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Executives

Harold Hoskens - Chief Executive Officer

Amy Liu - Chief Financial Officer

Paul Combs - Vice President of Strategic Planning

Analysts

Sanjay Shrestha - Lazard Capital Markets

John Hardy - AmTech Research

Burt Chao - Simmons Company

Rob Stone - Cowen & Company

Jed Dorsheimer - Canaccord Adams

Jonathan Hoopes - ThinkEquity

Paul Clegg - Jefferies

Sam Dubinsky - Oppenheimer

Dan Ries - Collins Stewart

Jesse Pichel - Piper Jaffray

Paul Leming - Soleil Securities

Solarfun Power Holdings Co. Ltd. (SOLF) Q3 2008 Earnings Call December 2, 2008 8:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Solarfun Power Holdings conference call. My name is Caressa and I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator Instructions)

I will now like to turn the presentation over to your host for today’s call, Mr. Paul Combs, Vice President of Strategic Planning; please proceed.

Paul Combs

Thank you Caressa and good morning everyone. Welcome to our call and thank you for your continued interest in Solarfun. Joining me today are my colleagues, Harold Hoskens our CEO; and our CFO, Amy Liu.

Before we continue with the formal commentary, I need to take a moment and remind you of the company’s Safe Harbor policy. This call will contain forward-looking statements, which are subject to risks and uncertainties.

Actual results may differ from those discussed today and therefore we refer you to a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission.

In addition, any projections about the company’s future performance represent management’s estimates as of today December 2, 2008. Solarfun assumes no obligation to update these projections in the future as business and market conditions change.

Certainly, no one would disagree that the environment, which we operate has changed significantly since the last time we had this call. I believe we all understand the macro issues at hand and their relative impact on the global business environment and financial conditions. So, we don’t plan to belabor the point, instead we’d like to get right down to business to help you understand, but this means specifically for the solar industry, how it impacts solar fund, directly both in the near and longer tem and most significantly how have we as a company prepared to navigate these turbulent times.

Let’s be frank, the third quarter did not meet our expectations, largely due to two factors: First, lower than anticipated shipment volume; and secondly our provision for inventory revaluation and at risk material pre-payment. Specifically, module shipment volume of 41.8 megawatts was below our plan. This is not due to our inability to produce or lack of customer demand; it is primarily a result of a polysilicon material supplier not delivering as expected.

We estimate that had polysilicon materials had been delivered according to plan, our full quarter shipment volume would have showed good quarter-to-quarter momentum and would have been more inline with our expectations. The $16.5 million non-cash provision was largely for revaluation of inventory as a result of the rapidly changing polysilicon pricing environment. This mark-to-market provision is based on the current market price as of our reporting date.

Additionally, the quality of some raw materials and finished goods was being not suitable for commercial use. This accounted for almost 80% of the provision. The remaining provision is for what we characterize as at risk pre-payments. This is money advanced to a few polysilicon suppliers and the spot market who failed to deliver and are judged likely not to deliver in the future. So, we believe our ability to recover the pre-payment is doubtful and again this is a non-cash provision that does not affect our cash position.

We do our very best to mitigate such risk at all times, but frankly in a period of robust demand and tight supply as we have experienced for much of 2008, when aggressively purchased raw materials, which sometimes leads to a higher degree of risk and lower quality material and/or non-delivery. I should note importantly that excluding these provisions, our third quarter results would have shown gross margins above 12%, a net income above $8 million and earnings per basic ADS of approximately $0.16.

We try to anticipate your questions in advance, after a very brief review of the 3Q financial highlights, Amy will describe the impact of currency on our operations and how we manage that risk as well as give you as much transparency as possible on our balance sheet, but particular focus on liquidity for 2009. Amy.

Amy Jing Liu

Thanks, Paul. Good morning everyone. Now speaking to the Q3 results quickly; some highlights from our perspective were the following: Shipments of 41.8 megawatts were 53% above the third quarter last year, but down slightly from the previous quarter. As Paul mentioned earlier, our shipments were held back by a lack of polysilicon materials. We don’t believe this will be an issue in the fourth quarter and beyond.

Average selling price for the quarter reached as still robust $4.04, although down from $4.17 recorded in the second quarter. The weakening Euro against the U.S. dollar was largely responsible for the decline. Revenues continue to be largely generated in Europe, with Germany accounting for 53% of sales and Spain 24%.

Gross profit of nearly $7 million was below both last year’s third quarter and this year’s second quarter. Mainly due to the provisioning discussed earlier. As a result, gross margins declined to 3.6%; however, I think it is important to highlight two things.

First as Paul mentioned without the provisions gross margin would have been 12.4% and near our expected levels; and second as we have predicted for number of quarters now, we actually began to see lower silicon based raw material costs per watts in the third quarter as a result of expanding in-house wafer supply. Unfortunately much of the benefits of expanding in-house wafer supply this quarter was offset by currency fluctuations.

On the operating expenses side, I’d like to point out the lower selling expenses category, which was down nearly $1 million from the second quarter. This is an operation from expectations going forward and was due to an adjustment in sales commission accruals. By reducing debts outstanding and through refinancing, we were able to reduce interest costs by about 1$ million from the second quarter.

The third quarter was the initialization of our hedging program and was very timely as the Euro declined. The net currency impact was positive in an amount of $0.4 million. Including the provisions, we recorded a net loss of $6.5 million or negative $0.13 per basic ADS. Without the provisions, net income would have been $8.3 million and earnings per basic ADS would have reached the $0.16.

Now, turning our attention to the balance sheet; we continue to make important progress on working capital management. DSO’s jumped again to 28 days from 37 days in the preceding quarter and inventory days outstanding also were reduced further to 58 days. We finished the quarter with close to $75 million in cash and over $300 million in working capital.

As mentioned earlier we’ve reduced our total bank borrowings to $177 million. We also reached the $71.9 million during the third quarter, while a sale of approximately $5.4 million ADS. We recorded a $16 million in capital expenditures; $30 million in supply pre-payments; and $26 million for the purchase of the remaining interest in out ingot company LYG during the third quarter.

Now let’s take a moment and review our currency risk and management. As a guideline, approximately 80% of our sales are denominated in Euros and the reminder in U.S. dollar. On the cost side of the equation, about 80% of the expenses are RMB denominated and 20% U.S. dollar. For the next 15 months that is the period through the end of 2009 would have hedged about 20% to 30% of our Euro, US dollar exposure, which should help to reduce our currency exposure risk.

Now, I’d like to shift to a review of our funding needs and sources of liquidity. As mentioned earlier, we finished the third quarter with $75 million in cash. During the fourth quarter, capital expenditures, supply pre-payments and additional acquisition payments were a total of about $100 million. This discrete payment, along with our cash flow from normal operations and additional bank facility accessed during the quarter will lead to an end of the year cash balances of around $40 million to $60 million.

At this time, we have not committed to any capacity expansion in 2009 and we are determined that if any additional expansion, it’s to occur as the year progresses. For 2009, we plan to expand $70 million for supply pre-payments, $13 million for the final payments of the LYG acquisition and $10 million for the very small capital investments.

We expect to turn overall cash flow positive in the second half of 2009. Based on the above, we expect to acquire approximately $50 million in additional funding in 2009, which is well below our credit lines of $100 million to $150 million, which are expected to be available to us as we enter 2009.

In summary, we feel that our 2009 funding needs are secure and we have the financial resources to compete in the current environment. Now, I will pass this call to Harold for some formal comments on our current tone of business, our view of directly involving business conditions for solar and to the best of our ability at this time set a tone for our expectations for 2009. Importantly, Harold will touch on our competitive position in the industry now and in the future and how we plan to maintain our growth trends going forward. Harold.

Harold Hoskens

Thank you, Amy. Good day to everybody. You are all aware of the changing market conditions beginning October and of course as participants in this market, we are experts as well. We observed two main changes: First, our customers have become more hesitant to make specific credit commitments in the face of changing and uncertain business conditions globally. Second, industry participants have prevailed output growth in anticipation of supply beginning to out trip demand.

This production adjustment is probably somewhat related to the global economic circumstances, but it also reflects some earlier older optimism about the short-term growth of the industry and the related investments needed for new production capacity. Now, in these circumstances, the industry will have to adjust till it has some oversupply in the pipe line.

On our last conference call after Q2, we got full year ‘08 shipment volume to a range of 175 megawatts to 119 megawatts. With the lower than expected volume in the third quarter due to the polysilicon material delivery issues that Paul mentioned earlier and in consideration of the just mentioned change of market condition, we feel it’s prudent to go towards the lower end of this range around or slightly below 175 megawatt.

This still implies reasonable progress in shipment volume quarter-to-quarter and more than doubling of our volume for 2008 compared to last year. We anticipate, some reduction in ASPs for fourth quarter, as customers react to the current environment, down less than 5% in year accounts as compared to Q3. From here, let’s turn our attention to 2009.

The aforementioned economic circumstances and pipe line adjustments, lead to a different industry perspective going into that New Year. This is visible in a couple of aspects. The intangible results of this reset for solar module makers is both a very significant drop of polysilicon prices and a higher degree of uncertainty with key customers and contract conditions; that is volume and the price for 2009.

We expect that the current dynamics continue to lead to adjustments of the capacity expansion plans for the different players in the industry. Total Installed capacities will expand as far as previously forecasted.

Overall, we expect downward pressure in the previous volume and pricing assumptions into the first quarter of ‘09. We expect that the downstream pipeline will carry too much inventories around year end and that this will have its impact in the demand seen by the players in the first quarter of ’09.

From there, we expect a more direct coupling between the market demands for solar modules than the supply. As a result, we believe that from there we’ll see an increase in clarity and flexibility for the total of 2009. Until then, our top line forecasts are difficult and less certain.

In such an uncertainty, it is probably best to operate with some different scenarios. At this point these scenarios vary mainly in pricing assumptions and sales volumes. To a certain extent however, these differences are leveled out towards the bottom line, because we assume that sales price development with correlate in 2009 quiet strongly with the price developments for polysilicon materials.

From these scenarios and within certain bank risks, we expect the changes to either be ASP or the material cost side will be reflective towards the other side and thus provide a sales stability towards the bottom line.

Our current base sketch for 2009 reflects a volume growth of around 50% for our regular module sales. Even in that scenario one presumes an ASP in the range of EUR 230 to EUR 250 and with market prices for polysilicon somewhat below current levels and the resulting gross margins would be in a 10% to 15% range, as always this on the stable U.S. to Euro rate going forward. We are confident that our vertical integration strategy with more volumes coming from our in-house wafer supply will give support to this increased gross margin.

To support our 2009 forecast, we have signed binding contracts with key customers totaling around 150 megawatts. The word binding here means that these contracts all include a commitment from the customers to provide cash or monetary guarantees to Solarfun before the end of 2008 and indicate the customers confidence in our ability to deliver high quality products and the intend to closely cooperate going forward.

Additionally we have around the same volume of contracts under active negation and expect to confirm a meaningful percentage of these into similar binding contracts. We also see potential with the growing list of newer customers, but anticipate the contacts would likely be in a form of framework agreements without up-front commitment from these customers. These contracts will be negotiated as pricing condition is different from the binding contracts with our key customers.

I’d also like to point out another very important development. As we have mentioned in our last earnings conference call, we have been working with Q-Cells on a contract for a three year manufacturing services agreement for 100 megawatt of PV modules per year for three years beginning early ‘09. We have moved in the meantime from a letter of intent to a formal contract, where we believe that once we finalize this, it will be significant not only for Q-Cells, but also for Solarfun.

It’s a sign of two leading solar companies, truly working in a partnership, which can especially be seen in a technology corporation part of this agreement. It leverages the respective capabilities and speaking from the Solarfun side, it will enable us to quickly add capacity and grow output.

Most of you, who are familiar with Solarfun, know we have historically been seen as handicapped by low visibility and high cost polysilicon base supply. About 80% of our costs of goods sold during recent quarters was polysilicon related, so it is a truly significant factor to us. It was extremely difficult to leverage our low cost manufacturing base. With the rapidly changing industry environment, we believe this effect will become one of our competitive advantages and there is room for us to significantly benefit from the declining cost in polysilicon.

For 2009, about 40% of our supply, either as wafers or polysilicon is on the contract at predetermined prices. For the rest of our volumes, we’re able to buy at close to stock market prices; because of this we’re able to profitably offer competitive pricing to our customers.

Our vertical integration efforts are progressing; we completed the acquisition of our LYG ingot manufacturing facility earlier in the year and are ramping capacity there quickly. Our new wire saw facility at Qidong have successfully started operation. Through these combined operations we expect the 250 megawatt of internal wafer capacity by the mid of 2009. This effort will improve the quality of the wafers used in our cell lines as well as provide a reduction in overall cost.

The focus today for both you and us is clearly the rapidly changing business conditions worldwide, but if I may I’d like to take the remaining few moments to shed some light on where we see the industry evolving longer term and how Solarfun is positioned in that environment.

Ultimately, our strength as a high quality, low cost converter of polysilicon into PV solar modules will come to the forefront. When polysilicon costs are normalized along all players worldwide non-Asian manufactures will have difficulties matching our cost structure or will have to make a sacrifice to profitability to do so.

The elements of competitive advantage are shifting. Shorter term the enhanced availability of polysilicon, demand adjustments and lower pricing has shifted to focus to other cost related parameters. As an industry it is now exited a phase were poly was a clear determining factor towards competitiveness.

The quality of the poly portfolio that’s measured by price and the availability of long term contracts was a key indicator for success. With cheaper and more plentiful silicon now available as [Inaudible] this element is becoming more and more a level playing field; there’s greater similarity between companies. Also the overall value of silicon to the total cost of the product has and will continue to decrease.

From this poly phase, we are entering a phase where the focus in terms of competitiveness will shift to conservation cost. With poly becoming less significant as described before, companies will face differences in the costs of converting the materials into products.

Different companies in the industry have in their perspective different customer trends. We believe that with our lower and more flexible cost structure, we will be able to enhance our competitive advantage in this phase. Also vertical integration is key at this stage to achieve and maintain a good overall position.

The next phase after that will focus on cost, but also on technology capabilities. Solarfun is clearly well positioned to compete here. We have initiatives in place and our technical areas, are marketing as well as in the other key business process areas.

Of course, no business exists without customers and we believe the importance of establishing good long term relationships that cannot be discounted. Exemplary service, product specifications and quality and product customizations will be required to sustain a competitive advantage.

In summary, we welcome the new challenging environment. It forces us to be at the top of our game. We look forward to working with a lower polysilicon cost. This is a market that we have expected, that has an environment where our competitive advantages should become more apparent.

Herewith, I would like to thank you for attention and from here we welcome any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sanjay Shrestha - Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets

A couple of quick questions: first off, you guys talked about your pre-payment and the capital requirements for Q4 of about $100 million, you’re totaling everything and there’s some $57 million in restricted cash and other $72 million in cash and cash equivalents and can you help us get a good sense as to your availability under your borrowing and the level of comfort that you guys have as to the cash requirement between now and end of 2009?

Amy Liu

Yes, thank you for the question and actually we feel very confident on our ability to arrange the needed liquidity for our business to support our business growth. Basically, we have the $75 million cash in hand, entering into Q4 and as mentioned before that we have totally $100 million discrete payments, which including CapEx is about $40 million; supply pre-payment of $ 45 million; and the payment for the LYG acquisition of $30 million.

So over the quarter, basically with the $75 million cash in hand and we have adequate bank financings, bank credit lines that are ready to draw and we’re confident that we have and we can draw down those loans and combining with the cash generated from our normal operation, we will be ending this year at any hedge about $40 million to $60 million. This quarter has been passed majority of the time, we’re very confident we’re going to reach that liquidity.

Sanjay Shrestha - Lazard Capital Markets

And what is your available borrowing under your bank credit line at this point in time?

Amy Liu

We have around $150 million, available solid bank credit lines that’s ready to draw down.

Sanjay Shrestha - Lazard Capital Markets

A couple of other questions; so you guys have reached an agreement with Q-Cell, your 100 megawatt a year? How should we think about that relationship sort of evolving overtime? I mean it obviously makes a lot of sense that they’re expertise is on the cell manufacturing and you guys basically being the module technology; do you see that component of your business representing an increasing mix of your overall sales or do you think that OEM type business like that sort of get capped out at 25%, 30% or maximum 50% of your overall sales and you can continue to do a lot of ongoing ingot to the module type work?

Paul Combs

We are very excited about to start of the business with Q-Cells. As we mentioned in the prepared comments, the volume is significant and will become available in a relatively short period. So, this gives us in a period where maybe the volumes in the industry are not so abundantly growing as earlier expected. This is a good opportunity to enhance our volume scale.

Next to that, we are very excited about working with a company which is certainly also a leader in this industry. That leadership position will allow us to corporate on technology aspects and on the faired enhancing module processes. From there, we are not close to other opportunities for production of module or these types, say part of our value chain. We continue to assess them on a case-by-case basis and if these make sense for our shareholder value creation, we will pursue them.

Sanjay Shrestha - Lazard Capital Markets

One last question then guys; given what’s going on in the spot market, is there any potential risk that you might have with your eight year 1.2 gigawatt contract with GCL and can you give us senses to this starting price point for that long term contract versus where the sport prices are hovering?

Also a side question on that if I may; you guys are a potential beneficiary of declining spot prices, but the question still remains, how much is actually really available in the sport market and how importantly the whole balance sheet and the procurement leverage is going to play out, given the ongoing dynamics and the spot poly and the spot wafer market?

Harold Hoskens

A couple of elements in your question; first we’ve seen quite a significant drop in the prices in the sport markets during the past 8 to 12 weeks. That brings of course the question on the table of what is the difference between the value of long term contract prices and these spot prices and that is something which we continue to asses for all longer term contracts as we go forward and we hope we can do that with our supply partners.

The second element, currently I think the Q4 in a certain way is a special situation; like I tried to illustrate in my prepared remarks, in a sense that there is a bit of a probably harder reset than previously was planned. So, currently I think the industry will look at a bit of a forced lower demand for polysilicon. I think in Q1, the pipeline situation will more normalize and we will get a better clarity on which levels the polysilicon prices will find themselves, so to say.

Sanjay Shrestha - Lazard Capital Markets

Okay, so then if I understand you correctly, there is some flexibility between you and GCL if the spot prices were to continue to hover around this $160 level. I mean you could potentially go back to them and renegotiate or is your starting point lower then $150 per kilogram?

Harold Hoskens

I think it is difficult to comment on individual contracts. I think in general, when polysilicon spot prices start to come down, the delta to the long term contract prices will change. We will have to asses that hopefully with our supplier partners in the different relations.

Operator

Your next question comes from John Hardy - AmTech Research. Please proceed.

John Hardy - AmTech Research

I wanted to ask you a question on the gross margin guidance for Q4 ’08, you’re calling for a sequential improvement; is that off the pro forma number of 12.4% or is that off the GAAP result of 3.6%?

Amy Liu

This gross margin, actually without the provision impacting the gross margin, our gross margin will be reaching 12.4% and after the provisions inventory and also risk pre-payment the gross margin actually will go down to a 3.6%.

John Hardy - AmTech Research

Right, but for the guidance for Q4, I think in the press release you’re calling for a sequential improvement from Q3. So, is that a sequential improvement from the 12.4% or from that 3.6%?

Amy Liu

This is really from the 3.6%, yes.

John Hardy - AmTech Research

And then I had a question surrounding the pre-payments that you’re deeming unrecoverable. Is that just with shorter term relationships or any of those unrecoverable pre-payments associated with long-term contracts?

Paul Combs

We have been pursuing the markets for spot poly, especially in the Q2, Q3 period, Q1; in early part of this year we have been pursuing that quite aggressively. We have in that also got more access to more individual trade type of business relations and in these relations we see that the yielding result is in all cases not so good in terms of the quality of the material and/or the recovery of pre-payment commitments. So, these are more single trade or a couple of trade type of partners and are not linked to our longer term contract.

John Hardy - AmTech Research

I guess my final question would be, if spot continues to fall, do you think that there is the potential for their mark-to-market issues or is that inventory completely accounted for at this point?

Amy Liu

We believe we did adequate assessment regarding ending inventory as of the end of Q3 and as we’re taking an early hit of the evaluation of inventory into our current account; however, as we’re in such a volatile market situation, the market price continues to change dramatically and at the time of the ending of Q4, if the price changes dramatically, we may need to think about another evaluation to ensure our inventories stay at the right level. However, what I said is that the current evaluation on inventory of the Q3 ending inventory, we have basically used the current market price level as of today.

John Hardy - AmTech Research

Okay, so it’s only three or four weeks less here in the quarter; you don’t think that there is a likelihood of any other for their mark-to-market issues for Q4?

Amy Liu

With the current visibility, we don’t think there is additional evaluation needed.

John Hardy - American Technology Research

Okay, one more question. I was wondering if you could talk a little bit about the makeup of banks that your credit lines are with. Are they primarily Chinese domestic banks or are you still sort of attempting to diversify internationally with those credit lines?

Amy Liu

Yes, thanks for the question our credit lines is as I mentioned firm and solid credit lines that are ready to draw and this is a combination of domestic banks and international banks, but largely these are related with the domestic banks.

As you all know, the credit environment in the west is not so stable and very fluctuating; instead the Chinese credit environment today is more stable and more available than the west. As an effort of stimulating the economy, the central bank has just announced the biggest rate cuts about a week ago. So, this is an indication that the Chinese government are determine to grow the economy and as also related to that, the banks are also prepared to support the economy growth.

Also talking about the micro side on the business level, silicon’s main operating base is based out of the City called Qidong, which is [Inaudible] City and silicon’s business together with our sister company Linyang Electric, which was founded by the same founder; these two companies account big portion of the local economy and that trade historically and going forward, we are getting sufficient support from the local government as well as from the bank in the local branch level.

So, we expect and we feel very confident and comfortable that we’ll continue to get support and also mutual support from each other with the local banks in Qidong and I have no doubt, we can continue to draw down these credit lines from our current available lines.

Operator

Your next question comes from Burt Chao - Simmons Company.

Burt Chao - Simmons Company

A couple of quick question, just to touch quickly on the bank loans in China; how at risk are the lines of credit when they reevaluate it at the end of the year with that lines of credit that they’ve given companies? I mean, do you feel confident that going forward that will be the amount as a base level or those get readjusted downward?

Amy Liu

Well, I think the banks as I mentioned in my earlier remarks that the banks are very supportive of silicon in Qidong and in return we’re also very supportive to the local banks. Also the bank’s actually taking a longer-term due on our business and this business is a fast growing and healthy business and has long term potentials. The banks recognize this and they have determined and promised to support us going forward. Together with the marketing credit environment in China, I’m confident we’re going to continuously get a support from them.

Burt Chao - Simmons Company

Okay great and Harold you mentioned the binding contracts that you currently have for 2009 and that they require some sort of payment or consideration from the clients before the end of this year, has the pricing been set on that or does that kind of fluctuate according to the kind of prevailing market rates, what’s the set up there?

Harold Hoskens

In general, the contract terms of course actually as you may imagine, they vary from customer-to-customer, but in general there is a mechanism of a forward pricing including the lease in these contacts.

Burt Chao - Simmons Company

Okay great and I assume that’s what gives you somewhat visibility into your constant Euro terms for ASPs. For FX you mentioned that you’re 10%, 20% to 30% hedged from the U.S. dollar, euro perspective. You’ve given kind of the ASP declines in general; what’s your go forward assumption including FX effects on the euro declining against the dollar for the ASP decline next year?

Amy Liu

Burt, can I repeat your question; you were asking what’s the foreign exchange impact to our ASP decline or…?

Burt Chao - Simmons Company

Yes, exactly. I guess you’ve given a kind of a euro constant rate of a 5% decline in ASPs; however, given the fact that you’re 20% to 30% hedged, what’s going to be the actualized ASP decline next year, when you actually bringing it back to say U.S. dollar terms?

Amy Liu

Yes, Burt I wanted to answer your question, in two separate points. One, is on the constant currency basis, we expect ASP will decline 5% to 10% from the Q4 price and secondly the 20% to 30% hedged portfolio, any gain will be reflected below the line.

Burt Chao - Simmons Company

And then I guess the final question; when you’re actually fully through with the vertical integration, what’s the targeted processing cost from polysilicon all the way to module and what would you say the non-silicon cost at that point would be, that you’re expecting?

Harold Hoskens

I think overall our company; one of the strength is a leading position in the cost of organization, the cost of conversion. We believe that is true for the solar module area, but we believe also after the first test in this certain integration within the meantime significant volume in Q4, coming out of our own wafer facility ingot and wire saw facility and we can offer competitive costs. I think for competitive reason it’s a bit difficult at this point to go into the detail on forward-looking objectives.

Operator

Your next question comes from Rob Stone - Cowen & Company.

Rob Stone - Cowen & Company

I want to understand a little bit better where you’re going with margins for Q4, because if you’ve taken the value of your inventory on hand, down to current market prices, then one would think that you would end up back at a more normalized margin for Q4, considerably better than 3.6%, so am I missing something there?

Amy Liu

Yes, I think you’re making the right assumption. In fact we’re seeing more cost advantage coming from our expanded in-house wafer supplier base and as we guided earlier in the earnings call before that this vertical integration strategy, the benefit will start to materialize in Q4 and we’re seeing of the currency impact.

Our gross margin will grow and improve in the fourth quarter; however, since the euro has frustrated significantly in the fourth quarter, which will lower our ASP and therefore lower our gross margin.

So, on a constant currency basis, we’re truly expecting gross margin improvement to the level of 10% to 15%; however, taking a weakening euro impact into consideration that will lower our overall gross margin and yes it’s more improved from the third quarter of 3.6%.

Rob Stone - Cowen & Company

Hasn’t the market price of raw material though largely capture this; in other words other companies pointed out that they expected to get back to more normalized margins once they worked through higher cost material and so it seems to me that the market price for materials by now has already adjusted both for the weaker demand and the ASP impact of the 10% plus decline sequentially.

So, I know there’s still potential fluctuation between now and the end of the quarter and it’s clear you don’t want to commit to a specific number, but it seems like unless something else changes dramatically through the end of the year. It should be something closer to high single digit gross margin at least or am I missing some adjustment there?

Amy Liu

Yes, the declining of the raw material price is actually coming in towards the end of October and also the company by that time would have build up some inventories and that inventories will digest over the course of Q4. So, solidifying the company in the past heavily exposed to spot, which was viewed as a disadvantage and today it will become an advantage to our business. So, we can fully leverage on the lower spot price available in the current market, but this full leverage will mostly come in the first quarter of 2009.

Rob Stone - Cowen & Company

Okay, so it’s really hitting the margins at the fact that you still have some higher cost material in the fall through, after the end of the quarter in the first month of Q4? What is the current spot price that you are seeing today for polysilicon?

Harold Hoskens

I think there is still a certain range of spot prices and we see various channels and let me briefly depict between the domestic channel and the channel from abroad. If we look now at early December, I think we look at a peak level, which is roughly 50% below the maximum we’ve seen before.

Rob Stone - Cowen & Company

That’s domestic?

Harold Hoskens

It in both, the estimate levels for both additions.

Rob Stone - Cowen & Company

Okay, Amy you mentioned the interest rate cuts, could you tell us what interest rates you would be paying on your available credit lines approximately?

Amy Liu

For the loan newly drawn down, we will definitely start to enjoy the new interest rate, which will be around a little over 6% for the short term working capital loan.

Rob Stone - Cowen & Company

And a final question; based on your Q4 CapEx plans, could just review what your year end capacity will be at each stage of your operations?

Amy Liu

Our year-end capacity is at 360 megawatt.

Harold Hoskens

360 megawatt sale capacity and we are in the process of installing both at wire saw and ingot making capacities to bring us by the middle of the year to 250 megawatt reflected into greater wafer making facility.

Paul Combs

And our output is approximately 80% of that figure.

Rob Stone - Cowen & Company

So, you would certainly have adequate selling module capacity for the 50% increase in volumes, but you wouldn’t quite be therefore vertically integrated ingot and wafer, am I understanding that correctly?

Harold Hoskens

That is correct, although it’s by design. We think that we need to run a meaningful mix in our front-end; on the one hand we want to invest internally to make sure that we have the technical and the cost capability to understand exactly what needs to be done to optimize the integral production flow. On the other hand to a smaller extent, we are committed to external longer-term wafer contracts and we would also like to be able to source a meaningful part of our total volume, domestically as well as internationally in the spot market for wafers.

So, we like to see this as a balanced portfolio where especially as the internal integrated manufacturing facilities need to be significant enough to maintain a good growth for technology footprint.

Rob Stone - Cowen & Company

But you will be getting certainly 20% or 25% of wafers on the outside, assuming that internal was running at full capacity?

Harold Hoskens

It’s a bit of an evolving picture, because we’re ramping up these capacities, but some of the main play capacity of 250 megawatts is once we have complete wire saw and ingot making through the 360 megawatt capacity for cell and therewith related module; you can project a bit of balancing when we look for on the let’s say shorter-to-medium-term.

Operator

Your next question comes from Jed Dorsheimer - Canaccord Adams.

Jed Dorsheimer - Canaccord Adams

Just a couple of questions as a lot have been asked already. I just wanted to dig into the ASP assumptions for next year. I guess cost and currency, you’re expecting about a 350 to 360 ASP in U.S. dollars for next year, is that correct?

Paul Combs

I think, in our base case scenario which we have highlighted, you could plug in a 230 to 250 euro type of ASP range. I would not expect that that translates to $3.5; I mean if you take down some currency.

Jed Dorsheimer - Canaccord Adams

And so, that’s what’s baked into the return to cash flow generation mid 2009, correct?

Harold Hoskens

That is our base case scenario, yes.

Jed Dorsheimer - Canaccord Adams

And in the base case scenario, what is the percentage that would be dedicated to Q-Cells in terms of the manufacturing?

Paul Combs

That’s a point which we made and need to highlight that, thanks for that. Our 360 megawatt nameplate capacity, we nominate that as coupled cell and modular capacity. That means for the 360 megawatts, we have both the cell and the module capacity in place and they’re even in production loading perspective link.

For the Q-Cells compact, we will put in place an additional separate module capacity necessary to cover the amount of 100 megawatt. So, our module capacity will quickly growth to 460, but it’s a kind of separate one and we continue to focus in terms of our nameplate capacity on the combination of cell and module as the denominating factor.

Harold Hoskens

I think it’s also important to divulge that all of our shipment guidance that we have given tonight excludes the 100 megawatts from Q-Cells.

Jed Dorsheimer - Canaccord Adams

Last question, just as you look into next year, the geographic mix, do you think it will stay roughly the same between Germany and Spain or what are baked into your assumptions?

Paul Combs

I think we will see in Europe certain moves where the relative way of both Germany and Spain will somewhat decrease in favor of some of the other, especially in Southern European or Latin European economies. We also see a meaning demand, meaningful shipment of our product coming up into Middle East and also we see a meaningful part of our modules next year ending up in the United States.

We expect that the double-digit percentage of our modules will find its useful life in the United States next year. This will not always be a reflective in our invoice; two numbers which we normally present, because some of our customers will not be located in these territories, but we’ll install these products in these territories.

Jed Dorsheimer - Canaccord Adams

Great and then just on the Q-Cells 100 megawatts, is Q-Cells paying for that expansion, because you had noted that I guess CapEx plans are on hold and since that is an addition to the 360, will that cost anything to expand out to the 100 megawatt capacity there?

Paul Combs

We have first of all with Q-Cells not to go into the details of the contract more than what we have disclosed publicly. In general, we could say that modules investments in our industry compared to wire saw or ingot making investments are relatively small and we continue to be prepared to make these investments also going into ‘09?

Amy Liu

This capital expenditure for the 100 megawatt module capacity is included in our ‘09 CapEx plan and our ‘09 CapEx plan, as we’ve mentioned it’s only a very small amount.

Paul Combs

In general, the return on invested capital for this project is quite high and the payback period is quite short.

Operator

Your next question comes from Jonathan Hoopes - ThinkEquity.

Jonathan Hoopes - ThinkEquity

During your prepared remarks Amy and during your answers to questions, you discussed write-downs of pre-payments that Solarfun has made on raw material from suppliers who have been unlikely to deliver. What about pre-payments that Solarfun has made to suppliers, who are still likely to deliver at raw material costs that are going to be higher or maybe higher than available market prices or the raw material deliveries that you may have to receive on economical costs? What’s the mechanics behind valuing the advance to supplier’s line item on the balance sheet?

Paul Combs

Let us go back to a couple of the other remarks. We see with the decreasing prices, we see more stress on the difference and the delta between the longer-term contract for prices and the spot prices. So that’s an element which we continue the needs to assess and the quality in that sense of the pre-payments is part of that.

In our outlook for 2009 which we have presented around these scenarios, we have made that assessment that we don’t see the need to do that as per today. Market circumstances significantly change of course 192 to revisit that subject.

Jonathan Hoopes - ThinkEquity

So, as you see it right now looking forward, is it because these pre-payments for raw materials as a percentage of total are small, and on the blended average basis they will make a difference or do you have to do them on a kilogram or per ton or per megawatt basis individually, the assessment?

Amy Liu

Basically, I think let’s look at it in a different angle. I think, first we need to access whether this long-term contracts are the good contracts or not. Basically I think, if the poly price continues to decline that we would like to go back to our supplier and probably re-discuss out some of the parameters in the contract and make sure as a strategic partner, we are in the win-win situation.

So, with the long term contracts, we think those guys are really our strategic partner and they would be willing to sit down and discuss with us on those problems and improve the winning factors on both sides.

Jonathan Hoopes – ThinkEquity

Now, I wanted to reconcile comments that were made earlier in the call with your expectations looking forward. One of the reasons attributed to the reduced shipment volume was inability to take delivery from a supplier and this is a supplier I presume you have some long term relationships, combined with short term relationships, but as you look forward to what you we see today as lower spot of raw material costs and what you’re expecting to be even further lower.

I guess the real question is what type of quantities are available in the marketplace to take delivery on? I’m just trying to reconcile, how a contracted relationship was unable to deliver the quantities and where you expect to be able to go into the market and get the quantities needed at the lower pricing?

Harold Hoskens

We must note that certain trends in the industry have changed significantly from Q3 to Q4. In Q3, at certain points in time, the availability was really constrained. Still in my view, probably another perspective that people were quite heavily ramping up capacities in Q4. We see that in Q4, maybe again the partly related to the drops of these increases that the availability is far or less constrained. So, that problem of not for taking these deliveries has been solved with the respective supplier and also in the rest of the spot marketing Q4, we see ample availability.

Paul Combs

Jonathan, I think it’s also important to note that we talked about 40% of our contracts being predetermined, prices are long-term in nature; the remaining 60% is not all spot in a sense that we just go out day-to-day and buy it; we do have one year or less contracts. This pricing is set with prevailing sort of market prices, so I don’t want to leave the impression that we are 60% exposed to sort of the day-to-day spot market.

Operator

Your next question comes from Paul Clegg - Jefferies.

Paul Clegg - Jefferies

I wanted to drilldown a little bit more on your bank line and actually can you say who your primary banks are in China?

Amy Liu

Yes, actually we’re working with a number of banks in China. These are all the first-tier, very strong and very credible banks, including the Bank of China, ICDC, those banks are the first-tier banks. So basically, they have a good ability to support us.

Paul Clegg - Jefferies

Okay and if I understand correctly, your bank lines do expire at the end of the year and have to be renewed. Am I correct in assuming that they all do or that the vast majority of them do?

Amy Liu

No, that’s not the situation. The bank credit line is on the revolving basis; so basically, the due date is different with each individual loan across the year. So, there is no like a sudden due date by the end of the year, but however as we mentioned, we have a solid bank credit line of $100 million to $150 million by the end of 2008 and entering into 2009, that we can draw at anytime.

Paul Clegg - Jefferies

Okay, so that $100 million to $150 million, how much of that would expire by the end of 2009?

Amy Liu

No one is going to be expired by the end of 2009. These credit lines are actually revolving, so as long as we maintain a good relationship with the banks and we would discuss revolving of those lines.

Paul Clegg - Jefferies

Okay, but they still have to go through credit process and be approved again by credit committees at these banks, presumably in China?

Amy Liu

Yes, that’s right.

Paul Clegg - Jefferies

Okay and how much do you think you would need to borrow to end with your estimated cash balance at the end of the year of $40 million to $60 million rather at the end of the 2008?

Amy Liu

For the fourth quarter of 2008, we expect to draw down anywhere from $20 million to $30 million US dollars in the fourth quarter of 2008 and entering into 2009, because as a company we haven’t locked ourselves into major capital investments in 2009. This provides a much better position on the liquidity situation and the overall cash flow will turn positive in the course of 2009 despite that we have about $90 million cash outlays in 2009.

So, basically combing the solid bank credit lines we have available to draw down with the positive cash flow generated from normal operation and we can adequately fund our 2009, more than adequate.

Paul Clegg - Jefferies

So, the cash outlay in ‘09 though represents CapEx and any pre-payments that are left; that was the $90 million that you referred to?

Amy Liu

About $90 million, $70 million is largely related to supply pre-payment and there is around $10 million related to small capital investments and about $30 million related to the final payment of the LYG acquisition. I’m talking about $70 million; this is a contractual obligation to our suppliers long-term LCC suppliers, through the possibility on the renegotiation of some of the long term supply contract pre-payments. So, these will be additional upside to our liquidity situation.

Paul Clegg - Jefferies

And one more on the bank lines; the $100 million to $150 million, is that based on a borrowing base? Is it based on asset based lending or you have a borrowing base where it’s secured by your accounts receivable and your inventory and there’s a formula?

Amy Liu

This is a combination. Actually, John thanks for the question, it’s actually very detail. Let me share some detailed background for you. The $100 million to $150 million bank credit line is a combination of term loan and working capital loan and trade financing. So, working capital loan is basically we can drawdown the loan.

As it is related to the working capital trade financing, we can finance through different angles like LC discounting or LC packing, which in the common sense is related to accounts receivable, but we have a combination of long-term loan, working capital and trade financing and those are solid lines.

Paul Clegg - Jefferies Analyst

Okay and just one final question, could you remind us what the restricted cash is for in the balance sheet?

Amy Liu

The restricted cash is for several purposes, some of the purpose is actually kind of deposits of cash in the bank for some special purpose. For instance we’ll have a deposit of cash in order to issue the letter of credit towards our supply. This is one of the purposes.

Paul Clegg - Jefferies

Okay and the primary use of that cash on your balance sheet is to backup the letters of credit?

Amy Liu

Yes, it’s one of the purposes.

Paul Clegg - Jefferies

It’s the most significant one though; is there anything else that you need to consider in that number or is that the most significant?

Amy Liu

I think those are the most significant one, yes.

Operator

Your next question comes from Sam Dubinsky - Oppenheimer.

Sam Dubinsky - Oppenheimer

Just a couple of housekeeping questions; what was your non-silicon cost this quarter?

Amy Liu

Sam, our non-silicon cost for the quarter, excluding the provisions is around $0.80.

Sam Dubinsky - Oppenheimer

And that includes moving more over reintegrated. Will that come down overtime as you scale or is it going to be around $0.80 going forward?

Amy Liu

I think as we continue to ramp our scale in both, in a vertically integrated supply chain, including ingot and wafer making and cell module we will see that this will be further leveraged.

Harold Hoskens

Yes. Of course, if you vertically manufacture, you have more non-silicon related materials, because each stage in the manufacturing process consumes a certain amount of other material costs and however we think that both in the industry climate, as well as with our increasing scales on our third crosses item, we can maintain significant leverages in Q2 ‘09.

Sam Dubinsky – Oppenheimer

Okay so to relate with your more vertical integrated though, should it be above $0.80, because there’s more processing steps or as you scale could it be below $0.80?

Harold Hoskens

I think in general, if you only change with vertical integration parameter in giving more, it would increase. I would not have the exact amalgamation of that for ‘09 at the moment.

Sam Dubinsky – Oppenheimer

Okay and did you mention, I may have missed this, what Q4 gross margins will be once you back with the currency adjustment and the inventory?

Amy Liu

The Q4 gross margin, as we discussed it earlier, it’s going to be improved from the current Q3 gross margin of 3.6%.

Sam Dubinsky – Oppenheimer

Okay and then for next year, I’m just trying to reconcile your comments. I think you touched on it before, but 10% to 15% gross margins, it seems like your polysilicon cost were still high in 2008. Theoretically shouldn’t your gross margin to be actually higher in Q1 or Q2 next year or meaningfully higher than 15% if poly is really down 50% off the peak?

Harold Hoskens

Yes probably it’s greater. We need to see that we see significant reduction in margin due to the currency effect. The currency in 2009 will eat away compared to Q2, Q3 a significant part of the margin, at least in our base case scenario.

We see that silicon costs continue to come down. We need to see that the overall silicon spot price did not have such a meaningfully impact for us in the course of ‘08 because we have very limited volume to our vertical integrated volumes and only that becomes very significant in ‘09. So, it’s a bit of apples-and-pears maybe.

Sam Dubinsky - Oppenheimer

You mentioned the inventory collection in the industry would probably last a bit through Q1 of next year. So for modeling sake, should we still model units up in Q1 of next year or do you think there will be sort of assets at this range going forward for another quarter or so at September?

Paul Combs

I think we have stated that our growth for next year will be at around a 50% level compared to ‘08, but that first quarter will be below that growth rate. At this point in time, I think that is specific as we can bring it. It is not the normal averaged rate; you would expect from a 50% growth rate.

Sam Dubinsky - Oppenheimer

Just a last question is, on the inventory charge in your release you said it was $16.5 million. From the pro forma reconciliation I think you had somewhere around $14.5 million. What’s the difference between those two numbers?

Amy Liu

We have to look at it. I’m not aware of this $14.5 million.

Paul Combs

As above $14.8 million going to your pro forma reconciliation, it’s different from the $15.5 million. We can always take this question offline.

Sam Dubinsky - Oppenheimer

And also while you’re checking for that, what’s the tax rate for next year?

Amy Liu

Tax rate will be 12.5% for next year. Let me give you the tax rate assumption; 12.5% for next year and increase to around 20% over ‘10 and back to the normal level of 25%, going forward starting from 2011.

Operator

Your next question comes from Dan Ries - Collins Stewart.

Dan Ries - Collins Stewart

The vertical integration strategy; the press release mentions that you have 100 megawatts at the year end and then 260 by mid year, but then it goes on to explain that CapEx plans are currently on hold. Are you fully committed to the 250 by mid year at this point or is it subject to something changing?

Harold Hoskens

We see ourselves as fully committed to expanding to 250 at this point in time.

Dan Ries - Collins Stewart

And given that it’s going to start with 100 of capacity and change during the year; what do you think the reasonable wafer production for the company is in 2009, just in megawatt terms?

Paul Combs

We expect in our base case scenario, that from our vertical integrated facilities we will draw about 60% of our total volume.

Dan Ries - Collins Stewart

60%, and is it targeted as a megawatt or are you literally targeting as a percent?

Paul Combs

No, we look at this sourcing mix and we try to optimize that sourcing mix and sometimes we talk to each other in terms of wafers, sometimes we talk to each other in terms of percentage and sometimes in megawatt; it’s trying to optimize the mix. I would not say we have one of the three fixed as the parameter. We look more as utilizations etc and various steps how we can make it more efficient.

Dan Ries - Collins Stewart

Okay, I’m sorry if I missed this; could you say what your wafer production was in the third quarter or what you might expect for the fourth quarter?

Paul Combs

We did not say that, but we will see to that 60% we are in a good track and we expect to deliver in Q4 anywhere slightly above 25% of our total production; maybe 30% from our internal.

Dan Ries - Collins Stewart

Okay and when you gave the non-silicon cost, I guess that would be a combination of the two. Would it be possible to just isolate for cell module what the non-silicon cost? I believe it had been something in the 70% to 75% range in prior quarters?

Harold Hoskens

I think we’re getting a bit more in detail that we have prepared for here.

Dan Ries - Collins Stewart

Okay, last question then, the accounts receivable days trend now two quarters in row, looks very good, among the best in the industry at about 25 days to 30 days, should we be modeling it at that level going forward?

Amy Liu

To be exact its 28 days in Q3 and we think we’ve made tremendous progress in this area and will continue this effort.

Dan Ries - Collins Stewart

And is there any factoring involved in that or…?

Amy Liu

This is the improvement on our terms and conditions, especially on the payment terms and conditions and also an effort in accelerating the collection process.

Operator

Your next question comes from Jesse Pichel - Piper Jaffray.

Jesse Pichel - Piper Jaffray

Building on Dan’s question, is your superior receivables due to your OEM agreements with certain European distributors and installers?

Amy Liu

Jesse, I think you’re correct. Our strategy is to work with big and reputable, credible strategic partners in Europe like Schuco and EDS. Actually this will be very good in basically obeying the contract and doing the right things. So, I think the strategy played out quite well.

Harold Hoskens

To make it a bit more specific, I would not say OEM is a strict word. I think we tried to work with a limited number of key players with which we have an intense relationship and which we hope that we also together can work to have them in the industry and in that close relation maybe that subject of collection is more on a narrow basis discussed between parties.

Jesse Pichel - Piper Jaffray

If I could on the Q-Cells contract a bit; you’re going to I guess toll Q-Cells cells, is that correct and not assemble your cells?

Harold Hoskens

Q-Cells is going to consign as we have discussed a bit earlier. Q-Cells is going to consign the cells. We have the services and the other materials and we invoice Q-Cells for the other service and the other materials.

Jesse Pichel - Piper Jaffray

And would that include the Q-Cells UMG blended cell and if so who would provide the module warranty on that, would it be Solarfun or would it be Q-Cells?

Harold Hoskens

We will use Q-Cells provided cells and we have agreed with Q-Cells not to go in an underlined way into further details of the specifics of the company.

Jesse Pichel - Piper Jaffray

Obviously, investors’ maybe concerned there, if you’re going to use UMG cells, since they have unproven production characteristics, but does your GCL contract need renegotiation for ’09 or are the terms within the market rate right now?

Harold Hoskens

In general, when the polysilicon prices would continue to drop, there is more attention on the difference between the long term contract prices and the spot prices and we hope that we can get together with the difference applied partners with whom we have a long term contract, to get together to discuss both pricing and other parameters of a contract.

Jesse Pichel - Piper Jaffray

One or two of your competitors thought that poly prices could actually go up in the second half of ’09 relative to the first half; do you agree with this?

Harold Hoskens

There is this view I said earlier, that we need Q1 where the pipeline clearing in our view will come to fruition to get a more coupled few on the demand and supply in the total industry. I think only from there it is well possible to take a view on cost and price and volume developments for the remainder of the year.

Operator

Your last question comes from Paul Leming - Soleil Securities. Please proceed.

Paul Leming - Soleil Securities

Just wanted to circle back on the polysilicon producer who did not deliver product to you in the quarter; can you tell us whether that was a domestic China based producer or an international producer?

Harold Hoskens

I think we look at a problem which occurred in Q3, which in a good and continuing relation with the supplier has been solved into Q4 and we hope with that same supplier that from there we can be find a good module of cooperation.

Paul Leming - Soleil Securities

Just trying to understand, this is a supplier that is China based or internationally based producer of polysilicon?

Harold Hoskens

I would like to leave at this particular place to a polysilicon material and supplier.

Operator

At this time there are no further in queue. I’d like to turn the call back over to Mr. Paul Combs for closing remarks; please proceed.

Paul Combs

Okay thank you for listening. If you have any further questions, of course as always we’ll be available. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect and have a wonderful day.

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Source: Solarfun Power Holdings Co. Ltd Q3 2008 Earnings Call Transcript
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