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Executives

Peter Schmidt - Financial Dynamics

Allen Wang - Chief Executive Officer

Randy Lau - Director, Investor Relations

Richard Gu - Vice President, Sales and Marketing

Analysts

Lu Yeung - Bank of America/Merrill Lynch

Rob Stone - Cowen & Company

Dylan Yu - Pacific Epoch

Paul Clegg - Jefferies

China Sunergy Co., Ltd. (CSUN) Q3 2009 Earnings Call November 18, 2009 7:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 China Sunergy earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Peter Schmidt with Financial Dynamics. Please proceed, sir.

Peter Schmidt

Thank you. Good morning and good evening, everyone and thank you for joining us today. Before we continue, please note that the discussion today will include forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risk and uncertainties and as such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC.

China Sunergy does not undertake any obligation to update any forward-looking statements expect as required under applicable law.

As a remainder, this conference is being recorded.

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

Allen Wang

Thank you, Pete and welcome, everyone to our 2009 third quarter conference call. Joining me today is our CTO, Dr. Zhao; VP of Sales and Marketing, Mr. Richard Gu; and the Director of Investor Relations, [Randy Bell]. Unfortunately, our CFO, Mr. Guo, has an [expected] business commitment so will not be able to join us today.

I am pleased to open the call by noting that during the third quarter of 2009, China Sunergy shipped 54.4 megawatts of solar product, at the upper end of our guidance range, [and why] we are reporting a gross margin of 10.2%. The 31.1% sequential shipment growth resulted in revenue of $80.1 million and with gross margin slightly improved to 10.2%. This result has shown the steady progress we are making to strengthening both our top line and bottom line operational and financial results. This growth was driven by our successes over the past months to generate strong demand from both new customers and existing relationships, as a result of an improved market environment along wtih our constant dedication towards greater market penetration, we continue to demonstrate the advantages of our solar products in satisfying client requirements and help them develop the products their customers demand.

We are continuing to supply our industry leading solar cells to module makers and other downstream clients. As well, we continue to supply customers with modules produced using our solar cell under OEM arrangement. We entered into a series of sales contracts with NU Energy, a leading Australian photovoltaic firm, for a total of 10 megawatts of OEM monocrystalline solar modules with full delivery scheduled to be completed by early 2010.

In addition, we have entered into a framework agreemeent with Opsun Technologies, a Canadian photovoltaic firm to deliver up to 100 megawatts of China Sunergy's existing of solar cells and modules for a period of six years.

To ensure we are able to maintain this demand, China Sunergy is consistently improving teh scope and technological leadership of our products. This allows us to better meet our client needs, generate strong brand reputation, and in some cases produce a price premium for our products, despite continued price erosion across the sector in general.

As evidence of this progress, during the quarter we sent several solar cells to the Fraunhofer Institute for Solar Energy Systems in Germany for third party verification. We are pleased that the Fraunhofer test results showed our monocrystalline M-type cells with a conversion efficiency of 19.13%. In addition, utilizing the new technology, we have developed a monocrystalline high efficiency P-type solar cell with target conversion efficiency of 19%. In the third quarter, the tests conducted by the Fraunhofer Institute for Solar Energy Systems in Germany has shown a conversion efficiency of 19.04%. The test results highlight the progress we have made in our leadership in the solar cell technology.

We are also glad to see that the output fo our facility has been consistently improving during the year, with a higher throughput, higher yields, and a high efficiency in this quarter than earlier in 2009, resulting in an accrued conversion cost in the third quarter. We expect that this trend will continue to the fourth quarter and the next year.

Although we have largely been able to benefit from a rapid changing solar enviornment, we have also had to face some challenging aspects. As we have discussed through early press releases, a long-term supply contract is signed with REC Wafer AS in 2009 was announced to be terminated by REC Wafer AS in the third quarter. China Sunergy initiated legal proceedings against REC Wafer AS in regard to the related contract and the related guarantees, and have recieved an injunction from a local Norwegian court against REC Wafer AS. Additionally, REC has been given until November 18th, today, to respond to a legal writ we filed regarding the viability of their claim position as party to a contract signed with REC SiTech. As the legal proceedings develop, we continue to believe that our case is valid and we will provide updates when appropriate.

Now, turning to our company itself, after conducting an extensive process of interviews, several thousand highly qualified candidates, we are pleased to welcome Mr. Siegfried Hsu as our new Chief Financial Officer. Siegfried has extensive financing, investment, and technological experience and brings a high level of direct relevant knowledge to China Sunergy through his previous management of key financial and strategic projects. As a member to the executive management team, Siegfried will leverage his vast experience to lead our finance division to continue to maintain high quality financial management and communications. Siegfried will work wtih our investor relations department to maintain an active and transparent dialog with our investors to serve the interests of all of our valued shareholders.

Although we recognize the challenges that remain on the horizon, given that we have faced and overcome in the past year, we are happy with our recent accomplishments, as we have made important progress and put in place effective managers that will contribute to our operational and financial performance going forrward.

I would now like to turn the call to Randy, our IR Director, who will walk through the financial results. After Randy, I will discuss what we anticipate for the next few quarters. Randy.

Randy Lau

Thank you, Allen, for the introduction and hello to everyone on the call. As our CFO is unavailable today, I will be discussing our financial results with you on his behalf. The results that I will be discussing are designated in U.S. dollars and have been prepared under U.S. GAAP except where noted.

During the third quarter of 2009, our revenues increased 14.3% sequentially to $80.1 million. Revenue generated from solar cells cells were $68.5 million, representing a 25.7% increase compared to the second quarter of 2009.

Gross profit for the quarter was $8.2 million, compared to gross profit of $6.8 million in the second quarter of 2009. This led to a gross margin of 10.2% compared to 9.7% during the same quarter of 2009.

Blended ASP for the third quarter declined to $1.32 per watt from $1.44 per watt in the previous quarter, due to a continual decline in sales prices. In the third quarter of 2009, blended wafer costs declined to $0.87 per watt compared to $0.96 per watt in the second quarter of 2009 as we continued to purchase raw materials on the spot market. Although the spot market continued to provide [the jump price] in benefits, we have noticed a recent stagnation in wafer costs just by the continuing erosion of ASPs. However, we believe that the wafer costs will continue the trend with ASPs over the long term.

Other production costs, which mainly consisted of other raw materials, labor, [inaudible], and utilities, were $0.29 per watt compared to $0.31 per watt in the second quarter of 2009. Wafer costs per watt as a percentage of total production costs per watt declined from 75.2% in the second quarter of 2009 to 74.7% in the third quarter of 2009, largely due to our improved utilization rate during the third quarter.

SG&A expenses in the third quarter of 2009 were $7.1 million, compared to $4.9 million in the third quarter of 2008 and $3.6 million in the second quarter of 2009. G&A expenses is higher in Q3 than Q2, primarily because the G&A expenses in the third quarter included $1.4 million of better data provision for accounts receivables, while we reversed $0.4 million of provision in the second quarter and we also booked legal fees of $0.8 million related to the REC legal proceedings.

Net profit was $7.8 million, compared to a net profit of $1.7 million for the second quarter of 2009.

Regarding our balance sheet, as of September 30, 2009, we had cash and cash equivalents of $113.4 million and a net operating cash outflow for the third quarter of $16.5 million, compared to the positive cash flow of $19.5 million in the second quarter of 2009, as the company made a full cash payment for the $14.6 million bank promissory note which was issued in January of 2009 and matured in this quarter, and [increased] to $32 million at the end of the third quarter from $25 million at the end of the second quarter.

In the third quarter of 2009, depreciation and amortization was $2.9 million and capital expenditures were $1.4 million, which inlcuded the remaining payments for equipments relating to the company's selective emitter cell lines.

You may notice that our short-term bank borrowing at the end of Q3 increased to $125 million from $76 million at the end of the second quarter. On September 30, we obtained a RMB200 million short-term bank loan from the Export and Import Bank of China. After receiving this loan, we paid off some short term bank loans from other banks ahead of schedule, as the we have a preferable interest rate from the Export and Import Bank of China.

During the quarter, China Sunergy also continued to conduct the foreign exchange hedging program to manage the foreign exchange exposure. For the remainder of 2009, we will remain competitive to cost control efforts and to keep our balance sheet healthy while providing sufficient financial support to our operations, given our expectation of strong growth over the coming quarters.

Thank you and I will now turn the call back to Allen.

Allen Wang

Thank you. With strengthening market demand and based on our sales efforts, as we look into the fourth quarter, we expect a strong shipment of 70 to 80 megawatts for the quarter, which will bring our total shipment to between 190 megawatts to 200 megawatts for the full year of 2009, nicely above the previous estimae, which we provided last quarter. And we anticipate the gross margin will be in the low teens for the quarter.

While we expect to end a challenging 2009 on a positive note, we continue to see a strong demand in 2010 for our products. We are increasing our sales force deployment in key regions. We have an industry leading product roadmap in the pipeline. We filled our very strong [alliance] and supply chain with many reputable companies. We have put in place a clear action plan to continue improving our operational efficiency and to lower our manufacturing cost.

While the specific numbers have yet to be worked out, with the solid foundation we have in place we expect to see a strong growth in 2010.

This concludes our prepared remarks and we would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Lu Yeung with Bank of America.

Lu Yeung - Bank of America/Merrill Lynch

Can you share with us what you see in Q1 demand and what are you seeing in 2010 for the year as a whole?

Allen Wang

Based on our diversified customer base, we are continuously getting orders from those existing customers and also some new customer developments, so we are seeing that Q1 in January might be low but in February and March can be picking up.

Lu Yeung - Bank of America/Merrill Lynch

What sort of margin do you expect going forward in 2010? Would it be sustainable from Q4 levels or further improved in Q4?

Allen Wang

I think right now we don't have the specific numbers yet but we still anticipate some improvement.

Lu Yeung - Bank of America/Merrill Lynch

I see. What sort of conversion cost do you expect in Q4 this year?

Allen Wang

I think we will probably improve by 8% to 10%.

Lu Yeung - Bank of America/Merrill Lynch

Which is in terms of dollars per watt, possibly how much?

Allen Wang

In terms of dollars per watt.

Lu Yeung - Bank of America/Merrill Lynch

Do you have a number that you can tell us?

Allen Wang

I think we -- the Q3 is the $0.29. In Q4, we are probably in the range of $0.26.

Lu Yeung - Bank of America/Merrill Lynch

Okay, and you highlight some of the high conversion efficiency cell that you have made -- what kind of contribution of the sales mix that you have will be coming from the high efficiency P-type cells?

Allen Wang

We don't have those numbers yet because those have just recently made out in the lab. We sent a small batch to Fraunhofer and the test result was very positive. Once we price out, we will let you know.

Lu Yeung - Bank of America/Merrill Lynch

Is it necessarily higher conversion costs with the P-type, high efficiency?

Allen Wang

It's possible, because there are more steps involved.

Lu Yeung - Bank of America/Merrill Lynch

I see. Last question I have is what is your CapEx plan for Q4 next year?

Allen Wang

Q4 next year -- we have not --

Lu Yeung - Bank of America/Merrill Lynch

Q4 and 2010.

Allen Wang

Just give me a second -- 2010, we are still working out 2010 CapEx plan. We don't have a solid plan yet. We probably will communicate that to you guys later.

Randy Lau

I will just give you some clarification -- in terms of CapEx in Q3, maybe you can notice from our release that we have $1.4 million CapEx payment in Q3, not just because of the remaining equipment related to our negative emitter lines. For Q4 of this year, CapEx, we don't think we have a big number there.

Lu Yeung - Bank of America/Merrill Lynch

I see. Last question for me is what is your plan for module integration?

Allen Wang

Right now, we have orders from our customers requesting us to provide modules. But basically those are the modules made under the OEM [inaudible] arrangement. This is one area we continue to explore into and it is still being discussed. There is no final decision that has been made yet but our intention is to meet our customer demand where it is viable.

Lu Yeung - Bank of America/Merrill Lynch

I see. Thanks a lot, congratulations.

Operator

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

Rob Stone - Cowen & Company

I wonder if you could comment, of the expected shipments in Q4, what the mix might be between cells, cells for OEM agreements, and modules?

Richard Gu

As Allen just mentioned, our Q4 guidance is from 70 megawatts to 80 megawatts, and our primary sales is still the solar cell shipments to our diversified customers. Our OEM modules only maybe accounts for about 5% to 6%, which is mainly new energy in Australia.

Rob Stone - Cowen & Company

Five to six percent of megawatt shipments?

Richard Gu

That's right.

Rob Stone - Cowen & Company

Okay, and I noticed that you had no sales for tolling this quarter -- do you expect to have tolling business come back or are you de-emphasizing that in favor of producing sales of your own material?

Allen Wang

Well, that's primarily from the demand of our customers -- if they continuously would order the module from us, we will do so.

Rob Stone - Cowen & Company

Okay. Can you comment on your ASP and wafer cost expectations for Q4?

Allen Wang

In Q4, because still the ASP pressures from the market, so we may expect about a 4% to 5% decrease compared with last quarter.

Rob Stone - Cowen & Company

And with respect to wafer costs?

Allen Wang

I think our wafer costs, we anticipate probably will have a 5% to 7% drop.

Rob Stone - Cowen & Company

Okay, so between that and the further improvement in conversion costs, that is what drives the gross margin expansion?

Allen Wang

Yes.

Rob Stone - Cowen & Company

Okay. You had some one-time items in operating expenses in Q3 -- shoudl we expect operating expenses to come back down in the fourth quarter or do you have a view?

Allen Wang

I think our normal cost is around $7.5 million to $8 million, including SG&A financing cost. We expect to come back, maybe the only one I would say is not clear at the moment is the legal fee.

Rob Stone - Cowen & Company

So when you say 7.5 to 8.5 including financing, you are referring to interest expense as well?

Allen Wang

Yes.

Rob Stone - Cowen & Company

Okay, and there will be some legal fees in Q4?

Allen Wang

There may be some.

Rob Stone - Cowen & Company

Okay. I noticed that the tax rate looks fairly high in Q3 -- was that influenced by some of these unusual items? How should we think about the tax rate going forward?

Allen Wang

The tax rate I think right now, our tax rate for this year is still like 12.5%. For this year, for 2009, for the full-year estimate, I think our overall tax rate should be about 12.5%. Does this answer your question?

Rob Stone - Cowen & Company

Well, in the Q3, it looks like the tax rate was more like 18%.

Allen Wang

Maybe I can give you some further clarification on the tax rate -- for this quarter, maybe according to our calculation, it may be higher, like as you said, maybe 18.8% or something. This is because every quarter when we do accounting, tax accounting, we needed to do some adjustment according to the full year estimate. That is why this quarter is a little bit higher but overall this year, we think that it should be around 12.5% for a full-year estimate.

Rob Stone - Cowen & Company

Great. My last question is this fairly sizable item relating to the change in the value of the derivative, do you have any sense of how that may trend -- what drove that and how might it trend in the fourth quarter?

Randy Lau

So you are asking the derivative -- this quarter we reversed it back $9.7 million, you mean this item?

Rob Stone - Cowen & Company

Yes, correct.

Randy Lau

Yeah, I think for the quarter, you won't see this number anymore because basically this, as you can look from our release, this [is] because of the termination of [pricing contract]. That contract was -- we signed it last year and it was a seven-year contract. And with the termination of this contract, so for this quarter, for the past quarter in Q3, the accounting [inaudible] has been booked, so [inaudible] piece of derivative accounting, which is the Euro hedging, okay, and in Q4 we will still expect to see some number but it won't be very big.

Rob Stone - Cowen & Company

So the big item was really the REC contract which will no longer show up starting this quarter?

Randy Lau

That's right.

Rob Stone - Cowen & Company

Thank you.

Operator

Your next question comes from the line of Dylan Yu with Pacific Epoch.

Dylan Yu - Pacific Epoch

Thank you for taking my question. Actually, I don't think your capacity supports 70 to 80 megawatts for one quarter. Do you expect any sub-contract or any purchase of solar cells from other cell makers in Q4, and does that hurt your margins?

Allen Wang

I think in general, 70 to 80 megawatts is already at the top of our production output but we will continue to improve the efficienty, the throughput -- looking to 2010, we may also be working with other allies to expand our capacity.

Dylan Yu - Pacific Epoch

Okay, so you don't expect to purchase solar cells in Q4?

Allen Wang

If there's any, it will probably be a minor number.

Dylan Yu - Pacific Epoch

Okay, thank you.

Operator

(Operator Instructios) Your next question comes from the line of Paul Clegg with Jefferies.

Paul Clegg - Jefferies

I was hoping you could discuss your pricing outlook for the first quarter versus the fourth quarter, if you have any visibility there. Some of your module peers are talking about being able to hold pricing in the first quarter versus the fourth quarter.

Richard Gu

We see maybe some price pressure but more or less it will be flat for some customer deliveries but also come customers might ask some -- a lower price in order to get certain volumes.

Paul Clegg - Jefferies

Okay, so would it be fair to say then you wil be net down but not by what you would have experienced in previous years?

Richard Gu

Yes.

Paul Clegg - Jefferies

Okay, and just a clarification question on Rob's question about operating expenses -- you mentioned $7.5 million to $8.5 million, including financing and I was wondering whether or not that includes any legal and then whether or not it includes interest income and other income kind of offsetting, as an offset.

Randy Lau

The operating expenses we just said -- I think it -- it does [include] as a financial cost, okay? Every quarter, it is around $1.8 million or $1.9 million. This quarter, it is like $1.8 million. And but for the SG&A expenses, it does include the legal fees.

Paul Clegg - Jefferies

Okay, so that is inclusive of some legal fees for next quarter as well, assuming that you will do some -- in other words, for 4Q, when you talked about $7.5 million to $8.5 million, that includes also some legal fees?

Randy Lau

A minor number but it will be included -- but it should be a minor number, I'd guess.

Paul Clegg - Jefferies

A minor number -- okay, thank you. And then, if I could, I think I know the answer but the termination of the REC contract and the unwinding of the derivative on that, was there any cash expense associated with that derivative accounting or was that the one-time derivative item or was that all non-cash?

Randy Lau

No, it's all a non-cash item.

Paul Clegg - Jefferies

Okay, and then one final -- how long before you could actually see 19% cells in commercial production? And then maybe you could talk about what that does to your ASP versus your current cell portfolio -- what sort of premium could you see getting versus cells? Obviously that is going to change over time but if you were to have 19% cells in the market today, what would you get as a premium versus your existing cells?

Randy Lau

I think based on our experience, every 1% increase we probably can anticipate a 5% increase in the premium, so if we think about 19% versus today, the majority is probably about 17.5%, we would probably see 7% to 8% premium.

Paul Clegg - Jefferies

Okay. Thanks very much.

Operator

At this time, we have no more questions in the queue. I would like to turn the call back over to the management for closing remarks.

Allen Wang

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

Operator

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

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