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Hanwha SolarOne Co., Ltd. (NASDAQ:HSOL)

Q3 2012 Earnings Call

December 11, 2012 8:00 a.m. ET

Executives

Paul Combs – Vice President-Investor Relations

Ki-Joon Hong – Chairman and Chief Executive Officer

Jung Pyo Seo – Chief Financial Officer

Min-Su KIM – President

D.K. Kim – Chief Strategy Officer

Analysts

Kelly Dougherty - Macquarie Research

James Medvedeff - Cowen & Co.

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Q3 2012 Hanwha SolarOne Co., Ltd. Earnings Conference Call. At this point in time all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions) I must advise you that this conference is being recorded today Tuesday, 11 December, 2012. I would now like to hand the conference over to your first speaker for today, Mr. Paul Combs. Thank you, sir. Please go ahead.

Paul Combs

Thank you, operator and good morning everyone. Welcome to our call. Joining me today are our Chairman and CEO, Ki-Joon Hong; our new President, Min-Su KIM; our CFO, Jay Seo; and D.K. Kim, our Chief Strategy Officer.

Chairman Hong will open with some general comments about our recent performance as well as provide a brief introduction of two of our new senior members of management. Jay will then follow with some financial highlights from the third quarter. D.K., will review our perspective on the current operating environment and how Hanwha SolarOne has positioned itself for industry leadership. Min-Su will offer some brief comments focusing primarily on our commercial opportunities going forward. We’ll then be happy to answer any questions you may have.

I’d like to remind you of our Safe Harbor policy which is included in the earnings release and posted in its entirety on slide two of the slide package. I need to remind you that our comments today will contain some forward-looking statements that are subject to risks and uncertainties. Please review our filings with the SEC for a complete rundown of these risks.

Now, it is my pleasure to turn the call over to Chairman Hong.

Ki-Joon Hong

Thank you, Paul, and good morning everyone. As you all know, the current industrial working environment remains challenging. I believe in spite of these depressed conditions we continue to make important strides in some of our key areas in Q3 and are increasingly better positioned to exit this downturn as a significant competitive force.

Specifically during the third quarter, we were able to show growth quarter-over-quarter in shipment volume, as well as further reduce our processing cost factor. From a longer-term perspective, the coming month of Hanwha is to become a leading total solar systems provider, continue to offer SolarOne with unwavering support. The completion of the acquisition of Q CELLS by Hanwha Chemical is a significant milestone towards this goal, and although we are in the early stage of integrating the company with the rest of our solar assets, we are excited about the potential it puts into the organization.

In other news, we made some important addition to our management team. Our former President, Charles Kim, has taken a similar role at Q CELLS following the process of acquisition. We brought in one of Hanwha’s most seasoned executive and one of the driving forces behind Hanwha’s entry into solar business, Mr. Min-Su KIM, to assume the role as President of Hanwha SolarOne. Min-Su is a 25-year veteran of the Hanwha organization and is well versed in the fundamentals of solar industry. He brings us strong commercial orientation which will be critical for leading our efforts to penetrate important growth markets like China, Japan and United States. You will hear more from Min-Su directly on the initiative later in the call.

We also appointed Dr. J.E. HONG as our Chief Technology Officer. J.E. has experience in both semiconductor and solar industry. He holds over 20 patents in Korea, Japan and United States. We view technical innovation as key to our future success and are fortunate to have J.E. onboard to direct these efforts. Now Jay Seo, our CFO, will talk on some financial highlights for the third quarter.

Jung Pyo Seo

Thank you, Joon Hong, and good morning everyone. My comments are summarized on slide three to seven. As Joon Hong mentioned, we were able to show quarter-over-quarter growth in shipments. PV module shipments including module processing services rose 3.8% to 239.5 megawatts in the Q3. This was more than 19% increase from the same quarter a year ago. The pricing environment remained very competitive and as a result we saw our ASP decline to $0.67 from $0.77 the preceding quarter.

We shipped to over 24 countries during the third quarter with our Europe Africa region remaining the largest at 63% of total shipments. Germany accounted for 39% of total shipments, down from 57% the previous quarter reflecting the impact of incentive changes in that market beginning July 1. The Asia Pacific region showed good momentum with China growing to 11% of total shipments and Korea accounted for 6%. Momentum began to build in the U.S. which represented 13% of total versus 7% the previous quarter.

The full geographic mix of shipments is illustrated on slide five. Higher volumes were more than offset by lower prices resulting in a quarter-over-quarter revenue decline of 9.9% to $153.7 million. In spite of continued progress in our processing cost, we were unable to maintain gross profitability in the face of continued selling price pressure. Gross loss for the quarter was $8.9 million and gross margin was a negative 5.8%. This compares to gross profit of $10.6 million and gross margin of 6.3% the previous quarter due primarily to the aforementioned decline in prices and to higher freight costs which saw our operating loss widen from $30 million the prior quarter to $40 million this quarter.

As a percent of revenues operating expenses at 20% were significantly higher than the 14% we recorded during the second quarter. We continued to hold a tight rein on operating expenses but near-term we will continue to face a challenging pricing environment. Interest expense remained relatively constant and we recorded a small gain of $2.9 million loss from the combined effect of foreign exchange loss with a gain from the change in the fair value of derivatives. On a GAAP basis, we recorded a net loss of $51.3 million or $0.61 per basic ADS, as compared to a net loss of $0.50 the previous quarter.

On a non-GAAP basis, we recorded a net loss of $48 million over $0.57 per basic ADS. This figure was not significantly impacted by the change in fair value of our convertible bonds this quarter as it has in some periods in the past, which is largely influenced by the movement of our stock price. Slide six illustrates the further progress we made in reducing our processing cost during the third quarter and our goal of achieving non-poly processing cost of $50 remains in sight. Our blended cost of goods sold feel 1.2% quarter-over-quarter from $0.72 to $0.71.

Our internal cost dropped at a faster rate declining 5.6% to $0.67. The primary factor driving cost reduction was further progress on a number of cost reduction initiatives. We still suffer a penalty for idle capacity of about $0.06 per watt, without that we believe our cost would approach those of industry leaders. We expect the price of polysilicon to decline further in the final quarter of 2012, with spot prices of polysilicon around $16 per kilogram. And this will benefit our cost structure.

Now let's take a quick look at the balance sheet as shown on slide seven. As of September 30, 2012, our cash and cash equivalent balance remained healthy at $256 million and we closed the quarter with net working capital of $146 million. Net cash used in operating activities declined during the quarter to a little over $51 million. Total short-term bank debt including the current portion of long-term borrowings remained constant at $300.09 million. Our outstanding long-term debt which includes a non-current portion of long-term bank followings and our convertible bonds declined about $12 million to $439 million.

During the third quarter we repurchased an additional $22 million of our convertible bonds. We have previously repurchased $50 million during Q1. So total repurchased CB is $72 million. Access to credit continues to tighten in China, broadly speaking, but we continued to have access to necessary funding through combined resources from China and Korea.

Accounts receivable increased $57 million to $184 million, reflecting higher shipment volumes as well as extended payment terms to compete with current industry standards. Days sales outstanding reflected more lenient credit terms and increased from 77 days in Q2 2012 to 126 days this quarter. Inventories increased around $12 million from the prior quarter to $120.4 million. Days inventory outstanding increased slightly from 60 days in the prior quarter to 63 days in the third quarter. Capital expenditures in the third quarter remained relatively small at only $12.7 million. Our capacity remained unchanged at 800 megawatt for ingot and wafer, 1.3 gigawatt for cell and 1.5 gigawatt for module. We have no specific plans to add capacity near-term and will continue to evaluate our needs as the operating environment evolves.

We anticipate spending around $100 million in capital in 2012, a reduction from our previous estimate of $150 million. D.K. will now make some brief comments on the solar industry and our strategic position going forward.

D.K. Kim

Thank you, Jay, and good morning everyone. My comments are summarized on slide 8 through 11. As Chairman Hong noted earlier, the operating environment remains very challenging. Inventories remain high at the manufacturers level, overcapacity still exists and historically large markets in Europe are contracting while pricing is very competitive and Chinese module suppliers are faced with new duties in the U.S. and possibly in Europe as well.

This environment is taking its toll on even the strongest companies. All of tier one Chinese players failed to record an EBIT profit in the third quarter this year. All though the industry is yet to bottom out, we see some encouraging signs of rationalization including a number of company failures reducing manufacturing capacity, Chinese banks tightening credit standards squeezing out marginal players. Some signs that leading competitors will take a more rational approach to pricing and sacrifice volume for profitability and momentum developing in important new growth markets, particularly China and Japan.

Hanwha group’s vision has always been to develop a total solar solution provider and Hanwha SolarOne plays a very critical role in executing this vision. The support of the parent becomes increasingly important in the eyes of the customers who buy our products to those providing financing for solar products, and to the banks who fund our growth, and even to regulatory bodies like the bankruptcy court in Germany handling the Q CELLS proceedings.

Hanwha Chemicals purchase of Q CELLS unquestionably has improved our competitive position and our odds for establishing industry leadership in the longer-term. Although we remain a separate legal and financial entity from SolarOne, the synergies between the two companies are very strong. Hanwha Q CELLS provides us with some immediate benefits as highlighted on slide ten. These benefits include enhanced scale with a combined capacity of 2.3 gigawatts. Strong brand. Reputation for high quality products and a potential to price at a premium, a strong technology platform, improved leverage with suppliers, expertise in downstream activities, as well as an important source of cells in the face of duties in the U.S. and possibly in Europe.

As shown on slide 11, we see three main paths to growing the solar industry. The first is the volume based growth where we are targeting the utility industry for higher sales volume which gives us economies of scale leading to better bargaining power and cost competitiveness. The second type is the value-based growth where traditional PV products are quickly becoming low cost commodities. We will achieve growth by selling higher value products through residential and commercial markets a strong brand.

The third is the downstream growth. We will create value downstream by bundling balance of system components, reaching customers through a variety of channels and expanding our project development, EPC, as well as the O&M business. Now, our new President, Min-Su KIM, will touch on some of the potential we see in important new growth markets.

Min-Su KIM

Thank you, D.K, good morning everyone. As Chairman Hong mentioned in his opening remarks, I joined Hanwha SolarOne as President in late October. I worked for Hanwha Group for more than 25 years in a variety of their businesses and functional areas. I spent more than 17 years on the overseas and domestic sales. So I have a strong commercial orientation. Immediately, prior to joining SolarOne, I lead Corporate Planning Team at Hanwha Chemical, where we successfully expanded into biopharmaceuticals, rechargeable battery materials, nanotechnology and of course, solar business. Our product team does recognize enormous potential of solar [long-term] and of the company's extent into this business.

So you can understand my passion and confidence for now having the opportunity to lead SolarOne into the next phase of industry leadership. Since the acquisition of SolarOne by Hanwha two years ago, the focus has been [institute the management system and procedures. Reducing our non-poly processing costs, improving product quality, adding adequate financing to fund the term operations and leveraging synergies with the parent company.

We have made significant in each of these areas and now we enter first of the company's growth focusing on two aspects. Introduction of high quality products with cost competitiveness and the improvement of sales network for China, Japan and United States markets. To achieve high quality, low cost products we plan to leverage the technology of Hanwha Q CELLS to our product in order to lead product quality and performance while still reducing costs. And we will launch newly designed modules, so-called E-Star Plus and anti-PID module for high (inaudible) and humidity areas. And anti-salt module based on market demand.

For your reference slide 12 shows in detail. I think you are aware of the shift in global demand, away from once dominant Europe to potentially larger markets like China, Japan, Africa, the Middle East and of course the United States. We are active in all these new areas and I would like to spend the remainder of my comments focusing on some of the opportunities we see here.

The China market is unquestionably poised for growth, enormous growth. The Chinese government had and will continue to institute policies to support solar industry. The government has listed solar business as one of the three industries under the 12th five-year plan and in the face of industry overcapacity and declining prices has launched a series of grid connection and incentive policies to promote growth. Based on these strong government policies the China market demand will range from 4 to 6 gigawatt this year depending on timing of project installations and with the potential of 8 gigawatt next year. (inaudible) have been main drivers so far and this year new government initiatives, there will an increasing number of operator PV projects.

SolarOne sees opportunity beyond wholesale production to include fields like EPC, where we can realize our brand and reputation of quality with local partners. We believe we can double shipments in 2014 to China with our conservative private of 150 megawatt.

Japan is a huge market in which we have aggressive new FIC incentive put in place in July of this year. The 2012 market would reach 2 gigawatt and has the potential for over 3 gigawatt in 2014. Hanwha is a recognized brand in Japan and our Korean (inaudible) work so much to our favor. The historical market was preliminarily residential Japan with a strong local brand dominating. We see huge growth driven by both commercial and utility installation, where the combined units of quality from Hanwha and Q CELLS and low cost manufacturing in China provides a good competitive platform to address these large applications.

These is expected to more than double our shipments to Japan in 2013, at least 100 megawatts. We have a plan to separate Japanese sales team from our (inaudible) division. And expand the sales force in our Japanese organization to achieve these goals.

Our efforts in the U.S. markets have been impacted near term by the antidumping investigation. Now under production from Hanwha Q CELLS in Malaysia, the antidumping issue impact on new business is very low. Overall demand in the United States remains healthy and exploration of test grades appear to have little impact. Demand could exceed 3 gigawatt this year and about 4 gigawatt next year. There is a strong utility scale pipeline, and commercial and regular sales will also grow. With the utility scale utilization continuing until 2017.

Like other markets, the financial environment for solar projects in the United States remain repeat and competitive and leasing models have driven residential installations. The strength of Hanwha organization and now the addition of Q CELLS reputation for quality and consistence, make us very bankable. Our expectation for volume growth in United States are high. [2014], for the first three months can be more than triple to 250 megawatt or higher than that of this year.

There are a number of other emerging markets with attractive potential and we don’t have time to address them all day. But our recent progress in South Africa illustrates the scale that is available. Just yesterday, we announced the largest contract in the company's history with 155 megawatt to be shipped during the first half of 2013 to be used in the Letsatsi and Lesedi Project. The award was selected by the South African Department of Energy under the first rounds bids in their new renewable energy program. This is the largest such grant in South Africa to date.

Now I would like to turn the call back to Jay for some final comments on the remainder of this year.

Jung Pyo Seo

Thank you, Min-Su. As is shown on slide 14, for the full year 2012 we have reduced our shipments forecast from 900 megawatt to 1 gigawatt to a range of 825 to 850 megawatt. Capital expenditure for the full year will approximate $100 million below our previous estimate of $150 million. We maintain our earlier projections at non-poly processing cost should fall to $0.50 per watt or below by year-end. Although we have made no formal Q4 projections, I believe you can derive from our annual shipment guidance that quarter-over-quarter shipments will likely decline in the fourth quarter.

Under this scenario and considering the continued comparative pricing environment, it will be difficult to record a positive gross profit. We are now happy to answer any questions you may have. Operator, please open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have your first question from Kelly Dougherty from Macquarie. Please ask your question.

Kelly Dougherty - Macquarie Research

Just following up on the last comment. Certainly it does look like the fourth quarter guidance is going to be down, so I just wondered if you could talk about the demand environment, because that tends to be different from what we're hearing from most of your peers from a demand perspective. Then I guess the follow on to that is, it looks like utilization is going to have to be lower again in the fourth quarter, so just wondering how you get to that $0.50 processing target, if you've got utilization headwinds or maybe that's before underutilization. If you could just give us a little more detail on that, that'd be great.

Jung Pyo Seo

This is Jay. As we mentioned, we lowered the guidance in six months and for full year down to 825 to 850. And so at the same time we are targeting at $0.50 or below in our cost. And so we are maintaining our utilization rate at around 60%. So actually the demand from the customers, we are thinking still remaining at the same level, however, the Q4 has kind of seasonal effect so we are targeting around the 200 or a little bit more than the megawatt in shipment. And so if we run our plants at more than 60 or 70 utilization rate so our annual shipments will be reaching to around 25 or 50.

D.K. Kim

Just to add on that, I mean I think in terms of the actual demand, I think the demand is still there but I think as we mentioned earlier it’s a matter of profitability and whether we want to sacrifice profitability for volume. And I think we are making a conscious choice to under-utilize our facilities in order to try to maintain as much profitably as possibly. And in terms of getting the non-poly processing cost down to $0.50 or below, I think there is still some room in terms of optimizing our supply chain and are actually pretty used for those modules as well as increasing -- and we will also continue to increase our cell efficiency which is helping with per watt cost.

Kelly Dougherty - Macquarie Research

But is that $0.50 -- I think you said what, $0.06 headwind from the low utilization in the third quarter. Is that $0.50 before or after that number? Like it would be $0.50 if you were running at a high utilization and then you put that $0.06 on top of it or...?

Jung Pyo Seo

The $0.50 is including $0.06 so as for devoting $0.06 lower utilization rate the loss, and so our processing cost will be around $0.46 or $0.47.

D.K. Kim

So when we say $0.50 or below we are counting the underutilization.

Kelly Dougherty - Macquarie Research

So what is it right now, I guess, or how did you get so much out of non-poly costs into the circle. I mean if you've got a $0.06 headwind and you're going to take another number of cents out of it in the fourth quarter and yet still run at lower utilizations, I guess I'm just trying to get my head around where exactly you made the changes. Maybe a better question is can you break down your processing costs into what relies to wafer, cell, and module?

D.K. Kim

So regarding the breakdown of the processing cost I can say, ingot $0.04, wafer $0.11, cells $0.13 and modules is $0.25. So total $0.52 in Q3.

Kelly Dougherty - Macquarie Research

Okay. And where do you think the most benefit comes from as you move into Q4?

Jung Pyo Seo

I think as D.K. already mentioned there is room through our whole procedure. And so from ingot through cell and module. However, generally, from cell and modules we can't think there will be more room than others.

Kelly Dougherty - Macquarie Research

Okay, that's helpful, thanks. And then just OpEx interest, I mean they seem to continually be rising, so I was just wondering what the plan is to get them under control. It seems like we're on a much lower gross margin environment going forward on a sustainable basis. I guess maybe the question is what do you think is a good, sustainable gross margin for this business? And then how do you get OpEx and interest lower than that to be able to turn back to profitability at some point?

Jung Pyo Seo

So regarding the OpEx management, I am sure we can manage the OpEx very well in the absolute amount level. And so recently just the freight increased, so that is the only reason why the OpEx has increased. However, the price went down. So then that is why the percentage of OpEx has increased from last quarter. So as I mentioned the absolute market is under good managed and before next year actually -- so even though there will be increase in shipment and revenue, so will ship a little bit lower level of OpEx. So currently we are adding around $10 million OpEx per month and $120 million OpEx per year but next year I am expecting our OpEx will be lower than that. And generally our OpEx is squeezed already. And so only freight is the opportunity that is a little bit -- will be the opportunity to be [needed].

D.K. Kim

And I think when are asking more and more in general in terms of what the industry gross margin will be and how some of the players will maintain profitability despite the OpEx and interest costs, I mean I think it’s a matter of rational pricing that’s going to have to come. I think a lot of our peers and throughout the manufacturing sector there has been a lot of inventory and there has been a lot of liquidation of inventory at below cash cost and I think this is something that cannot continue as people are losing money everywhere. And I think at least the industry leaders should be able to gain gross margins in the teens for this industry to be sustainable. And I think obviously we are going to have to continue on trying to decrease the OpEx as much as possible but I think this kind of negative even single-digit gross margin is not something that is very sustainable in the longer term.

Operator

(Operator Instructions) Your next question comes from James Medvedeff from Cowen. Please ask your question, thank you.

James Medvedeff - Cowen & Co.

I have a question about the fourth quarter environment, specifically what sort of ASPs are you seeing so far this quarter?

Jung Pyo Seo

Our ASP forecast of fourth quarter is $0.65 per watt.

James Medvedeff - Cowen & Co.

And could you remind me again your cost, including the underutilization is $0.50 plus about $0.15 again, for wafer?

D.K. Kim

I think our poly cost should be lower because as you know the spot pricing for polysilicon is around $16 but I mean we do have some longer-term contract that are going to be slightly higher in price but I think if you apply 6 grams per watt, I think it should be around $0.10-$0.12 for the poly cost. So I think you can make the calculation there and if we can achieve $0.50 in our poly processing cost, it should add up to around $0.60.

James Medvedeff - Cowen & Co.

So you should be able to report a positive gross margin even in this soft volume environment for you, right?

D.K. Kim

I think the cost of goods sold is different matter from the cost of goods manufactured and I think depending on how much inventory we carryover, I think it should be pretty close in terms of whether we are going to be able to post a positive gross margin.

James Medvedeff - Cowen & Co.

Okay. And just one final one. Did you buy any wafers in the quarter and what did they cost?

Jung Pyo Seo

We bought wafers and the purchase price is around $0.22.

Operator

(Operator Instructions) You have a follow-up question from Kelly Dougherty from Macquarie. Please ask your question.

Kelly Dougherty - Macquarie Research

Just a quick follow up for me. I want to just think about how the project business would impact Hanwha SolarOne. So would you be solely the module supplier to projects that were done by Hanwha the parent or Hanwha or -- I'm sorry by Q CELLS, so we wouldn't have to worry about any kind of revenue recognition issues or anything going on your balance sheet? Is that the way to think about it?

D.K. Kim

I mean I think overall that would be the right way to think about it. And I think the only exception might be some projects where we might, for various reasons, take a equity stake or some projects in China where we are already doing EPC work as well.

Kelly Dougherty - Macquarie Research

Can you help us quantify that? I mean is it a big number in the overall things or we should start to break it out, or....?

D.K. Kim

You mean the Chinese EPC piece or which.....?

Kelly Dougherty - Macquarie Research

Right. Just, so the project. I mean where we're going to have to start thinking about a higher ASP, hopefully higher gross margins, and then maybe some revenue recognition issues. Because I don't imagine, if you're doing the projects, you'll be able to recognize the revenue immediately.

D.K. Kim

I think our general strategy, I think maybe Jay or Min-Su can add on to my comments, but I think our general strategy is that we are trying to not really invest significant equity into any of the projects if we can help it at all. And I think even in China I think our general strategy is that we want to sell the project as soon as it’s done. And I think we are also trying to do more of a modeling EPC rather than actually owning the projects ourselves. And I think the Chinese market, there is still a very big question mark on how big we want to get into the Chinese market next year. And I think it also has to do with possibility of the new antidumping.

Operator

(Operator Instructions) As there are now further questions at this point, I would like to hand the conference back to your presenters for today. Thank you, sir. Please go ahead.

Paul Combs

Okay. Thank you, operator. Thank you everyone for tuning in and for your continued interest in Hanwha SolarOne. As we know we are always happy to answer any follow up questions you may have. Have a great day. Thank you.

Operator

Thank you very much sir. Ladies and gentlemen that does conclude our conference for today. Thank you for participating. You may now disconnect.

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