Solarfun Power Holdings Co. Ltd. Q3 2009 Earnings Call Transcript

Solarfun Power Holdings Co. Ltd. (SOLF)

Q3 2009 Earnings Call

November 18, 2009 8:00 am ET

Executives

Paul Combs - VP, Strategic Planning

Peter Xie - President

John Breckenridge - Managing Director and Operating Partner

Terry McCarthy - Interim CFO

Analysts

Burt Chao - Simmons & Company

Paul Clegg - Jefferies

Rob Stone - Cowen & Company

John Hardy - Broadpoint AmTech

Josh Baribeau - Canaccord Adams

Jake Greenblatt - Barclays Capital

Emily Lu - Areth Research

Dan Ries - Collins Stewart

Sam Dubinsky - Oppenheimer

Dillon Low - Pacific Etak

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2009 Solarfun Power Holdings [Corporated] Limited Earnings Call. My name is Stephanie and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]

I would now like to turn the conference over to your host for today, Mr. Paul Combs, VP of Strategic Planning. You may proceed, sir.

Paul Combs

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

Before we continue with our 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, November 18, 2009. Solarfun assumes no obligation to update these projections in the future, as business and market conditions change.

As you read from our results, our business momentum is quite robust. Our profitability as measured by gross margins remains solid and our outlook for the remainder of this year and next is quite optimistic. In many respects, 2009 has proven to be a year of transition for our industry as well as for our company. John will start up with a few observations about our management team; Peter will make introductory remarks about some accomplishments for Solarfun so far this year; followed by Terry with a quick review of our financial results.

Peter will then conclude with a progress report on our global realignment initiative, plans for the China market and what we now refer to as our future focus program, which will include some discussion of our planned reductions and non-poly processing cost. We'll conclude with our outlook for the 2009 fourth quarter, as well as a glimpse into our early thoughts for 2010. John?

John Breckenridge

On behalf of Good Energies and the Board, we are very excited about the progress that we made at Solarfun in the recent past. We’re happy that investors are going to start to see that as a continued improvement in our operating result.

Besides if you look in the rear-view mirror, Solarfun had a number of challenges and we focused early in 2009 in tackling those challenges. We’re now leaving those behind us and really planning for the future, and again you’ll see that in the results.

One of the most important things; our approach for this year was to upgrade and build out the management team. The most important part of that was the hiring of Peter Xie, who you will hear from later as our President, and one of the important things that the Board has done since we last spoke is that we have promoted Peter from President of China to President of Solarfun Holding Company. So he is the President of the company.

We’ve also added a very capable manager to our sales organization in the United States, as well as the chief technical person, and we have upcoming announcements regarding our CFO and some other key sales people in the next several weeks.

We continue to see an improvement in the management team, we think that’s related to improving results, but we still have a lot to do, and I think that what you can count on from Solarfun is the conservative and realistic forecasting and reporting which we’d like to have a reputation with among investors and then continuous improvement as our management team continues to get traction.

We have a competitive cost structure. We have a continuing strong marketing organization, Good Energies is very happy to be helping where we can, more and more just as an independent company.

With that I would like to hand it over Peter Xie, and we look forward to your questions later. Peter?

Peter Xie

2009 had been a year of change. We experienced steep decline at the beginning of this year, and a swift recovery that started in Q2 and is expected to continue through the remainder of 2009. First I would like to give a summary of Solarfun has accomplished during this period of industry change.

For year 2009 module shipments are estimated to exceed 300 megawatt, which is about 80% above 2008 volumes. This was particularly notable when you consider that 25% of our 2008 volume were to Spain, a market that’s just a fraction of what it was a year ago. Our raw material supply base has been renegotiated to match current market pricing and to provide us the flexibility to mix and match internal, external sourcing.

Gross margins exceed 20% for the past two quarters, which are the highest levels in the company’s history. We started the shipments to Q-Cells; we won several contracts in our whole market of China; and have build an organization to capture additional shares in this expanding market.

During an industry downturn and the period of scarce capital, we were able to manage our balance sheet so that we will be entering this next cycle stronger than before, and to maintain discipline in working capital management, maintain this present and existing and a new banking relationship primarily in China, added some equity financing with little to no receivable issues, and we have adequate cash on hand to fund the near term growth goals.

I would now let Terry give a quick overview of our financial results, then I will come back later to give an overview of our strategy and the direction. Terry?

Terry McCarthy

As you see from our release, we exceeded our volume and revenue forecast as previously guided, and recorded a better gross margin because of some of the things that we will be discussing as I go along. This provided earnings above our consensus expectations.

Revenue for the third quarter reached $145 million. This was a 15% quarter-over-quarter gain from Q2 of 2009. This is particularly notable when you consider ASPs dropped to $2.03 versus $2.66, just a quarter ago. Shipments of 102.6 megawatt grew nicely as compared to both the same quarter last year at 41.8 megawatt, and to the preceding quarter at 64.3 megawatt.

For the third quarter just concluded, about 40% of shipments were [tolling] related. We had better geographic diversity in the third quarter, as shipments to Germany totaled 60%; to the Czech Republic continued to grow accounting for 9% of shipments; and we saw a resumption in demand in both, Portugal and Spain, with 11% and 6% of total shipments respectively. Australia, Italy and South Korea combined for another 14% of total shipments.

On a US GAAP basis, gross profit was $29.9 million and gross margins reached 20.7%. Higher gross margins were a function of a stronger euro as well as the continued reduction in raw material and processing cost, somewhat offset by a $10 million mark-to-market reserve for inventory.

Operating profit reached $19 million or 13.1% of revenues. This compares to operating losses in both the third quarter a year ago and the 2009 second quarter. Quarter-to-quarter, the company experienced higher selling expenses, due to a higher commission rate related revenues and organizational growth and increases in R&D spending. This is offset somewhat through tight control of G&A expenses.

Other income statement items of note were a $7 million rise in interest expense and a $3 million net exchange loss which was composed of an actual loss of $1 million and an unrealized mark-to-market loss of $4 million.

As we previously have discussed, the quarter-to-quarter fluctuations in convertible bond valuations under the new rules can be quite volatile, and something we have no control over. For the quarter just ended, the fair value of the conversion feature of the company's convertible bonds increased approximately $12 million.

On a US GAAP basis, net income was $20 million; a notable improvement over both the third quarter a year ago and the second quarter of 2009; both periods which recorded net losses. Net income for basic ADS for the third quarter just completed was $0.37.

Turning to some balance sheet highlights; accounts receivable rose about $28.3 million quarter-over-quarter to $104 million. This is a result of higher shipment volumes, particularly late in the quarter. We’re quite diligent on both the quality and aging of our receivables and maintain a good discipline as to credit offered. DSOs for the quarter were 56 days versus 38 days in the last quarter.

We did experience a small increase in inventories to $118 million. This is evidence of the continuing market demand going into Q4. Our liquidity is excellent, with cash building to a $116 million and [positive] on working capital of $255 million. We repositioned about $55 million in debt from short-term to long-term, with total short-term borrowings now below $150 million. We intend to pay down additional debt in Q4.

Since signing the equity distribution agreement with Morgan Stanley in September, we have raised to-date, a total of $23.1 million in net proceeds, from the sale of $3,888,399 ADSs.

Capital expenditures totaled $4.2 million for the third quarter and $40 million year-to-date. We plan to take total module capacity to 700 megawatt next year. Total capital spending for 2010 remains fluid, as we continue to reevaluate the positives and negatives of build versus buy, particularly for sales.

In any case, we believe our cash on hand and available credit lines are more than adequate to meet our capital needs for next year.

I’ll now hand the call over to Peter, who will give you an update on our progress in China, review our plans to reduce processing costs, and give you some specific guidance on our expectations going forward. Peter?

Peter Xie

Starting in Q2, 2009 we launched our global realignment effort and focused on the following prime areas; customers, liquidity, long-term supply contracts, inventory control and the product process innovation. On this call, I would like report that most of these efforts have been largely completed, and now we are starting to concentrate on what we call future focus initiative in the beginning of 2010. Now, let me review our global realignment initiative.

First, customer base expansion; we are continuing our strong, strategic relationship with our leading customers. We are also expanding our customer base quarter-by-quarter. The number of customers that were served in each quarter has nearly doubled.

From the beginning of this year, we now have over 40 customers as we enter Q4. Our OEM module processing business is growing, but it makes up a smaller percentage of total revenue base.

Second; geographic diversification, dependence on Germany has been reduced to around 60%, as we expand into other markets. Spain, China, Italy, Czech Republic, Portugal, Australia and the South Korea are becoming meaningful markets for us, clear emerging markets.

In the US, we added Bruce Ludemann to our team. He is a Senior Executive who has a great amount of experience in the renewable energy space. He will head our US operations and help position the company for future growth, especially in 2010.

In China, we are positioning the company to participate in the three growth sectors. First one is utility company led by five state-owned enterprise. We plan to enter, [join] a development program with them to co-develop the market. Second one is the municipal government led by six provinces in the western part of China, including Mongolia, Xinjiang, Tibet, Gansu, Ningxia, Qinghai. We have entered a project development agreement with Hohhot City in Inner Mongolia to develop 600 megawatt PV stations. Phase one of this project is expected to start in first half of 2010.

Commercial sectors; we have already established a footprint downstream in China with assistance, integration and the installation subsidiary in Shanghai. We are pulling that business into our much larger organization to capture business in China.

Recently, we have been contracted to build solar rooftops on the [German] Hall at the Shanghai 2010 World Expo. A European company will work together with us to complete this installation. We also plan to shape more than 10 megawatt into this market in Q4, by taking advantage of the subsidy given by both the central government and the local provincial government.

Adequate funding and the liquidity have been key to our second initiative of global realignment. We have been able to continue improving our balance sheet by adding bank financing, reducing inventory, and managing our collections.

Our receivable period is among the lowest in the industry. Our cash balance is close to $116 million at the end of Q3 and is more than adequate to fund the future growth in 2010. The third element of our global realignment effort has been to sort out our long term supply contract, with the polysilicon and the wafer supplies.

Today, I am pleased to say that we have renegotiated with all our long-term supply contract suppliers, and that we were able to find a common ground with almost all of them. We were able to realign our poly based raw materials at prevailing market prices.

We have had only one exception where we are currently in arbitration, but we do not expect this to pose any material risk for us. Another element of our global realignment effort has been inventory control. It’s a delicate balance between meeting customer demands and the cash flow.

In today's environment there remains enough uncertainty market demand, and this is only amplified by a typical seasonal effect.

At the end of Q3, our inventory was on the high side in anticipation of a strong demand in October and November. Going forward, we expect to see our inventory level come down to a more manageable level towards the end of Q4.

Last key to our global realignment effort has been processed in the product innovation. We have recently launched several new products including low lying deals to degradation modules, high efficiency [square mono] modules, and the Black Diamond modules. Mono and the poly efficiency is approaching over 17% and 16% respectively. We are starting to ship those newly developed modules [involved] in Q4.

Technology development requires experience and talent. Our newly appointed VP of Technology, Mohan received a Ph.D. from the University of New South Wales and studied under famous Professor Martin Green. Dr. Narayanan accumulated over 17 years of technology development experience at BP Solar. He has brought with him a technology team, and with their addition our development efforts we’ll further accelerate and reach new levels.

We are also currently reorganizing our operations to enhance manufacturing and engineering capabilities. Our recent focus has been on managing our ways through our rapidly changing cost in a pricing environment, then maximizing cash profits. For year-end, we'll have largely completed our global realignment initiative.

We believe this initiative will prepare for transition in 2009 and growth in 2010 and beyond. We have expanded our nameplate module capacity to over 500 megawatt. In 2010, our plan is to further expand our nameplate module capacity to over 700 megawatt to satisfy customer demand, especially from emerging markets.

These accomplishments bode well for further progress in 2010 and beyond. With that in mind, we believe we are now well positioned to concentrate on our future focus initiatives with the following primary goals.

We plan to build scale in the market share, gain a foothold in new developing large scale market, particularly in China and the United States, reducing processing cost is a target of $1 per watt. Drive product and the process innovation, maintain a driven and a stable managing team.

To name a few of these initiatives, we believe with the recent decline in module prices and expected reductions in the future, it is essential to our long-term competitiveness and the profitability to reduce processing cost. Our goal is to reach $1 per watt over the next two years. As a frame of reference, our non-poly cost is now around $0.90 per watt.

There are three main passage to accomplish this; technology advancement, economies of scale, and the manufacturing efficiency improvement. Our technology roadmap targets to improve our mono and poly-conversion efficiency to 18% and the 17% respectively within two years.

We see near-term opportunities for reduction as follows; improving sale manufacturing yield rates and the sale efficiencies, reducing grams per watt in ingot production, increasing pieces per kilogram in our [Warsaw] operations, reducing consumable cost at all stages of operation between ingot making to module processing. Some of the more significant room for improvement includes [cutting] oils, [steel] lines, sensitization paper and the coated glass.

In closing, let me give you some direction to our near-term expectations. For the fourth quarter now underway, we expect shipment to be approximately 110 megawatt, including module processing services. This implies nearly 70% sequential increase in our nano-processing business.

Module processing service shipments will be around 20% of our total shipments. ASP for the fourth quarter to decline approximately 5% in constant currency; gross margin to stabilize in the high teens, with minor variation offering quarter-to-quarter, depending on our seasons mix, specifically our module processing services.

In the fourth quarter of 2010, we continue to see good demand with prices declining slightly from the fourth quarter of 2009.

Finally, we believe 2010 will be a period of robust demand for the industry for a number of reasons. Including accelerated demand in Germany prior to feed-in-tariff reductions, growth in the US and the China, and improving conditions for the funding of solar projects.

We see a potential of 500 megawatt in 2010 shipments, with module processing and services representing about 20%. This implies shipment growth of approximately 70% in 2010 for our base business. I hope from all our comments that you’ll recognize the progress we have made, the momentum we see ahead and the confidence and the enthusiasm that we share in our future.

Now we will open the call to respond to any of your questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Burt Chao with Simmons & Company. You may proceed.

Burt Chao - Simmons & Company

Congratulations on the strong margins. First quick question; Peter, I think you mentioned that margins next year should be settling in high-teens level. Moving from the very robust 21% margin this quarter, is that primarily as a function of decreasing the amount of tolling, because tolling, I assume has been a much higher margin business. Or do you think the core business margin will actually come in significantly as well?

Peter Xie

Yes. That’s a very good question. So we continue to see strong demand. I think the margins are a function of our price and also the cost. We continue to see a strong initiative within the company to drive down the cost, but same time, we also expect the ASP to come down a little bit.

So it depends how far the price is coming down. I think that you will see variations. So right now, our expectancy is that the price will come down, maybe a little bit faster than the cost. That’s why we see that the margin [yield] is less than 20%, that’s still going to be in very healthy high-teens, absolutely.

Burt Chao - Simmons & Company

You mentioned $1 per watt full cost in the next two years. Currently your non-poly cost you said is about $0.90 a watt. So how much of the getting down to $1 per watt with the cost of poly, ingots and wafer, how much of that is going to be reductions in polysilicon costs from what we see today and how much of it will actually be processing cost improvement?

Peter Xie

That's a very good question. I think right now the poly cost that is not a significant part of the whole margin cost. It's actually less than 60%. I will not name the specific percentage numbers. So we're seeing when the poly cost, when it goes down to around $35 to $40 from the current available, the big part of the whole module cost should could from non-silicon cost.

Burt Chao - Simmons & Company

So that dollar per watt, by let’s call it 2011, 2012 that assumes $35 to $40 poly?

Peter Xie

Correct.

Burt Chao - Simmons & Company

One last quick housekeeping question, can you give me a capacity run-down of all your different segments from module cell, kind of ingoting and wafering right now or just wafer?

Peter Xie

The current capacity level?

Burt Chao - Simmons & Company

Yeah, in the different segments.

Peter Xie

Right now our module capacity is about 510 megawatt. Our cells is 360 megawatt, and I think our [wafer] and the poly plants, we've been making kind of matching their levels.

Burt Chao - Simmons & Company

Matches at 360?

Peter Xie

Yeah.

Operator

[Operator Instructions]. Your next question comes from the line of Paul Clegg with Jefferies. Sir you may ask your question.

Paul Clegg - Jefferies

I wanted to just try to reconcile your comments about expanding capacity with the comment about the build versus buy decision. So if I understood you correctly, is it possible you could expand your module footprint further but then buy cells, and if so what would be the impact on CapEx and gross margins for next year.

Peter Xie

I think that’s a very good question. Right now we would have in mind, we’re cautiously looking at the demand and the supply situations. Right now I think there is a lot of demand available, but at the same time we are also to be cautious to make sure that we can meet customer demands. So we probably would not expand our sale capacity to math the 700 megawatt. We will expand, I believe, right now in place about [four lines] about over 100 megawatt solar cell capacity, so that will not give up 700 to a mixture of buy versus make internally.

Paul Clegg - Jefferies

With respect to the potential gross margin impact of that if you end up buying of the cells.

Peter Xie

Our internal cost is lower than buying from outside; but if you look at the current margin from many of the wafer makers or the cell makers, the margins are not very high. So you see the margin erosion actually just for buying from outside is not huge. That situation may change, but right now we see some impact but it’s not huge.

John Breckenridge

Can I add something that I think. The other issue there is that as in Peter’s plan that we’ve talked about is that by having a very smaller capacity as you go further upstream, we keep that capacity fully utilized and by purchasing on a selective basis to fill in instead of having our capacity kind of partially utilize because the demand is not flat over a quarter. We are actually providing over a higher margin, and all these is targeted against the lowest absolute cost in addition to being efficient with capital.

Paul Clegg - Jefferies

What I am trying to get at is, when you guys look at your – when you talked about the mid or mid-high teens or the teens numbers for the gross margins for next year. Does that include the assumption that you buy cells for a significant part of that increase to 500 megawatts in production.

Peter Xie

2010 plan does include that mixture.

Paul Clegg - Jefferies

If I could just have one quick follow up here on the margin – sorry on the outlook for ASPs. Some of your competitors have started to talk about flattish ASPs in the first quarter versus the fourth quarter, given the strong demand particularly from Germany. Are you also seeing that trend?

Peter Xie

Actually we are seeing the market is still very competitive, and we see it does not come down as quickly as before. So right now many of our customers still expect a slight decrease. Actually we do expect to see a slight decrease but not huge.

I think if you see the announcement from other company that’s a different question, but as we see from the market, we often times we see the customers saying, hey look at the price they got. So I think that’s different from what we see from announcement.

Operator

Your next question comes from the line of Rob Stone with Cowen and Company. Sir you may ask your question.

Rob Stone - Cowen & Company

My first question is with respect to your Q1 ASP commentary, perhaps if you could be any more specific on what you mean by slight? In percentage terms, would that be low single digits or 5% or what you are thinking of?

Peter Xie

I am thinking about low single-digits.

Rob Stone - Cowen & Company

Can you comment on when during 2010, you expect to reach the 700 megawatt of module capacity?

Peter Xie

Our plan is to reach that capacity by Q3, Q3 time frame.

Rob Stone - Cowen & Company

A final housekeeping question, what is your current utilization in grams per watt?

Peter Xie

Six grams per watt, around.

Operator

Your next question comes from the line of John Hardy with Broadpoint AmTech. You may proceed.

John Hardy - Broadpoint AmTech

A quick question for Terry on the margin trajectory in to Q4. If I strip up the write down, I am assuming the write-downs will be pretty limited in Q4 if you get to high 20%, 28% gross margins. I was curious what you though that trajectory would be into Q4?

Terry McCarthy

I think we guided high-teens in the Q4.

John Hardy - Broadpoint AmTech

If I could sneak in another quick one; along with the pricing down slightly in Q1, I was wondering what you thought the shipment trajectory associated with that would be, and if you don’t want to give a hard number perhaps then you could just talk about what the conversations have been like with your big distributor or customer in Germany and your trends for 2010?

Paul Combs

Terry I'm going to take that one. John, we did not provide specific guidance in the first quarter. I think the rationale behind that is we had a really strong third quarter; we got a really strong fourth quarter. The indications as you mentioned from our established relationships and existing customers and new growing customers is quite positive.

In terms of firm orders to give you a number that we are extremely confident, and it's just something we chose not to do. I don't think you should interpret that in any way as a measure of our lack of enthusiasm or visibility for the business, but you know we've always tried to be somewhat conservative, and I think in this case that's the position we'll take.

John Hardy - Broadpoint AmTech

That's definitely very much appreciated. One other quick one; did you guys have any plans for utilization rates towards the end of Q4, Q1 as enter sort of a typical slow seasonal period?

Paul Combs

Well I don't think it’s going to be slow. I mean we did not give a specific number for the first quarter, but we're running at 100 megawatts or so per quarter, and we have the potential to do that in the first quarter. So we would be running pretty full utilization in our internal ingot manufacturing that would put us at pretty good utilization on the cell side with current capacity, and probably close our near-to-full utilization on the module.

Operator

Your next question comes from the line of Jed Dorsheimer with Canaccord Adams. You may proceed.

Josh Baribeau - Canaccord Adams

Hi this is actually Josh Baribeau for Jed, just a couple here. Could you talk just a little bit about the inventory write-down, if that was finished goods, raw materials?

Terry McCarthy

We do a general mark-to-market on our inventory each quarter, and so it’s really across the board, and we’ve always been relatively conservative with that to be sure that we’re not overstating our gross margin. So, we will look at may be the low side of expected ASPs and then we do that mark-to-market after that. So these all quality goods is not an issue about usability at all.

Josh Baribeau - Canaccord Adams

Lastly the cell revenue spiked up a bit in the quarter. Could you talk a little bit about if that’s something you expect; that run rate is something you expect going forward? And also were you purchasing in cells in the quarter from outside sources as well as tolling some cells from outside customers? Is that what am I understanding?

Peter Xie

Can you repeat the question again?

Paul Combs

I think the questions Peter was we report some cell revenues. Those are downgraded cell. So that as you know it’s a small proportion of our business on an ongoing basis, so I wouldn’t read anything into that for the quarter and I am sorry your second question.

Josh Baribeau - Canaccord Adams

More along the lines, what’s the percentage of sales that you purchased from outside customers or outside players?

Peter Xie

We do small amount of purchase cells. Right now it’s not substantial (inaudible). Actually in the future, as we see our 2010 plan, we do expand our [baking] module capacity by the [less] on the cells. So if that plan does say, and if our demand has come very strong, we would expect to start buying more cells. Right now it’s a small amount.

John Breckenridge

I’d just add that actually cell expansion is not as extremely high CapEx. So if that made the most sense from earnings per share of standpoint then we are all expanding the cell capacity needs.

Josh Baribeau - Canaccord Adams

Just one very quick follow-up; you had mentioned that you might another four lines of cell capacity to get to about 460 megawatts by next year. Would you add another 100 or so megawatts of ingot and wafer plant as well or you would keep that around 360?

Peter Xie

Right now there are no plans with Ingot wafer capacity, there are a plenty of capacity available.

Operator

The next question comes from the line of Vishal Shah with Barclays Capital. You may proceed.

Jake Greenblatt - Barclays Capital

This is Jake Greenblatt for Vishal Shah. You guys gave 60% of the company’s total PV module shipments from Germany in Q3. Could you give us any clarity on what German shipments will be like in Q4 and Q1?

Paul Combs

We don’t make a habit of giving geographic forecast. I think it's important though to say that we have a strong business in Germany. I think we had very good visibility in Germany in the fourth quarter and Peter correct me if I am wrong, but I suspect that percent may go up in the fourth quarter relative to the third.

Peter Xie

Correct. We do not have a specific number at this point, but we do not see a major change.

Jake Greenblatt - Barclays Capital

What was that number like for all of 2008. I know you gave Q2, but what’s like the historical run rate for Germany.

Peter Xie

Historically we are running at about 80%.

Operator

The next question comes from the line of Emily Lu with Areth Research. You may proceed.

Emily Lu - Areth Research

I’m just wondering whether the company can comment on some of the emerging markets such as Czech Republic and South Korea in terms of the market size. What’s your internal estimate in those markets?

Peter Xie

Our expectation on Czech Republic in next year is going to be very strong year, and South Korea is less. Actually we see other markets, for example, Australia is going to be a strong market and Turkey will be also a strong market and the US especially and China will be a strong market as well.

Actually next year we see many strong markets coming besides Germany. That’s why you would see our geographic diversification. We are actually going to spend more into more emerging markets.

Emily Lu - Areth Research

I have a quick follow-up, because, as far as we understand the ASP in US is actually lower than in Europe. Do you see the ASP disparity across the different geographic markets?

Peter Xie

ASP in US lower. So, I think, actually ASP in US is lower. What I think is or what I like in US is, I think, US actually has a very sustainable policies, because it’s based on the tax equity, based on this PPA agreements. So if the ASP, the BOF keeps coming down, the inverter price coming down, the module price coming down, actually then there can be a very sustainable demand. That’s why I think the US is going to be a very interesting market to participate.

So even though initially I think that they maybe facing some margin pressures and low ASPs, but I think it is the worst way of positioning yourself in the US market. That’s why we choose to focus in this market in the coming year.

Operator

Your next question comes from the line of Dan Ries with Collins Stewart. You may proceed.

Dan Ries - Collins Stewart

When you are going out now to procure wafers, are you being asked for prepayment, wafer or polysilicon, are you being asked at this point for the prepayments. Secondly your advances to suppliers on the balance sheet, the entire $121 million is included in current assets. Does that imply that you expect to drive down these into you head.

Peter Xie

That's a very good question, so right now as you are signing new agreements, nobody is expecting you to pay a prepayment for both silicon and wafers. So there is no prepayment anymore. Now for our existing balance on our balance sheet, we do expect to draw down that as we go, as we speak. There are amortizations agreements with our current suppliers, so that the timing and percentage is different, it depends on the suppliers. So you'd expect that number to come down.

Dan Ries - Collins Stewart

Because it came down only about $7 million in the third quarter, but it had dropped significantly first quarter to second quarter. Can I assume that the 121 balance may go -- maybe not totally be zero over the next four quarter but pretty close to zero? I mean that would be a significant source of cash.

Peter Xie

I do not expect to go to zero in next quarter, but maybe in next couple of years.

Operator

[Operator Instructions]. Your next question comes from the line of (inaudible) with Allianz. You may proceed.

Unidentified Analyst

I just wanted to ask if the recent developments in LDK Q-Cells dispute has any impact to solar fund in any way.

John Breckenridge

I will take that, although I don't have any inside knowledge about Q-Cells. At this point, those are totally separate situations and there is no impact one way or the other between the Q-Cells LDK situation and the relationship between solar fund and LDK, they are totally separate relationship.

Unidentified Analyst

At some point one can think that the cancellation of the contracts were the dispute going in between them related to further problems along the industry. How do you guys see that?

John Breckenridge

LDK has their set of challenges and they have to talk to that. We see that as isolated situation between Q-Cells and LDK which has become a very technical, legal matter between the German and Chinese courts as I understand it and that’s an LDK issue that doesn’t have direct impact on us and I am not sure what the broader implications are.

Unidentified Analyst

One more questions if I may, as far as more capital rates, have you guys - you can’t be certain about it, but as far as capital raises and issuance of shares according to [related] report, do you guys see that into foreseeable future or is there something that would require more of industry look out to see if you guys need more capital?

Terry McCarthy

That would be more of an industry lookup to see if we need more capital.

Operator

Your next question comes from the line Paul Clegg with Jefferies.

Paul Clegg - Jefferies

I may have missed it, but did you actually give wafer cost for the quarter and then what you expect it to get down in 4Q.

Peter Xie

Wafer cost for the quarter, I mean the buying wafer from outside.

Paul Clegg - Jefferies

Well actually let’s take first the combination of your outside and inside, but what was your wafer cost?

Paul Combs

As far as that Paul, that blended rate, let’s assume that we are buying away for it $0.85 a watt roughly and we can now make a wafer as cheap as we can buy it.

Paul Clegg - Jefferies

Does that come down. Do you expect that to come down in the fourth quarter as you presumably integrate more of your internal manufacturing wafer or….

Paul Combs

We are running at the 70% utilization roughly in the third quarter, and our ingot plan will run close to a 100%. I suspect there is some economic advantage to that.

Paul Clegg - Jefferies

Okay. Then I guess the gross margin pressure really is that you are probably going to be maybe a little bit down on wafer cost, but ASPs are going to provide a little bit more pressure in the fourth quarter.

Paul Combs

Now our projections on ASP were down approximately 5% in constant currency.

Paul Clegg - Jefferies

And that’s why that. If I may just the reason for the OEMs [showing] step down in the fourth quarter is just seasonal demand and we can expect that to kind of rebound in the subsequent year, not on a percentage basis but maybe more on an absolute.

Peter Xie

Yeah I think that the OEM business is fluctuated from time to time, and we see that the relationship continues to grow, but we continue to see robust demand from that OEM business. I think we announced the 100 megawatt a year right?

Paul Combs

Yeah we are contractually committed to or they are contractually committed to buy 100 megawatts for 12 month period. So that’s sort of the minimum expectation. I think even though we have seen some volatility quarter-to-quarter, we are running at rates higher than that, and I think our expectation would be for that relationship to remain fairly strong.

Operator

Your follow-up question comes from the line of Burt Chao with Simmons & Company. You may proceed.

Burt Chao - Simmons & Company

Guys, a quick question on the tolling business; Q-Cell, obviously makes up the vast majority. What is the composition of the additional megawatts? Is it all solar Q-Cell or there are other customers that have approached to you about OEM manufacturing?

Peter Xie

I think right now we do not disclose specific customer names, but we do offer OEM business to a variety of customers.

Burt Chao - Simmons & Company

Also on the inventory breakdown, I am sorry if this has already been asked. Do you have a rough breakdown between finished goods and work-in-progress and then also just polysilicon or wafer?

Terry McCarthy

You mean, a rough breakdown as to.

Burt Chao - Simmons & Company

The value. I mean, if 20% of the value of inventory is in wafer or is it 20%?

Terry McCarthy

About 20% within wafer and poly, and then a little less than half within cells.

Burt Chao - Simmons & Company

Last quick question on that, just trying, at large, obviously you [want] to use in and out of that, and there is no clarity on when things are going to move forward? Do you have any visibility or any perhaps, even just educated conjecture of when you think the Chinese market will start moving forward once again for instance in the cell market?

Peter Xie

I will take that question. I think you asked a very good question, and the way you start seeing down the market has already started moving as I indicated. We are going to ship over 10 megawatt modules into that market starting in Q4.

So what I expect in 2010 there will be a substantial movement in that market, and that seems to be fluctuate quarter-by-quarter depending on the policy changes. I think we expect there is a policy announcement by the end of this year or early 2010. So we suspect there is substantial changes around that policy announcement.

Operator

The next question comes from the line of Sam Dubinsky with Oppenheimer. You may proceed.

Sam Dubinsky - Oppenheimer

Just more clarity on the China wins. Can you maybe just give some color on how pricing is determined through these projects? Is there an open bidding system or just how are the ASPs presuming (inaudible) projects determined and I have a follow-up?

Peter Xie

I think the China project I think is very complex. Right now I see different models. In some models people are saying abandoning contracts the core development. Basically the module supplier doing the joint development of this, the utility companies that jointly develops the PV stations. I also see just purely buying the cells (inaudible). People just do open bidding with module players to bid on contracts. Often time you see like 10-11 module players to bid on one contract. So the price competition is pretty fierce.

Sam Dubinsky - Oppenheimer

What is the average pricing for a China project, a module sold into China?

Peter Xie

Average price is varied between $1.30 to $1.60.

Sam Dubinsky - Oppenheimer

Just one more thought on your processing cost. You’ve done a good job lowering your processing cost. Can you give some color on what your wafer processing cost are, you cell processing cost and your module processing cost, just to get some granularity?

Peter Xie

We typically don't break down those numbers. I do not have this number handy with me, but I guess we can talk offline Sam.

Operator

The following question comes from the line of Dan Ries with Collins Stewart.

Dan Ries - Collins Stewart

My question was just asked and answered.

Operator

The next question comes from the line of [Dillon Low with Pacific Etak]

Dillon Low - Pacific Etak

I have a question about your OEM business as well as you made only 20% of OEM business for Q4. As I know the demand for module in Q4 is much stronger than Q3. Why you didn’t get as much as OEM contract in Q4 than Q3, and what’s the exact [reason] for Q1 OEM business.

Terry McCarthy

If I could add to (inaudible) a little bit. If you look at the OEM business, a lot of these projects (inaudible) and because these projects related business can sometimes be lumpy and I think it’s just a matter of Q4 happening to be a little bit of a lull just a few months passed, and we certainly expect robust (inaudible) 2010 and throughout the year, so nothing beyond that.

Operator

At this time, there are no further questions. I’d like to turn the call over to Mr. Paul Combs for closing remarks.

Paul Combs

Okay. Thanks again everybody for your continued interest. We will conclude the call here, as you know we are always available for further question. So thanks again. Good bye.

Operator

Ladies and gentlemen this concludes today’s conference. You may now disconnect and have a great day.

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