SolarCity (SCTY) Lyndon R. Rive on Q2 2016 Results - Earnings Call Transcript

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SolarCity Corp. (SCTY) Q2 2016 Earnings Call August 9, 2016 5:30 PM ET

Executives

Aaron N. Chew - VP-Investor Relations

Lyndon R. Rive - Chief Executive Officer & Director

Elon Reeve Musk - Chairman

Peter Rive - Co-Founder & Chief Technology Officer

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

Analysts

Philip Lee-Wei Shen - ROTH Capital Partners LLC

Brian Lee - Goldman Sachs & Co.

Benjamin Joseph Kallo - Robert W. Baird & Co., Inc. (Broker)

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Michael Morosi - Avondale Partners LLC

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

Vishal B. Shah - Deutsche Bank Securities, Inc.

Jeffrey Osborne - Cowen & Co. LLC

Gordon Johnson - Axiom Capital Management, Inc.

Operator

Greetings, ladies and gentlemen. And welcome to the SolarCity Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Aaron Chew. Thank you, sir. You may begin.

Aaron N. Chew - VP-Investor Relations

Thank you and good afternoon to all those joining us today for SolarCity's second quarter 2016 earnings conference call. Leading the discussion today will be our Chief Executive Officer, Lyndon Rive; and, also available to answer questions are our Chief Financial Officer, Tanguy Serra; our Chief Technology Officer, Peter Rive; and our Chairman, Elon Musk.

As a reminder, today's discussion will contain forward-looking statements that involve our views as of today based on information currently available to us. Forward-looking statements should not be considered a guarantee of future performance or results and reflect information that may change over time.

Please refer to SolarCity's quarterly Shareholder Letter issued today and the slides accompanying this presentation, as well as our periodic reports filed with the Securities and Exchange Commission for a discussion of our forward-looking statements and the factors and risks that could cause our actual results to differ from our forward-looking statements. We do not undertake any obligation to publicly update or revise any forward-looking statement.

In addition, during the course of this call, we'll use a number of specially defined terms relating to our business metrics and financial results, including non-GAAP financial metrics. We refer to definitions of these terms and required reconciliation between GAAP and non-GAAP financial metrics included in the Shareholder Letter issued today and the slides accompanying this presentation, which are available on our Investor Relations website at investors.solarcity.com.

With that finally behind us, I would like to introduce SolarCity's CEO, Mr. Lyndon Rive.

Lyndon R. Rive - Chief Executive Officer & Director

Thanks, Aaron. Today, we're not going to go through the presentation. I'd rather spend time answering questions. Before getting to the questions, let me just provide you with a quick summary.

For the quarter guidance, we came in nicely above our guidance. We installed 201 megawatts. Our bookings increased 40% over last quarter. You will see a large increase in cash and loans. We now are roughly 20% of our bookings is cash and loans. We're expecting that to increase significantly in Q4. Cash and loans actually improve the cash generation of the business dramatically.

Our customer acquisition costs came down 27%. We expect the customer acquisition costs to reduce further in Q3. We're also seeing an increase in the value of our solar systems that we are installing. As you may recall, in January we increased pricing. We're starting to see the effect of that pricing increase and our system value has increased $0.16 per watt. On a gigawatt, that would be equivalent to $160 million increase in net present value.

Looking at our customer billings, that'd be leases and power purchase agreements, we're now almost at $100 million per quarter. And once we pay back tax equity, debt, and maintenance for the solar systems, SolarCity is generating $34 million of recurring cash flows.

Next point I'd like to address is our cash outlook. For the quarter, we consumed $216 million. A big cause of this was the Tesla announcement. The Tesla announcement delayed our tax equity funds and just – the tax equity fund had to go back to credit committee to get approval. Those have all now been approved and have been funded, but this caused a delay in Q2.

I just want to spend a few minutes describing the two primary sources of our financing. We have tax equity, and then we have debt. Tax equity is roughly two-thirds of the cash needed to finance the systems and debt is roughly one-third. Once we closed the tax equity fund, we needed to get it approved by debt provider, which is the aggregation facility. We have one large aggregation facility that approves all our tax equity funds and that takes roughly 45 days to approve. They are now approving them in Q3 and we expect that cash balance for Q3 to increase over our cash balance in Q2. For Q4, we expect our cash balance to increase over Q3.

One final point I want to make before getting into questions, and this one I'm really very excited about, is in Q1 we announced our new grid services offering. As a reminder, the grid services offering is services that we provide to the utility; so, the utility is our customer. When providing grid services to the utility, we leverage our existing infrastructure and we provide things like demand load shifting, voltage control or reactive power. Just within the first few months, we've established partnerships with PG&E, Southern California Edison, and the Energy Commission of California. We have a strong pipeline of over $100 million in prospective opportunities.

When it comes to grid services, we're really unique. We have the software and we also have the deployment infrastructure. Nobody else has this capability. So we're excited to help utilities manage the grid a lot better as you see large solar and storage being deployed.

For 2016, and actually 2015, we've invested a lot into products. We believe that, in order to differentiate ourselves in the future, we're going to have to have significant product differentiation. And to maintain our leadership and actually expand our leadership, we need to invest into products. We're going to be launching two new products at the end of this year, which we expect will meaningfully increase our sales in 2017.

With that said, I want to open it up to questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Philip Shen with ROTH Capital. Please proceed with your question.

Philip Lee-Wei Shen - ROTH Capital Partners LLC

Hi. Thanks for taking my questions. The first one is on the Tesla deal and acquisition offer. The final deal and offer price was actually lower than the original price. Can you comment on – and it might be hard for you to do this, but the rationale for taking the lower offer and how that came about? Thanks.

Elon Reeve Musk - Chairman

Sure. I can comment. It's Elon here. And, yeah, (6:44) now joins us and this call the first time is – that we can answer questions like this. This was a negotiation of the independent board members. I actually wasn't part of – any part of it. It was simply what they came up with after, I think, a quite exhaustive discussion that lasted a week or two. So I've not inquired about the details and I'm not privy to the details, but it was ultimately what they concluded was fair between the independent board members of SolarCity and the board members of Tesla. Obviously, this is now up to the shareholder votes – independent shareholder votes where, obviously, I'm recusing myself. I'm not legally obligated to recuse myself; I'm just doing so because I think it's morally the right thing to do, and so is Lyndon and Pete and JB Straubel.

Philip Lee-Wei Shen - ROTH Capital Partners LLC

Okay. Thanks, Elon. In terms of the Silevo manufacturing facility, can you give us an update on what the latest – what's going on now? Are we – are you guys on track to hitting your targets of 1 gigawatt by year end 2017, I believe? And if not, perhaps how much might be in place by the end of the year, what the cost structures might be and so forth? Thanks.

Peter Rive - Co-Founder & Chief Technology Officer

Sure. This is Peter. So we're actually going to be able to start making modules out of Buffalo faster than we had anticipated. Right now, we're actually expecting to ramp the module lines by Q2 of 2017. So – and we're going to be making a pretty interesting product, and I'm excited to kind of reveal it to you all at some point, but it is not just your typical module. It is both very efficient and it looks really, really good.

Elon Reeve Musk - Chairman

It's a solar roof as opposed to a module on a roof.

Peter Rive - Co-Founder & Chief Technology Officer

Yeah. So, I mean, I think that in – a couple of weeks ago, we talked about us wanting to start actually having a roofing integrated product, and a large part of that module manufacturing being there is going to be for that.

Elon Reeve Musk - Chairman

Yeah. And I'd just like to emphasize, I think, this is really a fundamental part of achieving differentiated product strategy where you have a – it's not even a beautiful roof; that it is a solar roof. It's not a thing on a roof, it is the roof. That's – which is quite a difficult engineering challenge, and not something that is available really anywhere else that is at all good. I think this will be something that's quite a standout and (9:37). So this is one of the things I'm really very excited about the future. So...

Lyndon R. Rive - Chief Executive Officer & Director

And it's just addressing a really big market segment. So just in the U.S., there's 5 million new roofs installed every year. And this is a product we'll focus on the – primarily focus on the new roof market.

Elon Reeve Musk - Chairman

Yeah. I mean, I think the interesting thing about this is that it actually doesn't cannibalize the existing product of putting solar on roof, because essentially if you've got – if your roof is nearing end-of-life, you definitely don't want to put solar panels on it because you're going to have to replace the roof. So, there's a huge market segment that is currently inaccessible to SolarCity because people know they're going to have to replace their roofs. You don't want to put solar panels on top of a roof you're going to replace.

However, if you are close – if your roof is nearing end-of-life, well, you've got to get a new roof anyway. As Lyndon was saying, there's 5 million new roofs a year just in the U.S. And so, why not have a solar roof that's better in many others ways as well. We don't want to show all of our cards right now, but I think people are going to be really excited about what they see. And like I said, the cool thing is that it doesn't cannibalize the existing business because you got two classes of customer – like, customers that – where the roof's nearing end-of-life and customers where they've just put in a new roof. And so, you actually get – this is a great situation where you get to introduce new product without cannibalizing the existing product.

Peter Rive - Co-Founder & Chief Technology Officer

And this is a product that we're going to be kind of expediting module manufacturing for, out of Buffalo.

Elon Reeve Musk - Chairman

Right. And this is – exactly – and this is why it's really important to do the manufacturing in-house because you're – it (11:29) control of the aesthetics and ideally really design – it's kind of like making a custom car. Like when somebody orders a car from Tesla, they'll pick a wide array of options. That car will be custom made to their preferences; and you really want the roof custom-made to the individual customer as a kit and then sent to – that would be the delivery team to get installed.

Peter Rive - Co-Founder & Chief Technology Officer

I'd just want to note that the majority of the capital expenses in order for us to get going on module manufacturing have essentially being incurred. So as exciting as a product as this is, the majority of the manufacturing expenses just for the module line here are essentially incurred. And then, we also have been looking at ways to significantly improve the capacity of the manufacturing facility in Buffalo. And we have both process equipment improvements as well as layout improvements that, I think, gives us the ability to meaningfully increase it above a gigawatt a year. And what's really important for us in the factory is that it's competitive for years to come. So we're going to take the time to make equipment modifications as you get the layouts exactly right. We don't want to rush to actually initiate some of the equipment installation for the cell line and then have that be a regretful layout only months later.

So – but from a high level, I'm pretty excited about what we're doing at Buffalo. We're going to have module manufacturing ahead of schedule and we have designs that will give us the ability to increase the capacity beyond a gigawatt.

Operator

Thank you. Our next question comes from the line of Brian Lee with Goldman Sachs. Please proceed with your question.

Brian Lee - Goldman Sachs & Co.

Hey, guys thanks for taking the questions; maybe just start off with a high level one. As you see some of the business mix evolving here, what do you think the appropriate growth rate is as you transition to more of a loan system sale driven strategy versus – or product mix versus the PP and lease model before, given the different financing mechanisms behind the two types of products. And then, how quickly – I know you said, Lyndon, it's up to 20% of bookings, but how quickly do you think that goes to 50%-50% for you guys?

Lyndon R. Rive - Chief Executive Officer & Director

So, let me answer the second part. So, we're pushing quite a bit on the cash and loan. We like cash and loan. It actually – from a cash generation, for the business, it improves it dramatically. It's also a lot easier to raise loan financing. There's only, I'll call it, a dozen or so tax equity providers, but there are many providers that like high quality cash growth. Cash equity is a unique financing source as we're financing straightforward solar systems is a lot easier. It'd be hard for me to give you exact forecast; I mean, I think it'd be 50%-50%. I'm expecting to increase dramatically in Q4. It'd just be a little hard for me to give you an exact forecast of how much more, but it'll be a big focus for us in Q4. Frankly, it's a big focus for us right now, but the effect of it will happen in Q4.

Brian Lee - Goldman Sachs & Co.

Okay.

Elon Reeve Musk - Chairman

Yeah, and – pardon me for tagging on. I talk too much, but I think the – I think what we'll – if you look a little bit beyond that, it is going to be a lot more towards cash and loan. It's actually economically more efficient for the end customer to do that. So, if the end customer has a good cost of capital or bad cost of capital, which they usually do, then SolarCity – it's fundamentally not (15:27) going to be more efficient for them to take the debt on themselves; and then, has the benefit of, from a SolarCity standpoint, of decreasing dependence on the tax equity and securitization market.

Brian Lee - Goldman Sachs & Co.

Okay. Thank you. That's helpful. Maybe related to that, if we look at the competitive dynamics and market share over the course of several years, there was clearly a big consolidation happening across the space as you and some of your peers were gaining a lot of share and just in recent quarters that seems to – the momentum there has reversed a bit. As you see loans and cash system sales and those financing mechanisms coming into play, does that reverse that momentum, again, where you start to see broader consolidation in the residential vertical? And then, I think one of the shifts we've also seen in the marketplace is some of these online kind of marketplace platforms starting to gain some traction. Is that something you have any initiatives around or you would even look to doing a partnership around to gain access to that channel?

Lyndon R. Rive - Chief Executive Officer & Director

Yes. So I think part of our – if you look at our customer acquisition costs in Q1, we just had tremendous sales inefficiency. So, we made changes there; sales efficiency has improved a lot. And so, with the sales efficiency improvement, we now have seen bookings increase. So we feel good about that.

In terms of the lease versus loans, I don't think that's going to be the big differentiator. Financing has never really been a big differentiator; everybody has always had financing. Initially, what our biggest differentiator has been is that we're vertically integrated. We provided better services to our customers than any of our other competitors. Over time, our competitors have vertically integrated their services as well. Now our focus is on products and we are releasing products that our competitors will not have, and that will be the biggest driver to differentiating and growth.

Elon Reeve Musk - Chairman

Yeah, absolutely.

Brian Lee - Goldman Sachs & Co.

Okay.

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

To answer your last question, we're also focused, obviously, on developing an online channel and the ability for customers to purchase a solar roof or solar system through the Internet.

Brian Lee - Goldman Sachs & Co.

Okay. Great. Thank you. Maybe if I could just squeeze one housekeeping one in for you, Tanguy, on the P&L, the pre-production expense went from being in COGs last quarter to it's now listed in OpEx. Just can you walk us what drives the delta from quarter-to-quarter in the accounting and how that's going to be treated in Q3 and Q4? Thank you, guys.

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

Sure, absolutely, Brian. So this is a consequence of what Pete just discussed, which is some of the cells that we're manufacturing. Given the focus on the module line in Buffalo and then the solar roof, some of this other manufacturing in Q3, Q4 are now becoming R&D. And so – sorry, in Q1, Q2, are now becoming R&D, as we're classifying that spend as R&D, which is below cost. So, it's just a matter of a decision to be made and the consequence of that from an accounting perspective.

Brian Lee - Goldman Sachs & Co.

Thanks, guys.

Operator

Thank you. Our next question comes from the line of Patrick Jobin with Credit Suisse. Please proceed with your question.

Unknown Speaker

Hi, everyone. It's Andrew (18:48) on for Patrick. A couple questions; one on 2016 guidance, and specifically volume expectations for the fourth quarter with that big ramp and it being C&I focused; there has been some delays in the C&I business for you guys in the past. Just curious your level of confidence in being able to deliver those megawatts with, it looks like, the majority being in the commercial segment.

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

Yeah. So, I think that's a fair comment. So, things – we've got the significant portion of those megawatts that we're booking, they're already significantly underway. So they are either actually under construction or through the permit and interconnection process. And so, we've got line-of-sight on the vast majority of those megawatts. The other comment I'd make is that includes some megawatts in Mexico, for the first time sort of real megawatts volume in Mexico, where – those that are cash sales and where the permitting structure is a little bit different and easier (19:50) and so – and there's no weather issues, so we feel good about those megawatts.

Unknown Speaker

Great. That's helpful. And then, in terms of just selling into California right now with NEM 2.0 underway in certain utility territories, how that is going? And then, how you guys anticipate even beyond that the sales process evolving from your perspective as, you know, we come into the time-of-use rate net metering program in California beyond that?

Lyndon R. Rive - Chief Executive Officer & Director

So we've actually moved our sales team over to selling net metering 2.0 already. So remember the – we have to set the expectation with the customer of when the system is interconnected. And it's hard to forecast exactly when net metering 2.1 occurs – sorry, 1.0 occurs versus 2.0. And so, in our proposals we actually give expectation to our customers of what net metering 2.0 look like. And so, it's already incorporated in our sales channel in PG&E. At Southern California Edison, we have a longer lead-time. And the effective sales, actually the sales efficiency has improved in July, so I don't think it's going to have that much of an effect. In fact, it hasn't had much.

Peter Rive - Co-Founder & Chief Technology Officer

I mean, in the long-term, we've been investing a lot in being able to integrate knowledge of the customers' usage patterns with our rate structure databases with things like storage control, smart thermostat control, in order to be able to adjust when the customers' energy is actually going to be used. So I think you'd maybe have like this short-term anomaly which isn't having that much of an impact on us, but in the long run I think it's going to be a further point of differentiation for us.

Unknown Speaker

That makes sense. And just one more, if I may, and kind of segueing off that, can you discuss at all your current attachment rate of storage today in the U.S., and then what your expectations are on a forward basis, particularly as you get into 2017 and NEM 2.0, and then even further on into time-of-use? I'd be really curious, sort of 2019, what you expect storage attachment rates to be with new systems. And I'll hop back in the queue. Thanks.

Peter Rive - Co-Founder & Chief Technology Officer

Sure. So the majority of the storage bookings and deployments that we've had to-date has been in commercial as well as utility scale. Last earnings call I was talking to you about having a backlog of over 100 megawatt hours in those market segments. And so, that's where the majority of the traction has been. I think that when we think about the business in the long run, if I look into the -maybe like 2020 and beyond, I see us having 100% attach rate.

I think that the next kind of phase of solar adoption is going to be one that is almost always coupled with storage. And so, I would just say that, I guess it's kind of like a linear attachment rate between where we are right now, which is single-digit percentages, all the way to 100% as we enter the next decade.

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

And in some instances you'd actually go back and either retrofitting the utility scale or wind farm...

Peter Rive - Co-Founder & Chief Technology Officer

Yeah.

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

...or a residential or commercial with the (23:07) benefit from the economics at the time.

Peter Rive - Co-Founder & Chief Technology Officer

Yeah, absolutely. It's one of the questions that we always get from our hundreds of thousands of customers, like, hey, when are you going to be able to retrofit my system and storage? That will be a massive up-sell opportunity with all the systems that we already have deployed as well (23:23).

Operator

Thank you. Our next question comes from the line of Ben Kallo with Robert W. Baird. Please proceed with your question.

Benjamin Joseph Kallo - Robert W. Baird & Co., Inc. (Broker)

Hey, thanks. On those lines, how much utility sales do we think you'll have, call it, in two years versus your traditional business?

Lyndon R. Rive - Chief Executive Officer & Director

So, we have a small team focused on that right now. If you – total utility volume, that's essentially customers that we've sold where the end buyer is the actual utility, in the company's history is around 60 megawatts or so. I do see that growing, but it'd be hard to give you an exact forecast of whether it'd be in two years' time. There's long lead-time on that. Our primary focus today is on residential and commercial customers, but that will become a bigger market of ours in the later years.

Peter Rive - Co-Founder & Chief Technology Officer

And as you remember that, like, when people say utility – like, we structured our products and services that we have something to offer in generation as well as distribution and transmission. And if you go to our website, you'll see the way that we're explaining the services. But on generation, I see us being able to be a massive participant in the next phase of utility-scale solar generation, which is to provide solar power through all of the peak hours. I think that you can look at many utility-scale generation markets and see that they're almost at the point of saturation for typical solar. So what we're positioning ourselves for is this next wave. And this is going to be kind of planet-wide; it's not just going to be a U.S. thing. And then, also, making sure that, through distributed generation, we can also offer products and services that are alternatives to traditional distribution and transmission-related expense. So...

Benjamin Joseph Kallo - Robert W. Baird & Co., Inc. (Broker)

Elon (25:36).

Peter Rive - Co-Founder & Chief Technology Officer

I'm sorry?

Benjamin Joseph Kallo - Robert W. Baird & Co., Inc. (Broker)

I had two questions for Elon real quick.

Peter Rive - Co-Founder & Chief Technology Officer

(25:51) I think I'm just going to say that, yeah, so we offer products and services, also, for distribution and transmission; but, I'm sorry, go ahead.

Benjamin Joseph Kallo - Robert W. Baird & Co., Inc. (Broker)

So, Elon, you've seen a lot of money invested, I'm sure, in the Valley into next-generation solar; a lot of money lost. Can you help us with the manufacturing side with Silevo, number one? And number two, how do we think about leadership going forward? You have lots of competent people at SolarCity, but how do we think about who actually does day-to-day management if Tesla does get to buy SolarCity? Thank you.

Elon Reeve Musk - Chairman

Well, I think the – one thing on the solar side is to – on the panel and module side and cell side is to create a high level of product differentiation, in particular with respect to aesthetics. Most people care a great deal about that. I mean, technically, you could live in a house without drywall and just have all the insulation and wiring just hanging there, but people care about drywall. People care about remodeling their kitchen. People care about their yard. They care about making sure that their primary asset, typically being their house, is something that they – that it looks good and that they're proud to show off. And that's one of the primary – that's like the most important element of product differentiation here.

And then, there is also, of course, the efficiency of the panel. Are you able to get a very high efficiency, but still at a low cost? And Silevo has, I think, some important elements of that. And I think we'll probably – we won't be talking about Silevo as a name, really, because we'll be adding a lot of – assuming it's going to be – the merger is approved by shareholders, we'll be adding considerably to the technical team there. It will become something far more than the original Silevo.

We're also entertaining some discussions with strategic partners on the solar cell manufacturing, and some of those could head in an interesting direction. Our default path is still to continue the – assuming – again, assuming we come together as a company to – the default path is still to continue with the cell engineering internally and bolster that team with – by recruiting world-class engineers, but we may conceivably on the solar cell side – I want to distinguish that from the module and from the overall roof system – there may be some merit to bringing in a strategic partner as Tesla has with the battery cell manufacturing.

Operator

Thank you. Our next question comes from the line of Colin Rusch with OppCo (29:11). Please proceed with your question.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Hi. Thanks so much. Can you talk a little bit – or give us a sense of the percentage of potential customers that have said no to buying a solar system historically because of the age of their roof or issues that might lead to replacement of the roof?

Lyndon R. Rive - Chief Executive Officer & Director

It's hard to give you a rough estimate of how many systems actually get disqualified because of the age of the roof.

Elon Reeve Musk - Chairman

Disqualified from a SolarCity standpoint.

Lyndon R. Rive - Chief Executive Officer & Director

From SolarCity's standpoint; but it's hard to know – if you have an old roof, you're probably not looking to get solar. So that customer probably didn't even come to SolarCity in the first place. If we look at our current roofs that don't qualify, Tanguy, it's around 8%, 10%?

Tanguy Vincent Serra - President, Chief Financial & Accounting Officer

It's 10%, correct.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah.

Peter Rive - Co-Founder & Chief Technology Officer

That's not the relevant number. I mean, the issue is right now (30:05) from the top of the funnel.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah. That's the biggest issue, hands down.

Elon Reeve Musk - Chairman

But what we do know is they're not even considered.

Lyndon R. Rive - Chief Executive Officer & Director

Yes.

Peter Rive - Co-Founder & Chief Technology Officer

Exactly.

Elon Reeve Musk - Chairman

I mean, the number is probably close to 20% to 30% or more. I mean, figure – like essentially, the basic math is like, let's say, you've got a 20-year roof, right? And how far are you into the life of that roof? If you are, let's say, more than 10 years or 12 years into the life of your roof and you've got, say, eight years left, you're probably not going to want to put solar on your roof, right, because you know you're going to want to replace it. So that's sort of where it transitions. Certainly, if you've got like four years or five years left on a 20-year roof, you're definitely not going to get solar. So that suggests pretty obvious top-level analysis of something on the order of 30%, but conceivably as high as 40%.

Lyndon R. Rive - Chief Executive Officer & Director

The answer to – once you've announced this product, you – when a customer needs to upgrade his roof, it's something that bugs him for a long time. They've got to do it; they've got to do it; oh, they've got to do it. And so, there is another buying motivation beyond just saving money off your electricity or using clean energy. And so, I should (31:27) think that will increase the sales demand more than just what we're experiencing today and starting a savings proposition.

Elon Reeve Musk - Chairman

Yeah, it's like what if we can offer you a roof that looks way better than a normal roof? What if we could offer you a roof that lasts far longer than a normal roof? Like now, it's a different ballgame.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Okay.

Lyndon R. Rive - Chief Executive Officer & Director

(31:53) getting a new roof...

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

That's super helpful, guys. Thanks a lot. All right, so with Tesla's mission to really transform the energy economy, I trust you guys are far down the road at looking at energy efficiency, seeing as that's the most efficient, most cost effective energy source. How long is it going to be before the combined entity introduces a home energy management system or some sort of robust energy efficiency offering?

Peter Rive - Co-Founder & Chief Technology Officer

I'll just say that, it would also be a great feature in our roof, if it were also energy efficient. And then, I think that in terms of home energy management systems, SolarCity's Gateway has, for many years, been kind of a brain in the customers' household that has a handle on how much energy they're using as well as how solar's being produced. We have integrations with smart thermostats.

So I think that that's kind of already in place to some degree through the SolarCity App. You can log on. You can see, in general, where your energy is going. You can get real-time reading on how much energy you're consuming. So a lot of that stuff is kind of already in place, but it's something that we're going to be elaborating on in the coming years for sure.

Elon Reeve Musk - Chairman

And certainly, integrating that with the stationary battery pack so there's not a duplication of systems, which would otherwise be the case. (33:25) on the Tesla call – I mean, really like solar and battery go together like peanut butter and jelly. It's like a – you obviously need the battery, particularly as you get to scale and you want to have solar be a bigger and bigger percentage of the grid. If you don't have the batteries there to balance the grid and buffer the power, you really can't go beyond a certain percentage of solar in a particular neighborhood. You can – maybe you can go up to about 20% solar, but more than that, it starts to unbalance the grid and you need to buffer it, because the – I mean, obviously the energy generation is low at dawn and dusk. It's high in middle of the day, and it's zero at night. So you got to smooth that out.

And so, in order to – if you like sort of fast forward to where do we want the world eventually to be is we want the world to have both sustainable energy generation and sustainable energy consumption. So that really requires three – the three critical ingredients for that is the solar panels, the stationary batteries, and electric vehicles.

So – and like I said, you just – you can't get beyond a certain scale with solar unless you have the batteries to go with it to buffer the power. And then, you got to manage all of that because you'll have millions of these batteries. You've got to manage that, integrate it with the utility.

I do want to emphasize there's still a very important role for utilities here, because sometimes people think that this is an either/or thing; it's like either rooftops are going to win or centralized generation is going to win, and actually both are going to win because the electricity usage is going to increase dramatically as we transition away from burning old dinosaurs to electric cars, and then to electric transport. We'd see roughly a doubling of electricity consumption as all transport moves to electric. And then, there is a tripling of electricity usage if you take all heating and make that electric as well, because, obviously, most heating is from oil and natural gas, particularly. So...

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Okay. That's super helpful. And – the heating timeframe, low-single-digits right now, and timeframe on the cars. I think we can take some of that offline, but I think my question is really about timeline for energy efficiency offering; and it sounds like it's in the works. So I can take the rest of it offline. Thanks a lot guys.

Elon Reeve Musk - Chairman

Yeah. It's a high priority and we think it's important.

Operator

Thank you. Our next question comes from the line of Michael Morosi with Avondale Partners. Please proceed with your question.

Michael Morosi - Avondale Partners LLC

Hi. Thanks for taking the question. You called out Mexico as factoring heavily into 4Q shipments. Just looking at Tesla and the fact that over 50% of sales in 2015 came from international markets, how could international sales and international storage play a factor in the combined company?

Lyndon R. Rive - Chief Executive Officer & Director

So, once again, assuming once the transaction is approved by the shareholders, I mean, Tesla's footprint internationally is super valuable. We'll definitely look at that. We'll analyze what's the cost of energy in all the different countries. That's the number one ingredient. And then, when you combine solar combined with storage, you're not tied to policy. So you don't need net metering internationally. You don't need a feeding tariff. You don't need different programs. You can just be competitive to the current cost of energy. And so, we'll look at those markets to see where the two combined can be very competitive and we will absolutely expand to (37:46).

Elon Reeve Musk - Chairman

Yeah. And I think there's also a lot of opportunity at the utility scale, providing integrated solar battery system to utilities so that they can provide sustainable energy that's load-leveled and buffered to their customers. And we've got a huge project in Hawaii that's happening right now. I think it's the biggest in the U.S. or...

Peter Rive - Co-Founder & Chief Technology Officer

I don't know of any of other firm (38:16) solar system that is bigger when you combine the demand with (38:18).

Elon Reeve Musk - Chairman

Yeah. We think it's the biggest solar battery utility-scale installation in the United States, maybe the world. So, I think there's going to be actually a lot of business with utilities, as we provide them with an option to have sustainable, centralized power generation. That's what I want – I really want to emphasize, like, our goal is to work with utilities and to collectively to solve the future energy electricity demands of the world, as the electricity demand rises tremendously due to electrification sustainability. I mean, I don't think anybody wants to have huge new power lines pulled through their neighborhoods and vast expansion of substations and all the things that would be necessary to fully electrify transport and heating. It's a huge headache to do that. It's not something that, I think, any consumer wants and it's not a headache that utilities want to have to go through. But if you don't have localized generation combined with central, that's what's going to have to happen and that would suck. So it's just sort of terrible in every way. So this is something that's a cooperative solution for the future.

Lyndon R. Rive - Chief Executive Officer & Director

We're really seeing an uptick in that. The utilities want to look at solutions, how you manage large-scale deployment of solar and storage. As I mentioned in my opening remarks, we have three products really going with utilities. Utilities wanted – we're starting to see a movement of utilities wanting to collaborate and we have entire focus there. I highly recommend you go to our website and look at all the utility services that we provide. It's a big focus for the company.

Elon Reeve Musk - Chairman

Yeah, I think it also – I mean, it helps to use that as an example of one of the reasons to combine Tesla and SolarCity is that in order to do this big wide utility solar battery project, it had to go through the independent committees of both boards. There had to be discussions back and forth. It took a few months to get that all worked out.

And as we do many more of those deals, if we go to dozens of those deals, hundreds, potentially thousands in the future, this is completely unworkable. I mean, there's just no way we could get all of that through independent board committees. It's completely unworkable. So the irony, which I mentioned before, is that this combination is about getting rid of the conflicts of interest so we can work together effectively to provide solutions to consumers and to utilities and large commercial customers.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Thanks.

Operator

Thank you. Our next question comes from the line of Pavel Molchanov with Raymond James. Please proceed with your question.

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

Hi. Thanks for taking the question, guys. Can I just ask about the geographic footprint? How many states are you currently in? Are you looking to exit any of your existing states? And then, conversely, are you looking to enter any new ones in the foreseeable future? That's my only question Thanks.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah. We're in kind of roughly 19 states, and probably open up one or two more states before the end of the year.

Elon Reeve Musk - Chairman

And if I may add, also, just because I – particularly, I want to add things that I think are beneficial with combination of the companies, is that Tesla is currently operating in over 40 countries and, thus, we have a presence around the world. And we'd love to bring solar solutions to all of those countries – our solar battery solutions. And I think this is particularly powerful in places like Germany and Australia and in many other parts of the world. So, I think there's a lot of potential to amplify the expansion of sustainable energy generation.

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

Okay. Just quickly following up, you've entered a number of states just in the last six months. And I guess what I'm curious is, is your mix changing as you're entering these new states or are you still very heavily tied to kind of the legacy California, New York, Arizona that you've historically been in for a longer period of time?

Lyndon R. Rive - Chief Executive Officer & Director

Yes. The way I'd view state expansion is any new state that we're expanding in next year, the effect of that new state is going to be very small. The following year, however, that new state will have a larger effect and then the mix will start changing. It just takes time to build out the infrastructure, get the installations going; and then, of course, the year after that, those states will continue to grow. So most of the volume that we'll get in any specific year will be because of states that we expanded to the year before. So the states that we're expanding into this year, most of that volume and the impact you'll see in 2017.

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

All right. It's useful. I appreciate it.

Operator

Thank you. Our next question comes from the line of Vishal Shah with Deutsche Bank. Please proceed with your question.

Vishal B. Shah - Deutsche Bank Securities, Inc.

Yeah. Hi. Thanks for taking my question. I just wanted to understand the customer behavior ahead of some of the Silevo manufacturing ramp. Are you seeing a pause in customer demand or are your customers still asking you to sort of place – giving you orders for that – for the new equipment that they'll be installing at some point next year or are you seeing no change at all?

Lyndon R. Rive - Chief Executive Officer & Director

Yes. Just in terms of the efficiency, the biggest benefit is to us in operations. So for our customers, the difference to them would be two different panels. So, we're not seeing a delay in our current option for customers for the modules that we have today. So, no, we're not seeing it. As far as the solar modules (45:01) and be focused on a different market segment, primarily, and is going to be focused on the new roofing market. So, it's addressing a market that we don't address today.

Vishal B. Shah - Deutsche Bank Securities, Inc.

Okay. That's helpful. And also, it sounds like there is great availability. I mean, there's no constraint in terms of loan availability. Are you thinking about – or is it possible to actually take the loan offering to the existing installed base of lease customers and convert some of those lease customers into loan customers?

Lyndon R. Rive - Chief Executive Officer & Director

No, that's something we won't be able to do. The way it's structured, the tax equity investors owns the equipment. That equipment will be on the roof for 20 years. The – all the focus would be on new customers.

Vishal B. Shah - Deutsche Bank Securities, Inc.

I appreciate it. Thank you. And then, one last question just on the mix, earlier question. What percentage of your mix – as some of these new states become important, what percentage of mix will from California in 2017?

Lyndon R. Rive - Chief Executive Officer & Director

It's hard to give you a forecast on that mix. I don't want to set that expectation. The – yeah, we don't break out our state volume.

Vishal B. Shah - Deutsche Bank Securities, Inc.

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Jeff Osborne with Cowen & Co. Please proceed with your question.

Jeffrey Osborne - Cowen & Co. LLC

Hey, good afternoon, guys. I had just a couple more questions on Silevo, if you don't mind. I think in the past you had talked about certain level of capacity achieving kind of a low to mid-$0.50s cost per watt, just given what's going on in the broader module market. I was wondering if you could just confirm what capacity levels you're building for the Silevo silicon-based product in Buffalo? And then, also update us if there's been any technology advancements that perhaps would lower that cost per watt number?

Lyndon R. Rive - Chief Executive Officer & Director

Yes. So like I was saying before, we actually think we will be expanding the capacity. At this point, I don't want to get specific and say what we think that we'll be expanding it by just yet, but I think that we'll be expanding it beyond a gigawatt.

And I think that the cost potential over time is definitely in the $0.40 to $0.50 a watt range, but I also – what I found in many discussions is people draw this comparison between essentially high efficiency modules, and then the cost of standard efficiency modules. And the benefits of high efficiency, economically, are, first, that you typically win more deals in front of the customers. The customers prefer to have standard efficiency. You also get more revenue per customer, and your balance and system costs are lower. So, I don't think that it's a fair comparison to compare the cost structure that we believe that we will have to the cost structure of our standard efficiency modules.

Jeffrey Osborne - Cowen & Co. LLC

Perfect. And the follow-up I had was just on (48:15).

Elon Reeve Musk - Chairman

I think it's worth adding like, at Tesla, we're achieving the lowest cost per kilowatt hour for battery packs, at the cell level and at the pack level, in the world, despite having the highest energy density. So we have the best cell at the lowest – best cell and pack at the lowest price – lowest cost. I'm confident we can achieve that at SolarCity as well.

Jeffrey Osborne - Cowen & Co. LLC

Got it. And then just, I wanted to see if Elon or someone else on the floor there could elaborate on the $150 million in synergies. It just seemed like the press and other analysts had some skepticism of that. I don't cover Tesla, as you know, but is there any further discussion or elaboration that you could offer would be helpful?

Elon Reeve Musk - Chairman

I think this is – I mean, obviously, when you combine two companies, there is some level of overlap. And then, at the product level there is some level of overlap with the solar battery solution. If you have two separate companies, you have to have two separate computers, operating systems. You've got to have separate communication systems interfacing with two separate server networks. You are developing two separate phone apps for the consumer to monitor their system. You've got to do two installation businesses instead of one. So, I would say that $150 million is a very conservative number.

Lyndon R. Rive - Chief Executive Officer & Director

And then, if just look at the sales synergy, if we just reduce $0.10 a watt in our acquisition cost, that alone would be $100 million at a gigawatt run rate. And that we may get just by virtue of having some real estate or access to (50:11).

Peter Rive - Co-Founder & Chief Technology Officer

Right.

Jeffrey Osborne - Cowen & Co. LLC

Got it. Yeah. Just real quickly as a follow-up, is the intent for SolarCity in the future as its roofing product comes along to either partner with local roofing in solar or do you actually have – intend to have your green bands (50:25) be both roofing companies as well as an electrician? I'm just trying to understand what you look like in two years to three years. Are you going to be actually mounting the shingling replacement product as...?

Lyndon R. Rive - Chief Executive Officer & Director

So, on the roofing, Todd, we're going to keep the rest of the stuff a little secret and...

Elon Reeve Musk - Chairman

We're going to have a few cars to show, okay. I could have shown you quite a lot of leg here. Okay?

Jeffrey Osborne - Cowen & Co. LLC

Yes.

Peter Rive - Co-Founder & Chief Technology Officer

But the vans been on the...

Jeffrey Osborne - Cowen & Co. LLC

Thanks very much guys. I appreciate it.

Operator

Thank you. Our next question comes from the line of Gordon Johnson with Axiom Capital. Please proceed with your question.

Gordon Johnson - Axiom Capital Management, Inc.

Hey, thanks for taking my questions, guys. So for Q2, when looking at installations and bookings, can you let us know what percent of those installations and bookings were sales from SolarCity to Tesla versus sales to rooftops? And then, I have a follow-up.

Lyndon R. Rive - Chief Executive Officer & Director

I don't understand that question.

Gordon Johnson - Axiom Capital Management, Inc.

Okay. Sure. Tesla has a Gigafactory. There were some solar systems installed on the rooftops of the Gigafactory. So I'm trying to figure out if there was a large order in Q2 that helped installations and, additionally, potentially bookings associated with sales of systems from SolarCity to Tesla. And if so, what percent of installations and bookings were those sales?

Lyndon R. Rive - Chief Executive Officer & Director

I'm not even familiar with what the number is. This is definitely not measurable.

Elon Reeve Musk - Chairman

Zero.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah. I don't.

Elon Reeve Musk - Chairman

Zero, we've not actually ordered any. We will, but we haven't, yet.

Gordon Johnson - Axiom Capital Management, Inc.

Okay. So, there were no sales. Okay, I got it. And then, just with respect to the acquisition, one question I had is it seems like there were comments out of Tesla as recently as November of 2015 that combining a battery and a rooftop solar company didn't make a ton of sense because, effectively, when you have a rooftop solar company with net metering, the grid acts as, effectively, a battery, ruling out the need for a battery technology. So can you help us understand those comments that were made in 2015 and now, fast forwarding to today, the rationale behind the acquisition?

Lyndon R. Rive - Chief Executive Officer & Director

Yeah. Let me just talk about net metering, where we see net metering evolving over the next few years, because I think this is a really important part of how storage is a combination with the solar. The case that I'd like everybody to review is what just recently happened in New York. This is a collaboration of the local utilities and the solar industry. And the collaboration is net metering for the next three years, and then a phasing to more of a grid services model where you combine solar, storage, smart inverters and provide all these additional grid services, and you phase that in; and then, essentially, you phase-out net metering into that grid services model.

And so, we see that probably happening as a standard policy and we're going to promote that across all the different states. But you – we have to get to a point where it is grid services, so that utilities recognize the value that solar and storage can provide to the grid.

Elon Reeve Musk - Chairman

It's also just a relative scale thing. Up through the 20% power level produced by solar, you don't need – you know, there's some value to a battery, but there's – it's not totally necessary. And, in fact, actually, up through a certain – I mean, at least through the 10% level all the way up to the 20% level, solar actually helps the grid because it generates energy when people use it most. Like, the electricity demand peaks during the day because that's when the air conditioning is running at maximum power. That's when companies who are operating machinery is operating. So, solar actually helps utilities – like rooftop solar, localized rooftop solar actually helps utilities up to a certain percentage. And that's – you can sort of debate that percentage, but it's somewhere between like 10% – minimum 10%, but all the way up to 20%.

But then, beyond that point the – it gets very difficult to balance the power distribution in the grid, and then you really have to have the batteries to scale, ultimately, to 100%. Long-term, it's tautological we have to have sustainable energy across the board or, by definition, it would be unsustainable. So just looking at it from a macro standpoint, you have to have a large number of batteries combined with a lot of solar. Wind will play a significant, but smaller role. Hydro will play, also, a small role. Nuclear will play a small role. Geothermal will play a small role, but the really heavy lifting is going to be solar. And, particularly for solar, and even more so for wind, being able to buffer the power is fundamental to the solution.

Gordon Johnson - Axiom Capital Management, Inc.

Okay. So I just want to make sure I understood the answers correctly. What you guys are saying is you're going to phase out net metering and shift to a different strategy, and you're also saying that power peaks at, I guess, in the middle of the day at 12 o' clock?

Lyndon R. Rive - Chief Executive Officer & Director

No, I wouldn't – I mean, that's to say a little hard statement. We're saying that over time as large volume gets deployed, you're going to phase out of net metering, and then provide grid services as you phase it out. The key point is as large volume gets deployed.

Elon Reeve Musk - Chairman

Yeah. And so – yeah, exactly. To reiterate, in the beginning, rooftop solar helps utilities. But as it becomes a bigger percentage of the grid power, you really need batteries to smooth out that power. And, yeah, it's really, I mean, just common sense. I mean, when is the sun the brightest? Yeah, like middle of the day; and it's weaker at dusk and dawn, and it's off at night. So, clearly, you need to buffer the power.

Lyndon R. Rive - Chief Executive Officer & Director

Yeah. I mean, I just want to repeat the statement: it's based on large volume. And to make the statement that we think net metering should end is just a mis-quote and an incorrect representation.

Gordon Johnson - Axiom Capital Management, Inc.

Thank you.

Operator

Thank you. Ladies and gentlemen, at this time there are no further questions. I would to like turn the floor back to management for closing comments.

Lyndon R. Rive - Chief Executive Officer & Director

We don't have any closing comments. Thank you so much for everybody's time (57:52).

Elon Reeve Musk - Chairman

Yeah, let me just like – one little thing, which is like, I mean, there is a lot of focus on this month or that month or this quarter or that quarter, but I think it's worth raising – lifting our gaze a little bit to think longer-term to a year, or two years or several years out and, ultimately, to where do we – what do we want the world to look like and are we going there as fast as possible? I think, really, any rational person who believes in science thinks that it's important for the world to transition to sustainable energy generation and consumption sooner rather than later.

In fact, even if you just assign a probability instead of saying it's black and white, what is your probability that going to sustainable energy – non-CO2 generating energy is good versus bad? Even if you think it's like – if you take the devil's advocate position and say, well, we think it's 1% likely that – hypothetically, that massively increasing the CO2 in the oceans and atmosphere is bad. Well, okay, we're 1%, but you only have one planet. So even if you think it's highly unlikely that global warming is real and that there's only a small chance that it's bad, we should still accelerate the advent of sustainable energy. And anyone who thinks that – is 100% certain that global warming is fake and that massively changing the chemical composition of the oceans and atmosphere is fine, is a bloody fool, obviously.

So that's what this is all about. This is about trying to accelerate to where we know we need to get to anyway. And not unlike small potatoes, put some pieces away, but in a very big macro scale way.

Lyndon R. Rive - Chief Executive Officer & Director

Thank you, everybody. Have a good day.

Operator

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

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