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.

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.

Thank you. And hello, everyone. Welcome and thanks for joining us today. Canadian Solar deliver strong second quarter results as we managed through the ongoing impact of 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 thought, but we continued to grow our shipment and the market share. Over the past few weeks, we have seen a sharp re-improvement in demand across most of our end markets, including the US, LatAm, Europe, Japan, Australia and China. [indiscernible] some projects have been delayed by a quarter or two, but, 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 COVID-19 challenges. R&D manufacturing innovation and increased level of economics of scale in the past few years have brought solar to grid parity in 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…

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. And 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…

Before I review the numbers, I'd like to share a quick thought with you. The keyword I will use to describe the Canadian Solar in 2020 is resilience. In Q1, as the coronavirus first hit China… [Technical Difficulty]

I think we lost Mr. Huifeng Chang.

I'm here now. Can you hear me? Hello, can you hear me? Yeah, yes. So I can continue. Okay, thank you. Yeah, the keyword I would use to describe Canadian Solar in 2020 is resilience. In Q1, as the coronavirus first hit China, we lost the production for a few weeks. But our teams worked incredibly hard to catch up safely, but 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 in 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 OpEx. The next, foreign exchange loss in the second quarter was $4.5 million, which was harder 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 take some currency risk. In this quarter, for example, the high FX 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…

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

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 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 – and changed 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?

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

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?

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 source. 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 stable, more stable than through the remainder of 2020, through 2021, rather than the big decline we have seen in the past few years. Because of that, right now, we are focusing on new product, and we're offering new product to the market rather than to rush 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.

Let me add 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 contract we find. Remember, there is lot of demand that contracted demand. So, this depends a lot on our long-term contract signing, for example, in US and also 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 and we have – like, we have quite a few large contracts that are three years long-term contracts based on cost plus model and that is already locked. And I think the entire US-Thailand capacity of 3 GW are, to me, is locked because US demand is high and the market is healthy. And also, we have market like Japan because, in Japan, we have different channels including the residential system sales that are – it's a distribution business that are very loyal channel. 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 also, 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. And globally, we have direct sales channel handled by separate team, selling small volume at higher price to the installers, going into residential and commercial top. Those customers are repeat customer. So, they will come in. And we have our own project that needs module and that the 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 answers your question.

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.

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 needs to support both volume and profit and return.

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?

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. And so, I would rather share – but what I can let you know is that the demand for the pre-IPO – 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 Instructions]. Next question is from Brian Lee of Goldman Sachs.

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?

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 investor know how to negotiate with me. But on the other hand, as I said in my answer to the previous question, the demand to 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 expected.

Maybe a couple of housekeeping questions for Huifeng. Huifeng, on the 3Q 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?

That breakdown, we don't have – don't provide a number yet. But mostly still in the MSO side. In the 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, Q4, there will be some closure.

I guess maybe just to follow-up on that, if you take the implied price per watt in 2Q since 2Q revenue was almost all modules and you assume a fairly small contribution from Energy in 3Q, that would imply module pricing is going up from 2Q to 3Q, 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 3Q is embedding a decent amount of energy revenue relative to 2Q, I think more in line with what you saw in 1Q. But just trying to understand the puts and takes here because the pricing otherwise would be implicitly going up here.

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

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 3Q since the majority of your revenues in 3Q are still going to be module based. Should we expect gross margins to sequentially decline further in 4Q, 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?

Let me take that question. This is Yan, Brian. Well, for Q3, the margin is lower for module businesses because module contract was signed few months earlier for Q3. And suddenly, we're experiencing a polysilicon shortage and price up, 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, 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 certain point of 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 going down trend will not continue into Q4. Q4, we should do better.

Okay.

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

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

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?

We experienced just some impact from COVID-19 on direct sales channel on the residential markets and commercial markets in some markets, for example, in the US, and they started to warm up. And however, the impact varies from country to country. And like Japan, which is the – in terms of revenue, the biggest residential market for us, was not affected 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 – China's is strong. The only markets that are still have – we're experiencing negative impact is US and Brazil. But still, even in the US, the market is already better now. It's better than Q2. So, direct sales channel, I think for Q2, we still did well actually 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 21% of gross margin for Q2. And so, I would say, the pricing for 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 that sensitive than the professional utility scale markets.

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, challenges on financing where you guys might be able to step in and capture some outsized value?

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

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

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 3Q? The 14% to 16% guidance, can you say what that might have been without the poly disruption?

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

Well, I think the impact is pretty major. I've made a calculation. I think majority of the impact comes from the silicon, right? But, however, once something happens, everybody is trying to ride the same boat to reach their pricing. So, all together, I think when it comes to module, the impact is two-thirds of US. And so, however, in Q3, for pricing – for module price up, we tried to reach price for module, but 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.

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.

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 relationship team. We thank you for your continued support. I hope you and your families are safe and healthy. Thank you.

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