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China Sunergy Co., Ltd. (NASDAQ:CSUN)

Q3 2012 Earnings Call

November 27, 2012 8:00 a.m. ET

Executives

Elaine Li – Senior IR

Stephen Cai – CEO

Yongfei Chen – CFO

Analysts

James Medvedeff - Cowen & Company

Operator

Ladies and gentlemen thank you for standing by and welcome to the Q3 2012 China Sunergy Company Limited earnings conference call. (Operator Instructions) I must advise you that this conference is being recorded today, Tuesday 27th of November, 2012. I would now like to hand the conference over to your speaker today Ms. Elaine Li, Senior Investor Relations Manager. Thank you. Please go ahead.

Elaine Li

Thank you, operator and welcome to China Sunergy’s third quarter 2012 earnings conference call. This is Elaine Li speaking, China Sunergy’s Senior Investor Relations Manager. Apologize first for the delay. As you know we cannot start the call until the press release is being distributed. Once again, we are really sorry about the waiting. We have posted a presentation for this call on our website. Today we’ll be closely following and referring to that presentation in our prepared remarks. The company’s CEO Mr. Stephen Cai and our CFO, Mr. Yongfei Chen are here with us today.

Today, before the market opened, the company issued a press release announcing our third quarter financial results and our guidance for the fourth quarter of 2012. This press release is also available on the Investors section of China Sunergy’s website at www.chinasunergy.com.

To start, Stephen will present an overview of the third quarter results and the important developments that have taken place in the quarter. And then our CFO, Mr. Chen, will explain our financial results in more detail. Following that, Stephen will give a technology update and then close with Q4 guidance. Afterwards, they will all be available to take questions.

Before I turn the call over to Stephen, may I remind our listeners that management-prepared remarks include forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. And as such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. China Sunergy does not undertake any obligation to update any forward-looking statements, except as required under applicable law. As a reminder, this conference is being recorded.

Now, I’d like to turn the call over to CEO, Mr. Stephen Cai. Stephen?

Stephen Cai

Thank you all for joining today’s conference call again. At the end of November with only another month to go toward the end of this year, it’s clear that solar industry has gone through the toughest year in this industry. We have seen a massive oversupply of the solar panels, continuously dropping ASP and a slowing global demand. In major European markets, large incentives were pulled back by government entities and the trade disputes in the U.S. and EU have worried the industry. All this resulted in a very challenging market environment for all solar companies in 2012.

China Sunergy is cautiously confident that we have adjusted our strategies appropriately to endure. We believe that this company’s business model is sustainable and we are well positioned to benefit from the industrial eventual recovery. In our view through core strategies of China Sunergy to ensure our long term competitiveness in the solar industry are: One, to continuously advance in technology and the production efficiency, and two, moving forward into launching (ph) the products business.

Along these two strategic lines our current operational priorities include: first, diversifying our geographical focus from traditional European market to fast growing ones, including the U.S. Second, moving part of our manufacturing bases to overseas to better serve our global customers and hedge the risks brought up by trade dispute. And third, continuously bringing down the production costs. We will talk about these in more detail in the later part of my presentation.

As expected previously, this quarter’s revenue and the shipments are lower than those reported in the second quarter due to weaker market demand and deliberately going after only the financially strong customers. In the quarter, we generated revenues of $59.5 million and shipped a total of 82.5 megawatts in line with our guidance.

Our ASP was slightly lower to $0.71 per watt this quarter from $0.75 in the previous quarter. This quarter we successfully achieved a better geographical diversification with a revenue contribution from the Europe declining to 63% from the 82% in the second quarter. In particular, we have lowered our exposure to Italy this quarter and we plan to continue such policy over the next couple of quarters.

We have seen a strong pickup in revenue contribution from Asia Pacific region this quarter, specifically from Australia and Japan. Australia has become our largest end market for the first time accounting for 26% of our overall revenue in the third quarter and we expect this country to remain one of our most critical markets next year. On our future market prospects, in addition to Australia we believe that China, U.S., Japan, UK, Germany, France and Turkey will be important solar markets for China Sunergy in 2013. Japan in particular has become one of the most promising solar markets for global vendors and offers attractive returns, especially after the new solar incentive scheme announced in June this year.

According to the market consensus, it is expected that solar installations in Japan in 2012 could exceed 2 gigawatts. This third quarter we had shipments of approximately 7 megawatts to Japan, up from zero during the same period last year. We expect another 5 megawatts to be shipped to Japan in the fourth quarter.

Separately, we believe that there is a great potential for Turkey in 2013 as there will be new incentive scheme commencing next year. The high profile local Turkish partner had established an exclusive partnership with China Sunergy to not only manufacture module but also engage in downstream EPC and projects. China Sunergy has moved cell and module manufacturing equipment from China to Turkey. The first 100 megawatt cell and a module line which was moved over to Istanbul from our Shanghai facility will start production from late December this year. And we will evaluate further expansion based on the demand potential in the European region. We are confident about winning the Turkish market together with our partner with all the preparations we’ve made to date.

We are also working on penetrating other emerging markets such as the Brazil, South Africa and some ASEAN countries. Solid local partnership and the local legal and government environments are all very important factors to us.

Our gross margin showed improvement from the negative 0.3% in the second quarter to positive 0.7% in the third quarter. This was primarily driven by lower wafer costs. Adjusted non-GAAP gross profit, excluding the inventory provision was $1.7 million leading to adjusted non-GAAP gross margin of 2.8% in the third quarter of 2012. This quarter conversion costs of the cells, cells and modules manufactured were at $0.17 and $0.23 per watt respectively, better than our expectation. Although there were quarter on quarter increases in conversion costs in Q3, which was supported by strategically lowered utilization rates, I want to reaffirm our conversion cost reduction roadmap which is targeted to achieve cell and module conversion cost of $0.15 and $0.21 per watt at the end of this year. We will achieve this through better supply chain management, better production efficiency and higher capacity utilization rate.

Recently, we have put a great effort into advancing the business strategies by expanding our European project team and increasing our know-how in project financing, technologies, sales and legal aspects of projects of this nature. Earlier this month we invested in 10 megawatts of the solar plants in UK, marking our first officials step into the downstream project business. We possess a solid pipeline through the first half of 2013 of over 15 megawatts in Europe and China. And we expect to make more announcements about downstream development in coming quarters. We are targeting to have about 20% of our revenue generated from the downstream project next year which represents a significant evolution in our business model.

Lastly, I would like to add a few words on the trade dispute in the U.S. and Europe. Certainly with U.S. government decision to impose countervailing duties and anti-dumping tariffs on Chinese PD cells and modules. That said, China Sunergy will of course comply with this ruling. With our firm belief in the great potential of the U.S. market, we recently added a strong and experienced management team member in the U.S. who will be onboard in December.

Similarly, we have faced in European markets, although we are waiting for the final ruling to be determined next year, China Sunergy is mitigating the potential risks of tariffs by setting up a production facility in Turkey with a strong local partner. These moves not only demonstrate China Sunergy’s commitment to our customers in the U.S. and Europe but also showcase how China Sunergy proactively adapts to the changing industry dynamics. Our modest scale and the size makes us more nimble, enabled to effect change more easily. We are confident that China Sunergy is well positioned to weather this current industry transition and benefit from the long-term industry recovery.

Now I would like to turn the floor over to Yongfei Chen, our CFO go through the numbers in detail. Mr. Chen?

Yongfei Chen

Thank you, Stephen. Please turn to page 5 to 11 in the PowerPoint presentation. In the third quarter of 2012, we shipped a total of 82.5 megawatts, a decline of 45.1% from the second quarter but within our guidance of 80 to 85 megawatts. Slow shipments this quarter as predicted earlier are a result of weaker demand from European markets.

Our revenue this quarter was $59.5 million, down 46.1% from the last quarter due to drops in both shipment volume and ASP. Our ASP at $0.71 per watt was $0.04 lower than the previous quarter driven mainly by market forces. Even though the decrease in ASP continued, we observed a minor ASP decline in the third quarter of 2012.

Our gross profit in terms of quality (ph) to $392,000 this quarter with gross margin rising to 0.7% from the negative level reported in the second quarter, mainly as a result of lower wafer costs. Adjusted non-GAAP gross profit including the $1.7 million inventory provision was $1.3 million leading to a non-GAAP gross margin of 2.8% in the third quarter of 2012.

In the third quarter we recorded $12.3 million of bad debt provision for several Italian and Indian customers which was included in our SG&A expenses. This resulted in large operating expenses of $28.4 million in the third quarter. The operating losses in this quarter were $28.1 million. Excluding the bad debt provision, our non-GAAP operating expenses would be $16.1 million this quarter.

Our net losses for the third quarter were $23.2 million, an improvement from net losses of $30.3 million in the second quarter. On adjusted non-GAAP basis, our net losses for the third quarter were $9.6 million. Our net loss per ADS was negative $1.74 on the basic and diluted basis. Our adjusted non-GAAP net loss per ADS was negative $0.72 on a basic and diluted basis.

This quarter we generated a one-time foreign exchange gain of $7.8 million. We also recorded interest income of $2.1 million this quarter with the increase coming nearly from short term investments in banks, waste management products. As you may have read in our press release there is a pending accounting issue related to our long leased assets. We will engage independent third party firm to evaluate whether asset impairment is necessary, particularly considering the current challenges the industry is facing. We expect this exercise to be conclude in the fourth quarter and we will update the market as soon as practicable. But please be aware that this may or may not impact our results for the quarter.

Going into our balance sheet items, this quarter (inaudible) points reached $610 million, up 5.9% from the second quarter. While the increase in our overall debt level is minor, we did see a unfavorable change in the mix of short term and long term debt in the third quarter. Our short term loan position rose to $515 million this quarter for working capital dollars and to maintain a healthy level on cash on hand. Going forward, we aim to not only monitor our overall debt level but also achieve better debt mix with more long term loans. We are in discussion with major Chinese banks about extending the relationship beyond working capital needs and to increase our U.S. dollar denominated loans which has lower cost than RMB ones.

Inventory levels increased slightly to $56.1 million this quarter. The increase in the third quarter was primarily to prepare for spot market demand observed and we confirmed that we elected inventory bidder (ph) has mostly been sold in the first quarter of 2012. As always, we will strive to maintain inventory at a reasonable level.

CapEx was $7.6 million this quarter mostly for the expansion of our R&D center for high efficiency QSAR products and Shanghai facilities. As we mentioned in the second quarter conference call, we are carefully considering any capacity expansion and still taking a slow and more conservative approach in order to conserve cash. We maintain a healthy cash position. At quarter end we had $439 million of cash and cash equivalents and the restricted cash, up from $417 million at the end of the second quarter.

This quarter we include operating cash outflow of $3.6 million, a significant improvement from the cash outflow of $55.9 million in the previous quarter. Cash flow in the third quarter remained positive at $25.5 million and we continue to target a positive operating cash flow for the entire year. We’re struggling hard to control our expenses and our key focus will be on minimizing cash flow.

Now Stephen will update you on our latest technology progress and provide guidance for the fourth quarter.

Stephen Cai

Thank you, Mr. Chen. We have made solid progress in our technology in the third quarter. The batch average efficiency of the QSAR cells was 19% in the quarter and topped 19.7% at the times. During the quarter, we developed a new type of the multi-cells using new patent design and achieved 17.4% average efficiency. This type of the high efficiency multi-cells has path series attached including TUV and ammonia resistance and salt spread tests. The test result showed less breakage and a much low power loss.

We have shipped over 5 megawatts to our customers in Europe so far and received great feedbacks. We are applying for the patent and chip mode now. We mentioned our R&D center in previous earnings calls. It will be opened in the first quarter of 2013 with the QSAR cells capacity of 140 megawatts. In Q4 we will launch commercial production of our QSAR second generation lines which are upgraded from our existing production lines. These have achieved an average efficiency of 19.2% and a power output of 275 watts per panel without increasing cost per watt.

Now I would like to close with a guidance for the fourth quarter of 2012. We expect shipments in Q4 to be in range of 90 megawatts to 100 megawatts. Gross margin is expected to be at low single digit level again and thus we are still forecasting a net loss in the fourth quarter.

We reaffirm our guidance for full year shipments in 2012 at 400 megawatts to 420 megawatts. The above guidance is based on the best available information we have at present and assumes a euro-U.S. dollar exchange rate that is based on the average in September. We will update the market if we have further insights or specific updates.

Now, we would like to take your questions. Our Senior Investor Relation Manager, Elaine Li and Finance Controller (inaudible) will facilitate this session and assist management in answering questions. If anything does not get answered satisfactorily on this call, please do contact us afterwards. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from James Medvedeff from Cowen & Company.

James Medvedeff - Cowen & Company

Just a couple of questions. What are you seeing in terms of ASP pressure in the fourth quarter here?

Stephen Cai

Yeah, it seems like the ASP, we predict the number is close to or around is $0.60 per watt.

James Medvedeff - Cowen & Company

$0.60 this quarter?

Stephen Cai

Next quarter, Q4.

James Medvedeff - Cowen & Company

Okay. So there must be some offsetting cost declines in order to keep your gross margins the same or higher, right?

Stephen Cai

Yes, we expect it.

James Medvedeff - Cowen & Company

Where do you see your mix geographically – strategically where would you like it to be let’s say in one or two years?

Stephen Cai

Okay. That’s in terms of the strategies our company, so we’re focused on for the next – for the coming years. Geographical as the focus, we will focus on emerging countries such as the China, U.S., Australia, Japan and Germany of course, France and UK and last one is Turkey. All of these countries have different scenarios, we will steer that. But we look at that, that’s the different potential level and different demand from all of these eight countries in the coming two years. Specifically I will mention that Australia this year we have a very high level of the market share there. And the second one, it’s a good news for us is that we started to get business in Japan in this year. And those two countries, so we will see that still – there will be potential and big potential of profit that we can get in the next year.

And in terms of Turkey, Turkey is a future potential opportunity in coming years. So Turkey, now we not only moved our facility equipment to Turkey to set up our own manufacture there with our partner but also we will focus on the downstream project to get the more profit through this downstream market. So in terms of the Europe market now, we are very focused on the UK market because the last year we know bidding tariff process in the UK and this year lot of the developer and the businessmen or including the investor to focus on the UK for the downstream market. So that’s why I bought – so that’s why I bought this 10 megawatts as the first try for the downstream business. So in general speaking even though this year we had the toughest year in the solar history but anyway I think still there will be a great opportunity for solar business. So it depends on how do you diversify your geographical segments in the world.

James Medvedeff - Cowen & Company

Just one more here back down into the weeds, can you say what your – you said wafer – declining wafer prices was one of the drivers of lower cost. Can you say what you’re paying for wafers in the quarter and what that might look like in Q4?

Stephen Cai

You mean cost of the wafer?

James Medvedeff - Cowen & Company

Yes, thank you.

Stephen Cai

That’s tough to see that because we are not – we’re going through this wafer business but still we could give just round numbers – this quarter our wafer cost is $0.27 per watt. But as to the prediction of the wafer cost in Q4 it’s about $0.22 per watt.

Operator

(Operator Instructions) There are no further questions at this time. I would now like to hand the conference back to today’s presenters. Please continue.

Stephen Cai

Thank you for participating in today’s quarterly earnings call. We look forward to speaking with you again on the next earnings call or in between calls. Thank you.

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