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Canadian Solar Inc.(NASDAQ:CSIQ)

Q4 2013 Earnings Conference Call

March 5, 2014 8:00 AM ET

Executives

Ed Job – Director of Investor Relations

Shawn Qu – Chairman, Chief Executive Officer and President

Michael G. Potter – Chief Financial Officer and Senior Vice President

Analysts

Colin W. Rusch – Northland Capital Markets, Research Division

Paul Coster – JPMorgan Securities LLC

Philip Shen – ROTH Capital Partners, LLC, Research Division

Aditya Satghare – FBR Capital Markets

Patrick S. Jobin – Credit Suisse Securities

Timothy Lam – Citigroup Inc, Research Division

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Canadian Solar Fourth Quarter and Fiscal Year Earnings 2013 Earnings Conference Call. My name is Lacie, and I will be your operator for today. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your hoist for today, Mr. Ed Job, Canadian Solar's IR Director. Please go ahead, sir.

Ed Job

Thank you, Lacie, and welcome everyone to Canadian Solar’s fourth quarter and fiscal year 2013 earnings conference call. Joining us on the call today are Dr. Shawn Qu, our Chairman and Chief Executive Officer; and Mr. Michael G. Potter, Senior Vice President and Chief Financial Officer.

Before we begin, may I remind our listeners that in today's call, management's prepared remarks will contain forward-looking statements, which are subject to risks and uncertainties, and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1997. Actual results may differ from management's current expectations and, therefore, we refer you for more detailed discussion of the risks and uncertainties in the company's Annual Report on Form 20-F filed with the Securities and Exchange Commission.

In addition, any projections as to the company's future performance represents management's estimates as of today, March 5, 2014. Canadian Solar assumes no obligation to update these projections in the future unless otherwise required by applicable law.

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

Shawn Qu

Thank you, Ed, and thank you all for joining us on the call today. We are very pleased with our results for the fourth quarter, which capped a year of many successful accomplishments that positioned as well for the future.

Importantly, during 2013, we have returned the company to profitability and significantly strengthened our balance sheet. Established a track record of success in utility-scale project development from greenfield origination, permitting, financing to final and customer delivery, and successfully repositioned us as a leading provider of total solar energy solutions and Tier-1 brand name solar modules.

We also increased our pipeline of late-stage solar project to approximately 1.3 gigawatts, mostly in low-risk countries, expanding our business visibility well into the future. Our results for the year underscore the successful execution of our strategy to extend our higher margin total solutions business, which contributed 28.6% of total annual revenue in 2013 compared to 11.5% in 2012.

At the same time for our module business, we are focused on profitable growth, providing high quality product rather than competing for volume at unattractive prices and at expense of product quality. And even so we have been share risk-taking customers. We were able to shift close to 1.9 gigawatt compared to 1.5 gigawatt in 2012, maintaining our position as the world third largest manufacturer of solar modules.

In the fourth quarter of 2013, our revenue and gross margins exceeded our guidance. We achieved gross margin of 19.5%. We shift approximately 621 megawatts, comfortably exceeding our shipment guidance of 480 megawatts to 500 megawatts for the quarter.

From a geographic standpoint, we saw strong demand from China, which represented 43% of our shipment volumes in the quarter. Japan, U.S., as well as other emerging markets in Asia, total made significant contributions to our shipments in Q4. As we have previously discussed, demand in Europe has been relatively weak due in part for the European economic environment and policy and in part due to negative impact of the solar trade dispute settlement. As a result, we have reduced our exposures to Europe, during 2013 and shifted our focus to more attractive rapidly growing emerging markets.

Let me now provide the highlights of the progress we are made in our total solutions business. In Q4, we completed the sale of one utility-scale solar project plant, two in Canada valued at over C$61million to TransCanada. Our backlog of late-stage solar project and EPC service contracts in Canada, now totaled around 477 megawatt. This represent an estimated revenue opportunity for over US$1.7 billion. Once the projects are built and connected to the grid 2014 and 2015.

In Japan, we expanded our pipeline of late-stage solar projects to 329 megawatt DC. All of these projects have the massive feed-in tariff approval and are in Stage 1, 2 or 3 of the utility connection approval process. We expect to start building our first solar power plant in Japan in third half of 2014.

In U.S, our project pipeline at the end of Q4 totaled 164 megawatts. Finally, in China, we completed the constructions of two solar power plant totaling 14 megawatts, and we expanded our late-stage pipelines to 219 megawatts. In total, our global utility-scale pipelines including owned our joint venture project, as well as EPC and service contract now stands at approximately 1.3 gigawatt.

In addition, our early stage solar project pipeline, now totaled over 3.2 gigawatt. We expect a good portion of these to turn into a successful project over the next two to three years. Our project development team continues to work hard as the evaluating and developing opportunities across many geographics in the world.

Clearly in 2013, we make significant progress in our business transformation from a pure module manufacturer into a provider of solar energy solutions.

The total solutions business requires a unique set of capabilities that are not easy to replicate, including specialized skills in project development, permitting, EPC and investment banking. As a result, we believe that this space is a lot less crowded than the module manufacturing space and provides us with the right platform to power our profitable growth in the years ahead.

In support of our planned growth, we raised approximately US$255.7 million in net proceeds in the first quarter of 2014, through our concurrent offering of common shares and convertible bonds. We plan to use the proceeds to expand our module business by seeking profitable growth opportunities in existing and emerging markets.

To further expand the total solutions business this includes the ability to hold quality solar power generation asset for relatively a longer period of time in order to demonstrate the performance of these assets. This will allow us to seek more attractive excess strategies and evaluation, and to selectively expand our manufacturing capacity in order to catch the demand for our solar module products.

Now, let me comment on our guidance for Q1 and full-year 2014. We expect Q1 shipments will be in the range of approximately 470 megawatts to 490 megawatts. Revenue for the first quarter of 2014 is expected to be in the range of US$415 million to US$413 million. We continue to see strong demand for our product, as the seasonality in Chinese market more than compensated by the demand from Japan and U.S.

Our revenue and gross margin in the first quarter of 2014 were adversely affected by the severe winter conditions in North America, which delayed project constructions and delayed approximately $100 million of revenue recognition from our project business to future quarters. We expected gross margin in the first quarter of 2014 is adversely impacted by approximately 1% due to the reason reported fire incident at our cell plant in Suzhou, we expect to fully recover losses from our property and business interruption insurance in later quarters.

For the full year 2014, we expect to further growth of our annual module shipments to the range of 2.5 gigawatt to 2.7 gigawatt, including 400 megawatt to 500 megawatt through our own projects. In addition, we expect to build and hold up to 250 megawatt of project assets by the end of 2014. We expect to increase our annual revenue to approximately US$2.7 billion to US$2.9 billion, which approximately – with approximately 50% of the revenue coming from our total solutions business.

The Company's Canadian and U.S. project revenue recognition is expected to be back-end loaded in 2014 due to permitting schedule and construction schedule as well as US GAAP accounting rules which, for most the Canadian project, allow revenue recognitions after commercial operation date and the transfer of ownership to the end customers.

The estimated commercial operation date of all of our late-stage project at disclosed in this press release in order to provide better granularity to investors.

Now, let me turn the call over to our CFO, Michael Potter for a more detailed review of our financials. Michael, please go ahead.

Michael G. Potter

Thank you, Shawn. Net revenue for the fourth quarter of 2013 was $519.5 million, up 5.8% sequentially and up 76.2% compared to the year ago period. Gross profit in Q4 was $101.3 million, compared to $100.2 million in Q3 and $14.9 million in the comparable period of last year. The sequential increase in gross profit was primarily due to increased module sales and lower warranty costs that listed the gross margin of our pure module business.

Gross margin in Q4 was 19.5% compared to 20.4% in Q3 and 5% in the fourth quarter of 2012. This comfortably exceeded our original guidance of 13% to 15% primarily driven by the recognition of the Mississippi Mills project sold to TransCanada and by the lower warranty costs by mentioned.

Operating expenses were $56 million in Q4, compared to C$44.9 million in Q3 and C$106.4 million in the fourth quarter of 2012. Interest expense in Q4 was $9.9 million compared to $11.8 million in Q3 and $9.9 million in the comparable period last year. The sequential decrease in interest expense was primarily due to lower bank charges in Q4, 2013.

Interest income was $2.8 million in Q4, compared to $2.7 million in Q3, and $3.7 million in the year ago period. In Q4, we recorded a gain in the fair value of derivatives of $8.9 million compared to a loss of C$1.6 million in Q3 and a gain of $2.3 million in Q4 of last year. Net foreign exchange loss in Q4, was $18.5 million compared to a net foreign exchange gain of $2.3 million in Q3 and a foreign exchange loss of $10.8 million in Q4 of last year.

Income tax expense in the fourth quarter of 2013 was $3.7 million compared to an income tax expense of $12.4 million in Q3 and income tax benefit of $3.3 million in Q4 of 2012. Net income attributable to Canadian Solar shareholders for Q4 2013 was $20.9 million, or $0.39 per diluted share, compared to a net income of $27.7 million, or C$0.56 per diluted share in Q3, and net loss of $105 million, or $2.43 per diluted share in Q4 of last year.

Moving on to the balance sheet. In Q4, cash and cash equivalents decreased to $228.3 million at the end of Q4 compared to $273.7 million at the end of Q3. The restricted cash balance was $451.2 million at the end of Q4, up from $408 million at the end of Q3. Our accounts receivable balance, net of allowance for doubtful accounts was $280.7 million at the end of Q4, up from $271.8 million at the end of Q3. Inventories increased to $231.2 million at the end of Q4, compared to $220.6 million at the end of Q3.

Short-term borrowings at the end of Q4, totaled $778.5 million, down from $801.6 million at the end of Q3. Long-term debt at the end of Q4 was $151.4 million, compared to $190.5 million at the end of Q3. Total net debt at the end of Q4 was down to $250.5 million compared to a total shareholder equity of $401.5 million. Short-term borrowings and long-term debt directly related to utility-scale solar power projects totaled $201.9 million at the end of Q4.

On February 18, 2014, we closed a concurrent offering of approximately 3.2 million shares and US$150 million of convertible senior notes and received net proceeds of approximately US$255.7 million. This significantly improves our financial flexibility. We kindly use the proceeds for general corporate purposes, as described by Shawn earlier.

We’ve been working on potential securitization vehicle, such as the yieldco. We’re focusing on local solutions for local problems with a goal of recycling equity investments into our projects as fast as possible will maximize in returns for our existing shareholders. We have opened the partnering with others, where that approach makes the most sense.

Our basic model remains build and sell for solar power plants, and some geographies may require a longer holding time once the project is built. We would hold and operate solar power plants as a business if the cost of capital was appropriate and the returns justified it. I do want to address a few housekeeping items for your reference, after the offering, and without the effect of the newly – new convertible senior notes, the basic share count is approximately 54 million shares.

On an as – on an if converted basis, the convertible senior notes would add approximately an additional 3.3 million shares and employee stock awards and options would add approximately 3 million more shares to a potential total of 60 million shares if considered on a fully diluted basis.

We’ve also picked up some new analyst coverage and we’ve been discussing our project business with investors for sometime. We try to put a lot more detail into our press release this time to make it easier to forecast our business.

As shown by the COD timing of our Canadian projects, the majority of revenue from them is expected in the second half of 2014. Our combination of permit timing and harsher than normal weather this winter has pushed a few projects later into this year.

In summary, we are very pleased with the progress we've made in the transformation of our business from a pure module supplier to a provider of solar energy solutions. In 2013, we returned Canadian Solar to profitability, generated approximately $229.5 million in cash from operations, and significantly improved our balance sheet.

Clearly, Canadian Solar is coming out of the recent downturn as a strong leader. We believe we’re well positioned and we are focusing on delivering profitable growth in the quarters ahead.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Colin Rusch with Northland Capital Markets. Please proceed.

Colin W. Rusch – Northland Capital Markets, Research Division

Thanks so much, guys. Can you talk a little bit about the strategy with these projects in China and this potential yieldco? What are the dynamics around monetizing those projects right now in terms of timing? And what kind of structures are you exploring in terms of floating a yieldco potentially?

Shawn Qu

So the first thing in order to do a yieldco you would have-to-have sufficient project assets and we wouldn’t have sufficient assets to consider until probably near the end of this year or perhaps the beginning of next year. And the main consideration of why you would want to do a yieldco today is the prices available in the end market are not as good as what you can get from holding in operating the project longer-term.

The returns aren’t as good for selling the project versus keeping them. It’s always possible a year from now so there will be enough good end buyers that have entered the market that building and selling will make logical sense. Right now it doesn’t appear to be so, so we’re looking at various ways that we could do a securitization and recycle the equity.

The most directing way would be to do with yieldco not that’s really a yieldco it is more like a growth IPP where you have listed on a stock market and then used that offering to return the equity to the development part of the company and hold an operate the projects long-term.

So that would be probably the main way we would be looking at doing it, but there are other ways potentially that could come up in China as there are different financial products that could possibly want to hold and own the projects with us.

Colin W. Rusch – Northland Capital Markets, Research Division

Great. And then can you talk a little bit about the seasonality on the model shipments and your full-year guidance? The full-year guide implies that you're going to be running well ahead of capacity. So could you walk us through what’s impacting the seasonal decline in module shipments in 1Q? And how you expect to be able to get to those higher shipment modules or the module shipments as we go through the year?

Shawn Qu

Hi, Colin, this is Shawn speaking. Now first of all for China, Q4 China experienced an exceptional high year end rush and the demand for solar modules and continued almost through last week of the – of Q4. Now for Q1, there is no such year end rush, but the normal module demand in China is still going. So I don’t see as a downturn just a return to normal after a year end rush.

However, we are in a year end rush for Japan, because Japan's fiscal year will end on March 31. As you know, we are the largest non-Japan brand name in Japan, operating the Japanese market. And U.S. market is also quite strong in a way that we put – we have to shift some of the shipment with China customer end of last year. So this year – this quarter we start to put more emphasize to Japan and also to U.S. customer.

However, as you know, the first week of February is Chinese New Year, and so the volume is down a lot, up or down a lot during the Chinese New as usual. And also, because this quarter we are shipping more to U.S., and so the shipping time, the boat time is around four weeks then we have to ship clear to customer, ship modules to the customer site.

So which means the module shipment in March will usually only become revenue for the U.S. if it ships for a U.S. customer in Q4. So the factory is very busy, still very busy right now. We see that continued to be very busy into Q2, but just because the change of geographic shift - shipment pattern and also the effect of Chinese New Year. So that the module shipment member looks low in Q1, but I don’t think that reflect any overall weakness of the market.

Now, in terms of the total capacity that we can produce over 200 megawatt of solar module every month right now. And we’re increasing that capacity further more. So that by I think starting from Q2, our annual capacity will be 3 gigawatt for the molecules.

And which means the quarter production capacity we will be some were around 700 megawatt to 800 megawatt. So the capacity is there and I believe the market and market demand is also there for us to reach the shipment numbers.

Colin W. Rusch – Northland Capital Markets, Research Division

Great and just a couple last ones before I hop back into queue. Can you just quantify the impact of the models that will be in transit impacting 1Q? And then if you could talk a little bit about pricing dynamics right now and then the potential for cost improvements on your non-silicon costs as you go through out this year is there a particular target that you guys are looking at by the end of 2014?

Michael G. Potter

Colin, we don’t really do forecast for Q2 during this call, we just talk about Q1. So Shawn just describe the dynamics in Q4 you could ship all the ways to the end of the quarter and recognized because you shipping the clients inside China which are very close. Whereas you don’t have the same luxury this quarter.

So we normally do have a down Q1 compared to Q4 that is normal seasonality, and that the ship from Chinese demands, overseas demand there is reason why if a little bit more pronounced for us this quarter versus other quarters. And Shawn, if you want to address the other part of the question about the costs.

Shawn Qu

Colin, we just had a little bit more color to what Michael just said. These days our production volume is about 200 megawatt per module for a mile as I said. So that works out to be roughly 6 megawatt or 7 megawatt per day. And Chinese New Year like holidays roughly when we the production level in that one week is very low. In 2007 three of that one week are the official holidays, so we don’t operate and the other days the production volumes are low, because a lot of operators go back to home. So we’ve reduced the shift. And with the same number, I mean 6 megawatts to 7 megawatts per day, you can somehow estimate the impact of or the effect of longer shipping distance at the end of Q1.

Now talking about the pricing environment, there is no significant change in terms of pricing. The – in Japan just came back from the [indiscernible] in Japan. In our case the pricing is stable and in the Japanese yen term we actually move up a little bit. But I do see low price competition going into Japan and I don’t want to name the company, but indeed there are some companies shipping low price in Japan. But they operate in a totally different market segment than us.

So I don’t see our Japanese market share price getting that much influence by that kind of competition. And U.S. market, the price is slightly moving up this quarter. However, as you know, the wafer price also inched up a little bit. So the net effect should be the same, and China pricing is also more or less holding steady.

Colin W. Rusch – Northland Capital Markets, Research Division

Great. I will take the questions off-line. Thanks.

Shawn Qu

Thanks, Colin.

Operator

And our next question will come from the line of Paul Coster with JPMorgan. Please proceed.

Paul Coster – JPMorgan Securities LLC

Yes, thanks for taking my questions. And perhaps first you can talk a little bit about the 250 megawatts of projects that are being built and to hold into presumably 2015. Can you tell us what the criterion for selecting those projects were, what the mix is by geography to the extent you can share that? And to what extent we might see more of this moving forward and hence or changes to our expectations for the year?

Shawn Qu

Hi, Paul, this is Shawn speaking. For all of our Canadian – existing Canadian pipeline, we’re pretty much viewed as sell. So that we will have a very quick cash return. For the Japan projects by the end of this year we probably have over longer megawatt project in construction, but actual COD number will be very less than that. So in Japan our current model is to work with the local partners, for local job manager. So for the Japan project, we may – there maybe as the job manager partner either a minority or majority partner for those projects.

And so for the 250 megawatt build and expect to hold at the end of the year will mainly refer to China, because we see that, we think that the exit strategy or the business strategy for China will be different that the strategy will be viewed in that project, high quality of projects and then established the year of track record, including the electrically generation and cash payment track record and then to seek for exit strategy at which Michael already commented in this speech.

Michael G. Potter

And just as an accounting note, which Shawn described what we were doing in Japan with quite likely result in a sale transaction. We simply would work with local partners in order to acces the low cost of capital in Japan.

Paul Coster – JPMorgan Securities LLC

All right thank you. Now, Michael, I am new to the stock, as you know, so I'm a little bit surprised by the big foreign-exchange impacts on the translated results. I am curious on a number of levels here. First of all, did FX benefit or hit the gross margin and operating margins? And moving forward what can you do to mitigate the effects of FX fluctuations on reported results?

Michael G. Potter

So the – the first thing is that we are impacted by Canadian dollar and by Japanese yen is the two main currencies, and also RMB, the U.S. dollar is somewhat as well, the yen and the Canadian dollar both reaching against the U.S. dollar, which caused most of the fluctuation in the quarter. You can see that we do hedge, so we hedged almost half of the impact. And earlier this year actually we were more exposed, because we didn’t have as much hedging lines available but with our return to profitability or increase cash flow.

Hedging lines are now much more readily available, so we’re able to hedge more effectively and get more of it hedged. It does not impacts the gross margin immediately, what it dose to over time is example in Japan, we sell in yen. So if the yen depreciates against the dollar and the yen selling price stays stable, it has the impact of lowering ASP over time. However, like Shawn noted, with the yen depreciating and a lot of cost in solar being non-yen, the prices in yen are starting to come up. So over time that will also correct itself.

Paul Coster – JPMorgan Securities LLC

Okay. And then two quick questions perhaps for Shawn. The first one is going back to the cost of production, can you talk a little bit about the overall – your expectations for system-level cost decline year over year in 2014 and even in 2015 on a like-for-like basis? And the other question is, to what extent is the ITC review of imports panels into the U.S. impacting you if at all?

Shawn Qu

Yes, Paul. Well, the – in terms of cost, the system cost is consisting – consists of the module cost and other BOS cost. For the module cost if we used wafer and produced cell, a module cell, then the manufacturing cost – few manufacturing cost being and Q4 is almost $0.48. But if we use kind of – the Taiwanese solar cell and produce modules for Japan, for example, then the cost will be roughly $0.06 higher for that portion. So the blended cost will be I believe for Q4 is like $4.50, that will be the blended cost. And so based on that number, the EPC – pure EPC costs if in both U.S. and China is somewhere around US$1.5 for loss, somewhere in that range. And Japan is higher and Canada so far is higher, because it requires local content.

Now turn to the ITC decisions. Right now ITC and DOC are just exactly the case starting investigation. And so, the first stage staff are the DOC preliminary rulings on AD and CVD. And finally is the ITC final ruling, which will be at the end of this year. And from our point of view, we believe this particular petition, yes, doesn’t have any base, and I’m very fortunate to see it happen that the whole U.S. solar in metric may get hijacked.

And now in our case, our – the – we do have a module factory in Canada, which has 500 megawatt capacity. And we can or have or be able to allocate capacity for the U.S. market from Q4 this year. And so that will be, I believe that will give us a better way to handle the situation even under the worst scenario.

Now, also you may notice that, let’s say out of the 3 gigawatt, 2.5 gigawatts or 2.6 gigawatts for 2014, the U.S. shipment will be probably less than 20%. So even the U.S. shipment volume is affected and going down because of any anti-dumping duty effect I believe that volume can be picked up from other markets.

Paul Coster – JPMorgan Securities LLC

Thank you.

Michael G. Potter

Just to clarify Shawn said $0.40 at the beginning for internal cost, he meant $0.50.

Shawn Qu

$0.50.

Michael G. Potter

If we surely the purely internal processes it’s closer to $0.50. And when you purchase cells, particularly Taiwanese cells and blend it altogether, it goes more than $0.53 or $0.54.

Paul Coster – JPMorgan Securities LLC

Shawn didn't actually answer the question of how we expect the price to decline year-on-year. But I can take that off-line if necessary, but can you answer that?

Michael G. Potter

We don’t expect there to be a large amount of price pressure during the year, that’s effective more by geographic mix. So the prices in a market like China, for example, tend to be lower. So if you ship more to China, your overall ASP comes down.

Paul Coster – JPMorgan Securities LLC

No, my bad, I meant cost – how do you see the cost of the system per watt going down year-on-year?

Michael G. Potter

Modules, which we control more directly maybe a couple of pennies down by the end of the year, we’re pushing hard to get the cost down there. Overall balance of system, prices have been relatively stable, they went down quite a bit the last couple of years, and then recently they have somewhat stabilized. Honestly a big savings could be in the area of soft cost in some markets such as the U.S. are very legal intensive and the permitting costs that’s can be quite expensive so there is a lot of area to improve in terms of the soft cost in some geographies and we do see some movement inverters and some movement in other areas as well, but not as much as the last couple of years.

Paul Coster – JPMorgan Securities LLC

Thank you so much, very helpful.

Michael G. Potter

Thank you, Paul.

Operator

Our next question comes from the line of Philip Shen with ROTH Capital. Please proceed.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Hey, guys, thanks for taking my questions. I would like to start off with Japan. I believe you have 13 projects totaling approximately 25 megawatts slated for completion in 2014. Can you share with us who some of the buyers might be and also talk perhaps about what the system ASPs are that you are expecting in the region?

Shawn Qu

Yes, Philip, indeed we have 20, 40 [ph] megawatts, which show expected 2014 COD. Those projects are expected to go to all the permitting in the first half of this year. So we should be able to get started some of the project very soon. I will comment now who are the partner and customers, we are working with some Japanese customers, but we are also working with at least a one international fund managers who we have a long relationship who is very interested in moving towards Japan. Now because – we haven’t closed the JV contract or cell project yet, I can’t really provide the selling price. So just stay tuned.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Great. And Shawn can you share what kind of system ASPs are that you are expecting?

Shawn Qu

That would be the selling price, which were not in a position to share right now, it’s a little bit too early in our negotiations and we are talking to several different parties right now. So we are trying to be a little bit quieter on that. We expect the margins of the projects to be good and we’re hoping to be at least as good as our Canadian projects.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Okay, great. And in terms of China, how many megawatts do you see in commercial operation possibly in 2014?

Shawn Qu

Well, as we have said in the press release, our target is to build and hold up to 250 megawatt at the end of this year. And permitting lines, we have access to more permits than this, but I do want to cherry pick the good quality of project to viewed rather than doing the gold rush. So I’m going to take reasonably aggressive approach, but I’m not going to be that aggressive as some of my competitors. So my target is up to 250 megawatts. But, of course, with our cash position, we can do more if indeed good – more good opportunities for our labs.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Great.

Michael G. Potter

So we have about 40 megawatts of operating solar projects we completed in 2013. So if you add that to 250, we’ll have close to 300 megawatts by the end of 2014.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Okay, thanks, Michael. Let's talk about capacity. You mentioned your plans to expand module. Can you give us some more color on your use here? We’ve seen some of your competitors make some moves by acquisitions and JVs. Are you guys contemplating capacity expansion in wafer or cell? And how would you go about doing it if so, would it be by acquisitions or do you prefer to expand via greenfield operations?

Shawn Qu

Yes, Philip, we are now contemplating any expansion on wafer side. For the solar cell we are targeting another manufacturing base in which the first half we’re putting one line, 60 megawatts. But that base will allow us to ramp it up increased capacity to 300 megawatt if we wish within a short time. But we haven't finalized that decision yet.

And on the – meanwhile we have worked on some good partnerships with some large scale cell only players in China and those people will produced cells according to our design, according to our sale patents. And in some cases, we provide what wafer and we supervise their production process.

So that will allow us to meet the module demand with out putting too much of our own cash into the module into the solar cell capacity increase. On the module side and we’re adding capacity here in China, so that we will soon achieve 3 gigawatt per year module capacity.

Philip Shen – ROTH Capital Partners, LLC, Research Division

Great, thanks. One last question and I will jump back in queue. Can you talk about what your CapEx plans are for 2014 in light of some of this capacity expansion? And if you could split it out between maintenance versus expansion CapEx that would be helpful. Thank you.

Michael G. Potter

Modules will be about $12 million to $15 million potentially $30 million or $40 million on sell capacity and maintenance CapEx could be another $10 million or so.

Operator

Our next question comes from the line of Aditya Satghare – FBR Capital Markets. Please proceed.

Aditya Satghare – FBR Capital Markets

Thank you, I had two questions. Going back to your earlier comment where you talked about, Shawn, you mentioned that your plan to be selective in terms of the number of projects you develop in China and then you compared that to some of your competitors, they have much larger targets. So in that context maybe – can you talk about some of the attributes of what one used to watch out for when developing projects in China? And do you expect to see any change in the type of buyers who eventually buy these projects?

Shawn Qu

That’s a good question, I guess we adopted this strategy because we already have a well diversified global portfolio so we can afford to be global rather than put the basket all the actually one basket and them the China Project certain criteria, for example, we want to search our final price was good changing condition and the reasonably good feed-in tariff level. It has to be close to the grid point, and you better have a flat land rather than on our heels.

And also the some arrangements with utility also make a difference and so over risk have impact and another factor will be a understanding of the grid expansion plan and also the – how many PV plants may be permitted in the next few years, because you may get into a place, where you have enough line capacity if we review the project. But three years later, the government, local government permits too many projects then you may have grid congestion. So those are all the issues.

And one potential issue of building solar projects all around China, and China is a big country, is that maintenance is – can be a headache or a issue, it allowed us, because you think about it, 20 years, right, and each projects, 10, 20, 30 or 40 megawatts, and you have to deal with all the local grid, so and all the local grid operators.

So all of these are factors to be considered, and I think it takes time, it’s prudent to move in an aggressive or not too aggressive step. So we can learn by walking before when you run, so that’s my philosophy. And then like Shawn said at the beginning, we have the luxury of having a very good pipeline outside of China, so we don’t have to put all of our eggs inside one basket and we can be a lot choosier about what projects we do.

Aditya Satghare – FBR Capital Markets

My second question is on China. China is becoming an increasing part of the [Indiscernible]. Can you just touch on the local market price environment and how we should think about that as [Indiscernible]?

Shawn Qu

The pricing environment in Q4 is reasonable. We are selling at a belief roughly $0.52 to $0.53, sorry, I got it wrong again, and it’s $0.62 to $0.63 range – in that range. But it's – we used all the local sourced local materials and local shipping. So the margin is not too bad. And the – fro Q1, the margin we haven’t seen too much change on the module price. I guess it is because – maybe it's partially, because we have other markets like Japan market, U.S. market to balance it.

So we don’t have to go for the low price orders. So we haven’t seen in all order we haven’t seen that much price change in China. However, cash flow as you know, you probably already know that, many Chinese customer demand say 10% – 5% or 10% retainers for a year or even 5 years as a qualitative retainers. So that going to hurt peoples capital and if people just want shoot for volume. So we are very careful there. We typically want to minimize it and even to eliminate that.

Aditya Satghare – FBR Capital Markets

Great, thanks. Thanks for all of the color, thank you.

Shawn Qu

Thank you.

Operator

And our next question comes from the line of Patrick Jobin with Credit Suisse. Please proceed.

Patrick S. Jobin – Credit Suisse Securities

Hi, good morning, thanks for taking the question. First, Michael, how do you expect your cash flow to evolve throughout the year if you retain more projects? Just want to get a sense of percent equity investment you expect as you potentially leverage some of those projects up. That would be helpful, thanks.

Shawn Qu

Typically you can leverage 75% as a worth on, so 75% of the cost you can bore on and 25% is your equity. So as a rule of thumb that’s the way to look at it, to build 250 megawatts in China the cost inside China that’s part of our plan and part of the reason why we did the capital rise. Also, our cash flow generation is sufficient to support as well. The majority of our operating cash is going to come in the second half of the year from our normal operations. First half of the year will be a lot of financing cash flow as we ramp up construction and put assets into our project asset part of our balance sheet.

Patrick S. Jobin – Credit Suisse Securities

Great. Second question, then I have one more, just a housekeeping item. But if we look at OpEx, it kind of came above at least sequentially in Q4. How should we expect that? Should we expect leverage in the model or should we think about that as a percent increase year over year or what is the best way to look at OpEx in 2014?

Michael G. Potter

There is going to be leverage in the model through 2014, our revenue will grow faster than our operating expenses as a percentage of – as a percent of revenue to go down. There was close to $4 million write-off of some mono-crystalline furnaces that we’re selling. So that also impacted our G&A expenses in Q4.

Patrick S. Jobin – Credit Suisse Securities

Okay, that makes sense. And last question just housekeeping, can we back into gross margin for module sales in Q4, so stripping how to systems business, and is there…

Shawn Qu

We said it’s going to between 13% to 15% it was at the higher end of that range in Q4.

Patrick S. Jobin – Credit Suisse Securities

Okay. So modules were at 15%. And is there a way to break out for the systems revenue the contribution from large projects versus residential kits?

Michael G. Potter

Typically our Canadian projects are about between 20% to 25% growth margin and the kits now are not too far away from 20% growth margin so there is not too much of difference between them.

Patrick S. Jobin – Credit Suisse Securities

Okay, and on the revenue front, I just want to make sure I am doing the math correctly as far as revenue that is in that systems line from kits. Thank you.

Michael G. Potter

So the system kits was I think you are about 10 megawatt in the quarter or 12 megawatts in Q4 and they were 20-ish odd million dollars with the revenue may be and the rest of the revenue came from larger scale project.

Patrick S. Jobin – Credit Suisse Securities

Okay thank you very much.

Operator

And our final question will come from the line of Timothy Lam with Citigroup. Please proceed.

Timothy Lam – Citigroup Inc, Research Division

Thank you taking my question. I have two questions about the Japanese [indiscernible]. Firstly, I think you mentioned about the cost in China. Would you mind to share with us what you see in terms of the total installation cost in Japan and whether the Company will have a full engineering team to approach this Japanese new installation? And the second question is in terms of [indiscernible] for the new projects in Japan, opportunity in China, is there any guidance on the required IRR the Company will be looking for? And the last question I have is the Company will look into entering business into some of these new emerging markets such as the EMEA areas? Thank you.

Shawn Qu

Yes, hey, Tim this is Shawn speaking. First of all for Japan, we have over 100 people local Japanese team, 100 people around 50 to 100 people on the solar project side. We have own EPC managers and engineers. Of course, we also for the detail design we ask the local design firm to do it. And then our team will leverage the local sub-contracts to do the EPC just tracking construction work.

And for the EPC cost in Japan, really Japan depend on what type of project it is and now we are using – typical using like $2, $2.50 as a budget estimate for now. But it really depends on small project and large project the different land type all those variables are those factors. So that’s on the Japan. And what’s your question Tim?

Timothy Lam – Citigroup

The next question is – is there any particular guidance on – when you look at these projects develop whether you do these projects required IRR to look at these projects.

Shawn Qu

All right its on IRR right. Okay. For the China projects typically our model shows and leverage IRR around 9% to 10%, but then leverage are we’re depend on leverage ratio, but I should emphasize, that all modules seem to be conservative than some of our peers module. We do factoring for example in the performance ratio, which we will try to take into consideration for let’s say weather conditions does our occasionally – occasional breakdown. You merger off time all those factors.

So our number maybe we also factoring learning curve, so our number maybe conserving and I’ll hope that all our project actively beat our models just like what, what we have did in Canada. And for Japan we’re not also for China, but IRR and also Japan what IRR use base interest rate of these days that I think that 6.55, but the interest where maybe on right. So for the 10 years, 15 years loan the interest they could different, so we’re conservatively in considering all those factors.

And for Japan IRR can be higher considering the lower financing cost, much lower financing cost in Japan, and now for you talked about the yen right and for those regions we do have personal volume in Europe, we’re look into European project, our European team there, and looking into European projects and there are some interesting project opportunities in Europe.

And for Middle East, we have a team in located in Dubai and we’re actively looking into those opportunities in those areas.

Michael G. Potter

And you’ve already seen as reported in the past module sales in that area and typically module sales of the Vanguards are doing project business.

Timothy Lam – Citigroup

Thank you.

Operator

This concludes our question-and-answer portion for today’s call. I would like to turn the call back to management for closing comments.

Shawn Qu

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

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may all disconnect. Good day, everyone.

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