China Sunergy's Q2 Results: Questions About Related Party and Production Capacity

| About: China Sunergy (CSUN)

Click to enlargeChina Sunergy (NASDAQ:CSUN) strengthened its margins in the second quarter 2010; however, it posted a negative operating cash flow. The company is planning to increase its solar cell production capacity by 25% by the end of 2010 and has made strategic acquisitions to better position itself in the downstream photovoltaic market as the company continues to develop into a comprehensive solution provider. China remained the largest market for the company. Germany is the second largest, the company suffered a significant decline in revenue from Germany.

The company is in the top half of the peer group on many metrics, including free cash flow-to-net income, the cash conversion cycle, research and development and cash-to-debt. The company’s cash conversion cycle increased in the second quarter.. Strong cash balances relative to debt provides the company with more financial flexibility and has the company ranked 11th among the peer group.

The company quarterly disclosure is limited and its annual filings are missing various pieces of key information, including warranty reserves, revenue and cost by product, conversion efficiencies, cost per watt and solar cells sold in megawatts. Quarterly filings fail to provide cash flow statements and full footnote disclosures. The number of related party transactions concern us.

We calculated an average cost per watt of $1.14 for the second quarter 2010, down from $1.17 in the first quarter 2010 and $1.42 in the fourth quarter. In 2009, cost per watt was $1.68, down from $3.02 in 2008.

The company claims it had blended wafer costs of $0.83 per watt in the second quarter 2010, compared to $0.78 per watt in the first quarter 2010. Other production costs declined approximately 3% in the second quarter 2010. For the first quarter 2010 other production costs declined to $0.22 per watt, compared to $0.25 per watt in the fourth quarter 2009. Other production costs decreased due to increased production volume.

Our calculated revenue per watt was $1.35 in the second quarter 2010, down from $1.39 in the first quarter 2010. On an annual basis, revenue per watt decreased from $3.51 in fiscal year 2008 to $1.57 in fiscal year 2009. The company says its blended average selling price in the second quarter 2010 was $1.31 per watt, up from $1.26 per watt in the first quarter 2010 and fourth quarter 2009.

The company claims an average selling price for its solar cells of $3.32 per watt in 2008 and $1.36 per watt in 2009. The decrease was due primarily to decreased prices of silicon raw materials, increased manufacturing capacity and decreased demand for solar power products in the first quarter 2009 caused by the global economic downturn and credit crisis. In the third quarter 2010, the company expects a 2% to 3% price increase.

Annual production capacity has remained at 320 megawatts since 2008. In its second quarter 2010 earnings release, the company did not disclose whether production capacity remained the same or if it increased. If the 320 megawatts of annual capacity is assumed, capacity utilization in the second quarter would be 103%.

In the first quarter 2010, production utilization jumped to 94%, based on 75 megawatts of solar cells produced and an annual production capacity for solar cells of 320 megawatts (approximately 80 megawatts per quarter). By the end of 2010, the company expects to expand its solar cell manufacturing capacities through the addition of three new solar cell lines. The new lines are expected to add 80 megawatts and cost approximately $13 million in capital expenditures.

During March 2010 two related party transactions to acquire 100% equity interests were initiated. The acquisitions were expected to close June 30, 2010. The total consideration is $46.9 million, 24.6% of the company’s June 30, 2010 equity. On July 2, 2010, the company said it entered into a renegotiation process concerning the two targeted companies’ margin performance due to recent economic fluctuation. The company expects an agreement will be reached by the end of 2010. No other updates were provided regarding the acquisitions in the second quarter 2010 earnings release. Also, second quarter 2010 related party sales represented 64.2% of total revenues.

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