SunEdison Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: SunEdison, Inc. (SUNEQ)

SunEdison (SUNE) Q3 2013 Earnings Call November 6, 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

Andrew Hughes - BofA Merrill Lynch, Research Division

Shahriar Pourreza - Citigroup Inc, Research Division

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

Jerimiah Booream-Phelps - Deutsche Bank AG, Research Division

Patrick Jobin - Crédit Suisse AG, Research Division

Shailender Randhawa - RBC Capital Markets, LLC, Research Division

Stephen Chin - UBS Investment Bank, Research Division

Shawn E. Lockman - Piper Jaffray Companies, Research Division

Y. Edwin Mok - Needham & Company, LLC, Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to SunEdison Third Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Mr. Chris Chaney, Director of Investor Relations. Please go ahead, sir.

Chris Chaney

Good morning, and thank you for joining SunEdison's Third Quarter 2013 Results Conference Call. I am Chris Chaney, Director of Investor Relations, and 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 third quarter performance, and Brian will then review the financial results. Brian's discussion will reference slides 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 financial 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 press release and the slides published today for a more complete description.

And now I'd like to 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.

Overall, we did what we said we're going to do. Our results were in line with and in some cases, at the high end of our guidance. Our Semiconductor business, with the strong leadership team, continues to execute well in spite of continued weak environment, focusing on what they can control, like improving customer service and quality, driving lean efforts and improving efficiency and overall, making the most of an extended downturn.

The business maintained share during the quarter and generated cash. Overall, the Semiconductor business is very well positioned for the eventual upturn in the market.

During the quarter, we announced our intent to conduct a partial IPO of our Semiconductor business, which we expect should occur by early next year subject to market conditions. As we head toward the planned IPO of our Semiconductor business, I'm going to focus my remarks mainly on our Solar business. I wanted to take this opportunity to provide investors with a better understanding of how we think about solar business and leave you with some insights on the potential for value creation.

In Solar Energy, our mission is to be the most respected and profitable platform in the industry and hence, the most valuable. To be the most valuable, our megawatt growth rate has to be healthy, the value per watt extracted from our installation must be high and the balance sheet must be strong. So starting with our growth rates. We have grown our annual megawatts completions from less than 40 in 2009 to more than 900 megawatts, at the midpoint of our 2014 guidance. That is about 90% compound growth rate over a 5-year period. And while I have seen significant growth and our megawatts developed, we have been replacing them in our pipeline at least as quickly, and our diversified pipeline now stands at 3.1 gigawatts, up from 2.9 last quarter. We are a leading brand in a fragmented market in a high-growth industry. So we are optimistic about the long-range growth of our megawatts.

Now turning to the extraction of value per watt. At the significantly higher quarterly megawatts run rate that we are projecting, we believe we can now begin to build and extract more project value for shareholders. As an emerging company, at lower run rates, there was a greater need to sell all projects outright to maintain a business flow, primarily for cash management, as well as for accounting purposes and GAAP earnings. At a run rate such as 200 to 250 megawatts per quarter that we have projected for 2014, we have new opportunities to optimize the value per watt we create. Our business today generates around $1.97 for every watt of solar we install. This is discounted cash flow value of a project over its life. At the midpoint of our guidance of 2013 for 523 megawatts that means we have created over a $1 billion of value in our downstream business in 2013. Brian will provide more details and walk you through a sample model in the few minutes.

Today, this value per watt is shared by downstream value chain. About 2/3 goes to solar project buyers and 1/3 to our company in the form of gross margin on project sales. Project buyers today are able to earn the large share of project value for the 3 main reasons: first, the rate of return that a single investor requires is higher than using a public vehicle. This implies high discount rates for solar projects despite the demonstrated low-risk profile of solar installation. Second, they only pay for the first 20 years of project life, despite the fact that project will produce power for at least 30 years, so there's no appreciation for the residual value. We call this remaining portion the tail of a project. Third, there's friction loss due to negotiations, including disagreement on panel degradation rates and project output.

We, as the leading O&M company in the world, know that there's a lot of value left on the table. We intend to capture much of this value by using public vehicles that will offer a fair discount rate for project purchases versus current discount rates and by retaining certain high-value projects on our balance sheet and in fact, keeping the residual value for ourselves. There are examples today in the public arena of low-cost financing available in the capital markets for projects of this type. We believe the solar financing market is about to reach a significant inflection point and that this near-term shift in financing costs will drive significant value creation for the industry. Our model is to generate the highest returns for our shareholders in a capital-efficient manner.

In the short-term, we are working to strike the proper balance between value creation and long-term cash generation against short-term EPS and cash flow benefits for the selling projects. This is not a change in our business model, but rather the evolution we told you about at our Capital Markets Day in March. Because of our growth, balance sheet and development engine, we are in a position to increasingly deliver on the promise going forward. In the third quarter, for example, although demand for our projects is much higher than our supply, we added 25 megawatts to our balance sheet for future monetization, creating value that is not reflected in our P&L statement. We did this while increasing projects under construction from 200 megawatts at the end of Q2 to 558 megawatts at the end of Q3, yet still managing our cash balance.

As for the balance sheet strength, we continue to take actions that will bolster and ensure that we have appropriate levels of cash and liquidity to support our growth. During the quarter, we completed a stock offering, raising approximately $240 million and bringing our cash and liquidity to over $800 million. This quarter, $1 billion is significant in positioning us for 2014 and '15 growth. The Semiconductor IPO will also reinforce the strength of the balance sheet as we're being asset-light on capital expenditures.

So in summary, our Semiconductor business has the right leadership and is focused on incrementally improving positioning while looking forward to the eventual market upturn. Our solar business is in the midst of a significant second half ramp and has put the pieces in place to have a strong 2014. Following our stock offering, we have increased our cash and liquidity to support our growth. And with our mission to be the most respected and profitable platform in the industry, following significant annual growth since 2009, we are now poised to capture more value per watt. So with the expected significant solar ramp in Q4 and the IPO planned for Q1 and target of up to about 1 gigawatt in 2014, we are excited about where we stand as a company and the opportunities ahead.

I'll now turn the call over to Brian to discuss the quarter and provide additional insights. Brian?

Brian Wuebbels

Thank you. 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 Third Quarter 2013 Results Conference Call presentation posted in our Investor Relations section of our website.

So let's begin on Slide 3 in our presentation, titled the Quarter Overview. I'm happy to report that the third quarter progressed in line with our expectations. The semiconductor wafer market continued to be challenging, characterized today by competitive pricing and sluggish volumes. Still, we again generated positive cash flow in the quarter. We believe we are positioned well for a cyclical recovery, and we remain focused on executing our plan to further improve manufacturing efficiency and lower our cost structure, while providing excellent products and support to our top-tier customer base.

Non-GAAP revenue on our Solar Energy segment grew nearly 75% compared to last quarter, driven by sales of our solar energy projects. Our momentum heading into the fourth quarter continues to build. As Ahmad mentioned, we have 558 megawatts of solar projects under construction at the end of the third quarter, with over half of this scheduled to complete by the end of the year. We are focused on driving a higher NPV per watt through retaining 25 megawatts of projects, as we discussed on our last call on September 9, for a first half 2014 public vehicle launch.

Now let's move on to a more detailed discussion of our third quarter results. On Slide 4, you will see a summary of the metrics we guided on our September 9 call. All the metrics were in line with our guidance. On Semiconductor revenue -- Semiconductor Materials revenue was at $231 million in the quarter and was in the middle of our guidance range. Despite a market environment characterized by weaker volumes and pricing, the Semiconductor Materials business generated positive cash flow. Because we don't control the market, we have an intense focus on controlling our costs while maintaining strong customer relationships. We believe our past success on these 2 fronts has positioned us well for when the market recovers.

We sold 75 megawatts of solar projects in the quarter, at the high end of our 60- to 80-megawatt guidance range. We built and retained an additional 25 megawatts of projects during the third quarter, also at the high end of our range, for total project completions, which is the sum of products sold and the projects retained, of 100 megawatts for the quarter. Our fully developed ASP was at $3.73, which was higher than what we guided, mainly due to project timing and mix. Our capital spending was $32 million, also in line with our $30 million to $40 million range. Our CapEx strategy continues to remain asset-light in Solar and focused on strategic spend in our Semiconductor Materials business.

On Slide 5, you'll see 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. Third quarter 2013 non-GAAP revenue was $672 million, of which 65% was generated from our Solar Energy Segment and 35% from our Semiconductor Materials business.

On Slide 6, we show our period comparisons. Total non-GAAP sales grew 37% sequentially, reflecting higher Solar Energy segment sales, offset by partially lower Semiconductor Materials sales. Total gross profit doubled and gross margin increased with higher solar project volume megawatts and operating losses declined. The project gross -- the project's gross margins also improved significantly to the high-teens level as the percentage of EPC-only projects dropped to an insignificant level during the quarter.

Over the last few quarters, we have increased our OpEx in order to execute a considerably higher quarterly megawatt run rate, mostly in our DG and flow businesses. In addition, we had $2 million of additional stock option expense in the quarter and $3 million related to the Semiconductor IPO. Over the next few quarters, we expect our OpEx to continue to rise but at a much more moderate pace.

Now let's talk about the Semiconductor Materials business on Slide 7. Semiconductor Materials faced a difficult market environment during the third quarter, but the team continued to execute well and the segment generated positive cash. Revenue was down 3% quarter-over-quarter, driven by 2% lower volume, while the pace of our ASP erosion moderated, declining only 1%. As Ahmad mentioned, it appears the pricing may be approaching a bottom. Although not all market data from the third quarter is in yet, we believe we have maintained the share gains we achieved over the last several quarters. With only a portion of our semiconductor manufacturing base in Japan, the weak yen continues to be a challenge for us. We are focused on improving our margins by driving a richer sales mix with higher-ASP products while lowering our costs through operational effectiveness and our lean initiatives.

Now on to the Solar Energy segment. The third quarter Solar Energy segment revenue grew nearly 75% sequentially as our solar projects volume grew, driven by both megawatt volume and price. Sales of our solar materials were also higher, driven by solar wafers and opportunistic module sales. Of the $441 million in the 2013 third quarter Solar Energy segment sales, solar projects generated $244 million, up from the $144 million in the previous quarter. Upstream solar materials sales were at $160 million versus $72 million in the prior quarter. The remaining $37 million was split between energy, O&M and other. Year-over-year sales were down $27 million due primarily to lower project ASP and a $37 million benefit last year due to the contract settlement with Conergy, offset by $22 million benefit related to a contract cancellation with Gintech.

Solar Energy segment operating profit grew $32 million sequentially, driven primarily by higher project sales. Compared to last year, operating profit was down $116 million due primarily to the $95 million in net benefits of last year's third quarter associated with a contract settlement with Conergy and favorable restructuring. Also driving the year-over-year decline at Solar were project prices and higher OpEx to support the megawatts growth for this year and into 2014.

As Ahmad mentioned -- on Page 9, as Ahmad mentioned, our pipeline grew again in the third quarter to 3.1 gigawatts from the 2.9 gigawatts in the second quarter. Including the 100 megawatts of project completions this quarter, our gross pipeline was up over 300 megawatts sequentially. Our pipeline continues to be well diversified, with 55% in North America, 24% in Europe and Latin America and 21% in emerging markets like South Africa, the Middle East and Asia.

Our pipeline is also well diversified by project size. 18% of our pipeline consists of projects that are smaller than 10 megawatts in a category that we call DG or distributed generation. Midsized projects between 10 and 50 megawatts are about 1/3 of our pipeline, and projects between 50 and 100 megawatts are about 1/4 of the pipeline, with projects over 100 megawatts representing the remaining 1/4. During the quarter, we interconnected 55 megawatts, most of this was from projects in North America and South Asia. As we mentioned earlier, over the last several months, we have substantially increased our project construction activity. At end of the third quarter, we had 558 megawatts in various stages of construction, up from the 200 megawatts last quarter.

On Slide 10, you will find some details of our backlog and projects under construction. As a reminder, backlog represents projects with signed PPAs or backed by feed-in-tariffs and include projects under construction. Our backlog at the end of the third quarter was 1.1 gigawatt, up from 1 gigawatt at the end of the second quarter. Similar to our pipeline, our backlog is well diversified, with 60% in North America, 21% in Europe and Latin America and the remaining 19% in emerging markets. Most of our backlog is planned for completion over the next 2 years. Our projects under construction are also diversified geographically, with about 33% in Europe and Latin America, 30% in the emerging markets, 16% in Canada and 20% in the U.S. -- in the other parts of the world, sorry.

On Slide 11, we share with you how our project development activities are shaping up over the next several quarters. Note, however, that the timing and composition of project completions can change and that this is our best estimate of how things look today. The ranges on the chart on the left reflect uncertainty and timing, not whether the projects will actually be completed or not. Last quarter, we mentioned that our increased development spend would result in a rapid increase in our project completions this year. Third quarter results provided the early evidence of this. And as you see from the chart, we have built momentum, and we will maintain this through 2014 and beyond. From Q4 2013 through Q4 2014, we expect to complete over 1 gigawatts of projects, which is -- about 1/2 of this is supported by our current backlog. The remainder is expected to come from projects that will convert from our pipeline to the backlog in the next couple of quarters or short-cycle-time DG projects, most of which never appear in our backlog.

On Slide 12, we detail the largest of our approximately 70 individual projects for which we plan to recognize megawatts in the fourth quarter. There are 8 projects exceeding 10 megawatts each, and they are geographically diversified across regions such as Latin America, South Africa, the U.S. and Europe. All of the projects listed on the page are currently under construction. As I mentioned in the last slide, we expect a rapid ramp in fourth quarter completions based on projects we currently have in our backlog and under construction. Some of these projects are scheduled to complete next year, but because they are accounted for under percentage of completion accounting, recognition of megawatts will be prorated in the fourth quarter.

Now let's talk about driving a higher NPV per watt. Our completed megawatts have grown tremendously over the last few years, and we expect this trend to continue into 2014. From 2009 through 2014, we expect to post a CAGR of 90%. Our leading brand in a very fragmented and growing market is one of the major factors of our success. It is because of this growth that we -- today, we now have the scale required to optimize the value per watt of our projects. Retaining projects allows us to capture additional value and eliminate inefficiencies in the underwriting process. In addition, we receive low-risk cash flow streams from projects that we hold. Our balance sheet will be the enabler for our strategy, and we have worked to strengthen our balance sheet through our recent follow-on offering, the upcoming IPO of our Semiconductor business and aggressive working capital management as demonstrated by our ability to grow projects under construction from 200 megawatts to 558 megawatts in the third quarter.

On Page 14, as I mentioned before, we have experienced tremendous growth. Our leading brand in multiple channels and multiple regions has contributed to this -- contributed heavily to this growth. Having grown rapidly over the last several years, we have now reached the scale that gives us the flexibility to best optimize value per watt on our solar projects. We can choose whether to sell a project directly [ph] , as we have in the past or retain projects. When we retain them, we can drop them into any of the various public vehicles that are available or that will be -- we will be developing.

This has 2 distinct advantages for SunEdison: the first, it contributes to the company's growing flow business by adding recurring contracted cash flows, which helps smooth out the development business; and second, we can create higher value for the company by capturing several pieces of the project value that are otherwise captured by third-party project buyers. The advantages, however, come at the cost of reducing current-period results because we do not recognize the revenue or margins associated with the sale of the project immediately, rather, over the life of the project, through repeatable, recurring revenue streams.

While retaining projects does require capital, we have a tremendous global project finance team that is known throughout the industry for pioneering unique and innovative financing structures. In the near term, they are working to develop debt securitizations, yield vehicles and other structures that will enable us to grow our portfolio of projects while utilizing third-party capital and enjoying the benefits of a repeatable, reoccurring revenue stream. Innovative structures not only allow us to capture more of the value chain, but they also allow us to accelerate our growth in the coming years.

Now let me take you through an example on Page 15. Here, we show the example of a typical project, the economics. The blue bar on the left shows the per watt margin when we monetize a project using our current method, just selling it directly. The orange bar on the right represents the full benefit of all of the cash flows of a project throughout its life. This is the present value of the project cash flows over the project's useful life, which is typically 30 years or more. The 3 gray bars in the middle represent the additional value that is captured by retaining the project versus selling it to a third-party buyer. We estimate the cost of higher discount rates demanded by one-off project buyers or investors today as compared to leading-edge clearing prices is $0.45 a watt. The underlying risks associated with the asset class and SunEdison-developed projects are quickly becoming understood by the market, and yields are driving towards 6% or lower.

The next piece of the bridge relates to the frictional costs associated with sale. As Ahmad mentioned, the underwriting by a one-off investor includes a number of assumptions, including panel degradations that are overly conservative. This amounts to another $0.30 per watt. The next significant piece of this bridge is the residual value of the project. Solar PPAs are typically 15 to 20 years in length. However, solar panels will continue to produce energy well beyond the average term of the PPA. Projects sales are based only on the life of the PPA, ascribing little to no value to the asset beyond the length of the PPA. Thus, we believe project buyers today are capturing significant latent value in buying projects that will continue to produce energy for years beyond the original PPA terms. An analysis of our own project shows that this residual value amounts to approximately $0.48 per watt. Optimizing capital costs and underwriting assumptions and getting paid for the residual value yields $1.23 per watt, in excess of the $0.74 a watt earned in an outright project sale.

So what does this mean to us? On Page 16, if we take what we've discussed previously, where we plan to retain 100 megawatts in the second half of the year, 25 in the third quarter and 75 in the fourth quarter, using the figures on the last slide, you can see that if we sold these projects, we would generate $74 million in margin, represented by the left bar. However, by retaining these projects, we will capture an additional $123 million, for a total benefit to the company of $197 million. The full benefit can be monetized in 2 ways: one is ongoing cash flow in the business adding to the period cash flows as energy is produced and sold; or two, selling the projects into vehicles at a cost of capital that is more accurately reflective of their risk profile. As these public vehicles are developed, we believe we will be able to capture much of the $1.23 per watt that we are giving up today in a direct sale to a third party while enjoying the benefits of the repeatable, recurring revenue streams and doing this all in a very capital-efficient manner.

On Slide 17, as we've discussed, our high growth has brought us scale to optimize our value per watt. Now we will discuss our balance sheet and cash flow. Effectively managing our balance sheet will allow us to accelerate our growth and continue to add more value to our company. On Page 18, we began the third quarter with $438 million of cash and ended with $640 million, growing the cash balance by $202 million. Primary drivers were the follow-on offering and the change in net working capital, offset by the outflows related to the high level of solar project construction that I referenced earlier. We managed our working capital aggressively, particularly in light of the accelerated solar construction from 200 megawatts under construction at the end of Q2 to the current 558 megawatts under construction.

On Page 19, at the end of the quarter, we had $1.9 billion of solar energy assets offset by $2.3 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 primarily. 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 the purposes of our debt covenant calculations, this nonrecourse debt is not included. Our liquidity position strengthened during the quarter due to the increase in cash and is now at $810 million. Overall, we are comfortable with our balance sheet and our liquidity position.

Now let's move on to our outlook. On Slide 20, for the fourth quarter, we expect Semiconductor Materials revenues to be in the range of $220 million to $230 million. We expect solar project megawatts sold to be in the range of 234 megawatts to 264 megawatts. Note that our 4Q guidance reflects our reaching the high end of our Q3 range as we were ultimately able to pull in megawatts from Q4 into Q3. Solar projects retained in the balance sheet are expected to be 75 to 80 megawatts during the quarter, and total completions are expected to be in the range of 309 to 334, in line with what we told you on the September 9 call. Fully developed project ASP is expected to be in the range of $2.75 to $3.50 and as we mentioned before, is highly dependent upon timing and mix. And CapEx will again be primarily focused in our Semiconductor Materials business and should be in the range of $28 million to $38 million.

On Page 21, for the full year 2013, we expect Semiconductor Materials revenues to be $920 million to $930 million, slightly lower than our prior guidance, reflecting the current softness in the market. Our full year 2013 project megawatts sold are expected to be 405 to 435 megawatts. Projects retained in our balance sheet are expected to be in the range of 100 to 105 megawatts. Total megawatts completed are expected to be 505 to 540, again, in line with what we told you on our September 9 call. Project pricing guidance remains unchanged, and finally, our full year CapEx forecast is $130 million to $140 million.

In summary, I'm happy with our third quarter results and proud of the execution in both of our business segments. In Semiconductor Materials, the environment remains challenging, with a prolonged cyclical downturn, which has now lasted over 2 years. During this period, we have seen significant price erosion. We took swift and decisive actions early on to lower our cost structure, and the results now show that we've been -- we've made considerable progress lowering our breakeven point. Still, we are not done, and we will remain focused on further cost reductions in the coming periods. We are well positioned for an upturn, and we are armed with the industry's strongest foundries and IDMs as our top customers.

In Solar Energy, I am very encouraged by the firming end markets and the numerous positive catalysts in the market today. We are differentiated by our deep pipeline and significant backlog and our strategy to add multiple layers of recurring revenue streams to the business model. We believe there is a significant value created by building selected projects and retaining the value of those associated cash flows. As Ahmad mentioned, the industry is in the early innings of a re-rating of the cost of capital, and we plan to be a large participant in this, which we believe will drive significant value in our company.

Our brand name has helped us win valuable project contracts, achieve lower financing costs and will enable our global growth. We have a solid liquidity position and remain focused on improving our balance sheet, driving profitable growth and delivering strong returns to our shareholders. With that, we'll now open the call up for questions.

Operator, you may begin the Q&A session now. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] First, we'll go to the line of Krish Sankar with Bank of America Merrill Lynch.

Andrew Hughes - BofA Merrill Lynch, Research Division

This is Andrew Hughes on for Krish. Specifically with respect to the yield co IPO or -- and securitization. But on the yield co, how do you think about your ability to continue to grow the dividend in such a structure? Especially as you add projects here in the U.S. that may be coming in at lower PPA rates, is that a concern?

Brian Wuebbels

I think -- thank you for the question, by the way. To me, it's about 2 things. Number one is you absolutely have to grow, and you'll grow it through increasing the volume and size of the yield vehicle. I mean, we expect that the volumes will continue to accelerate in this business and now will outweigh the lowering PPA prices that will exist in the future. So we still see tremendous value available in these projects as cost reductions continue to come down. We are seeing significant value. So we're not worried too much about that. It is absolutely in the front of our mind, but we believe by continuing to grow the yield vehicle by putting more and more projects and more profitable projects in it, that will be off -- be able to offset that impact.

Andrew Hughes - BofA Merrill Lynch, Research Division

Okay. And then just in terms of the 1 gigawatt of projects expected to complete between, I guess, Q4 this year and Q4 '14, do you have a sense of the amount of DG projects that will be in there?

Brian Wuebbels

Yes. I mean, during our last call, we kind of laid out that, last year, we did about 40 megawatts in DG projects. This year, we expect to do about 80, and next year, we expect that to double again, to greater than 150 megawatts of projects.

Operator

Next, we'll go to the line of Shahriar Pourreza with Citigroup.

Shahriar Pourreza - Citigroup Inc, Research Division

When you think about the assets -- I have 3 questions. When you think about assets that are typical in a yield co, they're highly levered, usually 7 to 8x. And you've got a very large pipeline, 1/2 of which is centered around North America, very large backlog. The question is, on the 25 megawatts, is that an initial megawatts that you've kind of traded for a potential drop down into a yield co? And -- or is that what you expect to launch the vehicle at? Could we assume higher megawatts?

Brian Wuebbels

Thank you, Shahriar. That's merely a project that we have in Asia that we believe we're going to be able to launch multiple vehicles, as we talked about on the last call, even regional ones from that perspective. The 25 megawatts is merely a strategic decision on our part that we felt like that would be one good project to be part of the mix. Clearly, you need significantly larger megawatts to launch one of these things successfully because you need to be able to build up recurring cash flows that are probably in the $40 million to $50 million a year range to have a successful launch, so 1 project won't get you there. But again, this is just 1 step, and as we see our volume is continuing to accelerate and we'll have assets on our books as well that we currently have and we expect to term out more in the fourth quarter and into next year that we could also use to seed one of these vehicles.

Shahriar Pourreza - Citigroup Inc, Research Division

And then, so let me ask you -- Brian, that was helpful. When you think about -- I just want to make sure I get this point is, when you think about a public financing vehicle, you're -- it's not one or the other, right? So within the options, you've talked about doing an asset-backed security and a yield co, both of which could happen in 2014.

Brian Wuebbels

Yes.

Shahriar Pourreza - Citigroup Inc, Research Division

Okay, got it. Very helpful. And then just one last question here is on the -- you guys, obviously, completed a lot of megawatts in the quarter. And I think you've talked about the fourth quarter being a potential run rate going forward. Are you still comfortable with that? Or do you think that you could publicly do more installations next year on a quarterly basis?

Brian Wuebbels

Yes. I think we -- clearly, Q4, we're going to be up over 300, and what we said is, heading into 2014, we think we can be in the 200 to 250 range. Clearly, the business is accelerating. I think Ahmad mentioned it. The industry backdrop is there's a lot more positives in the industry than there has been in a long time. There are numerous new markets opening up. You've seen recent announcements, even within the last 2 days, from us on activities that we're doing in Chile to continue to expand our presence there. So we feel very comfortable about the business accelerating. I think for the time being, I'd like to stick with the guidance that I gave. And certainly, we would love to do a Capital Markets Day a lot earlier next year, and I think you're going to hear a lot more exciting things coming.

Operator

And next, we'll go to the line of Brian Lee with Goldman Sachs.

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

I have 2. On your retained value analysis, what do you guys believe the third-party project buyers are generating in terms of IRRs today? And then as you guys go forward and monetize this more optimally for yourself, how do you think about what your realizable project IRRs will be? And then what would be the expected range, if there is a delta on the existing backlog versus projects in the pipeline?

Brian Wuebbels

All right. Brian, you get the award for the most loaded question today. So look, it's very -- it is not consistent from region to region and from project size to project size. But clearly, you're seeing weighted average cost of capital on projects in the -- I don't know, you pick it, aggressively, down into the 7% range; conservatively, up in the 8.5% range as a total weighting of debt and equity and tax equity for a U.S. project. You can probably get some projects and we've done them that are lower than that, and we believe that the world is converging to the 6%. I mean, you can see some of the public yield vehicles that are out there and where they're trading at today. You can look at where debt costs are. Even though interest rates are rising, the spreads are still significant for project finance. So I still think there's room here as we get some more of these public vehicles and the pool of capital is deeper. So that's kind of how I would look at it, Brian. I mean, it's a regional- and a channel-specific question. Clearly, the cost of capital expectations for a residential project versus a DG projects versus a utility project are different because the cash flows are different. So I think the best I could give you is the answer that I gave you. But we do see the cost of capital compressing, as it gets much more competitive for these projects. As Ahmad mentioned, the number of really high-quality projects that are out there, people are going after them quite aggressively today.

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

Okay, that's helpful. I appreciate it. Maybe Brian, a more straightforward question here. Given the strategy to optimize NPV per watt, how should we be thinking about the retained megawatt target for 2014? And then what factors would move you to take the 100-megawatt guidance you issued a couple of months ago for next year higher?

Brian Wuebbels

Yes. I think, again, I will stick with my previous guidance, but I would tell you that the catalysts behind it are -- the math is real. And as our liquidity position, as we've talked about before, continues to build and continues to strengthen and we launch one of these vehicles, those are going to be the catalysts to allow us to accelerate that. And I think it's going to happen. It's impossible for me as the CFO of the company and Ahmad as the CEO to look at $1.97 of value to our shareholders versus $0.75 and say that's a bad idea. So it's -- the key is doing it in a capital-efficient manner and making sure the quality of projects that you put into it and we believe our underwriting is world-class is what's going to drive the lowest cost to capital on one of these public vehicles. So that's how we see it.

Ahmad R. Chatila

Yes. Maybe I'll add an example for you of how we've seen value creation just by the market changing. When we entered Canada, we did some development by ourself, but also we bought projects. And when we bought projects initially, we paid, like, $0.25 a watt. We have never shared this number, I'll share it today. We paid, like, around $0.25 a watt. Well, the module costs and the balance system costs declined very rapidly, and all of a sudden, if you want to buy a project in Canada today, it is for $1 to $1.25, sometimes even $1.50. Actually, we sold projects at those prices, and that was -- is a clear indication that when something in the economics change, the value of your pipeline changes. Our view is we have 2 strengths. We know how to underwrite projects. We have never had an abandoned project, never had a stranded project. 1,200 projects, all of them were executed and sold. And number two, we have tremendous growth engine. We are one of the most respected brands. And how do we know that this thing is changing on the yield co and the value of our pipeline is skyrocketing a little bit? It's because the demand on our projects have really gone up, shot up. All of a sudden the demand on selling projects is a lot higher than supply. And I'm now in a mode where I can sell all the projects in Q3 and Q4, Brian, I really can, easily actually, more than easily. But I don't want to do it because I can make a lot of money by injecting in the yield co. So that's how we see it.

Operator

Next, we'll go to the line of Vishal Shah with Deutsche Bank.

Jerimiah Booream-Phelps - Deutsche Bank AG, Research Division

This is Jerimiah Booream on for Vishal Shah. Just wondering if you could talk about where -- you just touched on demand being higher, and where you're seeing that demand and specifically how that can help you drive projects going forward.

Brian Wuebbels

Yes. No, great question, Jeremiah. Definitely, in the -- as we've talked about before, in the emerging markets, where solar is economical today at the delivered cost, we were seeing great progress. Latin America, South Africa, Southeast Asia, the developing countries, we've talked about the Middle East before, these are new areas that solar makes economic sense and is becoming a growth engine for our diversified business. But it's -- also, we're seeing it in the United States. We're seeing the acceleration of residential and small commercial type projects. You're seeing the DG business, as we've talked about earlier, accelerating its growth. So those are the areas that we see as being the catalyst of our future growth.

Jerimiah Booream-Phelps - Deutsche Bank AG, Research Division

Great. And maybe can we just have an update on any progress for the Samsung JV and the polysilicon plant?

Brian Wuebbels

Steady as she goes. Same thing we told you last time, the project is progressing as we said. We should get silicon out and ramp it in the beginning of next year and get to full volumes by late next year as -- the full benefit into our business by late next year, as we've discussed previously. So no change.

Operator

Next, we'll go to the line of Patrick Jobin with Crédit Suisse.

Patrick Jobin - Crédit Suisse AG, Research Division

Just first question, so as we think about the yield co structure next year, I guess, is there a right size for assets in that?

Brian Wuebbels

It's really based on cash flows, I mean it has to be of a scale, and diversity of the cash flows that would make it interesting for an investor. And I think I mentioned a number on the call. I think the minimum is like $40 million to $50 million of ongoing cash flows coming out of the yield co. So could it be bigger? Yes. Do we have the engine to drive it in the future? Yes.

Patrick Jobin - Crédit Suisse AG, Research Division

Okay. And then just a clarifying question. I guess, thanks for the color on the NPV per watt, for the $1.98 of the retained projects. Should we look at that as kind of the current mix of projects that have been retained? Or is that more incremental retained value for projects? And is there a difference between DG and as you kind of go to that flow business?

Brian Wuebbels

Yes. No, great question, actually, Patrick. What that is representative of is about 200 and I think, it's 37 megawatts of projects that we've looked at that are both 2013 -- inclusive of the 100 megawatts we've talked about in 2013 and projects that we are looking at for 2014. So it's that portfolio of projects. There is no question that there is a difference depending on the channel, right? As ASPs are higher and costs have continued to come down, you will see higher benefits in the smaller systems than you do the larger systems, there's no question. Right now, I'd tell you this is a portfolio mix, and that's how we best think it represents our very diverse portfolio of projects that we develop. But there is going to be regional and segment differences, but I would tell you that they're not dramatically different. They may move around pennies here and there, but you're not talking about moving around dollars.

Ahmad R. Chatila

It closely mimics our 3-gigawatt pipeline.

Brian Wuebbels

Yes.

Patrick Jobin - Crédit Suisse AG, Research Division

Okay. And then last question, I promise, just briefly on OpEx. Looking forward for the next few quarters, how should we expect that to trend?

Brian Wuebbels

Yes. So as I mentioned, there's probably $5 million to $8 million of cost in this quarter that I would call nonrecurring, right, non-repeating. I mentioned 2 of them. There's a few other small things. So if you take that out of the run rate, the run rate would be normally about $100 million for this quarter. That's how I would look at our actual OpEx for the quarter. And I think you should expect that, that will continue to grow. As I've said previously, you should probably expect that number to grow for next year in 15% to 20% range as we more than double our megawatts, and it could be even a little bit higher.

Ahmad R. Chatila

In preparation for 2015, which is bigger than '14.

Brian Wuebbels

And as you get to the back half of '14, you're going to see an uptick again as we prepare for '15. Thank you, Ahmad.

Operator

Next, we'll go to the line of Mahesh Sanganeria with RBC Capital Markets.

Shailender Randhawa - RBC Capital Markets, LLC, Research Division

This is Shailender for Mahesh. Ahmad and Brian, I just want to ask -- going back to the yield co. So you guys talked about projects at -- it's a portfolio mix right now, and there will be regional and size difference in the projects. But I'm wondering, for the same projects, how would you decide whether to put in the yield co or decide to sell it to a buyer.

Brian Wuebbels

Great question. Clearly, it all comes down to the value creation that we think we can get. The key for any public vehicle is to have very consistent repeatable cash flows in any yielding vehicle, so underwriting will be absolutely critical. We think we are very good at underwriting. And so it really comes down to which projects do we think fit the mix of the portfolio better in the yield co versus those that we think will sell. And again, that will change over time, but I think that's kind of -- it's -- there's not a bright line that I would tell you that says, "Oh, this one goes here, and this one goes there." It really has to do with the mix that's in there and how do you make sure you have a good diverse mix that drives the cost of capital as low as it possibly can for the yield vehicle. So that's how we look at it.

Shailender Randhawa - RBC Capital Markets, LLC, Research Division

Okay, great. And then...

Brian Wuebbels

Theoretically, all the projects could go in it, but I think what we're saying is we think our underwriting is good enough that all of our projects would go in it. It's more of a selection of which ones we put in, which ones we don't.

Shailender Randhawa - RBC Capital Markets, LLC, Research Division

Okay, got it. And then one more question. Can you talk about the gross margin in the backlog now? I mean, what is a typical gross margin for the projects that are sold right now? And then how does that compare to the projects in backlog?

Brian Wuebbels

Yes. As we've said in the last few quarters, it's in that $0.65 to $0.75 range. The example we showed here was at the high end of that range, but I would say that should be consistent. But again, the focus is more going to be on retaining some of this value versus directly selling out at a lower value.

Operator

Next, we'll go to the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank, Research Division

Just wanted to follow up there, Brian, on the SunEdison gross margin in the third quarter. Did you say it was in the mid-teens? Because with such a high ASP, I was a little surprised maybe it wasn't higher. So maybe you could talk about some of the puts and takes that happened in the third quarter gross margin at SunEdison. Maybe there were some onetime events in the third quarter that go away in the future.

Brian Wuebbels

Yes, great. Thank you, Stephen. Yes, I mean, as I said, it was in the high-teens, and it's approaching our target of 20%-plus on gross margins. You always have little nits and nats here and there every quarter. I would tell you if that -- if all perfect execution would happen, of course, we would be at our target margins. So nothing is specific. I mean, what you have to be careful of is with our broad geographic mix and regional mix, you have a lot of diversity in these projects. So a lot of smaller projects in the quarter that had high ASPs, but some of those were in Canada and they have high cost as well. So it's -- like I said before, our ASP, if I took out 1 project or 2 projects from our quarter, you can materially move my ASP by $0.10, $0.20. It really just has to do with the geographic mix and the regional mix. But nothing, Stephen, in the quarter on the projects margins to call out specifically that would say that it wasn't bad. But it's in line with our targeted 20% gross margins.

Ahmad R. Chatila

But I would say also the volume has a little bit of impact.

Brian Wuebbels

Sure.

Ahmad R. Chatila

Like last quarter, the volume was much lower so it had much significant impact. This quarter, we have higher volumes so it's much higher gross margin. When the volume stabilizes at 200 to 250, then we're closer to our target model.

Brian Wuebbels

Yes and better probably.

Ahmad R. Chatila

Yes.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Maybe as a follow-up, if I could just follow up on the SunEdison target next year of about 1 gigawatt of projects. It looks like the 2014 target might require a higher percentage of bookings to come from outside the U.S., where the markets are still developing a little bit. So I'm wondering how much confidence you have on booking those projects. Or could you maybe backfill some of that next year with more of these North American projects, where the solar project business is getting a little bit more mature?

Brian Wuebbels

Yes. Stephen, great question. We feel very confident. Our development engine in our emerging markets has really been our differentiator vis-à-vis our competition. Our first-mover advantage is in places like Latin America. We have a very strong position in South Africa. We were very well positioned there in multiple rounds of winning projects. So we feel like we have very clear a line of sight to how we're going to get to those megawatts next year by project. So it's not like we're hoping we'll get a couple hundred megawatts in a region. We know exactly what the project is. We know exactly when we expect the permit to happen, when we expect the construction to start and when we expect to deliver it. Will there be some variability? Of course, there always is week-to-week here and there, but not on the certainty. I am very optimistic about North America. I think as we continue to see the momentum building back in our DG business and our small commercial business, I'm very optimistic about what that looks like heading into 2014. And I do think you're going to see some incremental growth there beyond what we've been talking about.

Operator

Next, we'll go to the line of Shawn Lockman with Piper Jaffray.

Shawn E. Lockman - Piper Jaffray Companies, Research Division

This is Shawn on for Jagadish Iyer. Just wondering if you could talk a little bit about -- as you sort of discussed the retained value versus the sale on those slides, if you could talk a little bit about how, over the course of the year, things such as residual value may have changed as the project portfolio sort of evolved. And what kind of the variables are there that kind of -- could kind of impact that $1.97?

Brian Wuebbels

Yes. I mean, it really -- it has -- it goes back to what the PPA rates are, what the -- what markets you're in, what are your assumptions of where electricity prices are going to be in 21 years from now. So there is some variability to it. But like I said, those are the 2 biggest drivers for why we'd expect ...

Ahmad R. Chatila

Well, even in the yield co, I mean, if you think about it, you're assuming 6%, Brian, right?

Brian Wuebbels

Yes.

Ahmad R. Chatila

But today, for example, it's lower. In some places, we're seeing lower numbers. You're going to add $0.25, $0.30, $0.40, so it can't go higher because of that. Lower PPAs can make it lower. We feel comfortable with $1.97 that we're giving you right now. It's a well-thought-out number that is not high risk that we can live with.

Brian Wuebbels

Yes, and it's backed by real projects, real PPAs, real cash flows.

Ahmad R. Chatila

If our yield number is lower than the vehicle, it will be better, but we're going to stick with this number for now.

Brian Wuebbels

Yes.

Shawn E. Lockman - Piper Jaffray Companies, Research Division

Okay, very helpful. And just 1 follow-on. Could you talk a little bit about or at least provide us some kind of color on when you think this sort of -- give us an update on when this -- your target for reaching 10% operating margin is achievable? And any light you could shed there just in terms of timing on that?

Brian Wuebbels

Yes. And I think as we've talked previously about it, as we get up to the 200 to 250 megawatts range in 2014, that should be an expectation because we'll get the scale and the leverage on the OpEx that we've talked about.

Operator

Next, we'll go to the line of Edwin Mok with Needham & Company.

Y. Edwin Mok - Needham & Company, LLC, Research Division

So if I look at your presentation, 1 thing I noticed is that slide up in there, which is a slide that you guys put in for the last few quarters, right, where you talk about how much of the project expected is going to be in backlog. Looks like that percent has come down a little bit. Just 2 questions around that. One is, is it just more, call it, just DG or small commercial project that you mentioned that you expect to do? Or are you just planning on converting more from your pipeline? And is that a way to think about, longer term, how much of that should -- is from your backlog versus some of these things that can turn quicker?

Brian Wuebbels

Great questions, Edwin. My view is this is a good representation, and you nailed exactly the drivers. Clearly, our DG and small commercial type business is accelerating, and that will become a larger percentage of our total megawatts. And those things don't show up in backlog. So yes, there's a big chunk of this that we see for next year that adds on to this. The second piece is a lot of these are -- it's just timing. It is literally -- if I look at the EMEA or Lat Am, as I mentioned earlier, in that 500 or almost 600 megawatts, we know exactly what project that is and exactly when we're expecting to get the permit or the PPA signed, that would then convert it into backlog. So if you remember, our definition of pipeline is that we have the land identified, we have site control and there's a high likelihood that we're going to get a PPA signed. So we feel very good that we're being conservative in how we measure pipeline. So converting pipeline when we know exactly the project in regions like this, we feel, is a very low risk. And so I don't think there's anything here, Edwin, that worries me. I think it just shows that we have a very good and diligent process by which we don't let anything in the backlog until it's very tight.

Y. Edwin Mok - Needham & Company, LLC, Research Division

I see. Great. And then just a quick question on kind of yield co securitization, right? How do you guys think about doing the yield co versus asset-backed debt securities? And you mentioned that you might look and do them both. What will make you decide one way or the other? And what projects are included in those?

Brian Wuebbels

Yes. So I think both are required. I mean, if you can optimize the cost of capital, the lowest debt cost and the lowest equity cost in the project is the one that wins. And so having access to the public markets on both would be nirvana. I would tell you that I think the distributed generation, high-quality projects and customers really fit the securitization bill because they can be very repetitive and more standardized. And I would tell you that the yield cos, given that you needs scale, cash flows that gets the people excited about it, tend to make more sense in the medium-sized kind of projects, the larger projects. So I mean that's a general, but that's not specific. I mean, there's applicability of both in both project sizes.

Ahmad R. Chatila

I think probably the most important thing for us, the way we add on yield co, aside from the first cash flow target that we need to have, which is easy for us to do, is really that we have a growth engine behind it. And that's what makes a yield co very exciting. Rarely you'll find a company that has a development engine that can feed into yield co systematically that will drive the EBITDA multiple higher, and that's where we come in as a brand.

Brian Wuebbels

Thank you, Edwin, and thanks, everyone. Appreciate the call. Appreciate the questions today, and have a great day.

Operator

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

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