scty-10k_20161231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark one)

    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

Or

    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-35758

 

SolarCity Corporation

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

02-0781046

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

3055 Clearview Way

San Mateo, California 94402

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (650) 638-1028

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”).    Yes      No  

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

 (Do not check if a smaller reporting company)

  

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of June 30, 2016 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of voting stock held by non-affiliates of the registrant based on the closing price of $23.93 for shares of the registrant’s common stock as reported by the NASDAQ Global Select Market, was approximately $1,615.7 million.

Since November 21, 2016 and on January 31, 2017, 100 shares of the registrant’s common stock, $0.01 par value, were outstanding, all of which were owned directly by Tesla, Inc.

REDUCED DISCLOSURE FORMAT

The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format.

DOCUMENTS INCORPORATED BY REFERENCE: NONE

 

 

 

 

 


TABLE OF CONTENTS

 

 

 

 

 

Page

 

PART I 

 

2

 

Item 1.

 

Business

 

2

Item 1A.

 

Risk Factors

 

6

Item 1B.

 

Unresolved Staff Comments

 

24

Item 2.

 

Properties

 

24

Item 3

 

Legal Proceedings

 

24

Item 4.

 

Mine Safety Disclosures

 

26

 

PART II 

 

27

 

Item 5.

 

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities

 

27

Item 6.

 

Selected Consolidated Financial Data

 

27

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

28

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

36

Item 8.

 

Financial Statements and Supplementary Data

 

37

 

 

Report of Independent Registered Public Accounting Firm

 

38

 

 

Consolidated Balance Sheets

 

39

 

 

Consolidated Statements of Operations

 

41

 

 

Consolidated Statements of Equity

 

42

 

 

Consolidated Statements of Cash Flows

 

43

 

 

Notes to Consolidated Financial Statements

 

45

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

95

Item 9A.

 

Controls and Procedures

 

95

Item 9B.

 

Other Information

 

96

 

PART III 

 

97

 

Item 10.

 

Directors, Executive Officers, and Corporate Governance

 

97

Item 11.

 

Executive Compensation

 

97

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

97

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

97

Item 14.

 

Principal Accountant Fees and Services

 

97

 

PART IV 

 

99

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

99

 

 

Signatures 

 

 

 

 

 

 

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

The discussions in this Annual Report on Form 10-K contain forward-looking statements reflecting our current expectations that involve risks and uncertainties. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, profitability, expected cost reductions, capital adequacy, expectations regarding demand and acceptance for our products, growth opportunities and trends in the markets in which we operate, prospects and plans and objectives of management. The words “anticipates”, “believes”, “estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “will”, “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not assume any obligation to update any forward-looking statements.

 

 

 

 

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PART I

ITEM 1. BUSINESS

Overview

SolarCity’s founding vision is to accelerate mass adoption of sustainable energy. We believe solar power can and will become the world’s predominant source of energy, and that we can speed widespread adoption of solar power by offering products that save our customers money. In November 2016, we were acquired by Tesla, Inc., or Tesla, with a goal of creating the world’s first vertically integrated sustainable energy company to provide customers with a simple one-stop experience for clean energy generation, storage and transportation.

We sell renewable energy and energy storage solutions to our customers, typically at prices below utility rates, and are focused on reducing the costs of adopting solar energy. We make it easy for our customers to adopt solar energy by designing, permitting, financing, and installing our solar energy and storage systems, and performing maintenance and monitoring services. We offer our customers the ability to go solar for little to no upfront costs, or we sell solar energy and energy storage systems to our customers with a variety of financing alternatives.

2016 Operational Highlights:

Our 2016 operational highlights include the following:

 

Acquisition by Tesla – With our acquisition by Tesla, we have combined to create the world’s only vertically integrated sustainable energy company, offering customer solutions ranging from clean energy generation to storage to transportation.

 

Solar Roof Announcement – With Tesla, we announced the launch of our Solar Roof, seamlessly integrating high-efficiency solar energy production with aesthetically pleasing and extremely durable glass roofing tiles, designed to complement and power customer homes.

 

Manufacturing Relationship with Panasonic – We entered into long-term agreements with Panasonic to manufacture custom solar cell and solar panels at the Riverbend manufacturing facility located in Buffalo, New York, designed to accompany Tesla’s Powerwall and Powerpack energy storage products.

 

Worldwide Microgrid Service – We made continued advancements in our GridLogic microgrid services, with an installation on the island of Ta’u in American Samoa designed to replace the costly need to transport diesel fuel for generators with affordable, reliable solar power.

Our Approach

Through our collaboration with Tesla, our vertically-integrated offerings enable our customers to lower their energy costs with distributed solar energy in a simple and efficient process. We have disrupted the industry status quo by providing renewable energy directly to customers, typically for less than they are currently paying for utility-generated energy. Unlike utilities, we provide energy with a predictable cost structure that does not rely on limited fossil fuels and is insulated from rising retail electricity prices. We also provide assurances to our customers as to the amount of electricity produced by our solar energy systems. Our strategy is to create a best-in-class vertically-integrated operation focused on leveraging differentiated technology and our significant scale to lead the way in driving down the cost of solar energy to an affordable level for more and more people across the country and, eventually, the world. By focusing on technology solutions, we are working to build a cleaner, more affordable, more resilient energy distribution grid. By putting cleaner and more affordable energy in the hands of the consumer, we are building a broad portfolio of customers with relationships we aim to retain for life and ultimately a network of distributed solar energy systems that could transform the way energy is delivered globally.

Our Financial Strategy and Product Offerings

SolarCity is an industry leader in offering innovative financing alternatives for our customers. In 2008, we launched the SolarLease, offering customers a fixed monthly fee at rates that typically translated into lower monthly utility bills with an electricity production guarantee from a SolarCity-owned system. This was followed in 2009 by the launch of the SolarPPA, a power purchase agreement charging customers a fee per kilowatt hour, or kWh, based on the amount of electricity produced by our solar energy systems at rates typically lower than their local utility rate. Our current standard SolarLease and SolarPPA offerings have 20-year terms, and we typically offer the opportunity to renew for up to an additional 10 years. In 2014, we launched our first loan product with a SolarCity-financed loan allowing customers to finance the purchase of a solar energy system, and we followed that in 2016 with our current Solar Loan product. Our current Solar Loan offers third-party financing alternatives to finance the purchase of a solar energy system and allow customers to take direct advantage of federal tax credits to reduce their electricity costs.

 

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Our long-term SolarLeases and SolarPPAs create high-quality recurring payments, investment tax credits, accelerated tax depreciation and other incentives. We perceive our recurring customer payments as high-quality assets because electricity is a necessity, and our customers typically include individuals with high credit scores, commercial businesses and government agencies. In addition, we have experienced extremely low historic default rates on payments from our customers, with average net loss rates in 2016 less than 1%. Our financial strategy is to monetize these assets at the lowest cost of capital. We share the economic benefit of this lower cost of capital with our customers by lowering the price they pay for energy.

Historically, we have monetized the assets created by our customer agreements through financing funds we have formed with fund investors and by leveraging the value of our residual interests. In general, we contribute and sell solar assets to the financing funds in exchange for upfront cash and a residual interest. The allocation of the economic benefits, as well as the timing of receipt of such economic benefits, among us and the fund investors varies depending on the structure of the financing fund. We use the cash received from financing funds and borrowings against the value of our residual interests to cover costs associated with installing the related solar energy systems. At the end of 2016, we had over 54 financing funds with 22 different investors, comprised mostly of large financial institutions and large blue chip corporations, and had engaged in a number of long-term strategic transactions, including securitization and cash equity transactions.

Our customer base is comprised primarily of residential homeowners, commercial businesses, schools and universities, and federal, state and local government entities.  We have completed installations in 28 states, the District of Columbia, Puerto Rico, Canada and Mexico, and maintain operations centers across the United States. We generally group our commercial, educational and governmental customers together for our internal customer management purposes. We intend to expand our footprint domestically and internationally wherever distributed solar energy generation is a viable economic alternative to utility generation.

In addition, we are continuing to develop proprietary microgrid and other battery management systems designed to work seamlessly with Tesla energy storage products to enable remote, fully bidirectional control of distributed energy storage that can potentially provide significant benefits to our customers, utilities and grid operators.

We are organized and operate in a single segment. See Note 2 to our consolidated financial statements included in Part II, Item 8 of this annual report on Form 10-K.

Operations and Suppliers

We purchase major components such as solar panels and inverters directly from multiple manufacturers. As of December 31, 2016, our primary solar panel suppliers were Canadian Solar Inc., Trina Solar Limited, REC Americas LLC, Hanwha Q-Cells America, and LG Electronics, among others, and our primary inverter suppliers were ABB Inc., SolarEdge Technologies, Inc., Fronius USA, LLC, Solectria Renewables, LLC and Delta Electronics, among others. We typically enter into master contractual arrangements with our major suppliers that define the general terms and conditions of our purchases, including warranties, product specifications, indemnities, delivery and other customary terms. We typically purchase solar panels and inverters on an as-needed basis from our suppliers at then-prevailing prices pursuant to purchase orders issued under our master contractual arrangements.

In December 2016, we entered into long-term agreements with Panasonic to manufacture custom solar cells and solar panels at the Riverbend manufacturing facility located in Buffalo, New York, with negotiated pricing provisions and the intent to manufacture 1 Gigawatt of solar panels annually.

We offer a range of warranties and performance guarantees for our solar energy systems. We generally provide warranties of between 10 to 30 years on the generating and non-generating parts of the solar energy systems we sell, together with a pass-through of the inverter and module manufacturers’ warranties that generally range from 5 to 30 years. Where we sell the electricity generated by a solar energy system, we compensate customers if their system produces less energy over a specified performance period than our guarantee. We also provide ongoing service and repair during the entire term of the customer relationship. Costs associated with such ongoing service and repair have not been material to date, but are expected to increase as our customer base expands, inverters require replacement and the systems age.

Competition

We believe our primary competitors are the traditional local utilities that supply energy to our potential customers. We compete with these traditional utilities primarily based on price, predictability of price and the ease by which customers can switch to electricity generated by our solar energy systems rather than fossil based alternatives. We believe that our favorable pricing and focus on lifetime customer relationships allows us to compete favorably with traditional utilities in the regions we service.

 

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We also compete with companies that provide products and services in distinct segments of the downstream solar energy and energy-related products value chain. Many companies only install solar energy systems, while others only provide financing for these installations. In the residential solar energy system installation market, our primary competitors include Vivint Solar Inc., Sunrun Inc., Trinity Solar, Sungevity, Inc., and many smaller local solar companies. In the commercial solar energy system installation market, our competitors include SunPower Corporation, Safari Energy, Greenskies Renewable Energy, Borrego Solar Systems, Inc and numerous other companies.

We believe that our favorable pricing, focus on lifetime customer relationships, and integrated customer-facing approach to delivering solar energy allows us to compete favorably with these companies. While we offer in-house sales, financing, engineering, installation, monitoring, and operations and maintenance, many of our competitors offer only a subset of the products and services we provide.

Intellectual Property

Our intellectual property is an essential element of our business, and our success depends, at least in part, on our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of patent, trade secret, trademark, copyright and other intellectual property laws, confidentiality agreements and license agreements to establish and protect our intellectual property rights.

As of December 31, 2016, SolarCity and our wholly owned subsidiaries had approximately 131 issued patents and 296 patent applications pending with the U.S. Patent and Trademark Office, 64 patents issued/registered and 135 patent applications pending with foreign patent and trademark offices. These patent assets cover various SolarCity technologies, such as solar cells, installation and mounting hardware, financial products, electrical hardware, monitoring solutions and related software. Our issued patents start expiring in 2025. SolarCity intends to continue to file additional patent applications. In addition, SolarCity and our wholly owned subsidiaries had approximately 60 trademark registrations and 46 pending trademark applications. SolarCity’s registered and unregistered trademarks in the United States and in certain other countries cover, for example, “SolarCity” and “SolarCity and Sun logo.”

All of our employees and independent contractors are required to sign agreements acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property and assigning to us any ownership that they may claim in those works.

Securing Our Solar Energy Systems

For solar energy systems installed under our SolarLease and SolarPPA, we file a uniform commercial code financing statement, or UCC-1, on the systems in the real property records where each system is located prior to or when the system is installed. We file the UCC-1 to provide notice of our interests in the solar energy system to anyone who might perform a title search on the address where the system is located.

A UCC-1 fixture filing is not a lien against a customer’s home and does not entitle us to the proceeds of the sale of a home in foreclosure. Typically, when a foreclosed home is sold by the lender, we negotiate with the prospective buyer to assume the existing agreement.  We believe the prospective buyer is generally motivated to assume the existing agreement to receive its benefits. The number of solar energy systems identified for recovery has been immaterial to date.

Government Regulation

We are not a “regulated utility” in the United States under applicable national, state or other local regulatory regimes where we conduct business. For our limited operations in Ontario, Canada, our subsidiary is subject to the regulations of the relevant energy regulatory agencies applicable to all producers of electricity under the relevant feed-in tariff, or FIT, regulations, including the FIT rates.

To operate our systems, we obtain interconnection agreements from the applicable local primary electricity utility. Depending on the size of the solar energy system and local law requirements, interconnection agreements are between the local utility and either us or our customer. In almost all cases, interconnection agreements are standard form agreements that have been pre-approved by the local public utility commission or other regulatory body with jurisdiction over interconnection agreements. As such, no additional regulatory approvals are required once interconnection agreements are signed. We maintain a utility administration function, with primary responsibility for engaging with utilities and ensuring our compliance with interconnection rules.

Our operations are subject to stringent and complex federal, state and local laws and regulations governing the occupational health and safety of our employees, wage regulations and environmental regulations. For example, we are subject to the requirements

 

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of the federal Occupational Safety and Health Act, as amended, or OSHA, and comparable state laws that protect and regulate employee health and safety. We have a robust safety department led by safety professionals, and we expend significant resources to comply with these regulations, requirements and industry best practices.

Federal and/or state prevailing wage requirements, which generally apply to any “public works” construction project that receives public funds, may apply to installations of our solar energy systems on government facilities. The prevailing wage is the basic hourly rate paid on public works projects to a majority of workers engaged in a particular craft, classification or type of work within a particular area. Prevailing wage requirements are established and enforced by regulatory agencies. Our in-house prevailing wage personnel monitor and coordinate our continuing compliance with these regulations.

Government Incentives

U.S. federal, state and local governments have established various policies, incentives and financial mechanisms to reduce the cost of solar energy and to accelerate the adoption of solar energy. These incentives include tax credits, cash grants, tax abatements and rebates. These incentives help catalyze private sector investments in solar energy, energy efficiency and energy storage measures, including the installation and operation of residential and commercial solar energy systems.

The federal government currently provides an uncapped investment tax credit, or Federal ITC, under two sections of the Internal Revenue Code of 1986, as amended, or IRC: Section 48 and Section 25D, both of which were modified and extended at the end of 2015.

Section 48(a)(3) of the IRC allows a taxpayer to claim a credit of 30% of qualified expenditures for a commercial solar energy system that commences construction by December 31, 2019. The credit then declines to 26% for systems that commence construction by December 31, 2020 and to 22% for systems that commence construction by December 31, 2021.  The credit is scheduled to decline to a permanent 10% effective January 1, 2022. Historically, we have utilized the Section 48 commercial credit when available for both our residential and commercial projects, based on ownership of the solar energy system. The federal government also provides accelerated depreciation for eligible commercial solar energy systems.

Section 25D of the IRC allows a taxpayer to claim a credit for a residential solar energy system that is owned by the homeowner. This credit is available at 30% for systems that are placed in service by December 31, 2019, at 26% for systems placed in service in 2020, and at 22% for systems placed in service in 2021.  The credit is scheduled to expire effective January 1, 2022. Customers who purchase their solar energy systems for cash or through our Solar Loan are eligible to claim the Section 25D investment tax credit.

Approximately half of U.S. states offer a personal and/or corporate investment or production tax credit for solar, which are additive to the Federal ITC. Further, more than half of U.S. states, and many local jurisdictions, have established property tax incentives for renewable energy systems, which include exemptions, exclusions, abatements and credits.

Some utilities offer rebates or other cash incentives for the installation and operation of a solar energy system or energy-related products. Capital costs or “up-front” rebates provide payments to solar customers based on the cost, size or expected production of a customer’s solar energy system. Performance-based incentives provide cash payments to a system owner based on the energy generated by their solar energy system during a pre-determined period, and they are paid over that time period.

Forty-one states, Washington, D.C. and Puerto Rico have a form of regulatory policy known as net energy metering, or net metering, available to new solar customers. Net metering typically allows solar customers to interconnect their on-site solar energy systems to the utility grid and offset their utility electricity purchases by receiving a bill credit at the utility’s retail rate for energy generated by their solar energy system that is exported to the grid in excess of electric load used by customers. Each of the states where we currently serve customers has adopted a net metering policy except for Texas, where certain individual utilities have adopted net metering or a policy similar to net metering. Typically, at the end of the billing period, the customer simply pays for the net energy used or receives a credit at the retail rate if more energy is produced than consumed.

Some states have established limits on net metering. For example, in October 2015, the Hawaii Public Utilities Commission capped the state’s net metering program at existing levels and net metering no longer is available to new customers. In late December 2015, the Nevada Public Utilities Commission (PUCN) also effectively capped the state’s net metering program at existing levels and net metering no longer was available to new customers. At that time, the PUCN also adopted new rules that include significant additional monthly charges on customers who interconnect their solar energy systems, and a significant reduction in the amount of bill credit customers receive for energy generated by their solar energy system that is exported to the grid in excess of electric load used by customers. Subsequently, the PUCN modified portions of the new rules to be more favorable for solar customers, including

 

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providing grandfathering treatment for existing net metering customers and reopening a specified capacity of net metering for new customers in northern Nevada. However, at this time net metering still is not available to new customers in southern Nevada.

California investor-owned utilities are required to provide net metering to their customers until the total generating capacity of net metered systems exceeds 5% of the utilities’ “aggregate customer peak demand.” In January 2016, the California Public Utilities Commission established a new net metering program requiring that customers utilize a time-of-use tariff, with no participation cap that will apply after the utility’s 5% cap on the original net metering program is reached. PG&E and SDG&E have reached their 5% caps on the original program and now offer the uncapped new net metering program to new customers.

Sales of electricity and non-sale equipment leases by third-parties, such as our SolarLeases and SolarPPAs, face regulatory challenges in some states and jurisdictions. Other challenges pertain to whether third-party owned systems qualify for the same levels of rebates or other non-tax incentives available for customer-owned solar energy systems, and whether third-party owned systems are eligible for these incentives.

Many states also have adopted procurement requirements for renewable energy production, such as an enforceable renewable portfolio standard, or RPS, or other mandated renewable capacity policy that requires covered entities to procure a specified percentage of total electricity delivered to customers in the state from eligible renewable energy sources, such as solar energy systems, by a specified date. In addition, several other states have set voluntary goals for renewable generation. Many states with RPS policies require a minimum portion of the RPS be met by solar, with substantial penalties for non-compliance. To prove compliance with such mandates, utilities typically must surrender renewable energy certificates. A solar renewable energy certificate, or SREC, is a tradable credit that represents all of the clean energy benefits of electricity generated from a solar energy system. Every time a solar energy system generates 1,000 kWh of electricity, one SREC is issued or minted by a government agency. The SREC can then be sold or traded separately from the energy produced, generally through brokers and dealers facilitating individually negotiated bilateral arrangements. SRECs are primarily valuable because they help utilities and other energy suppliers comply with RPS standards.

Employees

As of December 31, 2016, we had approximately 12,243 total employees. Approximately 5,332 worked in operations, installations and manufacturing; 4,155 in various sales and marketing related departments and 2,756 in general and administrative and research and development related departments. Our employees are not currently represented by any labor union or subject to any collective bargaining agreement. We have not experienced any work stoppages, and we consider our relationship with our employees to be good.

Corporate Information

We were incorporated in June 2006 as a Delaware corporation. In November 2016, we were acquired by, and now operate as a wholly owned subsidiary of, Tesla, Inc. Our headquarters are located at 3055 Clearview Way, San Mateo, California 94402, and our telephone number is (650) 638-1028. You can access our website at www.solarcity.com. Information contained on our website is not a part of, and is not incorporated into, this annual report on Form 10-K, and the inclusion of our website address in this annual report on Form 10-K is an inactive textual reference only. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Exchange Act are available free of charge on the Investors portion of the Tesla web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. You may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.

 

 

ITEM 1A. RISK FACTORS

You should carefully consider the risks described below, together with the other information contained in this annual report on Form 10-K, including our consolidated financial statements and related notes. The risks described below are not the only risks facing our company. Any of the following risks and additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition, results or operations. In such case, our ability to repay borrowed amounts when due may be impaired, and you may lose all or part of your original investment.

 

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Risks Related to our Operations

Existing electric utility industry regulations, and changes to regulations, may present technical, regulatory and economic barriers to the purchase and use of solar energy systems that may significantly reduce demand for our solar energy systems or adversely impact the economics of existing energy contracts.

Federal, state and local government regulations and policies concerning the electric utility industry, utility rate structures, interconnection procedures, internal policies and regulations promulgated by electric utilities, heavily influence the market for electricity generation products and services. These regulations and policies often relate to electricity pricing and the interconnection of customer-owned electricity generation. In the United States, governments and utilities continuously modify these regulations and policies. These regulations and policies could deter potential customers from purchasing renewable energy, including solar energy systems. This could result in a significant reduction in demand for our solar energy systems. For example, utilities commonly charge fees to large, industrial customers for disconnecting from the electric grid or for having the capacity to use power from the electric grid for back-up purposes. These fees could increase our customers’ cost to use our systems and make our product offerings less desirable, thereby harming our business, prospects, financial condition and results of operations. In addition, depending on the region, electricity generated by solar energy systems competes most effectively with higher priced peak-hour electricity from the electric grid, rather than the lower average price of electricity. Modifications to the utilities’ peak-hour pricing policies or other electricity rate designs, such as a lower volumetric rate, would require us to lower the price of our solar energy systems to compete with the price of electricity from the electric grid.

Future changes to government or internal utility regulations and policies could also reduce our competitiveness, cause a significant reduction in demand for our products and services, and threaten the economics of our existing energy contracts. For example, in October 2015, the Hawaii Public Utilities Commission capped the state’s net metering program at existing levels and net energy metering no longer is available to new customers.

In other jurisdictions, it has been proposed that additional fees and other charges be assessed on customers purchasing energy from solar energy systems. In particular, the Salt River Project, or SRP, in Arizona has imposed anticompetitive penalties on new solar customers in an attempt to exclude rooftop solar, and in response in March 2015 we filed a lawsuit in federal court in Arizona, asking the court to stop SRP’s anti-competitive behavior. In 2016, seventy one actions relating to fixed charges were taken by utilities around the country.  In the event that effective net metering programs are limited in California, Arizona and other key markets or any such fees or charges are imposed, our ability to attract new customers and compete with the price of electricity generated by local utilities in these jurisdictions may be severely limited, and such unaccounted for increases in the fees or charges applicable to existing customer agreements may increase the cost of energy to those customers and result in an increased rate of defaults under our customer agreements. Any of these results could reduce demand for our solar energy systems, harm our business, prospects, financial condition and results of operations.

We rely on net metering and related policies to offer competitive pricing to our customers in our key states.

Forty-one states, Washington, D.C. and Puerto Rico have a regulatory policy known as net energy metering, or net metering, available to new customers. Each of the states where we currently serve customers has adopted a net metering policy except for Texas, where certain individual utilities have adopted net metering or a policy similar to net metering. Net metering typically allows our customers to interconnect their on-site solar energy systems to the utility grid and offset their utility electricity purchases by receiving a bill credit at the utility’s retail rate for energy generated by their solar energy system that is exported to the grid in excess of the electric load used by the customers. At the end of the billing period, the customer simply pays for the net energy used or receives a credit at the retail rate if more energy is produced than consumed. Utilities operating in states without a net metering policy may receive solar electricity that is exported to the grid when there is no simultaneous energy demand by the customer without providing retail compensation to the customer for this generation.

Our ability to sell solar energy systems and the electricity they generate may be adversely impacted by the failure to expand existing limits on the amount of net metering in states that have implemented it, the failure to adopt a net metering policy where it currently is not in place, the imposition of new charges that only or disproportionately impact customers that utilize net metering or reductions in the amount or value of credit that customers receive through net metering. Our ability to sell solar energy systems and the electricity they generate may also be adversely impacted by the unavailability of expedited or simplified interconnection for grid-tied solar energy systems or any limitation on the number of customer interconnections or amount of solar energy that utilities are required to allow in their service territory or some part of the grid. In addition, utilities in some states, such as SRP in Arizona, imposed additional monthly charges on customers who interconnect solar energy systems installed on their homes. If such charges are imposed, the cost savings associated with switching to solar energy may be significantly reduced and our ability to attract future customers and compete with traditional utility providers could be impacted.  If such charges are imposed on existing customers in a way that adversely impacts the economics of existing energy contracts, we could further see an increase in the default rate of existing energy contracts or we may find it necessary to renegotiate our pricing of affected customers.

 

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Limits on net metering, interconnection of solar energy systems and other operational policies in key markets could limit the number of solar energy systems installed in those markets. For example, in late December 2015, the Nevada Public Utilities Commission (PUCN) effectively capped the state’s net metering program at existing levels and net metering no longer was available to new customers. Subsequently, the PUCN modified portions of the new rules to be more favorable for solar customers, including providing grandfathering treatment for existing net metering customers and reopening a specified capacity of net metering for new customers in northern Nevada. However, at this time net metering still is not available to new customers in southern Nevada. If the caps on net metering in key markets are reached and not extended or if the amount or value of credit that customers receive for net metering is significantly reduced or eliminated, future customers will be unable to recognize the current cost savings associated with net metering and existing customers may not recognize the economic benefits that were available at the time their energy contracts were entered into. We rely substantially on net metering when we establish competitive pricing for our prospective customers and the absence of net metering for new customers could greatly limit demand for our solar energy systems.

Regulatory limitations associated with technical considerations may significantly limit our ability to sell electricity from our solar energy systems in certain states.

Regulatory limits associated with technical considerations may curb our growth in certain key states. For example, the Federal Energy Regulatory Commission has promulgated small generator interconnection procedures that recommend limiting customer-sited intermittent generation resources, such as our solar energy systems, to a certain percentage of peak load on a given electrical feeder circuit. Similar limits have been adopted by various states and could constrain our ability to market to customers in certain geographic areas where the concentration of solar installations exceeds the limit. For example, Hawaiian electric utilities have adopted certain policies that limit distributed electricity generation in certain geographic areas. While these limits have constrained our growth in certain parts of Hawaii, policy developments in Hawaii generally have allowed distributed electricity generation penetration despite the electric utility-imposed limitations. Furthermore, in certain areas, we benefit from policies that allow for expedited or simplified procedures related to connecting solar energy systems to the power grid. If such procedures are changed or cease to be available, our ability to sell the electricity generated by solar energy systems we install may be adversely impacted. As adoption of solar distributed generation increases, along with the operation of large-scale solar generation in key markets such as California, the amount of solar energy being fed into the power grid may surpass the amount planned for relative to the amount of aggregate demand. Some utilities claim that within several years, solar generation resources may reach a level capable of causing an over-generation situation that could require some solar generation resources to be curtailed to maintain operation of the grid. The adverse effects of such curtailment without compensation could adversely impact our business, results of operations and future growth.

Our business currently depends on the availability of rebates, tax credits and other financial incentives. The expiration, elimination or reduction of these rebates, credits and incentives may adversely impact our business.

U.S. federal, state and local government bodies provide incentives to end users, distributors, system integrators and manufacturers of solar energy systems to promote solar electricity in the form of rebates, tax credits and other financial incentives such as system performance payments, payments for renewable energy credits associated with renewable energy generation and the exclusion of solar energy systems from property tax assessments. We rely on these governmental rebates, tax credits and other financial incentives to lower our cost of capital and to encourage fund investors to invest in our funds. These incentives enable us to lower the price we charge customers for energy and for our solar energy systems. However, these incentives may expire on a particular date, end when the allocated funding is exhausted or be reduced or terminated as solar energy adoption rates increase. These reductions or terminations often occur without warning.

The federal government currently offers a 30% investment tax credit under Section 48(a)(3) and Section 25D of the IRC, or the Federal ITC, for the installation of certain solar power facilities. Additionally, under Section 48, energy storage systems that are installed at the time of the solar power facility and, as required by IRS guidelines, store the energy of the solar power facility, are also eligible for the Federal ITC.

The credit under Section 48(a)(3) has been modified to remain at 30% of qualified expenditures for a commercial solar energy system that commences construction by December 31, 2019, then decline to 26% for systems that commence construction by December 31, 2020 and to 22% for systems that commence construction by December 31, 2021.  The credit is scheduled to decline to a permanent 10% effective January 1, 2022.  Historically, we have utilized the Section 48 commercial credit when available for both our residential and commercial leases and power purchase agreements, based on ownership of the solar energy system.

The credit under Section 25D has been modified to remain 30% of qualified expenditures for a residential solar energy system owned by the homeowner that is placed in service by December 31 2019, then decline to 26% for systems placed in service by December 21, 2020, and to 22% for systems placed in service by December 31, 2021.  The credit is scheduled to expire effective January 1, 2022. Loan product customers can currently claim the Section 25D investment tax credit. Customers who purchase their solar energy systems for cash are also eligible to claim the Section 25D investment tax credit.

 

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Reductions in, eliminations of, or expirations of, governmental incentives could adversely impact our results of operations and ability to compete in our industry by increasing our cost of capital, causing us to increase the prices of our energy and solar energy systems and reducing the size of our addressable market. In addition, this would adversely impact our ability to attract investment partners and to form new financing funds and our ability to offer attractive financing to prospective customers.

Our business depends in part on the regulatory treatment of third-party owned solar energy systems.

Our leases and power purchase agreements are third-party ownership arrangements. Sales of electricity by third-parties face regulatory challenges in some states and jurisdictions. Other challenges pertain to whether third-party owned systems qualify for the same levels of rebates or other non-tax incentives available for customer-owned solar energy systems, whether third-party owned systems are eligible at all for these incentives and whether third-party owned systems are eligible for net metering and the associated significant cost savings. In some states and utility territories, third-parties that own solar energy systems are limited in the way that they may deliver solar energy to their customers. In jurisdictions such as Arizona, Florida, Kentucky, North Carolina, Oklahoma and the Los Angeles Department of Water and Power service territory, laws have been interpreted to prohibit the sale of electricity pursuant to our standard power purchase agreement. This has led us and other solar energy system providers that utilize third-party ownership arrangements to offer leases rather than power purchase agreements in such jurisdictions. Imposition of such limitations in additional jurisdictions or reductions in, or eliminations of, incentives for third-party owned systems could reduce demand for our systems, adversely impact our access to capital and cause us to increase the price we charge our customers for energy.

We need to enter into additional substantial financing arrangements to facilitate our customers’ access to our solar energy systems, and if this financing is not available to us on acceptable terms, if and when needed, our ability to grow our business would be materially adversely impacted.

Our future success depends on our ability to raise capital from third-party fund investors to help finance the deployment of our residential and commercial solar energy systems. In particular, our strategy is to reduce the cost of capital through these arrangements to improve our margins, offset future reductions in government incentives and maintain the price competitiveness of our solar energy systems. If we are unable to establish new financing funds for third-party ownership arrangements when needed, or on desirable terms, to enable our customers’ access to our solar energy systems with little or no upfront cost, we may be unable to finance installation of our customers’ systems, or our cost of capital could increase and our liquidity may be significantly constrained, any of which would have a material adverse effect on our business, financial condition and results of operations. To date, we have raised capital sufficient to finance installation of our customers’ solar energy systems from a number of financial institutions and other large companies (including some that may be considered competitors to Tesla). In the past, challenges raising new funds have caused us to delay customer installations for brief periods of time.

The availability of this tax-advantaged financing depends upon many factors, including:

 

the continued confidence of banks and other financing sources in the solar energy industry and the quality of our customer contracts;

 

the state of financial and credit markets, and the liquidity needs of banks and other financing sources;

 

our ability to compete with other renewable energy companies for the limited number of potential fund investors, each of which has limited funds and limited appetite for the tax benefits associated with these financings;

 

changes in the legal or tax risks associated with these financings;

 

non-renewal of government incentives or decreases in the associated benefits; and

 

no adverse changes in the regulatory environment affecting the economics of our existing energy contracts.

Under current law, the Federal ITC will be reduced from 30% of the cost of solar energy systems to 26% of the cost of solar energy systems for systems that commence construction by December 31, 2020, and then reduced again to 22% of the cost of solar energy systems for systems that commence construction by December 31, 2021, until the Section 25D investment tax credit expires and the Section 48(a)(3) investment tax credit declines to a permanent 10% effective January 1, 2022.

In addition, U.S. Treasury grants are no longer available for new solar energy systems. Moreover, potential fund investors must remain satisfied that the structures we offer make the tax benefits associated with solar energy systems available to these investors, which depends both on the investors’ assessment of the tax law and the absence of any unfavorable interpretations of that law. Changes in existing law and interpretations by the Internal Revenue Service and the courts could reduce the willingness of fund investors to invest in funds associated with these solar energy system investments. In addition, changes by state energy regulators impairing the economics of existing energy contracts causing an increased risk of default may also reduce the willingness of fund investors to invest. We cannot assure you that this type of financing will be available to us. If, for any reason, we are unable to finance

 

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solar energy systems through tax-advantaged structures or if we are unable to realize or monetize depreciation benefits, we may no longer be able to provide solar energy systems to new customers on an economically viable basis. This would have a material adverse effect on our business, financial condition and results of operations.

Solar energy has yet to achieve broad market acceptance and depends on continued support in the form of performance-based incentives, rebates, tax credits and other incentives from federal, state, local and foreign governments. If this support diminishes, our ability to obtain external financing, on acceptable terms or otherwise, could be materially adversely affected.

Our ability to draw on financing commitments is subject to the conditions of the agreements underlying our financing funds, including the mix of types of energy contracts that we contribute and measures of customer credit. If we do not satisfy such conditions due to events related to our business or a specific financing fund, developments in our industry (including related to the Department of Treasury Inspector General investigation) or otherwise, and as a result we are unable to draw on existing commitments, it could have a material adverse effect on our business, liquidity, financial condition and prospects. If any of the financial institutions or large companies that currently invest in our financing funds decide not to invest in future financing funds due to general market conditions, concerns about our business or prospects, the pendency of the Department of Treasury Inspector General investigation or any other reason, or materially change the terms under which they are willing to provide future financing, we may be unable to raise sufficient financing to engage in the third-party ownership arrangements that have fueled our growth to date.

Servicing our debt requires a significant amount of cash and we may not have sufficient cash flow from our business to pay our substantial debt; other actions we are forced to take to satisfy our obligations under our indebtedness may not be successful.

Our total consolidated indebtedness was $3,580.4 million as of December 31, 2016, representing outstanding recourse indebtedness of $1,628.8 million and non-recourse indebtedness of $1,951.6 million.

While our non-recourse credit facilities have been structured to be supported solely by the assets that are pledged as collateral, and, to date, we have not experienced any failure to pay such non-recourse indebtedness, our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness depends on such factors as:

 

our future operational and financial performance;

 

global economic, financial, competitive and other factors beyond our control;

 

incorrect assumptions as to the amount of future cash flows to be produced by the solar assets subject to the non-recourse credit facilities;

 

the potential for widespread failure of solar energy systems and related components due to product defects;

 

the potential of widespread disasters for which our insurance coverage proves to be insufficient; and

 

changes in laws, regulations or policies that adversely affect the treatment of third-party owned solar energy systems.

As a result of these and other factors, our business may not be able to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. In addition, we may not fully achieve the full anticipated benefits and other cost reductions as a result of our acquisition by Tesla.  If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as reducing our operations and operating expenses, selling assets, restructuring debt or obtaining additional capital on terms that may be onerous.

Our ability to refinance our existing indebtedness will depend on the financial markets and our financial condition at such time, and the occurrence of certain events and concerns regarding our business and liquidity, and general market conditions may make it difficult for us to access the financial markets or to refinance our existing indebtedness or raise additional funds on acceptable terms. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations or otherwise significantly limit our ability to respond to periods of increased liquidity pressure.

We expect to incur substantially more debt or take other actions which would intensify the risks discussed above.

A major part of our financial strategy is to monetize the customer payments and incentives associated with the deployment of solar energy systems under our third-party ownership arrangements through non-recourse borrowings against our interests to finance our operations. We and our subsidiaries expect to incur substantial additional non-recourse debt in the future, subject to the restrictions contained in our debt instruments, some of which may be secured debt. Incurring such additional debt could have the effect of diminishing our ability to make payments on existing indebtedness when due, and otherwise limiting our ability to respond to periods of increased liquidity pressure. Although certain of our existing credit facilities restrict our ability to incur additional indebtedness, including recourse and secured indebtedness, we may be able to obtain amendments and waivers of such restrictions or may not be

 

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subject to such restrictions under the terms of any subsequent indebtedness. As the total amount of indebtedness we carry increases, we may be unable to enter into new credit facilities or refinance existing credit facilities and other indebtedness on acceptable terms, any such failure could constrain our liquidity and adversely impact our business, results of operations and future growth.

We may have trouble refinancing our existing indebtedness or obtaining new financing for our working capital, equipment financing and other needs in the future or complying with the terms of existing credit facilities. If credit facilities are not available to us on acceptable terms, if and when needed, or if we are unable to comply with their terms, our ability to respond to periods of constrained liquidity and to operate our business in accordance with current operating plans would be adversely impacted.

As of December 31, 2016, we had the ability to draw up to an additional $468.0 million under all of our credit facilities. Our secured revolving credit facility, our primary working capital facility, currently has a maximum size of $500 million (with $393.5 million currently committed from several lenders and an additional $106.5 million subject to further conditions) that matures in December 2017. The working capital facility requires us to comply with certain financial, reporting and other requirements. During the first and second quarters of 2016, the margins of our compliance with these financial covenants decreased, particularly with respect to the amount of unencumbered liquidity. While our lenders have given us waivers of certain covenants we have not satisfied in the past, there is no assurance that the lenders will waive or forbear from exercising their remedies with respect to any future defaults that might occur.

If we are unable to satisfy financial covenants and other terms under existing or new facilities, obtain associated waivers or forbearance from our lenders, or if we are unable to obtain refinancing or new financings for our working capital, equipment, convertible senior notes and other needs on acceptable terms if and when needed, our business would be adversely affected.

Although our acquisition by Tesla in an all-stock transaction did not result in a “fundamental change,” we continue to be responsible for payments of interest during the term and may need to repay principal at maturity unless the stock price of Tesla significantly appreciates and the convertible senior notes are converted into Tesla common stock. We may need to refinance the convertible senior notes. Our failure to pay amounts when due or repurchase the convertible senior notes when required would constitute a default which could also result in defaults under other agreements governing our existing or future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the convertible senior notes.

We have incurred losses and may be unable to achieve or sustain profitability in the future.

We have incurred net losses in the past, and we had an accumulated deficit of $77.9 million as of December 31, 2016. We may continue to incur net losses from operations if we are unable to fully achieve the anticipated benefits of our acquisition by Tesla, or if we increase our spending to finance any expansion of our operations, engage in additional product development activities (including solar-integrated roofing products) and implement internal systems and infrastructure to support our growth. We do not know whether our revenue will grow rapidly enough to absorb these costs, and our limited operating history in many of these areas makes it difficult to assess the extent of these expenses or their impact on our operating results. Our ability to achieve profitability depends on a number of factors, including:

 

successful integration with Tesla;

 

growing our customer base;

 

increasing the mix of cash sales and loans;

 

finding investors willing to invest in our financing funds;

 

maintaining and further lowering our cost of capital; and

 

reducing the cost of components for our solar energy systems.

Even if we do achieve profitability, we may be unable to sustain or increase our profitability in the future.

The Office of the Inspector General of the U.S. Department of Treasury has issued subpoenas to a number of significant participants in the solar energy installation industry, including us. The subpoena we received requires us to deliver certain documents in our possession relating to our participation in the U.S. Treasury grant program. These documents are being delivered to the Office of the Inspector General of the U.S. Department of Treasury, which is investigating the administration and implementation of the U.S. Treasury grant program.

In July 2012, we and other companies that are significant participants in both the solar industry and the cash grant program under Section 1603 of the American Recovery and Reinvestment Act of 2009 received subpoenas from the U.S. Department of

 

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Treasury’s Office of the Inspector General to deliver certain documents in our respective possession. In particular, our subpoena requested, among other things, documents dated, created, revised or referred to since January 1, 2007 that relate to our applications for U.S. Treasury grants or communications with certain other solar companies or certain firms that appraise solar energy property for U.S. Treasury grant application purposes. The Inspector General is working with the Civil Division of the U.S. Department of Justice to investigate the administration and implementation of the U.S. Treasury grant program, including possible misrepresentations concerning the fair market value of the solar power systems submitted for grant under that program made in grant applications by solar companies, including us. We intend to cooperate fully with the Inspector General and the Department of Justice and continue to produce information as requested by the Inspector General. We are unable to anticipate when the Inspector General will conclude its review. If, at the conclusion of the investigation, the Inspector General concludes that misrepresentations were made, the Department of Justice could bring a civil action to recover amounts it believes were improperly paid to us. If the Department of Justice were successful in asserting such an action, we could then be required to pay damages and penalties for any funds received based on such misrepresentations (which, in turn, could require us to make indemnity payments to certain of our fund investors). Such consequences could have a material adverse effect on our business, liquidity, financial condition and prospects. Additionally, the period of time necessary to resolve the investigation is uncertain and this matter could require significant management and financial resources that could otherwise be devoted to the operation of our business.

If the Internal Revenue Service or the U.S. Treasury Department makes additional determinations that the fair market value of our solar energy systems is materially lower than what we have claimed, we may have to pay significant amounts to our financing funds or to our fund investors and such determinations could have a material adverse effect on our business, financial condition and prospects.

We and our fund investors claim the Federal ITC or the U.S. Treasury grant in amounts based on the fair market value of our solar energy systems. We have obtained independent appraisals to support the fair market values we report for claiming Federal ITCs and U.S. Treasury grants. The Internal Revenue Service and the U.S. Treasury Department review these fair market values. With respect to U.S. Treasury grants, the U.S. Treasury Department reviews the reported fair market value in determining the amount initially awarded. The Internal Revenue Service and the U.S. Treasury Department may subsequently audit the fair market value and determine that amounts previously awarded must be repaid to the U.S. Treasury Department or that excess awards constitute taxable income for U.S. federal income tax purposes. A small number of our financing funds are undergoing such audits. With respect to Federal ITCs, the Internal Revenue Service may review the fair market value on audit and determine that the tax credits previously claimed must be reduced. If the fair market value is determined to be less than we reported, we may owe our financing fund or fund investors an amount equal to this difference, plus any costs and expenses associated with a challenge to that valuation. We could also be subject to tax liabilities, including interest and penalties.

The U.S. Treasury Department has previously determined to award U.S. Treasury grants for some of our solar energy systems at a materially lower value than we had established in our appraisals. As a result, we have been required to pay our fund investors a true-up payment or contribute additional assets to the associated financing funds. It is possible that the U.S. Treasury Department will make similar determinations in the future. In response to such shortfalls, two of our financing funds filed a lawsuit in the United States Court of Federal Claims to recover the difference between the U.S. Treasury grants they sought and the amounts the U.S. Treasury paid; to the extent that these lawsuits are successful, any recovery would be used to repay us for amounts we previously reimbursed those funds. Our fund investors have contributed to our financing funds at the amounts the U.S. Treasury Department most recently awarded on similarly situated energy systems in order to reduce or eliminate the need for us to subsequently pay those fund investors true-up payments or contribute additional assets to the associated financing funds.

The Internal Revenue Service or the U.S. Treasury Department may object to the fair market value of solar energy systems that we have constructed, or will construct, including any systems for which grants have already been paid, as a result of:

 

any pending or future audit,

 

the outcome of the Department of Treasury Inspector General investigation, or

 

changes in guidelines or otherwise.

If the Internal Revenue Service or the U.S. Treasury Department were to object to amounts we have claimed as too high of a fair market value on such systems, it could have a material adverse effect on our business, financial condition and prospects. For example, a hypothetical 5% downward adjustment in the fair market value of the $501.2 million of U.S. Department of Treasury grant applications that have been awarded from the beginning of the U.S. Treasury grant program through December 31, 2016 would obligate us to repay up to $25.1 million to our fund investors.

 

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We have historically benefited from the declining cost of solar panels and other system components, and our business and financial results may be harmed as a result of increases in costs or tariffs imposed by the U.S. government on imported solar panels and other system components.

The declining cost of solar panels and the raw materials necessary to manufacture them has been a key driver in the pricing of our solar energy systems and customer adoption of this form of renewable energy. In the event of a significant increase of solar panel and raw materials prices, our ability to compete and our financial results could suffer. Further, the cost of solar panels and raw materials could potentially increase in the future due to a variety of factors which we cannot control, including the imposition of duties, subsidies and/or safeguards or other trade-related costs or penalties or shortages of essential components. Currently, global production of solar panels is at a point of oversupply, and prices are continuing to decline.  As we increase our solar panel manufacturing operations (including our manufacturing relationship with Panasonic and our solar-integrated roofing products), future price declines may harm our ability to compete and produce solar panels at prices equal to or less than our competitors.

The U.S. government imposes antidumping and countervailing duties on solar cells manufactured in China and/or Taiwan. Based on determinations by the U.S. government, the antidumping and countervailing duty rates range from approximately 33%-255%. Such antidumping and countervailing duties are subject to annual review and may be increased or decreased.

In addition, the U.S. government imposed additional tariffs on solar modules manufactured in China (with solar cells manufactured in other countries) and solar cells manufactured in Taiwan. In early January 2015, the U.S. government announced its affirmative final determinations in both the countervailing duty and antidumping cases against China and in the antidumping case against Taiwan.

Since these tariffs are reflected in the purchase price of the solar panels and cells, these tariffs are a cost associated with purchasing these solar products. In the past, we purchased a significant number of the solar panels used in our solar energy systems from manufacturers that were based in China. We continue to be affected by these tariffs/duties and any changes to them as many of the solar panels we currently purchase contain components, including solar cells, from China and Taiwan.

If additional tariffs are imposed or other negotiated outcomes occur, our ability to purchase these products on competitive terms or to access specialized technologies from countries like China and Taiwan could be limited. Further, foreign suppliers in other countries could also be the subject of these or future trade cases. Any of these events could harm our financial results by requiring us to account for the cost of trade penalties or to purchase and integrate solar panels or other system components from alternative and potentially higher-priced sources.

In September 2014, we acquired Silevo, a solar panel technology and manufacturing company with manufacturing operations in China. In May 2015, we were contacted by the U.S. Customs and Border Protection (CBP) to provide information regarding our importation of solar panels from China. Based upon the information we provided, CBP agreed that our solar panels were not subject to the scope of antidumping and countervailing duty Orders on Crystalline Silicon Photovoltaic Cells/Modules from China (Orders); however, CBP instructed us to obtain a determination from the Department of Commerce (DOC). In June 2016, the DOC issued its final determination finding that Silevo’s solar panels, manufactured in China, are within the scope of the antidumping and countervailing Orders. We are currently challenging that final determination in the Court of International Trade (CIT). However, until this issue is resolved, we have not and do not intend on importing Silevo solar panels produced in China for our U.S. operations without depositing the applicable antidumping and countervailing duties.

A material drop in the retail price of utility-generated electricity or electricity from other sources would harm our business, financial condition and results of operations.

We believe that a customer’s decision to buy renewable energy from us is primarily driven by their desire to pay less for electricity. The customer’s decision may also be affected by the cost of other renewable energy sources. Decreases in the retail prices of electricity from the utilities or other renewable energy sources would harm our ability to offer competitive pricing and could harm our business. The price of electricity from utilities could decrease as a result of:

 

the construction of a significant number of new power generation plants, including nuclear, coal, natural gas or renewable energy technologies;

 

the construction of additional electric transmission and distribution lines;

 

a reduction in the price of natural gas, including as a result of new drilling techniques or a relaxation of associated regulatory standards;

 

the development of energy conservation technologies and public initiatives to reduce electricity consumption; and

 

the development of new renewable energy technologies that provide less expensive energy.

 

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A reduction in utility electricity prices would make the purchase of our solar energy systems or the purchase of energy under our lease and power purchase agreements less economically attractive. In addition, a shift in the timing of peak rates for utility-generated electricity to a time of day when solar energy generation is less efficient could make our solar energy system offerings less competitive and reduce demand for our products and services. If the retail price of energy available from utilities were to decrease for any reason, we would be at a competitive disadvantage. As a result of these or similar events impacting the economics of our customer agreements, we may be unable to attract new customers and we may experience an increased rate of defaults under our existing customer agreements.

A material drop in the retail price of utility-generated electricity would particularly adversely impact our ability to attract commercial customers.

Commercial customers comprise a significant and growing portion of our business, and the commercial market for energy is particularly sensitive to price changes. Typically, commercial customers pay less for energy from utilities than residential customers. Because the price we are able to charge commercial customers is only slightly lower than their current retail rate, any decline in the retail rate of energy for commercial entities could have a significant impact on our ability to attract commercial customers. We may be unable to offer solar energy systems in commercial markets that produce electricity at rates that are competitive with the unsubsidized price of retail electricity. If this were to occur, our business would be harmed because we would be at a competitive disadvantage compared to other energy providers and may be unable to attract new commercial customers.

The terms of our agreement with the Research Foundation for the State University of New York, as amended, pertaining to the construction of the Buffalo Riverbend Manufacturing Facility, among other things, require us to comply with a number of covenants during the term of the agreement. Any failure to comply with these covenants could obligate us to pay significant amounts to the Foundation and result in termination of the agreement.

In September 2014, Silevo entered into an amended and restated research and development alliance agreement, as amended from time to time, referred to as the Riverbend Agreement, with the Research Foundation for the State University of New York, referred to as the Foundation, for the construction of an approximately 1 million square foot manufacturing facility capable of producing 1-gigawatt of solar panels annually on an approximately 88.24 acre site located in Buffalo, New York, referred to as the Manufacturing Facility.

Under the terms of the Riverbend Agreement, the Foundation will construct the Manufacturing Facility and install certain utilities and other improvements, with participation by us as to the design and construction of the Manufacturing Facility, and acquire certain manufacturing equipment designated by us to be used in the Manufacturing Facility and other specified items. The Foundation will cover construction costs related to the Manufacturing Facility and certain manufacturing equipment, in each case up to a maximum funding allocation from the State of New York, as well as additional specified items, and we will be responsible for any construction and equipment costs in excess of such amounts. The Foundation will own the Manufacturing Facility and manufacturing equipment it acquires for the project. We are also responsible for the acquisition of certain manufacturing equipment, which equipment we will own. Following completion of the Manufacturing Facility, we will lease the Manufacturing Facility from the Foundation for an initial period of 10 years for $2 per year plus utilities, and the Foundation will grant us the right to use the manufacturing equipment owned by it during the initial lease term at no charge.

In addition to the other obligations under the Riverbend Agreement, we must (i) use our best commercially reasonable efforts to commission the manufacturing equipment within three months of Manufacturing Facility Completion and reach full production output within three months thereafter, (ii) employ personnel for at least 1,460 jobs in Buffalo, New York, with 500 of such jobs for the manufacturing operation at the Manufacturing Facility, for the initial two years of collaboration commencing after Manufacturing Facility Completion, and we have committed to the retention of these jobs for five years, (iii) employ at least 2,000 other personnel in the State of New York for five years after Manufacturing Facility Completion, (iv) employ a total of 5,000 people in the State of New York by the tenth anniversary of Manufacturing Facility Completion, (v) spend or incur approximately $5 billion in combined capital, operational expenses and other costs in the State of New York during the 10 year period following full production, (vi) make reasonable efforts to provide first consideration to New York-based suppliers, (vii) invest and spend in manufacturing operations at a level that ensures competitive product costs for at least five years from full production, and (viii) negotiate in good faith with the Foundation on an exclusive “first opportunity basis” for 120 days before entering into any agreement for additional solar panel manufacturing capacity that Silevo may wish to develop during the term of the agreement. If we are not able to hire the specified number of employees or identify and qualify local vendors and suppliers, we would face the risk of not only failing to meet the performance criteria under the Riverbend Agreement but also not being capable of running the operations related to the Manufacturing Facility. If we fail in any year over the course of the ten-year term to meet these specified investment and job creation obligations, as described above, we would be obligated to pay a “program payment” of $41.2 million to the Foundation in any such year. In addition, we are subject to other events of defaults, including breach of these program payments and certain insolvency events, that would lead to the acceleration of all of the then unpaid program payments by us to the Foundation. Our failure to meet our contractual obligations under the Riverbend Agreement may result in our obligation to pay significant amounts to the Foundation in scheduled program

 

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payments, other contractual damages and/or the termination of our lease of the Manufacturing Facility. Any inability on our part to raise the capital necessary to operate the Manufacturing Facility and meet the specified requirements of the Riverbend Agreement during the 10-year period following full production would also cause a material adverse effect upon our business operations and prospects.

In December 2016, we entered into agreements with Panasonic to manufacture solar cells and modules at the Manufacturing Facility.  Our expectations as to the cost of building the Manufacturing Facility, acquiring manufacturing equipment and supporting our manufacturing relationship with Panasonic and other operations may prove incorrect, which could subject us to significant expenses to achieve the desired benefits under the Riverbend Agreement. In the event of any cost overruns in construction, commissioning, acquiring manufacturing equipment or operating the Manufacturing Facility, we may incur additional capital and operating expenses that would have a material adverse effect upon our business operations and prospects.

Our projections as to the time and expense necessary to build the Manufacturing Facility and acquire the manufacturing equipment may prove incorrect and subject us to significant delay and additional expense.

We currently anticipate commencing solar module and solar roof manufacturing in the second half of 2017 with photovoltaic cells sourced from Panasonic, and are working towards ramping production to 1 gigawatt of solar cell production by 2019.  We are working with the State of New York to finalize orders of manufacturing equipment related to solar module production.

We have recently identified potential modifications to the manufacturing equipment and factory layout related to the solar cell manufacturing line that may offer the ability to increase the production capacity of the Manufacturing Facility above 1 gigawatt per year. We believe that the short delay in finalizing the overall configuration will help maintain the long-term competitiveness of the Manufacturing Facility. However, this is an aggressive schedule and we may experience additional delays.

There are a number of risks which may delay the completion of the Manufacturing Facility and commencement of operations, including:

 

delays in placing orders for necessary equipment with long lead times;

 

failure or delay in obtaining necessary permits, licenses or other governmental support or approvals;

 

the time necessary for the construction of related utility and infrastructure improvements;

 

unforeseen engineering problems;

 

the inability to identify and hire qualified construction and other workers on a timely basis or at all;

 

construction delays and contractor performance shortfalls;

 

work stoppages or labor disruptions, including efforts by our employees to enter into collective bargaining agreements;

 

availability of raw materials and components from suppliers and any delivery delays in such materials or components;

 

delays resulting from environmental conditions, and any design changes or additions necessary to remediate prior environmental hazards at the site; and

 

adverse weather conditions, such as an extreme winter, and natural disasters.

Any delay in the completion of the Manufacturing Facility and commencement of our operations will result in us incurring additional expenses and could negatively affect our operating results, financial condition and prospects.

Rising interest rates could adversely impact our business.

Changes in interest rates could have an adverse impact on our business by increasing our cost of capital. For example:

 

rising interest rates would increase our cost of capital; and

 

rising interest rates may negatively impact our ability to secure financing on favorable terms to facilitate our customers’ purchase of our solar energy systems or energy generated by our solar energy systems.

The majority of our cash flows to date have been from solar energy systems under lease and power purchase agreements that have been monetized under various financing fund and borrowing structures. One of the components of this monetization is the present value of the payment streams from our customers who enter into these leases and power purchase agreements. If the rate of return required by investors rises as a result of a rise in interest rates, it will reduce the present value of the customer payment stream and consequently reduce the total value that we are able to derive from monetizing the payment stream. Interest rates are at historically

 

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low levels, partially as a result of intervention by the U.S. Federal Reserve. The U.S. Federal Reserve has taken actions to taper its intervention, and should these actions continue, it is likely that interest rates will rise, which could cause our cost of capital to increase and impede our ability to secure financing. As a result, our business and financial condition could be harmed.

In addition, we evaluate our business with a long-term view based on cash flows relating to our customer agreements, third-party financing funds and other arrangements. To date, we have taken limited actions to mitigate the risk of rising future interest rates. In 2014, we initiated a strategy of purchasing limited long-term derivative securities to economically hedge the effect of future interest rate increases. We may continue to engage in such transactions and the cost and outcomes of such transactions are currently not known.

We are expanding our international activities and customers, and plan to continue these efforts, which subject us to additional business risks, including compliance with international and trade regulations.

Our long-term strategic plans include international expansion and we intend to sell our solar energy products and services in international markets. For example, in August 2015, we acquired S.A. de C.V., or Ilioss to expand our operations into Mexico.

Risks inherent to our international operations include the following:

 

multiple, conflicting and changing laws and regulations, including energy regulations, export and import restrictions, tax laws and regulations, environmental regulations, labor laws and other government requirements, approvals, permits and licenses;

 

trade barriers and trade remedies such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our products and make us less competitive in some countries;

 

potentially adverse tax consequences associated with our permanent establishment of operations in more countries, including repatriation of non-U.S. earnings taxed at rates lower than the U.S. statutory effective tax rate;

 

difficulties and costs in recruiting and retaining individuals skilled in international business operations;

 

changes in general economic and political conditions in the countries where we operate, including changes in government incentives relating to power generation and solar electricity, and availability of capital at competitive rates;

 

political and economic instability, including wars, acts of terrorism, political unrest, boycotts, curtailments of trade and other business restrictions;

 

the inability to work successfully with third-parties with local expertise to co-develop international projects;

 

relatively uncertain legal systems, including potentially limited protection for intellectual property rights and laws, changes in the governmental incentives we rely on, regulations and policies which impose additional restrictions on the ability of foreign companies to conduct business in certain countries or otherwise place them at a competitive disadvantage in relation to domestic companies;

 

international business practices that may conflict with CBP or other legal requirements enforced by partner government agencies;

 

financial risks, such as longer sales and payment cycles and greater difficulty collecting accounts receivable; and

 

fluctuations in currency exchange rates relative to the U.S. dollar.

Doing business in foreign markets requires us to be able to respond to rapid changes in market, legal, and political conditions in these countries. The success of our business will depend in part on our ability to succeed in differing legal, regulatory, economic, social and political environments. We recognize that we must understand the risks and opportunities relating to trade remedies so that we can develop and implement policies and strategies that will be effective in each location where we do business.

We are subject to the Foreign Corrupt Practices Act of 1977, or the FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the USA PATRIOT Act, and other anti-bribery and anti-money laundering laws in countries in which we conduct activities. We face significant risks if we fail to comply with the FCPA and other anticorruption laws that prohibit companies and their employees and third-party intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to foreign government officials, political parties, and private-sector recipients for the purpose of obtaining or retaining business. In many foreign countries, particularly in countries with developing economies, it may be a local custom that businesses engage in practices that are prohibited by the FCPA or other applicable laws and regulations. We may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities (for example, Mexico’s electricity sector is federally owned and controlled by the Federal Electricity Commission). We can be held liable for the corrupt or

 

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other illegal activities of our employees, representatives, contractors, partners, and agents, even if we do not explicitly authorize such activities. Any violation of the FCPA, other applicable anticorruption laws, and anti-money laundering laws could result in whistleblower complaints, adverse media coverage, investigations, loss of export privileges, severe criminal or civil sanctions and, in the case of the FCPA, suspension or debarment from U.S. government contracting, which could have a material adverse effect on our business, financial condition, cash flows and reputation. In addition, responding to any enforcement action may result in a materially significant diversion of management’s attention and resources and significant defense costs and other professional fees.

Our vertical integration and continued international expansion efforts may subject us to additional regulatory risks that may impact our operating results. For example, we will have to ensure we are in compliance with any bilateral and/or multilateral free trade agreements in addition to understanding trade remedies that directly affect those products and components involved in the construction of our solar energy systems, which are procured from vendors and manufacturers outside of the United States.  Some of these components, particularly solar panels and mounting hardware made from aluminum extrusions, may be subject to antidumping and countervailing duties.

In March 2015, we conducted an internal review of our supply chain and import practices for our subsidiary, Zep Solar, which included a review of the classification of products manufactured overseas. We identified instances in which some of the products and system components imported into the United States were misclassified. As a result of these misclassifications, we discovered that two legacy products might be subject to antidumping and countervailing duties. In September 2015, we submitted a voluntary disclosure to the CBP identifying these and other potential misclassifications, cooperating fully with CBP to finalize this review. In April 2016, we perfected our disclosure tendering $5.3 million to CBP for import duties owed by our acquired subsidiary relating to items imported since August 2012. For items potentially subject to antidumping or countervailing duties, CBP may require us to obtain a determination from the DOC.

In the event that we fail to or are unable to comply with the legal requirements in the jurisdictions in which we operate, we may be subject to significant fines, penalties and other amounts which could materially harm our operations and financial results.

We may not realize the anticipated benefits of past or future acquisitions, and integration of these acquisitions may disrupt our business.

In August 2015, we acquired Iliosson S.A. de C.V., a commercial and industrial solar project developer in Mexico.  In September 2014, we acquired Silevo, LLC, a solar panel technology and manufacturing company. In 2013, we acquired Zep Solar, Common Assets, certain assets of Paramount Solar and completed other smaller acquisitions. In the future, we may acquire additional companies, project pipelines, products or technologies, or enter into joint ventures or other strategic initiatives. Our ability as an organization to integrate acquisitions is unproven. We may not realize the anticipated benefits of our acquisitions or any other future acquisition or the acquisition may be viewed negatively by customers, financial markets or investors.

Any acquisition has numerous risks, including the following:

 

difficulty in assimilating the operations and personnel of the acquired company;

 

difficulty in effectively integrating the acquired technologies or products with our current products and technologies;

 

difficulty in maintaining controls, procedures and policies during the transition and integration;

 

disruption of our ongoing business and distraction of our management and employees from other opportunities and challenges due to integration issues;

 

difficulty integrating the acquired company’s accounting, management information and other administrative systems;

 

inability to retain key technical and managerial personnel of the acquired business;

 

inability to retain key customers, vendors, and other business partners of the acquired business;

 

inability to achieve the financial and strategic goals for the acquired and combined businesses;

 

incurring acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results;

 

failure of due diligence processes to identify significant issues with product quality, legal and financial liabilities, among other things;

 

inability to assert that internal controls over financial reporting are effective; and

 

inability to obtain, or obtain in a timely manner, approvals from governmental authorities, which could delay or prevent such acquisitions.

 

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If we are unable to maintain effective internal controls over financial reporting and disclosure controls and procedures, or if material weaknesses are discovered in future periods, the accuracy and timeliness of our financial and operating reporting may be adversely affected, and confidence in our operations and disclosures may be lost.

In the past we have identified material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

In connection with this annual report on Form 10-K, our management has performed an evaluation of our internal control over financial reporting as of December 31, 2016 pursuant to Section 404 of the Sarbanes-Oxley Act, and has concluded that our internal control over financial reporting and our disclosure controls and procedures were effective as of December 31, 2016.

If we are not able to maintain effective internal control over financial reporting and disclosure controls and procedures, or if additional material weaknesses are discovered in future periods, a risk that is significantly increased in light of the complexity of our business and investment funds, we may be unable to accurately and timely report our financial position, results of operations, cash flows or key operating metrics, which could result in late filings of our annual and quarterly reports under the Exchange Act, restatements of our consolidated financial statements or other corrective disclosures, an inability to access commercial lending markets, defaults under our secured revolving credit facility and other agreements, or other material adverse effects on our business, reputation, results of operations, financial condition or liquidity.

Updates or changes to our IT systems affecting our customer billing and control environment may disrupt our operations.

As we continue to evaluate and implement upgrades and changes to our IT systems affecting our customer billing and control environment, some of which are significant, we may encounter unexpected challenges, outages and other issues. Upgrades involve replacing existing systems with successor systems, making changes to existing systems, or cost-effectively acquiring new systems with new functionality. We are aware of inherent risks associated with replacing these systems, including accurately capturing data and system disruptions, and believe we are taking appropriate action to mitigate the risks through testing, training, and staging implementation, as well as ensuring appropriate commercial contracts are in place with third-party vendors supplying or supporting our IT initiatives. However, there can be no assurances that we will successfully launch these systems as planned or that they will occur without disruptions to our operations. IT system disruptions, if not anticipated and appropriately mitigated, or failure to successfully implement new or upgraded systems, could have a material adverse effect on our results of operations, and our ability to timely and accurately report our financial and operating results.

We are not currently regulated as a utility under applicable law, but we may be subject to regulation as a utility in the future.

Federal law and most state laws do not currently regulate us as a utility. As a result, we are not subject to the various federal and state standards, restrictions and regulatory requirements applicable to U.S. utilities. In the United States, we obtain federal and state regulatory exemptions by establishing “Qualifying Facility” status with the Federal Energy Regulatory Commission for all of our qualifying solar energy projects. In Canada, we also are generally subject to the regulations of the relevant energy regulatory agencies applicable to all producers of electricity under the relevant feed-in tariff regulations (including the feed-in tariff rates), however we are not currently subject to regulation as a utility. Our business strategy includes the continued development of larger solar energy systems in the future for our commercial and government customers, which has the potential to impact our regulatory position. Any local, state, federal or foreign regulations could place significant restrictions on our ability to operate our business and execute our business plan by prohibiting or otherwise restricting our sale of electricity. If we were subject to the same state, federal or foreign regulatory authorities as utilities in the United States or if new regulatory bodies were established to oversee our business in the United States or in foreign markets, then our operating costs would materially increase.

In our lease pass-through financing funds, there is a one-time reset of the lease payments, and we may be obligated, in connection with the resetting of the lease payments at true up, to refund lease prepayments or to contribute additional assets to the extent the system sizes, costs and timing are not consistent with the initial lease payment model.

In our lease pass-through financing funds, the models used to calculate the lease prepayments will be updated for each fund at a fixed date occurring after placement in service of all solar energy systems in a given fund or on an agreed upon date (typically within the first year of the applicable lease term) to reflect certain specified conditions as they exist at such date, including the ultimate system size of the equipment that was leased, how much it cost and when it went into service. As a result of such a true up, the lease payments are resized and we may be obligated to refund the investor’s lease prepayments or to contribute additional assets to the fund. Any significant refunds or capital contributions that we may be required to make could adversely affect our financial condition.

 

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We have guaranteed a minimum return to be received by an investor in one of our financing funds and could be adversely affected if we are required to make any payments under this guarantee.

We have guaranteed payments to the investor in one of our financing funds to compensate for payments that the investor would be required to make to a certain third-party as a result of the investor not achieving a specified minimum internal rate of return in this fund, assessed annually. Although the investor has achieved the specified minimum internal rate of return to date, the amounts of any potential future payments under this guarantee depend on the amounts and timing of future distributions to the investor from the fund and the tax benefits that accrue to the investor from the fund’s activities. Because of uncertainties associated with estimating the timing and amounts of future distributions to the investor, we cannot determine the potential maximum future payments that we could have to make under this guarantee. We may agree to similar guarantees in the future if market conditions require it. Any significant payments that we may be required to make under our guarantees could adversely affect our financial condition.

We face competition from both traditional energy companies and renewable energy companies.

The solar energy and renewable energy industries are both highly competitive and continually evolving as participants strive to distinguish themselves within their markets and compete with large utilities. We believe that our primary competitors are the traditional utilities that supply energy to our potential customers. We compete with these utilities primarily based on price, predictability of price and the ease by which customers can switch to electricity generated by our solar energy systems. If we cannot offer compelling value to our customers based on these factors, then our business will not grow. Utilities generally have substantially greater financial, technical, operational and other resources than we do. As a result of their greater size, these competitors may be able to devote more resources to the research, development, promotion and sale of their products or respond more quickly to evolving industry standards and changes in market conditions than we can. Utilities could also offer other value-added products and services that could help them compete with us even if the cost of electricity they offer is higher than ours. In addition, a majority of utilities’ sources of electricity is non-solar, which may allow utilities to sell electricity more cheaply than electricity generated by our solar energy systems.

We also compete with solar companies in the downstream value chain of solar energy. For example, we face competition from purely finance driven organizations which then subcontract out the installation of solar energy systems, from installation businesses that seek financing from external parties, from large construction companies and utilities and increasingly from sophisticated electrical and roofing companies. Some of these competitors specialize in either the residential or commercial solar energy markets, and some may provide energy at lower costs than we do. Many of our competitors also have significant brand name recognition and have extensive knowledge of our target markets. Competitors have increasingly begun vertically integrating their operations to offer comprehensive products and services offerings similar to ours, and, recently, we have seen increased consolidation of competitors in our primary markets.

Projects for our significant commercial and government customers involve concentrated project risks that may cause significant changes in our financial results.

During any given financial reporting period, we typically have ongoing significant projects for commercial and governmental customers that represent a significant portion of our potential financial results for such period. For example, Walmart is a significant customer for which we have installed a substantial number of solar energy systems. These larger projects create concentrated operating and financial risks. The effect of recognizing revenue or other financial measures on the sale of a larger project, or the failure to recognize revenue or other financial measures as anticipated in a given reporting period because a project is not yet completed under applicable accounting rules by period end, may materially impact our quarterly or annual financial results. In addition, if construction, warranty or operational issues arise on a larger project, or if the timing of such projects unexpectedly shifts for other reasons, such issues could have a material impact on our financial results. If we are unable to successfully manage these significant projects in multiple markets, including our related internal processes and external construction management, or if we are unable to continue to attract such significant customers and projects in the future, our financial results could be harmed.

We depend on a limited number of suppliers of solar panels and other system components to adequately meet anticipated demand for our solar energy systems. Any shortage, delay or component price change from these suppliers could result in sales and installation delays, cancellations and loss of our ability to effectively compete.

We purchase solar panels, inverters and other system components from a limited number of suppliers, which makes us susceptible to quality issues, shortages and price changes. If we fail to develop, maintain and expand our relationships with existing or new suppliers, including our recent long-term manufacturing relationship with Panasonic, we may be unable to adequately meet anticipated demand for our solar energy systems or we may only be able to offer our systems at higher costs or after delays. If one or more of the suppliers that we rely upon to meet anticipated demand ceases or reduces production, we may be unable to satisfy this demand due to an inability to quickly identify alternate suppliers or to qualify alternative products on commercially reasonable terms.

 

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In particular, there are a limited number of inverter suppliers. Once we design a system for use with a particular inverter, if that type of inverter is not readily available at an anticipated price, we may incur additional delay and expense to redesign the system.

In addition, production of solar panels involves the use of numerous raw materials and components. Several of these have experienced periods of limited availability, particularly polysilicon, as well as indium, cadmium telluride, aluminum and copper. The manufacturing infrastructure for some of these raw materials and components has a long lead time, requires significant capital investment and relies on the continued availability of key commodity materials, potentially resulting in an inability to meet demand for these components. The prices for these raw materials and components fluctuate depending on global market conditions and demand and we may experience rapid increases in costs or sustained periods of limited supplies.

In addition to purchasing from New York-based suppliers, we anticipate that we will need to purchase supplies globally in order to meet the anticipated production output of the Manufacturing Facility. Despite our efforts to obtain raw materials and components from multiple sources whenever possible, many of our suppliers may be single-source suppliers of certain components. If we are not able to maintain long-term supply agreements or identify and qualify multiple sources for raw materials and components, our access to supplies at satisfactory prices, volumes and quality levels may be harmed. We may also experience delivery delays of raw materials and components from suppliers in various global locations. In addition, we may be unable to establish alternate supply relationships or obtain or engineer replacement components in the short term, or at all, at favorable prices or costs. Qualifying alternate suppliers or developing our own replacements for certain components may be time-consuming and costly and may force us to make modifications to our product designs.

Our need to purchase supplies globally in order to meet the anticipated production output of the Manufacturing Facility and our continued international expansion further subjects us to risks relating to currency fluctuations. Any decline in the exchange rate of the U.S. dollar compared to the functional currency of our component suppliers could increase our component prices. In addition, the state of the financial markets could limit our suppliers’ ability to raise capital if they are required to expand their production to meet our needs or satisfy their operating capital requirements. Changes in economic and business conditions, wars, governmental changes and other factors beyond our control or which we do not presently anticipate, could also affect our suppliers’ solvency and ability to deliver components to us on a timely basis. Any of these shortages, delays or price changes could limit our growth, cause cancellations or adversely affect our profitability and ability to effectively complete in the markets in which we operate.

We act as the licensed general contractor for our customers and are subject to risks associated with construction, cost overruns, delays, regulatory compliance and other contingencies, any of which could have a material adverse effect on our business and results of operations.

We are a licensed contractor or use licensed subcontractors in every community we service, and we are responsible for every customer installation. For our residential projects, we are the general contractor, construction manager and installer. For our commercial projects, we are the general contractor and construction manager, and we have historically relied on licensed subcontractors to install these commercial systems. We may be liable to customers for any damage we cause to their home or facility and belongings or property during the installation of our systems. For example, we frequently penetrate our customers’ roofs during the installation process and may incur liability for the failure to adequately weatherproof such penetrations following the completion of construction. In addition, shortages of skilled subcontractor labor for our commercial projects could significantly delay a project or otherwise increase our costs. Because our profit on a particular installation is based in part on assumptions as to the cost of such project, cost overruns, delays or other execution issues may cause us to not achieve our expected margins or not cover our costs for that project.

In addition, the installation of solar energy systems and energy-storage systems requiring building modifications are subject to oversight and regulation in accordance with national, state and local laws and ordinances relating to building codes, safety, utility interconnection and metering, environmental protection and related matters. It is difficult and costly to track the requirements of every individual authority having jurisdiction over our installations and to design solar energy systems to comply with these varying standards. Any new government regulations or utility policies pertaining to our systems may result in significant additional expenses to us and our customers and, as a result, could cause a significant reduction in demand for our systems.

Compliance with occupational safety and health requirements and best practices can be costly, and non-compliance with such requirements may result in potentially significant monetary penalties, operational delays and adverse publicity.

The installation of solar energy systems requires our employees to work at heights with complicated and potentially dangerous electrical systems. The evaluation and installation of our energy-storage and related products requires our employees to work in locations that may contain potentially dangerous levels of asbestos, lead or mold. We also maintain a fleet of thousands of vehicles that our employees use in the course of their work. There is substantial risk of serious injury or death if proper safety procedures are not followed. Our operations are subject to regulation under the U.S. Occupational Safety and Health Act, or OSHA, and equivalent state laws. Changes to OSHA requirements, or stricter interpretation or enforcement of existing laws or regulations, could result in

 

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increased costs. If we fail to comply with applicable OSHA regulations, even if no work-related serious injury or death occurs, we may be subject to civil or criminal enforcement and be required to pay substantial penalties, incur significant capital expenditures or suspend or limit operations. In the past, we have had workplace accidents and received citations from OSHA regulators for alleged safety violations, resulting in fines and operational delays for certain projects. Any such accidents, citations, violations, injuries or failure to comply with industry best practices may subject us to adverse publicity, damage our reputation and competitive position and adversely affect our business.

Problems with product quality or performance may cause us to incur warranty expenses and performance guarantee expenses, may lower the residual value of our solar energy systems and adversely affect our financial performance and valuation.

Our solar energy system warranties are lengthy. Customers who buy energy from us under leases or power purchase agreements are covered by warranties equal to the length of the term of these agreements—typically 20 years for leases and power purchase agreements. Depending on the state where they live, customers who purchase our solar energy systems for cash are covered by a warranty up to 10 years in duration. We also make extended warranties available at an additional cost to customers who purchase our solar energy systems for cash. In addition, we provide a pass-through of the inverter and panel manufacturers’ warranties to our customers, which generally range from 5 to 30 years. One of these third-party manufacturers could cease operations and no longer honor these warranties, leaving us to fulfill these potential obligations to our customers. For example, Evergreen Solar, Inc., one of our former solar panel suppliers, filed for bankruptcy in August 2011. Further, we provide a performance guarantee with our leased solar energy systems that compensates a customer on an annual basis if their system does not meet the electricity production guarantees set forth in their lease.

We rely upon assumptions and judgments based on our operating history and accelerated life cycle testing regarding a number of factors, including our anticipated rate of warranty claims and the durability, performance and reliability of our solar energy systems. Our assumptions could prove to be materially different from the actual long-term performance of our systems, causing us to incur substantial expense to repair or replace defective solar energy systems in the future or to compensate customers for systems that do not meet their production guarantees. Product failures or operational deficiencies would also reduce our revenue from power purchase agreements because they are dependent on system production. Any widespread product failures or operating deficiencies may damage our market reputation and adversely impact our financial results.

In addition, we amortize the costs of our solar energy systems over 30 to 35 years, which typically exceeds the period of the component warranties and the corresponding payment streams from our operating lease arrangements with our customers. In addition, we typically bear the cost of removing the solar energy systems at the end of the lease term. Furthermore, it is difficult to predict how future environmental regulations may affect the costs associated with the removal, disposal and recycling of our solar energy systems. Consequently, if the residual value of the systems is less than we expect at the end of the lease, after giving effect to any associated removal and redeployment costs, we may be required to accelerate all or some of the remaining unamortized expenses. This could materially impair our future operating results.

Compliance with environmental regulations can be expensive, and non-compliance with these regulations may result in adverse publicity and potentially significant monetary damages and fines.

We are required to comply with all foreign, federal, state and local laws and regulations regarding pollution control and protection of the environment. In addition, under some statutes and regulations, a government agency, or other parties, may seek recovery and response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for such release and not otherwise at fault. While we and the State of New York have performed environmental diligence relating to the construction of the Manufacturing Facility, the site where the Manufacturing Facility is to be located is on the former site of Republic Steel and has been considered a “brownfield.”

The operation of our manufacturing and research and development facilities, including in Hangzhou, China, Buffalo, New York and Fremont, California, involves the use of hazardous chemicals and materials which may subject us to liabilities for any releases or other failures to comply with applicable laws, regulations and policies. Any failure by us to maintain effective controls regarding the use of hazardous materials or to obtain and maintain all necessary permits could subject us to potentially significant fines and damages or interrupt our operations.

Product liability claims against us could result in adverse publicity and potentially significant monetary damages.

We would be exposed to product liability claims if one of our solar energy systems or other products injured any property or persons. Because solar energy systems and many of our other current and anticipated products are electricity-producing and storing devices, it is possible that property or persons could be harmed by our products for reasons including product malfunctions, defects or improper installation. We rely on our general liability insurance to cover product liability claims and have not obtained separate product liability insurance. Any product liability claim we face could be expensive to defend and could divert management’s attention.

 

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Any product liability claims against us and any resulting adverse outcomes could result in potentially significant monetary damages that could require us to make significant payments, as well as subject us to adverse publicity, damage our reputation and competitive position or adversely affect sales of our systems and other products.

The production and installation of solar energy systems depends heavily on suitable meteorological conditions. If meteorological conditions are unexpectedly unfavorable, the electricity production from our solar energy systems may be substantially below our expectations and our ability to timely deploy new systems may be adversely impacted.

The energy produced and revenue and cash receipts generated by a solar energy system depend on suitable solar and weather conditions, both of which are beyond our control. Furthermore, components of our systems, such as panels and inverters, could be damaged by severe weather, such as hailstorms or tornadoes. In these circumstances, we generally would be obligated to bear the expense of repairing or replacing the damaged solar energy systems that we own. Sustained unfavorable weather also could unexpectedly delay our installation of solar energy systems, leading to increased expenses and decreased revenue and cash receipts in the relevant periods. For example, certain states in which we operate, such as New York and Massachusetts, commonly experience inclement winter weather. Weather patterns could change, making it harder to predict the average annual amount of sunlight striking each location where we install. This could make our solar energy systems less economical overall or make individual systems less economical. Any of these events or conditions could harm our business, financial condition and results of operations.

Our business may be harmed if we fail to properly protect our intellectual property.

We believe that the success of our business depends in part on our proprietary technology, including our hardware, software, information, processes and know-how. We rely on many forms of intellectual property rights to secure our technology, including trade secrets and patents. We cannot be certain that we have adequately protected or will be able to adequately protect our technology, that our competitors will not be able to use our existing technology or develop similar technology independently, that any patents or other intellectual property rights held by us will be broad enough to protect our technology or that foreign intellectual property laws will adequately protect us. Moreover, our patents and other intellectual property rights may not provide us with a competitive advantage.

Despite our precautions, it may be possible for third-parties to obtain and use our intellectual property without our consent. Reverse engineering, unauthorized use or other misappropriation of our proprietary technology could enable third-parties to benefit from our technology without compensating us for doing so. In addition, our proprietary technology may not be adequately protected because:

 

our systems may be subject to intrusions, security breaches or targeted thefts of our trade secrets;

 

people may not be deterred from misappropriating our technology despite the existence of laws or contracts prohibiting it;

 

unauthorized use of our intellectual property may be difficult to detect and expensive and time-consuming to remedy, and any remedies obtained may be inadequate to restore protection of our intellectual property;

 

the laws of other countries in which we do business may offer less protection for our proprietary technology; and

 

reports we may be required to file in connection with any government-sponsored research contracts may disclose some of our sensitive confidential information because they are or will be generally available to the public.

Any such activities or any other inabilities to adequately protect our proprietary rights could harm our ability to compete, to generate revenue and to grow our business.

Claims of patent and other intellectual property infringement are complex and their outcomes are uncertain, and the costs associated with such claims may be high and could harm our business.

Our success in operating our business depends largely on our ability to use and develop our proprietary technologies and manufacturing know-how without infringing or misappropriating the intellectual property rights of third-parties, many of whom have robust patent portfolios, greater capital resources and decades of manufacturing experience. Any claim of infringement by a third-party, even those without merit, could cause us to incur substantial legal costs defending against the claim and could distract our management and technical personnel from our business. In particular, the validity and scope of claims relating to photovoltaic technology patents may be highly uncertain because they involve complex scientific, legal and factual considerations and analysis. Furthermore, we could be subject to a judgment or voluntarily enter into a settlement, either of which could require us to pay substantial damages. A judgment or settlement could also include an injunction, a court order or other agreement that could prevent us from engaging in certain activities. In addition, we might elect or be required to seek a license for the use of third-party intellectual property, which may not be available on commercially reasonable terms or at all, or if available, the payments under such license may harm our operating results and financial condition. Alternatively, we may be required to develop non-infringing technology, redesign our products or alter our manufacturing

 

22


techniques and processes, each of which could require significant research and development efforts and expenses and may ultimately not be successful. Any of these events could seriously harm our business, operating results and financial condition.

We are subject to legal proceedings and regulatory inquiries and we may be named in additional claims or legal proceedings or become involved in regulatory inquiries, all of which are costly, distracting to our core business and could result in an unfavorable outcome or a material adverse effect on our business, financial condition, results of operations or the trading price for our securities.

We are involved in claims, legal proceedings (such as the class action and derivative lawsuits filed against us) and receive inquiries from government and regulatory agencies (such as the pending Treasury and Department of Labor investigations) that arise from our normal business activities. In addition, from time to time, third-parties may assert claims against us. We evaluate all claims, lawsuits and investigations with respect to their potential merits, our potential defenses and counter claims, settlement or litigation potential and the expected effect on us. In the event that we are involved in significant disputes or are the subject of a formal action by a regulatory agency, we could be exposed to costly and time-consuming legal proceedings that could result in any number of outcomes. Although outcomes of such actions vary, any claims, proceedings or regulatory actions initiated by or against us, whether successful or not, could result in expensive costs of defense, costly damage awards, injunctive relief, increased costs of business, fines or orders to change certain business practices, significant dedication of management time, diversion of significant operational resources or some other harm to our business. In any of these cases, our business, financial condition or results of operations could be negatively impacted.

We make a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. In our opinion, resolution of all current matters is not expected to have a material adverse impact on our business, financial condition or results of operations. However, depending on the nature and timing of any such controversy, an unfavorable resolution of a matter could materially affect our future business, financial condition or results of operations, or all of the foregoing, in a particular quarter.

We typically bear the risk of loss and the cost of maintenance and repair on solar systems that are owned or leased by our fund investors.

We typically bear the risk of loss and are generally obligated to cover the cost of maintenance and repair on any solar systems that we sell or lease to our fund investors. At the time we sell or lease a solar system to a fund investor, we enter into a maintenance services agreement where we agree to operate and maintain the system for a fixed fee that is calculated to cover our future expected maintenance costs. If our solar systems require an above-average amount of repairs or if the cost of repairing systems were higher than our estimate, we would need to perform such repairs without additional compensation. If our solar systems, a majority of which are located in California, are damaged in a natural disaster beyond our control, losses could be excluded, such as earthquake damage, or exceed insurance policy limits, and we could incur unforeseen costs that could harm our business and financial condition. We may also incur significant costs for taking other actions in preparation for, or in reaction to, such events. We purchase Property and Business Interruption insurance with industry standard coverage and limits approved by an investor’s third-party insurance advisors to hedge against such risk, but such coverage may not cover our losses.

Any unauthorized disclosure or theft of personal customer information we gather, store and use could harm our reputation and subject us to claims or litigation.

We receive, store and use personal information of our customers, including names, addresses, e-mail addresses, credit information and other housing and energy use information. Unauthorized disclosure of such personal information could harm our business, whether through breach of our systems by an unauthorized party, employee theft or misuse, or otherwise. If we were subject to an inadvertent disclosure of such personal information or if a third-party were to gain unauthorized access to customer personal information in our possession, our operations could be seriously disrupted and we could be subject to claims or litigation arising from damages suffered by our customers. In addition, we could incur significant costs in complying with the multitude of federal, state and local laws regarding the unauthorized disclosure of personal customer information. Finally, any perceived or actual unauthorized disclosure of such information could harm our reputation, substantially impair our ability to attract and retain customers and have an adverse impact on our business.

Any failure to comply with laws and regulations relating to our interactions with current or prospective residential customers could result in negative publicity, claims, investigations, and litigation, and adversely affect our financial performance.

As the country’s largest residential solar installer, we rely on our ability to engage in transactions with residential customers. In doing so, we must comply with numerous federal, state and local laws and regulations that govern matters relating to our interactions

 

23


with residential consumers, including those pertaining to privacy and data security, consumer financial and credit transactions, home improvement contracts, warranties and door-to-door solicitation. These laws and regulations change frequently and are interpreted by various federal, state and local regulatory bodies. Changes in these laws or regulations or their interpretation could dramatically affect how and where we conduct our business, acquire customers, and manage and use information we collect from and about current and prospective customers and the costs associated therewith.

Even though we may believe that we maintain effective compliance with all such laws and regulations, we may still be subject to claims, proceedings, litigation and investigations by private parties and regulatory authorities, and could be subject to substantial fines and negative publicity, each of which may materially and adversely affect our business and operations. For example, a putative class action was filed against us in November 2015 alleging violations of the federal Telephone Consumer Protection Act. We have incurred, and will continue to incur, significant expenses to comply with such laws and regulations, and increased regulation of matters relating to our interactions with residential consumers could require us to modify our operations and incur significant additional expenses, which could have an adverse effect on our business, financial condition and results of operations.

In addition, we are subject to federal, state and international laws relating to the collection, use, retention, security and transfer of personal information of our customers. In many cases, these laws apply not only to third-party transactions, but also to transfers of information between one company and its subsidiaries. Several jurisdictions have passed new laws in this area, and other jurisdictions are considering imposing additional restrictions. These laws continue to develop and may be inconsistent from jurisdiction to jurisdiction. Complying with emerging and changing requirements may cause us to incur costs or require us to change our business practices. Any failure by us, our affiliates or other parties with whom we do business to comply with a posted privacy policies or with other federal, state or international privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others, which could have a detrimental effect on our business, results of operations and financial condition.

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

 

ITEM 2. PROPERTIES

Our corporate headquarters and executive offices are located in San Mateo, California, where we occupy approximately 68,025 square feet of office space under a lease that expires in December 2021, with a renewal option. We also lease a regional headquarters in Salt Lake City, Utah, as well as larger offices in San Francisco, San Rafael and Fremont, California. In addition, we lease sales offices, warehouses and manufacturing facilities across the United States and in Mexico and China. We also lease sales and support offices in Ontario, Canada. We believe that our existing facilities are adequate for our current needs and that we will be able to lease suitable additional or alternative space on commercially reasonable terms if and when we need it.

 

 

ITEM 3. LEGAL PROCEEDINGS

In July 2012, the Company, along with other companies in the solar energy industry, received a subpoena from the U.S. Treasury Department’s Office of the Inspector General to deliver certain documents in the Company’s possession that were dated, created, revised or referred to after January 1, 2007 and that relate to the Company’s applications for U.S. Treasury grants or communications with certain other solar energy development companies or with certain firms that appraise solar energy property for U.S Treasury grant application purposes. The Inspector General and the Civil Division of the U.S. Department of Justice are investigating the administration and implementation of the U.S Treasury grant program relating to the fair market value of the solar energy systems that the Company submitted in U.S. Treasury grant applications. The Company has accrued a reserve for its potential liability associated with this ongoing investigation as of December 31, 2016.

In February 2013, two of the Company’s financing funds filed a lawsuit in the United States Court of Federal Claims against the United States government, seeking to recover approximately $14.0 million that the United States Treasury was obligated to pay, but failed to pay, under Section 1603 of the American Recovery and Reinvestment Act of 2009. In February 2016, the government filed a motion seeking leave to assert a counterclaim against the two plaintiff funds on the grounds that the government, in fact, paid them more, not less, than they were entitled to as a matter of law. The Company believes that the government’s claims are without merit and expects the plaintiff funds to litigate the case vigorously. Trial in the case is set for the latter half of 2017. The Company is unable to estimate the possible loss, if any, associated with this lawsuit.

On March 28, 2014, a purported stockholder class action lawsuit was filed in the United States District Court for the Northern District of California against the Company and two of its officers. The complaint alleges violations of federal securities laws, and seeks unspecified compensatory damages and other relief on behalf of a purported class of purchasers of the Company’s securities from March 6, 2013 to March 18, 2014. After a series of amendments to the original complaint, the District Court dismissed the

 

24


amended complaint and entered a judgment in the Company’s favor on August 9, 2016. The plaintiffs have filed a notice of appeal. The Company believes that the claims are without merit and intends to defend against this lawsuit vigorously. The Company is unable to estimate the possible loss, if any, associated with this lawsuit.

On June 5 and 11, 2014, stockholder derivative actions were filed in the Superior Court of California for the County of San Mateo, purportedly on behalf of the Company and against the board of directors, alleging that the board of directors breached its duties to the Company by failing to prevent the conduct alleged in the pending purported stockholder class action lawsuit. The Company and the individual board member defendants filed a motion to dismiss the complaint, which the Superior Court granted on December 17, 2015, while allowing the plaintiffs an opportunity to file an amended complaint to remedy the defects in the original complaint. On or about March 2, 2016, the plaintiffs informed the Company and the Superior Court that they had sold their shares in the Company during the pendency of the suit. Consequently, the plaintiffs no longer had standing to bring their lawsuit, which they voluntarily dismissed.

In June 2014, the Company along with Sunrun, Inc., or Sunrun, filed a lawsuit in the Superior Court of Arizona against the Arizona Department of Revenue, or DOR, challenging DOR’s interpretation of Arizona state law to impose property taxes on solar energy systems that are leased by customers. On June 1, 2015, the Superior Court issued an order rejecting the interpretation of the Arizona state law under which the DOR had sought to tax leased solar energy systems. In that same order, the Superior Court held that a separate Arizona statute, which provides that such systems are deemed to have no value for purposes of calculating property tax, violated certain provisions of the Arizona state constitution. Both the DOR and the Company have appealed the Superior Court’s ruling, and the Court of Appeals heard argument on November 15, 2016. The Company will continue to vigorously pursue its claims.

On March 2, 2015, the Company filed a lawsuit in the United States District Court for the District of Arizona against the Salt River Project Agricultural Improvement and Power District and the Salt River Valley Water Users’ Association, or SRP, alleging that SRP’s imposition of distribution charges and demand charges on new solar energy customers in its territory violates state and federal antitrust laws. On June 23, 2015, SRP moved to dismiss the complaint. On October 27, 2015, the District Court denied SRP’s motion to dismiss in part and granted it in part. In particular, the District Court held that the Company may proceed on its antitrust claims against SRP to seek an injunction blocking SRP’s new charges and may proceed with claims for damages under state laws other than antitrust laws. Furthermore, the District Court held that the Company may not recover monetary damages on its antitrust theories and dismissed two of its antitrust claims while allowing the others to proceed. Discovery has concluded. On September 20, 2016, the District Court entered a stay of the litigation while SRP appeals the District Court’s earlier decision, holding that SRP is subject to state and federal antitrust laws. The Court of Appeals heard argument on November 18, 2016. The Company intends to pursue its claims vigorously.

In April 2015, Borrego Solar Systems Inc., or Borrego, commenced an arbitration against the Company alleging that the Company wrongfully terminated a construction services agreement. The Company engaged in discovery and participated in an arbitration hearing in February 2016. After the hearing, on April 12, 2016, the arbitrator entered an interim award in favor of Borrego and ultimately entered a final award in the amount of $2.0 million, which the Company has satisfied in full.

On September 18, 2015, a stockholder derivative action was filed in the Court of Chancery of the State of Delaware, purportedly on behalf of the Company and against the board of directors, alleging that the board of directors breached its duties to the Company by approving stock-based compensation to the non-employee directors that the plaintiff claims is excessive compared to the compensation paid to directors of peer companies. At the Company’s 2016 annual meeting of stockholders, the non-employee director compensation plan was approved and ratified, including by a majority of the shares held by the disinterested stockholders of the Company. As a result, the case has been dismissed, and the matter has been resolved.

On September 21, 2015, the Company filed a lawsuit in the United States District Court for the District of Massachusetts against Seaboard Solar Operations LLC, or Seaboard, and its principal, Stuart Longman, alleging breaches of the various written contracts between the Company and Seaboard, fraud, conversion and unfair business practices. The Company sought a declaratory judgment that it owns and has the right to develop the specified projects and of damages of approximately $16.0 million. In December 2015, the Company settled the lawsuit in exchange for $16.1 million to be paid by Seaboard; upon making the payment, Seaboard will have the rights to the projects.

On November 6, 2015, a putative class action lawsuit, Morris v. SolarCity, was filed in the United States District Court for the Northern District of California against the Company. The complaint alleges that the Company made unlawful telephone marketing calls to the plaintiff and others, in violation of the federal Telephone Consumer Protection Act. The plaintiff seeks injunctive relief and statutory damages, on behalf of himself and a certified class. The Company filed a motion to dismiss the complaint, which the District Court denied on April 6, 2016.   Following discovery, plaintiff filed a motion for class certification on December 15, 2016.  Briefing on class certification is expected to be complete in late February 2017, and the certification motion will be heard in March 2017.  SolarCity continues to believe that the claims are without merit and intends to defend itself vigorously. The Company has accrued a reserve for its potential liability associated with this matter and the Gibbs matter described below, as of December 31, 2016.

 

25


On June 1, 2016, a putative class action lawsuit, Gibbs v. SolarCity, alleging that the Company made unlawful telephone marketing calls in violation of the federal Telephone Consumer Protection Act, was filed against the Company in the United States District Court for the District of Massachusetts. The two named plaintiffs seek injunctive relief and statutory damages, on behalf of themselves and a certified class. The Company has moved to dismiss the complaint; the hearing on that motion was held on December 8, 2016. The Company believes that the claims are without merit and intends to defend itself vigorously.  The Company has accrued a reserve for its potential liability associated with this matter and the Morris matter described above, as of December 31, 2016

On August 15, 2016, a purported stockholder class action lawsuit was filed in the United States District Court for the Northern District of California against the Company, two of its officers and a former officer. The complaint alleges that the Company made projections of future sales and installations that the Company failed to achieve and that these projections were fraudulent when made. The plaintiffs claim violations of federal securities laws and seek unspecified compensatory damages and other relief on behalf of a purported class of purchasers of the Company’s securities from May 5, 2015 to February 16, 2016. The Company believes that the claims are without merit and intends to defend against them vigorously. The Company is unable to estimate the possible loss, if any, associated with this lawsuit.

On September 26, 2016, Cogenra Solar Inc., or Cogenra, and Khosla Ventures III, L.P. filed a lawsuit in the United States District Court for the Northern District of California alleging that the Company and its subsidiary, Silevo Inc., had misappropriated trade secrets obtained from Cogenra during interactions governed by non-disclosure agreements and during the course of diligence in 2014, when the Company considered acquiring Cogenra. The Company believes that the claims are without merit and intends to defend itself vigorously. The Company is unable to estimate the possible loss, if any, associated with this lawsuit.

From time to time, claims have been asserted, and may in the future be asserted, including claims from regulatory authorities related to labor practices and other matters. Such assertions arise in the normal course of the Company’s operations. The resolution of any such assertions or claims cannot be predicted with certainty. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the Company’s results of operations, prospects, cash flows, and financial position.

 

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

 

 

 

26


PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES

On November 21, 2016, Tesla, Inc. completed its acquisition of SolarCity Corporation. Following this date, all SolarCity Corporation common stock is held by Tesla, Inc., and no established public trading market exists for SolarCity Corporation common stock.

SolarCity Corporation has never declared or paid dividends on its capital stock. Any decision to declare and pay dividends in the future will be made at the discretion of SolarCity Corporation’s board of directors.

 

 

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

Omitted pursuant to General Instruction I(2)(a) of Form 10-K

 

 

 

27


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes to those statements included elsewhere in this annual report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this annual report on Form 10-K. Furthermore, the following discussion and analysis has been abbreviated pursuant to General Instruction I(2)(a) of Form 10-K.

Results of Operations

The following table sets forth selected consolidated statements of operations data for each of the periods indicated (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases and solar energy systems incentives

 

$

422,326

 

 

$

293,543

 

 

$

173,636

 

Solar energy systems and components sales

 

 

308,016

 

 

 

106,076

 

 

 

81,395

 

Total revenue

 

 

730,342

 

 

 

399,619

 

 

 

255,031

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases and solar energy systems incentives

 

 

253,653

 

 

 

165,546

 

 

 

92,920

 

Solar energy systems and components sales

 

 

225,269

 

 

 

115,245

 

 

 

83,512

 

Total cost of revenue

 

 

478,922

 

 

 

280,791

 

 

 

176,432

 

Gross profit

 

 

251,420

 

 

 

118,828

 

 

 

78,599

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

442,590

 

 

 

457,185

 

 

 

238,608

 

General and administrative

 

 

228,980

 

 

 

244,508

 

 

 

156,426

 

Pre-production expense

 

 

69,306

 

 

 

 

 

 

 

Restructuring and other

 

 

105,922

 

 

 

 

 

 

 

Research and development

 

 

54,963

 

 

 

64,925

 

 

 

19,162

 

Total operating expenses

 

 

901,761

 

 

 

766,618

 

 

 

414,196

 

Loss from operations

 

 

(650,341

)

 

 

(647,790

)

 

 

(335,597

)

Interest and other expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense – recourse debt

 

 

42,162

 

 

 

28,145

 

 

 

14,522

 

Interest expense – non-recourse debt

 

 

74,527

 

 

 

29,905

 

 

 

13,537

 

Other interest expense and amortization of debt discounts and fees, net

 

 

39,965

 

 

 

33,889

 

 

 

27,699

 

Other expense, net

 

 

13,660

 

 

 

25,767

 

 

 

10,611

 

Total interest and other expenses

 

 

170,314

 

 

 

117,706

 

 

 

66,369

 

Loss before income taxes

 

 

(820,655

)

 

 

(765,496

)

 

 

(401,966

)

Income tax benefit (provision)

 

 

308

 

 

 

(3,326

)

 

 

26,736

 

Net loss

 

 

(820,347

)

 

 

(768,822

)

 

 

(375,230

)

Net loss attributable to noncontrolling interests and

   redeemable noncontrolling interests

 

 

(1,059,121

)

 

 

(710,492

)

 

 

(319,196

)

Net income (loss) attributable to parent

 

$

238,774

 

 

$

(58,330

)

 

$

(56,034

)

 

Revenue

 

 

 

Year Ended December 31,

 

 

Change 2016 vs. 2015

 

 

Change 2015 vs. 2014

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2014

 

 

$

 

 

%

 

 

$

 

 

%

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases and solar energy systems

   incentives

 

$

422,326

 

 

$

293,543

 

 

$

173,636

 

 

$

128,783

 

 

 

44

%

 

$

119,907

 

 

 

69

%

Solar energy systems and components sales

 

 

308,016

 

 

 

106,076

 

 

 

81,395

 

 

 

201,940

 

 

 

190

%

 

 

24,681

 

 

 

30

%

Total revenue

 

$

730,342

 

 

$

399,619

 

 

$

255,031

 

 

$

330,723

 

 

 

83

%

 

$

144,588

 

 

 

57

%

 

 

28


2016 Compared to 2015

Total revenue increased by $330.7 million, or 83%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015.

Operating leases and solar energy systems incentives revenue increased by $128.8 million, or 44%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily attributable to the increase in solar energy systems placed in service under leases and power purchase agreements. The average aggregate megawatt production capacity of solar energy systems placed in service under leases during the year ended December 31, 2016 increased by 47% as compared to the average during the year ended December 31, 2015. In addition, the megawatt hours produced by solar energy systems under power purchase agreements increased by 68% during the year ended December 31, 2016, as compared to the year ended December 31, 2015. The impact of the installed base on the increase in revenue varied in part by the mix between solar energy systems under leases, for which revenue is recognized on a straight-line basis over the lease term, and under power purchase agreements, for which revenue is recognized based on energy produced and when the systems were placed in service.

Revenue from sales of solar energy systems and components increased by $201.9 million, or 190%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to the $124.6 million increase in revenue from solar energy systems sold under Solar Loans and the $19.6 million increase in revenue from cash sales to residential customers. Additionally, revenue from MyPower contracts, which are recognized into revenue as cash is received, resulting from the cumulative increase in sales under MyPower contracts, increased by $69.3 million. These increases were partially offset by the $5.4 million decrease in revenue from sales to commercial customers and the $6.2 million decrease in revenue from sales to government entities. In the third quarter of 2016, we completely discontinued offering MyPower contracts, and we have been offering Solar Loans as the replacement, which are accounted for as sales of solar energy systems and components. Revenue from sales of solar energy systems and components has varied considerably in the past, and as we expect that direct sales and Solar Loans will increase as a percentage of future customer contracts, we expect revenue from sales of solar energy systems and components to increase in future periods as well.

2015 Compared to 2014

Total revenue increased by $144.6 million, or 57%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014.

Operating leases and solar energy systems incentives revenue increased by $119.9 million, or 69%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily attributable to the increase in solar energy systems placed in service under leases and power purchase agreements in 2015. The in-period average of the aggregate megawatt production capacity of solar energy systems placed in service under leases and power purchase agreements during the year ended December 31, 2015 increased by 79% as compared to the in-period average during the year ended December 31, 2014. This significant growth was attributable to our continued success in the installation and operation of solar energy systems under lease and power purchase agreements in new and existing markets. In addition, revenue from the monetization of ITCs increased by $19.8 million, for the year ended December 31, 2015 as compared to the year ended December 31, 2014, as we recognized such revenue from more solar energy systems in the year ended December 31, 2015. We recognize revenue from the monetization of ITCs on the anniversary date of each solar energy system’s placed in service date as ITC recapture provisions expire.

Revenue from sales of solar energy systems and components increased by $24.7 million, or 30%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to the $29.8 million increase in revenue from MyPower contracts, the $13.0 million increase in revenue from outright sales to residential customers, the $4.0 million increase in revenue from sales to government entities, the $1.1 million increase in revenue from sales by Ilioss, which we acquired in August 2015, the $0.8 million increase in revenue from sales of battery storage products and the $0.3 million increase in revenue from sales of Silevo products as we fulfilled open customer orders following our acquisition of Silevo. These increases were partially offset by the $9.0 million decrease in revenue from sales of Zep Solar products, the $8.7 million decrease in revenue from long-term solar energy system sales contracts recognized on the percentage-of-completion basis and the $7.5 million decrease in revenue from sales to commercial customers. Revenue from sales of solar energy systems and components has varied considerably and will continue to vary considerably from period to period due to the successful adoption of our MyPower product and the unpredictability of sales to commercial customers, long-term solar energy system sales contracts recognized on the percentage-of-completion basis and sales to government entities.

 

29


Cost of Revenue, Gross Profit and Gross Profit Margin

 

 

 

Year Ended December 31,

 

 

Change 2016 vs. 2015

 

 

Change 2015 vs. 2014

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2014

 

 

$

 

 

%

 

 

$

 

 

%

 

Operating leases and solar energy systems

   incentives

 

$

253,653

 

 

$

165,546

 

 

$

92,920

 

 

$

88,107

 

 

 

53

%

 

 

72,626

 

 

 

78

%

Solar energy systems and components sales

 

 

225,269

 

 

 

115,245

 

 

 

83,512

 

 

 

110,024

 

 

 

95

%

 

 

31,733

 

 

 

38

%

Total cost of revenue

 

$

478,922

 

 

$

280,791

 

 

$

176,432

 

 

$

198,131

 

 

 

71

%

 

$

104,359

 

 

 

59

%

 

2016 Compared to 2015

Cost of operating leases and solar energy systems incentives revenue increased by $88.1 million, or 53%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to the increase in depreciation expense arising from the higher aggregate cost of solar energy systems placed in service. Additionally, costs incurred on customer contracts that were ultimately canceled, costs from our dedicated operations and maintenance department and other costs to maintain our operating leases also increased for the year ended December 31, 2016, as compared to the year ended December 31, 2015.

Cost of solar energy systems and component sales increased by $110.0 million, or 95%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to the introduction of our Solar Loan product offering and an increase in residential sales.

2015 Compared to 2014

Cost of operating leases and solar energy systems incentives revenue increased by $72.6 million, or 78%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to greater depreciation expense arising from the higher aggregate cost of solar energy systems placed in service. Additionally, we incurred $15.5 million of increased period costs related to customer contract cancellations, our dedicated operations and maintenance department and customer warranties. We also incurred $7.5 million of increased expenses due to the continuing amortization of intangible assets related to the Silevo acquisition in the third quarter of 2014.

Cost of solar energy systems and component sales increased by $31.7 million, or 38%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was partly due to higher sales of solar energy systems and components and also the recognition of $17.0 million of warranty expenses associated with sales under MyPower contracts. The warranty expense for a sale under a MyPower contract is recorded upon the delivery of the solar energy system while the associated revenue and cost of revenue are recognized over the term of the MyPower contract as the customer pays-down the principal balance of the MyPower loan. We expect to continue to record negative gross margins in future periods as sales under MyPower contracts increase and revenue is recognized over the term of the MyPower contracts.

Operating Expenses

 

 

 

Year Ended December 31,

 

 

Change 2016 vs. 2015

 

 

Change 2015 vs. 2014

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2014

 

 

$

 

 

%

 

 

$

 

 

%

 

Sales and marketing

 

$

442,590

 

 

$

457,185

 

 

$

238,608

 

 

$

(14,595

)

 

 

(3

)%

 

$

218,577

 

 

 

92

%

General and administrative

 

 

228,980

 

 

 

244,508

 

 

 

156,426

 

 

 

(15,528

)

 

 

(6

)%

 

 

88,082

 

 

 

56

%

Pre-production expense

 

 

69,306

 

 

 

 

 

 

 

 

 

69,306

 

 

 

 

 

 

 

 

 

 

 

 

 

Restructuring and other

 

 

105,922

 

 

 

 

 

 

 

 

 

105,922

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

54,963

 

 

 

64,925

 

 

 

19,162

 

 

 

(9,962

)

 

 

(15

)%

 

 

45,763

 

 

 

239

%

Total operating expenses

 

$

901,761

 

 

$

766,618

 

 

$

414,196

 

 

$

135,143

 

 

 

18

%

 

$

352,422

 

 

 

85

%

 

2016 Compared to 2015

Sales and marketing expense decreased by $14.6 million, or 3%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This decrease was primarily due to our restructuring and the corresponding decrease in the average number of personnel in sales and marketing personnel and our focus on increasing the efficiency of sales operations.

General and administrative expense decreased by $15.5 million, or 6%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. The decrease was primarily due to reversal of previously accrued Silevo contingent consideration and Founder Awards as a result of the Tesla acquisition. The decrease was offset by the increase in the average number of personnel in

 

30


general and administrative departments and an increase in professional services fees primarily due to legal costs. However, as a result of our restructuring activities, the number of personnel in general and administrative departments has decreased since June 30, 2016.

Costs that we incur at our Fremont, California manufacturing facility prior to attaining commercial production (including salaries, other personnel-related costs, raw materials costs and other production costs for solar modules run through the production line during this period) are treated as pre-production expense. We commenced operations at our Fremont, California manufacturing facility in the fourth quarter of 2015.

We recorded $105.9 million of restructuring and other expenses in the year ended December 31, 2016, primarily consisting of certain amounts due to us since 2014 related to an uninstalled commercial project (but not related to any customer contracts or loans) that were determined to be unrecoverable, certain acquired sales and marketing-related intangible assets that became fully impaired, a revision of the useful lives of our manufacturing equipment in China, one-time employee termination benefit expenses due to our restructuring activities and transaction related expenses arising from our merger with Tesla.

Research and development expense decreased by $10.0 million, or 15%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This decrease was primarily due to the decreased level of research and development activities undertaken by Silevo as such expenses are now recorded in pre-production.

2015 Compared to 2014

Sales and marketing expense increased by $218.6 million, or 92%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to more expansive sales and marketing efforts, which have resulted in increases in the number of customers, system installations and system deployments. This initiative increased the average number of personnel in sales and marketing departments by 103% for the year ended December 31, 2015, as compared to the year ended December 31, 2014. As a result of this growth in headcount, employee compensation costs increased by $137.9 million (of which $7.8 million was related to stock-based compensation) and facilities and operations costs increased by $25.7 million. In addition, promotional marketing costs increased by $53.5 million as part of this broadening of the scope of our marketing activities, including enhanced digital marketing activities to increase brand awareness and customer reach. In the future, we expect to reduce our sales and marketing expenses, on a per Watt basis, by focusing on our more efficient sales channels, renegotiating or eliminating our higher cost sales channels and other cost efficiency initiatives.

General and administrative expense increased by $88.1 million, or 56%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to the increase in the average number of personnel in general and administrative departments, which grew by 103% for the year ended December 31, 2015, as compared to the year ended December 31, 2014. As a result of this growth in headcount, employee compensation costs increased by $45.5 million (of which $4.2 million was related to stock-based compensation) and facilities and operations costs increased by $13.6 million. In addition, professional services fees increased by $22.9 million primarily due to increased legal costs and accounting services fees. Furthermore, Ilioss, which we acquired in August 2015, incurred $1.7 million of general and administrative expenses in the year ended December 31, 2015.

Research and development expense increased by $45.8 million, or 239%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to the greater level of research and development activities undertaken by Silevo and the corresponding increase in the average number of personnel in research and development departments, which grew by 227%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014.

Other Income and Expenses

 

 

 

Year Ended December 31,

 

 

Change 2016 vs. 2015

 

 

Change 2015 vs. 2014

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2014

 

 

$

 

 

%

 

 

$

 

 

%

 

Interest expense  - recourse debt

 

$

42,162

 

 

$

28,145

 

 

$

14,522

 

 

$

14,017

 

 

 

50

%

 

$

13,623

 

 

 

94

%

Interest expense  - non-recourse debt

 

 

74,527

 

 

 

29,905

 

 

 

13,537

 

 

 

44,622

 

 

 

149

%

 

 

16,368

 

 

 

121

%

Other interest expense and amortization of debt

   discounts and fees, net

 

 

39,965

 

 

 

33,889

 

 

 

27,699

 

 

 

6,076

 

 

 

18

%

 

 

6,190

 

 

 

22

%

Other expense, net

 

 

13,660

 

 

 

25,767

 

 

 

10,611

 

 

 

(12,107

)

 

 

(47

)%

 

 

15,156

 

 

 

143

%

Total interest and other expenses, net

 

$

170,314

 

 

$

117,706

 

 

$

66,369

 

 

$

52,608

 

 

 

45

%

 

$

51,337

 

 

 

77

%

 

 

31


2016 Compared to 2015

Interest expense – recourse debt, increased by $14.0 million, or 50%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to 19% increase in the average carrying balances of interest bearing recourse debt for the year ended December 31, 2016, as compared to the year ended December 31, 2015, as well as the increase in interest rates for the year ended December 31, 2016, as compared to the year ended December 31, 2015.

Interest expense – non-recourse debt increased by $44.6 million, or 149%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to the 98% increase in the average carrying balances of interest bearing nonrecourse debt for the year ended December 31, 2016, as compared to the year ended December 31, 2015, as well as the increase in interest rates for the year ended December 31, 2016, as compared to the year ended December 31, 2015.

Other interest expense and amortization of debt discounts and fees, net, increased by $6.1 million, or 18%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This increase was primarily due to the higher average balances of debt discounts and issuance costs related to our debt for the year ended December 31, 2016, as compared to the year ended December 31, 2015.

Other expense, net, decreased by $12.1 million, or 47%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015. This decrease was mainly due to the $3.0 million loss from the changes in the fair value of our interest rate swaps in 2016 as compared to the $11.6 million loss from the changes in the fair value of our interest rate swaps in 2015. We account for our interest rate swaps as non-hedging derivatives. Additionally, we incurred $2.4 million loss from settlement of a matter and the $5.3 million increase in accretion on the contingent consideration related to the Silevo acquisition in 2015.

2015 Compared to 2014

Interest expense – recourse debt, increased by $13.6 million, or 94%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to the 90% increase in the average carrying balances of interest bearing recourse debt for the year ended December 31, 2015, as compared to the year ended December 31, 2014.

Interest expense – non-recourse debt, increased by $16.4 million, or 121%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was primarily due to the 146% increase in the average carrying balances of interest bearing non-recourse debt for the year ended December 31, 2015, as compared to the year ended December 31, 2014.

Other interest expense and amortization of debt discounts and fees, net, increased by $6.2 million, or 22%, This increase was primarily due to the higher average balances of debt discounts and issuance costs related to our debt for the year ended December 31, 2015, as compared to the year ended December 31, 2014.

Other expense, net, increased by $15.2 million, or 143%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014. This increase was mainly due to the $11.6 million loss from interest rate swaps related to our debt facilities, the $2.4 million loss from the settlement for a matter and the $5.3 million increase in accretion on the contingent consideration related to the Silevo acquisition, in the year ended December 31, 2015. We have entered into forward interest rate swaps in order to fix the variable interest rates for each draw under certain credit facilities. We account for interest rate swaps as non-hedging derivatives. This increase was partially offset by the $3.1 million decrease in loss on debt extinguishment.

Net Loss Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests

 

 

 

Year Ended December 31,

 

 

Change 2016 vs. 2015

 

 

Change 2015 vs. 2014

 

(Dollars in thousands)

 

2016

 

 

2015

 

 

2014

 

 

$

 

 

%

 

 

$

 

 

%

 

Net loss attributable to noncontrolling

   interests and redeemable noncontrolling

 

$

(1,059,121

)

 

$

(710,492

)

 

$

(319,196

)

 

$

(348,629

)

 

 

(49

)%

 

$

(391,296

)

 

 

(123

)%

 

The net loss attributable to noncontrolling interests and redeemable noncontrolling interests represents the share of net loss that was allocated to the investors in the joint venture financing funds. This amount was determined as the change in the investors’ interests in the joint venture financing funds between the beginning and end of each reported period, calculated primarily using the HLBV method, less any capital contributions net of any capital distributions. The calculation depends on the specific contractual liquidation provisions of each joint venture financing fund and is generally affected by, among other factors, the tax attributes allocated to the investors including tax bonus depreciation and ITCs or U.S. Treasury grants in lieu of the ITCs, the existence of guarantees of minimum returns to the investors by us and the allocation of taxable income or losses including provisions that govern the level of deficits that can be funded by the investors in a liquidation scenario. The calculation is also affected by the cost of the

 

32


assets sold to the joint venture financing funds, which forms the book basis of the net assets allocated to the investors assuming a liquidation scenario. Generally, significant loss allocations to the investors have arisen in situations where there was a significant difference between the fair value and the cost of the assets sold to the joint venture financing funds in a particular period accompanied by the absence of guarantees of minimum returns to the investors by us, since the capital contributions by the investors were based on the fair value of the assets while the calculation is based on the cost of the assets. The existence of guarantees of minimum returns to the investors by us and limits on the level of deficits that the investors are contractually obligated to fund in a liquidation scenario reduce the amount of losses that could be allocated to the investors. In addition, the redeemable noncontrolling interest balance is at least equal to the redemption amount.

2016 Compared to 2015

The net loss allocation to noncontrolling interests and redeemable noncontrolling interests for the year ended December 31, 2016 was $1,059.1 million compared to the $710.5 million net loss allocation for year ended December 31, 2015. The net loss allocation for the year ended December 31, 2016 was primarily due to a $959.7 million loss allocation from financing funds into which we were selling or contributing assets and $99.4 million loss allocation related to financing funds that were fully funded and that we were not selling or contributing additional assets. The net loss allocation for the year ended December 31, 2015 was primarily due to a $701.9 million loss allocation from financing funds into which we were selling or contributing assets.

2015 Compared to 2014

The net loss allocation to noncontrolling interests and redeemable noncontrolling interests for the year ended December 31, 2015 was $710.5 million compared to the $319.2 million net loss allocation for year ended December 31, 2014. The net loss allocation for the year ended December 31, 2015 was primarily due to a $701.9 million loss allocation from financing funds into which we were selling or contributing assets. The net loss allocation for the year ended December 31, 2014 was primarily due to a $345.4 million loss allocation from financing funds into which we were selling or contributing assets. This loss allocation was partially offset by a $25.9 million income allocation related to financing funds that were fully funded and that we were not selling or contributing additional assets.

 

 

 

33


Liquidity and Capital Resources

We finance our operations, including the costs of acquisition and installation of solar energy systems, mainly through a variety of financing fund arrangements that we have formed with fund investors, recourse and non-recourse credit facilities, other corporate borrowing and cash generated from our operations.

As described below under “Financing Fund Commitments,” as of December 31, 2016, we had $481.4 million of available commitments from our fund investors. Our ability to draw-down the available commitments from our fund investors is dependent on our ability to originate and transfer qualifying solar energy systems and the associated customer lease or power purchase agreements into the financing funds. Some of the financing funds have restrictions regarding the mix of customer leases or power purchase agreements that can be assigned to them, as well as measures of minimum customer credit. We expect to be able to draw-down on substantially all of the available commitments from our fund investors within the next 12 months. The proceeds from our financing fund arrangements are available for general working capital purposes.

As of December 31, 2016, we had $411.8 million of unused borrowing capacity available under our credit facilities (or $468.0 million including the $56.2 million available under the MyPower revolving credit facility), subject to our continuing compliance with the terms and covenants of our credit facilities. Of this amount, $387.4 million was available under our non-recourse debt facilities (excluding the MyPower revolving credit facility).

The secured revolving credit facility requires us to have unused commitments and a sufficient borrowing base in order to both borrow additional amounts and to allow borrowed funds to remain outstanding. We anticipate maintaining a sufficient borrowing base to support substantially all of the committed capital under our secured revolving credit facility in the next 12 months; such borrowings are available for general working capital purposes.

Our non-recourse debt facilities require us to have unused commitments, to provide qualified security (such as solar energy systems or our interests in financing funds) and to remain in compliance with the terms of the facilities in order to make additional borrowings. In the event that we fail to meet specific terms for additional borrowings, our ability to borrow unused commitments may be suspended until we resume compliance. We anticipate that our operations will provide sufficient qualified security and that we will be in compliance with the terms to draw on substantially all of the committed capital under our non-recourse debt facilities in the next 12 months; such borrowings are available for general working capital purposes, subject to nominal reserve requirements.

The MyPower revolving credit facility is only available for funding costs associated with sales under MyPower arrangements; as we have discontinued offering MyPower arrangements, we do not expect to incur additional borrowings under the MyPower revolving credit facility.

In future periods, we expect to incur additional capital expenses as we invest further in our solar roof and other module manufacturing operations, technology platform and proprietary mounting and racking hardware. As a result of our manufacturing relationship with Panasonic Corporation and its affiliates, or Panasonic, we anticipate significantly reduced expenditures related to manufacturing operations at the Riverbend Manufacturing Facility in Buffalo, New York.

We have agreed to spend or incur approximately $5 billion in combined capital, operational expenses, costs of goods sold and other costs in the State of New York during the 10-year period following full production of the Riverbend Manufacturing Facility. Generally, these obligations commence following the manufacturing facility completion date, which occurs upon the arrival of manufacturing equipment, the receipt of certain permits and other specified items. These committed amounts commence with $130.0 million in cumulative investments in the first year after the completion date, and we are required to pay a $41.2 million “program payment” in any year that we do not meet these requirements. We anticipate meeting these obligations through our operations at the Riverbend Manufacturing Facility and other operations within the State of New York, as well as Panasonic’s manufacturing operations at the Riverbend Manufacturing Facility, over the 10-year term of the agreement, and we do not believe that we face a significant risk of default.

The amount of our liquidity and capital resources as of a given date is also dependent upon, among other things, the relative timing of our investments in solar energy systems and the timing of subsequent draws on our financing funds and utilization of our credit facilities. As a result, the amount of our liquidity and capital resources may significantly fluctuate within a reporting period by amounts that are not reflected by comparing our cash and cash equivalents balances at each balance sheet date. For example, solar energy systems deployed towards the end of a fiscal quarter may not be transferred to a financing fund in sufficient time for the funds to be received and reflected in our cash and cash equivalents balance as of the quarter-end. In addition, any delays in large commercial projects are also likely to impact our liquidity and capital resources, for example, in situations where we have already spent funds to purchase components for solar energy systems that are installed in subsequent periods. As our business grows and cumulative system installations increase, the amounts by which our liquidity and capital resources may fluctuate within a quarter are likely to increase.

 

34


Our operating plans and expected cash requirements for the next 12 months are primarily dependent on the cost, number and size of future solar energy systems that we expect to install and our ability to successfully monetize the related future customer payments, as well as the mix of sales that involve upfront cash proceeds versus long-term contracted payments. We believe that the cash requirements of our operations (including repayment or refinancing of our recourse indebtedness) will be satisfied for at least the next 12 months by: (i) our existing cash and cash equivalents, (ii) an improving mix of direct system sales and Solar Loan contracts that provide upfront cash proceeds, (iii) the funds available under our recourse and non-recourse credit facilities (excluding amounts available under the MyPower revolving credit facility) that may be drawn-down during this period, (iv) the funds available under our existing financing funds that may be drawn-down during this period, (v) the continued interest of investors in, and our track record of, entering into new financing funds and non-recourse debt facilities, (vi) reduced customer acquisition costs as a result of our acquisition by Tesla and (vii) improved access to capital as a result of our acquisition by Tesla.

As of December 31, 2016, we were in compliance with all financial covenants contained in our debt agreements, and we expect to remain in compliance with these financial covenants. However, if our assumptions prove inaccurate and we are unable to adjust our operating plan to comply with these financial covenants, then we could be in default under our debt agreements. In that circumstance, the amounts outstanding under our debt agreements could be accelerated, which would negatively impact our liquidity and capital resources. In particular, under the terms of our secured revolving credit facility, the occurrence of an event of default with respect to a credit facility (including both recourse and non-recourse indebtedness) having an aggregate principal amount of more than $10.0 million could trigger a cross-default that could result in the acceleration of or the taking of other remedies under our secured revolving credit facility. In addition, the occurrence of an event of default that results in the acceleration of more than $50.0 million of recourse indebtedness could trigger a cross-default that could result in the acceleration of or the taking of other remedies under our convertible senior notes.

Under the terms of our secured revolving credit facility, we are subject to the following financial covenants:

Interest Coverage Ratio: We are obligated to maintain an interest coverage ratio of at least 1.5-to-1 as of the end of each fiscal quarter. The interest coverage ratio is measured by dividing (a) an amount equal to the excess of (i) our trailing 12-month consolidated gross profit over (ii) 20% of our trailing 12-month consolidated general and administrative expenses by (b) our unconsolidated trailing 12-month cash interest charges excluding interest charges on non-recourse debt.

Unencumbered Liquidity: We are obligated to maintain unencumbered liquidity at an amount equal to at least 20% of the sum of (a) the amount committed under our secured revolving credit facility plus (b) the aggregate outstanding principal amount of Solar Bonds that mature prior to our secured revolving credit facility’s maturity date, as of the end of each month. However, unencumbered liquidity must always be greater than $50.0 million, as of the end of each month. Unencumbered liquidity is defined as our average daily balance of cash and cash equivalents, in deposit accounts controlled by the borrower or the guarantors of our secured revolving credit facility.

Under the terms of a borrowing by one of our subsidiaries, the subsidiary is obligated to maintain a debt service coverage ratio of at least 1.05-to-1 as of certain specified dates and periods. The debt service coverage ratio is measured by dividing (a) the specified cash receipts of the subsidiary less the specified cash payments made by the subsidiary in the period by (b) the scheduled principal payments due and payable by the subsidiary plus the interest payments due and payable by the subsidiary, at the end of the period.

Financing Fund Commitments

We have financing fund commitments from several fund investors that we can draw-on in the future upon the achievement of specific funding criteria. As of December 31, 2016, we had entered into 63 financing funds that had a total of $481.4 million of undrawn committed capital. We allocate customer leases, power purchase agreements and the related economic benefits associated with the solar energy systems to our financing funds, in accordance with the criteria of each fund. Upon such allocation and our satisfaction of the conditions precedent, we are able to draw-down on the financing fund commitments. Once received, these proceeds provide working capital to deliver solar energy systems to our customers and form part of our general working capital.

 

35


Contractual Obligations

Set forth below is information concerning our contractual commitments and obligations as of December 31, 2016 (in thousands).

 

 

 

 

 

 

Less Than

 

 

 

 

 

 

 

 

 

 

More Than 5

 

 

 

Total

 

 

1 Year

 

 

1-3 Years

 

 

3-5 Years

 

 

Years

 

Long-term borrowings

 

$

3,580,405

 

 

$

828,584

 

 

$

1,461,115

 

 

$

376,749

 

 

$

913,957

 

Firm purchase commitments

 

 

376,563

 

 

 

335,166

 

 

 

18,224

 

 

 

7,702

 

 

 

15,471

 

Interest(1)

 

 

598,609

 

 

 

131,179

 

 

 

167,736

 

 

 

105,625

 

 

 

194,069

 

Lease obligations

 

 

253,105

 

 

 

60,306

 

 

 

88,945

 

 

 

38,371

 

 

 

65,483

 

Performance guarantee

 

 

6,611

 

 

 

6,611

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,815,293

 

 

$

1,361,846

 

 

$

1,736,020

 

 

$

528,447

 

 

$

1,188,980

 

 

(1)

Excludes interest payments on sale-leaseback financing obligations, which is included in lease obligations.

Off-Balance Sheet Arrangements

We include in our consolidated financial statements all assets, liabilities and results of operations of the financing fund arrangements that we have entered into. We have not entered into any other transactions that have generated relationships with unconsolidated entities, financial partnerships or SPEs. Accordingly, we do not have any off-balance sheet arrangements.

 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks as part of our ongoing business operations. Our primary exposures include changes in interest rates because certain borrowings bear interest at floating rates plus a specified margin. For fixed-rate debt, interest rate changes do not affect our earnings or cash flows. Conversely, for floating-rate debt, interest rate changes generally impact our earnings and cash flows, assuming other factors are held constant. Pursuant to our risk management policies, in certain cases, we utilize derivative instruments to manage some of our exposures to fluctuations in interest rates on certain floating-rate debt. We do not enter into any derivative instruments for trading or speculative purposes. In addition, we entered into capped call option agreements that could potentially reduce the dilution to our parent’s common stock upon the conversion of our outstanding convertible senior notes.

Changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and reducing our funds available for capital investments, operations or other purposes. In addition, we must use a substantial portion of our cash inflows to service our borrowings, which may affect our ability to make future acquisitions or capital expenditures. A hypothetical 10% change in our interest rates would have increased our interest expense for the year ended December 31, 2016 and 2015 by $5.2 million and $2.3 million, respectively.

 

 

 

36


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

SOLARCITY CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

Page

Report of Independent Registered Public Accounting Firm

 

38

Consolidated Balance Sheets

 

39

Consolidated Statements of Operations

 

41

Consolidated Statements of Equity

 

42

Consolidated Statements of Cash Flows

 

43

Notes to Consolidated Financial Statements

 

45

  

The supplementary data required by Item 8 is presented under Part II, Item 7 and is incorporated herein by reference.

 

 

 

 

37


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholder of

SolarCity Corporation

We have audited the accompanying consolidated balance sheets of SolarCity Corporation (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations, equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SolarCity Corporation at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

/s/ Ernst & Young LLP

Los Angeles, California

March 1, 2017

 

 

 

38


SolarCity Corporation

Consolidated Balance Sheets

(In Thousands, Except Shares and Share Par Values)

 

 

 

December 31,

 

 

 

2016

 

 

2015

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

290,710

 

 

$

382,544

 

Short-term investments

 

 

 

 

 

11,311

 

Restricted cash

 

 

74,717

 

 

 

39,864

 

Accounts receivable (net of allowances for doubtful accounts of $14,829 and $4,292

   as of December 31, 2016 and December 31, 2015, respectively)

 

 

66,949

 

 

 

33,998

 

Rebates receivable (net of reserves of $2,803 and $2,207

   as of December 31, 2016 and December 31, 2015, respectively)

 

 

10,339

 

 

 

11,545

 

Inventories

 

 

172,713

 

 

 

342,951

 

Prepaid expenses and other current assets

 

 

77,497

 

 

 

79,925

 

Total current assets

 

 

692,925

 

 

 

902,138

 

Solar energy systems, leased and to be leased – net

 

 

5,828,755

 

 

 

4,375,553

 

Property, plant and equipment – net

 

 

244,736

 

 

 

262,387

 

Build-to-suit lease asset under construction

 

 

807,593

 

 

 

284,500

 

Goodwill and intangible assets – net

 

 

461,989

 

 

 

517,109

 

MyPower customer notes receivable, net of current portion

 

 

517,244

 

 

 

488,461

 

MyPower deferred costs

 

 

232,369

 

 

 

215,708

 

Other assets

 

 

345,145

 

 

 

241,262

 

Total assets(1)

 

$

9,130,756

 

 

$

7,287,118

 

 

 

39


 

 

 

December 31,

 

 

 

2016

 

 

2015

 

Liabilities and equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

207,643

 

 

$

364,973

 

Distributions payable to noncontrolling interests and redeemable noncontrolling interests

 

 

24,085

 

 

 

26,769

 

Payable to parent – net

 

 

11,693

 

 

 

 

Current portion of deferred U.S. Treasury grant income

 

 

14,348

 

 

 

15,336

 

Accrued and other current liabilities

 

 

265,987

 

 

 

276,506

 

Current portion of deferred revenue

 

 

124,722

 

 

 

103,078

 

Current portion of long-term debt

 

 

617,588

 

 

 

180,048

 

Current portion of solar bonds

 

 

16,582

 

 

 

13,189

 

Current portion of solar bonds issued to related parties

 

 

165,000

 

 

 

165,120

 

Current portion of solar asset-backed notes

 

 

19,628