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SunEdison (NYSE:SUNE)

Q2 2013 Earnings Call

August 07, 2013 8:00 am ET

Executives

Chris Chaney - Director of Investor Relations

Ahmad R. Chatila - Chief Executive Officer, President and Director

Brian Wuebbels - Chief Financial Officer and Executive Vice President

Analysts

Brandon Heiken - Crédit Suisse AG, Research Division

Vishal Shah - Deutsche Bank AG, Research Division

Brian K. Lee - Goldman Sachs Group Inc., Research Division

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Shahriar Pourreza - Citigroup Inc, Research Division

Stephen Chin - UBS Investment Bank, Research Division

Krish Sankar - BofA Merrill Lynch, Research Division

Operator

Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the SunEdison Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Director of Investor Relations, Mr. Chris Chaney. Please go ahead.

Chris Chaney

Good morning, and thank you for joining SunEdison's Second Quarter 2013 Results Conference Call. I am Chris Chaney, Director of Investor Relations. With me today are Ahmad Chatila, President and Chief Executive Officer; and Brian Wuebbels, Chief Financial Officer.

After my remarks, Ahmad will provide an overview of the significant events and commentary on the company's second quarter performance, and Brian will then review the financial results. Brian's discussion will reference slides that we have made available in the Investor Relations section of our website at www.sunedison.com.

Our discussion today will refer to certain non-GAAP financial measures. A reconciliation of these non-GAAP measures has been provided in our earnings press release financials published earlier this morning.

Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statement contained in the earnings release and the slides published today for a more complete description.

And now I'll turn the call over to Ahmad.

Ahmad R. Chatila

Thanks, Chris. Good morning, everyone. I'll make a few brief remarks and then, turn it over to Brian to review the quarter in more detail. The second quarter was generally in line with our expectations and the targets we laid out last quarter.

In our Semiconductor business, we again grew sales during the quarter, as well as profits and cash flow. I'm very pleased with our Semiconductor team and with their systematic efforts to drive continuous improvement. The team has done an outstanding job in a very difficult market. They have made the most of an extended downturn, being meticulous in identifying and exploiting opportunities for efficiency and cost improvements that will continue to benefit us going forward. For example, lean implementation and other manufacturing efficiency improvement at multiple plants helped enable the business to ship record volume in the second quarter and drive growth.

As we look at the second half, visibility has diminished to some degree, with demand not firming up across all segments as expected. To mitigate pricing pressure, we will continue our aggressive focus on cost reduction.

Turning to our Solar Energy business. Earlier this year, we indicated that the first and second quarters would be relatively weak. This was an artifact of our modest development spend in the first half of last year. This played out as expected. We also indicated that the second half of 2013 would constitute a strong ramp that would continue into 2014. Our view has not changed.

Projects under construction increased in Q2, and we added significantly more at the outset of Q3. During the second quarter, we grew our project pipeline by more than 200 megawatts to 2.9 gigawatts, and grew our backlog by more than 100 megawatts to 1 gigawatt. We continue to have a robust growth engine and maintain good diversity in our pipeline, both in terms of geography and project size.

Last quarter, I alluded to a few of the actions we are taking in the Solar business that we expected to have an increasing beneficial impact. One of them has been to enhance our business development efforts and ensure that we have a team dedicated to evaluating late-stage projects and partnerships to improve the size and quality of our pipeline and backlog and complement our organic growth engine.

Among other achievements, the team has recently closed 3 development-stage acquisitions in U.S. utility and DG that will benefit 2014, nearly all our late-stage projects were PPAs.

Another action I mentioned last quarter, and said that we would talk more about in the future, was growing what we are -- we call our flow businesses to provide more steady streams of revenue. These businesses include: services, energy sales and distributed generation.

Brian will share with you some new information so you can begin to track our progress on initiatives there, including the growth of our North American DG business. While the solar industry continues to be tough, with government tariffs on polysilicons through modules, as well as changing government policies, we believe we are uniquely positioned to be a long-term winner in this market.

The flexibility of our supply chain in diverse locations such as China, Korea, Malaysia and Taiwan and broad control over manufacturing, including, for example, our Kuching facility and module manufacturing in Malaysia, allow us to circumvent or withstand significant tariffs and other market pressures. It has allowed us to continue to grow and show significant increases in installed megawatts each year and work on strengthening our business in a difficult environment.

Our polysilicon JV in Korea will be an additional element in the supply chain. We expect this facility to ramp in the first half of 2014, with meaningful financial impact in the second half. Something that has been helping both our Semiconductor and Solar business, and is increasingly becoming a competitive weapon, is the internal culture transformation initiative that we embarked on just over a year ago.

I have never seen a faster or more positive impact on a culture than I've seen here from this initiative. Our teams are working together around a common purpose with a shared way of thinking, resulting in innovative new ideas, better collaboration within and across the team and better workforce engagement and motivation.

We are still relatively early in the process, but the results, so far, are very encouraging, and have already led to process and cost improvements that would otherwise not have occurred, and have attracted strong new talent to this organization.

So overall, while the first and second quarters were each in line with target, they collectively represented what we -- what was undoubtedly a tough first half of the year.

In the second quarter, our Semiconductor team continued to execute nicely and grew revenue, profits and cash flow in a difficult market environment. Our Solar business is preparing for a strong second-half ramp and a strong sustained business level in 2014, with reduced quarter-to-quarter volatility.

Both of our businesses continue to work on efficiency improvement, and have positioned themselves well to capitalize on future market opportunities. We continue to focus on cash and are taking actions to ensure that our strong Solar growth translates into profit.

Overall, I remain very excited about our progress and positioning as a company.

Now I would like to turn the call over to Brian to discuss the quarter and provide additional insights. Brian?

Brian Wuebbels

Thank you, Ahmad, and good morning, everyone. My comments today reflect information found in the press release and financial tables distributed earlier this morning, and will reference the second quarter 2013 results conference call presentation posted in the Investor Relations section of our website.

Now let's begin with Slide 3 in the presentation, titled Quarterly Overview. As Ahmad mentioned, the second quarter played out pretty much the way we expected. We met most all of our metrics we guided to in our first quarter call, with the exception of our fully-developed ASP, which was less, mainly due to project timing and closeouts.

Our Semiconductor Materials segment performed well despite the challenging business environment. Improvements in operational efficiency and cost containment programs have enabled us to grow revenue, operating profit and cash flow, despite continued pressure on pricing. The strong foundation we have will be our advantage in what remains a less certain industry backdrop during the second half of this year.

Our Solar Energy segment revenue grew 25% and sale of solar projects grew 32% in the quarter. Our momentum is building as we scale the platform to a higher level through the second half of this year.

Also in Solar, we are driving towards increased flow revenue, the growth of which will help reduce the volatility in our Solar projects business and improve profit margins and linearity in 2014 and beyond. Our competitive position in both our market segments remains strong.

In our Semiconductor business, we are aligned with many of the most successful semiconductor device manufacturers in the world. Our strong customer relationships are an asset during periods of uncertainty. In Solar, we expect to accelerate our solar project volume starting in the third quarter and continuing into fourth, and we are delivering these projects from our 1 gigawatt of backlog. We are preparing for a step function change in our business level and are adding necessary resources to ensure our success.

Now let's move on to a discussion of our performance in the second quarter. On Slide 4, as I mentioned earlier, we achieved most of the metrics we guided on our last quarterly call. Now I'll review them in more detail.

Semiconductor revenue was $239 million in the second quarter and was in the middle of our guidance range. Segment margin and cash flow also grew sequentially. We sold 51 megawatts of solar projects in the quarter, on the high side of our target range. This includes both fully developed and EPC-only projects. Of the 51 total megawatts, 14 megawatts were EPC projects and 37 were fully-developed projects.

Recall that we have previously said in -- that in the second quarter, much like the first, we would opportunistically execute on a number of EPC projects to help fill the temporary void created by reduced development spend last year to cover our OpEx in the short term.

Our fully-developed ASP of $3.32 was slightly lower than was expected for the quarter, due to the timing of closing out of various projects. Lower priced EPC projects comprised about 27% of our delivered megawatts, and similar to the first quarter, these weighed on our ASP.

In the third quarter, our mix will swing almost entirely to fully-developed projects, and we expect our third quarter ASPs to be higher. Our capital spending for the quarter was $39 million. This included $9 million due to an allocation related to the TCS plant we acquired through the contract amendment of our Evonik contract last year.

For the past 2 years, our strategy has remained asset-light in Solar, with the vast majority of our CapEx spend focused on keeping our Semiconductor Materials capabilities world-class. This will continue to be our strategy going forward.

And now let's turn to Slide 5. Second quarter 2013 non-GAAP revenue was $492 million, and was split fairly evenly between our Semiconductor and Solar Energy segments. As our revenue in our Solar Energy business begins to accelerate over the next couple of quarters, we will once again see Solar constitute the majority of our revenue mix.

On this page, we show our GAAP and non-GAAP summary P&L. As a reminder, the only difference between our GAAP and non-GAAP P&L is related to the direct sale and financing sale-leaseback solar projects. The operating income adjustment is due to the timing differences between GAAP and non-GAAP.

Now if we turn to Page 6, we'll review the period comparisons. Total non-GAAP sales reflected sequentially higher volume in both semiconductor units and solar megawatts. The year-over-year decline was primarily driven by the 98 megawatts of projects we sold in the second quarter of last year, which were delayed from the 2011 fourth quarter due to the adverse market conditions in Europe. Semiconductor Materials gross and operating margins improved sequentially, with higher volume and a continued focus on manufacturing efficiency initiatives.

Similar to our 2013 first quarter, sales for solar projects in 2013 second quarter were gated by lower development spending in 2012, and remain below our breakeven level. In addition, the mix of EPC projects also weighed in our ASP and solar revenue.

Our increased commitment to development spending this year will allow us to deliver projected volume in coming periods, starting in the third quarter. Sequentially lower gross margin was caused by the $25 million of margin in the 2013 first quarter from a contract amendment with Tainergy, which did not repeat in 2013 second quarter. Our gross margin rate was again lower, similar to Q1, due to the underutilization in our Solar Materials business due to the low-project megawatts and the high mix of EPC projects. However, our fully-developed project margins were 17% during the period, and on track to achieve our target margins in the second half of the year as planned.

Operating expense grew $13 million as we added additional resources in preparation for the considerably higher project deliveries we expect to execute on in the second half of the year, and will continue into 2014. We expect the growth in OpEx to moderate in coming quarters as we achieve the step function change in the size of our Solar business.

And now let's turn to Page 7, and we will review the Semiconductor Materials business. Semiconductor Materials delivered another quarter of sequential growth in revenue, operating profit and cash generation. Revenue was up 4% quarter-over-quarter, driven by 6% higher volume, while ASP was down 2%. Most of the ASP pressure being delivered -- driven by large diameter wafers. The price pressure we saw in the first half of the year appears to be moderating, but there are still challenges ahead, especially with the weaker yen. We plan to navigate the second half of the year with a focus on improving our customer and product mix, which has helped us maintain our ASPs. And we will continue to focus on operational excellence and lean initiatives in the second half of the year.

Now let's turn to Slide 8. Because of the adjustments defined by our non-GAAP metric pertain to Solar Energy business, all financial figures on this page are non-GAAP. The second quarter results were pretty much in line with our expectations. Solar Energy segment sales in 2013 second quarter grew sequentially due to the higher solar project deliveries and external material sales, but was down year-over-year. Compared to the prior year, our solar project sales were gated by our decision to slow development spending in 2012. And recall that during last year's second quarter, we delivered the 98 megawatts of European projects that were delayed from 2011 Q4. Of the $253 million in the second quarter Solar Energy segment sales, solar projects generated $144 million, which was up 32% from $109 million in the previous quarter. Our upstream Solar Materials represented $72 million compared to $51 million in the previous quarter. The remaining $37 million came from energy, O&M and other revenue.

As I mentioned earlier, Solar Energy operating profit fell sequentially due to 2 primary factors: first, the prior quarter included the $25 million contract amendment with Tainergy; second, we've been adding the necessary resources to enable higher project deliveries in the second half of the year, as we are expecting a step function change in the size of our business and want to ensure that we flawlessly execute our plan.

Solar Energy operating profit fell year-over-year, largely due to the European projects sold in the previous year.

Now let's turn to Slide 9, and we'll review our pipeline. As Ahmad mentioned earlier, our pipeline is now 2.9 gigawatts at the end of the quarter, up 218 megawatts from the 2.7 gigawatts we reported last quarter. And including the 51 megawatts we turned out in the quarter, our gross additions were nearly 270 megawatts.

During the quarter, we interconnected 22 megawatts. And at the end of the quarter, we had over 200 megawatts in various stages of construction, up from 135 megawatts in the prior quarter as we prepare for the back-half ramp. We have a well-diversified pipeline, both geographically and by size, with over 850 projects globally. We believe diversification is a prudent strategy given the constant changing global politics, economies and policy. 60% of our pipeline is in North America, 40% of our pipeline lies in geographies like Latin America and emerging markets, where we believe opportunities for healthy growth exist.

Our pipeline also remained diversified in terms of size, with projects less than 50 megawatts constituting about half of our total megawatts. We believe there is tremendous opportunity for growth in projects less than 10 megawatts in a category we call DG or distributed generation, and we have been dedicating more resources to this category.

In a couple of slides, I'll share with you some additional details regarding our flow business, of which DG is an integral component.

Now let's flip to Slide 10, and we will review the backlog. Much like the pipeline, our backlog at the end of the first quarter was up to 1 gigawatt, and up almost 119 megawatts from last quarter. And it's also very well diversified, containing over 500 projects globally. Most of these are planned for completion over the next 2 years. As a reminder, backlog represents projects with signed PPAs or backed by feed-in-tariffs and include projects under construction. We continue to believe our backlog, as it sits today, can generate gross profits of around $0.75 to $0.80 per watt.

As you can see in the bar graph on the left of the slide, over half of our backlog is located in the United States, which we continue to believe is one of the most attractive markets, having among the most stable policy and political environments globally.

Distributed generation projects constitute about 40% of our U.S. backlog. Of the DG business we are planning for this year and next, some of this will come from backlog, but a portion will not because some smaller commercial rooftops, as an example, can be built and sold within the quarter and thus, never show up in our reported quarterly backlog.

And now let's turn to Slide 11. This is a slide we showed on our last quarterly call in an effort to provide further transparency into our backlog and project completion plans. And we said we would update it on subsequent calls. Of course, the timing and composition of project completion changes frequently, but this is how it looks today. The ranges you see on the chart on the left reflect uncertainty in timing, not whether the projects will actually be completed or not.

On the left side of the chart, you can see that through the second half of 2012 and the first half of 2013, our project completions have ranged between 50 and 100 megawatts quarterly. This relatively low level was a result of our decision to curtail development spending last year in order to reduce stress on our balance sheet as we restructured our Materials business and exited long-term legacy contracts.

In the near term, we are aligning our resources and infrastructure for a step change in our project volume that you can see in the chart. We have made considerable progress towards improving our cash-to-cash cycle and have built an impressive team of project finance and business development professionals to take us to the next level.

From Q3 2013 through Q3 2014, we expect to deliver over 1 gigawatt of projects, of which nearly 60% is supported by projects currently in our backlog. The remainder is expected to come from projects that convert from pipeline to backlog in the next couple of quarters or short-cycle time DG projects, most of which don't ever appear in our backlog.

On Slide 12, we'll give a description of our flow business. During our Capital Markets Day back in March, we discussed, for the first time, our flow business strategy, which is aimed at reducing quarter-to-quarter volatility in our Solar project business, by growing a revenue stream that would be more consistent and enhance not only the potential segment margin potential, but also lower the working capital requirements for the business.

Our definition of flow revenue stream includes distributed generation projects, or DG; energy; operations and maintenance and other services.

On the left side of the page, you will see our expectations for distributed generation growth in North America. The business will double in 2013 versus 2012, and we expect the business to again double in 2014. We believe North America DG is a good example of how our flow model can improve our downstream Solar business. Benefits of an improving DG mix include better geographic and project diversification, a higher ASP and profit margins.

In addition, the smaller average size, typical of DG projects, leads to reduced average cycle time, which helps improve working capital management and reduce dependence on backlog. Energy is essentially revenue we sell from projects we own and is predictable and high-margin, typically only having debt service, O&M and insurance costs. We intend to build and hold select solar projects in the future as we seek high IRR opportunities and we'll generate a steady stream of ongoing cash flow from them.

O&M and other services are also predictable revenue streams, which we believe can generate operating profit margins that can be about twice our project margins. And the key to our success in services is growing our megawatts under management and realizing benefits of scale. At the end of the second quarter 2013, we had over 1.3 gigawatts under management compared to about 800 megawatts this same period in 2012.

Now let's flip to Page 13. We began the first quarter with $422 million of cash and ended the quarter with $438 million of cash, generating about $16 million of cash during the quarter. Solar project financing, improved cash collections and better working capital management contributed to the cash generation in the period.

Now let's flip to Slide 14. At the end of -- at the quarter-end, we had $1.5 billion in Solar Energy assets, offset by $1.8 billion in nonrecourse debt. It is important to understand the nature of the nonrecourse debt and how it is tied to our sale-leaseback projects. Unlike the corresponding asset, this debt is non-amortizing, and the full balance is extinguished upon the last lease payment, typically 20 years after the project is sold, at which time, a GAAP gain will be realized. Accordingly, the nonrecourse debt will always exceed the corresponding asset balance.

For purposes of our debt covenant calculations, this nonrecourse debt is not included. Our liquidity position remains strong at $628 million and is comprised of our $438 million of cash and $190 million of unused capacity in our corporate revolver, which is being used only to back letters of credit.

Total capacity in our nonrecourse construction revolver remained at $150 million in the second quarter, of which, only $20 million was drawn, bringing the remaining capacity to $130 million. Overall, we are very comfortable with our balance sheet and our liquidity position.

And now let's turn to Slide 15, and we'll talk about the Q3 2013 outlook. We expect Semiconductor Materials revenue to be in the range of $230 million to $250 million, again, driven mostly by volume. We expect total solar project volume to be in the range of 60 megawatts to 100 megawatts. Solar projects retained on the balance sheet are expected to be up to 10 megawatts, and our fully-developed project ASP will recover and is expected to be in the range of $325 million -- $3.25 and $3.50 a watt, and is highly dependent on timing and project mix. And CapEx will, again, be primarily focused on our Semiconductor Materials and will be in the range of $30 million to $40 million.

On Slide 16, we'll talk about our full year. For the full year 2013, we now expect our Semiconductor Materials revenue to be $940 million to $980 million, slightly lower than our previous guidance. In recent weeks, there have been mixed signals regarding Semiconductor market strength in the near-term, with the band not firming up across all sectors as expected. Despite this increased uncertainty, we are confident that our market positions will remain strong, and we believe our healthy customer relationships will enable us to better navigate any challenges in the second half of the year.

On our Solar projects business, we -- our range remains unchanged at 430 megawatts to 500 megawatts. We still plan to retain certain projects in our balance sheet, most of which are in Latin America. These projects are in regions with high solar radiance and low overall install costs, resulting in high IRRs for SunEdison. The range of 50 megawatts to 100 megawatts represents the uncertainty in timing of project completion as opposed to the uncertainty in our decision to keep the project. The project pricing should be in the $3.10 and $3.40 range, unchanged from our prior estimate, and this includes all projects, both fully-developed and EPC. Our CapEx forecast of $120 million to $140 million also remains unchanged.

And in closing, we are very proud of our performance for our Semiconductor Materials segment, especially in light of the competitive pricing environment, and we remain focused on improving our sales mix with premium products that carry a higher ASP and margin. We are also very encouraged by what we see in the solar market today. Our Solar Energy business is fundamentally strong, with a deep pipeline and significant backlog to fuel the business in coming quarters. Our brand name has helped us win valuable project contracts, achieve lower financing costs that will enable our global growth in the future. We have a solid liquidity position and remain focused on maintaining a healthy balance sheet, driving profitable growth and delivering strong returns for our stakeholders.

With that, we will now open the call up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from the line of Patrick Jobin with Crédit Suisse.

Brandon Heiken - Crédit Suisse AG, Research Division

This is Brandon Heiken, speaking on behalf of Patrick Jobin. And it sounds like you guys are increasing your focus on late-stage project evaluation and acquisition. Can you clarify how much of these new additions to your pipeline and backlog came from this new late-stage project focus versus organic development? And then, what is the effect on OpEx for the rest of this year and next year with the growth in solar project deliveries?

Brian Wuebbels

Great. Thank you very much for the question. The first one, on late-stage projects, a small percentage of our growth in the second quarter was due to these business development projects. Majority of that, as Ahmad mentioned and I mentioned, you're going to see coming into play over the next several quarters. These are activities that we've had underway, and we absolutely do see SunEdison being a magnet for these types of projects and these developers as we go forward. So it will be an area we focus on, but so far, most of our growth that you see in our backlog and pipeline has been due to our organic activity. On the second one, the OpEx, we certainly had a step change in our OpEx in the second quarter to prepare for the back half. And as I said in my remarks, we expect that to moderate going forward. We will see increases, but those increases will be not as near as significant as they were in the second quarter, as we continue to grow the business. As we said earlier, our goal is to get the business to a greater than 200- to 250-megawatt run rate from our historic 50 to 100 megawatts. So hopefully that helps.

Brandon Heiken - Crédit Suisse AG, Research Division

And on Slide 11, you are showing the cumulative project completions from the third quarter this year to the third next year, and about 60% of that is in backlog and some of it is DG. Can you clarify, for the remaining 40% not in backlog, how much of that is DG versus what needs to come into that collective?

Brian Wuebbels

Yes, so as we said earlier, the DG projects are ones that turn very quickly. So if you take a look at our DG -- just our North America DG outlook for next year, you'll see that we expect significant growth in that business. So you could expect a portion of this 60% or this remaining 40% to come from there. But I would tell you that a larger portion of it will come from projects that we will be converting out of our pipeline into our backlog over the next couple of quarters.

Operator

Our next question today comes from the line of Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank AG, Research Division

One, can you just clarify, Brian, what level of development spending you have today versus, say, a couple of quarters ago -- I'm just trying to figure out what the run rate of installations or completions would be as you look into 2014. I mean, you're still looking at 200, 250 megawatts, there's upside there. And what kind of balance sheet constraints do you have in developing and growing your backlog, as well as projects in 2014?

Brian Wuebbels

Great questions, Vishal. So as we mentioned during the Capital Markets Day, last year, our development spending was approximately $30 million to $40 million for the full year. And this year, we projected that gross spending to be $160 million. So a sizable increase in development spending. And so we feel very comfortable that, that level of development spending will lead to the 200- to 250-megawatt run rate that will be on, starting in Q4 of this year. So it is a step function change, and that started, primarily, in the first quarter of this year. The -- as far as the backlog -- sorry, can you please repeat your second question? The second portion of your question.

Vishal Shah - Deutsche Bank AG, Research Division

I'm just wondering if there is any balance sheet constraint in growing your megawatts?

Brian Wuebbels

At this point in time, no. We feel very comfortable with our balance sheet and our liquidity position. As we mentioned earlier, there is a tremendous focus inside the company on cycle time reduction and cash-to-cash cycle. And that's really the key to optimizing the business model, vis-à-vis, where we were at a year ago, is by improving that cycle time, improving the cash-to-cash on our projects, enables us to grow the business without putting the additional stress on the balance sheet that we've seen in the past. So we feel very comfortable with our position.

Vishal Shah - Deutsche Bank AG, Research Division

Some of these companies like NRG have decided to spin off the assets of their Yield [ph] transaction. Are you thinking along those lines as well? What's the optimum way to monetize these assets?

Brian Wuebbels

Yes. No, thank you very much for your question. No question, I mean, at the end of the day, the goal for us and for any projects in the solar business is to reduce the cost to capital on the projects. Financing is a considerable portion of the cost of goods sold of a project. So anything that you can do to lower that cost to capital generates more returns and profits for the company. And I do believe that there will be a continued trend of moving from traditional project finance to public markets, all right? There are deeper pools of capital. They should -- they generally will take a lower cost to capital because they were able to carve up the risk more appropriately. So I think that's a trend that you're going to see. And I'd be lying to you if I told you we weren't active in this area, and more to come in the future in this front. But that is definitely a trend of the future.

Operator

Our next question comes from the line of Brian Lee with Goldman Sachs.

Brian K. Lee - Goldman Sachs Group Inc., Research Division

I had a couple. First off, if I look at your megawatt guidance for Q3 on Slide 11, it seems like the range has gotten wider versus what you had in the same slide back in last quarter, while the fourth quarter range has gotten tighter. Is this a large project timing issue? Or is it being driven by any particular geography? I'm just trying to get a sense here.

Brian Wuebbels

No, it's the project timing. There's a couple of projects that are just under 20 megawatts each, and whether they fall in the last week of September or the first week in October, is why we are showing that range. So it's 2 very specific projects.

[

:p id="136863176" name="Brian Lee" type="A" />

2 projects. Okay, great. That's helpful. And then, just kind of a follow-up on Vishal's question. You're implying at least a 200-megawatt quarterly run rate for 4 straight quarters, exiting this year. I guess, I'm wondering, are there any operational bottlenecks or capacity issues that you need to address to get there? And then related to that, can you quantify how much more financing capacity you would need and in what time frame to fund those volumes?

Brian Wuebbels

So operationally, I don't see any significant bottlenecks. As Ahmad mentioned earlier, the flexible and diverse supply chain that we have built, where we both have internal supply, as well as external procurement, allows us that flexibility to grow to this level. So we feel pretty comfortable about that area. The 200-megawatt per quarter range, we made the investment in OpEx, and we'll continue to make smaller, incremental investments. That's really where the priority is. To handle this project volume, it's really about having the right project finance, operation and business development people to continue to grow the business. So that's really the area that we have put in place that we believe will enable this growth into next year and make it happen. So we are investing to make this happen. The second -- the last piece is financing. I don't really see that being a constraint at all. We've -- last year, in the worst of times, we raised over $2 billion of project finance equity. And we believe, with some of the new vehicles that are becoming more and more available, as well as our relationships, that we'll continue to be able to get the proper financing that we need. And you're going to hear more and more announcements and actions coming forward from us. But you can do the math. I mean, if we're going to do that range of a gigawatt and the average price is, let's just say, $3, then you need $3 billion worth of capital that you got to raise. So we feel very confident that we can raise that kind of capital. And from a cycle time point of view, we're already starting those activities now. So we -- last year, we started in September, October for capital raises this year. So the key is to get out ahead of it, to be proactive and to open up new markets. And that's what our team has been well known for, and so I'm very confident in their ability to continue to support our growth.

Brian K. Lee - Goldman Sachs Group Inc., Research Division

Okay. Great. And if I could just squeeze one last one on gross margin. You mentioned, Brian, 17% this quarter for fully-developed solar projects. What range does that go to in the back half, given your view on higher volumes and the implied better mix?

Brian Wuebbels

Yes, I mean, we've always guided that we believe that our normalized run rate for gross margins would be 20% for the fully-developed projects. And I definitely see that as the direction that we're heading in the back-half of the year.

Operator

Our next question is from the line of Sanjay Shrestha with Lazard Capital.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

First, I have a quick question, and I want to come back to Slide 11, too. In terms of your Samsung poly JV, right, as it ramps up in the sort of, like, the second half of 2014, do you plan to use that for the in-house purposes? Or are you actually going to look to, potentially, sell that in the merchant market, given it's going to be low-cost, and the price of poly has probably gone up by then?

Ahmad R. Chatila

Sanjay, this is Ahmad. We would -- we'll do both. The nice thing about the SBR technology, not only is it low cost, but we can feed it into monocrystals in a cost-effective way. Usually, you have to add a couple of dollars per kilo to chip the silicon poly, so it's even more cost-effective for mono. And our demand is pretty strong on the project development side, so we need the poly. We might sell, also, the outside. People want that poly. They always -- actually, we have more demand than supply in that regard.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Okay. Fair enough. Now coming back, again, to this Slide 11, right. So what I'm just -- so just to round things up, so let's say, 1 gigawatt, low-end of your gross margins, so it's about like $700 million in gross profit visibility in some sense you guys have just in the next 4 quarters, right? Now the question I had was, one, how do I think about that translating into, sort of, the overall cash generation? And two, can you update us on some of your internal wafer capacity, which obviously we get the margin boost where the utilization goes up. And who are some of your existing, sort of, the cell and the module suppliers? And is there any change in that view given what's happening in China?

Ahmad R. Chatila

So Sanjay, this is Ahmad again. Let me share with you how you should think about us. One, if you want to ramp the business, you need more capacity on the surface, more capacity in everything. In people, and in factories, and finance. On the finance side, we have a lot [indiscernible] on our projects than supply, believe it or not. And as Brian said, in 2012, when we -- which was a very difficult year, we were at $2.3 billion. So we see no issue. If anything, we're going to go and try to progress on the public vehicles to improve our pricing, so that's one. On our capacity, it is very flexible. We don't have -- we're not tied to 1 tenacity [ph]. We're tied to crystalline, mono, multi panels. So we can buy as much as we want. And since our deployment of farm, our global nature in Chile, in Latin America in general; South Africa, in India; in Europe, in Canada, U.S., all of a sudden, we have a lot of flexibility where to buy panels. So in the case of Chile, we can buy them from China. In the case of Canada, we can buy cells from China. In the case of U.S., we buy cells from Taiwan. And let me -- it's not easy to ramp the business. Let me tell you, I mean, my supply chain guys won't probably agree with Brian that it's easy. They will say that their hair's up [ph] a little bit. But we don't see a major barrier at all to ramp the business to much higher levels in 2014. On Kuching, just specifically, today, we're at 150 megawatts a quarter. That's our capacity. With efficiency improvement and without adding CapEx, we think we can ramp it to 800 megawatts by early of next year. Because of the higher wattage per wafer and higher yields in the factory, so while we built a 600-megawatt plant, we see a range of 800 per gigawatt in the long run in terms of the capacity there. But we're not tied to it. We can ramp higher and if it is lower demand on our installation, we can sell the wafers outside. So I hope that helps you.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

That's very helpful. And just finally, just on that service, from the cash generation standpoint, sort of, how should we be thinking about sort of over the cash cycle as you're building this larger project pipeline?

Brian Wuebbels

Yes, I think as we have said previously, as we -- you need to invest to get to the next level. And once you get to this next level, the key for cash generation is going to be linearity. And if you look at us over time, over multiple quarters, we have cash generation. The issue we've had in the past has been it's been more lumpy. And so as you get to the back half and into the middle of 2014, that's when you should really see the volatility calming down in the cash generation of the business. And you will see that -- that flow-through of those margins. And as we taper off the OpEx growth, you're going to see those returns coming through. You'll continue to invest in the business. As we said earlier, we are going to be investing in development spend. And so -- but I definitely see cash generation of this business as it becomes less volatile through 2014 on a consistent basis.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Terrific. That's great. And I'm sorry, can I just squeeze 1 in real quick on the whole wafer capacity side, right? So you guys talk about project utilization, operating margin leverage, right? But one of the areas where you're also hurting right now is on the solar materials side. So shouldn't your -- not that I'm trying to put words in your mouth, shouldn't your overall margin target for the broad Solar business be even higher than what you talked about because there is no longer a negative drag because you are dealing with this underutilization of the capacity right now?

Brian Wuebbels

Great question. You can't put words in my mouth, Sanjay. But at the end of the day, we are experiencing a drag on the solar materials business, absolutely, as the utilization is very low. And as that normalizes, then, you're going to be able to see those margins in the project businesses shine through. And that's how I look at it. Could there be a catalyst for upside in the future? One would -- we would expect it, however, market dynamics are what's the wild card in this thing. So what's going to happen to other tariffs and market pressure, and all these other wild cards. So we feel very comfortable with what we said, which is that our target margins are 20% in this business. And as the mix improves for DG, will that be better? Yes. These are all positive catalysts. My goal, right now, is continue to execute in the business and over deliver as we achieve this ramp. That's going to be the goal in our business, and our mindset. Does that make sense?

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

That's great. That makes perfect sense.

Operator

Our next question comes from the line of Shahriar Pourreza with Citigroup.

Shahriar Pourreza - Citigroup Inc, Research Division

Most of my questions have been answered by now, but maybe just a couple of strategic questions. With the Samsung Fine Chemicals JV, I'm sort of wondering whether there's any opportunities beyond third-party sales or in-house use to potentially license that technology? I mean, it's clearly been pretty lucrative, right now. So I'm wondering if that's any kind of a strategic focus?

Ahmad R. Chatila

This is Ahmad. Thank you, Shahriar. Yes, the answer is absolutely. Not only -- there's 2 places where we're looking at licensing and building JVs. One is on SBR, which is -- think of it as a $12 cost technology, including interest and other things, like less than $15, which is around $5 to $10 lower than Siemens in the same token. And the other one is Solaicx. And Solaicx in there is another $8 advantage per kilo on crystal. In both of these cases, we are in deep dialogue, in a few places, on licensing and building JVs. And the way we're thinking about it is through equipment sales, as well as limited ownership. We can generate some cash to the company and improve all of our supply chain dynamics so that we can reach the $0.40 a watt of cost in 2015, which we're very confident of reaching with high-efficiency panel. So it is there. It is not part of our forecast or guidance. If it happens, we will tell you about it, but today, we are in discussions. And they are deep discussions, they're not shallow, very far-fetched. They are real and it might happen, I would say.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Got it. Very helpful. Let me just shift over to your backlog because I'm sort of wondering, if you start to shift your business mix to more distributed generation, how much emphasis should we actually look at backlog? Because theoretically, if you start to shift to DG, you can actually see your backlogs slightly deteriorate, but that's not really a fundamentally driven thing, it's just this shift in the business mix. So I'm just wondering, how much emphasis on the backlog we should place in the outer years?

Brian Wuebbels

Shahriar, this is Brian. Great question. The answer is there is no question, as we move to more flow business and more DG, that a larger percentage of our sales is going to come from things that don't go pipeline -- leads, pipeline, backlog, then, build it out, right? And the other way to think about it is also, outside the U.S., that tends not to happen either, right? Because you tend to, in a lot of places like South Africa is a great example, right? You don't get a PPA or a project until it's all fully baked, right? And so the DOE won't give you anything until you have financing, everything lined up. So in those instances, they go from a lead, in our definition, to, bam, right into the backlog. I think my view is, as we head into 2014 and especially, in the back half of 2014, and our DG percentage of our total and small -- residential and small commercial business becomes a larger percentage. You're absolutely right. There will be -- my view is less focused on the backlog as the value driver in the company, but there is no question the backlog and pipeline are still very, very valuable. And they will be monetized over the next 2 to 3 years, so we shouldn't discount it. But I think your point is very valid, which is, there's more to the story than just backlog and pipeline in the value creation of this business going forward. And we'll talk a lot more about it as we go on in each quarter.

Shahriar Pourreza - Citigroup Inc, Research Division

And then, let me just ask you 1 last question, if it's okay. I'm sort of wondering what -- as you start to think about potential other avenues to finance, i.e., hybrid MLP-type structures, I guess, what we could start to monitor? Is it an increase in your captive assets? And the other question is, what are you looking at when you look at these transactions that are occurring and obviously, there's probably more transactions that will occur on the drop down, MLP-type structures. What are you monitoring? Are you monitoring the performance of how the owners operate or is it the cost to capital? I'm sort of wondering what things you look at from a decision-making standpoint.

Brian Wuebbels

No. Great question, Shahriar. Clearly, the first leading indicator is the cost to capital, right? How those vehicles are trading, how they're performing, how people are -- how the market is perceiving them, I think is very important. We all believe it's the right direction, the question is, do you have the right mix of projects and do you have the right credibility and quality of assets that create a good quality public vehicle, so that's number one. Number two is, we'd love to see it but you don't know, and that is, you'd love to have 5 years of history of how one of these vehicles performed, right? Because I think that's going to be the next key is that -- yes, there's some -- there's first-movers out there. There's a lot of people talking about it. The people who will differentiate themselves in this space are the ones who have high-quality assets, demonstrated performance, demonstrated return for their shareholders. Because if you don't, that's what's going to make one of these public vehicles a disaster. And so that's our -- what we look at is making sure that the cost to capital is coming in and is beneficial. And number two, making sure the quality of the asset base is very high so that the investors feel confident in this asset class. So that's what we look at, and like I said, clearly, more to come in the future on this. And yes, you will -- as we move in that direction, you will see us maintain a carry in projects and things like that, that will also create ongoing profit revenue streams for the company.

Ahmad R. Chatila

We have -- this is Ahmad. Let me add a couple of things. We have, really, a strong competitive advantage in 2 ways. One, we have significant development engine, probably second-to-none. We're probably the best in the world in that regard. And you'll see it in '14 and '15. Because of that, we are able, then, to drop down beautiful assets into these vehicles as time progresses, because you can't just launch them, you have to have things in them. So not everybody can do one of these. The second competitive advantage is our O&M business. On our O&M business, probably we'll do more than 2 gigawatts end of this year, will be managing. And we're managing other people's assets. And we have, probably, around 100 megawatts worth of thin films in those. We have 30 different module manufacturers, old inverter companies. So we have a very sophisticated understanding of who performs what in this world. And because of that, the investors will view that very favorably. Because once we say that something is going to perform, that means it's going to perform. And today, our fleet is performing a few percentage points above our commitment. So that helps us a lot in that regard. So we have a lot of range of weapons to be able to execute nicely on public vehicles if we want to.

Shahriar Pourreza - Citigroup Inc, Research Division

Very helpful. And just to reiterate, you're very comfortable with 200 megawatts per quarter run rate in Q4 and beyond?

Brian Wuebbels

Yes.

Ahmad R. Chatila

Yes, totally. Totally.

Operator

Your question today comes from the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank, Research Division

Ahmad and Brian, maybe just a follow-up question on the full-year guidance. How many solar projects do you think need to be finished to hit the fourth quarter solar run rate that you're talking about, of over 200 megawatts? By our count, it looks like it's something along the lines of 15 or so. Is that kind of the execution that you're trying to shoot for?

Brian Wuebbels

The 15 represents what, Stephen?

Ahmad R. Chatila

Project.

Stephen Chin - UBS Investment Bank, Research Division

Yes. How many projects are you trying to finish?

Brian Wuebbels

Highly variable. If you look at Q4, it's going to be more than 15 projects. It's probably -- if you look -- if you do our average size, which is very small, right? We've said historically -- and it's not exactly the case in Q4, but our historical average has been less than 3 megawatts, right? The average size of our project, what's in our pipeline and everything else. It's a little bit heavier than that in Q4 because we do have some larger projects coming through. But it's probably 3x to 4x the number of projects that you just mentioned.

Stephen Chin - UBS Investment Bank, Research Division

And then, just a follow-up, back on the gross margin in the Solar division for the fully-developed projects. I'm just trying to figure out what the delta was in the fully-developed gross margin of, I think, you called out 17%? And why that appears lower than the implied gross margin in the Solar backlog, of around 25% or so? Is that mostly due to the regional mix and maybe you can share some color on the different margins by region?

Brian Wuebbels

It is. And again, part of the gross margin drag on the quarter, as well, even in the fully-developed projects, are the low megawatts, right? I mean, we do have some cost of goods sold type costs that have to be burdened on the few projects that we have, right? We have quality people, we have all the engineering people. Everything else have to be burdened by the current projects. So there is a little bit of that drag on the projects. So when you take that off, you clearly have a better chance of getting to the 20-plus-percent. The other thing is, though, is that there is a mix of projects that we have coming up in the future that are different than some that we've had in the past. There's no question that some of the developing markets, when the markets open, that the margin opportunities are much greater than an established market. And so those are a couple of the other catalysts, Stephen, that are coming down the pipe. And so, yes, we feel very comfortable about our implied gross margins that are in the future.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Maybe a last question on the Semiconductor gross margins. I know Ahmad talked about some price pressure, but does that change your view on the company's operating margin targets in the Semiconductor division? Or can your manufacturing efficiencies keep offsetting some of the semiconductor price pressure that you're seeing out there in the industry?

Ahmad R. Chatila

Steve, the answer is, we still feel that we can get to the target that we have laid out. It might be a little bit later, with just the visibility we have, a little bit been foggy, I would say, in the last few weeks. The wireless segment is a little bit weak, in our view. There are some cost reduction activities that are incoming that will allow us to get there. If it doesn't happen end of this year, it will be early in 2014.

Operator

And we have time for 1 final question today, and that will come from the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch, Research Division

Brian, some of the solar projects you're keeping on the balance sheet, how long are you keeping it for and will they be, ultimately, put up for sale? Or are you looking to build an operating portfolio of projects and maybe do an LCoE?

Brian Wuebbels

So as the current operating assets that we have on our books are primarily ones that we, historically, were required to hold for at least 2 to 3 years due to equity ownership requirements, our thinking is right now, if they are high-yielding assets, then, we will retain them. We want to retain them. And I think the answer is, yes, we would like to build a portion of our portfolio being operating assets that would generate ongoing energy revenue streams. That percentage will vary. But as we've said, this year, we wanted to do 100 megawatts out of the 500. So that's about 20%, 15% to 20%, and I think that's a pretty good number as we look forward, as well, that we would like to retain. Again, very selective, high-IRR opportunities. But as some of the previous questions have alluded to earlier, as you move more to these public-type vehicles, then there's other ways to maintain ownership in these projects, and you will see that being a trend with us. We believe it is another enabler for us getting to more stable profit and cash flow generation in this business.

Krish Sankar - BofA Merrill Lynch, Research Division

Got it. And then, just a follow-up. On the semi side for Ahmad. The pricing pressure you're seeing on your semi wafer business, how much of it is related to the weak yen versus the, like, slightly lower-than-expected demand?

Ahmad R. Chatila

All of the above, Krish. The weak yen is not helping. The wireless segment weakness is not helping. So this is what's going on. I would say, the weak yen is not helpful at all in that regard.

Brian Wuebbels

Thank you. Appreciate the questions. Thanks, everyone.

Operator

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation, and using the AT&T Executive Teleconference. You may now disconnect.

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