Earnings Call Transcript - MAXN Q3 2023

Operator, Operator

Good day ladies and gentlemen. Welcome to Maxeon Solar Technologies' Third Quarter 2023 earnings call. Currently all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. And now I would like to turn the call over.

Robert Lahey, Chief Executive Officer

Thank you, operator. Good day, everyone, and welcome to Maxeon's Third Quarter 2023 Earnings Conference Call. With us today are Chief Executive, Bill Mulligan, Chief Financial Officer, Kai Strohbecke and Chief Strategy Officer, Peter Aschenbrenner. Let me cover a few housekeeping items before I turn the call over to Bill. As a reminder, a replay of this call will be available later today on the Investor Relations page of Maxeon's website. During today's call, we will make forward-looking statements that are subject to various risks and uncertainties that are described in the Safe Harbor slide of today's presentation, today's press release, the 6-K and other SEC filings. Please see those documents for annual information regarding those factors that may affect these forward-looking statements. To enhance this call, we have also posted a supplemental slide deck on the Events and Presentations page of Maxeon's Investor Relations website. Also, we will reference certain non-GAAP measures during today's call. Please refer to the appendix of our supplemental slide deck, as well as today's earnings press release, both of which are available on Maxeon's Investor Relations website for a presentation of the most directly comparable GAAP measure as well as the relevant GAAP to non-GAAP reconciliations. With that, let me turn the call over to Maxeon's CEO, Bill Mulligan.

Bill Mulligan, CEO

Thanks, Rob. Maxeon experienced dramatically different trajectories in our two businesses during the third quarter. Our US utility scale revenue was up 10% versus the previous quarter and we are on track to exit the year with fully ramped manufacturing facilities and a sold-out backlog at higher prices that we expect to make material margin contributions in 2024 and the achievement of important milestones with respect to our planned US factory. In our DG business, we faced significant demand challenges caused by the suspension of shipments to SunPower and the effects of a broad market dislocation in Europe. I'll spend a few minutes now detailing these different market environments and the respective implications for Maxeon. Kai will then review our Q3 financial performance and provide guidance for the rest of the year, and then we'll conclude with Q&A. The US utility scale market is a key focus for us and our primary growth driver. With our existing North America utility scale supply chain reaching important operating efficiency and profitability milestones in our planned New Mexico factory entering the engineering and design stage. We believe that Maxeon is positioned to be a leader in helping reshore advanced solar cell and panel manufacturing to the United States at meaningful scale. Towards this end, we are working intensively with the US Department of Energy's loan program office to finance a 3.5 gigawatt solar cell and panel factory in Albuquerque. This capacity represents an increase of 500 megawatts compared with our original design. With site preconstruction work well underway, we've hired a general manager for the facility who has secured options on adjacent parcels to allow for future capacity expansion. In order to accelerate and de-risk the ramp of our US factory, we plan to install a TOPCon pilot line in our existing Fab 3 in Malaysia and expect this line to be up and running next year well ahead of the anticipated factory ramp in Albuquerque. We expect this pilot line will provide valuable process development experience and serve as a training platform for copy and exact technology transfer to our US factory. Finally, we are advancing well in negotiations for multiple offtake agreements, which we plan to execute prior to the closing of the DOE loan. Q3 shipments in our utility scale business were at an annual run rate of over 1.3 gigawatts with 100% of this volume shipped into the United States. Pricing increased from the first half of the year and we expect pricing to further increase in 2024 as we transition to shipments for orders booked during 2022. Note that ASPs may fluctuate from 2024 onwards as we transition to index pricing structures tied to certain cost inputs. Contracted backlog now stands at 3.3 gigawatts for delivery through 2025, plus an additional 500 megawatts of supply allocated in each of 2025, 2026 and 2027. Let's now turn the attention to our DG business. Since June of this year, conditions have deteriorated rapidly due to an oversupply of Chinese commodity modules in Europe and SunPower falling short of their contractual purchase obligations. However, we continue to be bullish regarding the importance of this sector in the mid to long term. This view is supported by increasing global retail electric prices, integration of battery storage to create smart and dispatchable systems, and avoidance of grid congestion as a potential barrier to continued renewable energy penetration. The DG sector is currently experiencing headwinds associated with high interest rates, policy disruptions as well as excess supply and inventory. None of these challenges are unique or unprecedented, but in combination, they have produced a very challenging industry environment. We are confident, however, that the DG sector will continue to be a vital part of the solar industry in the long run. We remain focused on our DG strategy, which primarily involves developing, manufacturing and selling the world's best solar panels through a differentiated direct-to-installer sales channel with increasing attachment of beyond the panel hardware and software that enables homeowners to control their energy usage. As many of you know, our recent financial performance in DG has been severely hampered by a dispute with SunPower that led us to suspend shipments from July through the end of Q3. I'm pleased to announce that we have reached a settlement with SunPower earlier this week that enables us to resume shipments. The settlement calls for the parties to transact on 85 megawatts of IBC panels through February 2024 at previously contracted prices and resolve outstanding claims and contract breaches. The parties have also agreed to other contractual supply obligations by the end of this quarter, including purchase obligations by SunPower beyond the 85 megawatts and constraints on Maxeon product sales to SunPower installers. Offering panels directly to installers will eliminate the markup SunPower has historically added to our products, allowing us to deliver the world's best panels to customers at more competitive pricing. This will enable our plans to aggressively ramp our sales in the US market. Leveraging our recent Solaria acquisition, which nearly doubled the number of dealers actively buying our product to over 170. The Solaria transaction also accelerated the development of our channel sales and marketing infrastructure with the addition of key talent, including Vikas Desai, the former President of Solaria who is now our North America General Manager. Vikas was the original architect of SunPower's installer channel and successfully grew that business to over a $1 billion run rate in just five years. He will be focused on replicating that success here at Maxeon. While we currently expect a year-over-year decline in US residential market demand in the first half of next year, with California being the key variable, we expect that demand will recover by the time we begin sizable shipments of our new Maxeon 7 panels starting in mid-2024. Turning to Europe. Our shipments were down 37% sequentially due to elevated industry-wide module inventories. In most key European markets, Maxeon sells primarily directly to installers, which has allowed us to successfully maintain healthy ASPs and positive gross margins, albeit with reduced volume. Our SunPower reserve battery product is now widely available to our dealers in Belgium, France, Italy, Spain and Australia, and we have received excellent customer feedback regarding product quality and ease of installation. As we mentioned in our last call, we increased our sales focus into the commercial and industrial segment, and we are pleased to announce an early win as a module supplier for Italy's Turin airport, as well as a growing pipeline of similar high-profile projects in the region. Let me now say a few words about our IBC solar panel technology. Our sixth generation panels were a significant step forward compared with the second-generation products they replaced and have been a critical contributor to our DG business, particularly in the US. With near-term US DG volume expected to decrease due to the discontinuation of the SunPower offtake, we have made the decision to phase out our Maxeon 6 technology and focus on Maxeon 7 and future generations. We now plan to bring Maxeon 7 to market a full quarter earlier than previously planned and we will reserve Fab 5 for future Maxeon 8 capacity. We will pre-manufacture sufficient Maxeon 6 volume to ensure a smooth product transition to Maxeon 7 in all of our key markets and plan to utilize the space freed up in Fab 3 to install the TOPCon pilot line mentioned previously. We are very excited about our seventh generation IBC platform, which is the first IBC technology developed and commercialized by Maxeon since the spin. Maxeon 7 delivers increased efficiency and other performance attributes that will extend our technology leadership and allow homeowners to generate even more power from their limited roof space, thereby maximizing bill offset in this era of electric vehicle adoption. Since NREL efficiently crowned Maxeon 7 as the world's most efficient solar panel back in June, our early-stage production runs have continued to improve, with nearly half of our module output currently exceeding 24% efficiency. However, as we'd like to remind people, it's not just about efficiency. Maxeon 7's architecture achieves these record performance levels while simultaneously controlling hotspots and other degradation issues that are common challenges for high-performance solar technologies and which we observed with regularity in our competitors' products. We expect to start shipping Maxeon 7 panels from next summer, which corresponds with the peak selling season in the US residential market. Finally, I want to say a few words about intellectual property. With Maxeon 7, we are taking another major step forward with respect to IBC architecture, and we are adding to our considerable IP moat in this field. As our competitors attempt to close the performance gap to our products, they are finding it increasingly difficult to navigate around the IP portfolio that we have developed over the last several decades. Earlier this year, we filed a patent infringement action against Tongwei and sent cease and desist letters to several European distributors related to our shingled cell panel technology. Yesterday, we filed a patent infringement action against Icosolar and European distributors related to our IBC solar cell architecture. With over 1,600 granted patents and 360 pending patent applications across 30 countries, Maxeon has a formidable IP portfolio addressing fundamental enabling elements for creating high-performance solar cell and panel architectures. We plan to continue to defend our IP aggressively. In summary, our US utility scale business is on track to deliver increasing margins as we prepare to deploy our next major capacity increment in New Mexico. Although we and many others were surprised by the speed and magnitude of the changes in the DG industry this year, we are well positioned with our technology and channel initiatives and expect our DG margins to recover in the back half of 2024 as Maxeon 7 is introduced. With that, I'll turn it over to Kai.

Kai Strohbecke, CFO

Thank you, Bill. I will discuss the drivers and details of last quarter's performance and then provide guidance for the full year. Total shipments for the third quarter were 628 megawatts. And for the first time in Maxeon's history, the majority of shipments went to utility-scale customers. We expect this to be our new normal for the foreseeable future, though with a continued sizable DG market share in the highest ASP geographies. Also, for the first time in Maxeon's history, our utility scale shipments went entirely to customers in the United States. Total shipments were consistent with our updated guidance range and down 22% sequentially, largely due to the dispute with SunPower, which also resulted in a significant inventory build-up. Shipments were also impacted by the industry-wide supply-demand imbalance in Europe, which caused our European volumes to decline more than 30% year-on-year. Revenues for the third quarter were $228 million and included a 10% sequential increase in US utility scale revenues attributable to higher volumes. On a blended basis, ASPs declined sequentially due to a lower mix of DG sales. Our ASP in USDG was largely flat sequentially at above $0.70 per watt with only limited shipments to SunPower early in the quarter. ASPs for our performance series in the global DG market were down 13% sequentially and partially offset by COGS reductions. Gross profit in the third quarter was $3 million or 1% of revenues. This significant sequential decline was driven by the dispute with SunPower, Europe DG oversupply conditions and inventory write-downs. GAAP operating expenses were $67 million and included restructuring charges of $24 million, primarily in connection with the cancellation of purchase orders for the previously planned capacity expansion of Maxeon 7 at our Fab 5 in the Philippines. As announced in early October, our decision to convert existing Maxeon 3 manufacturing capacities to Maxeon 7 at our Fab 4 instead of expanding in Fab 5 is expected to result in net CapEx savings of approximately $100 million after accounting for these cancellation charges and allows us to accelerate the introduction of Maxeon 7. Non-GAAP operating expenses were $38 million in the third quarter below our guidance range of $43 million, plus or minus $2 million due to austerity measures that we put in place. The decline does not include any impact from our announced reduction in force, which I will discuss in the context of our fourth quarter outlook. Adjusted EBITDA in the third quarter was negative $20 million, consistent with our October pre-announcement. Net loss attributable to stockholders came in at $108 million compared to $2 million in the previous quarter. The sequential decline was primarily driven by lower gross profit combined with the $24 million in restructuring charges and $37 million attributable to the remeasurement loss on our prepaid forward. Moving onto the balance sheet. We closed the third quarter with cash, cash equivalents, restricted cash and short-term investment of $277 million compared to $456 million at the end of the second quarter. Total inventory levels increased sequentially from $349 million to $386 million due in part to suspended shipments to SunPower. Cash levels were also impacted by lower shipments and margin dollars from our global DG business, the reduction of contract liabilities related to our US utility scale business capital expenditures during the quarter, restructuring expenses and a reduction in short-term debt. Capital expenditures came in at $15 million for the third quarter below the low end of our guidance range as we took actions to execute the lower CapEx plan associated with the introduction of Maxeon 7. Going into the fourth quarter, we expect the distinct dynamics that have been unfolding in our utility scale and distributed generation businesses to largely continue. Volume shipments and ASPs in our utility scale business for the United States have been contractually locked in and are increasing over time, and manufacturing costs are tracking favorably. By comparison, the DG business outlook has more uncertainties due to the industry headwinds in Europe and elsewhere. Given the velocity of those headwinds that have developed over the course of only a few short months, we have taken decisive action to quickly pivot our manufacturing capacity while maintaining strict austerity measures to ensure a healthy liquidity and safeguard our ability to invest in our priorities. Most notably into Maxeon 7 as well as the preparations for our manufacturing project in the United States. Cash and working capital management have always been a high priority for Maxeon's finance organization, and we are re-doubling our efforts in this area. We have reduced raw material orders and are moderating our IBC manufacturing volumes in line with inventory on hand and existing orders while rightsizing our manufacturing footprint and related resources. As a result, we expect significantly reduced inventory levels as we exit the year. We have also negotiated more favorable payment terms with many of our suppliers. And as mentioned, our CapEx plan is substantially reduced by our pivot of the Maxeon 7 ramp. On the sales side, we are focusing on a narrow set of DG growth initiatives. First, expansion of our Maxeon branded US residential channel and leveraging the Solaria acquisition. Second, further penetration of the commercial and industrial segment of the DG market in Europe and the United States. Third, scaling of our beyond the panel offerings. And finally, market introduction of Maxeon 7 in mid of next year. With this context in mind, I'll now turn to our guidance for the fourth quarter and its implications on the full year guidance. We project fourth quarter shipments of between 610 and 650 megawatts. This includes shipments to SunPower as contractually agreed under the settlement agreement. Also, the midpoint of this guidance includes continued growth in our US utility scale volume, while Europe is projected to be relatively flat sequentially with growth in C&I, offset by a decline in residential. We project fourth quarter revenues of $220 million to $260 million. A slight sequential increase at the midpoint, mainly due to higher shipments to SunPower. Incremental sales resulting from our Solaria acquisition will start having a net positive impact on sequential revenue, but carry a lower ASP than our previous IBC only pricing in the United States. Non-GAAP gross loss is expected to be in the range of $5 million to $15 million, which includes certain idle charges and excess costs related to our IBC capacity pivot potential liquidated damages because of delivery delays in our utility scale as well as the risk of further inventory write-downs, adding up to approximately $25 million combined. GAAP operating expenses are expected to be $113 million, plus or minus $4 million. These include restructuring expenses totaling approximately $70 million for the write-down and accelerated depreciation of certain Maxeon 6 manufacturing assets charges for Maxeon 7 related purchase orders canceled in the beginning of the fourth quarter as well as severance costs for our previously announced reduction in force. We originally expected that 15% of our global workforce would be affected, but with the decision to entirely phase out Maxeon 6 as well as other operational realignment we now expect that number to be approximately 22%. Non-GAAP operating expenses are expected to be $38 million, plus or minus $2 million. As an increase in US sales and marketing head count is offset by austerity measures. Note that the vast majority of the reduction in force initiated during the quarter impacts our manufacturing operations and therefore, will have a disproportionate impact on cost versus OpEx. Adjusted EBITDA in the fourth quarter is expected to be between negative $27 million and $37 million. The expected sequential decline is attributable to lower gross income on largely unchanged non-GAAP OpEx levels. Fourth quarter capital expenditures are projected to be in the range of $10 million to $20 million, a majority of which is planned for our Maxeon 7 ramps and initially preparatory spending for our Albuquerque site. While this initial CapEx for the US facility may be bridged by our balance sheet, the expectation is that we will secure the majority of capital needed to build the facility in the months ahead from the DOE and customer co-investments. As implied by our 3Q results and 4Q guidance, we update our 2023 revenue guidance to $1.114 billion to $1.154 billion. Our adjusted EBITDA guidance to $4 million to $14 million and our annual CapEx guidance to $66 million to $76 million. With that, I'll turn the call back to Bill to summarize before we go to Q&A.

Bill Mulligan, CEO

Thanks, Kai. Reducing our headcount this quarter was a painful but necessary decision in response to a suddenly increased DG demand profile. I'm pleased by the professionalism displayed by Maxeon's leadership team and the speed of our response. Acceleration of Maxeon 7, rightsizing our IBC capacity settling our SunPower dispute and related channel expansion initiatives should get DG back on track by the second half of next year. Kai and his team are laser-focused on cash management and our operations growth continues to grind out cost reduction and yield improvements. We expect success on these fronts will get us back to adjusted EBITDA profitability within 2024, and as we work toward deploying our Albuquerque cell and module factory. We appreciate your support. Now let's go to Q&A. Operator, please proceed.

Operator, Operator

Thank you. Our first question comes from Julian Dumoulin-Smith with Bank of America. Your line is open.

Alex Vrabel, Analyst

Hey, guys. It's actually Alex Vrabel on for Julian. Maybe if I may, I mean, you guys have made a lot of adjustments, I think, to kind of what your manufacturing footprint was versus what it will look like in 2024. Obviously, some one-time items causing a gross loss, which we alluded to previously. And it sounds like the adjusted EBITDA losses might continue into the first half. I'm wondering if you can kind of just help us with the cadence that you guys are putting out there. How big is this TOPCon line, for example, what's the phase down of Maxeon 6 look like as far as revenue contributions? And when do you expect to kind of be able to get back on track from an adjusted EBITDA lens in 2024 with all these moving pieces?

Bill Mulligan, CEO

Yes, hi, Alex. Bill Mulligan here. Thank you for the question. We've experienced very strong demand in the first half of this year. The current downturn has provided us with a chance to quickly shift to our new next-generation Maxeon 7 technology, and we plan to implement this in a much more cost-effective way than originally intended. It's essential to respond aggressively to industry downturns like this. Our outlook for Europe next year is rather cautious, so we've chosen to reduce capacity to achieve a more balanced structure moving forward. By taking these actions, we're effectively managing our inventory. Without the SunPower disruption, we would have actually reduced our inventory this quarter, so we're proactive about this situation. Recovery will take some time, but I believe that by the second half of next year, we should start to see profitability again.

Kai Strohbecke, CFO

Yes, this is Kai, Alex. I would like to add that the inventories reached a record high at the end of the third quarter, primarily due to the accumulation of inventories for SunPower and some other distributed generation markets, but mostly for SunPower since we suspended shipments. We have now reached a settlement with SunPower, and we will ship them 85 megawatts through February. Currently, all that inventory is on hand. From a cash perspective, we don't anticipate needing to invest additional cash into working capital, as that inventory will convert into cash. In terms of the Max 6 phase-out we mentioned, we are currently operating at about half capacity, using up the remaining materials and adding them to inventory. We believe we will have sufficient Maxeon 6 inventory to facilitate the transition to Maxeon 7 around mid-next year.

Alex Vrabel, Analyst

Got it. And maybe just a follow-up. As you guys think about sort of looking at your exposures as the way I'll frame it on Max 7 into mid-'24, I think, is when you sort of talked about unveiling that product to the market. What I mean with the breakage with SunPower, what's sort of your sales strategy going forward. Obviously, you guys have the Solaria channel, which seems like one opportunity, the Green Tech channel has already existed. But how are you thinking about sort of bringing that into market relative to what your brand has been associated in the past versus what it will be going forward? Thanks.

Bill Mulligan, CEO

Yes. Yes, thanks. Well, our IBC products are still absolutely the best panel on the market. And Max 7 just really helps take that to the next level. And there's a large base of folks in the United States that know that and believe that and want that product. And so there's latent demand for this product out there. I think this transition from SunPower allows us to control our own destiny. As we mentioned in the prepared remarks, having Vikas Desai and the Solaria team is a big plus for us. It's really jump-starting our build-out of our own channel here. So we're really optimistic about that, bringing in a great product with a rebuilt team to a market that knows this product and appreciates this product and has historically very strong ASPs. So we feel good about it. It's going to take a little while to rebuild. But like I said, by the back half of next year, we should be in a much stronger position.

Alex Vrabel, Analyst

Awesome. Just a quick clarification, if I may. Just on the SunPower megawatts, is there any sort of cadence commentary you can give us? Otherwise, we'll take the rest offline.

Kai Strohbecke, CFO

I would say, out of the 85, the majority, the 85, I think we have disclosed is going to run through February. The majority is going to be in this current fourth quarter.

Operator, Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Brian Lee with Goldman Sachs and Company. Your line is open.

Brian Lee, Analyst

Good afternoon, everyone. I appreciate the opportunity to ask my question. I have a few topics I'd like to discuss. To start, I want to understand the development of the SunPower dispute resolution. You mentioned that there is 85 megawatts of volume committed at fixed pricing based on the original agreement. However, it seems you are allowing them to terminate the contracts for 2024 and 2025. I'm unclear on what you are gaining by releasing them from both contracts since it appears they are not meeting the volume commitments for the 2023 agreement, and now the 2024 and 2025 contracts are being removed. I’m just trying to understand how this situation works. I realize you want to resolve the dispute and move forward, which could provide better clarity for the next few years, but I sense there's something I might be overlooking. It seems like this resolution might be somewhat one-sided.

Bill Mulligan, CEO

Yes. Yes. Thanks, Brian. Well, the settlement does include warrants for us. So that's part of the upside for us. I come back to, though, that the primary reason was for us to be able to go out directly to these installers. Really cutting out the middleman with SunPower in a challenged market like this, there's just really not a lot of room for stacked margins. So we're going to be able to offer installers better pricing and also achieve higher ASPs ourselves by eliminating the markup that SunPower has historically applied to our products. So that is really our view is we wanted to be able to get out of this exclusive relationship, diversify our customer base. So it was really a strategic move. And we felt this was the right time to do so.

Brian Lee, Analyst

Okay. That makes sense. I guess as a follow-up to that, it's going to take a little bit of time, right, to recover, if you will. But in the medium term, it sounds like this is a good transition for you, Bill, as you mentioned, you're going to get higher ASPs, you cut the middleman out. Presumably higher ASPs, I would assume that means higher margins for you as well. So in the interim, it does sound like margins are going to be pretty negatively impacted by underutilization on IBC relative to performance. When do you think we see kind of margins get back to a point where you're significantly higher on IBC versus performance like we were probably seeing in the first half of this year when you were doing consolidated mid- to high teens gross margins?

Bill Mulligan, CEO

Yes. We're absolutely excited about this for the long term, right? Just taking control of our destiny in the US market, which is becoming increasingly important to us. With the world's best product, we think we're well positioned for the long haul. You're right that there's a little bit of a time between here and there. It's the reason we're taking pretty dramatic action on rightsizing our capacity because we don't want underutilized capacity, right? So we're dealing with that now so that we can work through the problem quickly. And so I think we've sort of struck the right balance there between capacity for growth and maintaining profitability and positive cash flow in the near term to the extent possible. so that we're strong coming out of the second half next year.

Kai Strohbecke, CFO

Yes. And I would add that talking about the second half of next year, if you think about it, we're going to have a completely revamped product portfolio for the DG markets. In Europe, we're going to introduce Performance Series 7. So the latest incarnation of that product which the sales team is really excited about. And also, we're going to have 100% of our IBC production on Maxeon 7 on the very latest technology. So all these moves are designed to bring us back to these margin profiles that we have enjoyed in the past. And in the United States, we're also going to deploy Maxeon 7 and then we'll also have the new Solaria suite of products that we are importing into the United States. In addition to that, we are ramping up beyond the panel complementary offerings to really have a full suite of products for DG homeowners. So that's our strategy, and we think that's going to play out successfully after the transition in the first half and then coming to a full swing in the second half of next year.

Brian Lee, Analyst

Okay, that's helpful. I have one last question before passing it on. Kai, you mentioned in your prepared remarks some customer co-investments related to the New Mexico facility. Could you elaborate on that? What discussions are happening, and what magnitude could we potentially expect if these come to fruition? Also, is this in line with the construction timeline? What should we be considering regarding this potential cash source?

Kai Strohbecke, CFO

Yes. It's something, Brian, that we have talked about pretty consistently actually as the main pillars of our financing of the US manufacturing side, which are the DOE loan and customer co-investment. Customers are very, very excited about that new facility and we've been in touch with them and discussing all these things that you just mentioned around volumes, pricing timing terms and conditions and so on. We're not in a position right now where we would disclose the details. But I think suffice it to say that these things have to come together, the DOE loan and the customer co-investment as the two main pillars of that financing and both of these items are on track.

Brian Lee, Analyst

Okay. Thanks, guys. Appreciate all the color.

Kai Strohbecke, CFO

Thanks, Brian.

Operator, Operator

Thank you. Please stand by for our next question. Our next question comes from the line of Pavel Molchanov with Raymond James. Your line is open.

Pavel Molchanov, Analyst

Yeah, thanks for taking the question. Let me shift gears and ask about Europe. Given all the changes surrounding SunPower, is it fair to say that Europe will be more than half potentially a lot more than half of your sales in the first half of '24 or even all of '24?

Bill Mulligan, CEO

No, I mean, keep in mind that the US utility scale market is a significant segment for us, and it is becoming the major part of our shipments. This segment is growing very nicely right now, and we expect to move into double-digit gross margins next year, which represents a primary growth area for us. Europe remains important, though we anticipate that market will be fairly flat this year and next year. We are looking to expand our share in various segments of that market, always focusing on the premium segments or offering our complete beyond-the-panel solution, which now includes integrated storage, EV charging, panels, software, and control software. We believe this product is exciting and gaining some traction. However, due to the high levels of inventory in the European channel at the moment, we have to be somewhat conservative about the outlook there. The inventory levels are considerable. While Europe will continue to be important, the US remains our strongest market, and I believe that US distributed generation will quickly recover to a size that is comparable to or even larger than Europe.

Pavel Molchanov, Analyst

Okay. China will be, by far, the largest market of '23 and indeed, probably the only market where new build estimates have actually increased since the year started. What's the latest on the JV in China? How is it benefiting from the domestic installation boom?

Bill Mulligan, CEO

Yes. Our JV partners are driving their own domestic consumption. We use the JV primarily or exclusively for offtake in our international markets. So I don't really want to comment too much on the domestic Chinese market. It's extremely competitive, let's just say, right now. There's just not enough homes for all these panels worldwide based on the massive amount of production capacity that's out there. For us, the JV has been very successful because we're able to take off a residential format panel that has been a great product for us in Europe. We're just introducing our seventh generation performance line panel. That's a TOPCon client-based panel that's really state-of-the-art. We expect that to have really strong competitiveness in Europe. So we're benefiting from the joint venture in that regard. You're right, the majority of the volume from the joint venture does go into the domestic Chinese market. That helps us from the standpoint that they have scale and a very attractive cost structure which we benefit for our foreign offtake.

Pavel Molchanov, Analyst

Last question, deliberately zooming out here. Module pricing, when we look at the benchmarks is down 30% over the last six months, deepest drop since the global financial crisis. Do we have evidence to suggest whether this magnitude of price decline is starting to stimulate a bounce on the demand side, which sort of Econ 101 would suggest to be the case?

Peter Aschenbrenner, CSO

Hey, Pavel, this is Peter. I would say not yet. Some people have mentioned that possibility. However, it's important to remember that module pricing, especially in the distributed generation segment, is only a small part of the total installed cost for homeowners. In both Europe and the US, higher interest rates are negatively impacting the payback periods for end users, which means we haven't observed that shift yet. On the utility sales side, there’s a delay due to project and power purchase agreement cycle times. So we might see changes in the Rest of World PowerPoint business first. In the US, we’re also seeing that higher interest rates are offsetting potentially lower module costs in the spot market for the near term.

Pavel Molchanov, Analyst

All right. Thank you guys.

Peter Aschenbrenner, CSO

Long winded. No, not yet. I think.

Pavel Molchanov, Analyst

Yep. Appreciate it.

Operator, Operator

Thanks. Please stand by for our next question. Our next question comes from the line of Philip Shen with ROTH MKM. Your line is open.

Philip Shen, Analyst

Hey, thanks for taking the questions. First one is on margins. So I know you're not providing guidance for '24, but you did make a commentary that you expect margins to recover until back half 2024. So I was wondering if you might be able to quantify in any way what margins might look like in Q1 and 2? Should we expect it to be similar to current levels or a modest recovery in Q1 and 2 and then stronger performance in the back half of '24. Thanks.

Kai Strohbecke, CFO

Philip, this is Kai. Regarding your question, we are not providing guidance at this time. However, we have indicated that we anticipate a recovery in margins and EBITDA in the second half of the year, which will be driven by the new introductions of our seventh generation performance series and further progress on our US utility scale. We mentioned in our prepared remarks that we expect additional cost reductions, efficiency improvements, and increases in average selling prices, which could potentially raise our margins into the double digits. This is a positive outlook, although we will be working through remaining inventories of Maxeon 3 and Maxeon 6 in the first half of the year and likely will carry some into the second half as well. In terms of the fourth quarter, I addressed some nonrecurring items in my remarks that will impact margins in our guidance. We expect those issues to be temporary, and we are taking steps to improve our overall manufacturing operations, reduce costs, and properly size our operations. This will allow us to enter 2024 on a stronger footing.

Philip Shen, Analyst

Okay. Thanks, Kai. On the flip side, let's talk about pricing, again, if we can for IBC. You're going to be controlling your own destiny, Bill, as you mentioned earlier, a number of times. And so that happens in March. And heading into March, I can imagine you're working on deals to try to secure agreements with different players. And so I was wondering if you could share how those conversations might be going now? Is it a little bit premature to get a feel for how close you are in locking down volume and pricing? And then some of our checks suggest modules in the US resi channel may not clear until after Q2 of next year. So high efficiency module pricing has already come down dramatically since the summer. What kind of pricing can you guys secure in a post-SunPower relationship with your benchmark. Well, you guys are typically the benchmark. But as you think of other peers that are trying to do what you guys do and their pricing is, I don't know, maybe $0.40, $0.50 for a lower volume, but maybe $0.40 plus with that level for higher volume. Are we going to need to see you guys pricing that kind of $0.50 range as we think about modeling ASPs for our IBC volume in '24? Thanks.

Bill Mulligan, CEO

Thanks, Phil. I want to clarify that we can start engaging with our dealers from January 1. While we have exclusivity on the Maxeon 6 product until the end of Q1, we can begin selling Maxeon 3 and Maxeon 7 at the start of the year. It’s still early to gauge how that will go, but we have been careful not to approach SunPower dealers while our contract is still valid. This will continue to be true for several dealers until the end of the year. With about six weeks left, including three holiday weeks, January 1 will arrive quickly, and we’ll act quickly at that time. Regarding average selling prices, we're maintaining healthy ASPs in Europe. We chose not to drive ASPs down aggressively, as we have a premium product and believe it's unwise to race to the bottom, preferring to accept lower volume while keeping our pricing steady. This approach has been successful in Europe. In the US, pricing remains significantly higher than in Europe, even though it has decreased somewhat. However, with the elimination of the markup imposed by SunPower on our panels, we believe we can be competitive. A lot of our success hinges on promoting the premium product narrative. I'm thrilled to have Vikas Desai back, as he was instrumental during our previous collaboration from 2005 to 2010. He understands how to convey our story effectively. We have the best panels available, and we need to spread that message appropriately, which we plan to do. We are confident about our pricing, which will be substantially higher than the figures you mentioned.

Philip Shen, Analyst

Great. Okay. Thanks. A couple more here, and then I'll pass it on. In the SunPower 8-K, there was some mention of effective components and some sharing or split between you and SunPower on the cost of those defective components. Can you provide a little bit more color on what that is and maybe quantify what it might be and what the split might be between the two companies? And then shifting over, I think, in your release, you guys gave some detail on some $30 million payment security bond that SunPower sped up. Can you provide a little bit of detail on the mechanics of that? And how that might work? Thanks.

Bill Mulligan, CEO

Sure. Sure. So the issue you're alluding to is a warranty issue that is a long-standing warranty issue that goes back to the time of the spin. I think it's certainly beneficial for all parties to get that dispute behind us. So I think it's as simple as that. On the payment bond, maybe, Kai, you could give some color on that.

Kai Strohbecke, CFO

So Phil, it's just basically a payment security. Of course, we have experienced a time where SunPower has not paid us at the very beginning of this dispute that we have now settled. I think both parties have an interest that we don't get into such a situation again. So this payment bond is there to secure our deliveries because there are payment terms and that's just the security for making sure that we collect the money.

Philip Shen, Analyst

Got it. Okay. Thanks very much, guys. I'll pass it on.

Kai Strohbecke, CFO

Thank you.

Operator, Operator

Please stand by for our next question. Our next question comes from the line of Donovan Schafer with Northland Capital Markets. Your line is open.

Donovan Schafer, Analyst

Thanks for the questions. I want to ask about an article in the Albuquerque Journal that mentioned you requested a $2.4 billion revenue bond. The article suggests this bond is related to property tax abatement and that the $2.4 billion figure refers to the estimated amount you plan to invest within the city limits or the City Council's jurisdiction. Is this $2.4 billion a useful reference point for expected costs, or could there be aspects that might mislead us, perhaps regarding what costs can be included in the estimate? Additionally, is this amount connected to the 3 gigawatt initial capacity or the 3.5 gigawatt capacity?

Peter Aschenbrenner, CSO

Don, this is Peter. That's not a useful reference point. We're not planning to invest anywhere close to that amount of money, as we've said pretty consistently. The other thing we've said in our prepared remarks today was that we've settled on the 3.5 gigawatt capacity for the project.

Donovan Schafer, Analyst

Thank you for clarifying. Regarding the DOE timeline, in your release about the DOE loan guarantee and the offtake agreements, you mentioned that your goal is to provide updates on both before the fourth quarter call. Does that suggest that if the outcomes of the offtake agreements are better than expected, it could reduce the need for the DOE loan guarantee, or is the timing of the updates on both fronts just coincidental?

Peter Aschenbrenner, CSO

Don, this is Peter again. The latter, the timing of the closure of the DOE loan and of the going effective of the customer co-investment agreements would be contemporaneous.

Donovan Schafer, Analyst

Okay. My last question is about Maxeon 7. You mentioned that it offers not only efficiency but also improvements in hotspot degradation. Do you expect to extend the 40-year warranty currently offered on Maxeon 6 to Maxeon 7? Is there a possibility that the warranty could exceed 40 years, or might it be shorter? Additionally, regarding the warranty dispute between your company and SunPower that came up in response to Phil's question, could you discuss whether the length of the warranty has any impact on that situation, particularly in relation to warranties lasting for decades?

Bill Mulligan, CEO

Yes. We regularly assess the warranty length, but currently, we are satisfied with the 40-year warranty. There hasn’t been significant customer demand for a longer warranty. We evaluate our warranty reserves, and with our higher reliability products, there may be adjustments we can consider. However, I don’t anticipate any major changes to the warranty at this time. This aspect is largely competitive; many of our competitors face issues such as hotspots and degradation over time. For example, technology like HJT, which some of our competitors are using, is fundamentally unstable and highly susceptible to moisture degradation. Our extensive field experience with various products informs us on this matter. We strive to create the best panels, where the attributes are crucial, and it’s not solely about efficiency. That is our focus. While we mention the warranty, we don’t expect significant changes, but we remain open to discussing it, and we will respond to market needs as they arise.

Peter Aschenbrenner, CSO

Donovan, this is Peter. Just your last question about the warranty dispute. That had nothing to do with the solar panel itself.

Donovan Schafer, Analyst

Very helpful. Very helpful. Okay. Great. Thanks, guys. I'll take the rest of my questions offline.

Operator, Operator

Thank you. Please standby for our next question. Our next question comes from the line of William Grippin with UBS. Please line is open.

William Grippin, Analyst

Great. Thanks for the opportunity good to speak with you all here. My first question was just you talked earlier in the call about getting out there and telling your story on the modules and the premium position that you kind of hold in the market. Could you address maybe what you're thinking in terms of costs for ramping your DG customer base or investments that might be needed to do that and kind of backfill this lost SunPower demand?

Bill Mulligan, CEO

Yes. Will, yes, we're trying to do it with a light touch approach. This is not an area where we feel like we have to make a huge amount of additional investment. We have the model working today in Europe. The basic plan is to replicate that model back here in the U.S. And again, we have a lot of people at this company that have a lot of experience in developing and operating this kind of a channel. So we know how to do it efficiently, and that's our goal.

Peter Aschenbrenner, CSO

The only thing I would mention, Will, is that when we look at our historical operating expenses, it's fair to say that the cost of managing a channel sales organization is in the single-digit gross margin percentages. So it's not very costly to execute. Additionally, we already have many of these personnel on board, primarily due to our Solaria acquisition. In terms of extra spending, there are some marketing costs, but overall, I believe we are prepared to accomplish what we need to in 2024.

William Grippin, Analyst

Got it. I appreciate that. Just last one here. On the production changes, you talked in the pre-announcement about replacing Maxeon 3 capacity with Maxeon 7. And now you're talking about running down Maxeon 6. So just as you transition here, is there going to be a gap in your DG module production as a result of the shift? Just really trying to understand the cadence and timing of these changes.

Bill Mulligan, CEO

Yes. Well, as we mentioned in the remarks, we are going to prebuild some Maxeon 6 technology to bridge us through the transition. And again, this is an opportunistic time given with demand down to make a change like this and do a transition because you obviously can't continue to manufacture at 100% while you're making a transition. So we're going to prebuild some inventory, manage a fairly rapid transition then ramp back up, and that's our bridging strategy.

Kai Strohbecke, CFO

And I just want to add in spite of prebuilding that inventory, we still expect inventories to go down from here with the expected shipments to SunPower and also further shipments into DG channels. So we are kind of modulating it in a way that we continue to sell more than we are making for the time being in order to get closer to an equilibrium.

William Grippin, Analyst

You perfectly anticipated my follow-up. Thank you. That's all I had.

Kai Strohbecke, CFO

Thanks, Will.

Operator, Operator

Please stand by for our next question. Our next question comes from the line of Andrew Percoco with Morgan Stanley. Your line is open.

Andrew Percoco, Analyst

Great. Thanks so much for taking the question. And maybe this is a follow-up. So I’ll ask it. But as we think about moving into next year, obviously, you're highlighting margin pressure could continue into early next year. How are you thinking about the cadence of free cash flow? And what point would you consider the need to raise additional capital? Are there any liquidity thresholds or balance sheet metrics that you're hoping to maintain as you go through this transition period?

Kai Strohbecke, CFO

Yes. Thank you, Andrew. So I think it has, of course, a lot to do with the things that we have been discussing. You've seen the negative cash flow in this quarter, which had a lot to do with the growing imbalance between our manufacturing operations and sales that has developed during the third quarter, and that's, of course, then reflected in changes in working capital. We have taken all these decisive actions on the working capital side on the side of our manufacturing footprint and so on and modulating the capacities in order to address, especially that. So we think that with the current cash balance that we have and all these measures that we talked about during the call and in the prepared remarks, that we are in a good position to generate sufficient cash and maintain sufficient cash levels for our existing business.

Andrew Percoco, Analyst

Great. That's super helpful. The rest of my questions have been answered, so I'll take the rest offline. Thank you.

Kai Strohbecke, CFO

Thanks, Andrew.

Operator, Operator

Thank you. Ladies and gentlemen, I'm showing no further questions in the queue. This concludes today's conference call. Thank you for your participation. You may now disconnect.