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Solarfun Power Holdings Co., Ltd. (ADR) (SOLF)

Q2 2009 Earnings Call

August 18, 2009 8:00 am ET

Executives

Paul Combs - Vice President of Strategic Planning

Peter Xie - President, China

Terry McCarthy - Interim Chief Financial Officer, Director

John Breckenridge - Managing Director & Operating Partner

Analysts

Burt Chao - Simmons & Company

Jed Dorsheimer - Canaccord Adams

Paul Clegg - Jefferies

Rob Stone - Cowen & Company

Vishal Shah – Barclays Capital

Pranab Farm - Diwar Securities

Sam Dubinski - Oppenheimer

Arch Pei - JLM Pacific

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2009 Solarfun Power Holdings Co., Ltd Earnings Conference Call. My name is Tom and I will be your coordinator for today. (Operator's Instructions) We will be conducting a question-and-answer session at the end of this conference. (Operator's Instructions) As a reminder this call is being recorded for replay purposes. I would now like to turn the presentation over to Paul Combs, VP of Strategic Planning. Please proceed.

Paul Combs

Thank you, Tom, and good morning everyone. First of all we owe you an apology for the late delivery of the earnings release. We had some formatting issues with the business wire. I know you would have liked to have more time and again we apologize for that, but it's something out of our control so hopefully you'll have a chance to review it as we go forward here.

Welcome to our call and thanks for your continued interest in Solarfun. Joining me today are my colleagues Peter Xie, our President, Terry McCarthy, a Board member and Interim CFO, and John Breckenridge, a Managing Director of our largest shareholder Good Energies, and a Member of our Management Committee.

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 risk and uncertainties. Actual results may differ from those discussed today and therefore we refer you to a more detailed discussion of the risk and uncertainties in the company's filings with the SEC. In addition, any projections about the company's future performance represent management's estimates as of today, August 18th, 2009. Solarfun assumes no obligation to update these projections in the future as business and market conditions change.

John will begin with some high-level introductory remarks about the key elements of our progress followed by Terry with a review of the second quarter financial highlights. Peter will then conclude with additional comments including our view of the China market, our improving cost structure, and an outlook for the remainder of this year. I will now turn the call over to John.

John Breckenridge

Thanks, Paul, and good morning, everyone. I would like to give a brief overview of the quarter before handing it over to Terry and Peter as Paul said. First of all, we're quite pleased with the operating progress that we've continued to make during the quarter and hope to continue to make going forward. I'd like to highlight several of the significant accomplishments from my perspective.

First of all, excluding non-cash items, we're very pleased with both the volume improvement and the margins for Q2. Margins on a pro forma basis were over 20%, that's a significant improvement over Q1 and really a result of the significant efforts that we've made in terms of reducing our costs, which I'll talk about more in a minute.

Now volume, we had significant growth and initiation of our Q-Cells contracting business and we're very pleased with that and the outlook for that. In addition we have growth in our core business and more importantly, less concentration in that business and I think that bodes well for going forward as the market continues to grow our ability to grow more broadly in that market.

Our liquidity situation continue to improve and we feel that importantly, our balance sheet is strong and that continues to be an important aspect for the company going forward, and then overall, it's very important for Solarfun, as I think for any company in this marketplace, to have a competitive cost structure. And coming out of last year with high poly prices and uncertain and varying volumes, the cost situation was something that we focused on very aggressively and we're really very pleased. And as evidenced in this quarter we believe that our cost situation both from a supply and external poly costs and our own internal costs, is now at a position where we’re ready to compete very effectively, whatever happens in this marketplace.

We did have some write-offs in the last quarter. We had indicated beforehand that this might happen as part of restructuring nearly $200 million worth of prepayments that we've had on our balance sheets. We've had strenuous negotiations with all our supplies. We're very pleased to say that that is essentially completed at this point although there are some aspects that will continue going forward, but for the most part we are in a position going forward now where the main supplier negotiations have been done. There was some need to take a provision that will affect some of the prepayments for some of those contracts, but that position is left to be better on an ongoing basis both on a P&L and cash flow basis and those are non-cash items so we're comfortable with that being prudent and we think that positions us again going forward.

The team continues to improve. You'll hear from Peter in a little while, and he's done a tremendous job in continuing to improve our overall operations, but we have more coming in that regard. So the overall — looking back on the quarter, very strong quarter we think for solid finance positions for strength going forward.

Looking ahead, we still continue growth in Q3 and you will hear more about that later. We expect to break 100 megawatts in shipments in the quarter and that will be an important milestone for us this year. Also probably equally important we’ve been very aggressively looking to augment our team, particularly in the sales and marketing aspect and we're late in the stages of working to add people that we think will be a significant upgrade and continued improvement to our team and will help us going forward.

We continue to believe that our balance sheet is strong for the future, as I said, and I think importantly, Solarfun understand where we think this market is going. We're comfortable that there's continued sector growth, that the lower ASPs in the marketplace are going to continue to provide growth, however, we have to be prepared for the fact that there is a possibility that there will continue to be some pressure on pricing and we need to be in a position to make reasonable margins in that environment and I think that we're positioning ourselves to be in that situation and we're basically there now. So we're looking forward to whatever comes and we feel comfortable that we can survive whatever happens in this marketplace going forward and that with additional strength on our sales and marketing efforts — again, you'll hear more about the China markets, but we're also aggressively pursuing growth in Europe and the US, that Solarfun has got a very bright future.

So with that I will hand it over to Terry to go through some of the financial highlights and then Peter after that and I look forward to addressing some of your questions later. Thanks, Terry?

Terry McCarthy

Thanks, John, and good morning, everyone, or good evening, depending on where you are. Hopefully you've had a good chance to review the numbers that we released, therefore I’ll focus on some, but not all of the key trends. Before I begin I would like to alert you that we filed a 6-K for the first quarter of 2009 along with our Q2 earnings release. The first quarter reflects certain accounting adjustments, the net result of which was net income increase of $4 million or $0.07 per ADS. Previously the reported net loss was $2 million or $0.02 per ADS.

Our commentary today reflects comparisons that are computed on the adjusted March figures.

The key points we left with you last call were that shipment volumes would improve over the Q1 numbers. Secondly, ASPs would continue to fall, raw material costs would decline, therefore we would achieve further improvement in gross margins, and that we had addressed most of our inventory valuation issues. Also, we indicated the potential for a financial provision in the event that we could not successfully renegotiate some of our supply contracts.

So I believe you will find our Q2 results to be pretty much in line with our comments and expectations.

First let me address the non-cash provision for prepayments and convertible debt adjustments. We had $202 million in advances to suppliers on our balance sheet. We felt it was prudent to take a roughly $35 million provision to best reflect prepayments that have or potentially will be forfeited as we align our supply contracts with prevailing market prices. Our net prepayment balance has now been reduced to $157 million.

Because our mark-to-market counting for our convertible debt instrument, in the current year we're required by US GAAP to book a loss for the quarter of $18 million. This is a non-cash adjustment and strangely enough, fluctuates inversely with the market price of our stock and the volatility of comparable companies.

Both the advances to suppliers provision and the convertible debt adjustments, as we said, are non-cash adjustments.

Let's now discuss our actual quarterly operations. We experienced improved demand during Q2 and volumes were boosted by our initial shipments of Q-Cells. PV module shipments reached 64 megawatt with manufacturing services accounting for about one-third of that total. This is 80% above the preceding quarter and 45% higher than the second quarter last year.

Revenues were $125 million, a 25% increase quarter to quarter, though a decline of 37% compared to last year, reflecting declining ASPs. As we said, average selling price declined to $2.66 from $2.78 last quarter and $4.17 for the comparable quarter a year ago.

As John mentioned, we expect prices to decline further throughout the remainder of the year, but we intend to compete strongly in the industry for volume. Peter will add some more color on that point later. Germany remains our biggest market. I should remind you this data comes from where we invoice the customer, not where the module is installed. Based on invoice data, our largest two shipments were Germany with 83%, the Czech Republic, a new market for us which made up 6% of our shipments, followed by Australia 5% and Korea at 3%. We saw some small resumption of business in Spain which totalled 2%.

I'd like to focus on gross profit before the net non-cash provisions, as I believe it illustrates the progress we have made and better describe our business on a go-forward basis. For the second quarter, pro forma gross profit of $26.5 million was up almost fourfold from the preceding quarter's $7.2 million. Quarter-to-quarter gross margins improved from 7.2% to 21.5%. Our operating expenses, as a percentage of sales, were improved to 8.1% as costs were spread over a higher revenue dollar number.

Operating expenses rose above 6% quarter to quarter. We continue to maintain a tight reign on organizational costs and as volumes go in this category, we expect the percentage of our operating costs to be from 6%-7% of revenues.

Other categories of note were interest expense, which declined to $777 million from the preceding quarter as a result of reduced average short-term bank borrowings. On a pro forma basis, the company was profitable, recording net income of $5.6 million or $0.10 per basic ADS share.

Turning our attention to the balance sheet, we ended the second quarter with an increased cash balance totalling $72.4 million. Bank borrowings declined slightly to $231 million outstanding. The lending environment of China remains accommodative and we have secured good relationships with nearly 10 domestic banks. Currently we have over $80 million of on-drawn credit lines. We remain comfortable with our liquidity and our ability to fund operations through 2009 and into 2010.

We ended Q2 with $189 million in working capital due to a tight focus on working capital management. Receivables rose by $45 million to $75 million due to a large percentage of shipments made later in the quarter. Daily sales outstanding rose only slightly to 38 days, well below most of our peers.

Total inventories declined to $101.9 million and inventory turns improved from 98 to 73 days quarter to quarter. Inventories were split about two thirds to finish goods and one third to raw materials as we build finish goods inventory in anticipation of a pickup in second half demand. We continue to believe we are adequately reserved for changing raw material prices.

Capital outlays were just under $4 million for the second quarter. By September, we expect to add an additional 50 megawatt of module capacity. Peter will comment further about 2010 expansion plans. I'll now turn the call over to Peter Xie who will focus on the current business environment and what we see for the reminder of the year.

Peter Xie

Thank you, Terry. Good morning, everyone. Since our last call, the current market environment is much improved and our cost structure continues to improve. This is obviously critical as we see market prices (inaudible) margin following below $2, and then as a result we see incremental new demand.

Other opportunities to exist in most all parts of the food chain including margin, but utilization rates at our factory are much improved. Financing for solar projects remains tight, but we sense some loosening, and the price competition is intense.

While low material costs have stabilized, we do believe that they is still room for further politic and price declines later in the year. To better position the company in this marketing environment, as we have indicated in our last earnings call, we have launched a global realignment effort, with focuses in the following five areas: customers, liquidity, long-term supply contract, inventory control, and the product-process innovation.

These initiatives are already paying off as evidenced by our improved gross margin--over 20%--reported by Terry. In this call I would like to further report our progress in those areas.

Our first priority is customer focus. We are continuing strong strategic relationships with our leading customers. We made our first shipment of Q-Cells during the second quarter and we have seen that volume grow in the third quarter.

Our lost-cost manufacturing base clearly helped our partners to adjust their cost structure to a low price environment and to develop downstream patterns. We expect shipments to our manufacturing service partner to approach 100 megawatts for the calendar year of 2009.

Further, to geographic diversification, we are expanding into Czech Republic, Italy, France, Greece, and the Turkey markets. We have already signed (inaudible) purchase agreements with a customer in Czech totalling 14 megawatts in second half of 2009. We believe over 10% of our business in Q3 will come from Czech and the Italy directly or indirectly.

Emerging markets; in US they have opened our sales office in California. We expect to see results in Q3 and in Q4 (inaudible) with partners with as significant presence in US to form strategic alliance to address US market which should start being improved in 2010.

In China we believe the market is merely being divided into three market segments, the first being utility companies. Those are led by five state owned enterprises. Development plans ranges from 200 megawatt to a gigawatt above in three to five years. We are actively engaged in all of them.

Municipal governments, led by six provinces in western part of China, namely Mongolia, Guangxi, Ningxia, Tibet, and Xinjiang. Each province has partnered in the plan to develop a few hundred megawatts in the next three to five years.

Thirdly, commercial sectors; those sectors typically application are ranging from a few hundred kilowatt to a megawatt, mostly for rooftop applications. We are actively engaged in all three market segments. Although much has been written about the potential for solar energy in China and we are encouraged by the steps taken by the Chinese government at all levels--national, provincial, and the city, to promote and to support renewable options--many details remain to be defined, particularly a (inaudible) installation is still not clear.

We believe the market will grow to rival that of Germany within a few years. We have already had a footprint downstream in China, with our systems (inaudible) and installation subsidiary in Shanghai. We have now forwarded that business into a much larger organization to capture business in China. We have bid on a number of projects in the above mentioned three segments and expect contract awards to begin soon.

For example, we have received indications from Gansu Province that we'll be awarded a minimum of 20 megawatts on projects as part of the provincial incentive program. Adequate funding and the liquidity is key between our second initiative of global realignment effort.

Since Q1, we have increased our bank facility to over $300 million and we believe the support from Chinese banks will continue as our business grows. In addition, we are seeing increasing willingness from Chinese banks to support project financing and to finance accounts receivable.

The third element of our global realignment effort is long-term supply contracts. In today's sensitive market, maintaining a cost competitive position is of paramount importance. Our first priority in our cost reduction effort has been to drink down our raw material costs and align them with current market prices.

As you have noticed that we do have a large sum of prepayments paid to our silicon suppliers and quite a few long-term supply contracts. For the last six months we have been actively engaged with our strategic supplies and have luckily renegotiated all of our long-term supply agreements. I'm pleased to say that we have largely accomplished that mission and are poly-based raw materials have been aligned with prevailing market prices.

The provision we took in this quarter was the final step. So going forward we are waiting and able to compete more aggressively for business and do so profitably. Another element of the global realignment effort is inventory control, which is a delicate balance between meeting customer demands and the cash flow. In today's environment there remains enough uncertainty in market demand simplified by seasonal effects. Going forward we expect to see our inventory level fluctuate and to come down to a more manageable level towards end of Q4.

The last key ingredient to our global realignment effort is process and product innovation. Leveraging our growing vertical integration upstream to an (inaudible) wafer level and optimizing process steps, we expect to reduce our cost structure substantially. We now have wafer capacity exceeding 250 megawatts and would expect internal wafers to account for approximately 70% of our total wafer needs in 2009.

With experience and with skill, we are progressing to top levels, competitive, and below current pricing. And we have better control over quality and the reliability of delivery.

Vertical integration capability will also allow us to optimize each of the process steps to realize how to push efficiency and have reduced costs. Our model in the poly-conversion efficiency is approaching 17.5% and 16.5% respectively. Our product development in 2009 will remain focused, focusing on high-powered high conversion efficiency and a low-light induced degradation.

Our recent focus has been on managing our way through our rapidly changing cost and pricing environment and to maximize cash profits. By year-end we shall largely complete our global realignment initiative. Those initiatives will prepare the company for transition in 2009 and growth in 2010 and beyond.

By adding 50 megawatt marginal capacity in Q3 2009, we expect to have marginal capacity exceeding 500 megawatts in early September. In 2010 our plan is to further expand our mainplace marginal capacity to 700 megawatts to satisfy customer demands, especially from the emerging markets.

Our beliefs, as recently reported, substantiate our ability to meet that goal. Now going forward with a low-cost manufacturing base in place, we are focused on capturing share both in traditional European markets as well as emerging growth markets like China and the US. We are aggressively focused on improving product features and the quality and to expand the breadth and depth of our marketing organization.

Markets remain unpredictable as to both demand and the pricing making forecasts still difficult. At this juncture we anticipate shipment to reach around 100 megawatt for the third quarter of 2009. Visibility is less clear for the fourth quarter, but we see shipment potential around 80 megawatt.

As we indicated earlier, pricing is intense. Today we see last year's projects at below $2 and we would expect this level to persist if not decline further through the remainder of this year. Reflecting this environment, we would expect gross margins to stabilize in the mid-teens.

This concludes our formal comments and we will be happy to respond to any questions you may have.

Question-and-Answer Session

Operator

(Operator's Instructions) Your first question comes from Burt Chao with Simmons & Company. Please proceed.

Burt Chao - Simmons & Company

Good evening, guys. Thanks for taking the questions. Congratulations on strong shipment and shipment guidance. First question specifically, I mean I’m sure you're aware, Q-Cells in the last couple of weeks and months has really dropped down, not only their production by shutting down their German manufacturing for the most part, but also basically realigning their global strategy. How does that affect your totaling agreement and the volume that you anticipate for Q-Cells for I think that 100 megawatts for the year?

John Breckenridge

Hi, Burt, maybe I'll take that one. From our viewpoint as a customer of Q-Cells, what we see is that the part of Q-Cells that we are supporting is the growing part of Q-Cells. The part that's involved with their project business and module business. So we think whatever efforts Q-Cells makes going forward to improve its own business is very much aligned with our own. So at this point we're in continuous discussions with their purchasing organization and their project organization and that seems very positive for us.

We also are continuing to get forecasts from them that are encouraging so from our perspective as a customer in the aspect of the business that we see, we are quite encouraged. We can't really comment or don’t have information beyond that.

Burt Chao - Simmons & Company

Great, John. And just kind of touching base on that, I know in your facility in Shidong you have availability to expand your capacity to do business with Q-Cells. Is that something that at this point there is any positive traction towards or is it still kind of static as before where you just have to wait and see?

John Breckendridge

Well, as you heard from Peter, we are continuing to expand our module capacity throughout the rest of this year and our current thinking is that that will continue to happen through next year. Of course some of that's dedicated to Q-Cells, but that module capacity is quite flexible so the Q-Cell business also helps us as we've become bigger and bigger in module capacity balance and fill that and provide higher utilization. So early in the process we had a lot of dedicated aspects for Q-Cells only. We still have some of that, but going forward we expect that we're going to continue to grow our module business; some will be for Q-Cells and some will be for general business and that's going on right now.

Burt Chao - Simmons & Company

Okay, great. And last question is with about a 25% decline in project ASPs to about $2 a lot, are you A, going to be able to reduce your cost of goods sold whether it's through poly or processing costs as aggressively to preserve margin, or will you think there will be expanded margins and then ultimately at what level — if you are able to provide maybe a blended processing cost, non-wafer, for the quarter?

Peter Xie

Burt, this is Peter. I'd like to answer this question. So we see the price is going to drop below $2 a lot, and we feel pretty comfortable we will be able to compete tat that level with our non-silicone costs and also our silicone processing price at prevailing market price. So we feel that we still will be able to maintain a gross margin at around 15% or better at just below $2 a lot.

Burt Chao - Simmons & Company

Okay. And any color on kind of what non-silicon processing costs in the quarter?

Peter Xie

This question is a very tricky one because each person has different definitions. At this point I would maybe make you more confused than rather clarification, so I would say just from a gross margin point, maybe just better indications.

Burt Chao - Simmons & Company

Okay. I guess to that point, I mean do you have blended wafer costs? I mean that is, I guess, a little probably more straightforward?

John Breckenridge

Burt, I don't think we're going to offer that information. I think from the gross margin calculation that's a conservative one from us. I think historically we’ve talked about our cell and module processing costs in the 60-70 range, I think quite competitive with most all of our peers. So we're making progress on the wafer costs. As you know, the spot market for wafers is below $0.90 a watt. We're beginning to build scale on our vertical integration at LYG very rapidly and with the demand increase we see in the second half we should be able to run that plant pretty aggressively so I think we'll enjoy some benefit there from reduced wafer costs as well.

Burt Chao - Simmons & Company

Great. Thanks for the questions. Sorry about taking so much time and congrats on eh quarter again.

Operator

(Operator's Instructions) Your next question comes from Jed Dorsheimer with Canaccord Adams. Please proceed.

Jed Dorsheimer - Canaccord Adams

Hi. I was wondering if you could just give us a bit of more color of the utilization rates at LYG, maybe this quarter and going forward?

Peter Xie

Yes. So I want you to (inaudible) think right now is it depends on the time of the quarter and its around 70%. We see that going higher as we go forward.

Jed Dorsheimer - Canaccord Adams

Okay. And any plans on expanding capacity there? I know you talked about 700 megawatts of module capacity, but anything else on the cell side or on the wafer or ingots side.

Peter Xie

Yeah. We do not have a plan to expand on the ingots side, but we do have plans to expand on the cell side. But I think the priority will be expand the module first followed by the cells. So in the cells there will probably be an additional four lines.

John Breckenridge

Which would be about 100 megawatts.

Terry McCarthy

And if I could just add a general comment on that because that' san important question. We think that from a configuration standpoint, number one, being vertically integrated is important, but number two, having a gradual higher capacity as you go downstream through the production process is important because it gives you better efficiencies in terms of capital utilization, and then number two, it allows you to take advantage of what is happening in the market. Sometimes we see wafer pricing that's disconnected from the market. We can take advantage of that. Other times poly pricing is at its low point so we're going to always have that balance.

Jed Dorsheimer - Canaccord Adams

Okay, great. Well, I guess that's two so I'll jump back in the queue.

Operator

Your next question comes from Paul Clegg with Jefferies. Please proceed.

Paul Clegg - Jefferies

Hi, guys. Thanks for taking my question. I was wondering if you could talk about what level of an internal ingot and wafer production you were actually doing in Q2 and then what kind of cost impact does it have as you bring more of that internal, and I have a follow-up?

Peter Xie

Yes. Our internal ingot-wafer production accounts close to 70% of our total demands.

Paul Clegg - Jefferies

70% was also during the second quarter?

Peter Xie

Yes.

Paul Clegg - Jefferies

Okay. And I guess incrementally, what kind of impact does it have as you bring that further up if you bring it to 100%, for example?

Peter Xie

Yeah. We will see improved cost structure because as we run the (inaudible) then utilization will bring down the fixed costs which will be spread out over larger volumes so depreciation gets much better. So in theory we actually see our costs in material produced wafers as lower costs than spot market prices, but right now the market sometimes is irrational. You never know.

So that's why what John mentioned earlier, depends where you're (inaudible) external and the internal supplies to balance it out if they do see an opportunity then we'll try to maybe balance out how to utilize the factory more efficiency.

Paul Clegg - Jefferies

Okay. I guess what I'm after is I'm trying to understand, relative to purchasing wafers externally, how much do you save by producing the ingot and the wafer internally, relative to an external purchase?

John Breckenridge

If I could just add a comment on that one, Paul? It's really hard to generalize on that one because the wafer purchasing market fluctuations significantly. So in general we would expect to have improved margins from our internal processing that would typically match standard margins for a wafer manufacture. But with the way the market is today, you can see spot prices for wafers moving all over the place and so we could have moments where we can buy wafers at lower than we can manufacture themselves just because of analogies in the market so it's difficult for us to pin that down specifically and I think that’s one of our strategies is to take advantage of that.

Paul Clegg - Jefferies

Okay. And then just the historical — I don't know if you gave a grams per watt figure, I didn't hear one, and I was curious about the historical $0.60-$0.70 of processing costs ex-wafers, whether or not that had depreciation in the number?

Terry McCarthy

To answer your second question, yes, and grams per watt, we are between 6.5-7, comfortably below seven.

Paul Clegg - Jefferies

Gotcha. Okay, thanks very much. I'll jump back in the queue.

Operator

Your next question comes from Rob Stone with Cowen & Company. Please proceed.

Rob Stone - Cowen & Company

Hey, guys. I wonder if you could just put a little more color on your expansion plans with respect to how you think about CapEx costs per watt for the various phases of your operation? Thank you.

John Breckenridge

Well basically per line you're looking at maybe a stated cost of around $7 million so if we expand four lines obviously that is $28 million for next year and Peter, what would you say the watts per line, maybe 120 megawatts.

Terry McCarthy

It is 120 megawatts cell and module combined with the 30 million roughly speaking. Cell line is more expensive than module lines, but the combined total for 120 megawatts would be 7-8 million per 30 megawatts, about 30 million.

Rob Stone - Cowen & Company

Okay. And then if you do expand internal ingot wafer, roughly what is your cost for that?

Terry McCarthy

Rob, let us noodle that one and we will give you a response later.

Rob Stone - Cowen & Company

Great. Given the fact that you’ve renegotiated a bunch of contracts, I'm wondering if you can comment maybe in percentage terms how you expect your poly costs to trend in the second half and in 2010? Related to that, it seems like your ASP has actually been somewhat higher than some other periods that have reported, so I'm wondering what accounts for that delta as well.

John Breckenridge

As far as the ASPs go, I'm not sure how we can specifically attribute what may be different from us as from others. I think we do know we do sell some higher value products. We do sell products that have customized features for some of our customers so it's not a complete apples to apples comparison with some of our customers that are selling a more commodity type of product so that may attribute to some of it. We do see, as Peter said earlier, we do see ASPs declining through the quarter and continuing to do so some in Q3. And the other question was?

Rob Stone - Cowen & Company

You had talked about getting to mid-teens gross margin in the second half and I think ASPs slightly below $2. What I'm trying to get at is the potential for poly-cost reduction with some others talking about ASPs down to around $1.80 in Q4.

John Breckenridge

Okay, yes. First of all, please recognize that our cost in Q2 is the overall average cost in Q2, so that is a declining — we have got all these curves moving in the same direction so our costs at the end of Q2 is lower than our costs at the beginning of Q2 so we would expect that our costs will continue to decline as we go forward.

As I think has been widely stated in the marketplace, poly prices today, spot market, is $60-$70 a kilogram. We're experiencing those same kind of prices. We don't have a great crystal ball. It's hard to see how prices are going to go up but it's hard — we do seem to be at a point where they've stabilized to some extent so if we are able to take in $60 poly and continue to have our reduction in non-poly costs then the prices that we've talked about or the prices that you just talked about are prices that we're comfortable with. I mean as I said at the beginning, we're committed to thriving in this market wherever it goes and part of that is we understand that one way it may go may be continued decline.

Rob Stone - Cowen & Company

I was trying to get at whether you had actually, in the renegotiations you mentioned with your suppliers already contemplated lower silicon costs incoming purchase price in the second half and in 2010. I understand it's all blended and some of it's inventory that was produced this quarter that ships next quarter, et cetera, but I'm just trying to get a general directional guide on your raw material costs.

Peter Xie

I'd like to take this question. Right now the way we are working with suppliers is we have a mechanism built into our amended agreements, namely that when the market price is moving plus or minus 10%, then we need to go back to the negotiation table to renegotiate the price. So basically in the declining environment we will now see as scenario that we will be buying polysilicon at a high price because we have already built in the mechanism automatically so the price will drop to the market price.

Rob Stone - Cowen & Company

Okay. That's very helpful. Thank you.

Terry McCarthy

Rob, just as a round number here for both ingot and wires — so making a wafer, about $100 million CapEx for 250 megawatts of capacity.

Rob Stone - Cowen & Company

Thank you.

Operator

Your next question comes from Vishal Shah from Barclays Capital. Please proceed.

Vishal Shah - Barclays Capital

Yeah, thanks for taking my question. I'm curious to know why you guys are guiding down shipments in Q4 when some of your peers are talking of a sequential increase in shipments. Can you talk about some of the trends that you are seeing right now? Is it a function of market share or something else? Thank you.

Peter Xie

Yeah. That is a very good question and we are getting done in Q4. I think if you look at the traditional marketing, especially in Germany, the Q4 typically is the weak season. In November nobody is doing any installation anymore. So in Europe we would expect the market is going to go down, however, having said that there is emerging markets coming up. So namely US and China. But right now we have very low visibility on those two markets. I think those are the big swings so we'd like to play conservatively on those markets.

So maybe there is a potential that in Q4 maybe the US and China will catch up. Then we would have numbers exceeding our forecast right now, 80 megawatts. Right now our amount is mostly based on — still largely coming from Europe, most of our revenue.

Vishal Shah - Barclays Capital

Okay. And the 80 megawatts, is it all going to Europe and specifically to Germany.

Peter Xie

No. We are going to actually be much more diversified. They are going to be mostly Europe and also Korea, Australia, and in Europe there will be Italy, France, Spain — many countries. Germany still will be the largest factor.

Vishal Shah - Barclays Capital

What percentage of your 80 megawatts shipment guidance do you already have contracted?

Peter Xie

When we said earlier we had 200 megawatts in a framework of purchase agreements already, for the Q4 numbers we think we have close to half of that. We have a pretty good indication that we are going to have foreign orders.

Vishal Shah - Barclays Capital

Okay. So you have got about 40 megawatts of foreign orders for Q4.

Peter Xie

Pretty close, yeah.

Vishal Shah - Barclays Capital

Close to 40 megawatts, and most of it is still coming from Germany, (inaudible) more diversified. And then also talking about pricing plans, you said $2 or lower prices for large projects today, where do you think prices are for some of the medium priced projects and how are you referring to any sort of large products, are you referring to the commercial projects because I don't think you're participating in the (inaudible) projects, right?

Peter Xie

Yeah. I mean, the large projects we are talking about is 3 megawatts and above, mostly 5-10 megawatts, those large projects. We see actually the spread between large project and the small project actually getting smaller because the market can become pretty competitive right now.

Terry McCarthy

And a better word maybe than project would have been customers. For volume agreements we will prive obviously more aggressive than for smaller volumes so it's not only project, it's also customer size.

Vishal Shah - Barclays Capital

Yeah. And I must have missed this question, but it seems like you’ve got a slight premium over some of your Chinese peers in terms of pricing and a lot of them are talking about $2 — actually $1.80 board price in Q4. What is your pricing strategy going to be in order to be competitive in that environment? Do you see prices going down to those levels or do you think that you'll be able to maintain a premium?

Peter Xie

As mentioned earlier by John, there are things that are two market segments. One segment we serve to customers who have very specific requirements. Those unique requirements kind of demand a premium because many of them have, for example, special junction box, special (inaudible) sheet, and things like that.

And also there are another type of product which carry less premium. Those are kind of commodity types. The price can tend to be — you have to compete at market levels. So we actually we have two segments. I think the reason you see a premium is because we also serve another segment which requires a premium because of special requirements.

Vishal Shah - Barclays Capital

Okay, great. Thank you so much.

Operator

Your next question comes from Pranab Farm with Diwar Secutities. Please proceed.

Pranab Farm - Diwar Securities

Yes . Thank you for taking my questions and congratulations on a good tight quarter outlook. My first question is could you comment a bit on ASP in the China project since you have got about 220 megawatts on you hand and what type of ASP you are looking at compared to other projects and when are you likely to deliver those shipments?

Peter Xie

Yeah. I think that's a very good question. ASP in China is all over the place and so it's hard to name because right now we do not have significant volume in China right now. In RMB wise, in China typically there is kind of at turnkey system. I see, for awhile, system integration costs anywhere from 20-30 RMBs per watt. They are at 20 RMBs per watt. The installation is a turnkey system. But in some key cases we see price lower than that too so I don't think that's rational, but we see it is quite a big range.

Terry McCarthy

And understand this may not just be a module sale, it may be actually developing a project which would be more of an IRR calculation rather than a price per watt for a module.

Pranab Farm - Diwar Securities

And when are you going to ship those products?

Peter Xie

Yes. So the plan will be around Q4, but because of the government, they have a plan — the government, sometimes the plan, they change. So right now the plan is to start in Q4.

Pranab Farm - Diwar Securities

So your 80 megawatt guidance for Q4, does it include any shipment to China or it doesn't at this point?

Peter Xie

At this point it does not include any shipment into China.

Pranab Farm - Diwar Securities

Okay. So there could be upside if you get a China shipment.

Peter Xie

There could be upside, yes.

Pranab Farm - Diwar Securities

Okay. And my second question is on your provision side. Do you need to put any more provision either on inventory or advanced prepayment on the Q3, or have you done everything by Q2?

John Breckenridge

Yeah. I mean the expectation — I mean every quarter we're mark to market. Obviously if you turn your inventory during the quarter and the ending inventory is down to current market prices then you wouldn’t expect any additional provision. Obviously this would be a larger quarter so we hope that by the end of the quarter we will have turned our inventory and have very little new provision to put on ending inventory.

Terry McCarthy

And I think as both Peter and John had indicated in earlier comments, we think we've adequately provisioned for our supply contracts. We're well through those renegotiating processes and what is not completed I think we've been quite conservative in our assumptions there so.

Pranab Farm - Diwar Securities

And what's on contract — is it fair to say 80% of your advance contracts are already negotiated or it's a less than 80% renegotiated.

Peter Xie

So I can comment that actually 100% of our contracts have been renegotiated, however renegotiation is ac continuing process. As you know, the American credit condition changes so actually we are continuing negotiating with our suppliers as the market condition changes and we do expect a poly significant price to drop continuously so we are building a market mechanism with our suppliers so we will continue to talk with our suppliers on a long-term basis.

Pranab Farm - Diwar Securities

Okay. Thank you.

Operator

Your next question comes from Sam Dubinski with Oppenheimer. Please go ahead.

Sam Dubinski - Oppenheimer

Hey, guys. Sorry if I missed this, but how much in-house wafer capacity did you have in Q2, what do you expect by year end, and how much should we think about in-house wafers for 2010?

John Breckenridge

You did miss it, Sam (laughter).

Peter Xie

Okay. So our in-house capacity is — well, just 250 megawatts.

Sam Dubinski - Oppenheimer

Okay. And by year-end?

Peter Xie

Well, we do not have any plan to expand by year end. 2010 we have a plan to add another 120 megawatts.

Sam Dubinski - Oppenheimer

Okay, so 120. And then also just to be clear, the incremental capacity expansion this quarter, that includes 100 megawatts for the module processing business.

Peter Xie

Yeah, correct.

Sam Dubinski - Oppenheimer

Okay. So then your expansion by year end and into 2010, what percent — or how many megawatts of expansion are going to module processing versus your core module business?

Terry McCarthy

Sam, we have a contract with Q-Cells that calls for a minimum of 100 megawatts of modules per annum. We'll clearly do, about on a calendar basis this year, I think as John had indicated in his comment earlier we have some flexibility in how we dedicate that capacity so I don't think that additional module capacity is necessarily focus don Q-Cells, but I think it's a combination of what we see in increased market demand overall which would be — that level would be adequate to handle additional Q-Cells volume.

Sam Dubinski - Oppenheimer

Okay. So basically that capacity can go back and forth to handle either additional Q-Cells or just your backlog is big enough to support that without Q-Cells upping its contract?

Terry McCarthy

Correct.

John Breckenridge

Because this is an important point may I just add one more comment, which is that in terms of our ability to expand, historically we had to expand all of our operations to expand output and spend that CapEx. I think going forward, given the current market environment and over supply in certain areas, we're going ot be very conservative about expanding our ingot and wafer capacity because that is the most capital intensive and there is a lot of capacity available in the market so we think we can buy those effectively in parallel with manufacturing of our own.

Cell manufacturing, there may be times where we actually purchase cells if we need to, to supply our modules, but where we can we will expand cell lines because that is relatively less expensive compared to ingots and wafers. And then the most cost effective or capital effective way for us to expand is our module capacity and we'll dot hat internally as much as we need to.

Sam Dubinski - Oppenheimer

I gotcha. And just for modeling figures, I know you expected about 100 megawatts from Q-Cells, but in terms of linearity for Q3 and Q4 your megawatts shipment guidance and factory about module processing per quarter? How much for Q3 and Q4?

Terry McCarthy

Sam, we indicated in our press release that we began our shipments in the second quarter. It was not a full quarter of volume shipments, but I think we indicated in the press release a total volume of something around a third. I think we'll see a pickup from that volume level in absolute terms, not necessarily in percent terms in the third quarter and I think probably something at that level or slightly less in the fourth.

Sam Dubinski - Oppenheimer

Okay, thank you.

Operator

(Operator's Instructions) Your next question comes from Arch Pei with JLM Pacific. Please proceed.

Arch Pei - JLM Pacific

Thank you for taking my question. I wonder what kind of suppliers are you writing down the advances to, are they major (inaudible) companies, are they majorly Chinese wafer suppliers and poly supplier or overseas suppliers?

Peter Xie

Yes. At this moment we have a bunch of suppliers both international and as well as Chinese for our domestic suppliers. Because of the sensitive nature we would like not to disclose the specific names at this call, but as you know we have a mixture of domestic and also international suppliers so those provisions are for those suppliers.

Arch Pei - JLM Pacific

And also considering your receivables increased by more than 150% quarter on quarter and also you're amount due from related parties also increased so are you using looser credit standards to customers and do you think that then you are risking your future that you have to let down your accounts receivables?

John Breckenridge

Receivables increased mainly because of the increase in volume number one, and the fact that most of the shipments went on the second half of the quarter so they were mostly pretty much under the normal credit terms. Credit terms obviously are loosening a little bit, but the aging is in very good shape. We actually have no accounts receivable reserve on any of our receivables at this time.

Terry McCarthy

And you can note the absolute amount went up, but DSOs increased from 35 to 38 and I suspect at 38 we're well at the top in terms of DSOs versus our peers.

Arch Pei - JLM Pacific

And my next question is what is your depreciation cost in this quarter and what will be the depreciation costs in the next few quarters?

Peter Xie

We typically do not breakout depreciation costs.

Terry McCarthy

Total processing costs, it's a very small number.

Peter Xie

Yeah, depreciation is very small numbers, yeah.

Arch Pei - JLM Pacific

So you do not reach the depreciation to increase significantly since you are still ramping up your wafer capacity?

Peter Xie

Yeah. We do not expect a huge increase in depreciation because as John mentioned earlier, we can do a ramp starting mostly with the excess capacity and if you can utilize excess capacity in the marketplace, namely we start buying polysilicons, ingots, or wafers, and then those are the most expensive ones. So by increasing the marginal capacity, we do not expect to increase our depreciation significantly.

Arch Pei - JLM Pacific

Great. Thank you for taking my questions.

Operator

(Operator's Instructions) This concludes the question-and-answer portion of today's call. I will now turn the call over to Paul Combs for closing remarks.

Paul Combs

Okay, great. Thank s, everyone, for your interest and your questions. As always, we hope to be as transparent and as helpful as we can so for those of you that need follow-up calls, you know how to find me so I'm available. Thanks again and we again apologize for the lateness of the earnings release. Have a great day. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation.

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