 million in future economic value. 

Debt about more than just covering cost shortfalls
The company spends about twice as much on operating expenses and inventory as it generates in cash flows right now, so it has had to rely on debt to fund growth. The company had $3.1 billion in debt at year end, at reasonable costs and relatively long-term in nature:

Source: SolarCity presentation. 

This is up by more than double from the $1.4 billion in debt to start 2015, but it is paying for more than just sales growth. Management reiterated on the earnings call that it plans to attain cash-flow-positive results by the fourth quarter of 2016, but that is unlikely to mean the company won't take on any more debt. After all, the long-term and high-quality nature of the cash flows it will collect from its customers has proven to be a very attractive asset to lenders. 

Another key debt-related measure the company reported this quarter, was that it is now financing more than 100% of its installation costs, collecting adjusted asset financing worth $2.73 per watt deployed in 2015. This will lead to more debt, but the return it can generate on those assets -- expected to be $3.64 per watt on Q4's deployments -- makes for a strong return on that low-cost capital. And as its quarterly cash flows from existing contracts grows, debt should play a smaller role for funding growth. 

Debt also paying for manufacturing expansion, but delays may be imminent
SolarCity continues to work toward taking its 2014 acquisition of panel maker Silevo to full-scale manufacturing and has relied on debt to fund this initiative. Management expects that making its own panels will do two things:

• Give better supply chain certainty as global solar manufacturing nears peak capacity in coming years.
• Decrease installation costs with more efficient, cheaper panels. 

However manufacturing won't happen before sometime in 2017 at the soonest. On the earnings call, management said the company is facing longer lead times than expected, and key manufacturing equipment won't be installed before next year. This means the benefits of panel makes are probably at least 18 months away at the soonest. 

Guidance, NEM 2.0, and Nevada impact 
SolarCity's guidance for full year 2016 reflects over 40% growth in MW installed, but guidance for the first quarter is 18%. CEO Lyndon Rive said that about 20 MW of sales from Nevada will be lost versus last year, but also commercial sales are heavily backloaded in the first quarter. And because the company's record at accurately forecasting commercial business has been lackluster at best, management has chosen to not forecast deals simply to give guidance that Wall Street expects to see. 

Furthermore, Rive said that the company will ramp up marketing investment in other markets after ceasing operations in Nevada, but that it would take time for that reallocation of resources to pay off in driving new sales.

In other words, the business is there, but some of the bigger commercial deals may roll into Q2, and it will take time to rebuild the lost pipeline from Nevada, so Q1 guidance is weak while full-year guidance is strong, and unchanged from what was announced in late 2015. 

Speaking of Nevada, CEO Lyndon Rive says he thinks a public referendum would happen there by the end of the year, and that the state's voters would act to reinstitute net metering in the state. 

There has also been much uncertainty around the Impact of NEM 2.0 in California, which is that state's new net metering regime.

In short, NEM 2.0 will allow utilities to place residential solar customers on "time of use," meaning that the credits they receive for peak power generation could be lower value than the power they use at night, making residential solar less economically viable. CTO Peter Rive addressed this concern, saying that it was a "reasonable give and take" between utilities and residential solar and grid maintenance costs. 

Looking ahead 
Between the Nevada net metering ruling and fears that California's NEM 2.0 time of use concession will hurt, and weak sales guidance to start 2016 seeming to support those fears, there is cause for concern. But at the same time, the extension of the federal ITC and the fact that net metering was kept in place in California are huge wins for SolarCity.

Looking past the stock's drop in a fearful market, SolarCity delivered solid results that were in line with what management said to expect, and that included a focus on lowering key cost metrics and delivering strong growth. Whether Q1 weak guidance will be a blip on the radar or a downward trend remains to be seen. But if it is just a blip -- as company guidance suggests it will be -- then investors who weather this downturn could end up glad they did.