Earnings Call Transcript - CSIQ Q2 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Canadian Solar Second Quarter 2023 Earnings Conference Call. My name is Melissa, and I will be your operator for today's call. 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 Isabel Zhang, IR Director at Canadian Solar. Please go ahead.

Isabel Zhang, IR Director

Thank you, operator, and welcome everyone to Canadian Solar second quarter 2023 conference call. Please note that we have provided slides to accompany today's conference call, which are available on Canadian Solar's Investor Relations website, within the Events and Presentations section. Joining us today are Dr. Shawn Qu, Chairman and CEO; Yan Zhuang, President of Canadian Solar's majority-owned subsidiary, CSI Solar; Dr. Huifeng Chang, Senior VP and CFO; and Ismael Guerrero, Corporate VP and CEO of Canadian Solar's wholly-owned subsidiary, Recurrent Energy, also formerly Global Energy. All company executives will participate in the Q&A session after management's formal remarks. On this call, Shawn will go over some key messages for the quarter. Yan and Ismael will respectively review the highlights of the CSI Solar and Recurrent Energy businesses, followed by Huifeng who will go through the financial results. Shawn will conclude the prepared remarks with the business outlook, after which we will have time for questions. Before we begin, may I remind listeners that management's prepared remarks today, as well as their answers to questions, will contain forward-looking statements that are subject to risks and uncertainties. The company claims the protection of the Safe Harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from management's current expectations. Any projections in the company's future performance represent management's estimates as of today. Canadian Solar assumes no obligation to update these projections in the future unless otherwise required by applicable law. A more detailed discussion of the risks and uncertainties can be found in the company's Annual Report on Form 20-F filed with the Securities and Exchange Commission. Management’s prepared remarks will be presented within the requirements of SEC Regulation G regarding Generally Accepted Accounting Principles or GAAP. Some financial information presented during the call will be provided on both a GAAP and a non-GAAP basis. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends. Management uses non-GAAP measures to better assess operating performance and to establish operational goals. Non-GAAP information should not be viewed by investors as a substitute for data prepared in accordance with GAAP. And now, I would like to turn the call over to Canadian Solar's Chairman and CEO, Dr. Shawn Qu. Shawn, please go ahead.

Shawn Qu, Chairman and CEO

Thank you, Isabel. Hi, everyone. Welcome and thank you for joining us today. Please turn to Slide 3. We achieved strong financial and operating results in the second quarter of 2023. We delivered record module shipments of 8.2 gigawatts with $2.4 billion in revenue and gross margin at 18.6%. Importantly, we delivered record total net income for Canadian Solar shareholders of $170 million or $2.39 per diluted share. Let me share a few key Q2 messages before Yan, Isabel, and Huifeng review our performance in more detail. Please turn to Slide 4. First, we successfully completed the IPO of our CSI Solar subsidiary on the Shanghai Stock Exchange Power Board. This was a major achievement, and I would like to thank our entire team for their efforts in reaching this goal. Investor demand was strong and we raised approximately $975 million in gross proceeds, 17% more than our original target. These funds will be used to support our growth plans across both our solar and energy storage businesses, including our strategic investments in vertical integration to further drive technological knowledge and cost improvements. This is the latest example of how we are building long-term value for the company and shareholders. Please turn to Slide 5. Second, against the backdrop of the Inflation Reduction Act, we continue to strengthen our competitive position in the U.S., one of our core markets. In June, we announced the establishment of a solar PV module production facility in Texas. This plant will have an annual output of 5 gigawatts and represents an investment of over $250 million. Production is expected to begin near the end of this year with approximately 1,500 skilled jobs created once fully ramped up. We are proud to be embarking on these growth initiatives with long-term partners such as EDF Renewables, with whom we signed a multi-year module supply agreement of 7 gigawatts of high-efficiency N-type TOPCon solar modules. We expect this to be the first of many important partnerships. We also continue to solidify our market position in the U.S. in our downstream project development business. Recurrent Energy is developing some of the most valuable solar and battery energy storage projects, including the 1.2 gigawatt-hour Papago standalone storage project in Arizona. At the same time, our e-STORAGE team will be supplying the equipment integration services and the long-term services for Papago. This is another great example of how we focus on capturing more value from each project over its lifetime. Of our 6.6 gigawatts of solar PV development pipeline in the U.S., we have over 2 gigawatts of projects with interconnection agreements, of which 45% are sited in energy communities. Likewise, 45% of our advanced storage pipelines in the U.S. are also sited in energy communities. We see significant potential in the U.S. market, particularly after the passing of the IRA, and we'll continue to build on our competitive position and track record in this market. Lastly, turning to Slide 6, I would like to highlight Canadian Solar's latest Annual ESG Sustainability Report, which we published a few weeks ago. This year, we made significant improvements in our systems and disclosures. We hope the report will serve as a transparent account of our efforts to integrate sustainability and ethics into every aspect of our business. For example, we significantly expanded our participation in international ESG initiatives and certifications. We are now supporters of the United Nations' Sustainable Development Goals and recently joined the United Nations Global Compact Committee to support and adhere to the 10th Principle of the UNGC on human rights, labor, environment, and anti-corruption. We also submitted our commitment letter to the Science-Based Targets initiative, indicating our intention to track the near-term net zero science-based climate target. We also continue to ensure that our operations, as well as those of our suppliers, follow ethical labor practices. I'm grateful that these efforts have not gone unnoticed, having received a Prime ESG rating from Institutional Shareholder Services and an excellent ESG rating from Achilles. With that, let me turn over to Yan who will provide more detail on our CSI Solar business. Yan, please go ahead.

Yan Zhuang, President of CSI Solar

Thanks, Shawn. Please turn to Slide 7. In Q2, the CSI Solar division delivered 8.2 gigawatts of solar module shipments and $2 billion in revenue. This is a record quarter, as it's the first time we're crossing the $2 billion mark. Gross margin was 14.3%, down around 4.2 percentage points quarter-over-quarter. This included a $31 million inventory write-down, driven by the sharp decline in raw material costs. Without the write-down, gross margin would have been 15.8%. Let me go over the key drivers behind these numbers. Please turn to Slide 8. First, while you can see that polysilicon prices declined significantly during the quarter, wafer and cell prices have not fallen nearly as much as polysilicon. Note that we ended last year with 20 gigawatts of cell capacity despite expecting 30 gigawatts to 35 gigawatts of module shipments. This means that our non-vertically integrated capacity was not the most optimal from a cost standpoint. We're working to improve this meaningfully as we ramp up cell and wafer capacity in the second half of 2023. In the meantime, we are restricting our procurement of third-party cells in order to protect margins before our cell capacity is fully ramped up. Second, which is perhaps the larger factor, is the decline in module prices. This was mainly driven by the distributed generation segment across most regions, specifically the residential sector. Overall market inventory levels are higher than usual, and that has led to destocking. We expect to see improvements in the DG segment as we move through the second half of 2023 once the destocking is complete. We also saw some utility-scale customers pause or even delay orders, given the sharp pricing declines. Despite the near-term pricing volatility and destocking, we remain very confident given the strong demand across nearly every market. And we are already starting to see polysilicon prices rebounding over the past few weeks. Projects can only be delayed for so long before they start to incur liquidated damages, and the development pipeline we see in the market has eclipsed previous levels. Near term, based on the factors I've just mentioned, we expect the market to improve as we move through the second half of '23. Third, our logistics costs continued to decline in Q2, mostly driven by lower logistics costs in China. We've also been locking in shipping contracts once they are lower to protect ourselves from any increase as the market rebounds. Combined with our higher operating leverage, our operating profit nearly doubled year-over-year to $119 million. Actually moving into Q3, we already see that the gross margins are improving. So moving into Q4, we expect a further improvement. Turning to Slide 9. We made the strategic decision to rebrand our utility-scale turnkey and storage business under our new e-STORAGE brand, which we believe more clearly articulates our business. In the second quarter of 2023, we signed approximately $630 million in new bookings. As of the end of Q2, we had a contracted backlog of $2.1 billion, including contracts under long-term service agreements. We expect shipments to ramp up significantly in the second half of 2023 as we complete our planned transition from a white-label product into our manufactured products. Importantly, given our bookings and the 26 gigawatt-hour total pipeline, we believe e-STORAGE is firmly on track to become a $1 billion business in 2024. I'm very proud of our e-STORAGE team for achieving such impressive growth in just three years. Now, let me pass the call to Ismael for an overview of Recurrent Energy, Canadian Solar's global project development business. Ismael, please go ahead.

Ismael Guerrero, Corporate VP and CEO of Recurrent Energy

Thank you, Yan. Please turn to Slide 10. In Q2, we delivered $360 million in revenue with a 43.9% gross margin, mainly driven by the sale of our flagship 100-megawatt Azuma Kofuji project in Japan. As previously guided, Q2 was one of our largest quarters in terms of revenue and profit. We are now concentrating more of our efforts on executing projects to hold them long term, as opposed to monetizing them immediately in the short term. In particular, we are going to be building several gigawatts of projects over the next few quarters, specifically in Europe and the U.S., where we believe we can capture higher value by remaining as the long-term asset owner and operator. Please turn to Slide 11. As of June 30, our total pipeline stood at 25 gigawatts for solar and 52 gigawatt-hours for battery storage projects. We are being more selective in originating more PV pipeline as our current pipeline is significantly mature and gives us strong visibility for execution and growth over the next few years. On the project side, we continue to originate projects, focusing on regions where solar penetration is high and grid reliability risks are also relatively high. We remain far ahead of the industry in terms of track record, market understanding, and positioning. We are very confident that we can execute on this pipeline to build increased value for the company and shareholders. Please turn to Slide 12. Over the past few years, we've seen significant inflation in CapEx costs and increases in the cost of capital, which combined have driven PPA prices higher. Demand has been very strong due to the large influx of new players who were attracted by competitive economics and the interest to secure electricity needs through clean and reliable sources. According to SBTi data, at the end of 2020, 620 companies had publicly pledged to reduce their greenhouse gas emissions. Less than three years later, this number has grown to over 5,800 companies, a growth of more than 9X. Yet the lineup of good quality projects in the market remains scarce. Over the past three years, Recurrent Energy signed over 2 gigawatts of PPAs in late-stage reconstruction projects. In addition, we have approximately 1.5 gigawatts of PPA contracts in advanced negotiations in the U.S. and Europe for projects that are expected to be held longer term. Taking the U.S. market as an example, our long-term positioning and ability to develop high-quality clean energy assets have allowed us to successfully raise U.S. PPA prices by approximately 20% to 40%. And as Shawn mentioned earlier, among the 6.6 gigawatts of solar PV development pipeline in the U.S., we have over 2 gigawatts of projects with interconnection agreements, of which 45% are sited in energy communities. In addition, 45% of our advanced storage pipeline in the U.S. is also sited in energy communities. Thanks to the IRA, we expect to monetize the ITC in a significant portion of our projects. This includes the recently signed Papago standalone storage project in Arizona of 1.2 gigawatt-hours, which will help the state meet the surge in electricity demand. We expect the IRA to support more flagship projects like these, and we will continue to work relentlessly to execute and deliver on them to serve our customer needs. Now, let me pass it on to Huifeng, who will go through the financial results in more detail. Huifeng, please go ahead.

Huifeng Chang, Senior VP and CFO

Thanks, Ismael. Please turn to Slide 13. In Q2, we delivered $2.4 billion in revenue, up 39% quarter-over-quarter and up 2% year-over-year. Gross margin was 18.6%, a small sequential decrease of 6 basis points. Gross margin was driven by lower ASPs and an inventory write-down due to the sharp decline in raw material costs, offset by high-margin project sales. Without the inventory write-down, gross margin would have been 19.9%. Selling and distribution expenses were flat quarter-over-quarter, despite the significant increase in shipment volume, reflecting our operating leverage and a further decline in unit logistical costs. General and administrative expenses increased, mainly due to a $36 million share-based compensation expense related to the CSI Solar IPO. We expect to amortize the remaining approximately $25 million of IPO expense over the coming quarters. Overall, the 39% revenue growth far outpaced the 26% increase in OpEx, as we achieve greater scale and operating leverage in our business. The net foreign exchange and derivative gains in the second quarter were $34 million, mainly driven by the stronger U.S. dollar relative to the Chinese RMB. Total net income was $198 million, with net income attributable to Canadian Solar shareholders at $170 million, or diluted EPS of $2.39. Now turning to the cash flow and balance sheet. Next slide, please. In Q2, we generated approximately $290 million in operating cash and spent around $280 million in CapEx. Our full-year 2023 CapEx expectation remains unchanged at approximately $1.5 billion. We ended the period with a higher total cash balance of $3.3 billion and a total debt of $3.3 billion. Our leverage, as measured in net debt to EBITDA excluding restricted cash, was at 1.4 times, the lowest it has been in many years. As you can imagine, we have deployed the cash raised from the CSI Solar IPO towards growth projects and therefore expect future leverage to increase slightly towards a more normal level. Now, let me pass it back to Shawn who will conclude with our guidance and the business outlook. Shawn, please go ahead.

Shawn Qu, Chairman and CEO

Thanks, Huifeng. Let's turn to Slide 15. For the third quarter of 2023, we expect solar module shipments by CSI Solar to be in the range of 8.5 gigawatts to 8.7 gigawatts, including approximately 13 megawatts to Recurrent Energy projects. Total revenues are expected to be in the range of $1.9 billion to $2.1 billion. Gross margin is expected to be between 17.5% to 19.5%. This reflects a margin improvement in CSI Solar, offset by a lower contribution from Recurrent Energy compared to Q2. For the full year of 2023, we reiterate CSI Solar's total solar module shipment guidance to be in a range of 30 gigawatts to 35 gigawatts and CSI Solar's battery storage shipment to be between 1.8 gigawatts to 2 gigawatt-hours, representing this year's transition from white-label to own manufactured product. Full-year 2023 revenue is expected to be between $8.5 billion to $9 billion, mainly due to the rapid decline in solar module prices. While we expect the industry to remain highly competitive, Canadian Solar's successful IPO of our CSI Solar subsidiary, strong balance sheet, and global brand position will help us achieve profitable growth and create lasting value for our shareholders. With that, I would now like to open the call to your questions. Operator?

Operator, Operator

Thank you. Our first question comes from Brian Lee with Goldman Sachs. Please proceed with your question.

Brian Lee, Analyst

Hey, guys. Thank you for taking the questions. Appreciate the time. I guess, first question was just on the gross margin guidance here. I know you're not giving the specific numbers, but one, are you assuming any additional inventory adjustments in the Q3 margin guidance for CSI Solar? And then two, if you're not, which I presume you're not, how would CSI Solar gross margins look in the Q3 guidance relative to the sort of normalized margin you would have printed in 2Q, if it wasn't for the adjustment? I think you said 19% ex the adjustment. How is CSI Solar gross margins expected to trend relative to that adjusted number in 3Q?

Shawn Qu, Chairman and CEO

Yeah, Brian. I'll answer your first question. We don't expect any significant inventory adjustment for Q3. Now, I would let Yan to comment on your second question. Yan?

Yan Zhuang, President of CSI Solar

Hi. So in Q3, I think most of the revenue is going to come from CSI Solar. So that gross margin that we provided for Q3 really indicates improvement of the gross margin for CSI Solar.

Brian Lee, Analyst

The midpoint is 18.5, and you achieved 19 after the adjustment. It seems you might be suggesting it is flat to slightly down.

Yan Zhuang, President of CSI Solar

Yeah.

Brian Lee, Analyst

Okay. Fair enough. Looking beyond the third quarter, I know you have good visibility since you book out multiple quarters in advance. In this declining pricing environment, where do you see average selling prices trending and what about margins for CSI Solar in the fourth quarter and possibly into early next year, if you've already started quoting for that period?

Shawn Qu, Chairman and CEO

It's a big question for Yan. You want to comment first?

Yan Zhuang, President of CSI Solar

I believe that everyone would agree that demand will significantly increase in Q4. Overall demand, particularly in the residential sector, has declined since Q2 globally. However, after the destocking we previously discussed, we expect a rebound moving into Q4. Utility-scale projects are also anticipated to surge in that timeframe, which will contribute to a strong demand. This may lead to some increases in upstream costs. At the same time, we are witnessing a rapid increase in TOPCon cell capacity, as cell prices have remained high since Q2. As we approach Q4, we expect to see a notable rise in the supply of TOPCon cells in the market. We believe this will lead to a rebalancing period, and while there is uncertainty, we see potential for improvement in Q4. Additionally, for Canadian Solar specifically, we have a pipeline of utility-scale storage projects that we plan to begin shipping in the second half of the year, with the majority of that volume occurring in Q4. Therefore, I think we may have already seen the worst of the situation.

Brian Lee, Analyst

Okay. I have a couple more questions before I pass it on. I joined late, so I might have missed it, but did you give any update on the plan to ship one-third of 2023 volume as TOPCon technology? Additionally, it seems that you pushed back the cell and module capacity expansion from Q1 '24 to Q4 '24 based on the press release. Can you clarify what is driving that decision and what the expected ramp-up will be from March to December? Will it be linear, or how should we approach modeling that? Thank you.

Shawn Qu, Chairman and CEO

Yes, Brian. This is Shawn. We haven't postponed any of our solar cell projects. Currently, the equivalent supply is quite constrained. Additionally, the supply of critical components, such as quartz tubes and quartz crucibles, is also limited. As a result, companies are transitioning from PERC to TOPCon technology. There are some adjustments being made, but our targets remain unchanged. We are currently increasing our TOPCon capacity to about 30 to 40 gigawatts. Right now, we have nearly 20 gigawatts of PERC capacity. Once we complete the ramp-up, two-thirds of our capacity will be TOPCon. We also have plans for an additional 10-gigawatt TOPCon project. By the end of next year, we anticipate reaching approximately 60 to 70 gigawatts of TOPCon. The ramp-up will not be linear; after finishing a facility, we begin installing the machines, and once they are calibrated, we will see a significant increase in cell capacity.

Yan Zhuang, President of CSI Solar

Yeah. And in Q4, our TOPCon capacity is going to be significantly higher than Q3. And, therefore, the TOPCon shipment in Q4 is also much higher. So as Shawn mentioned, it is not linear, it's a jump in Q4.

Brian Lee, Analyst

Okay. Thanks for all the color, guys. I'll pass it on.

Operator, Operator

Thank you. Our next question comes from Philip Shen with Roth MKM. Please proceed with your question.

Matt Koranda, Analyst

Hi, guys. This is Matt on for Phil. Thank you for taking the questions. First, I just wanted to ask when shipping to the U.S. market this year, have any of your modules been detained by CBP in '23? And then secondly, on a different topic for the U.S. module facility that you guys have announced, where do you expect to source the cells and wafers for that facility? And then are there eventually plans to have U.S. cell and wafer, and what would it take to make that decision?

Shawn Qu, Chairman and CEO

Yeah, Matt. This is Shawn. I'll answer this question. In 2023, we haven't had any of our modules detained by CBP. And second, we will use our Thailand solar cell facility to supply to the factory in Mesquite, the County of Dallas, and we are looking into the facility of a solar cell factory in the United States.

Matt Koranda, Analyst

Okay. Thank you for the color there. I'll pass it along.

Operator, Operator

Thank you. Our next question comes from the line of Colin Rusch with Oppenheimer. Please proceed with your question.

Colin Rusch, Analyst

Thanks so much, guys. Could you give us a sense of how the shipping expenses are going to trend through the balance of the year and the full impact on the SG&A if you think about the operating leverage as we go forward?

Shawn Qu, Chairman and CEO

Yeah. Yan, do you want to comment on this question, the shipping expansion and its full impact on SG&A?

Yan Zhuang, President of CSI Solar

Yes. So the shipping costs came down in Q2, and in Q3 is kind of stabilizing, and some lines may go up, while most are stabilizing. We're actually, as I mentioned before, signing long-term contracts to secure the shipping space at low cost. So we believe that our shipping cost will remain at a lower level. So we're helping, continue to help on our SG&A.

Colin Rusch, Analyst

Okay, I'll take the rest offline. And then on the battery side, there's an awful lot happening from a battery chemistry perspective, as well as pack design perspective. Can you talk about the cadence of evolution of your products and how much R&D or incremental design changes are being implemented right now and kind of evolution of that as you look at your pipeline, or are you really locked in with chemistry and design on that pipeline at this point and R&D, product development is going to be ongoing and what future focus effort.

Shawn Qu, Chairman and CEO

We primarily utilize LFP batteries to enhance our battery energy storage systems. Currently, our key product is the 3-megawatt hour SolBank, and we are in the process of developing new products. Although we are not ready to share the specifications of these new products, they will offer significantly higher power density and improved safety. We continue to trust in lithium battery chemistry, so we are not planning any major changes in chemistry at this time, but we are actively designing and developing new products.

Colin Rusch, Analyst

Thanks so much, guys.

Shawn Qu, Chairman and CEO

Thank you, Colin.

Operator, Operator

Thank you. At this time, I'm not showing any other questions. I will turn the floor back to Canadian Solar's CEO, Dr. Shawn Qu. Please go ahead.

Shawn Qu, Chairman and CEO

Thank you and thank everyone for joining us today, and also for your continued support. If you have any other questions or would like to set up a call, please contact our Investor Relations team and have a great rest of the summer and take good care. Thank you.

Operator, Operator

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.