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Suntech Power Holdings Company Ltd. (NYSE:STP)

Q3 2006 Earnings Call

November 20, 2006 8:00 am ET

Executives

Steven Chan - Vice President of Business Development

Zhengrong Shi - Chairman and CEO

Stuart Wenham - CTO

Amy Zhang - CFO

Boxun Zhang - Financial Controller

Analysts

James Fessel - Natexis Bleichroeder

Stuart Bush - RBC Capital Markets

David Smith - Citigroup

Sunil Gupta - Morgan Stanley

Angello Chan - Credit Suisse

David Edwards - ThinkEquity

Kevin Monroe - Thomas Weisel

Jeff Osborne - CIBC

Jesse Pichel - Piper Jaffray

Rob Stone - Cowen and Company

Tienyu Sieh - Merrill Lynch

Ming Yang - Piper Jaffray

Bernab Samma - Divor Securities

Presentation

Operator

Good day ladies and gentlemen, and welcome to the Third Quarter 2006 Suntech Power Holdings Earnings Call. My name is Minoshia, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today's presentation. (Operator Instructions).

I would now like to turn the presentation over to your host for today’s call Mr. Steven Chan, Suntech's Vice President of Business Development. Please go ahead sir.

Steven Chan

Thank you. Hello everyone and welcome to Suntech's third quarter 2006 Earnings Call. My name is Steven Chan, Suntech’s Vice President of Business Development. From Suntech, on the call today will be Dr. Zhengrong Shi, Suntech's Chairman and CEO; Amy Zhang, our Chief Financial Officer; and Dr. Stuart Wenham, our Chief Technology Officer. Also Boxun Zhang, our Financial Controller and myself, will be participating in the question-and-answer session following Dr. Shi’s closing remarks.

Before we continue, allow me to take you through the Safe Harbor policy. During this conference call, we will make certain forward-looking statements in an effort to assist you in understanding the company and its results. The forward-looking statements will be made under the Safe Harbor provision of the U.S. Private Securities Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, Suntech’s future results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in Suntech’s public filings with the U.S. Securities and Exchange Commission. Suntech does not undertake any obligation to update any forward-looking statements, except as required under applicable law. We encourage you to read the earnings release posted earlier today together with the attached financial statement.

As a reminder, this conference call is being recorded and a webcast of management’s prepared remarks will be available on the Investor Relations section of Suntech’s website after this call. Also, please make note that all figures mentioned during this conference call are in US dollars.

I will now turn the call over to Suntech’s Chairman and CEO, Dr. Zhengrong Shi.

Zhengrong Shi

Thank you, Steve. Hello, and I thank you for joining us today. In the third quarter, we continued to see strong results as we rapidly expanded our production capacity and output shipping high-performance solar cells and modules into increasingly diverse geographic markets. We are extremely pleased to have been able to achieve industry leading organic growth margin of 26% while purchasing more than 70% of our silicon in the spot market. The reason we have purchased so much of silicon from the spot market is to maximize our market share and EPS. The price of silicon that we purchased in the spot market likely peaked this quarter. This makes us particularly exited as we look into 2007 and beyond since we will likely have more benefit than our competitors as our low cost and our long-term silicon supply contract take effect and our silicon costs start to decline. Particularly, silicon accounts for over 80% of our solar cells costs of goods sold.

Our recently installed production lines have ramped up ahead of schedule to give out 270 megawatt capacity. On the quarter, the Suntech Group achieved total net revenue of $163 million, production output of 42.5 megawatt, and a non-GAAP net income of $32.8 million or $0.21 per diluted ADS.

Our newly acquired MSK subsidiary's results were lower than our expectations as they experienced an unexpected shortfall in solar cells supplies during the quarter and the transition to US GAAP accounting method. If you exclude the MSK contributions, the Suntech's organic result for the third quarter were $148.5 million in revenues, product output of 40 megawatts and non-GAAP EPS of $0.22.

We see the recent news out of Germany in terms of a slower sales growth and some decline pressure in ASPs playing into our core strengths in a number of ways. For once, it enables us to free up more of our production output for delivering into other fast growing international market at a better price. For another, it comes at a good time leading into 2007, when our long-term silicon supply contracts would provide us with competitively priced silicon that will reduce our dependence on spot market silicon, thereby help to offset a reduction in ASPs. More importantly, as we expand our sales globally, we continue to see a growing demand for Suntech product.

And finally, as we strengthen our position in the solar market, we are seeing a number of smaller PV players that will opportunistically sell into the German market, reducing their sales and in many cases retiring from the market.

It is important to sit back and note that ASPs have historically trended downwards by 5 plus percent every year until the recent silicon supply constraints affected the solar industry two years ago.

As soon as silicon constraints began, PV supplies have been able to pass a lot much of increase in silicon costs to end-users through higher ASPs. We feel that with the Germany situation, we should conservatively model our units to assume that ASPs have peaked during the third quarter, and that they will resume their historic trend downwards at a rate of 5 plus percent per year similar to the annual step down in German feed-in tariff, which is a good example of our incentive system designed to gradually bring the solar energy industry to sales sustainability and (inaudible).

In addition, this silicon constraint environment has presented Suntech with an opportunity to grow our revenues and a net income quicker that any of our competition due to our ability to obtain limited silicon, although at relatively high prices to maximize profit and market share.

Other reasons include: first, we have the lowest CapEx cost of expansion and has the lowest production cost in the industry by far, which have allowed us to grow more cost effectively at the lowest cost per watt than nearly all our peers. Second, the quicker we grew and the larger we get, the more we are able to attract larger silicon suppliers and correspondingly, a large percentage of the limited silicon in the market in a form of long-term and low-cost contract. As we do this, we can grow even faster and expand our competitive advantage versus our peers.

Third, our low-cost structure also expands into industry leading low operating expenses. When factoring that, our long-term and our low price silicon contracts come into effect in 2007 and our production output and our corresponding revenues keep growing rapidly. We will see ever increasing leverage on both our growth and operating margin as we maximize market share and EPS.

Lastly, we are continuing to innovate our technology and our production methods, which will further enhance our results. Our CTO, Stuart Wenham, who won the World Technology Award for Energy, just two weeks ago, will speak to you more shortly about our technology. To achieve this path of production growth and an increasing EPS in an environment of silicon supply shortages is truly remarkable.

With government's policy incentive propelling the growth of PV market worldwide, we are determined to establish foothold in a wide range of geographies, in order to diversify our customer base, minimize market concentrating exposure and develop truly international brand recognition. We have achieved some notable recent successes in this effort, particularly in the United States and Spain.

In the US, we just signed our multi-year contract with a large distributor for around 25 megawatt of modules. Our Spain sales have grown more than 200% over the year and now account for 4.7% of total sales in third quarter, with even more impressive gains in store for Q4.

A quick word about MSK, after only three months since the closing of the acquisition, we are already seeing the strategic benefits of our MSK acquisition. As part of our integration initiative, we quickly realized that the core strength of MSK was not to maximize module sales since Suntech is already too successful in that area. Amy will talk more about the MSK numbers later. I wanted to give you a sense of the more qualitative merits of MSK that we look to capitalize and build upon.

Suntech and MSK have complementary distribution networks and that we are looking to optimize the way we sell both the MSK and the Suntech modules through those channels. A particular area of focus would be on growing sales in MSK's industry-leading building-integrated PV product, for which MSK has already seen great traction in Japan. The integration of key operating functions, including manufacturing, sales and purchases as well as research and development and back all those utilities, will continue to be a focus in the coming quarters.

And finally, let's not forget our home turf. In the third quarter, we continued to move forward our strategy to establish a network of system integration in key regions of China. In particular, we just completed a massive on-grid project, where the local utility in Jiangsu Province, our home province, has agreed to pay the end user of our installed project a feeding rate of 45 ESM per kilowatt hour.

Linking into the grid with this high of feeding rate is a very significant event and is a strong validation of our system integration strategy in China. This is an extremely promising sign for the future of similar solar power grid projects, such as our new Shenzhen Suntech business already has achieved tucking in.

Before Amy takes you through the financials, Dr. Stu Wenham will give you an update of the technology highlights in the quarter. Congratulations on your work, Stuart.

Stuart Wenham

Thank you, Dr. Shi. Suntech believes more strongly than ever that the many strong attributes of crystalline silicon will ensure its continued market dominance for well over the next decade. These attributes of silicon include its abundance, low cost, stability, durability, market acceptance, demonstrated performance over several decades as well as its non-toxic and environmentally friendliness. As a result, Suntech is vigorously continuing its research and development with its five distinct crystalline silicon based photovoltaic technologies. These include, firstly, its conventional screen printing technology, where we have now demonstrated about 97% yields with [wifins] of only 150 microns thickness. Secondly, its new semiconductor finger technology currently being implemented into large scale production. Thirdly, its new 20% efficient technology planned for pilot production during 2007. Fourthly, its thin film silicon cell technology. And fifthly, and perhaps most excitingly, its innovative technology being developed collaboratively with the University of New South Wales for the new generation of low cost, low purity silicon that has enormous potential for cost reduction. Rapid developments in this latter area by the Suntech and through our collaborators might facilitate large scale production of such technology prior to 2010, with corresponding large cost reductions and elimination of silicon supply issues.

Now, I will turn the call over to our CFO, Amy Zhang, to take you through our financials. Thank you, Amy.

Amy Zhang

Thank you, Stuart. Many of you will have noticed in the press release that we gave you both our consolidated group results, as well as the financial results, excluding MSK. As the integration of MSK continues and it ramps up to a more normalized operating level, we will provide both sets of numbers to give you a clear indication of our progress on both fronts.

Also, please note certain measures I will talk about are non-GAAP in nature. We believe that these measures are more reflective of the operating dynamics of the company and we will provide these measures in the future. Specifically, these measures exclude $3.6 million of share-based compensation expenses and $0.6 million of amortization expenses related to the acquisition of MSK Corporation. You can find a reconciliation of these measures in the financial tables at the end of our press release.

Let me talk briefly about MSK's contribution in the third quarter. As Dr. Shi mentioned, MSK experienced an unexpected shortfall in solar cell supply, which impacted their ability to produce modules. We also had near-term impact as MSK converted their revenue booking method from Japanese to US GAAP.

I will first talk about Suntech results for the third quarter of 2006, excluding MSK and then to talk -- then to talking about Suntech Group's consolidated results for the third quarter of 2006 including MSK. Exceeding the top end of our revenue guidance, Suntech Group's net revenue excluding MSK for the third quarter of 2006 were $148.5 million representing an increase of 162.2% year-over-year. Excluding MSK, we shipped a total output of 40 megawatts during the quarter. The ratio of our PV cell output to PV modules were 30 to 70 in the third quarter of 2006, relatively stable compared with the previous quarter.

Suntech's non-GAAP gross margins excluding MSK was 26% for the quarter, mainly due to the increase in the cost of silicon as Suntech purchased additional silicon from the spot market in order to accelerate production and expand our market share.

Our average purchase costs increased significantly to $5.32 per 5-inch wafer. And we believe that the cost of silicon reached its peak during the quarter and expect that the cost will begin to fall in early 2007.

Total share-based compensation expenses for the third quarter of 2006 were $3.5 million. Of this amount, $0.3 million were recognized as cost of revenues, $0.8 million as R&D, and $2.4 million as G&A expenses. The increase of $0.7 million from last quarter was mainly due to new equity incentives granted in Q3, and in fourth quarter share-based compensation may rise as we expect to grant further equity incentives to employees and external suppliers.

Non-GAAP selling and marketing expenses, excluding MSK, increased by 62% sequentially primarily due to increased headcount, sales activities as we continue to expand our distribution and sales network in a growing number of international markets.

Increased gains from foreign currency exchange in Q3 caused non-GAAP G&A expenses excluding MSK to decrease by 3% sequentially.

After deducting share-based compensation expenses and increases in raw material cost related to R&D activities, non-GAAP R&D expenses excluding MSK were roughly in line with the second quarter of 2006.

Non-GAAP operating margin excluding MSK was 21.3%. The operating margin decreased sequentially mainly due to the effect of the lower gross margin.

Turning to the consolidated Suntech Group results, we recorded total net revenue of $163 million in the third quarter meeting the lower end of our guidance. This represents an increase of 188% year-over-year. Suntech Group's non-GAAP gross margin decreased sequentially to 23.3% due to principally to the impact of MSK, lower than expected results and the higher silicon cost during the quarter. Suntech Group's non-GAAP operating margin was 18.3% for the quarter.

Moving to Suntech Group balance sheet as of September 30, 2006, we had cash and cash equivalents of approximately $314.2 million. Accounts receivable rose to $45 million from $29 million in the second quarter, as we increasingly employed letter of credit settling for international transactions.

Our inventory balance of advances to suppliers rose as we increased production and our purchases of raw material during the quarter. The increased intangible assets was mainly related to the valuation premium on MSK's technology patents, brand names, and customer relationships. The increase in other non-current receivables were related to an interest free loan that Suntech lent to MEMC. The outstanding loan will be gradually repaid within the next two years.

Approximately $121 million were recognized as other long-term assets, was mainly due to the share-based compensation expenses related to warrants granted to MEMC. Of this amount approximately $118 million will be amortized according to the contract delivery schedule, which begins in 2007 and lasts for 10 years. As noted in the release, short-term debt rose to $212.7 million due to a one year $100 million bridge loan used to help finance the first step of the acquisition of MSK. The remainder of the ongoing short-term debt amount is mostly related to transactions made by the company to address currency controls of the Chinese Renminbi.

With respect to our financial guidance for the fourth quarter and the full year 2006, please note that the following outlook statements are based on current expectations. These statements are forward-looking and actual results may differ materially.

Suntech expects its fourth quarter total net revenue, excluding MSK, to be in the range of $166 million to $170 million, representing year-over-year growth of 87% to 91%. Suntech expects its total production output, excluding MSK, to be in the range of 45 megawatts to 46 megawatts in the fourth quarter of 2006. This is equivalent to total output for the full year 2006 of between 147 megawatts to 148 megawatts, well above our original guidance of 130 megawatts to 140 megawatts.

Suntech expects its total production output, excluding MSK, in 2007 to be 250 megawatts. In the fourth quarter, MSK is expected to contribute $62 million to $66 million or approximately 28% to Suntech's total net revenue, with production output in the range of 14 megawatts to 15 megawatts. Looking into 2007, we expect the volume of modules shifted by MSK to be flat to slightly down as we concentrate on growing MSK's higher value-added BIPV sales. At this time I would like to turn the call back to Dr. Shi.

Zhengrong Shi

Thank you, Amy. Once again, thank you all again for joining us today. I will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question will come from the line of James Fessel of Natexis Bleichroeder. Please go ahead.

James Fessel - Natexis Bleichroeder

Hi, thank you. I was basically wondering if you are going to continue to disclose the results of MSK, separately throughout the remainder of this year and next?

Zhengrong Shi

Yes. We will continue to disclose this MSK financials separately.

James Fessel - Natexis Bleichroeder

Okay. And do you expect the results of MSK to improve going forward?

Zhengrong Shi

Yes. Definitely we -- as we already said that this quarter it was due to unexpected shortfall of silicon supplies and which is unexpected. In other words, some suppliers did not supply sales according to contract. And I think with integration going on in the future, definitely the MSK's performance we expect were going to improve.

James Fessel - Natexis Bleichroeder

Okay. Was this primarily attributable to the companies that supplied MSK with sales that basically switched -- they switched and supplied to other vendors --.

Zhengrong Shi

I think, there are a number of reasons for the shortfall of supplies of total sales. For example, like it could be some of the suppliers they did not get enough wafers for their production. So, that’s one possibility. So, I think in the future as the integration is going on, as Suntech move forward, we should be able to meet all of our customers' delivery requirements.

James Fessel - Natexis Bleichroeder

Okay. Because MSK obviously result were really great, so I guess, I'm just looking for a little bit more clarity around the future of MSK and exactly how you see it, kind of (inaudible).

Zhengrong Shi

Really, I think, we ought to see some of the synergistic type trends. For example, we are now in a process to integrate our sales channels together as we mentioned earlier. Our sales network actually is complementary. So, combined two sales channels together that will further increase our distribution channel. And with Suntech's capability, we will make sure, MSK customers -- where their demand will be fulfilled, or in the case of before acquisition, this may not be the case but after integration we should be able to fulfill all the demands of MSK's existing customers and also future customers.

James Fessel - Natexis Bleichroeder

Okay, thanks. I will get back in the queue.

Operator

And your next question will come from Stuart Bush of RBC Capital Markets.

Stuart Bush - RBC Capital Markets

Hi, good evening. My question is, I was hoping you could talk a little bit more about the localized feed-in tariff that you commented on your local province. If you could expand and tell me what you think about the development of the total domestic China market for solar?

Zhengrong Shi

Yes, I think -- I can tell you, we can smell everyday the market is really agitating and improving everyday. And I am not sure, I expressed to you guys about China market development. We separate them into three phases. The first phase, we call a standalone system, mainly rely on government subsidy to alleviate the areas -- live in remote area without electricity. So, this is the first phase. Second phase is the commercial, solar commercial application such as, solar street lights and [elastin] lights. And the third phase where we're connected to the market. So we think the first phase is -- we have some project needs to be done, but not a lot, altogether may be another 300 megawatt. The second phase now actually has just started. We think there is a big market here and also grew very fast. So I think every year growth in this market probably is around 20 to 25% annually. The third market, with connect market with South Korea around three years time. And -- but the good thing is now, like with company like Suntech being [working] interactively with government, with local government, like our Jiangsu Province, so really to make it happen the government realized they can promote the market and promote this technology by providing intensive programs, such as in this case. That’s why Suntech is going to establish Suntech Shanghai and Suntech Shenzhen to capitalize the opportunities in this region.

Stuart Bush - RBC Capital Markets

Okay, great. So do you have any insight into how many megawatts you would expect to be installed in, say, next year, for example?

Zhengrong Shi

This year we -- it's been really early this year we already reported that we got our own 2 megawatt system integration, and for full year, we expect around 3 megawatt. And next year, we expect at least a double of this quantity in China.

Stuart Bush - RBC Capital Markets

Okay. Next, can you guys give any statistics on how many grams per watt a silicon you guys use for production?

Zhengrong Shi

Maybe Stuart can answer your question.

Stuart Wenham

Well, I guess we often don't refer to grams per watt as such, because we see it a somewhat meaningless metric unless apples are being compared with apples. In other words, different manufacturers are using different qualities of silicon, and so it's a bit pointless to compare grams per watt unless you are comparing the time quality of silicon. And I guess what we would tell is that like all other manufacturers we are endeavoring to continuously use less silicon, because it is probably more so for us it dominates the cost of our solar cells. Our solar cell costs more than 80% coming from the silicon wafer, because we bought so much silicon on the spot market. So, reducing the amount of silicon in our solar cells is very important to us, and some of our recent studies have shown that we are now able to handle 150 micron thick wafers with greater than 97% yields with our standard technology. So, I guess, we're making very good progress in that particular area.

Stuart Bush - RBC Capital Markets

Okay, fantastic. Last question is, with these new long-term supply silicon contracts, what percentage of the silicon you'll need for the next couple of years are on contract versus what you'll be buying on spot?

Zhengrong Shi

Okay. I think, this spot market and long-term contract market, there is price difference. I think the only maybe is true in the last year and this year because silicon supply was a serious issue. With time, I think, this -- probably there is not much difference there in price anyway and that's one point. Second point, as I just mentioned earlier, because of this market become more healthy so the small players they are screen out and the competition for silicon from spot market actually is reduced quite significantly. So, now like -- I mean people -- there is no question of availability of the silicon, now it is really a cost issue. So people they all rush to sign -- want to sign contract with us. I think, okay, if you want to sign the contract, you have to meet our cost demand, cost requirement. If you cannot meet the cost requirement, we are out. So, I think in the future probably in the long term and spot market price will not be that different or the spot price will be -- the terminology will be diminished in the future.

Stuart Bush - RBC Capital Markets

Yes. I understand. One -- so, if you do not see the spot and contract pricing very --

Zhengrong Shi

Having said that, I think next year we will have several different types of long-term contracts, but still the price is slight different in between but blended cost next year and '08 will be much lower than the price -- blend price we've got this year.

Stuart Bush - RBC Capital Markets

Okay. Thank you very much.

Zhengrong Shi

Yeah.

Operator

(Operator Instructions). Your next question will come from David Smith of Citigroup.

David Smith - Citigroup

Hi gentlemen. Can you tell us really what the timing on the MSK integration is going to be and where you think that gross margin will end up once that integration is complete?

Zhengrong Shi

Okay. As we mentioned earlier, the integration process is really going well at this moment and also as we mentioned in the press release, we now like -- we are in a process of combining our sales force and sales channel. And our goal is try to maximize the group profitability, and MSK's strategy in the future, we are focused on growing this in a more value-added and BIPV product. Okay so because this product has much higher margin than average modules. So, at this moment, we will probably before end of the year, we will give our full planning for MSK's forecast for the next year.

David Smith - Citigroup

Okay. And just a follow up if I could on, you gave a brief hint into the Phase II facility on about a gigawatt of planned future production capacity?

Zhengrong Shi

Yeah.

David Smith - Citigroup

Can you just give us a sense of how that rolls out? Where you -- is that like 2010 or is it 2008 or 2012, just a sense of how you --

Zhengrong Shi

We plan to hit the target by 2010.

David Smith - Citigroup

Okay. Great. Thank you.

Operator

Your next question will come from Sunil Gupta of Morgan Stanley.

Sunil Gupta - Morgan Stanley

Hi. Good afternoon -- good evening, thank you very much. Dr. Shi I've a couple of questions on Q4 expectations. Could you talk about what do you see in terms of pricing trends for Q4 on ASPs and also, what do you expect in terms of wafer costs, do you think in Q4 the wafer costs on a blended basis is going to be lower than what you had in Q3 or would it be similar? And finally, do you have a gross margin guidance for Q4 excluding MSK?

Zhengrong Shi

Yeah. I think -- okay, maybe Amy can take this question.

Amy Zhang

Hi, Sunil. Good evening.

Sunil Gupta - Morgan Stanley

Yeah. Hi, Amy.

Amy Zhang

Good morning to you. Regarding the ASP guidance for Q4, we expect that it will still be going up by 1% to 2% in Q4 and cost per wafer which is [APP] will stay flat in Q4. We'll see that some of the long-term contracts will start contributing to the decrease of wafer costs in Q4 for Suntech. Regarding the gross margins, like what was communicated before for the output, MSK alone will be around 14 to 15 megawatts, and Suntech alone in Q4 will be 45 to 46 megawatts and net margin -- net profit -- gross margins for MSK alone will be around 7% to 8% and for Suntech alone will be within the range of 24% to 26%. One thing to correct, regarding the average sales price guidance for Q4, blended average for MSK plus Suntech together will be around 1% to 2% down for Q4. Wafer costs will stay flat.

Zhengrong Shi

Wafer actually will come down little bit like -- little bit, and so definitely it is not going up. It is coming down.

Sunil Gupta - Morgan Stanley

And in terms of the wafer cost Dr. Shi is it essentially because your reliance on the spot market declines in Q4 compared to Q3?

Zhengrong Shi

Yes.

Amy Zhang

Yes.

Zhengrong Shi

Yes.

Sunil Gupta - Morgan Stanley

So what percentage do you expect in terms of your sourcing from spot market in Q4 --

Zhengrong Shi

Well, I think, may be I'd say around 2% this, I mean, Q4, Q4 reduction may be around 2%.

Sunil Gupta - Morgan Stanley

Sorry. It is 2% reduction in the wafer cost or reduction in percentages on spot?

Zhengrong Shi

On spot.

Sunil Gupta - Morgan Stanley

Wafer cost. So how much of your sourcing in Q4 is likely to come from spot market?

Zhengrong Shi

I think, it is around 75% in Q4.

Sunil Gupta - Morgan Stanley

And my final question is on your inventories in September, so I feel that the inventories have grown somewhat in line with the outside of a business, could you help us understand how much of that is raw material versus finished good inventory versus work in progress?

Amy Zhang

You mean the inventory, the split of inventory for the material versus goods in transit or work in progress?

Sunil Gupta - Morgan Stanley

Yes.

Amy Zhang

Work in progress balance would be quite trivial out of the three items contained -- or captured on the inventory balance. For the goods in transit, approximately I think fifty-fifty between goods in transit versus raw material balance.

Sunil Gupta - Morgan Stanley

Great, thank you.

Zhengrong Shi

Thank you.

Operator

(Operator Instructions) Your next question will come from Angello Chan of Credit Suisse.

Angello Chan - Credit Suisse

Good evening, Dr. Shi and Amy, and the rest of the team. Can you tell us the split of your sales in the third quarter and going forward in terms of regional -- region sales, and just a clarification of your answer just previously on ASP for third quarter and fourth quarter, is the change in ASP for cells and modules the same and you are alluding to the fact that earlier on, you said that the split in the third quarter is the same as the second quarter which is 70:30. Would that split -- do you expect that split to change between cells and modules? Thanks.

Zhengrong Shi

Okay, maybe I will answer your this question first, for modules and a solar cells. I think in Q4, Suntech's sales were mainly the sale in module. So, this actually, this also reflects the change of the market as I have mentioned earlier, some small players has retired from selling products. So, like in the second quarter, our cells and modules -- I'm sorry, in the third quarter ratio of cells and modules about 30 to 70%. But in Q4 like, because these guys -- in Q3 the reason we sell solar sales is mainly many through domestic Chinese customers. These people, the sales total wafers for us, they all produce wafer into sales and our sell solar cells back to them. So, they are landing up sales into modules and then try to sell modules in European market. But because of the market change, these people, they cannot sell the product anymore. So, they are not going to compete wafer purchasing market from us. So, now that's why in Q4 we expect more than 90% or even 95% of sales sell in format of module, so, this ASP, flat ASP declines actually just for module.

Okay, so hopefully that answers your first question -- the second question. The first question, the breakdown of the regional sales. We mentioned in Spain it is 4.7%, and I think in Germany, our sales should be around -- let me have a look at my computer here -- in Germany is around 50%, European altogether is around 68%, the China is 28% and all others account for 10%. Okay?

Boxun Zhang

Hey Angello, this is Boxun, just one comment on the sales for Germany. Because we mainly sell our product to the distributor in Germany like Conergy and IBC Solar and that we believe the sales to these two companies, I suppose actually goes to the rest of European countries.

Zhengrong Shi

That is a good point.

Angello Chan - Credit Suisse

Thank you very much.

Zhengrong Shi

My pleasure.

Operator

And your next question will come from the line of David Edwards of ThinkEquity.

David Edwards - ThinkEquity

Hi there.

Zhengrong Shi

Hello.

David Edwards - ThinkEquity

Two questions here. One is, can you tell us how the MSK accounting transition affected your operating expenses in the current quarter and how we should think about this going forward? Secondly, hoping that you could walk through some of your expectations for next year, I understand it's early but what do you see in terms of ASPs, wafer costs, gross margins, those types of things, just to see out pass next quarter and into next year?

Amy Zhang

Okay. I think may be I can answer your first question regarding the transfer of the GAAP utilized by MSK. The transformation of the GAAP for accounting treatment only affects at the level of first of all revenue recognition and secondly cost of goods sold booking. Actually, it hasn't come down to the level of operating expenses yet. So, regarding the impact of the change of GAAP -- accounting GAAP, it will affect down to the level of gross profit and operating margins -- operating expenses will stay quite similar to what has been down now. And what second question, regarding the --

Zhengrong Shi

Second question, next year's ASP and for ASP and also wafer costs, I think, average across the full year the ASP drop should be around 5%. I think wafer price reduction will be reduced at least to blended, at least would be by I think 10%.

David Edwards - ThinkEquity

So that would mean obviously that at STP proper, there should be -- the gross margin expansion one would assume between that and MSK one would assume to be similar?

Zhengrong Shi

MSK, like I said, in the future that we're focused more on growing of building-integrated photovoltaic product. It is supposed to have better margin than the standard modules within.

David Edwards - ThinkEquity

Okay, great. Thank you.

Zhengrong Shi

Thank you.

Operator

Your next question will come from Kevin Monroe of Thomas Weisel.

Kevin Monroe - Thomas Weisel

Good evening. Just a follow-up on Dave's question. Historically, you've given kind core Suntech gross margin guidance, I think, of 27% to 29%. I mean, as we look towards 2007 your silicon costs are coming down. Are you guys still comfortable with that range or is it something else?

Zhengrong Shi

Well, silicon price comes down and ASPs also comes down. So, I think, it's truly positive margins for next year as we have several contracts. We -- it takes a few weeks to finalize.

Kevin Monroe - Thomas Weisel

Can you -- in your press release you say, pricing for silicon is favorable in '07 versus the current spot. Can you quantify maybe just in percentage terms?

Zhengrong Shi

As I said -- as I just mentioned blended, the reduction of wafer price will be at least 10%.

Kevin Monroe - Thomas Weisel

10%, okay. In terms of pricing you said, down 5%, but from where -- from current levels or from some other?

Zhengrong Shi

From current level.

Kevin Monroe - Thomas Weisel

Okay. Thank you.

Zhengrong Shi

Yes.

Operator

And your next question is from the line of Jeff Osborne of CIBC.

Jeff Osborne - CIBC

Great, thank you. Good evening. I was just wondering if you could provide some details on MSK in '07. I know we've talked about it to some extent, but just should the run rate be in the 60 millionish range? You hinted about just focusing on the building-integrated product market with higher margins. And then also, just do you have any target gross margins exiting '07 for that unit?

Zhengrong Shi

No, not at this moment.

Jeff Osborne - CIBC

So no target margins or expected run rate?

Zhengrong Shi

We have -- we have this numbers, but as I said we feel more comfortable to provide this guidance at later stage.

Jeff Osborne - CIBC

Great, thank you.

Operator

And your next question is from Jesse Pichel of Piper Jaffray

Jesse Pichel - Piper Jaffray

Hi, good evening. How are you?

Zhengrong Shi

Hi.

Jesse Pichel - Piper Jaffray

You are showing massive core business upside there, you are tracking to about 148 megawatts up from 130 to 140 megawatts because you are tapping the spot market. Why are you not taking the extra cells and putting them through MSK? Why should MSK experience the shortage itself?

Zhengrong Shi

Well, I think this is at early stage of integration and for us to sell through MSK's brand, there is certification of the product, which takes time. And also like as I have said, we are in a process of integrating our sales channels and in the future whether we will sell product through MSK and through their customer or directly, say, from Suntech to MSK's customer, that's something we will have to look out because the goal is we will have to maximize the margin.

Jesse Pichel - Piper Jaffray

Did some of the other cell vendors cut off MSK in the quarter?

Zhengrong Shi

I don't think we are cutoff. And just like, some -- (inaudible) supply as I said earlier because of due to their own problem.

Jesse Pichel - Piper Jaffray

They -- MSK is the last to get fulfilled probably, because they are a competitor. Do you think your ownership of MSK had something to do with that?

Zhengrong Shi

Well, from (inaudible) position if I was -- MSK supplier I would have been.

Jesse Pichel - Piper Jaffray

And your fourth quarter calls for an additional 50 metric tons of polysilicon, is that all from MEMC?

Zhengrong Shi

No.

Jesse Pichel - Piper Jaffray

In the past, you mentioned that MEMC might have a slug of polysilicon available to you based on their own --

Zhengrong Shi

MEMC did supply some polysilicon to us in quarter three and quarter four.

Jesse Pichel - Piper Jaffray

But where is the extra polysilicon going to come from in Q4 to show this kind of upside?

Zhengrong Shi

Well, as I said -- there is more silicon available in the market because few people compete silicon with us from the market.

Jesse Pichel - Piper Jaffray

And the German companies are starting to push back on the poor quality coming out of China, and we think this is because China is using recycled wafers and scrap more than anyone else. Does Suntech use better quality silicon versus other Chinese competitors?

Zhengrong Shi

I think, what they mean pushback some -- I will say, this is perhaps of poor quality. This is the quality they should use -- use that (inaudible). Anyway, the module maybe there wasn't any -- the modules maybe haven't got enough certificate, so they are treated as defective modules.

Jesse Pichel - Piper Jaffray

Well, specifically they say that the Chinese cells break at about 8% rates, whereas the German cells break at 1%. And they say that because of the poor quality --

Zhengrong Shi

I'm not sure if they are talking about module quality or solar cell quality, because when usually when we ship a module they shouldn’t experience.

Jesse Pichel - Piper Jaffray

Right, in the module you wouldn’t see it but --

Zhengrong Shi

Exactly. I think by -- in any case, as I've said, Suntech product is in great demand. I mean, we have world-class products.

Jesse Pichel - Piper Jaffray

Okay. Can I get a clarification on your Q4 guidance? You are giving core guidance of 24 to 26%, ASP is up, but cost per wafer flat, something doesn’t seem right there.

Amy Zhang

No, no, ASP 1 to 2% down in Q4.

Jesse Pichel - Piper Jaffray

Down.

Amy Zhang

Yes, and Suntech gross margin alone 24 to 26 range.

Jesse Pichel - Piper Jaffray

Yes.

Amy Zhang

And average or blended average cost per wafer stayed flat.

Jesse Pichel - Piper Jaffray

Dr. Shi, did you look at PowerLight? You were rumored there to be looking at PowerLight and I am wondering why you didn’t finalize things.

Zhengrong Shi

No. We didn’t look at those possibilities. We believe our existing marketing and sales economy, US works greatly. So, we are happy with the arrangements we have at this moment.

Jesse Pichel - Piper Jaffray

Who are your biggest suppliers in the US at this point?

Zhengrong Shi

Who are the big suppliers?

Jesse Pichel - Piper Jaffray

Customers?

Zhengrong Shi

Customers, well there are number of customers signed long-term contract. I think in the next week or two we'll have some news out.

Jesse Pichel - Piper Jaffray

Fair enough. Thank you very much.

Zhengrong Shi

Thank you.

Operator

And your next question is from Rob Stone of Cowen and Company.

Zhengrong Shi

Hello, Rob.

Rob Stone - Cowen and Company

Hello. I wonder if you could spend a minute on the new technologies starting with the semiconductor fingers as that ramps up in 2007, what proportion of production would you expect will experience the higher conversion efficiency?

Zhengrong Shi

Well, the semiconductor finger technology is one that we’re implementing into large scale production in June Q4 on to the first of our production lines. And I guess, we will be evaluating how the technology is going during that period of time and looking at things like just very pilot testing of the product and looking at yields et cetera. And then throughout next year we will be endeavoring to ramp that up through the remainder of our production lines. So, I guess, our expectation at this point in time is that by the end of 2007 that we will have increased the average efficiencies of our monocrystalline cells to 18%, but for the year as a whole probably 7.5% average is a more -- is a reasonable estimate.

Rob Stone - Cowen and Company

And with respect to the 20% efficient technology and thin film, can you give us a sense of the time line on that in terms of pilot production and when those possibly begin to scale?

Zhengrong Shi

Yes. With regard to the 20% efficient technology, we have actually designed the pilot production facility for that now and we have been placing orders for some of the equipment. And we will be implementing the pilot production of that technology during 2007. With regard to thin film, we've got two thin film technologies, one based on microcrystalline silicon and one based on polycrystalline silicon and 2008 is our estimation for the production of the microcrystalline silicon technology.

Rob Stone - Cowen and Company

Great. Thank you.

Operator

And your next question is from Tienyu Sieh of Merrill Lynch.

Tienyu Sieh - Merrill Lynch

Hi. I was wondering if you could share with us the gross margins for the different businesses, the cells, module, systems integration and MSK?

Amy Zhang

Right. Regarding MSK, they actually have only two major business vehicle product mix, one is module, one is in the form of BIPV, building-integrated photovoltaics product. From the ASP, definitely we have higher ASP compared to the traditional modules regarding the gross margins because currently because of this niche achieving the target of Q3, we actually don’t have this announced yet given the relatively smaller size of the sales in Q3, which is only altogether 2.4 megawatts. But next quarter, the gross margin for the total MSK is expected to be within the range of 7 to 8% blended.

Tienyu Sieh - Merrill Lynch

What was your cell and your module margins for this past quarter?

Amy Zhang

You mean for Q3 or Q4?

Tienyu Sieh - Merrill Lynch

For Q3.

Amy Zhang

For Q3, for Suntech alone?

Tienyu Sieh - Merrill Lynch

Yeah. Just Suntech alone --

Amy Zhang

Blended is 26%.

Zhengrong Shi

Tienyu, it's me. I think for the PV cells gross margin is -- for Suntech alone is around 25.5% and for the PV module, it is around 25.9%, and we also have (inaudible) gross profit margin around of 28.4%.

Tienyu Sieh - Merrill Lynch

Thank you very much, Boxun.

Operator

And your next question is from Ming Yang of Piper Jaffray.

Ming Yang - Piper Jaffray

Hello. Good morning. Thank you for taking my call. I have just few quick questions. Can you talk about your capacity plans? I guess you said you will be at 270 megawatt for year-end, what about next year?

Zhengrong Shi

In next year, we -- towards the end of the next year, we will probably hit above 390 megawatts.

Ming Yang - Piper Jaffray

And then for this quarter, how much of your silica is in the US?

Amy Zhang

2.5.

Zhengrong Shi

Megawatts?

Amy Zhang

Megawatt.

Ming Yang - Piper Jaffray

2.5 megawatt.

Amy Zhang

Yes.

Ming Yang - Piper Jaffray

And then a quick question about the German market. I have heard that price is weakening in Germany but you are only guiding down 1% to 2% for the winter. Can you address that.

Zhengrong Shi

Yes. I think this is, as I said, for different suppliers, situation is different. First of all, I think this price weakening a little bit, I think is healthy. So, as we have said, traditionally we experience 5 plus percentage decreased price every year. So, I think in the last three years, due to silicon supply issues, this price went up really too much.

Ming Yang - Piper Jaffray

Yes.

Zhengrong Shi

So, coming down is expected and I think with our -- like for example our Q3 blended price is only around 380, $3.78 per watt. So, we expect from this level 5% reduction will be the price for the future.

Ming Yang - Piper Jaffray

Okay, and last if I could just confirm the margin number you just gave, you said PV sales was 25.5 and modules was 25.9.

Amy Zhang

25.9.

Zhengrong Shi

25.9, system integration is 28.4.

Ming Yang - Piper Jaffray

So cells was 25.5?

Zhengrong Shi

Yes.

Amy Zhang

Yes.

Ming Yang - Piper Jaffray

These are GAAP margin or non-GAAP?

Boxun Zhang

It is on GAAP basis.

Amy Zhang

It is GAAP basis.

Ming Yang - Piper Jaffray

GAAP basis. Okay, thank you very much.

Zhengrong Shi

Pleasure.

Operator

And your question is a follow-up from James Fessel.

James Fessel - Natexis Bleichroeder

Hi, this is James Fessel again on behalf of Paul Clegg. I just wanted to clarify a little bit more on the BIPV. I was wondering the statement in the press release that basically says that the module shipped by MSK will be flat to down as you focus on BIPV products. It seems kind of unclear to me.

Zhengrong Shi

Okay, what we mean that is actually like another gentleman from Piper Jaffray asked a question, why done we sell modules through MSK's channel. So, he is exactly is right, and we'll combine our sales channels together maybe in the future for standard products, the module will be shipped directly from Suntech China to our worldwide customers, no matter he is a Suntech customer or MSK customer. So, while MSK Japan where we focus on more growing the BIPV and value-added PV products to maximize the profit for the group. Got it?

James Fessel - Natexis Bleichroeder

Right, so you are not -- you are not providing guidance as far as BIPV?

Zhengrong Shi

We are working on that. Give us a bit more time.

James Fessel - Natexis Bleichroeder

Okay, and you are going to break that out going forward?

Zhengrong Shi

Yes.

Operator

And your next question is from [Bernab Samma] of [Divor Securities].

Bernab Samma - Divor Securities

Thank you for taking my question. The first one is on your balance sheet item, I guess you have more than $100 million goodwill and intangible assets and your MSK is probably performing slightly lower than your current expectations? Do you think you have to do some asset impairment by end of fourth quarter?

Boxun Zhang

No, actually. We are going to perform our impairment testing probably in the fourth quarter 2007. And by that time we think our integration will be completed and MSK is going to receive the UL certification and we are able to sell Suntech product. So, I think from the long-term perspective, we are quite bright about MSK's future sales and the divestments. So, we don't see any possibility that we are going to do any kind of impairment provision for MSK.

Bernab Samma - Divor Securities

Thank you. And another one is on say, you have given 250 megawatt probably production target for 2007. Out of that output how many percentage is already -- probably you have sold out and how many percentage still you have to put under spot market to sell?

Zhengrong Shi

We will say -- I will put this way like this is almost sold out like just still several contracts, we are in a final stage of negotiating the terms. So--

Bernab Samma - Divor Securities

So, its fair to say that whatever you have sold out is about 5% below that is per current year ASP sort of range?

Zhengrong Shi

Yeah.

Bernab Samma - Divor Securities

Okay. Thank you very much.

Zhengrong Shi

Yeah.

Operator

Your next question is from David Smith of Citigroup.

David Smith - Citigroup

Hi, guys. Just as far as the -- just to follow up again on the feed-in rate, can you again just mention what the feed-in rate that you had mentioned earlier for your province areas in China and then --

Zhengrong Shi

$0.45 per kilowatt hour.

David Smith - Citigroup

How many, sorry?

Zhengrong Shi

$0.45.

David Smith - Citigroup

And then what's the current -- what's the cost of electricity in the area?

Zhengrong Shi

Cost of the electricity is about $0.08.

David Smith - Citigroup

Okay. Great. And then --

Zhengrong Shi

Not probably the (inaudible)

David Smith - Citigroup

Right. Right, cost from the grid.

Zhengrong Shi

Yes.

David Smith - Citigroup

Okay. And then how do you see this playing out in the rest of Asia not just in China? Are you hearing of other things in terms of the rest of Asia as far as feed-in tariffs go?

Zhengrong Shi

Yes, like -- like feed-in tariff where the Thai government is talking about it and Malaysia government talking about it. Korea is already in place, and the Japan of course, I mean, well nothing to mention.

David Smith - Citigroup

Right.

Zhengrong Shi

And yeah, that's probably about it. All the Taiwan, Taiwan wasn't mentioned but.

David Smith - Citigroup

Okay. So as it stands now, you do think there is a possibility we could see more in China along this way?

Zhengrong Shi

Definitely for sure.

David Smith - Citigroup

Okay. Great. Thanks.

Operator

Your next question is from Sunil Gupta of Morgan Stanley.

Sunil Gupta - Morgan Stanley

Thank you. I just wanted to follow up on some of the wafer cost number that were mentioned earlier. Amy, I think you have mentioned wafer cost in the third quarter on a 5-inch basis, was it $5.32, did I get it right?

Amy Zhang

Yeah. That's the -- from the spot -- because of the high portion on spot purchase.

Sunil Gupta - Morgan Stanley

And that’s got blended cost, right, your spot plus contract blended?

Amy Zhang

Yes, you are right.

Sunil Gupta - Morgan Stanley

And in terms of your cost of goods in third quarter, what percentage of your cost of goods sold was wafer cost?

Amy Zhang

You mean out of the total cost of production? Wafer cost still takes more than 75% of the total cost of production.

Sunil Gupta - Morgan Stanley

Okay. And finally, in terms of the expectations of wafer cost, so this 10% decline in 2007, is it from this current level of $5.32 and the 10% decline is average for '07 or is it by end of ’07?

Amy Zhang

Yeah. It is just in current price.

Sunil Gupta - Morgan Stanley

So, a decline of 10% from $5.32?

Amy Zhang

Yes.

Sunil Gupta - Morgan Stanley

And Dr. Shi, would that become available to you right in the beginning of ’07 or is it something that comes off gradually as some of the new contracts kick in?

Zhengrong Shi

Gradually.

Sunil Gupta - Morgan Stanley

Okay. So, between now and end of ’07 down about 10%, would that be a fair assumption?

Zhengrong Shi

Yes.

Sunil Gupta - Morgan Stanley

Okay, great. Thank you very much.

Zhengrong Shi

Yes.

Operator

Your next question is a follow up from Angello Chan.

Angello Chan - Credit Suisse

Hi, Dr. Shi, I just wanted to -- actually I was looking for some guidance on the MSK, the outlook for module sales because previously, I think, your team has been guiding towards module put of up to 70, 80 megawatts for 2007. So are we now expected to just focus on the revenue from MSK solely on BIPV applications and zero from module --

Zhengrong Shi

No, we cannot say zero, as I'd said like we are still in the process of our integration, the next year's MSK's products split in sales will be our proper priority in a next week or two. We will like to give guidance by then. Okay?

Angello Chan - Credit Suisse

So, in the next week or two, we will have a better guidance on--

Zhengrong Shi

Yes for MSK. So, as I have mentioned earlier,--

Angello Chan - Credit Suisse

(multiple speakers) in terms of revenue

Zhengrong Shi

Whatever we do is try to maximize the group profitability.

Angello Chan - Credit Suisse

I see. Okay, thank you.

Operator

We have time for one more question and it will come from the line of Stuart Bush.

Stuart Bush - RBC Capital Markets

Alright, yes, hi, just a follow-up question. What was the average thickness of the wafers that you guys use for production in Q3?

Zhengrong Shi

Q3 is 200 micron wafer and finished total cells of thickness probably 180 microns or slightly lower.

Stuart Bush - RBC Capital Markets

So, I'm sorry so, 200 micron--

Zhengrong Shi

When start was 200 micron.

Stuart Bush - RBC Capital Markets

Yes.

Zhengrong Shi

When finished, the total sales -- the thickness of total cells is probably 180 microns or even thinner.

Stuart Bush - RBC Capital Markets

And how do you expect the average to be in '07?

Zhengrong Shi

2007, it really depends on our wafer supplies capability. Some people may be they kind of supply 180 microns. I am not sure, if there are any people who can supply 150 micron in large quantity yet, although we already have -- deploy the capability doing so. I think we will be around 180 to 200 microns for '07.

Stuart Bush - RBC Capital Markets

So, if you could secure 150 micron wafers you would--

Zhengrong Shi

We can produce it.

Stuart Bush - RBC Capital Markets

With reasonable yields?

Zhengrong Shi

97%.

Stuart Bush - RBC Capital Markets

97% for 150 micron wafer thickness.

Zhengrong Shi

Yes.

Stuart Bush - RBC Capital Markets

Thank you.

Operator

Due to time constraints, that will conclude our question-and-answer session. I would like to turn the call over to Suntech's CEO, Dr. Shi.

Zhengrong Shi

Again, I thank you for joining us today. If you have any other further question, please do not hesitate to contact any of the Investor Relations representatives in the future. Have a nice day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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