Earnings Call Transcript - CSIQ Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Canadian Solar's Second Quarter of 2020 Earnings Conference Call. My name is Annie, and I will 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'd now like to turn the call over to Isabel Zhang, Investor Relations Manager at Canadian Solar. Please go ahead.

Isabel Zhang, Investor Relations Manager

Thank you, operator. And welcome everyone to Canadian Solar's second quarter 2020 earnings conference call. Joining us today are Dr. Shawn Qu, Chairman and Chief Executive Officer; Yan Zhuang, President and COO; and Dr. Huifeng Chang, Senior VP and CFO. On this call, Shawn will provide an update on the market environment and Canadian Solar's long-term strategy, followed by Yan who will review our recent progress and business outlook; and Huifeng will then review our financial results and capital management strategy. After the prepared remarks, 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. 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. Any projections of 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. At this time, 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. And hello, everyone. Welcome and thanks for joining us today. Canadian Solar delivered strong second quarter results as we managed through the ongoing impact of the COVID-19 pandemic. We continue to deliver clean, reliable, and affordable solar energy to our customers while operating under strict health protocols. Despite these challenges, we delivered higher-than-expected diluted earnings per share of $0.34 in the second quarter. Now, let me give you an update on the market environment and Canadian Solar's long-term strategy. I will also share some thoughts on our recent announcement to access China's capital markets. On the last call, I said that global demand for 2020 might decline for the first time in 20 years. Well, even as a veteran in this industry, I think I might have underestimated the strength of the solar market. The global demand situation was soft in the first half, but we continued to grow our shipments and market share. Over the past few weeks, we have seen a sharp rebound in demand across most of our end markets, including the US, Latin America, Europe, Japan, Australia, and China. Although some projects have been delayed by a quarter or two, overall, the demand situation is very strong, and we're now running at full capacity. Our team has done an excellent job staying focused on serving our customers in the face of the COVID-19 challenges. R&D, manufacturing innovation, and increased levels of economies of scale in the past few years have brought solar to grid parity in a growing number of cities. This is why demand quickly rebounded. Today, projects are less driven by subsidy deadlines but more by project economics and other competitive factors. So, the underlying demand is strong. IEA forecasted 110 GW to 140 GW of global demand this year. We now believe it will be somewhere in the middle or probably towards the higher end of this range. The only limiting factor is the availability of raw material supply and ability to sustain in the next few months. For 2021 and 2022, IEA's middle point estimates for global demand are 150 GW to 160 GW, respectively. This is consistent with what we have heard through our own channel checks. We are extremely excited about the long-term opportunities in the industry, and we are positioning Canadian Solar more assertively for growth. On Module and System Solutions, our MSS business, we recently announced our strategic decision to list our wholly-owned MSS subsidiaries on the Chinese stock market. If the listing is successful, we expect to have greater access to cheaper sources of capital that will support us in capturing a greater share of market growth and value creation. Additionally, as market consolidation accelerates, we have a unique advantage, having spent so many years building a top-tier brand and reputation, robust global sales channel, and an incredibly strong operational and financial track record. We believe we are better positioned for growth than anyone else. And by accessing China's capital markets, we will also benefit from the low cost of capital. Another key motivation for pursuing that listing is to unlock value for shareholders. We hope to address our views and justify the Canadian Solar and our China listing this year. As an update on where we are in the process, we have started the pre-IPO capital raising process to bring in new partners to our MSS business and converting it into a Sino-foreign joint stock company, which is required by Chinese securities regulations for listing in China's stock market. This investment is expected to be completed by the end of September and will bring in fresh capital to support the forthcoming MSS expansion and growth plans for next year before the expected listing. Capital raised from the pre-IPO round will also allow us to use past available technology and equipment to support our new module shipment plan for 2021. We'll update you further as we reach further milestones. We remain fully committed to our NASDAQ listing and to growing our global energy business. We reiterate the five-year growth guidance we gave last quarter, which includes achieving around 25% CAGR in project sales volume. With that, let me turn over to Yan who will go through our business results and outlook. Yan, please go ahead.

Yan Zhuang, President and COO

Thank you, Shawn. Let me start with three key messages. Firstly, we achieved strong financial and operating results in Q2, with revenue and profitability both above our expectations. We are proud that even under the challenging market circumstances, we adjusted swiftly and continued to deliver strong results. However, in the near term, we see some margin pressure due to cost increases from polysilicon supply shortages. But given our strong market position and pricing power, we expect to share a portion of the higher costs with customers. Most importantly, we are positioning ourselves for long-term growth by expanding capacity and increasing vertical integration in our module business and strategically investing in solar plus storage capabilities. Now, let me go through our Q2 2020 operating results. On the MSS business side, shipments in Q2 grew over 30%, both sequentially and year-over-year, to 2.9 GW, well above guidance. Q2 revenues of $669 million were also ahead of our expectations, but were down sequentially as the volume growth was not enough to offset the ASP decline. Manufacturing costs were also lower in Q2. And despite the expected decline, gross margin remained at a healthy level of 21.1%. One of the exciting developments in Q2 was our new product launches as we introduced modules of 500 to 600 watts. When I joined Canadian Solar back in 2007, the standard module wattage was over 100 watts. So, we have come a very long way. Over that time, Canadian Solar has been the leader by bringing a series of innovative new solutions to the market as we increase the benefits to customers. Our latest modules have higher cell efficiencies, larger wafer sizes, longer product warranties, and ultimately, offer our customers lower LCOE and better returns. On the Energy business side, due to the previous higher volatility in the capital markets, we had some delays in project sales. This is the main reason why both our energy revenues and gross profits were down in Q2. Our strategy is to take a balanced approach between recycling our capital quickly while maximizing the valuation of our solar power plants. Financial markets appear to have stabilized over the past few months, and currently, demand for our projects is strong. For example, we recently announced the financial closing of our Maplewood projects of 367 megawatts. We expect to make more announcements over the coming months as we reach closure. While Energy business revenues were soft in Q2, gross margin was higher than usual at 43.4%. Gross margin benefited from stable high-margin revenues from our operations and maintenance business, which now has around 3 GW of projects under contract. We expect to drive additional growth in our O&M business as we accumulate a growing portfolio of partial ownership in operating assets. In terms of business development, we signed two private PPAs in Q2 in Brazil, totaling 274 MW. Brazil is one of our key markets. We were one of the first solar companies to enter this market in 2013 and even set up a module factory in Sao Paolo. Over the past seven years, we have cemented our leadership position in the Brazilian market, both as a project developer and as a module supplier and system integrator. We continue to see significant growth potential in this market, given the strong energy demand, higher solar irradiance, stable capital markets, and attractive project returns. Now, let me comment on our guidance and business outlook. For the third quarter of 2020, we expect total module shipments to be in the range of 2.9 GW to 3.1 GW. Total revenue is expected to be in the range of $840 million to $890 million and gross margin is expected to be between 14% and 16%. For the full year of 2020, we now expect total module shipments to be in the range of 11 GW to 12 GW. In the near term, as reflected in our guidance, we're seeing some margin pressure due to higher costs from the polysilicon supply shortage. However, given our leadership position in premium markets and the strong overall demand rebound, we expect we'll be able to share part of the higher costs with customers and have already started to raise module prices. We currently expect the impact of the polysilicon supply disruption to lessen as supply expands in the coming quarters. On the Energy side, the exact timing and recognition of certain project sales remain uncertain. In terms of volume, we expect to recognize a large part of this year's project sales in Q4, with some projects potentially moving into next year, as we previously communicated, mainly due to delays and the impact of COVID-19. Over the longer term, I'm very excited about our growth outlook, given the compelling solar market dynamics and Canadian Solar's company-specific catalysts. We are expanding capacity and increasing vertical integration for our module business, which will allow us to capture more global market share, enhance pricing power, control costs, and improve profitability. In fact, next year, we're planning on 18 GW to 20 GW of shipments. We're in the process of completing capacity and CapEx plans that will support our long-term growth. And we plan to give an update during the next quarter's results tentatively scheduled for November. Importantly, we are seeing industry consolidation accelerate. And as the global leader in both the energy and module businesses, we are uniquely positioned to capture an outsized share of industry profits to generate long-term sustainable returns for investors. From a technology standpoint, we are building our expertise and ramping up quickly in the solar PV plus storage space. In this quarter, we almost doubled our total pipeline and backlog of storage projects. In the US, for example, some of the customers that we previously sold utility-scale solar projects to are coming back to us to help them retrofit the power plants with our proprietary battery storage solution. We're also starting to build our storage pipeline in other parts of the world, including Latin America, Europe, and Australia. Every day, I'm reading news articles about how conventional fossil fuel generators are being retired earlier than expected. So, I think we'll see a lot more growth in the solar plus storage space. At Canadian Solar, we're committed to innovation and building the technology DNA to lead the next wave of growth in the energy industry. Now, let me turn over the call to Huifeng for more details on our financial results and capital management strategies. Huifeng, please go ahead.

Huifeng Chang, Senior VP and CFO

Before I review the numbers, I'd like to share a quick thought with you. The keyword I will use to describe Canadian Solar in 2020 is resilience. In Q1, as the coronavirus first hit China, we lost production for a few weeks. But our teams worked incredibly hard to catch up safely, and the production issues were resolved. Demand issues emerged in Q2, and we became extremely cautious with our liquidity management. Over the years, our management team has developed a habit of being extra alert to potential challenges. When we see one on the horizon, we ring the alarm bells and plan for the worst. We always face the situation head-on. Because of this habit, most times, things eventually turn out to be better than what we initially expected. I'm very proud of our teams for working through these challenging times with resilience, focus, and acceptable results. Now back to the financials. Yan reviewed the revenues and profitability, so I won't go through it again. Total operating expenses in Q2 were $102 million, down 17% year-over-year. The decline was partly driven by lower travel expenses, as well as our continued efforts to control operating expenses. The foreign exchange loss in the second quarter was $4.5 million, which was higher than usual. As a global company, we managed our currency risk through a comprehensive hedging program, but hedging 100% is cost prohibitive. So, we take a balanced approach by hedging our exposures only to a level we consider reasonable and taking on some currency risk. In this quarter, for example, the high foreign exchange loss was mainly due to the unfavorable moves in the Brazilian real and the Thai baht. Moving on to the balance sheet, as demand and the capital market conditions have both improved, we are working to strike a balance between investing for long-term goals and preserving cash. Our leverage and liquidity metrics were stable this quarter. Total debt was at $1.9 billion. Non-GAAP net debt to EBITDA was 2.4 times and the EBITDA to net interest coverage was 7.9 times. Both of these metrics are healthy and are broadly unchanged from the previous quarter. We also continued to focus on working capital management where one could argue that we have been too successful at managing working capital. Given the recent raw material price increases, we almost wish we had built a large inventory. But the tide could turn quickly, and it is not a risk we are willing to take. Capital expenditures in the first half were $86 million. Our CapEx plan for the full year of 2020 is slightly higher than what we said last quarter, around $300 million, as we are expediting capacity expansion in response to the stronger demand. At the same time, we remain disciplined in our capital allocation decisions. Our goal is always to pursue returns-accretive opportunities. Our potential listing in China, if successful, will give us the additional resources to deliver higher future earnings goals and a return on capital. Given the confluence of several factors, including the opening of China's financial markets, strong solar demand growth, and the cost of solar reaching grid parity across an increasing number of markets, and accelerating market consolidation, we currently see a strategic window of opportunity to invest in growth, capitalize on long-term opportunities, and unlock sustainable value for our shareholders. And with that, I would now like to open the call to your questions.

Operator, Operator

Thank you. [Operator Instructions]. First question is from the line of Philip Shen of ROTH Capital Partners.

Philip Shen, Analyst

The first one is on your 2021 guidance. It's a nice and large increase versus 2020. And, Shawn, I think you mentioned in your prepared remarks that today it is driven less by subsidy and more by project economics. I was wondering if you're seeing, with the lower module pricing, any result of greater unsubsidized demand creation? We saw this pattern in early 2019 after the May 31, 2018 downturn when China reduced its feed-in tariff program. Do you think we could see something similar for 2021? And how much of 2021 demand do you think could come from unsubsidized markets versus what we've seen in prior years?

Shawn Qu, Chairman and CEO

Hi, Philip. This is Shawn speaking. Well, my answer is that I believe almost all the 2021 demand will come from unsubsidized demand rather than government-subsidized demand.

Philip Shen, Analyst

Great. And how much of 2021 do you have visibility into? Let's say, your guidance is 19 GW at the midpoint. Do you have already visibility or even contracts for 25% of it or something even more?

Shawn Qu, Chairman and CEO

No. This is the demand we're facing, and this is what we believe we can ship. We did our channel check. We think there are – first of all, there are demand – the 2020 projects getting pushed to 2021 will be one of the demand sources. Second, there are many projects prepared for 2021 anyway. And third, the availability of increased financing in the capital market will fuel the growth in 2021, so that – and as a matter of fact, we believe that the module ASP will probably start to be more stable than through the remainder of 2020 rather than the big decline we have seen in the past few years. Because of that, right now, we are focusing on new products, and we're offering new products to the market rather than rushing out to sign up contracts. But we do have a lot of quotations out already. We're monitoring and in close negotiation on many of the big potential contracts.

Yan Zhuang, President and COO

Let me add to Shawn's comments. So, Philip, actually, when we're talking about how much volume we have locked in, I think it's not just the contracts we find. Remember, there is a lot of contracted demand. So, this depends a lot on our long-term contract signing, for example, in the US, and also the demand/supply relationship. Like, the US demand can only be met by the southeast nation capacity. That does not have that much bankable capacity. So, we have over 3 GW of capacity in Thailand that are almost – everything's reserved for the US. We have quite a few large contracts that are three years long-term contracts based on cost-plus model that are already locked. And I think the entire US-Thai capacity of 3 GW is, to me, locked because US demand is high, and the market is healthy. And also, we have markets like Japan because, in Japan, we have different channels including residential system sales that are a distribution business that has very loyal customers. They're repeat customers, so they're not going to change. So, we know that volume of business is coming in every year with stability. And even for utility projects in Japan, the demand is close to two or three years ahead of time, so it doesn't change suddenly. So that will come in for sure. Globally, we have a direct sales channel handled by a separate team, selling small volume at higher prices to the installers, going into the residential and commercial top. Those customers are repeat customers, so they will come in. We have our own project that needs the modules, and that volume is going to go up significantly next year. That volume is locked. So, to count all those in, I think we have half already locked in. So, that's my answer. I hope that addresses your question.

Philip Shen, Analyst

So, looking at the other side of the equation in terms of your capacity expansion potential, I know you mentioned that you would like to share more on the next call. But given the visibility that you have, I was wondering if you might be able to provide a little bit of color today. So, specifically, how much expansion could you see potentially in 2021 as it relates to wafer and sell a module? And how much do you expect to have to spend to invest in that vertical integration and expansion? Thanks.

Yan Zhuang, President and COO

Philip, I can give you some indication, but I cannot give you detailed numbers because we're still in the last phase of planning and we do need to get the board's approval. So, before that, I cannot share tangible numbers. But I can tell you that we already have a shipment guidance for next year. So, we need to expand our capacity to support that volume of shipment and also to sustain our profitability. So, you know our culture; you know Shawn; you know our management team that we're very rational and we're very numbers-driven. Once we invest in capacity, we have our margin target, a profit target. So, the vertical integration and the capacity expansion need to support both volume and profit and return.

Philip Shen, Analyst

One last one, if I may. As it relates to the China listing, how much do you think you could raise via the pre-IPO process? And then, ultimately, how much would you target during the IPO process in China?

Shawn Qu, Chairman and CEO

Well, first, we do have our target, but we are in the pre-IPO talk right now. I would rather share this number with you after we close the round. That's only going to be less than two months. But what I can let you know is that the demand for the pre-IPO target is very, very strong. We are receiving phone calls from the large and verifiable investment funds on a daily basis. So, we think that our pre-IPO fund quarter will be oversubscribed.

Operator, Operator

[Operator Instructions]. Next question is from Brian Lee of Goldman Sachs.

Brian Lee, Analyst

Maybe just a quick follow up to Phil's last one. On the pre-IPO discussions you're having, any sort of sense of range of valuations that you're hearing investors are comfortable with for that segment?

Shawn Qu, Chairman and CEO

That's another question I would rather answer after we have a number. I don't want to give an indication, so that the pre-IPO investors know how to negotiate with me. But on the other hand, as I said in my answer to the previous question, the demand for our investment quarters is very high. So, I think we'll see some healthy competition, so that the evaluation will be probably on the high end of what we have been expecting.

Brian Lee, Analyst

Maybe a couple of housekeeping questions for Huifeng. Huifeng, on the Q3 guidance, can you give us a sense of what mix of energy versus MSS sales is embedded in that? And then, the kind of gross margin ranges for each of the segments, given how lumpy it's been through the first couple of quarters here?

Huifeng Chang, Senior VP and CFO

That breakdown, we don't provide a number yet. But mostly still in the MSS side. In Q3, there will be some project sales closure, but not a significant contribution. And there also is the uncertainty of the closing time. But I think before the end of the year, between Q3 and Q4, there will be some closures.

Brian Lee, Analyst

I guess maybe just to follow up on that, if you take the implied price per watt in Q2, since Q2 revenue was almost all modules and you assume a fairly small contribution from Energy in Q3, that would imply module pricing is going up from Q2 to Q3, which I don't think we're really expecting that? I don't know if that's what you're telegraphing here. But it seems like Q3 is embedding a decent amount of energy revenue relative to Q2, I think more in line with what you saw in Q1. But just trying to understand the puts and takes here because the pricing otherwise would be implicitly going up here.

Huifeng Chang, Senior VP and CFO

Okay. Well, maybe I'll come back to you later on the follow-up with more details.

Brian Lee, Analyst

Okay, I'll take that offline. And then, maybe just one last one for you. On the gross margins, presumably, they're going down for modules in Q3 since the majority of your revenues in Q3 are still going to be module-based. Should we expect gross margins to sequentially decline further in Q4, just given the volatility in poly pricing and the timeline between what you're purchasing and, ultimately, what you're passing through in terms of higher costs?

Yan Zhuang, President and COO

Let me take that question. This is Yan, Brian. Well, for Q3, the margin is lower for module businesses because module contracts were signed a few months earlier for Q3. And suddenly, we're experiencing a polysilicon shortage and prices have gone significantly up. So, we are increasing our module pricing. But for the contracts that are already signed, we will not be able to raise all the pricing for all the signed contracts. So, that is why you're seeing lower margin for Q3 in our module business. And when we enter into Q4, because a few months ago, like in the past few months, we decided not to take on those super low price deals for Q4. So, we still have – when the costs came up, when the costs went up, we had a pretty good idle capacity for Q4 to sell that we will be able to sell at a better pricing today. So, that was a good decision. It was a good call. And so, Q4 – and also, we believe that the cost will be stabilized when we get into Q4. So, maybe at a certain point in Q4, I don't know, I wouldn't say it will go down, but at least it will not go up more. But module pricing, we can do better in Q4 than Q3. So, I think the margin downward trend will not continue into Q4. Q4, we should do better.

Brian Lee, Analyst

Okay.

Yan Zhuang, President and COO

And also, on the project side in Q4, we might have a chance to close – to have more closures on project sales in Q4 than Q3.

Operator, Operator

[Operator Instructions]. Next question is from the line of Colin Rusch of Oppenheimer.

Colin Rusch, Analyst

Thanks so much, guys. Can you talk a little bit about the mix shift and changes with the direct sales channel and how we should think about pricing with some of the bigger volume deals versus the pricing dynamics with that direct sales channel?

Yan Zhuang, President and COO

We experienced just some impact from COVID-19 on the direct sales channel on the residential and commercial markets in some markets, for example, in the US, but they started to warm up. However, the impact varies from country to country. In Japan, which is the biggest residential market for us, there was no impact at all. So, there's no impact. And other markets, Europe, I think, have come back already, so there's no impact anymore. And the only markets that are still experiencing negative impact are the US and Brazil. But still, even in the US, the market is already better now, better than Q2. So, in Q2, we still did well on the direct sales channel. The proportion is close to 50% for the total shipment in Q2. So, that's actually pretty high. And that is why we have achieved a gross margin of 21% for Q2. I would say the pricing for the direct sales channel is actually more robust than the utility-scale projects during the pandemic crisis. Maybe it's the nature because this market has more inertia to pricing. The price elasticity is not as sensitive compared to the professional utility-scale markets.

Colin Rusch, Analyst

And then, in the project business, can you guys talk about opportunities for acquiring distressed projects, what's happening with your customers in terms of push-outs, and challenges on financing where you guys might be able to step in and capture some outsized value?

Shawn Qu, Chairman and CEO

Colin, if we see any good distressed asset, we'll be interested and we will take on opportunities. At this moment, we haven't really seen big ones yet. But you should let us know if you heard any opportunities. We'll be interested, Colin.

Operator, Operator

Next question is from Mark Strouse of J.P. Morgan.

Mark Strouse, Analyst

Yeah, thanks for taking our questions. Most of them have actually been answered. I wanted to follow up on one of Brian's questions, though. Huifeng, are you able to quantify the impact of the poly supply shortages in Q3? The 14% to 16% guidance, can you say what that might have been without the poly disruption?

Huifeng Chang, Senior VP and CFO

I think Yan knows the answer better. Yan, would you please answer the question?

Yan Zhuang, President and COO

Well, I think the impact is pretty major. I've made a calculation. I think the majority of the impact comes from the silicon, right? However, once something happens, everybody is trying to ride the same boat to reach their pricing. So, together, I think when it comes to modules, the impact is two-thirds of the US. However, in Q3, for pricing – for module price up, we tried to reach prices for modules, but it does not mean we can reach 100%. So, I would say we still lost at least 5% of margin. That's probably the rough number.

Operator, Operator

Thank you. Ladies and gentlemen, that's the end of our question-and-answer session. And now, I'd like to turn the conference back to our CEO, Dr. Qu, for closing comments. Please continue.

Shawn Qu, Chairman and CEO

Well, thank you for joining today's call and for your continued support. If you have any questions or would like to set up a call, please contact our investor relations team. We thank you for your continued support. I hope you and your families are safe and healthy. Thank you.

Operator, Operator

Ladies and gentlemen, that concludes your conference for today. Thank you for participating. You may all disconnect.