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Canadian Solar Inc. (NASDAQ:CSIQ)

Q3 2012 Results Earnings Call

November 15, 2012 8:00 AM ET

Executives

David Pasquale - Global IR Partners

Dr. Shawn Qu - Chairman and CEO

Michael G. Potter - Senior Vice President and CFO

Ed Job - Director, Investor Relations

Analysts

Kelly Dougherty - Macquarie

Sanjay Shrestha - Lazard Capital Market

Shawn Lockman - Piper Jaffray

Mark Bachman - Avian Securities

Brandon Heiken - Credit Suisse

Operator

Good day, ladies and gentlemen. And welcome to the Canadian Solar Third Quarter 2012 Earnings Conference Call. My name is [Dapa], and I’m your operator for today. At this time, all participants are in listen-only. We’ll conduct a question-and-answer session towards the end of the conference. (Operator Instructions)

As a reminder, this call is being recorded for replay purposes and will be ready one hour after the conclusion of this conference call. The telephone number to dial is 1-888-286-8010, and the passcode to use is 83917942.

I would now like to turn the call over to Mr. David Pasquale of Global IR Partners. Please proceed.

David Pasquale

Thank you, Operator. Welcome everyone to Canadian Solar's third quarter 2012 earnings conference call. With us today from the company are Dr. Shawn Qu, Chairman and Chief Executive Officer; Mr. Michael G. Potter, Senior Vice President and Chief Financial Officer; and Mr. Ed Job, Director of Investor Relations.

Before we begin the call, please be advised that management's prepared remarks and responses to your questions during this call may contain forward-looking statements that involve a number of risks and uncertainties that could cause actual results to differ materially from expectations implied by these forward-looking statements. These forward-looking statements are made under Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995.

You should not place undue reliance on forward-looking statements and we encourage you to review a more detailed discussion of the risks and uncertainties contained in the earnings press release issued earlier today and in the company's annual report on Form 20-F with the Securities and Exchange Commission.

All information provided on this call is as of today's date, unless otherwise stated and Canadian Solar undertakes no duty to update such information except as required under applicable law.

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

Dr. Shawn Qu

Thank you, David, and thank you, all, for joining us on the call today. During the third quarter, both the solar industry, competitive environment and the micro economic background remain challenging. At 384 megawatt our shipment came in close to our expectations, while gross margins came within the range of our guidance.

Other than expected demand in Europe and strength in emerging market were offset by slow sales in North America. Despite the difficult environment we continue to execute well on all the key elements of our strategy.

Our approach differentiates us and gives us a strong platform for future growth and expansion. Our focus remains on expanding our total solutions business and enhancing our product offerings to protect and enhance our margin.

We are also focused on increasing our market share in a right market to gain scale, reduce our total cost of production and ownership, and ensure our customers have access to the high reliability, high performance product for which we are known world-wide.

In the third quarter, we continued to consolidate our position among the top three or four larger suppliers globally, making Canadian Solar the partner of choice across all major geographic.

On the manufacturing front, we further reduced our all-in module manufacturing costs to $0.64 per watt, down from $0.67 per watt in the second quarter. In addition to benefiting from lower poly and wafer costs, we were also able to reduce cell and module processing costs. We remained on track to achieve our goal of all-in module manufacturing costs in a range of $0.55 to $0.60 per watt by the end of 2012.

Clearly, our progress in this area reinforces our position as one of the lowest costs module suppliers in the world. Our achievements on cost reduction, together with our continue improvement in solar module efficiency positions us to be competitive and gain additional market share in the quarter’s ahead.

Let me now give you an update of our total solutions business, we continue to make impressive gains in expansion of this business. During the third quarter, we completed the sales of our utility-scale PV power plant to Stonepeak Infrastructure Partners for approximately US$48 million.

In past a few weeks we also completed construction on two more projects, previously sold to TransCanada and often noted to proceed for six out of the seven remaining projects which we have also agreed to sale to TransCanada after completion.

In addition, we submitted 16 projects acquired from SkyPower Ltd for renewable energy approval. Our pipeline of late stage project in the U.S. that we announced last quarter has expanded to approximately 243 megawatt DC.

Geographically, the majority of our current projects are in Canada and U.S., but we also have projects in various development stages in Japan, China, South East Asia and Europe.

In China, we have approval for over 60 megawatts of so called Golden Sun projects and we have closed to 100 megawatt of ground-mounted projects in various stages of approval process. Like all of our projects, we are seeking committed end buyers before starting construction.

Our total solution business remains a competitive advantage and is a major point of differentiation for Canadian Solar. We believe this will drive both of our long-term success and improved profitability.

We estimate that we will generate approximately 13% of our revenue from our total solution business segment in 2012 and over 50% in 2013. This will allow Canadian Solar to transform itself from a pure module manufacturer to PV total solution provider.

Another core focus for us is on R&D front. We are proud of Canadian Solar's rich history in innovation. We have led the market with numerous efficiency improvements and product introductions. As an example, we continue to enhance of our ELPS Solar cell technology.

And in the last, we have achieved sales conversion efficiency of up to 18.8% for polycrystalline cells and 21.1% for monocrystalline cells. This translates to modules efficiency of up to 17.4% and power output of up to 280 watt on a 6-inch 60-cell module.

We have been commercially producing our ELPS high-efficiency PV modules since last fall and have delivered 13.6 megawatt to customers in Europe, Japan, U.S. and China. We will convert more of our existing cell lines to ELPS.

We are also working very closely with our technology partners to design, test and optimize of our new AC modules, targeted at residential market. Our AC modules stand out because they combine module with microinverter under our industry-leading warranty, backed by an insurance policy underwritten by investment-grade insurance companies from the U.S. and Europe. We are in testing and certification phase and expect to do our full launch shortly.

Now, let me comment on our guidance for Q4 and full year 2012. We expect Q4 shipments will be in a range of approximately 380 to 420 megawatt. Gross margin are expected to be in the range of 1% to 3%.

We expect that we will continue to execute our cost on roadmap and bring our blended module costs to reach $0.55 to $0.60 per watt before the end of year. For the full year 2012, we update our guidance for shipments to approximately 1.5 to 1.6 gigawatt.

This concludes my formal business update. And now, I will turn the call to Michael Potter, our CFO. Michael, please go ahead.

Michael G. Potter

Thank you, Shawn. I’ll review a few points before opening the call to Q&A. Please refer to our press release for additional details.

Net revenue for the third quarter of 2012 was $326 million, down 6.4% sequentially and down 34.8% compared to the year ago period. Gross profit in Q3 was $7.3 million, compared to $43.2 million in Q2 and $11.9 million in the comparable period of last year.

Gross margin in Q3 was 2.2%, compared to 12.4% in Q2 and 2.4% in the third quarter of [2001]. The sequential increase in gross margin was driven by lower shipment volumes, as well as lower ASPs, only partially offset by lower manufacturing cost.

Also in the second quarter of 2012, we recorded a one-time adjustment equivalent to 4% of revenue that resulted from the recognition of the benefit from our purchase warranty insurance.

The year-over-year decline in gross profit and margin was primarily due to the sustained decline in average selling prices over the past several quarters, which is only partially offset by a lower manufacturing cost.

Also in the third quarter of 2012, we recorded an additional charge of approximately $2.1 million, representing 0.65% of revenue to reflect the higher countervailing duty on our products imposed by the U.S. Department of Commerce in its final trade investigation determination. This was from earlier this year before we switched fully to non-Chinese cells for our shipment to the U.S.

Operating expenses were $41.8 million in Q3, compared to $46.2 million in Q2 and $42.6 million in Q3 of 2011. The sequential decline in operating expenses was primarily driven by lower shipping costs on the back of lower shipping volume and unit costs.

We also have lower administrative expenses, as a result of a reversal in a previously recorded bad debt reserve. The year-over-year decline in operating expenses was driven by lower research and development expenses, partially offset by higher selling, general and administrative expenses.

Interest expense in the third quarter of 2012 was $15.2 million, compared to $15.1 million in the second quarter of 2012 and $10.8 million in the third quarter of 2011. In Q3, we recorded a loss in the change of fair value of derivatives of $5.3 million, compared to a loss of $1.1 million in Q2 and a gain of $14.5 million in Q3 of 2001.

Net foreign exchange gain in Q3 was $7 million, compared to a net foreign exchange loss of $7.2 million in Q2 and a net loss of $23.9 million in Q3 of 2001.

Income tax benefit in the third quarter of 2012 was $1.8 million, compared to an income tax expense of $2.1 million in the second quarter of 2012, and an income tax benefit of $3.4 million in the third quarter of 2011.

We considered that some portion of the deferred tax assets related to current year operating loss is in our Chinese manufacturing operations would not be fully realized based on our current forecast. Therefore, we recorded approximately $4.4 million in an income tax charge as a result of including the valuation loss allowance in the annual estimated tax expenses in the third quarter of 2012.

Net loss attributable to Canadian Solar’s shareholders for Q3 2012 was $43.7 million or $1.01 per diluted share, compared to a net loss of $25.5 million or $0.59 per diluted share in Q2 2012, and a net loss of $43.9 million or $1.02 per diluted share in Q3 of last year.

Moving on to the balance sheet. In Q3, cash and cash equivalents decreased to $319 million on September 30, 2012 from $330 million at the end of Q2. The restricted cash balance was $371.9 million at the end of Q3, up from $362.5 million at the end of Q2. The increase primarily resulted from additional cash collateral for bank borrowings.

Our accounts receivable balance, net of allowances for doubtful accounts declined to $257.8 million at the end of Q3 from $262.2 million at the end of Q2. Inventory decreased to $317.8 million at the end of Q3, compared to $343.8 million at the end of Q2. Inventories remain a focus area for the company and we hope to continue to make progress in this area.

Short-term borrowings at the end of the third quarter of 2012 totaled $890.6 million, compared to $927.7 million at the end of the second quarter of 2012. Long-term debt at the end of the third quarter 2012 was $224.2 million, compared to a $136.3 million at the end of the third quarter of 2012.

Let me now take a minute to update you on our project business. Our EPC and solar system kits business represented about 21.5% of total revenue in 2012. Because of the expected recognition of the first two TransCanada projects in Q1 2013, we do not expect this to reach 25% of revenue in 2012. But continued to believe it will be at least 50% of revenue in 2013.

Let me now discuss our Canadian project business in more detail. In Q3, we completed the sale to Stonepeak Infrastructure Partners of a utility-scale solar power plant for approximately $48.4 million.

We also recently finished construction of two projects, Brockville 1 and William Rutley, totaling 20 megawatts AC, which was previously announced we agreed to sell to TransCanada.

Final payment and revenue recognition for these two projects will be determined by the completion of acceptance testing, which is currently underway. We currently expect payment and revenue recognitions on these two projects to split into Q1 of 2013, though it is possible, but unlikely that one may be recognized in Q4 of 2012.

We have received renewable energy approval or REA, and are currently constructing or will start construction soon on six of the seven remaining Canadian Solar owned projects that we have previously agreed to sell to TransCanada. These six projects are targeted for commercial operations to start in Q2 to Q3 of 2013. And we expect them to generate over $300 million of revenue for Canadian Solar.

In general, we recognize revenue, approximately one quarter after commencement of commercial operations for these projects under the completed contract method. As previously announced, we’ve also entered into an EPC and O&M agreement with Penn Energy to build and operate three utility-scale projects totaling 28.7 megawatts. These projects are expected to enter into commercial operation between July and September of 2013. These will be recognized on a percentage of completion basis.

Additionally, we have now submitted all 16 of the former SkyPower projects for REA approval. The first REA approvals for this group of projects are expected in Q1 of 2013. As we previously indicated, these 16 projects are expected to generate over $800 million in revenue for Canadian Solar over the next 18 to 24 months. We are very advanced in the process of select and buyers for these projects, and expect to be able to announce something soon. There has been very high demand for these projects.

For the owned projects we sold to TransCanada, we will be using the completed contract methods to recognize revenue. Typical revenue recognition will be in the quarter after we finished construction.

Normally, we recognize revenue on projects that we do not own, but are providing EPC services for, on a percentage of completion basis and in the future, we expect the structure of sales contract to allow recognition of revenue on a percentage of completion basis for all of our own projects. This would include the SkyPower projects currently in the REA process.

Clearly, our Canadian project business is building momentum and we expect it to be highly accretive to our results in 2013. We believe that we have a strong position in Ontario and each project we complete builds on our lead, as the most experienced and dependable developer in Ontario to take a project from the development stage to full operation.

Turning to our U.S. projects business. We previously announced the acquisition of a 140 megawatt utility-scale project pipeline in the U.S. This has now grown to over 240 megawatts of projects we either own or have a significant investment in.

Currently, we expect up to 5 megawatts to be built and recognized in the fourth quarter of 2012, including our recently announced 2.5 megawatts PV solar power plant in Laurinburg, North Carolina. In 2013, we expect the U.S. projects business to ramp up rapidly with construction of up to 130 megawatts during the year.

In summary, we continued to successfully execute on our business strategy. We are in a great position to build on our momentum and our clearly differentiated business model.

With that, I’d like to now open the call to questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question comes from the line of Kelly Dougherty from Macquarie. Please go ahead.

Kelly Dougherty - Macquarie

Hi, guys. Thanks for taking the question. Just a quick housekeeping one to start. You mentioned in 3Q that projects were 21.1 megawatts. Can you tell how much of the revenue came from the project business during the quarter?

Michael G. Potter

I believe it was 21.5…

Dr. Shawn Qu

Total Solution.

Michael G. Potter

… total solutions, that includes the $48.4 million from the one project we sold. The remainder would be from kits or other systems business.

Kelly Dougherty - Macquarie

The $48.5 million is the revenue.

Michael G. Potter

$48.4 million is the revenue from the project we sold to Stonepeak -- Stonepeak Infrastructure Partners in Canada.

Kelly Dougherty - Macquarie

And then how much would the kits relate to?

Michael G. Potter

It would be the remainder of the revenue for the quarter, for total solutions.

Kelly Dougherty - Macquarie

Okay. And did you disclose that number?

Michael G. Potter

We disclosed the total percent from the business and we disclosed the amount we sold the project for.

Kelly Dougherty - Macquarie

Okay. Great. Thanks. And then how much of the change in the full year guidance relates to, maybe some of these projects slipping into next year versus just general weak demand on the module side of things?

Michael G. Potter

So the two projects that slipped from Q4 into Q1 are May slip. There is still a chance that one of them, we’ll recognize in Q4, would have been maybe 25 megawatts of total modules. So in terms of the overall megawatt guidance, it’s more of the reflection of the business environment that we are in right now.

Kelly Dougherty - Macquarie

And is that you saying, hey, we don’t want to sell these modules at these prices or is it just overall demand? I mean, can you kind of give us some insight into kind of demand versus pricing that you are seeing right now?

Michael G. Potter

We could sell a lot more models today, if we are willing to sell at a loss. But obviously that’s not something that we are willing to do.

Kelly Dougherty - Macquarie

And then, maybe can you help us think about what's going on with the gross margin for the fourth quarter, remaining where it is and maybe for the third quarter give us a breakdown between ASP under utilization, things like that, if you kind of walk us through what happened in the third quarter? And then, how you are getting to that 1% to 3% for the fourth quarter, that would be great?

Michael G. Potter

So our utilization is going to be last, particularly towards the end of the quarter. We’ve started seeing slowness compared to forecasting Q2. If remember, we started talking about pulling back on production and trying to control inventory from both the middle of Q2.

We’ll continue that into Q4. So our utilization in our cell factory, for example, will be between 50% to 60% towards the end of the quarter. Our module factory is a little bit fuller than that, because we do purchase some modules, some cells from outside just what we make.

In terms of the total Q4 and the margin, the main driver is the fact that costs are continuing to come down and the ASPs are coming down as well. Because ASPs come down, whatever we have in inventory at the end of Q3 is going to continue to negatively impact our margins in Q4.

In addition, the costs are coming down but not quite as fast, as the ASPs have been coming down in the last couple of quarters and that’s pressuring margins.

Kelly Dougherty - Macquarie

Can you give us a -- just last one from me? Can you just give us any kind of magnitude of the ASP pressure you saw in the third quarter and then, maybe what you are expecting for the fourth quarter?

Michael G. Potter

I think it wasn’t terribly severe in the third quarter. Although, there was a continued decline in ASPs, we expect little bit more severe ASP decline once you get into the ends of Q4.

There will be a time period in which you won’t be at a ship in recognized revenue for places outside China. So most of the revenue you get towards the end of the year will be in a much closer markets and ASPs are lower there.

Kelly Dougherty - Macquarie

Great. Thanks very much guys.

Operator

Thank you. And your next question comes from Sanjay Shrestha of Lazard Capital Market. Please go ahead.

Sanjay Shrestha - Lazard Capital Market

Great. Thank you. Few questions guys. So when you talk about $400 million in revenue from the systems business in 2013. Can you remind us all as to what kind of profit opportunity that will likely be associated with that and therefore buffer you guys from this irrational behavior in the direct module sales business?

Michael G. Potter

Well, that $400 million -- it is $300 million for one set of projects which is the TransCanada project, the six TransCanada project and $800 odd million from the SkyPower projects spread over the next 18 months.

I have said for the Canadian pipeline in total, it will be over 20% gross margins and the TransCanada project we’ve said, we expect those to be over 25% gross margin. We also have always said over $300 and over $800 million. We expect better than those numbers and when we have the final contracts for the SkyPower projects, we’ll have a much better idea what those numbers will be.

So at least 25% -- 20% gross margin in total for the Canadian pipeline and over 25% for the TransCanada one.

Sanjay Shrestha - Lazard Capital Market

Got it. So one of the comments, good to hear from you guys that you don’t want to kind of get too involved with this pricing where it’s not below cost and getting pretty irrational. So can you elaborate on that a bit more for us as to what you’re guys seeing from the capacity standpoint in China?

Is it largely happening because we’re seeing a phase of an inventory liquidation right now and it’s really not coming from newer guys trying to get into the market. So that whole install base in China, how much of that is being shutdown. Any color you guys could share with us on that?

Dr. Shawn Qu

Yeah. This is Shawn speaking.

Sanjay Shrestha - Lazard Capital Market

Hello, Shawn. How are you?

Dr. Shawn Qu

Yeah. Pretty good. And as far as I can see, for example, in October and November, we have been running our module shops at full capacity and actually over capacity. And our workshop as Michael mentioned, we have a little bit lower utility rate and utilization rate because we are buying some third-party sales.

Sanjay Shrestha - Lazard Capital Market

Of course.

Dr. Shawn Qu

And as far as I know, our utilization rate especially for the module factory is among the highest -- among the tier one module producers. And for the tier 2 and tier 3 module producers, I believe most of them have their capacity idled already.

Sanjay Shrestha - Lazard Capital Market

Got it. Okay. That’s very helpful. One final question. So there is a lot of chatter about sort of about some type of the consolidation in Asia and how do you potentially and maybe it’s premature but if there is anything you guys could share with us as to potential outlook for demand in China, now in light of the new leadership and things along those lines. Is there anything we could expect here over the next three to six months of massive silver subsidy or any talks about that?

Dr. Shawn Qu

Now, first of all on the consolidation of the manufacturers, I do see a consolidation happen. On the right hand, yeah, the local government sometimes try to save those companies in order to save jobs.

Sanjay Shrestha - Lazard Capital Market

That’s right.

Dr. Shawn Qu

But on other hand, the [Mctivemue] itself make -- have already made the customers fly away. So we’re seeing many customer who used to be the customer of other companies came to us just because the [Mctivemue] of -- for some other manufacturers.

Now, turning to the question of China policy for photovoltaic, we do see a lot of movement these days. And as you know, the Chinese Premier Wen have given several instructions to the utility of the companies to open up the China’s PV market because the government has seen that, first of all, China has a very high production capacity but very small application market and you do want to change the situation.

And second, the price of solar has come down so much so that implementing Solar become more viable options to balance its energy mix. So for example, about two weeks ago, the China State Grid announced a new connection policy and the grid will now provide a free connection to PV Systems.

They also set up the new rule so that the PV systems can be connect -- rooftop PV Systems can be connected to the low power -- the low voltage side rather than have to connect with high voltage side. That helps the distributed generation a lot. And also the State Energy Bureau recently released a plan to develop 500 megawatt distributed like PV Diamond program for province now add up to 15 gigawatt. So that application process is going on right now.

All this demonstrate the positive movement to the put to the positive side. However, the industry is still waiting for the policy to be like fully announced and coordinating. For example, industry steel waiting for the feed-in tariff for the distributed generation. And as far as we know, the experts in Beijing, the government have called in the expert group to discuss those feed-in impact levels. There’s a lot of discussions and consolation meeting going on.

Sanjay Shrestha - Lazard Capital Market

Yeah.

Dr. Shawn Qu

I’ll call you and give you the timeline but I expect with the leadership transition now completed, that we should see the further advance on the PV policies in the near future.

Sanjay Shrestha - Lazard Capital Market

Got it Shawn.

Michael G. Potter

But in reference to what we’re doing about the market with that backdrop is that this is a time to build alliances and to get projects in the pipeline for approval. But they aren’t necessarily to go forth and spend a lot of money building the projects. Because there is certainly a finding in end buyer and getting paid in a reasonable timeframe, it’s not there yet.

So we’re applying the same rules. In China, we’ve applied, in every new market, we’ve gone into and it’s not much different than most emerging markets when the solar market first turns on. There is a period of time in which the local banks and the end-buyers become coordinated and understand how the system works. And till that happens, it’s better to be cautious than to spend a lot of money and hope to get paid.

Dr. Shawn Qu

And I’ll carry on what Michael has just said. Our advantage is that we already started our entry into the project business back in 2006. So we have built strong pipelines in Canada, in U.S. and also start to build strong pipelines in Japan. And those are mature markets, where the projects were sellable. So that will give us strong project business in the next two years. And I believe with two-year timeframe, we will see China’s markets getting matured.

Sanjay Shrestha - Lazard Capital Market

Got it. One final question. I’m actually sorry, if I can actually put one more in. So you guys have obviously done a very good job and select few others into managing cash in this, sort of, the unprecedented sector downturn. But there is a lot of players, larger ones who are arguably considered tier 1 sitting on a lot of -- with a lot of debt on the balance sheet in China. Do you envision a scenario where there will actually be some high profile bankruptcy there or given that this is more about jobs that it continue to get support on -- under the prudential level?

Michael G. Potter

Yeah. That’s a very interesting question. And I don’t want to be the fortune teller. And but as I commented to a last question, whether those companies goes through a major like bankruptcy process, just being idled, it doesn’t really -- it doesn’t matter so much because the [Mctivemue] and the fact that those company carry out very weak balance sheet already made their customers file away from them. So I see a natural consolidation and process already happen.

Sanjay Shrestha - Lazard Capital Market

That’s terrific. Thank you so much guys.

Operator

Thank you. And your next question comes from the line of Ahmar Zaman from Piper Jaffray. Please go ahead.

Shawn Lockman - Piper Jaffray

Hi. Good morning. Good evening. This is Shawn on for Ahmar. I was wondering if you could walk us through just sort of your different cost as related to your COGS, your wafer cell module, poly costs for the quarter and your outlook going ahead forward?

Dr. Shawn Qu

Hi. This is Shawn. First of all, we buy very little poly because we have business model that we focus on down stream. We call it reverse parallel models. So we have more module capacity than cell and more cell capacity than the wafer. So that gave us, let us to have a light asset and therefore better balance sheet.

Because of this reason, we buy only smaller amount of polys and through Q3, I see the poly price below $20 and because we don’t have those long-term contracts which made the situation of some of the competitors worse. In our case, we have decided -- we have insisted not to sign the poly long-term contract for the past few years so that right now, we enjoy the market price.

Move into Q4, we see the poly price further come down. We have seen a fewer situation that poly price go down to somewhere around $16, $17 and that’s for poly. And for the sell through like wafer to cell conversion cost, the industry -- the leading, let say, the figure for the leading players is around $0.17 to $0.16 per watt. That’s what you will see from tier 1 in China and Taiwan.

And for module -- sale for module conversion cost, typically in Q3, typically you’ll see somewhere around $0.22 to $0.25 and so add up together, you arrive being a total all-in module cost just below $0.60 for the tier 1 but in our case as Michael mentioned, we have some inventories, we brought in from Q2. Therefore our blended all-in manufacturing cost for Q3 is about $0.64.

Shawn Lockman - Piper Jaffray

Great. And can you talk a little bit about, you talked earlier in your prepared remarks about getting cost down to as low as $0.55 but end of the year, can you talk a little bit about the leverage you’re going to have to pull to get those cost down that low and what -- how likely that is you’ll be able to do that?

Dr. Shawn Qu

Actually, the answer is simple. The wafer cost, the wafer price in the market these days is already below $0.20, which is market price in Taiwan and China. And there as I said, the cell conversion cost is about $0.13 to $0.16 and the cell to module conversion cost is the below $0.20. So you add them together, you will get just below $0.60.

Shawn Lockman - Piper Jaffray

Great. And just one final one, can you talk a little bit about, you had some commentary that U.S. was little slow for you in 3Q. Can you talk about what you’re seeing in U.S. market so far fourth quarter and why 3Q was slow for you guys and then as well, talk about what you see in U.S., I guess, North America market as well for 2013?

Dr. Shawn Qu

Yeah. That’s a very good question. My observation is that the market in U.S. is still going. They’re just slower than we expected and the reason could be and as I said could be, number one, the customers are waiting for rulings on the trade tariff therefore there is a waiting mode. The market is in waiting mode because the players don’t know how the ruling will affect the market, the module market in U.S.

And the second factor, I think we think if the end of the 1603 Safe Harbor module, the incentive the end of last year and therefore the market is looking for new ways to finance the solar installations. People are turning more into the commission of ITC, the investment tax credit method and that will take a little while to get mature. So, that’s our observation.

Shawn Lockman - Piper Jaffray

Great. Thank you very much.

Dr. Shawn Qu

Thank you.

Operator

Thank you. And the next question comes from the line of Mark Bachman from Avian Securities. Please go ahead.

Mark Bachman - Avian Securities

Hi, gentlemen. Thanks for taking my call. Michael can you just go back over your Q4 margin in guidance. I would expect in something more in the double-digit, is that just a direct result of those project then pushing out in the Q1?

Michael G. Potter

I would have had two projects as at least $50 million each at over 25% gross margin. So, that’s the major impact for us. The rest of it is most of the factors that impacted on our Q1, So, Q3 gross margins, which is lower ASPs inventory being carried from Q3 into Q4, so even though our costs are coming down we don’t get the full benefit of it and promise of inventory reserves at the end of the quarter.

Mark Bachman - Avian Securities

Okay. Shawn, last quarter in mid-August you were very confident that here in order book or something like over 600 megawatts for the shipment headed into Q4 that number is being cut by the third here. What change that eroded that confident be able to ship that much in Q4?

Dr. Shawn Qu

Well, there were two reasons. First of all the summer, the August and September, the market was a little bit slow, little bit slower than what we thought. So we do see some customers waiting and so some shipment got delayed a little bit. And also we did ship a lot of product but due to our conservative sales recognition policy there are some shipment, which we order ship in Q3, but we only recognize sales in Q4.

Michael G. Potter

And I think the final thing was is that some of the sales we expected to get in Q4 that we had orders for indication from customers, the pricing is move to a point where it’s not really something we want to chase after. So we’re willing to let other people take the shipments at the price points, which we don’t think are profitable.

Mark Bachman - Avian Securities

I guess, Michael but you answered a previous ASP question and said that ASP erosion wasn’t that bad in Q3. So you are saying just massive ASP erosion than in the Q4 that made those kind of sales not attractive anymore?

Michael G. Potter

There is some markets where the ASPs are lower than other markets. So, we are selective on who we sell to. So our ASPs went down but I wouldn’t call it a massive erosion in Q3. But if we chase every available shipment possibility, no matter what the price you will see a lot different ASP in the churn.

Mark Bachman - Avian Securities

Okay. Question on kit sales in the Japan, how do this -- are they profitable for you and how do they compare to your overall corporate performance?

Dr. Shawn Qu

Yeah. This is Shawn. The kit sale into Japan has been and continued to be very profitable. We are enter the Japan market in 2006 -- no, 2009. We start to see significant sales in 2010. And this year we’ll have seeing our shipment level going up quarter-by-quarter and we still maintain a pretty reasonable profit margin.

And as a matter of fact, if I read the profit margin all key markets, Canada and Japan will rank it first and then the European market and maybe Australia market and then the U.S. market and the lowest margin market will be China, India and Thailand.

Mark Bachman - Avian Securities

Okay. Thank you for that. How do we think about third-party sales, you mentioned a couple of times that that you are happened to buy a sales from outside of China. On the average, how many megawatts you are buying per quarter and how much of that is actually headed into the U.S.?

Michael G. Potter

Pretty much. Everything we shipped into the U.S., we use non-Chinese cells. We buy Chinese third-party cells for shipments to other places in the world or we manufactures cells ourselves. It depends on exactly what type of cell is needed and quite honestly what the prices are in the marketplace. There has been some cases recently where the pricing has been attractive and after that it’s better to buy itself from the market then to make it and when that occurs we do that.

Dr. Shawn Qu

This is Shawn. More comment here, we do make a document call between self producing the sales and purchase. For Q4, for example, we have guided the total shipment of close to 400 megawatt and our internal sales will probably be around, somewhere around 250 megawatt. So, I would say over 100 megawatt third-party sales. Some of those are Thailand cells which we’ll use to satisfy our U.S. customers and some mainly because in today’s market somehow.

In some cases, the third-party sales, it’s even cheaper thought what we can make ourselves. And in that case, we do all decision yeah to purchase more because that help us to lower our cost and also conserve all cash.

Mark Bachman - Avian Securities

Okay. Just last question for me when do you expect to give a view into 2013?

Dr. Shawn Qu

Initially, we gave the 2013 guidance in our Q4 earning call. At that time, we also announced the unaudited pro forma 2012 annual numbers. So, I will expect it to be somewhere in March.

Michael G. Potter

And we did try and give a lot more guidance about the project business going into next year because it’s going to be such a big driver so that’s why we talk about 2013 project stuff so much in this call because 2013 is only a month and half away.

Mark Bachman - Avian Securities

Right. I was just like can you give us any tidbits on how you think the market gross next year in other words, where you think installations are in a worldwide basis right now. It’s sounds like you think you are taking a little bit of a share here but where do you think that the market growth for next year?

Dr. Shawn Qu

Yeah. This is Shawn. No, this is very -- again a very interesting question. We do see the global market side measured by gigawatt either remained the same or have a small growth from 2012. And in terms of the high growth market, we see China as high growth market, also Japan and Canada will also see a high growth. But Canadian market itself is small and by gigawatt it’s small.

And we also see reasonable growth in U.S. now but at the same time, German number will probably go down, because German have announced their new policy which will reduced the feeding tower month-by-month if the installation level is higher than what government expected. And so, that’s our overall biding for 2013. And as I said in answer to the previous question, usually in March we will provide our guidance for -- more concrete guidance for 2013.

Mark Bachman - Avian Securities

Excellent. Thank you so much, gentlemen.

Operator

Thank you. The next question comes from the line of Satya Kumar of Credit Suisse. Please go ahead.

Brandon Heiken - Credit Suisse

Hi. This is Brandon Heiken speaking on behalf of Satya Kumar. Thanks for taking the question guys. I noticed in the press release you mentioned geographical mix for overall business but I was wondering for the third-party module business, what would be the approximate geographical mix of shipment in 2012 and what do you think would be in 2013?

Michael G. Potter

I’m not sure. You mean third-party cell?

Brandon Heiken - Credit Suisse

Modules.

Dr. Shawn Qu

Module.

Brandon Heiken - Credit Suisse

Module business, yeah, exactly.

Dr. Shawn Qu

You say third-party module?

Brandon Heiken - Credit Suisse

I’m not exactly sure what you mean by module as opposed to systems -- excluding systems.

Michael G. Potter

Shipments in excluding projects -- excluding kits, excluding project.

Dr. Shawn Qu

You mean the project, the shipment fuel module cell?

Brandon Heiken - Credit Suisse

Yeah.

Dr. Shawn Qu

Excluding the project, right?

Brandon Heiken - Credit Suisse

Correct. Yeah. Thank you.

Dr. Shawn Qu

All right. Most of the project total solution cells happen in Canada and Japan, all other places mainly third-party module sales.

Brandon Heiken - Credit Suisse

Okay. Do you have any idea of what that geographical mix might be then?

Michael G. Potter

I think if you take the numbers on our press release, we don’t have it directly in front of us. But there is under 50 megawatts of shipments of actual modules in Canada and I will get the number for Japan in a second.

Dr. Shawn Qu

Brandon, I will take it up with you offline this then.

Brandon Heiken - Credit Suisse

Okay.

Dr. Shawn Qu

But the rest of it really coming from Japan. So the two of them would be the total solution shipments and then that would just, all the rest of the shipments will be pretty much the same. Like Europe, we normally have total solution whatever numbers in the press release is the European number for example.

Satya Kumar - Credit Suisse

Okay. Are you guys seeing any impact with European customers at this time due to the initiation of the investigation there?

Dr. Shawn Qu

No. We don’t see any impact. Because the European trade investigation process will be a 15 men’s process and so this moment is business as usual.

Satya Kumar - Credit Suisse

Great. Thank you.

Michael G. Potter

Thank you.

Operator

Thank you. Sir, you have no questions at this time. (Operator Instructions) I would now like to call -- turn the call over to management for closing remarks.

Dr. Shawn Qu

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

Operator

Thank you for joining today’s conference. This concludes the presentation. You may now disconnect and good day.

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