Canadian Solar (NASDAQ:CSIQ) Q1 2019 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to Canadian Solar's first quarter 2019 earnings conference call. My name is Albert and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Merima. With Canadian Solar's IR department, please go ahead. Thank you, operator, and welcome everyone to Canadian Solar's first quarter 2019 earnings conference call. Joining us today on the call are Yan Zhong, our acting chief executive officer, and Dr. Hui-Feng Chen, our senior vice president and chief financial officer.

0:47 Before we begin, I remind our listeners that management's proposed remarks today will contain forward-looking statements, which are subject to risk and uncertainty, and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the safe harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from management's current expectations, and therefore we refer you to a more detailed discussion of the risks and uncertainties in the company's annual report on Form 20-X, filed with the Securities and Exchange Commission. In addition, any projections as to the company's future performance represent management's estimates as of today's core. Canadian Solar assumes no obligation to update these projections in the future unless otherwise required by approval law.

1:45 At this time, I would like to turn the call over to our CFO, Dr. Huifeng Chen. Huifeng, please go ahead.

1:53 Welcome, everyone, to our Q1 call. Earlier, we sent out a press release that explained why Sean cannot join us on this call. Sean is resting at a rehabilitation center in Beijing from a recent physical injury. He has been in constant communication with us during this period. He asked me to tell you he regrets his absence, he is recovering well, and he looks forward to speaking to you soon. Sean knows that we all miss him. So via telephone, he hopes to speak at our Solar Future Forum to be held in New York City on June 20th.

2:38 He says that he appreciates your support over the years and he looks forward to speaking to you soon. To allow Sean and his family to focus on recovery and ensure continued operations without disruption, our board decided to appoint Yan as acting CEO. We are delighted to have Yen speak about our Q1 results. Many of you have met with Yen and are familiar with him already. Yen has worked for Canadian Solar for over 13 years. In 2006, he served as a director of Canadian Solar. In 2009, he became vice president of Global Sales and Marketing and was later promoted to Chief Commercial Officer and President of the MSS business.

3:36 Yan has worked extremely close with Xiaohua and fully understands the operations of the company. We are in good hands during this interim period. With that said, let's welcome Yan.

3:53 Thank you, Huifeng. We appreciate everyone taking the time to join us today. The takeaways from Q1 are, one, we delivered module shipments, revenue and gross margin above expectations. Two, our core business remains strong with demand increasing in key markets worldwide. Three, ASTs have been relatively stable. And four, we remain fully on track to monetize the majority of our 3.4 gigawatts late-stage pipeline in 2020 or later. We told you last quarter there would be a pullback in Q1 compared to Q4. This healthy pulse came after we achieved close to 140% growth of net profit in 2018 from the 2017 level.

4:48 There were a number of external factors that impacted our overall financial performance. These included the acceleration of some high-profit project sales from 2019 into 2018, the appreciation of RMB, lost manufacturing days related to our ERP system upgrade, and the impact of Chinese New Year on production and sales volume. Even with headwinds, Our total solar module shipments for Q1 were 1,575 megawatts with gross margin of 22.2%. Total revenue for the quarter was $484.7 million compared to 1,951 megawatts in Q4 with revenue of $901 million. In Q1, revenue from our MFF business was $453.1 million, growth margin was 21.6, and operating income was $19.5 million.

5:59 The better-than-expected growth margin benefited from a lower blended module manufacturing cost and stabilized average module selling price. We continue to benefit from our premium brand, which helps offset some price pressure. Customers buy reliability, quality, and performance. We're also pleased with interest in our high-efficiency modules such as by Haiku, Haiku, and Haidian. As we announced yesterday, we signed a multi-year module supply agreement with EDF Renewables North America to deliver 1.8 gigawatts of our efficiency by Haiku and Haiku modules to EDX projects in the U.S., Canada, and Mexico.

6:50 This is the largest single-module supply agreement in our company's 18 years of history. Our high-efficiency products continue to gain popularity with customers due to the higher ROI. This is important to Canadian Solar because we prefer to sell as a quality solution, which carries an ASP premium. We also continue to carefully invest in R&D and capacity to make sure we have the higher efficiency solutions customers want. This is another competitive advantage for us. We have the scale to support our R&D roadmap, even in the softer period. We remain on track to convert all of our cell capacity, both poly and mono, into the PERC technology by the end of this year.

7:43 In addition, we are pleased with the progress of our P4 cells, i.e. cells with cassette mono, sorry, P5 cells, i.e. cells with cassette mono technology that can have close to mono efficiency while still enjoy the cost advantage. We set a new world record of 22.28%. for the conversion efficiency for our P-type multicrystalline P5 cells when tested in April. Further, we're also pleased with our progress with our EPC business and O&M business. We now have 966 megawatts of EPC projects under execution and a growing O&M portfolio of over 2.6 gigawatts.

8:37 contracted projects globally. Our energy business also continues to make solid progress despite the timing of project sales I noted earlier. To give you a few examples, during Q1, we sold a 10 megawatt solar power plant in China and four megawatt solar power plant in Japan. In April, we entered into agreement to sell 80% interest in our 482.6 MW late-stage portfolio in Brazil, and we expect to close the sales in coming months. In May, we completed the sale of the 134 MW Mustang solo power plant in the U.S., and the sale of our 68 MW solo power project in Mexico.

9:27 As you know, we take a long-term view on our business. were working to close project sales and manage our module business. At the same time, our strategy relies on successfully recycling our capital to replenish our late-stage project pipeline. We continue to use the strict criteria to help us ensure higher ROI projects. To give you a few examples, in March, we signed a power purchase agreement on a 280 megawatts project in Texas. and a 20 years 35 megawatts PPA on the Slate project in California. We also signed PPAs in Canada and Israel. Among others, our portfolio of late stage utility-scale solar power projects as of April 30, 2019, including those under construction, was approximately 3.4 gigawatts.

10:28 Our projects in operation as of April 30th, 2019 total 984 megawatts with an estimated resale value of approximately 1.2 billion. Our goal is to build and sell these projects at COD or to sell them before COD either at NTP or before NTP based on the market conditions. Due to the typical development cycle, we expect to realize cells for the majority of our current 3.4 gigawatt late-stage project pipeline in 2020 or later. Now, let me comment on our guidance for Q2 2019.

11:14 We currently expect total Q2 module shipment to be in the range of approximately 1.95 gigawatts to 2.05 gigawatts. including 50 megawatts of shipments to our own utility-scale solar projects. We expect the revenue for the second quarter of 2019 to be in the range of $970 million to $1.01 billion. We expect the gross margin for Q2 to be between 13% to 15%. Gross margin This growth margin reflects a higher contribution of lower margin project sales. Overall, our fundamental business remains strong, led by healthy demand and stable price. We view Q1 2019 as a one-time bump in our nearly spotless record of consistently delivering profitable results in both up and down markets.

12:22 We're working to achieve improving results through 2019 and longer term. And we're actually very optimized about the rest of the year. And we think we have a very good chance to meet and even beat the previous four years module shipment guidance. In our MSS business, We're currently running at about 50% to 60% of our long-term capacity booked. We have historically left some capacity to meet the needs of higher margin near-term sales. This has been a very successful strategy and remains an important element of our planning, execution, and track record of success.

13:12 Let me now turn the call back to our staffer, Huifeng Zhang, for a more detailed review of our results for the first quarter. Huifeng, please go ahead.

13:21 Thank you, Yan. Our results for the first quarter were above our expectations. We achieved better than expected total margin shipments, gross margin, and revenue was on the high end of our guidance. Although Q1 net income was impacted by issues Yan mentioned earlier, the issues like lost manufacturing base from the ERP system upgrade will not repeat in Q2. We also expect Q2 to benefit from increased project sales, higher volume of module sales, and the depreciation of RMB. Now allow me to go over the details in the financial numbers.

14:10 Net revenue for Q1 was $484.7 million, down 46.2% sequentially from Q4, and down 66% compared to year-ago period. Net revenue for Q1 was comprised of 453.1 million from our MXS business and 31.6 million from our energy business. This reflects the pooling of products into Q4 from Q1. Gross profit in Q1 was 107.4 million compared to 271.3 million in Q4 and 143.9 million in Q1 last year.

14:57 Gross margin in Q1 was 22.2% compared to 30.1% including the benefit of the CVD reversal of 16.1 million in Q4 or 28.3% excluding the CVD reversal benefit and 10.1% in Q1 last year. Total operating expenses were $100.8 million in Q1 compared to $134.7 million in Q4 and $65.7 million in Q1 of the prior year. The sequential decrease was mainly driven by bad debt reversal and lower sales commission.

15:42 The year-over-year increase was due to less contribution of other operating income related to the project sales. Income from operations was 6.6 million in Q1 compared to 136.6 million in Q4 and 78.2 million in Q1 of last year. Operating margin was 1.4% in Q1 compared to 15.2% in Q4 and 5.5% in Q1 of the prior year. Foreign exchange loss in Q1 was 12.6 million. compared to a gain of 7.3 million Q4 and a loss of 8.5 million Q1 of the prior year. We recorded a loss on change in fair value of the derivatives of 1.3 million Q1 compared to a loss of 7.3 million Q4 and a gain of 4.5 million in the first quarter of 2018. Income tax benefit in Q1 was 7.5 million.

16:46 compared to income tax expense of $36.7 million in Q4 and income tax expense of $4.1 million in Q1 the prior year. Net loss attributable to Canadian solo shareholders for Q1 was $17.2 million or $0.29 per diluted share compared to net income of $111.6 million or $1.81 This is their first real loss for the company in five years. We reported a loss prior due to a government error that was later reversed. But we view Q1 as a bump in our near spotless record of delivering profitable results in the up and down markets.

17:46 And as Yen noted in the outlook, we expect to achieve great improvements moving through 2019. Now, moving on to the balance sheet. At the end of Q1, our balance sheet of cash and cash equivalents was 370.2 million, compared to $444.3 million at the end of Q4. Our restricted cash balance was $542.2 million at the end of Q1 compared to $496.7 million at the end of Q4. The inventories at the end of Q1 was $384.1 million compared to $262 million at the end of Q4. The inventory turnover was 81 days in Q1 compared to 44 days in Q4.

18:37 Short-term borrowings and the current portion of long-term borrowings on project assets at the end of Q1 totaled $1.4 billion compared to $1.3 billion at the end of Q4. Long-term borrowings at the end of Q1 were $433.5 million compared to $393.6 million at the end of Q4. Total debt at the end of Q1 was approximately 1.92 billion, of which 765.6 million was non-recourse and the short-term borrowings and long-term borrowings directly related to utility-scale products, which include a full 175.9 million of non-recourse borrowings, totaled 735 million at the end of Q1. compared to 735.1 million at the end of Q4. Finally, we repaid the entire 127.5 million outstanding balance of our senior convertible notes in February 2019.

19:44 Overall, we exited Q1 in a strong business and financial position. We will continue to carefully manage our pipeline in order to secure the highest return from our assets. We remain focused on driving profitability and building value for our shareholders. With that, I now would like to open the call to your questions. Operator? Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press star 1 on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Again, it's star 1 to ask a question.

20:34 Your first question comes from the line of Brian Lee from Goldman Sachs. You may now ask a question.

20:44 Hey, guys. Thanks for taking the questions here. Maybe, Weifeng, first on the gross margin in the quarter, quite a good result, 22%. Guidance, I know, is lower here for the second quarter, even excluding the project impact. But, you know, as you mentioned, you have a view of increasing profitability moving through the year. I know you're probably talking about the yes line, but what should we think about in terms of the gross margin trend as we move through the second half off the year? Thank you, Brian.

21:23 First of all, this guidance for Q2 gross margin includes both the module business and the project business. And then now, already Two months have passed in the Q2, and the last two months we closed the significant size project of Mustang, which actually we have a public announcement sold to your firm, Goldman Asset Management, and that project is... is sold at total enterprise value, which means the size of the transaction is our cash equity plus tax equity and plus the debt.

22:10 So in that case, the denominator is huge and the profit, the numerator, is unchanged. So that transaction pulled down the guided Q2 profit margin significantly. But in the meantime, we also closed the project in Mexico, which is also a COD sales. Also, in that case, the denominator is the entire value of the project asset, and then, of course, the numerator is the profit. So those two transactions have a significant impact on the host market in the guidance. But overall, the module business At least till this point, two-thirds of Q2 have passed.

22:59 I think we are making good, healthy profit. And not only the ASP price has remained strong, but also on the cost side, we did a good job in lower the cost. And then maybe later on, Yan can talk about is the view for the second half of 2019 for the module business. Thank you, Brian. Your next question comes from the line of Philip Shen from Roth Capital Partners. You may now ask a question.

23:49 Hi, everyone. Thanks for the questions. First one is on... The context and situation around Sean was wondering if you guys might be able to provide a little bit more color on what happened and also perhaps some sense of timing as to when he could return. It seems like he still may be recuperating through much of June, given your comments about him calling in to a... to a conference. So any more context there would be great. Thanks.

24:28 Thank you, Phil. We can discuss with you here about Sean's abilities related to his CLEO function, but there is a respect for the privacy for the family. I can tell you that I went to the rehab center last week and talked to Sean and he is in good shape. I was told that throughout the process From the day that the accident happened until today, Xiang has never lost consciousness. He's always clear what is happening and communicating with people.

25:16 And then... He is recovering very fast. Actually, I talk to him almost every day in the last 10 days. The only issue is that his voice, The quality of the voice is hoarse or cracked or throaty. So he preferred to stay and resting at the rehab center in Beijing instead of joining our call today. But I was told that any day, He can be on the phone with you guys. And also he has the capability of reading and responding some simple email. But I think for Sean and for the family, at this point, the priority is recovery. and I'm sure that in the very near future, especially he told me that he hopes to speak to you guys over the phone for our solar forum, solar future forum to be held in New York on June 20th. So we are confident that Sean will be back with us very soon.

26:39 Great. Well, we wish him our best and a fast recovery. Shifting gears to ASPs, we calculate a rough module ASP in Q1 of about maybe 26 or 27 cents. Can you talk to us about what was the ASP in Q1 and what the expectations are for Q2 and about half the year? Thanks.

27:07 Well, for Q1, actually, our ASP was around 30 cents. Space Price, Contract Price, ASP is around 30 cents. For Q2, we have a margin guidance. ASP-wise is lower than Q1, but it still maintains strong. That's all I can tell you. As I mentioned, that the ASC has been stabilized with, I would say stable decline, but stable.

27:57 Okay, great. And then as it relates to the outlook for China demand, do you expect a ramp up of activity in Q3 and then strength in Q4? and just give us your view on when do you think the NEA will provide greater clarity on the project list for subsidies for the back half of the year and how demand should evolve?

28:30 Well, actually we have both the grid parity projects and the subsidized bidding projects policy also just came out today. So now we have clarity. So according to our analysis, the rooftop, residential rooftop is around three gigawatts for this year. And the 2019, we're talking about the subsidy projects is 11.5 gigawatts. And also there's something about 2020 Projects, 20 gigawatts. And we have this, oh sorry, this is from 20, sorry, it's around three gigawatts for residential.

29:23 Then we have this subsidized utility fiscal project, which is 37.5 gigawatts, but we have to assume that, A significant portion of that will be dragged, slipped into next year. As always, we know China. There's always a great period that when people cannot connect on time, they slip into next year. So we also have this poverty elevation projects. We have this top running projects. So also national grid parity projects. So also something more is the self-consumption projects without the necessity of permits and subsidy.

30:12 So that also has a pretty big gigawatt level of demands. So total is like 50 gigawatt, but if you take a discount on module supply, so we come up with around 40 gigawatts of the total demand for 2019. So, this is our number. So, since we only installed until now, 7 gigawatts installed. So, we believe in Q3 and Q4, the demand should be high. At a certain point, there could be a shortage.

30:52 that which will drive up the price by like 10%, something like that, it's very possible.

30:57 So not too sure when the rush will start, maybe September, maybe October, we don't know. But we're closely monitoring the situation and Canadian solar has been very good at monitoring and control our pace for for all their closure and the price guidance to maximize our profit. So we've been keeping very close monitoring of the situation.

31:32 Great. Thank you for all that detail, Yan. Why, if the policy is out, do you think the rush would start so late in September or October? Why would it not start earlier?

31:46 Well, first of all, that's my only personal opinion. Judgment that they may start September, you know, around there. Because the effective date of the reverse auction bidding, the policy effective date is July the 1st. So people would need a little bit time to prepare until they need module. So it's not all the projects are ready to be built right away. So that's why I believe that people will still need a couple of months before actually they need module to be shipped.

32:29 Okay, great. One last housekeeping question. You didn't mention officially the full year guidance that you gave last quarter. Is that reiterated in this quarter? So you still are keeping that guidance for the year?

32:46 Yeah, we're keeping the guidance for the year with confidence.

32:52 Great. Okay. Thank you very much, Yan and Huifeng.

32:55 I'll pass it on. And we're also optimistic about second half demand. Thank you. Your next question comes from the line of Colin Rouge of Oppenheimer. Please ask a question.

33:14 Thanks so much. Can you talk a little bit about the shifting dynamics with your customer base? What's happening there? It seems like you may be seeing some larger customers, but I would love to get a sense of what the customer base is starting to look like and what it looks like going forward if you're going to be dealing with a fewer number of larger customers, and then if you could comment a little bit about some of the geographic exposure. As we go into 2Q and 3Q, you know, what sort of mix you're looking at in the U.S. versus Europe?

33:47 Well, that's a good question. Actually, we have been over time, over a number of years, we've been trying to develop our channel strategy. So we try to be more selective and more efficient on the module, on the channel side. So In all the mature markets, we have a separate direct selling team that are selling small volume orders to smaller customers by passing the channel to achieve premium pricing. So that alone actually today, so we have that in U.S., Europe, in Brazil, in China, and also in Australia and Japan. So the direct channel worldwide gives us like 30% of our total shipping volume with a significant price premium.

34:52 I can't give you too much detail, but it's a significant price premium. On top of that, we also have priority allocation of our capacity to higher priced markets like Japan, like Australia, like Europe, US, and even Brazil. It's also our premium market. So that also has an incremental volume that enjoys a healthy pricing. And also as you know, we have our own project team. So our own project needs module. And on top of that, we also have our, starting from end of last year, we have a significant, we have made a significant progress on We have closed one gigawatt project that are under execution on turnkey EPC.

35:55 That actually alone, also all the modules we ship to those projects has also very healthy pricing. So if you add up all those volume, whatever left is the capacity that we will have to compete in the competitive market. So we have the luxury to be more selective on who to sell those capacity. This is one important strategy for the company to maximize our profit. But having said that, of course, we need to balance between just the profit with also cash flow, right?

36:41 Payment terms are also important. Like Indian, it's up from LC. China, for us, it's all up from pay. And also the shipping time, which is the inventory turnover. So we need to have to balance all the factors to optimize our business in terms of profit and cash flow.

37:03 Okay, that's helpful. You know, just turning to the balance sheet, you know, are there adjustments that you guys would like to make in terms of optimizing the capital structure for the company, reducing debt expense? Are there opportunities for that as you look through the balance of 2019?

37:26 Corey, this is Hui Feng. Overall, compared to 12 months ago, or even 24 months ago, our balance sheet is in much, much better shape. And that's the result of almost over $2 billion worth of solar access monetization. and then we paid off the convertible and also a 150 million US dollar loan to a Chinese bank early this year in Q1. So now talking about the debt asset ratio, I think that we now in the lower 70%, However, on the cash flow side, we also doing better than 12, 24 months ago. Recently, we finally received the tax refund from the U.S. federal government IRS, which is a significant number.

38:33 However, with that said,

38:35 We have more project opportunities in the pipeline and also in the market available for us to bid. I can tell you that our teams are in different regions. They compete for the limited capital we have at the corporate. Everyone wants more projects, more business in their business. We have to optimize at the corporate level. And so for that, we are open to find people in the form of either partnership or loan or whatever so that we can do more projects.

39:25 The project for FritzBerry continues to be healthy and then Q1 this year, 2019, is the season of drought. You guys can see the number. But for Q2, we started picking up in project sales. And then Q3, Q4 will be much higher. Now, there are news out there in the market that we are selling projects in the U.S., selling projects in Japan, et cetera, et cetera. I'm here not confirming this news, but that's our business model. We already shifted from COD sales to NTP sales, and it seems like things are getting better and better.

40:11 We are doing more projects every major market in the world. Thank you.

40:18 Thank you. Your next question comes from the line of Mark Strauss of JP Morgan. Your line is now open.

40:30 Yeah, thank you very much for taking our questions, and we'd also like to wish Sean a speedy recovery. So most of our questions have been asked already, but I think I just wanted to talk about your project sales, the majority of which you said are scheduled for 2020 or later. Can you just talk about, though, the The willingness or the appetite to sell those earlier in the process, perhaps at NTP versus at COD, and just trying to get a rough sense of what your expectations are that's baked into 2019 guidance. Thank you.

41:13 Hi, Mark. I guess this is probably either your second or first participation into our earnings call. I look forward to see you in person in New York. To answer your question, let me talk about two sides. From us, the seller side, and also the other side, the buyer side, and also different markets. Overall, from us, the better use our capital still in the development stage, not to own the assets, because there are a lot of people in the world that their capital cost is much lower than ours. So we want to take more development opportunities instead of owner's assets with our limited capital.

42:05 But also there is another reason of cash flow management. because a lot of projects when you started the construction and during the project life, it eats up lots and lots of capital. And we want to avoid that and we want to get investors in earlier so that they pay for all the costs in the construction period. And then from the buyer's side, in the past, especially when we were selling, The six huge projects in the U.S., mostly in California. And then we had a public auction.

42:51 And then many of our partners, the buyers, they paid hefty professional fees, but at the end, they didn't win the bid, which created some kind of awkward situation. So... We have been many times told by our buyers that they wish that they can move in earlier in the product stage so that in other way they also can make a higher IRR return on the project that is to be developed versus the COD projects. And for us, usually even now we do NTP sales, But when we sign contracts, the PSA with the buyer, and the same time we sign the module supply agreement, We signed the EPC. So we still get the benefits to run the project and to supply the modules, such as our project in Mexico, a typical example, and also another project in Argentina.

44:00 So we become more and more supply our own module to our projects all around the world. Thank you very much. Thank you. turning ahead and again to the downside. Now, I guess it's about 2.2, 2.3%. A year ago, when it was around 3% that people were talking about, may go back to 5%. Obviously, if that's the case, that's a negative factor for our asset value. But now, long-term interest rates keep coming down, and there are a lot of money in the world, pension funds, Thank you very much.

44:55 Thank you. Energy companies such as Duke, such as AES, they are also moving into the renewable space. And how they do that, they start by buying solar projects. So the demand is there. I think it will be there for at least the next five to 10 years, not a problem. So in that sense, our project business, we will continue to, enhance putting more investment and make the team stronger.

45:43 And now we have gained a lot more experience in the emerging markets. And we are now looking into new opportunities in the markets such as Southeast Asia, like the Philippines, Sri Lanka, Thailand, Vietnam, but also now we have a huge pipeline in Australia. So 2019 is really the year For another cycle of growing our project business, we have significant projects to deliver in 2020 and 2021, and that will be published in our press release. If you have more questions, I'm coming back to New York the week after, after the SNAC conference in Shanghai, and I'll be happy to see you in your office.

46:31 Okay, very helpful. Thank you very much. Once again, if you wish to ask a question, please press star one from your telephone keypad and wait for your name to be announced. Again, it's star one to ask a question. Your next question comes from the line from UBS. You may now ask a question. Hello, your line is now open. Once again, to ask a question, please press star one from your telephone keypad to ask a question.

47:29 We have no further questions at this time. I would now turn the floor over to the management. Thank you.

47:37 Well, we thank you for your continued support. If you have any further follow-up questions, please contact our investor relations. Have a great day.

47:46 Have a great day. See you guys in New York. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.