Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Suntech Power Holdings Co. Ltd. (NYSE:STP)

Q2 2006 Earnings Conference Call

August 15, 2006 8:00 am ET

Executives

Cindy Shao - IR Coordinator

Dr. Zhengrong Shi - Chairman and CEO

Dr. Stuart Wenham - Chief Technical Officer

Amy Yi Zhang - CFO

Yunsheng Jiang - Investment Controller

Analysts

Rob Stone - Cowen & Co.

Tienyu Sieh - Merrill Lynch

Jesse Pichel - Piper Jaffray

Paul Leming - Soleil Securities

Kevin Munroe - Thomas Weisel

Ming Yang - Piper Jaffray

Sunil Gupta - Morgan Stanley

Chang Qiu - Forun Technology Research

David Edwards - ThinkEquity

Angello Chan - Credit Suisse

Paul Clegg - Natexis Bleichroeder

Presentation

Operator

Good morning ladies and gentlemen, and welcome to the second quarter 2006 Suntech Power earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Ms Cindy Shao, Investor Relations Coordinator. Please proceed, ma’am.

Cindy Shao

Hello everyone and welcome to Suntech’s second quarter 2006 earnings conference call. My name is Cindy Shao, Suntech’s Investor Relations Coordinator. From Suntech, on the call today we have Dr. Zhengrong Shi, Suntech Chairman and CEO; Amy Zhang our Chief Financial Officer; and Stuart Wenham our Chief Technology Officer. Also Yunsheng Jiang, our Investment Controller, will be participating in the Q&A following Dr. Shi’s closing remarks.

Before we continue, allow me to take you through the Safe Harbor policy. During this conference call we will make certain forward-looking statements in an effort to assist you in understanding the Company and its results. The forward-looking statement were will made under the Safe Harbor provision of the U.S. Private Securities Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, Suntech’s future results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in Suntech’s corporate filings with the U.S. Securities and Exchange Commission. Suntech does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

As a reminder, this conference call is being recorded and a webcast of management’s prepared remarks will be available on the Investor Relations section of Suntech’s website after this call. Also, please make note that all figures mentioned during this conference call are in U.S. dollars. I will now turn the call over to Suntech’s Chairman and CEO, Dr. Zhengrong Shi.

Zhengrong Shi

Thank you, Cindy. Hello, and I thank you for joining us today. We are encouraged by another quarter of strong results as we continue to execute our strategy of expanding our markets while locking in silicon supply, growing in production capacity, and of course, advancing technologies. Our willingness to pay higher prices on the spot market for extra silicon supply has enabled us to rapidly expand market share and exceed the top end of our net revenue guidance by $11 million. With total production output of 35.5 megawatts for the quarter, also exceeding our previous guidance of 31 megawatts to 33 megawatts.

Despite the higher silicon prices, better control of production costs and operating expenses allowed us to maintain gross margins of 28.2%, well in line with our previous guidance.

With demand for PV modules worldwide greatly exceeding available supply, larger numbers of customers remain dissatisfied with their current supplier’s ability to fill orders. Suntech’s aggressive market share expansion is enabling us to establish many new, long-term relationships with such customers during this time of tight silicon supply. We feel the slight impact on our gross margin is more than made up for by the long-term strategic benefit of this approach.

In addition to the increasing converting efficiencies and a lowering cost per watt, which our CTO Dr. Stuart Wenham will discuss more in a moment, we are expanding our market by focusing on developing PV products for value-added specialty applications, such as street lamps and building integrated PV. We believe that in the future, these specialty applications will be a significant driver of margins in the solar industry. We are positioning ourselves to capture leading positions in this market.

During the second quarter, we expanded our geographic market and further diversified our customer base. In Europe, we began to ramp sales in France, Greece and Portugal, all of which have strong government initiatives in place supporting the use of solar power. We are particularly enthusiastic about the potential for solar power in France, which has recently passed government incentives that have the potential to exceed even Germany, which in the second quarter accounted for 46% of Suntech’s total sales.

Approximately 28% of our sales during the quarter was with customers based in China. While much of this was for export, we are encouraged by the increased demand by end users in China, especially in the areas of system integration.

We have seen rapidly increasing sales in the U.S. market where there is also a strong trend towards increased government incentives. With the establishment of our Suntech American subsidiary, we are confident that we will rapidly develop our distribution channels and our market share in that important market. With sales to the U.S. only commencing in Q2, the achievement of 6% of our total revenues coming from the U.S. market represents an important development for the Company.

While tight silicon supply is an ongoing challenge to the entire solar industry, our branded solar model strategy of combining long-term contracts from both domestic and international suppliers with OEM exchange programs and spot market purchases has helped us to increase our production output at a rapid speed. We believe this will help position Suntech for greater market share and profitability over the long term.

I’m pleased to announce that our silicon strategy, combined with the recently announced ten-year silicon supply agreement with the MEMC, has allowed us to successfully lock in 100% of silicon supply needed for Suntech’s planned 2007 production.

We also continue to grow our production capacity in a cost-effective manner. In April, we installed an additional 30 megawatt production line, which reached full capacity ahead of schedule in June, and we remain on course to reach 240 megawatts annualized PV production capacity by the end of the third quarter of this year.

In addition, our subsidiary Luoyang Suntech will start to produce PV cells at the end of third quarter, and will bring another 30 megawatts capacity to Suntech.

We believe that the recently announced acquisition of MSK is a great addition to Suntech and will further our core strategy on several fronts. Number one, the acquisition expands our international market reach, giving us the leading distribution network and brand name in one of the most difficult markets in the world to enter.

Number two, by bringing our portfolio of leading technologies, such as built-in integrated PV, and the single-cell modules, the acquisition furthers Suntech’s strategy of focusing more on value-added PV products.

Number three, we believe that the deal will generate strong synergies in terms of manufacturing, sales and purchasing, as well as research and development and the back office functions of financial management and IT.

Of course, in the solar industry nothing is more important than remaining on the forefront of technology, so before our CFO, Amy Zhang takes you through our financials, I would like to turn the call over to our Chief Technology Officer, Dr. Stuart Wenham who will give you some technical highlights of the quarter.

Stuart Wenham

Thank you, Dr. Shi. During Q2, Suntech continued to place high priority on its technology development with good progress both with reducing wafer thickness in production, and in the development of its new, high efficiency technologies, with our newest technology expected to achieve efficiencies above 20% in large scale production.

In our previous earnings release, we reported that we were in the process of designing the pilot production facility for this new technology. We now have completed designing this facility and fully specified in the equipment requirements, with pilot production expected during 2007. Further details on this new technology are expected to be available in the near future, once patent protection has been secured. In the meantime, Suntech’s new 18% efficient technology remains on track for large scale production by the end of 2006.

With regard to reducing wafer thicknesses, we have now demonstrated the ability of our production to handle 180 micron thick wafers in large scale production while simultaneously achieving breakage rates below 2%. Our actual mix in production, however, has an average thickness somewhat above this, due to the silicon supply shortage necessitating us using whatever wafers the manufacturers feel most comfortable in producing.

Another important development for Suntech has been the extension of the collaborative research agreement with the University of New South Wales, the world record holders for silicon solar cell efficiencies, and arguably the world leaders in developing crystalline silicon solar cell technology.

The new agreement extends the collaboration through to the end of 2010, committing Suntech to a minimum of $1 million per year in support of this collaborative research. Now I will hand the call over to our CFO Amy Zhang to take you through our financials.

Amy Yi Zhang

Thank you, Stuart. Instead of repeating all the numbers in the press release, I’ll provide some highlights on certain key results for the second quarter of 2006, and provide financial guidance for the third quarter.

In the second quarter, we recorded net revenue of $128.2 million, representing an increase of 205.9% year-over-year. During the quarter, we shipped a total output of approximately 35.5 megawatts, compared to 27 megawatts in the first quarter of 2006. The ratio of our PV cell output to PV modules was 30 to 70 in the second quarter of 2006, compared to 50/50 for the previous quarter. The rise in output of modules to cells reflects our effort to target the end user market and reduce indirect competition from the OEM cell exchange program.

Our gross margin decreased sequentially to 28.2% for the quarter, as we purchased additional silicon on the spot market for the purpose of expanding our production and taking market share from our competitors. As Dr. Shi mentioned, we believe that the slight impact on the gross margins resulting from more expensive spot market purchases is more than offset by the strategic advantages.

For the rest of 2006, we expect Suntech, excluding MSK, to maintain gross margins in the range of 27% to 29%, as we realize the benefits of technology improvements and a higher proportion of silicon supply locked in through long-term contracts.

Operating income for the second quarter was $28.2 million, and operating margin was 22%, up over 1% year-over-year and marginally down from the previous quarter. The year-over-year increase was mainly due to the relatively stable back office operating expenses, despite the rapid increase in manufacturing capacity.

Total share-based compensation expenses for the second quarter remained at $2.8 million. Of this amount, $0.5 million was recognized as cost of goods sold, $0.6 million as R&D, and $1.7 million as G&A expenses. After deducting share-based compensation expenses and increases in raw material costs related to R&D activity, R&D on a pro forma basis was over twice the level of the previous quarter, as we devoted more of our resources towards production innovation and increasing conversion efficiencies.

G&A expenses decreased marginally from the first quarter, as we instituted better costs control and streamlined back office systems. To minimize the exchange risk between the RMB and the US dollar we expanded our foreign currency hedging provision during the quarter. As a result, other expenses in second quarter rose to $1.4 million, up from negative $0.2 million in the first quarter.

During the second quarter we maintained a strong balance sheet, with cash and cash equivalent of approximately $313 million. To better control our international transactions, we transitioned from telegraphic transfer to letter of credit as our primary settlement instrument for international transactions during the second quarter. The resulting increase in the time to collection of accounts receivable was reflected in the balance sheet, with accounts receivable rising to $29 million from $5 million in the first quarter. Restricted cash also increased in order to satisfy the requirements to obtain letters of credit.

During the second quarter we continued to provide cash advances to suppliers to ensure preferential allocation of silicon supply and allow them to expand their production capacity. Advances to suppliers increased from $50 million at the end of the first quarter to $67 million at the end of the second quarter.

With respect to our financial guidance for the third quarter and full year 2006, please note that the following outlook statements are based on the current expectations. These statements are forward-looking and actual results may differ materially.

Total net revenues in the third quarter, including MSK, are expected to be in the range of $162 million to $169 million, representing year-over-year growth in the range of 186% to 198%.

For the quarter we anticipate total output will be in the range of 45 megawatts to 47.5 megawatts. Please note that MSK’s revenue contribution of total net revenue and total sales output in the third quarter only includes the period following the closing of the MSK transaction from August 12, 2006 to September 30, 2006. MSK’s quarterly results will be fully consolidated into Suntech beginning in the fourth quarter of 2006.

For the full year 2006, we expect total output will be between 160 megawatts to 172 megawatts. Of the total output for the full year 2006 we expect MSK will contribute approximately 30 megawatts to 32 megawatts. At this time I’d like to turn the call back to Dr. Shi.

Zhengrong Shi

Thank you, Amy. The second quarter was a great one for Suntech as we ramped up our production capacity and expanded our market amidst strong global demand for PV products. We believe that this demand will continue to grow rapidly as more governments worldwide adopt support for clean solar energy. At the same time, while tight silicon supply will likely remain a reality for years to come, we believe that Suntech is well-positioned compared to our competitors. The ten-year supply agreement we recently signed with MEMC, while a true breakthrough in this area, is just one of the long-term supply arrangements that we have in place to ensure a steady supply of competitively-priced silicon to support Suntech Group for the long term.

Also, while we continue to make a gains in converting efficiencies, we have also begun to emphasize key solutions tailored to specific value-added applications, both through leveraging our significant research and development advantages, and through the acquisition of MSK Corporation. This is a long-term strategy that we believe will drive margins and help win high value customers in key markets.

Overall, the second quarter was a solid one, but I assure you we are just getting started. Thank you again for joining us today. I will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Rob Stone -Cowen and Co.

Rob Stone - Cowen & Co.

Good evening, Dr. Shi. Congratulations on a great quarter.

Zhengrong Shi

Thank you.

Rob Stone - Cowen & Co.

I wonder if you could give us a little more color on your expectations for MSK in terms of a business model? For example, are the prevailing module prices for MSK in Japan likely to be similar or higher or lower than Suntech’s modules prices? What type of gross margins do you think MSK will have?

Zhengrong Shi

I think MSK has a variety of PV products. They have standard products and also more value-added products. I think that the margins, we believe, for different markets are different. For example, for the standard product it’s more prevailing market price as most high quality PV manufacturers. For the small value-added BIPV and other more value-added products, I think the margin will probably be higher.

Rob Stone - Cowen & Co.

Okay. Can you comment on the cost of the bridge loan that you will be financing the first phase of the acquisition with?

Zhengrong Shi

I think these are based on Japanese interest rates. So as you can imagine, they are quite low.

Rob Stone - Cowen & Co.

Great. Thank you.

Operator

Your next question will come from the line of Tienyu Sieh - Merrill Lynch.

Tienyu Sieh - Merrill Lynch

I was wondering if you could give us an update in terms of what the material price trend would look like over the next couple of quarters, what are you anticipating?

Zhengrong Shi

I think material prices, the spot material prices are probably more or less reaching the ceiling. I think the material price will gradually become stabilized in the next quarter or even next year.

Tienyu Sieh - Merrill Lynch

Right. You would therefore look for the module prices to similarly peak out as well?

Zhengrong Shi

We think so.

Tienyu Sieh - Merrill Lynch

I was wondering if you could give us an update on new initiatives in terms of technology? Do you have any updates as to when you might look at thin film, for example?

Stuart Wenham

I think in terms of new technology, our immediate plans are as we described in conjunction with our wafer-based technologies, where we have two new technologies, one already in pilot production, and scheduled to go into large production by the end of this year. Then we have a newer, very exciting technology which we believe will be capable of achieving 20% efficiency in commercial production, which we expect to have in pilot production next year.

During this period of time, we’re certainly very interested in thin-film photovoltaics as well, particularly based on polycrystalline silicon. We believe silicon is the ideal material for photovoltaics both in wafer form and in film form. So our interest is in evaluating thin-film photovoltaics based on polycrystalline silicon.

Our expectation at this point in time is that we will be entering pilot production of our technology around 2008. In terms of when we would scale that up to our large scale production, we’re keeping that as a fairly open issue at this point in time, because a lot depends on the competitiveness of the thin-film versus our wafer-based technologies which are doing very, very well.

We do, however, see the important niche markets developing for thin-film products and so we see an importance in that having a thin-film product developed and able to supply those particular niche markets, particularly in BIPV types of applications.

Tienyu Sieh - Merrill Lynch

Thank you very much.

Operator

Your next question is from the line of Jesse Pichel - Piper Jaffray.

Jesse Pichel - Piper Jaffray

Thank you very much. Nice quarter Dr. Shi.

Zhengrong Shi

Thank you.

Jesse Pichel - Piper Jaffray

Is the mass efficiency improvement that was referred to on the call, is that laser etch technology? And if so will you roll out laser etch to the rest of your lines? What might the incremental CapEx per line be for the laser etching equipment?

Stuart Wenham

We have, as I mentioned, two new technologies, the one that’s in pilot production at the moment which we call our semiconductor finger technology, we do currently use laser etching for the formation of the semiconductor fingers, and that does give us a very nice improvement in the performance of our solar cells.

For that we are purchasing large laser equipment for the formation of those semiconductor fingers. We are implementing large-scale production of that technology by the end of this year on the first of our lines, and then we will gradually evaluate that technology in large scale production and gradually roll that out over the remainder of our lines, over the following 12 months. Our expectation is that by the end of 2007, we’ll have our average cell efficiencies up to about 18% with the new technologies being on all of our lines.

With regard to the CapEx costs, the inclusion of the laser equipment does add to our CapEx costs. It adds about $2 million for each production line which is about a 30 megawatts capacity.

Yunsheng Jiang

Regarding the efficiency being reported in the press release all these efficiencies are still using our existing technology.

Jesse Pichel - Piper Jaffray

That’s great. And regarding your thin-film initiative, I’ll use the name micro-morph -- I’m not sure if that’s what you call it -- but [Q-Cells] announced a micro-morph initiative in conjunction with Applied Materials. I’m wondering, is it your strategy there to partner with a big equipment player? Or would it be to find a domestic Chinese supplier of the tool required to lay down an amorphous and crystalline dual thin-film process? Thank you.

Stuart Wenham

I think we’re probably more interested in polycrystalline silicon than the micro-morph type of technology which is based on micro crystalline silicon. The different technologies have their different supporters and their different strengths and weaknesses. But I think with regard to a lot of the thin-film technologies around at the moment, the CapEx costs tend to be very high and it’s certainly a key issue that we are addressing in terms of the development of our new thin-film technology.

So we’re very keen to work with manufacturers of equipment in China, to be able to have a technology initially in pilot production and then eventually full scale production that has a relatively low CapEx cost compared to what other manufacturers around the world are currently doing.

Jesse Pichel - Piper Jaffray

Thank you very much.

Operator

Your next question comes from the line of Paul Leming - Soleil Securities.

Paul Leming - Soleil Securities

Good evening. A couple of questions. First I just wanted to clarify, you talked about a 17/30% split and I wanted to clarify whether that was revenues or shipments on a megawatt basis?

Yunsheng Jiang

It was based on shipment output.

Paul Leming - Soleil Securities

Thank you. You also say in your press release that you’ve now covered 100% of your raw material needs for year 2007 planned production. Could you quantify what your 2007 planned production is?

Yunsheng Jiang

250 megawatts.

Paul Leming - Soleil Securities

Finally, could you discuss at all the broad parameters of the pricing embedded in the long-term contract that you signed with MEMC? Can you help us understand whether you want to talk in terms of the actual wafer pricing or the poly silicon values embedded in it, but where that contract starts on a pricing basis, and where it’s likely to move down to over the course of the ten-year period?

Yunsheng Jiang

According to our agreement we are not in a position to disclose the deal structure. All we can say is as we indicated in the press release, this is a ten-year contract and with total value of about $5 billion or $6 billion. The price is reduced each year, so that means all the prices is fixed for every year but will be reduced every year. I think it is similar to most long-term contract cost structures.

We believe that this agreement is really beneficial for both MEMC and for Suntech, especially for Suntech. We have good visibility of supply in the future and also we believe we have a competitive cost in the future.

Paul Leming - Soleil Securities

Thank you very much.

Operator

Your next question is from the line of Kevin Munroe - Thomas Weisel.

Kevin Munroe - Thomas Weisel

Good evening. Just a follow up to that question. Of the 250 megawatts production, how much is MSK?

Yunsheng Jiang

This is not including MSK because this 250 megawatts is purely for silicon manufacturers. MSK’s production is mainly for all types of module products.

Kevin Munroe - Thomas Weisel

While you can’t give pricings specifics on the MEMC contract, maybe another way to ask the question in terms of the margins for ’07; can we think about this 27% to 29% on gross margins, or is it something different?

Yunsheng Jiang

Sorry, I cannot disclose this information.

Kevin Munroe - Thomas Weisel

Okay. Thank you.

Operator

Your next question is from the line of Ming Yang - Piper Jaffray.

Ming Yang - Piper Jaffray

Hi Dr. Shi. Congratulations on a great quarter.

Zhengrong Shi

Thank you.

Ming Yang - Piper Jaffray

Can we talk about your spot poly prices? How much are you paying or what are you seeing in the market currently?

Yunsheng Jiang

I think the spot market usually compared to, in the spot market there’s a range, there’s no fixed cost. I think on average, the spot market compared to a long term is reasonably -- long term I think is around 20% more expensive.

Ming Yang - Piper Jaffray

Okay. That’s on a wafer basis?

Yunsheng Jiang

Yes, wafer basis.

Ming Yang - Piper Jaffray

Can you talk about your blended wafer costs for the quarter. I believe it was $4.30 last quarter.

Amy Yi Zhang

It is $4.55 blended average per unit of wafer in Q2.

Ming Yang - Piper Jaffray

Can you talk about your raw material mix between the spot, your wafer-exchange program and your long term contracts for the quarter?

Yunsheng Jiang

I think that for ‘07, 70% is long-term contracts, 30% is spot rate.

Ming Yang - Piper Jaffray

What’s your expectation for the rest of ‘06?

Yunsheng Jiang

The rest of ‘06 are still in line with our guidance, 40% is long term contracts.

Ming Yang - Piper Jaffray

Is there any update on your cell efficiency for the quarter? Was it similar to last quarter?

Yunsheng Jiang

I think the multi-crystalline silicon efficiency has been increased to average of 15.5%. Mono stayed the same.

Ming Yang - Piper Jaffray

Okay. Great. Thank you.

Operator

Your next question is from the line Sunil Gupta - Morgan Stanley.

Sunil Gupta - Morgan Stanley

Hi. Good evening Dr. Shi, and congratulations on a great quarter. I wanted to understand the guidance for Q3 and the rest of the year better, in terms of numbers without MSK, so that I can compare what the existing quarters have been. So could you help us understand what would be the output, excluding MSK in Q3, and what would the revenue be?

Zhengrong Shi

For Q3, Suntech including the MSK will have output in the range of 38 megawatts to 40 megawatts. MSK is only consolidated after August 12. For the rest of the third quarter MSK can contribute around 7 megawatts to 7.5 megawatts.

Sunil Gupta - Morgan Stanley

So 7.5 megawatts should be for Q3 for MSK?

Zhengrong Shi

It’s Q3. But we finished the acquisition after August 11, so we can only consolidate part of this in our Q3 financials. It starts from August 12 to September 30, we think MSK can contribute from 7 megawatts to 7.5 megawatts.

Sunil Gupta - Morgan Stanley

How about the revenue guidance, excluding MSK for Q3?

Zhengrong Shi

Could you repeat again, Sunil?

Sunil Gupta - Morgan Stanley

The revenue expectations for Q3 excluding MSK?

Zhengrong Shi

For the guidance, which is around $162 million to $169 million, around $25 million to $27 million in revenue is contributed by MSK.

Sunil Gupta - Morgan Stanley

Amy mentioned that you expect a gross margin in the second half in the range between 27% to 29% excluding MSK. What would the gross margin be including MSK in the second half?

Zhengrong Shi

The gross margin should be in the range of around 24% to 26%. The reason for that is MSK is only a PV module manufacturer. So they generally have lower margins than Suntech.

Sunil Gupta - Morgan Stanley

Okay, great. Thanks a lot.

Operator

Your next question is from the line of Chang Qiu - Forun Technology Research.

Chang Qiu - Forun Technology Research

Good evening. I have a few questions, and maybe first a clarification on the MEMC contract. From we read, it is a pay or take kind of contract. So my question is, in the economic downturn, if there is an over-supply for silicon wafer, if that happens, what’s your option? You still take all the wafers, or what’s your options?

Zhengrong Shi

I think, before we formed this agreement, both sides will have carefully analyzed the PV market situation. We believe this contract is well within our capacity of demand, and also that of our customer requirements. Also the price of the wafer is reduced every year. So, as I mentioned earlier, we believe this is a very beneficial and a competitive price. And that’s why we believe we feel very comfortable with this long-term ten-year contract.

Chang Qiu - Forun Technology Research

Okay. And on the MSK acquisition side, what is the net profit margin for MSK? Are they profitable?

Zhengrong Shi

In the last quarter they are breakeven.

Chang Qiu - Forun Technology Research

What about on an annual basis?

Zhengrong Shi

That’s what I mean. From ‘05 to ‘06 financial year, they are breakeven.

Chang Qiu - Forun Technology Research

They are breakeven, I see, okay. Thank you.

Operator

Your next question is from David Edwards - ThinkEquity. Please go ahead.

David Edwards - ThinkEquity

Hi, I wanted to ask a couple more questions on MSK. Can you talk a little bit about your outlook for the Company, in terms of top line growth rates?

Yunsheng Jiang

I think, as I mentioned just now, in the Q3 their output should be in the range around 7 megawatts to 7.5 megawatts. But in Q4, because have received this capital injection from Suntech just last week, we believe MSK will be able to access sufficient funds to secure more raw material in the fourth quarter. So we believe the outlook in the fourth quarter, for MSK, should be in the range of around 23 megawatts to 25 megawatts.

David Edwards - ThinkEquity

Also in terms of the raw materials, how should we look at that in terms of MSK’s sourcing strategy going forward? Should we be looking at that as purely additive? Or should we be expecting internal transfers almost from STP to MSK?

Zhengrong Shi

Okay. At present, because the silicon supply issue, I think MSK has many independent sources for silicon and silicon solar cells for their own products.

David Edwards - ThinkEquity

Yes. What about going forward?

Zhengrong Shi

Yes, going forward we see the supply changing. And for the most importantly, with the acquisition of MSK, as I said, our strategy with MSK’s market channels in Japan and globally is to increase market shares. Also we gain the PRPV and other value-added PV product technologies, which will enable us to increase our product diversification for our Company.

David Edwards - ThinkEquity

But in terms of their cell strategy, would it be safe to assume that you might take cost advantages of producing the cells internally rather than continuing to source externally?

Zhengrong Shi

That would depend on the market situation. If the supply was still quite tight, I think there is no harm for MSK to source more materials independent of Suntech. That would be accretive.

David Edwards - ThinkEquity

Finally, one more question. How can you help us think about expectations for a percentage of your business in China for the remainder of the year?

Zhengrong Shi

Our guidance for the whole year, the average business from China should be around 20% to 25%.

David Edwards - ThinkEquity

Okay, great. Thanks very much.

Zhengrong Shi

Thank you.

Operator

Your next question is from Angello Chan - Credit Suisse.

Angello Chan - Credit Suisse

Hi, good evening Dr. Shi, Amy, Stuart and Yunsheng, congratulations. My question is on your silicon prices. For 2007, when you have locked in your supply volume, have you locked in your prices for next year’s total supply?

And if that is the case, Dr. Shi you were commenting earlier on that you anticipate a potential picking up of your silicon wafer price, either within this year or next year. Would you project that your ‘07 average purchase price for silicon wafers might be similar or lower than your 2006 average price? Thank you.

Zhengrong Shi

I think for ‘07, as I said, for ‘07 about 70% of the price is based on long-term contracts. I think long-term contract means not spot purchase. We believe our ‘07 wafer price, should be not higher. Either the same or below.

Angello Chan - Credit Suisse

Thank you.

Operator

Your next question will come from the line of Sunil Gupta - Morgan Stanley.

Sunil Gupta - Morgan Stanley

Hi, Dr. Shi, I wanted to follow up on the earlier comments about wafer costs. Could you clarify what was the average wafer costs in second quarter? Was it $4.55 or $4.35?

Amy Yi Zhang

It’s $4.55.

Sunil Gupta - Morgan Stanley

Okay. What do you expect the wafer cost to be in Q3?

Amy Yi Zhang

Actually, in Q2 compared to Q1, average blended wafer cost increased by 13%. We expected that in Q3 the increased range would be within the range of 3% to 5%.

Sunil Gupta - Morgan Stanley

Okay. What do you expect your ASPs to be for the modules themselves, going forward in Q3?

Amy Yi Zhang

We expect that the ASP will still be increased slightly, ranged from 2% to 4% in Q3.

Sunil Gupta - Morgan Stanley

I missed your last comments. Do you expect ASP to increase in Q3 for both cell and modules?

Amy Yi Zhang

2% to 4% in Q3 compared to Q2.

Sunil Gupta - Morgan Stanley

2% to 4% for both?

Zhengrong Shi

Yes, quarter to quarter, yes.

Amy Yi Zhang

Yes.

Sunil Gupta - Morgan Stanley

Okay. Thank you.

Operator

Your next question is from the line of Paul Clegg - Natexis Bleichroeder.

Paul Clegg - Natexis Bleichroeder

Good evening, Dr. Shi. Just when you talk about the 100% of silicon needs being secured for 2007, that does not include MSK, is that correct?

Zhengrong Shi

Yes, does not include.

Paul Clegg - Natexis Bleichroeder

In terms of how much of MSK’s silicon needs are secured for 2007, have you set that number?

Zhengrong Shi

Not yet, because we just complete the transaction last Friday. So we are trying to in our outlook, to be fixed somewhere in the next month or two, during the integration process.

Paul Clegg - Natexis Bleichroeder

Okay, very good. And if I may, could you also please give an update?

Zhengrong Shi

We give a guidance of Q4. Q4 they will produce around 25 megawatts. So that’s for Q4, I think the Q4 is more or less back to normal. You sort of can guess what’s going to happen in the next year.

Paul Clegg - Natexis Bleichroeder

Okay. But we still haven’t said whether or not their silicon supply needs are fully locked in for 2007?

Zhengrong Shi

They have [inaudible].

Paul Clegg - Natexis Bleichroeder

Okay, very good. Can you also just give an update, on your efforts to domestically source silicon, there in China? Given the MEMC contract, has that put those efforts a little bit on the back burner for the moment?

Zhengrong Shi

Those efforts continue, like the MSK contract can only supply part of Suntech’s requirements. So we are still continuing to form long-term contracts with those other international suppliers. Also in particular, what’s quite interesting is we’ve formed several long-term contracts with domestic suppliers. So we believe in the long term, wafer manufacturing costs in China will be low.

Paul Clegg - Natexis Bleichroeder

Do you think we will see some announcements on that over the next year?

Zhengrong Shi

There will be some announcements, yes. Stay tuned.

Paul Clegg - Natexis Bleichroeder

When you buy silicon at the spot market, I just want to be clear on this. This is a strategic move for you to take market share, right? Or can you actually make incremental profit when you do that?

Zhengrong Shi

Yes, we actually we increased overall profit. That’s why we are in the spot market.

Paul Clegg - Natexis Bleichroeder

Okay. Marginal increase in profit. Okay, very good. Thank you.

Zhengrong Shi

Yes.

Operator

Your next question is a follow up for Paul Leming.

Paul Leming - Soleil Securities

Yes, I just wanted to ask, on the blended wafer price that you gave of $4.55 for the third quarter. Could you walk through what your mix of wafers, in fact, was for the quarter? Also, is it possible to give a number of what you pay per watt for wafers?

Zhengrong Shi

Well, I think, really you can work out how much we paid per wafer because we already gave you the number of total megawatts that we produce, and also the wafer price. So if you want to work it out, you can work it that way.

Yunsheng Jiang

In terms of the wafer mix, we have 70% of the wafer is mono, and 30% is multi.

Paul Leming - Soleil Securities

Is there much of a difference on the pricing in terms of the size of the wafer? Are you buying mostly 5-inch wafers or are you mostly buying 6-inch wafers?

Zhengrong Shi

I think 70% is still in 5-inch, because with the majority of wafers we produce, they are mono wafers. The mono wafers, the majority of the size are still in 5-inch and the 30% is in 6-inch.

Paul Leming - Soleil Securities

Okay. Thank you very much.

Operator

Your next question is a follow up from Rob Stone.

Rob Stone - Cowen & Co.

Hi, two quick questions. One, Amy, can you tell us what the tax rate will be that you will pay on MSK profits in Japan?

The other question is, could you repeat the percentage of Q2 revenue that came from the U.S. market? Thank you.

Amy Yi Zhang

Can you please repeat your second question again?

Rob Stone - Cowen & Co.

The percent of your Q2 revenues that were generated in the United States?

Amy Yi Zhang

Okay. By talking about the tax, we are actually in the process of assessing the relevant tax implications because MSK has always been managed as a private company. We also involved the tax specialists, and tax consultants to do relevant audit. we will soon be working out a proper report to file in a month or two, during the integration process.

Regarding the revenue distribution in Q2 to the U.S., as you know that, we obtained a U.S. certificate just in Q2, at the beginning of April. The allocation of sales to U.S. is 6% in Q2.

Rob Stone - Cowen & Co.

Great. Thank you.

Amy Yi Zhang

You’re welcome.

Operator

Your next question is from the line of Chang Qiu.

Chang Qiu - Forun Technology Research

Good evening, a few follow-up questions. Can you also break out your revenues to the other major key profit areas, like Germany and the newer one like France?

Amy Yi Zhang

Germany took about 45% to 46% of the total revenue. China took 28% and U.S. took 6%, as I mentioned. 20% was going to the rest of the world.

Chang Qiu - Forun Technology Research

Dr. Shi, maybe I’d like you to maybe use your judgment, and maybe even somewhat of imagination, to maybe answer this question. In ten years, what would be the efficiency, and also the wafer thickness you can use? Say in, maybe in ten years time, by that time, how thin we can go, and how high is the efficiency we will go?

Zhengrong Shi

I think the efficiency is certainly will be around 20% or above. The thickness I think it will be around 100 micron.

Chang Qiu - Forun Technology Research

I see. Do you think that can be achieved earlier, if there is any breakthroughs or anything?

Zhengrong Shi

I think efficiency can certainly be achieved earlier, and as we said, Suntech is projected to produce over 20%, to start to produce over 20% efficiency in 2008.

In terms of the wafer thickness, now we are already, can handle of 160, 180 microns, particularly in larger productions, with the breakage rate below 2%. I think it is a matter of wafer manufacture, they can slice thinner wafers, down to 100 micron. So I think that they are making very good progress.

Chang Qiu - Forun Technology Research

Okay, okay. That’s great.

Operator

Your last question is from the line of Jesse Pichel.

Jesse Pichel - Piper Jaffray

Amy, how should we model cash pre-payments for poly silicon for the balance of 2006?

Amy Yi Zhang

Can you please repeat your question again?

Jesse Pichel - Piper Jaffray

There were cash payments made in the quarter for securing poly silicon and I am wondering for cash flow purposes, how do we model these pre-payments for the rest of the year? Will they continue at this level?

Amy Yi Zhang

Yes. Actually, regarding the pre-payment we use different suppliers, or even different contracts from the same supplier, we have different terms, according to its duration of supply and quantity of supply, with different advance payment conditions.

Jesse Pichel - Piper Jaffray

I understand, but how much for the next two quarters, for the balance of 2006, how much cash will you use for pre-payment purposes?

Amy Yi Zhang

By the end of ‘06 the balance will be controlled to the level of something like $90 million.

Jesse Pichel - Piper Jaffray

$90 million. And that’s with a couple of suppliers right?

Amy Yi Zhang

Yes.

Jesse Pichel - Piper Jaffray

For Dr. Shi, a couple of questions on MSK. Will Kasahawa-San stay with the Company? Also would you move some of their module assembly to China? Or are there other cost savings that you could enact for MSK?

Zhengrong Shi

I think Kasahawa at least will stay in office for another four years, and most likely until his retirement; because MSK is his baby, and it’s his life.

In terms of cost reduction, of course, we’ll have to work together with MSK to further reduce their costs. For some more labor-involved processes, of course, to move to China is one sensible option. In our transaction agreement, in the first year we are not going to lay off any of the staff. So we will defer this decision to be made until sometime next year.

Jesse Pichel - Piper Jaffray

In the last meeting I met with MSK, I believe Motech was one of their big cell suppliers. I am wondering, will Motech continue to honor its supply agreement with MSK? Or is there some type of change of control provision that may stop some of the cell deliveries to MSK?

Zhengrong Shi

MSK has a number of agreements with big solar cell manufacturers. I think their biggest supplier is actually in Europe and in Japan. So we checked with the order of supply agreement, there is no clause related to the change of ownership.

We also understand Dr. Kasahawa had a very good relation with all their suppliers. In a coming international conference in Dresden we are going to co-host several meetings with those suppliers. And as we guided earlier, in Q4 they are going to produce 25 megawatts. So that indicates that cell procurement is in good shape.

Jesse Pichel - Piper Jaffray

Great. We’d like to meet with you as well in Dresden. But also in terms of your forward integration strategy, are you seeing many supply constraint module manufacturers for sale? What’s next for your forward integration strategy? What other regions are next? Would you need another facility?

Zhengrong Shi

Oh, you mean other M&A activity?

Jesse Pichel - Piper Jaffray

Yes.

Zhengrong Shi

Apart from MSK you mean?

Jesse Pichel - Piper Jaffray

That’s correct.

Zhengrong Shi

It’s hard to predict. You cannot take it for granted anyways. Also you cannot pursue somebody; it is like you meet somebody and get married, and it’s not easy. Provided everything is right, then you can take action.

First of all you have to date. We thought we’d keep our options open. As long as it fits our strategy, and is a good year, then we have to see.

Jesse Pichel - Piper Jaffray

Another technology question. I am seeing a lot of your cell competitors replace the PECVD anti-reflective coating machines, with higher through-put PVD. I am wondering if you’ve taken a look at this trend, and what you think? Is that something that would be beneficial for Suntech?

Stuart Wenham

We have a very strong R&D team, we’ve probably got one of the largest R&D teams in the world, with 64 full-time staff. So our technology is something that we are constantly developing and evaluating each aspect of it. And certainly the anti-reflection coating is a very important part of the whole process. It is a big contributor to the high performance cells. So it’s an area that we are constantly considering.

One of the things you will probably notice is that Suntech has very low CapEx costs compared to our competitors around the world. So we always have an important emphasis on reducing the cost of, particularly the most expensive processes.

But PECVD is a process that we’ve been comfortable using for some time. It gives us very good performance with our devices. All I can really say is that it’s an area that we are constantly evaluating and doing development on. If there’s a better option at any point in time for us to either reduce CapEx costs or reduce costs, or improve performance, then we strongly consider it.

Jesse Pichel - Piper Jaffray

With the other process improvements and the efficiency improvements, if we were to look at 2007 and 2008 might your 30 megawatt lines actually be 35 megawatt lines, or perhaps even 40 megawatt lines? How should we think of modeling the lines in the future?

Stuart Wenham

Certainly when we have a nominal capacity for a production line, then obviously if we increase the efficiency of our cells, then proportionately the capacity of the lines go up with that. So yes, you are quite correct in terms of scaling up the capacities along those lines.

Jesse Pichel - Piper Jaffray

Thank you very much.

Operator

You have no further questions at this time. I would like to turn the call over to Dr. Shi for closing comments.

Zhengrong Shi

Once again, thank you for joining us today. See you next time.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Suntech Power Q2 2006 Earnings Conference Call Transcript (STP)
This Transcript
All Transcripts