Canadian Solar - Q2 2023

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to Canadian Solar Second Quarter 2023 Earnings Conference Call. My name is Melissa, and I will be your operator for today's call. 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 would now like to turn the call over to Isabel Zhang, IR Director at Canadian Solar. Please go ahead.

Isabel Zhang (Director of Investor Relations)

Thank you, operator, and welcome everyone to Canadian Solar second Quarter 2023 Conference Call. Please note that we have provided slides to accompany today's Conference Call, which are available on Canadian Solar's Investor Relations website within the Events and Presentation section. Joining us today are Dr. Shawn Qu, Chairman and CEO; Yan Zhuang, President of Canadian Solar's majority-owned subsidiary, CSI Solar; Dr. Huifeng Chang, Senior VP and CFO; and Ismael Guerrero, Corporate VP and CEO of Canadian Solar's wholly-owned subsidiary, Recurrent Energy, also formerly Global Energy. All company executives will participate in the Q&A session after management's formal remarks. On this call, Shawn will go over some key messages for the quarter. Yan and Ismael will respectively review the highlights of the CSI Solar and Recurrent Energy businesses, followed by Huifeng, who will go through the financial results.

Shawn will conclude the prepared remarks with the business outlook, after which 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. 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. Now, I would like to turn the call over to Canadian Solar's Chairman and CEO, Dr. Shawn Qu. Shawn, please go ahead.

Shawn Qu (CEO)

Thank you, Isabel. Hi, everyone. Welcome, thank you for joining us today. Please turn to slide three. We achieved a strong financial and operating result in the second quarter of 2023. We delivered record module shipments of 8.2 GW, with $2.4 billion in revenue and gross margin at 18.6%. Importantly, we delivered record total net income for Canadian Solar shareholders of $170 million, or $2.33 per diluted share. Let me share a few key Q2 messages before Yan, Isabel, and Huifeng review our performance in more detail. Please turn to slide four. First, we successfully completed the IPO of our CSI Solar subsidiary on the Shanghai Stock Exchange STAR Market.

This was a major achievement for us. I would like to thank our entire team for their efforts in reaching this goal. Investor demand was strong, we raised approximately $975 million in gross proceeds, 70% more than our original target. These funds will be used to support our growth plans across both our solar and energy storage businesses, including our strategic investment in vertical integration to further drive technology and cost improvements. This is the latest example of how we are building long-term value for the company and shareholders. Please turn to slide five. Second, under the backdrop of the Inflation Reduction Act, we continue to strengthen our competitive position in the U.S. one of our core markets. In June, we announced the establishment of a solar PV module production facility in Texas.

This plant will have an annual output of 5GW, represents an investment of over $250 million. Production is expected to begin near the end of this year, with approximately 1,500 skill jobs created once fully ramped up. We are proud to be embarking on these growth initiatives with long-term partners such as EDF Renewables, with whom we signed a multi-year module supply agreement of 7 GW of high-efficiency N-type TOPCon solar modules. We expect this to be the first of many important partnerships. We also continue to solidify our market position in the U.S. in downstream project development business. Recurrent Energy is developing some of the most valuable solar and battery energy storage projects, including the 1.2GWh Papago standalone storage project in Arizona.

At the same time, our e-STORAGE team will be supplying the equipment integration services and long-term services for Papago. This is another great example of how we focus on capturing more value of each project over its lifetime. Of our 6.6GWt of solar PV development pipelines in the U.S. we have over 2 GW of projects with interconnection agreements, of which 45% are sited in energy communities. Likewise, 45% of our advanced storage pipelines in U.S. are also sited in energy communities. We see significant potential in the U.S. market, particularly after the passing of the IRA, and will continue to build on our competitive Hello? Hello? Am I still online? Hello. Yes, Shawn, you're still on. I'm still on, right? Okay. All right.

We see significant potential in the U.S. market, potentially, particularly after the passing of the IRA, and will continue to build on our competitive position and track record in this market. Lastly, turning to slide six, I would like to highlight Canadian Solar's latest annual ESG sustainability report, which we published a few weeks ago. This year, we made significant improvements in our systems and disclosures. We hope the report will serve as a transparent account of our efforts to integrate sustainability and ethics into every aspect of our business. For example, we significantly expanded our participation in international ESG initiatives and certifications. We are now supporters of United Nations Sustainable Development Goals, and recently joined the United Nations Sustainable Development. Recently joined the UN Global Compact, committing to support and adhere to the 10 principles of the UNGC on human rights, labor, environment, and anti-corruption.

We also submitted our commitment letter to SBTi, our, our Science Based Targets initiative. This indicates our intention to set the near-term net zero science-based climate targets. We also continue to ensure that our own operations, as well as those of our suppliers follow ethical labor practices. I'm grateful that these efforts have not gone unnoticed. Having received a prime ESG rating from Institutional Shareholder Services, our ISS, and an excellent ESG rating from Achilles, from Achilles. With that, let me turn over to Yan, who will provide more details on our CSI Solar business. Yan, please go ahead.

Yan Zhuang (President of CSI Solar)

Thanks, John. Please turn to slide seven. In Q2, the CSI Solar division delivered 8.2 GW of solar module shipments and $2 billion in revenue. This is a record quarter, as it's the first time we're crossing the $2 billion mark. Gross margin was 14.3%, down around 4.2 percentage points quarter-over-quarter. This included a $31 million inventory write-down, driven by the sharp decline in raw material costs. Without the write-down, gross margin would have been 15.8%. Let me go over the key drivers behind these numbers. Please turn to slide eight. First, while you can see that polysilicon prices declined significantly during the quarter, wafer and cell prices have not fallen nearly as much as polysilicon.

Note that we ended last year with 20 GW of cell capacity, despite expecting 30-35 GW of module shipments. This means that our non-vertically integrated capacity was not the most optimal from a cost standpoint. We're working to improve this meaningfully as we ramp up cell and wafer capacity in the second half of 2023. In the meantime, we're restricting our procurement of third-party cells in order to protect margins before our cell capacity is fully ramped up. Second, which is perhaps the larger factor, is the decline in module prices. This was mainly driven by the distributed generation segment across most regions, just specifically, the residential sector. Overall, market inventory levels are higher than usual, that has led to destocking.

We expect to see improvement in the DG segment as we move through the second half of 2023, once the destocking is complete. We also saw some utility scale customers pause or even delay orders, given the sharp pricing declines. Despite the near-term pricing volatility and destocking, we remain very confident, given the strong demand across nearly every market. We are already starting to see polysilicon prices rebounding over the past few weeks. Projects can only be delayed for so long before they start to incur liquidated damages, and the development pipeline we see in the market has eclipsed previous levels. Near term, based on the factors I've just mentioned, we expect the market to improve as we move through the second half of 2023. Third, our logistics costs continued to decline in Q2, mostly driven by lower logistic costs in China.

We've also been locking in shipping contracts when they're lower, to protect ourselves from any increase as the market rebounds. Combined with our higher operating leverage, our operating profit nearly doubled year-over-year to $119 million. Actually, moving into Q3, we already see that the gross margin is improving. Moving into Q4, we expect a further improvement. Turning into slide nine. We made the strategic decision to rebrand our utility scale turnkey energy storage business under our new e-STORAGE brand, which we believe more clearly articulates our business. In the second quarter of 2023, we signed approximately $630 million in new bookings. As of the end of Q2, we had a contracted backlog of $2.1 billion, including contracts under long-term service agreements.

We expect shipments will ramp up significantly in the second half of 2023, as we complete our planned transition from a white label product into our own manufactured products. Importantly, given our bookings and the 26 GW hour of total pipeline, we believe e-STORAGE is firmly on track to become a billion-dollar business in 2024. I'm very proud of our e-STORAGE team for achieving such impressive growth in just three years. Now, let me pass the call to Ismael for an overview of Recurrent Energy, Canadian Solar's global project development business. Ismael, please go ahead.

Ismael Guerrero (Corporate VP and CEO of Recurrent Energy)

Thank you, Yan. Please turn to slide 10. In Q2, we delivered $360 million in revenue with a 43.9% gross margin, mainly driven by the sale of our flagship 100 MW Azuma Kofuji project in Japan. As previously guided, Q2 was one of our largest quarters in terms of revenue and profit. We are now concentrating more of our efforts on executing projects to hold them long-term, as opposed to monetizing them immediately in the short term. In particular, we are going to be building several GW of projects over the next few quarters, specifically in Europe and the U.S. where we believe we can capture higher value by remaining as the long-term asset owner and operator. Please turn to slide 11. As of June 30th, our total pipeline stood at 25 GW for solar and 62 GWh for battery storage projects.

We are being more selective in originating more PV pipeline, as our current pipeline is significantly mature and give us a strong visibility for execution and growth over the next few years. On the storage side, we continue to originate projects, focusing on regions where solar penetration is high and grid reliability risks are also relatively high. We remain far ahead of the industry in terms of track record, market understanding, and positioning. We are very confident that we can execute on this pipeline to build increased value for the company and shareholders. Please turn to slide 12. Over the past few years, we've seen significant inflation in CapEx costs and increases in cost of capital, which combined, have driven PPA prices higher.

Demand has been very strong due to the large influx of new players who were attracted by competitive economics, as well as the interest to secure electricity needs through clean and reliable sources. According to SBTi data, at the end of 2020, 620 companies had publicly pledged to reduce their greenhouse gas emissions. In less than 3 years, this number has grown to over 4,800 companies, a growth of more than 9x. Yet, the line-up of good quality projects in the market remains scarce. Over the past 3 years, Recurrent Energy signed over 2 GWs of PPAs in late-stage reconstruction projects. In addition, we have approximately 1.5 GWs of PPA contracts in advanced negotiations in the US and Europe, for projects that are expected to be held longer term. Take the US market as an example.

Our long-term positioning and ability to develop high-quality clean energy assets has allowed us to successfully raise U.S. PPA prices by approximately 20%-40%. As Shawn mentioned earlier, among the 6.6 GWs of solar PV development pipeline in the U.S., we have over 2 GWs of projects with interconnection agreements, of which 45% are site in energy communities. In addition, 45% of our advanced storage pipeline in the U.S. is also sited in energy communities. Thanks to the IRA, we expect to monetize the ITC in a significant part of our projects. This includes the recently signed Papago standalone storage project in Arizona of 1.2 GW hours, which will help the state meet surging electricity demand.

We expect the IRA to support more flagship projects like these, and we will continue to work relentlessly to execute and deliver on them to serve our customer needs. Let me pass it on to Huifeng, who will go through the financial results in more detail. Huifeng, please go ahead.

Huifeng Chang (SVP and CFO)

Thanks, Ismael. Please turn to slide 13. In Q2, we delivered $2.4 billion in revenue, up 39% quarter-over-quarter, and up 2% year-over-year. Gross margin was 18.6%, a small sequential decrease of 6 basis points. Gross margin was driven by lower ASP and an inventory write-down due to the sharp decline in raw material costs, offset by high-margin product sales. Without the inventory write-down, gross margin would have been 19.9%. Selling and distribution expenses were flat quarter-over-quarter, despite the significant increase in shipment volume, reflecting our operating leverage and a further decline in unit logistical costs. General and administrative expenses increased, mainly due to a $36 million share-based compensation expense related to the CSI Solar IPO. We expect to amortize the remaining roughly $25 million of IPO expense over the coming quarters.

Overall, the 39% of revenue growth far outpaced the 26% increase in OpEx, as we achieve greater scale and operating leverage in our business. The net foreign exchange and the derivative gain in the second quarter was $34 million, mainly driven by the stronger U.S. dollar relative to the Chinese RMB. Total net income was $198 million, with net income attributable to Canadian Solar shareholders at $170 million, or diluted EPS of $2.39. Now, turning to the cash flow and balance sheet. Next slide, please. In Q2, we generated approximately $290 million in operating cash and spent around $280 million in CapEx. Our full year 2023 CapEx expectation remains unchanged at approximately $1.5 billion.

We ended the period with a higher total cash balance of $3.3 billion and a total debt of $3.3 billion. Our leverage, as measured in Net Debt to EBITDA, excluding received cash, was at 1.4x, the lowest it has been in many years. As you can imagine, we have deployed the cash raised from the CSI Solar IPO towards growth projects and therefore expect the future leverage to increase slightly towards a more normal level. Now, let me pass it back to Shawn, who will conclude with our guidance and business outlook. Shawn, please go ahead.

Shawn Qu (CEO)

Thanks, Huifeng. Let's turn to slide 15. For the third quarter of 2023, we expect solar module shipments by CSI Solar to be in the range of 8.5-8.7 GWs, including approximately 13MW through Recurrent Energy project. Total revenue are expected to be in a range of $1.9 billion-$2.1 billion. Gross margin is expected to be between 17.5%-19.5%. This reflects a margin improvement in CSI Solar, offset by a lower contribution from Recurrent Energy comparing to Q2.

For the full year of 2023, we reiterate CSI Solar's total solar module shipment guidance to be in a range of 30-35 GW, and CSI Solar's battery storage shipment to be between 1.8-2 GWh, representing this year's transition from white label to own manufactured product. Full year 2023 revenue is expected to be between $8.5 billion-$9 billion, mainly due to the rapid decline in solar module prices. We expect the industry to remain highly competitive, Canadian Solar's successful IPO of our CSI Solar subsidiary, strong balance sheet, and global brand position us to achieve profitable growth and create lasting value for our shareholders. With that, I would now like to open the call to your questions. Operator?

Operator (participant)

Thank you. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Brian Lee with Goldman Sachs. Please proceed with your question.

Brian Lee (Research Analyst)

Hey, guys. Thank you for taking the questions. Appreciate the time. I guess the first question was just on the gross margin guidance here. I know you're not giving the specific numbers, but. One, are you assuming any additional inventory adjustments in the Q3 margin guidance for CSI Solar? Two, if you're not, which, which I presume you're not, how would CSI Solar gross margins look in the Q3 guidance relative to the sort of normalized margin you would have printed in two Q if it wasn't for the adjustment? I think you said 19% X the adjustment. How, how is CSI Solar gross margins expected to trend relative to that adjusted number in three Q?

Shawn Qu (CEO)

Yeah, Brian, with answer your first question, we don't expect any significant inventory adjustment for Q3. Now, I would let Yan to comment on your second question. Yan?

Yan Zhuang (President of CSI Solar)

Hi, so, in Q3, I, I think, most of the revenue is gonna come from CSI Solar. That gross margin that we provided for Q3, it really indicates an improvement of the gross margin of CSI Solar.

Brian Lee (Research Analyst)

Okay. I mean, the midpoint is 18.5, you did-

Yan Zhuang (President of CSI Solar)

Yeah.

Brian Lee (Research Analyst)

I guess the midpoint is 18.5, and you did 19x the adjustment, so maybe it's flat to down a little bit, is what you're inferring here?

Yan Zhuang (President of CSI Solar)

Yeah.

Brian Lee (Research Analyst)

Okay, fair enough. Then maybe just, you know, looking beyond 3Q, 'cause I know you guys have a lot of visibility, given how you book out to, you know, multiple quarters in advance. Kind of sense for, in this declining pricing environment, where you see ASP trending and margins also for CSI Solar in Q4, and then maybe into early next year, if you've already started quoting activity there?

Shawn Qu (CEO)

Oh, it's a big question. Yan, you want to comment first?

Yan Zhuang (President of CSI Solar)

Yeah. Well, I think, first of all, everybody would agree that in Q4, the demand will come much stronger, so overall demand. That include, include both the DG market, especially the residential market, has been really down since Q2, you know, almost globally. That after the destocking, as we mentioned about, you know, moving into Q4, is going to come back. The utility scale is going to have a rush in Q4 as well. We're going to see a very strong demand. That may cause certain rebound on the upstream upstream cost. However, at the same time, we are observing a rapid ramping up of TOPCon cell capacity. The cell price has been staying high in Q2 and until now.

Moving into Q4, we're going to see more supply, significantly more supply on, on TOPCon cells in the industry. We think, we're gonna see, it's gonna be a rebalancing time, but Q4, although it's uncertain, but we see a chance for improvement. Also for Canadian Solar in specific, we have a pipeline of utility scale storage projects. That's gonna be, you know, we're gonna start to ship in Q in second half, and most of that volume is gonna be in Q4. You know, I think, the worst, may have, passed.

Brian Lee (Research Analyst)

Okay, fair enough. Maybe two last ones, then I'll pass it on. I, I jumped on late, so maybe I missed it, but did you provide any update on the plan to, you know, ship one third of 2023 volume as TOPCon technology? Also, I, I think you delayed the cell and module capacity expansion from 1Q 2024 to 4Q 2024, if I see the-- if I'm reading the press release correctly. Could you maybe speak to what's driving that and, and what the expected ramp is from March to, to December? Is it gonna be linear, or how should we model that? Thank you.

Shawn Qu (CEO)

Yeah, Brian, this is Shawn. We didn't delay any of our solar cell project. However, right now, the equipment supply is quite tight. Also, some of the crucial parts, for example, the quartz tubes. Not only the quartz crucible, but quartz tubes, supply is also tight. As people are moving, switching from PERC to TOPCon, there are some lease on bonds, I would say. Our target is still the same. We are, that we are ramping up about 30-40 GW of TOPCon. As we speak, we have close to 20 GW of PERC capacity right now, and as I said, we are ramping up around 30-40 GW of TOPCon as we speak.

Yes, after that, once we finish the ramp up, two-thirds of our capacity will be TOPCon. We also, we also plan another project, TOPCon project, a 10-GW project. Altogether. That's why by end of next year, you'll see around 60-70 GWs of TOPCon. It's not the ramp up is not linear, linear, because once you complete the facility, you start to install those machines. Once the machines are, are tuned up, then you will see a bump of the, you know, a leap of the of the cell capacity.

Yan Zhuang (President of CSI Solar)

Yeah, in Q4, our TOPCon capacity is going to be significantly higher than Q3, and therefore, the TOPCon shipment in Q4 is also much higher. As Shawn mentioned, it's not a linear, it's a jump in Q4.

Brian Lee (Research Analyst)

Okay, thanks for all the color, guys. I'll pass it on.

Operator (participant)

Thank you. As a reminder, if you'd like to join the question queue, please press star one on your telephone keypad. Our next question comes from the line of Philip Shen with Roth MKM. Please proceed with your question.

Speaker 8

Hi, guys. This is Matt on for Phil. Thank you for taking the questions. First, I just wanted to ask, when shipping to the U.S. market this year, have any of your modules been detained by CBP, in 2023? Secondly, on a different topic, for the U.S. module facility, that you guys have announced, where do you expect to source the cells and wafers for that facility? Are there eventually plans to have U.S. seller wafer, and what would it take to make that decision?

Shawn Qu (CEO)

Yeah, Matt, this is Shawn. I'll, I'll answer, answer this question. In 2023, we haven't had any of our modules detained by CBP. Second, we will use our Thailand solar cell facility to supply to the, our factory, factory in Mesquite. Mesquite, the county of Dallas. We are looking into the possibility of a solar cell factory in the United States.

Speaker 8

Okay, thank you for the color there. I'll pass it along.

Operator (participant)

Thank you. Our next question comes from the line of Colin Rusch with Oppenheimer. Please proceed with your question.

Colin Rusch (Managing Director and Senior Research Analyst)

Thanks so much, guys. You know, could you give us a sense of how the shipping expenses are going to trend through the balance of the year, and the full impact on the SG&A, we think about the operating leverage, as we go forward?

Shawn Qu (CEO)

Yeah. Yan, do you want to comment on this question, the shipping expenses and its full impact on SG&A?

Yan Zhuang (President of CSI Solar)

Yes. The shipping cost came down in Q2, and in Q3 is kind of stabilizing, and some lines may go up, some line, you know, most, most are stabilizing. We're actually, as we mentioned, as I mentioned before, we sign- we're signing a long-term contract to secure the ship- shipping space at low cost. We believe that our shipping cost will remain at lower level, so will helping continue to, you know, to help on our SG&A.

Colin Rusch (Managing Director and Senior Research Analyst)

Okay, I'll take the rest offline. Then on the battery side, you know, there's, there's an awful lot happening from a battery chemistry perspective as well as pack design perspective. Can you talk about the cadence of evolution of your, your products and how much R&D or, or incremental design changes are being implemented, right now, and kind of the evolution of that as you, as you look at your, your pipeline? Or are you really locked in with chemistry and design on that pipeline at this point, and the, the R&D product development is, is going to be ongoing and, and more future, you know, future-focused effort?

Shawn Qu (CEO)

Yeah, as you know, we use the LFP battery, mainly use the LFP battery to construct our Battery Energy Storage System. Our main product, our killer product right now is the 3 MWh SolBank. But we are developing new product. Now, we are not releasing the new spec yet, but the new product will have much higher power density, but also much higher safety. In terms of the chemistry, we believe in the lithium lithium battery chemistry. We are not looking for any major change on the chemistry yet, but we are developing design, develop new products.

Colin Rusch (Managing Director and Senior Research Analyst)

Thanks so much, guys.

Shawn Qu (CEO)

Thank you, Colin.

Operator (participant)

Thank you. Once again, as a final reminder, if you'd like to ask a question, please press star one on your telephone keypad. We'll pause a moment to allow for any other questions. At this time, I'm not showing any other questions. I'll turn the floor back to Canadian Solar CEO, Dr. Shawn Qu. Please go ahead. Shawn Qu, did-

Shawn Qu (CEO)

Thank you. Thank you, and thank everyone for joining us today and also for your continued support. If you have any other questions or would like to set up a call, please contact our investor relations team. Have a great rest of the summer and take good care. Thank you.

Operator (participant)

Thank you. This concludes today's Conference Call. You may disconnect your lines at this time. Thank you for your participation.