Canadian Solar Reports Second Quarter 2016 Results

Canadian Solar Inc. (“Canadian Solar” or the “Company”) (NASDAQ: CSIQ), one of the world’s largest solar power companies, today announced its financial results for the second quarter ended June 30, 2016.

Second Quarter 2016 Highlights

• Total solar module shipments recognized in revenue were 1,290 MW, compared to 1,172 MW recognized in revenue in the first quarter of 2016, and second quarter guidance in the range of 1,200 MW to 1,250 MW.
• Net revenue was $805.9 million, compared to $721.4 million in the first quarter of 2016, and second quarter guidance in the range of $710 million to $760 million.
• Net revenue from the total solutions business as a percentage of total net revenue was 8.5%, compared to 6.3% in the first quarter of 2016.
• Gross margin was 17.2%, compared to 15.6% in the first quarter of 2016, and second quarter guidance in the range of 15.0% to 17.0%.
• Net income attributable to Canadian Solar was $40.4 million, or $0.68 per diluted share, compared to $22.6 million, or $0.39 per diluted share, in the first quarter of 2016.
• Cash, cash equivalents and restricted cash balances at the end of the quarter totaled $1.0 billion, compared to $1.0 billion at the end of the first quarter of 2016.
• Net cash provided by operating activities was approximately $145.2 million, compared to net cash used in operating activities of $108.3 million in the first quarter of 2016.
• The Company now owns a portfolio of solar power plants in operation totaling 472 MWp, with an estimated resale value of approximately $850.0 million and profit margin contribution^[1] in the mid-teens.

Second Quarter 2016 Results

Net revenue in the second quarter of 2016 was $805.9 million, up 11.7% from $721.4 million in the first quarter of 2016 and 26.6% from $636.7 millionin the second quarter of 2015. Module shipments recognized in revenue totaled 1,290 MW, compared to 1,172 MW recognized in revenue in the first quarter of 2016 and 809 MW recognized in revenue in the second quarter of 2015. Solar module shipments recognized in revenue in the second quarter of 2016 included 18.7 MW used in the total solutions business, compared to 24.8 MW in the first quarter of 2016 and 90.0 MW in the second quarter of 2015.

By geography, in the second quarter of 2016, sales to the Americas represented 47.6% of net revenue, sales to Asia represented 39.5% of net revenue, and sales to Europe and others represented 12.9% of net revenue, compared to 43.1%, 44.4% and 12.5% respectively, in the first quarter of 2016 and 47.6%, 45.5%, 6.9% respectively, in the second quarter of 2015.

Gross profit in the second quarter of 2016 was $138.5 million, compared $112.5 million in the first quarter of 2016 and $96.5 million in the second quarter of 2015. Gross margin in the second quarter of 2016 was 17.2%, compared to 15.6% in the first quarter of 2016 and 15.2% in the second quarter of 2015. The sequential increase in gross margin was primarily due to lower module manufacturing cost.

Total operating expenses were $98.9 million in the second quarter of 2016, up 33.5% from $74.1 million in the first quarter of 2016 and up 54.4% from$64.1 million in the second quarter of 2015.  The sequential and year-over-year increases in total operating expenses were primarily due to higher general and administrative expenses.

Selling expenses were $33.9 million in the second quarter of 2016, down 2.7% from $34.8 million in the first quarter of 2016 and up 5.0% from $32.2 million in the second quarter of 2015. The sequential decrease in selling expenses was primarily due to lower shipping and handling expenses and lower external sales commissions partially offset by higher labor costs. The year-over-year slight increase in selling expenses was primarily due to higher labor costs and higher shipment volume, partially offset by lower shipping and handling unit costs.

General and administrative expenses were $60.0 million in the second quarter of 2016, up 72.3% from $34.8 million in the first quarter of 2016 and up 118.1% from $27.5 million in the second quarter of 2015.  The sequential and year-over-year increases in general and administrative expenses were primarily due to higher non-recurring professional service fees, including the write-off of $10.8 million in deferred expenses related to the now terminated YieldCo launch, and tornado damage to the Company’s solar cell factory in Funing County, Jiangsu Province, estimated at approximately$7.6 million.  Research and development expenses were $5.1 million in the second quarter of 2016, compared to $4.5 million in the first quarter of 2016 and $4.3 million in the second quarter of 2015.

Income from operations was $39.6 million in the second quarter of 2016, compared to $38.4 million in the first quarter of 2016, and $32.5 million in the second quarter of 2015. Operating margin was 4.9% in the second quarter of 2016, compared to 5.3% in the first quarter of 2016 and 5.1% in the second quarter of 2015.

Non-cash depreciation and amortization charges were approximately $25.5 million in the second quarter of 2016, compared to $25.7 million in the first quarter of 2016, and $22.7 million in the second quarter of 2015. Non-cash equity compensation expense was $1.9 million in the second quarter of 2016, compared to $2.5 million in the first quarter of 2016, and $2.0 million in the second quarter of 2015.

Interest expense was $11.9 million in the second quarter of 2016, compared to $16.1 million in the first quarter of 2016, and $12.9 million in the second quarter of 2015.

Interest income was $2.4 million in the second quarter of 2016, compared to $3.4 million in the first quarter of 2016 and $4.1 million in the second quarter of 2015.

The Company recorded a loss on change in fair value of derivatives of $1.6 million in the second quarter of 2016, compared to a gain on change in fair value of derivatives of $2.7 million in the first quarter of 2016 and a gain on change in fair value of derivatives of $1.6 million in the second quarter of 2015. The loss on change in fair value of derivatives of $1.6 million in the second quarter of 2016 included a foreign currency hedging loss of $5.9 million, a loss in change in fair value of swap/swaption for projects in the U.S, Canada and U.K. totaling $1.6 million, and a gain on change in fair value of warrants of $5.9 million. The warrants were issued in conjunction with the $180 million in financing arranged by Credit Suisse in the fourth quarter of 2015.  These warrants can be settled in cash at the discretion of the holder and as a result are liability derivatives which were fair valued at issuance and are subsequently marked to market at the end of each reporting period.

The Company recorded a foreign exchange gain in the second quarter of 2016 of $24.9 million compared to a foreign exchange gain of $8.5 million in the first quarter of 2016 and a foreign exchange loss of $4.4 million in the second quarter of 2015.

Income tax expense was $16.3 million in the second quarter of 2016, compared to $12.3 million in the first quarter of 2016 and $2.7 million in the second quarter of 2015.

Net income attributable to Canadian Solar was $40.4 million, or $0.68 per diluted share, in the second quarter of 2016, compared to net income of $22.6 million, or $0.39 per diluted share, in the first quarter of 2016, and net income of $17.9 million, or $0.31 per diluted share, in the second quarter of 2015.

Financial Condition

The Company had $1.0 billion of cash, cash equivalents and restricted cash as of June 30, 2016, compared to $1.0 billion as of March 31, 2016.

Accounts receivable, net of allowance for doubtful accounts, at the end of the second quarter of 2016 were $356.7 million, compared to $394.0 millionat the end of the first quarter of 2016. Accounts receivable turnover was 60 days in the second quarter of 2016, compared to 72 days in the first quarter of 2016.

Inventories at the end of the second quarter of 2016 were $309.7 million, compared to $413.2 million at the end of the first quarter of 2016. Inventory turnover was 51 days in the second quarter of 2016, compared to 58 days in the first quarter of 2016.

Accounts and notes payable at the end of the second quarter of 2016 were $937.3 million, compared to $961.2 million at the end of the first quarter of 2016.

Short-term borrowings at the end of the second quarter of 2016 were $1.37 billion, compared to $1.35 billion at the end of the first quarter of 2016. Long-term debt at the end of the second quarter of 2016 was $828.5 million, compared to $818.5 million at the end of the first quarter of 2016. Senior convertible notes totaled $128.0 million at the end of the second quarter of 2016, compared to $132.2 million at the end of the first quarter of 2016. Short-term borrowings and long-term debt directly related to utility-scale solar power projects totaled $834.9 million at the end of the second quarter of 2016, compared to $758.9 million at the end of the first quarter of 2016.

At the end of the second quarter of 2016, the Company booked approximately $1.8 billion of solar power plant assets under non-current assets compared to $1.6 billion at the end of the first quarter of 2016. These assets include plants owned and operated and plants under construction.

Dr. Shawn Qu, Chairman and Chief Executive Officer of Canadian Solar, remarked: “We are pleased with our results for the second quarter which again came in above our guidance.  Our core solar module and project businesses remain strong, with a healthy balance sheet to support our near and long-term plan.  Our strategic decision to no longer pursue a YieldCo reflects the market environment and our primary focus on extracting the highest value for shareholders from our operating assets.  As a global leader, we are optimistic and remain favorably positioned moving forward.  Our low cost manufacturing structure, project asset scale, consistent execution and conservative strategy are helping us to mitigate the impact of headwinds facingthe broader market, which are realistically never quite as bad as investors may think.   Our energy business now has approximately 472 MWp of solar power plants in operation, and approximately 900 MWp of additional solar power plants, after adjusting for our effective ownership, that will reach commercial operation in the second half of 2016.  Once completed, we will own approximately 1.37GWp of operating solar power plants, with a resale value of approximately $2.1 billion. We are actively pursuing several regional options to monetize these assets in the second half of 2016 and 2017.”

Dr. Huifeng Chang, Senior Vice President and Chief Financial Officer of Canadian Solar, added: “We achieved revenue and gross margin above our guidance in the second quarter of 2016.  We benefited from a combination of strong demand for our modules, better than expected selling prices and solid cost control at our factories. We were also able to reduce inventory levels by over $100 million, secure financing for our solar power projects and sign the first agreement to monetize our solar power plants in China.  Our solar project construction schedule in the U.S., Japan, China and the U.K.remain on schedule.  In order to provide improved visibility into our operating plan, we made the formal decision to no longer launch a YieldCo.  We are instead implementing a flexible, localized strategy with respect to our solar project asset monetization.  We expect this decision and added clarity will help investors to more appropriately reflect the higher value of our business and operating assets.”

Utility Scale Solar Project Pipeline

The Company’s utility-scale solar project pipeline totals 20.4 GWp, including approximately 2.4 GWp of projects in late-stage development, and 18.0 GWp in early- to mid-stage development. The Company cautions that some of the projects under development may fail to secure all the required permits and grid-connection approvals and as a result may not reach completion.

Late-Stage Solar Project Pipeline

Canadian Solar’s late-stage, utility-scale solar project pipeline totals approximately 2.4 GWp, of which 1,263 MWp are in the U.S., 576 MWp are in Japan, 384 MWp are in Brazil, 121 MWp are in China, 63 MWp are in Mexico, and 19 MWp are in the United Kingdom.

In the United States, seven of the Company’s solar projects totaling 1,185 MWp are currently under construction with Barren Ridge, Mustang and Tranquillity expected to reach commercial operation before the end of September of 2016, while Astoria 1, Astoria 2, Garland and Roserock are expected to reach commercial operation before the end of December 2016.

The Company’s late-stage, utility-scale solar project pipeline in the U.S. is detailed in the table below:

In Japan, during the second quarter of 2016, the Company started commercial operation of two solar power plants, with a total capacity of approximately 700 KWp. As of August 1, 2016, the Company’s pipeline of late-stage utility-scale solar power projects in development totaled approximately 576 MWp, with 112 MWp in construction and an additional 134.7 MWp at the ready-to-build stage.

The expected commercial operation schedule of the Company’s late-stage utility-scale solar power projects in Japan is detailed below:

METI has recently made two rule changes that will affect the Company’s pipeline in Japan. In April 2016, METI announced that solar power projects that fail to execute an interconnection agreement with the applicable utility operator by April 1, 2017 will lose the approved feed-in tariff (“FIT”). In addition, in June 2016, METI announced that solar power projects which have not executed the interconnection agreement by August 1, 2016 must achieve commercial operation date (COD) by April 1, 2020.  Solar power projects that execute an interconnection agreement after August 1, 2016, (and beforeApril 1, 2017) but do not reach commercial operation by the April 1, 2020 deadline will be subject to a penalty of either: 1) A FIT reduction of 5%/year or 2) reduction in the term of the FIT contract. The detailed penalty rules will be decided by METI’s Calculation Committee for Procurement Price in the coming months.

As of August 1, 2016, Canadian Solar had executed interconnection agreements for 376.2 MWp of projects. The Company expects that, by April 1, 2017it will have executed interconnection agreements for an additional 131.4 MWp of projects, thereby securing the existing FIT contract subject to meeting the COD deadline. The Company is working to advance an additional 89.4 MWp of projects, so that the interconnection agreements can be executed byApril 1, 2017 in order to secure the existing FIT contract.

During the second quarter of 2016 the Company connected to the grid one solar power plant in China totaling 22 MWp, bringing its total to 218MWp of solar power plants in operation in China.

Solar Power Plants in Operation

In addition to its utility-scale solar project development pipeline, the Company now has a portfolio of solar power plants in operation totaling approximately 472 MWp. Revenue from the sale of electricity from these plants in the second quarter of 2016 totaled $22.5 million, compared to $10.2 million in the first quarter of 2016. The resale value of these plants is estimated at approximately $850.0 million, with expected profit margin contribution in the mid-teens. The market situation may however change, resulting in different resale values when the Company sell these projects. The sale of projects recorded on the balance sheet under project assets (built-to-sell) will be recorded as revenue once revenue recognition criteria is met, and the gain from sale of projects recorded on the balance sheet under property plant and equipment (built-to-own) will be recorded as other operating income in the income statement.

Manufacturing Capacity 

The Company has revised its 2016 manufacturing capacity, as summarized in the table below:

The Company expects to increase its wafer capacity using new diamond wire-saw technology. This technology works compatibly with our proprietary Onyx black silicon multi-crystalline solar cell technology, significantly increasing solar cell efficiency while reducing silicon usage and therefore manufacturing cost. The Company’s wafer manufacturing capacity is expected to reach 1.3 GW by the end of 2016, of which at least 900MW is expected to utilize diamond wire-saws.

As previously disclosed, a tornado damaged the Company’s solar cell factory in Funing County Jiangsu Province on June 23, 2016. The Company responded promptly by dispatching its internal emergency response team to work with local government entities to support its employees and the local communities. Although damage to the property and manufacturing equipment was severe, there have been no casualties among the Company’s employees. The recovery effort at the Funing factory is currently under way. The Company has removed damaged equipment from the site and together with its insurers, is carrying out an appraisal of damage caused to the factory and manufacturing equipment. The Company expects to have full capacity restored at this facility by the second quarter of 2017 and expects to recover substantially all of its financial losses through insurance.

The Company’s cell manufacturing capacity is expected to reach 3.05 GW by the end of 2016, which includes the new 850 MW cell manufacturing plant located in South Eastern Asia, to be commissioned in September of 2016, offset by the temporary reduction of 1.0GW capacity in the tornado affected factory in Funing.

Based on its latest market assessment, the Company has decided to slow down solar module capacity expansion. The Company now expects internal module capacity to reach 5.8GW by the end of year, instead of 6.4GW as disclosed in the past. This includes 650 MW in South Eastern Asia already commissioned this month and 360 MW in Brazil to be commissioned in September of 2016.

Business Outlook

The Company’s business outlook is based on management’s current views and estimates with respect to operating and market conditions, its current order book and the global financing environment. It is also subject to uncertainty relating to customer final demand and solar project construction schedule.  Management’s views and estimates are subject to change without notice.

For the third quarter of 2016, the Company expects total solar module shipments to be in the range of approximately 1.2 GW to 1.3 GW, including approximately 10 MW of shipments to the Company’s utility-scale solar power projects that may not be recognized in third quarter 2016 revenue. Total revenue for the third quarter of 2016 is expected to be in the range of $660 million to $710 million, with gross margin expected to be between 14% and 16%. We have previously announced an agreement to sell two of our solar power plants in China. We expect the close of that transaction in Q4, therefore, our revenue guidance for the third quarter of 2016 does not include the sale of project assets.

For the full year 2016, the Company maintains its guidance for total module shipments to be in the range of approximately 5.4 GW to 5.5 GW, with approximately 5.0 GW recognized in revenue. Management also maintains its revenue guidance for the full year 2016 to be in the range of $3.0 billion to 3.2 billion. The Company is actively exploring opportunities to monetize its solar power plant assets, and subject to timing of these sales reported revenue may exceed the Company’s revenue guidance.

Dr. Shawn Qu, Chairman and Chief Executive Officer of Canadian Solar, remarked: “Canadian Solar is in an excellent position to compete as we execute on our proven, long-term strategy.  We are an industry leader in quality, performance, efficiency and cost.  Our diversified project pipeline and strong backlog further sets us apart.  Importantly, we remain in the early stages of solar adoption, with our key markets in the U.S., Japan and Chinaunderpenetrated.  We are reducing the cost of incoming materials and processing cost in the meantime to maintain a mid-teen gross margin for our manufacturing business during the industry headwinds, while further reducing inventory and tightening credit controls. Our ongoing efforts to upgrade our technology and to improve our cost structure through selected capacity expansion are on track and we expect to end 2016 with 3.1 GW of internal cell capacity, including 850W in a tariff free location in South East Asia. At the same time, we continue to make progress as one of the leading developers and owners of high quality solar power plants around the world, with 472MW of solar power plants in operation and over 1.0GW of solar power plants under construction. Our focus remains on maximizing profitability, sustainable free cash flow and building shareholder value.”

Recent Developments

On July 11, 2016, Canadian Solar announced that it had entered into a private placement with Prudential Capital Group, pursuant to which, Prudential Capital Group agreed to purchase non-recourse notes with principal amount totaling approximately JPY6.2 billion (US$60.0 million). The proceeds from the private placement have been used to finance a portfolio of solar power projects in Japan totaling 21.2MWp.

On July 6, 2016, Canadian Solar announced that it had entered into a project sale agreement to sell its operating solar power projects in Funing, Jiangsu, China to Create Technology & Science Co., Ltd. for approximately RMB218.5 million (US$32.8 million).

On May 23, 2016, Canadian Solar announced that it had closed a £36.4 million (US$52 million) project financing facility with BayernLB to refinance a portfolio of four solar power plants in the UK, totaling 40.2MWp.