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Executives

Bonnie Clarke [ph] – IR, Financial Dynamics

Allen Wang – CEO

Kenneth Luk – CFO

Analysts

Paul Clegg – Jefferies & Co.

Lu Yeung – Merrill Lynch

Sanjay Shrestha – Lazard Capital Markets

Rob Stone – Cowen & Company

Emily Liu – Arete Research

China Sunergy Co., Ltd. (CSUN) Q3 2008 Earnings Call Transcript November 25, 2008 8:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 China Sunergy Company Limited earnings conference call. My name is Anna and I will be your coordinator for today’s call. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. At this time, all participants are in listen-only mode, and we will be facilitating a question-and-answer session toward the end of the presentation. I would now like to turn the presentation over to Bonnie Clarke [ph] of FD. Please proceed.

Bonnie Clarke

Thank you. And welcome to the third quarter 2008 conference call. Joining us today are China Sunergy’s CEO, Dr. Allen Wang; CFO, Mr. Kenneth Luk; and CTO, Dr. Zhao.

Before we continue, I would like to remind you that this announcement contains forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements other than historical facts in this announcement are forward-looking statements, including but not limited to, the company's ability to raise additional capital to finance the company's activities; the effectiveness, profitability, and the marketability of its products; the future trading of the common stock of the company; the ability of the company to operate as a public company; the period of time for which its current liquidity will enable the company to fund its operations; the company's ability to protect its proprietary information; general economic and business conditions; the volatility of the company's operating results and financial condition; the company's ability to attract or retain qualified senior management personnel and research and development staff; and other risks detailed in the company's filings with the Securities and Exchange Commission.

These forward-looking statements involve known risks and uncertainties and are based on current expectations, assumptions, estimates and projections about the company and the industry. The company undertakes no obligation to update forward-looking statements to reflect subsequent occurring events or circumstances, or to changes in its expectations, except as may be required by law. Although the company believes that the expectations expressed in these forward looking statements are reasonable, they cannot assure you that their expectations will turn out to be correct, and investors are cautioned that actual results may differ materially from the anticipated results.

With that, I’d like to introduce Allen Wang, the CEO of China Sunergy. Allen?

Allen Wang

Thank you. And I welcome everyone to our call today. I would like to start by walking you through our third quarter highlights before Kenneth reviews some of those numbers for you. Following that, I would like to discuss in more detail what we have seen since the close of the quarter and comment on our outlook for the coming months.

Despite experiencing a deteriorating market environment toward the end of the quarter, I’m pleased that we were able to meet our gross margin and potential goal in guidance while sharpening our focus on the future by signing an important sales agreement and securing high quality silicon supplies at flexible and favorable prices. Although our recent performance was impacted by the extreme and unprecedented business conditions, which we faced over the past few months, in particular, October, we have already seen a correction [ph] in the sector during November and believe that with a return to pricing equilibrium, the long-term potential of our company remains strong.

As I just noted, our top line results were in line with the expectations, but slightly shadowed by some impact of the global slowdown late in the quarter. Despite softening in September, we reported revenue for the quarter of $190 million, an increase of 143% compared to last year and about 7% sequentially. And our production levels doubled year-over-year to 35.7 megawatt.

Shipments, although 105% higher compared to last year’s at 34.1 megawatts, did see a slight decline sequentially due in part to 4.3 megawatts of orders been canceled in September. I believe the progress we have made since this time last year is impressive. And so, though during the third quarter we still were obtaining polysilicon from the spot market, we benefited from our increased production of higher efficiency solar cells product and our tightening of cost control.

Our focus on cost effective processes and our high efficiency product helped us to achieve gross margin within guidance of 9.3% despite the competitive environment. Although a slight decline from the second quarter, our gross margin was significantly higher compared to last year when our reliance on the spot market meant we were exposed to the high polysilicon price.

While our third quarter margins remained within our expected range, we have more recently experienced a severe pressure on our margins as ASP for our product declined rapidly and the customers have renegotiated contracts. As I will discuss in more detail later, this price erosion was not immediately passed upstream to our suppliers, which directly impacts margins.

However, toward the end of October, we began to see polysilicon pricing show weakness, lowering our material cost under the pressure of margins. In recent days, we have actually seen our polysilicon cost drop to a greater extent than ASP decline. And we believe that going forward wafer cost will trend comparatively with any future ASP decline.

The economical crisis also impacted our bottom line results during the third quarter. Given that, a significant portion of our sales are in the European market along with several of our peers, we experienced a substantial foreign exchange loss as a result of euro depreciation. The realized and unrealized foreign exchange losses totaled $3.8 million during the quarter, which resulted in our reporting a very slightly net profit of only $0.2 million.

I would like to note that if we pull out our foreign exchange losses, share-based compensation expenses and the loss from embedded derivatives, we had a profit of $5.8 million for the quarter. China Sunergy was also cash flow positive for the quarter. We are not pleased with this follow-on performance, but I also believe that the financial results do not accurately present underlying operational strength of our company.

Turning to our operational side, we continue to see progress with regard to our high efficiency cell offerings during the quarter. Thus we began to benefit from the conversation of our four production lines to HP cells before the beginning of the quarter. Cells produced in these HP lines achieved an average conversion efficiency rate of around 16.7%, and the 34% of our shipments during the quarter consistent with high efficiency cells, although cells with the efficiency run about 17%. The average conversion efficiency for our more advanced selective immediate cells was 17.2% in the third quarter 2008.

With regard to our technology, we have achieved a significant break-through in the development of our N-type cells and have consistently achieved a conversion efficiency of 19% – over 19% under laboratory conditions. We have developed a plan to start commercial production of N-type cells in late Q4 of 2009 with expected minimal average efficiency of 18.5%. As planned, we expect our four new SE lines to be fully operational by the beginning of the first quarter of 2009, bringing the total number of SE lines to five. Combined with the existing lines, this will bring our total production capacity for the year to 320 megawatts based on 6-inch wafers.

This addition of high efficiency capacity is particularly relevant, as I have mentioned that these more efficient cells are higher margin products. As we sell our products on a per-wattage basis, the better efficiency means higher margins. And our customers are willing to pay a price premium for cells with over 70% conversion efficiency. The expected increase in high efficient cell production in 2009 is expected to contribute to an improvement in our gross margin. Once operational, we look to focus production on these SE lines until their production capacity is fulfilled.

During the quarter, we signed two important contracts with leading solar sector firms. We negotiated a multi-year agreement with the Japanese Hitachi High-Technologies Corporation to further secure our supply of 6-inch high quality single crystal line ingots. The agreements secure a supply of 1,472 tons of ingots to be delivered between September 2008 and the end of 2011, enough for us to produce approximately 210 megawatts of solar cells. The contract has been structured in a very flexible nature, ensuring a consistent supply with a favorable cost structure.

We also entered into a seven-year sales agreement with Wuxi Guofei Green Energy Source, a leading Chinese solar energy company, to supply them with 10 megawatts of monocrystalline cells each year beginning in 2009 and conclude in 2015. It is important to note that the existing long-term contracts have not yet begun to positively impact our operations and will really only become relevant during 2009 as well as the four benefits of the improved wafer quality.

We are looking diligently to fund additional supply and sales agreement and we will always ensure the pricing support, support our desire for strengthening margins and profitability. Overall, we began to experience some challenges in the third quarter, and while we are not satisfied with our bottom line performance, we execute well on our business plans and we will ensure that we continue to operate in a manner that is most appropriate for the current market conditions.

I would like to turn the call now to Kenneth for a review of the third quarter numbers before speaking more on what we are currently seeing in our market. Ken?

Kenneth Luk

Thank you, Allen. During the third quarter of 2008, revenues increased 142.9% on a year-over-year basis and 6.6% sequentially to $119 million. We increased quarter-on-quarter sales of solar cell products by 8.6% as compared to the previous quarter. And the percentage of solar cell sales in overseas market of total solar cell sales was 45.1% in the third quarter of 2008 compared to 48.3% and 39.5% in the third quarter of 2007 and the second quarter of 2008 respectively.

Gross profit for the quarter was $11.1 million, which led to a blended gross margin of 9.3% down from 10.4% in the previous quarter mainly as a result of less OEM volume. The gross margin of solar cells was largely the same as the previous quarter. We saw an impact from revenues in euro, affecting gross margin due to the depreciation of that currency.

Blended ASP for the third quarter of 2008 rose from $3.37 per watt in the previous quarter to $3.48 per watt mainly due to favorable pricing at the beginning of the quarter. The blended ASP for the third quarter of 2007 was $2.85.

Wafer costs continued to account for a large proportion of overall manufacturing costs. In the third quarter of 2008, wafer costs rose to $2.87 per watt compared to $2.45 and $2.79 per watt in the third quarter of 2007 and the second quarter of 2008, mainly due to the price increase of wafer.

Our SG&A expenses in the third quarter of 2008 were $4.9 million compared to $4.2 million in the third quarter of 2007 and $5.1 million sequentially, which included share-based compensation charge $0.9 million, $0.1 million, and $0.9 million, respectively.

Profit from operations was $5.7 million. This is compared to an operating loss of $3.6 million and an operating profit of $6.0 million for the third quarter of 2007 and the second quarter of 2008, respectively. In the third quarter we had other expenses amounting to $3.7 million, mainly from unrealized foreign currency exchange loss due to the decrease of euro exchange rate against Renminbi.

Under the US GAAP in the third quarter, we had a loss due to the change in fair value of derivative amounting to $0.8 million, which was caused by the seven-year supply contract with REC signed at the end of the previous quarter. Going forward, we believe the impact of foreign exchange fluctuation would be less significant for China Sunergy. Based on the forecast performed by over ten major worldwide banks, the euro is expected to fluctuate between $1.22 to $1.30 during 2009. This implies that the rapid depreciation we saw in October is not expected to recur.

Additionally, we have established a hedging policy, which ensures that we will hedge all cells made in Europe as soon as a contract is signed and the price fixed, mainly due to the exchange loss and embedded derivatives, net profit reduced to only $0.2 million in this quarter compared to a net income of $3.1 million in the previous quarter and a net loss of $4.4 million in the third quarter of 2007. On July 1, 2008, the company issued 54.5 million, 4.75% senior convertible notes, which are due June 15, 2013. Total issuance costs of the senior convertible notes were approximately 3.9 million.

Net operating cash flow for the third quarter was $1.8 million, meaning as of the end of September 2008, the company had cash and cash equivalents of $122.1 million. We also have access to an untapped bank credit facility of $70 million as at the end of September. And at this point of time, we see no issues in our ability to renew existing bank loans or to obtain new lines of credit, should that be necessary.

In this quarter, depreciation and amortization were $1.4 million and capital expenditures were $8.7 million. The capital expenditures in Q3 were payments made for equipment relating to the expansion of our selective emitter cell lines. The outstanding payment for the four SE lines is $12 million and the budget for our R&D Center in Shanghai is $8 million. These two items have already been accounted for. The only new CapEx requirement is approximately $8 million for the conversion of one SE line to N-type in 2009. And we see no issues in generating this funding internally out of our 2009 profits.

I would like to stress that given our balance sheet, liquidity is not an issue for China Sunergy. We remain cash flow positive and actually took this opportunity to reduce our bank loan from 123 million in Q2 to 103 million in Q3. Our inventory was at the same level Q3 versus Q2, and working capital ratio improved from 178% in the second quarter to 212% in the third quarter. Although the reported financial results are below our target, the financial health of our company is strong and we are able to finance our operations for the foreseeable future.

I would like to turn it back to Allen at this point.

Allen Wang

Thank you, Ken. I would now like to provide you with some observations around what we have been experiencing since the end of September as the financial crisis has taking a tighter grip. We currently believe that the global economic environment will certainly have a significant impact on our fourth quarter and full year results, due primarily to the severe disruption that was experienced in October.

As I touched upon earlier, the rapid decline in ASP for solar cells during October was not immediately matched with the reduction in our upstream costs, largely polysilicon. This led to a very disappointing October and will impact our fourth quarter for reasons that I would like to cover now. Utilizing a combination of existing supply contracts and the shorter opportunities, we typically commit to at least a quarterly plan for materials in sale. However, with the indications of upcoming turbulence really been observed in September, we reduced our wafer commitment to encompass October only, limiting our forward exposure.

Despite this effort and negotiations with suppliers and customers, October was a very difficult month as we suffered due to the ASP retraction, resulting in a net gross margin for our products and a conscious decision to reduce our production of solar cells. Despite some polysilicon cost corrections and ASP stabilization in early November, there has been a little demand for solar products as many firms decided to delay purchases. These have led to reduced shipments, liberty opportunities to compensate for the weak beginning to the quarter.

Although October will impact our results for the entire quarter, I would like to stress that since then the metrics have been substantially more positive and reassuring. We have seen polysilicon prices decrease significantly, resulting in our upstream cost actually declining to a greater degree than ASP. Indeed, we are actually buying wafers in the spot market at a very low price to prepare for our first quarter production of solar cell. One of our advantages at this point is the flexible procurement strategy we utilize, and we expect to continue to benefit from this strategy as we seek the best pricing for high quality wafers.

Despite the vastly improved market conditions that we are now seeing, we still expect to report a negative gross margin for the fourth quarter. Given our active production restraint [ph] during the beginning of the quarter, we’re now estimating production volume in the range of 15 to 20 megawatts for the fourth quarter, leading to a reduction of full year 2008 production target to the range of 107 to 112 megawatts, out of which around 44 megawatts are high efficiency products.

Looking into 2009, as I mentioned, since the middle of November we are seeing the pricing differential improve drastically. And we believe that the price of polysilicon will continue to trend down comparatively to match ASP levels. Given the flexible procurement of polysilicon and recently observed pricing trends, we expect to see margins quickly return to at least a level similar to the June quarter 2008.

In addition, the expected improvement in wafer quality for our overseas suppliers will contribute to improved margin in 2008. We produced 100% of our wafers from local suppliers in China, while in 2009 we will be sourcing more than 50% from overseas markets. For those products produced using wafers from overseas suppliers, there is an estimated 4% in absolute increase to our gross margin.

Despite the potential benefits to our margins, the multitudes of uncertain factors lead us to reduce our production target for 2009 from 220 to 250 megawatts down to 180 to 210 megawatts, including 20% from OEM business. We are confident in achieving the 180 megawatt level, as we already have 160 megawatts of orders either confirmed or in the final stages of negotiation.

The improvement in factors contributing to our margin leads us to anticipate a gross margin of 15% to 19% for 2009. These growth plans are flexible, and we will be prudent yet optimistic based on market conditions. We have actually seen that there does not appear to be any truly insurmountable issues in winning orders, but are seeing a lengthening in the negotiation process.

These factors imply to us that the demand for our products exists and that the pricing is the delaying factor. This potential demand means that we will not operate a full capacity to simply produce cells. But we would take further advantage of any strength we see in the solar market with the underlying commitment to proceed at a sufficiently profitable level.

Our flexibility will allow us the ability to purchase raw materials at the low prices and in turn sell our finished products at the favorable prices. Despite the damage created in October, as a result of the global financial crisis, we are positive regarding the long-term prospects. Our gross margin has already recovered since October and we expect to improve further throughout 2009, as we are able to benefit from our advanced solar cell production, improve the wafer quality, our ability to take advantage of reduced polysilicon pricing, and not being tied down by long-term fixed price supply contracts.

We have no liquidity or funding concerns. And now N-type solar cells is planned for commercial shipment in late 2009. Our financials remain strong, and we have the strategy, technology, production capabilities, an industry leading research and development to drive our success in the long run.

Finally, I would like to thank you all for your ongoing support and now like to open the call for questions. Operator?

Question-and-Answer Session

Operator

And the first question comes from the line of Paul Clegg. Please proceed.

Paul Clegg – Jefferies & Co.

Good evening, guys. Thanks for taking my questions.

Allen Wang

Hi, Paul.

Paul Clegg – Jefferies & Co.

At this point, what are you seeing in the market – in the end markets that give you the degree of confidence to make a 2009 forecast? I guess, what gives you the confidence that customers are going to follow through with their orders after their deferred orders out of 4Q?

Allen Wang

I think that, Paul, we are – actually we are negotiating contracts with our customers – and for 2009. I think up to this point, either order concepts have been confirmed or we are in the final stage negotiation. And I think we are – we are confident that at least we can get 160 megawatts of orders for 2009 at this point of time.

Paul Clegg – Jefferies & Co.

Okay. And then relative to that number where you are today, how much would be actually contracted for ’09 and what percentage of that, if any of it, at this point is priced?

Allen Wang

I think most of our – right now, we have 160 close to be closed, very close, out of which half of those are already signed. But basically our contracts are on a quarterly price adjustment.

Paul Clegg – Jefferies & Co.

They are based quarterly price adjustments, but at this point, the half that are signed, are those actually priced?

Allen Wang

Again, the first quarter – some of those are – first quarter, already have price determined.

Paul Clegg – Jefferies & Co.

Okay. For the fourth quarter, you’ve got price determined. So you probably have better visibility on what the number is for the first quarter. And then if I could follow up, how do you – how are the current prices that you are seeing for wafers in China – and I understand they are coming down very quickly, how do those compare to the long-term contract prices that you’re seeing outside of China that you mentioned at the end of the call?

Allen Wang

I think, Paul, what we can see at this point of time is that the current spot price in China is more than 50% lower than the Q3 price.

Paul Clegg – Jefferies & Co.

Than the what? Than the Q3 price, okay.

Allen Wang

Yes, more than 50% lower.

Paul Clegg – Jefferies & Co.

50% lower. And relative to the long-term contract prices that you expect to pay in 2009?

Allen Wang

We have only one long-term contract, and that is with REC. And I think that contract is around 30 – 38% lower than the Q3 spot price.

Paul Clegg – Jefferies & Co.

Okay. And what percentage of your outlook for 2009 is made up from the REC contract?

Allen Wang

It’s around 40 megawatts.

Paul Clegg – Jefferies & Co.

About 40 megawatts. And I’m sorry, just one follow-up. Your CapEx plans, I understand that you you talked about already having accounting for about $20 million of the amount that you broke out, the $12 million for the SE lines and the $8 million for R&D facility and then the other $8 million for the N-type. Does that mean that you have accounted for them either putting it in prepayments or restricted cash? I guess, where do we find that on your balance sheet?

Kenneth Luk

For the what?

Paul Clegg – Jefferies & Co.

For the – of the $20 million out of the $28 million that you described as your CapEx means. You talked about the $12 million for the SE lines and $8 million for the R&D facility already been accounted for. I’m just wondering where – is that in your prepayments and restricted cash on the balance sheet?

Kenneth Luk

No, no. It would be paid out from our cash balance.

Paul Clegg – Jefferies & Co.

Okay. So we would actually – so, of the $12 million, the $8 million for the R&D and the $8 million for the N-type line, those will all come out of your cash balance?

Kenneth Luk

Yes.

Paul Clegg – Jefferies & Co.

Okay. Thank you.

Operator

And the next question comes from the line of Lu Yeung. Please proceed.

Lu Yeung – Merrill Lynch

I have a question on your cash flow. What is the operating cash flow in 3Q?

Kenneth Luk

Our operating cash flow, what do you mean, Lu?

Lu Yeung – Merrill Lynch

You said your cash flow is positive, just do you have the number?

Kenneth Luk

It’s positive $1.8 million.

Lu Yeung – Merrill Lynch

$1.8 million. And one more question will be, your margin, you said that your margin returned to normal in November. So do you have any higher price wafer that you need to digest, or are you pretty much now can source freely on the spot?

Kenneth Luk

I think we have consumed all the expensive wafers, which we purchased at the end of September or in October.

Lu Yeung – Merrill Lynch

Should I expect the margins to stabilize and will continue to improve in the coming months?

Kenneth Luk

Actually, Lu, I think based on the ASP today and based on the wafer cost in the spot market today, our gross margin actually is better than what we had in Q2.

Lu Yeung – Merrill Lynch

Okay. And you said that your silicon costs dropped 50% from Q3.

Kenneth Luk

More than 50%.

Lu Yeung – Merrill Lynch

More than 50%. And also on your Q1 outlook, what kind of shipment level do you expect? Do you expect at least the same level as in Q4?

Allen Wang

I think we feel very comfortable to have 30 to 35 megawatts. I think it is a number, which we feel very comfortable. And it would be stretched to go to 40.

Lu Yeung – Merrill Lynch

I see. So –

Allen Wang

So I think you may assume that in the range of 30 to 40, and you can (inaudible).

Lu Yeung – Merrill Lynch

One more thing to clarify is that the only CapEx that you do next year is only upgrading one production line to N-type and you will not expand [ph] capacity. Is that correct?

Allen Wang

Again, Lu.

Lu Yeung – Merrill Lynch

So the only CapEx that you do next year is for your N-type line?

Allen Wang

Yes, that is the only CapEx requirement, the new one – the new CapEx requirement at $8 million, which we have to turn existing SE lines to N-type.

Lu Yeung – Merrill Lynch

Do you have any silicon prepayments that you need to pay?

Allen Wang

No, no. Actually even in 2008, we had long-term contracts with local suppliers. Long-term contracts, we mean one-year contracts. And for some of the contracts, we need to make prepayments. And I think nowadays we are purchasing wafers in the spot market on cash-on-delivery basis. And I think when we are talking with some local suppliers in China for supplies in 2009, I think they are not asking for prepayment anymore.

Lu Yeung – Merrill Lynch

I see. So it looks like the cash will remain pretty healthy.

Allen Wang

Yes, correct. You can bet the assumption, yes.

Lu Yeung – Merrill Lynch

Okay, very good. Thanks a lot.

Operator

And the next question comes from the line of Sanjay Shrestha. Please proceed.

Sanjay Shrestha – Lazard Capital Markets

Great. Thank you. Couple of quick question, guys. First one, when you talk about your margin expectation for next year, what are you taking into consideration as to how to see the cell ASP unfold throughout the year? And second part of that question. How much of that shipment is covered by Europe, coming REC contracts and how much would you actually have to by in the spot market?

Allen Wang

I think your first question – you’re asking about ASP level right, Sanjay?

Sanjay Shrestha – Lazard Capital Markets

Yes, exactly.

Allen Wang

I think right now because we are in active negotiation with our customers, we are not ready to disclose that information at this moment. Regarding the supply coverage, REC covers 40 megawatts in 2009. The Hitachi also covers roughly 40 megawatts. We also have one more supply contract, which will cover about 20 megawatts. So we already have like 100 megawatts coming from overseas. And we have a lot of offers from local suppliers in terms of wafers or ingot or poly and the like. We are actually now very selective in making those deals. So in terms of supply coverage, we see no issues.

Sanjay Shrestha – Lazard Capital Markets

Got it. So –

Allen Wang

Sanjay, actually further than that, you know, based – I’d say based on the current ASP and based on the existing spot wafer costs, I think our gross margin is already better than what we had in Q2. And on top of that, we will have more SE products in 2009. And based on our calculation, I think that will help our gross margin by something like 2%. I think another factor that you have to pay attention to is that in 2008 we suffered a lot from poor wafer quality. Because we changed the supply map in 2009, more than 50% of our wafers will be purchased by overseas suppliers. And that improvement in wafer quality based on our calculation, we will have our gross margin by 4%.

Sanjay Shrestha – Lazard Capital Markets

Okay. So that’s 2% then, okay. So that’s that to that number. And in terms of the spot prices right now, I guess the poly number is somewhere around $150 a kilogram. But the question I have for you guys is, how much of transaction is really taking place in the spot market? And what type of volume can you actually buy, granted the prices have fallen a lot since the middle of October to the middle of November? But how much – what type of volume is available there in the spot market right now?

Allen Wang

I think right now the initial problem is not on the supply side, because in Q4, the demand probably has kind of slowed down and we have offers all over the place. As Ken mentioned that, we see offers, which have spot price 50% below what we’ve seen in Q3. But really the issue is on the demand side.

Sanjay Shrestha – Lazard Capital Markets

Exactly.

Allen Wang

And we did some check. We’ve gone around our suppliers and did some check. We believe that there’s quite a supply there. So if the demand is there, they probably can meet the price terms – the pricing terms.

Sanjay Shrestha – Lazard Capital Markets

Okay. Now, are you now seeing the trend where the poly prices have started to stabilize, but the cell and the module price continue to go down? And is that the reason why given what happened to you guys in your sort of the – in terms of the way you guys do the poly purchase on a quarter-out basis ended up impacting your gross margin as much as it did in Q4, because you couldn’t react fast enough, because cell pricing went down faster than what you could sort of offset that by buying more spot poly in Q4?

Allen Wang

Yes, pretty much that’s the case.

Sanjay Shrestha – Lazard Capital Markets

Okay. That’s what happened, okay. One last question then, guys, in terms of the tax outlay for next year, clearly I mean the CapEx number, you guys don’t have any advance payments. So do you potentially foresee a scenario where if in fact you do have a bit of a flexibility with your cash balance, you’re reducing your bank borrowing I guess as well? Do you envision a situation where you might choose to actually build inventory a bit, especially if you do see this at favorable prices to be able to sort of in some sense confirm that you can actually get to that 15% plus type of gross margin? Would you envision doing that?

Kenneth Luk

Sanjay, can you repeat?

Sanjay Shrestha – Lazard Capital Markets

Sure. Do you foresee building inventory, especially if you can get a cheap poly in the spot market in the beginning of 2009?

Kenneth Luk

Okay. Actually what we are doing now is that I can tell you that this week compared with last week, the spot price dropped by another 10%. Okay? So actually we are buying – we bought quite – something like a few million US dollars of wafers last week and then we continue buying.

Sanjay Shrestha – Lazard Capital Markets

Okay. And one last actually, the N-type –

Kenneth Luk

Yes, stocking up for the Q1 production.

Sanjay Shrestha – Lazard Capital Markets

Okay, okay. Terrific. So then in terms of the actual guidance that you guys provided or your outlook for 2009, I take it that does not include any N-type cells and anything on the N-type –?

Allen Wang

No, (inaudible). I think as preliminary guidance, the gross margin of N-type will be in the range of 25% to 30%.

Sanjay Shrestha – Lazard Capital Markets

Perfect. And good job on the cash flow management, guys, during the quarter.

Allen Wang

Thank you, Sanjay.

Operator

And the next question comes from the line of Rob Stone with Cowen & Company. Please proceed.

Rob Stone – Cowen & Company

Hi, guys. I know you are not ready to put a specific number on this because you are still in negotiations. But could you give us a sense for just directionally ASP between where they are right now versus Q1? Would you expect a meaningful change in ASP between Q4 and Q1? Or have prices already dropped to the level you anticipate in Q1?

Allen Wang

I think right now the pricing is kind of – the drop in trend has slowed down. Okay? We see different numbers all the place, but the sense we got is like it’s kind of stabilizing in terms of the ASP.

Rob Stone – Cowen & Company

So assuming there is not another big shift in currency pricing, it looks fairly stable Q4 to Q1?

Allen Wang

That’s our expectation.

Rob Stone – Cowen & Company

Okay. I have a few balance sheet related questions, if I may.

Kenneth Luk

Okay.

Rob Stone – Cowen & Company

First of all, what is the mechanism that drives your level of restricted cash, and might that increase or decrease in the next couple of quarters?

Kenneth Luk

Actually for the REC contract, we did not need to make any prepayment. They ask what bank guarantee of something like 51 million. And for that bank guarantee, we have to put some sort of cash deposit with the bank as collateral.

Rob Stone – Cowen & Company

So that’s going to stay at that level or would it –?

Kenneth Luk

That is the reason why you see the increase in restricted cash.

Rob Stone – Cowen & Company

Okay. But my question is in terms of – as REC delivers on the contract, would that restrict – would the guarantee and therefore the related restricted cash balance work its way down during 2009?

Kenneth Luk

No, no. It’s the same amount everyday.

Rob Stone – Cowen & Company

Okay. So that’s going to stay flat all year. I noticed your advances to suppliers actually went down some quarter-on-quarter. What would you expect the trend in that balance to be? Is that also going to decline?

Kenneth Luk

What’s that?

Rob Stone – Cowen & Company

Advances to suppliers?

Kenneth Luk

Yes. I think – because now, as I said, we used to – the suppliers in China, they used to ask for prepayments, and now they deliver and then after that we pay. And I think that item will be substantially reduced at the end of Q4. It would be – I think it would be in the range of $10 million to $15 million.

Rob Stone – Cowen & Company

Okay. So that’s actually going to throw off cash during Q4?

Kenneth Luk

Correct.

Rob Stone – Cowen & Company

So with respect to the CapEx that you mentioned, you had about $20 million that you had previously discussed, $8 million in new, can you give us some sense of how much of that is going to be spent in the fourth quarter versus in 2009?

Kenneth Luk

I think $12 million we need to spend in Q4 for sure for the ASP line. And then for the R&D concept, I think you can assume it’s $4 million Q1, $4 million Q2.

Rob Stone – Cowen & Company

Okay. And –

Kenneth Luk

And then we will stop spending for the N-type – conversion of the SE line to N-type I think in the beginning of Q3.

Rob Stone – Cowen & Company

Okay. The final question, currently substantial increase in the balance sheet line item amount due from related parties. Can you comment on what that is and how that might trend?

Kenneth Luk

That is the prepayment we made to our related parties for polysilicon supply, but for some reason they failed to make the delivery. And we are asking for a refund, and we are expecting the refund to come in in December.

Rob Stone – Cowen & Company

But that should also go back down?

Kenneth Luk

Exactly.

Rob Stone – Cowen & Company

So it sounds like from the point of view of your balance sheet, because you’re going to be operating at a lower level of revenues, which implies lower accounts receivable, working capital, several of these line items are going down. From an operations basis, you should actually generate a good bit of cash in Q4. Am I correct?

Kenneth Luk

For Q4, yes or no, because we are expecting a couple of prepayments from our customers. So, depending on whether those prepayments will come in on time or not. I think if you ask a question whether – what will be our operating cash flow in Q4, it would be in the region of below – since we are expecting a negative gross margin. So we won’t have any net positive income in that end. So I will say my projection will be plus or minus $5 million.

Rob Stone – Cowen & Company

Okay. I guess what I was getting at is notwithstanding negative gross margin because the number of these balance sheet accounts are going to throw off cash, you won’t consume a lot of cash in the fourth quarter.

Kenneth Luk

Yes.

Rob Stone – Cowen & Company

Great. Thank you.

Kenneth Luk

You’re welcome.

Operator

(Operator instructions) And the next question comes from the line of Emily Liu from Arete Research. Please proceed.

Emily Liu – Arete Research

Hi, thank you for taking my question, because I wonder whether – what currency is your contract with REC. And given the depreciation of the euro, do you have a savings in that when it comes to sourcing?

Kenneth Luk

No, the contract is in US dollar. It’s about 20% of our total production in 2009. And we will have 20% of our sales in 2009 in US dollars. So that will be a natural hedge.

Emily Liu – Arete Research

Okay. Okay, great. So if 20% production sourcing for REC, that’s in US dollars. What about the contract with Hitachi and other overseas suppliers? Are they all in US dollars?

Kenneth Luk

Yes, Hitachi also in US dollars, yes.

Emily Liu – Arete Research

What about the other supplier? Also in US dollars?

Kenneth Luk

For the rest – you can – let’s say, half of 50% in US dollars from overseas. The remaining will be in Renminbi.

Emily Liu – Arete Research

Okay, okay. Can you elaborate more on natural hedging? And how do I match this with the revenue breakdown in terms of currency?

Allen Wang

Let’s say, when – I think right now in the 160 megawatts contract, we are either secured or close to secure. Half of those will be USD denominated, and the other probably close to 30% will be in euro denominated, and the rest will be in RMB denominated.

Emily Liu – Arete Research

Okay. And just curious, does that mean you sell directly 50% to US and 30% to 40% to Europe, or do you have a contract with a European customer denominating in US dollars to avoid currency risk? Is that how it is?

Kenneth Luk

No, I think the USD contract does not limit to the contract to US market. We are marketing in other Asian countries. They all denominate in USD.

Emily Liu – Arete Research

Okay. So you sell directly to Europe about 30%, 40%. Is that a fair assumption?

Kenneth Luk

Yes.

Emily Liu – Arete Research

Okay. And then if you sell to other parts of Asia, it’s US dollars. Okay, great. And then the remaining in RMB. Okay, thank you.

Allen Wang

All right. You’re welcome.

Operator

And there are no further questions at this time. I would now like to turn the conference back over to Mr. Allen Wang, CEO. Please proceed.

Allen Wang

Thank you for your attention, and I look forward to updating you on our progress in the future. Bye.

Kenneth Luk

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. And you may now disconnect. Have a good day.

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Source: China Sunergy Co., Ltd. Q3 2008 Earnings Call Transcript
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