Jul 28, 2015
Executives
Robert Okunski - Senior Director of Investor Relations Tom Werner - Chairman, Chief Executive Officer and President Chuck Boynton - Chief Financial Officer and Executive Vice President Howard Wenger - President of Business Units
Analysts
Benjamin Kallo - Robert W. Baird Brian Lee - Goldman Sachs Vishal Shah - Deutsche Bank Patrick Jobin - Credit Suisse Krish Sankar - Bank of America/Merrill Lynch Julien Dumoulin-Smith - UBS Pavel Molchanov - Raymond James
Operator
Good afternoon, and welcome to SunPower Corporation's Second Quarter 2015 Results Conference Call. Today's call is being recorded.
If you have any objections, please disconnect at this time. I would like to turn the call over to Mr.
Bob Okunski, Senior Director of Investor Relations, SunPower Corporation. Thank you sir, you may begin.
Robert Okunski
Thank you, Shiela [ph]. I would like to welcome everyone to our second quarter 2015 earnings conference call.
On the call today, we will start off with an operational review from Tom Werner, our CEO; followed by Chuck Boynton, our CFO, who will review our second quarter 2015 financial results. Tom will then discuss our outlook for Q3 and 2015.
As a reminder, a replay of this call will be available later today on the Investor Relations page of our website. During today's call, we will make forward-looking statements that are subject to various risks and uncertainties that are described in the Safe Harbor slide of today's presentation, today's earnings press release, our 2014 10-K, and our quarterly reports on Form 10-Q.
Please see those documents for additional information regarding those factors that may affect these forward-looking statements. To enhance this call, we have also posted a set of PowerPoint slides, which we will reference during this call, on the Events & Presentations page of our Investor Relations website.
In the same location, we have posted a supplementary data sheet detailing some of our historical metrics. Finally, we are currently targeting November Analyst Day in New York City.
We are still in the planning stages at this point, but we will provide additional details related to the timing and the agenda of the event at a later day. With that, I'd like to turn the call over to Tom Werner, CEO of SunPower, who will begin on Slide 4.
Tom?
Tom Werner
Thanks, Bob, and thank you for joining us today. I'll start by providing some brief comments on the quarter before discussing our performance in greater detail.
Q2 was another solid quarter for SunPower. In addition to meeting our financial goals for the quarter, we achieved three key milestones that position us well for future growth.
First, the launch of 8point3, our joint yield curve vehicle with first solar, which we believe will lower our cost of capital and provide a sustainable competitive advantage. Second, the acquisition of Infigen’s 1.5 gigawatt U.S.
solar project development portfolio, which significantly enhances our power plant pipeline through 2020. Third, the introduction of three innovative utility channel partnerships for our residential business, including our announcements with Dominion and ConEdison Solutions.
I will speak more about these milestones throughout my formal remarks. Moving on to the specifics for the quarter, the quarter was characterized by strong execution across all geographies and segments reflective of continued growth in global solar demand.
We replaced and successfully launched 8point3 energy partners, Chuck will go into more detail on 8point3 in his comments later in this call. For power plants, in addition to our Infigen portfolio acquisition, we achieved important completion milestones in a number of large scale projects including Solar Star and Quinto, while initiating construction at both Henrietta and Hooper.
We also continue to grow our international power plant business in key global markets. Our distributed generation business remains solid, driven by residential market demand in both the U.S.
and Japan. Our DG bookings rose materially in both the residentially and commercial segments.
We added to our growing North American commercial pipeline with our recent 22 megawatt announcement for the current county, school, district. Upstream we performed extremely well achieving record cell output in manufacturing yields.
Average solar cell efficiency across all lines was close to 23% during the quarter. I would now like to provide more color on each segment of our business starting with power plants.
Please turn to slide 5. In the Americas, as I mentioned at the start of my remarks we are very pleased to announce the acquisition of Infigen’s U.S.
power plant portfolio for $38 million. We believe that this acquisition significantly enhances our visibility through 2020.
This portfolio consists of approximately 35 early to late stage project of up to 100 megawatts inside. With our strong record of project construction and technology leadership we are well positioned to develop these projects profitability over the next 5 years.
This pipeline also comprises projects that are very well suited for drop down to 8point3, supporting significant volume growth beyond 2016. We also completed construction at our 579 megawatt Solar Star projects and the world’s largest PV power plant is now grid connected.
We want to EPC and supply chain teams for their incredible efforts in constructing this landmark project ahead of schedule and under budget. In relation to our holdco assets, construction at both 135 megawatt Quinto project and 102 megawatt Henrietta project are on track and we plan to contribute these projects to our 8point3 joint yield curve vehicle over the next 12 months.
We also continue to expand our pipeline organically and recently announced a new 100 megawatt project for NV Energy. In EMEA, we are focused on enhancing our market foot print in both South Africa and France.
In South Africa our 86 megawatt Prieska project is on plan. As we mentioned last quarter, we now have more than 150 megawatts of power plant either completed or under construction in South Africa.
France remains our top EU power point market and we continue to work with Total to expand our project pipeline. In APAC, Japan remains a key power plant market for us with 40 megawatts installed today and a solid pipeline of future opportunities.
Additionally, we are working closely with our JV partners in China on new project development. Our Apple projects remain on plan.
With more than 2 gigawatts of power plants installed globally, including the world’s largest PV plant and a significantly - and a significant and growing project pipeline SunPower is in a very strong competitive position in the power plant market. I would now like to briefly discuss our DG business, please turn to slide 6.
Q2 was again a great quarter for our DG segment and a strong demand for our industry leading smart energy solutions and financing options. Once again the U.S.
and Japan were the key drivers of the business that we saw improvement in the EU with revenue and megawatts up sequentially. We expect to end the year with more than 500,000 global DG customers.
In our residential business, Q2 was another strong quarter as we grew megawatts sequentially and saw further traction with our lease product. Both lease bookings and installed megawatt doubled year-over-year.
We are further leveraging our residential solar platform by developing channel partnerships with electric utilities who want to bring the benefits of clean solar power to their customers. This unique model combines SunPower's industry-leading solutions and channel platform to facilitate utility participation in the residential solar energy business.
For example, we recently announced partnerships with Dominion in New Jersey, as well as this morning’s announcement with ConEdison for New York. We expect these innovative channel partnerships will significantly expand our foot print in key markets in the United States.
We are thrilled to be working with electricity, industry leaders to accelerate the adoption of SunPower’s high performance solar solutions. We also made important progress on a number of technology elements.
As you know, last fall we formally announced our new micro-inverter panel with shipments made in the first quarter of this year. I can you tell you that customer acceptance of this product has significantly exceeded our expectations and we are increasing manufacturing capacity to meet this demand.
We expect further traction with this product as we will be shortly launching our 96 sales solution that will drive even better economics. Customers want this technology because it offers more flexible and quicker installation, superior statics and better performance.
Along with mobile investments in storage systems and software, our ACPV solutions are a key piece of our smart energy strategy and complete solution approach. As a reminder, the goal of our smart energy strategy is to give customers greater control of their energy use in a superior user experience.
We are also pleased to announce that we will be launching our X-Series panel, the world’s most efficient model in Japan this quarter. Global demand for this product remains extremely high.
As a result [ph] we are increasing our production of this panel going forward and expect X-Series manufacturing volume to increase more than 300% year-over-year. In the commercial segment, we executed well and added to our pipeline.
For example, we announced the largest school district contract in the United States with Kern County, California bringing our commercial project pipeline to over $1 billion. Under this contract, SunPower will deploy 22 megawatts over 27 district sites.
With construction scheduled to be completed by the end of 2016, the Kern County School District is expected to save $80 million in electricity costs over the next 25 years by using SunPower technology. Additionally, we expanded our footprint in the retail sector with our long term partner Macy's.
We will install 10 megawatts for them this year at California and Merlin, and this will bring our footprint with Macy’s to 58 facilities across the U.S. Japan remains a key DG market for SunPower both in residential applications as well as small commercial solutions where we see increasing demand in significant long term opportunity.
We are also investing in new technology and are also close to completing the development of a new suite of low cost commercial products including standard solutions for rooftop and ground-mount applications with the release slated for the second half of the year we expect these products to further strengthen our position in the commercial market as well as drive better economics for SunPower. Finally, we expect 2016 to be a very strong year in distributor generation as demand fundamentals remained solid due to technology improvements, cost reduction in the ITC policy environment.
We are also increasingly positive on prospects for 2017 and 2018 as the DG pipeline continues to build both in the U.S. and internationally.
I would now like to touch on our project pipeline as well as future deployment plans, please turn to slide 7. Overall, we remained very bullish on the global solar market as we see strong growth dynamics.
Our diversified end market strategy continues to position us well across multiple geographies. Our project pipeline now stands at 12 gigawatt including a recent acquisition of Infigen U.S.
solar portfolio. To put our development efforts into prospective, we have doubled our global pipeline in just two years while rapidly expanding our footprint in a number of existing and emerging markets.
We continue to aggressively manage our projects through the pipeline with greater than 50% of our pipeline in what we define as middle to late stage with projected COD dates through 2020. Both SunPower and 8point3 have significant project and dropdown visibility in the next five years.
I’d like to finish my formal remarks with the brief discussion of our deployment expansion through 2019. Please turn to slide 8.
This chart is very similar to the version we showed at our Analyst Day in November. For 2016, we continue to see a very strong growth opportunity with deployed megawatts increasing approximately 25% year-over-year.
Also as a result of our significant pipeline growth, we are increasing our deployment forecast for 2018 and 2019 compared to Analyst Day as well as raising our compounded annual growth rate to 30% from 2015 to 2019. We will provide further details including an update on product geographic mix at our next Analyst Day this November.
In summary, Q2 was another solid quarter as we executed on our project commitments, expanded our pipeline and progressed on our cost and technology roadmaps. With the launch of 8point3, the acquisition of Infigen’s U.S.
pipeline in our new utility partnership model, we are well positioned to achieve our short and long term goals. With that, I would like to turn over the call to Chuck to review our financials.
Chuck?
Chuck Boynton
Thanks, Tom. Good afternoon, and please turn to slide 9.
For today’s call, I will focus my remarks on our Q2 results and 8point3. Q2 was a very good quarter for the company generating $64 million in EBITDA while successfully managing our holdco asset strategy with the launch of 8point3.
Our strong performance was driven by North American residential, the completion of Solar Star and the IPO of 8point3. In addition, our Q2 results reflect the impact of our holdco strategy which differs revenue and margin benefit to the future.
Q2 bookings and pipeline build have been the strongest we’ve seen in years and positions us well for long term growth, specifically on the P&L. Non-GAAP revenue and margin were in line with our forecast.
Power plant revenues declined sequentially as we continue to build projects under the balance sheet rather than sell them prior to construction. Our non-GAAP gross margin for the quarter was 17.6% and also in line with forecasts.
Power plant margins were on plan led by our large U.S. projects while commercial margins were stable.
We continue to expect our commercial margins to increase overtime to the high teens, low 20s as we launch new products later this year that offers significant cost reductions and decreased installation times compared to our current generation of commercial products. In residential, our business was solid as we saw record North American installations in Q2.
Non-GAAP residential margin for the quarter was 23.3% driven by strong cash sales. North American cash and loan sales totaled 61% of our shipments while 39% were leased.
Overall, we deployed 77 megawatts of residential products globally. Lease bookings were 22 megawatts in Q2 with cumulative lease bookings of 263 megawatts.
Net contracted payments at the end of the quarter were $820 million excluding the residual value. This value is net of the approximately 6,000 leases we sold to 8point3 which represented $190 million of our contracted payments.
In addition, NCI for the quarter was $30 million primarily the result of strong installs in the channel. We also recognized $23 million in OIE which was the gain of the dropdown of the residential leases we sold to 8point3.
Note that this sale was not recorded as revenue because the leases are already in service. If it was recorded in revenue, our top line and margins would have been substantially higher but with no impact to earnings.
Second quarter non-GAAP OpEx was up slightly as we prudently managed our expenses. We expect OpEx to increase slightly as we continue to invest in pipeline growth and our smart energy strategy as well as other key initiatives.
Our factories ran at full utilization with record yields and sell output. Additionally, we are continuing the construction of Fab 4 and expect output of at least 225 megawatts in 2016.
CapEx for the quarter was $44 million and we expect spending to increase throughout the year as construction of Fab 4 nears completion. I will explain how 8point3 will impact our financials.
First, to get a better understanding of the impact, I would like to walk through an overview of the accounting of future transaction between SunPower and 8point3. Please turn to slide 10.
First, the benefits, we will recognize 100% of the revenue from the project sales to 8point3 at the time of the sale. We will 100% of the cash for the project upfront.
Additionally, we will benefit from increased dividends from 8point3 overtime as we drop down projects and overtime we expect to realize significant benefits from the growth of IDRs. In contrast to our holdco plan, we will reduce project debt and deleverage the balance sheet.
And now on the impact on our financials due to our ownership, while revenues are recorded at 100% gross margin is reduced by our ownership percentage in 8point3, approximately 41%. This will understate gross margins and EBITDA for SunPower at the time of the initial sale compared to the cash we received.
Additionally, we will record our share of the earnings from 8point3 in our minority interest line based on our ownership percentage. Finally, when 8point3 issues new equity we will recognize part of the deferred benefit on the dilution.
Now, let’s move on to Q2 specifically, please turn to slide 11. For the quarter, we deferred both revenue and margin primarily due to Quinto as the project is now being sold to 8point3 but will not reach COD until October.
We expect to recognize this revenue and margin in the fourth quarter. On a GAAP basis, we do not expect to recognize any 2015 revenue or margin on our power plant and commercial projects sold to 8point3 due to the real estate accounting rules.
Note that we report non-GAAP for these sales based on IFRS results which are audited and reported to total for their financial results. In a couple of years, GAAP and IFRS will converge for revenue recognition which based on our current understanding will be more in line with how we report non-GAAP results.
For the balance sheet, project assets increased to $423 million again related to the continued development of our IPO and ROFO assets. Of this amount, over $350 million is related to the 8point3 IPO projects.
Also note that while the market value of our ownership in 8point3 is significant, we are carrying this at a book value of $68 million. We expect book value to increase as we reach COD for our projects.
Finally, we use part of the IPO proceeds to deleverage our balance sheet by paying off certain construction loans and residential back leverage debt. I would like to reiterate while we believe that 8point3 offers both sponsors significant opportunities to lower our long term cost of capital while driving shareholder value for 8point3.
Please turn to slide 12. Also in the appendix of today’s deck, we have added the detailed breakdown of both our initial and ROFO portfolio for reference.
There are key highlights for 8point3. The projects are long term contracted assets with a weighted average life of more than 20 years ensuring stable cash flows over the PPA periods.
Additionally, we believe both portfolios offer investors a lower risk profile due to our diversification by geography and end segment. Our assets generally have escalators that exceed degradation that should provide an increase to cash flows over time.
8point3 is supported by two of the leading solar developers in the industry who have a combined pipeline of 13 gigawatt of mid to late stage projects which is growing as evidenced by recent wins at energy and the recent Infigen pipeline acquisition. We have a conservative capital structure with four times leverage.
Finally, our focus remains on a long term sustainable annual dividend growth. We believe both our IPO and ROFO portfolios will enable us to achieve our targeted growth through mid 2018.
The additional pipeline development will allow for sustained growth. I’d now like to provide an update to our holdco strategy, please turn to slide 13.
This chart summarizes the changes in our holdco asset portfolio for the second quarter as well as the asset designed for 8point3 post IPO. At the start of the quarter, we held 679 megawatts on our balance sheet and added 131 megawatts during the quarter for a total of 810 megawatts.
Net of our residential portfolio of contributions for the 8point3 IPO, we ended the quarter with 764 megawatts. Now, please turn to slide 14, we will provide a more specific view of our holdco asset status by project.
You can see from the chart, we deployed approximately 140 megawatts in the second quarter and expect to install an additional 50 megawatts of holdco assets in the third quarter. All assets listed are either part of our initial 8point3 portfolio or part of the ROFO.
Before turning the call back to Tom, I would like to let our investors know that going forward, we will focus on EBITDA rather than earnings per share in both reporting and guidance. As you know, we have been moving towards using EBITDA as a core metric since our analyst day last November.
There are a number of reasons for this change. First, we will continue to focus on our holdco strategy to maximize project returns which means we will be using our balance sheet for project development.
As you know, project timing is not linear and as we move to a holdco asset strategy, we believe EBITDA is a better way to measure the value in our business. EBITDA fully captures all NCI benefits related to our project sales.
SunPower plant and commercial projects will be financed with partnership flips meaning we will have NCI income along with revenue and margin from the sale. As you know, under other models the NCI benefit is classified as revenue and it is really the value received for selling the tax attributes.
We will provide non-GAAP net income consistent with prior practice to the end of 2015. Looking forward, as a result of our pipeline development, continued strong industry fundamental and the launch of 8point3, we are raising our 2015 EBITDA guidance from our November Analyst Day.
Tom, will now cover this and the rest of guidance in more detail. Tom?
Tom Werner
I would now like to discuss some of the highlights of our guidance for the third quarter as well as 2015. As a reminder, per Chuck’s comments, we feel that given our current model, EBITDA will be more appropriate measure of our ongoing business that we will be providing annual non-GAAP EPS guidance for 2015 only.
Please turn to slide 16. For Q3, non-GAAP guidance is as follows.
We expect revenue of $400 million to $450 million, gross margin of 10% to 12%, EBITDA of zero to $15 million and megawatts deployed in the range of 300 megawatt to 330 megawatts. On a GAAP basis, the company expects revenue of $400 million to $450 million, gross margin of 11% to 13% and GAAP loss per share of $0.60 to $0.50 per share.
Please note that our Q3 and 2015 GAAP guidance reflects the impact of our holdco strategy as well as the deferral of revenue and margin due to real estate accounting treatment. Capital expenditures in the third quarter are expected to be in the range of $100 million to $125 million and full year CapEx of between $250 million to $300 million as we continue to ramp construction of Fab 4.
We expect meaningful volume from Fab 4 in Q1 2016. For 2015, our guidance is as follows; non-GAAP revenue of $2.4 billion to $2.6 billion, gross margin of 21% to 23%, earnings per share of $1.50 to $1.80, and megawatts deployed in the range of 1.25 to 1.3 gigawatts.
On a GAAP basis, the company expects 2015 revenue of $1.5 billion to $1.7 billion, gross margin of 10% to 12% and a GAAP loss per share of $2.35 to $2.05 per share. We are also raising our 2015 non-GAAP EBITDA guidance first given at our Analyst Day last November to $425 million to $475 million and we expect 2016 EBITDA growth of approximately 20% from the midpoint of our 2015 guidance or approximately $540 million.
With that, I would like to turn the call over for questions. In addition to Chuck, we also have Howard Wenger, President Business Units and Bob Okunski, our Senior Director of Investor Relations.
Operator
Thank you. [Operator Instructions] Our first question comes from Ben Kallo.
Please announce your company name.
Benjamin Kallo
Hi, Robert W. Baird.
Thanks for taking my question and congratulations on all the work guys. Looking ahead on the acquisition of the pipeline you announced yesterday, could you just talk us through post ITC world, it looks like you have some faith in the U.S.
market and so just walk us through there. And then also maybe give us an update on Fab 4 and the cost structure there.
It looks like holdco was a little higher on projection this quarter. Thanks guys.
Tom Werner
Thanks, Ben. First on Infigen, we are really pleased with the acquisition because it’s scale, its 1.5 gigawatts and the pipeline is split into thirds where a third of it is fairly advanced, the third intermediate to advance and then third of it is early stage.
So we will build those as you pointed out in your question, those are probably the next five years the majority of those. And in fact 55 megawatts of it includes PPA with SoCal Edison that is particularly well-suited to drop down in 8point3.
Now, to your question, if you look to one of our projects that we announced recently, you saw a sub-$50 megawatt hour on project. And if you do the math on that and you project post-ITC, and you continue protecting our cost down and performance increases in our systems, that's where we get our confidence in a potential post-ITC world.
So, we think that our solar energy is interesting to utilities already post-ITC, assuming there is a post-ITC and we'll see what that looks like. So that would be my comment on Infigen and the economics pre and post-ITC.
Secondly on output, we in fact had really, really good output. We are getting more output, primarily a result of more output out of our two large fabs, one in the Philippines and one in Malaysia.
Both outperformed in the quarter, both beat yield and both beat the utilization of the equipment so-called OEE or overall equipment effectiveness. So we got more output because the two fabs performed better.
As I mentioned on the last earnings call, the technology for Fab 4 has already been run in large scale, and is performing at or above plan. And the Fab will be coming online later this year and we’ll have a material impact on 2016, which will be all X-Series, the latest generation of our technology.
Benjamin Kallo
Great. Thanks guys.
Chuck Boynton
Thanks, Ben.
Operator
The next question comes from Brian Lee. Please announce your company name.
Brian Lee
Hey guys, it's Goldman Sachs. Thanks for taking the questions.
I had two, both on the outlook. Maybe first – and I apologize if you went over this – but if I look at the Analyst Day guidance from late last year, I know you guys had withdrawn that, given the holdco and the pending IPO of 8point3.
But it looks like the deployed megawatts forecast for 2015 has actually come down here versus what you had talked about last November; although the out years are going up. I understand why the recognized megawatts would be going lower, but just wondering what might be driving the deployed megawatts guidance coming down here in the near term.
Tom Werner
Sure. The quick answer to your question is that we're going to do somewhat less of our C7 product in China.
While we have put in 100 megawatts so far this year and things are going well, and we're doing more than any solar Western company is in China; such a great market. Having said that, we are going to install a bit less C7 in China this year.
Brian Lee
Okay. That’s helpful.
Thank you. And then the follow up was just on the updated guidance around the EBITDA.
So it implies you guys are maybe pulling forward your 2016 EBITDA outlook versus what you outlined at the end of last year. So, wondering what the drivers of the improved outlook are here, and if that implies anything is coming out of the 2017 view, or if it's all incremental.
Thanks.
Tom Werner
Brian, thank you for the question. It's Chuck, it’s all incremental.
So we had a very strong year. 8point3 has certainly helped better than we expected, so it’s good news and we’ve increased 2016 outlook as well.
So the overall view is its fundamental to the business.
Brian Lee
Okay. Thanks guys.
Operator
The next question comes from Vishal Shah, please announce your company name.
Vishal Shah
Deutsche Bank. Just wanted to [technical difficulty].
Okay, yes. I just wanted to better understand the cost outlook at the system level between both the residential and the utility scale market.
What do you think the cost reduction potential is? And when you are signing these deals [technical difficulty] pricing environment, what kind of cash-on-cash yield are you looking at for these markets right now?
Thank you.
Tom Werner
Okay. I’ll comment on the cost reduction potential, and maybe Howard, you can add to that.
And cash-on-cash yield, Chuck, if you would take that. So, we introduced an Oasis product or solution for the power plant market two or three years ago.
And we are now on the third generation of that and the concept has worked great, and that is to have preconfigured blocks that are - also take labor out of the field, particularly the expensive labor. And then reduce the amount of material content so these are engineered solutions for power plants that concept we can now are reporting those similar concepts over to both the commercial and residential segments.
That’s part of the cost and there is also the soft costs that are a meaningful part of the cost in both of those markets, particularly residential and we are attacking that as well. And I'll say one more thing and turn it to Howard.
And that I would say that those two markets, commercial and residential, have been a little bit untapped for us on the cost reduction side. So I think there is a lot more potential to take cost out.
If you look at what we’ve been able to do in power plants, and the kind of PPFAs that we signing and making profitability, if you took that trend I think you started to look at commercial and residential. Could you expect us to replicate that?
Howard, can you add anything?
Howard Wenger
What Tom stated was exactly right. We are focused on complete solutions in both residential and commercial DG, and just wanted to note that for commercial we are developing complete solutions for the roof and for carports and ground tracking systems.
So the reduction is on the order of 5% to 15% per year depending on residential and which type of commercial solution we are talking about. And that's at the solution level, so we're very focused on standardizing all of our systems across the distributed generation taking cost out and improving quality.
Chuck Boynton
And this Chuck. Your cash-on-cash yield question, Vishal.
Obviously there is a lot of variables in North America things like tax equity, and then which channel we are selling through. What we’ve seen with the assets that we’ve developed and sold are selling to 8point3.
The unlevered returns are quite significant mid-teens. We have not provided this level of detail or granularity, but if you look at other markets around the world, they could be higher in some locations and lower.
But it’s hard to generalize though across the portfolio.
Vishal Shah
Thank you.
Operator
The next question comes from Patrick Jobin. Please announce your company name.
Patrick Jobin
Hi, Credit Suisse. Thanks for taking the questions.
A few here. First, just briefly on Q3 gross margin guidance, and I apologize if I missed it earlier in the prepared remarks.
Why is guidance for a lower gross margin on a non-GAAP basis sequentially into Q3?
Chuck Boynton
Q3 we don’t have the large project margins hitting in Q3. What we expect very strong residential margins.
We see increase in commercial margins which you saw two quarters in a row of increasing commercial margins. And the power plant margins are a little bit lower than what we’ve seen in Q1 and Q2, and quite a bit lower than what we will see in Q4.
So Q4 you will see very, very strong margins based on our Quinto project and commercial project, and we expect longer term commercial to be in the high teens to low 20. So I think Q3 is a bit of a transitional quarter from a margin standpoint between the Solar Star model and the holdco model now evolving into recognition with 8point3.
Patrick Jobin
Got it. Thank you.
And then just two higher-level questions. First, could you maybe talk about your market expectations for the residential segment?
The DG space in 2017, just given the ITC rules as they stand today, with going to 0% ITC for a cash sale. And then the second question would be on the longer-term strategy for allocating assets to get monetized through 8point3 versus third-party sale of – how you dial that percentage, and if there's any difference in your realized profit, that'd be helpful.
Thanks.
Tom Werner
Okay. So, Howard, why don't you take the first question about 2017 in DG?
Howard Wenger
Sure. So first of all, we are really pleased with the performance of our residential team, kudos to them, they are increasing customer satisfaction while scaling the business.
We doubled over year-on-year the residential business in the quarter and the outlook is really strong where we are looking to increase by on the order of 50% first half 2015 to second half 2015. And so the outlook for the residential business is really going into the back half of 2015 and into 2016.
That will give us a great basis for attacking the business in 2017 as we mentioned before we are reducing cost, we are scaling the channel, we are deploying more lease, we doubled our lease volume year-on-year, 25% sequentially quarter-on-quarter and so what we see for 2017 is to be in position to continue to drive that business going forward. You mentioned the 30% tax rate gone away for cash customers for the customer that owns the system and that’s correct.
And so we do see the economics for lease continue to be strong with the 10% ITC, which is a default decline for commercially owned systems or third party owned systems and with the makers depreciation. So, the economics with the cost reduction performance increase channel scaling customer acquisition costs being driven lower we should have a robust business going into 2017.
Tom Werner
And then Patrick I will comment briefly and then turn it to Chuck on the allocation of direct sale, or outright sale versus 8point3 and I’d say, just broadly we are in a position for several where we in fact will have that option. We have an abundance of dropdown assets and of course with the momentum we have we think that will continue, but we will see.
And just one quick point about that choice there are customers who have preferences for – what interest rate they used to discount the cash flows of a project and depending on what interest rate they use that may favor dropdown versus in outright sale, and then there is, sometimes there is tax reasons that Chuck could elaborate on. So, we’ve always been about customer choice and customer orientation in the residential channel offering cash lease loan for several years now.
Similarly, this will add then to 8point3 will help us customize things for our customers.
Chuck Boynton
Great thank you. So, Patrick I think the key way to think about this is we will build up our holdco strategy and have assets on the balance sheet that will sell that 8point3.
When we would sell outside of 8point3, we primarily be because it is a geography that is not suitable for 8point3, think about that like non-OACD countries or areas where there is different risk profile or there could be things with the PPA or the contract that maybe don’t meet the – sort of the high standards that we are setting for 8point3 we might sell those to other parties. But as to the majority of the assets that will develop in OACD countries we would intend to sell the 8point3.
The benefits are obvious, we get a cash sale upfront, we get a 100% revenue treatment. We will not recognize the full margin of the cell to 8point3 as I mentioned in the prepared remarks, but the great thing is we will get dividend growth and future IDR.
So, we are very motivated to develop assets, hold them until completion and then sell the 8point3.
Patrick Jobin
Got it. Thank you.
Operator
The next question comes from Krish Sankar, please announce your company name.
Krish Sankar
Yes, hi it is Bank of America/Merrill Lynch. I have two questions.
The first one, it's on the module economics associated with the ConEd deal that you announced. How do you balance doing business like that when there is no long-term cash flow upside because of no drop-down to 8point3?
And the second follow-up question is more on Asia, Japan and China is a focus for you. I'm kind of curious what you see on the China demand side, given all the noise you are hearing on the macro.
And also on the Japan side, you guys price in US dollars. Are you seeing any competition because of the module – the other competitors pricing in Japanese yen?
Thank you.
Tom Werner
Sure I will take the first one Krish, thank you. On the ConEdison deal, this is a terrific transaction for SunPower, we have a channel that we are going to sell in New York that is a great partner and so we look at this as accretive to our overall model.
We are going to do business many different ways across the country and around the world. Many of those will be buy and hold and sell to 8point3 and many of those will be a cash sale.
And we look at ConEd as a terrific partner and a win-win for us and the utility.
Chuck Boynton
I will expand China, Japan and also comment on ConEd. First China, the short story is that the fundamentals remain quite strong for power plant business.
And the reasons china is going solar of course of the economics that we are seeing around the world and the need, the obvious need to improve air quality and those macro trends I think it is a plant the near term concerns that you read about. So, China is quite strong and we will remain quite strong.
And as I mentioned we’ve installed the 100 megawatts and our pipeline is growing in China. On Japan, you are right there is FX headwinds, Howard runs the DT business since it is a global business.
He is allocating product as you can infer from our comments and our financials around the world; and we’ve had a long history as a company. It is one of the reasons why we are diversified in all meaningful solar markets so that we can flex when there is things like FX or policy change and in fact you are seeing that in our financials and the tie to ConEd is that as Howard remarked, our residential business is doing great and we expect it to do even better and one of the ways it will happen is we will have a diversity of channels to the customer and ConEd, just a great example of how things are evolving.
Krish Sankar
Thanks, Tom. Thanks, Chuck.
Operator
The next question comes from Julien Dumoulin-Smith, please announce your company name.
Julien Dumoulin-Smith
UBS. Good afternoon.
Chuck Boynton
Hi Julien.
Julien Dumoulin-Smith
Hi. So, a quick question here, more in the context of thinking about the pipeline here.
Your 12 gigs to 13 gigs for 8point3, and then ultimately the 1.5 gig Infigen deal, how do we think about reconciling those three, ultimately? Ultimately what's reflected in that 13 gigawatts for 8point3 as far as we should be thinking about the latest developments here?
Chuck Boynton
Sure. Mark and I spent a lot of time in the roadshow talking about the pipeline we have a very strong pipeline between both companies and that’s medium to late stage pipeline it is not the combined pipeline between the two companies, you know primarily in OACD countries and so the way we look at this is we have the ROFO list that effectively allows us to go through the guidance period at 12% to 15% and then beyond there we have the additional portfolio of assets between both companies and so I look at that as additional fire power for sustained long term growth and execution.
You know both of us are very motivated to have a very low cost to capital long term, we see it as a competitive advantage for both companies and I think it is a big advantage for the 8point3 shareholders to have such great visibility for long term execution.
Julien Dumoulin-Smith
Right. But just to be clear, the Infigen portfolio didn't qualify as medium stage, for instance?
Chuck Boynton
As Tom mentioned, Infigen is in three buckets, it is in early stage around many different states in North America, medium stage which is concentrated in a few states, and late stage which for example 55 megawatts is already contracted and would be great assets to sell the 8point3.
Julien Dumoulin-Smith
Okay, fair enough. And then just on the partnership side, obviously the utility announcements are great.
Just curious, how are you thinking about that scaling that up across the country? What are you hearing out there in the marketplace to realize those opportunities, be it on the residential or utility scale side?
Howard Wenger
Yes, this is Howard. We are really excited about the three utility partnerships, two of which we have announced in Dominion and ConEd Solutions, just a quick word about the ConEd Solutions, which makes it particularly interesting, it is in probably the second leading market in the U.S.
and New York. It’s a sister company is the incumbent regulated utility and ConEd Solutions is the unregulated utility and marketing in the same location and the reason I bring that up is that it is really an indication of the trend of what utilities really want to be part of the solar business now.
That’s what we are seeing. There is a no longer really fighting solar, but we are trying to figure out a solution to combine solar with the traditional utility business.
So we are in talks with a number of companies to – and we are well positioned because SunPower as you know has a great differentiated solution, we are developing a turnkey solution with both hardware and software, so we are able to essentially white label and be co-marketing, co-branded offering to customers in partnership with utilities. You asked about scaling up.
This will be my final comment is around how we’re going to do that. The utility business if you look at there is over 35,000 electric utilities serving North America.
So it's unlike other parts of the world where you might have one or two dominant utilities. In the U.S.
there really are single dominant utilities. So we see the way to scale up is partnering with a number of utilities while continue to develop our own independent channel in parallel.
Solar delivers less than 1% of the electricity business in North America so there is a lot of room for growth.
Julien Dumoulin-Smith
Got it. But just to be specific here, are you having conversations with vertically integrated regulated utilities in the context of providing them a solar platform or a solar product market?
Tom Werner
Yes. One of the emerging new models is called community solar, shared solar, there are a number of different models that are subsets of that and we are working with a couple of utilities, for example, regulated utilities to develop a product and offering around that model.
So the answer is yes.
Julien Dumoulin-Smith
Great. Thank you.
Howard Wenger
Thanks.
Operator
We have time for one final question. It comes from Pavel Molchanov.
Please announce your company name.
Pavel Molchanov
Raymond James. As I'm sure you've noticed guys, your stock is trading like you are in the oil business of late; same as six months ago.
So I thought I would just ask you to comment on any linkage between your operating geographies – certainly Japan, Mideast to petroleum pricing, vis-à-vis power economics. And if you can quantify what the percentage exposure of your business mix is, that would be helpful.
Tom Werner
Yes, Pavel. Thanks for the question.
And I think you’ve written on is but if not hopefully I'm consistent with your comments as well; which is that I think it’s like 10% of the world’s electricity is actually made from petroleum. Or less than 10%, I think it’s actually 9%.
So the direct correlation is quite low on that measure. There are correlations, right?
You have FX, and FX influences both businesses. So, it would be fair to say that it’s not really an economic tie, it’s certainly not a direct economic tie between the two.
It’s perhaps a macro environment tie only. And in time as we drive the economics of solar, I think that correlation will be broken and in fact countries when there are a macro challenges, will actually be incented to go to solar.
So we would expect that correlation to not be very good going forward, but we will see.
Pavel Molchanov
Appreciate it.
Tom Werner
Okay. Thanks, Pavel.
Thank you all for joining us today. We look forward to talking to you in three months time in our next quarter call.
Thank you.
Operator
That concludes today's conference. Thank you for participating.
You may disconnect at this time.