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Executives

Paul Combs - VP, IR

Jay Seo - CFO and Head of China Business

Seong-woo Nam - Chairman and CEO

Analysts

Parag Verma - AM Capital

Gordon Johnson - Axiom Capital Management

Dan Ries - Ardsley Partners

Hanwha SolarOne Company Limited (HSOL) Q2 2014 Earnings Conference Call August 28, 2014 8:00 AM ET

Operator

Thank you for standing by and welcome to today’s Hanwha SolarOne Q2 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions) Please be advised that this conference is being recorded today, August 28, 2014.

I would now like to hand the conference over to your speaker today, Mr. Paul Combs. Please go ahead.

Paul Combs

Thank you, Carmen and good morning everyone, welcome to our call. Joining me today are our Chairman and CEO, Seong-woo Nam and Jay Seo, our CFO and Head of our China Operations. I would first like to remind you of our Safe Harbor policy which is included in the earnings just released and as posted in its entirety on Slide 2 of the slide package which you can find on our Web site.

Note that our comments today will contain forward-looking statements that are subject to risk and uncertainties. Please review our filings with the SEC for a complete rundown of these risks. Chairman Nam will make some general comments on the second quarter as well as review some key activities for the remainder of the year. Then Jay Seo, our CFO will give a brief rundown of second quarter results and the outlook for our China business.

Now I will turn the call over to Chairman Nam. His comments are summarized in Slide 3 through 6, Chairman?

Seong-woo Nam

Thank you, Paul. Good morning, everyone. Our second quarter showed some sign of business progress including a return to positive shipment growth and although this still refers our net growth, that figure was reduced by nearly $13 million. We maintained our strong position in Japan began to see the early stage of rebound in China and began to penetrate to some new [indiscernible] accepting influencing our profitability was a $0.02 decline in ASP resulting from some softness in other parts globally, a smaller proportion of our business done in this relatively higher priced EU markets and the growing percentage of shipments to China as that market begin to rebound but had a lower average selling price than the other three largest global markets including the EU, Japan and the U.S.

The combination of lower price and the stable growth lead to the natural decline in gross margin. We continue to maintain strict discipline in managing our operating distances and the slow positive reversal in foreign exchange and the derivative hedging. The opportunity for shipment growth in the second half of [indiscernible] in fact we are confident third quarter volume will increase 15% to 20% quarter-over-quarter and reach around 1,200 megawatts. This will give you a view of quarterly volume growth for the company. This is largely due to growth in China business, which Jay will cover in more details in just a minute.

Borrowings in the first quarter robust as well leading us to maintain our annual guidance of 1.5 gigawatt to 1.6 gigawatt which is something at the lower to mid-point of the range most likely. The remainder of the year we will see some auto work in our manufacturing operation leading to largest [indiscernible] improved efficiencies and lower cost. We also introduce our next-generation cells technology based on 4 busbar architecture. Specifically the following accomplishments can be expected over the remainder of the year leading to an estimated 8% to 10% reduction in our manufacturing cost.

First, our capacity expansion for both cells and modules is well on the way and will be completed by the end of this year with some capacity available during the fourth quarter if needed. By year-end, cells capacity will exceed 1.5 gigawatt and the modules comfortably in excess of 2.0 gigawatts. At the same time existing capacity has begun conversion to full optimization, a process that will continue till spring of next year. Both of these initiatives will lead to enhanced quality in addition to lower manufacturing cost.

The investment we made in our internal ingot and wafering facility has started to become evident. This quarter it came out [indiscernible] and higher utilization lead to wafer manufacturing unit, improved quality and reduced cost going forward. As you may remember from previous comments, the gap in the cost structure between us and industry leader falls largely in this area, so we look forward to leveling if not eliminating that gap.

A new initiative we call S Project internally will be launched as well. This is an effort to optimize both the production process by innovative process management improvement and reducing BOM by finding a functionally better but cost effective material and [indiscernible]. We continue to coordinate with our sister company Hanwha Tech M to integrate supply chain where appropriate. This will also contribute to our cost reduction program as we buy in great quantities and source globally.

As mentioned earlier, we will launch new cell production based on 4 busbar technology during the second half. This will also contribute to module cost reduction of up to 5% and the module power output and enhanced cells efficiency basically targeted at 18% by year-end.

Let me now shift to the rundown we want to see in major market currencies. The EU market has become less effective due to its smaller size and competitive effect of the five undertaking model. As a result, we are focused on the new emerging markets like Turkey and the other non-European markets like Chile and Northern America and Northern Africa where we can access pipeline or establish the European EPC customer.

In traditional markets such as Germany, we are increasing focus on rooftop markets with the current economy for ground mounted projects does not support aggressive development. As you have seen the regulatory environment in the U.S. continues to evolve. Based on the most recent decision, we will shift production from Taiwanese cell to China made product and import under the total and share rate. There remains a lot of customer uncertainty currently however we are aggressively moving to the secured, larger scale supply contracts at competitive pricing.

The Japan market remains our best opportunity to our first mover advantage and solid brand recognition, bankability and the reputation for quality. Competition from other Chinese players is growing and this has affected the pricing environment there. We benefit from our relationship with Q CELLS who also has global advantage of growth and good market presence in Japan. We continue to get key module supplier to them for their Japanese activities. Going forward we see potential demand for our own brand and tolled module up to 1 gigawatt in 2015.

There are a number of emerging markets with good potential and we have seen some early progress in Algeria, Chile and Turkey in particular. Pricing in emerging markets, there is an eliminated currency non-effective, our strategy is now build volume at any price and therefore continues to focus on the market we serve and try and strike a balance between volume and the top quality.

Now Jay Seo will comment on our second quarter results and our activities and the presence for the China market.

Jay Seo

Thank you, Chairman. First let’s take a quick review of the second quarter financial highlights which are summarized on Slide 7 through 11. Revenues fell by 2.7% quarter-over-quarter to $178.5 million. Module processing services accounted for a little over 13% of total revenues. Shipments which includes module processing services increased by about 5% to 339.5 megawatt. Our ASPs declined about 3% to $0.67 a watt but still remain relatively high in comparison to many of our competitors in an environment of softer global pricing.

Volume rebound in shipments to the lower price to China market as well as less business per [indiscernible] in the higher priced EU market accounted for much of the decline in our average selling price. We shipped to 23 countries in Q2 and continued to penetrate new emerging markets. The Asia Pacific region remained the largest by far at 70% of total shipments, followed by North America at 18% and Europe and Africa at 12%. Our presence in Japan remained strong and accounted for 53% of total shipments.

The UK market declined this quarter to account for 9% of total shipments. Due to a lower demand for utility scale solar projects, following the incentive change April the 1st. As a result, the U.S. became the second largest market for the company during the second quarter. Deliveries to Korea and Canada improved reaching 9% and 7% of total volume respectively.

As Chairman Nam noted earlier, the China market noticeably began to improve. However, we still expect demand to be back positive for the year. The National Energy Administration recently confirmed a revised target of 13 gigawatts for 2014 and it is implementing some policy changes to support demand. Particularly for distributed generation project only around 3 gigawatts was installed in the first half of the year. So to meet the government target, you can see the potential for accelerated demand. The third quarter is off to a good start in China and we have started to receive some large orders like the 50 megawatt agreement with Baotou Shansheng New Energy for a project in inner-Mongolia that we previously announced.

Shipments to China for the remainder of this year would increase 5 to 6 times over our first half results. We continue to see opportunities for downstream project development including in cooperation with strategic partners. Even though shipments increased, gross profits was impacted by a lower ASP and therefore lower revenues and fell [indiscernible] a 3.5% quarter-over-quarter to $16.9 million. Gross margins dropped to 9.5% from just under 14% the previous quarter. Our blended cost of goods sold remained constant at $0.59 per watt.

As Chairman Nam described, we have a number of initiatives underway to reduce our cost structure during the second half which will aid gross margins however further ASP reduction could offset some of this benefit. We recorded an operating loss of $6.4 million, operating expenses stood at just over $23 million or 13.1% of revenues we will continue to maintain operating expenses, expense discipline and we would expect over spending for the last two quarters to be similar with Q2 spending levels.

On a GAAP basis our net loss decreased to $8.8 million and $0.10 per basic ADS share. 59% improvement compared to a net loss of $21.5 million or $0.24 loss per share the previous quarter. For the period ending June 30, 2014, our cash balance was $158.2 million, net working capital declined to a negative $194 million as we were required to replace by our outstanding Korea [indiscernible] due in April 2015 to our current liability. This quarter, we returned to a position of positive operating cash flow totaling $21 million versus the negative operating cash flow of $46.7 million in Q1 2014. Total short-term bank debt [indiscernible] current portion of long-term borrowings rose to $470.5 million as we were required to replace by our outstanding term loans to a current liability reflecting the 2015 maturity.

Following on from this, our outstanding long-term debt which includes the non-current portion of long-term bank borrowings decreased $290 million to $261 million. The credit environment in China remains tight but banks continue to roll over one year revolving credit facilities. We continue to have good banking relationships overseas and the backing of a strong parent company. Accounts receivable decreased to $103 million and days sales outstanding stayed constant at 116 days. Inventories remained relatively flat at $137.5 million. Days inventory outstanding rose from 70 days to 73 days this quarter.

Capital expenditures in the second quarter rose to $13.6 million as we begun converting all of our existing module lines to full automation and began our cell and module capacity expanding. As previously announced, we are also expanding both our cell and module capacities to more than 1.5 gigawatts and 2.0 gigawatts respectively by year-end which positions us to capture expected growth in demand in 2015. Our third quarter and full year 2014 outlook and guidance is shown on Slide 12 and 13.

For the third quarter, we expect shipment volumes to achieve a new quarterly record at approximately 400 megawatts. For the full year 2014, our shipment volume forecast remains unchanged at 1.5 gigawatts to 1.6 gigawatts. Capital expenditures will total about $80 million.

Now we will be pleased to respond to any further questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Parag Verma with AM Capital.

Parag Verma - AM Capital

Hi. Thank you for taking my question. My first question is on your automated line, once all the lines are converted to automated, what will be the production cost of the module? Currently, I think your production cost is still pretty much high compared to our peers?

Jay Seo

Yes, our module workshop module line will be transferred to full automation line and the process cost will be reduced by, as already mentioned by Chairman Nam, 5% to 10%, most likely 8% so which will be driven by new products what are called as S Project as well as automation, I mean we can decrease our resources, I mean operators.

Seong-woo Nam

And I think if you look at our cost structure in a non-poly processing basis, the significant difference between us and our competitors is not in the cell and module area although we will see improvement in module cost through automation but it’s primarily in ingot and wafering operations. And we have begun to make some significant progress there and expect that to contribute greatly to cost reduction in the remainder of the year.

Parag Verma - AM Capital

[Indiscernible] And the second thing is obviously you have very high interest expenses on your income statement, what is the measure you have taken to lower this interest expenses particularly about the 10%, 12% of our revenue, going on non-interest expenses now?

Seong-woo Nam

I am sorry, you broke up. Could you speak a little slower and a little more clearly please?

Parag Verma - AM Capital

Your interest expenses on your income statement it is about like 10% to 12% of revenue and what are the measures you have taken in order to reduce this interest expenses if you consider recapitalization measures?

Jay Seo

So, in Q2 our interest expense was increased a little bit, so that’s just an accounting treatment, so as long as the amount of borrowings remains balance remain and so the interest expense will be stable. So, there is no big fluctuation to interest expense.

Seong-woo Nam

And I think you would see on a gross basis our interest expense is not large relative to many of our competitors and the percent comparison that you referred to I think is more a reflection of the lower revenue base. Revenues you will see will increase as our volumes increase and also our cost of most of our loans are substantially lower than many of our competitors particularly our offshore loans.

Operator

Your next question comes from the line of Gordon Johnson with Axiom Capital Management.

Gordon Johnson - Axiom Capital Management

I guess the first question is, you guys clearly have a big presence in Japan, ASPs were down on a little less than 3%. Are we seeing, are you guys seeing any pressure on ASPs in Japan. Where were they in Q2 and where do you expect them to be in Q3?

Jay Seo

Okay. As you may know, the product competition in Japan market is very severe with our Chinese competitors, but we expect within this year there was no price decline, a large price decline. So we expect ASP in Japan markets will be maintained or a little bit decrease not too much.

Gordon Johnson - Axiom Capital Management

And then with respect to your shipments this quarter, it looked like they came in slightly below the low-end of your prior guidance. Can you give us any hints as to what kind of drove that slight weakness?

Seong-woo Nam

Yes, Gordon I think it was clearly China I think when we made the forecast last quarter, we expected it maybe a little quicker development in the China market and it happened just later than we had anticipated. It’s very developing quite nicely though on the third quarter.

Gordon Johnson - Axiom Capital Management

Okay. And can you guys talk about your project ambitions, do you guys have a backlog of projects do you anticipate building your backlog of projects and specifically what we are hearing is that it has taken a little longer to actually start collecting payments from the government due to the recent flutter of investigations into fraud. And one guy even told us it’s taking roughly a year to collect the payments from the government once you connect. Is that in line with what you guys are seeing, and if so, could holding the projects on balance sheet if you guys have ambitions there be a little longer than expected?

Jay Seo

So actually we announced some MOUs, with some [indiscernible] partners and according to them we secured almost around 1 gigawatt pipelines. So as you mentioned it takes a longer time than expected. Because we are very cautiously selecting the projects, and so we are expecting almost around 100 megawatts in this year which can be started, so it -- as you mentioned again, so it takes a little longer time mainly due to the delay the government policy change. So I don’t know about any kind of the question or something like that. But mainly our delay in a project is due to our very careful taking the steps.

Gordon Johnson - Axiom Capital Management

And then just two more if I could. Can guys give us a breakout of what our geographical mix is going to look like in Q3?

Seong-woo Nam

Gordon, hold on one second here, we’ll get you an answer.

Gordon Johnson - Axiom Capital Management

Sure thanks.

Seong-woo Nam

So do you have another question, Gordon, why don’t we take that and then we will come go back to it?

Gordon Johnson - Axiom Capital Management

Sure, sure. The last question is on we did some math, where we looked at the current level of inventory for the five guys that have reported. If you look at their cost per watt and backed into kind of what their inventory level on a dollar basis back into what their inventory on a megawatt basis was and then we assumed based on historical finished goods as a percent of total inventory what their finished goods was. And then we looked at their market share and we backed into about 5 gigawatts to 6 gigawatts of inventory in China right now based on what guys have produced versus based on what China installed in the first half 3.3 gigawatts. I guess the question is do you guys see some levels of excess inventory built in China right now in anticipation of the strength in the second half. And I guess if so do you think there maybe inventory currently is sufficient to quench that thirst for demand in the second half or do you think we are going to see prices rising in the second half ASPs for modules in China?

Jay Seo

So as [indiscernible] the annual expectation of the project will be around 13 gigawatt, so only about 3 gigawatt was done so in the first half of the year. So we are expecting around 10 gigawatts for the second half of this year. And so I heard some of the companies picked up the inventories for the project. So we have not picked up the project. So we don’t have any access in the level of the inventory. But as you mentioned maybe we can expect slightly increase in the price of the module, so considering the project in the second half of the year plus so nobody can guarantee about the price increase or decrease.

Seong-woo Nam

Gordon we can answer your geographic split question.

Jay Seo

So we have 25% in Japan market and 30% in Chinese market and 15% in European market and others.

Gordon Johnson - Axiom Capital Management

I am sorry. I just want to make sure I heard this right. 25% in Japan, 30% in China and then I am sorry what was the other breakout?

Jay Seo

Yes, USA market, NA market.

Gordon Johnson - Axiom Capital Management

Okay. The EU market, was that 15%?

Jay Seo

No, no, NA market.

Seong-woo Nam

North America.

Gordon Johnson - Axiom Capital Management

NA is 15%?

Jay Seo

Yes.

Gordon Johnson - Axiom Capital Management

And then the balance in the rest of the world?

Jay Seo

Yes, including EA.

Gordon Johnson - Axiom Capital Management

Okay. And I guess one last question and it seems like you are shifting significantly out of Japan, should we expect OpEx to continue to rise as a percent of revenue looking ahead?

Jay Seo

Actually I think you could expect the opposite. The operating expenses are going to remain relatively constant for the remainder of the year. If we hit our shipment guidance and pricing does not deteriorate too much then we should we see a higher revenue base.

Operator

Your next question is from the line of Dan Ries with Ardsley Partners.

Dan Ries - Ardsley Partners

A clarification question, Slide 9 where you show the shipments by geography, is that for the Hanwha branded or is that inclusive of the tolling module?

Jay Seo

It’s inclusive.

Dan Ries - Ardsley Partners

It is inclusive of it okay, and do you -- I am sorry if I missed it, did you breakout the mix of tolling versus Hanwha modules of your shipment?

Jay Seo

We don’t give that by shipments, what we normally do is do it by revenues. It was 13% of revenues this quarter. I think the previous quarter around 9%.

Dan Ries - Ardsley Partners

Okay. And you have mentioned Japan the pricing pressure I think was referred to as severe. Could you maybe size percentage decline that might occur 2Q to 3Q in Japan?

Jay Seo

5%.

Dan Ries - Ardsley Partners

5?

Jay Seo

Yes.

Dan Ries - Ardsley Partners

And then I see some of the long-term debt has now been is put into, is due within a year, when you discussed that you mentioned that you have good relationships with Chinese banks, international banks and a supportive corporate parent. Do you anticipate that in getting new long term debt assuming that that’s what you would like to do to replace the debt that’s maturing that Hanwha Chemical would be guaranteeing any of your future debt?

Jay Seo

All the short-term loans which we transferred from long-term loan, so it’s matured in April next year, is guaranteed loan by the parent company. So, if and when we are in the maturity then I am sure the parent will provide the guarantee again. And so other than this we are pushing a lot of other ways at the same time, so if any of other ways can be done, so we can switch, replace that guaranteed loan with the other loans. However, at least we are guaranteed by the parents for the matured loan in April next year.

Seong-woo Nam

Which is the largest, Dan, at around pardon me if I am wrong Jay, 180 million.

Jay Seo

$180 million.

Dan Ries - Ardsley Partners

I mean is the borrowing cost significantly different if it’s from a Korean bank with or without I assume it’s significantly different, can you size the difference that the borrowings are facing currently?

Seong-woo Nam

With or without the guarantee?

Dan Ries - Ardsley Partners

Yes.

Jay Seo

So, with the guarantee, so our interest rate, the borrowing is around 3% or slightly higher than 3%. So, without guarantee, so the interest rate is around 5%.

Operator

There are no other questions at this time.

Seong-woo Nam

Okay. Thank you, operator, thank you everyone for your participation, thanks for the good questions as always for here to be accessible if you have any other follow-up questions. Have a great day. Thank you.

Operator

Thank you again for participating in today’s conference. You may now disconnect.

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Source: Hanwha SolarOne's (HSOL) CEO Seong-woo Nam on Q2 2014 Results - Earnings Call Transcript

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