MEMC Electronic Materials Q1 2010 Earnings Call Transcript

Apr.30.10 | About: SunEdison (SUNEQ)

MEMC Electronic Materials (WFR) Q1 2010 Earnings Call April 29, 2010 5:30 PM ET

Executives

Timothy Oliver - Chief Financial Officer and Senior Vice President

Bill Michalek - Director of IR & Corporate Communications

Ahmad Chatila - Chief Executive Officer, President and Director

Analysts

Stuart Bush - RBC Capital Markets Corporation

Rafi Hassan - FBR Capital Markets & Co.

Satya Kumar - Crédit Suisse First Boston, Inc.

Stephen Chin - UBS Investment Bank

Vishal Shah - Barclays Capital

Krish Sankar - BofA Merrill Lynch

Gary Hsueh - Oppenheimer & Co. Inc.

Paul Clegg - Jefferies & Company, Inc.

Stephen O'Rourke - Deutsche Bank AG

Hendi Susanto - Gabelli & Company, Inc.

Timothy Arcuri - Citigroup Inc

Christopher Blansett - JP Morgan Chase & Co

Paul Leming - Soleil Securities Group, Inc.

Operator

Ladies and gentlemen, thank you for standing by and welcome to the MEMC First Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to our host, the Director of Corporate Communications for MEMC, Mr. Bill Michalek. Please go ahead, sir.

Bill Michalek

Good afternoon, and thank you for joining our conference call. With me today are Ahmad Chatila, President and Chief Executive Officer; and Tim Oliver, Chief Financial Officer. Before we begin, please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management’s current expectations. These risks are described in earnings release published today and in our 2009 Form 10-K. As a supplement to this call, we have provided slides on our website which provide more detail regarding the quarter. Please go to the Investor section of memc.com. I will now turn the call over to Ahmad for his opening remarks, and then Tim will review the financial results and outlook.

Ahmad Chatila

Thanks, Bill. Good afternoon, and thanks for joining us. On our conference call last quarter, I described to you our view of 2010 as the year of positioning for MEMC, and that's why we are cautiously optimistic about our prospects.

Let me give you a summary of where we stand. In the first quarter, revenue was ahead of our internal expectations. On the other hand, profitability was below expectations. We made progress in several operational areas that will position us for improved margins on profitability as we progress through 2010. For the full year, we believe that we're on track to meet our annual EPS and cash flow guidance and that revenue may exceed the high end of our previous range.

To improve transparency, we are now reporting our results by three operating segments. Going forward, you'll see the significant operational changes that we are making and be able to track the progress of each segment. So now let me look at each of the three.

First, the Semiconductor segment. The cyclical business bottomed early last year in Q1 ‘09. Business volumes are growing. As a result of our customer service improvements over the past year, our market share has nearly doubled. In the first quarter, our effective utilization rates [ph] (1:04:02) increased and costs and margins improved. Regarding the financial performance of the segment, while we have improved our margins significantly from the bottom, our margins in Q1 are still way below where they need to be and must and will come up. Our extensive efforts to improve our manufacturing and customer service operation continue and are poised to yield increasing results.

We will also be shutting down wafering operations at two U.S. facilities, saving us $65 million annually based on third quarter 2009 volumes. Given current industry demand, we may delay the closing by a few months, but they will happen, and this will provide some buffer if the market pricing declines in 2011 and 12. In the near term, we are seeing positive pricing momentum in Q2 and Q3.

The second view [ph] (1:03:16), Solar Materials. Volumes are up significantly due to customer diversification activities that we executed throughout 2009. Operating income was still positive, declined significantly, in part due to our reliance on external wafering subcontractors. We always considered that not having our own capacity could put us in that situation, which is the main reason for launching our own wafering plant. We need to control our destiny and drive costs down.

During the quarter, wafer capacity got tight, we kept our commitment to our own customers on pricing. We were challenged by pricing at our subcons [ph] (1:02:41). We honored our pricing because we are here to support our customers over the long term, and we are comfortable with that decision. We are in discussion and will develop strong partnerships with outsource partners that share our common strategies.

In Q2, pricing will improve in the solar space and there's still question surrounding market environment for the second half, but so far so good on pricing for Q3. We are moving ahead at full speed with our wafering plant. It will not have significant impact to our profitability in 2010, but will have a significant impact in 2011. The plant is not a standard plant, it’s a unique advanced plant with high-intellectual property content. We believe that it will give us a cost advantage even versus world-class companies. We intend to be the lowest cost, highest-quality provider and as a result, expect to generate solid returns on the investments that we are currently making.

Now SunEdison and our third view. We are very pleased with that segment. The company is now fully integrated, and the first quarter results are better than expected. Based on the contracts we have signed and deals that we are negotiating, we are pleased with our positioning as we move through 2010 and beyond. SunEdison has a history of building readily financeable solar plants and identifying sufficient funding resources to have them built, and today it's no different.

We are looking into several new financing options to help facilitate future growth and we will provide details as we progress through the year. We are disciplined about growing the business and our approach to growing the pipeline. We see enormous potential in this business. If we can execute well, we are putting the infrastructure in place. We don't expect this business to be easy, but we have a solid market strategy and we are moving ahead aggressively. It includes a strong marketing plan, careful selection of projects and partners, intelligent financing and professional project management. We have the talent placed to excel in each of those critical areas.

And in summary, we have good reasons to be cautiously optimistic about our future. Growth looks promising in all segments. I expect to see improvements in sales, margin, income and cash flow as we progress through 2010, with sales already expected to be above our previous guidance. We will be disciplined in growing the business, execute on costs and focusing on cash. Our continued operational progress in cost improvement, customer service, restructuring efforts, additional growth, initiative and our ability to attract and retain the best talent, will be the gauge for our performance in 2010 and the foundation for sustainable success over the long term. And with this, I thank you again. And now here's Tim.

Timothy Oliver

Great. Thanks, Ahmad. Good afternoon to all of you who have dialed in. My comments today will reference charts provided on our website, which both summarize the data provided in our press release and its attachments. They also provide additional analysis. Since Bill has already reviewed the cautionary Safe Harbor language, I'll move right to Slide 3, which is titled Q1 results summary.

Walking down the income statement, revenue in the quarter was $438 million, an increase of 23% sequentially. This result includes higher revenue from all three of our reported segments, with about a third of the growth coming from our legacy materials businesses and the remaining 2/3 coming from SunEdison, which posted its first full quarter as a part of MEMC. Year-over-year revenue was up 105% or 76% when you exclude the $61 million benefit from the addition of SunEdison. Wafer volumes in both of our Materials businesses were up significantly.

Gross profit rate decreased 140 basis points to 13.5%. We'll discuss profitability at the segment level in a couple of slides. But in summary, profitability in our Semiconductor business is improving in concert with demand. Margin rate at SunEdison was above its typical run rate due to an advantageous revenue mix of high European direct sales. And at Solar Materials, the absence of our own wafering facility Ahmad just described, and the resulting price cost dynamic put significant pressure on margin rates.

Moving to operating expense. Excluding restructuring, expenses were $73.3 million, up $10 million sequentially, due primarily to the inclusion of SunEdison’s expenses for the full quarter. Year-over-year, OpEx was up $34 million and includes $19 million for SunEdison, $5 million for a new EPO [ph] facility that has yet to transition to full production and higher selling and customer freight expenses, which both tend to vary with volume.

Below that is a small restructuring amount that is current period costs for previously announced capacity moves. This all totals up to an operating loss of $15.3 million. Other income and expense flipped to an expense of $10.4 million from income in both the year-ago first quarter and last year's fourth quarter. Financing cost specific to this quarter's Italian power plant transactions of about $7 million and higher interest expense due to the inclusion of SunEdison nonrecourse solar project debt of about $6 million account for that change.

The deal-related costs were specific to this quarter's direct sales. And going forward, will most often fall into cost of goods sold. We expect this line to average about $3 million of expense in each of the remaining quarters of the year, driven by this net interest expense. And the fair value of the SunTech warrants was adjusted down by $5.3 million. Because these warrants fall outside our control, our plan presumes that they have no net impact on the company for the full year, and that's what we include in our guidance. The non-cash fluctuation in these warrants did reduce our GAAP EPS by about $0.02.

Moving past the tax benefit to equity and earnings of JV and minority interests. This line includes the impact of the successful conclusion of the Q sales [ph] (56:59) joint venture project and represents the recognition of all of the profit deferred and the wafers sold into this joint venture, netted against the sales price. We expect to receive the remaining cash in this project over the next several months.

The walk completes at the bottom of the page with an EPS loss of $0.04 a share, including the previously discussed $0.02 loss attributable to the SunTech warrants.

As Ahmad said earlier, these results represent a decent start to our year, a year that's likely to benefit from continued improvement in end-market demand and that should translate into strong revenue growth. With the wind at our backs, execution is key. We need to capitalize in current period growth opportunities, drive margin rates higher, convert our profit to cash and then make prudent but significant investments to sustain this growth in future periods.

The next three slides give you an overview of our reporting segments. Each of these slides provides a rolling five-quarter summary of sales and segment margin, though the SunEdison side only includes segment margin detail for the post-acquisition periods.

So moving to Slide 4. Q1 results for Semiconductor Materials. The Semi business continues to benefit significantly from improved end-market demand and from efforts over the last several quarters to regain market position and customer share. Revenue increased 274% year-over-year and 6% sequentially. Almost all of the growth is attributable to high-wafer volumes.

Price was up modestly versus last quarter and is still down slightly versus the previous year. While segment margin remains slightly negative this quarter, higher volume, better fixed cost absorption and productivity have all pulled margins up significantly from the very difficult lows of 2009. The absolute level of profitability is not satisfactory, but the improving trend should continue as restructuring efforts progress, as productivity’s aided by volume and as price continues to recover.

Moving to Slide 5, Q1 results for Solar Materials. The Solar Materials business continued to see very strong demand for wafers. That admittedly reduced prices. Volume was up significantly sequentially and nearly doubled versus the prior year, with lower prices offsetting most of those increases.

Price declines were much more modest in Q1 than in previous quarters and appeared to be stabilizing and maybe improving as we come into Q2. We continued to make progress in diversifying our customer base beyond our four long-term agreements. Segment margin continued on an anticipated downward trend paced by price. But margin rates this quarter were even lower than we had planned. While we expected and planned for the lower pricing, tight supply of wafers in Q1 caused prices to firm and made acquiring wafers from our subcontractors much more expensive.

We will be subject to this price cost dynamic until we have our own wafering solution up and running, which as Ahmad said, should be very early in 2011. Year-over-year, the strategic decision to sell best [ph] (53:53) raw polysilicon also impacted our profitability.

And at Chart 6, titled Q1 results for Solar Energy, we'll talk about SunEdison. SunEdison got out to a good start. They interconnected almost 11 megawatts in the quarter, including seven megawatts in Italy that were sold directly. The remaining four megawatts were North American projects that were funded with nonrecourse financing.

From a profitability perspective, project margin rate was somewhat higher than its more typical level for two reasons: first, the rich mix of European direct sales; and second, the P&L geography of about $7 million of deal financing costs that I described earlier, some of which might otherwise be considered cost of goods sold.

Forecasting SunEdison revenue and reported profitability for any given quarter will be difficult due to the lumpiness of project closures and the variability of mix off take, meaning the mix of direct sales versus financed projects. We will continue to provide P&L and balance sheet details and any other operating metrics that may help to allow you to discern the impact of this business on MEMC's total reported financial results.

Move now to slide titled, free cash flow walks, Side 7. Free cash usage was $132 million in this first quarter as cash outflow for working capital to support current period growth and capital investment to support future period growth outpaced cash inflows. The working capital and other line increased $149.4 million, including $94 million in higher receivables to support Semiconductor and Solar Materials business segments. And $54.2 million in higher inventory for solar power plant development and for projects that will be expect [ph] (52:04) to be sold directly later in 2010.

On receivables, too much of our revenue occurred in the latter half of the quarter, which deferred collection beyond the end of this quarter. While this is a temporal issue and the cash will be collected in Q2, a more linear revenue profile is important, not just to quarterly free cash flow metrics, but also to operational efficiency and to customer satisfaction. We are making changes to drive improvement in this metric and our ability to offset growing receivables balances with higher payables was hampered by tight capacity at our wafering subcontractors that caused much faster payment terms than we would accept in a more normalized supply-demand environment.

With regard to the inventory growth at SunEdison, the primary driver of the increase is the initial spending for the 72-megawatt Rovigo solar plant which we expect to sell by the end of this year. Moving to investment activities, we invested $46.2 million in CapEx related to the planned growth in Semiconductor and Solar Materials business units. These investments will expand our Semiconductor wafering capacity and increase our polysilicon output at Merano.

Finally, the last major categories when analyzing our cash flow are related to the funding of construction of solar energy systems and the eventual proceeds from financing these systems with nonrecourse debt and capital lease obligations. Cash used in construction of these solar energy systems was $44.9 million for the first quarter. These are projects that the company does not currently plan to sell directly, but rather to finance through either a sale lease-back or some other form of nonrecourse debt financing.

In this regard, we executed off-takes from financing that generated $73 million in cash flow. Therefore, the net of these two items provided a $27.9 million benefit to cash in the first quarter. While we continue to plan significant investment in growth across all three business segments, we are still expecting positive free cash flow for the full year as working capital growth in our Semiconductor and Solar Materials segments normalizes and our power plants are sold or financed in the SunEdison business.

Before I leave cash flow, I want to make a quick comment on a consolidated balance sheet that is included in the attachment to the press release. We fielded some questions in the last call about changes in customer deposits and in the absence of better answers from us wrong conclusions might be drawn. So short-term customer deposits in this quarter are down $24 million. This decreased by previous quarters is due to the renegotiation of long-term agreements under which these deposits were originally made. All four of our contracts have been mutually amended over time to better represent the new market reality and to describe a mutually beneficial relationship as we go forward. When changes are made, like they were to one contract this quarter, balances are moved out of short-term customer deposits and into other line items, including deferred revenue, other long-term liabilities or in some instances, revenue, dependent upon the renegotiated agreement terms. We also, on occasion, temporarily allow the application of customer deposits to their receivables and allow those deposits to be replenished. It’s important to note that all customer deposits or LCs are currently appropriately funding relative to our current agreements.

Finally, turning to Chart 8. I pulled forward into this deck of chart [ph] (48:32) that I used to provide full year guidance at our –- at Investor Day back in early April, early February. The first quarter I just described is reasonably consistent with our outlook at that time with some important modifications. First, the important addition of a large solar project in Rovigo, Italy to our plant for SunEdison. With that addition, it is very likely this business will exceed our original financial plan, particularly if we're successful selling this project directly, and that is our current thought.

Secondly, the margin rate we are going to be able to generate in the Solar Materials business will be significantly lower than we planned. While demand remains strong and pricing had stabilized, the strategic challenge of not owning our own wafering operations will persist through this year and we'll cap our profitability in this business. Taken together, these two changes, while we may exceed the higher end of our previously guided range on revenue, the margin dollars we generate will be very similar to those in our outlook back in February. This obviously means that total company segment margin rates will be lower than our outlook at that time.

Taking all this together, we are still very comfortable with our $0.70, to $0.80 EPS guidance and a positive free cash flow for the full year, even after funding $350 million of expansion to our existing businesses. With that, I'll conclude my comments. Before I take questions, because I know you're going to have them, we have not planned to give guidance for each quarter, but I think probably some qualitative guidance here will be helpful.

On revenue for Q2, we expect another good sequential growth quarter in both Semi and Solar Materials with strong demand in both segments. We will not, however, chase empty revenue in the Solar Materials business and will meet or out [ph] (46:42) our revenue there based on our ability to obtain a fair margin. At SunEdison, we’ll interconnect and sell directly fewer projects in Europe in Q1, but will importantly ramp up our work in Rovigo. Our profitability, margins at Semi will continue to expand with demand, driven both by volume and by price. Margins at Solar Materials will be relatively similar to what they were this quarter. And SunEdison’s reported margins will remain heavily dependent upon the mix of optic and the corresponding accounting treatments of those optics.

With that, we will conclude our remarks. Bill, we'll take questions. Greg, we're ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first we go into the line of Sanjay Shrestha with Lazard Capital Markets.

Unidentified Analyst

This is Sara [ph] in for Sanjay. Can you provide any further detail on the SunEdison business pipeline for this year in terms of both third party sales and PPA projects?

Ahmad Chatila

This is Ahmad. The -- qualitative to the pipeline is expanding rapidly for us, so we're very pleased with that. We told you that we'll do around -- greater than 100 megawatts in 2010. We probably do now with Rovigo close to 150. So there’s some addition, some subtractions. So that's what we will do this year.

Timothy Oliver

The mix of PPA to direct sales, admittedly for April to close, typically would be about 40% direct sales and 60% PPA. With the anticipated sale of Rovigo, we would get above that – we’d probably flip that ratio to 60 direct and 40 PPA. That's always hard to predict.

Operator

And next, we turn to the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank

Just a first question on the Semiconductor operating margin in the March quarter, was some of the lack of margin upside, was some of that due to the ramping of the Malaysia factory, so maybe cost of goods sold were higher because of the build out in Malaysia? And then my second question is, do you have any plans to expand capacity in Semiconductor wafers given the moving trends that we’re seeing, Ahmad?

Timothy Oliver

I'll take the first half and then I'll give Ahmad the second part. On the cost side, it’s true that we have an awful lot going on to that business to move capacity around the globe, and it’s expensive to do so and not all of it can be capitalized so some of it does go through margin rate. We'll start to see more return on those investments and less costs from them as the year plays out.

Ahmad Chatila

First of all, let me go back to the margin overall. If you compare MEMC with other players in the industry, you'll see that our margin rate is pretty healthy. The problem that we have is the overall industry, price decline in 2009 was so severe, and we’re trying to inch our way out of it. So if you compare MEMC to other world-class companies, we're probably around five to 10 points ahead of them on our EBIT and EBITDA. So that's what I tell you. Now on the capacity, we are doing two things. One is we're moving underutilized assets around the globe from one factory to another, just trying to move machines from Japan to Italy, Italy into Malaysia, Taiwan into Korea and vice versa. So that's why we are going to increase our capacity. The other way is we're adding some 300-millimeter capacity, because that's where the utilization is the highest. And that we will probably take it from 450 to probably 550 or something like that in the next six to 12 months. We are very cautious. We don't want to destabilize the industry. As I said, the oil industry is in trouble from a pricing perspective in the past, and that's why you see a lot of price increases in Q2 and Q3, and we're comfortable to say that the price increases, first of all in Q1, we had like low single digits. In Q2 and Q3 we'll have mid to high single-digit increases quarter-on-quarter.

Operator

Next, we'll turn to the line of Stephen O'Rourke with Deutsche Bank.

Stephen O'Rourke - Deutsche Bank AG

I want to try and understand a little bit of the dynamic of what's going on in the Solar Materials business. It sounds like you're having some maybe unexpected cost increases and you had the opportunity maybe to raise prices but chose not to, is that dynamic just as bad going into Q2?

Ahmad Chatila

The answer is, no, not as bad as Q2, but you got it right. Let me actually tell you one thing that happened before so that you know our mindset. You know in Q3, when we had our Pasadena incident, and now you know our results because now we show you the segments. The Solar Materials business was highly profitable. At that moment, we could have easily moved all the polysilicon that we had to fund the Solar Materials business and ride through that quarter with limited exposure from a P&L perspective, but we absolutely loaded our Semi business and ensured our Semi customers are protected. We were trying to gain market share. And Steve, we did the same thing this time. We could have easily turned around and raised price on our Solar customers. We just didn't want to do it. While we’d have shown a much better result this quarter, but they would have missed all their plans and we just didn't feel that that's the right thing for us to do. So we have given them heads up, and now in Q2 we're raising price, and the price is increasing as much as it declined from Q4 to Q1, it's increasing from Q1 to Q2. And we see a firmness as well in Q3, but it's still early, but so far so good.

Stephen O'Rourke - Deutsche Bank AG

And is there a way to quantify kind of what’s happened to this outsourcing cost from Q4 to Q1 and then Q1 going into Q2?

Ahmad Chatila

So what happened is when we walked into Q1, we had, I would say gentlemen's agreement and handshakes to have a cost roadmap for the year with our subcontractors. And as you know, a lot of them have a lot of pressure on them. And basically, those agreements were thrown out of the window within a few weeks, and the pricing increased dramatically from Q4 to Q1 rather than declining from Q4 to Q1. So we walked into the quarter thinking that the price’s going to decline because there's productivity gains in all companies and throughout the year, and that dynamic changed. We also, during that time we committed to our customers a price decline from Q4 to Q1. We kept that commitment and, unfortunately, it kind of damaged our performance for Q1. But again I repeat, Steve, we are very comfortable with that decision. It's the right decision, it will make us very successful in the long run with our customers.

Timothy Oliver

Steve, this is Tim. If you were to take the miss-in-margin rate against what you would've expected, paying attention to guidance we provided previously, about half of the unexpected or the miss in margin rate could be attributed to these higher prices in the subcons.

Operator

Next, we turn to the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch

Ahmad, my first question was, can you talk a little bit about the Semi wafer pricing trend across the various diameters, and how do you think that's going to trend into, once we get into the second half of the year?

Ahmad Chatila

On Semi pricing, 300 millimeter's a lot tighter utilization, not the same case on 200 millimeter. So on 300-millimeter, the pricing increasing happened faster. A lot of it had to do with epi [epitaxial] wafers, so those have even more demand on them than everybody has expected. I would say, though, on the 200 millimeter, it's also increasing because of significant demand from the discrete and automotive and all these kind of accounts, so that's increasing as well. And we are comfortable to say that in Q2 and Q3 the pricing will increase significantly, and significantly means mid to high single digits. We have no view on Q4 yet. We do not know what's going to happen then. But we are taking advantage of the situation today, and one of the reasons why we only had a single-digit increase, a low single-digit increase in Q4 to Q1, although we recognized the tightness in August of last year, is because we closed some deals with big winners in the 300-millimeter space that we know they're going to be around for the next 10 years because of their size and their funding that will get us to compromise on price, but keep the price kind of flat for three years in a row. So that's the dynamic that we're seeing right now.

Krish Sankar - BofA Merrill Lynch

Can you shed some light on kind of the nature of negotiations you’re having with the Solar Materials contract with some of your customers versus compared to a year ago? How is the contract negotiation trending and what kind of [indiscernible] (36:33) are they are offering you from a contract standpoint?

Ahmad Chatila

I think the discussion has flipped from the price is not good enough to the volume that you're giving me is not good enough. And I don't know if they have the long-range view required to tell us what's going to happen in the future. Why do I say that? Because now we run SunEdison, so we have a clearer view of what's going on across the value chain. And we’re not convinced how sustainable the demand is. I mean, I want to remind you what happened here. So we walk into the year thinking that the market’s going to increase but not that much. Then Germany, there was noise in there about reducing the feed and tariff rates. All of a sudden there was like an absolute anarchy in how much we can build power plants in Germany across many, many, many, many, many installers. And in that situation, then the demand for wafers skyrocketed. So then our subcons raised price. Our customers wanted more wafers. And that's what's happening. But we don't know what's going to happen in Germany in the second half of the year. We have no view of it. On the other plants, I would say, where we are very aggressive in terms of building our pipeline, which is Italy, Spain, Greece, France, U.S., Canada, India, I think there's a lot of double ordering there and we are worried about it. So we are very cautious about what's happening in the Solar Materials business. We will not make short-term decisions. We know that right now the price on subcontractor’s high and the demand is high, but we are not sure if it's going to stay like that forever. Just imagine if few gigawatts were built in Q1 in Germany, what do you think the German government will do? I really don't know, but I don't think they’ll be pleased about it then and I don't know their reaction’s going to be to the feed and tariff rates. So we are very cautious about that market.

Operator

Next, we turn to the line of Satya Kumar with Credit Suisse.

Satya Kumar - Crédit Suisse First Boston, Inc.

I was wondering on the solar wafer business, if you could say, do you expect the business to remain positive margins for the whole year? And can you perhaps go back to selling polysilicon temporarily if the wafering costs go out of hand?

Ahmad Chatila

The answer is, we expect it to be positive throughout the year. That's my expectation today. Q2 will be better than Q1. We will continue to sell wafers. We’re a technology company. Wafers, we think, is the way to go in the long run from a cost roadmap in the solar installation space. I think there's a lot more juice in reducing the wafer cost than in polysilicon across the globe. I'm not talking about pricing, I'm talking about cost, cost of material. So that's where we see our future, and we're building a plant that is very advanced and very innovative and more productive than the best-known methods. So we'll stay in it.

Satya Kumar - Crédit Suisse First Boston, Inc.

I thought you mentioned that half of the miss was due to drilling issues. What was the other half due to? I just wanted to get some color how the linearity [ph] (33:13) of the silicon production was in the quarter. And on the same topic of cost, I was wondering if you could also give some additional color on how the cost reductions are progressing for the rest of the year in the silicon and the wafer business.

Timothy Oliver

Poly production in the quarter was okay. It was not as good as the previous quarter, but it was okay. Looking back over time, it was the third or maybe fourth best output quarter we've had as a company. So some of the other -- maybe 25% of that would be poly cost and the remainder was other costs or lack of productivity. But poly was okay. We expect it to get better as the year plays out and significantly so as the year closes out.

Ahmad Chatila

On the Semi roadmap, we’re progressing nicely. There's a lot of work to be done. As I've said, part of the roadmap, which we have visibility until August of 2011, is shutting down our U.S. plants. We might delay those for a few months here and there to keep customer commitments and expanded demand actually that they’re having right now, which is kind of really high demand, but that will have a significant impact on our margin as well. So I expect also the Semi business, step by step, to improve its performance and profits. Next quarter will be better than this quarter.

Operator

Next, we'll turn to the line of Vishal Shah with Barclays Capital.

Vishal Shah - Barclays Capital

You lowered your full year operating margin guidance. I just wanted to get a sense of what's contributing to that. It looks like you said your SunEdison megawatt shipments would increase by about 50 megawatts. So if I do the math, and that math would imply that you lower your operating margin guide as well by 200 basis points [ph] (31:19). First of all, is that the right assumption to make?

Timothy Oliver

I like the way you're doing the math, and my answer would be: We're not sure. It depends entirely upon the mix that comes in. What mix is in that revenue? So as you’ve heard Ahmed say, the uncertainty in the margin rates and the solar wafer business caused us to pause. They are absolutely not going to be as high as we thought that they once might be when we gave the guidance back in early February. So the decline in margin rate for the total company is not at Semiconductor. In fact, we still expect Semiconductor to close out the year with very, very good margins, very close to where they've been historically. And we do expect, however, the solar wafer business to be much lower than we came into the year. The offset then in margin dollars is coming from the outside in revenue at SunEdison. You will remember that the SunEdison gross margins are lower than our Material businesses on average, or the reported margins in that business.

Vishal Shah - Barclays Capital

Is that the case even for the European business? Because in Italy, for instance, your SunEdison gross margins would be comparable to your other businesses.

Timothy Oliver

Yes. You're right. When we can sell projects directly in Europe, the margin rates are very similar to the average rates we'd see, let's say, in Semi. So you're right. It’s just a little bit early for us to conclude that, that mix is going to come our way. You are right. If, in fact, we are successful in selling, 60% of our SunEdison revenue or SunEdison megawatts, it would push margin rates higher.

Vishal Shah - Barclays Capital

And then the other question is your wafer capacity tightness comment. Can you just elaborate on that, please? Because the way I see it, as –- Ahmad, you said the German government is not going to allow these gigawatts of installations, but there’s been a poly capacity coming online, and if you look at the wafering capacity, it's still going to be tight. So if there's a slowdown, poly prices have to drop as well. So how do you think about this business and do think that you'll always be constrained on the wafering side until you have your own in-house capacity?

Ahmad Chatila

Let me go back a little bit. First of all, I didn't say that the German government will react. I said, we're worried that they might react. So I'm correcting myself. Probably I said it, but I'm correcting myself. So that's where our caution comes in. We are prepared for polysilicon cost reduction on the Solar. We just want it to be systematically going down on a fixed roadmap, so that we can operate around it and manage our business based on it. What we cannot handle, Vishal, is a surprise, fluctuations. That, we cannot manage. So that's where it comes from.

Vishal Shah - Barclays Capital

But why –- I mean, are you not able to find any wafering supplier or what's going on? And do you think this is going to continue in the second half?

Ahmad Chatila

There are wafers, but the question is what's the price that you want to get them for. As Tim said in his opening remarks, we will not chase empty calorie business. So you can get the wafers, but you have to pay, and we’re not willing to pay and get zero margins. So that's the issue. And right now, there's a lot of spot market dynamic. It's not only a wafer, the modules, the cells, the wafers, everything. And if the German situation changes –- let’s imagine it does in the second half of the year, I think that overall demand will continue to increase because as many countries that are coming online better than we expected. However, the supply will be much higher than the demand. So that's how pricing collapses. It's not about the overall demand, it's the relationship between supply and demand that matters. And I think people are just adding a lot of capacity potentially.

Operator

Next, we turn to the Paul Clegg with Jefferies.

Paul Clegg - Jefferies & Company, Inc.

Did you just say that the Solar margins would be much lower at the end of the year than when you came into the year, i.e., relative to the first quarter?

Timothy Oliver

No, no, no. No, much lower than we presumed when we gave you our guidance back in February. So no, I would anticipate that the margin rate you just saw is the lowest we're willing to do business at. And as Ahmad said, we're not going to chase revenue if it's going to be empty. So we anticipate those margin rates being better in the second quarter. And in the absence of firm commitments in Q3, we’re just going to say we think it will still be tough, but that we don't expect them to go lower.

Paul Clegg - Jefferies & Company, Inc.

But you expect silicon volumes to also rise sequentially throughout the year then still?

Timothy Oliver

The volumes for certain, and revenue, probably. Again, we reserve the right to rein in volume in that business if we don't like the profitability we can get.

Paul Clegg - Jefferies & Company, Inc.

What I really wanted to ask you about though was the -- what portion of your solar wafers are subcontracted today? And I think if you could just talk a little bit about the margin impact as you bring on your own internal wafer supply or own internal wafer capacity versus the cost of subcontracting today and versus the cost of the wafering plants that you're planning on shutting down?

Timothy Oliver

Sure. And I’ll do the first part, which is easy. All of our wafers are externally manufactured and then, Ahmed, I’ll let you do the. . .

Ahmad Chatila

The way I'll answer is, is I do not know exactly what the margin would be at that time, but I would share with you where the cost would be. As we said before, our cost will be around $0.10 per watt lower than the best-known method. But we have a lot of headroom. Think about the world like this, there are the expensive guys, there are the average guys, and then the best guy in the world and they show you the roadmap. We will be below the best guy in the world. The price will tell you what the margin’s going to be. So I don't know what the price dynamic will be at that moment.

Operator

And we have a question from the line of Chris Blansett with JPMorgan.

Christopher Blansett - JP Morgan Chase & Co

Ahmed, I just had a quick question about your expectation for price increases for the Semi wafer side. You indicated kind of mid single- to high single-digit increases for the next few quarters. I'm not sure how that gets you back to the same margin profile you had before the downturn. Could you kind of give a little more color around that?

Ahmad Chatila

Yes. So between those price increases and our cost-reduction roadmap that we shared with you early February, we will get there. So that's how we see it. So a little bit higher utilization across roadmap, higher pricing, but later on if the market changes, then our U.S. plant, and shutting those down, will help us a lot. It's in the 5% to 10% gross margin range.

Christopher Blansett - JP Morgan Chase & Co

And then the second question I have is related to you adding more capacity. In spite of what may still be underutilized overall semi-wafer market, wafer-production market -- and I wasn't sure how this ties into your share gains and if you can explain more how that's not going to be a problem as far as causing more oversupply.

Ahmad Chatila

We're not adding a lot of supply on the 300 millimeter. We're not adding on 200, we're just moving machines around. On 300 millimeter, we're adding 100,000 wafers a month. The worldwide capacity’s like 3.5 million to 4 million. So it's really not a big number. And we're adding it in Korea, where there's significant customers there. And the Korean companies like to buy Korean products. So that's how we’re doing it. Now we’re expanding our capacity in Taiwan, where TSNC [ph] and UNC [ph] and the Dirham [ph] (23:22) guys are. And we -- the rest of it’s in Japan. And Japanese companies are buying from those 300 millimeters planned. So we have a measured way of increasing capacity. We're not going all out trying to dominate the world. We just want to be a 30% gross margin company with 20% EBITDA or more on Semi. We see it. We can make it. We don't want to destabilize the market by any means. And you know what, let me tell you, this year if the market becomes so hot, we might lose market share because other people might be filling up their capacity that has idled. Maybe they do that. Frankly speaking, I don't care as much. The only thing I care about is our margins increasing and our profits increasing. And that's our thinking at this time, Chris.

Christopher Blansett - JP Morgan Chase & Co

I just wanted to confirm that you're adding capacity based on additional volume contracts you signed with certain, you know, specific customers. Is that the kind of way we should think about it?

Ahmad Chatila

No. There’s some of that, but not all of it is like that, Chris. A lot of it has to do with recurring relationships and having better service and deploying assets where the customer is. In some of our regions, we have like five meetings a day in the local language with the big giant companies. So that's why we get share. If you do it from another country or a different language, it's hard. So we're measured around it. Not contracts across the board, but much stronger ties with the customers.

Operator

Next, we turn to the line of Atif Malik with Morgan Stanley.

Unidentified Analyst

This is Mike Sue [ph] (21:45) for Atif. My question is around the solar wafering costs. It looks like that could actually move higher before it moves lower. Given that you have contracts with some of your solar wafer customers and it looks like the margins aren't attractive, is there a way for you to actually reduce the volumes to those customers? And kind of the second part, is there any way you can actually pull in bringing the wafering in-house to try to bring the costs of the wafers down in the latter part of the year?

Ahmad Chatila

Thanks, Mike. First of all, we're trying our best to pull in the schedule. Right now it’s already been aggressive. So I don't think we're going to have a lot of luck there. We'll try our best. From a pricing perspective, we have a lot of flexibility. The pricing in the contracts that we bid before were extremely high and we were very flexible in reduction in the past. We can raise them as well without having trouble, frankly speaking. If anything, we have a lot of headroom, and we're not going to use it. So we can easily raise the price a lot actually, but this will make our customers unsuccessful, and we're not going to do it. But we have the power to change it, and we are.

Timothy Oliver

The important thing is making sure that if we enter the quarter we have confirmed with our subcons what our wafer costs are going to be such that we can price appropriately and protect our margin rates. That's why I keep talking about metering this out and making sure that those two are moved together.

Unidentified Analyst

I see. So you can secure the wafering cost at the beginning of the quarter before you commit your wafer customers on the volumes that you plan to ship to them?

Ahmad Chatila

We're being more cautious on there. So we are securing cost. It's more logical now because the dust has settled, okay, the price is higher. That's okay. We raise our price. That's okay. And we have some productivity gains elsewhere. So we feel that Q1 to Q2 will be an increase in the margin for the Solar Materials business.

Operator

Next, we turn to the line Hendi Susanto with Gabelli & Company.

Hendi Susanto - Gabelli & Company, Inc.

I would like to ask more about your solar wafer cost. Knowing that solar wafer demand will still be strong in Q2, will your subcon costs stay high and still impacts your margin in the second quarter?

Timothy Oliver

Yes, it will. Pricing will be better and costs will be higher, but the net margin to us will be better.

Hendi Susanto - Gabelli & Company, Inc.

Generally, you have the payment of $60 million to one supplier because of a purchase shortfall, like may I know whether debt payment was part of your cost of goods sold in your Solar Materials segment?

Timothy Oliver

We need to get back to you on that.

Ahmad Chatila

We're looking at each other with a puzzled look. So let's get back to you on that.

Hendi Susanto - Gabelli & Company, Inc.

It's in your 10-K. And then last question. How much is the split of your solar wafer cells between contracts and selling at the support market?

Ahmad Chatila

We do not have contracts with the solar wafering suppliers at this moment.

Operator

Next, we return to the line of Stuart Bush with RBC Capital Markets.

Stuart Bush - RBC Capital Markets Corporation

You’ve talked about the whole synergy [ph] (18:21) between the SunEdison and the wafer business. Can you give us any color on what percentage of your 150 megawatts of your plant this year are sourcing panels that are based off of MEMC wafers?

Timothy Oliver

As you know, we'll sell far more wafers than 150 megawatts in the wafer business for the year. And we've also not drawn a direct connection between our wafers going into panels that are installed by the folks at SunEdison. What we have done, however, is when we’ve talked to our big partners to whom we are both a customer and a supplier, we’ve talked to them a great deal about pairing up purchasing with their orders. So I think we've done a very good job of deepening our relationship with folks who make modules and panels and it’s helped us a great deal in forward pricing for the folks at SunEdison such that they continue to build backlog and capture future business based on that price curve.

Stuart Bush - RBC Capital Markets Corporation

Has there been any examples yet of where SunEdison has chosen a panel supplier based on MEMC wafers?

Ahmad Chatila

The answer is yes. Many, many, many. Across the board. Not every module they buy is a relationship we have, but most of them are.

Timothy Oliver

But I want to be clear, the benefit of the acquisition has little to do with pulling through our exact wafers into the exact panel and everything to do with giving us guaranteed off take of panels as we put the capacity in place going forward. So right now SunEdison is very, very small in total megawatts relative to the size of our wafer business. They will catch up in short order, and when that happens, it will be a much more important influence on how we procure modules in panels. It already is and it already has changed the way we buy and changed the way we sell. But we do not make a direct link between projects and our wafers.

Stuart Bush - RBC Capital Markets Corporation

Can you clarify exactly how much CapEx you're planning on spending on the in-house wafering and when you think that will be ramped up fully?

Ahmad Chatila

That's a question that will -- it's a little bit open-ended. The first phase is only 600 megawatts. The spend will be spread across -- a little bit in 2010 and more in the first half of 2011. But we are going to incrementalize our way there. So we have sufficient footprint to go much, much larger than that, a multiple of 600 megawatts. But we’ll meter out debt spending as we see demand and as we see the guaranteed off take or the proposed off take from the folks at SunEdison as their backlog grows. So expect us to continue to invest incrementally over the next many years in our wafering capacity.

Operator

We have a question from the line of Mehdi Hosseini with FBR Capital Markets.

Rafi Hassan - FBR Capital Markets & Co.

This is Rafi Hassan for Mehdi. Could you please clarify one of the previous questions, what is the margin differential between selling a project in Europe and U.S.? And looks like this $45 million project, still you may end up having a sale, lease-back. Do you really see SunEdison being a IPD [ph] in the long run and how much of the projects that SunEdison own and operate currently? And if I may, what is your distribution of [indiscernible] (14:38) production between Semi and Solar?

Timothy Oliver

The profitability -- the spread in profitability between projects directly sold in Europe versus those that we build and finance in North America, I think all you’d have to do is look at the dollars per watt that you can sell projects for in each country. It has a lot to do with how sunny it is and a lot to do with what the tariff is in country. So it depends on country. But suffice it to say that from a GAAP perspective, when you sell a project outright, you get to take the revenue and profit instantaneously. When you sell it -- when you finance a project and wrap a PPA around it, you spread that profitability from a GAAP perspective over the next 20 years. The cash flows are relatively similar. Admittedly right now pricing is better per watt in Europe, so you would do slightly better there, but there's a few more variables than you described. That was the first of your two questions. I have to admit I missed them. Ahmed, did you catch any others?

Rafi Hassan - FBR Capital Markets & Co.

If you can talk about SunEdison, how much does it own and operate right now in terms of megawatts for projects? Is 45 megawatts of sale, leasebacks, are you really prepared to take it in-house?

Timothy Oliver

We will not take them in-house. We set up LLCs and we finance those through nonrecourse vehicles. The only thing that's in-house is the operation and the maintenance contract on which we get paid a fair margin and which we get access to those customers for a very long time. So we do not finance those on our own balance sheet. They show up as debt on our balance sheet, but the recourse is not to us, and it's project – paired off project debt [ph] (12:48). We don't intend to use our own cash to fund projects.

Rafi Hassan - FBR Capital Markets & Co.

If you could tell the distribution of poly production between Semi and Solar.

Timothy Oliver

No. I mean, what I would say is we intend to use all the poly we make and we hope to be able to make sufficient poly to support all of our wafers, but you could probably guess, if you guess the number of wafers in each business you can get there, but I don't have that in front of me.

Operator

Next, we'll turn to the line of Paul Leming with Soleil Securities.

Paul Leming - Soleil Securities Group, Inc.

First, could you just give us an indication of how much industry shipments in the Semiconductor Wafer business increased Q1 versus Q4, just what the overall industry performance was?

Ahmad Chatila

We do not know that number yet, Paul, we need probably few more weeks for all the data to come out for the industry.

Paul Leming - Soleil Securities Group, Inc.

Second question, were your solar wafer prices in the first quarter materially different from the kind of $0.80 to $0.85 per watt range that were seen reported by the major independent wafer producers?

Timothy Oliver

We've been careful, but it's a pretty fluid market so your data is probably not bad, but we don't tend to talk about our own prices. What I’d say is we talked about the decline from the previous quarter, from the sequential quarter being modest, and talked about getting back all of that decline in price in the quarter we’re currently in, which would suggest that for the first half of this year, our prices to be relatively -- average price relatively stable to what we saw at the close of 2009, if that helps.

Paul Leming - Soleil Securities Group, Inc.

It does. And doing some back-of-the-envelope arithmetic, it looks to me like you're tolling fees were up about $0.05 per watt Q4 to Q1, am I kind of in the right ballpark with that calculation?

Timothy Oliver

I think you can see the deterioration in margin rate. And I would attribute all of the deterioration in margin rate to the delta in the spread between -- since pricing is relatively similar at the first half of the year to the fourth quarter, all that deterioration in margin rate to a higher cost. And like I said earlier, I would attribute most of that higher cost to the subcon squeeze.

Ahmad Chatila

And Paul, let me add one other comment for you. I wish it was only $0.05. Let me say it this way. It's a lot higher than that.

Paul Leming - Soleil Securities Group, Inc.

Finally, can you give us any color at all on the breakdown in depreciation and amortization between Sunny Solar [ph] and SunEdison? You did that on an annual basis when you gave us the annual numbers back in late February or early March. Any color at all on the depreciation split between the three segments for the quarter?

Timothy Oliver

It should be relatively linear. The depreciation over the course of the year across quarters should be relatively linear. So I would take the same percentages we gave you then and apply them to the quarter. I'll go back and check and make sure. If there’s any delta there, we'll include it next quarter as a disclosure.

Operator

Next, we'll turn to the line of Tim Arcuri with Citi.

Timothy Arcuri - Citigroup Inc

Part of the issue on the solar wafering side that I believe some of your contracts are tied to poly pricing so that you really can't raise prices because poly prices aren't going up, so you're getting pinched because of that. Is that part of the issue?

Timothy Oliver

No, not at all.

Ahmad Chatila

Not at all, Tim.

Timothy Arcuri - Citigroup Inc

Okay, so there’s no – In fact, none of your contracts are keyed to poly prices?

Timothy Oliver

No, none.

Ahmad Chatila

All our contracts are keyed to wafering pricing.

Timothy Arcuri - Citigroup Inc

Can you break out, Tim, the 219 Semi revenue by 200 and by 300 millimeter?

Timothy Oliver

I don’t believe we’ve ever done that before. I don't have it here. I'll ask Bill if we’ve done it before and have him give you a call back.

Timothy Arcuri - Citigroup Inc

Okay. Last, can you break out the $61 million from SunEdison direct and PPA?

Timothy Oliver

Sure. We said that about $40 million this year in revenue annually will come from previous period of PPAs and obviously, we'll add to that as the year goes on. But if you guess $10 million of PPA revenue in the first quarter, the remainder would be the direct sales of the 7 megawatts in Italy.

Operator

And we have a question from the line of Gary Hsueh with Oppenheimer & Co.

Gary Hsueh - Oppenheimer & Co. Inc.

Back to Solar Materials. If you're not in long-term contracts with wafering subcontractors, what kind of visibility do you have, other than a long term contract, on bringing wafering cost maybe flat in Q2 and maybe potentially, hopefully down in Q3 and Q4? I guess, what kind of confidence level do you have that you can kind of start to bring that down, particularly in the back half of the year?

Timothy Oliver

It's very hard to have confidence in a fluid market like this where you are in somewhat a strategic disadvantage. We know where we want to be in the first quarter of 2011 and we’re confident we’re going to get there. We're fighting hard to get through the next three quarters to only do business where it makes sense and we generate incremental margin dollars for the company at admittedly a lower-margin rate. And we’ve said that for the second quarter, where we sit today with the contracts we’ve negotiated, the orders we negotiated for the second quarter, we feel good about the rate going up. In this fluid environment, I don't think you could get either Ahmed or I to commit to a margin rate in the third or fourth quarter.

Gary Hsueh - Oppenheimer & Co. Inc.

And I realize you want to bring a captive in-house wafering capacity. Is there any kind of stop gap or consideration in maybe building in some kind of protection in terms of potentially wafering costs going up even further maybe in the back half of the year or perhaps next year?

Timothy Oliver

Yes. That’s a great question. Thanks for asking it. We were a little bit surprised at how significant the squeeze is and how quickly it came on. We have reacted not only by trying to pull forward our own wafering capacity in 2011, but also by launching some strategic solutions that will not just be three-quarter solutions. Because as I said before, we'll only bring so much of our own wafering capacity in-house. This is a long game for us, and with SunEdison onboard, we know we are going to need lots of wafers to supply lots of modules in the future. And we're hoping that we're able to find some strategic partnerships out there that want to play with us over the next several years.

Gary Hsueh - Oppenheimer & Co. Inc.

I think you said 25% of the impact on the margin side for Solar Materials came from higher poly cost. Did I hear that right?

Timothy Oliver

Yes, I said about 25% would be from our internal -- the delta between the tremendous performance in the fourth quarter of last year and then not quite as good performance in the first quarter of this year.

Gary Hsueh - Oppenheimer & Co. Inc.

So would it be fair to say that the Pasadena cost per kilogram in terms of poly maybe went up 20% to 30%?

Timothy Oliver

Remember, we make poly in a couple of different places, and we're making pretty major investments in a couple of them that are [indiscernible] (4:59). So no, I don't think that would be right. I just say cost and aggregate of cost are poly infrastructure were up somewhat versus Q4 and we expect them to be ahead of Q4 in Q2.

Operator

From the line of Marissa Hernandez [ph] (4:36) with Neuberger Berman.

Marissa Hernandez

Did you have any manufacturing issues or downtime in the production of polysilicon in Q1, please?

Ahmad Chatila

Some, but nothing out of the ordinary. I think, as we have just discussed, our production was not as high as it was in the fourth quarter, but nothing out of the ordinary, nothing that we need to talk about.

Marissa Hernandez

At the risk of beating a dead horse, I just wanted to clarify, did you say that these are higher tolling costs that you saw in Q1 could be flat in Q2? Is that what you said?

Timothy Oliver

No. I think what we said was, remember all we really care about is the delta between the price at which we can sell the wafer and the cost at which we can acquire it. What we said was we expect that delta to be better in the second quarter. We expect pricing to be better on wafers externally, and we probably will pay a little bit more than we did last quarter for the wafer ourselves, but fundamentally, the margin to us will be higher.

Marissa Hernandez

So do you think the margin can increase again in Q3 or is it too early to tell?

Timothy Oliver

It's too early to tell.

Marissa Hernandez

I guess in the Solar Materials, you did about 22 operating margin in Q4, is that internally something that you can target getting to in Q2 or in 2010 at all? Just trying to get a flavor to how bad this is, margin wise.

Timothy Oliver

Well I would expect a very modest improvement in Q2 versus Q1 levels. And in Q3 and Q4, we think the dynamic that we are seeing now may abate because of changes in Germany, but we don't know that. And unless we see those changes, we can't be certain. So we'll wait until -- we'll give you more color next quarter. I think that concludes our call. Thanks very much everyone for attending.

Ahmad Chatila

Good night. Thank you.

Operator

And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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