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Suntech Power Holdings Co., Ltd. (NYSE:STP)

Q3 2010 Earnings Call Transcript

November 17, 2010 8:00 am ET

Executives

Rory Macpherson – Director, IR

Dr. Zhengrong Shi – Chairman and CEO

Andrew Beebe – Chief Commercial Officer

Dr. Stuart Wenham – Chief Technology Officer

Amy Zhang – CFO

Analysts

Ming Shui – Jefferies

Satya Kumar – Credit Suisse

Lu Yeung – UBS

Sanjay Shrestha – Lazard Capital

Burt Chao – Simmons & Company

Tim Arcuri – Citi

Rob Stone – Cowen and Company

Vishal Shah – Barclays Capital

Pranab Sarmah – Daiwa Capital Markets

Edwin Mok – Needham & Company

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Suntech Power Holdings earnings conference call. My name is Eric. I'll be your audio coordinator for today. And at this time, all participants are in a listen-only mode. We will facilitate a question and answer session at the end of the presentation. (Operator Instructions) As a reminder, the conference is being recorded for replay purposes.

I would now like to turn your presentation over to Rory Macpherson, Director of Investor Relations. Please proceed.

Rory Macpherson

Hello, everyone. And welcome to Suntech's third quarter 2010 earnings conference call. My name is Rory Macpherson, Suntech's Director of Investor Relations.

From Suntech, we have on the call today Dr. Zhengrong Shi, Suntech's Chairman and CEO, Andrew Beebe, our Chief Commercial Officer; Dr. Stuart Wenham, our Chief Technology Officer; Amy Zhang, our Chief Financial Officer. Also Ian Tu, our Senior Financial Analyst will participate in the Q&A following Dr. Shi's closing remarks.

Before we continue, 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 provisions 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 our earnings release issued today and our SEC filings. Suntech does not undertake any obligation to update any forward-looking statements except as required under applicable law. To enhance our presentation of information and data during this conference call, we have provided a set of PowerPoint slides to your reference. This presentation is posted on the main page of the Investor section of our website.

As a reminder, this conference call is being recorded and the webcast replay will also be available on the Investor Relations section of Suntech's website after this call. Please make note that all figures mentioned during this conference call are in U.S. dollars.

I would also like to inform you that we will be hosting an Investor and Analyst Day in New York on December 6 for institutional investors and equity analysts. We hope that you will join us to hear presentations from our top executives from North America, Asia and Europe. For information or to register for this event, please contact our Investor Relations representatives located in New York. You can find their contact information in today's press release.

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

Dr. Zhengrong Shi

Hello. And thank you for joining us. Today, I will discuss some of our quarterly highlights and latest initiatives. Andrew Beebe, our Chief Commercial Officer will give an overview of our sales performance. Stuart Wenham will provide an update on Suntech innovation. And Amy Zhang will give further color on our financial performance.

The third quarter of 2010 was the most productive period in company history. Shipments were up by 25% compared to the second quarter and 107% year-over-year, driving revenues of $743.7 million. This equates to revenue growth of 19% quarter-over-quarter and 57% year-over-year. Gross margin came in at 16.4%, in line with our expectations. And we generated a net income of $33.1 million, or $0.18 per diluted ADS.

Our record shipments for the quarter were driven by continued strong sales and capacity additions that brought our annualized cell and module capacity to 1.6 gigawatts at the end of the third quarter. With demand for Suntech products running way ahead of our ability to supply, we will continue to expand capacity in the fourth quarter and are on track to achieve 1.8 gigawatts of installed cell and module capacity by year-end.

In 2011, we intend to expand our capacity in order to satisfy incremental demand from existing customers, grow into new markets and expand our market share. We will give details of our 2011 capacity plan at our Analyst Day in New York on December 6.

On the supply front, the price of silicon wafer on the spot market has progressively increased over the last few months, due to a bottleneck in wafer supply. Given Suntech's industry leading position, large appetite for silicon and healthy relationship with upstream suppliers, we were able to partially mitigate this temporary upstream. However, our wafer costs still increased marginally in the third quarter of 2010.

Now I'd like to discuss our progress on our upstream integration initiative. Our stated upstream strategy has been to invest in upstream supplies, to secure access to high quality and low cost polysilicon and silicon wafers. I am pleased to announce that we are taking this one step further and are in the process of acquiring 375 megawatts of ingot and wafer slicing capacity in China.

The wafer manufacturing capacity is being spun-off from a subsidiary of Glory Silicon Technology Investments Hong Kong Limited, in which Suntech holds an equity investment. We will acquire the remaining 70% shares of the capacity for a total cash consideration of approximately $127 million, which is the total consideration after – an offset of approximately $80 million of liabilities owed to Suntech.

Post to the acquisition, Suntech will own 100% of the 375 megawatts of wafer manufacturing capacity. We will take operational control in the fourth quarter of 2010 and expect it will be immediately accretive to earnings. We expect to receive numerous benefits from this acquisition.

Firstly, it will meaningfully reduce our silicon costs, wafer costs and will have an increasingly positive impact on our earnings profile. Secondly, we expect to realize significant production and efficiency synergies through integrated research and development initiatives.

Since Suntech's inception, we have maintained research and development personnel focused on silicon wafer optimization. By bringing our team together, we will enhance our collective expertise in all aspects of ingot and wafer production. We are confident that this will enable us to achieve best-in-class cost structure, wafer quality and reliability in the coming years.

Thirdly, this strategy will enable us to balance the dual goals of larger scale and low cost. We believe that this is a low risk strategy and expect to maintain 100% utilization of our ingot and wafer facilities on almost all market scenarios.

We intend to ramp wafering capacity to at least 30% of our cell and module capacities within next 12 months. We will provide more details on our expansion plans at our upcoming Analyst Day.

Now, I will provide an update on our investment in Global Solar Fund. In the third quarter, GSF successfully closed and received draw down from the European financing. In total, we received 33 million euro towards the 2009 receivables in the third quarter.

Secondly, we made further shipments to GSF investee companies in the third quarter, resulting in revenues of $144 million. We have already received 100% of the payment for these sales made in the third quarter.

Thirdly, GSF investee companies completed construction of 10 megawatts of projects in Italy in the third quarter, resulting in a non-cash gain to Suntech of $19.8 million. I would like to explain the reason for this gain in further detail.

GSF is an investment company and it accounts for its investments in projects using fair value. We account for our investment gain and loss in our income statement, according to the equity investment method of accounting.

In the third quarter, GSF completed construction of 10 megawatts of projects. Based on the achievement of this milestone, GSF reevaluated the fair value of the projects based on the discounted cash flow over the estimated life of the projects, which was in turn benchmarked against the market value of comparable projects.

While this gain is non-cash, it provides a fairly accurate reflection of the market value of these assets, which will be translated into cash if the projects are sold. The positive news is that this equity gain will occur in multiple quarters.

Aside from the objects completing in the third quarter, GSF has around 140 megawatts of projects currently under construction. According to our understanding, at least 80 megawatts of these should complete construction in the fourth quarter of 2010 and the remainder in the first quarter of 2011. We are pleased to see that our investment in GSF is starting to generate returns for Suntech and for our shareholders.

Now, turning to corporate matters, we recently announced the resignation of Jason Maynard from our Board of Directors. We are very grateful for his significant contribution to Suntech and wish him the best in his future endeavors. We have initiated search to identify this replacement and will update you in due course.

I will now turn the call over to our Chief Commercial Officer, Andrew Beebe. Thank you, Andrew.

Andrew Beebe

Thank you, Dr. Shi. Throughout 2011, we continue to invest in building our regional sales structure to supply globally coordinated, but regionally independent decision making in service delivery to our customers. This strategy has proven successful in providing substantive support for our customers in local languages and in local time zones. I'm also happy to report that the Suntech products continue to be recognized as among the most bankable in the industry.

With solar panels customers are coming to realize that they are buying a 25 year relationship not just a product. In the third quarter, roughly 31% of our product was shipped to German customers, 37% to the rest of Europe, 17% to North America, 8% to Asia and 7% to the rest of the world.

This breakdown is significant, because it demonstrates the diversified nature of Suntech's business model. With a strong team in each of our core regions we have built channels in both mature solar markets, such as Germany and Japan and the solar growth drivers of the future, in Italy, Asia and the Middle East, Africa and the Americas. This diverse sales mix reduces Suntech's geographic risk, policy risk and also enables us to shift product allocation in the event of any unpredicted market fluctuation.

Over the next 12 months, we expect our sales mix to continue to diversify as we expand our sales effort in rapidly growing solar markets. To give you a sense of the shift that is occurring, in the second quarter of 2010, roughly 74% of the product was shipped to European markets and 26% to the rest of the world.

Despite growth in absolute megawatts shipped to Europe, by the first quarter of 2011 we expect this will change to roughly 55% shipments to Europe and 45% to the rest of the world. Diversification has its benefits. For example, according to our internal estimates, we are the number one solar module supplier to Israel, Thailand and Australia with market share exceeding 30% in each of these exciting new markets.

In Europe, we continue to address demand through our network of loyal value added retailers and partnerships with Tier 1 project developers. In fact, we are the leading vendor to seven of the top 10 VARs in Europe to combined account for roughly 80% of the distribution market in Europe. While a couple of national markets are in flux, we are confident about the long term growth of this region.

Because of the combination of bank ability and our cost position we believe that the current feeding tariff outlined for Germany in 2011 will continue to provide attractive returns for our customers. With high retail cost of electricity and excellent sun resources, Italy is shaping up to be an important solar driver in Europe and Suntech remains a strong local presence – maintains a strong local presence in that market.

In addition to these cornerstone markets, we have built healthy relationships and channels in France, Greece, Benelux and now the U.K. With the exception of France, which is in the midst of a policy discussion, we expect all of these countries to help drive European demand growth in 2011 and beyond.

In North America, we are making good progress on all fronts and are confident that the market is on course to easily exceed 1 gigawatt for the first time in 2010. In the third quarter, Suntech's shipments to this region increased by more than 60% sequentially and represented 17% of sales compared to 13% in the second quarter.

According to our analysis, we are currently the number one supplier in the market. In fact, in the third quarter we shipped more solar products to North America than our total shipments to that market in all of 2009. In Canada, we've experienced strong customer pull through due to the Ontario incentives.

Earlier this year, we announced a letter of intent to help finance the expansion of Ontario based Calisolar that will enable us to qualify for the more stringent local content regulations coming in 2011. This is just one of a number of avenues that we are exploring to build our presence in Canada in 2011 and beyond.

We're also proud to have launched our U.S. manufacturing facility in October of this year. We plan to expand this facility, located in Goodyear, Arizona to reach 50 megawatts of annual production capacity in early 2011.

Outside of Europe and North America, we are encouraged by a host of new markets that are growing across the Asia Pacific, Middle East and Africa regions. An example of our success in new markets is our selection for the second phase of a 44 megawatt solar power plant in Thailand, which will be one of the largest in South East Asia.

Across the continent, we are part of the bidding process to supply hundreds of megawatts to large scale projects. Due to Suntech's scale, bank ability and a lack of conflict in the developer channel, many large scale EPCs and developers are turning to Suntech as a real partner in multi-megawatt proposals.

Turning to trends in our average sales price, our ASP was slightly lower than the second quarter, as we met commitments that we had made earlier in the year and tried to minimize price raises despite the rise in wafer costs. Given Suntech's strategy of building long term relationships with Tier 1 customers, we intend to benefit less from short-term price hikes or opportunistic selling to the spot market. That said, in the fourth quarter we expect ASPs to increase slightly, mainly due to the stronger euro.

Turning now to 2011, while we intend to provide a detailed outlook at our Analyst Day in New York, we can say that we are very optimistic about the demand for Suntech products next year. We recently conducted a bottoms-up analysis of customer demand in 2011 and after a conservative discount it was 30% above our ability to supply for the entire year. These numbers have only been validated by the negotiations we have been under with customers about 2011 shipments.

Despite significant capacity addition throughout the value chain during 2010, it is clear that there are still supply constraints for modules that are both competitive and bankable. With our new wafering integration and superior bank ability, we expect to be both costs competitive and bankable across our regions.

Now I'll turn the call over to Stuart Wenham, to discuss our technology initiatives. Stuart.

Dr. Stuart Wenham

Thank you, Andrew. I'm pleased to report that our Pluto technology continues to be well received on the market. The higher efficiency of Pluto enabled solar panels means that customers can generate higher system power output and benefit from the lower balanced system cost per watt.

Pluto cells have consistently performed above expectations and I'm pleased to say that we have now resolved the bottleneck for the production of the modules that utilize Pluto cells. We have, however, decided to maintain production rate at around 6 megawatts per month for the time being.

This is because to be able to ramp up our Pluto production lines to full capacity, we need to firstly discontinue the current manufacturing of screen printed cells. Secondly, we need to reconfigure the production line and thirdly train our staff for the new processes.

With overwhelming demand for Suntech's products running far ahead of our ability to supply, we need to delay switching to Pluto at this stage. We plan to gradually shift capacity to Pluto once we have the breathing room to meet all our customer orders. And we will keep you updated on our progress.

In conjunction with our acquisition of wafer manufacturing capacity, we are increasing our emphasis on wafer R&D initiatives. As Dr. Shi noted, our global R&D organization of over 350 personnel includes a team that is dedicated to silicon wafer material and process optimization. We believe that there is significant room for us to reduce wafer thickness, kerf loss and improve wafer quality and purity through these R&D initiatives. We look forward to providing further updates on this in later calls.

Let me now turn the call over to Amy Zhang for our financials. Thank you, Amy.

Amy Zhang

Thank you, Stuart. Net revenue for the third quarter was $743.7 million, representing sequential growth of 19% and 57% growth year over year. Total revenue – total net revenues for the investee companies of GSF were $143.8 million in the third quarter of 2010.

Revenue and profit related to the sales to investee companies of GSF during the third quarter of 2010 were fully recognized with accounts receivable, fully collected during the same period. Gross profit increased in the third quarter to $122 million from $113.9 million in the second quarter. However, gross profit margin decreased in the third quarter 2010 to 16.4%, from 18.2% in the second quarter of 2010.

The sequential decline in gross margin was primarily due to the moderate decrease of our average selling price and a marginal increase in the cost of silicon wafers used in production. Gross margin for the core wafer to module business was 18.2%. Our consolidated margin was lower than our core business margin, mainly due to a small percentage of system sales to China and around 7% of outsourced production.

At $0.52 per watt, our non-silicon costs were virtually unchanged during the third quarter. To help with comparison to some of our peers, please note that non-silicon costs include the cost of all non-silicon materials, processing, depreciation but exclude freight charge and share based compensation.

Operating expenses for third quarter of 2010 were $59.5 million or 8% of revenue, down from $132.9 million in the second quarter. Third quarter operating expenses included roughly $5 million of provision for bad debt. Excluding those, operating expenses were approximately $54.5 million in the third quarter of 2010.

The high operating expenses in the second quarter were primarily due to a non-cash impairment charge of thin film equipment of $54.6 million and then a prepayment provision of $25 million to account for credit risks associated with the delivery of silicon wafers from Shunda.

Income from operations was $62.6 million and operating margin was 8.4% in the third quarter of 2010, compared to operating loss of $19.1 million and operating margin of negative 3.1% in the second quarter of 2010.

Net interest expenses were relatively flat at $23 million. Please note that $9 million of this was non-cash interest expense, which was mainly due to the accounting treatment of our convertible notes.

FX gain in the third quarter was $42 million, compared to a loss of $61.4 million in the second quarter of 2010. The increase in FX was mainly due to the appreciation of the euro against dollar by approximately $0.13 from June 30 to September 30, 2010. Our FX gains were offset by hedging losses of $74.1 million, mainly because of a temporary mark-to-market revaluation of our hedge contracts.

Equity in earnings of affiliates in the third quarter of 2010 was $23 million, compared to equity in loss of affiliates of $100.6 million in the second quarter of 2010. The equity in earnings of affiliates in the third quarter of 2010 was primarily related to a $19.8 million increase in the fair value of GSF's investments in 10 megawatts of projects which were completed in the third quarter of 2010.

Equity in loss of affiliates in the second quarter was primarily related to an impairment of equity investments in Shunda Holdings, which is amount to $101.1 million. Net income attributable to holders of ordinary shares for the third quarter of 2010 was $33.1 million or $0.18 per diluted ADS, up from second quarter net loss of $174.9 million or $0.97 per ADS.

The major non-cash related expenses were share based compensation charges of $3.2 million, the $9.4 million of non-cash interest expenses that I mentioned earlier and depreciation and amortization expenses of $26.7 million.

CapEx, which was primarily for newly installed cell and module capacity, totaled $137 million in the third quarter, bringing CapEx in the first three quarters of 2010 to $302 million.

Turning to the balance sheet, our cash and cash equivalents amounted to $946.2 million at the end of quarter, up from $765.6 million as of June 30, 2010. The increase in cash and cash equivalents was mainly due to stringent working capital management and additional financing activity.

Accounts receivable totaled $443.7 million as of September 30, 2010 compared with $405 million as of June 30, 2010. Days sales outstanding were 54 days in the third quarter of 2010, compared to 58 days in the second quarter of 2010.

Accounts receivable due from investee companies of GSF was $59.7 million as of September 30, 2010, compared with $94.2 million as of June 30, 2010. The sequential decrease was due to the collection of approximately 33 million euro in the third quarter.

Inventory increased to $447.4 million in the third quarter, while days inventory outstanding decreased by two days to 66. Accounts payable totaled $394.6 million as of September 30, 2010 compared with $366.1 million as of June 30, 2010.

Now, turning to the guidance, in the fourth quarter of 2010 we expect at least 10% sequential growth in shipments. And we target to ship more than 1.5 gigawatts of solar products for the full year 2010, respecting year-over-year growth of at least 113%.

Consolidated gross margin in the fourth quarter of 2010 is expected to be approximately 17%, which is based on an assumed exchange rate of U.S. $1.35 to the euro.

GSF is in the process of constructing a further 140 megawatts of projects in the following quarters, of which at least 80 megawatts are expected to be completed in the fourth quarter of 2010. As a result, we expect that the fair value of those projects will increase significantly and we will recognize a related gain in the earnings of affiliates in our fourth quarter of 2010. As each of the project economics and timing of completion of these projects is very different and it is difficult to provide an accurate estimation of the gain at this time.

Full-year 2010 capital expenditures are expected to be approximately $350m. We target to achieve 1.8 gigawatts of installed cell and module production capacity by the end of 2010.

That concludes our prepared remarks for today. Operator, please go ahead with questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Question comes from the line of Jesse Pichel with Jefferies. Please proceed.

Ming Shui – Jefferies

Hi. This is Ming Shui for Jesse Pichel. Good morning, Dr. Shi, Amy and Andrew. Congratulations for your strong top line and wafer capacity acquisition, Dr. Shi, regarding your newly acquired wafer capacity, what is the wafer processing cost for that capacity? And what do you expect the 2011 CapEx will be now we see a wafer capacity expansion plan? And I have a follow-up for Amy.

Dr. Zhengrong Shi

Okay. Like as we know, this acquisition is part of split Glory and they have been operating the plant for two plus years. So their processing cost is best in class. So it’s in the ballpark figure. And, as we mentioned earlier, we plan to increase this in-house wafer capacity to about 50% of our cell capacity within next 12 months, so with CapEx probably around $0.40 per watt.

Ming Shui – Jefferies

Okay. Great. So, for Amy, is there any plan to pay down the $540 million convertibles? And also, for the GSF, if they successfully execute on their 80 megawatts projects in Q4, how much will it add to Suntech’s bottom line?

Amy Zhang

Regarding the convertible notes, I think currently trading value in the spot market – in the bond market is relatively less favorable to us if we have an early retirement of this long-term liability. Given that it’s going – it’s not going to be due until March 2013, we currently don’t have any plan for the time being.

Regarding GSF, as I said, currently we’ve got a recognized value written up for 10 megawatts completed projects with a $19.8 million value. Again, the project economics in GSF, out of that 80 megawatts that they have plan to build and complete, they are very different. So it is rather difficult for us to estimate, for the time being, of the value and implication to our bottom line for the fourth quarter and going forward.

Ming Shui – Jefferies

Okay. Thank you very much.

Dr. Zhengrong Shi

But I think, in any case, this revaluation is – as we sort of can judge, is not small.

Ming Shui – Jefferies

Okay. Thanks for the color.

Operator

Your next question comes from the line of Satya Kumar with Credit Suisse. Please proceed.

Satya Kumar – Credit Suisse

Yes. Hi. Thanks for taking my question. Dr. Shi, I think the question that a lot of investors are asking me and I have as well, is the price that you’re paying for this wafer capacity that you’re buying from Glory. You’re getting a 70% stake – the remaining 70% stake, there is this debt that they already owed you. So it appears that the capacity is being purchased at $0.79 per watt. And you’re saying that you can add new capacity at $0.40 and there are some companies saying they can add new capacity at $0.20. Could you help us understand why the price paid for this capacity is significantly higher than market price to add new capacity?

Dr. Zhengrong Shi

Look, it’s strategically is very important for Suntech to have some in-house wafering capability very quickly. I think time is essence. So, at this moment, the – of course we can build our own wafers. That probably will take like ten months, if not longer. So, if we look at valuation, I think it’s only talking about two times book value and a P/E of 9 of 2010 earnings. So, I think it’s already a discount of the market value in the market to the peers.

Satya Kumar – Credit Suisse

All right. In terms of your geographical diversification is looking better, so a good job on that. I was wondering if you could quantify what you think your market share is in the U.S. and Canadian markets in 2010. And you mentioned that you expect to ship a certain portion to the North American markets in 2011. I was wondering if you can break that down between U.S. and Canada for next year.

Dr. Zhengrong Shi

Yes. Maybe Andrew can give you some color.

Andrew Beebe

Sure. As I said, basically, the period of growth over the last couple of years in the U.S. has been fantastic and we are now – we believe we’re now in the number one position in terms of market share.

In terms of Canada, we are just ramping there and the demand has been very strong and next year we believe we’ll be in a strong position there, but I don’t want to try and state the exact market share.

Satya Kumar – Credit Suisse

Right. Fair enough.

Operator

(Operator Instruction) Your next question comes from the line of Lu Yeung with UBS. Please proceed.

Lu Yeung – UBS

Thanks for taking my question. I’m just wondering, to expand further from the current acquisition of Glory, how would you increase your wafer capacity, whether through buying some equipment or are you looking into acquiring additional wafer company? And based on your wafer integration, I am just wondering what kind of cost savings we can achieve on a relative basis when you achieve 50% of internal wafers.

Dr. Zhengrong Shi

Okay. Look, just to give you some color and it’s very important for us to start from this platform. I think acquisition of this 375 megawatts is a good start and especially they already operated it for more than two or three years, so we have acquired experience. And also, we have – since the inception of the company; we have established a strong research team on casting and wafer technology. So – and at this moment, we plan to build up our in-house wafer capacity by organic growth. And, as I said, within next 12 months we’re going to increase the capacity to about 50% of our cell and module capacity. It’s roughly around 1 gigawatt.

So I think it just gives you color about cost savings. At this moment, as you reported from many public companies the wafer saving – probably the wafer cost is probably about $0.60 per watt depending on – assuming polysilicon prices around 50 kilogram – $50 per kilogram. So at market, we’ll probably buy wafers that’s probably $0.85 or even higher in Q3, so that sort of gives you a ballpark. For every watt, you can save about $0.25 or more. So, it’s quite significant and it’s probably contributing about 15% gross margin, so that is – per 1 watt. That probably will give you some color of cost situation.

Lu Yeung – UBS

I see. I have a follow-up on the pricing. Do you expect the Q4 ASP, on a U.S. dollar basis, to be higher than the second quarter? And what are you seeing in Q1 next year for pricing, whether you’re still commanding premium with your peers in China?

Dr. Zhengrong Shi

Andrew, could you?

Andrew Beebe

Sure. Q4 versus Q3, we would expect a slight increase and then in Q4 we expect basically flat, plus or minus, on a global blended basis. There’ll be regional variation, but on a global basis that’s the way we see it moving.

Lu Yeung – UBS

And Q1 next year?

Andrew Beebe

Flat from Q4, plus or minus, but flat.

Lu Yeung – UBS

On a U.S. dollar basis or on a euro dollar basis?

Andrew Beebe

Sorry, on a U.S. dollar basis.

Lu Yeung – UBS

Okay. Thank you very much.

Operator

Your next question comes from the line of Sanjay Shrestha with Lazard Capital. Please proceed.

Sanjay Shrestha – Lazard Capital

Thank you. A few questions, guys. First, with the acquisition of your wafer capacity here, does that change your existing wafer supplier relationship with MEMC? How is that impacted?

Dr. Zhengrong Shi

Actually, we are going to increase our production volume next year.

Sanjay Shrestha – Lazard Capital

Okay.

Dr. Zhengrong Shi

And we have some portion of our supply is long-term contract and some short-term contract and we will have additional volume. So this in-house wafering capacity actually is part of like short-term contract and also our expanded volumes. So we will continue to buy wafers from our long-term partners. So – and we don’t want to integrate it to 100%, so still we’ll continue to buy wafers from our long-term partners.

Sanjay Shrestha – Lazard Capital

Okay. Great. One more question for me, if I may. So you guys talk about having done the bottoms-up analysis and you have 30% more demand than your capacity, but there is a lot of chatter in the market about looming crash, crisis, so much supply. I mean, help us put those two things together, guys? What is it that you guys and your end customers are seeing, versus maybe what some of the folks in the investment community are seeing? Who is going wrong where? And can you talk about that a little? Where is it coming from? What visibility do you have? How confident are you? And if you can just sort of tie those two together for us that would be great?

Andrew Beebe

Sure. As I mentioned earlier, the geographic diversification is coupled with a diversification across segments, so one of the benefits of being number one is that we are playing in every market in every segment.

Sanjay Shrestha – Lazard Capital

Yes. Okay.

Andrew Beebe

And as we do that and as we have done that for now many gigawatt – multiple gigawatts of products out into the marketplace, we have gotten pretty good at forecasting, when we spend a great deal of time with a small number of 3P customers in every single market. So, we feel like we do have a pretty good pulse. But beyond just what we’ve heard, we’ve been happy to see many analysts across the market picking up on a critical differentiation, which is the simple concept of bankable supply versus demand.

Sanjay Shrestha – Lazard Capital

Okay.

Andrew Beebe

More and more, we are seeing people map bankable supply versus demand and even bankable cost-competitive supply versus demand. And of course, we believe that we sit at the top of that bank ability and right in the middle of that cost-competitive zone. And that allows us to be in a different position across the marketplace. I’ve seen recent reports that states very clearly that for 2010, '11 and likely at least part of ‘12; we will see an over-demand of bankable cost-competitive supply. And because of that, we’re very confident about the feedback we’ve been receiving from customers.

But I will say additionally, we are sold out in Q1 globally and we have extremely strong signals that Q2 will go the same way. And so the – not just the, sort of, statistical data that we’re reading but the empirical reality of what our frontline sales people are telling us come together quite nicely.

Sanjay Shrestha – Lazard Capital

Great. Can I ask a follow-up on that? So what’s your view, then, for the size of the German market? And do you think, with the robust growth in Italy, Italy starts to not see any growth in 2011? Can you comment on those two?

Andrew Beebe

I’m sorry; I didn’t catch that about Italy?

Sanjay Shrestha – Lazard Capital

What do you think is going to be the growth rate for Italy from ‘10 to ‘11? And what do you think is the size of the German market next year?

Andrew Beebe

Well, the German market obviously is going through some level of transformation in the beginning of next year, so we are – as I said earlier, perfectly – we believe strongly that customers in Germany are going to see acceptable returns even after the change that comes in January. And that will mean that the market in Germany will be likely flat throughout the year.

Italy is picking up steam and obviously having really great demand across the board. We have had a team in place there for a while. I think we have now five people on the ground. And they’ve been very well received, as has the product been and we believe we have a leadership position in the market. That market will continue to expand and we’ll be there with it. And I think we’ll see it moderate itself, as Germany has done through changes in their feed-in tariff.

Sanjay Shrestha – Lazard Capital

Okay. That’s great. Thank you, guys.

Operator

Your next question comes from the line of Burt Chao with Simmons & Company. Please proceed.

Burt Chao – Simmons & Company

Yes. Good morning or good evening. Thanks for taking the question. Maybe Dr. Shi, initial question and then a follow-up for Dr. Wenham. When you look at the wafer capacity and your ability to build it out, I think Lu has mentioned regarding your current strategy, when you look forward, if you’re able to achieve these benefits to cost that you see in the wafer – in cost for wafer processing, what’s your long-term strategy on wafer? Does it make sense for you to build out wafer all the way up to the point where you have 80% coverage for your cell and module capacity, or is it never going to reach that big of a percentage of total capacity?

Dr. Zhengrong Shi

Hi. I think the PV industry is quite young, it’s quite dynamic and especially at this moment the supply chain is not quite mature. So, as the number one panel and cell manufacturer in the world, we realize we need to have capability because our customers become more and more dependent on us. We need to make sure we have stable supply situation and cost situation to maintain our competitive position. So, I think at this moment we decide strategically to integrate about 50% of in-house wafer capacity.

So, going forward, I think to have in-house wafer capacity has a couple of advantages. And the first advantage, apart from cost, there will be the quality guarantee and there’s also integrated process advantage in our cells and wafers. And also, we can try a lot of new technologies for ingot and wafering, so like otherwise we were not able to do so.

And going forward, I think we would like to maintain at this level and – but if market becomes too mature, as I said, vertical integration is not the way to go; we may decide to do otherwise. Or maybe the market could be another situation, so – because price pressure and so on, integration, maybe you need to be further expanded. I think we could do that too. So, I think at the 50% level we have a lot of flexibility to either expand or shrink. So, that basically is the strategy and the position we are taking at this moment.

Burt Chao – Simmons & Company

Okay. Great. And on Pluto, Dr. Wenham, I think you mentioned your run rate was, I believe and please correct me if I am wrong, 6 megawatts a month and you’re holding that flat. Has there been any change on your ability and the cost for you to convert from traditional lines to the Pluto line? And with your schedule kind of being held flat for some time, (inaudible) improvement, as you weigh an order on doing that, or is that something we are not going to find out until you’re actually in the process of conversion?

Dr. Stuart Wenham

We announced publicly several months ago that we’d actually increased the capacity of our Pluto production to 450 megawatts. We did that on track. And the lines that we implemented at that time were flexible lines. We deliberately implemented them in a way where we could run those lines with either our conventional technology or our Pluto technology. Now, our intention at that time was to run it with the Pluto technology. But, as we mentioned before, we had some bottlenecks with some of the new equipment in the module and capsulation side of things.

So we didn’t have any problem at all with the Solar Cell Technology itself, but due to the bottlenecks in the encapsulation for Pluto we have been therefore running those lines with our conventional screen printing technology since that time. And so, when I made the comment about converting the lines across, to be able to do that we need to shut down the lines in their present form and reconfigure them for Pluto. So they’re already able to produce the Pluto technology, but they need to be reconfigured and our operators retrained.

And our intention is to do that as soon as we can, but at this present point in time I guess we are in a fortunate position of having demand way exceeding our ability to supply, which is a nice problem to have, but it means that we are having to delay that switching across of the lines to the Pluto technology.

Burt Chao – Simmons & Company

Okay. Great.

Dr. Zhengrong Shi

I just want to add that it may sound like – okay, we do Pluto, but because of this capacity utilization situation we can’t convert. So, then we have to wait. But in reality, we are very much committed to realization and expansion of production of Pluto really, really seriously.

And, we can’t let this market demand situation restrict us from realizing our premium technology and product. So, actually, once like – as we said, we’ll reach 1.8 gigawatts before end of the year. So, once we have additional capacity, so then we will convert this line into – conventional into Pluto, anyway. So start from later this year and January next year and onwards.

Burt Chao – Simmons & Company

Okay. Great. And one just – one quick follow-up. When you look at GSF and the modules that you’re either selling to them now or looking in the future, are those at a preferential price, or are they somewhat at your market ASPs? Do you give any preferential pricing because of the relationship you have with GSF?

Dr. Zhengrong Shi

I would rather let Andrew answer your question.

Burt Chao – Simmons & Company

Okay. Thank you.

Andrew Beebe

Sure. Yes, GSF is a major customer of ours and we’ve had long-term contracts in place with them, so the pricing is based on market dynamics and not preferential. They are very large, so they have large volume prices.

Burt Chao – Simmons & Company

Okay. But no systematic discount because of the relationship that you have there?

Andrew Beebe

No systematic discount.

Burt Chao – Simmons & Company

Okay. Wonderful. Thanks again for taking the questions.

Dr. Zhengrong Shi

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Tim Arcuri with Citi. Please proceed.

Tim Arcuri – Citi

Hi, guys. It’s Tim. I was wondering if you could just maybe give just a little bit further color I guess on the current markets in Europe. I think there has been – it seems like there has been some markets that might have been slower. There seems to be some stories of inventory build there, but it doesn’t seem like that’s the case. If you could just give a little color there?

Andrew Beebe

Sure. A number – a couple of markets are going through some level of flux or transition. The Czech Republic is one. France is in the midst of policy discussions that could go either way and Germany has made their announced – or is in the process of going through their announced changes.

Broadly speaking, I’d just say that we have very tight relations with all of our customers, many of them longstanding and many of them involved and ability to have deep understanding into their inventories. And we’ve seen no build up, certainly of our products, in the marketplace at all.

Additionally, we have, I think prudently, over the last year been steadily reducing dependency, at least exposure as a percentage basis on Germany. But I should say we remain very committed to that market. We think it’s a great market. As you all know, the dynamics there are shifting towards smaller and smaller project sizes.

That changes the type and behavior of investors there and it also changes the type of channel more and more towards bar players and that really plays to our strengths that we've been building there for some years. Italy and Greece remain very strong for us, although quite different as markets. And I think – and in France we have a strong position as well.

Dr. Zhengrong Shi

Yeah. I just want to add a little bit, like actually there is physical confirmation about the strong demand in Q1 and beyond, at least in Q1, from this point of time. Look, now we're already past middle of November, so basically the goods which are shipped, now, actually will be installed in early next year.

So I think if there is a softening or worry of the market in next year, especially Q1, there is seasonality and others, so customers probably will delay their ordering or stop ordering. So I think – but in reality, still we don't have enough products to ship. So I think that sort of demonstrates that the demand is strong, entering 2011.

Another thing is that we are not just focusing on Europe, as Andy just said. And very soon our dependence on Europe will be reduced to probably under 50%, around 55%. So there is much stronger growth from rest of world, so I think we shouldn't lose sight of that.

Tim Arcuri – Citi

Just one quick follow-up. Could you give us any color in terms of the shape or timing of how your wafer costs might change over the coming quarters here, given the acquisition?

Dr. Zhengrong Shi

Okay. As we said, this acquisition will give us accretive immediately, but we will not fully consolidate the acquisition in Q4, but we will do it in Q1 next year. But as the investment in equity gain will be fully realized in Q4, so you sort of can take that gain into gross margin model for Q1.

Tim Arcuri – Citi

Great. Thanks.

Dr. Zhengrong Shi

Thanks.

Operator

Your next question comes from the line of Rob Stone with Cowen and Company. Please proceed.

Rob Stone – Cowen and Company

Hi. Good evening, everyone. Dr. Shi or Amy, I wonder if you could comment on where you see your cost for poly next year and external wafer purchases? Obviously, you are going to get a big benefit from the integration, but just wondering how you see the third-party supply situation and cost for next year. Thank you.

Dr. Zhengrong Shi

Hi, Rob. And, yes, the poly, I think that depends on its contract price or the spot price. I would say in a contract price next year, probably range from $40 to $55 per kilogram next year. And the spot price, it really depends on the situation. At this moment, it is up a little bit. And I think next year – but in any case, in our case, majority of poly is based on long-term contracts.

And for third party wafer price, Q3 has been up from Q2, so Q4 and Q3 flattish, a little bit – up a little bit, slightly. And Q1 next year will come back probably to Q3 or a little bit below Q3 level. So that is the wafer situation in next year. In early next year.

Rob Stone – Cowen and Company

The pricing you suggested, what does that mean for your external poly costs year-on-year percentage?

Dr. Zhengrong Shi

I'd say for Q1, probably, I think third party – our poly cost, okay. I think the long-term contracts – blended long-term contracts for next – probably I would say market average probably about $55 per kilogram.

Rob Stone – Cowen and Company

Okay. But what does that translate to on a year-on-year change, versus what you've been paying this year?

Dr. Zhengrong Shi

Sorry, I didn't get it.

Rob Stone – Cowen and Company

I am just trying to get a sense of how much you think your external poly cost will decline in percentage terms in 2011 versus 2010?

Dr. Zhengrong Shi

I think, long-term contracts, usually the reduction in price is probably about 5% to 10%, year after year. But as I said, we have different contracts with blended cost. So, the number I gave to you is actually industry blended.

Rob Stone – Cowen and Company

Okay. A follow-up question for Amy, if I may. When GSF eventually sells some of these projects and they realize a cash gain, you would see an increase in equity income, I guess. But do you expect cash ultimately to be returned to Suntech, or is the plan for GSF to continue scaling its project investments with retaining any earnings?

Amy Zhang

I think cash returned to Suntech would incur in two different cases. One is, GSF projects start to generate operating income from selling electricity to the grid, as planned. And the other is a so-called exercise the split structure to sell the projects to other long-term investors. That would incur a cash return for Suntech, based on our shareholding position.

Rob Stone – Cowen and Company

Do you expect delay?

Dr. Zhengrong Shi

To answer your second question, Rob. Investment in this downstream is our long-term strategy. But the amount of money we are going to invest is yet to be determined. And I think, for the first part to GSF is only €300 million, so after we have done that there could be the new structure to be formed. And if some of these projects cash out in the future, I guess we will get a return. And then, like simultaneously, there may be some investment to occur as well, so yes.

Rob Stone – Cowen and Company

Okay. Do you expect to collect the roughly 60 million still outstanding from last year before the end of this quarter?

Dr. Zhengrong Shi

Look, the good news is that they've already started to draw from European banks, eventually. So I think now the installation and construction is going well and on track. And we expect we could receive rest of – in outstanding ADR, before the end of the year.

Rob Stone – Cowen & Company

Great. Thank you.

Dr. Zhengrong Shi

Thank you.

Operator

Your next question comes from the line of Vishal Shah with Barclays Capital. Please proceed.

Vishal Shah – Barclays Capital

Yeah. Hi. Thanks for taking my question. Dr. Shi, I just wanted to clarify something you said earlier. You said that the Pluto conversion will begin when you have some breathing room. And you also said that you will start conversion in late December, early January. So would it imply that you will have some breathing room in Q1 and Q1 will be a seasonally weak quarter?

Dr. Zhengrong Shi

Yes.

Vishal Shah – Barclays Capital

Okay. And so, what your capacity will be down sequentially in Q1, would that mean?

Dr. Zhengrong Shi

Capacity?

Vishal Shah – Barclays Capital

Yeah, capacity. You're sold out but your capacity will be down slightly.

Dr. Zhengrong Shi

Okay. Yeah. As Stuart just mentioned, we retrofitted about 450 megawatt Pluto line. Okay? So they are already on track. So we just need to turn this line to make Pluto cells. Like as Stuart said, we need to train our workers and so on. So the bottleneck two lines a bit, so that's the process we are doing.

Andrew Beebe

Just to add, this is new capacity. It's new capacity during that period. So the capacity will not be a lower number during Q1.

Vishal Shah – Barclays Capital

So the shipments will be flattish in Q1?

Dr. Zhengrong Shi

Yeah. Yeah, shipments will not be lower, yes.

Vishal Shah – Barclays Capital

Okay. Have you signed any contracts with German customers for Q1? And if so, is the price around €1.20, as we've heard from a number of your competitors, or is it actually higher than that?

Andrew Beebe

We have signed contracts for delivery in Q1 and we are scheduling those now. We've signed a substantial number of them. The prices are in line with – as we guided earlier, in line with Q4.

Vishal Shah – Barclays Capital

So, no decline in German pricing?

Andrew Beebe

We are not seeing a decline in German pricing for our products.

Vishal Shah – Barclays Capital

Okay. Great. And then one last question. Wafer supply from Glory in Q4, will you have some Glory silicon wafers?

Dr. Zhengrong Shi

Yes.

Vishal Shah – Barclays Capital

Okay. So, in that case, if you think about your mix of Q4 and Q3 shipments also, you are selling about 25% to 30% of your product to GSF, which I am assuming will be a slightly better price since it's going to the Italian market. Why is your wafer – why is your overall margin still down sequentially, in that case, from Q3 –

Dr. Zhengrong Shi

Because like…

Amy Zhang

I'll take this.

Dr. Zhengrong Shi

Okay. Amy will answer your question.

Amy Zhang

Vishal, sales to GSF counted for 18% of our total revenue in Q3, not more than 20%. That's one thing. And second is, because of our wafer price slightly going up and also with the pressure of R&D appreciation, the cost of goods sold has got these two impacts in the P&L.

And also, thirdly, out of our sales mix, we have got longer-term agreements and obligation to fulfill to our downstream customers and they are our long-term partners. We don't take the short-term opportunity to grab this quick money off our table.

And also, Glory, again, for the time being, is not actually captured above our gross margin. As Dr. Shi said, currently it's still – their contribution to Suntech is still at equity return level, instead of above the gross margin and cost of goods sold, until the entire transaction is completed and we've got full consolidation in Q1. But in Q4, the wafer cost contribution is not going to really be from Glory until Q1.

Dr. Zhengrong Shi

It's not reflected in gross margin level.

Amy Zhang

No.

Vishal Shah – Barclays Capital

Okay. Okay. Great. Thank you very much. Amy, can you remind us what your operating cash flow was in Q3 and also what can you expect for the full year 2010? Thank you.

Amy Zhang

I think, as you can see from our improvement of DSO and DPO and also inventory management and other financial instruments being implemented to speed up the cash collection and cash cycle, we are continuously managing our working capital very effectively.

And also, with the higher volume to be sold and relatively quite good margin generated, we'll be able to – regarding our own planned capacity expansion; we'll be able to finance that. And also, from the banker side, again, we've got quite substantial facility already approved and reserved for us. And of course we take very careful consideration when we make a draw-down action. But if we do, we've got a different source of cash to leverage to finance our expansion and operations.

Operator

Your next question comes from the line of Pranab Sarmah with Daiwa Capital Markets. Please proceed.

Pranab Sarmah – Daiwa Capital Markets

Hi. Thank you for taking my questions. My first question is on wafer integration business. I think you do have some investment made with Shunda. What is happening out there? And whether – will you be taking over some of the capacity of Shunda at some point? And if at all, what should be the price on there?

Dr. Zhengrong Shi

Okay. Shunda is one of the wafer manufacturers. We have equity in it. And at this moment, Shunda also supplies wafers to us and at market price.

Pranab Sarmah – Daiwa Capital Markets

Do you have any intention to take some of the capacity out there and integrate it to your own capacity, whatever you have got from Glory now?

Dr. Zhengrong Shi

At this moment, there is no such plan.

Pranab Sarmah – Daiwa Capital Markets

Okay. Got it. And Amy, could you also elaborate a bit like how you have got that hedging loss of $32 million? Thank you.

Amy Zhang

Right. Actually, hedge impact – hedge impact, actually is normally reflected along the P&L, starting from the top line. For example, currently, we've got the – we've got a euro exchange rate riding up from Q2 going into Q3. As I said before, the difference between the two and of the two quarters were about $0.13 equivalent. So we've got this translation gain against our net exposure of euro, which is $42 million and that's one item.

And also the other upside of euro rate going up has been captured on the top line as well, because revenue recognition is translated into – the euro-denominated revenue recognition is translated into U.S. dollar upon the spot rate by each period.

And because of that, we've got certain amounts of hedge contracts locked up below $1.36, so this loss of hedging is a temporary mark-to-market valuation. But these contracts are rather longer term and in the end we – it's all entering into Q2, Q3, Q4 of 2011. So, to justify the real gain or loss is still going to be determined by time.

And again, according to our current policy, if I say based on the assumption of euro rate fixed at current level of $1.35, the net of euro – net of foreign exchange fluctuation in Q4 would be within the range of $15 to $16 million plus. That's it. Hopefully, this explains what you were asking about.

Pranab Sarmah – Daiwa Capital Markets

Yes. It's a bit – a bit clear. Maybe I need to follow up later on. And last one, Dr. Shi, I think previously when you have talked about your Suntech Group going for the virtual vertical integration, now we have moved to the – from virtual to a real vertical integration. What made you think differently, so that you have to go for the real vertical integration? Do you think that you need to go even poly side at some point on the real vertical integration?

Dr. Zhengrong Shi

Yes. This one reflects the dynamic change of market. I still believe the industry – when industry matures, so, people should specialize in what they do best. And on the other hand, we also realized phototech industry is such a young and immature industry and the supply chain is not quite mature.

And we are now the number one in cell and module manufacturer. And our customers very much depend on our ability to provide – to stabilize supply chain and also our cost. So that's why we believe, for the time being, doing some percentage of in-house wafering is necessary to maintain our competitiveness.

Long-term wise, as I said earlier, we like – at the 50% of position, we will decide we either continuously expand the vertical integration or shrink. It depends on the market situation, because we have to somehow hedge for the future since this changes so fast. And you ask me whether we should go to polysilicon. My answer is clearly no, because polysilicon is entirely different business from the rest of our value chain. So that is our strategy at this moment.

Operator

Your next question comes from the line of Edwin Mok with Needham & Company. Please proceed.

Edwin Mok – Needham & Company

Hi. Thanks for taking my question. So, can I ask you, did you guys recognize, or what was the system revenue in the third quarter and the fourth quarter in terms of your project business? And how do you guys think about that going into 2011, in terms of your project business?

Dr. Zhengrong Shi

Okay.

Amy Zhang

We do have a very trivial portion of revenue recognized from the system integration department, but that takes less than 1% of the total mix. And also, according to the current market situation, we don't have any short-term plan to expand that business. So, with the – of course, with a single-digit or low-teen kind of gross margin, it does affect our – it does become a dilutive impact to our general gross margin. But again, the size of the system integration business, to recognize revenue and cost in line with the percentage of completion is going to be trivial and not countable.

Edwin Mok – Needham & Company

Okay. That's helpful. And then, from what I remember, your systems business has been mostly if not all in China. Is that a reflection that the Chinese market might take longer than what you expected? And then, Dr. Shi, if you have a view of the China market recovery for 2011.

Dr. Zhengrong Shi

Actually, China market is also growing at a better rate than before. But again, China is a very cost-competitive market. So we have done some – several big projects in the past in China, but at the present time, the economics is not quite attractive here and plus we don't have enough product to supply to our other customers overseas. So that's why we have been…

We have been participating in almost all the bidding processes and projects at our own criteria or conditions. So we're still very active in China market, but I think we also have our criteria about economics. So, if the economics doesn't work out, so we'd rather not participate.

Edwin Mok – Needham & Company

Sorry. Just one quick follow-up on Pluto. You guys are producing a little bit right now and probably starting to sell to the market. Are you guys seeing any premium for the high-efficient cell? And then, lastly, based on your comments, am I just assume that you're still somewhat capacity constrained, at least for the first half of 2011?

Dr. Zhengrong Shi

Andrew, maybe you can answer that.

Andrew Beebe

Sure. Across the board, we've seen customers rewarding product differentiation and superiority. So the higher-efficiency product definitely commands a premium and we've been selling it at such. We are – I think you can infer that we are capacity constrained and we have seen more demand than we have supply now and into the first half of next year.

Dr. Zhengrong Shi

Yes. Because, as Andrew said, like customers love such products and are willing to pay a premium price. So that's why, as I said, once we have this additional capacity come on line, we have a little bit breath space, going to convert these conventional lines into Pluto lines, gradually from January.

Edwin Mok – Needham & Company

Great. Thank you.

Dr. Zhengrong Shi

Yeah.

Operator

Ladies and gentlemen, this concludes our Q&A session. I would like to turn the call over to Dr. Shi for closing remarks.

Dr. Zhengrong Shi

Thank you very much. If you have further questions, please just talk to our Investor Relationship and other executives. Thank you. Have a nice day.

Operator

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

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