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SolarCity Corp. (NASDAQ:SCTY)

Q1 2013 Earnings Call

May 13, 2013 5:00 pm ET

Executives

Aaron Chew – Vice President-Investor Relations

Lyndon Rive – Founder and Chief Executive Officer

Robert Kelly – Chief Financial Officer

Peter Rive – Founder, Chief Operations Officer and Chief Technology Officer

Analysts

Satya Kumar – Credit Suisse Securities LLC

Krish Sankar – Bank of America Merrill Lynch

Brian K. Lee – Goldman Sachs & Co.

Y. Edwin Mok – Needham & Co. LLC

Phil L. Shen – ROTH Capital Partners LLC

Pavel S. Molchanov – Raymond James & Associates, Inc.

Operator

Good morning. And welcome to SolarCity’s 2013 first quarter earnings conference call. Today’s call is being recorded and we have allocated 45 minutes for prepared remarks and question-and-answer. At this time, all participants are in a listen-only mode. (Operator Instructions) And as a reminder, today’s conference is being recorded.

At this time, I would like to turn the conference call over to Mr. Aaron Chew, Vice President of Investor Relations at SolarCity. Thank you, Mr. Chew, you may begin.

Aaron Chew

Thank you and good afternoon and good evening to all those joining us from further East. I’d like to thank everyone for joining us for SolarCity’s first quarter 2013 earnings conference call. Leading the presentation today will be a discussion from our two founders both CEO, Lyndon Rive and COO, Peter Rive, as well from our Chief Financial Officer, Bob Kelly. After which point in time, we will open up to the call to questions. We end to limit the duration of the call today to 45 minutes.

But just as we’re geared up and ready to go, I have to of course in object with customary disclaimers, as a reminder, today’s discussion will contain forward-looking statements that involve risks and uncertainties, including forecasts regarding SolarCity’s 2013 financial and operational results. Words such as we believe, may, estimate, continue, anticipate, intend, expect, predict, potential and similar expressions as they relate to SolarCity, its business and its management are intended to identify forward-looking statements.

Forward-looking statements should not be considered a guarantee of future performance or results, and will not necessarily be accurate indications of the time at or by which such performance or results will be achieved if at all. Forward-looking statements are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed and/or suggested by the forward looking statements, including risks identified in SolarCity’s earnings press release issued today and in the slides accompanying this presentation, as well as additional risks and uncertainties identified in the section entitled Risk Factors in our annual report on Form 10-K, which has been filed with the Securities and Exchange Commission. We do not undertake any obligation to publicly update or revise any forward looking statement whether as a result of new information, future development or otherwise.

In addition, during the course of this call we will use a number of especially defined terms relating to our business metrics and financial results. We referred to definitions on these terms included in the slides accompanying this presentation, which are available on our investor relations website at investors.solarcity.com.

And with that finally behind us, I would like to introduce SolarCity Chief Executive Officer, Mr. Lyndon Rive.

Lyndon Rive

Thank you, Aaron. Now that SolarCity has been public almost 6 months, we have many new investors. I want to reiterate what SolarCity is building. We're creating the most compelling energy company of the 21 century by delivering cleaner, cheaper power through distributed generation.

Give us a second; it looks like the slides are getting stuck. I apologize for that. Good thing we’re not selling software and we’re selling energy. So on that note, I am just going to get started. I am going to go through the slides as if we are going through and when it comes up, we’ll catch up.

As I was mentioning, we are creating the most compelling energy company of the 21st century and let me walk you through the value proposition. So the value proposition to our customer is extremely simple. We sell cheaper, cleaner electricity. On average we save our customer’s 10% to 15% of their electric bill. There is no cost. We install the system for free and sell the electricity at a lower rate than you can buy it from the utility. Our customers also can lock in their energy rates for 20 years. And our customers have control of their energy bill, as before they had no option but to pay whatever the utility gave them.

We also make it easy for home owners to transfer their agreement to the new home owner. We expect that most of our home owners during the 30 year life of the relationship will move. At the size that we are today, a customer moves almost every other day or every day. The solar system actually adds additional value to the house as it is reducing its energy cost. At the same time as we create value for our customers, we are also creating value for our shareholders. Every customer is a highly predictable income stream for the next thirty years. Let’s go into some highlight for Q1.

We added little over 7,000 customers in Q1 with now over 57,000 customers. We expanded our New York market into Long Island. We like Long Island as Long Island’s cost of electricity is extremely high. In fact it’s one of the highest in the U.S. We have announced 1000th customer with Shea Homes. Shea Homes is a new home builder. We’re excited about the new home builder market. Just for reference, the new home builder market and the market that we service install roughly 120,000 to 150,000 new homes a year. The entire solar industry does not install that amount of systems. So when you look at the size of our market, rooftop solar, it is massive. In fact the market is growing and becoming bigger every year at the current installation rate.

We’ve deepened our commercial business and with additional school districts and new big box retailers, we announced Walgreens and additional Walmart stores. We have opened central call center and support center in Nevada. This is to help reduce our operating cost and we announced a strong partnership with Honda Motors to provide financing in an effort to promote SolarCity to their customer base and dealers

Now going in to nominal contracted payments; our contracted payments have grown nicely. We’re now over $1.2 billion in contracted payments remaining to SolarCity. You will notice that our 2012 year-end contracted payments has increased slightly from where we reported back in March.

We excluded contracts that had contingencies and those contingencies have since then been removed. We still have a very strong backlog. Our backlog today is 195 megawatts. Some of this backlog will be deployed over multiple years.

Firstly, I'm not a big fan of the backlog metric. The backlog metric is a metric that we actually want to bring down, not go up. Our long-term goal is to get it down significantly and eventually get to a point where we can install solar the same amount that we sell it. So going forward, we’re actually going to stop reporting our backlog number. We don’t like the metric, we want it to come down. And instead of reporting the backlog number, we’ll report our bookings for the quarter.

Now I’m going to hand it over to Peter Rive, our Chief Operating Officer.

Peter Rive

Thanks, Lyndon. Hi, guys, so I want to talk about Q1 deployment. So total deployments for Q1 were 46 megawatts, residential deployments were 33 megawatts, which represents 137% increase from the same quarter in 2012. As always, commercial deployments can swing based on a few projects and does not represent the same steady flow of deployments as our residential business does.

Our residential deployment capacity continues to scale as planned and as a result, we are on really good position to reach our goal of 250 megawatts deployed in 2013. In the coming months we will announce some very exciting enhancements for energy efficiency products with over 15,000 detailed energy efficiency audits performed using our best-in-class audit tools combined with advanced software simulation [where a point] [ph] that our database can yield some incredible insights.

Basically we know where every joule of energy in the building is going and can assist the homeowner making smart choices when it comes to energy efficiency upgrade. In general, we are moving towards a more integrated energy efficiency in solar service and as a result, do not believe that the number of transactions from other energy products is a meaningful metric going forward, but more to come in that in the coming months.

I want to talk a little bit about our energy production. So we reached our first 1.7 gigawatt hour day in April. And it’s very exciting to see us approaching the 2 gigawatt hour milestone so quickly after having reached 1 gigawatt hours just recently. Of course, the great thing about the energy we produce is that it’s free of carbon dioxide emission, it does not incur any transmission and distribution cost and has minimal maintenance and no feedstock costs.

Last quarter, there was some confusion as to the seasonality by revenue given the way that solar energy is produced over different seasons. In general, Q2 and Q3 are the highest selling energy quarters for us. But what you will see is that the increase in our solar deployments will catch up with the lowest periods of production. As you can see from the graph, the low points in our 2012 production in the winter is higher than the high point of summer production in 2011. Roughly 45% of our installed base of operating these contracts are PPAs that are variable based on production, while around 55% are leases based on fixed monthly payments.

Looking at our – we continue to see our economies of scale providing great cost benefits with G&A and acquisition cost on a dollar per watt basis being just about half of where they were four years ago. As we increase our deployments over the coming quarters, we expect a continued decline in our cost. I want to remind everyone that these OpEx cost are incurred largely for the developments of new solar energy systems whereas the revenue is primarily derived from the systems developed in prior periods.

And with that, I’ll hand it over to our CFO, Bob Kelly.

Robert Kelly

Thanks, Pete. I want to give you an update on our financial strategy and some of the trends we’re seeing in our financings. As Lyndon showed during an earlier side, the value proposition for our customer, we create a recurring predictable cash flow stream. Our financial strategy is to maximize the retained value for the shareholders by covering our investment activities with cash generated from our operating and our financial activities.

The foundation of the strategy starts with the tax equity financing. As of May 10, we have 158 megawatts of financing capacity in this area. This compares to 115 megawatts when we last talked in March. The deal flow in this area is excellent. We also during this quarter added two new investors. It’s important to increase the sources of capital here and new investors are very important in broadening the amount of financing capacity.

After we deploy the asset into the tax equity funds, the second piece of paper, which we utilize is what we call aggregation facilities. We aggregate the megawatts up to a certain size, usually around $100 million. That gives us a piece of paper, which we can take to the capital markets.

We’re in the late stage negotiations on new facilities, these are similar to the ones we previously announced of $10 million, which was refinanced late 2012 at 3.45%.The final stage as you move from the tax equity financing aggregate the megawatts then you take them out in the long-term capital markets essentially you’re financing the customer receivables and raising capital to invest on the rooftop.

We’ve commenced our discussions with the rating agencies as our first aggregation facilities now both ready. We are introducing the asset class and specifically the SolarCity and the SolarCity assets. We have a little advantage here in that now we have five years of history related to the customer contracts, the predictability of the cash, how often and how assets are transferred? What the default rates are on these contracts, and the performance data. So we have a pretty good portfolio, which we can talk to the agencies about. I think you'll hear some pretty good news over the next couple of months regarding tax equity aggregation and long-term financing.

Next let's turn to the statement of operations for the first quarter of 2013. As always we'll start with the operating leases. These are the 20-year contracts that we produce energy and get paid for over the next 20 years. Comparing Q1 2012 to Q1 2013, the numbers have almost double. This quarter was also a transition quarter as we move from Treasury Grant 1603 into investment tax credit or ITC. What you’ll see in the future is that the ITC for non-partnership projects will be recognized annually over five years. So you’ll see some of this come through in probably Q3 and Q4 of this year. Just want to let you know what’s occurring in that item.

Turning to the gross profit, pretty stable comparing quarter-over-quarter, 42% this year, 41% last year. As Lyndon talked about it will change depending on operating lease and system sales that will move the gross profit around.

Turning to the operating expenses increased from $24.7 million, up to $34.5 million. As we mentioned before, these are primarily the customer acquisition, and the other development costs. We expensed these in the year that they’re incurred. They generate an asset, the operating lease asset, which is typically over 20 years.

On the statement of cash flow on the next slide, it was $9 million for the quarter ending March 2013. The cash flow from operations return to a steady state in this quarter compared to last quarter. There was a large working capital swing in Q4 December 2012. It was around $54 million relating to some specific accounts receivable, payables and accruals.

As I stated in my financial strategy, we take a look at the operating cash flow, return to the investments and that tells us the amount of money we need to finance in the quarter. Investing activities for the quarter were almost $141 million. And we raised $98 million of financing. This resulted in a decrease in cash for the quarter of $32.8 million. We expect to finance some projects which went online in Q1 and Q2 with our upcoming financings. You should see a positive net cash flow in Q2 2013.

With that I’ll turn it back to Lyndon.

Lyndon Rive

Thanks. Bob. So looking at retained value, this is an important metric when we’re looking at our business. Just as a reminder what retained value is. Retained value is of the discounted cash coming through SolarCity over the next 30 years discounted on today’s value at 6%. This is after we paid back our fund investors and covered our operating and maintenance cost. This includes replacing the inverters as well. So our current retained value forecast is $569 million.

To make it easy we’ve calculated the retained value on a dollar per watt. Our retained value has increased to $1.25 per watt. As we improve our fund economics and reduce our cost, our retained value should continue to increase.

Now let’s look for an outlook for Q2 and then the remaining of the year. So for Q2 we are expecting to install between 48 and 53 megawatts. In addition to the megawatt forecast, many were asking for some GAAP numbers. So we’ll be giving some GAAP forecast as well. The forecast for GAAP and the operating revenue, we expect between $16 million and $18 million. For solar energy system sales, we expect between $5 million and $10 million. The big swing is due to some commercial systems that may or not make it into that quarter.

If you look at our gross margin, we expect between 40% to 55%, once again the gross margins depend on the commercial system sales. Operating expenses between $38 million and $42 million. We will not be forecasting non-controlling interest in the P&L. And as Bob mentioned, we should be cash flow positive in Q2.

Looking at the full year, we feel very confident to still meet our 250 megawatt target and we should achieve cash flow positive in Q4 2013 and maintain it thereafter.

Now let’s go on to Q&A. Operator, you can open up the question.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And the first question comes from Satya Kumar of Credit Suisse. Please go ahead.

Satya Kumar – Credit Suisse Securities LLC

Yeah, hi. Thanks for taking my questions. I just wanted to understand the dynamics behind the megawatt guidance for the year; clearly you came in much better than you thought for Q1. And if I look at your guidance for the second half, megawatts is up roughly 50% from the first half. Is that sort of capacity constraints on your part or the fact that you don't want to really extend your visibility beyond short-term from a bookings standpoint that you're not raising the full year megawatt guidance?

Peter Rive

At this stage, we still find ourselves delivery constrained. And so it is just a mater of scaling our residential operations as well as bringing in our commercial projects on schedule that prevents us from increasing the guidance from 250 megawatts where it is right now. But at this stage we're still just focusing on increasing our operational capacity.

Satya Kumar – Credit Suisse Securities LLC

Okay. And then a follow-up on the tax equity side, one of your peers did talk about being constrained on in terms of availability of tax equity and I thought your comments were a bit more sanguine on availability and cost of tax equity. I was wondering if you could add any color as to why there may be a difference or just overall what you're seeing in terms of that tax equity market in terms of breadth of participations.

Lyndon Rive

Yeah, I can't comment about, (inaudible) comment but some of these are slightly different as we’re vertically integrated. We do all the services ourselves. So we have all the data and we have five years of experience in this space. We have a broad set of investors. So based on our current performance, we’ve seen a strong pipeline for new fund investors and have closed a significant amount as well.

Operator

Thank You. The next question is from Krish Sankar of Bank of America Merrill Lynch. Please go ahead.

Krish Sankar – Bank of America Merrill Lynch

Yeah, hi, thanks for taking my questions. I had a couple of them, first, you guys did say one of the biggest constraint is on the installation side. I was trying to figure out can you quantify that for us in terms of megawatt per employee or per installation crew or some kind of a metric and can you talk about what you’re doing to improve that one?

Peter Rive

So we don’t disclose productivity on a per employee basis. I mean it’s just continuously an influx and there is a whole bunch of continued improvement initiatives that just make that measurement quite dynamic. But one of the biggest kind of step function changes that are currently underway is the movement away from rail based installation hardware to installation hardware that doesn’t depend on the rail, which dramatically reduces the number of cutting, drilling and transportation operations that are required in order to be able to install solar. There is also a significant software technology investments that we continue to make that lowers the [staff] [ph] costs associated with deploying solar.

Krish Sankar – Bank of America Merrill Lynch

Got it, that’s very helpful, Lyndon. And just quick a follow-up…

Peter Rive

That was Peter.

Krish Sankar – Bank of America Merrill Lynch

Sorry, Peter. Just a quick follow-up in terms of the positive net cash flow in Q2, is that because some of the financing associated with the Q1 projects will come in Q2, that is offsetting some of the cash burn or what exactly was the reason?

Robert Kelly

No, there are some – there is a small amount, which you’ll finance in Q2 related to Q1 deployment. but we also expect a pretty good quarter.

Operator

Thank you. The next question is from Brian Lee of Goldman Sachs. Please go ahead.

Brian K. Lee – Goldman Sachs & Co.

Hey, guys. Thanks for taking the question. I guess booking seems flat with deployments this quarter, I know you don’t want to focus on backlog. But how would you expect the ratio of bookings to deployments to trend from here. is this a one-to-one metric we should be expecting or do you expect that bookings velocity to accelerate through year?

Lyndon Rive

So in order to actually get our backlog down and have the same [amount] [ph] installed, eventually you have to get your installations to exceed your bookings at some point, otherwise you always going to have this tail. So there is an incredible amount of demand, but we need to see what we can do to bring in this backlog. So the investment into operations is at a higher level than the investment in sales and marketing.

Brian K. Lee – Goldman Sachs & Co.

Okay, fair enough. And then my follow-up was on retained value, if I look at the change in your retained value versus last quarter, it seems like you added about $67 million in retained value on an incremental 30 megawatts. If my math is correct, that implies about 2.25 per watt retained value on those incremental megawatts versus the 1.25 overall. Is there anything unique about the mix in the quarter or is that correct run rate to think about for future megawatts? Thanks.

Lyndon Rive

Yeah, it's not too far off. Remember the retained value you also have your existing installs that you have smaller retained amount. As we close new [funds] [ph], we give less of the economics to the investor and keep moving economics to SolarCity. So it is getting closer to the $2 range on new [funds] [ph].

Peter Rive

Again the two big variables that affect that number are essentially the cost of capital and the cost of installation. So as both of those come down, you'll see the retained value increase.

Operator

Thank you. The next question is from Edwin Mok of Needham & Co. Please go ahead.

Y. Edwin Mok – Needham & Co. LLC

Hi, thanks for taking my question. So first question is actually thanks for providing the breakdown between lease and PPA, I was wondering how does that – how would do you expect that to change, let's say exiting this year and at least give us some color in terms of how that mix would change, maybe including what is in your backlog at this point?

Lyndon Rive

So going forward, I expect it to probably be closer to 70% PPAs and 30% leases. That will bleed off the backlog over time.

Y. Edwin Mok – Needham & Co. LLC

Is that why – just quick follow-up, is it because you got to sign more PPAs now even with consumer or is that – why is it that PPA increase?

Lyndon Rive

In certain states we have to sell leases, you can’t sell PPAs. But the actual difference to the customer is very little. We sell them both the same ways, so sell them in terms of cost per kilowatt hour. So the PPA cost per kilowatt hour and the lease cost per kilowatt hour is roughly the same. One’s paid fixed over every month and the one is slightly variable every month, but net it ends up at the same place. So we still sell it as kilowatt hours although it is a lease.

Operator

Thank you. The next question is from Phil Shen of ROTH Capital Partners. Please go ahead.

Phil L. Shen – ROTH Capital Partners LLC

Hi, everyone, thank you for taking my questions. First one is on the aggregation facilities. I think Bob in your prepared remarks you were talking about aggregating megawatt or contracts in certain sizes. Can you talk us about what the size of your first aggregation facility is and then going forward what the optimal asset grouping size might be?

Lyndon Rive

I'll answer the second one first, when you look at the portfolio and the nature of the contracts, an optimal size that were some around $100 million, essentially you can take a $100 million and then in theory have capital markets compete against that asset class of a sufficient size, long duration, highly predictable cash flow and great default characteristics. So what we're trying to achieve is to increase the sources of capital by having multiple capital markets compete for the long-term takeout of this asset. But first of one I think will be a low smaller probably in the $50 million or $60 million range. That's somewhat related to the historical transactions or jobs that we have. Thereafter I think that will be – that range between a $100 million and probably above that $200 million as we develop the strategy.

Phil L. Shen – ROTH Capital Partners LLC

Great, thanks. Second one here is on potential increasing rate environment, if we start to see rates creep up, what is your strategy to deal with this potential situation?

Robert Kelly

We look at the interest rate risk in our financings and we make efforts to hedge that given the current environment.

Lyndon Rive

Yeah, (inaudible) as our asset gets more data and the investment community is realizing that this is an energy bill, this is not like financing a car or a boat that this is an energy bill that has to be paid. So the asset quality is extremely good as the asset quality matures that they were hopeless to offset some of the increasing interest rate.

Operator

Thank you. We have time for one more question. And last question comes from Pavel Molchanov of Raymond James. Please go ahead.

Pavel S. Molchanov – Raymond James & Associates, Inc.

Thanks for taking the question. Just on your OpEx guidance, it looks like a sequential increase of 10% to 20%. Is that mainly just to do with the appreciation of the shares and higher stock comp?

Lyndon Rive

No, this is more development into new assets. So remember, we have to make the investments today for installations that occur six months down the road. So we got to look at what is the installation volume six months down the road start making those operating investments today.

Pavel S. Molchanov – Raymond James & Associates, Inc.

Okay, understood. And then how many states are you currently operating in and how do you think that number is going to change over the next 12 months?

Lyndon Rive

So we have what I call 12 main states and two small other states, that’s 14. We are content with where we are right now. The market is so big, we could meet our growth targets for the next 10 years just focusing on one state. I mean it's such a big market. So as our cost come down, and cost of retail electricity increases, we'll continue evaluating new markets. We are looking at new markets and might open up one more new market this years, but it's still (inaudible).

Operator

Thank you. Ladies and gentlemen that was all the time we had for questions. I would like to turn the floor back over to management for any additional and closing remarks.

Lyndon Rive

Well, I thank everybody for your time today. We're off to a great start. We have achieved our megawatt target and we still feel very confident with our full year goal. So look forward to speaking to you again in three months. Take care.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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