SunPower Inc. (SPWR) Q4 2011 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the SunPower Corporation's Fourth Quarter Year End 2011 Results Conference Call. Today's call is being recorded. If we have any objections, please disconnect at this time. I'd now like to turn the call over to your host, Mr. Bob Okunski, Senior Director of Investor Relations at SunPower Corporation. Sir, you may begin.

Thank you, Ed. I'd like to welcome everyone to our Fourth Quarter 2011 Earnings Conference Call. On the call today, we will start off with an operating review from Tom Werner, our CEO; followed by Dennis Arriola, our CFO, who will review our fourth quarter and 2011 financial results. Tom will then discuss our strategy for 2012, as well as our guidance for the year. We will then open up the call for questions. As a reminder, a replay of this call will be available later today on the Investor Relations page of our website. During today's call, we will make forward-looking statements that are subject to various risks and uncertainties that are described in our 2010 10-K, our quarterly reports on Form 10-Q, as well as today's press release. Please see those documents for additional information regarding those factors that may impact these forward-looking statements. To enhance this call, we have also posted a set of PowerPoint slides, which we will reference on this call, on the Events and Presentations page of our Investor Relations website. In the same location, we have posted a supplemental data sheet detailing some of our historical metrics. On Slide 2 of our PowerPoint presentation, you will find our Safe Harbor. Our prepared remarks will run approximately 25 minutes, and then we will take questions. With that, I'd like to turn the call over to Tom Werner, CEO of SunPower, who will begin on Slide 3. Tom?

Thanks Bob and thank you for joining us today. Before Dennis covers the financials, I would like to take a few minutes to review our Q4 2011 operational results. 2011 was a transitional year for the industry. Excess capacity sharply compressed ASPs while policy changes in a number of European markets affected the timing and scope of demand. Once again, we proved that our world-leading high efficiency solar panels and solar systems continue to be the preferred solution, as we maintain our pricing premium. We flexed our diversified downstream channels, as we adjusted our delivery plans within quarters between business segments and geographic markets to respond a changing market condition. We are on track with our accelerated cost reduction roadmap which puts us in a competitive position versus panels on an efficiency adjusted basis. And we completed our company restructuring, Tenesol acquisition, and advanced our Total strategic initiatives. These milestones will improve our access to market, strengthen our balance sheet, and increase operating cost efficiency. Turning to slide 4. In the fourth quarter of 2011, we had solid non-GAAP operating results on revenue, gross margin, EPS, and free cash flow. Our utility and power plant business outperformed with a significant start of major construction activities at California Valley Solar Ranch, as well as a 54-megawatt supply agreement with NRG for delivery between 2011 and 2012. We also had excellent success with new initiatives in our residential business with strong demand for our leased product as well as adding high profile partners like Nissan and Orchard Supply Hardware through our Alliance program which already includes Force. Our accelerated cost reduction programs are on track, the most important of which is our manufacturing step reduction program which will reduce cell production cost by 15% by the end of 2012. In the fourth…

Thanks, Tom, and please turn to Slide 5. As Tom mentioned, our financial and operating performance in the quarter was solid despite the challenging market environment. We took bold actions in the quarter to improve product and service delivery to our customers by reorganizing our company into focused regional groups. We also made difficult but necessary cuts to our operating expense structure that should reduce our overall SG&A costs by 10% year-over-year, without sacrificing any of our research and development spending. Our non-GAAP revenue for 2011 was nearly $2.5 billion, up 12% over 2010. Non-GAAP revenue in the fourth quarter 2011 includes approximately $186 million from the commencement of construction of NRG's California Valley Solar Ranch project. Our GAAP financial results will be recognized -- will begin recognizing revenue from the CVSR project beginning in the first quarter of 2012. And our GAAP and non-GAAP revenue for the year will be nearly identical on a full year basis. In 2011, we produced 922 megawatts of cells compared to 584 megawatts in 2010. And we recognized 766 megawatts in revenue, up 40% from 546 megawatts in 2010. We purposely reduced megawatt production in the fourth quarter compared to Q3 2011 in order to manage our inventory levels. In the fourth quarter, non-GAAP revenue was $749 million, up 6% over Q3 2011. Our fourth quarter 2010 results included revenue from the sale of 66 megawatts of projects in Italy. The United States was by far our strongest market in the quarter, both in terms of revenue and megawatts, followed by Germany and Italy. Our non-GAAP gross margin for the quarter improved to 12.4% from 11.4% in the third quarter, despite the unabsorbed cost related to our fab capacity optimization in the quarter. Let me now turn to our business segments. In our…

Thanks Dennis. Please turn to Slide 7. We’ve built our company to succeed in the current market environment starting with a differentiated technology that drives customer demand across a wide range of customer segments in markets. Strategically, we are focusing on four key areas. Our go-to-market strategy, including leveraging our Total strategic investment and recent acquisition of Tenesol, our technology leadership position in both cells and systems, our accelerated cost reduction roadmap and our strong balance sheet and liquidity. Now let me elaborate on our go-to-market strategy which I will discuss by focusing on our three geographic regions as we complete our go-to-market segmentation. The restructuring program that we are implementing improves our operational efficiency and supports our operating expense reduction plan. While we have not finalized our new segment reporting structure for 2012, the combination of geographies and market segments under regional leadership in three global regions will give us a much better view of the overall health of our business. First North America. As I discussed earlier, we have seen excellent progress in our North American UPP business. It just finished a strong year of growth in our commercial business. CVSR is on plan to meet its Phase I construction milestone in Q3 2012. The CVSR team has made good progress in installing panels and as the EPC contractor, we are responsible for taking care of our local environmental and cultural resources. Approximately 350 people are hired in working on site. This is great evidence of the economic opportunity that comes from large scale solar investment. We are working closely with our partners to ensure that the team meets all required DOE loan disbursement milestones and to finalize the formal application to draw down on the funds. The DOE is very diligently managing the milestone completion process. We…

[Operator Instructions] Our first question comes from Vishal Shah. Scott Reynolds – Deutsche Bank AG, Research Division: Deutsche Bank. This is actually Scott Reynolds for Vishal Shah. I just wanted to touch on the UPP business, 85% booked for the year, gross margins were better than our expectations. Can you talk about some of the main drivers behind the gross margin beat? And then also, on the R&C side, the second quarter of down margins, can you talk about some of the dynamics there that drove that performance?

Sure, I will let Howard Wenger take both of those questions; gross margin upside and UPP and R&C.

This is Howard. Yes, we're really pleased with the performance of the UPP segment. We are in great position to have the 85% of our forecast plan booked for the year. Big drivers there are the CVSR project we announced; the deal with NRG for 54 megawatts, which included 30 megawatts of Oasis power block system. We also have a number -- it includes sales internationally as well. And the gross margin beat is associated with those sales and our forecast for cost reduction during the time period. And as far as R&C, as you know, the industry is going through dynamic change, significant oversupply. Our R&C business is predominantly a turns business, so we are subject to the forces in the market. So there has been a significant margin pressure in compression during the period, and that was the primary reason for the decrease in direct margin in the R&C part of the business. We're pleased, however, with our volume of sales in that segment.

I would add a couple of comments – this is Tom, on the UPP business with strong this year and in 2013. The North America team, particularly has done a great job of getting PPA signed and advancing projects through the development pipelines of both ’12 and ’13 look pretty strong in North America UPP. And we are hitting both BOS and panel cost reduction. So that explains performance there. The residential and commercial, I would give you a little look forward. The majority of our business is moving to a leasing model. And as we do subsequent calls, we will talk more about leasing economics and revenue recognition associated with leasing. But we are making a dramatic switch to a leasing model. And broadly speaking, that would be a positive on all fronts; margin, cash flow. However, it would be a big challenging by virtue of revenue recognition. Thank you for your question.

The next question comes from Sanjay Shrestha. Sanjay Shrestha – Lazard Capital Markets LLC, Research Division: Great. Lazard Capital Markets. Two questions here, please. The first one on UPP segment. Are there significant permitting milestones you have to make to achieve your 2012 UPP targets?

This is Howard. The short answer is no. We've got the permit in hand for CVSR, and that's the big driver in UPP. So we're in good shape. Sanjay Shrestha – Lazard Capital Markets LLC, Research Division: Got it. Great. And the second question, though, on Tom's prior comment, could you elaborate a little bit more on the relative economics of this new tracker -- the tracker product in terms of cost, potential margin? And what does it mean in terms of the future opportunity here?

The new tracker product is a seven times concentration product, which as you look forward, means that we can take capacity out of our fab and recognize revenue with six to seven times the capacity of a fab when we utilize this technology. So it’s a real growth engine for your company and very, very capital efficient. And at the same time, where there is high solar influence, specifically direct normal sunlight, we can hit levelized cost of energy that we believe is up to 20% better than any other product in the market. So we are in a position to compete on a differentiated technology that has better levelized cost of energy economics and has great capital utilization, and we are commercializing – it will be our third project to build but it will be our first commercial project later this year and we are building the pipeline, it will become a significant part of our business in ’13, ’14, and ’15. We are also investing the capital in the next couple of quarters to have the manufacturing capacity to support the growth in ’13, ’14, and ’15. So needless to say, we are very, very bullish on this product.

The next question comes from Jesse Pichel. Jesse Pichel – Jefferies & Company, Inc., Research Division: Jefferies. I'd like to ask Scott Reynolds' question, but instead of for Q4, for 2012. Can you talk a little bit about your non-GAAP gross margin guidance of 7% to 10% for 2012 and what the components of that are between UPP and R&C? And I have a follow-up question.

Sure. This Tom. I will say a few words and then either Dennis or Howard, you guys can comment as well. So one aspect of this is what you expect pricing to do, and we’ve built in to our turns business which is largely our residential and light commercial business, up to high teens reductions in ASPs this year. We think there’s a very wide range of possible outcomes on ASPs and of course, we are accelerating cost reductions that we are prepared to deal with the – as much of the range as possible. The residential and commercial businesses are largely dependent on those two variables. The commercial business is – having said that, the commercial business is booked solidly through Q3. So the economics are pretty much known. So it’s an execution variable there. And we fully expect to execute. The UPP business is essentially booked. And Howard’s emphasized CVSR, there are a number of other projects that are much smaller in nature but meaningful, and those have also completed their permitting process and are soon to complete their financing process. So we’ve got a number of projects. So it’s execution in UPP, in its progress on Oasis and so far so good on Oasis. So while our margin guidance is lower on that because we still see a transitional year in ’12, where it’s going to be extremely competitive in the turns business. And I think we all set. Jesse, we will take the next question. Jesse Pichel – Jefferies & Company, Inc., Research Division: Yes. Leasing seems to be one of the fastest-growing segments of the market and appears to expand the solar TAM beyond the 1 percenters. How is your leasing product different from some of your competitors like SolarCity? If you could maybe highlight some of the differences.

Sure. Leasing products, I will say a few words and I think Howard would want to say some, but if you think about it, a leasing product is perfect for our product because it rewards high energy production. And it’s – then the purchaser of a lease can get the world’s best solar technology and economics that is good or better than any other option. And so when you can get equal or better economics and a better superior technology with a couple of billion dollar company backing it on you know, a couple of billion dollar public company that has the Top 15 company in the world backing it, I think it’s got reasons to feel comfortable that the lease is stable and that your “future proof” that you are not going to have buyer’s remorse at some point in the future. You’ve got the best technology. So as soon as we turn the switch on leasing in Q3, in Q4 it was apparent that that hypothesis is correct.

Yes. This is Howard. I would just add that we have a much larger footprint than the competition. So when we've got a lease, we've got a very scalable model. We can roll it out. And you can see that in the market share results that we showed in the slides where we jumped up 8 points absolute in our market share to 25% in California, as an example. So that's another big advantage for us. And I think the customers really appreciate that the company that's supplying the lease is the one that's producing the technology backed by a very large company. So they know that we're going to be around in the future. It's making a big difference.

Yes, Jesse, this is Dennis. I think the other competitive advantage we have here is we're working with third-party financial providers. Banks basically provide the capital for that leasing. When they look at SunPower, our balance sheet, as well as the support that we get from Total, that allows us to actually get more competitive financing rates that we can pass on to our customers. So when you couple that with the technology, our service and the overall cost of capital, we've got several advantages.

Our next question comes from Kelly Dougherty. Kelly A. Dougherty – Macquarie Research: Macquarie. Tom, just wanted to talk about the cost improvements and how much of that you expect to come from the higher efficiency Gen 3 cells versus the process simplification, versus maybe focusing on the supply chain either on the poly side or on the -- just the component side and reducing costs there.

The Gen 3 technology would be less than a few percent of our production this year ramping to 10% or 20% in ’13. So it’s not a big driver in the next year, but will be a platform that will develop off of a significantly step reduced higher efficiency product. And of course that’s sort of a Holy Grail. That’s what everybody’s targeting for is high efficiency at low cost. And our Gen 3 platform gives this foundation for that in the ’13, ‘14 timeframe. So it’s split between more effective procurement and that’s across everything we buy. When there is an inversion of supply and demand it happens all the way through the value chain. We partnered with some significant suppliers over the year when it was the other way around. And so we are finding our partners to do – to partner with us in this market condition as well. The step reduction program is the more significant driver. I’d call it kind of 60:40, Kelly. That’s a rough estimate. Step reduction is more powerful because it allows us to make same products with less capital equipment, less touches of the wafer, which means less yield loss, less chems and gases and electricity, and it’s like energy efficiency, there’s nothing better than eliminating the use of. The other thing that’s really powerful about our step-reduction program, is its sustainable differentiation. It’s something that no one else is doing, and has many patents pending. So step reduction is what’s going to drive us, but it’s probably 60% of the economics of the cost reduction. Kelly A. Dougherty – Macquarie Research: Great, that's helpful. And then just with the CapEx, you previously mentioned having a reallocation more toward cost improvements, less towards just straight capacity expansion. Just wondering if you can break out your CapEx guidance for this year, what it -- $110 million or $130 million, how much of that you're spending on cost reduction? Is any of it for building capacity for the tracker? Just maybe how you think about the needs for tracker CapEx going forward -- or I'm sorry, for the concentrator?

Let me comment philosophically very briefly and then Dennis or Chuck are going to answer your question specifically. You are exactly right. By virtue of our C7 product, we can expand significantly in ’13, ’14, and ’15 without adding nearly as much as fab capacity. So part of our CapEx for this year is pretty net capacity in place. I think they are going to tell you, is between – it’s 10% to 15% of that overall number. The balance of it is split between the step reduction programs and the advancement of our Gen 3 product that we talked about in the earnings call. So broadly speaking that would be the split. If you guys want to give…

Yes. I think that's accurate. As we look at -- for 2012, about 2/3 overall, you could put into the bucket of manufacturing, with a good portion of that coming -- almost half of that coming on step reduction. And the other, roughly half of that, coming in the form of modco -- what we're doing in Mexicali. And then we're investing quite a bit on C7 as well. So that's -- those are the breakups. Kelly A. Dougherty – Macquarie Research: If I could just -- one more quick one, any comments on the trade situation and maybe how you see that playing out and affecting or not affecting SunPower in some way?

My understanding is that the ruling or decision is pushed out a couple of weeks. So we will see – we have never been through a trade suite. We are not planning to capitalize either up or down. We are working with Total to accelerate our cost reduction roadmap and compete incredibly, aggressively. And if it happens, to be a positive that would be incremental or icing on the cake, so to speak.

Our next question comes from James Medvedeff.

Cowen and Company. I want to ask a little bit -- just a little bit of clarity on the R&D and SG&A comments that you made. With Tenesol coming in, is R&D basically flat year-over-year? And does SG&A drift up a little bit? Or are they actually both lower in 2012?

This is Tom. I will take 20 seconds. R&D will increase also by virtue of our work with Total, a meaningful investment of four years, $24 million. It’s not – that’s not built into that numbers that you see. So you’d see a moderately increasing standalone R&D investment with the addition of Total on top of that.

Yes. This is Dennis. And if you look at the SG&A excluding R&D, there's really 2 ways -- 2 buckets to look at. SunPower, excluding Tenesol, will be down year-on-year. As we said, approximately 10%. On an absolute basis, when you add Tenesol, it'll be up. But it's on a relative basis. When you look at the SG&A as a percentage of revenue, we're down year-on-year.

Great. That's what I was looking for. Just another one, you mentioned the bad debt expense. Can you just flesh that out a little bit and maybe give a sense of who, why, where and what it's looking like right now?

Sure. This is Dennis again. I think, we, like most companies, have policies based upon delayed payments or tardy payments. We take a very strict look at that. And we had a handful of customers that were having some challenges, and we made the decision per our policies to set up reserves for those. So remember, whenever you do set up bad debt reserves, it doesn't necessarily mean that you forget about it. And we're going after these customers, either supporting them in prepayments or payment plans and/or looking at what legal ramifications or remedies we have.

Are they -- is this in Europe? Or is it in the U.S. or Asia? Or where geographically?

Primarily Europe.

Yes, that makes sense. One final one. Why would LCOE only be down sort of 20% if the efficiency gains of the C7 Tracker are 7x? Is it the cost? Is it that much more expensive? Or is there some...

If it come in at 20%, it’s 20% of competing technologies at the time we are in mass production. So the LCOE drop is significantly more than that, but it’s 20% better than competing technologies and ’13 and’14 timeframes.

Our next question comes from Joe Osha. Joseph Osha – BofA Merrill Lynch, Research Division: Bank of America Merrill Lynch. Two and a half questions, I would say. First, on the UPP pipeline, can you talk about how much of that is DOE 1705 guaranteed?

I think that’s pretty straight forward. That’s CVSR only and over what timeframe Joe. Joseph Osha – BofA Merrill Lynch, Research Division: Well, I assume that most of your pipeline now, being as it's February, was stuff that kind of went into the pipeline late last year. So...

So if you think of our overall pipeline, it’s 20% of our overall pipeline. We would put a number 5 gigawatt in our pipeline. Joseph Osha – BofA Merrill Lynch, Research Division: Okay. And so that, essentially, other than CVSR, the rest of it is not related to what's going on with 1705?

My math is horrible, I believe that would be more like 5%. And I’d call it 2.50 out of 5 gigawatts. Joseph Osha – BofA Merrill Lynch, Research Division: Secondly, and this is the half question, there was some news out about some static, possibly related to the disbursements of the DOE guarantee for CVSR. Do you have any comment on that?

Beyond what we said in our script, the short answer is no. We did – if you go back and take a look at the transcript, we covered that in a few sentences. Joseph Osha – BofA Merrill Lynch, Research Division: Okay. So I heard that. I just wondered -- okay. Last, in terms of -- I know you don't want to disclose too much, but any comment on how ASPs might have trended in the Utility versus your retail and Commercial business?

We are trying to – I think catch the end of it. So how ASPs trended and then it kind of faded out. Joseph Osha – BofA Merrill Lynch, Research Division: Your UPP versus Residential and Commercial.

Oh sure. ASPs in the UPP business are set one in two years prior. It’s a two to three year cycle business. And of course you’re forecasting where your costs are going to be in. And so, I think of the market price reference, and go down from there, to give you some sense of where things are at. And residential and commercial, I’ll let Dennis comment.

Yes. For the full year ASPs, and we look at it from the RLC basis blended around the world, were down just below 30%. And for the quarter, the reduction was in the single digits.

The next question will come from Brian Lee. Brian K. Lee – Goldman Sachs Group Inc., Research Division: Goldman Sachs. I just had 2. First off, if I take your cash balance and then strip out the retirement of the debt in Q1 and your guidance for ending '12 at $300 million or so, it seems to imply a cash burn of an additional $150 million over the next 12 months. Does that sound about right? And how do you think about your need for additional capital heading into 2013?

Yes, that's -- Brian, this is Dennis. That's approximately correct. Basically, what I say is we are generating a positive operating cash flow. We talked about what our CapEx program is. We did also absorb some cash as part of the Tenesol acquisition. But as far as our overall capital raising plan for 2012, we don't anticipate today that we're going to be requiring to go out into the market in the capital side. I mean, if you look at where we ended up in the fourth quarter, with $658 million in available cash, as well as another $25 million under our revolver, we feel really comfortable that we have the resources necessary to finance our plan. Brian K. Lee – Goldman Sachs Group Inc., Research Division: Okay. And then -- just my second question was on CVSR. How many megawatts did you guys recognize in Q4? And was that in line with your original expectations? Or would you say that you were able to accelerate that a bit?

I would say, largely on plan and accelerating significantly in Q1.

Our next question comes from Timothy Arcuri. Timothy M. Arcuri – Citigroup Inc, Research Division: Citigroup. First thing. Tom, when you're efficiency adjusting your module cost, you're taking your costs down about $0.38. And I always thought that it was about $0.035 per 100 basis points working efficiency. So are you comparing it to first solar or crystalline? Because it seems like you're comparing it to first solar. And then I had a follow-up.

Sure. I think you can use your range of $0.03 to $0.08 at least. And it depends on the location. And it’s technology agnostic. So if you – we’d essentially, just like you would, we put it into a LCOE calculation. And so solar influence and cost of BOS are big drivers and creates the range. If we have low cost BOS and low sunshine, you are at the low end of the range; high sunshine, high BOS the other end of the range. And don’t forget that that’s compared to our average panel price. For us a very large scale – we have a variety of sizes, and our large scale panel is substantially lower cost. So if we were to say – to target exclusively our large scale power plants, we would make one SKU that would be a large scale panel and our costs would come down rather dramatically. Timothy M. Arcuri – Citigroup Inc, Research Division: Right. I guess the reason why I ask is because if you compare to crystalline and it's on the low end of that range, it's about a $0.20 adjustment. So even if you get to $1 per watt, you're going to be efficiency adjusted to like $0.80. So you're going to be selling modules effectively at cost if that's what crystalline is selling for. And then second question that I had was what are the restrictions, if there are any, on Total for buying the remainder of the shares outstanding?

You got me. I have to comment on the $0.80 that if the competition is selling at $0.80, it suggests their costs should be in the $0.60s. And if we – we have a lot of people who are benchmarking and analyzing other people’s products, and if we see evidence of that happening, you can be rest assured, we are not going to stick to our targets, but we are pretty comfortable that an $0.80 cost is going to be extremely competitive. And we will see and we have to adjust we are wrong. There is a standstill agreement that was part of our deal with Total. Of course, they can be adjusted by the independent directors. But it is a process managed by our independent directors in compliance with the standstill agreement.

Yes. And, Tim, this is Dennis. The actual components of that are contained within the affiliation agreement which we filed with the SEC as part of the overall acquisition. And you can see where the step-ups are, and as Tom said, any requirement for modifications are.

So we are going to wrap up the call here. Please contact Bob Okunski, particularly the people in queue, if we did not answer your questions, I am really sorry about that. If we look at this side, going into a continuing transition year, we are on the offense. We have a differentiated go-to-market, differentiated technology. Our cost plan is on track. And we have Total partnership, we are in a position to be on the offense. So we look forward to the call next quarter. Thank you for your time.