Canadian Solar Inc. (CSIQ) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to your Canadian Solar Fourth Quarter and Fiscal Year 2012 Earnings Call. My name is Bhukandar, I'll be your event manager today. [Operator Instructions] I would like to advise all parties, this conference is being recorded for replay purposes. And now I would like to hand the conference over to Ed Job, Canadian Solar's Director of Investor Relations. Please proceed, sir.

Thank you, operator. Welcome, everyone, to Canadian Solar's Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. Joining us on the call today are Dr. Shawn Qu, our Chairman and Chief Executive Officer; and Michael Potter, Senior Vice President and Chief Financial Officer. Before we begin, may I remind our listeners that, in this call, management's prepared remarks will contain forward-looking statements which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from management's current expectations, and therefore, we refer you to more detailed discussions of the risks and uncertainties in the company's annual report on Form 20-F filed with the Securities and Exchange Commission. In addition, any projections as to the company's future performance represents management's estimates as of today, March 11, 2013. Canadian Solar assumes no obligation to update these projections in the future unless otherwise required by law. At this time, I would like to turn the call over to Dr. Shawn Qu. Shawn, please go ahead.

Thank you, Ed. And thank you all for joining us on the call today. 2012 has been a difficult year for the whole solar industries, with its persistent module ASP declines, module margin pressure and escalating trade disputes. In this difficult environment, we have fared relatively well. We measure our success based on the execution of our strategy, which is to increase market share, reduce cost and differentiate our business model by expanding our total solution business while maintaining prudent financial management. For the full year 2012, we have shipped 1,543 megawatts, maintaining the track record of continuously increasing our shipment volume and market share every year. We have continued to diversify our customer base, reducing our reliance on European markets while successfully pursuing growth opportunities in Asia and North America. We are especially proud of our success in the Japanese market, where we tripled our module shipments during the year. We also significantly reduced our manufacturing cost, exiting 2012 with all-in module manufacturing cost of $0.55 per watt. This is one of the lowest in the industry and also at the low end of our target of $0.55 to $0.60 per watt which we announced in early 2012. In addition, we've maintained one of the strongest balance sheet among our peers and attracted support from leading global financial institutes, which gives us the flexibility to expand our total solution business. I want to emphasize that, ever since our IPO in 2006, Canadian Solar has adopted a growth strategy different from most of our competitors. Rather than committing capitals to the upstream polysilicon business, we have focused our investments in the mid- and downstream manufacturing steps such as sales and modules, as well as the development of our downstream total solution business. As a result, we do not have to…

Thank you, Shawn. Net revenue for the fourth quarter of 2012 was $294.8 million, down 9.5% sequentially and down 37.8% compared to the year-ago period. Gross profit in Q4 was $14.9 million compared to $7.3 million in Q3 and $41.4 million in the comparable period of last year. The sequential increase in gross profit was driven by higher shipment volume and lower manufacturing costs. Our gross profit in the fourth quarter of 2012 is net of a $6.8 million depreciation charge, representing 2.3% of revenue related to the underutilization of our manufacturing assets. Gross margin in Q4 was 5% compared to 2.2% in Q3 and 8.7% in the fourth quarter of 2001 (sic) [2011]. Our gross margin came in above guidance primarily due to higher-than-expected ASPs. Operating expenses were $106.4 million in Q4 compared to $41.8 million in Q3 and $62.9 million in the comparable period of last year. The sequential and year-over-year increase in operating expenses was primarily driven by non-cash onetime charges totaling $61.2 million, including $31.2 million for doubtful accounts and $30 million for an arbitration decision against the company. We dispute the merits of the arbitration award and are continuing to evaluate our legal options. We are also hopeful that we will recover some or all of the doubtful accounts. However, it is uncertain today that we'll be able to do so, so we felt reserving the accounts now was prudent. Interest expense in the fourth quarter was $9.9 million compared to $15.2 million in the third quarter of 2012 and $11.7 million in the fourth quarter of 2011. The sequential and year-over-year decline in interest expense is due mostly to the change in the mix of our bank borrowings, with the higher portion related to the construction of projects. As a result, interest expense on…

[Operator Instructions] We have our first question. It's from the line of Kelly Dougherty from Macquarie.

I just wanted to see if you could give us some idea in the mix between kind of straight module sales versus modules for the projects in the first quarter and in 2013 guidance? And then maybe given your expectations for when you plan to build the projects and recognize revenue, maybe a sense for how much revenue will come in the first half versus the second?

I will answer the first part of question, and then I will let Michael to answer the second part. This is Shawn. And for Q1, the Q1 guidance of 290 to 310 megawatt doesn't contain any utility projects. It will contain a little bit of the system kits business in Japan. Now as to the revenue recognition question, I defer -- I refer you to Michael.

Shawn, can I have a real quick follow-up on that? How about in the full year, the mix between modules and projects from a megawatt perspective?

Okay. For the full year, we gave a guidance of 1,600 to 1,800 megawatt total, in which we expect the pure module sales to be around 1,300 to 1,400 megawatt, while the remaining, which is about 300 to 500 megawatt, will from the project business. However, on the revenue side, the revenue contribute from project business is going to be more than 50% of the total revenue.

In terms of the revenue recognition, and actually, we will recognize a small amount of modules from utility projects in Q1 for some percentage-of-completion contract projects we're doing, but it won't be that significant in Q1. The revenue for projects will be stacked more towards the back half of the year, a Q3 or Q4 time frame, mainly driven by the fact that the TransCanada projects that we use completed-contract methods, 5 of them are expected to be recognized either at the very end of Q3 or more likely than not in Q4. So that will tilt the revenue more into Q -- the second half of the year, that alone. Also, we're going to be ramping up construction of the projects that we bought off of the former SkyPower Limited throughout the year. So as we go through the year, more and more of them will be under construction and contributing revenue. So again, that's going to tilt the revenue more towards the second half of the year.

That's helpful, guys. Then just a quick one on the cost. How should we think about the progression of the production cost this year? Obviously, you made a bigger per minute in 2012. So do you have a new target for how much lower your costs can go this year?

That's a good -- it's a good question. And this is Shawn. And as I -- as we mentioned, by the end of last year, we have achieved the $0.55 per watt all-in module manufacturing cost. And for this year, from pure processing point of view, we see somewhere around $0.02 to $0.05 further reduction, but that's on the pure processing side and because of the module is also affected by the polysilicon price, which we cannot accurately predict. Now assuming the polysilicon price and the resulting wafer price stay the same, then the module all-in manufacturing cost may trend towards $0.50 to $0.53 per watt range by the end of the year.

Next question is from the line of Satya Kumar from Crédit Suisse. Satya Kumar - Crédit Suisse AG, Research Division: I was wondering if we could talk a little bit about the gross margin potential of your total system business this year and next year?

So in 2013, the revenue is going to be dominated by our business in Canada, with some revenue contribution from our business in the U.S. Our Canadian projects are expected overall to average over 20% gross margin, with our projects we're selling to TransCanada to be over 25% gross margin. That's consistent with the guidance we've given in the past on that. Margins in the U.S. are lower than the 20% Canadian average. We do have some projects in other areas of the world, but they're not significant enough to discuss and not certain enough today to put onto our pipeline. They tend to range between 15% and 20% gross margin. Satya Kumar - Crédit Suisse AG, Research Division: How do you expect the OpEx for your business to track as you start getting -- recognizing these revenues from the utility business? Is the OpEx level more or less a function of your megawatts? Or will that start to scale as the utility revenues also start to increase?

There shouldn't be a significant rise in operating expenses because of the project pipeline. We've been building the infrastructure to support that for the last couple of years. There could be some adjustments in operating expenses going forward depending on what the different geographies of our revenues turn out to be, but that will be the natural turnover that you've seen in the industry over the last few years as solar markets have opened up and closed. Satya Kumar - Crédit Suisse AG, Research Division: Okay. And what were the details on the arbitration that you talked about that you took a charge for in Q4? Was that a purchasing contract only or something else?

This is Shawn. That's a arbitration decision made by the -- a arbitration board body in Shanghai regarding a contract dispute between Canadian Solar and LDK. And the result of that arbitration decision was in the news in December last year. And right now, the case is in the court system in Suzhou, City of Suzhou, and we continue to defend our position, we believe. We dispute the merit of this decision and will continue to defend ourself.

And it was for a wafer purchasing agreement. Satya Kumar - Crédit Suisse AG, Research Division: And one last thing. Michael, I think you said that you'd be -- or Shawn, I forget, but you're expecting to be profitable for the full year. Are you expecting to turn profitably in Q2 or, because of the revenue recognition being more weighted to second half, it's probably more a Q3 event?

Yes, this is Shawn. We -- at this moment, we are targeting the -- to be profit for the whole year. And as the quarter -- as the year goes on, there's better and better visibility for the profitability. And if everything goes our way, yes, we have a good chance for Q2. But however, at this moment, we are still looking at how -- when the first 2 projects which we built for TransCanada will go through all the permitting and testing and phase. So I will leave it, leave the answer to this question, to our Q1 Earning Call, probably in May.

[Operator Instructions] Next question is from the line of Nitin Kumar from Nomura.

A quick question on today's news regarding potentially a change in China's policy where they're talking about cutting feed-in tariffs to -- I mean, point at a [ph] CNY 0.75 per kilowatt hour, and I think the distributed number is also lower at 0.35 per kilowatt hour. I mean, how do you see it impacting demand? And do you think that the ASP -- lower ASPs in China will -- I mean, how do you see that impacting your gross margins?

Yes, this is Shawn. And as a matter fact, well, I haven't seen the news, today's news yet. However, we have heard those rumors in the past few months. There are lots of discussions of whether the feed-in tariff level in China will be reduced and -- but on the other hand, as everybody know, there's very little real cash payment for FIT from Chinese government yet. So, so far, this is only a policy. We haven't really see the cash payment flow yet. That's why, in our press release, we have cautioned the investor about the risk of business in China. And this is also why we have not given a guidance of high shipment in China. We are taking a cautious approach. And for this year, we are still going to focus our efforts to the markets which can give us profit rather than go for profitless growth. And as I -- as we said, this year's target is to return to profit.

Shawn, just switching gears here. I mean, a lot of your peers in China, like Yingli, Suntech, Trina, LDK, they have stretched balance sheets, focusing on China market. Now obviously, if you're not getting paid, the balance sheet gets even more stretched. Do you see these companies continuing to get bank support? Or do you think 1 or 2 may fall off the cliff sometime soon, or maybe it will in the next 12 months?

Well, that's a good question. And this is exactly why Canadian Solar has avoid this business approach. And we have budgeted very small module sales in China and we are developing pipeline -- project pipelines in China, but we are also very cautious in actually building any project in China. This is -- it's exactly because our desire to avoid those risks. And indeed, as you said, I -- we -- not -- many company have stretched their balance sheet by doing that. And -- but I can't -- I don't know, I can't really comment how the bank will react to their action. However, today, I did see the news from Bloomberg that Bank of China and -- or -- and a group of Chinese banks have started to sue Suntech for their bad loan.

And this is Michael. I could say that, towards the second half of last year, we increased shipments into the Chinese market to try and test the market and to see if we could establish reasonable and profitable growth there. And the bad debt expense that we recorded in Q4, about 2/3 of that is coming from Chinese customers. So it's quite possible that, over time, we'll recover a good portion of that doubtful receivables, but by our fairly conservative standards, we don't think it's probable or that we can say with great confidence today we can collect it. And that's one of the reasons why we're trying not to chase after growth where we can't assure collectibility in a reasonable time frame and we can't -- where we can't assure reasonable margins.

I mean, just a follow-up question on this. So if we assume -- I mean, basically, these companies are known as the big 4 or big 5, right? And if 4 of these companies don't have enough working capital, I mean, they can't stretch their balance sheets further, they would have to start cutting on their shipments elsewhere globally. Are you seeing demand gains -- faster demand gains in other markets? And if yes, do you have plans for capacity expansions for serving the remaining markets?

Well, at this moment, I don't have a plan for capacity expansion. Our strategy is to remain cautious. Especially, we remain cautious on pure module sales. For pure module sales, we'll only focus on low-risk countries and high-margin market. And meanwhile, we'll put our dollars into projects in total solution business but also focus on low-risk countries, such as Canada, U.S. and Japan. This approach seems to be conservative and it's clearly different from many of our competitors, but we believe that this approach is prudent, and we are -- and is -- we -- and is a responsible business approach.

Next question is from the line of Aaron Chew from Maxim Group.

Wondering if you guys could just offer an update on how utility-scale system pricing is trending across various markets. I mean, I guess you primarily have exposure to U.S. and Canada, so maybe you could focus on there. And if you have any additional insights into maybe how Europe and the rest of Asia is, that would be helpful as well.

Yes, this is Shawn. That will depend on the feed-in tariff offered by different countries. For example, the project we have in Canada was issued under so-called FIT 1.0, which guarantees a feed-in tariff of CAD 0.40 to CAD 0.43 per kilowatt hours for 20 years. So that's a very good feed-in tariff, so it can support a high project selling price. And for U.S., most of the projects without feed-in tariff is pure PPA and -- but with the investment tax credit, so that results in a lower selling price. Japan also have a high feed-in tariff, so the system price in -- the project price in Japan is also expect to be good. However, the -- there's also a discussion in Japan that the feed-in tariff level may be adjusted after the current fiscal year. So we are watching how it develop. So to answer your question, it all depends on the solar radiation condition and also the feed-in tariff level.

Okay, fair enough. And then just one follow-up. I wonder if you guys can comment on the prospective poly tariff coming out of China and how that may affect your wafer supply. I'm -- I know that you don't directly buy much poly. But if it seems that, that could potentially impact your wafer costs, or have you mostly figured out a way to get around that? Any color there would helpful.

Yes, well, as we said in the, yes, formal statement, that this is one of the uncertainties, one of the risks. And however, so far, we haven't seen much impact yet. Indeed, the polysilicon price increased a little bit. It increased from around $18 per kilogram to around $20 per kilogram, but this cost increase was more or less absorbed by the wafer producer. So we, as a cell module producer, haven't seen much impact yet. Now moving forward, we also have the wafer supplier and cell suppliers in -- outside China. So I believe we will have a reasonable approach to have wafer suppliers -- not really poly, but wafer suppliers using both China poly and oversea poly. So I think we have a strategy to respond to the potential tariff.

We have no further questions in the queue. Okay, we have another question now from Pranab Sarmah from Daiwa Capital.

My first question is on for 2013 outlook. Can you just remind me from which market you are -- what type of targets you are looking at, the different markets? Like from Canada and North America, how much of your total target, and how much will be from your Japan and other part of the world?

Are you talking about the total module shipment or only the project business?

Total module shipment targets, how you are dividing for 2013 outlook.

Oh, that's a very good question. But if you look at our Q4 geographic distribution, in Q4, about -- both Asia Pacific and Europe account for about 40%, respectively. North America is about 20%. Now moving into 2013, I see the contribution from Europe going down but the contribution from both Asia Pacific and North America going up, moving up. So as a result, well, North America and Asia Pacific will be the 2 leading areas while Europe will be -- probably be the #3.

And can you also give, by ASP differences, how it is looking at between Asia Pacific regions, especially China versus Japan and other part, and also North America's ASP prospects [ph]?

Yes, are you talking about module ASP?

Module ASPs, that's correct.

Yes, module ASPs are lower in China and India and fairly low in Europe and higher in other areas of the world.

The lowest is now in Europe, then followed by China and India. And after that [indiscernible] U.S....

No, the lowest module price have been in India, China and Thailand. And Europe is a little bit high -- is higher, and U.S. is a little bit more higher. And in Canada and Japan, we have higher price. And then in some emerging market, the price is even -- now you see, it's much better, but those emerging market doesn't demand much volume. And however, the situation may also change. For example, Japanese yen have went down almost 20% in the past few -- a couple of months, and that results in the profit margin in Japan shrink significantly. But still, Japan is one of the high-margin market for us. It's also because, in Japan, we adopted a brand strategy. Rather than selling OEM, we sell Canadian Solar brand in Japan, so we had a chance to sustain a good price. And also in Japan, we -- for the residential market in Japan, we deliver the complete kits rather than deliver only module. So by providing the roof -- residential roof solutions, we also sustain a reasonable price in Japan.

[Operator Instructions] Next question is from the line of Timothy Lam from Citigroup.

My question is related to company's plans for the shipments into 2013. Given that the market is quite strong in Japan and in China, it -- what kind of percentage of sales the company anticipates to sell to these markets as the overall in view of that? I know that -- secondly, a follow-up question to this is, I know that company has not been engaging too much into the Chinese development projects, but does this see any opportunities to target some of the projects that are happening in Japan?

Well, I can give you a snapshot of what we see at this moment. At this moment, out of the forecasted 300-megawatt shipment in Q1, I see around 1/3 goes into North America. And then I will say about 1/3 goes to Asia Pacific and Europe is a little bit lower, and then the rest goes into other part of the world. So you may use this number as an indication for the full year geographic distribution.

Yes, and commenting on the China projects and Japan projects. We're very active in the Chinese project market and we're building what we believe will be a very solid pipeline for the future, but we're not engaging in building out large projects in China until the market is more certain, until the end buyers and the process to find end buyers is more certain as well. So like our module sales, we're pursuing profitable growth, not profitless growth. In terms of Japan, we've been in Japan for quite a long time and we're actively building a pipeline there, and we believe we'll have good news to disclose in the future from our results there.

Now I will add one statement. As you all know that I'm a China-born Canadian citizen, so I know China very well. I believe in the Chinese -- China market. I believe that this market will eventually -- well, this year, China market may become the biggest, but it's not going to be the -- a good market because of the -- there's almost no profit, and also the credit risk. But into the future, China may become a big but also solid market. So that's why we are preparing for this market, but I'm -- I prepare to -- only prepare the market for the growth in 2014 and 2015.

And I'm not a -- as people who've met me know, I'm not a Chinese-born Canadian, I'm a Canadian-born Canadian, I guess. And I also strongly believe the market in China is going to be very strong in the next couple of years. And if you go back and look, even the Canadian market, there was a lot of delays in the rollout of the market and a lot of uncertainty. And it took a couple of years before the government policies and the desire to do solar started turning into solar power plants being built. So China is no different. There's only a lot more people and a lot more opportunity here, but it's going to take a while to work from policy into action, into a system that works well.

Yes, and I want to further echo that, what Michael said. For example, Canada, Ontario issued its Green Energy Act in 2009. So we submit the project. In early 2010, they issued a first round of FIT approval, but only by the end of 2012 the REA got start to get released, so the project only get to be built in late 2012 and then 2013. That shows how much time a new market will take to get developed. So China is no exception. It's somewhat a belief that a China project market can turn into a mature market overnight. Personally, I think, not agree. So our strategy, again, is to focus on growth, but focus on growth with profit and also focus on low-risk countries.

We have no further questions in the queue. I would now like to turn the call back to you for any closing remarks.

Thank you, operator. And thank you, everyone, for joining the call today, and thank you for your continued support. If you have any further follow-up questions after today's call, please contact us. And have a great day. Thank you.

Ladies and gentlemen, that concludes your call for today. Thank you for joining. You may now disconnect.