SolarCity Earnings: Great Growth, Funny Math

| About: SolarCity Corp. (SCTY)


SolarCity revenue growth in the quarter continues to be spectacular.

Several red flags in the earnings conference call into question sustainability of company's business.

Overstatement of retained value is still the big elephant in the room that management fails to see.

SolarCity Inc (NASDAQ:SCTY) announced its Q1 2014 quarterly results on May 7th. While the company continues to be on a tear in terms of revenue growth, we are highly skeptical of its retained value, its core profit margins, and its growth projections.

As far as Q1 earnings go, here are the highlights:

- MW Deployed of 82 MW compared to guidance of 78-82MW

- Operating Leases and Solar Energy Systems Incentives Revenue was $29.1 million compared to guidance of $23-27M

- Operating Leases and Solar Energy Systems Incentives Gross Margin was 45%, within guidance of 40%-50%

- Solar Energy Systems Sale Revenue was $34.5M well above the guidance of $23-27 million

- Total Operating Expenses were $81.8 million compared to guidance of $70-75M

- Non-GAAP EPS was ($0.82) compared to the guidance ($0.70)-($0.80)

- Retained value rose to $1.291B from $1.051B last quarter

For Q2 guidance, the company provide the following guidance:

- GAAP Operating Lease and Solar Energy Systems Incentive Revenue: $39 million-$43 million

- GAAP Solar Energy Systems Sale Revenue: $17 million-$21 million

- GAAP Operating Lease and Solar Energy Systems Incentive Gross Margin: 50%-55%

- GAAP Operating Expenses: $100 million-$110 million

- Non-GAAP EPS: ($0.90)-($1.00)

While the revenue growth may look attractive, a closer look behind the numbers shows a much less appealing story. Here are some red flags where investors need to pay special attention:

- System/Cash sales: System sales (as opposed to leases and PPAs) were up from $14.9M in Q1 2013 to $34.5M in Q1 2014. The corresponding cost of revenue went up from $16.7M to $32.8M. Management says, excluding onetime items, that cash sales were approximately breakeven on a GAAP basis. That sounds a lot like they are making a small loss on every cash sale! With the cost per watt prices of solar installations going down, we expect cash sales to be increasingly bigger part of the revenue mix. Cash sales are not only bleeding money for SolarCity but have no retaining value component. In the long term, we do not believe SolarCity has a cost structure to compete with local and regional installers. SolarCity can walk away from these cash sales and focus on lease/PPA sales but that would mean higher sales costs and a loss of market share. The music can stop abruptly if ITC expires at the end of 2016.

- Commercial vs. Residential: Growth in Commercial, a much more desirable sector in the long term than residential, has stalled in the quarter (15MW in Q1 2014 compared to 14MW in Q1 2013). Commercial results can be lumpy but this is an item that warrants attention.

- Fixed costs: Fixed cost per watt was higher on a quarter-to-quarter basis for the first time since the company has been presenting the cost information. The company is adding a substantial amount of overhead in anticipation of growth. If the growth is funded by company's cash generation then that would be fine. With a negative cash flow, this rising of fixed costs is a very high risk gamble.

- Non-GAAP losses: The company's Non-GAAP loss for the quarter came in at $0.82 and higher than its forecast of $0.70-0.80 and management is forecasting Non-GAAP loss of $0.90-1.00. So, the losses are growing with revenue growth which is not a desirable investment attribute.

- Retained value: This is the elephant in the room that management is not seeing. We believe the company's assumptions behind retained value are unrealistic and will be looking for the company to either justify these metrics or adjust them. We believe these are inflated by at least 20%. In a worst-case scenario, the company may not be generating ANY shareholder value. As a public company, SolarCity must sanitize and share its assumptions.

While the company's management has been very savvy in creating financial structures, the above risk factors give us very little confidence in the operational aspect of company management.

Our sentiment: Avoid

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.