Canadian Solar Q1'16 Earnings Conference Call: Full Transcript

Operator:

Ladies and gentlemen, thank you for standing by. Welcome to <b>Canadian Solar Inc.</b> CSIQ First Quarter 2016 Earnings Conference Call. My name is Leslie and I will be your Operator for today. At this time all participants are in a listen-only mode. There will be a presentation followed by 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 Ed Job Canadian Solar’s IR Director. Please go ahead.

Ed Job, CFDirector, Investor Relations:

Thank you Leslie and welcome everyone, to Canadian Solar’s first quarter 2016 earnings conference call. Joining us on the call today are Dr. Shawn Qu, our Chairman and Chief Executive Officer; Mr. Michael G. Potter, Senior Vice President and Chief Financial Officer and Dr. Huifeng Chang, who will be taking over the CFO position on May 22nd 2016.

Before we begin, may I remind our listeners that in today’s 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, this 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 a more detailed discussion 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, May 11 2016. Canadian Solar assumes no obligation to update these projections in the future unless otherwise required by applicable law.

At this time, I would like to turn the call over to Dr. Shawn Qu. Shawn, please go ahead.

Shawn Qu:Chairman, President and Chief Executive Officer:

Thank you, Ed and thank you all for joining us on the call today. Q1 was another strong quarter for us. Shipments, revenue and gross margin all came in above guidance reflecting strong demand for PV modules and stable ASP’s.

Our results continue to reflect our leadership position, in both solar module and downstream total solution businesses. In Q1 we benefited from strong demand from several key markets. The U.S. in particular is a bright spot with shipments for the quarter exceeding 400 megawatts.

Sales to the Americas as a whole represented 43% of revenue mainly driven by module sales in U.S. Asia on the other hand represented 44% of revenue primarily driven by solid demand for modules in Japan, China and India. Meanwhile, Europe and other regions accounted for about 13% of revenue.

We also made solid progress in the execution of our energy business strategy. We exceeded Q1 with nearly 438 megawatts of solar power plants in operation in our HoldCo. These plants have a resale value estimated at over $950 million and potential gross margin of close to $200 million.

In addition, our late stage solar project pipeline totals approximately 2.1 gigawatts with an estimated resale value exceeding $4.5 billion and gross margin contribution of over $850 million. This gives us considerable flexibility as well as visibility into our business results in the quarters ahead as we consider selling some of our solar power plants assets to enhance revenue and recycle capital.

Our capacity expansion, technology and cost reduction efforts remain on track. We expect to end the year with 1 gigawatt of wafer, 3.9 gigawatts of cell and 6.4 gigawatts of module manufacturing capacity. Our focus is really to upgrade our technology and to improve our cost structure through selected investments especially in the midstream part of the value chain.

The new and state-of-the-art wafer and cell capacity will help us to raise the module power output and lower our cost and to prepare us for future competition. Our capacity expansion plan includes a 700 megawatt cell and 800 megawatt solar module manufacturing capacity in Southeastern Asia that is expected to start production in August and fully ramp up in Q4 of this year.

Overall, we are executing on our long-term strategy to remain global scale and manufacture cost advantages while also leading the way with our competitive technology and a differentiated business model. We have stressed these key themes over years. This approach continues to serve us well and drive profitable growth as we build our Tier 1 position in solar modules and our total solutions business. We remain confident in our outlook based on our project pipeline, market growth expectations and our technology and cost reduction roadmaps. We continue to expect long-term growth as solar energy continues to take share from other sources of energy.

The fact remains unchanged, solar penetration is still in a low single digit worldwide and is expected to go through a long growth journey in the years ahead.

Now let me comment on our guidance for Q2 2016. We currently expect total Q2 module shipments to be in the range of approximately 1200 to 1250 megawatts including 30 megawatts of shipments to our own utilities scale solar projects. Revenue for the second quarter of 2016 is expected to be in the range of $710 million to $760 million, with gross margin expected to be between 15% and 17%. Our Q2 revenue will mainly come from the sales of solar modules and electricity revenue from the operating solar power plants under our ownership.

For the full-year 2016, we continue to expect total module shipments of 5.4 gigawatts to 5.5 gigawatts with approximately 5 gigawatts to third-party customers and therefore recognized into revenue.

Meanwhile, we are raising our revenue guidance for the year by $100 million to the range of $3 billion to $3.2 billion as we prepare to sell some of our operating solar power plants in the second half of the year.

We expect to add 1.1 gigawatt of operational solar power plants to our portfolio by the end of 2016 which provides us with valuable inventories and great flexibility. Our annual revenue may increase by additional $200 million to $400 million should we decide to sell more solar power plants. We are actively considering more options to monetize our solar power plant assets. These options include for example outright sales of solar power plants or asset-backed securitization and potentially our public or private YieldCo depending on the market conditions.

We believe that our solar power plant assets in low-risk OECD countries are valuable and very liquid. Our goal is to maximize the long-term return to our shareholders.

Finally before I hand the call over to Michael, let me welcome Dr. Huifeng Chang to our management team. Huifeng will be taking over the CFO position from Michael. He brings to Canadian Solar many years of valuable experience in capital markets and risk management in a global context and we look forward to his contribution in this new phase of our development.

Meanwhile, we are indebted to Michael for his years of service during which Canadian Solar has transformed itself from a solar module manufacturing and sales company to a vertically integrated global leader in the solar industry.

Michael has made important contributions to the development of Canadian Solar in his nine years with us, five years as CFO and before that as an independent director for the company. I personally will miss his advice but I am happy that he will be available to consult us if necessary. We wish him well in his future endeavors.

Let me now turn the call over to Michael for a more detailed review of our results for Q1. Michael, please go ahead.

Michael Potter:Chief Financial Officer:

Thank you, Shawn. Net revenue for the first quarter of 2016 was $721.4 million, down 35.6% sequentially and down 16.2% compared to the year ago period. Revenue for the quarter was well above our guidance of $645 million to $695 million.

Gross profit in Q1 was $112.5 million compared to $200.5 million in Q4 and $153 million in the comparable period last year. Gross margin in Q1 was 15.6% compared to 17.9% in Q4 and 17.8% in the first quarter of 2015. Q1 gross margin came in well above our guidance as a result of higher than expected module ASP and lower module manufacturing costs.

Total operating expenses were $74.1 million in Q1 compared to $95.2 million in Q4. Income from operations was $38.4 million in the first quarter of 2016 compared to $105.3 million in the fourth quarter of 2015 and $78.7 million in the first quarter of 2015.
Operating margin was 5.3% in the first quarter of 2016 compared to 9.4% in the fourth quarter of 2015 and 9.1% in the first quarter of 2015. Net foreign exchange gain in Q1 was $3.5 million compared to $10.4 million in Q4 and $6.8 million in Q1 of last year.

The company recorded a gain on the change in fair value of derivatives of $2.7 million in the first quarter of 2016 compared to a loss of $9.4 million in the fourth quarter of 2015 and a gain of $7.9 million in the first quarter of 2015.

Income tax expense in Q1 of 2016 was $12.3 million compared to $31 million in Q4 of 2015 and $19.7 million in Q1 of last year. Net income attributable to Canadian Solar shareholders for Q1 2016 was $22.6 million or $0.39 per diluted share compared to net income of $62.3 million or $1.05 per diluted share in the fourth quarter of 2015 and net income of $61.3 million or $1.04 per diluted share in the first quarter of 2015.

Moving on to the balance sheet, in Q1, cash and cash equivalents was $412.4 million compared to $553.1 million at the end of Q4. The restricted cash balance was $587.1 million at the end of Q1 compared to $581.6 million at the end of Q4.

Our trade accounts receivable balance was $394 million at the end of Q1 down from $426.8 million at the end of Q4. Inventories increased to $413.2 million at the end of Q1 compared to $334.5 million at the end of Q4. Short-term borrowings at the end of Q1 totaled $1.35 billion compared to $1.16 billion at the end of Q4.
Long-term debt at the end of Q1 was $818.5 million compared to $606.6 million at the end of Q4. Senior convertible notes outstanding totaled $132.2 million, down from $150 million at the end of fourth quarter of 2015. Short-term borrowings and long-term debt directly related to utility scale solar power projects totaled $758.9 million at the end of Q1.

We were very pleased to deliver a gross margin of 15.6% which is well above our guidance of 12% to 14%. This reflects the overall health of our solar module business, the higher-margin opportunities we are capturing and our ability to closely manage both cost and inventory. We expect to benefit from higher efficiency in our manufacturing as we move through 2016 with investments made in advanced production technologies.

We remain in a period where the strong get stronger. We will continue to leverage our global track record of performance in blue-chip portfolio of solar power projects to capture an even greater share of the more profitable solar module and sought after project opportunities worldwide.

One recent notable financing transaction for us this quarter was the closing of $100 million LC facility with Export Development Canada. This facility will allow us to support the global development efforts of our energy business without requiring us to use cash on deposits for certain programs and bids. We continue to be able to close project financing as required which is a reflection of our reputation as a prudent and bankable global developer.

With the greatly reduced ability to launch an IPO for the YieldCo in the short term, we are executing on our secondary plans to sell projects. This is reflected in increasing our annual guidance by $100 million as our certainty of some sales has increased. We expect to sell more projects in the second half and will update you on our progress and expectations next earnings call unless we have material news before that.

Now I would like to say a few words about the CFO transition. Nine years ago I joined the Canadian Solar Board as an independent director. About five years ago Shawn asked me to step down as an independent Board member and help him transform the company as the CFO. Shortly after I joined, I also took over the legal function.
It’s been a hard and rewarding nine years. I’ve been able to help Shawn and his team build the company up to a global leader. Not many people are blessed to have such an opportunity in their lives and I thank Shawn and our Board for their trust and support during this time.

When I started as CFO, I moved to Shanghai for a few years and I moved back to the USA a few years ago. I told Shawn when I started I could probably last maybe four years and then I needs to reduce the constant time zone changes and dateline crossing travel. In the end I made a one-year longer than my original guess but I seem to be good at underestimating what I can do. The reality is I tend to be my biggest critic and never allow myself to give less than 100%.

I have been running full out as we executed the maximized growth while the window is open.

Today I have personal obligations that require me to spend more time closer to home than a 12-hour plane flight would allow me to do. I have been working closely with Huifeng for a while now even before he joined the company and will be available to help if needed but honestly doubt he will need much help.

Thank you to all the partners, investors and financial industry professionals that believed in us. A special thank you to my finance and legal team who are a truly extraordinary in the results they delivered and their friendship. I expect to be doing something different soon but will take a short break to try some personal projects I have wanted to try for a long time.

Before we open the call to your questions, let me turn the call over to Dr. Huifeng Chang for some closing remarks. Huifeng, please go ahead.

Huifeng Chang:Incoming CFO:

Thank you, Michael. Everyone on the phone, thank you for joining us. Please allow me to say a few words to introduce myself.

Actually much has been said about me in the press release. Given my 17 years in the capital markets, many of you have met with me before and know me pretty well. I think my Wall Street background will enable me to do more focus on enhancing shareholder values. Or at least more communications with you in the future.

I will make myself more available to meet with you in New York or Hong Kong or many other cities.

When I decided to join Canadian Solar, my friends asked me, hey Huifeng you have been in the capital market business for so long, why did you joining a solar company? Well I see three things unique in Canadian Solar.

First, the company has built a sound global platform with huge potential to grow in many countries like the TMT sector in the early 1990s. Second, great leadership; Shawn and Michael have built a high-quality globalized management team. Among the middle up 50 managers we have about 25 (Inaudible). We are truly a global business managed by a global team.

Third, we have a stable manufacturing business in the upstream and a high growth project business in the downstream. We are strategically well-positioned.

So what is my plan? Several years down the road when I look back, I hope I have accomplished the following. First, implement a sound risk management process. Like Charlie Munger said, know where and how others die and then never go there. I will make sure we will always stay within the safe zone during the rapid development.

And second, build a strong partnership with super big and cheap capital providers and third, make our shareholders happy.

So again thank you very much and I look forward to working with you for the years to come.

Ed Job:

With that I would like now open the call to your questions. Operator?

Question & Answer

Operator:

Thank you Shawn. Ladies and gentlemen, we will now begin the question-and-answer session. If you would like to ask a question please press star, one on your telephone keypad and wait for your name to be announced. If you wish to cancel your request please press the pound or the hash key. we have the first question from the line of Colin Rusch. Please ask your question.

Colin Rusch:Oppenheimer:

Thanks a lot and congratulations to everybody. It sounds like this is actually a well thought out transition that’s going to work for everybody. As you guys talked about the strong getting stronger here in this environment, can you talk a little bit about what’s happening in terms of module sales, the demand environment and the dynamics as you have seen some of your larger competitors go out of business and potentially looking at some of the local Chinese suppliers looking for new markets in the second half of this year?

Shawn Qu:

Hi, how are you and this is Shawn speaking. See in the first quarter, we delivered close to 1.2 gigawatts and the second quarter, our guidance is 1.2 gigawatts to 1.25 gigawatts and for the whole year we guided a shipment of 5.4 gigawatts to 5.5 gigawatts which means we see more shipments, more megawatt shipments in the second half than the first half. So that speaks about our look into the solar module business. Now the market always switch, always change and we do see the market in the past 10 years with the past 10 years experience we do see market go from one country to another country.

However, Canadian Solar has a diversified market coverage so we do have a balanced sales network. So we think this network will allow us to handle the market fluctuation from one or two particular markets and you also asked me to comment on some of our competitors. Every year we see probably one or two major players either fail or trip and but I think that’s natural for any business and this will only help the industry to consolidate and Canadian Solar has been constantly maintain our position as one of the Tier 1, top three, top four solar module manufacturers and I see myself, Canadian Solar continue to maintain at this position.

And I also want to make a comment that Canadian Solar’s target on the module side is to be a strong Tier 1 player. A strong Tier 1 player means megawatt shipment wise we want to be in the top three, top four, and but we want to have a reasonable profit structure and also have a strong credit and account receivable control. We never aim to be just the number one shipment company in solar, but we aim to be a Tier 1 solar module provider with a combination of strength. I think that’s what separates the winners from the losers.

Colin Rusch:

Great. Thanks and then as you shift your strategy a bit on the project business, can you guys and this is specifically for the finance tem talk about how you are expecting to be able to access capital, the opportunities you are seeing out there for flexible project facilities and then your expectation in terms of managing cost of capital going forward. Your plans for how you do that and support the credit comments that Shawn just made?

Michael Potter:

Hi, Colin it’s Michael. So I have actually been working with Huifeng on a lot of this stuff over the last year or so. Our ability to access the capital markets and project financing is quite strong. We are very well regarded in the banking community as a company that can execute and it is quite reasonable in the projects that we bring them.

We have been able to close innovative financing in Japan for example where we had an asset-backed financing about 1.4% interest for 20 years for a project. In Canada, we were able to leverage our strength as a leading Canadian company and exporter to deliver $100 million of LC capacity that allows us to not tie up cash when we bid for PPAs and make interconnect agreements.

We are able to access local financing in China with strong support over the years from CDB for example, particularly for long-term financing. I think our cost of debt financing has always been better than many other players in the industry and I expect that to continue. The real trick is going to be figuring out how to balance the equity commitments and how we can drive the cost of equity down and we talked about that a few times in our calls for the last year. Obviously a YieldCo would be a nice option if it would work.

But market reality now says we need to focus more on private partnerships and other sources of less expensive equity. There’s lots of indication of people liking to come in and join and partner with us and Huifeng will be kept quite busy closing on a bunch of these deals that are stacking up.

Colin Rusch:

Great. Thanks a lot guys.

Operator:

We have the next question from the line of Philip Shen from Roth Capital Partners. Please ask your question.

Philip Shen:Roth Capital Partners:

Great, thanks. Michael, best of luck with your next steps and Huifeng, we look forward to working with you. In terms of your guidance for the year, it looks like you took it up by about $100 million and that suggests maybe 50 plus megawatts of project sales. What factors may influence your decision to perhaps increase that number and do you see more partial sales or more outright sales ahead and in addition to that, have you identified the buyers and also which geographic locations do you expect to sell down as we get into the back half of the year?

Shawn Qu:

Philip, that’s a good question. We think with the current the project asset price where the market currently talking about, we can make money by selling assets in several countries. For example, our UK assets, China assets and also Japanese assets, we can definitely make money, make margins for those assets and the Our decision based on a few factors, I guess one is to manage the cash flow and managing cash flow means we recycle the capital with the most efficient ways either by ABS, a bond structure or through signing a project. The second will be to manage our revenue and we have this nice asset inventory.

For me that’s a very valuable inventory for us which gives us the flexibility to support our revenue if we see necessary for a certain quarter. So that will be another consideration.

Michael Potter:

One comment I would make on the U.S. market, the pricings look quite reasonable in the U.S. market right now. One advantage we have in selling projects in the U.S. market is with the ITC extension we have over five years of runway to develop and add more projects to our portfolio.

So it’s a market that we can easily execute in and where the financing is quite deep and the market is quite mature in terms of buyers and financing. So that is also a market we are quite good and quite strong in.

Philip Shen:

Great, thanks. Let’s talk about module shipment mix. You guys increased it in the first quarter to 40%-ish. Can you break out the specific volumes shipped to China, India and Japan for example? How do you expect that mix to shift in Q2, and the back half of the year?

Shawn Qu:

I don’t have that number handy at this moment. I can dig it out for you. However, overall in Q1, the number one market in terms of shipment is U.S. And the number two is let me see -- I think number two if I look at megawatts, number two is China and number three is Japan and number four is India and in all of these countries, we shipped more than 150 megawatts. That should give you a rough picture.

Philip Shen:

Great. I will squeeze one more in there. China looks like it was a number two and gaining some of the mix. With the step down of the feed-in tariff on June 30 in China, how do you expect the China shipments to evolve in Q3? And also China recently announced that utilities will be required to generate 15% of their power from renewable energy by 2020 excluding hydro. Do you expect an immediate impact on the demand for solar as a result of this policy? And if not, what do you see as the impact from this policy? Thank you.

Shawn Qu:

That’s a very good question, Philip. We are not giving specific guidance for Q3 and Q4 yet. So let’s wait until that time, wait until August before I give specific guidance numbers for Q3 and Q4. Now your comment on a few factors for the China market. As far as we know, we are expecting the -- to reduce the no, not reduce to publish the quarter for this year and some part of the quarter for this year. I think China this year was divided into a sort of quarter into few categories. One is associated with the project for the poor countryside area.

There was a specific target there and category project assigned for that and to support the poor and underdeveloped area in countries. The talk in the street is that we will probably see those quarters released by-- either this month or next month I hope it is this month. Now you also talked about the new sort of renewable energy portfolio standard requirement indicated by -- we have seen those documents too. I think this document will provide another stimulus to the China’s PV market. Meanwhile we are also watching for the details press about how is it going to be implemented.

Philip Shen:

Okay fair enough. Thank you and I will jump back in the queue.

Operator:

We have the next question from the line of Carter Driscoll from FBR. Please ask your question.

Carter Driscoll:FBR Capital Markets:

Good morning, gentlemen, and congratulations on moving on to your next endeavor, Michael. The first question is you talked about additional projects you are hoping to add by the end of year. Can you talk maybe geographically where you are hoping the composition of that additional project capacity?

Shawn Qu:

I think you are talking about numbers, about new projects COD by the end of this year. For that, in terms of megawatts, the biggest challenge comes from the United States. In total we have seven large projects, a total close to 1.2 gigawatts to be COD in Q3 and Q4. Now we have sold some of the shares and the ownership of those projects.

So our effective ownership in those 1.2 gigawatts will be just over 700 megawatts, somewhere around 700 to 800 megawatts. So that is how much we were up in the US. And then in the UK, we just recently add around 40 megawatts in the first quarter is the catch the rock 1.3 support in the UK and after March 31, the UK support scheme becomes rock 1.2 but 1.2 is still quite economic we can still develop projects with good returns. So we think we will add another at least 50 to 60 megawatts so that for the total year could reach 100 megawatts or even more in UK. Now I do want to mention that the UK’s support cycle for solar is from April to March so maybe some of those projects will be connected before March 31 next year rather than December 31 this year. But for UK, that is considered like a 12-month season.

Another place is Japan. We think we are at 40, 50 megawatts in Japan COD but we are going to NTP a lot of projects. We are going to start construction project in Japan so we should see higher COD number for Japan in 2017 and 2018. Altogether we still have somewhere close to 600 megawatts of projects in our Japanese project pipeline.

And as I mentioned, around 40 megawatts will be COD this year and the balance we hope to COD them, to bring them to commercial operation in the next three years. Of course you know that in Japan, METI is considering another review of solar projects by March 31, 2017. So we are also waiting to see that particular requirement by METI to become to be finalized.

The last region for COD will be China and we look at somewhere around 100, 200 megawatts of CODs, of new projects in China.

Carter Driscoll:

Appreciate that detail. And then just a clarification, I think I heard you in your prepared comments talk about ending 2016 with 6.4 gigawatts of module capacity. I think previous plans are maybe closer to 5.7, 5.8. Can you just comment on that?

And then in the context of certainly some industry discussion maybe there would be some overcapacity in the second half of the year and then just kind of vet that with your strong gets stronger comments and why you feel comfortable. It sounds almost as though your expectations for margins might be higher than people had originally forecast for the back half of the year which I think would give a lot of relief to the street. Thank you.

Shawn Qu:

Thank you. That is an interesting question and I have an interesting answer for you. We added around 500 megawatts of new capacity because there was one building, one factory building just closed, a cell factory which is available for sale. We can get that land and building at a very low cost. We don’t have to spend much money to convert into a module factory. So we think it is perfect.

Logistically, the logistic cost for shipping cell is almost a zero. It is just across the street, 200 meters from our cell factory and the building is perfect. So we like it so we just snapped onto that opportunity.

Meanwhile, although we showed 6.3 gigawatts of module capacity by the end year. But remember we are delivering, shipping and delivering 5.5 gigawatts this year. So even if we don’t grow next year 2017, we will still be 5.5 gigawatts which is very close to 6.3 gigawatts of module capacity.

Now the module machine is relatively inexpensive so adding a little bit capacity to prepare for the high season is good because if you talk about annual production of 5 or 6 gigawatts, you don’t expect the shipments or production to be perfectly even. You will have one month with more orders and one month with less orders. So you do need to have a little bit of extra capacity to handle that and because in the past, we do some module OEMs so if we have extra demand for module for a particular quarter (inaudible) we outflow it to an OEM module assembly factory.

However, that is a cost and we did a calculation that as long as we can make our internal module workshop 70% full, we will be making. We will be making more money by doing it ourselves than farm out and not to mention that doing the modules ourselves will help us to control the quality and also reduce the vendor risk. So that is all the reason. 6.6 gigawatts is not aggressive at all considering our current shipment and considering next year I think it is 6.6 gigawatts is right on and even at 6.6 gigawatts, we might still have to run overtime let’s say a particular high demand month.

Carter Driscoll:

Excellent. I appreciate all of the detail. Thanks. I will get back in the queue.

Shawn Qu:

Thank you.

Operator:

We have the next question form line of Yang Wang. Please ask your question.

Yang Wang:CIC

Thank you for taking my question. First of all, I wanted to ask about your (inaudible). As I noticed you raised your capacity expansion target by 2015 and by about 700 megawatts. I just wanted the consideration behind the risk of the capacity expansion of the module and the second is about module ASPs.

So you mentioned about the higher gross margin due to higher ASP and lower cost. So can you just give a number of ASP and the manufacture cost in 1Q and give guidance in the remainder of the year? Thank you.

Michael Potter:

So the higher ASPs I will address first. Our mix was a little bit more focused on higher ASP countries. We did a little better in Japan than we expected and we did a little better in the US than we expected and we also had some help from currency. The US dollar was weaker towards the end of the quarter and that’s helped push our ASPs up.

In terms of the factory, it wasn’t a lot, it was less than $0.01 different than our expectation. But when your costs are below $0.40 like they are for us now it is certainly easy to get a percent or two better just from a small movement in cost. That was the main driver there. We have said we are going to have our costs at least $0.39 a watt by the end of this year and we haven’t updated that guidance but obviously we are working as hard as we can to beat that. So that’s the information on that.

I think in terms of why we are adding the capacity and the extra increase compared to last time, Shawn just explained to the last caller that recently we had an opportunity to purchase some lands right across the street from our cell factory and if we look at during peak season sometimes we have to use OEMs. Having a little bit of flex capacity of module only is actually economically viable if you want to keep it 70% full. So that is the main reason for the change there.

If for some reason the market is not as strong as we think it might be, we will just postpone adding the module equipment a little bit and wait a little bit longer until the demand is a little firmer.

Yang Wang:

Okay, thank you. Because the module price just go down a bit in the last several weeks so what is your outlook for the module price where the rush order and price in the second half were below us?

Michael Potter:

I’m sorry, but we don’t really talk about the last couple of week trends when we do calls and we don’t focus on the China market as a main market for us. We are in a lot of strong markets across the globe and demand is expected to grow and be strong this year based on what outside forecasters say.
So prices always go down, usually in track with ASPs, with our costs. We are expecting our costs to go down. Our competitors are expecting costs to go down so naturally in the solar industry ASPs tend to follow. So lowering ASPs is normal in what we expect.

Yang Wang:

And then the final question is about your selling and so where are you likely to sell more China assets in the world? What about the gross margin for those sales?

Michael Potter:

You mean sell-in China power plants?

Yang Wang:

Yes. Will you sell more China power plants and what about a gross margin for such sales?

Shawn Qu:

We haven’t sold the China power plant yet so I better not say before I sell it and I don’t want to complicate my negotiations. But meanwhile typically for the China power plant based on our development and EPC costs, we are looking for somewhere around 10% to 15% gross margin. That is our target. But it really depends on the projects.

For example, we have one project where the performances is just exceptionally good. So then you can’t just do a cost plus. It is really an IRR question.

Michael Potter:

I can give you another bit of color about selling projects. We’ve been talking about expected margins in Japan for quite a long time if we did sell any projects and we thought there would be at least as good as the projects in Canada of 20% plus gross margin. But we actually sold a little bit over a megawatt in the form of two small projects in Japan and we were much higher than even our 20% number. So we certainly have good projects in good locations that can generate very good margins for us.

The choice of which to keep and which to sell, it will depend on investor interest and our ability to replace those projects in the future.

Yang Wang:

Okay.

Michael Potter:

So we will go on to the next question operator.

Operator:

Thank you sir. We have the next question from the line of Sven Eenmaa from Stifel. Please ask your question.

Sven Eenmaa:Stifel:

Great. Thanks for taking my question and let me add my best wishes and congratulations here. First, wanted to ask in terms of your plans to recycle capital this year, I understand that some of the thoughts here on how it will be done are evolving still. But what is the kind of ballpark amount of capital you look to recycle this year?

Shawn Qu:

Well I guess we gave a guide and we have mentioned that we plan to sell 100 megawatts worth of projects. $100 million and then we also mentioned that if we choose to sell more than we think, we are budgeting maybe additional $200 million to $400 million that’s in our press release. We did give you some kind of ballpark estimate in our press release.

Michael Potter:

Yes. And if you are conservative and assume that sales are in places like China and the US, we say 10% to 15% gross margin. We will get a bunch of the cash we put in the form of equity. Financing is about 30% equity, 70% debt is a rough rule of thumb.

So when you sell a project you get your equity back and you get your gross margin on top of that. So if you want a rough guide of how much additional cash that could be recycled, that should help you.

Sven Eenmaa:

Got it. Thank you and second question I have is in terms of could you just tell us where do you spend on your blended internal kind of module production cost currently and where would you expect that to trend here in the second half of the year?

Michael Potter:

So the blended module cost if it is purely internal source is slightly below $0.40 per watt right now with purchase sales, it’s a little above $0.40 a watt right now. So it depends if it is purely internal or not. We have less than 50% of our module capacity is supplied by our internal cells. On average, we are pretty close to $0.40 a watt now.

We are expecting that to go as low as $0.39 a watt by the end of the year. Obviously if we can do better, we are going to take the opportunity to come up with a lower price, lower cost. We had said that next year we expect costs to be at least $0.36 a watt so we are expecting more cost downs in 2017 and we haven’t change that guidance.

Sven Eenmaa:

Got it. Thank you.

Operator:

We have the next question from the line of sorry go ahead sir.

Michael Potter:

Yes let’s take that question.

Operator:

Thank you sir. We have the next question from the line of Paul Strigler from… Please ask your question.

Paul Strigler:

Hey guys Congratulations on the solid quarter. Two quick, just housekeeping questions. I think you reported operating cash flow in the press release but can you share CapEx and just the free cash flow for the quarter?

Michael Potter:

Can you ask the second question? I will get you the CapEx number in a second.

Paul Strigler:

Just it captures the CapEx, just the free cash flow in the quarter.

Michael Potter:

We don’t really measure free cash flow. Our CapEx in the first quarter was relatively small if you don’t count the investment into the solar power projects, $60 million.

Paul Strigler:

Great. And then just one question on the US market. Are you shipping from China to the US and paying the tariff or are you using an OEM partner in Vietnam or Thailand? Are US shipments margin accretive or margin dilutive? I know they are ASP accretive but on the margin side, are they helping or hurting margins?

Michael Potter:

We are mainly shipping from China to the U.S. and paying the tariff although we do ship some product from Vietnam using Taiwanese cells and pay a lower tariff. Margins in the US are lower than our corporate average. It’s accretive as in it is positive gross margin but it brings our total margin average down because it is lower than corporate average.

So the more sales we do in the US, the lower our gross margin is as a percent.

Paul Strigler:

Thanks, guys. Congrats on Q1 and the solid guide.

Operator:

As there are no further questions at this time, I would like to hand the call back to your speakers for today.

Michael Potter:

We just want to say thank you to everybody for joining the call. Shawn and Huifeng look forward to taking your calls, your questions and answering them next quarter and if you have any follow-up questions, please contact Ed Job. Thanks, everybody.

Operator:

Thank you sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating you may all disconnect.