Behind SunPower Corp's Terrible Quarter

Image source: SunPower.

Yesterday, SunPower Corp (SPWR +0.00%) reported its most disappointing earnings report since the depth of the solar market in 2012. There's a lot to unpack, so I'll get straight to the numbers.

The headline-grabbing numbers

On a GAAP basis, revenue was $420.5 million in the second quarter, gross margin was 9.8%, and net loss was $70.0 million, or $0.51 per share.  

On a non-GAAP basis, which adjusts for the project timing irregularities in GAAP results, revenue was $401.8 million, gross margin was 13.1%, and net loss was $30.1 million, or $0.22 per share. Losses were expected because a few large projects will be completed and sold in the back half of the year, and these figures met or exceeded guidance on nearly all counts. But this is where the disappointment arose.  

Guidance for the full year was reduced pretty dramatically from a quarter ago. Here's what the reduction looks like:

Data source: SunPower earnings presentations.

To add to the disappointment, management said 2017 would see a loss of $100 million-$200 million and EBITDA of just $300 million-$400 million. I'll cover why guidance was reduced -- and the implications -- below.

Management also said it was realigning manufacturing, moving module assembly from the Philippines to Mexico and upgrading some of its manufacturing facility to the new X-Series modules, which will result in a 150 MW reduction in 2016 production. Layoffs will result in a 15% reduction of workforce, or about 1,200 employees, primarily in the Philippines.

And now, what happened beyond the headlines.

The bad news

All of the weakness seen in Q2 2016 through 2017 will be in the power plant business. We knew weakness was coming, which I mentioned in my earnings preview, we just didn't know how bad it would be. Right now, it appears 2017 will be terrible in the power plant business, and 2016 is seeing some weaker-than-expected results as well.

The reduction in guidance for 2016 was driven by two events, both in the power plant business. The first was a large project for which management expected to get a power purchase agreement late in 2015 or in early 2016, which hasn't yet been signed. The project won't be done until 2017, and any earnings or EBITDA won't be seen in 2016.

The second item of bad news was a lower sale price for projects that will close in 2016. Buyers are demanding higher returns than expected, partly because the yieldco market hasn't recovered as quickly as they had expected. Ironically, yieldcos have recovered in the past month or two, but that didn't help SunPower selling projects in April and May. This reduction in prices is a direct hit to the bottom line, and that's the biggest reason everything from gross margin down to net income will be lower than expected. 

Image source: SunPower.

SunPower has a long history of underestimating the timing and prices it gets for projects, so that's why this was such a surprise to investors. The consistent part of the business that should be predictable was suddenly unpredictable. 

Strategically, SunPower decided it would focus the power plant development business in the Americas and France, leading to a small number of the layoffs mentioned above. These are markets where SunPower has experience, and they will contain the company's focus in power plants, moving some focus to distributed generation, which I'll cover below. In other markets, it will sell system solutions, potentially working with parent Total (TOT +0.00%) as the developer or future owner of projects. This is where SunPower will sell its Oasis design, including modules, trackers, and other components. There's also flexibility to sell X-Series or the new, low-cost P-Series modules depending on market needs.

The shift in focus will be a big one financially because SunPower has gotten a tremendous windfall from large solar projects over the last few years. And 2017 looks like it'll be a breakeven power plant business at best. The only bright spot is 2018 and beyond, when global demand is expected to grow rapidly. SunPower is already signing projects that will be completed in 2018-2020, but that doesn't help the challenge it faces in 2017. 

The great news

Power plants will get most of the attention from investors because they're the biggest driver of revenue and earnings today, but it's not the only business for SunPower. About half of solar panels go to distributed generation, or residential and commercial projects, where SunPower is seeing strong demand. 

Image source: SunPower.

Residential deployments grew 25% from a year ago as the Equinox system with high-efficiency solar panels and micro inverters saw strong demand. Equinox now accounts for around half of all new orders, which is a big reason management decided to upgrade manufacturing to this more efficient product.

Commercial solar was also strong, with the pipeline now at $1.3 billion. GTM Research expects the commercial market to grow 20% on a compound basis between now and 2020, and with some of the largest customers in the country choosing SunPower, this should be a big market.

In short, high-efficiency solar panels are doing very well in residential and commercial solar, which we should expect given the limited space environment. In 2017, about half of SunPower's production will go to residential and commercial solar, which are generating solid margins and have less risk in single projects than power plants. And that's what SunPower will lean on next year. It won't overcome the losses in power plants, but this is why investors want a business with a diverse group of customers. 

A bridge to the future

As you can see, it's a complex story for SunPower in the next 18 months, and management has to find a way over this abyss of demand in power plants to get to 2018, where it's already building a large backlog.

The good news is, there's $590 million of cash on the balance sheet, and that will likely grow by the end of the year as projects on the balance sheet are sold. Management's announcements of restructuring will also reduce operating expenses around 10% next year.

These moves, along with strong growth expected in residential and commercial solar, will provide a bridge over 2017 and into 2018, when demand is already picking up. And with the yieldco market already improving, the financing environment could begin to open up. 

Time to give up on solar?

The solar industry goes through some wild swings every few years, and this is one of its downturns, which was expected. But unlike 2009 or 2012, companies like SunPower have a better competitive position and better balance sheets to fall back on. Also, the policy environment is becoming more friendly to solar, even if that friendliness won't show up until 2018 in many places.

As a SunPower investor, I'm as disappointed as anyone with weaker-than-expected project pricing and the delayed project in 2016, though we knew about the rest of the 2017 weakness I outlined above before Tuesday. 2017 is going to be weak in power plants, SunPower is going to gain market share in residential and commercial markets, and it will begin selling more components to international markets.

What's important to keep in mind is that SunPower is still in a good strategic position to benefit from long-term industry trends. Distributed generation customers are demanding more high-efficiency solar solutions and paying with cash or loans, which favors SunPower. And North and South America are going to be large, growing solar markets in 2018 and beyond.

If there's a fundamental weakness, it's in the rising rates of return customers are demanding and the competitive prices competitors are bidding in the power plant business. That requires a strategic shift, but with a diverse business, it's an adjustment SunPower can make. The problem is that fruit from that shift may not appear on the financial statements until 2018, which isn't a timeframe investors like to hear.