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Executives

Robert Okunski - Senior Director of Investor Relations

Julie Blunden - Vice President of Public Policy and Corporate Communications

Dennis Arriola - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Howard Wenger - President of Utilities & Power Plants Business Group

James Pape - President of Residential & Commercial Business Group

Thomas Werner - Chairman, Chief Executive Officer And President

Analysts

Smittipon Srethapramote - Morgan Stanley

Michael Horwitz - Robert W. Baird & Co. Incorporated

Constance Wang - Jefferies & Company, Inc.

Kelly Dougherty - Macquarie Research

Sanjay Shrestha - Lazard Capital Markets LLC

Steven Milunovich - BofA Merrill Lynch

Unknown Analyst -

Robert Stone - Cowen and Company, LLC

SunPower (SPWRA) Q1 2011 Earnings Call May 12, 2011 4:30 PM ET

Operator

Good afternoon, and welcome to the SunPower Corporation First Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Bob Okunski, Senior Director of Investor Relations at SunPower Corporation. Sir, you may begin.

Robert Okunski

Thank you, Holly. I'd like to welcome everyone to our First Quarter 2011 Earnings Conference Call. On the call today, we will start off with Tom Werner, our CEO, providing an overview of our first quarter performance and the Total investment announcement we have made earlier this quarter, followed by Dennis Arriola, our CFO, who will review our first quarter financial results and discuss our Q2 and 2011 guidance. We will then open up the call for questions. We have allotted 30 minutes for today's call and a replay will be available later today on the Investor Relations page of our website.

During today's call, we will make forward-looking statements subject to various risks and uncertainties that are described in our 2010 10-K, as well as in today's press release. Please see those documents for additional information regarding those factors that may impact these forward-looking statements. To enhance this call, we have also posted a set of PowerPoint slides, which we will reference during the call on the Events and Presentations page of our Investor Relations website. In the same location, we have also posted a supplemental data sheet, detailing some of our historical metrics. On Slide 2 of our PowerPoint presentation, you will find our Safe Harbor statement.

Our prepared remarks will run approximately 15 minutes, which will allow time for 15 minutes of questions. With that, I'd like to turn the call over to Tom Werner, CEO of SunPower, who will begin on Slide 3. Tom?

Thomas Werner

Thanks, Bob. And thank you for joining us today. We are pleased to report that we met our gross margin and EPS goal from Q1 as we navigated the changes and market conditions in Italy.

Our downstream vertical integration allows us to manage our panel allocation geographically and across our end channels, using our demand driven manufacturing strategy, we plan to reduce inventory levels in Q2 as we execute our adjusted plans. Under the new Italian decree, SunPower is very well positioned to take advantage of the uncapped rooftop market in both Italy, both this year and next year.

Our network of approximately 500 dealer partners in Italy commands the number 2 position in market share. However, the new Italian decree is unfavorable in the long-term for large ground-mounted power plants. Our Italian power plants in construction will be complete before the end of August and we expect to monetize our Italian development pipeline. We will allocate less product to power plants in Italy and increase allocation to the Residential and Commercial business. We will provide you with the detailed view of our reallocation and monetization plans when we host our revised 2011 guidance call before the end of the second quarter.

As we mentioned on our last call, we're continuing to execute on our plan to rebalance our UPP business to focus on the North American market starting this year. An example of our success is our 250-megawatt California Valley Solar Ranch power plant, which met 2 key milestones in the last couple of months. In April, we received final county permit approval for the project by unanimous vote both the planning commission and the board of supervisors.

In addition, we were pleased to host Secretary Chu's announcement of DOE's $1.2 billion loan guarantee conditional commitment for CVSR, a key milestone to beginning construction in the second half of 2011. Secretary Chu made the announcement at the April dedication of our 75-megawatt Silicon Valley solar panel manufacturing facility where he was joined by California Governor Brown who signed the state's landmark 33% Renewable Portfolio Standards Bill. This RPS Bill expands the value of our extensive pipeline of UPP projects in North America beyond CVSR.

Now let me turn to our operational performance in Q1. Accelerated cost reduction is our top priority and I am pleased to report that we exceeded our manufacturing cost reduction targets in all fabs for the quarter. Specifically, we once again exceeded our targets in fabs 1 and 2 with record sell outputs, overall equipment effectiveness, and yields. We are also making significant progress on reducing our raw material costs. The automation of our back-end processes in fab 2 is complete and our step reduction programs remain on track for 2012 implementation.

Fab 3 also exceeded our expectations on key operational metrics. We will be operating our fabs on a demand driven basis and expect inventory to decline as we execute on our plan to reallocate panels across markets and channels. In summary, we remain on track to meet our panel costs plan of $1.08 per watt on an efficiency adjusted basis in the fourth quarter of this year. Let me spend a moment discussing the planned transformational investment in SunPower from Total that we announced last month.

As we mentioned in the announcement, SunPower has been considering strategic options to accelerate our growth by structurally improving our balance sheet.

In parallel, Total has been seeking a growth engine within the solar sector for several years and it chose to invest in SunPower's technology and strategy. Total's long-term disciplined investment horizon will support our plans to build significant value for our shareholders. Total's rationale for the transaction demonstrates our strategic alignment. They are investing in the highest efficiency, highest reliability solar panels and systems as well as our people, vertical integration and downstream footprint.

Total's $1.3 billion investment in SunPower demonstrates their confidence in our cost reduction roadmap. Together we have a complementarity vision on what it takes to be a long-term winner in this industry. A $1 billion credit support agreement with Total will improve our cost of capital and make available restricted cash and cash collateral that currently resides on our balance sheet. In addition to the credit support agreement, there are other synergies between Total and SunPower, including R&D and Total's global market footprint.

With respect to timing, Total's tender offer was initiated on May 3 and the transaction has already received clearance to proceed under U.S. antitrust regulations. The EU antitrust clearance is still pending. Any further updates on this transaction will be provided through SEC filings as appropriate.

In summary, with Total's global presence and credit support, we plan to accelerate our growth plans in the increasingly competitive solar sector. With that, I would like to turn the call over to Dennis who will discuss our Q1 financial performance in greater detail, provide our outlook for Q2 and some comments about 2011. Dennis?

Dennis Arriola

Thanks, Tom. Please turn to Slide 4. Our first quarter results can be categorized by those things we could not influence and those which we could. The delayed feed-in tariff decree in Italy, was one of those things where we could not influence the timing or the eventual outcome. As a result, overall revenues for the quarter were impacted as customers awaited clarity in Italy, which delayed projects and pushed out some sales in systems.

In spite of the uncertainty in the market, we had solid results and recorded revenues of $451 million, a 30% increase above Q1 of 2010, but short of our original target range at the start of the year of $475 million to $525 million. Megawatts recognized in revenue for the quarter increased 43% to 133 megawatts from 93 megawatts in the first quarter of 2010.

The U.S. was our most active market with nearly 1/3 of overall revenues and megawatts in the quarter. Our business segment, our Utility and Power Plant group or UPP recorded revenues of $246 million in the quarter, up nearly 71% over the comparable period last year. The majority of the quarter's revenues were recorded in France, Italy, Canada and the United States.

In our Residential and Commercial Business group, revenues were up slightly to $206 million from $203 million in last year's first quarter. We experienced strong growth in terms of both megawatts in revenues in the U.S., primarily fueled by our growing backlog of business in our North American Commercial group. Non-GAAP gross margin on a consolidated basis was 20.3%. and within the range we provided for the quarter. UPP's gross margin of 18% was impacted by both mix and delayed system sales in Italy.

In the R&C segment, gross margin improved to 23.1% in the quarter versus 21.3% in the fourth quarter of 2010 as we benefited from stronger sales in the U.S.

Operating expenses was an area where we could influence the outcome and we moderated our spend rate given the market conditions. For the quarter, operating expenses on a non-GAAP basis were $70.5 million compared to $80.2 million in the fourth quarter of 2010. We'll continue to actively managed our variable expense base going forward, but we will also continue to invest in our important Research and Development and Operation groups, which will drive our cost reduction roadmap.

Other income and expenses on a non-GAAP basis for the quarter was a $12.8 million expense and was more favorable than our original [ph] plan. Our non-GAAP tax rate for the quarter was 14.4%. And for the quarter, we earned $0.15 per diluted share on a non-GAAP basis, which was consistent with the guidance we've previously provided and better than the $0.05 per share we earned in the first quarter of 2010.

Turning to our GAAP financial results. We recorded a $0.02 per diluted share loss, which was favorable relative to our previous guidance. In the first quarter of 2010, our GAAP earnings per share results were positively impacted by a $31 million tax benefit. So from an operational perspective, the first quarter of 2011 was solid despite the uncertainty caused by the Italian market.

Let me now briefly discuss our balance sheet and liquidity position. We ended the quarter with $671 million of cash and cash equivalents. And our inventory levels were higher than planned at $487 million at the end of the quarter due to the lower than anticipated revenues and more favorable yields and output from our fabs in the Philippines and our JV fab in Malaysia.

As Tom mentioned, we're focused on reducing our inventory levels and are modulating our future manufacturing output to closely align to demand signals in our pipeline and the market. Capital expenditures in the first quarter were $45 million and we contributed $20 million of capital to our fund to fund our share of the Malaysian JV with AU Optronics.

Please turn to Slide 5. While the change in the Italian feed-in tariff is still being digested by the market, we're also taking this opportunity to further analyze the environment to decide how best to take advantage of the new reality. As a result, we're in the process of determining how much of our product will be reallocated from our UPP group to our Residential and Commercial group where we can deleverage the uncapped rooftop market in Italy, a market segment where our high efficiency technology has a clear differentiated advantage.

We expect our second quarter revenues to be in the range of $500 million to $550 million and for megawatts recognized in revenue to be in the range of 160 to 190 megawatts. We're also analyzing the optimization and distribution of products for the remainder of 2011 and are looking at different scenarios to maximize our margin contribution from our different downstream channels and geographic markets.

We continue to expect our 2011 megawatt shipments to be in the range of 825 to 920 megawatts for the full year. We'll provide you with additional details on Q2 and revised 2011 guidance reflecting the impact of the recent solar policy changes in Italy once we complete our analysis by the end of the second quarter. With that, I'll hand it back to Tom.

Thomas Werner

Thanks, Dennis. We'll now open the call to questions. In addition to myself, we have Howard Wenger, President of our Utility and Power Plants Group; Jim Pape, President of our Residential and Commercial segment; Julie Blunden, our EVP of Public Policy and Corporate Communication; Chuck Boynton, Vice President of Finance and Corporate Development; and Bob Okunski, our Senior Director of Investor Relations. And we're going to answer questions for a short period of time so we really would like to stick to one question each please and if possible we'll get you back in queue since we're going to have a follow-up call very soon. So let's go and go to questions Bob and Holly.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jesse Pichel.[Jefferies & Company]

Constance Wang - Jefferies & Company, Inc.

This is Connie Wang for Jesse. Can you please give us a more regional breakout of your European exposure in Q1 by country, if you may have it and how would this trend for full year '11?

Thomas Werner

Sure, Connie, I just want to make sure I got your question. You want regional breakout of revenue for Q1 and how it looks going forward?

Constance Wang - Jefferies & Company, Inc.

Right, by country, if you may have that. Specifically Italy, Germany and France.

Thomas Werner

Okay, so Dennis can take that.

Dennis Arriola

Yes, Connie, let me tell you overall by revenue for the first quarter, the United States was our largest market with, as I said, with over 1/3 of our overall revenues. The next largest market was Italy with about 17%, followed by France with about 16%. Those were our 3 largest markets.

Thomas Werner

And go forward?

Dennis Arriola

And going forward, the United States is going to be both from a Residential and Commercial and a UPP will be one of our largest contributors. Germany and Italy and France, we're actually going through the process right now of trying to determine how best to reallocate those products. So we don't have a specific number for you. But I can tell you that all 3 of those markets, we think, especially driven by the rooftop market will be good for us in the second half of the year.

Constance Wang - Jefferies & Company, Inc.

Okay, great. If I may ask a quick follow-up, can you give us an idea of when we may expect the Total transaction to close?

Dennis Arriola

Yes. This is Dennis. It has to stay open for 20 business days, so assume that's the end of this month, here in May, and then depending upon the -- when we get the European approval, probably talking about sometime in June.

Thomas Werner

Yes, I'd like to remind everybody, since we have a short period of time for call, please if you have a follow-up, take it back in the queue.

Operator

Next question comes from Sanjay Shrestha. [Lazard Capital Markets]

Sanjay Shrestha - Lazard Capital Markets LLC

Quick question. Can you talk about sort of the growth prospects that you guys see in Japan in light of the recent unfortunate events and what the policy shift seems to be there?

Julie Blunden

Sure, Sanjay, this is Julie. Certainly, the Japanese nuclear disaster has fundamentally shifted their outlook on the opportunity for renewables to play a substantial role in their long-term energy policy, and we are fortunate to be in a good position to start in Japan with our partner Toshiba and feel well positioned to support the Japanese people as they look to increase their power supplies rapidly to accommodate the reduction in nuclear capacity.

Operator

The next question comes from Rob Stone. [Cowen and Company]

Robert Stone - Cowen and Company, LLC

I know you're not giving a full year update yet but if you could just comment on Q2 conditions with respect to pricing, and in which markets do you see the best demand this quarter?

James Pape

Yes, Rob. This is Jim Pape. I'll take that one. First of all, Q1 was good for us, low single-digit decline. Clearly, there's pressure in the markets going forward. We're going to keep managing price to keep our value proposition fresh, using mix, regional mix and revenue stream mix. We think we can still, at least in R&C, I'm confident that I can continue to produce in accordance with my original plan and the big markets for Q2

[Audio Gap]

[Technical Difficulty]

Robert Stone - Cowen and Company, LLC

Okay. You were just about to say which markets look good for Q2.

Thomas Werner

Yes, sorry about that. We obviously have a communication issue. So it would be fair to say Italy, Germany and U.S. are the strong markets in the second half of this year. All 3 are doing very well for us, particularly the rooftop, Residential and Commercial market. Policy in Europe has clearly moved to a rooftop market. That's our heritage by virtue of PowerLight, and so it's moving to a strength and so we feel very positive and we're allocating more product to Jim Pape's channel. So I'd say those 3 countries in that market segment.

Robert Stone - Cowen and Company, LLC

I was specifically asking though about this quarter, Tom.

James Pape

Q2, will indeed be about -- Q2, Rob, will be exactly the same answer. It's about the German demand going into the midyear, FiT, it's about Italian resurgence and it's about continued strength in North America.

Operator

Michael Horwitz.[Robert W. Baird]

Michael Horwitz - Robert W. Baird & Co. Incorporated

Have you started to see or did you even see in the last few months disintermediation amongst tier 2 and tier 3 players as prices have come down quite a bit and perhaps their product isn't as welcome in the marketplace?

Thomas Werner

Yes, Michael, in our core business of -- our core Rooftop business, things ran according to plan. The one exception being the Commercial business in Italy, Commercial Rooftop business in Italy did pause. But that pause is ending and that business is coming right back. Worldwide, things went flying in the Rooftop business with the exception of that period in Italy. As we mentioned in our remarks, in the large-scale systems, we do see the policy environment not being favorable in the long-term, in the short-term we're going to monetize the project. And worldwide, things are going great in that channel. And as I look at other customer remarks and other things going on in the channel, I think it's not, I would say it's not materially inconsistent like you suggested. In other words, yes.

Operator

The next question comes from Kelly Dougherty. [Macquarie Research]

Kelly Dougherty - Macquarie Research

Just a question about the inventory. How much of that do you think is just what you built up for the project business, and then how much just due to the general slowdown? And how do we think maybe about the impact of underutilization in the second quarter as you work through that?

Thomas Werner

Sure, Kelly. So first of all, we are going to reduce our inventory over the next couple of quarters. That is a priority for the company. The inventory build is really 2 things. It's finished goods affected by seasonality, which we always have but on top of the seasonality, it's the pause in the European large-scale projects that we maintained optionality during that pause, that pause ended up being longer than they projected. Therefore, across the quarter boundary, so there are a few projects that we were in the process of building that held inventory. That's a primary driver of our inventory. The secondary one would be inverters. We over-ordered inverters in the second half of last year and will work our way through that inventory over the next couple of quarters. Obviously we're not buying more inverters and we will be working off that inventory and that will happen over the next couple of quarters. In terms of factory utilization, we should be fine. According to our current plan, it's straightforward for us to modulate module production to the degree needed. Note that we're forecasting materially the same output in Q2 that we had previously. And that we plan on running our fabs per plan. So I've got nothing to guide you on in terms of material absorption issues -- I mean factory absorption issues.

Operator

The next question comes from Smitti Srethapramote.[Morgan Stanley]

Smittipon Srethapramote - Morgan Stanley

I just wanted to follow-up on the Italian market. How many of the 130 megawatts of projects that you had put on hold do you think you can get completed before the grace period expires on August 31. And when you spoke about reallocating modules from the UPP business to the rooftop market in Italy, will you be reallocating the modules from the Italian UPP business or the U.S. UPP business?

Howard Wenger

This is Howard Wenger, I'll take the question. We're going to -- our current plan is to complete 2 projects that we currently have under construction already by the end of the August period. And they total approximately 15 megawatts in size, that's per plan. We do plan on monetizing the rest of our pipeline in Italy either through the sale of permits alone or permits plus equipment. And in terms of reallocation, I'm going to let Tom answer that question.

Thomas Werner

Yes, so the reallocation, Smitti, is only Italy -- Italian projects we might have built that we're not going to or that we're not going to monetize with modules. UP -- our Utility scale projects in America are on plan, we're ahead of plan and we will have actually more modules going to those projects. It's strictly Italy and projects reallocation.

Operator

Alan Rush [ph]

Unknown Analyst -

This is actually Brandon Molarfer [ph] Calling. The question that we have is, I guess, how do you expect your relationship with Total to evolve in terms of gaining access to developing countries and managing relationships with governments around the world.

Thomas Werner

Of course we're in the planning stage. We're pretty closed, and when we had our call 2 weeks ago, we talked about already there were a couple such opportunities. There's now more than 5 of those. The idea would be again planning that they have a strong presence on 130 countries. They would bring opportunities to us. We would also identify countries where we would like to proactively go sell and have a stronger presence. We will then capitalize on their presence in those countries where we will let them know what are the appropriate people that we want and need. The presumption is in most of those markets we are going to have those relationships, and so far, so good, in terms of planning. So we're still in the process of identifying exactly how that's going to work but it's actually going faster than we originally thought, and it looks like it's going to be pretty straightforward.

Operator

Steve Milunovich.[BofA Merrill Lynch]

Steven Milunovich - BofA Merrill Lynch

I didn't see the cost per watt in the quarter. Could you provide that and could you also provide some anecdotes perhaps of your customer partner and particularly employee reaction to the Total deal?

Thomas Werner

Sure. I'm going to let Dennis take the first question, I'll answer your second one and wrap up the call. Let me answer the second one, the employee reaction to Total was really interesting, Steve. We put a lot of effort into our communications because we wanted our employees to react to data and not rumor and innuendo and emotion. And they did a wonderful job of that and they see the opportunity for us to take the solar industry to that mainstream stage and how radically transformative this is because they are well aware of the fact that it takes a lot of capital to develop projects and to build factories. So I think our employees were readily able to see the financial benefit. Then they heard about R&D and they heard about other parts of the value chain in the 130 offices. So they all felt great about that. There was a little bit of concern of gee it would be great if it wasn't an oil company and we pointed out to our employees, it's an energy company and it's an energy company that definitely is in the Oil and Gas business but they're taking oil and gas money and they're putting it into solar and what could be more transformational and direct than that. Our employees thought that was great. Sure, there's probably a couple of -- a minority of employees who are still troubled. But by far, the vast majority see the value of this transaction and see it for the way we've communicated. I appreciate that question. Dennis, for you, cost and...

Dennis Arriola

Yes, on the cost per watt we're at $1.68. And we're basically on plan to meet our end of the year target.

Thomas Werner

Let me wrap up the call. I appreciate everybody for dealing with our communication issue in terms of the phone lines. The good news is that we're going to have a follow-up call very soon. We're going to go into more detail then. We really appreciate your time, SunPower and Total, as we pursue this transaction. We feel very good about our future. And particularly positive about how things are going in the rooftop business, both the Residential and Commercial. More on that on our next call. So thank you very much.

Dennis Arriola

Thank you.

Operator

Thank you. This does conclude today's conference. You may disconnect at this time.

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