First Solar, Inc. (NASDAQ:FSLR)
2017 Guidance Conference Call
November 16, 2016 16:30 ET
Steve Haymore - Investor Relations
Mark Widmar - Chief Executive Officer
Alex Bradley - Chief Financial Officer
Andrew Hughes - Credit Suisse
Tyler Frank - Robert W. Baird
Colin Rusch - Oppenheimer
Vishal Shah - Deutsche Bank
Philip Shen - ROTH Capital Partners
Paul Coster - JPMorgan
Jeff Osborne - Cowen and Company
Julien Dumoulin-Smith - UBS
Brian Lee - Goldman Sachs
Cynthia Motz - Williams Capital Group
Edwin Mok - Needham & Company
Good afternoon, everyone and welcome to First Solar’s 2017 Guidance Conference Call. This call is being webcast live on the Investors section of First Solar’s website at firstsolar.com. [Operator Instructions] As a reminder, today’s call is being recorded. I would now like to turn the conference over to Steve Haymore from First Solar Investor Relations. Mr. Haymore, you may begin.
Thank you. Good afternoon, everyone and thank you for joining us. Today, the company issued a press release announcing updates to its Series 6 roadmap, restructuring of operations resulting from the acceleration of that roadmap, updates to 2016 guidance as well as guidance for 2017. A copy of the press release and the presentation are available on the Investors section of First Solar’s website at firstsolar.com.
With me today are Mark Widmar, Chief Executive Officer and Alex Bradley, Chief Financial Officer. Mark will first discuss the technology updates and operations, restructuring. Alex will then discuss the updated guidance for 2016 and 2017 guidance. We will then open up the call for questions.
Most of the financial numbers discussed on today’s call are based on U.S. generally accepted accounting principles. In the few cases where we discussed non-GAAP measures such as non-GAAP EPS, we have reconciled the non-GAAP measures to the corresponding GAAP measures at the back of our presentation. Please note 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 statements contained in today’s press release and presentation for a more complete description.
It’s now my pleasure to introduce Mark Widmar, Chief Executive Officer. Mark?
Thanks, Steve. Good afternoon and thank you for joining us today. Turning to Slide 4 and 5, I will begin by highlighting the important announcement we made today regarding the acceleration of our Series 6 product roadmap. This is a significant development that we believe will greatly enhance our competitive position in the coming years.
As we have indicated on our Q3 earnings call, we have been extensively evaluating the best competitive response to address the current challenging market environment. As a result of this analysis and following the review progress with our Board of Directors, we have decided to undertake the decision that will accelerate Series 6 production into 2018, a year earlier than we previously communicated. We believe that the Series 6 module will have an advantage combination of high efficiency and low cost and a balanced system compatibility that combined will differentiate it from other module technologies in the market.
One of the key factors enabling the pull forward of the Series 6 technology is that we are able to use existing manufacturing infrastructure. When we introduced Series 6 at our Analyst Day in April, we believe Greenfield factories will be necessary to deploy this technology. However, as we continue our Series 6 development, we have determined that will be beneficial to change the leading edge orientation of the module in the manufacturing process. This change reduces the Series 6 manufacturing footprint to be consistent with existing factories and thus enables the faster technology deployment at a lower CapEx and risk profile than originally envisioned. To create the fastest path to the market for Series 6, it requires that we begin to phase out our Series 4 production and cancel plans for our Series 5 product. Simply stated, the best use of our factory space is to produce Series 6, our lowest cost and highest efficiency product.
Our Series 5 module with its larger form factor was positioned to significantly reduce balance of system cost as compared to Series 4. However, the challenge is required to enable the larger form factor resulted in a Series 5 module cost per watt to be in slightly higher than Series 4 which has proven to be prohibited in the current low ASP environment. We are aggressively pursuing Series 5 cost reduction opportunities, but without enough success to justify continued development. Combined with the accelerated development of Series 6 and the benefits of reusing our existing manufacturing space, the decision to bypass Series 5 and go directly to Series 6 became clear.
Regarding Series 4, we will begin phasing out the production later this year and the process will continue across our manufacturing lines over the course of 2017 and 2018. Unfortunately, these decisions will impact the number of our valued manufacturing associates. While such decisions are very difficult and not taken lightly, they are necessary and best positioned First Solar for a long-term growth with the most competitive technology available to us.
Turning to Slide 6, I will touch upon the market factors that are resulting in the need to restructure operation and also help put our 2017 outlook into perspective. From the demand side, there are several dynamics impacting our current competitor situation. The lower demand in China in the second half of 2016 has been one of the key catalysts of the recent module pricing decline. With the feed-in tariff structure that was stepped down after June 30, there was a tremendous rush to ship modules in the first half of the year. The spillover effect of this has rippled through the international markets over the past several months and has resulted in tremendous downward pressure on ASPs.
Looking forward, there maybe additional pressure on global demand resulting from the Chinese National Energy Administration’s proposal to lower the [indiscernible] installed 2020 solar target from 150 to 110 gigawatts. Effectively, this potential reduces annual China demand through 2020 from 20 gigawatts to 9 gigawatts a year. On the supply side of the equation, decisions like competitors to maintain or increase production levels in the face of demand headwinds has only added to the pricing pressures. Over the course of 2016, we have seen over 20 gigawatts of capacity additions by module manufacturers with cell and module capacity ramping outside of China this year, the declines in the U.S. ASPs have been more rapid than in international markets as module manufacturers have sought ways to circumvent existing tariffs and duty structures. And recently, there have been signs of some stabilization. However, it’s unclear if this will persist or it’s only temporary pause before further price declines.
Pricing pressure has not only been on modules. We continue to see PPA pricing reach new lows, particularly in the international markets based on bids by developers that may prove to be uneconomical. How long such behavior may persist is unclear. As we take into account all of these market factors, the decision has become clear to us is the need to deploy our cost advantage Series 6 technology as quickly as possible. We feel strongly that our Series 6 modules provide a path for long-term growth and attractive returns even if today’s challenging market conditions continue.
Turning to Slide 7, I will highlight the advantages of our Series 6 module. One main advantage of Series 6 is the ASP entitlement potential, which is driven by the higher conversion efficiency and inherent energy yield advantages of our thin-film cad-tel technology. While Series 4 also has an energy yield advantage versus crystalline silicon, the smaller form factor creates a higher BoS cost. Year-to-date, the value of energy yield has been greater than the higher BoS cost. However, as crystalline silicon bins have recently increased led by multi-perk and the availability of more competitively priced mono cells in some cases, the Series 4 energy value is less than the incremental BoS cost.
With the larger form factor Series 6, the incremental BoS cost is eliminated and therefore creates an incremental ASP value of $0.06 versus Series 4, for example. At launch, we expect the Series 6 module to have an efficiency of greater than 18% and exceed 420 watts per panel. When both the energy yield and efficiency advantages are taken together, we believe this will entitle Series 6 to a price benefit relative to market pricing of crystalline silicon whether multi or mono-perk technologies.
Turning to module manufacturing costs, the chart also shows the relative cost of our module technology using Series 4 as the baseline. Our Series 4 thin-film cad-tel manufacturing process requires fewer and less costly inputs, fewer process steps, less labor and less capital end-to-end than computing silicon technology. However, in recent years, our competitors have squeezed their supply chain and manufacturing costs, reducing our relative cost advantage. Additionally, as mentioned previously, the smaller Series 4 form factor relative to other module technologies does not allow us to realize the full value of our technology. While the Series 5 concept addresses the product form factor challenge, the core module manufacturing costs remains unchanged relative to Series 4, while the incremental cost of adding rails to enable an overall lower installed cost made the product economics challenge in today’s low ASP environment.
The clear choice for our long-term competitiveness is Series 6, which realizes a drastic reduction in overall manufacturing costs through factory and product formatting scaling. Series 6 provides the manufacturing cost of approximately 40% lower than Series 4, while eliminating any significant form factor difference. This dramatic reduction in expected module cost is a function of a larger form factor enabling higher throughput and a lower CapEx per watt. As stated in April, we expect the Series 6 CapEx to be around $0.40 per watt for Greenfield sites, that’s approximately 40% lower than a Greenfield site for Series 4. Today with the reuse of existing factories, which in total can accommodate up to 5 gigawatts production, we believe we can achieve a CapEx profile of up to 25% lower than a Greenfield investment. In many regards, our transition to larger glass size in the manufacturing is analogous to similar transitions that have been made in the thin-film display manufacturing and have resulted in dramatic reductions in display cost per square meter while simultaneously building larger and higher performance displays. Thin-film manufacturers are unique in this regard, whereby factory scaling intrinsically reduces costs. Value efficiency and low costs are powerful combination which we believe placed us an impact of differentiation from other technologies and create the highest module margin entitlement in the industry.
Slide 8 addresses the availability of Series 6 and contains our updated production roadmap, including a 3-year view of the expected transition from Series 4 to Series 6. Firstly, note that one impact of the Series 6 pull forward is that 2017 production will be lower than previously communicated. We expect approximately 2.2 gigawatts of production next year versus over 3 gigawatts this year. We will begin taking higher cost or higher production offline this year in order to commence work on a pilot line. Then over the course of 2017 and ‘18, we will continue to phase out Series 4 production while Series 6 production ramps. We now anticipate up to 1 gigawatts of Series 6 production in the second half of 2018 compared to our prior Analyst Day roadmap, which did not achieve the first Series 6 production volume until 2019. The 2019 volumes in the prior road map were less than 1 gigawatt versus the more than 3 gigawatts we now expect. Note, from a cost per watt perspective, we now expect 2019 module cost to be approximately 40% lower than the 2019 blended cost presented in our 2016 Analyst Day.
In addition to deploying Series 6 on our existing Ohio and Malaysia factories, we are also considering using our factory in Vietnam that was constructed but never utilized. While we have an international manufacturing footprint, Ohio will continue to be our innovation hub, representing the state-of-the-art in cad-tel research and development. Following our ramp of over 3 gigawatts of Series 6 production by 2019 and subject to market conditions, we expect our focus to turn to growing and scaling our business. Slide 9 is similar to the view we provided in our Analyst Day highlighting the incremental contribution margin that can result as we grow.
As a reminder, with an OpEx profile that is largely fixed in nature, we anticipate we would be able to support additional gigawatts of sales with relatively small incremental investment. The resulting benefit in this example is the operating margin could be expected to expand meaningfully. With Series 6, we feel that we will be in the most competitive position, a position of strength to grow the business and realize the benefits of scale. To recap, we feel strongly that we are at an inflection point to add an even greater strength to our competitive position over the next 3 years as we deploy our Series 6 technology. Having carefully evaluated this technology, we believe it is the lowest CapEx per watt, the fastest payback and the highest return of capital any solar technology available, including our own Series 4 and Series 5 products. We feel strongly this is the right decision and are moving rapidly to execute on this opportunity.
Alex will now review the updated 2016 guidance and discuss 2017 outlook.
Thanks Mark. Before discussing our revised 2016 guidance, I would like to briefly add to Mark’s comment on initiatives we have announced today. As the management team and Board reviewed the strategic alternatives to move the company forward, it became clear that accelerating Series 6 and saving out the Series 4 product was the best choice for the long-term. We carefully evaluated the capital requirements necessary to undertake this plan and are very confident we can execute on our strategy while maintaining a strong balance sheet. The return of the Series 6 program is highly attractive and represents prudent deployment of capital. The ROIC on the investment exceeds our WACC and we believe that we can achieve the payback time between 2 years to 3 years, even if challenging market conditions persist. We continue to operate in a disciplined manner focusing on the objectives of growth, profitability and liquidity which we expect to continue to benefit our shareholders.
On Slide 11, we summarized the pretax restructuring and asset impairment related charges, expected to impact our 2016 financials, resulting from the Series 6 acceleration. Keep in mind that a significant majority of these charges are non-cash in nature. Firstly, we expect asset impairment charges between $475 million and $585 million. These charges comprise of asset impairments for our current Series 4 production equipment as well as the write-off of store tools in certain Series 5 equipment. Also included in this total are our open purchase orders of Series 5 equipment, which may result in cash charges of $50 million to $70 million. Secondly, a potential non-cash goodwill impairment of up to $80 million is included and is subject to valuation during our year end close process. Thirdly, included in our restructuring charges are severance costs of $10 million to $15 million. These charges will be incurred primarily in 2016, but a portion will fall in 2017. This includes charges for our factory employees that will be impacted this year and next as we take down Series 4 production.
In addition, given the challenging market environment and the lower megawatt sales volume next year, we are reducing our workforce across all corporate functions. While these decisions are never taken lightly, they are necessary in order to transition to the Series 6 platform as quickly as possible and in order to best position the company for the long-term. Fourthly, other charges of between $15 million and $20 million are related to shutdown of Series 4 equipment and will fall primarily in 2017. Note that these latest restructuring charges are in addition to those previously announced related to our TetraSun and EPC organizations. And finally in Q4, we expect to distribute between $700 million and $750 million in cash to the U.S. from a foreign subsidiary, primarily in order to fund Series 6 CapEx for our Ohio factory as well as to fund the restructuring of domestic operations. As a result, we anticipate a tax expense charge in the range of $220 million to $250 million. While the P&L impact from distribution is large, the cash impact is relatively small, approximately $10 million through the effective utilization of U.S. tax attributes. Note this action does not have any impact on our tax holiday in Malaysia.
Continuing on to Slide 12, I will discuss the impact of these charges in our 2016 guidance. Our net sales and gross margin guidance for 2016 is unchanged and not impacted by any of today’s announcements. Operating expenses on a GAAP basis have increased to a revised range of $965 million to $1.16 billion, resulting from the restructuring and asset impairment charges announced today. Tax expenses and updated to include a charge from the distribution of cash to the U.S, partially offset by the tax benefit associated with other restructuring items. The effect of these changes results in a revised GAAP loss in the range of $4 to $2 per share. On a non-GAAP basis and excluding restructuring and related items, our operating expenses, operating income and tax expense guidance is unchanged. The only non-GAAP update is to our earnings per share range, which has increased by $0.30 to $4.60 to $4.80. This increase stems from the inclusion of the sale of our entire 34% interest in Stateline, which has now been approved by our Board.
Transitioning now to 2017 on Slide 13, I will discuss our guidance assumptions for the upcoming year. Please note that these assumptions do not reflect the adoption of the new revenue standard, which we expect to adopt early in Q1 of 2017. We continue to evaluate any impact of this and update our guidance of an adoption. Several factors are combining to make 2017 a challenging year. In the U.S., with the previously anticipated ITC expiry, many projects will pull forward into 2016. While the ITC was later extended given the timeline of U.S. project development, there were limited options for increased systems business in 2017. Internationally, systems opportunities have proven to be very challenging from a PPA pricing perspective. In addition, the recent module ASP environment has also reduced margins in the module business. These elements combined with the product transition we are announcing today combined to make 2017 a challenging year that we do not believe is reflective of the longer term earnings potential of the company. It’s important to keep this in mind as we discuss the 2017 guidance.
Additionally, following the recent presidential election, some uncertainty has risen around federal programs benefiting the renewable energy development in the United States such as the ITC. While we believe that existing federal programs supporting solar power are sound and should remain in effect to their full term, any longer term impacts for such programs will not be known at least until the energy and tax policies of the new administration are established.
Starting with production, our output next year is expected to be approximately 2.2 gigawatts with a lower volume compared to 2016 resulting from taking Series 4 lines down in preparation for the Series 6 transition. Our entire 2017 production will be our Series 4 products. Our fleet average efficiency is projected to be 16.9% next year, a slight increase from our expected 2016 exit. With the phase-out of our Series 4 manufacturing, we are focusing on incorporating further efficiency improvements into the Series 6 launch. For this reason, our fleet efficiency will remain relatively flat during the course of the year.
As Mark highlighted, Series 6 module efficiency is expected to be over 18% at launch with more upside in the future. Our 2017 volume shipped is expected to be between 2.4 and 2.6 gigawatts, including 2016 inventory rollover of approximately 400 megawatts. Consistent with the statements made on our recent earnings call, we expect to ship between 600 and 700 megawatts to systems projects. This range includes contracted projects and the one awarded project, but it is expected to book in the next few months. Note that this range does not include the Moapa project and the first phase of the California Flats project as these project shipments are largely complete. The remaining 1.8 to 1.9 gigawatts is comprised of module-only sales. Our 2017 revenue guidance assumes the sale of the Moapa and California Flats projects, which will drive a higher systems mix. Systems revenue including O&M is expected be 70% to 75% where the balance comprised of third-party module sales. And highlighting our continued manufacturing improvements, our module cost per watt for 2017 is expected to decline 9% versus the current year.
On Slide 14, we provided to view our future project pipeline in order to further highlight projects we will be shipping to in 2017 and those projects with deliveries beyond this horizon. Regarding 2017 projects, the timing of shipments does not always correspond to the timing of revenue recognition. We anticipate the number of systems megawatts recognized to be higher than the shipment range due to the timing of the Moapa and California Flats sales. Beyond 2017, we are encouraged that we already have PPAs in place to projects totaling approximately 1.3 gigawatts DC. In addition to this contracted pipeline, we have a late-stage pipeline in Japan of up to 200 megawatts. While this Japan pipeline has 6 feed-in tariff arrangements, it’s not yet included in our contracted volume and in the completion of certain development activities, including interconnection agreements. Our product development teams, both in the U.S. and internationally, continue to work diligently to secure additional PPA opportunities in this timeframe, but we believe this provides an important start to our systems business in these years.
On Slide 15, we have an updated view of our operating expense profile that we anticipate for 2017. As we prepare to enter a year with lower megawatt volumes and more challenging margins on module sales, it has become imperative to lower our OpEx. We are attempting to reduce OpEx from 2016 to 2017 by over 20% to a targeted midpoint of $290 million. This breaks down to approximately $95 million of R&D, $185 million of SG&A expense, and $10 million of plant startup. Note that, despite the reduced R&D spend, we are keeping in place all the necessary personnel and resources needed to meet our Series 6 targets. Altogether we expect to be able to reduce OpEx as a percentage of shipments from 2016 to 2017 despite the drop-off in volume to be shipped. This reflects our focused efforts to control costs.
I will now cover the 2017 guidance ranges on Slide 16. Our net sales guidance is between $2.5 billion and $2.6 billion, with a gross margin percentage between 12.5% and 14.5%. As indicated, 2017 revenue includes the Moapa and California Flats projects. The low expected gross margin percentage range is due to the low gross margins on the aforementioned projects as well as low gross margins on the – of those low module ASP assumptions. Operating expenses are expected to range between $280 million and $300 million with the midpoints of R&D, SG&A and plant start-ups discussed previously. The resulting non-GAAP operating income is expected to be $40 million to $80 million, resulting in earnings per share between breakeven and $0.50. Note that our projections include net interest expense of approximately $20 million and minimal ad contribution from equity and earnings.
Turning to cash, we expect operating cash flow to be between $550 million and $650 million. Stronger cash flow relative to earnings is due to the sale of the Moapa and California Flats projects. The cash outflows to construct those projects were largely incurred in 2016. Capital expenditures in 2017 are projected to range from $525 million to $625 million, including approximately $500 million for Series 6 equipment. While this is a sizable investment, as we highlighted earlier, we believe there is a high return on this invested capital. While the operating cash flow largely offsetting our CapEx, the ending net cash balance in 2017 is expected to be between $1.4 billion and $1.6 billion. Despite the sizable CapEx requirements enable the Series 6 transition, we are confident that our balance sheet will remain in a very strong position at the end of next year. In terms of the financing cash flows, we expect debt to increase by approximately $250 million in 2017. The additional debt will be non-recourse project level funding for projects in construction, primarily in Japan and Australia.
So in summary, while 2017 will be a transition year for First Solar, we are confident in the decisions we are making. We believe that Series 6 has the greatest combination of value and the return on investment of any solar technology available. We have the financial resources, technology expertise and discipline necessary to deploy this technology. And we continue to operate in a disciplined manner remaining focused on the objectives of growth, profitability and liquidity.
With that, we conclude our prepared remarks and open the call for questions. Operator?
Thank you. [Operator Instructions] And we will take our first question today from Andrew Hughes with Credit Suisse.
Hey, guys. Thanks for the question. On 2017 CapEx, I think I heard $500 million in Series 6. That sounds like 1.6 gigawatts on your $0.30 a watt number, so just curious if that’s right and how – why it takes so long for that production to sort of show up? And then also in terms of the cost trajectory towards 2019 on Series 6, you guys highlighted 9% down for next year. Is that sort of linear to that 40% overall reduction we can expect in 2019 or what does that trajectory look like? Thanks.
Yes, I will do the CapEx and then I guess the timeline around Series 6 and then I think Alex can handle the cost per watt, the 9% decline in the cost per watt. Yes, I think the reasonable zone as it relates to the production. So, we have always said before maybe a little bit more transparent, so $0.40 a watt is what we said the CapEx would be for Greenfield and we communicated it in my section, I think that it will be 25% lower, so it’s actually that says $0.30 a watt, so if you are $500 million at $0.30, it’s going to get you kind of 1.5-gig type of number. So, you are pretty close to your estimate. In terms of the timeline, look, this is – first off, there is a process of ramping down the existing production. So, we are going to start here in Perrysburg and we are going to ramp down the existing production. So, we have got to ramp down everything we have here. We have to clear the floor, right and then we have to start bringing in the tooling for the new production and that’s going to take time. So, there has been lead times around that. And the various pieces will come together at various points of time and we will probably have the front-end of the line up and operational before we have the back end of the line up and operational. But what that allows us to do is validate the front end as we are still waiting for tools and lead time for the back end of the line. So, it’s really – it’s very complex process. You’ve got to again think about taking your existing production, ramping it completely down, moving the equipment and getting new equipment into the facility, getting it up ramped, stabilized and fully integrate it. So the timeline as we have laid out of having this production within 18 months, six quarters to me is a pretty aggressive timeline and the team is committed to do that. What we said in the prepared remarks is we expect production in the second half of ‘18 and part of that is we are leaving ourselves a little bit of room for the potential schedule or slippage of commitments that we may have across our vendor base. But we are confident this product will be in the market in ‘18, we are very excited once it gets there.
Yes, Andrew, to the cost per watt number. So, the 9% referred to is the Series 4 reduction year-over-year from the fleet average 2016 to the fleet average 2017. The key number I think that’s relevant here for you is the Series 6 number. And for that I’d refer you back to Mark’s comments and then the slides where we mentioned roughly 40% decline in cost per watt from 2016 Series 4, out to a Series 6 in 2019 on the run rate basis.
Tyler Frank with Robert W. Baird has our next question.
Hi guys. Thanks for taking the question. Looking forward and given the current market environment, do you think that 2017 is a trough year and would you expect growth in 2018, growth in production as well as earnings. And then beyond that, what need to occur for your Series 6 products to be validated in the field and be bankable for potential customers, to what that product and is there any sort of risk around that?
Mr. Tyler I will take the first part of that. So on the future off to 2017 and we are not going to give any detail around 2018 or beyond today. What I will say is 2018 is also going to be a transition year. So we would expect to see a shift in profitability as the Series 6 comes online in the second half of 2018. I think there are really two impacts in ‘17, the first half of ‘18, so you have to think through relative to the second half of ‘18 and into ‘19 and beyond. Firstly, we are going to have much lower production volume as we are retooling from Series 4 to Series 6. So that will continue into 2018, as we continue the retooling process. Secondly, you have to look at that delta in value that Mark discussed and was mentioned on previous question between the two products, both around the ASP entitlement side and then cost per watt benefits. So if you look at those two, you should be able to model out a view of the company on the Series 6 run rate basis, which is why we think the long-term value creation is and how we are thinking about the business post-transition in the second half of ‘18 and into 2019.
Yes. I think the only thing – again, I think while we look at ‘18 is that the exit of leaping off point of 2018 Q4 with the vast majority of the production, at that point in time being Series 6, earnings power as we exit ‘18 is going to be dramatically higher than our run rate would be for ‘17 or the first half of ‘18, it makes sense because again the first half of ‘18 as well as all of ‘17, we are going to be in our Series 6 platform and as we indicated, the cost profile as well as the elimination of the BoS penalty when you move into Series 6 provides for a meaningful margin expansion opportunity. As it relates to the Series 6 in the product validation process, we are engaging on some aspects of that already. We are also, as I have mentioned before, we will probably have our front end of our line here in Perrysburg, up and operational before the back end. We will actually start producing pretty significantly high volume of modules on the front end of the line. We will actually then cut those modules into a smaller form factor, finish them on the back end of the line here at Perrysburg. But what that allows us to do is to get that product independent of the fact that it’s going to be a smaller form factor, but the semiconductor and all the other changes that are embedded in Series 6 will be there just in a smaller form factor and have that out in the field, getting field performance, engaging with IEs and others to ensure that once the product is up and ramped that we then have enough information and validation in the field to support it. We will also look to harvest the vast majority of the early production into our own development projects so that we can capture our own data there as well as it becomes a little bit less of technical challenge obviously trying to sell-through into a new customer, so it will be another point of contact where we will capture additional information around field performance.
Next, we will hear from Colin Rusch with Oppenheimer. Mr. Rusch, your line is open.
Apologies for that, if we look at 2017 guidance, can you walk us through the underlying assumptions on ASP declines. And then also, how much of the monetization is going to come through 8.3 and underlying assumptions on the return profile for those drop downs?
So as it relates to the assumptions around ASP, we are not assuming any improvement in the market as it relates to ASPs and we are assuming effectively that crystalline silicon will sell through at cash cost, which is not only approaching cash costs, but includes shipping and warranty plus their OpEx cash profile. And so that’s how we are thinking about a row the position around ASPs. We modeled our plan appropriately against that and that’s kind of our baseline. Now, what I will also say Colin what we have done in the past is we have continued to find pockets of where our technology is most advantaged and we will look to target those markets and those markets on Series 4, in particular, will be – I would say hot humid climates, but markets as well that are fixed relative to tracker because the value of the BoS penalty is slightly lower and a fixed application is a tracker. So we will be selective in where we are going to target and sell-through and to capture the greatest value for the energy differentiation that we have inherent, our technology. But the baseline that we have is starting with as an assumption of crystalline silicon cash cost ASP profile.
Vishal Shah with Deutsche Bank has our next question.
Yes. Hi. Thanks for taking my question. So Mark, I understand you have another $300 million to $400 million of CapEx that you need to spend in 2018 in order to achieve the 3-year production number, but can you really talk about your cash – operating cash assumptions in that year especially given that you will have 1 gigawatt of few states capacity up and running and as I see your breakdown of systems backlog, you have what, 400 megawatts of projects that you can bring online in 2018, is that the right number you think you can pull forward some of those projects from 2019 – into 2019. And in the scenario where you have to expedite some of the pipeline development, the ITC was to expire earlier, is the Series 4 production, can you keep making money with those projects? Thank you.
So you are right that if you would think about getting to the 3 gigawatts or so platform in 2019, there is another call $400 million or so of CapEx that we would have to spend in ‘18 in order to position ‘19 for the type of volume. So we are not getting into the specifics around ‘18 and as Alex indicated in his comment previously. However, what I will say is that we are very happy with our net cash position as we exit ‘17. We have looked at this as a view of two things that have to happen in terms of coming through this transformation from a company’s perspective. We clearly need to execute and deliver against the Series 6 roadmap and the commitments inherent in it. And then we need to come through with a very strong balance sheet and not having an adverse impact to our overall liquidity and strength of balance sheet such that we can then engage in the market from a position of strength with the best possible technology, with the best balance sheet and ample liquidity continued to invest and fund the development of this company, not only the R&D side, but over time, the expansion of new manufacturing capacity around the world. From a pipeline standpoint look, we are continuing to look at all kinds of alternatives around how do we monetize the pipeline, when do we monetize the pipeline, how do we capture the highest value, how do we recycle capital as quickly as possible. One of the things that we did a number of years ago was we held assets longer and we held them through COD. If you look at – prior to that in 2011, ‘12 or so, even into ‘13, we used to sell down an SMTP. And part of the reason that we made that decision was because we didn’t think the risk profile of the construction risk was being properly evaluated. Now, you also have to remember we used to have 500 megawatt type projects and construction periods were much longer. What we see now is that we think the market is better appreciative, our understanding of what the construction risk is, which is relatively nominal, projects have become smaller in size and the installation velocity and the construction velocity going from SMTP to COD is much shorter. So we may look to monetize system projects earlier and include with either an EPC agreement or could be a module agreement, we will have to look at what makes the most sense from that standpoint. But that may be the most efficient strategy to think about the monetization, especially with the U.S. assets over the next couple of years. Around Series 4, clearly, we are going to be using Series 4 for our project in 2017, our Cuyama project in 2017. We are very happy with the margins embedded in those projects with the Series 4. Would it have been ideal to have had a Series 6, clearly it would. I mean, if you look at the gigawatt plus of development assets we have, if we had Series 6 at a 40% less cost profile than Series 4 with no – with a lower balance of system cost, it’s the right product to monetize those development assets. But there is – as it relates to having any adverse impact of the economics relative to our initial expectations on those two assets I previously mentioned, we are very happy with what we will be able to capture for margins in both Cuyama and [indiscernible] with the Series 4 product.
Next we will hear from Philip Shen with ROTH Capital Partners.
Mark, Alex, thanks for taking my questions. Just as a follow-up on ASPs, as you and the board went through your decision process and looked through 2019, what kind of ASPs were you assuming in 2019? Earlier you talked about 2017 assumptions being around cash cost plus warranty etcetera. But as you look out to 2019 you had to make some assumptions there when the real Series 6 volume starts to ramp, what kind of prices were you really thinking about – are you thinking about for that year?
Yes. So, we haven’t given out ASPs, but what I would say is I think similar to what Mark said earlier the way we have been looking at this is assuming that our competitors will continue to operate effectively at cash cost which is where we believe a lot of the market is today. So, we think on a cost per watt basis even on the Series 4 we are competitive today with everyone else out there in the market. What we have done in the long-term plan is look both at our internal analysis as well as using third-party data and bringing in expert analysis to say where do we believe that cash cost is going to be – that’s cash cost on a COGS basis shipping warranty and then a cash OpEx basis and we tried to price against that. So, even against that assumption, which we don’t necessarily believe to be sustainable, we are confident that Series 6 product will be able to stack up competitively.
And so the other thing I just added that we also assumed that we gave, we assumed everything transitioned to mono, right. So it’s mono-perk, we are talking 370 type watt panels that we have looked at from that perspective and we have assumed the lowest possible cost profile as Alex referenced. And we believe our Series 6 product with 420 watts to start off with, with the ability to scale up from there at initially 18% efficiency and ability to scale up from there at the cost profile that we referenced. We are very happy with the competitive position of that product in that type of situations.
Next, we will hear from Paul Coster with JPMorgan.
Thanks. Mark, perhaps you could share with us what you will be divulging over the course of next 18 months to 2 years so that we know the Series 6 products is on schedule and how will we know – how will you share the progress with your customers so that you don’t lose central pipeline deals?
Yes. So, as it relates to Series 6 and kind of progress and what we should be measured by, I think our plan is that we are going to give very transparent and continuous updates around Series 6 progress, schedule, expectations around cost, so that we will be spending time on the earnings calls to make sure everyone stays up-to-date around that. The other metric that we will continue to report around is our overall liquidity and expectations around forward-looking liquidity and net cash position, because I think those are the two metrics that need to be most measured and focused on as we go through this journey. I mean, clearly, we need to deliver against revenues and earning commitments in those type of things. But schedule and cost around Series 6, validating the installation protocol in the field, validating the supply chain and aligning the supply chain to ramp up, to facilitate, providing infield data and performance around infield data as it becomes available, that’s what’s going to be important and we need to be transparent and then couple of that with the overall strength of the balance sheet. Now, that is relatively the same type of information that we will be communicating with our customers and our partners. What I will tell you now is that the Series 6 product is so advantaged and so disruptive from both an energy yield and a cost perspective. Customers are going to want to align with us and who are going to want to engage with us as early as possible to ensure that they have the potential to capture that product when it’s available in the marketplace. So, I am not worried about losing customers. We will have between now and the middle of ‘18 over 3 gigawatts of Series 4 product, which is still a great product. It has only inherent energy advantages of what’s embedded in Series 6. This is slightly smaller form factor. So, that’s still a great product to meet most of our customers’ needs and as Alex referenced, we believe it’s still very competitive against crystalline silicon.
Next, we will hear from Jeff Osborne from Cowen and Company.
Hey, good afternoon. Two quick ones. Is there any risk that the 2018 project pipeline decides to defer the decision and wait for 2016 – sorry, wait for the Series 6? And then also Mark, I was wondering if you can just touch on the capital equipment that’s going to be used for Series 6? Is there any change to the configuration or the size or the deposition process to use more off the shelf equipment and just trying to get a better sense of how you were able to accelerate the deployment of Series 6 so quickly?
So look, we are going to continue to evaluate the best way to monetize our development assets. And we clearly would love to – everything that sits beyond ‘17 COD without the final path that would allow us to use Series 6 with a product as the inherent value that it will creep to that asset. So, we will look at those options. But even if we do some of those options, it maybe a structure as I referenced in one of my other comments to a question earlier in the call was we may just get a fully developed site and we may then enter into a module agreement with the ultimate owner of the asset and then they can engage their own EPC and then we sell down the site and we capture the module contract with it and that maybe the vast majority of the profit pool embedded in those two opportunities, right? So, we will look at that and again that allows us to recycle the capital faster.
In terms of what are we doing to that’s enabling us to accelerate the timeline for Series 6. The single biggest item is we have found a way to use our existing facilities. And really what we have done is that the footprint that we are going to need for the new toolset can fit inside our existing facilities, because we are changing the – as we have referred to it the leading edge orientation of the module that it basically goes through the manufacturing process. So, we changed it, flipped it around so that the narrow side will actually be then going through our coders and ovens and everything else. And what that does then is it sort of compresses the footprint that is needed. So, that’s really what the key enabler is by using those existing facilities we can get to the market faster. The toolset, the vast majority of the toolsets and the vendors especially on the pilot side are the same tools and vendors that we are using today just to accommodate a much larger footprint, form factor and a much higher throughput rate.
Julien Dumoulin-Smith with UBS has our next question.
Thanks, Steve for taking the question. Perhaps to kick it off, can you first comment briefly on the value proposition of Series 6? I think you have talked about $0.06 a watt, is that kind of a good number to kind of at least initially think about the uplift from deploying the product in terms of your capturing that value? I know you talked about a much larger number in terms of the actual cost savings, but in terms of net-net, what you might receive in terms of a margin improvement? And then separately, a small detail here, can you elaborate a little bit in revenue recognition rules if that’s material at all?
Yes. Look on the Series 6 uplift you have to look at both the ASP side and the cost per watt side. So what we have said in the slide deck there and you can refer to that number is indicatively here, we have guided to $0.06 uplift relative to the Series 4 module and that’s a function of reducing the BoS requirements plus the energy advantage. Now, that’s an indicative number and varies depending on a whole bunch of factors, including where the project is, whether it’s fixed tilt to attract the site specifics, the soil, PPA pricing, etcetera. There is a lot of moving pieces, but that’s a good midpoint of a range you use as the target number. The other piece then obviously is the cost per watt side, what we talked about that capital cost being so much lower and getting you to a roughly 40% lower cost entitlement on Series 6 versus the 2016 as for exit rate. So, combining those two pieces gets you to the total margin realization entitlement that we have. On the rev-rec side, I don’t think it’s going to be hugely significant. We may see some change to the top line revenue and therefore to gross margin percentages, but I wouldn’t expect significant changes through gross margin dollars and then down through EPS, but will provide updates on that as we adopt that guidance and understand fully the impacts on the guidance numbers.
Brian Lee with Goldman Sachs has our next question.
Yes, guys. Thanks for taking the questions. First on cash, can you give us some sense of how much of the operating cash flow guidance for 2017 is coming from the Moapa and California Flats projects versus what might be considered more 2017 organic core business? And then separately on the OpEx, how should we be thinking about the sustainability of OpEx down here at these levels beyond 2017 as you start to ramp up Series 6? Thanks.
Yes. Brian, I will take the cash question as it relates to Moapa and CA Flats and then Alex can take the OpEx question. So clearly, Brian, as you would expect that there is a meaningful portion of the operating cash flow that’s benefited from the monetization and the realization of the sale of both Moapa and CA Flats. What I will tell you is that, and I think we indicated this in the last call, the tax equity has been structured for Moapa and those proceeds will be vastly – vast majority of those proceeds will be received in 2018 or 2017, excuse me, let’s just say closer about half, not the vast majority. So, you are going to have some of the benefit of Moapa hitting our cash numbers for this year and that’s fully reflected in the guidance that we provided, but about half of it is going to be in next year. So that piece of Moapa is clearly benefiting the operating cash flows. The CA Flats based on how we are currently structuring the payment schedule around CA Flats plus the fact that we will have continuous outflows on CA Flats, because you have to remember CA Flats is just the first phase, so it’s two phases of 280. The first phase is 130, plus there is another 150 after that. CA Flats won’t – while we will recognize the sale of the first phase and effectively get paid for that portion of it, the ongoing cash outflows will largely mitigate the benefit of that cash flow. So, you are going to see some net positive cash flow from CA Flats, but the real item is think of it as Moapa and think of it as about half of the proceeds were received this year with the tax equity financing and the other half was next year. So, you can get an estimate of what you think – excuse me, what Moapa is worth and about 50% of the cash proceeds will benefit operating cash next year.
Yes. And Brian looking at the OpEx, I mean, there has been a huge aim to bring this number down. Clearly, the R&D spend is important, has come down partly based on taking out our TetraSun products and another drive towards focus. We, earlier in the year, talked about reducing our EPC business. We have moved out of TetraSun to the focus is the key piece of what you are seeing. The absolute dollars have come down. That’s enabled us to keep the dollar per watt number relatively flat. We do have a highly fixed OpEx base. What we would anticipate is as the watts increase over time, we scale the business. We have limited aggregate dollar increase and that will enable us to have a dollar per watt decrease, which is the benefit of scaling that OpEx. So, a lot of it really is the drive towards focus in the business, while it’s maintaining enough R&D spend to enable the Series 6 transition.
Cynthia Motz with Williams Capital Group has our next question.
Hello, hi. Thanks for taking the question. Yes, Alex, this is a question for you and I had sort of following up on Julia as I know you don’t want to give specifics, but if we do look at the cost savings that you are anticipating here with the Series 6, it looks like there could be significant operating income improvement expansion. And I know you don’t want to give any hints, but let’s say into the second half of ‘18, let’s say, 2017, in the first half of ‘18 are kind of the trough, could we see ramping in ‘19 and ‘20 back to levels that we were used to maybe certain quarters of ‘16 or any guidance there would be helpful? Thanks.
Yes. So, we can’t give out numbers. I think the best thing I can point you to is to look and you should be able to model out, if you look through the capacity we have given in the slides, take that and look at the entitlement we are showing on the ASP side relative to wherever you think the crystalline silicon prices. So on that slide, we have shown blind buffer for crystalline ASPs, you can put in what you think that market this, then look at the entitlement above that, that we believe is inherent to the technology. And then take what you think today represents and then look at a lower cost profile associated with the Series 6 module and that should enable you to model out combined with the capacity ramp we are showing what you think a second half of ‘18 run rate and then into 2019 will look like. So if you would go through that math, it should enable you to get to a reasonable answer around the operating cash flow profile.
Our final question will come from Edwin Mok with Needham & Company. Mr. Mok…
I am sorry about that. Thanks for taking my question. So just curious in terms of Series 6, what gives you confidence that you can actually ramp to reasonably, I think on your prepared remarks, you compare it to kind of production I think that could be potential risk for that, what do you think you can run to reasonable yield for Series 6 and that could – that might not that you are going to achieve the cost target that you have and what data have you guys collected so far in terms of producing this module?
Yes. What I will say, I will start off first and foremost is that we have some of the brightest and most talented people that understands this technology inside and out, in our R&D, in our manufacturing operations organization. We spent 4-hour working session with our Board of Directors going line item by line item of everything that needs to happen from all aspects and understanding interdependencies, understanding the kind of failure mode potentially embedded in the manufacturing process, the tooling, designs, everything you can possibly think of and it was extremely encouraging and enlightening to understand how deep and how talented our team is that are embarked upon leading us in this journey. So first off, it’s going to start with our people, right. Secondly, it is embedded in the fact that what we are taking largely is a product that we already know, we understand the manufacturing process, we have the existing facility, the existing people, the existing technology, the semiconductor stack really is not changing. We are just scaling into a much larger form factor that is driving a tremendous amount of cost up. So from that standpoint, it’s something that we know and it’s somewhat in our wheelhouse that what we do best. So I am highly confident that our organization and our team will be able to deliver on schedule and the cost that we have committed to. We would not be going down in this path if we didn’t have that little confidence in the organization.
The only thing I would add to that is if you – and I think we have showed some info about it on our Analyst Day this year, if you look at our track record of meeting efficiency targets and module cost work targets across 2013, ‘14, ‘15, we have consistently met those goals. So as Mark said, there is a very deep understanding of what it takes to transition these technologies, improve the technologies and we have shown a track record of being able to hit those targets. We are confident of being able to do that again in our transition to Series 6.
Ladies and gentlemen, that will conclude today’s conference call. Thank you for your participation. You may now disconnect.
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