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Yingli Green Energy Holding Co. Ltd. (NYSE:YGE)

Q2 2009 Earnings Call

August 19, 2009 8:00 am ET

Executives

Miao Liansheng - Chairman and CEO

Bryan Li - CFO

Robert Petrina, US Managing Director

Stuart Brannigan, Europe Managing Director

Miao Qing - IR

Analysts

Jesse Pichel - Piper Jaffray

Vishal Shah - Barclays Capital

Kelly Dougherty - Macquarie

Dan Ries - Collins Stewart

Sanjay Shrestha - Lazard Capital Markets

Lu Yeung - Banc of America/Merrill Lynch

Rob Stone - Cowen & Company

Sunil Gupta - Morgan Stanley

Operator

I would like to welcome everyone to the Yingli Green Energy Holding Company Limited second quarter 2009 financial results conference call. (Operator Instructions)

Now, I would like to transfer the call to Courtney Shike from Brunswick.

Courtney Shike

Thank you everyone for joining us today for Yingli's second quarter 2009 financial results conference call. On the call today from Yingli Green Energy, are Mr. Miao Liansheng, Chairman and Chief Executive Officer; Mr. Bryan Li, Chief Financial Officer; Mr. Robert Petrina, US Managing Director, Mr. Stuart Brannigan, Europe Managing Director, and Ms. Miao Qing, IR Director.

Just now, Yingli issued second quarter 2009 earnings release, which can be found on the company's website at www.yinglisolar.com. The call today will feature a short presentation from Mr. Miao covering business and operation developments, and then Bryan Li will take you through a discussion of the company's financial performance. After their prepared remarks, the presenters will open the floor to questions from the audience.

Before beginning, Yingli Green Energy's Management team would like to remind the audience that this presentation contains statements constituting forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and as defined in the US Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as will, expects, anticipates, future, intends, plans, believes, estimates, target and similar statements.

Such statements are based upon Management's current expectations and current market and operating conditions, and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond Yingli Green Energy's control, which may cause Yingli Green Energy's actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding these and other risks, uncertainties or factors is included in Yingli Green Energy's filings with the US Securities and Exchange Commission. Yingli Green Energy does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under applicable law.

I would now like to turn the call over to Miao Liansheng.

Liansheng Miao

[Foreign Language]

Hello everyone, and thank you for joining us today. I would like to take a few minutes to discuss some quarterly business highlights and achievements before handing the call to Bryan Li, our CFO who will take you through our second fiscal quarter financial results.

Let me begin with our sales highlights. In the second quarter our shipments increased by 72% over the first quarter allowing us to generate net revenue of $219.5 million up 50% over last quarter. There were two driving forces behind those numbers. First, as the global economy started picking up, financing conditions and market demand in key solar markets have improved.

This was something we observed first hand when we attended Intersolar 2009, in Munich, in late May, an event we saw as a turning point for PV market, as it hacks out of global financial crisis. Our meetings with customers at Munich conference indicated increasing brand recognition of Yingli products and reinforced our view of gradually improving market conditions.

The second driving force was our continued efforts in diversifying our customer portfolio and executing a pricing strategy that leveraged our strong innovation and cost control capabilities to expand our market share. We continue to focus on reaching out to distributions with broader sales channels and solid financing conditions, while maintaining our focus on major EPC customers by providing high quality PV products with very competitive prices.

As a result our shipments to (inaudible) distributors increased significantly and we expect to see our customer portfolio further optimized, which we believe will minimize any negative impact from macro environment we have in our business.

In the second quarter we continued to build our presence in existing solar markets worldwide. I would like to take you through highlights from some of existing markets. First United States; as many of you know, we have established US subsidiaries with two offices in New York and in San Francisco.

We have put together a top notch Swiss team, consisting of experts with strong technical background, excellent network resources, and a rich experience in the PV industry. Some have been working in the industry for more than 10 years. With our enhanced presence in the US, we plan to expand our technical support and after sales service for North American customers and pursue new partnership in the region.

In the US, our solid brand recognition and a reputation for high quality allows us to enter into several notable partnerships such as exclusive polysilicon PV module framework supply agreement with AES Solar, under which we have already shipped 4.35 megawatts of PV modules and our strategic sales agreement with Recurrent Energy.

Leveraging our low cost structure, strong (inaudible) capabilities and a clear positioning as a high-quality PV module supplier, we look forward increasing our market share in these important emerging markets. Another key new market for us as you all know is China.

In March, the Chinese government enhanced its [staffer] to promote solar energy with announcement at the first PV subsidize. However I mentioned during the first quarter earnings call that Chinese government was planning to announce another wider scale subsidy program, the Golden Sun. The program was finally announced in July and it would incentivize the domestic PV market.

Taking advantage of the foreseeable boost in the Chinese solar market, our strategy is to position Yingli as a high-quality, low cost supplier of PV margin and to enter into strategic partnership with utility components in the large [commissioned] energy companies.

We had been focusing on expanding our preferred range and have already set up eight processes in different parts of China, in fact we have reached several milestones during second quarter. For one, we became the exclusive supplier for a 10 megawatts on-grid solar plant in Dunhuang, Gansu Province, and we also formed a strategic alliance with subsidiary of China Guangdong Nuclear Power Holding Company to develop on-grid solar projects both in China and overseas.

We believe this partnership will fully enhance our brand name and reputation amongst the domestic solar developers. Also we just received a piece of good news that we signed a sales contract with China Energy Conservation Investment Corporation to supply module at a volume of 10 megawatts for on-grid projects located at (inaudible) region.

In addition by holding a minority stake of 20%, we recently partnered with Hainan Development and Hainan Provincial Waters Conservancy Power Group to form a joint venture Hainan and Yingli Power which will develop and operate on-grid solar projects in Hainan Province.

If you may have already known, Hainan is an island, a province in the south most part of China, with a (inaudible) it established a great system. So the province has great advantage in solar development and is committed to become an international (inaudible) tourist island. We expect the joint venture will develop projects totaling up to 300 megawatts by 2011 in Hainan.

This July we posted China on-grid PV power plant construction forum in (inaudible) and Shanghai, the first of its kind in China. With large scale domestic state [grade] of goods and the government officials in attendance, the firm demonstrated our influence in Chinese PV markets and they provided a platform for our existing and potential customers to share experience and information for further development of on-grid PV projects in China.

As an industrial leader, Yingli has more than 10 years of PV industry experience, and a proven track record. By leveraging our leading position and strategy, we are very optimistic about the achievements Yingli will make in China.

Looking now to Europe which has probably our largest market; during the second quarter we continue to focus on strengthening our position and gaining market share.

In this competitive market, we greatly benefited concentrating our efforts on our European sales team to refine our employment (inaudible), as effect of (inaudible) strategy. Thanks to their hard work, we have established a comprehensive sales network and a strong reputation for quality and service throughout Europe.

[Foreign Language]

Our sales volume in Europe increased about approximately 73% from the first quarter and approximately 46% from the same quarter last year, which demonstrated our solid improvement in the market expansion in the second quarter of 2009, as we benefited from distribution to diversifying markets.

We are optimistic about our sales volume will likely to increase by at least 80% from the second quarter, mainly from different areas in Europe. In Spain, we have recently signed a sales contract with Elecor, S.A.U, a Spanish PV system integrator to supply 9 megawatts of PV modules from third quarter of this year.

In addition to our existing subsidiaries in Germany, Spain and US, we opened up our Italian subsidiary in June and are actively preparing to establish subsidiary in [France], with aim provide our European customers with swift response and a customized service for improving our customer satisfaction and further expanding our market share.

I want to take a moment to discuss some of our research and development initial tests and operating aspects.

Project PANDA moved forward smoothly in schedule, this project we are dealing with advanced technologies that can significantly increase efficiency of crystalline silicon cells we produce.

On the cost front in the second quarter, we further renegotiated with our long-term polysilicon suppliers to bring contracted price down. We also reduced polysilicon usage per watt to continuous improvements in (inaudible) and solar efficiency.

Furthermore then we have adopted (inaudible) for our in-house poly plant at Fine Silicon. We're optimistic about expanding our overall cost advantage by further reducing polysilicon costs. With the infrastructure construction for Fine Silicon coming to end, we're focusing on installation and start production of relevant equipments as well as training in new plant (inaudible).

On the production capacity front, in July, we successfully completed expansion of additional 200 megawatts capacity, bringing our total annual production capacity to 600 megawatts, in addition along with our long-term development strategy. To take advantage of favorable conditions of Hainan Provincial Government we partnered with Hainan Provincial Development Holding Company Limited to form a joint venture Hainan Yingli New Energy Resources. The joint venture will have annual production capacity of 400 megawatts and the each polysilicon ingots and a wafer PV cell and a PV module in Haikou, Hainan Province.

Looking forward we expect to see global macroeconomic continue to improve and product financing and market condition continue to pick up in our key markets. We believe that only by reaching solar-grade parity we will achieve few environmental assistance ability and we are actively working toward this goal, combined with our continued efforts to expand our presence in emerging solar markets, enhance our R&D capability, improve upon our cost advantage and improve capital structure.

We are very excited about upcoming opportunities as we move towards a brighter and a cleaner future.

I will now hand the call over to Bryan Li, who will take you through the financial result for the quarter.

Bryan Li

Thank you, Mr. Miao. Good morning and good evening to everyone on the call, and I thank you for being with us today.

To begin with, I'd like to give you an overview of our financial results in the second quarter. We have achieved a very strong second quarter result. To compare quarter-over-quarter, shipment volume increased about 72.3%, gross margin increased to 18.3% from 15.3%. Income from operations increased about 424% to RMB106.8 million, equivalent to $15.6 million.

GAAP net income increased to RMB119.8 million, equivalent to $17.5 million from a loss of RMB77.1 million, and then GAAP EPS increased to RMB0.91, equivalent to $0.14 from a loss per share of RMB0.61 in the first quarter.

I will now walk you through our financial performance for the second quarter of 2009. Our total net revenue were RMB1,498.9 million, equivalent to $219.5 million in the second quarter of 2009, and a increase of 49.9% for RMB999.9 million in the first quarter of 2009. The increase was primarily due to increased PV module shipment volume as a result of the improved credit environment in the major PV markets increased brand awareness, continued promotional efforts aspects and improved product ability and was partially offset by a lower average selling price.

On our last earning call in May, we mentioned that we saw a gradual recovery in demand, and I am now pleased to note that this positive trend has continued throughout the entire second quarter. With increase in global legislative support for solar sector and given that the third quarter is typically the peak selling and installation season, we are looking forward to an even stronger second half of the year.

Despite a sequential decline the average selling price since the fourth quarter of last year, our gross margin has steadily increased about 13.2% in the fourth quarter of 2008 to 15.3% in the first quarter of 2009, and 18.3% in the second quarter of 2009, as we continue to benefit from the decrease in the unit cost of blended polysilicon as a result of lower polysilicon purchase prices and a consumption of comparatively higher price of polysilicon inventory, with strong support from decrease in polysilicon usage per watt and the polysilicon cost.

Our cost advantage and quality of products have made solid gross margin even in the very difficult fourth quarter of 2008 and the first quarter of 2009. So from an accounting standpoint, we didn't provide significant provision to markdown the inventory cost or polysilicon prepayments, therefore our comparatively higher price to polysilicon inventory therefore has been consumed constantly over the quarters.

Furthermore, we have further renegotiated with our long-term polysilicon suppliers and have brought contracted prices down towards the spot market prices. All these factors have been contributed to the continuously decreasing blended cost of polysilicon.

After leading vertically integrated PV manufacturers with low cost structure, we have been reducing polysilicon usage per watt and then on polysilicon costs through continuous improvement in [your] rates and the sale efficiency rate together with a tighter cost control.

As for Project PANDA, it's progressing smoothly. We believe the cell conversion efficiency rate will be meaningfully improved once the technology commercialized. And we expected our polysilicon usage per watt and then the polysilicon costs would continue to decline as we are pushing forward various research and a developmental projects.

As we move towards the second half of 2009, we still plan to ramp up of our in-house polysilicon plant at Fine Silicon in late year 2009, we expect to see the increasing contribution from our in-house polysilicon production in 2010 and outwards to further reduce the blended polysilicon costs and to improve operating efficiency, which will help stress our cost leadership and further improve our gross margin.

Operating expenses in the second quarter of 2009 were RMB167 million, equivalent to $24.4 million; compared to RMB132.1 million in the first quarter of 2009.

Operating expenses as a percentage of total net revenue was 11.1% in the second quarter of 2009, compared to 13.2% in the first quarter of 2009, and 5.8% in the second quarter of 2008.

The decrease in operating expenses as a percentage of total net revenues from the first quarter of 2009 was mainly due to the increase in total net revenues and a better control of general and administrative expenses.

After excluding the cash interest expenses, interest expense was RMB79.1 million equivalent to $11.6 million in the second quarter of 2009, compared to our RMB72.2 million in the first quarter of 2009.

The weighted average interest rate for these borrowings in the second quarter of 2009 was 6.88%, which decreased from 7.34% in the first quarter of 2009, both on a basis excluding non-cash interest expenses. The decrease in weighted average interest rate was a result of our efforts to reduce funding costs.

In the second quarter, we repaid several high interest of financing including our ADM Capital [loans] with the proceeds received from our equity offerings in June 2009.

Additionally, we took active steps towards stabilizing the floating rate of our long term loans. We believe that these efforts will have a positive impact on the level and the visibility of our interest expenses going forward.

Foreign currency exchange gain was RMD108.7 million equivalent to $16.9 million in the second quarter of 2009, compared to a foreign currency exchange loss of RMD 93.6 million in the first quarter of 2009.

The foreign currency exchange gain in the second quarter of 2009 was primarily due to the appreciation of the euro against the RMD. We will continue to take active yet prudent steps such as hedging arrangements, balancing euro assets, and liability to mitigate currency volatility risks.

Income tax expenses were RMB16 million, equivalent to $2.3 million in the second quarter of 2009, primarily levied upon the net operating income generated by Tianwei Yingli in the quarter.

Under the PRC Enterprise Income Tax Law and the various implementation rules, Tianwei Yingli and Yingli China are subject to enterprise income tax rates of 12.5% and 15% respectively for the year of 2009.

Before we move on to the bottom line, I want to draw your attention to two non-recurring and non-cash accounting charges that we recognized during the second quarter, which negatively impacted our bottom line on a GAAP basis.

It's important to note that those charges were non-recurring and non-cash charges that had no impact on our cash flow, nor did those charges affect our robust operational performance in the second quarter.

In the second quarter of 2009, we recognized RBM244.7 million, equivalent to $35.8 million non-recurring, non-cash loss on debt extinguishment, which was a result of the early fully repayment of the $15 million three year loan facility provided by ADM Capital in January, 2009.

The loss represents the difference between the amount repaid and the carrying value of the loan on the date of the debt repayment.

In addition, we also recognized RMB204.2 million, equivalent to $29.9 million non-recurring, non-cash loss on derivative liabilities in the second quarter of 2009, which was primarily due to the change in the fair value of the derivative liabilities relating to the embedded conversion feature of the $20 million convertible notes issued to Trustbridge in January in 2009, and the warrants issued to ADM Capital in connection with the $15 million loan facility.

As a result of the factors discussed above on a US GAAP basis, net loss was RMB393.7 million, equivalent to $57.6 million in the second quarter of 2009, compared to a net loss of RMB141.6 million in the first quarter of 2009.

Diluted loss per ordinary share and per ADS was RMB3.03, equivalent to $0.44 in the second quarter of 2009, increased from diluted loss per ordinary share and per ADS of RMB1.11 in the first quarter of 2009.

On a non-GAAP basis, which excludes those net cash, non-recurring accounting charges, net income was RMB119.8 million, equivalent to $17.5 million in the second quarter of 2009, compared to adjusted non-GAAP net loss of RMB77.1 million in the first quarter of 2009.

As a result of our strong sales performance, continued cost leadership, and operating efficiencies, adjusted non-GAAP diluted earnings per share was RMB0.91, equivalent to $0.14 in the second quarter of 2009, compared to loss per share of RMB0.61 in the first quarter of 2009.

Now, let's take a quick look at the balance sheet. Accounts receivable increased slightly to RMB2,048.4 million equivalent to $299.9 million as of June 30, 2009. Our RMB was 1,899.7 million as of March 31 of 2009, despite a 49.9% increase in net revenues.

Day sales outstanding was 123 days in the second quarter of 2009, compared to 171 days in the first quarter of 2009, which was primarily attributed to the recovery of the broad markets. Improvement in collection of accounts receivables resulted from our continued credit risk control efforts and the improvement in product [bankability].

Inventory as of June 30, 2009, was RMB1,903.8 million equivalent to $278.7 million, decreased from [RMB2,355.4] million as of March 31, 2009, which was due to the decreasing level of the comparatively high priced polysilicon inventory.

We have maintained an appropriate finished goods level in anticipation of a stronger third quarter, as a result we improved the collection of accounts receivable and effective inventory management.

We have generated a positive operating cash flow of RMB600 million, equivalent to $87.8 million in the second quarter of 2009.

In the second quarter of 2009, we have further strengthened our balance sheet and improved our capital structure through a series of efforts. We issued 18.390 million ADS and we received net proceeds of $227.4 million in aggregate for our recent equity follow-on offerings.

By repaying several high interest financings, including the ADM Capital Loans with the proceeds received from this equity follow-on offering in June 2009 and a restructuring of some working capital loans to long-term facilities, our capital structure and the cash position have been substantially improved. As a result we have RMB2,452.7 million, equivalent to $359.1 million in cash as of June 30, 2009 up from RMB1,059.7 million as of March 31, of 2009.

Our working capital balance as of June 30, 2009 was RMB4,356.4 million equivalent to $637.8 million increased of our RMB2,780.4 million as of March 31 of 2009.

Long term bank borrowings increased to RMB1,971.9 million equivalent to $288.7 million as of June 30, 2009 from RMB1,172.4 million as of March 31 of 2009 and a short-term borrowings decreased to RMB1,817.5 million equivalent to $266.1 million as of June 30, 2009 from RMB2,601.9 million as of March 31 of 2009.

We continued to maintain close relationships with top tier commercial banks; large multi-national foreign banks and policy banks in China. In the second quarter, we have renewed RMB1 billion credit facilities with the Export and Import Bank of China, a government policy bank under the direct leadership of China's Central Government, under which a total of RMB800 million working capital loan was structured into long term bank facilities.

In addition, we received two new credit facilities, with principle amounts of $100 million and the RMB300 million respectively from the Bank of Communications Company Limited. As of today, we had approximately RMB7.4 billion, equivalent to $1.1 billion in authorized lines of credit, of which RMB4.9 billion, equivalent to $0.7 billion had to be utilized.

With that, I will turn to our guidance. Given the strong second quarter results and the visibility into the second half of the year, we now reaffirm our PV module shipment targets for the fiscal year of 2009 to be in the estimated range of 450 megawatts to 500 megawatts, which represents an increase of 59.9% to 77.6%, compared to the fiscal year of 2008.

In addition, by leveraging our competitive cost structure and achieving our goal in market share expansion, we now expect that our gross margin target for the fiscal year of 2009 to be in the estimated range of 18% to 20%.

Now, I would like to also give some indicative targets and expectations for ASP and the gross margin in the third quarter of 2009. As Mr. Miao has commented earlier, we are looking forward to an even stronger second half of 2009, and expect to see 80% plus increase in shipments in the third quarter overall shipments in the second quarter.

In addition, our competitive polysilicon processing costs, combined with continuously declining blended rates of polysilicon will further improve our gross margin in the third quarter of 2009, to be in the estimated range of 19% to 21%.

I will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jesse Pichel from Piper Jaffray.

Jesse Pichel - Piper Jaffray

It looks like you were guiding down your gross margins a bit, and we're just wondering is that the ASP trends we're seeing in the market, is that the impact of a poly plant and/or is that the impact of your selling to the distribution model?. If you could you just comment on that.

Liansheng Miao

[Foreign Language]

The main reason for the guide down on the gross margin is really due to the increased competition in the whole industry and also with the global financial crisis that drove down the ASP. However, we are very confident with our poly plant that in the long-term it should be able to help us with some gross margin expansion.

Qing Miao

We are still very confident with our shipment guidance which we gave and we just reiterate our annual shipment guidance.

Jesse Pichel - Piper Jaffray

It looks like you have a large distribution customer contract that's expiring this year. I think it's a 90 megawatt contract. Can you talk a little bit about, do you have any indication there whether this contract will be extended into the following year and do you anticipate that this distributor is conducting any kind of bakeoff there amongst the different Chinese vendors there, if you could just comment on those things?

Bryan Li

[Foreign Language]

We do have some large distributors in this customer portfolio and given the long-term strategy of partnership has build up with those large distributors and so far we haven't seen any problems with orders from those distributors and in the second half of the year and the next year we're anticipating to see more orders from those largest distributors.

Jesse Pichel - Piper Jaffray

The proposed expansion in Haikou, when will you make that decision to move forward with it and can you just give us an update on what you think the timing would be when this plant would start to produce modules?

Bryan Li

We have started the order preparation work and investigation work recently. Of course, this is a project directly as sponsored by Hainan Government and also it's a provincial level investment. So the provincial government has put in a lot of efforts in all the aspects to help Yingli start audit and detail the preparation work in Hainan Province and at this moment we haven't finalized the feasibility study work and investigation work at this moment. So we can't comment when is the timing we think we will start the manufacturing schedule.

Based on preliminary discussion with the government we think we will start the construction and equipment selection late this year and so the most of the CapEx would be spend at the beginning of next year and then target to start a ramp the Haikou capacity in the mid of next year. So that was the plan and we will update our progress in the next Earnings Call.

Operator

Your next question comes from the line of Vishal Shah from Barclays Capital.

Vishal Shah - Barclays Capital

Can you just maybe talk about what your outlook is for ASPs in Q3, expectation on a sequential basis?

Bryan Li

In our current expectation on ASP in Q3, we'll be further down mid to high-teens from the second quarter's level. I can also share with you our expectation on the blended polysilicon cost in Q3 and we are also expecting the polysilicon cost in Q3 were down mid to high 30s from the second quarter level.

Vishal Shah - Barclays Capital

Mid to high 30s. And can you maybe talk about Q4 expectations at this point?

Bryan Li

Sorry. Can you repeat your question again?

Vishal Shah - Barclays Capital

Can you talk about your Q4 ASP expectations, what kind of a decline you expect in Q4?

Bryan Li

Q4, we are expecting a mid-to-high single digit from Q3s level.

Vishal Shah - Barclays Capital

What happens to these shipments in Q4, will they be up or down from Q3 levels? It looks like, based on your guidance shipments could be down.

Bryan Li

You mean Q4?

Vishal Shah - Barclays Capital

Yeah.

Bryan Li

Yeah, because in Q4, due to the weather condition, and that normally it will be the slow season in terms of the solar installation. At this moment, based on the orders and the contracts we have signed, we see the Q4 demands would be lower than Q3 demands -- Q3 shipments. But we are confident in maintaining 450 to 500 annual guidance for this year.

Vishal Shah - Barclays Capital

So if Q4 is down sequentially, how should I think about your gross margins, if your utilization rates go down? And can you also maybe talk about your target margins for 2010, a number that you would be happy with given the increased competition?

Bryan Li

Our gross margin target for 2010 would be depending on certain facts, for example, in the successful ramp up in the cost level of our in-house polysilicon plant. So at this moment, I can't give you comments on 2010 gross margin targets, but we believe, based on order information and order facts, we have held and our gross margin level in 2010 should be higher than 2009.

Vishal Shah - Barclays Capital

The Q4 level will be down sequentially from Q3 gross margins.

Bryan Li

Currently, we see it will be down slightly from Q3 level.

Vishal Shah - Barclays Capital

One last question; given that what [FSLR's], we talked about this rebate program recently, has that changed your pricing strategy and have you been discussing with some of the potential customers about some of these contracts?

Bryan Li

I think as Mr. Miao explicitly commented in the prepared remarks, that this year, 2009 is a tough year for the solar industry. But it's also the [calm] before it takes off in next year. So in this year, we are really spending a lot of efforts in expanding our market reach to the different corners of the world. As we are taking those active steps, we are actually getting more market shares from the other competitors. When we price our product, we will also bear order facts and our long-term strategy in our mind.

Vishal Shah - Barclays Capital

One last question; what percentage of your Q4 shipments outlook currently you have in the contract?

Miao Qing

At least 70%, and the confirmed is not always seen. We have already entered into legally pending contracts. It means that, we would double confirm with our customers and also (inaudible) as well.

Vishal Shah - Barclays Capital

This is Q4 or Q3?

Miao Qing

For both, for second half of the year.

Operator

[Operator Instructions]. Your next question comes from the line of Kelly Dougherty from Macquarie. Please proceed.

Kelly Dougherty - Macquarie

I am just wondering if you can talk to us about your processing costs reductions in the second half and then going into next year. Have you gotten most of your non-poly improvements already, and if not, where do you expected to be at the end of this year and then at target processing cost for 2010.

Bryan Li

Thank you for your question Kelly. We are pleased to share with you on the processing costs in the second quarter has been reduced by $1 level in the first quarter to $0.90 to the second quarter. One thing I would like to remind you is; the $0.90 that we're talking about here is the [auditing] cost, which includes the depreciation, insurance, freight charge as well as the sales and warranty. So it's [auditing] cost basically.

In the third quarter and the fourth quarter, as we are pushing forward, it's a different R&D initiative in Project PANDA and we think we can gradually reduce our (inaudible) processing costs from $0.90 to $0.85 all in towards the end of the year. In the next year, it could be a meaningful improvement and once the Project PANDA is commercialized.

Kelly Dougherty - Macquarie

Sorry to take conversion efficiency as probably the biggest swing factor in improving processing cost, is that how we should think about that?

Bryan Li

For Project PANDA the purpose is to improve the cell conversion efficiency rate.

Kelly Dougherty - Macquarie

Okay, great. And then you talk about pricing competitively to take market share, and I am just wondering if you have an idea if you can share with us who you think you are taking share from and are there cash specific sub-sectors of the market that you are, they will be looking at kind of dependent on of who is in that market and you are just they are the areas that you are focusing on?

Miao Liansheng

[Foreign Language]

As you all know that we have been positioned, always positioned our sales in no matter existing and in new and emerging market as low cost, high quality PV producer whether done I mean to take any shares in to the system integrators.

So actually we are solidifying in taking market shares from both system integrators and those distributors. And I think Stuart first, and Robert follow-on, can give some very brief supplement through this question. Please, Stuart. Thanks.

Stuart Brannigan

I think that what we've seen this year in Europe is that a number of our long term partners have started to take a much higher percentage of their total module portfolio from Yingli. I think that that means that they've decided that we offer the best value price-quality combination for them, and so I think it's really our customers that have decided that they prefer Yingli to other brands and therefore, we've seen some of our distributors move from taking 20 or 30% of their product to 50-60%, and in some cases 90%.

So I think in Germany as a core that's happened, and then we've seen expansion into the Czech market, in France, in Italy, even in Israel and Bulgaria. So I think it's a combination of further demonstrating the value and the quality of the product to our existing customers and then moving into these new European markets, which is allowing us to sort of hit that level.

I think that in SMA's earnings call the other day they talked about a total global market of around 5.7 gigawatts. We've always said from the beginning of this year, we thought about 5.3 to 5.5, so kind of 450 to 500 megawatt level gives us getting reasonably close to 8% to 10% market share. So I think that's [only] on Europe. Robert.

Robert Petrina

Kelly from our perspective in the US, I think it's very important to recognize that what we've seen with what our pricing and just our competitive position is that, a lot of developers IPPs and also utilities are very interested in looking at the Yingli as a major supplier to some of the utilities or field projects, and we see that as a recognition of our cost structure as well as what Stuart said, a quality product that is certainly seen as very important to their plans. And this is albeit in terms of what we've seen is access to tremendous amount of pipeline in the US market and more recently we've been very, very active and in (inaudible) California as well as other areas.

Stuart Brannigan

I think if I could just add one thing which is back to Jessie's question around distributors, large scale distributes of contract. We have a one-year rolling contract with most of our large scale distribution people, and so every year that contract in effect comes to an end. But because it's been a long-term partnership now over four or five years that will just continue on.

And then with that particular customer they are exactly the same as I outlined before is, they've taken a larger percentage of Yingli modules this year in that total portfolio compared to last year, and we expect that to continue in 2010.

Operator

Your next question comes from the line of Dan Ries from Collins Stewart.

Dan Ries - Collins Stewart

As we think about you doing some of the system business later this year and certainly into 2010, how should we think of the margin structure on that business in comparison to your normal margin?

Bryan Li

Thanks for the question Dan. For the system installation business, we don't expect it will have a large component in our sales performance this year, and it will be a 2010 and 2011 story. And for when we are determine the system installation business, we actually combine the returns we can get from the system installation work together with the traditional module or module sales, and after determining the overall combined return for these two type of business.

So, for every business we think it will give us better than normal traditional sales of modest returns. That would be our measurement.

Dan Ries - Collins Stewart

And I know you have some deal signed, is there any ballpark as to maybe what megawatt you though, you think you can install during 2010.

Bryan Li

At this moment we can't comment, because we are still waiting. I think the China market is still waiting for the feeding tariff and to be announced by the NDRC. So until everything has been cleared and before that we can't really make comments.

Dan Ries - Collins Stewart

And just one quick one; the R&D line nearly doubled sequentially, I'm sorry if I missed it. Is that the new basis or were the one-time items included in that just for modeling going forward for the rest of the year.

Bryan Li

The higher R&D expenses is resulted from the expenses incurred in connection with Project PANDA. And as we said, the purpose of Project PANDA is to improve the cell conversion efficiency rates on the existing cell capacities.

So we spent a lot of efforts on these projects and we will continue to expect the similar level of the R&D expenses contributed to Project PANDA in the third quarter. And for Project PANDA everything is moving smoothly as we originally expected, and we are scheduled to start power commercialization later this year or beginning of next year.

Before I end up this question, and one thing I would like to talk about is the gross margin line, because one very important things I would encourage everybody to pay attention to is, starting from the fourth quarter of 2008 and up to now and YGE Yingli has never provided any significant provision for inventory and prepayments.

So that actually makes our polysilicon cost or production cost not at the same basis as those companies who have already provided the provisions? So if we have written down our inventory in this quarter to the spot market price and all gross margin could be as higher as 40% plus. Thank you.

Operator

Your next question comes from the line of Sanjay Shrestha of Lazard Capital Markets. Please proceed.

Sanjay Shrestha - Lazard Capital Markets

Couple of quick follow-ups, I just want to confirm you guys said that for the second half of 2009 you have 70% of that already in the backlog. And if that's correct, can you give us a geographic breakdown of where do you expect majority of that sales to occur?

Bryan Li

For the second half of the year and in our backlog we currently expect roughly 50% of the order goes to German markets, and about 35% to 40% of the orders goes to the other regions of Europe, and the rest of them as it will go to the other corner of the world.

Sanjay Shrestha - Lazard Capital Markets

So kind of talking about one of the points we made, which -- thank you for that clarification about not writing it down if you did, it was going to be 40% gross margin. So, along those lines, in 2010, two-part question; one, with the steep decline in the ASP here this year, how fast do you see the ASP decline in 2010, number one; and number two, what do you expect, including both in-house as well as spot purchases in 2010 your blended poly price to be?

Miao Liansheng

Now for 2010 -- and let me start answering your questions. You know, for 2010 we currently expect, there will be another 10% to 15% price reduction from the fourth quarter level, which will get the pricing levels to the level close to 1.7, 1.65 probably that's the ballpark.

Sanjay Shrestha - Lazard Capital Markets

And what about the blended poly prices?

Miao Liansheng

It would be in the range of $50 to $70 per kilograms that would depend on the ramp-up in our Fine Silicon because for next year the total polysilicon demand would be approximately 4,800 metric tons and we estimate that half would be sourced from our in-house polysilicon plant which is Fine Silicon.

Sanjay Shrestha - Lazard Capital Markets

So 50 is if you are successful in-house, and 70 is if you just kept the existing long-term contract and the spot purchase.

Miao Qing

Actually Fine Silicon will support a price for 50% and few long-term contracts will have another around 35%, the rest of them would be from the spot market.

Sanjay Shrestha - Lazard Capital Markets

Okay, but what I'm trying to get at is the way you guys get to that $50 price of poly in 2010 is if you are successful producing in-house, correct? Or is that without even being successful producing polysilicon in-house and that's what you have kind of sort of view of the long-term contract as well as where do you see spot going. That's what I was trying to clarify.

Bryan Li

Yes, we are actually taking a considerable haircut for the cost level of Fine Silicon in next year. So it's on a conservative basis and we are factoring certain portion of Fine Silicon's cost contribution, but we haven't factored in 100% of their cost benefits for Fine Silicon.

If we can ramp-up the Fine Silicon as we planned in next year to reach 50% of our 2010 polysilicon needs that will actually further breakdown the blended cost from what Mr. Miao indicated.

Sanjay Shrestha - Lazard Capital Markets

Got it. That's what I was trying to get. One last question then guys. In terms of 2010, so with the ASPs expected to be where it is, obviously means pretty significantly better delivered cost of electricity. So what's your expectation in terms of high level shipment and kind of the magnitude of growth, a range is fine at this point in time; and two where do you see that incremental growth to materialize from, is it the US or North America for you guys, is it China, and what do you think is going to be your concentration in the European market in 2010? Thank you.

[Foreign Language]

Miao Liansheng

First, I think that the three major markets both EU countries, China and the US would take over, I promised it will take 85% of total of our 2010 output, and the Europe there will be focused on still [determining] to expand and it will also look at certain other countries in the Europe and Stuart can get some supplement to this question as well.

Stuart Brannigan

Okay. I think that as we talked about prices declining next year over quarter four, I mean that's simply a function of the dominant German feed-in tariff, and customers expecting that that 8% to 10% percent reduction to match with the change in feed-in tariff and then to make sure that the returns on these larger scale projects and then projects in general stay competitive.

So I think that we are seeing a much less weaker quarter one in 2010 compared to 2009. And in general as the current markets pick up stronger and stronger available demand in Germany, we see France as a very strong market in 2010. Italy will be stronger again in 2010, 2009 as of the (inaudible) bureaucracy around the largest scale projects in Italy.

Czech Republic looks like there are some really serious returns we made on projects there and so its simply a learning curve in terms of understanding how the financial models work over there. So we are looking forward to, we've already got a very strong third quarter and looking good in the early part of the fourth quarter of this year. We are looking towards to really strong 2010.

Miao Qing

Sorry, (inaudible) would like Robert to give some colors on how we position our sales in the US market in next year. Rob are you there?

Robert Petrina

So to add to Stuart's point. From our perspective we see the US market obviously as a market with tremendous potential. We have seen that there is a significant number of new players coming in and looking opportunities both from the larger utility scale side, on the commercial side, and certainly you are seeing a number of different models are coming out on the residential side.

From our side, we think the Yingli is well-positioned in the US market, and lots of our incremental growth will come from this market. Again, there is a tremendous amount of difficulty financing projects in the first half of 2009. However, we've seen things improve, and certainly we feel that we have relationships with customers that will certainly give us a substantial part of their business going forward.

Sanjay Shrestha - Lazard Capital Markets

Got it. One point I just want to clarify. So, when I'm doing, sort of the quick math here, at $70 price of poly, even at 85 or 87 processing cost, take a midpoint of that $1.70 ASP next year, you're still talking about somewhere around 24% to 25% gross margin for the year, with the potential for either an ASP cut or the margin expansion of poly were to go to 50. Is that the right way to think about it?

Bryan Li

Yeah, you can form your estimation based on your assumptions. As we commented earlier, we are actually looking at a higher gross margin in 2010 compared from 2009 level. And that will give us more power to decide if we are going to aggressively expand the market share.

Sanjay Shrestha - Lazard Capital Markets

Exactly; that's exactly what I was trying to get at.

Operator

Your next question comes from the line of Lu Yeung from Banc of America/Merrill Lynch. Please proceed. Mr. Young, your line is open.

Lu Yeung - Banc of America/Merrill Lynch

Just wanted to get some update on project and what kind of conversion business are you guys looking at the end of the year and next year? What kind of technologies it is based on, whether by contact or selectively made or -- and can you provide some more color on this?

[Foreign Language]

Miao Liansheng

We have already actually achieved the Phase I kind of milestone, and it's been running very smoothly, but for the detail list of efficiency, I would disclose, in fourth quarter of this year once we achieved our second milestone which we are ready to do announcement. And the [assumption] to PANDA products it will both host proper increase of efficiency as well as to gross margin.

Bryan Li

(inaudible) The Project PANDA is a technology to optimize the existing sales structure for the purpose to reduce the loss in the conversion process, so as to raise sale conversion efficiency rate at a [sale] level in the module level. And given the confidentiality, we can't talk about to much on that, but we will give a regular update in the next quarter's earning conference call. Thank you.

Stuart Brannigan

Bryan, I think it's also important to say that the plan is that the Project PANDA sales will run on most of our existing equipments, so they won't have to be any major fit outs.

Lu Yeung - Banc of America/Merrill Lynch

One more follow up to the margin question that the margin could have been 40% if there are write downs. Just want to know if the higher price policy will be concerned in the third quarter and what kind of silicon cost reduction you are projecting in the fourth quarter?

Bryan Li

Actually the significant portion of the high cost policy again has been consumed in the first half of the year, and the impact in the second half of the year is getting less and less insignificant, and also the majority part of the remaining effect of the high cost polysilicon will be consumed in the third quarter of this year. So I will be expecting much lesser impact of the high cost polysilicon in the fourth quarter of this year in our words.

Operator

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

Rob Stone - Cowen & Company

Hi. I wonder if you could just provide your average selling price --.

Operator

Please stand-by. Your line is open.

Rob Stone - Cowen & Company

My question was about the ASP for Q2.

Bryan Li

The ASP in Q2 was down low teen from the first quarter level.

Rob Stone - Cowen & Company

Okay. Can you comment on how many megawatts you expect to ship in China this year?

Bryan Li

In this year we don't expect a significant volume of the shipments in China this year. But in next year, it could be risen to a considerable portion.

Rob Stone - Cowen & Company

Can you say what do you mean by that much volume? Are you talking about less than 50, less than 25?

Bryan Li

You mean next year?

Rob Stone - Cowen & Company

No. Of the 450 to 500 megawatts, I am just trying to get some sense of how much of that is based on projects in China in the second half?

Bryan Li

In second half we currently expect roughly around less than 5%.

Miao Qing

But that does not include the news which is just announced by Mr. Miao, its (inaudible) project and that represent of the total - I mean of the total project volume will be [safely] expected in this year.

Rob Stone - Cowen & Company

A question regarding your capacity plans and capital spending; I know you said you don't have full details on the joint venture in Hainan Province. But other than the expansion there, do you expect to add additional capacity in 2010, and can you say roughly what your capital spending budget might be for next year?

Bryan Li

For next year and currently as of now, we only plan the investment in Hainan Province, but we will consider the possibility of any further expansion projects depending on the market status. And for the Hainan projects and that was actually as I mentioned earlier, it's a provincial government sponsored project. So we don't expect to put in a large amount of the capital to support this project and the most of the proceeds will be provided by the bank, arranged by the provincial government.

So, that was the idea for the investment in Haikou Province. The real purpose for the Hainan investment is really to take the market shares in Hainan province, which in terms of the essential irradiation is the best in China.

Rob Stone - Cowen & Company

Okay. Can you put any kind of a range on capital spending for next year? I imagine we'll have something for the poly plant, right?

Bryan Li

Yeah, for the poly plant, as we commented in the past quarter's earning conference call, we are negotiating with one of the largest domestic bank to support the poly plant, and the negotiation goes well, but the process, it's a little bit slower than we originally expected.

So for the purpose of slowdown the construction work of polysilicon, we are also planning to temporarily use our money to fund this plant for us to make sure the poly plant will be up and running as we originally scheduled, to provide -- to support our long term cost leadership in these challenging markets.

Operator

Your final question comes from the line of Sunil Gupta from Morgan Stanley. Please proceed.

Sunil Gupta - Morgan Stanley

Bryan, I had couple of questions on your inventory; what is your inventory policy going forward in terms of your raw material?

Bryan Li

You mean the inventory accounting policy?

Sunil Gupta - Morgan Stanley

No, not accounting policy; how much of inventory do you want to keep going forward.

Bryan Li

For our inventory turnover day now is about 100 to 120 days, and for the polysilicon our policy is to have less than two months, and polysilicon free stock in the inventory to prepare for the production. In this quarter, in the inventory balance as of June 30, '09, we have approximately 50% of the inventory of the polysilicon and other raw materials, and 25% is for the work-in-progress and the other 25% for the finished goods.

Sunil Gupta - Morgan Stanley

In terms of your silicon cost for the polysilicon inventory, at the end of Q2 what was cost in terms of dollars per kg?

Bryan Li

The average cost of polysilicon has been, as I talked about earlier, the [blended area] of polysilicon has been reduced by a low 20 from first quarter level.

Sunil Gupta - Morgan Stanley

So what is the carrying cost as of end of Q2?

Bryan Li

At the beginning of the year and there are plenty reasons about it's close to 200 level. That has been down low 20 in the second quarter, and it will further get down mid-to-high 30 in the third quarter, and another mid-to-high teen in the fourth quarter.

Sunil Gupta - Morgan Stanley

In terms of your silicon usage, I don't know if I have missed this number, you said that you have reduced the silicon usage, so what did you actually consume in Q2 and what do you expect to do in Q3 and Q4?

Bryan Li

In Q2, the polysilicon usage per watt is close to 6.2 level, and in the rest of the year, towards the end of the year our target is to further reduce to six level, six grand towards the end of the year.

Sunil Gupta - Morgan Stanley

Okay. And in terms of your non-silicon manufacturing costs, what was the cost in Q2 including depreciation?

Bryan Li

Including everything, the all-in costs for non-poly processing cost in Q2 is about $0.90, 90, including depreciation, amortization and the insurance recharge warranty everything.

Sunil Gupta - Morgan Stanley

And what should we be expecting by the end of this year?

Bryan Li

End of this year, we are targeting $0.85 towards the end of the year. And then next year it could be a meaningful reduction and once we commercialize Project PANDA.

Sunil Gupta - Morgan Stanley

Okay, understood. And my last question is in terms of your debt, the non-cash charge that you have taken. Can you help me understand why do you have that charge, and does it mean that there was some kind of a non-cash gain earlier that you had in previous quarters, which you had to basically cancel out now, because I presumed this debt has been extinguished now right?

Bryan Li

Yes. Those (inaudible) recurring and cash charge was incurred as a result of the difference between the carrying value and the principal of that (inaudible) when we earlier repeated that. In the previous quarter, we never recorded a gain.

The reason is because initially when we complete the ADM deals and according to the accounting requirement we will have to bifurcate the value of the derivatives embedded in that [holes] and then the remaining of that debt becomes the current value of that debt.

And then when we repay the principal of that debt, we need to immediately write-off all the discrepancy between the current value and principal of the debt to the P&L. So that was really the accounting requirement, it's a non-cash, non-recurring items. It's not a kind of the load over of the previous gain.

Sunil Gupta - Morgan Stanley

Is it got something to do with accruals that the accruals were not adequate to cover the cash that you had to pay on extinguishing of this loan?

Bryan Li

No it's not accrual. Before we repay in full the ADM loans, we have a derivative liability recorded on the balance sheet and also the remaining value becomes the carrying value of that debt reported in the balance sheet as well.

And while we repay the debt in [full], and we actually repay that debt in 50 million in cash and then the discrepancy between the 50 million and the carrying value of the debt based on the market value at that day as well will become a non-cash, non-recurring loss under that extinguishments. So that's purely a accounting requirement.

Sunil Gupta - Morgan Stanley

And on the derivative which was associated with this debt, did you have a gain on that. I am trying to figure out if you did not have a contravening, non-cash gain then where's this loss coming from?

Bryan Li

Let me give you a simple example. For example, when we complete a deal and we [power] $50 million for ADM Capital. And then immediately after we complete a deal and wanted to do a valuation to bifurcate the embedded derivates in the ADM loans, because attached to the ADM, there's also a warrant.

So basically these embedded derivatives need to be fair valued from time to time, until we repay the principal in full where the liability accounting has been extinguished. So that's why you would see a derivative loss when we repay the debt in full.

Sunil Gupta - Morgan Stanley

Maybe I can take this offline, since we're running out of time.

Operator

And that concludes our call today. Now, I'd like to transfer the call back to Ms. Miao Qing for closing remarks.

Miao Qing

All right, thanks for joining with us for today's call. Due to very limited time, maybe we cannot take all of your questions. If you have any follow-up questions, please just contact or reach Bryan, our CFO or myself. Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Yingli Green Energy Holding Company Q2 2009 Earnings Call Transcript
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